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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, 2012

 

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

 

11-3024080

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

 

 

1114 Avenue of the Americas,
New York, NY

 

10036

(Address of Principal Executive Offices)

 

(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 x  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 April 30, 2012 was 71,693,466 shares of Common Stock, $0.0001 par value.

 

 

 



Table of Contents

 

WARREN RESOURCES, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

PART I—

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011

 

 

 

 

 

 

 

Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and 2011

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011

 

 

 

 

 

 

 

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. Removed and Reserved

 

 

 

 

 

 

 

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,
2012
(Unaudited)

 

December 31,
2011

 

 

 

(in thousands, except share
and per share data)

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

7,199

 

$

10,614

 

Accounts receivable — trade

 

12,190

 

13,660

 

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

 

132

 

135

 

Derivative financial instruments

 

416

 

309

 

Other current assets

 

1,680

 

948

 

 

 

 

 

 

 

Total current assets

 

21,617

 

25,666

 

 

 

 

 

 

 

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 $23,284 and $22,963 as of March 31, 2012 and December 31, 2011)

 

284,087

 

275,443

 

Property and equipment—at cost, net

 

16,409

 

16,926

 

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

 

1,188

 

1,214

 

Other assets

 

4,325

 

4,383

 

 

 

 

 

 

 

Total other assets

 

306,009

 

297,966

 

 

 

$

327,626

 

$

323,632

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current maturities of debentures and other long-term liabilities

 

$

2,357

 

$

2,831

 

Accounts payable and accruals

 

29,908

 

38,234

 

Derivative financial instruments

 

 

980

 

 

 

 

 

 

 

Total current liabilities

 

32,265

 

42,045

 

 

 

 

 

 

 

Long-Term Liabilities

 

 

 

 

 

Debentures, less current portion

 

1,486

 

1,486

 

Other long-term liabilities, less current portion

 

16,081

 

16,510

 

Line of credit

 

99,500

 

89,500

 

 

 

 

 

 

 

 

 

117,067

 

107,496

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

8% convertible preferred stock, par value $.0001; authorized 10,000,000 shares, issued and outstanding, 10,703 shares and 10,703 in 2012 and 2011, respectively (aggregate liquidation preference $128 in 2012 and $128 in 2011)

 

128

 

128

 

Common stock - $.0001 par value; authorized, 100,000,000 shares; issued 71,688,375 shares in 2012 and 71,518,810 shares in 2011

 

7

 

7

 

Additional paid-in-capital

 

465,403

 

464,985

 

Accumulated deficit

 

(286,767

)

(290,578

)

Accumulated other comprehensive income, net of applicable income taxes of $164 in 2012 and $181 in 2011

 

251

 

277

 

 

 

179,022

 

174,819

 

Less common stock in Treasury—at cost; 632,250 shares in 2012 and 2011

 

728

 

728

 

Total stockholders’ equity

 

178,294

 

174,091

 

 

 

$

327,626

 

$

323,632

 

 

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)

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Operating revenues

 

 

 

 

 

Oil and gas sales

 

$

28,354

 

$

23,180

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

Lease operating expense and taxes

 

8,500

 

7,735

 

Depreciation, depletion and amortization

 

10,105

 

6,129

 

General and administrative

 

4,293

 

3,563

 

 

 

 

 

 

 

Total operating expenses

 

22,898

 

17,427

 

 

 

 

 

 

 

Income from operations

 

5,456

 

5,753

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

Interest and other income

 

25

 

19

 

Interest expense

 

(775

)

(571

)

Loss on derivative financial instruments

 

(878

)

(5,772

)

 

 

 

 

 

 

Total other expense

 

(1,628

)

(6,324

)

 

 

 

 

 

 

Income (loss) before taxes

 

3,828

 

(571

)

 

 

 

 

 

 

Deferred income tax expense

 

17

 

5

 

 

 

 

 

 

 

Net income (loss)

 

3,811

 

(576

)

 

