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Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

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

 

For the Quarterly Period Ended March 31, 2010

 

OR

 

o

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

 

For the transition period from              to             

 

Commission File No. 000-33275

 

WARREN RESOURCES, INC.

(Exact Name of Registrant as Specified in its Charter.)

 

Maryland
(State or other jurisdiction of
incorporation or organization)

 

11-3024080
(I.R.S. Employer
Identification Number)

 

 

 

1114 Avenue of the Americas,

New York, NY
(Address of Principal Executive Offices)

 

10036
(Zip Code)

 

Registrant’s telephone number, including area code:

(212) 697-9660

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 and 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o  No  o

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No  x

 

The aggregate number of Registrant’s outstanding shares on May 5, 2010 was 70,814,547 shares of Common Stock, $0.0001 par value.

 

 

 



Table of Contents

 

WARREN RESOURCES, INC.

 

TABLE OF CONTENTS

 

PART I—

FINANCIAL INFORMATION

 

 

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009

 

 

 

 

 

Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009

 

 

 

 

 

Consolidated Statements of Cash Flows for three months ended March 31, 2010 and 2009

 

 

 

 

 

Notes to the Consolidated Financial Statements

 

 

 

 

 

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

 

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

Item 4. Controls and Procedures

 

 

 

 

 PART II—

OTHER INFORMATION

 

 

 

 

 

Item 1. Legal Proceedings

 

 

 

 

 

 Item 1A. Risk Factors

 

 

 

 

 

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

 

 

 

 

 

Item 3. Defaults upon Senior Securities

 

 

 

 

 

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

 

 

 

 

 

Item 5. Other Information

 

 

 

 

 

Item 6. Exhibits

 

 

 

 

 

Signatures

 

 

2



Table of Contents

 

PART I—FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS
 

Warren Resources, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS

 

 

 

March 31,
2010
(Unaudited)

 

December 31,
2009

 

 

 

(in thousands, except share
and per share data)

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

17,777

 

$

17,238

 

Accounts receivable — trade

 

12,611

 

11,104

 

Restricted investments in U.S. Treasury Bonds—available for sale, at fair value

 

99

 

97

 

Derivative financial instruments

 

689

 

421

 

Other current assets

 

1,085

 

600

 

 

 

 

 

 

 

Total current assets

 

32,261

 

29,460

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Oil and gas properties—at cost, based on full cost method of accounting, net of accumulated depreciation, depletion and amortization (includes unproved properties excluded from amortization of $28,049 and $27,976 as of March 31, 2010 and December 31, 2009)

 

222,028

 

224,552

 

Property and equipment—at cost, net

 

1,330

 

1,435

 

Restricted investments in U.S. Treasury Bonds—available for sale, at fair value

 

892

 

875

 

Other assets

 

4,054

 

4,097

 

 

 

 

 

 

 

Total other assets

 

228,304

 

230,959

 

 

 

$

 260,565

 

$

260,419

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current maturities of debentures and other long-term liabilities

 

$

947

 

$

1,051

 

Accounts payable and accruals

 

17,122

 

17,149

 

 

 

 

 

 

 

Total current liabilities

 

18,069

 

18,200

 

 

 

 

 

 

 

Long-Term Liabilities

 

 

 

 

 

Debentures, less current portion

 

1,486

 

1,486

 

Other long-term liabilities, less current portion

 

11,357

 

11,277

 

Derivative financial instruments

 

8,613

 

10,798

 

Line of credit

 

85,000

 

89,900

 

 

 

 

 

 

 

 

 

106,456

 

113,461

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

8% convertible preferred stock, par value $.0001; authorized 10,000,000 shares, issued and outstanding, 44,585 shares and 98,112 in 2010 and 2009, respectively (aggregate liquidation preference $535 in 2010 and $1,177 in 2009)

 

537

 

1,179

 

Common stock - $.0001 par value; authorized, 100,000,000 shares; issued 70,814,213 shares in 2010 and 70,651,160 shares in 2009

 

7

 

7

 

Additional paid-in-capital

 

461,521

 

460,787

 

Accumulated deficit

 

(325,414

)

(332,600

)

Accumulated other comprehensive income, net of applicable income taxes of $77 in 2010 and $74 in 2009

 

117

 

113

 

 

 

136,768

 

129,486

 

Less common stock in Treasury—at cost; 632,250 shares in 2010 and 2009

 

728

 

728

 

Total stockholders’ equity

 

136,040

 

128,758

 

 

 

$

 260,565

 

$

260,419

 

 

The accompanying notes are an integral part of these financial statements.

 

3



Table of Contents

 

Warren Resources, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Three Months Ended
March 31, (Unaudited)

 

 

 

(in thousands, except share
and per share data)

 

 

 

2010

 

2009

 

Operating revenues

 

 

 

 

 

Oil and gas sales

 

$

21,589

 

$

11,547

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

Lease operating expense and taxes

 

7,231

 

8,799

 

Depreciation, depletion and amortization

 

4,783

 

5,316

 

General and administrative

 

3,452

 

3,255

 

 

 

 

 

 

 

Total operating expenses

 

15,466

 

17,370

 

 

 

 

 

 

 

Income (loss) from operations

 

6,123

 

(5,823

)

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

Interest and other income

 

38

 

97

 

Interest expense

 

(872

)

(1,544

)

Gain on derivative financial instruments

 

1,894

 

734

 

 

 

 

 

 

 

Total other income (expense)

 

1,060

 

(713

)

 

 

 

 

 

 

Income (loss) before taxes

 

7,183

 

(6,536

)

 

 

 

 

 

 

Deferred income tax expense (benefit)

 

(3

)

18

 

 

 

 

 

 

 

Net income (loss)

 

7,186

 

(6,554

)

 

 

 

 

 

 

Less dividends and accretion on preferred shares

 

11

 

24

 

 

 

 

 

 

 

Net income (loss) applicable to common stockholders

 

$

7,175

 

$

(6,578

)

 

 

 

 

 

 

Earnings (loss) per share — Basic

 

$

0.10

 

$

(0.11

)

Earnings (loss) per share — Diluted

 

$

0.10

 

$

(0.11

)

 

 

 

 

 

 

Weighted average common shares outstanding — Basic

 

70,083,641

 

58,243,910

 

Weighted average common shares outstanding — Diluted

 

71,204,846

 

58,243,910

 

 

The accompanying notes are an integral part of these financial statements.

