United
States Securities and Exchange Commission
 Washington,
D.C. 20549
 
 Form
10-K
 
 (Mark
      One)þ
              Annual
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934For
      the fiscal year ended December 31, 2009Or ̈
              Transition
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934For
      the transition period from ___________to ________________________________________
                
                Commission
      file number 001-31657
                _____________________________Arena
      Resources, Inc.
                (Exact
      name of registrant as specified in its
charter)
 
 Nevada
              
              73-1596109(State
      or other jurisdiction of incorporation or organization)
              
              (I.R.S.
      Employer Identification Number)6555
      South Lewis Avenue
                Tulsa,
      Oklahoma
              
              74136(Address
      of principal executive offices)
              
              (Zip
      Code)
 
 (918)
      747-6060(Registrant’s
      telephone number, including area code)____________________________
 
 Securities
registered under Section 12(b) of the Exchange Act:
 
 Title of Each Class
              
              Name of Each Exchange On Which
      RegisteredCommon
      - $0.001 Par Value
              
              New
      York Stock Exchange
 
   Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
 Yes þNo  ̈
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.  Yes  ̈No þ
  Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.  Yes þNo  ̈
  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             ̈  No           þ  Not
Applicable
  
  1
 
 Indicate
by check mark if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained herein, and will not  be contained, to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer.
  Large
accelerated filer þAccelerated
filer  ̈Non-accelerated filer  ̈
  Indicate
by check mark whether the registrant is shell company (as defined in Rule 12b-2
of the Act). Yes  ̈No þ
  As of
June 30, 2009, the aggregate market value of the common voting stock held by
non-affiliates of the issuer, based upon the closing stock price of $31.85 per
share, was approximately $1,195,116,500.
  As of
March 1, 2010, the issuer had outstanding 38,793,963 shares of common stock
($0.001 par value).
         2
 TABLE
OF CONTENTS
 PART
      IPageItem
      1
              
              Business
              4Item
      1A
              
              Risk
      Factors
              8Item
      1B
              
              Unresolved
      Staff Comments
              14Item
      2
              
              Properties
              14Item
      3
              
              Legal
      Proceedings
              25Item
      4
              
              Submission
      of Matters to a Vote of Security Holders
              25PART
      IIItem
      5
              
              Market
      for Registrant's Common Equity, Related Stockholder
Matters
              27and
      Issuer Purchases of Equity SecuritiesItem
      6
              
              Selected
      Financial Data
              28Item
      7
              
              Management's
      Discussion and Analysis of Financial Condition
              28and
      Results of OperationsItem
      7A
              
              Quantitative
      and Qualitative Disclosures About Market Risk
              36Item
      8
              
              Financial
      Statements and Supplementary Data
              36Item
      9
              
              Changes
      in and Disagreement's With Accountants on Accounting
              36and
      Financial DisclosureItem
      9A
              
              Controls
      and Procedures
              37Item
      9B
              
              Other
      Information
              39PART
      IIIItem
      10
              
              Directors,
      Executive Officers and Corporate Governance
              40Item
      11
              
              Executive
      Compensation
              43Item
      12
              
              Security
      Ownership of Certain Beneficial Owners and Management
              49and
      Related Stockholder MattersItem
      13
              
              Certain
      Relationships and Related Transactions, and Director
      Independence
              51Item
      14
              
              Principal
      Accounting Fees and Services
              51PART
      IVItem
      15
              
              Exhibits
              52
  3
  Forward
Looking Statements
 
 All
statements, other than statements of historical fact included in this Annual
Report on Form 10-K (herein, “Annual Report”) regarding our strategy, future
operations, financial position, estimated revenues and losses, projected costs,
prospects, plans and objectives of management are forward-looking statements.
When used in this Annual Report, the words “could,” “believe,” “anticipate,”
“intend,” “estimate,” “expect,” “project” and similar expressions are intended
to identify forward-looking statements, although not all forward-looking
statements contain such identifying words. All forward-looking statements speak
only as of the date of this Annual Report. You should not place undue reliance
on these forward-looking statements. Although we believe that our plans,
intentions and expectations reflected in or suggested by the forward-looking
statements we make in this Annual Report are reasonable, we can give no
assurance that these plans, intentions or expectations will be achieved. We
disclose important factors that could cause our actual results to differ
materially from our expectations under “Risk Factors,” “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” and elsewhere in
this Annual Report. These cautionary statements qualify all forward-looking
statements attributable to us or persons acting on our behalf.
 
 Unless
the context otherwise requires, references in this Annual Report to “Arena,”
“we,” “us,” “our” or “ours” refer to Arena Resources, Inc.
 
 PART
I
 Item
1:Business
 
 General
 
 Arena Resources, Inc. was incorporated
in Nevada on August 31, 2000. Our principal executive offices are located at
6555 South Lewis Avenue, Tulsa, Oklahoma 74136, and our telephone number is
(918) 747-6060.  Our Internet website can be found at
www.arenaresourcesinc.com.  Our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act of 1934 will be available through our Internet website as soon as reasonably
practical after we electronically file such material with, or furnish it to, the
Securities and Exchange Commission.
 
 We are
engaged in oil and natural gas acquisition, exploration, development and
production, with activities currently in Oklahoma, Texas, New Mexico and
Kansas.  Our focus will be on developing our existing properties,
while continuing to pursue acquisitions of oil and gas properties with upside
potential.
 
 Business
Development
 
 Between
our inception in August 2000 through 2004, we built our asset base and achieved
growth primarily through property acquisitions.  Beginning in 2005,
while we continued to grow through acquisition, we shifted our focus to growth
through development of our existing properties.  From our inception
through December 31, 2009, we have increased our proved reserves to
approximately 69.5 million Boe (barrel of oil equivalent).  As of
December 31, 2009, our estimated proved reserves had a pre-tax PV10 (present
value of future net revenues before income taxes discounted at 10%) of
approximately $1.12 billion and a Standardized Measure of Discounted Future Net
Cash Flows of approximately $754.2 million.  The difference between
these two amounts is the effect of income taxes.  The Company presents
the pre-tax PV-10 value, which is a non-GAAP financial measure, because it is a
widely used industry standard which we believe is useful to those who may review
this Annual Report when comparing our asset base and performance to other
comparable oil and gas exploration and production companies.  We spent
approximately $485.6 million on acquisitions and capital projects during 2007,
2008 and 2009.
  4
 
 We have a
portfolio of oil and natural gas reserves, with approximately 86% of our proved
reserves consisting of oil and approximately 14% consisting of natural gas. Of
those reserves approximately 33% of our proved reserves are classified as proved
developed producing, or “PDP,” approximately 5% of our proved reserves are
classified as proved developed behind pipe, or “PDBP,” and approximately 62% are
classified as proved undeveloped, or “PUD.”
 
 Competitive
Business Conditions
 
 We
operate in a highly competitive environment for acquiring properties, marketing
oil and natural gas and securing trained personnel. Some of our competitors
possess and employ financial resources substantially greater than ours and some
of our competitors employ more technical personnel.  These factors can
be particularly important in the areas in which we operate.  Those
companies may be able to pay more for productive oil and natural gas properties
and exploratory prospects and to evaluate, bid for and purchase a greater number
of properties and prospects than what our financial or technical resources
permit. Our ability to acquire additional properties and to find and develop
reserves in the future will depend on our ability to identify, evaluate and
select suitable properties and to consummate transactions in a highly
competitive environment. Also, there is substantial competition for capital
available for investment in the oil and natural gas industry.
 
 The
actual price range of crude oil is largely established by major crude oil
purchasers and commodities trading.  Pricing for natural gas is based
on regional supply and demand conditions.  To this extent we believe
we receive oil and gas prices comparable to other producers.  There is
little risk in our ability to sell all our current production at current prices
with a reasonable profit margin.  The risk of domestic overproduction
at current prices is not deemed significant.  We view our primary
pricing risk to be related to a potential decline in prices to a level which
could render our current production uneconomical.
 
 We are presently committed to use the
services of the existing gathering systems of the companies that purchase our
natural gas production.  This commitment is tied to existing natural
gas purchase contracts associated with our production  This commitment
potentially gives such gathering companies certain short-term relative
monopolistic powers to set gathering and transportation costs, because obtaining
the services of an alternative gathering company would require substantial
additional costs (since an alternative gathering company would be required to
lay new pipeline and/or obtain new rights of way to any lease from which we are
selling production).  We are not subject to third party gathering
systems for our oil production.  Some of our oil production is sold
through a third party pipeline which has no regional competition.  All
other oil production is transported by the oil purchaser by trucks with
competitive trucking costs in the area.
 
 Major
Customers
 
 We
principally sell our oil and natural gas production to end users, marketers and
other purchasers that have access to nearby pipeline facilities. In areas where
there is no practical access to pipelines, oil is trucked to storage facilities.
Our marketing of oil and natural gas can be affected by factors beyond our
control, the effects of which cannot be accurately predicted. For fiscal year
2009, sales to three customers, Navajo Refining Company, ConocoPhillips and DCP
Midstream, LP, represented 75%, 13% and 8% of oil and gas revenues,
respectively.  At December 31, 2009, these customers represented 74%,
14% and 7% of our accounts receivable.  However, we believe that the
loss of these customers would not materially impact our business, because we
could readily find other purchasers for our oil and gas as
produced.
 
 5
 
 Delivery
Commitments
 
 As of
December 31, 2009, we are not committed to providing a fixed quantity of oil or
gas under any existing contracts.
 
 Governmental
Regulations
 
 Regulation
of Transportation of Oil
 
 Sales of
crude oil, condensate and natural gas liquids are not currently regulated and
are made at negotiated prices. Nevertheless, Congress could reenact price
controls in the future.
 
 Our sales
of crude oil are affected by the availability, terms and cost of
transportation.  The transportation of oil in common carrier pipelines
is also subject to rate regulation.  The Federal Energy Regulatory
Commission, or the FERC, regulates interstate oil pipeline transportation rates
under the Interstate Commerce Act.  Intrastate oil pipeline
transportation rates are subject to regulation by state regulatory
commissions.  The basis for intrastate oil pipeline regulation, and
the degree of regulatory oversight and scrutiny given to intrastate oil pipeline
rates, varies from state to state.
 
 Insofar
as effective interstate and intrastate rates are equally applicable to all
comparable shippers, we believe that the regulation of oil transportation rates
will not affect our operations in any way that is of material difference from
those of our competitors.  Further, interstate and intrastate common
carrier oil pipelines must provide service on a non-discriminatory
basis.  Under this open access standard, common carriers must offer
service to all shippers requesting service on the same terms and under the same
rates.  When oil pipelines operate at full capacity, access is
governed by pro-rationing provisions set forth in the pipelines’ published
tariffs.  Accordingly, we believe that access to oil pipeline
transportation services generally will be available to us to the same extent as
to our competitors.
 
 Regulation
of Transportation and Sale of Natural Gas
 
 Historically,
the transportation and sale for resale of natural gas in interstate commerce
have been regulated pursuant to the Natural Gas Act of 1938, the Natural Gas
Policy Act of 1978 and regulations issued under those Acts by the FERC. In the
past, the federal government has regulated the prices at which natural gas could
be sold. While sales by producers of natural gas can currently be made at
uncontrolled market prices, Congress could reenact price controls in the
future.
 
 Since
1985, the FERC has endeavored to make natural gas transportation more accessible
to natural gas buyers and sellers on an open and non-discriminatory basis. The
FERC has stated that open access policies are necessary to improve the
competitive structure of the interstate natural gas pipeline industry and to
create a regulatory framework that will put natural gas sellers into more direct
contractual relations with natural gas buyers by, among other things, unbundling
the sale of natural gas from the sale of transportation and storage
services.  Although the FERC’s orders do not directly regulate natural
gas producers, they are intended to foster increased competition within all
phases of the natural gas industry.
 
 We cannot
accurately predict whether the FERC’s actions will achieve the goal of
increasing competition in markets in which our natural gas is
sold.  Therefore, we cannot provide any assurance that the less
stringent regulatory approach established by the FERC will continue. However, we
do not believe that any action taken will affect us in a way that materially
differs from the way it affects other natural gas producers.
 
 Intrastate
natural gas transportation is subject to regulation by state regulatory
agencies. The basis for intrastate regulation of natural gas transportation and
the degree of regulatory oversight and scrutiny given to intrastate natural gas
pipeline rates and services varies from state to state. Insofar as such
regulation within a particular state will generally affect all intrastate
natural gas shippers within the state on a comparable basis, we believe that the
regulation of similarly situated intrastate natural gas transportation in any
states in which we operate and ship natural gas on an intrastate basis will not
affect our operations in any way that is of material difference from those of
our competitors.
 
 6
 
 Regulation
of Production
 
 The
production of oil and natural gas is subject to regulation under a wide range of
local, state and federal statutes, rules, orders and regulations. Federal, state
and local statutes and regulations require permits for drilling operations,
drilling bonds and reports concerning operations. All of the states in which we
own and operate properties have regulations governing conservation matters,
including provisions for the unitization or pooling of oil and natural gas
properties, the establishment of maximum allowable rates of production from oil
and natural gas wells, the regulation of well spacing, and plugging and
abandonment of wells. The effect of these regulations is to limit the amount of
oil and natural gas that we can produce from our wells and to limit the number
of wells or the locations at which we can drill, although we can apply for
exceptions to such regulations or to have reductions in well spacing. Moreover,
each state generally imposes a production or severance tax with respect to the
production and sale of oil, natural gas and natural gas liquids within its
jurisdiction.
 
 The
failure to comply with these rules and regulations can result in substantial
penalties. Our competitors in the oil and natural gas industry are subject to
the same regulatory requirements and restrictions that affect our
operations.
 
 Environmental
Compliance and Risks
 
 Our oil and natural gas exploration,
development and production operations are subject to stringent federal, state
and local laws and regulations governing the discharge of materials into the
environment or otherwise relating to environmental protection. Historically,
most of the environmental regulation of oil and gas production has been left to
state regulatory boards or agencies in those jurisdictions where there is
significant gas and oil production, with limited direct regulation by such
federal agencies as the Environmental Protection Agency.  However,
while we believe this generally to be the case for our production activities in
Oklahoma, Texas, New Mexico and Kansas, there are various regulations issued by
the Environmental Protection Agency (“EPA”) and other governmental agencies that
would govern significant spills, blow-outs, or uncontrolled
emissions.
 
 In
Oklahoma, Texas, New Mexico and Kansas specific oil and gas regulations apply to
the drilling, completion and operations of wells, and the disposal of waste oil
and salt water.  There are also procedures incident to the plugging
and abandonment of dry holes or other non-operational wells, all as governed by
the applicable governing state agency.
 
 At the federal level, among the more
significant laws and regulations that may affect our business and the oil and
gas industry are:  The Comprehensive Environmental Response,
Compensation and Liability Act of 1980, also known as “CERCLA” or “Superfund;
the Oil Pollution Act of 1990; the Resource Conservation and Recovery Act, also
known as “RCRA,”; the Clean Air Act; Federal Water Pollution Control Act of
1972, or the Clean Water Act; and the Safe Drinking Water Act of
1974.
 
 Compliance with these regulations may
constitute a significant cost and effort for us.  No specific
accounting for environmental compliance has been maintained or projected by us
at this time.  We are not presently aware of any environmental
demands, claims, or adverse actions, litigation or administrative proceedings in
which either we or our acquired properties are involved in or subject to, or
arising out of any predecessor operations.
 
 In the
event of a breach of environmental regulations, these environmental regulatory
agencies have a broad range of alternative or cumulative remedies which
include:  ordering a clean-up of any spills or waste material and
restoration of the soil or water to conditions existing prior to the
environmental violation; fines; or enjoining further drilling, completion or
production activities.  In certain egregious situations the agencies
may also pursue criminal remedies against us or our principal
officers.
 
 7
 
 Current
Employees
 
 As of
December 31, 2009, we had 120 full-time employees, including 48 employed by
Arena Drilling Company, a wholly owned subsidiary. Our employees are not
represented by any labor union. We consider our relations with our employees to
be satisfactory and have never experienced a work stoppage or
strike.
 
 We retain
certain engineers, geologists, landmen, pumpers and other personnel on a
contract or fee basis as necessary for our operations.
 
 Item
1A.Risk
Factors
 
 The
following risks and uncertainties may affect our performance, results of
operations and the trading price of our common stock.
 
 Risks
Relating to the Oil and Natural Gas Industry and Our Business
 
 A
substantial or extended decline in oil and natural gas prices may adversely
affect our business, financial condition or results of operations and our
ability to meet our capital expenditure obligations and financial
commitments.
 
 The price
we receive for our oil and natural gas production heavily influences our
revenue, profitability, access to capital and future rate of growth. Oil and
natural gas are commodities and, therefore, their prices are subject to wide
fluctuations in response to relatively minor changes in supply and demand.
Historically, the markets for oil and natural gas have been volatile. These
markets will likely continue to be volatile in the future. The prices we receive
for our production, and the levels of our production, depend on numerous factors
beyond our control. These factors include, but are not limited to, the
following:
 
 •  changes in global supply
and demand for oil and natural gas;
 •  the actions of the
Organization of Petroleum Exporting Countries, or OPEC;
 •  the price and quantity of
imports of foreign oil and natural gas;
 •  political conditions,
including embargoes, in or affecting other oil-producing activity;
 •  the level of global oil
and natural gas exploration and production activity;
 •  the level of global oil
and natural gas inventories;
 •  weather
conditions;
 •  technological advances
affecting energy consumption; and
 •  the price and availability
of alternative fuels.
 
 Lower oil
and natural gas prices may not only decrease our revenues on a per unit basis
but also may reduce the amount of oil and natural gas that we can produce
economically. Lower prices will also negatively impact the value of our proved
reserves. A substantial or extended decline in oil or natural gas prices may
materially and adversely affect our future business, financial condition,
results of operations, liquidity or ability to finance planned capital
expenditures.
 
 8
 
 A
substantial percentage of our proven properties are undeveloped; therefore the
risk associated with our success is greater than would be the case if the
majority of our properties were categorized as proved developed
producing.
 
 Because a
substantial percentage of our proven properties are proved undeveloped
(approximately 62%) or proved developed behind pipe (approximately 5%), we will
require significant additional capital to develop such properties before they
may become productive. Further, because of the inherent uncertainties associated
with drilling for oil and gas, some of these properties may never be developed
to the extent that they result in positive cash flow. Even if we are successful
in our development efforts, it could take several years for a significant
portion of our undeveloped properties to be converted to positive cash
flow.
 
 While our
current business plan is to fund the development costs with cash flow from our
other producing properties, if such cash flow is not sufficient we may be forced
to seek alternative sources for cash, through the issuance of additional equity
or debt securities, increased borrowings or other means.
 
 Approximately
23% of our proven reserves depend upon secondary recovery techniques to
establish production.
 
 Approximately
twenty-three percent (23%) of our reserves for the year ended December 31, 2009
are associated with secondary recovery projects that are either in the initial
stage of implementation or are scheduled for implementation.  We
anticipate that secondary recovery will be attempted by the use of waterflood of
these reserves, and the exact project initiation dates and, by the very nature
of waterflood operations, the exact completion dates of such projects are
uncertain.  In addition, the reserves associated with these secondary
recovery projects, as with any reserves, are estimates only, as the success of
any development project, including these waterflood projects, cannot be
ascertained in advance.  If we are not successful in developing a
significant portion of our reserves associated with secondary recovery methods,
it could have a negative impact on our earnings and our stock
price.
 
 Drilling
for and producing oil and natural gas are high risk activities with many
uncertainties that could adversely affect our business, financial condition or
results of operations.
 
 Our
future success will depend on the success of our exploitation, exploration,
development and production activities. Our oil and natural gas exploration and
production activities are subject to numerous risks beyond our control;
including the risk that drilling will not result in commercially viable oil or
natural gas production. Our decisions to purchase, explore, develop or otherwise
exploit prospects or properties will depend in part on the evaluation of data
obtained through geophysical and geological analyses, production data and
engineering studies, the results of which are often inconclusive or subject to
varying interpretations. Please read “—Reserve estimates depend on many
assumptions that may turn out to be inaccurate” (below) for a discussion of the
uncertainty involved in these processes. Our cost of drilling, completing and
operating wells is often uncertain before drilling commences. Overruns in
budgeted expenditures are common risks that can make a particular project
uneconomical. Further, many factors may curtail, delay or cancel drilling,
including the following:
 
 •  delays imposed by or
resulting from compliance with regulatory requirements;
 •  pressure or irregularities
in geological formations;
 •  shortages of or delays in
obtaining equipment and qualified personnel;
 •  equipment failures or
accidents;
 •  adverse weather
conditions;
 •  reductions in oil and
natural gas prices;
 •  title problems;
and
 •  limitations in the market
for oil and natural gas.
  9
 
 If
our assessments of recently purchased properties are materially inaccurate, it
could have significant impact on future operations and earnings.
   
 •  the amount of recoverable
reserves;
 •  future oil and natural gas
prices;
 •  estimates of operating
costs;
 •  estimates of future
development costs;
 •  estimates of the costs and
timing of plugging and abandonment; and
 •  potential environmental
and other liabilities.
 
 Our
assessment will not reveal all existing or potential problems, nor will it
permit us to become familiar enough with the properties to assess fully their
capabilities and deficiencies. As noted previously, we plan to undertake further
development of our properties through the use of cash flow from existing
production. Therefore, a material deviation in our assessments of these factors
could result in less cash flow being available for such purposes than we
presently anticipate, which could either delay future development operations
(and delay the anticipated conversion of reserves into cash), or cause us to
seek alternative sources to finance development activities.
 
 Decreases
in oil and natural gas prices may require us to take write-downs of the carrying
values of our oil and natural gas properties, potentially requiring earlier than
anticipated debt repayment and negatively impacting the trading value of our
securities.
 
 Accounting
rules require that we review periodically the carrying value of our oil and
natural gas properties for possible impairment. Based on specific market factors
and circumstances at the time of prospective impairment reviews, and the
continuing evaluation of development plans, production data, economics and other
factors, we may be required to write down the carrying value of our oil and
natural gas properties. Because our properties serve as collateral for advances
under our existing credit facilities, a write-down in the carrying values of our
properties could require us to repay debt earlier than we would otherwise be
required. A write-down could also constitute a non-cash charge to earnings. It
is likely the cumulative effect of a write-down could also negatively impact the
trading price of our securities.
 
 Reserve
estimates depend on many assumptions that may turn out to be inaccurate. Any
material inaccuracies in these reserve estimates or underlying assumptions will
materially affect the quantities and present value of our reserves.
 
 The
process of estimating oil and natural gas reserves is complex. It requires
interpretations of available technical data and many assumptions, including
assumptions relating to economic factors. Any significant inaccuracies in these
interpretations or assumptions could materially affect the estimated quantities
and present value of our reported reserves.
 
 In order
to prepare our estimates, we must project production rates and timing of
development expenditures. We must also analyze available geological,
geophysical, production and engineering data. The extent, quality and
reliability of this data can vary. The process also requires economic
assumptions about matters such as oil and natural gas prices, drilling and
operating expenses, capital expenditures, taxes and availability of funds.
Therefore, estimates of oil and natural gas reserves are inherently
imprecise.
 
 Actual
future production, oil and natural gas prices, revenues, taxes, development
expenditures, operating expenses and quantities of recoverable oil and natural
gas reserves most likely will vary from our estimates. Any significant variance
could materially affect the estimated quantities and present value of our
reported reserves. In addition, we may adjust estimates of proved reserves to
reflect production history, results of exploration and development, prevailing
oil and natural gas prices and other factors, many of which are beyond our
control.
 