 

 

 

 

 

Less dividends and accretion on preferred shares

 

3

 

3

 

 

 

 

 

 

 

Net income (loss) applicable to common stockholders

 

$

3,808

 

$

(579

)

 

 

 

 

 

 

Earnings (loss) per share — Basic

 

$

0.05

 

$

(0.01

)

Earnings (loss) per share — Diluted

 

0.05

 

(0.01

)

 

 

 

 

 

 

Weighted average common shares outstanding — Basic

 

71,025,089

 

70,741,785

 

Weighted average common shares outstanding — Diluted

 

72,194,300

 

70,741,785

 

 

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

 

4



Table of Contents

 

WARREN RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

Three Months Ended
March 31, (Unaudited)

 

 

 

(in thousands, except share
and per share data)

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Net income (loss)

 

$

3,811

 

$

(576

)

Other comprehensive income (loss)

 

 

 

 

 

Holding losses on available for sale investments

 

(26

)

(8

)

 

 

 

 

 

 

Comprehensive income (loss)

 

$

3,785

 

$

(584

)

 

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

 

5



Table of Contents

 

WARREN RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For the three months ended
March 31 (Unaudited)

 

 

 

(in thousands)

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

3,811

 

$

(576

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Accretion of discount on available-for-sale debt securities

 

(14

)

(13

)

Amortization of deferred offering costs

 

51

 

52

 

Depreciation, depletion and amortization

 

10,105

 

6,129

 

Change in fair value of derivative financial instruments

 

(1,087

)

3,643

 

Stock option expense

 

383

 

358

 

Deferred tax expense

 

17

 

5

 

Change in assets and liabilities:

 

 

 

 

 

Decrease (increase) in accounts receivable—trade

 

515

 

(623

)

Increase in other assets

 

(724

)

(879

)

Increase (decrease) in accounts payable and accruals

 

692

 

(337

)

Decrease in other long-term liabilities

 

(858

)

(92

)

 

 

 

 

 

 

Net cash provided by operating activities

 

12,891

 

7,667

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase, exploration and development of oil and gas properties

 

(26,012

)

(5,742

)

Purchase of property and equipment

 

(293

)

(3,150

)

 

 

 

 

 

 

Net cash used in investing activities

 

(26,305

)

(8,892

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from line of credit

 

10,000

 

 

Payments on debt and debentures

 

(38

)

(734

)

Issuance of common stock, net

 

37

 

58

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

9,999

 

(676

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(3,415

)

(1,901

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

10,614

 

11,092

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

7,199

 

$

9,191

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid for interest, net of amounts capitalized

 

$

738

 

$

517

 

Noncash investing and financing activities

 

 

 

 

 

Accrued preferred stock dividend

 

3

 

3

 

 

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

 

6



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 California, Wyoming and New Mexico.

 

The accompanying unaudited financial statements and related notes present the Company’s consolidated financial position as of March 31, 2012 and December 31, 2011, the consolidated results of operations for the three months ended March 31, 2012 and 2011 and consolidated cash flows for the three months ended March 31, 2012 and 2011. 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, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2012. 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, 2011. These interim financial statements and notes thereto should be read in conjunction with the consolidated financial statements presented in the Company’s 2011 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 $0.4 and $0.4 million for the three months ended March 31, 2012 and March 31, 2011, respectively.

 

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

 

 

 

Three months ended March 31,

 

 

 

2012

 

2011

 

Dividend yield

 

0

%

0

%

Expected volatility

 

74.0

%

74.7

%

Risk-free interest rate

 

0.5

%

1.4

%

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, 2011

 

3,092,985

 

$

3.89

 

 

 

 

 

Granted

 

10,000

 

3.07

 

 

 

 

 

Exercised

 

(41,890

)

0.89

 

 

 

 

 

Forfeited or expired

 

(328,332

)

10.45

 

 

 

 

 

Outstanding at March 31, 2012

 

2,732,763

 

$

3.15

 

2.25

 

$

3,927

 

Exercisable at March 31, 2012

 

2,260,842

 

$

3.23

 

2.05

 

$

3,619

 

 

7



Table of Contents

 

The total intrinsic value of options exercised during the three months ended March 31, 2012 and 2011 were approximately $107,000 and $240,000 respectively.