 

4



Table of Contents

 

Warren Resources, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For the three months ended
March 31, (Unaudited)

 

 

 

(in thousands)

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

7,186

 

$

(6,554

)

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Accretion of discount on available-for-sale debt securities

 

(12

)

(12

)

Amortization of deferred offering costs

 

43

 

37

 

Depreciation, depletion and amortization

 

4,783

 

5,316

 

Change in fair value of derivative financial instruments

 

(2,452

)

(87

)

Stock option expense

 

732

 

543

 

Deferred tax expense

 

(3

)

18

 

Change in assets and liabilities:

 

 

 

 

 

(Increase) decrease in accounts receivable—trade

 

(815

)

3,345

 

Increase in other assets

 

(485

)

(1,068

)

Decrease in accounts payable and accruals

 

(989

)

(1,291

)

 

 

 

 

 

 

Net cash provided by operating activities

 

7,988

 

247

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase, exploration and development of oil and gas properties

 

(1,882

)

(17,833

)

Purchase of property and equipment

 

(6

)

 

 

 

 

 

 

 

Net cash used in investing activities

 

(1,888

)

(17,833

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from line of credit

 

 

7,350

 

Payments on long-term debt

 

(4,931

)

(28

)

Issuance of common stock, net

 

12

 

 

Repurchase of preferred stock, net

 

(642

)

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

(5,561

)

7,322

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

539

 

(10,264

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

17,238

 

29,688

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

17,777

 

$

19,424

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information Cash paid for interest

 

$

849

 

$

1,500

 

Noncash investing and financing activities Accrued preferred stock dividend

 

11

 

24

 

 

The accompanying notes are an integral part of these financial statements.

 

5



Table of Contents

 

WARREN RESOURCES, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE A—ORGANIZATION

 

Warren Resources, Inc. (the “Company” or “Warren”), was originally formed on June 12, 1990 for the purpose of acquiring and developing oil and gas properties. The Company is incorporated under the laws of the state of Maryland. The Company’s properties are primarily located in Wyoming, California and New Mexico.

 

The accompanying unaudited financial statements and related notes present the Company’s consolidated financial position as of March 31, 2010 and December 31, 2009, the consolidated results of operations for the three months ended March 31, 2010 and 2009 and consolidated cash flows for the three months ended March 31, 2010 and 2009. The unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010. The accounting policies followed by the Company are set forth in Note A to the Company’s financial statements included in Form 10-K for the year ended December 31, 2009. These interim financial statements and notes thereto should be read in conjunction with the consolidated financial statements presented in the Company’s 2009 Annual Report on Form 10-K.

 

NOTE BSTOCK BASED COMPENSATION
 

Stock Options

 

Compensation expense related to stock options and restricted stock awards recognized in operating results (general and administrative expenses) was approximately $0.7 and $0.5 million for the three months ended March 31, 2010 and March 31, 2009, respectively.

 

The following assumptions were used to value stock options calculated using the Black-Scholes options pricing model:

 

 

 

Three months ended March 31,

 

 

 

2010

 

2009

 

Dividend yield

 

0%

 

0%

 

Expected volatility

 

77.8%

 

69.3%

 

Risk-free interest rate

 

1.6%

 

1.5%

 

Fair value of options

 

$1.32

 

$0.25

 

Expected life

 

3.5 years

 

3.5 years

 

 

 

 

 

 

Weighted

 

Weighted

 

 

 

 

 

 

 

Average

 

Average

 

Aggregate

 

 

 

Number

 

Exercise

 

Remaining

 

Intrinsic Value

 

 

 

of Options

 

Price

 

Term (in years)

 

(in thousands)

 

Outstanding at December 31, 2009

 

3,419,040

 

$

6.02

 

 

 

 

 

Granted

 

1,058,500

 

2.42

 

 

 

 

 

Exercised

 

(23,234

)

0.51

 

 

 

 

 

Forfeited or expired

 

(614,000

)

9.05

 

 

 

 

 

Outstanding at March 31, 2010

 

3,840,306

 

$

4.57

 

3.61

 

$

3,235

 

 

 

 

 

 

 

 

 

 

 

Exercisable at March 31, 2010

 

1,532,182

 

$

8.21

 

2.85

 

$

1,005

 

 

6



Table of Contents

 

The total intrinsic value of options exercised during the three months ended March 31, 2010 was approximately $45,000. There were no options exercised in the three months ended March 31, 2009.

 

As of March 31, 2010, total unrecognized stock-based compensation expense related to non-vested stock options was $2.2 million, which we expect to recognize over a weighted average period of 2.3 years.

 

Restricted Shares

 

Restricted share activity as of March 31, 2010 was as follows:

 

 

 

Shares

 

Weighted
Average
Fair Value

 

 

 

 

 

 

 

Outstanding at December 31, 2009

 

81,113

 

$

11.00

 

Granted

 

533,437

 

2.42

 

Vested

 

(183,629

)

4.74

 

Forfeited

 

 

 

Outstanding at March 31, 2010

 

430,921

 

$

3.04

 

 

Restricted stock awards for executive officers and employees vest ratably over three years, excluding shares issued in March 2010 which vest ratably over nine months. Fair value of our restricted shares is based on our closing stock price on the date of grant.  As of March 31, 2010, total unrecognized stock-based compensation expense related to non-vested restricted shares was $0.9 million, which is expected to be recognized over a weighted average period of approximately 0.9 years.

 

NOTE CCHANGES IN STOCKHOLDERS’ EQUITY

 

The preferred stock pays an 8% cumulative dividend which is treated as a deduction of additional paid in capital, due to insufficient retained earnings. The holders of the preferred stock are not entitled to vote except as defined by the agreement or as provided by applicable law.  The preferred stock may be voluntarily converted, at the election of the holder, into common stock of the Company based on a conversion rate of one share of preferred stock for 0.50 shares of common stock. The accrual of the dividend is deducted from earnings in the calculation of earnings attributable to common stockholders.

 

Additionally, commencing October 1, 2009, holders of the preferred stock can elect to require the Company to redeem their preferred stock at a redemption price equal to the liquidation value of $12.00 per share, plus accrued but unpaid dividends, if any, (“Redemption Price”).  Upon the receipt of a redemption election, the Company, at its option, shall either: (1) pay the holder cash in the amount equal to the Redemption Price or (2) issue to the holder shares of common stock in an amount equal to 125% of the redemption price and any accrued and unpaid dividends, based on the weighted average closing “bid” price of the Company’s common stock for the thirty trading days immediately preceding the date of the written redemption election by the holder up to a maximum of 1.5 shares of common stock for each one share of preferred stock redeemed. The Company is accreting the carrying value of its preferred stock to its redemption price using the effective interest method with changes recorded to additional paid in capital. The accretion of preferred stock results in a reduction of earnings applicable to common stockholders. For the three months ended March 31, 2010, the Company redeemed 53,527 shares of preferred stock for an aggregate redemption amount of $642,324.

