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Warren Resources, Inc. (NASDAQ:WRES)

Q2 2012 Earnings Conference Call

August 7, 2012 10:00 AM ET

Executives

Espy P Price - Chairman & CEO

Steve Heiter - President of Principal Subsidiary

Ron Morin - Senior Vice President

Tim Larkin - Executive Vice President & CFO

Analysts

Jeffrey Connolly – Sidoti

Ray Deacon – Brean Murray

Leo Mariani – RBC

Jack Aydin – KeyBank Markets

Operator

Good day ladies and gentlemen and welcome to the Q2 2012 Warren Resources Earnings Conference Call. My name is Karen and I will be your operator for today. At this time all participants are in a listen-only mode. And then we will conduct a question-and-answer session towards the end of this conference. (Operator Instructions)

As a reminder this call is being recorded for replay purposes and I’d like to turn the call over to Espy Price, the Chairman and CEO of Warren Resources.

Espy Price

Good morning everyone. Thank you for joining us for Warren Resources second quarter 2012 financial and operating results conference call.

With me in Warrens’ Long Beach Office is Steve Heiter, the President of our Principal Subsidiary, Warren E&P in California and Ron Morin, our Senior Vice President responsible for development. Tim Larkin, our Executive Vice President and CFO, is joining us from our New York City headquarters.

This is my first earnings call as the new CEO of Warren and I’m very excited about the opportunities in front of us. Before I turn the microphone over to Tim to cover the financial results and Steve to discuss our oil and gas operations, I would like to briefly comment on our performance for the second quarter of 2012 and the future direction of the company.

First my primary is focus is to increase shareholder value. All of Warren’s operations are carried out and all plans are developed with the focus on enhancing shareholder value and increasing our stock price. Our company had a strong quarter as sales volumes, oil and gas revenues and operating cash flow each recorded significant gains compared to the second quarter of 2011. Warren had a record breaking quarter in terms of oil production. Our oil production for the quarter increased 31% to 293,000 barrels of oil compared to 224,000 barrels of oil produced in the second quarter of 2011. Along with double digit growth and average daily sales volumes, Warren delivered improved gross margins as [ph]release operating expenses continued to be carefully monitored and controlled.

Our cash flow from operating activates increased 61% to $32.2 million in the first six months of 2012 compared to $20 million in the first six months of 2011. Although, the operating environment has significantly improved during 2012 and we have obtained several key water injection permits during the year, we continue to face California regulatory challenges in obtaining water injection well permits.

As we work through the regulatory process needed to install our WTU natural gas sales line connection to the Southern California gas pipeline. We are also working to increase our WTU flare limitations. We will continue to diligently pursue these permits and work with governmental authorities. Regardless, we are forecasting that we will meet our targets of increasing our oil production by 20% over 2011 and maintaining a positive cash flow after capital expenditures.

Warrens’ management team has also [ph]expanded considerable time and effort in analyzing the current industry environment and Warrens’ position in that environment. The ongoing analysis is being conducted with the aim of developing and being responsive to options for the future. The analysis includes an understanding of our current challenges and opportunities.

We plan to be proactive in evaluating all alternatives to maximize shareholder value. With that overview, I will turn the call over to Tim Larken, our CFO.

Tim Larkin

Thanks Espy. Before I discuss the company’s financial results released earlier today, I would like to remind everyone that all statements made during our conference call that are not statements of historical fact constitute forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results could vary materially from those contained in the forward-looking statements. Factors that cause actual results to differ materially from those in the forward-looking statements are described in our Forms 10-K and 10-Q, other periodic filings with the SEC and our press releases.

As Espy mentioned, we are excited about the balance of 2012 and beyond. Our cash flow from operations continues to be solid and we are in a strong liquidity position with cash flow from operations of $19.3 million for the quarter and as of June 30, 2012 we had $30.5 million available under our senior credit facility.