 10
 
 You
should not assume that the present value of future net revenues from our
reported proved reserves is the current market value of our estimated oil and
natural gas reserves. In accordance with SEC requirements, we generally base the
estimated discounted future net cash flows from our proved reserves on prices
and costs on the date of the estimate. Actual future prices and costs may differ
materially from those used in the present value estimate. If future values
decline or costs increase it could negatively impact our ability to finance
operations, and individual properties could cease being commercially viable,
affecting our decision to continue operations on producing properties or to
attempt to develop properties. All of these factors would have a negative impact
on earnings and net income, and most likely the trading price of our securities.
These factors could also result in the acceleration of debt repayment and a
reduction in our borrowing base under our credit facilities.
 
 Prospects
that we decide to drill may not yield oil or natural gas in commercially viable
quantities.
 
 Our
prospects are in various stages of evaluation, ranging from prospects that are
currently being drilled, to prospects that will require substantial additional
seismic data processing and interpretation. There is no way to predict in
advance of drilling and testing whether any particular prospect will yield oil
or natural gas in sufficient quantities to recover drilling or completion costs
or to be economically viable. This risk may be enhanced in our situation, due to
the fact that a significant percentage (62%) of our proved reserves is currently
proved undeveloped reserves. The use of seismic data and other technologies and
the study of producing fields in the same area will not enable us to know
conclusively prior to drilling whether oil or natural gas will be present or, if
present, whether oil or natural gas will be present in commercial quantities. We
cannot assure you that the analogies we draw from available data from other
wells, more fully explored prospects or producing fields will be applicable to
our drilling prospects.
 
 We
may incur substantial losses and be subject to substantial liability claims as a
result of our oil and natural gas operations.
 
 We are
not insured against all risks. Losses and liabilities arising from uninsured and
underinsured events could materially and adversely affect our business,
financial condition or results of operations. Our oil and natural gas
exploration and production activities are subject to all of the operating risks
associated with drilling for and producing oil and natural gas, including the
possibility of:
 
  • 
environmental hazards, such as uncontrollable flows of oil, natural gas, brine,
well fluids, toxic gas or other pollution into the environment, including
groundwater and shoreline contamination;
 •  abnormally
pressured formations;
 •  mechanical
difficulties, such as stuck oil field drilling and service tools and casing
collapse;
 •  fires
and explosions;
 •  personal
injuries and death; and
 •  natural
disasters.
 
 Any of
these risks could adversely affect our ability to conduct operations or result
in substantial losses to our company. We may elect not to obtain insurance if we
believe that the cost of available insurance is excessive relative to the risks
presented. In addition, pollution and environmental risks generally are not
fully insurable. If a significant accident or other event occurs and is not
fully covered by insurance, then it could adversely affect us.
  11
 
 We
are subject to complex laws that can affect the cost, manner or feasibility of
doing business.
   
 •  discharge permits for
drilling operations;
 •  drilling
bonds;
 •  reports concerning
operations;
 •  the spacing of
wells;
 •  unitization and pooling of
properties; and
 •  taxation.
 
 Under
these laws, we could be liable for personal injuries, property damage and other
damages. Failure to comply with these laws also may result in the suspension or
termination of our operations and subject us to administrative, civil and
criminal penalties. Moreover, these laws could change in ways that substantially
increase our costs. Any such liabilities, penalties, suspensions, terminations
or regulatory changes could materially adversely affect our financial condition
and results of operations.
 
 Our
operations may incur substantial liabilities to comply with the environmental
laws and regulations.
 
 Our oil
and natural gas operations are subject to stringent federal, state and local
laws and regulations relating to the release or disposal of materials into the
environment or otherwise relating to environmental protection. These laws and
regulations may require the acquisition of a permit before drilling commences,
restrict the types, quantities and concentration of substances that can be
released into the environment in connection with drilling and production
activities, limit or prohibit drilling activities on certain lands lying within
wilderness, wetlands and other protected areas, and impose substantial
liabilities for pollution resulting from our operations. Failure to comply with
these laws and regulations may result in the assessment of administrative, civil
and criminal penalties, incurrence of investigatory or remedial obligations or
the imposition of injunctive relief. Changes in environmental laws and
regulations occur frequently, and any changes that result in more stringent or
costly waste handling, storage, transport, disposal or cleanup requirements
could require us to make significant expenditures to maintain compliance, and
may otherwise have a material adverse effect on our results of operations,
competitive position or financial condition as well as the industry in general.
Under these environmental laws and regulations, we could be held strictly liable
for the removal or remediation of previously released materials or property
contamination regardless of whether we were responsible for the release or if
our operations were standard in the industry at the time they were
performed.
 
 If
our indebtedness increases, it could reduce our financial
flexibility.
 
 We have a
$150 million credit facility in place with a current borrowing base of $75
million and the structure in place to increase that borrowing base an additional
$75 million.  As of December 31, 2009, no amount was outstanding on
our credit facility.  If in the future we utilize this facility, the
level of our indebtedness could affect our operations in several ways, including
the following:
 
 •a
      significant portion of our cash flow could be used to service the
      indebtedness,
 •a
      high level of debt would increase our vulnerability to general adverse
      economic and industry
conditions,
 •the
      covenants contained in our credit facility limit our ability to borrow
      additional funds, dispose of assets, pay dividends and make certain
      investments,
 •a
      high level of debt could impair our ability to obtain additional financing
      in the future for working capital, capital expenditures, acquisitions,
      general corporate or other
purposes.
 
 12
 
 In
addition, our bank borrowing base is subject to semi-annual redeterminations. We
could be forced to repay a portion of our bank borrowings due to
redeterminations of our borrowing base. If we are forced to do so, we may not
have sufficient funds to make such repayments. If we do not have sufficient
funds and are otherwise unable to negotiate renewals of our borrowings or
arrange new financing, we may have to sell significant assets. Any such sale
could have a material adverse effect on our business and financial
results.
 
 Unless
we replace our oil and natural gas reserves, our reserves and production will
decline, which would adversely affect our cash flows and income.
 
 Unless we
conduct successful development, exploitation and exploration activities or
acquire properties containing proved reserves, our proved reserves will decline
as those reserves are produced. Producing oil and natural gas reservoirs
generally are characterized by declining production rates that vary depending
upon reservoir characteristics and other factors. Our future oil and natural gas
reserves and production, and, therefore our cash flow and income, are highly
dependent on our success in efficiently developing and exploiting our current
reserves and economically finding or acquiring additional recoverable reserves.
If we are unable to develop, exploit, find or acquire additional reserves to
replace our current and future production, our cash flow and income will decline
as production declines, until our existing properties would be incapable of
sustaining commercial production.
 
 If
our access to markets is restricted, it could negatively impact our production,
our income and ultimately our ability to retain our leases.
 
 Market
conditions or the unavailability of satisfactory oil and natural gas
transportation arrangements may hinder our access to oil and natural gas markets
or delay our production. The availability of a ready market for our oil and
natural gas production depends on a number of factors, including the demand for
and supply of oil and natural gas and the proximity of reserves to pipelines and
terminal facilities. Our ability to market our production depends in substantial
part on the availability and capacity of gathering systems, pipelines and
processing facilities owned and operated by third parties. Our failure to obtain
such services on acceptable terms could materially harm our
business.
 
 Currently,
the majority of our production is sold to marketers and other purchasers that
have access to nearby pipeline facilities. However, as we begin to further
develop our properties, we may find production in areas with limited or no
access to pipelines, thereby necessitating delivery by other means, such as
trucking, or requiring compression facilities. Such restrictions on our ability
to sell our oil or natural gas have several adverse affects, including higher
transportation costs, fewer potential purchasers (thereby potentially resulting
in a lower selling price) or, in the event we were unable to market and sustain
production from a particular lease for an extended time, possibly causing us to
lose a lease due to lack of production.
 
 Hedging
transactions may limit our potential gains.
 
 In order
to reduce commodity price uncertainty and increase cash flow predictability
relating to the marketing of our crude oil and natural gas, we enter into crude
oil and natural gas price hedging arrangements with respect to a portion of our
expected production. Our hedges, consisting of a series of contracts, are
limited in duration, usually for periods of one to three years. While intended
to reduce the effects of volatile crude oil and natural gas prices, such
transactions may limit our potential gains if crude oil and natural gas prices
rise over the price established by the arrangements.
 
 13
 
 Risks
Relating to Our Common Stock
 
 We
have no plans to pay dividends on our common stock. You may not receive funds
without selling your shares.
 
 We do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. We currently intend to retain future earnings, if any, to finance the
expansion of our business. Our future dividend policy is within the discretion
of our board of directors and will depend upon various factors, including our
business, financial condition, results of operations, capital requirements and
investment opportunities. In addition, our credit facility prohibits us from
paying dividends.
 
 Provisions
under Nevada law could delay or prevent a change in control of our company,
which could adversely affect the price of our common stock.
 
 While we do not believe that we
currently have any provisions in our organizational documents that could prevent
or delay a change in control of our company (such as provisions calling for a
staggered board of directors, or the issuance of stock with super-majority
voting rights), the existence of some provisions under Nevada law could delay or
prevent a change in control of our company, which could adversely affect the
price of our common stock. Nevada law imposes some restrictions on mergers and
other business combinations between us and any holder of 10% or more of our
outstanding common stock.
 
 Item
1B:Unresolved Staff
Comments
 
 None.
 
 Item
2:    Properties
 
 General
Background
 
 From our
inception in August 2000 through 2004, we built our asset base and achieved
growth primarily through property acquisitions.  Beginning in 2005,
while we have continued to grow through acquisition, we have shifted our focus
to growth through development of our existing properties.
 
 As of
December 31, 2009, our estimated proved reserves had a pre-tax PV10 value of
approximately $1.12 billion and a Standardized Measure of Discounted Future Cash
Flows of approximately $754.2 million, approximately 80% of which relate to our
properties in Texas, approximately 15% of which relate to our properties located
in New Mexico, approximately 4% relate to our properties in Oklahoma and less
than 1% relate to our properties in Kansas. We spent approximately $485.6
million on acquisitions and capital projects during 2007, 2008 and
2009.  We expect to further develop these properties through
additional drilling.  We will closely manage our capital expenditures
to our cash flow.   As commodity prices change we will consider
the resulting impact on our cash flow and adjust our capital expenditures up or
down accordingly.  We have maintained a strong current cash position
with no long-term debt; we will continue to seek acquisition opportunities that
complement our core assets.
 
  14
 The
following table summarizes our total net proved reserves, pre-tax PV10 value and
Standardized Measure of Discounted Future Net Cash Flows as of December 31,
2009.
 Geographic
      Area
                
                Oil
                  (Bbl)
                
                
                Natural
      Gas (Mcf)
                
                
                Total
                  (Boe)
                
                
                Pre-Tax
      PV10 Value
                
                
                Standardized
      Measure of Discounted Future Net Cash FlowsNew
      Mexico
                
                
                9,012,390
                
                
                
                7,979,726
                
                
                
                10,342,345
                
                
                $
                185,626,509
                
                
                $
                123,864,486Texas
                
                
                47,973,061
                
                
                
                47,946,793
                
                
                
                55,964,193
                
                
                
                877,877,087
                
                
                
                592,237,629Oklahoma
                
                
                2,730,061
                
                
                
                228,959
                
                
                
                2,768,221
                
                
                
                57,048,503
                
                
                
                37,116,698Kansas
                
                
                -
                
                
                
                1,059,210
                
                
                
                176,535
                
                
                
                805,401
                
                
                
                1,014,944Total
                
                
                59,715,512
                
                
                
                57,214,688
                
                
                
                69,251,294
                
                
                $
                1,121,357,500
                
                
                $
                754,233,757
  Proved Reserves
 
 Our
69,251,294 Boe of proved reserves, which consist of approximately 86% oil and
14% natural gas, are summarized below as of December 31, 2009, on a net pre-tax
PV10 value and Standardized Measure of Discounted Future Net Cash Flows basis.
Our reserve estimates have not been filed with any Federal authority or agency
(other than the SEC).
 
 As of
December 31, 2009, our Texas proved reserves had a net pre-tax PV10 value of
$877.9 million and Standardized Measure of Discounted Future Net Cash Flows of
$592.2 million, our proved reserves in New Mexico had a net pre-tax PV10 value
of $185.6 million and Standardized Measure of Discounted Future Net Cash Flows
of $123.9 million, our proved reserves in Oklahoma had a net pre-tax PV10 value
of $57.0 million and a Standardized Measure of Discounted Future Net Cash Flows
of $37.1 million and our proved reserves in Kansas had a net pre-tax PV10 value
of $0.8 million and a Standardized Measure of Discounted Future Net Cash Flows
of $1.0 million.
 
 As of
December 31, 2009, approximately 33% of the proved reserves have been classified
as proved developed producing, or “PDP”.  Proved developed behind
pipe, or “PDBP” reserves constitute approximately 5% and proved undeveloped, or
“PUD”, reserves constitute approximately 62%, of the proved reserves as of
December 31, 2009.
 
 Total proved reserves had a net pre-tax
PV10 value as of December 31, 2009 of approximately $1.12 billion and a
Standardized Measure of Discounted Future Net Cash Flows of approximately $754.2
million, 35.1% or $394.0 million and $265.7 million, respectively, of which is
associated with the PDP reserves. An additional $69.5 million and $46.6 million,
respectively, is associated with the PDBP reserves, or 6.2% of total proved
reserves’ pre-tax PV10 value.  The remaining $657.9 million and $441.9
million, respectively, is associated with PUD reserves.
  Proved
Reserves Disclosures
  Recent SEC Rule-Making Activity.In December 2008, the SEC announced that it had approved revisions
to modernize the oil and gas reserve reporting disclosures. The new disclosure
requirements include provisions that:
  ·
              Introduce
      a new definition of oil and gas producing activities. This new definition
      allows companies to include in their reserve base volumes from
      unconventional resources. Such unconventional resources include bitumen
      extracted from oil sands and oil and gas extracted from coal beds and
      shale formations.
  ·
              Report
      oil and gas reserves using an unweighted average price using the prior
      12-month period, based on the closing prices on the first day of each
      month, rather than year-end prices.
  15
 ·
              Permit
      companies to disclose their probable and possible reserves on a voluntary
      basis. In the past, proved reserves were the only reserves allowed in the
      disclosures.  We have chosen not to make disclosure under these
      categories.
  ·
              Requires
      companies to provide additional disclosure regarding the aging of proved
      undeveloped reserves.
  ·
              Permit
      the use of reliable technologies to determine proved reserves if those
      technologies have been demonstrated empirically to lead to reliable
      conclusions about reserves volumes.
  ·
              Replace
      the existing “certainty” test for areas beyond one offsetting drilling
      unit from a productive well with a “reasonable certainty”
      test.
  ·
              Require
      additional disclosures regarding the qualifications of the chief technical
      person who oversees the company’s overall reserve estimation process.
      Additionally, disclosures regarding internal controls over reserve
      estimation, as well as a report addressing the independence and
      qualifications of its reserves preparer or auditor will be
      mandatory.
 
 We
adopted the rules effective December 31, 2009.
 
 The new
rule does not allow for prior-year reserve information to be restated, so all
information related to periods prior to 2009 is presented consistent with prior
SEC rules for the estimation of proved reserves.
 
 Internal Controls Over Reserves
Estimates. Our reserves estimates are prepared internally by our
Reservoir/Acquisitions Manager and our Reservoir Studies Manager in compliance
with SEC definitions and guidance and in accordance with generally accepted
petroleum engineering principles.  Our Reservoir/Acquisitions Manager
holds a Bachelor of Science in Petroleum Engineering and has over thirty (30)
years of industry experience in property evaluations and reserves estimates
preparation.  Our Reservoir Studies Manager holds a Bachelor of
Science and Master of Science in Petroleum Engineering and has over 37 years of
industry experience in reservoir engineering, property evaluations, and reserves
estimates preparation.  Our reserves estimates are prepared by
examination and evaluation of production data, production decline curves,
reservoir pressure data, logs, geological data, and offset
analogies.  Our reserves estimates are reviewed and approved by our
Operations Vice President and our President/Chief Executive
Officer.  Our Chief Financial Officer reviews the reserves estimates
to assure compliance with SEC reporting requirements.
 
 We engage third-party petroleum
consulting firms to audit all of our reserves.  See the Third-Party
Reserves Audit report in exhibits.
 
 Proved Undeveloped Reserves –Our reserve estimates as of December 31, 2009 include 43.4 million BOE as
proved undeveloped reserves.  As of December 31, 2008, our reserve
estimates included 40.6 BOE as proved undeveloped reserves.  Following
is a description of the changes in our PUD reserves from December 31, 2008 to
December 31, 2009.
 
 Conversion
of approximately 5.2 million BOE of reserve from PUD to PDP or PDBP through
capital expenditures of approximately $58.4 million.
 
 Downward
revision of approximately 8.6 million BOE as a result of commodity price changes
and revisions of estimates due to performance.
 
 16
 
 Recording
of approximately 16.6 million BOE in new PUD reserves as a result of
acquisitions and our continuing development of additional acreage.
  Our
proved reserves as of December 31, 2009 are summarized in the table
below.
 Oil (Bbl)
                
                
                Gas (Mcf)
                
                
                Total (Boe)
                
                
                %
      of Total Proved
                
                
                Pre-tax
      PV10 (In thousands)
                
                
                Standardized
      Measure of Discounted Future Net Cash Flows (In thousands)
                
                
                Future
      Capital Expenditures (In thousands)New
      Mexico:PDP
                
                
                3,116,024
                
                
                
                4,420,485
                
                
                
                3,852,772
                
                
                
                6
                %
                
                $
                53,780
                
                
                $
                35,886
                
                
                $
                -PDBP
                
                
                1,456,110
                
                
                
                1,274,437
                
                
                
                1,668,516
                
                
                
                2
                %
                
                $
                34,653
                
                
                
                23,123
                
                
                
                2,735PUD
                
                
                4,440,256
                
                
                
                2,284,804
                
                
                
                4,821,057
                
                
                
                7
                %
                
                $
                97,194
                
                
                
                64,855
                
                
                
                40,215Total
      Proved:
                
                
                9,012,390
                
                
                
                7,979,726
                
                
                
                10,342,345
                
                
                
                15
                %
                
                $
                185,627
                
                
                $
                123,864
                
                
                $
                42,950Texas:PDP
                
                
                14,920,662
                
                
                
                18,859,572
                
                
                
                18,063,924
                
                
                
                26
                %
                
                $
                332,309
                
                
                $
                224,184
                
                
                $
                -PDBP
                
                
                1,243,307
                
                
                
                2,589,005
                
                
                
                1,674,808
                
                
                
                2
                %
                
                $
                34,795
                
                
                
                23,474
                
                
                
                10,236PUD
                
                
                31,809,092
                
                
                
                26,498,216
                
                
                
                36,225,461
                
                
                
                52
                %
                
                $
                510,773
                
                
                
                344,580
                
                
                
                483,567Total
      Proved:
                
                
                47,973,061
                
                
                
                47,946,793
                
                
                
                55,964,193
                
                
                
                80
                %
                
                $
                877,877
                
                
                $
                592,238
                
                
                $
                493,803Oklahoma:PDP
                
                
                408,803
                
                
                
                99,760
                
                
                
                425,430
                
                
                
                1
                %
                
                $
                7,084
                
                
                $
                4,609
                
                
                $
                -PUD
                
                
                2,321,258
                
                
                
                129,199
                
                
                
                2,342,791
                
                
                
                3
                %
                
                $
                49,965
                
                
                
                32,508
                
                
                
                6,270Total
      Proved:
                
                
                2,730,061
                
                
                
                228,959
                
                
                
                2,768,221
                
                
                
                4
                %
                
                $
                57,049
                
                
                $
                37,117
                
                
                $
                6,270Kansas:PDP
                
                
                -
                
                
                
                1,059,210
                
                
                
                176,535
                
                
                
                1
                %
                
                $
                805
                
                
                $
                1,015
                
                
                $
                -Total
      Proved:
                
                
                -
                
                
                
                1,059,210
                
                
                
                176,535
                
                
                
                1
                %
                
                $
                805
                
                
                $
                1,015
                
                
                $
                -Total:PDP
                
                
                18,445,489
                
                
                
                24,439,027
                
                
                
                22,518,661
                
                
                
                33
                %
                
                $
                393,978
                
                
                $
                265,694
                
                
                $
                -PDBP
                
                
                2,699,417
                
                
                
                3,863,442
                
                
                
                3,343,324
                
                
                
                5
                %
                
                
                69,448
                
                
                
                46,597
                
                
                
                12,971PUD
                
                
                38,570,606
                
                
                
                28,912,219
                
                
                
                43,389,309
                
                
                
                62
                %
                
                
                657,932
                
                
                
                441,943
                
                
                
                530,052Total
      Proved:
                
                
                59,715,512
                
                
                
                57,214,688
                
                
                
                69,251,294
                
                
                
                100
                %
                
                $
                1,121,358
                
                
                $
                754,234
                
                
                $
                543,023
 
 17
 
 Estimated
Costs Related to Conversion of Proved Undeveloped Reserves to Proved Developed
Reserves
 
 The following table indicates projected
reserves that we currently estimate will be converted from proved undeveloped or
proved developed non-producing to proved developed, as well as the estimated
costs per year involved in such development.
  Year
                
                Estimated
      Oil
                  Reserves
                  Developed
      (Bbls)
                
                
                Estimated
      Gas
                  Reserves
                  Developed
      (Mcf)
                
                
                Total
      Boe
                
                
                Estimated
      Development Costs2010
                
                
                15,262,194
                
                
                
                12,262,170
                
                
                
                17,305,889
                
                
                $
                153,627,1732011
                
                
                11,963,553
                
                
                
                8,237,414
                
                
                
                13,336,455
                
                
                
                179,091,8862012
                
                
                9,818,416
                
                
                
                9,494,082
                
                
                
                11,400,763
                
                
                
                182,626,3162013
                
                
                2,166,220
                
                
                
                1,343,823
                
                
                
                2,390,191
                
                
                
                19,897,500Remaining
                
                
                2,059,640
                
                
                
                1,438,172
                
                
                
                2,299,335
                
                
                
                7,780,00041,270,023
                
                
                
                32,775,661
                
                
                
                46,732,633
                
                
                $
                543,022,875
  Production
 
 Our
estimated average daily production for the month of December, 2009, is
summarized below. These tables indicate the percentage of our estimated December
2009 average daily production of 7,254 Boe/d attributable to each state and to
oil versus natural gas production.
  State
                
                Average
                  Daily
                  Production
                
                
                Oil
                
                
                Natural
                  GasTexas
                
                
                88.23
                %
                
                
                75.48
                %
                
                
                12.75
                %New
      Mexico
                
                
                8.73
                %
                
                
                7.09
                %
                
                
                1.65
                %Oklahoma
                
                
                2.26
                %
                
                
                2.16
                %
                
                
                0.10
                %Kansas
                
                
                0.77
                %
                
                
                0.00
                %
                
                
                0.77
                %Total
                
                
                100.00
                %
                
                
                84.73
                %
                
                
                15.27
                %
  Summary
of Oil and Natural Gas Properties and Projects
  Significant
New Mexico Operations
  East Hobbs San Andres Unit – Lea
County, New Mexico.  In May, 2004 we acquired an 82.24% working
interest and a 67.60% net revenue interest in this lease.  The
property has been in continuous production since that time.  “Net
revenue interest” is the owner’s percentage share of the monthly income realized
from the sale of a well’s produced oil and gas.  The net revenue
interest is a lesser number as compared to the working interest, due to the
mineral owner royalty and other overriding royalties on the well.  The
lease contains approximately 920 acres, all held by production, on which there
are 31 producing wells.  We believe the property has additional
potential through waterflooding.  A waterflood operation is a method
of secondary recovery in which water is injected into the reservoir formation to
displace residual oil.  The water from injection wells physically
sweeps the displaced oil to adjacent production wells.  These
estimates are included in our estimates of PUD potential.
 