 

Notwithstanding the forgoing, if the closing “bid” price of the Company’s publicly traded common stock as reported by the NASDAQ stock market, or any exchange on which the shares of common stock are traded, exceeds 133% of the conversion price then in effect for the convertible preferred shares for at least 10 days during any 30-day trading period, the Company has the right to redeem in whole or in part the convertible preferred stock at a redemption price of $12 per share (plus any accrued unpaid dividends) or convert the convertible preferred shares (plus any accrued unpaid dividends) into common stock at the then applicable conversion rate.

 

7



Table of Contents

 

NOTE D—EARNINGS (LOSS) PER SHARE

 

Basic earnings (loss) per share is computed by dividing net earnings (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share is based on the assumption that stock options and warrants are converted into common shares using the treasury stock method and convertible bonds and preferred stock are converted using the if-converted method. Conversion is not assumed if the results are anti-dilutive.  Potential common shares for the three months ended March 31, 2010 and March 31, 2009 of  69,462 and 96,941 respectively, relating to convertible bonds and preferred stock, were excluded from the computation of diluted earnings (loss) per share because they are anti-dilutive. Potential common shares of  2,725,465 and 5,261,133 respectively, relating to stock options, warrants and restricted stock were excluded from the computation of diluted earnings (loss) per share for the three months ended March 31, 2010 and 2009, respectively, because they are anti-dilutive. Stock options have a weighted average exercise price of $4.57 and $6.29 at March 31, 2010 and March 31, 2009, respectively. At March 31, 2010, the convertible bonds may be converted from the date of issuance until maturity at 100% of principal amount into common stock of the Company at a price of $35 to $50.  The preferred stock may be converted at the discretion of the holder or upon meeting certain conditions at the discretion of the Company (see Note C).

 

Basic and diluted net earnings (loss) per share are computed based on the following information:

 

 

 

Three Months
Ended

March 31, 2010

 

Three Months
Ended

March 31, 2009

 

 

 

(in thousands, except for per
share data)

 

Net earnings (loss) available to common shareholders

 

$

7,175

 

$

(6,578

)

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

70,083,641

 

58,243,910

 

Effect of dilutive securities — stock options

 

1,121,205

 

 

Effect of dilutive securities — preferred stock

 

 

 

Effect of dilutive securities — warrants

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - diluted

 

71,204,846

 

58,243,910

 

 

 

 

 

 

 

Basic net earnings (loss) per share

 

$

0.10

 

$

(0.11

)

Diluted net earnings (loss) per share

 

$

0.10

 

$

(0.11

)

 

8



Table of Contents

 

NOTE E—LONG-TERM LIABILITIES

 

Long-term liabilities, excluding derivative financial instruments (see Note I), consisted of the following for the balance sheets dated:

 

 

 

March 31,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

Line of Credit

 

$

85,000

 

$

89,900

 

Convertible debentures

 

1,651

 

1,651

 

Debt collateralized by treasury stock

 

343

 

374

 

Asset retirement obligations

 

8,696

 

8,689

 

Litigation allowance

 

3,100

 

3,100

 

 

 

98,790

 

103,714

 

Less current portion

 

947

 

1,051

 

Long-term portion

 

$

97,843

 

$

102,663

 

 

On November 19, 2007, the Company entered into a five year, $250 million credit agreement with Merrill Lynch Capital (now owned by GE Business Financial Services, Inc.) The Credit Facility provides for a revolving credit line up to the lesser of (i) the borrowing base, (ii) $250 million or (iii) the draw limit requested by the Company. The Credit Facility matures on November 19, 2012. It is secured by substantially all of our assets. The borrowing base will be determined by the lenders at least semi-annually on each April 1 and October 1 and is based in part on the proved reserves of the Company. The current borrowing base is $120 million. Interest payments are made in arrears. The Company repaid $4.9 million under the Credit Facility during the first quarter of 2010, leaving $35 million of currently available credit. Credit line interest of approximately $0.1 million was accrued as of March 31, 2010. As of March 31, 2010, the Company has $85 million outstanding on its borrowing base.

 

The Company is subject to certain covenants under the terms of the Credit Facility which include, but are not limited to, the maintenance of the following financial ratios (1) minimum current ratio of current assets (including unused borrowing base in current assets) to current liabilities of 1.0 to 1.0 and (2) a minimum annualized consolidated EBITDAX (as defined by the Credit Facility) to net interest expense to of 2.5 to 1.0.

 

Depending on the current level of borrowing base usage, the annual interest rate on each base rate borrowing under the Credit Facility will be at our option either: (a) a “Base Rate Loan”, or any other Obligation other than a LIBOR Loan, which has an interest rate equal to the sum of the “Base Rate” plus the applicable “Base Rate Margin”, calculated to be the higher of (i) the Agent’s prime rate of interest announced from time to time, or (ii) the Federal Funds rate most recently determined by the Agent, plus 3.0% per annum, plus an applicable margin that ranges from 1.5% to 2.25%, or (b) a “LIBOR Loan”, which has an interest rate equal to the sum of the applicable LIBOR period plus the applicable “LIBOR Margin”, that ranges from 2.75% to 3.50%.

 

The convertible bonds may be converted from the date of issuance until maturity at 100% of principal amount into common stock of the Company at prices ranging from $35 to $50. Each year the holders of the convertible bonds may tender to the Company up to 10% of the aggregate bonds issued and outstanding. During the three months ended March 31, 2010, there were no Bond Redemptions.