Today, we reported net income of $5.3 million for the quarter or $0.07 per diluted share and adjusted net income of $4.8 million excluding gains from hedging activities of $500,000. Also, we achieved record oil and gas production of 499,000 barrels of oil equivalent for the quarter or approximately 5,500 barrels of oil equivalent per day.

Additionally, natural gas production primarily from our Atlantic Rim Project in Wyoming was strong and overall natural gas production was flat at 1.24 billion cubic feet during the second quarter compared to the second quarter of 2011.

The average realized oil price for the second quarter of 2012 was $95 per barrel, compared to $97 per barrel during the second quarter of 2011, a decrease of 2%. Our average realized gas price for the second quarter was $1.84 per Mcf, compared to $4.13 per Mcf in the second quarter of 2011, a decrease of 55%.

Effective August 1, 2012 we entered into a new oil purchase contract with Phillips 66 company, whereby the company sells its oil at Midway Sunset price less $4.20 per barrel plus a premium for gravity adjustment which should approximate $0.20 per barrel. Midway Sunset is currently selling at $10 premium to WTI. As a result, since August 1, Warren is currently receiving a $6 premium to WTI compared to the weighted average premium price of 102% received in the second quarter of 2012.

Also during the second quarter, we recorded a net gain from derivatives of $500,000 which included a realized loss from derivatives of $500,000 and an unrealized gain from future derivatives of $1 million. In order to protect the company against the decline in oil prices but allowing for unlimited upside to oil prices, the company currently owns approximately $333,000 rent puts with the strike price of $90 for calendar year 2012 or approximately 1,800 barrels per day for the balance of 2012.

The company also currently owns approximately an 184,000 WTI puts with a strike price of $70 per barrel for calendar year 2012 or approximately 1,000 barrels of oil per day for the remainder of 2012. As a result of increased oil production, oil and gas revenues for the second quarter increased 12% to $30.2 million compared to 2011.

Total operating expenses increased 29% to $24.6 million during the second quarter of 2012 compared to 2011. We expect oil LOEs to average approximately $20 per net barrel for the balance of 2012.

Depletion, depreciation and amortization expense for the second quarter increased 64% to $11.2 million compared to the second quarter of 2011. DD&A was $22.50 per BOE during the second quarter of 2012 compared to $15.92 per BOE during the second quarter of 2011.

This increase in DD&A on a per barrel basis resulted from higher estimated future development costs associated with our increase in proved undeveloped oil reserves as of December 31, 2011 compared to 2010, and a reduction in our proved gas reserves.

General and administrative expense increased 73% to $6.2 million during the second quarter of 2012. This increase primarily resulted from a $2 million severance package to our former Chief Executive Officer who departed from the company effective June 1, 2012. Interest expense increased 7% to $800,000 during the current quarter, due to an increase in the borrowings under our credit facility.

As mentioned previously net cash provided by operating activities was $19.3 million during the second quarter of 2012 compared to $12.3 million during the second quarter of 2011. Cash flows for the six months ended June 30, 2012 were $32.2 million compared to $20 million in 2011.

As Steve Heiter will discuss in more detail and assuming a minimal level of activity in Wyoming, our revised 2012 capital budget is $62 million, $57 million relating to our California oil fields and $5 million related to our Wyoming natural gas fields. It includes expenditures of approximately $44 million for drilling up to 17 producing wells and one injector well in our WTU and NWU oil fields in California. Additionally, this includes approximately $12 million for facilities and $1 million for a 3-D seismic shoot of our California properties which will be completed in 2013.

During December of 2011, Warren entered into a 5-year $30 million senior credit facility with the Bank of Montreal as the administrative agent and five other participating banks. Our borrowing base was increased to $130 million. Our next borrowing base re-determination is scheduled for October 2012. As the operator of the WTU and NWU oil assets in California and co-joint venture of the Atlantic Rim Project with Anadarko, the company has the ability to modify its capital expenditure budget as commodity and financial markets change. We reported third quarter and full-year 2012 production capital expenditure guidance in our press release disseminated this morning.