 

As of March 31, 2012 total unrecognized stock-based compensation expense related to non-vested stock options was approximately $0.6 million, which we expect to recognize over a weighted average period of 1.3 years.

 

Restricted Shares

 

Restricted share activity as of March 31, 2012 was as follows:

 

 

 

Shares

 

Weighted
Average
Fair Value

 

 

 

 

 

 

 

Outstanding at December 31, 2011

 

615,731

 

$

4.22

 

Granted

 

 

 

Vested

 

(197,169

)

11.15

 

Forfeited

 

 

 

Outstanding at March 31, 2012

 

418,562

 

$

4.21

 

 

Restricted stock awards for executive officers and employees vest ratably over three years. Fair value of our restricted shares is based on our closing stock price on the date of grant.  As of March 31, 2012, total unrecognized stock-based compensation expense related to non-vested restricted shares was $1.7 million, which is expected to be recognized over a weighted average period of approximately 1.9 years.

 

NOTE CSTOCKHOLDERS’ 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, 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 has accreted 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.

 

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.

 

8



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, 2012 and March 31, 2011 of 52,522 and 52,522 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 1,002,979 and 3,897,054 respectively, relating to stock options and restricted stock were excluded from the computation of diluted earnings (loss) per share for the three months ended March 31, 2012 and 2011, respectively, because they are anti-dilutive. Stock options have a weighted average exercise price of $3.15 and $3.97 at March 31, 2012 and March 31, 2011, respectively. At March 31, 2012 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 per share are computed based on the following information:

 

 

 

Three Months
Ended
March 31,
2012

 

Three Months
Ended
 March 31,
 2011

 

 

 

(in thousands, except for per
share data)

 

Net earnings (loss) applicable to common shareholders

 

$

3,808

 

$

(579

)

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

71,025,089

 

70,741,785

 

Effect of dilutive securities — stock options

 

1,169,211

 

 

 

 

 

 

 

 

Weighted average shares outstanding - diluted

 

72,194,300

 

70,741,785

 

 

 

 

 

 

 

Basic net earnings (loss) per share

 

$

0.05

 

$

(0.01

)

Diluted net earnings (loss) per share

 

$

0.05

 

$

(0.01

)

 

9



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,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

 

 

 

 

 

 

Line of Credit

 

$

99,500

 

$

89,500

 

Convertible debentures

 

1,651

 

1,651

 

Debt collateralized by treasury stock

 

65

 

103

 

Asset retirement obligations

 

15,108

 

15,507

 

Litigation allowance

 

3,100

 

3,100

 

Drilling rig note payable

 

 

466

 

 

 

119,424

 

110,327

 

Less current portion

 

2,357

 

2,831

 

Long-term portion

 

$

117,067

 

$

107,496

 

 

On December 15, 2011, the Company entered into a five-year $300 million Second Amended and Restated Credit Agreement with Bank of Montreal. This replaced the prior $250 million credit agreement with GE Business Financial Services, Inc. The Credit Facility provides for a revolving credit facility up to the lesser of: (i) $300 million, (ii) the Borrowing Base, or (iii) the Draw Limit requested by the Company. The Credit Facility matures on December 15, 2016, is secured by substantially all of Warren’s oil and gas assets, and is guaranteed by the two wholly-owned subsidiaries of the Company. The initial Borrowing Base is $130 million. The maximum amount available is subject to semi-annual redeterminations of the borrowing base in April and October of each year, based on the value of the Company’s proved oil and natural gas reserves in accordance with the lenders’ customary procedures and practices.  Both the Company and the lenders have the right to request one additional redetermination each year.  Credit line interest of approximately $0.1 million was accrued as of March 31, 2012. As of March 31, 2012, the Company has $99.5 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 of 2.5 to 1.0. The Company is in compliance with these covenants as of March 31, 2012.