 

9



Table of Contents

 

NOTE F—CONTINGENCIES

 

In January 2008, the Los Angeles city attorney filed a complaint against Warren E&P, Inc., a subsidiary of the Company (“Warren E&P”), and six of its individual employees and independent contractors in the Superior Court of California, County of Los Angeles (State of California v. Warren E&P, Inc., et al.). The complaint alleged eight misdemeanor violations concerning four alleged events in Wilmington, California during 2007. The complaint asserts one count of failing to report the discharge or threatened discharge of oil into marine waters for an event occurring on or about March 7, 2007; one count of failing to prepare and implement an oil spill contingency plan; four counts of violating the California Fish and Game Code by placing petroleum or its by-products in or at a place where they can pass into waters of the state; and two similar violations of the California Clean Water Act. The complaint alleges all eight counts against Warren E&P, Inc. and one to four counts against each of the individuals. Warren E&P has been discussing and negotiating a resolution of this case, and has reached a tentative, oral agreement with the City Attorney’s office and the District Attorney’s Office to settle this case. The oral agreement must be documented in writing, but generally provides that the criminal case will be dismissed against all defendants, and Warren will be required to enter into a Consent Decree and Civil Compromise Agreement, which will require it to pay certain costs and civil penalties and fines in the approximate amount of $100,000. In December of 2009, Warren E&P was able to obtain a dismissal of the six individual defendants from the case. Warren E&P and its counsel are currently working with the District Attorney’s office on the specific terms of the Consent Decree and Civil Compromise Agreement, and both anticipate this case will be resolved and ultimately settled in the second quarter of 2010.

 

In 2005, Warren recorded a provision for $1.8 million relating to a contingent liability that the Company may face as a result of a lawsuit originally filed in 1998 by Gotham Insurance Company in the 81st Judicial District Court of Frio County, Texas (Gotham Insurance Company v. Pedeco, Inc., et al.,) seeking a refund of approximately $1.8 million paid by Gotham and other insurers under an insurance policy issued for a well blow-out that occurred in 1997. After several appeals to the Texas Court of Appeals and the Texas Supreme Court, the case was remanded to the trial court for further proceedings. Both parties filed Motions for Summary Judgment in mid-2009, and on November 19, 2009, the trial court heard oral arguments on both Motions for Summary Judgment. On January 22, 2010, the court granted Gotham’s Motion for Summary Judgment for restitution in the amount of $1,823,156 and also awarded prejudgment interest at the rate of 5% per annum in the amount of $976,011. As a result of the January 2010 Summary Judgment, Warren recorded an additional provision of $1.3 million in the fourth quarter of 2009 relating to this contingent liability. Warren intends to appeal the order of the trial court to the Texas Court of Appeals. Although Warren believes that it has meritorious grounds for the appeal, if its appeal is unsuccessful, it will pay the amount of restitution to Gotham, as ordered by the trial court.

 

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

 

NOTE G—COMPREHENSIVE INCOME

 

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

 

 

 

Three months ending

 

 

 

March 31,

 

 

 

2010

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

Net income (loss)

 

$

7,186

 

$

(6,554

)

Holding gains (losses) on available for sale investments

 

4

 

(26

)

 

 

 

 

 

 

Comprehensive income (loss)

 

$

7,190

 

$

(6,580

)

 

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NOTE H - FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The estimated fair values of financial instruments recognized in the Consolidated Balance Sheets or disclosed within these Notes to Consolidated Financial Statements have been determined using available market information, information from unrelated third party financial institutions and appropriate valuation methodologies, primarily discounted projected cash flows. However, considerable judgment is required when interpreting market information and other data to develop estimates of fair value.

 

Short-term Assets and Liabilities. The fair values of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses and other current liabilities approximate their carrying values because of their short-term nature.

 

U.S. Treasury Bonds - Trading and Available-For-Sale Securities.  The fair values are based upon quoted market prices for those or similar investments and are reported on the Consolidated Balance Sheets at fair value.

 

Collateral Security Agreement Account (included in other non-current assets). The balance sheet carrying amount approximates fair value, as it earns a market rate.

 

Convertible Debentures: Fair values of fixed rate convertible debentures were calculated using interest rates in effect as of period end for similar instruments with the other terms unchanged.

 

Other Long-Term Liabilities.  The carrying amount approximates fair value due the current rates offered to the Company for long-term liabilities of the same remaining maturities.

 

Line of Credit. The carrying amount approximates fair value due the current rates offered to the Company for lines of credit.

 

 

 

March 31, 2010

 

December 31, 2009

 

 

 

Fair

 

Carrying

 

Fair

 

Carrying

 

 

 

value

 

amount

 

value

 

amount

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial assets

 

 

 

 

 

 

 

 

 

U.S. Treasury Bonds

 

$

991

 

$

991

 

$

972

 

$

972

 

Collateral security account

 

3,158

 

3,158

 

3,158

 

3,158

 

Financial liabilities

 

 

 

 

 

 

 

 

 

Fixed rate debentures

 

$

1,779

 

$

1,651

 

$

1,760

 

$

1,651

 

Other long-term liabilities

 

343

 

343

 

373

 

373

 

Line of credit

 

85,000

 

85,000

 

89,900

 

89,900

 

 

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FAIR VALUE MEASUREMENTS:

 

Fair value as defined by authoritative literature is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a three level hierarchy for measuring fair value. The statement requires fair value measurements be classified and disclosed in one of the following categories:

 

Level 1:   Quoted prices (unadjusted) in active markets for identical assets and liabilities that we have the ability to access at the measurement date.

 

Level 2:  Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived from observable market data by correlation or other means. Instruments categorized in Level 2 include non-exchange traded derivatives such as over-the-counter forwards and swaps.

 

Level 3:  Unobservable inputs for the asset or liability, including situations where there is little, if any, market activity for the asset or liability.

 

The valuation assumptions utilized to measure the fair value of the Company’s commodity derivatives were observable inputs based on market data obtained from independent sources and are considered Level 2 inputs (quoted prices for similar assets, liabilities (adjusted) and market-corroborated inputs).

 

The following tables present for each hierarchy level our assets and liabilities, including both current and non-current portions, measured at fair value on a recurring basis.

 

March 31, 2010

 

Assets

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Restricted investments in US Treasury Bonds — available for sale, at fair value

 

$

991

 

$

 

$

 

$

991

 

Commodity derivative asset

 

$

 

$

689

 

$

 

$

689

 

 

Liabilities

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Commodity derivative liability

 

$

 

$

8,613

 

$

 

$

8,613

 

 

December 31, 2009

 

Assets

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Restricted investments in US Treasury Bonds — available for sale, at fair value

 

$

972

 

$

 

$

 

$

972

 

Commodity derivative asset

 

$

 

$

421

 

$

 

$

421

 

 

Liabilities

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Commodity derivative liability

 

$

 

$

10,798

 

$

 

$

10,798

 

 

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NOTE I — DERIVATIVE FINANCIAL INSTRUMENTS

 

To minimize the effect of a downturn in oil and gas prices and protect our profitability and the economics of our development plans, we enter into crude oil and natural gas hedge contracts. The terms of contracts depend on various factors, including management’s view of future crude oil and natural gas prices. This price hedging program is designed to moderate the effects of a crude oil and natural gas price downturn while allowing us to participate in some commodity price increases. Management regularly monitors the crude oil and natural gas markets and our financial commitments to determine if, when, and at what level some form of crude oil and/or natural gas hedging and/or basis adjustments or other price protection is appropriate. Currently, our derivatives are in the form of swaps and a costless collar.  However, we may use a variety of derivative instruments in the future to hedge. The Company has not designated these derivatives as hedges for accounting purposes.