 18
 
 Humphrey Queen Unit – Lea County,
New Mexico.  We acquired a 100% working interest and a 75.08%
net revenue interest in this mature waterflood in December, 2007.  The
property contains 16 producing wells and approximately 760 acres, all held by
production.  We believe the property can support activities to drill
12 additional PUD wells, which are included in our reserve
estimates.
 
 Langlie Mattix Queen Unit – Lea
County, New Mexico.  We acquired a 100% working interest and a
75.09% net revenue interest in this mature waterflood property in December,
2007.  The property has 16 producing wells on approximately 1,040
acres, all held by production.  We believe the property can support
activity to drill 14 additional PUD wells, which are included in our reserve
estimates.
 
 South Leonard Queen Unit – Lea
County, New Mexico.   We acquired a 100% working interest
and a 75.09% net revenue interest in this mature waterflood in December,
2007.  The property contains seven producing wells on approximately
680 acres with all of the acreage being held by production.  We
believe the property can support activity to drill four additional PUD wells,
which are included in our reserve estimates.
 
 North Benson Queen Unit – Eddy
County, New Mexico.  We acquired a 100% working interest and a
69.44% net revenue interest in this mature waterflood property in October,
2003.  The property has 27 producing wells and contains approximately
1,800 acres, all held by production.  We have reactivated the
waterflood by constructing a new water supply system, building new injection
facilities, and returning previously idle water injection wells to
service.  We think the property can support workovers in existing
wells to open additional zones and drilling 28 additional wells which are
included as PUD in our reserve estimate.
 
 Red Lake Unit – Eddy County, New
Mexico.  In October, 2007 we acquired a 100% working interest
and an 80.56% net revenue interest in this property.  The lease has 16
producing wells on approximately 1,090 acres, all held by
production.  We believe the property can support activity to drill
three additional PUD wells, which are included in our reserve
estimates.
 
 Phillips Lea, Hale State, State 36
and Corbin 35 leases – Lea County, New Mexico.  In June, 2008
we acquired a 100% working interest with net revenue interests ranging from
80.31% to 82.81% in these leases.  The leases have 16 producing wells
on approximately 800 acres, all held by production.  We think the
property can support workovers in existing wells to open new zones in existing
wells and drilling 10 additional wells which are included as PUD in our reserve
estimate.
 
 Significant Texas
Operations
 
 Fuhrman Mascho leases – Andrews
County, Texas.  In December 2004 we acquired a 100% working
interest and a 75% net revenue interest in these leases.  Throughout
2005 through 2009 we acquired working and net revenue interests in additional
producing leases and acquired additional undeveloped acreage in and around our
Fuhrman Mascho leases.  The working interests range from 20-100% and
the net revenue interests range from 16-80%. In total, we now own 46,888 acres,
with 35,246 acres developed and held by production and the remaining 11,642
acres being undeveloped.  We believe the Fuhrman Mascho leases contain
considerable remaining potential drilling.  Our reserve estimate
includes 941 PUD wells.   Our reserve estimates include potential
development expenditures.
 
 Y6 lease – Fisher County,
Texas.  We acquired a 100% working interest and an 80% net
revenue interest in this partially developed waterflood property in June,
2001.  There are 15 producing wells on approximately 1,697 acres,
which is held by production.  We believe the property can support
activity to drill four additional PUD wells, which are included in our reserve
estimates.
 
 19
 
 Significant
Oklahoma Operations
 
 Ona Morrow Sand Unit – Cimarron and
Texas Counties, Oklahoma.  We acquired a 100% working interest
and an 81.32% net revenue interest in this waterflood property in June,
2001.  There are 13 producing wells on approximately 2,120 acres,
which is held by production.  We believe the property can support
three additional PUD wells, which are included in our estimate of
PUD.
 
 Midwell, Appleby, Smaltz, and Hanes
Leases – Cimarron County, Oklahoma.  We acquired a 100% working
interest and an 80% net revenue interest in these leases in September,
2002.  The leases contain 11 wells on approximately 2,280 acres, which
is held by production.  We believe the leases contain PUD potential
from waterflood operations and six PUD wells, which are included in our estimate
of PUD.  We began implementing the waterflood operations and will
continue those efforts.
 
 Acreage
 
 The
following table summarizes gross and net developed and undeveloped acreage at
December 31, 2009 by region (net acreage is our percentage ownership of gross
acreage). Acreage in which our interest is limited to royalty and overriding
royalty interests is excluded.
 
 Developed
      Acreage
                
                Undeveloped
      Acreage
                
                Total
      AcreageGross
                
                Net
                
                Gross
                
                Net
                
                Gross
                
                NetNew
      Mexico
                
                9,850
                
                9,038
                
                -
                
                -
                
                9,850
                
                9,038Texas
                
                34,569
                
                33,923
                
                16,116
                
                14,411
                
                50,685
                
                48,335Oklahoma
                
                5,529
                
                5,046
                
                -
                
                -
                
                5,529
                
                5,046Kansas
                
                5,200
                
                5,200
                
                0
                
                0
                
                5,200
                
                5,200Total
                
                55,148
                
                53,206
                
                16,116
                
                14,411
                
                71,264
                
                67,618
 Production
History
 
 The following table presents the
historical information about our produced natural gas and oil
volumes.
 Year
      Ended December 31,2007
                
                2008
                
                2009Oil
      production (Bbls)
                
                1,316,025
                
                2,018,335
                
                2,004,498Natural
      gas production (Mcf)
                
                1,503,611
                
                1,911,713
                
                2,172,790Total
      production (Boe)
                
                1,566,627
                
                2,336,954
                
                2,366,630Daily
      production (Boe/d)
                
                4,292
                
                6,385
                
                6,484Average
      sales price:Oil
      (per Bbl)
                
                $          66.89
                
                $          94.16
                
                $          57.51Natural
      gas (per Mcf)
                
                8.02
                
                9.84
                
                5.04Total
      (per Boe)
                
                63.89
                
                89.37
                
                53.34Average
      production cost (per Boe)
                
                $            7.34
                
                $            7.63
                
                $            6.57Average
      production taxes (per Boe)
                
                3.61
                
                4.50
                
                2.73
 The
average oil sales price amounts above are calculated by dividing revenue from
oil sales by the volume of oil sold, in Bbl.  The average gas sales
price amounts above are calculated by dividing revenue from gas sales by the
volume of gas sold, in Mcf.  The total average sales price amounts are
calculated by dividing total revenues by total volume sold, in
Boe.  The average production costs above are calculated by dividing
production costs by total production in Boe.
 
 20
 
 Productive
Wells
 
 The
following table presents our ownership at December 31, 2009, in productive oil
and natural gas wells by region (a net well is our percentage ownership of a
gross well).
  Oil
      Wells
                
                Gas
      wells
                
                Total
      WellsGross
                
                Net
                
                Gross
                
                Net
                
                Gross
                
                NetNew
      Mexico
                
                194
                
                173
                
                -
                
                -
                
                194
                
                173Texas
                
                893
                
                876
                
                -
                
                -
                
                893
                
                876Oklahoma
                
                36
                
                32
                
                -
                
                -
                
                36
                
                32Kansas
                
                -
                
                -
                
                10
                
                10
                
                10
                
                10Total
                
                1,123
                
                1,080
                
                10
                
                10
                
                1,133
                
                1,090
 
 Drilling
Activity
 
 The following table represents our
drilling activity for the years ended December 31, 2007, 2008 and
2009:
 
 2007
                
                2008
                
                2009Gross
                Net
                
                Gross
                Net
                
                Gross
                NetProductive
      development wellsTexas
                
                133
                130
                
                223
                219
                
                176
                173Oklahoma
                
                1
                1
                
                -
                -
                
                -
                -New
      Mexico
                
                -
                -
                
                1
                1
                
                5
                4Total
      productive development wells
                
                134
                131
                
                224
                220
                
                181
                177Dry
      development wells
                
                -
                -
                
                -
                -
                
                -
                -Total
      development wells
                
                134
                131
                
                224
                220
                
                181
                177Productive
      exploratory wells
                
                -
                -
                
                -
                -
                
                -
                -Dry
      exploratory wellsTexas
                
                -
                -
                
                -
                -
                
                1
                1Total
      dry exploratory wells
                
                -
                -
                
                -
                -
                
                1
                1Total
      exploratory wells
                
                -
                -
                
                -
                -
                
                -
                -Total
      productive wells
                
                134
                131
                
                224
                220
                
                181
                177Total
      dry wells
                
                -
                -
                
                -
                -
                
                1
                1Total
      wells drilled
                
                134
                131
                
                224
                220
                
                182
                178
 
 As of December 31, 2009, we were in the
process of drilling five wells with an additional fourteen wells in various
stages of completion, all in Texas.  While we have small working
interest partners in three of these wells, we own the majority of the working
interest; therefore this information is correct for both gross and net
wells.
 
 21
  Cost
Information
 
 We conduct our oil and natural gas
activities entirely in the United States. As noted previously in the table
appearing under “Production History”, our average production costs, per Boe,
were $7.34 in 2007, $7.63 in 2008 and $6.57 in 2009 and our average production
taxes, per BOE, were $3.61 in 2007, $4.50 in 2008 and $2.73 in 2009. These
amounts are calculated by dividing our total production costs or total
production taxes by our total volume sold, in Boe.
 
 Costs incurred for property
acquisition, exploration and development activities during the years ended
December 31, 2007, 2008 and 2009 are shown below.
  For
      the Years Ended December 31,2007
      (1)
                
                
                2008
                
                
                2009Acquisition
      of proved properties
                
                $
                53,554,064
                
                
                $
                16,782,225
                
                
                $
                3,942,103Acquisition
      of unproved properties
                
                
                542,650
                
                
                
                -
                
                
                
                -Exploration
      costs
                
                
                -
                
                
                
                -
                
                
                
                -Development
      costs
                
                
                113,084,344
                
                
                
                190,584,617
                
                
                
                107,064,257Total
      Costs Incurred
                
                $
                167,181,058
                
                
                $
                207,366,842
                
                
                $
                111,006,360
  (1)  The
amount shown for 2007 for acquisition of proved properties is net of proceeds
received from the sale of our interest in the West San Andres
property.
 
 Reserve
Quantity Information
 
 Our estimates of proved reserves and
related valuations were based on internal reports and audited by Williamson
Petroleum Consultants, Inc. independent petroleum engineers.  The
estimates of proved reserves are inherently imprecise and are continually
subject to revision based on production history, results of additional
exploration and development, price changes and other factors.
 
 Our oil and natural gas reserves are
attributable solely to properties within the United States. A summary of the
changes in quantities of proved (developed and undeveloped) oil and natural gas
reserves is shown below.
 
 22
 Natural
      GasOil
      (Bbls)
                
                (Mcf)Balance,
      December 31, 2006
                
                36,064,273
                
                42,424,199Purchase
      of minerals in place
                
                7,021,972
                
                4,330,246Extensions
      and discoveries
                
                6,016,660
                
                6,852,346Production
                
                (1,316,023
                )
                (1,503,611
                )Revisions
      of estimates
                
                (373,560
                )
                (4,028,218
                )Balance,
      December 31, 2007
                
                47,413,322
                
                48,074,962Purchase
      of minerals in place
                
                3,638,095
                
                2,364,908Extensions
      and discoveries
                
                9,547,981
                
                11,391,853Production
                
                (2,018,335
                )
                (1,911,713
                )Revisions
      of estimates
                
                (2,735,806
                )
                (1,115,348
                )Balance,
      December 31, 2008
                
                55,845,257
                
                58,804,662Purchase
      of minerals in place
                
                1,589,141
                
                2,791,611Extensions
      and discoveries
                
                14,360,492
                
                13,605,184Production
                
                (2,004,498
                )
                (2,172,790
                )Revisions
      of estimates
                
                (10,074,880
                )
                (15,813,979
                )Balance,
      December 31, 2009
                
                59,715,512
                
                57,214,688
 Our
proved oil and natural gas reserves are shown below.
  For
      the Years Ended December 31,2007
                
                2008
                
                2009Oil
      (Bbls)Developed
                
                14,951,794
                
                20,231,477
                
                21,144,906Undeveloped
                
                32,461,428
                
                35,613,780
                
                38,570,606Total
                
                47,413,222
                
                55,845,257
                
                59,715,512Natural
      Gas (Mcf)Developed
                
                30,783,255
                
                28,659,033
                
                28,302,469Undeveloped
                
                17,291,707
                
                30,145,629
                
                28,912,219Total
                
                48,074,962
                
                58,804,662
                
                57,214,688Total
      (Boe)Developed
                
                20,082,337
                
                25,007,982
                
                25,861,985Undeveloped
                
                35,343,379
                
                40,638,052
                
                43,389,309Total
                
                55,425,716
                
                65,646,034
                
                69,251,294
 Standardized
Measure of Discounted Future Net Cash Flows
 
 Our
standardized measure of discounted future net cash flows relating to proved oil
and natural gas reserves and changes in the standardized measure as described
below were prepared in accordance with generally accepted accounting principles.
 23
 
 Future
income tax expenses are calculated by applying appropriate year-end tax rates to
future pre-tax net cash flows relating to proved oil and natural gas reserves,
less the tax basis of properties involved. Future income tax expenses give
effect to permanent differences, tax credits and loss carryforwards relating to
the proved oil and natural gas reserves. Future net cash flows are discounted at
a rate of 10% annually to derive the standardized measure of discounted future
net cash flows. This calculation procedure does not necessarily result in an
estimate of the fair market value or the present value of our oil and natural
gas properties.
 
 The standardized measure of discounted
future net cash flows relating to the proved oil and natural gas reserves are
shown below.
  December
      31,
                
                2009
                
                
                2008
                
                
                2007Future
      cash flows
                
                $
                3,721,873,750
                
                
                $
                2,391,888,946
                
                
                $
                4,634,645,500Future
      production costs
                
                
                (902,963,847
                )
                
                
                (716,121,604
                )
                
                
                (790,284,047
                )Future
      development costs
                
                
                (543,022,875
                )
                
                
                (330,672,457
                )
                
                
                (321,485,125
                )Future
      income taxes
                
                
                (746,548,080
                )
                
                
                (394,800,287
                )
                
                
                (1,254,982,170
                )Future
      net cash flows
                
                
                1,529,338,948
                
                
                
                950,294,598
                
                
                
                2,267,894,15810%
      annual discount for estimated timing of cash flows
                
                
                (775,105,191
                )
                
                
                (489,607,688
                )
                
                
                (991,727,804
                )Standardized
      Measure of Discounted Cash Flows
                
                $
                754,233,757
                
                
                $
                460,686,910
                
                
                $
                1,276,166,354
 The changes in the standardized measure
of discounted future net cash flows relating to the proved oil and natural gas
reserves are shown below.
  2009
                
                
                2008
                
                
                2007Beginning
      of the year
                
                $
                460,686,910
                
                
                $
                1,276,166,354
                
                
                $
                545,439,675Purchase
      of minerals in place
                
                
                28,329,307
                
                
                
                41,597,736
                
                
                
                325,058,027Extensions,
      discoveries and improved recovery, less related costs
                
                
                253,485,559
                
                
                
                129,110,323
                
                
                
                297,610,301Development
      costs incurred during the year
                
                
                107,237,470
                
                
                
                190,631,820
                
                
                
                113,109,335Sales
      of oil and gas produced, net of production costs
                
                
                (110,697,316
                )
                
                
                (190,374,853
                )
                
                
                (82,949,751
                )Accretion
      of discount
                
                
                48,058,341
                
                
                
                131,684,244
                
                
                
                69,291,660Net
      changes in price and production costs
                
                
                619,543,318
                
                
                
                (1,526,963,575
                )
                
                
                592,749,069Net
      change in estimated future development costs
                
                
                6,550,757
                
                
                
                (22,637,628
                )
                
                
                (111,175,136
                )Revision
      of previous quantity estimates
                
                
                (447,110,784
                )
                
                
                293,723,576
                
                
                
                (7,424,163
                )Revision
      of estimated timing of cash flows
                
                
                (35,543,586
                )
                
                
                (409,158,356
                )
                
                
                (62,546,312
                )Net
      change in income taxes
                
                
                (176,306,219
                )
                
                
                546,907,269
                
                
                
                (402,996,351
                )End
      of the Year
                
                $
                754,233,757
                
                
                $
                460,686,910
                
                
                $
                1,276,166,354
 Management’s
Business Strategy Related to Properties
 
 Our goal
is to increase stockholder value by investing in oil and gas projects with
attractive rates of return on capital employed. We plan to achieve this goal by
exploiting and developing our existing oil and natural gas properties and
pursuing acquisitions of additional properties. Specifically, we have focused,
and plan to continue to focus, on the following:
 
 Developing and Exploiting Existing
Properties.    We believe that there is significant
value to be created by drilling the identified undeveloped opportunities on our
properties.  We own interests in a total of 58,092 gross (43,607 net)
developed acres and operate essentially all of the net pre-tax PV10 value of our
proved undeveloped reserves.  In addition, as of December 31, 2009, we
owned interests in approximately 13,172 gross undeveloped acres (9,879
net).  We believe that our current and future cash flow will enable us
to undertake the exploitation of our properties through additional drilling
activities.   We will closely manage our capital expenditures to
our cash flow.   As commodity prices change we will consider the
resulting impact on our cash flow and adjust our capital expenditures
accordingly, be it up or down.
 
 24
 
 Pursuing Profitable
Acquisitions.    We have historically pursued
acquisitions of properties that we believe to have exploitation and development
potential comparable to our existing inventory of drilling
locations.  We have developed and refined an acquisition program
designed to increase reserves and complement our existing core
properties.  We have an experienced team of management and engineering
professionals who identify and evaluate acquisition opportunities, negotiate and
close purchases and manage acquired properties.  While our emphasis in
2010 and beyond is anticipated to focus on the further development of our
existing properties, we will continue to look for acquisition opportunities with
existing cash flow from production and future development
potential.
 
 Controlling Costs through Efficient
Operation of Existing Properties.    We operate
essentially 100% of the pre-tax PV10 value of our total proved reserves, which
we believe enables us to better manage expenses, capital allocation and the
decision-making processes related to our exploitation and exploration
activities. For the year ended December 31, 2009, our oil and gas production
costs per Boe averaged $6.57, our oil and gas production taxes per Boe averaged
$2.73 and general and administrative costs averaged $5.68 per Boe
produced.
 
 Other
Properties and Commitments
 
 Our principal executive offices are in
a company owned building in Tulsa, Oklahoma.  This office building has
approximately 16,000 square feet.  Additionally, we own the building
in Hobbs, New Mexico which serves as our primary field office.  This
office building has approximately 7,500 square feet.  We also own an
office building in Andrews, Texas for the operation of our wholly-owned
subsidiary Arena Drilling Company and for use by additional Arena Resources
field personnel.  This office building has approximately 6,000 square
feet.  At December 31, 2009, we were expanding the office in Andrews
by an additional 5,000 up to 11,000 square feet.  Subsequent to year
end the expansion was completed and the additional space will be used by Arena
Resources field personnel.  Lastly, we are currently leasing
approximately 1,869 square feet of space in Midland, Texas.  Our
Midland office is maintained for the purchase of developed and undeveloped
leaseholds and for land department support.  We believe the office
space will be adequate for our current operations as well as allowing for
continued growth.
 
 Item
3:Legal
Proceedings
 
 In the
ordinary course of business, we may be, from time to time, a claimant or a
defendant in various legal proceedings.  We do not presently have any
material litigation pending or threatened.
 
 Item
4:Submission of Matters to a
Vote of Security Holders
 
 Our annual shareholders’ meeting was
held on December 11, 2009.  The shareholder’s re-elected Messrs.
Stanley M. McCabe, Lloyd T. Rochford, Clayton E. Woodrum, Anthony B. Petrelli
and Carl F. Fiddner as Directors with terms ending in 2010.  The
shareholders approved an amendment to the Company’s executive stock option plan
to increase the number of shares of Common Stock that may be granted under the
plan from 5,500,000 to 6,000,000.  The shareholders also approved a
restricted stock award plan that will use shares from that same pool available
for grant as restricted stock awards.  The following reflects the
votes cast for each matter voted on at the annual meeting:
  25
 Votes
      for
              
              Votes
      against
              
              AbstainLloyd
      T. Rochford
              33,035,317
              
              2,797,173
              
              -Stanley
      M. McCabe
              27,834,068
              
              7,998,422
              
              -Clayton
      E. Woodrum
              27,820,843
              
              8,011,647
              
              -Anthony
      B. Petrelli
              33,734,756
              
              2,097,734
              
              -Carl
      H. Fiddner
              33,733,780
              
              2,098,710
              
              -Amendment
      to stock option plan
              23,285,445
              
              9,184,761
              
              3,362,284Restricted
      stock award plan
              21,516,700
              
              10,958,283
              
              3,357,507
            
 26
  PART
II
  Item
      5:
                Market for
      Registrant’s Common Stock, Related Stockholder Matters and Issuer
      Purchases of
      Equity
Securities
  Market
for our Common Stock
 
 Our
common stock is been traded on the New York Stock Exchange, under the symbol
“ARD”.  The following table shows the high and low sales prices for
each quarter during the last two years.
  Period
                
                High Sale
                
                
                Low Sale1st
      Quarter 2008
                
                $
                44.17
                
                
                $
                29.252nd
      Quarter 2008
                
                
                57.60
                
                
                
                38.003rd
      Quarter 2008
                
                
                56.59
                
                
                
                32.474th
      Quarter 2008
                
                
                39.03
                
                
                
                17.631st
      Quarter 2009
                
                $
                31.51
                
                
                $
                18.622nd
      Quarter 2009
                
                
                38.04
                
                
                
                26.033rd
      Quarter 2009
                
                
                36.06
                
                
                
                27.574th
      Quarter 2009
                
                
                45.24
                
                
                
                32.761st
      Quarter 2010 (through March 1, 2010)
                
                $
                45.06
                
                
                $
                38.34
 
 Record
Holders
 
 As of February 23, 2010, there are
approximately 30,521 holders of record of our common stock.  As of
February 23, 2010, 532,606 shares, or approximately 1.4%, of the 38,793,963
shares issued and outstanding as of such date are held by management or
affiliated parties.
 
 Dividend
Policy
 
 We have not paid any dividends on our
common stock during the last three years, and we do not anticipate paying any
cash dividends on our common stock in the foreseeable future. We currently
intend to retain future earnings, if any, to finance the expansion of our
business. Our future dividend policy is within the discretion of our board of
directors and will depend upon various factors, including our results of
operations, financial condition, capital requirements and investment
opportunities. In addition, our credit facility prohibits us from paying
dividends.
 
 Securities
Authorized for Issuance Under Equity Compensation Plans
 
 In March
2003, our board of directors adopted an executive stock option plan which was
subsequently approved by our shareholders at our annual meeting in July 2003,
and which has been subsequently amended by votes of our
shareholders.  Additionally, in December 2009 the shareholders
approved a restricted stock award plan.  Information regarding these
plan and the options and stock that have been granted under this plan may be
found in this Annual Report under Part III, Items 10 and 11.
 