 

Depending on the amount outstanding and the level of borrowing base usage, the annual interest rate on each base rate loan under the Credit Facility will be, at the Company’s option, either: (a) 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 1.75% to 2.75%, or (b) 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”, 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 one-half percent, plus an applicable “Base Rate Margin” that ranges from 0.75% to 1.75%. The weighted average interest rate as of March 31, 2012, was 2.75%.

 

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, 2012, there were no bond redemptions.

 

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NOTE F—ASSET RETIREMENT OBLIGATION

 

The estimated fair value of the future costs associated with dismantlement, abandonment and restoration of oil and gas properties is recorded generally upon acquisition or completion of a well. The net estimated costs are discounted to present values using a risk adjusted rate over the estimated economic life of the oil and gas properties. Such costs are capitalized as part of the related asset. The asset is depleted on the units-of-production method. The associated liability is classified in other long-term liabilities, net of current portion, in the accompanying Consolidated Balance Sheets. The liability is periodically adjusted to reflect (1) new liabilities incurred, (2) liabilities settled during the period, (3) accretion expense, and (4) revisions to estimated future cash flow requirements. The accretion expense is recorded as a component of depreciation, depletion and amortization. The Company has cash held in escrow with a fair market value of $3.2 million that is legally restricted for potential plugging and abandonment liability in the Wilmington field which is recorded in other assets in the Consolidated Balance Sheets. A reconciliation of the Company’s asset retirement obligations is as follows:

 

 

 

March 31,

 

 

 

2012

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

15,507

 

Liabilities incurred in current period

 

94

 

Liabilities settled in current period

 

(858

)

Accretion expense

 

365

 

Balance at end of period

 

$

15,108

 

 

NOTE G—CONTINGENCIES

 

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. On July 7, 2010, Warren E&P commenced to appeal the order of the trial court to the Texas Court of Appeals. The San Antonio Court of Appeals assigned and transferred this appeal to the El Paso Court of Appeals.  Based on extensions given by the El Paso Court of Appeals, the Frio County District Court Clerk certified and filed the Record on Appeal on October 26, 2010.  On March 14, 2011, Warren filed its appellate brief with the El Paso Court of Appeals. Gotham filed its response to Warren’s brief on May 31, 2011. Warren replied to Gotham’s response on June 23, 2011. Oral arguments were heard before the Texas Court of Appeals in January 2012.  On April 18, 2012 the Texas Court of Appeals reversed the judgment of the trial court and rendered its appellate decision in favor of Warren ruling that Gotham Insurance take nothing against Warren. Additionally, the Texas Court of Appeals ordered that Warren can recover all costs of the appeal from Gotham Insurance. In response to the April 18, 2012 ruling, Gotham may file a motion for rehearing with the Court of Appeals, which would be due on May 3, 2012. Gotham may also petition the Texas Supreme Court seeking a review of the ruling, which review is discretionary and may or may not be accepted by the Court.

 

The Company is a party to various other matters of litigation arising in the normal course of business. Management believes that the ultimate outcome of the matters will not have a material effect on the Company’s financial condition or results of operations.

 

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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 to 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 to the current rates offered to the Company for lines of credit.

 

Derivatives. The fair values are based upon 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) and are reported on the Consolidated Balance Sheets at fair value.

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Fair

 

Carrying

 

Fair

 

Carrying

 

 

 

value

 

amount

 

value

 

amount

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial assets

 

 

 

 

 

 

 

 

 

Collateral security account

 

$

3,163

 

$

3,163

 

$

3,163

 

$

3,163

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

Fixed rate debentures

 

$

2,131

 

$

1,651

 

$

2,195

 

$

1,651

 

Other long-term liabilities

 

65

 

65

 

103

 

103

 

Line of credit

 

99,500

 

99,500

 

89,500

 

89,500

 

 

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 literature 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.