Now, let me turn the call over to Steve, who will provide a brief operational update. Steve.

Stephen Heiter

Thank you Tim. Now, I would like to update Warren’s operational details in the second quarter of 2012. Warren produced 293,000 net barrels of oil an increase of about 18% over the first quarter of 2012 and 1.24 Bcf of natural gas, a nominal increase over the first quarter. In the second quarter, Warren drilled and completed 6 new producing wells at WTU consisting of one Ranger well, 4 Tar wells and one Upper Terminal well. One additional Upper Terminal well was drilled to casing point and the productive interval will be completed later this month. Thirty-day initial production rate for the new Tar well has averaged 141 BOPD resulting in greater than 100% rate of return for these wells at $85 realized oil pricing.

The first Upper Terminal well in the second quarter averaged about 114 BOPD resulting in an 80% rate of return, at $85 realized oil pricing. The new Ranger well averaged about 60 BOPD resulting in a 25% rate of return. Considering oil wells, overall project economics for the new wells drilled in the second quarter resulted in a rate of return of about 80%. The DOGGR recently approved our Ranger injection water injection application and we’re planning to convert an existing oil well to injection which will provide pressure support for the new well and for other Ranger wells in the southwest area of the unit.

Warren’s new drilling rig continued to perform relatively trouble free during the second quarter. Significant performance improvements have been implemented throughout 2012, resulting in an average drilling and completion time per well this year of 11 days compared to 17 days in 2011 or 35% reduction.

Our 3-D seismic shoot has been delayed from August 2012 to January 2013 due to the addition of another local company as a partner in an expanded shoot. The addition of the second part and we will improve the resolution and overall quality of our data, and as well work the way. Upgrades to the production and water handling facilities in the company’s North Wilmington Unit will be completed this month. This work will accommodate anticipated increased oil production from NWU, when drilling activity is resumed.

The drilling schedule is contingent upon timely approval by the DOGGR of our proposed water injection wells. In addition, we are making significant progress in acquiring the necessary townlots around or NWU central facility for a second drill site for the nearly 50 wells in our development plan.

Lease operating expenses at the field level for our California operations for the first half of the year were $13 per barrel of oil net compared to $16.25 for the first half of last year or a 25% decrease. The field level expenses exclude taxes and plugging in abandonment expenses. We expect fairly flat field expenses throughout 2012, depending primarily on the number of down hole pump failures experienced at both units, and the level of expenditures required to conduct DOGGR mandated casing integrity testing.

In Wyoming, Anadarko has received bids for their precision in the Atlantic Rim, including all of their operated Coalbed Methane assets, the 50% interest in the mid-stream assets, and mineral rights in the deeper formations. Once notified by Anadarko of the results of the bids, we will make a decision regarding exercising our preferential rights to purchase an interest in Anadarko's Coalbed Methane assets, and also their share of the midstream assets.

Thank you for participating today, and operator, we will now take any questions.

Question-And-Answer Session

Operator

(Operator Instructions) First question comes from the line of Jeffrey Connolly of Sidoti. Your line is open. Please go ahead.

Jeffrey Connolly – Sidoti

Good morning guys and thanks for taking the questions. I was just going to ask, in the press release, you note that WTU Ranger and Ford reservoirs have unique challenges in securing the DOGGR permits I believe. Can you provide a little more detail on that?

Ron Morin

Yes, this is Ron. On the Ranger, we are drilling some of the first horizontal wells that the DOGGR has seen, and we have some bad areas adjacent to that AUR. So, that’s taking a little longer. We did get through that. It took about nine months instead of three months. So, that was a big challenge there.