 Issuer
Repurchases
 
 We did not make any repurchases of our
equity securities during the quarter ending December 31, 2009.
  27
 
  Item
6:Selected Financial
Data
  The
selected consolidated financial information set forth below is derived from our
consolidated balance sheets and statements of operations as of and for the years
ended December 31, 2009, 2008, 2007, 2006 and 2005.  The data set
forth below should be read in conjunction with “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” and the consolidated
financial statements and related notes thereto included in this Annual
Report.
  For
      the Year Ended December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Statement
      of Operations Data:Revenues
                
                $
                126,240,777
                
                
                $
                208,858,645
                
                
                $
                100,089,698
                
                
                $
                59,760,117
                
                
                $
                25,843,077Cost
      of revenues
                
                
                21,999,046
                
                
                
                28,351,514
                
                
                
                17,156,338
                
                
                
                9,960,178
                
                
                
                5,772,225Realized
      loss (gain) on oil derivative
                
                
                (14,884,846
                )
                
                
                4,275,330
                
                
                
                932,361
                
                
                
                -
                
                
                
                -Depreciation,
      depletion and amortization
                
                
                8,957,641
                
                
                
                29,789,794
                
                
                
                17,968,062
                
                
                
                7,900,099
                
                
                
                2,781,504Accretion
                
                
                410,926
                
                
                
                309,402
                
                
                
                190,904
                
                
                
                127,132
                
                
                
                102,585General
      and administrative
                
                
                13,453,384
                
                
                
                13,557,202
                
                
                
                7,815,721
                
                
                
                3,617,309
                
                
                
                1,365,590Net
      income
                
                
                42,294,179
                
                
                
                83,617,201
                
                
                
                34,441,939
                
                
                
                23,267,968
                
                
                
                9,460,683Basic
      income per common share
                
                $
                1.10
                
                
                $
                2.28
                
                
                $
                1.07
                
                
                $
                0.83
                
                
                $
                0.42Diluted
      income per common share
                
                
                1.09
                
                
                
                2.20
                
                
                
                1.02
                
                
                
                0.77
                
                
                
                0.38As
      of December 31,2009
                
                
                
                2008
                
                
                
                2007
                
                
                
                2006
                
                
                
                2005Balance
      Sheet Data:Current
      assets
                
                $
                80,655,878
                
                
                $
                89,530,137
                
                
                $
                30,823,214
                
                
                $
                14,674,345
                
                
                $
                7,673,860Oil
      and gas properties subject to amortization
                
                
                661,453,134
                
                
                
                548,714,235
                
                
                
                339,887,859
                
                
                
                171,708,200
                
                
                
                69,770,685Total
      assets
                
                
                657,554,954
                
                
                
                591,684,775
                
                
                
                350,980,663
                
                
                
                176,312,978
                
                
                
                74,421,907Total
      current liabilities
                
                
                18,256,893
                
                
                
                19,789,547
                
                
                
                19,216,475
                
                
                
                14,995,870
                
                
                
                6,737,806Total
      long-term liabilities
                
                
                116,631,301
                
                
                
                89,599,767
                
                
                
                73,953,223
                
                
                
                41,273,056
                
                
                
                8,919,826Total
      Stockholders Equity
                
                
                522,666,730
                
                
                
                482,295,461
                
                
                
                257,810,965
                
                
                
                120,044,052
                
                
                
                58,728,755
  Item
7:Management’s Discussion and
Analysis of Financial Condition and Results of
Operations
  Introduction
 
 The
following discussion and analysis should be read in conjunction with our
accompanying financial statements and the notes to those financial statements
included elsewhere in this Annual Report. The following discussion includes
forward-looking statements that reflect our plans, estimates and beliefs. Our
actual results could differ materially from those discussed in these
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below and elsewhere
in this Annual Report.
 
 Overview
 
 We are
engaged in oil and natural gas acquisition, exploration and exploitation
activities in the states of Oklahoma, Texas, New Mexico and Kansas. Over the
last six years, we have emphasized the acquisition of properties that provided
current production and upside potential through further
development.
 
 We have
increased our reserves significantly by investing approximately $111 million in
acquisitions and development in 2009, following total capital expenditures of
approximately $207.4 million in 2008 and $167.2 million in 2007.
 
 We will
closely manage our capital expenditures to our cash flow.   As
commodity prices change we will consider the resulting impact on our cash flow
and adjust our capital expenditures accordingly, be it up or down.  We
also intend to continue seeking acquisition opportunities which compliment our
current portfolio.  We could draw on our credit facility or funds
derived from future equity transactions for future acquisitions.
 
 28
 
 Our
business plan has involved increasing our base of proven reserves until we have
acquired a sufficient core to enable us to utilize cash from existing production
to fund further development activities.  When we originated our
business plan we believed this would allow us to lessen our risks, including
risks associated with borrowing funds to undertake exploration activities at an
earlier time.  We increased our base of proven properties and
initiated development activities as oil and natural gas prices
increased.
 
 While our
focus has shifted to include more development activity, we plan to continue our
strategy of acquiring producing properties with additional development,
exploitation and exploration potential.  Our focus has been on
acquiring operated properties (i.e. properties with respect to which we serve as
the operator on behalf of all joint interest owners) so that we can better
control the timing and implementation of capital spending.
 
 Our revenue, profitability and future
growth rate depend substantially on factors beyond our control, such as
economic, political and regulatory developments and competition from other
sources of energy. Oil and natural gas prices historically have been volatile
and may fluctuate widely in the future. Sustained periods of low prices for oil
or natural gas could materially and adversely affect our financial position, our
results of operations, the quantities of oil and natural gas reserves that we
can economically produce and our access to capital.
 
 In a worst case scenario, future
drilling operations could be largely unsuccessful, oil and gas prices could
further decline and/or other factors beyond our control could cause us to
greatly modify or substantially curtail our development plans, which could
negatively impact our earnings, cash flow and most likely the trading price of
our securities, as well as the acceleration of debt repayment and a reduction in
our borrowing base under our credit facilities.
 
 
 
 
 
 29
 
 Results
of Operations
 
 The following table sets forth selected
operating data for the periods indicated:
  For
      the Years Ended December 31,2007
              
              
              2008
              
              
              2009Net
      production:Oil
      (Bbls)
              
              
              1,316,025
              
              
              
              2,018,335
              
              
              
              2,004,498Natural
      gas (Mcf)
              
              
              1,503,612
              
              
              
              1,911,713
              
              
              
              2,172,791Net
      sales:Oil
              
              $
              88,025,225
              
              
              $
              190,050,617
              
              
              $
              115,284,731Natural
      gas
              
              
              12,064,473
              
              
              
              18,808,028
              
              
              
              10,956,046Average
      sales price:Oil
      (per Bbl)
              
              $
              66.82
              
              
              $
              94.16
              
              
              $
              57.51Natural
      gas (per Mcf)
              
              
              8.02
              
              
              
              9.84
              
              
              
              5.04Production
      costs and expensesOil
      and gas production costs
              
              $
              11,500,461
              
              
              $
              17,833,144
              
              
              $
              15,543,461Production
      taxes
              
              
              5,655,877
              
              
              
              10,518,370
              
              
              
              6,455,585Realized
      loss (gain) on oil derivative
              
              
              932,361
              
              
              
              4,275,330
              
              
              
              (14,884,846
              )Depreciation,
      depletion and amortization expense
              
              
              17,968,062
              
              
              
              29,789,794
              
              
              
              38,957,461Accretion
      expense
              
              
              190,904
              
              
              
              309,402
              
              
              
              410,926General
      and administrative expenses
              
              
              7,815,721
              
              
              
              13,557,202
              
              
              
              13,453,384
   30
 Year
Ended December 31, 2009 Compared to Year Ended December 31, 2008
 
 Oil and natural gas
sales.    Oil and natural gas sales revenue decreased
approximately $82.6 million to $126.2 million in 2009.  Oil sales
decreased $74.8 million and natural gas sales decreased $7.8 million. The oil
sales decrease was caused by a 39% decrease in the average realized per barrel
oil price from $94.16 in 2008 to $57.51 in 2009 and a reduction in sales volume
of 13,837 barrels in 2009.  These per barrel amounts are calculated by
dividing revenue from oil sales by the volume of oil sold, in
barrels.  The natural gas sales decrease was caused by a 49% decrease
in the average realized per Mcf gas price from $9.84 in 2008 to $5.04 in 2009,
partially offset by an increase in the sales volume of 261,078 Mcf. These per
Mcf amounts are calculated by dividing revenue from gas sales by the volume of
gas sold, in Mcf.  The volume increase for natural gas primarily
resulted from development of our existing properties in 2009.
 
 Oil and gas production
costs.    Our aggregate oil and gas production costs
decreased from $17,833,144 in 2008 to $15,543,461, and decreased on a Boe basis
from $7.63 in 2008 to $6.57 in 2009.  These per Boe amounts are
calculated by dividing our total production costs by our total volume sold, in
Boe.  This decrease in the aggregate and on a per Boe basis was the
result of lower average costs for services and equipment.
 
 Oil and gas production
taxes.    Oil and gas production taxes as a
percentage of oil and natural gas sales were 5.04% during 2008 and increased
slightly to 5.11% in 2009.  Production taxes vary from state to
state.  Therefore, these taxes are likely to vary in the future
depending on the mix of production we generate from various states, and on the
possibility that any state may raise its production tax.
 
 Realized loss (gain) on oil
derivative.    Realized loss (gain) on oil derivative
changed from a loss of $4,275,330 in 2008 to a gain of $14,884,846 in
2009.  This change is the result of significantly lower prices for the
majority of 2009 as compared to 2008.
 
 Depreciation, depletion and
amortization.    Our depreciation, depletion and
amortization expense increased by $9,269,371 to $39,368,567 in
2009.  The increase was a result of an increase in the average
depreciation, depletion and amortization rate from $12.88 per Boe during 2008 to
$16.63 per Boe during 2009.  These per Boe amounts are calculated by
dividing our total depreciation, depletion and amortization expense by our total
volume sold, in Boe.  The increased depreciation, depletion and
amortization were the result of an increase in estimated future development
costs.
 
 General and administrative
expenses.    General and administrative expenses
remained relatively steady, decreasing by $103,818 to $13,452,384 during
2009. This decrease was primarily related to a decrease in compensation expense
related to our stock option plan, partially offset by increases in other areas,
such as insurance and taxes and fees.
 
 Interest
income.    Interest income decreased $470,947 to
$828,992 in 2009. The decrease was primarily due to lower interest rates between
periods.
 
 Interest
expense.    Interest expense decreased $1,145,456 to
$0 in 2009. The decrease was due to not having any amounts outstanding on our
credit facility during 2009.
 
 Income tax
expense.    Our effective tax rate was 37% during
2008 and 37% during 2009.
 
 Net
income.    Net income decreased from $83,617,201 for
2008 to $42,294,179 for 2009. The primary reason for this decrease was the lower
average crude oil and natural gas prices received between periods.
 
 31
 
 Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
 Oil and natural gas
sales.    Oil and natural gas sales revenue increased
approximately $108.8 million to $208.9 million in 2008.  Oil sales
increased $102.1 million and natural gas sales increased $6.7 million. The oil
sales increase was caused by a sales volume increase of 702,310 barrels in 2008,
and a 41% increase in the average realized per barrel oil price from $66.82 in
2007 to $94.16 in 2008.  These per barrel amounts are calculated by
dividing revenue from oil sales by the volume of oil sold, in
barrels.  The natural gas sales increase was caused by a sales volume
increase of 408,102 Mcf in 2008, and a 23% increase in the average realized per
barrel oil price from $8.02 in 2007 to $9.84 in 2008. These per Mcf amounts are
calculated by dividing revenue from gas sales by the volume of gas sold, in
Mcf.  The volume increase for crude oil and natural gas primarily
resulted from development of our existing properties in 2008.
 
 Oil and gas production
costs.    Our aggregate oil and gas production costs
increased from $11,500,461 in 2007 to $17,833,144, and increased on a Boe basis
from $7.34 in 2007 to $7.63 in 2008.  These per Boe amounts are
calculated by dividing our total production costs by our total volume sold, in
Boe.  This aggregate increase was the result of the drilling of new wells
in 2008 and cost increases.  The increase on a per Boe basis is
attributable to rising rates for labor and services.
 
 Oil and gas production
taxes.    Oil and gas production taxes as a
percentage of oil and natural gas sales were 5.65% during 2007 and decreased to
5.04% in 2008.  Production taxes vary from state to
state.  Therefore, these taxes are likely to vary in the future
depending on the mix of production we generate from various states, and on the
possibility that any state may raise its production tax.
 
 Realized loss on oil
derivative.    Realized loss on oil derivative
increased from $932,361 in 2007 to $4,275,330 in 2008.  This increase
is the result of commodity price increases during most of 2008.
 
 Depreciation, depletion and
amortization.    Our depreciation, depletion and
amortization expense increased by $11,940,230 to $30,099,196 in
2008.  The increase was a result of an increase in the average
depreciation, depletion and amortization rate from $11.59 per Boe during 2007 to
$12.88 per Boe during 2008.  These per Boe amounts are calculated by
dividing our total depreciation, depletion and amortization expense by our total
volume sold, in Boe.  The increased depreciation, depletion and
amortization were the result of increased sales volume and an increase in
estimated future development costs.
 
 General and administrative
expenses.    General and administrative expenses
increased by $5,741,481 to $13,557,202 during 2008. This increase was primarily
related to increases in compensation expense associated with an increase in
personnel required to administer our growth and compensation expense related to
our stock option plan.
 
 Interest
income.    Interest income increased $414,949 to
$1,299,939 in 2008. The increase was due to higher cash balances during periods
of the year in 2008.
 
 Interest
expense.    Interest expense decreased $266,064 to
$1,145,456 in 2008. The increase was due to lower amounts of debt being
outstanding during periods of the year in 2008.
 
 Income tax
expense.    Our effective tax rate was 37% during
2008 and 38% during 2007.
 
 Net
income.    Net income increased from $34,441,939 for
2007 to $83,617,201 for 2008. The primary reasons for this increase include
higher crude oil and natural gas prices between periods and an increase in
volumes sold, partially offset by higher oil and gas production costs, oil and
gas production taxes and general and administrative expenses due to our
growth.
  32
 
 Liquidity
and Capital Resources
 
 Historical
Financing.    We have historically funded our
operations through cash available from operations, and from equity offerings of
our stock and warrants in 2007 and 2008.
 
 Credit
Facility.  In June 2009, we entered into an amended and
restated credit agreement that provides for a credit facility of $150 million
with a borrowing base of $75 million with the structure in place to increase
that borrowing base an additional $75 million.  The new facility has
an interest rate grid with a range of LIBOR plus 2.25% to 3.25%, depending upon
our level of utilization of the credit facility with the total interest rate to
be charged being no less than 4.00%.  All other terms and conditions
that existed under our prior credit facility remained the same.  As of
December 31, 2009, we were in compliance with all covenants and did not have any
amount outstanding under this credit facility.
 
 Cash
Flows.    Our primary sources of cash have been cash
flows from operations and equity offerings.  During the three years
ended December 31, 2009, we generated $349,504,656 from operating activities and
financed $222,388,933 through proceeds from the sale of stock and warrants and
exercise of warrants and options. We primarily used this cash generation to fund
our capital expenditures and development aggregating $497,777,217 over the three
years end December 31, 2009.  At December 31, 2009, we had cash on
hand of $63,635,078 and working capital of $62,398,985, compared to December 31,
2008 when our cash was $58,489,574 and working capital of
$69,740,590.
 
 We
continually evaluate our capital needs and compare them to our capital
resources. We will closely manage our capital expenditures to our cash
flow.   As commodity prices change we will consider the resulting
impact on our cash flow and adjust our capital expenditures accordingly, be it
up or down.    The level of capital expenditures is largely
discretionary, and the amount of funds devoted to any particular activity may
increase or decrease significantly depending on available opportunities,
commodity prices, cash flows and development results, among others.
 
 Schedule of Contractual
Obligations.   The following table summarizes our future
estimated lease payments for periods subsequent to December 31,
2009.  This lease pertains to an office building in Midland, Texas and
involves approximately 1,869 square feet of space.
  Year
                
                Lease
      Obligation2010
                
                
                20,7152011
                
                
                21,6492012
                
                
                22,5842013
                
                
                19,469$
                84,417
  Off-Balance Sheet Financing
Arrangements
 
 As of December 31, 2009 we had no
off-balance sheet financing arrangements.
 
 Critical
Accounting Policies and Estimates
 
 Our
discussion of financial condition and results of operations is based upon the
information reported in our financial statements. The preparation of these
statements requires us to make assumptions and estimates that affect the
reported amounts of assets, liabilities, revenues and expenses as well as the
disclosure of contingent assets and liabilities at the date of our financial
statements. We base our assumptions and estimates on historical experience and
other sources that we believe to be reasonable at the time. Actual results may
vary from our estimates due to changes in circumstances, weather, politics,
global economics, mechanical problems, general business conditions and other
factors. Our significant accounting policies are detailed in Note 1 to our
financial statements included in this Annual Report. We have outlined below
certain of these policies as being of particular importance to the portrayal of
our financial position and results of operations and which require the
application of significant judgment by our management.
 
 33
 
 Revenue
Recognition.    We predominantly derive our revenue
from the sale of produced crude oil and natural gas. Revenue is recorded in the
month the product is delivered to the purchaser. We receive payment from one to
three months after delivery. At the end of each month, we estimate the amount of
production delivered to purchasers and the price we will receive. Variances
between our estimated revenue and actual payment are recorded in the month the
payment is received; however, differences have been insignificant.
 
 Full Cost Method of
Accounting.    We account for our oil and natural gas
operations using the full cost method of accounting. Under this method, all
costs associated with property acquisition, exploration and development of oil
and gas reserves are capitalized. Costs capitalized include acquisition costs,
geological and geophysical expenditures, lease rentals on undeveloped properties
and cost of drilling and equipping productive and non-productive
wells.  Drilling costs include directly related overhead costs. All of
our properties are located within the continental United States.
 
 Oil and Natural Gas Reserve
Quantities.    Reserve quantities and the related
estimates of future net cash flows affect our periodic calculations of depletion
and impairment of our oil and natural gas properties. Proved oil and natural gas
reserves are the estimated quantities of crude oil, natural gas and natural gas
liquids which geological and engineering data demonstrate with reasonable
certainty to be recoverable in future periods from known reservoirs under
existing economic and operating conditions. Reserve quantities and future cash
flows included in this Annual Report are prepared in accordance with guidelines
established by the SEC and FASB. The accuracy of our reserve estimates is a
function of:
 
 ·
              the
      quality and quantity of available data;
 ·
              the
      interpretation of that data;
 ·
              the
      accuracy of various mandated economic assumptions; and
 ·
              the
      judgments of the persons preparing the
  estimates.
 
 Our
proved reserve information included in this Annual Report were based on internal
reports and audited by Williamson Petroleum Consultants, Inc., independent
petroleum engineers.   Because these estimates depend on many
assumptions, all of which may differ substantially from actual results, reserve
estimates may be different from the quantities of oil and natural gas that are
ultimately recovered. We continually make revisions to reserve estimates
throughout the year as additional properties are acquired. We make changes to
depletion rates and impairment calculations in the same period that changes to
the reserve estimates are made.
 
 All
capitalized costs of oil and gas properties, including estimated future costs to
develop proved reserves and estimated future costs of site restoration, are
amortized on the unit-of-production method using estimates of proved reserves as
determined by independent engineers.  Investments in unproved
properties and major development projects are not amortized until proved
reserves associated with the projects can be determined.
 
 34
 
 Impairment of Oil and Natural Gas
Properties.    We review the value of our oil and
natural gas properties whenever management judges that events and circumstances
indicate that the recorded carrying value of properties may not be recoverable.
We provide for impairments on undeveloped property when we determine that the
property will not be developed or a permanent impairment in value has occurred.
Impairments of proved producing properties are calculated by comparing future
net undiscounted cash flows using escalated prices to the net recorded book cost
at the end of each period (“Ceiling test”). If the net capitalized cost exceeds
net future cash flows, the cost of the property is written down to “fair value,”
which is determined using net discounted future cash flows from the producing
property. Current market conditions, in the form of low commodity prices, have
had a dramatic effect on this calculation.  The net discounted future
cash flow from producing properties is directly impacted by commodity
prices.  Different pricing assumptions or discount rates could result
in a different calculated impairment.  We have never recorded property
impairments as a result of the ceiling test.
  Our
reserve estimates as of December 31, 2009 are based on an average price of
$57.628 for oil and $4.904 for gas.  We have run an impairment test
analysis to determine at approximately what price level impairment would
result.  Because our reserves are predominantly oil, at approximately
85% of total reserves, this analysis was based solely on the oil price while
leaving gas prices at the levels used for preparing the reserve estimates as of
December 31, 2009.  Based on this analysis, our contracted oil price
would have to drop below $37 per barrel for the ceiling test to result in
impairment to our producing properties.
 
 Income
Taxes.    Deferred income taxes are provided for the
difference between the tax basis of assets and liabilities and the carrying
amount in our financial statements. This difference will result in taxable
income or deductions in future years when the reported amount of the asset or
liability is settled. Since our tax returns are filed after the financial
statements are prepared, estimates are required in valuing tax assets and
liabilities. We record adjustments to actual in the period we file our tax
returns.
 
 Derivative
Instruments.    The estimated fair values of our
commodity derivative instruments are recorded in the consolidated balance sheet.
At inception, all of our commodity derivative instruments represent hedges of
the price of future oil and gas production. The changes in fair value of those
derivative instruments that qualify for hedge accounting treatment are recorded
in other comprehensive income until the hedged oil or natural gas quantities are
produced. If a hedge becomes ineffective because the hedged production does not
occur, or the hedge otherwise does not qualify for hedge accounting treatment,
the changes in the fair value of the derivative are recorded in the income
statement as derivative income or expense.
 
 Our
hedges are specifically referenced to NYMEX prices. We evaluate the
effectiveness of our hedges at the time we enter the contracts, and periodically
over the life of the contracts, by analyzing the correlation between NYMEX
prices and the posted prices we receive from our designated production. Through
this analysis, we are able to determine if a high correlation exists between the
prices received for the designated production and the NYMEX prices at which the
hedges will be settled.
 
 Effects
of Inflation and Pricing
 
 We experienced increases and decreases
in costs during 2009 due to fluctuating demand for oil field products and
services as a result of fluctuating oil and gas prices.  The oil and
natural gas industry is very cyclical and the demand for goods and services of
oil field companies, suppliers and others associated with the industry puts
extreme pressure on the economic stability and pricing structure within the
industry. Typically, as prices for oil and natural gas increase, so do all
associated costs.  Material changes in prices impact the current
revenue stream, estimates of future reserves, borrowing base calculations of
bank loans and value of properties in purchase and sale transactions. Material
changes in prices can impact the value of oil and natural gas companies and
their ability to raise capital, borrow money and retain personnel. We anticipate
business costs will vary in accordance with commodity prices for oil and natural
gas, and the associated increase or decrease in demand for services related to
production and exploration.
 
 35
 
 Item
7AQuantitative and Qualitative
Disclosure About Market Risk
 
 Commodity
Price Risk
 
 Our major
market risk exposure is in the pricing applicable to our oil and natural gas
production. Market risk refers to the risk of loss from adverse changes in oil
and natural gas prices. Realized pricing is primarily driven by the prevailing
domestic price for crude oil and spot prices applicable to the region in which
we produce natural gas. Historically, prices received for oil and natural gas
production have been volatile and unpredictable. We expect pricing volatility to
continue. Oil prices we received during 2009 ranged from a low of $30.87 per
barrel to a high of $74.81 per barrel. Natural gas prices we received during
2009 ranged from a low of $0.72 per Mcf to a high of $11.92 per Mcf. A
significant decline in the prices of oil or natural gas could have a material
adverse effect on our financial condition and results of
operations.
 
 As of December 31, 2009 the Company’s
only derivative contracts are costless collars.  A collar is a
contract which combines both a put option or “floor” and a call option or
“ceiling.”  The Company receives the excess, if any, of the floor
price over the reference price, based on NYMEX quoted prices, and pays the
excess, if any, of the reference price over the ceiling price.  The
following is information relating to the Company’s collar position as of
December 31, 2009.
 