 

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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 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, 2012

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Assets

 

 

 

 

 

 

 

 

 

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

 

$

1,320

 

$

 

$

 

$

1,320

 

Commodity derivatives

 

$

 

$

416

 

$

 

$

416

 

 

December 31, 2011

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Assets

 

 

 

 

 

 

 

 

 

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

 

$

1,349

 

$

 

$

 

$

1,349

 

Commodity derivatives

 

$

 

$

309

 

$

 

$

309

 

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Commodity derivatives

 

$

 

$

980

 

$

 

$

980

 

 

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 puts and a gas differential swap.  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, 2012, 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

 

Oil

 

Brent Put

 

04/01/12 - 12/31/12

 

1,818 Bbl/d

 

$

90.00

 

Oil

 

NYMEX Put

 

01/01/12 - 12/31/12

 

1,000 Bbl/d

 

$

70.00

 

Natural Gas Differentials

 

Swap

 

01/01/12 - 12/31/12

 

3,000 Mcf/d

 

$

-0.51

*

 

13



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

 

The tables below summarize the amount of gains (losses) recognized in income from derivative instruments not designated as hedging instruments under authoritative guidance.

 

 

 

 

 

Derivatives not designated as

 

For the Three Months

 

Hedging Instrument under

 

Ended March 31,

 

authoritative guidance

 

2012

 

2011

 

(in thousands)

 

 

 

 

 

Realized loss on hedges

 

$

(380

)

$

(1,838

)

 

 

 

 

 

 

Unrealized loss on hedges

 

(498

)

(3,934

)

 

 

 

 

 

 

Total

 

$

(878

)

$

(5,772

)

 

The table below reflects the line item in our Consolidated Balance Sheet where the fair value of our net derivatives, are included.

 

 

 

Derivative Assets

 

March 31, 2012
(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Oil

 

current

 

$

640

 

Commodity—Natural Gas

 

current

 

(224

)

 

 

 

 

 

 

Total derivatives not designated as hedging instruments

 

 

 

$

416

 

 

 

 

Derivative Assets

 

December 31, 2011
(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Natural Gas

 

current

 

309

 

 

 

 

 

 

 

 

Total derivatives not designated as hedging instruments

 

 

 

$

309

 

 

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Derivative Liabilities

 

December 31, 2011
(in thousands)

 

Balance Sheet
Location

 

Fair Value

 

Commodity—Oil

 

current

 

(980

)

Total derivatives not designated as hedging instruments

 

 

 

$

(980

)

 

Derivative’s Credit risk

 

The Company does not require collateral or other security from counterparties to support derivative instruments. However, the agreements with those counterparties typically contain netting provisions such that if a default occurs, the non-defaulting party can offset the amount payable to the defaulting party under the derivative contract with the amount due from the defaulting party. As a result of the netting provisions the Company’s maximum amount of loss due to credit risk is limited to the net amounts due to and from the counterparties under the derivative contracts.

 

As of March 31, 2012, the counterparties to the Company’s commodity derivative contracts consist of two financial institutions. The Company’s counterparties or their affiliates are also lenders under the Company’s Senior Credit Agreement. As a result, the counterparties to the Company’s derivative agreements share in the collateral supporting the Company’s Senior Credit Agreement. The Company is not generally required to post additional collateral under derivative agreements.

 

The Company’s derivative agreements contain provisions that require cross defaults and acceleration of those instruments to any material debt. If the Company were to default on any of its material debt agreements, it would be a violation of these provisions, and the counterparties to the derivative instruments could request immediate payment on derivative instruments that are in a net liability position at that time.

 

NOTE J — INCOME TAXES

 

The Company’s effective tax rate differs from the federal statutory tax rate due to changes in the valuation allowance on the Company’s net deferred tax asset.