 

The following table summarizes the open financial derivative positions as of March 31, 2010, related to oil and gas production. The Company will receive prices as noted in the table below and will pay a counterparty market price based on the NYMEX (for natural gas production) or WTI (for oil production) index price, settled monthly.

 

Product

 

Type

 

Contract Period

 

Volume

 

Price per
Mcf or Bbl

 

Gas

 

Swap

 

02/01/09 - 12/31/10

 

3,000 Mcf/d

 

$6.88

 

Gas

 

Swap

 

03/01/09 - 02/28/11

 

3,000 Mcf/d

 

$6.02

 

Oil

 

Collar

 

01/01/10 - 12/31/10

 

1,000 Bbld

 

$65 - $106.50

 

Oil

 

Swap

 

01/01/11 - 12/31/11

 

1,225 Bbld

 

$61.80

 

Gas

 

Swap

 

01/01/10 - 03/31/10

 

2,500 Mmbtu/d

 

–$0.40*

 

Gas

 

Swap

 

02/01/10 - 12/31/10

 

6,500 Mmbtu/d

 

–$0.38*

 

Gas

 

Swap

 

04/01/10 - 11/30/10

 

2,500 Mmbtu/d

 

–$0.64*

 

Gas

 

Swap

 

04/01/11 - 11/30/11

 

2,500 Mmbtu/d

 

–$0.71*

 

Gas

 

Swap

 

01/01/12 - 12/01/12

 

3,000 Mmbtu/d

 

–$0.51*

 

 


*                                         This represents a differential spread between NYMEX and CIG pricing.

 

The tables below summarize the amount of gains recognized in income from derivative instruments.

 

Derivatives not designated as

 

Amount of Gain (Loss)
Recognized in Income for
Derivatives not designated as
Hedging Instruments under
authoritative guidance

 

Amount of Gain (Loss)
Recognized in Income for
Derivatives not designated as
Hedging Instruments under
authoritative guidance

 

Hedging Instrument under
authoritative guidance

 

Three months ended March 31, 2010
(in thousands)

 

Three months ended March 31, 2009
(in thousands)

 

 

 

 

 

 

 

Realized cash settlements on hedges

 

$

816

 

$

647

 

Unrealized gain on hedges

 

1,078

 

87

 

Total

 

$

1,894

 

$

734

 

 

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We present our derivative assets and liabilities in our Condensed Balance Sheets on a net basis. All derivatives are held with one counter party and gains and losses are offset in the Balance Sheet presentation. The table below reflects the line item in our Condensed Balance Sheet where the fair value of our net derivatives, are included.

 

March 31, 2010

 

 

 

Derivative Assets

 

(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Natural Gas

 

current

 

3,345

 

Commodity—Oil

 

current

 

(2,656

)

Total derivatives not designated as hedging instruments

 

 

 

$

689

 

 

 

 

Derivative Liabilities

 

(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Natural Gas

 

Non-current

 

455

 

Commodity—Oil

 

Non-current

 

8,158

 

Total derivatives not designated as hedging instruments

 

 

 

$

8,613

 

 

December 31, 2009

 

 

 

Derivative Assets

 

(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Natural Gas

 

current

 

1,239

 

Commodity—Oil

 

current

 

(818

)

Total derivatives not designated as hedging instruments

 

 

 

$

421

 

 

 

 

Derivative Liabilities

 

(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Natural Gas

 

Non-current

 

120

 

Commodity—Oil

 

Non-current

 

10,678

 

Total derivatives not designated as hedging instruments

 

 

 

$

10,798

 

 

NOTE J — RECENTLY ISSUED ACCOUNTING STANDARDS

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued new guidance and clarifications for improving disclosures about fair value measurements.  This guidance requires enhanced disclosures regarding transfers in and out of the levels within the fair value hierarchy.  Separate disclosures are required for transfers in and out of Level 1 and 2 fair value measurements, and the reasons for the transfers must be disclosed.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. The adoption of this guidance did not have any effect on the financial statements.

 

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

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

The Company has made in this report, and may from time to time otherwise make in other public filings, press releases and discussions with Company management, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning the Company’s operations, economic performance and financial condition. These forward-looking statements include information concerning future production and reserves, schedules, plans, timing of development, contributions from oil and gas properties, and those statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “projects,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions or variations on such expressions. For such statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company’s expectations include, but are not limited to, the Company’s assumptions about energy markets, production levels, reserve levels, operating results, competitive conditions, technology, the availability of capital resources, capital expenditures and other contractual obligations, the supply and demand for and the price of oil, natural gas and other products or services, the weather, inflation, the availability of goods and services, drilling risks, future processing volumes and pipeline throughput, general economic conditions, either internationally or nationally or in the jurisdictions in which the Company or its subsidiaries are doing business, legislative or regulatory changes, including changes in environmental regulation, environmental risks and liability under federal, state and local environmental laws and regulations, potential environmental obligations, the securities or capital markets, our ability to repay debt and other factors discussed in “Risk Factors” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s 2009 Annual Report on Form 10-K, this Form 10-Q and in the Company’s other public filings, press releases and discussions with Company management. Warren undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, subsequent events or otherwise, unless otherwise required by law.

 

Overview

 

We are an independent energy company engaged in the exploration and development of domestic onshore oil and natural gas reserves. We focus our efforts primarily on our waterflood oil recovery programs and horizontal drilling in the Wilmington field within the Los Angeles Basin of California and on the exploration and development of coalbed methane (“CBM”) properties located in the Rocky Mountain region. As of March 31, 2010, we owned natural gas and oil leasehold interests in approximately 148,500 gross, 79,300 net acres, approximately 80% of which are undeveloped. Substantially all our undeveloped acreage is located in the Rocky Mountains.