 Commodity
              Remaining
      Period
              
              Volume
      (Bbls)
              
              
              Floor
              
              
              CeilingWTI
      Crude Oil
              January
      2010 - December 2010
              
              
              730,000
              
              
              $
              65.00
              
              
              $
              93.00WTI
      Crude Oil
              January
      2010 - December 2010
              
              
              365,000
              
              
              $
              70.00
              
              
              $
              92.85Commodity
              Remaining
      Period
              
              Volume
      (MMBTU)
              
              
              Floor
              
              
              CeilingEl
      Paso Permian Gas
              January
      2010 - December 2010
              
              
              1,825,000
              
              
              $
              4.00
              
              
              $
              7.87
 
 There
were no hedges in effect as of December 3 1, 2009,
therefore the Company did not record an asset or a liability.  The
after tax impact of the change in the fair value of the hedge of $10,212,601 is
reflected in other comprehensive income as unrealized gain on oil derivative for
the period ended December 31, 2009.  Changes in the fair value of
derivative instruments designated as cash flow hedges, to the extent they are
effective in offsetting cash flows attributable to the hedged risk, are recorded
in other comprehensive income until the hedged item is recognized in
earnings.  Any change in fair value from ineffectiveness is recognized
currently in unrealized derivative gain or loss in the consolidated statements
of operations.
 
 Cash settlements of cash flow hedges
are recorded as a gain or loss on derivatives in the operating section of the
Company’s statement of operations.  Our statement of operations
includes a gain on derivative instruments of $14,884,846 for 2009 and a loss on
derivative instrument of $4,275,330 for 2008 and $932,361 for 2007.
 
 Interest
Rate Risk
 
 Our
current credit facility has a floating interest rate.  Therefore, if
we draw funds on this credit facility, interest rate changes will impact future
results of operations and cash flows.
 
 Item
8:Financial Statements and
Supplementary Data
 
 The
financial statements and supplementary data required by this item are included
at page 53.
 Item
9:Changes in and Disagreements
with Accountants And Accounting and Financial
Disclosure
  None.
 
 36
 
 Item
9A:Controls and
Procedures
 
 Evaluation of Disclosure
Controls and Procedures.
 
 We maintain controls and procedures
designed to ensure that information required to be disclosed in the reports that
we file or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission. As of the end of the
fiscal year ended December 31, 2009, our chief executive officer and chief
financial officer evaluated the effectiveness of our disclosure controls and
procedures. Based upon their evaluation of those controls and procedures, the
chief executive officer and the chief financial officer of the Company concluded
that as of the end of such period our disclosure controls and procedures are
effective in alerting them to material information in a timely manner that is
required to be included in the reports we file or submit under the Securities
Exchange Act of 1934.
 
 Management’s Annual Report
on Internal Control Over Financial Reporting.
 
 Our management is responsible for
establishing and maintaining adequate internal controls over financial
reporting.  Our internal control system was designed to provide
reasonable assurance to our management and Board of Directors regarding the
preparation and fair presentation of published financial
statements.
 
 All internal control systems, no matter
how well designed, have inherent limitations.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.
 
 In making our assessment of internal
control over financial reporting, our management used the criteria issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework.  Based on our assessment, we believe that, as of
December 31, 2009, our internal control over financial reporting is effective
based on those criteria.
 
 Hansen, Barnett & Maxwell, P.C.,
our independent registered public accounting firm, has issued an attestation
report on management’s assessment of Arena’s internal control over financial
reporting.
 
 Date:  March
1, 2010
  
  /s/ Phillip W.
      TerryChief
      Executive Officer/s/ William R.
      BroaddrickChief
      Financial Officer
 
 37
 
    HANSEN,BARNETT& MAXWELL,
      P.C.

                  A Professional
      Corporation
                  CERTIFIED PUBLIC ACCOUNTANTS
                  5 Triad Center, Suite 750
                  Salt
      Lake City, UT 84180-1128
                  Phone: (801) 532-2200
                  Fax: (801) 532-7944
                  www.hbmcpas.com
                Registered
      with the Public Company
                  Accounting Oversight
      Board
                  
                  graphic
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  To the
Board of Directors and Stockholders
   
 We have
audited Arena Resources, Inc.’s internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Arena Resources, Inc.’s management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on the Company’s internal control
over financial reporting based on our audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
 
 A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
 
 Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
 
 In our
opinion, Arena Resources, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
  We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the balance sheets and the related statements
of operations and comprehensive income, stockholders’ equity, and cash flows of
Arena Resources, Inc. and our report dated March 1, 2010 expressed an
unqualified opinion thereon.
   /s/
      HANSEN, BARNETT & MAXWELL,
P.C.
 Salt Lake
City, Utah
 March 1, 2010
  38
 
 Changes in Internal Control
Over Financial Reporting
 
 We made
no change in our internal control over financial reporting during our fourth
quarter of 2009 that has materially affected, or is reasonably likely to
materially affect our internal control over financial reporting.
 
 Item
9B:Other Information
 
 None
          39
  PART
III
 
 Item
10:Directors, Executive
Officers and Corporate Governance
 
 Executive
Officers and Directors
 
 The following table sets forth
information regarding our executive officers, certain other officers and
directors as of December 31, 2009:
  Name
                
                Age
                
                PositionLloyd
      T. Rochford
                
                63
                
                Chairman
      of the Board of DirectorsPhillip
      W. Terry
                
                62
                
                President
      and Chief Executive OfficerWilliam
      R. Broaddrick
                
                32
                
                Vice
      President and Chief Financial OfficerDavid
      D. Ricks
                
                49
                
                Vice
      President of OperationsStanley
      M. McCabe
                
                77
                
                DirectorClayton
      E. Woodrum
                
                69
                
                DirectorAnthony
      B. Petrelli
                
                57
                
                DirectorCarl
      H. Fiddner
                
                64
                
                Director
 Each of
the directors identified above were elected for a term of one year (or until
their successors are elected and qualified) at our annual meeting of
shareholders in December 2009.
 
 Messrs.
Rochford and McCabe have served as directors since our inception in August
2000.  Mr. Woodrum has served as a member of our Board since
2003.  Mr. Petrelli was elected to the Board by the remaining members
of the Board of Directors in January 2007 to fill the vacancy left by the death
of Mr. Chris V. Kemendo, Jr.  Mr. Fiddner was elected to the Board by
the remaining members of the Board of Directors on May 1, 2007, to fill the
vacancy left by the resignation of Charles Crawford.
 
 The
following biographies describe the business experience of our executive officers
and directors:
 
 Lloyd
T. Rochford – Chairman of the Board of Directors.
  Mr. Rochford, 63, has been active as
an individual consultant and entrepreneur in the oil and gas industry since
1973. In this capacity, he has primarily been engaged in the organization and
funding of private oil and gas drilling and completion projects and ventures
within the mid-continent region of the United States. In 1990 Mr. Rochford was
co-founder, director and CEO of a public company known as Magnum Petroleum, Inc.
(Magnum) which was listed on the New York Stock Exchange. Subsequently, Magnum
acquired Hunter Resources, Inc. in August, 1995. Mr. Rochford served as Chairman
of the Board of the combined companies from August, 1995 to June, 1997. From
July, 1997 until he committed to participate in Arena Resources, Mr. Rochford
had primarily devoted his time and efforts to individual oil and gas acquisition
and development.  In 1982, Mr. Rochford was co-founder of Dana Niguel
Bank, a publicly held California bank operation and served as a director until
1994. Mr. Rochford attended various college level courses in business from 1967
to 1970 in California.
 
 Phillip
W. Terry – President and Chief Executive Officer.
 
 Mr. Terry, 62, has served as
President and Chief Operating Officer since February 1, 2007 and as Chief
Executive Officer since May 20, 2008.  Mr. Terry joined the Company in
April 2003, and since that time he has been in charge of all engineering and
field operations. Immediately prior to joining the Company, Mr. Terry owned and
operated an independent petroleum engineering consulting firm. The Company was
one of his clients. In 2001 and 2002, Mr. Terry was Vice President of Drilling
and Production for Bird Creek Resources, Inc. Mr. Terry received his Bachelor of
Science degree in Mechanical Engineering from Oklahoma State University in 1970,
and is a registered Professional Petroleum Engineer with over 35 years
experience in engineering, production, drilling, completions, reservoir
engineering, property evaluations and corporate management in the oil and gas
industry.
 
 40
 
 William
R. Broaddrick – Vice President and Chief Financial Officer.
 
 Mr. Broaddrick, 32, was employed from
1997 to 2000 with Amoco Production Company, performing lease revenue accounting
and state production tax regulatory reporting functions.  During 2000,
Mr. Broaddrick was employed by Duke Energy Field Services, LLC performing state
production tax functions.  In September 2001, Mr. Broaddrick joined us
as chief accountant, and effective February 1, 2002, assumed responsibilities as
Vice President and Chief Financial Officer.
 
 Mr. Broaddrick received a Bachelor’s
Degree in Accounting from Langston University, through Oklahoma State University
– Tulsa, in 1999.  Mr. Broaddrick is a Certified Public
Accountant.
 
 David
D. Ricks – Vice President of Operations.
 
 Mr. Ricks, 49, joined the Company in
November 2007 as Vice President of Operations, he has over 28 years of petroleum
industry experience. Mr. Ricks began his career in 1982 as a production engineer
in Southeast New Mexico for Gulf Oil Co. Since then he has served in various
engineering capacities for Chevron USA, Amerada Hess Corp., Citation Oil and Gas
Corp., Newfield Exploration Mid-Continent, Inc., Apache Corp., and Latigo
Petroleum, Inc. His duties ranged from maintaining production, designing
workovers and recompletions and facility installation, to field supervision of
both primary and secondary production, including waterfloods and CO2 floods,
primarily in Oklahoma, North and West Texas and Southeast New
Mexico.
 
 Stanley
M. McCabe –Director.
 
 Mr. McCabe, 77, served from 1979 to
1989, as Chairman and CEO of Stanton Energy, Inc., a Tulsa, Oklahoma natural
resource company specializing in contract drilling and operation of oil and gas
wells. In 1990, Mr. McCabe also became a co-founder and subsequently an officer
and director of Magnum Petroleum, Inc., along with Mr. Rochford as previously
discussed. Subsequently, Mr. McCabe served as a director of Magnum Hunter
Resources, Inc., through December, 1996. From January, 1997, until he committed
to participate in Arena Resources, Mr. McCabe had primarily devoted his time and
efforts to individual oil and gas acquisition and development. Mr. McCabe
attended college courses at the University of Maryland, primarily in business,
in 1961 and 1962.
 
 Clayton
E. Woodrum – Director.
 
 Mr. Woodrum, 69, is a Certified Public
Accountant and has, from 1984 to present, been a principal shareholder in the
accounting firm of Woodrum, Kemendo, Tate & Westemeir, P.L.L.C., and has
been an owner of Computer Data Litigation Services, LLC and First Capital
Management, LLC.  Mr. Woodrum is currently the Chairman of our audit
committee and compensation committee.  From 1965 to 1975, Mr. Woodrum
was employed by Peat, Marwick, Mitchell & Co., serving as partner in charge
of the tax department during the final two years.  From 1975 to 1980
he served as CFO for BancOklahoma Corp. and Bank of Oklahoma.  From
1980 to 1984 Mr. Woodrum served as a partner in charge of the tax department at
Peat, Marwick, Mitchell & Co.
 
 41
 
 Anthony
B. Petrelli – Director.
 
 Mr.
Petrelli, 57, was elected to the Board by the remaining members of the Board of
Directors in January 2007 to fill the vacancy left by the death of Mr. Chris V.
Kemendo, Jr.  Since 1987 Mr. Petrelli has been with the firm of
Neidiger Tucker Bruner, Inc., which firm served as one of the lead underwriters
in our secondary registration of common stock in August of 2004.  Mr.
Petrelli is currently a Director and Senior Vice President of such
firm.  From August 2007 until June 2009, Mr. Petrelli also served on
the Board of Directors of XLR8 Inc., which had a class of securities registered
with the Securities and Exchange Commission.  Also, between January
2006 and March 2007 Mr. Petrelli also served on the Board of Directors of
Whitney Information Network, Inc., which has a class of securities registered
with the Securities and Exchange Commission.
 
 Carl
H. Fiddner – Director.
 
 Mr.
Fiddner, 64, joined to the Board in May 2007, to fill the vacancy left
by the resignation of Charles Crawford.  Mr. Fiddner is a certified
public accountant who managed his own public accounting firm for 25 years, prior
to joining Regier, Carr & Monroe, in Tulsa, Oklahoma, in December 2005. Mr.
Fiddner worked at Regier, Carr & Monroe through September 30, 2007 at which
time he became an independent financial consultant.
 
 Our
executive officers are elected by, and serve at the pleasure of, our Board of
Directors. Our directors serve terms of one year each, with the current
directors serving until the 2010 annual meeting of stockholders, and in each
case until their respective successors are duly elected and
qualified.
 
 Board
Committees
 
 Our Board
of Directors has established an Audit Committee, a Compensation Committee and a
Nominating and Corporate Governance Committee, the composition and
responsibilities of which are briefly described below.  The charters
for each of these committees can be found on our website
(www.arenaresourcesinc.com).  We shall also provide any person without
charge, upon request, a copy of the charters for each of these
committees.  Requests may be directed to Arena Resources, Inc., 6555
S. Lewis Ave., Tulsa, Oklahoma 74136, attention William R. Broaddrick, or by
calling (918) 747-6060.
 
 The Audit
Committee’s principal functions are to assist the Board in monitoring the
integrity of our financial statements, the independent auditor’s qualifications
and independence, the performance of our independent auditors and our compliance
with legal and regulatory requirements. The Audit Committee has the sole
authority to retain and terminate our independent auditors and to approve the
compensation paid to our independent auditors. The Audit Committee is also
responsible for overseeing our internal audit function. During 2009, the Audit
Committee was comprised of our three independent directors, Messrs. Woodrum,
Petrelli and Fiddner, with Mr. Woodrum acting as the chairman.  Our
Board of Directors determined that both Messrs. Woodrum and Fiddner qualified as
“audit committee financial experts” under the rules of the SEC adopted pursuant
to requirements of the Sarbanes-Oxley Act of 2002 (see the biographical
information for Messrs. Woodrum and Fiddner, infra, in this discussion of
“Directors and Executive Officers”). Each of Messrs. Woodrum, Petrelli and
Fiddner further qualified as “independent” in accordance with the applicable
regulations adopted by the SEC and Section 303A.02 of the New York Stock
Exchange Corporate Governance Standards.  (see the biographical
information for Messrs. Woodrum, Petrelli and Fiddner, infra, in this discussion
of “Directors and Executive Officers”).
 
 The
Compensation Committee’s principal function is to make recommendations regarding
the compensation of the Company’s officers.  In accordance with the
rules of the New York Stock Exchange, the compensation of our chief executive
officer is recommended to the Board (in a proceeding in which the chief
executive officer does not participate) by the Compensation
Committee.  Compensation for all other officers is also recommended to
the Board for determination, by the Compensation Committee.  During
2009, the Compensation Committee was comprised of our three independent
directors, Messrs. Woodrum, Petrelli and Fiddner, with Mr. Woodrum acting as the
chairman.
 
 42
 
 The
Nominating and Corporate Governance Committee’s principal functions are to (a)
identify and recommend qualified candidates to the Board of Directors for
nomination as members of the Board and its committees, and (b) develop and
recommend to the Board corporate governance principles applicable to the
Company.  During 2009, the Compensation Committee was comprised of our
three independent directors, Messrs. Woodrum, Petrelli and Fiddner, with Mr.
Woodrum acting as the chairman.
 
 There
have been no material changes to the procedures by which security holders may
recommend nominees to our Board of Directors.
 
 Our Board
may establish other committees from time to time to facilitate our
management.
 
 Code
of Ethics
 
 We have adopted a code of ethics (our
Code of Business Conduct) that applies to our principal executive officer,
principal financial officer and principal accounting officer or persons
performing similar functions (as well as our other employees and
directors).  The Code of Business Conduct can be found on our website
(www.arenaresourcesinc.com).  We
shall also provide any person without charge, upon request, a copy of such Code
of Business Conduct.  Requests may be directed to Arena Resources,
Inc., 6555 S. Lewis Ave., Tulsa, Oklahoma 74136, attention William R.
Broaddrick, or by calling (918) 747-6060.
 
 Section
16(a) Beneficial Ownership Reporting Compliance
 
 Based solely upon a review of Forms 4
furnished to us during our most recent fiscal year, we know of no director,
officer or beneficial owner of more than ten percent of our common stock who
failed to file on a timely basis reports of beneficial ownership of the our
common stock as required by Section 16(a) of the Securities Exchange Act of
1934, as amended, other than the following:
 
 William R. Broaddrick (Chief
Financial Officer) filed two Form 4’s late (one day each).
 
 Lloyd T. Rochford (Chairman of the
Board) filed two Form 4’s late (one day and two days).
 
 David D. Ricks (Vice President of
Operations) filed a Form 4 late (regarding the grant of 470 shares pursuant to a
restricted stock grant – 13 days).
 
 Item
11:Executive
Compensation
 
 Compensation
Discussion & Analysis
 
 This
section contains a discussion of the material elements of compensation awarded
to, earned by or paid to our principal executive and principal financial
officers, and our other three most highly compensated executive officers and
employees.  These individuals are referred to as the (“Named
Officers”) in this Annual Report on Form 10-K.
 
 Our
current executive compensation programs are determined and approved by our
Compensation Committee, after consideration of recommendations by our Chairman
of the Board and our Chief Executive Officer, as to the other Named Officers.
None of the Named Officers are members of the Compensation
Committee.  The Compensation Committee has the direct responsibility
and authority to review and approve the Company’s goals and objectives relative
to the compensation of the Named Officers, and to determine and approve (either
as a committee or with the other members of the Company’s Board of Directors who
qualify as “independent” directors under applicable guidelines adopted by the
New York Stock Exchange) the compensation levels of the Named
Officers.
 
 43
 
 Our
current executive compensation programs are intended to achieve two
objectives.  The primary objective is to enhance the profitability of
the Company, and thus shareholder value. The second objective is to attract,
motivate, reward and retain employees, including executive personnel, who
contribute to the long-term success of the Company.  As described in
more detail below, the material elements of our current executive compensation
program for Named Officers include a base salary, discretionary annual bonuses
and discretionary stock options grants.
 
 The
Company believes that each element of the executive compensation program helps
to achieve one or both of the compensation objectives outlined
above.  The table below lists each material element of our executive
compensation program and the compensation objective or objectives that it is
designed to achieve.
 
 Compensation
      Element
              
              Compensation
      Objectives Attempted to be AchievedBase
      Salary
              
              Attract
      and retain qualified executive’s
                Motivate
      and reward executives performanceBonus
      Compensation
              
              Motivate
      and reward executive’s performance
                Enhance
      profitability of Company and shareholder valueEquity-Based
      Compensation – stock options and restricted stock grants
              
              Enhance
      profitability of Company and shareholder value by aligning long-term
      incentives with shareholders’ long-term interests
 
 As
illustrated by the table above, base salary is primarily intended to attract and
retain qualified executives.  This is the element of the Company’s
current executive compensation program where the value of the benefit in any
given year is not wholly dependent on performance. Base salaries are intended to
attract and retain qualified executives as well as being linked to performance
by rewarding and/or motivating executives.  Base salaries are reviewed
annually and take into account: experience and retention considerations; past
performance; improvement in historical performance; anticipated future potential
performance; and other issues specific to the individual executive.
 
 There are
specific elements of the current executive compensation program that are
designed to reward performance and enhance profitability and shareholder value,
and therefore the value of these benefits is based on
performance.  The Company’s discretionary annual bonus plan is
primarily intended to motivate and reward Named Officers’ performance to achieve
specific strategies and operating objectives, as well as improved financial
performance.
 
 The
Compensation Committee, with input from both Messrs. McCabe and Rochford,
considers the salaries of comparable executives of peer companies for which such
information is publicly available.  The Compensation Committee
believes that bonuses and equity compensation should fluctuate with the
Company’s success in achieving financial, operating and strategic
goals.  The Committee’s philosophy is that the Company should continue
to use long-term compensation such as stock options to align shareholder and
executives’ interests and should allocate a portion of long-term compensation to
the entire executive compensation package.
 
 The
Company has never retained an outside consultant in establishing its
compensation program or in establishing any specific compensation for an
executive officer.
 
 44
 
 Current
Executive Compensation Program Elements
 
 Base
Salaries
 
 Similar
to most companies within the industry, our policy is to pay Named Officers’ base
salaries in cash.   Effective August 1, 2009, the Compensation
Committee increased salaries for Named Officers by an aggregate of
$60,000.  The raises were to Messrs. David R. Ricks, Thomas W. Wahl
and William C. Gaines, raising Mr. Ricks individual base salary to $200,000 and
raising Messrs. Wahl and Gaines individual base salaries to $150,000
each.  In approving these salary increases, the Committee took into
account factors including, peer group comparisons available to the Committee,
each executive’s individual experience and increased responsibilities and
improved performance for the Company.
 
 Annual
Bonuses
 
 In the
past, the Company has not had a formal policy regarding bonuses, and payment of
bonuses has been purely discretionary and is largely based on the
recommendations of the Chairman of the Board and the Chief Executive Officer
(except as to themselves).  In the recent past, annual bonuses have
been established as a percentage of each employee’s base salary.  The
Compensation Committee may reduce or increase the size of the payout for each
individual Named Officer at their discretion.  Cash bonuses were
declared and paid out in July and December of 2009 for all five of the Named
Officers.  Cash bonuses are not a significant portion of the executive
compensation package.  The annual discretionary bonus is reported in
the “Bonus” column of the “Summary Compensation Table” for each Named
Officer.
 
 Perquisites
 
 The
Company currently provides a vehicle allowance for some of its employees,
including two of the Named Officers.  Perquisites are reported in the
“All Other Compensation” column of the “Summary Compensation Table’ for each
Named Officer, if applicable.
 
 Equity-Based
Compensation – Restricted Stock Grants
 
 The
Company does not have a formal policy regarding granting of restricted stock,
and granting of stock is discretionary and is largely based on the
recommendations of the Chairman of the Board and the Chief Executive Officer
(except as to themselves).  In 2009, restricted stock was granted in
conjunction with the cash bonus declared and paid in December, to three of the
Named Officers.  Restricted stock grants are not a significant portion
of the executive compensation package.  The grant date fair value, as
determined under generally accepted accounting principles, of the annual
discretionary bonus is reported in the “Stock Grant” column of the “Summary
Compensation Table” for each Named Officer.
 
 Equity-Based
Compensation - Options
 
 It is our
policy that the Named Officers’ long-term compensation should be directly linked
to enhancing profitability and value provided to shareholders of the Company’s
common stock.  Accordingly, the Compensation Committee, (upon the
recommendation of Messrs. McCabe and Rochford, with respect to grants of options
other than to themselves) grants equity awards under the Company’s stock option
plan designed to link an increase in shareholder value to
compensation.  All of the Named Officer’s equity-based compensation
opportunity was awarded in the form of the Company’s non-qualified stock
options.  Stock option grants are valued using the Black-Scholes Model
and are calculated as a part of the executive compensation package for the year
based on the amount of requisite service period served.  Non-qualified
stock options for Named Officers and other key employees generally vest ratably
over five years.  The Compensation Committee believes that these
awards encourage Named Officers to continue to use their best professional
skills and to retain Named Officers for longer terms.
 
 45
 
 Grants
are determined for Named Officers based on his or her performance in the prior
year, his or her expected future contribution to the performance of the Company,
and other competitive data on grant values of peer companies.  Awards
may be granted to new key employees or Named Officers on hire date. Other grant
date determinations are made by the Compensation Committee, which is based upon
the date the Committee met and proper communication was made to the Named
Officer or key employee as defined in the definition of grant date by generally
accepted accounting principles.   Exercise prices are equal to
the value of the Company’s stock on the close of business on the determined
grant date.  The Company has no program or practice to coordinate
timing of grants with release of material, nonpublic information.
 