 

NOTE K — RECENTLY ISSUED ACCOUNTING STANDARDS

 

In June 2011, guidance was issued that (i) will require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and (ii) eliminates the option to present the components of other comprehensive income as part of the statement of equity. The Company adopted this guidance beginning January 1, 2012 and it did not have a material impact on the Company’s consolidated financial statements.

 

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

 

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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 2011 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, 2012, we owned oil and natural gas leasehold interests in approximately 129,588 gross, 69,641 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 decreased $3.4 million to $7.2 million during the three months ended March 31, 2012.  This resulted from cash provided from operating activities of $12.9 million and cash provided by financing activities of $10.0 million offset by cash used in investing activities of $26.3 million.

 

Cash provided by operating activities was primarily generated by oil and gas operations.  Cash used in investing activities was primarily spent on oil and gas properties and equipment.  Cash provided by financing activities primarily represented an increase in net debt under the Credit Facility.

 

On December 15, 2011, the Company entered into a new, five-year $300 million Second Amended and Restated Credit Agreement with Bank of Montreal, as Administrative Agent (the “Agent”), and various other lenders named therein, and Warren Resources of California, Inc. and Warren E&P, Inc., as Guarantors (the “Credit Facility”). The Credit Facility provides for a revolving credit facility up to the lesser of: (i) $300 million, (ii) the Borrowing Base, or (iii) the Draw Limit requested by the Company. The Credit Facility matures on December 15, 2016, is secured by substantially all of Warren’s oil and gas assets, and is guaranteed by the Guarantors, which are two wholly-owned subsidiaries of the Company. The initial Borrowing Base was increased to $130 million at closing. The maximum amount available is subject to semi-annual redeterminations of the borrowing base in April and October of each year, based on the value of the Company’s proved oil and natural gas reserves in accordance with the lenders’ customary procedures and practices.  Both the Company and the lenders have the right to request one additional redetermination each year.

 

The Company is subject to various covenants required by the Credit Facility, including the maintenance of the following financial ratios: (1) a minimum current ratio of not less than 1.0 to 1.0 (including the unused borrowing base and excluding unrealized gains and losses on derivative financial instruments), and (2) a minimum annualized consolidated EBITDAX (as defined in the Credit Facility) to net interest expense of not less than 2.5 to 1.0.

 

Depending on the amount outstanding and the level of borrowing base usage, the annual interest rate on each base rate loan under the Credit Facility will be, at the Company’s option, either: (a) 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 1.75% to 2.75%, or (b) a “Base Rate Loan”, or any other obligation other than a LIBOR Loan, which has an interest rate equal to the sum of the

 

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“Base Rate”, 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 one-half percent, plus an applicable “Base Rate Margin” that ranges from 0.75% to 1.75%. As of March 31, 2012, the Company had borrowed $99.5 million under the Credit Facility and was in compliance with all covenants. If oil and gas commodity prices were to decline to lower levels, the Company may become in violation of Credit Facility covenants in the future. 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. During 2012, the Company incurred $0.7 million of interest expense under the Credit Facility of which approximately $0.1 million was accrued for as of March 31, 2012. The weighted average interest rate as of March 31, 2012 was 2.75%.

 

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, due in part to the financial stresses affecting the liquidity of the banking system, the real estate mortgage industry and global financial markets generally.

 

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 the next twelve months, including puts and differential swap agreements for a portion of its 2012 production to reduce price volatility and reductions in discretionary expenditures. As of March 31, 2012, approximately 96% of the Company’s estimated 2012 oil production is covered with puts and 22% of its natural gas production is covered with price differential swaps. If the liquidity of the Company should 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 the next twelve months.