 

Liquidity and Capital Resources

 

Our cash and cash equivalents increased $0.5 million to $17.8 million during the three months ended March 31, 2010.  This resulted from cash provided from operating activities of $8.0 million offset by cash used in financing activities of $5.6 million and cash used in investing activities of $1.9 million.

 

Cash provided by operating activities was primarily generated by oil and gas operations.  Cash used in financing activities primarily represents repayments on our Credit Facility (as discussed in more detail below).  Cash used in investing activities was primarily spent on oil and gas properties and equipment.

 

On October 23, 2009, the Company sold 11.8 million shares of common stock at $2.60 per share.  The Company received net proceeds of $28.9 million after deducting $1.8 million of issuance costs.

 

On November 19, 2007, Warren entered into a five year, $250 million credit agreement with Merrill Lynch Capital (subsequently sold to GE Business Financial Services, Inc.) on behalf of itself and a syndicate of five participating banks (the “Credit Facility”).   The Credit Facility provides for a revolving loan up to the lesser of (i) the borrowing base (ii) $250 million or (iii) the draw limit requested by the Company.  The Credit Facility matures on November 19, 2012.  It is secured by substantially all of our assets.  The borrowing base will be determined by the lenders at least semi-annually on or about April 1 and October 1 of each year, and is based in part on the proved reserves of the Company. The current borrowing base

 

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is $120 million, representing an immediate availability of $35 million as of March 31, 2010.  The Company repaid $4.9 million under the Credit Facility during the first quarter of 2010.  The Company is subject to certain covenants required by the Credit Facility which include, but are not limited to the maintenance of the following financial ratios (1) a minimum current ratio (including the unused borrowing base and excluding unrealized gains and losses on derivative financial instruments) of not less than 1.0 to 1.0 and (2) a minimum annualized consolidated EBITDAX (as defined by the Credit Facility) to net interest expense of not less than to of 2.5 to 1.0.  As of March 31, 2010, the Company had borrowed $85 million under the Credit Facility and was in compliance with all covenants.  If the Company fails to satisfy its Credit Facility covenants, it would be an event of default.  Under such event of default and upon notice, all borrowings would become immediately due and payable to the lending banks.

 

Depending on the current level of borrowing base usage, the annual interest rate on each base rate borrowing under the Credit Facility will be at our option either: (a) a “Base Rate Loan”, or any other Obligation other than a LIBOR Loan, which has an interest rate equal to the sum of the “Base Rate” plus the applicable “Base Rate Margin”, calculated to be the higher of (i) the Agent’s prime rate of interest announced from time to time, or (ii) the Federal Funds rate most recently determined by the Agent, plus 3.0% per annum, plus an applicable margin that ranges from 1.5% to 2.25%, or (b) a “LIBOR Loan”, which has an interest rate equal to the sum of the applicable LIBOR period plus the applicable “LIBOR Margin”, that ranges from 2.75% to 3.50%. During the first quarter of 2010, the Company incurred $0.8 million of interest expense under the Credit Facility of which approximately $0.1 million was accrued for as of March 31, 2010. The weighted average interest rate as of March 31, 2010, was 3.4%.

 

Our operations are affected by local, national and worldwide economic conditions. We have relied on the capital markets, particularly for equity securities, as well as the banking and debt markets, to meet financial commitments and liquidity needs if internally generated cash flow from operations is not adequate to fund our capital requirements. Capital markets in the United States and elsewhere have been experiencing extreme adverse volatility and disruption for more than 18 months, due in part to the financial stresses affecting the liquidity of the banking system, the real estate mortgage industry and the financial markets generally. In recent months, this volatility and disruption has been reduced. As a result, our access to capital has improved as evidenced by our $29 million equity offering during October 2009.

 

If oil and gas commodity prices go lower, the Company may not generate sufficient cash flows to cover capital expenditures. In such case, the availability of funds under our Credit Facility is critical to our Company. The borrowing base is to be redetermined on or about May 15, 2010. If the Credit Facility’s borrowing base is reduced to a level below current borrowings, the Company would be obligated to begin reducing the deficiency by 25% within 90 days after the deficiency occurs and the remaining 75% within 180 days after the deficiency occurs.

 

The continuing crisis in the U.S. and world financial and securities markets could have a material adverse effect on our business and operations. Additionally, low commodity prices may restrict our ability to meet our current obligations. As a result, Management has taken several actions to ensure that the Company will have sufficient liquidity to meet its obligations through December 31, 2010, including a 2010 capital expenditure budget which is expected to be funded by discretionary cash flow, entered into price swap agreements, collars and differential swap agreements for a portion of its 2010 production to reduce price volatility, temporarily shut-in three pilot areas in the Atlantic Rim that are uneconomic at current prices to reduce lease operating expenses, employee reductions and reductions in discretionary expenditures. As of March 31, 2010, approximately 50% of the Company’s natural gas production and 40% of the Company’s oil production are covered by price swaps. It is not anticipated that these percentages will change significantly during the remainder of 2010. If the liquidity of the Company would worsen, the Company would evaluate other measures to further improve its liquidity, including, the sale of equity or debt securities, the sale of certain assets, entering into joint ventures with third parties, volumetric production payments, additional commodity price hedging and other monetization of assets strategies. There is no assurance that the Company will be successful in these capital raising efforts that may be necessary to fund operations during 2010.

 

During the first quarter of 2010, the Company had net income of $7.2 million (which included $1.1 million of unrealized gains on derivative financial instruments). This compares to the first quarter of 2009 when the Company incurred a net loss of $6.6 million (which included $87,000 of unrealized losses on derivative financial instruments). At March 31, 2010, current assets were $14.2 million more than current liabilities. Currently, the Company has a borrowing base of $120 million and $85 million outstanding under the Credit Facility.

 

In the future, if natural gas inventories rise to levels such that no natural gas storage capacity exists, certain U.S. natural gas production will need to be reduced or shut in.  Additionally, if commodity prices decline to levels that make it uneconomic to produce oil and natural gas, the Company or its partners may elect to shut in or reduce production.  As a result, some or

 

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Table of Contents

 

all of the Company’s oil and natural gas production may be shut in or curtailed during the next 12 months, which would have a material adverse effect on operations.