 The grant
date fair value as determined under generally accepted accounting principles is
shown in the “Summary Compensation Table” below.
  Compensation
Committee’s Report on Executive Compensation (1)
 
 Among the
duties imposed on our Compensation Committee under its charter, is the direct
responsibility and authority to review and approve the Company’s goals and
objectives relevant to the compensation of the Company’s Chief Executive Officer
and other executive officers, to evaluate the performance of such officers in
accordance with the policies and principles established by the Compensation
committee and to determine and approve, either as a Committee, or (as directed
by the Board) with the other “independent” Board members (as defined by the New
York Stock Exchange listing standards), the compensation level of the Chief
Executive Officer and the other executive officers.  During 2009 the
Compensation Committee was composed of the three non-employee Directors named at
the end of this report each of whom is “independent” as defined by the New York
Stock Exchange listing standards.
 
 The
Compensation Committee has reviewed and discussed with management the
disclosures contained in the Compensation Discussion and Analysis section of
this Item 11.  Based upon this review and our discussions, the Arena
Resources, Inc. Compensation Committee recommended to its Board of Directors
that the Compensation Discussion and Analysis section be included in this annual
report on Form 10-K.
 
 Compensation
Committee of the Board of Directors
 Clayton
E. Woodrum (Chair)
 Anthony
B. Petrelli
 Carl H.
Fiddner
 _____________________
 (1)  SEC
filings sometimes “incorporate information by reference.” This means the Company
is referring you to information that has previously been filed with the SEC, and
that this information should be considered as part of the filing you are
reading.  Unless the Company specifically states otherwise, this
Compensation Committee Report shall not be deemed to be incorporated by
reference and shall not constitute soliciting material or otherwise be
considered filed under the Securities Act of 1933 as amended, or the Securities
Exchange act of 1934, as amended.
 
 Compensation
Committee’s Interlocks and Insider Participation
 
 The
Compensation Committee members whose names appear above were committee members
during 2009.  No member of the Compensation Committee is or has been a
former or current Named Officer of the Company or had any relationships
requiring disclosure by the Company under the SEC’s rules requiring disclosure
of certain relationships and related-party transactions. None of our Named
Officers identified herein served as a director or a member of a compensation
committee (or other committee serving an equivalent function) of any other
entity.
 
 46
 
 Compensation
of Named Officers
 
 The
“Summary Compensation Table” set forth below should be read in connection with
the tables and narrative descriptions that follow.  The “Outstanding
Equity Awards at Fiscal Year End Table” and “Option Exercises and Stock Vested
Table” provide further information on the Named Officers’ potential realizable
value and actual value realized with respect to their equity
awards.
 
 The
Company does not have any pension plans, non-qualified deferred compensation
plans or severance, retirement, termination,
constructive termination or change in control arrangements for any of its Named
Officers for the year ended December 31, 2009.
  Summary
      Compensation TableName
      and Principal Position
                Year
                
                Salary
      ($)
                
                
                Bonus
      ($)
                
                
                Stock
      Grants (1)($)
                
                
                Option
      Awards (2)($)
                
                
                All
      Other Compensation ($)
                
                
                Total
      ($)Phillip
      W. Terry, President and
                2007
                
                $
                164,167
                
                
                $
                16,000
                
                
                $
                -
                
                
                
                3,863,309
                
                
                $
                12,408
                (3
                )
                
                
                4,055,884Chief
      Executive Officer
                2008
                
                
                250,000
                
                
                
                25,000
                
                
                
                -
                
                
                
                -
                
                
                
                20,750
                (3
                )
                
                
                295,7502009
                
                
                250,000
                
                
                
                25,000
                
                
                
                -
                
                
                
                -
                
                
                
                32,200
                (3
                )
                
                
                307,200William
      R. Broaddrick,
                2007
                
                
                89,583
                
                
                
                9,000
                
                
                
                -
                
                
                
                1,557,976
                
                
                
                1,400
                (5
                )
                
                
                1,657,959Vice
      President and
                2008
                
                
                100,008
                
                
                
                10,000
                
                
                
                -
                
                
                
                -
                
                
                
                4,500
                (5
                )
                
                
                114,508Chief
      Financial Officer
                2009
                
                
                100,008
                
                
                
                10,000
                
                
                
                -
                
                
                
                -
                
                
                
                6,000
                (5
                )
                
                
                116,008David
      R. Ricks, Vice President
                2007
                
                
                28,500
                
                
                
                1,425
                
                
                
                -
                
                
                
                714,645
                
                
                
                4,230
                (4
                )
                
                
                748,800of
      Operations
                2008
                
                
                190,072
                
                
                
                19,000
                
                
                
                -
                
                
                
                915,270
                
                
                
                27,523
                (4
                )
                
                
                1,151,8652009
                
                
                195,995
                
                
                
                29,750
                
                
                
                20,257
                
                
                
                -
                
                
                
                33,897
                (4
                )
                
                
                279,899Thomas
      W. Wahl,
                2007
                
                
                50,000
                
                
                
                2,633
                
                
                
                -
                
                
                
                1,125,176
                
                
                
                1,800
                (5
                )
                
                
                1,179,609Vice
      President of Land
                2008
                
                
                125,000
                
                
                
                12,500
                
                
                
                -
                
                
                
                -
                
                
                
                5,625
                (5
                )
                
                
                143,1252009
                
                
                142,869
                
                
                
                15,625
                
                
                
                15,645
                
                
                
                -
                
                
                
                8,572
                (5
                )
                
                
                182,711William
      C. Gaines,
                2007
                
                
                92,639
                
                
                
                9,741
                
                
                
                -
                
                
                
                981,129
                
                
                
                575
                (5
                )
                
                
                1,084,084Manager
      Reservoir
                2008
                
                
                125,000
                
                
                
                12,500
                
                
                
                -
                
                
                
                -
                
                
                
                6,000
                (5
                )
                
                
                143,500Engineering/Acquisitions
                2009
                
                
                135,417
                
                
                
                21,875
                
                
                
                15,645
                
                
                
                -
                
                
                
                9,438
                (5
                )
                
                
                182,375
  (1) See
discussion of assumptions made in valuing these awards in the notes to our
financial statements.
 (2) See
discussion of assumptions made in valuing these awards in the notes to our
financial statements.
 (3) All
Other Compensation to Mr. Terry included cash paid as vehicle allowances of
$12,000 for each year presented and $408, $8,750 and $20,200 for the years 2007,
2008 and 2009, respectively, as company matching for contributions to a 401k
program.
 (4) All
Other Compensation to Mr. Ricks included cash paid as vehicle allowances of
$2,520, $18,400 and $19,200 for the years 2007, 2008 and 2009 and $1,710, $9,123
and $14,697 for the years 2007, 2008 and 2009, respectively, as company matching
for contributions to a 401k program.
 (5) All
Other Compensation to Messrs. Broaddrick, Wahl and Gaines consisted of company
matching for contributions to a 401k program.
 
 The
Company awards stock options to key employees and the Named Officers either on
the initial date of employment or due to performance incentives throughout the
year.  During 2009, there were no option grants to any Named
Officer.
 
 As part
of annual discretionary bonus restricted stock awards were granted to three of
the Named officers during 2009.
 
 47
 
 Named
Officers are not separately entitled to receive dividend equivalent rights with
respect to each stock option.  Each nonqualified stock option award
described in the “Grants of Plan-Based Awards Table” above expires six-months
following the fifth anniversary of its associated grant date and vests in equal
installments over the course of five years.
 
 The
following table provides certain information regarding unexercised stock options
outstanding for each Named Officer as of December 31, 2009.
  Outstanding
      Equity AwardsName
      and Principal Position
                
                Number
      of Securities Underlying Unexercised Options (#)
    Exercisable
                
                
                Number
      of Securities Underlying Unexercised Options (#)
    Unexercisable
                
                
                Options
                  Exercise
                  Price
      ($)
                
                Option
                  Expiration
                  DatePhillip
      W. Terry
                
                
                40,000
                
                
                
                120,000
                
                
                
                19.23
                
                07/22/1260,000
                
                
                
                90,000
                
                
                
                37.59
                
                06/01/13William
      R. Broaddrick
                
                
                40,000
                
                
                
                60,000
                
                
                
                19.23
                
                07/22/1220,000
                
                
                
                30,000
                
                
                
                37.59
                
                06/01/13David
      R. Ricks
                
                
                20,000
                
                
                
                30,000
                
                
                
                35.54
                
                05/07/1310,000
                
                
                
                40,000
                
                
                
                45.68
                
                11/01/13Thomas
      W. Wahl
                
                
                -
                
                
                
                60,000
                
                
                
                26.96
                
                01/24/13William
      C. Gaines
                
                
                -
                
                
                
                60,000
                
                
                
                23.42
                
                12/01/12
 
 The
following table presents information regarding the exercise of stock options by
Named Officers during 2009.
 Option
      Exercises and Stock VestingOption
      AwardsName
                Number
      of Shares
                  Acquired
      on Exercise (#)
                Value
      Realized on
                  Exercise
      ($)Thomas
      W. Wahl
                20,000
                63,200William
      C. Gaines
                27,000
                277,020
  Director
Compensation
 
 During
all of 2009, all directors were compensated with a stipend of $1,500 per month
plus $1,000 for each meeting of the directors attended.  No director
receives a salary as a director.
  Director
      Compensation TableName
                Fees
      Earned or
                  Paid
      in Cash ($)
                Option
                  Awards
      ($) (1)
                All
      Other
                  Compensation
      ($)
                Total
      ($)Lloyd
      T. Rochford
                22,000
                -
                
                -
                
                22,000Stanley
      M. McCabe
                22,000
                -
                
                -
                
                22,000Clayton
      E. Woodrum
                22,000
                -
                
                -
                
                22,000Anthony
      B. Petrelli
                22,000
                -
                
                -
                
                22,000Carl
      H. Fiddner
                22,000
                -
                
                -
                
                22,000
  (1)  No
options or awards of restricted stock were granted to any of the directors
during the year ended December 31, 2009.
 
 48
 
 The
following table sets forth information concerning our executive stock
compensation plans as of December 31, 2009.
 Number
      of securities to be issued upon exercise of outstanding
      options
                
                
                Weighted-average
      exercise price of outstanding options
                
                
                Number
      of securities remaining available for future issuance under compensation
      plans (excluding securities in column (a))(a)
                
                
                (b)
                
                
                (c)Equity
      compensation plans
                  approved
      by security holders
                
                
                1,895,000
                
                
                $
                23.87
                
                
                
                1,294,774Equity
      compensation plans not
                  approved
      by security holders
                
                
                -
                
                
                
                -
                
                
                
                -Total
                
                
                1,895,000
                
                
                $
                23.87
                
                
                
                1,294,774
 Item
12:Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters
 
 The
following table sets forth, as March 1, 2010, information regarding the
beneficial ownership of our common stock: (i) by each of our directors and
executive officers; and (ii) by all directors and executive officers as a group.
The mailing address for each of the persons indicated is our corporate
headquarters.
 
 Beneficial ownership is determined
under the rules of the Securities and Exchange Commission. In general, these
rules attribute beneficial ownership of securities to persons who possess sole
or shared voting power and/or investment power with respect to those securities
and includes, among other things, securities that an individual has the right to
acquire within 60 days. Unless otherwise indicated, the stockholders identified
in the following table have sole voting and investment power with respect to all
shares shown as beneficially owned by them.
  Shares
      of Common Stock Beneficially OwnedName
                
                Number
                
                PercentLloyd
      T. Rochford
                
                365,200
      (1)
                
                1%Phillip
      W. Terry
                
                230,000
      (2)
                
                1%William
      R. Broaddrick
                
                191,200
      (3)
                
                1%David
      D. Ricks
                
                30,470
      (4)
                
                *Stanley
      M. McCabe
                
                350,000
      (5)
                
                1%Clayton
      E. Woodrum
                
                20,000
      (6)
                
                *Anthony
      B. Petrelli
                
                97,000
      (7)
                
                *Carl
      H. Fiddner
                
                38,736
      (8)
                
                *All
      directors and executive officers
                
                1,322,606
      (9)
                
                3%
 (1)
              Includes
      70,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 80,000 shares issuable upon the exercise of
      stock options that are exercisable within 60
  days.
 (2)
              Includes
      100,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 40,000 shares issuable upon the exercise of
      stock options that are exercisable within 60
  days.
  49
 (3)
              Includes
      60,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 20,000 shares issuable upon the exercise of
      stock options that are exercisable within 60
  days.
 (4)
              Includes
      30,000 shares issuable upon the exercise of stock options that are
      currently exercisable.
 (5)
              Includes
      270,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 80,000 shares issuable upon the exercise of
      stock options that are exercisable within 60
  days.
 (6)
              Includes
      10,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 5,000 shares issuable upon the exercise of stock
      options that are exercisable within 60
days.
 (7)
              Includes
      50,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 20,000 shares issuable upon the exercise of
      stock options that are exercisable within 60
  days.
 (8)
              Includes
      30,000 shares issuable upon the exercise of stock options that are
      currently exercisable.
 (9)
              Includes
      620,000 shares issuable upon the exercise of stock options that are
      currently exercisable and 245,000 shares issuable upon the exercise of
      stock options that are exercisable within 60 days by all executive
      officers and directors.
 *
                Represents
      beneficial ownership of less than
1%
 
 The
following table sets forth, as March 1, 2010, information regarding the
beneficial ownership of our common stock: by all persons known to us to own 5%
or more of our outstanding shares of common stock.
 
 Shares
      of Stock Beneficially OwnedName
      and Address
              
              Number
              
              PercentageNeuberger
      Berman Group, LLC
                605
      Third Avenue
                New
      York, New York 10158
              
              4,285,209
      (1)
              
              11.05%FMR
      LLC
                82
      Devonshire Street
                Boston,
      Massachusetts 02109
              
              3,233,498
      (2)
              
              8.30%BlackRock,
      Inc.
                40
      East 52nd
      Street
                New
      York, New York 10022
              
              2,915,226
      (3)
              
              7.51%T.
      Rowe Price Associates, Inc.
                100
      E. Pratt Street
                Baltimore,
      Maryland 21202
              
              2,147,920
      (4)
              
              5.54%
 ______________________________________
 (1)
              This
      share ownership information was provided by a Schedule 13G filed February
      17, 2010, which discloses that each of Neuberger Berman Group, LLC and
      Neuberger Berman, LLC possesses shared power to dispose or direct the
      disposition of 4,285,209 shares, and shared power to vote 3,562,743
      shares. The Schedule 13G further discloses that Neuberger Berman
      Management LLC possesses shared power to vote and dispose or direct the
      disposition of 1,909,522 shares, and Neuberger Berman, Equity Funds
      possesses shared power to vote and dispose or direct the disposition of
      3,403,528 shares.
 (2)
              This share ownership information was
      provided by a Schedule 13G filed February 16, 2010, which discloses that
      FMR LLC, possesses beneficial ownership of the reported
  shares.
 (3)
              This
      share ownership information was provided by a Schedule 13G filed January
      29, 2010, following the acquisition by BlackRock, Inc. of Barclays Global
      Investors, NA; the Schedule discloses BlackRock possesses sole power to
      dispose or direct the disposition and sole power to vote or to direct the
      vote of such shares.
 (4)
              This
      share ownership information was provided by a Schedule 13G filed February
      11, 2010, which discloses that T. Rowe Price Associates, Inc. possesses
      sole dispositive power of the reported
shares.
 
 Percentage
ownership calculations for any stockholder listed above are based on 38,793,963
shares of our common stock outstanding as of March 1, 2010.
 
 50
 
 Item
13:Certain Relationships and
Related Transactions, and Director Independence
 
 In July 2002, we borrowed $200,000 from
each of Messrs. Rochford and McCabe, which debts are evidenced by notes payable
which matured and were paid in January 2007.  The notes bore interest
at a rate of 10% per annum, and were secured by our assets (although such notes
were subordinate to our credit facility with our primary commercial
lender).
 
 As
discussed under Item 10 of this Form 10-K, the Board of Directors has determined
that Messrs. Woodrum, Petrelli and Fiddner, are each “independent” directors
within the meaning of Section 303A.00 of the New York Stock Exchange Listed
Company Manual.  None of our independent directors falls within any of
the categories of persons who would not be independent as described in Section
303A.00(b) of the New York Stock Exchange rules.  Because the Board of
Directors believes it is not possible to anticipate or provide for all
circumstances that might give rise to conflicts of interest or that might bear
on the materiality of a relationship between a director and the Company, the
Board has not established specific objective criteria, apart from the criteria
set forth in the New York Stock Exchange rules, to determine
“independence”.  In addition to such criteria, in making the
determination of “independence”, the Board of Directors considers such other
matters including (i) the business and non-business relationships that each
independent director has or may have had with the Company and its other
Directors and executive officers, (ii) the stock ownership in the Company held
by each such Director, (iii) the existence of any familial relationships with
any executive officer or Director of the Company, and (iv) any other relevant
factors which could cause any such Director to not exercise his independent
judgment.
 
 Item
14:Principal Accountant Fees
and Services
 
 The firm
of Hansen, Barnett & Maxwell, P.C., (“HBM”) has served as the Company’s
independent auditors since 2000.  The Audit Committee selected HBM as
the independent auditors of the Company for the fiscal year ending December 31,
2009.  The Audit Committee has adopted a policy that requires advance
approval of all audit, audit-related, tax services and other services performed
by the independent auditor.
 
 Fees
and Independence
 
 Audit Fees.  HBM
billed the Company an aggregate of $124,646 and $124,062 for professional
services rendered for the audit of the Company’s financial statements for the
years ended December 31, 2009 and 2008, respectively, and its reviews of the
Company’s financial statements included in its Form 10-Q’s for the first three
quarters of 2009 and 2008.
 
 Audit Related
Fees.  HBM billed the Company $0 and $37,024 for the years
ended December 31, 2009 and 2008, respectively, for its services in connection
with the review of the Company’s registration statements on Form S-3 and for the
audit of the Phoenix Petrocorp acquisition.
 
 Tax Fees.  HBM
billed the Company $5,000 for professional services rendered for tax compliance,
tax advice and tax planning for each of the years ended December 31, 2009 and
2008.
 
 All Other Fees.  No
other fees were billed by HBM to the Company during 2009 and 2008.
 
 The Audit
Committee of the Board of Directors has determined that the provision of
services by HBM described above is compatible with maintaining HBM’s
independence as the Company’s principal accountant.
 
 51
 
 Item
15:Exhibits
 
 (a)
                Financial
      StatementsSee
      Index to Financial Statements on page 54(b)
                Exhibits3.1
                Articles
      of Incorporation of Arena Resources, Inc. (i)3.2
                By-Laws
      of Arena Resources, Inc. (i)10.1
                Second
      Amended and Restated Credit Agreement dated as of June 30, 2009, effective
      as of July 2, 2009, among the Company, MidFirst Bank, Compass Bank and
      Capital One, N.A. (ii)23.1
                Consent
      of Williamson Petroleum Consultants, Inc., Independent Petroleum
      Engineers23.2
                Consent
      of Hansen, Barnett & Maxwell, P.C., Independent31.1
                Certification of
      CEO31.2
                Certification of
      CFO32.1
                Section 1350
      Certification - CEO32.2
                Section 1350
      Certification – CFO99
                Reserves Audit
      Report of Williamson Petroleum Consultants,
Inc.
 (i)  Incorporated
herein by reference to the exhibits to Arena Resources, Inc.’s Form SB-1 filed
January 2, 2001 (SEC File No. 333-46164).
 
 (ii)
Incorporated herein by reference to the exhibit to Arena Resources, Inc.’s Form
8-K filed July 29, 2009.
  52
  SIGNATURES
 
 In accordance with Section 13 or 15(d)
of the Exchange Act, the registrant caused this report to be signed on behalf by
the undersigned, thereunto duly authorized.
  Arena
      Resources, Inc.By:______________________Mr.
      Phillip W. TerryPresident
      and Chief Executive OfficerDate:  March
      1, 2010By:______________________Mr.
      William R. BroaddrickChief
      Financial OfficerDate:  March
      1, 2010
 In accordance with the Exchange Act,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
 
 ______________________Mr.
      Lloyd T. RochfordDirectorDate:  March
      1, 2010______________________Mr.
      Stanley McCabeDirectorDate:  March
      1, 2010______________________Mr.
      Clayton E. WoodrumDirectorDate:  March
      1, 2010______________________Mr.
      Anthony B. PetrelliDirectorDate:  March
      1, 2010______________________Mr.
      Carl H. FiddnerDirectorDate:  March
      1, 2010
  53
 ARENA
RESOURCES, INC.
 
 INDEX
TO FINANCIAL STATEMENTS
 
 
 PageReport
      of Independent Registered Public Accounting Firm
              55Consolidated
      Balance Sheets
              56Consolidated
      Statements of Operations
              57Consolidated
      Statements of Stockholders’ Equity
              58Consolidated
      Statements of Cash Flows
              59Notes
      to Consolidated Financial Statements
              60Supplemental
      Information on Oil and Gas Producing Activities
              76
 
  54
  HANSEN,BARNETT& MAXWELL,
      P.C.

                A Professional
      Corporation
                CERTIFIED PUBLIC ACCOUNTANTS
                5 Triad Center, Suite 750
                Salt
      Lake City, UT 84180-1128
                Phone: (801) 532-2200
                Fax: (801) 532-7944
                www.hbmcpas.com
              Registered
      with the Public Company
                Accounting Oversight
      Board
                
                graphic
   REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  
 To the
Board of Directors and Stockholders
 of Arena
Resources, Inc.
 
 We have
audited the accompanying consolidated balance sheets of Arena Resources, Inc.
and subsidiaries as of December 31, 2009 and 2008, and the related consolidated
statements of operations and comprehensive income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2009.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe our audits provide a reasonable basis for our
opinion.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Arena Resources, Inc.
and subsidiaries as of December 31, 2009 and 2008, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2009, in conformity with accounting principles
generally accepted in the United States of America.
 
 We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Arena Resources, Inc.’s
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated March 1, 2010 expressed an
unqualified opinion thereon.
 