 

During the first three months of 2012, the Company had net income of $3.8 million (which included $0.5 million of unrealized loss on derivative financial instruments). This compares to the three months of 2011 when the Company had a net loss of $0.6 million (which included a $3.9 million of unrealized loss on derivative financial instruments). At March 31, 2012, current assets were $10.7 million less than current liabilities. Currently, the Company has a borrowing base of $130 million and $99.5 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 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 commodity prices, compared to the cost of developing our undeveloped reserves and our estimated lease operating expenses, a portion of our future projects may become uneconomic.  The Company’s projects have material lease operating expenses.  Our oil operations include a secondary recovery waterflood with significant fixed costs.  During the first three months of 2012, our oil lease operating expenses were $20.85 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 three months of 2012, our natural gas lease operating expenses were $2.69 per net mcf of gas produced.

 

At March 31, 2012, we had approximately 2.3 million vested outstanding stock options issued under our stock based equity compensation plans. Of the total outstanding vested options, 0.5 million had exercise prices above the closing market price $3.26 of our common stock on March 31, 2012.

 

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

 

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maturing on or before the maturity of the bonds. Such U.S. treasury bonds had a fair market value of $1.3 million at March 31, 2012.  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, 2012

 

Total

 

Less Than
1 Year

 

1-3
Years

 

3-5
Years

 

More Than
5 Years

 

 

 

(in thousands)

 

Line of credit

 

$

99,500

 

$

 

$

 

$

99,500

 

$

 

Bonds

 

1,651

 

165

 

282

 

229

 

975

 

Drilling rigs

 

250

 

250

 

 

 

 

Other Accounts Payable

 

67

 

67

 

 

 

 

Leases

 

3,931

 

630

 

1,071

 

840

 

1,390

 

Total

 

$

105,399

 

$

1,112

 

$

1,353

 

$

100,569

 

$

2,365

 

 


*                                         Does not include estimated interest of $2.8 million less than one year, $5.7 million 1-3 years, $4.8 million 3-5 years and $1.1 million thereafter.

 

RESULTS OF OPERATIONS:

 

Three months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

 

Oil and gas sales. Revenue from oil and gas sales increased $5.2 million in the first quarter of 2012 to $28.4 million, a 22% increase compared to the same quarter in 2011.  This increase resulted from an increase in oil production and an increase in realized oil prices.  Net oil production for the three months ended March 31, 2012 and 2011 was 249 Mbbls and 210 Mbbls, respectively.  Net gas production for the three months ended March 31, 2012 and 2011 was 1.23 Bcf and 1.18 Bcf, respectively.  The average realized price per barrel of oil for the three months ended March 31, 2012 and 2011 was $100 and $87, respectively.  Additionally, the average realized price per Mcf of gas for the three months ended March 31, 2012 and 2011 was $2.85 and $4.15, respectively.

 

Lease operating expense. Lease operating expense increased 10% to $8.5 million ($18.72 per boe) for the first quarter of 2012 compared to $7.7 million ($19.07 per boe) in the comparable period of 2011. Primarily, this increase resulted from an increase in production.  Net production increased 12% to 454 thousand Boe during the first quarter of 2012 compared to 2011.

 

Depreciation, depletion and amortization. Depreciation, depletion and amortization expense increased $4.0 million for the first quarter of 2012 to $10.1 million, a 65% increase compared to the corresponding quarter last year.  The increase in depletion expense resulted from an increase in the 2012 depletion rate and an increase in production.  The 2012 depletion rate increased to $22.24 per boe compared to $15.11 per boe in 2011.  The increase in the 2012 depletion rate compared to the 2011 depletion rate on a boe basis reflects an increase in estimated future development costs.  Estimated future development costs were $171 million at March 31, 2012 compared to $84 million at March 31, 2011.  Additionally during the quarter, the Company recorded additional depreciation of $0.3 million compared to the corresponding quarter of last year related to its drilling rig.

 

General and administrative expenses. General and administrative expenses increased $0.7 million in the first quarter of 2012 to $4.3 million, a 20% increase compared to the corresponding quarter last year.  This increase resulted from an increase of $0.2 million related salaries, an increase of $0.2 related to the employer portion of taxes for stock option exercises and an increase of $0.1 for consulting expenses.