 

The Company’s proved reserves may decline in future years.  Due to current commodity prices, compared to the cost of developing our undeveloped reserves and our estimated lease operating expenses, a portion of our future projects are or may be uneconomic at this time.  The Company’s projects have material lease operating expenses.  Our oil operations include a secondary recovery waterflood with significant fixed costs.  During the first quarter of 2010, our oil lease operating expenses were $17.25 per net barrel of oil produced. Our natural gas operations include reinjecting the produced water into deep formations and compressing and transporting the gas with significant fixed costs. During the first quarter of 2010, our natural gas lease operating expenses were $3.16 per net mcf of gas produced. The Company’s proved reserves are based on assumptions that may prove to be inaccurate.

 

At March 31, 2010, we had approximately 1.5 million vested outstanding stock options issued under our stock based equity compensation plans. Of the total 1.5 million outstanding vested options, 1.0 million had exercise prices above the closing market price $2.52 of our common stock on March 31, 2010.

 

Contractual Obligations

 

The contractual obligations table below assumes the maximum amount under contract is tendered each year. The table does not give effect to the conversion of any bonds to common stock which would reduce payments due. All bonds are secured at maturity by zero coupon U.S. treasury bonds deposited into an escrow account equaling the par value of the bonds maturing on or before the maturity of the bonds. Such U.S. treasury bonds had a fair market value of $1.0 million at March 31, 2010.  The table below does not reflect the release of escrowed U.S. treasury bonds to us upon redemption.

 

 

 

Payments due by period *

 

Contractual Obligations
As of March 31, 2010

 

Total

 

Less Than
1 Year

 

1-3
Years

 

3-5
Years

 

More Than
5 Years

 

 

 

(in thousands)

 

Line of credit

 

$

85,000

 

$

 

$

85,000

 

$

 

$

 

Bonds

 

1,651

 

165

 

282

 

229

 

975

 

Drilling commitments

 

585

 

585

 

 

 

 

Leases

 

2,295

 

479

 

1,242

 

505

 

69

 

Total

 

$

89,531

 

$

1,229

 

$

86,524

 

$

734

 

$

1,044

 

 


*                      Does not include estimated interest of $3.1 million less than one year, $5.2 million 1-3 years, $0.4 million 3-5 years and $1.3 million thereafter.

 

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Table of Contents

 

RESULTS OF OPERATIONS:

 

Three months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

 

Oil and gas sales. Revenue from oil and gas sales increased $10.0 million in the first quarter of 2010 to $21.6 million, an 87% increase compared to the same quarter in 2009.  This increase resulted from an increase in realized energy prices.  The average realized price per barrel of oil for the three months ended March 31, 2010 and 2009 was $70.52 and $35.14, respectively.  Additionally, the average realized price per Mcf of gas for the three months ended March 31, 2010 and 2009 was $5.50 and $2.89, respectively.  Net oil production for the three months ended March 31, 2010 and 2009 was 223 Mbbls and 253 Mbbls, respectively.  Net gas production for the three months ended March 31, 2010 and 2009 was 1.1 Bcf and 0.9 Bcf, respectively.

 

Lease operating expense. Lease operating expense for the first quarter of 2010 decreased 18% to $7.2 million ($3.00 per Mcfe) compared to $8.8 million ($3.61 per Mcfe) in the comparable period of 2009. Primarily, this decrease resulted from reduced lease operating expenses in our Atlantic Rim Project resulted from shutting in uneconomic wells and reduced workovers on wells.  Additionally, this decrease resulted from reduced field expenses in our California oil properties.

 

Depreciation, depletion and amortization. Depreciation, depletion and amortization expense decreased $0.5 million for the first quarter of 2010 to $4.8 million, a 10% decrease compared to the corresponding quarter last year.  This decrease reflects a reduction in estimated future development costs which reduced overall depletion expense.  This decrease was partially offset by an increase in the depletion rate related to proved reserves in the full cost pool.  The 2010 depletion rate decreased to $1.99 per mcfe compared to $2.18 per mcfe in 2009.

 

General and administrative expenses. General and administrative expenses increased $0.2 million in the first quarter of 2010 to $3.5 million, a 6% increase compared to the corresponding quarter last year.  This reflects an increase in stock option expense of $0.2 million.

 

Interest expense. Interest expense decreased $0.7 million in the first quarter of 2010 to $0.9 million compared to the same quarter last year.  The decrease results from a decrease in borrowings under our Credit Facility and a decrease in interest rates.

 

Interest and other income. Interest and other income decreased $0.1 million in the first quarter of 2010 to $38 thousand, a 61% decrease compared to the same quarter in 2009. This represents a decrease in interest earned due to lower interest rates as compared to the corresponding quarter last year.

 

Gain (loss) on derivative financial instruments.  Derivative gains of $1.9 million were recorded in the first quarter of 2010. This amount reflects $0.8 million of realized gains and $1.1 million of unrealized gains resulting from mark to market accounting of our oil and gas swaps and costless collar positions.

 

CRITICAL ACCOUNTING POLICIES

 

Our discussion and analysis of our financial condition and results of operations are based on consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We believe that certain accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Our 2009 Form 10-K includes a discussion of our critical accounting policies.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Energy Price Risk

 

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

 

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Commodity Risk

 

Our primary market risk exposure is in the price we receive for our natural gas and oil production. Realized pricing is primarily driven by the prevailing worldwide price for crude oil and spot regional market prices applicable to our U.S. natural gas production. Pricing for natural gas and oil production has been volatile and unpredictable for several years, and we expect this volatility to continue in the future. The prices we receive for production depend on many factors outside of our control, including volatility in the differences between product prices at sales points and the applicable index price.

 

In 2009 and 2010 we entered into several financial derivative swap contracts and a costless collar to hedge our exposure to commodity price risk associated with anticipated future oil and gas production. Through a price swap, we have fixed the price we will receive on a portion of our natural gas and oil production. In a swap transaction, the counterparty is required to make a payment to us for the difference between the fixed price and the settlement price if the settlement price is below the fixed price. We are required to make a payment to the counterparty for the difference between the fixed price and the settlement price if the fixed price is below the settlement price. We believe we will have more predictability of our crude oil and gas revenues as a result of these financial derivative contracts.

 

The following table summarizes our open financial derivative positions as of May 5, 2010 related to oil and gas production. The Company will receive prices as noted in the table below and will pay a counterparty market price based on the NYMEX (for natural gas production) or WTI (for oil production) index price, settled monthly.