 
 /s/
      HANSEN, BARNETT & MAXWELL,
P.C.
 Salt Lake
City, Utah
 March 1,
2010
 
  55
 ARENA
RESOURCES, INC.
 CONSOLIDATED
BALANCE SHEETS
 December
      31,
                  
                  2009
                  
                  
                  2008ASSETSCurrent
      AssetsCash
                  
                  $
                  63,635,078
                  
                  
                  $
                  58,489,574Accounts
      receivable
                  
                  
                  13,103,483
                  
                  
                  
                  8,637,308Joint
      interest billing receivable
                  
                  
                  2,392,814
                  
                  
                  
                  2,836,948Receivable
      from oil derivative
                  
                  
                  -
                  
                  
                  
                  2,508,396Fair
      value of oil derivative
                  
                  
                  -
                  
                  
                  
                  16,210,478Prepaid
      expenses
                  
                  
                  1,040,513
                  
                  
                  
                  847,433Total
      Current Assets
                  
                  
                  80,171,888
                  
                  
                  
                  89,530,137Property
      and EquipmentOil
      and gas properties subject to amortization
                  
                  
                  661,453,134
                  
                  
                  
                  548,714,235Oil
      and gas gathering systems
                  
                  
                  2,134,876
                  
                  
                  
                  -Inventory
      for property development
                  
                  
                  1,052,538
                  
                  
                  
                  1,670,067Drilling
      rigs
                  
                  
                  6,694,841
                  
                  
                  
                  6,899,433Land,
      buildings, equipment and leasehold improvements
                  
                  
                  5,991,983
                  
                  
                  
                  5,799,045Total
      Property and Equipment
                  
                  
                  677,327,372
                  
                  
                  
                  563,082,780Less:  Accumulated
      depreciation , depletion and amortization
                  
                  
                  (100,428,326
                  )
                  
                  
                  (60,928,142
                  )Net
      Property and Equipment
                  
                  
                  576,899,046
                  
                  
                  
                  502,154,638Total
      Assets
                  
                  $
                  657,070,934
                  
                  
                  $
                  591,684,775LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable
                  
                  $
                  17,155,260
                  
                  
                  $
                  12,877,084Current
      taxes payable
                  
                  
                  314,700
                  
                  
                  
                  -Deferred
      income taxes
                  
                  
                  -
                  
                  
                  
                  6,046,508Accrued
      liabilities
                  
                  
                  1,101,633
                  
                  
                  
                  865,955Total
      Current Liabilities
                  
                  
                  18,571,593
                  
                  
                  
                  19,789,547Long-Term
      LiabilitiesAsset
      retirement liability
                  
                  
                  7,209,812
                  
                  
                  
                  5,066,348Deferred
      income taxes
                  
                  
                  108,622,799
                  
                  
                  
                  84,533,419Total
      Long-Term Liabilities
                  
                  
                  115,832,611
                  
                  
                  
                  89,599,767Stockholders'
      EquityPreferred
      stock - $0.001 par value; 10,000,000 shares authorized;no
      shares issued or outstanding
                  
                  
                  -
                  
                  
                  
                  -Common
      stock - $0.001 par value; 100,000,000 shares authorized;38,693,963
      shares and 38,210,187 shares outstanding, respectively
                  
                  
                  38,694
                  
                  
                  
                  38,210Additional
      paid-in capital
                  
                  
                  326,990,590
                  
                  
                  
                  318,701,383Retained
      earnings
                  
                  
                  195,637,446
                  
                  
                  
                  153,343,267Accumulated
      other comprehensive income
                  
                  
                  -
                  
                  
                  
                  10,212,601Total
      Stockholders' Equity
                  
                  
                  522,666,730
                  
                  
                  
                  482,295,461Total
      Liabilities and Stockholders' Equity
                  
                  $
                  657,070,934
                  
                  
                  $
                  591,684,775
 The
accompanying notes are an integral part of these consolidated financial
statements.
  56
 ARENA
RESOURCES, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
  For
      the years ended December 31,
                
                2009
                
                
                2008
                
                
                2007Oil
      and Gas Revenues
                
                $
                126,240,777
                
                
                $
                208,858,645
                
                
                $
                100,089,698Costs
      and Operating ExpensesOil
      and gas production costs
                
                
                15,543,461
                
                
                
                17,833,144
                
                
                
                11,500,461Oil
      and gas production taxes
                
                
                6,455,585
                
                
                
                10,518,370
                
                
                
                5,655,877Realized
      loss (gain) on oil derivative
                
                
                (14,884,846
                )
                
                
                4,275,330
                
                
                
                932,361Depreciation,
      depletion and amortization
                
                
                38,957,641
                
                
                
                29,789,794
                
                
                
                17,968,062Accretion
      expense
                
                
                410,926
                
                
                
                309,402
                
                
                
                190,904General
      and administrative (which includes $4,649,928, $6,586,279and
      $4,140,747,  respectively, in stock based
      compensation)
                
                
                13,453,384
                
                
                
                13,557,202
                
                
                
                7,815,721Total
      Costs and Operating Expenses
                
                
                59,936,151
                
                
                
                76,283,242
                
                
                
                44,063,386Income
      from Operations
                
                
                66,304,626
                
                
                
                132,575,403
                
                
                
                56,026,312Other
      Income (Expense)Interest
      income
                
                
                828,992
                
                
                
                1,299,939
                
                
                
                884,990Interest
      expense
                
                
                -
                
                
                
                (1,145,456
                )
                
                
                (1,411,520
                )Net
      Other Income (Expense)
                
                
                828,992
                
                
                
                154,483
                
                
                
                (526,530
                )Income
      Before Provision for Income Taxes
                
                
                67,133,618
                
                
                
                132,729,886
                
                
                
                55,499,782Provision
      for Income Taxes
                
                
                (24,839,439
                )
                
                
                (49,112,685
                )
                
                
                (21,057,843
                )Net
      Income
                
                $
                42,294,179
                
                
                $
                83,617,201
                
                
                $
                34,441,939Basic
      Net Income Per Common Share
                
                $
                1.10
                
                
                $
                2.28
                
                
                $
                1.07Diluted
      Net Income Per Common Share
                
                
                1.09
                
                
                
                2.20
                
                
                
                1.02Other
      Comprehensive Income (Loss)Net
      income
                
                $
                42,294,179
                
                
                $
                83,617,201
                
                
                $
                34,441,939Realized
      loss (gain) on hedge derivative contract settlements reclassified from
      other comprehensive loss (income), net of
      tax
                
                
                (10,222,546
                )
                
                
                12,381,887
                
                
                
                -Change
      in unrealized deferred hedging gains (losses), net of tax
                
                
                9,945
                
                
                
                632,212
                
                
                
                (2,801,498
                )Total
      Comprehensive Income
                
                $
                32,081,578
                
                
                $
                96,631,300
                
                
                $
                31,640,441
 The
accompanying notes are an integral part of these consolidated financial
statements.
 57
  ARENA
RESOURCES, INC.
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
 FOR
THE YEARS ENDED DECEMBER 31, 2007, 2008 AND 2009
 
 AccumulatedAdditional
                
                
                
                
                
                
                
                
                Other
                
                
                TotalCommon
      Stock
                
                
                Paid-in
                
                
                Deferred
                
                
                Retained
                
                
                Comprehensive
                
                
                Stockholders'Shares
                
                
                Amount
                
                
                Capital
                
                
                Compensation
                
                
                Earnings
                
                
                Income
      (Loss)
                
                
                EquityBalance
      December 31, 2006
                
                
                29,337,574
                
                
                $
                29,338
                
                
                $
                84,730,586
                
                
                $
                -
                
                
                $
                35,284,127
                
                
                $
                -
                
                
                $
                120,044,052Options
      exercised for cash
                
                
                570,000
                
                
                
                570
                
                
                
                1,851,930
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,852,500Warrants
      exercised for cash
                
                
                127,126
                
                
                
                127
                
                
                
                540,169
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                540,295Warrants
      exercised using cashless exercise provision
                
                
                139,079
                
                
                
                139
                
                
                
                (139
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Shares
      issued in property acquisition
                
                
                5,000
                
                
                
                5
                
                
                
                204,745
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                204,750Tax
      impact of option exercises
                
                
                -
                
                
                
                -
                
                
                
                4,298,722
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4,298,722Issuance
      of common stock for cash, net
                
                
                4,100,000
                
                
                
                4,100
                
                
                
                95,085,358
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                95,089,458Expense
      related to vesting stock based compensation
                
                
                -
                
                
                
                -
                
                
                
                4,140,747
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4,140,747Loss
      on change in fair value of oil derivative, net of tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (2,801,498
                )
                
                
                (2,801,498
                )Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                34,441,939
                
                
                
                -
                
                
                
                34,441,939Balance
      December 31, 2007
                
                
                34,278,779
                
                
                $
                34,279
                
                
                $
                190,852,118
                
                
                $
                -
                
                
                $
                69,726,066
                
                
                $
                (2,801,498
                )
                
                $
                257,810,965Options
      exercised for cash
                
                
                1,333,000
                
                
                
                1,333
                
                
                
                4,689,927
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4,691,260Warrants
      exercised for cash
                
                
                97,158
                
                
                
                97
                
                
                
                446,099
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                446,196Issuance
      of common stock for cash, net
                
                
                2,501,250
                
                
                
                2,501
                
                
                
                116,126,960
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                116,129,461Expense
      related to vesting stock based compensation
                
                
                -
                
                
                
                -
                
                
                
                6,586,279
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                6,586,279Gain
      on change in fair value of oil derivative, net of tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                13,014,099
                
                
                
                13,014,099Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                83,617,201
                
                
                
                -
                
                
                
                83,617,201Balance
      December 31, 2008
                
                
                38,210,187
                
                
                $
                38,210
                
                
                $
                318,701,383
                
                
                $
                -
                
                
                $
                153,343,267
                
                
                $
                10,212,601
                
                
                $
                482,295,461Options
      exercised for cash
                
                
                317,000
                
                
                
                317
                
                
                
                2,922,123
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,922,440Warrants
      exercised for cash
                
                
                161,550
                
                
                
                162
                
                
                
                717,161
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                717,323Expense
      related to vesting stock based compensation
                
                
                -
                
                
                
                -
                
                
                
                4,633,873
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4,633,873Restricted
      stock grant and vesting
                
                
                5,226
                
                
                
                5
                
                
                
                16,050
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                16,055Loss
      on change in fair value of oil derivative, net of tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (10,212,601
                )
                
                
                (10,212,601
                )Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                42,294,179
                
                
                
                -
                
                
                
                42,294,179Balance
      December 31, 2009
                
                
                38,693,963
                
                
                $
                38,694
                
                
                $
                326,990,590
                
                
                $
                -
                
                
                $
                195,637,446
                
                
                $
                -
                
                
                $
                522,666,730
  The
accompanying notes are an integral part of these consolidated financial
statements.
 58
 ARENA
RESOURCES, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
  For
      the years ended December 31,
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007Cash
      Flows From Operating ActivitiesNet
      income
                  
                  $
                  42,294,179
                  
                  
                  $
                  83,617,201
                  
                  
                  $
                  34,441,939Adjustments
      to reconcile net income to net cashprovided by operating activities:Depreciation,
      depletion and amortization
                  
                  
                  38,957,641
                  
                  
                  
                  29,789,794
                  
                  
                  
                  17,968,062Provision
      for income taxes
                  
                  
                  24,839,439
                  
                  
                  
                  49,112,685
                  
                  
                  
                  21,057,843Gain
      on sale of equipment
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (881
                  )Stock
      based compensation
                  
                  
                  4,649,928
                  
                  
                  
                  6,586,279
                  
                  
                  
                  4,140,747Accretion
      of asset retirement obligation
                  
                  
                  410,926
                  
                  
                  
                  309,402
                  
                  
                  
                  190,904Changes
      in assets and liabilities:Accounts,
      joint interest and oil derivative receivable
                  
                  
                  (1,513,645
                  )
                  
                  
                  9,835,045
                  
                  
                  
                  (14,165,921
                  )Current
      and deferred income taxes
                  
                  
                  -
                  
                  
                  
                  (612,480
                  )
                  
                  
                  -Prepaid
      expenses
                  
                  
                  (472,478
                  )
                  
                  
                  (714,040
                  )
                  
                  
                  (30,808
                  )Excess
      tax benefits from share-based payment arrangements
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (4,298,722
                  )Accounts
      payable and accrued liabilities
                  
                  
                  4,513,854
                  
                  
                  
                  (587,238
                  )
                  
                  
                  (814,999
                  )Net
      Cash Provided by Operating Activities
                  
                  
                  113,679,844
                  
                  
                  
                  177,336,648
                  
                  
                  
                  58,488,164Cash
      Flows from Investing ActivitiesProceeds
      from sale of property and equipment
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  7,000Proceeds
      from sale of oil and gas properties
                  
                  
                  -
                  
                  
                  
                  296,800
                  
                  
                  
                  1,915,640Purchase
      and development of oil and gas properties
                  
                  
                  (103,778,202
                  )
                  
                  
                  (207,022,666
                  )
                  
                  
                  (168,582,803
                  )Purchase
      of inventory for property development
                  
                  
                  (6,068,087
                  )
                  
                  
                  (1,670,067
                  )
                  
                  
                  -Construction
      of oil and gas gathering systems
                  
                  
                  (2,134,876
                  )
                  
                  
                  -
                  
                  
                  
                  -Purchase
      of buildings, machinery and office equipment
                  
                  
                  (192,938
                  )
                  
                  
                  (1,931,517
                  )
                  
                  
                  (8,615,501
                  )Net
      Cash Used in Investing Activities
                  
                  
                  (112,174,103
                  )
                  
                  
                  (210,327,450
                  )
                  
                  
                  (175,275,664
                  )Cash
      Flows From Financing ActivitiesProceeds
      from issuance of common stock and warrants, net of offering
      costs
                  
                  
                  -
                  
                  
                  
                  116,129,461
                  
                  
                  
                  95,089,458Proceeds
      from exercise of warrants, net of offering costs
                  
                  
                  717,323
                  
                  
                  
                  446,196
                  
                  
                  
                  540,295Proceeds
      from exercise of options
                  
                  
                  2,922,440
                  
                  
                  
                  4,691,260
                  
                  
                  
                  1,852,500Excess
      tax benefits from share-based payment arrangements
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,298,722Issuance
      of notes payable
                  
                  
                  -
                  
                  
                  
                  11,000,000
                  
                  
                  
                  65,700,000Payment
      of notes payable
                  
                  
                  -
                  
                  
                  
                  (46,000,000
                  )
                  
                  
                  (50,400,000
                  )Net
      Cash Provided by Financing Activities
                  
                  
                  3,639,763
                  
                  
                  
                  86,266,917
                  
                  
                  
                  117,080,975Net
      Increase in Cash
                  
                  
                  5,145,504
                  
                  
                  
                  53,276,115
                  
                  
                  
                  293,475Cash
      at Beginning of Period
                  
                  
                  58,489,574
                  
                  
                  
                  5,213,459
                  
                  
                  
                  4,919,984Cash
      at End of Period
                  
                  $
                  63,635,078
                  
                  
                  $
                  58,489,574
                  
                  
                  $
                  5,213,459
 For
      the years ended December 31,
                    
                    2009
                    
                    
                    2008
                    
                    
                    2007Supplemental
      Cash Flow InformationCash
      paid for income taxes
                    
                    $
                    -
                    
                    
                    $
                    612,480
                    
                    
                    $
                    -Cash
      paid for interest
                    
                    
                    -
                    
                    
                    
                    1,280,122
                    
                    
                    
                    1,463,328Non-Cash
      Investing and Financing ActivitiesCommon
      stock issued for properties
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    204,750Asset
      retirement obligation incurred in property acquisition and
      development
                    
                    
                    1,732,538
                    
                    
                    
                    1,459,534
                    
                    
                    
                    1,001,613Depreciation
      on drilling rigs capitalized as oil and gas properties
                    
                    
                    542,543
                    
                    
                    
                    640,977
                    
                    
                    
                    306,133Use
      of inventory in property development
                    
                    
                    6,685,616
                    
                    
                    
                    -
                    
                    
                    
                    -
  The
accompanying notes are an integral part of these consolidated financial
statements.
 59
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE
1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Organization and
Nature of Operations –Arena Resources, Inc. (the “Company”) is a Nevada
corporation that owns interests in oil and gas properties located in Oklahoma,
Texas, Kansas and New Mexico.  The Company is engaged primarily in the
acquisition, exploration and development of oil and gas properties and the
production and sale of oil and gas.  In 2006, the Company formed two
wholly owned subsidiaries, Arena Drilling Co. and ARD Production
Company.    The accompanying statements of operations and
cash flows include the operations of the above subsidiaries from the date of
acquisition/formation.
 
 Use of
Estimates – The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates.  Changes in the future estimated oil and natural gas
reserves or the estimated future cash flows attributable to the reserves that
are utilized for impairment analysis could have a significant impact on the
future results of operations.
 
 Consolidation
– The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries.  All significant
intercompany balances and transactions have been eliminated in
consolidation.
 
 Concentration of
Credit Risk and Accounts Receivable – Financial instruments that
potentially subject the Company to a concentration of credit risk consist
principally of cash and accounts receivable.  The Company has cash in
excess of federally insured limits at December 31, 2009.  The Company
places its cash with a high credit quality financial institution.
 
 Substantially
all of the Company’s accounts receivable is from purchasers of oil and
gas.  Oil and gas sales are generally unsecured.  The
Company has not had any significant credit losses in the past and believes its
accounts receivable are fully collectable.  Accordingly, no allowance
for doubtful accounts has been provided.  The Company also has a joint
interest billing receivable.  Joint interest billing receivables are
collateralized by the pro rata revenue attributable to the joint interest
holders and further by the interest itself.
 
 Cash – The
Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
 
 Oil and Gas
Properties – The Company uses the full cost method of accounting for oil
and gas properties.  Under this method, all costs associated with
acquisition, exploration, and development of oil and gas properties are
capitalized. Costs capitalized include acquisition costs, geological and
geophysical expenditures, lease rentals on undeveloped properties and costs of
drilling and equipping productive and non-productive wells. Drilling costs
include directly related overhead costs. Capitalized costs are categorized
either as being subject to amortization or not subject to
amortization.
 
 The
Company records a liability in the period in which an asset retirement
obligation (“ARO”) is incurred, in an amount equal to the discounted estimated
fair value of the obligation that is capitalized.  Thereafter this
liability is accreted up to the final retirement cost.  An ARO is a
future expenditure related to the disposal or other retirement of certain
assets.  The Company’s ARO’s relate to future plugging and abandonment
expenses of its oil and gas properties and related facilities
disposal.
 
 60
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 All
capitalized costs of oil and gas properties, including the estimated future
costs to develop proved reserves and estimated future costs to plug and abandon
wells and costs of site restoration, less the estimated salvage value of
equipment associated with the oil and gas properties, are amortized on the
unit-of-production method using estimates of proved reserves as determined by
independent engineers.  If the results of an assessment indicate that
the properties are impaired, the amount of the impairment is added to the
capitalized costs to be amortized.  Following is a table showing total
depletion and depletion per barrel-of-oil-equivalent rate, by year for the years
ended December 31, 2009, 2008, and 2007.
 For
      the Years Ended December 31,2009
                
                
                2008
                
                
                2007Depletion
                
                $
                38,659,746
                
                
                $
                29,554,184
                
                
                $
                17,885,561Depletion
      rate, per barrel-of-oil-equivalent (BOE)
                
                $
                16.34
                
                
                $
                12.65
                
                
                $
                11.42
 In
addition, capitalized costs less accumulated amortization and related deferred
income taxes shall not exceed an amount (the full cost ceiling) equal to the sum
of:
 
 1) 
the present value of estimated future net revenues discounted ten percent
computed in compliance with SEC guidelines;
 
 2) 
plus the cost of properties not being amortized;
 
 3) 
plus the lower of cost or estimated fair value of unproven properties included
in the costs being amortized;
 
 4) 
less income tax effects related to differences between the book and tax basis of
the properties.
 
 Drilling Rigs –Drilling rigs are valued at historical cost, adjusted for impairment loss
less accumulated depreciation.  Historical costs include all direct
costs associated with the acquisition of drilling rigs and placing them in
service.  Drilling rigs are depreciated over 10 years but are only
depreciated during periods during which they are in use and the depreciation is
capitalized as part of oil and gas properties subject to
amortization.  For the year ended December 31, 2009, 2008 and 2007 the
Company had depreciation of $542,543, $640,977 and $306,133, respectively, on
the company owned drilling rigs.
 
 Land, Buildings,
Equipment and Leasehold Improvements – Land, buildings, equipment and
leasehold improvements are valued at historical cost, adjusted for impairment
loss less accumulated depreciation.  Historical costs include all
direct costs associated with the acquisition of land, buildings, equipment and
leasehold improvements and placing them in service.
 
 Depreciation
of buildings and equipment is calculated using the straight-line method based
upon the following estimated useful lives:
  Buildings
      and improvements
                30
      yearsOffice
      equipment and software
                5-7
      yearsMachinery
      and equipment
                5-7
      years
 Depreciation
expense was $297,895, $235,609 and $62,921 for the years ended December 31,
2009, 2008 and 2007, respectively.  An aggregate value of $530,000 has
been attributed to the land on which the buildings sit and is not subject to
depreciation.
  Inventory for
Property Development – Inventories consist primarily of tubular goods
used in development and are stated at the lower of specific cost of each
inventory item or market value.
  61
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 Revenue
recognition – The Company predominantly derives its revenue from the sale
of produced crude oil and natural gas. Revenue is recorded in the month the
product is delivered to the purchaser.  At the end of each month, the
Company estimates the amount of production delivered to purchasers and the price
we received. Variances between the Company’s estimated revenue and actual
payment are recorded in the month the payment is received; however, differences
have been insignificant.
 
 Income
Taxes – Provisions for income taxes are based on taxes payable or
refundable for the current year and deferred taxes.  Deferred taxes
are provided on differences between the tax bases of assets and liabilities and
their reported amounts in the financial statements, and tax carry
forwards.  Deferred tax assets and liabilities are included in the
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled.  As changes in tax laws or rates are enacted,
deferred tax assets and liabilities are adjusted through the provision for
income taxes.
 
 Earnings Per
Share– Basic earnings per share is computed by dividing net income by
the weighted-average number of common shares outstanding during the
year.  Diluted earnings per share are calculated to give effect to
potentially issuable dilutive common shares.
 
 Major
Customers – During the year ended December 31, 2009, sales to three
customers represented 75% 13% and 8% of total sales, respectively.  At
December 31, 2009, these customers made up 74%, 14% and 7% of accounts
receivable, respectively.  During the year ended December 31, 2008,
sales to three customers represented 83% 8% and 5% of total sales,
respectively.  At December 31, 2008, these customers made up 84%, 9%
and 5% of accounts receivable, respectively.  During the year ended
December 31, 2007, sales to two customers represented 83% and 11% of total
sales, respectively.  At December 31, 2007, these customers made up
85% and 7% of accounts receivable, respectively.  The loss of any of
the foregoing customers would not have a material adverse affect on the Company
as there is an available market for its crude oil and natural gas production
from other purchasers.
 
 Stock-Based
Employee Compensation – The Company has outstanding stock options and
restricted stock grants to directors and employees, which are described more
fully in Note 7.  The Company accounts for its stock options and
restricted stock grants in accordance with generally accepted accounting
principles.  The generally accepted accounting principles require the
recognition of the cost of employee services received in exchange for an award
of equity instruments in the financial statements and is measured based on the
grant date fair value of the award. The generally accepted accounting principles
also requires the stock option compensation expense to be recognized over the
period during which an employee is required to provide service in exchange for
the award (the vesting period).
 
 Stock-based
employee compensation incurred for the years ended December 31, 2009, 2008, and
2007 was $4,649,928, $6,586,279 and $4,140,747, respectively.
 
 Stock-Based
Compensation to Non-Employees – The Company accounts for its stock-based
compensation issued to non-employees using the fair value method in accordance
with generally accepted accounting principles. Under generally accepted
accounting principles, stock-based compensation is determined as either the fair
value of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measurable.  The measurement date for
these issuances is the earlier of the date at which a commitment for performance
by the recipient to earn the equity instruments is reached or the date at which
the recipient’s performance is complete.
  62
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
  Derivative Instruments and Hedging
Activities Derivative Instruments and Hedging
Activities
  New Accounting
Policies –Recent SEC
Rule-Making Activity.In December 2008, the SEC announced that it
had approved revisions to modernize the oil and gas reserve reporting
disclosures. The new disclosure requirements include provisions
that:
  ·
              Introduce
      a new definition of oil and gas producing activities. This new definition
      allows companies to include in their reserve base volumes from
      unconventional resources. Such unconventional resources include bitumen
      extracted from oil sands and oil and gas extracted from coal beds and
      shale formations.
  ·
              Report
      oil and gas reserves using an unweighted average price using the prior
      12-month period, based on the closing prices on the first day of each
      month, rather than year-end prices.
  ·
              Permit
      companies to disclose their probable and possible reserves on a voluntary
      basis. In the past, proved reserves were the only reserves allowed in the
      disclosures.  We have chosen not to make disclosure under these
      categories.
  ·
              Requires
      companies to provide additional disclosure regarding the aging of proved
      undeveloped reserves.
  ·
              Permit
      the use of reliable technologies to determine proved reserves if those
      technologies have been demonstrated empirically to lead to reliable
      conclusions about reserves volumes.
  ·
              Replace
      the existing “certainty” test for areas beyond one offsetting drilling
      unit from a productive well with a “reasonable certainty”
      test.
  ·
              Require
      additional disclosures regarding the qualifications of the chief technical
      person who oversees the company’s overall reserve estimation process.
      Additionally, disclosures regarding internal controls over reserve
      estimation, as well as a report addressing the independence and
      qualifications of its reserves preparer or auditor will be
      mandatory.
 