In the Ford, the issue there is also bad wells in the Haywire [ph] area. We are working with DOGGR, and also trying to decide just exactly what kind of flood we are going to install there. If we do, what’s called the peripheral flood, we will have less exposure to that, going five spots, have a little more exposure to some of the bad wells, but currently – we have got some construction going on here. Probably some additional noise there, but – so, we are currently working with them, and we think we have some solutions, much like we have accomplished in the upper terminals. We are making progress and inspect on some resolution on Ford here in the next few months.

Jeffrey Connolly – Sidoti

All right. And then, can you comment a little bit on the Rangers 20-day production rate versus your expectations?

Ron Morin

Yes, our expectation was about 70. I think Steve said, we had 60 days, yes. That area, the southwest area of the Ranger is a little tight. So, you could experience some lower IPs and expect – and we also don’t have pressure export. We just receive that permits, so we will, as Steve mentioned earlier, we will convert an existing well out there to injection and increase the pressure. Some of the wells have seen some significant reduction in their gross because of larger pressure support out in that area.

Jeffrey Connolly – Sidoti

All right. Thanks a lot, guys. Nice quarter again.

Ron Morin

Sure, Jeff.

Operator

Thank you. Next question comes from the line of Ray Deacon of Brean Murray. Your line is open. Please go ahead. Ray, is your line muted?

Ray Deacon – Brean Murray

Yes. Good morning. I was wondering if you could talk about the CapEx on NWU and whether that would – if you do decide to exercise your perforates on Atlantic Rim, you still move forward?

Tim Larkin

Hi Ray, this is Tim. Yes, definitely, we don’t have – we don’t know what the bids are. Anadarko hasn’t sent us notice they would be even accepted bid, and so, it’s hard to answer the question without knowing the numbers, but certainly our plan would be proceed with the NWU regardless of exercising perforates in the Atlantic Rim.

Ray Deacon – Brean Murray

Okay. Got it. And just maybe a little bit more color, I remember, I think it was two quarters ago, David said that we was hoping that at some point this year, you know, you would kind of get to a normal course process for approval of the water injection permits. How is that working at the moment?

Ron Morin

Ray, this is Ron. Yes, it’s been slow, we are making progress on multiple fronts. Every reservoir is a little bit different, been pretty good shape on the tar and general when you want additional injector there, which they are currently working on. They have hired some new folks and there is some training and timing issues associated with that. So, it’s been a little bit steady progress.

So, we are currently moving ahead on all five of our reservoirs, the Tar and Ranger, Upper Terminal, NWU and the Ford, and we continue to find solutions with the DOGGR that in our opinion, for the past part, will allow us to mostly keep up with our development plans.

Ray Deacon – Brean Murray

Got it, okay. And any other thoughts on the Niobrara and the Green River, and you know, any plans to spend any money drilling a well there in the near term?

Espy P Price

This is Espy. We are looking at that as part of this Anadarko sale. We certainly don’t have any plans to do anything. As far as the deep potential at this point, we are curious as to see what Anadarko does and the other operators in the area. We feel like we are in a good position with our laces there and we are just trying to get additional data all of the time, but we certainly don’t have plans to do any deep testing.

Ray Deacon – Brean Murray

Got it, thank you.

Operator

Thank you for your question. Next question comes from the line of Leo Mariani of RBC. Please go ahead.

Leo Mariani – RBC

Hi guys. With respect to the Atlantic Rim properties, is the prep right arrangement here, just to match any potential offer that Anadarko would receive? Would that be your option?

Tim Larkin

That is correct, Leo.

Leo Mariani – RBC

Okay. I guess in terms of WTU, you guys talked about trying to basically lobby the dagger to increase flair limitations out there. I guess just curious as to why are you doing that at this point? Do you anticipate starting to produce more gas later this year that might start to hurt your oil production? Can you just give us some color on that?