 

Product

 

Type

 

Contract Period

 

Volume

 

Price per
Mcf or Bbl

 

Gas

 

Swap

 

02/01/09 - 12/31/10

 

3,000 Mcf/d

 

$6.88

 

Gas

 

Swap

 

03/01/09 - 02/28/11

 

3,000 Mcf/d

 

$6.02

 

Oil

 

Collar

 

01/01/10 - 12/31/10

 

1,000 Bbld

 

$65 - $106.50

 

Oil

 

Swap

 

01/01/11 - 12/31/11

 

1,225 Bbld

 

$61.80

 

Gas

 

Swap

 

01/01/10 - 03/31/10

 

2,500 Mmbtu/d

 

–$0.40*

 

Gas

 

Swap

 

02/01/10 - 12/31/10

 

6,500 Mmbtu/d

 

–$0.38*

 

Gas

 

Swap

 

04/01/10 - 11/30/10

 

2,500 Mmbtu/d

 

–$0.64*

 

Gas

 

Swap

 

04/01/11 - 11/30/11

 

2,500 Mmbtu/d

 

–$0.71*

 

Gas

 

Swap

 

01/01/12 - 12/01/12

 

3,000 Mmbtu/d

 

–$0.51*

 

 


*                                         This represents a differential spread between NYMEX and CIG pricing.

 

Interest Rate Risk

 

We hold investments in U.S. treasury bonds available for sale, which represents securities held in escrow accounts on behalf of certain debentures. Additionally, we hold U.S. treasury bonds trading securities, which predominantly represent U.S. treasury bonds released from escrow accounts. The fair market value of these securities will generally increase if the federal discount rate decreases and decrease if the federal discount rate increases. All of our convertible debt has fixed interest rates, so consequently we are not exposed to cash flow or fair value risk from market interest rate changes on this debt.

 

At March 31, 2010, we had debt outstanding under our Credit Facility of $85 million.  Depending on the current level of borrowing base usage, the annual interest rate on each base rate borrowing under the Credit Facility will be at our option either: (a) a “Base Rate Loan”, or any other Obligation other than a LIBOR Loan, which has an interest rate equal to the sum of the “Base Rate” plus the applicable “Base Rate Margin”, calculated to be the higher of (i) the Agent’s prime rate of interest announced from time to time, or (ii) the Federal Funds rate most recently determined by the Agent, plus 3.0% per annum, plus an applicable margin that ranges from 1.5% to 2.25%, or (b) a “LIBOR Loan”, which has an interest rate equal to the sum of the applicable LIBOR period plus the applicable “LIBOR Margin”, that ranges from 2.75% to 3.50%.

 

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Financial Instruments

 

Our financial instruments consist of the following, cash and cash equivalents, U.S. treasury bonds, collateral security accounts, line of credit and other long-term liabilities. The carrying amounts of these instruments approximate fair market value due to the highly liquid nature of these short-term instruments or they are reported at fair value.

 

Inflation and Changes in Prices

 

The general level of inflation affects our costs. Salaries and other general and administrative expenses are impacted by inflationary trends and the supply and demand of qualified professionals and professional services. Inflation and price fluctuations affect the costs associated with exploring for and producing natural gas and oil, which have a material impact on our financial performance.

 

Forward-Looking Statements and Risk

 

Certain statements in this report, including statements of the future plans, objectives, and expected performance of the company, are forward-looking statements that are dependent upon certain events, risks and uncertainties that may be outside the company’s control, and which could cause actual results to differ materially from those anticipated. Some of these include, but are not limited to, the market prices of oil and gas, economic and competitive conditions, exploration risks such as drilling unsuccessful wells, higher-than-expected costs, potential liability for remedial actions under existing or future environmental regulations and litigation, potential liability resulting from pending or future litigation, environmental and regulatory uncertainties that could delay or prevent drilling, and not successfully completing, or any material delay of, any development of new or existing fields, expansion, or capital expenditure, legislative and regulatory changes, financial market conditions, political and economic uncertainties of foreign governments, future business decisions, and other uncertainties, all of which are difficult to predict. Forward-looking statements are generally accompanied by words such as “estimate”, “project”, “predict”, “will”, “anticipate”, “plan”, “intend”, “believe”, “expect” or similar expressions that convey the uncertainty of future events or outcomes. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this report. Unless legally required, Warren does not undertake any obligation to update any forward-looking statements, as a result of new information, future events or otherwise. Certain risks that may affect Warren’s results of operations and financial position appear in Part 1, Item 1A “Risk Factors” of Warren’s 2009 Annual Report on Form 10-K.

 

There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and in projecting future rates of production and the timing of development expenditures. The total amount or timing of actual future production may vary significantly from reserves and production estimates. The drilling of exploratory wells can involve significant risks, including those related to timing, success rates and cost overruns. Lease and rig availability, complex geology and other factors can affect these risks. Fluctuations in oil and natural gas prices or a prolonged continuation of low prices may adversely affect the company’s financial position, results of operations and cash flows.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal controls over financial reporting or in other factors during the quarter ended March 31, 2010, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Information with respect to this item may be found in Note F to the Consolidated Financial Statements (Part I, Item 1), which is incorporated herein by reference.

 

Item 1A. Risk Factors

 

Our business has many risks. In addition to the other information set forth in this report and our press releases and other reports and materials that we file with the Securities and Exchange Commission, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, and in our Registration Statement on Form S-3, and the prospectus supplement thereto, in connection with our public offering on October 23, 2009, which could materially affect our business, financial condition, operating results or liquidity and the trading price of our common stock.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

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

 

a.               Not applicable

 

b.              Not applicable

 

c.               Not applicable

 

Item 3. Defaults upon Senior Securities

 

Not applicable.

 

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

 

None held in the first quarter of 2010.

 

Item 5. Other Information

 

Not applicable.

 

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Item 6. Exhibits

 

a)

Exhibits

 

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

 

Exhibit

 

 

Number

 

Description

 

 

 

31.1*

 

Certification of Chief Executive Officer pursuant to Rule 13a-15(e)/15d-15(e)

31.2*

 

Certification of Chief Financial Officer pursuant to Rule 13a-15(e)/15d-15(e)

32.1*

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

32.2*

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

 


*

 

Filed herewith.

 

 

 

 

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SIGNATURES

 

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

 

 

WARREN RESOURCES, INC.

 

(Registrant)

 

 

 

 

/s/ Timothy A. Larkin

Date: May 5, 2010

 

 

 

By:

Timothy A. Larkin

 

 

Executive Vice President,

 

 

Chief Financial Officer and

 

 

Principal Accounting Officer

 

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