 

Interest expense. Interest expense increased 36% to $0.8 million in the first quarter of 2012 compared to the same quarter last year.  The increase results from an increase in borrowings under our Credit Facility from $69.5 million at March 31, 2011 to $99.5 million at March 31, 2012.

 

Interest and other income. Interest and other income increased $6 thousand in the first quarter of 2012 to $25 thousand, compared to the same quarter in 2011.

 

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Gain (loss) on derivative financial instruments.  Derivative losses of $0.9 million were recorded during the first quarter of 2012. This amount reflects $0.4 million of realized losses and $0.5 million of unrealized losses resulting from mark to market accounting of our oil and gas swaps, puts, futures contracts 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. Our 2011 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.

 

Commodity Risk

 

Our primary market risk exposure is in the price we receive for our oil and natural gas 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 oil and natural gas 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.

 

Derivative Instruments and Hedging Activity

 

We have entered into several financial derivative swap contracts, calls and costless collars to hedge our exposure to commodity price risk associated with anticipated future oil and gas production. We believe we will have more predictability of our crude oil and gas revenues as a result of these financial derivative contracts. The total volumes which we hedge through the use of our derivative instruments varies from period to period, however, generally our objective is to hedge up to at least 50% of our current and anticipated production for the next 12 to 24 months. Our hedge policies and objectives may change significantly as commodities prices or price futures change.

 

We are exposed to market risk on our open derivative contracts of non-performance by our counterparties. We do not expect such non-performance because our contracts are with major financial institutions with investment grade credit ratings. Each of the counterparties to our derivative contracts is a lender in our Senior Credit Agreement. We did not post collateral under any of these contracts as they are secured under the Senior Credit Agreement.

 

The following table summarizes our open financial derivative positions as of May 1, 2012 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

 

Oil

 

Brent Put

 

04/01/12 - 01/31/12

 

1,818 Bbl/d

 

$

90.00

 

Oil

 

NYMEX Put

 

01/01/12 - 12/31/12

 

1,000 Bbl/d

 

$

70.00

 

Natural Gas Differentials

 

Swap

 

01/01/12 - 12/31/12

 

3,000 Mcf/d

 

$

-0.51

*

 


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

 

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Interest Rate Risk

 

At March 31, 2012, we had debt outstanding under our Credit Facility of $99.5 million.  Depending on the amount outstanding and the level of borrowing base usage, the annual interest rate on each base rate loan under the Credit Facility will be, at the Company’s option, either: (a) 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 1.75% to 2.75%, or (b) 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”, 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 one-half percent, plus an applicable “Base Rate Margin” that ranges from 0.75% to 1.75%. We are exposed to interest rate risk on our variable interest rate debt. If interest rates increase, our interest expense would increase and our available cash flow would decrease.

 

Other Financial Instruments

 

Other 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 oil and natural gas, 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 2011 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

 

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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.

 

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, 2012, 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 G 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, 2011, 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. Removed and Reserved

 

Item 5. Other Information

 

Not applicable.

 

Item 6. Exhibits

 

a)

Exhibits

 

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

 

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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

101**

 

The following financial information from Warren Resources, Inc. Quarterly Report on Form 10-Q for the period ended March 31, 2012, filed with the SEC on May 1, 2012, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statement of Operations for the three month period ended March 31, 2012, (ii) the Consolidated Statement of Comprehensive Income for the three month period ended March 31, 2012, (iii) the Consolidated Balance Sheet at March 31, 2012 and December 31, 2011, (iv) the Consolidated Statement of Cash Flows for the three months ended March 31, 2012 and 2011, and (v) Notes to Consolidated Financial Statements

 


*

 

Filed herewith.

**

 

Pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for the purposes of section 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities and Exchanges Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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)

Date: May 1, 2012

 

 

 

/s/ Timothy A. Larkin

 

By:

Timothy A. Larkin

 

 

Executive Vice President, Chief Financial Officer and Principal Accounting Officer

 

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