Steve Heiter

Yes, this is Steve. We have submitted an application. It’s the (inaudible), not the DOGGR, and we have submitted an application to them in June to remove the limit on the floor, even at full firing rate, we are well within the regulatory threshold for emission. So, that’s not the problem. But as we drill more wells, naturally the gas production goes up a few MCF per well, and we don’t want to get too close to our limit on the burning gas. And so, we thought it was prudent at this time to try to remove that limitation, and we are also going to need those burners when we go to gas sales to – as a backup and to burn the tail gas. And so, it’s part of the whole package for increasing our production from our development plan and also as we proceed over the next 12 months to gas sales.

Leo Mariani – RBC

Okay. Makes sense. Another comment, as you all made, was that, you might have to do some casing integrity tests in the field as well. Have you guys seen some stricter regulatory action on that front, or is that just normal course of business?

Steve Heiter

No, that’s normal course of business, as a well is idle for a certain number of years. You have to do certain types of testing. So, this is routine. We have a program every year to do this. If we have wells that meet those criteria from a dealer G [ph], and so, we had plans to do all this in the second half of the year, and we started last month. And until you get into a well and find out the condition, you don’t really know what’s it’s going to cost, but it just involves going in and testing the casing to make sure there are no leads. And it’s certainly routine. If you find an old well that’s been idle for years and years, it may be full of sand yet to clean it out, but generally we have been successful at this testing. And if we do find some promise, we will go ahead and abandon the well. So, that’s been our plan. We have been doing it three years.

Leo Mariani – RBC

Okay. And I guess as well, (inaudible) at NWU, I guess at this point, you guys are still planning to get drilling there in the fourth quarter, so the extent that you do not receive all of necessary injection permits. That’s going to slide a little bit. Just wanted to make sure I am thinking about that correctly.

Ron Morin

Yes, that’s correct. Our facilities will be completed, like I mentioned, this month. All we have left to do is grade and pay the site of the sellers we are in, everything is ready to go. We are –

with our electoral work. And so, it’s a matter of timing with respect to the water injection permits. We want to drill with producers until we get the injection wells approved as well. And so, the plan now is to be able to start up sometime in the fourth quarter, but like you mentioned, it may slip a little bit depending on our injection permits.

Leo Mariani – RBC

Okay, thanks guys.

Ron Morin

Thanks Leo.

Operator

Thank you for your question. The next question comes from Jack Aydin of KeyBank Markets. Please go ahead.

Jack Aydin – KeyBank Markets

Hi guys.

Ron Morin

Hi Jack.

Jack Aydin – KeyBank Markets

What is the book value of the North Atlantic and the Mid-Stream operation? What are you carrying them at book?

Ron Morin

It’s $75 million, Jack, approximately.

Jack Aydin – KeyBank Markets

Could you let us assume Anadarko gets an offer like that of something? Could you afford to do a yield, (inaudible) especially with natural gas prices at where they are there regarding the Atlantic Rim?

Ron Morin

We have no idea what the winning bid is tracked, and so, we are not going to apply, and obviously if the winning bid is well, we will seriously consider exercising our preps right. But I don’t want to speculate not knowing what the bid price is.

Jack Aydin – KeyBank Markets

Okay. The second question I have I think, Mr. Espy mentioned about options, future alternative, anything, could you elaborate? Is those option include potential resell of the company also? I mean, you threw that comment out there, so you open yourself for a lot of speculation.

Espy P Price

Jack, this is Espy. It’s in there because we think that’s the prudent thing to do by any company. When you have a business, you run the business as best you can, and you always consider other alternatives. We are not actively looking for those alternatives that we got to be responsive to anything that might come up. I think it’s just a prudent thing to do in any business is to look at alternatives and options, but we certainly not advertise in any specific plans.

Jack Aydin – KeyBank Markets

Thank you.

Operator

Thanks for your question. There is no further questions at this time. (Operator Instructions) There is no further questions coming through. So, I would like to now turn the call back over to Espy Price for closing remarks.

Espy P Price

Thank you everybody for participating.

Ron Morin

Thank you, appreciate your time.

Operator

Thank you very much for your participation in today’s conference call. This concludes the presentation. You may now disconnect. Have a good day.

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