 We
adopted the rules effective December 31, 2009.
 
 63
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
   
 Fair Value Option
Under US GAAP for fair value measurements, companies have an option to report
selected financial assets and liabilities at fair value. We adopted the new
guidance for optional fair value measurements as of January 1, 2008.
Adoption of the new guidance had no effect on our financial position or results
of operations as we made no elections to report selected financial assets or
liabilities at fair value.
 
 Derivative Instruments and Hedging
ActivitiesIn March 2008, the FASB issued new standards
which amended and expanded previous disclosure requirements related to
derivative instruments and hedging activities. The new standards require
qualitative disclosures about objectives and strategies for using derivative
instruments, quantitative disclosures about fair value amounts of derivative
instruments and related gains and losses, and disclosures about credit
risk-related contingent features in derivative agreements. We adopted the new
standards as of January 1, 2009. They provide only for enhanced disclosures, and
adoption of the new standards had no impact on our financial position or results
of operations. See Note 11. Derivative Instruments and Hedging
Activities.
 
 Subsequent Events
In May 2009, the FASB issued new standards which establish the accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued. In particular, the new standards set
forth:
  ·
              the
      period after the balance sheet date during which management of a reporting
      entity should evaluate events or transactions that may occur for potential
      recognition or disclosure in the financial statements (through the date
      that the financial statements are issued or are available to be
      issued);
  ·
              the
      circumstances under which an entity should recognize events or
      transactions occurring after the balance sheet date in its financial
      statements; and
  ·
              the
      disclosures that an entity should make about events or transactions that
      occurred after the balance sheet
date.
 
 We
adopted the new standards as of June 30, 2009. We have evaluated subsequent
events after the balance sheet date of December 31, 2009 through the time of
filing with the SEC on March 1, 2010, which is the date the financial statements
were issued.
 
 Accounting Standards
Codification In June 2009, the FASB established the FASB
Accounting Standards Codification (Codification), which officially commenced
July 1, 2009, to become the source of authoritative US GAAP recognized by the
FASB to be applied by nongovernmental entities.  Rules and
interpretive releases of the SEC under authority of federal securities laws are
also sources of authoritative US GAAP for SEC registrants.  Generally,
the Codification is not expected to change US GAAP.  All other
accounting literature excluded from the Codification will be considered
nonauthoritative.  The Codification is effective for financial
statements issued for interim and annual periods ending after September 15,
2009.  We adopted the new standards for our quarter ending September
30, 2009.  All references to authoritative accounting literature are
now referenced in accordance with the Codification.
 
 64
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
2 – EARNINGS PER SHARE INFORMATION
  For
      the years ended December 31,
                
                2009
                
                
                2008
                
                
                2007Net
      Income
                
                $
                42,294,179
                
                
                $
                83,617,201
                
                
                $
                34,441,939Basic
      Weighted-Average Common Shares Outstanding
                
                
                38,380,284
                
                
                
                36,732,000
                
                
                
                32,071,279Effect
      of dilutive securitiesWarrants
                
                
                75,924
                
                
                
                205,846
                
                
                
                325,034Stock
      options
                
                
                501,737
                
                
                
                986,251
                
                
                
                1,271,616Diluted
      Weighted-Average Common Shares Outstanding
                
                
                38,957,945
                
                
                
                37,924,097
                
                
                
                33,667,929Basic
      Income Per Common ShareNet
      income
                
                
                1.10
                
                
                
                2.28
                
                
                
                1.07Diluted
      Income Per Common ShareNet
      Income
                
                
                1.09
                
                
                
                2.20
                
                
                
                1.02
 
 NOTE
3 – OIL AND GAS PRODUCING ACTIVITIES
 
 Set forth
below is certain information regarding the aggregate capitalized costs of oil
and gas properties and costs incurred by the Company for its oil and gas
property acquisitions, development and exploration activities:
  Capitalized
      Costs Relating to Oil and Gas Producing ActivitiesDecember
      31,
                
                2009
                
                
                2008
                
                
                2007Unproved
      oil and gas properties
                
                $
                5,642,624
                
                
                $
                5,642,624
                
                
                $
                5,642,624Proved
      oil and gas properties
                
                
                655,810,510
                
                
                
                543,071,611
                
                
                
                334,245,235Oil
      and gas gathering systems
                
                
                2,134,876
                
                
                
                -
                
                
                
                -Inventory
      for property development
                
                
                1,052,538
                
                
                
                1,670,067
                
                
                
                -Drilling
      rigs
                
                
                6,694,841
                
                
                
                6,899,433
                
                
                
                6,254,737Land,
      buildings, equipment and leasehold improvements
                
                
                5,991,983
                
                
                
                5,799,045
                
                
                
                4,512,224Total
      capitalized costs
                
                
                677,327,372
                
                
                
                563,082,780
                
                
                
                350,654,820Less
      accumulated depletion, depreciation and amortization
                
                
                (100,428,326
                )
                
                
                (60,928,142
                )
                
                
                (30,497,371
                )Net
      Capitalized Costs
                
                $
                576,899,046
                
                
                $
                502,154,638
                
                
                $
                320,157,449Net
      Costs Incurred in Oil and Gas Producing ActivitiesFor
      the Years Ended December 31,
                
                
                2009
                
                
                
                2008
                
                
                
                2007Acquisition
      of proved properties (net of proceeds from property sale)
                
                
                3,942,103
                
                
                
                16,782,225
                
                
                
                53,554,064Acquisition
      of unproved properties (net of proceeds from property
sale)
                
                
                -
                
                
                
                -
                
                
                
                542,650Exploration
      costs
                
                
                -
                
                
                
                -
                
                
                
                -Development
      costs
                
                
                107,064,257
                
                
                
                190,584,617
                
                
                
                113,084,344Total
      Net Costs Incurred
                
                $
                111,006,360
                
                
                $
                207,366,842
                
                
                $
                167,181,058
 NOTE
4 – NOTES PAYABLE
 
 Notes Payable –In June 2009, the Company entered into a new agreement that provides for
a credit facility of $150 million with a borrowing base of $75 million with the
structure in place to increase that borrowing base an additional $75
million.  The new facility has an interest rate grid with a range of
LIBOR plus 2.25% to 3.25%, depending upon the Company’s level of utilization of
the credit facility with the total interest rate to be charged being no less
than 4.00%.  The Company is required under the terms of the credit
facility to maintain a 5-to-1 ratio of income before interest, taxes,
depreciation, depletion and amortization to interest expense, maintain a current
asset to current liability ratio of 1-to-1 and a rolling four quarter maximum
leverage ratio of no more than 2.5-to-1.  As of December 31, 2009, the
Company were in compliance with all covenants and did not have any amount
outstanding under this credit facility.
 
 65
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
5 – ASSET RETIREMENT OBLIGATION
 
 A
reconciliation of the asset retirement obligation for the years ended December
31, 2007, 2008 and 2009 is as follows:
  Balance,
      January 1, 2007
                
                $
                2,250,332Liabilities
      incurred
                
                
                1,027,945Accretion
      expense
                
                
                190,904Deletion
      related to property divestitures
                
                
                (26,332
                )Liabilities
      settled
                
                
                (45,019
                )Balance,
      December 31, 2007
                
                $
                3,397,830Liabilities
      incurred
                
                
                1,459,534Accretion
      expense
                
                
                309,402Liabilities
      settled
                
                
                (100,418
                )Balance,
      December 31, 2008
                
                $
                5,066,348Liabilities
      incurred
                
                
                1,732,538Accretion
      expense
                
                
                410,926Balance,
      December 31, 2009
                
                $
                7,209,812
 NOTE
6 – STOCKHOLDERS’ EQUITY
 
 The
Company is authorized to issue 100,000,000 common shares, with a par value of
$0.001 per share, and 10,000,000 Class “A” convertible preferred shares, with a
par value of $0.001 per share.
 
 Preferred
Stock – There is no preferred stock outstanding.
 
 Common Stock
Issued in Stock Split – In September 2007, the Company’s Board of
Directors authorized a 2 for 1 stock split.  The split was effective
to shareholders of record at the close of business on October 15,
2007.  The split was in the form of a stock dividend, with one
additional share distributed for every share held.  The additional
shares were distributed on October 26, 2007 and the Company’s stock began
trading at its post-split price on October 29, 2007.  Accordingly, all
amounts of common stock, warrants and options have been retroactively restated
throughout these financial statements to give effect to the 2 for 1 stock
split.
 
 Common Stock
Issued in Offerings – In June 2007, the Company issued 4,100,000 shares
of common stock, valued at $100,450,000, or $24.50 per share, in a private
placement.  Proceeds from the offering totaled $95,089,458, net of
offering costs and expenses paid of $5,360,542.
 
 In June
2008, the Company issued 2,501,250 shares of common stock, valued at
$119,434,688, or $47.75 per share, in a public offering pursuant to a shelf
registration statement.  Proceeds to the Company, net of offering
costs of $3,305,227, totaled $116,129,461.
 
 Common Stock
Issued from Warrant Exercises – During the year ended December 31, 2007,
the Company issued 127,126 shares of common stock from the exercise of warrants
for proceeds of $540,295.  Of these warrants, 20,000 had an exercise
price of $4.50 per share, 34,952 had an exercise price of $5.15 per share and
72,174 had an exercise price of $3.7425.  Additionally, during the
year ended December 31, 2007, the Company issued 134,120 shares of common stock
in a cashless exercise of 145,000 warrants with an exercise price of $3.7425 per
share and 4,959 shares of common stock in a cashless exercise of 5,824 warrants
with an exercise price of $5.15 per share.
 
 66
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 During
the year ended December 31, 2008, the Company issued 97,158 shares of common
stock from the exercise of warrants.  Of these warrants, 33,246 had an
exercise price of $4.50 per share, 23,132 had an exercise price of $3.7425 per
share and 40,780 had an exercise price of $5.15 per share, for total proceeds of
$446,159.
 
 During
the year ended December 31, 2009, the Company issued 161,550 shares of common
stock from the exercise of warrants.  Of these warrants, 42,772 had an
exercise price of $3.7425, 83,830 had an exercise price of $4.50 and 34,948 had
an exercise price of $5.15, for total proceeds of $717,323.
 
 Common Stock
Issued from Option Exercises – During the year ended December 31, 2007,
the Company issued 570,000 shares of common stock upon the exercise of options
for proceeds of $1,852,500, or an average of $3.25 per share.  As a
result of these exercises, the Company recognized an additional tax benefit in
the amount of $4,298,722, which was recorded against additional paid-in
capital.
 
 During
the year ended December 31, 2008, the Company issued 1,333,000 shares of common
stock from the exercise of options for proceeds of $4,691,260.  Of
these options, 1,140,000 had an exercise price of $1.85 per share, 60,000 had an
exercise price of $2.40 per share, 20,000 had an exercise price of $4.15 per
share, 20,000 had an exercise price of $13.70 per share, 40,000 had an exercise
price of $19.23 per share, 33,000 had an exercise price of $23.42 per share and
20,000 had an exercise price of $26.96 per share.
 
 During
the year ended December 31, 2009, the Company issued 317,000 shares of common
stock from the exercise of options for proceeds of $2,922,440.  Of
these options, 220,000 had an exercise price of $4.15, 20,000 had an exercise
price of $10.43, 20,000 had an exercise price of $13.70, 27,000 had an exercise
price of $23.42, 20,000 had an exercise price of $26.96 and 10,000 had an
exercise price of $35.53.
 
 Common Stock
Issued pursuant to Restricted Stock Award Plan – On December 17, 2009,
the Company issued 5,226 shares of common stock to key personnel.  The
shares issued are subject to a six month vesting period which ends in June
2010.  The shares were valued at $43.10, based on the closing price on
the date the shares were awarded.  The expense associated with this
issuance will be allocated ratably over the six month vesting
period.
 
 Warrants
Issued – Prior to 2007 the Company issued stock purchase warrants in
relation to various offerings.  No purchase warrants have been issued
in 2007, 2008 or 2009.  However, through 2009 some of the previously
issued warrants remained outstanding.  During the year ended December
31, 2009, the balance of the remaining outstanding warrants was
exercised.
 
 Stock
purchase warrants issued and exercised during the years ended December 31, 2009,
2008 and 2007 are summarized as follows:
  2009
                  
                  
                  2008
                  
                  
                  2007Warrants
                  
                  
                  Weighted-Average
      Exercise Price
                  
                  
                  Warrants
                  
                  
                  Weighted-Average
      Exercise Price
                  
                  
                  Warrants
                  
                  
                  Weighted-Average
      Exercise PriceOutstanding
      at beginning of the year
                  
                  
                  161,550
                  
                  
                  $
                  4.44
                  
                  
                  
                  258,708
                  
                  
                  $
                  4.50
                  
                  
                  
                  536,658
                  
                  
                  $
                  4.25Issued
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Expired
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (161,550
                  )
                  
                  
                  4.44
                  
                  
                  
                  (97,158
                  )
                  
                  
                  4.59
                  
                  
                  
                  (277,950
                  )
                  
                  
                  3.08Outstanding
      at end of year
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  161,550
                  
                  
                  $
                  4.44
                  
                  
                  
                  258,708
                  
                  
                  $
                  4.50
 67
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
7 – EMPLOYEE STOCK OPTIONS AND RESTRICTED STOCK AWARD PLAN
 
 In 2003,
the Company’s Board of Directors and shareholders approved and adopted a
non-qualified executive stock option plan, which was subsequently amended by the
shareholders.  The amendments effectively increased the number of
shares available under the plan to 6,000,000.  Additionally, in 2009
the shareholders approved the adoption of a restricted stock award
plan.  Shares granted under the restricted stock award plan come from
the same pool of available shares as the option plan.  There are
1,294,774 shares eligible for grant, either as options or as restricted stock,
at December 31, 2009.
 
 Employee Stock Options –
Following is a table reflecting the issuances during 2007 and 2008 and their
related exercise prices:
 
 Grant
      date
                
                #
      of options
                
                
                Exercise
      priceJanuary
      11, 2007
                
                
                100,000
                
                
                $
                18.675January
      22, 2007
                
                
                600,000
                
                
                
                19.23May
      1, 2007
                
                
                200,000
                
                
                
                23.42July
      24, 2007
                
                
                100,000
                
                
                
                26.96November
      1, 2007
                
                
                50,000
                
                
                
                35.53November
      7, 2007
                
                
                50,000
                
                
                
                35.54December
      1, 2007
                
                
                300,000
                
                
                
                37.59December
      17, 2007
                
                
                125,000
                
                
                
                37.851,525,000Grant
      date
                
                #
      of options
                
                
                Exercise
      priceMay
      7, 2008
                
                
                50,000
                
                
                $
                45.68May
      15, 2008
                
                
                50,000
                
                
                
                49.74July
      24, 2008
                
                
                50,000
                
                
                
                41.09August
      18, 2008
                
                
                50,000
                
                
                
                39.02September
      2, 2008
                
                
                25,000
                
                
                
                40.75225,000
 No
options were granted during 2009.
 
 All
granted options vest at the rate of 20% each year over five years beginning one
year from the date granted and expire six months after the date of complete
vesting.  A summary of the status of the stock options as of December
31, 2009 and changes during the years ended December 31, 2009, 2008 and 2007 is
as follows:
 
 68
  ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 2009
                
                
                2008
                
                
                2007Options
                
                
                Weighted-Average
      Exercise Price
                
                
                Options
                
                
                Weighted-Average
      Exercise Price
                
                
                Options
                
                
                Weighted-Average
      Exercise PriceOutstanding
      at beginning of the year
                
                
                2,252,000
                
                
                $
                22.12
                
                
                
                3,450,000
                
                
                $
                13.55
                
                
                
                2,610,000
                
                
                $
                3.31Issued
                
                
                -
                
                
                
                
                
                
                
                225,000
                
                
                
                43.53
                
                
                
                1,525,000
                
                
                
                26.45Forfeited
                
                
                (40,000
                )
                
                
                41.09
                
                
                
                (90,000
                )
                
                
                22.73
                
                
                
                (115,000
                )
                
                
                3.35Exercised
                
                
                (317,000
                )
                
                
                9.22
                
                
                
                (1,333,000
                )
                
                
                3.52
                
                
                
                (570,000
                )
                
                
                3.25Outstanding
      at end of year
                
                
                1,895,000
                
                
                $
                23.87
                
                
                
                2,252,000
                
                
                $
                22.12
                
                
                
                3,450,000
                
                
                $
                13.55Exercisable
      at end of  year
                
                
                705,000
                
                
                $
                20.96
                
                
                
                537,000
                
                
                $
                13.27
                
                
                
                1,050,000
                
                
                $
                2.33Weighted
      average fair value ofoptions
      granted during the year
                
                
                
                
                
                $
                -
                
                
                
                
                
                
                $
                17.52
                
                
                
                
                
                
                $
                10.84
 The
Company uses the Black-Scholes option pricing model to calculate the fair-value
of each option grant. The expected volatility is based on the historical price
volatility of the Company’s common stock. We elected to use the simplified method for estimating the expected term
as allowed by generally accepted accounting principles for options granted
through December 31, 2008 and 2007. Under the simplified method, the expected term is equal to
the midpoint between the vesting period and the contractual term of the stock
option. The risk-free interest rate represents the U.S. Treasury bill rate for
the expected life of the related stock options. The dividend yield represents
the Company’s anticipated cash dividend over the expected life of the stock
options.  The following are the Black-Scholes weighted-average
assumptions used for options granted during the years ended December 31, 2008
and 2007 (no options were granted during 2009):
  2008
                
                2007Risk
      free interest rate
                3.14%
                
                4.30%Expected
      life
                4.25
      years
                
                4.25
      yearsDividend
      yield
                -
                
                -Volatility
                45%
                
                47%
 
 As of
December 31, 2009, there was approximately $4,827,499 of unrecognized
compensation cost related to stock options that will be recognized over a
weighted average period of 2.07 years.  The aggregate intrinsic value
of options vested and expected to vest at December 31, 2009 was
$32,337,120.  The aggregate intrinsic value of options exercisable at
December 31, 2009 was $15,714,850.  The year end intrinsic values are
based on a December 31, 2009 closing price of $43.12.
 
 The
317,000, 1,333,000 and 570,000 options exercised during 2009, 2008 and 2007,
respectively, had an aggregate intrinsic value on the date of exercise of
7,963,220, $44,715,770 and $12,122,600, respectively.
 
 
 69
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 The
following table summarizes information related to the Company’s stock options
outstanding at December 31, 2009:
  Options
      OutstandingExercise
      price
                
                
                Number
      Outstanding
                
                
                Weighted-Average
      Remaining Contractual Life (in years)
                
                
                Number
      Exercisable4.15
                
                
                
                305,000
                
                
                
                0.50
                
                
                
                200,00010.425
                
                
                
                40,000
                
                
                
                1.30
                
                
                
                20,00013.70
                
                
                
                40,000
                
                
                
                1.95
                
                
                
                -18.675
                
                
                
                100,000
                
                
                
                2.53
                
                
                
                40,00019.23
                
                
                
                560,000
                
                
                
                2.56
                
                
                
                200,00023.42
                
                
                
                140,000
                
                
                
                2.84
                
                
                
                20,00026.96
                
                
                
                60,000
                
                
                
                3.07
                
                
                
                -35.53
                
                
                
                40,000
                
                
                
                3.33
                
                
                
                10,00035.54
                
                
                
                50,000
                
                
                
                3.35
                
                
                
                20,00037.59
                
                
                
                250,000
                
                
                
                3.42
                
                
                
                100,00037.85
                
                
                
                125,000
                
                
                
                3.46
                
                
                
                50,00039.02
                
                
                
                50,000
                
                
                
                3.85
                
                
                
                10,00040.75
                
                
                
                25,000
                
                
                
                3.87
                
                
                
                5,00041.09
                
                
                
                10,000
                
                
                
                4.07
                
                
                
                10,00045.68
                
                
                
                50,000
                
                
                
                4.13
                
                
                
                10,00049.74
                
                
                
                50,000
                
                
                
                4.17
                
                
                
                10,0001,895,000
                
                
                
                2.06
                
                
                
                705,000
 Any
excess tax benefits from the exercise of stock options will not be recognized in
paid-in capital until the Company is in a current tax paying position.
Presently, all of the Company’s income taxes are deferred and is only subject to
alternative minimum tax.  The Company has substantial net operating
losses available to carryover to future periods. Accordingly, no excess tax
benefits have been recognized for the years ended December 31, 2009 or
2008.
 
 Restricted stock grants– On
December 17, 2009, the Company granted a total of 5,226 shares of stock under
the Restricted Stock Award Plan.  The shares were valued based on the
market price of the shares on the grant date of $43.10 for an aggregate total of
$225,241.  These shares vest over a six month period and the Company
will record the expense over that period.  As of December 31, 2009,
the Company showed an expense of $16,055.  Unamortized deferred
compensation of $209,186 will be amortized over the next six
months.
 
 The
Restricted Stock Award Plan was approved by the shareholders during 2009,
therefore no shares were issued under the plan prior to
2009.  Additionally, no shares vested during any of the years 2009,
2008 or 2007.
  NOTE
8 – RELATED PARTY TRANSACTIONS
 
 In July
2002, the Company borrowed $400,000 from two of its officers under the terms of
secured, 10% promissory notes.  These notes and all accrued interest
were paid during 2007.
 
 70
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
9 – COMMITMENTS
 
 Standby Letters
of Credit– A commercial bank has issued standby letters of credit on
behalf of the Company to the states of Texas, Oklahoma and New Mexico totaling
$686,969 to allow the Company to do business in those states.  The
Company intends to renew the standby letters of credit for as long as the
Company does business in those states. No amounts have been drawn under the
standby letters of credit.
 
 Operating leases– Effective August 20, 2008, the Company entered into a lease agreement
for office space in Midland, Texas.  The lease is for approximately
1,869 square feet and is for five years commencing November 2008.  The
Company incurred lease expense of $19,780 and $3,271 for the years ended
December 31, 2009 and 2008, respectively.  The following table
reflects the future minimum lease payments under the operating lease as of
December 31, 2009.
 
 Year
                  
                  Lease
      Obligation2010
                  
                  
                  20,7152011
                  
                  
                  21,6492012
                  
                  
                  22,5842013
                  
                  
                  19,469$
                  84,417
  NOTE
10 – INCOME TAXES
 
 At
December 31, 2009, the Company calculated alternative minimum income tax of
$798,690 of which $314,700 is currently payable, due to a previous
overpayment.  At December 31, 2008, the Company had no alternative
minimum income tax due and had no current tax liability.  The
provision for income taxes consisted of the following:
 Provision for income
      taxes
                
                2009
                
                
                2008
                
                
                2007Current
                
                $
                4,661,395
                
                
                $
                -
                
                
                $
                -Minimum
      tax
                
                
                798,690
                
                
                
                
                
                
                
                539,793Benefit
      of net operating loss
                
                
                (4,661,395
                )Deferred
                
                
                24,040,749
                
                
                
                49,112,685
                
                
                
                20,518,050$
                24,839,439
                
                
                $
                49,112,685
                
                
                $
                21,057,843
 The
following is a reconciliation of income taxes computed using the U.S. federal
statutory rate to the provision for income taxes:
  Rate
      Reconciliation
                
                2009
                
                
                2008
                
                
                2007Tax
      at federal statutory rate (34%)
                
                $
                22,825,430
                
                
                $
                45,128,161
                
                
                $
                18,869,926Non-deductible
      expenses
                
                
                -
                
                
                
                29,406
                
                
                
                13,939State
      tax, net of federal benefit
                
                
                2,014,009
                
                
                
                4,380,086
                
                
                
                1,831,493Other
                
                
                -
                
                
                
                (424,968
                )
                
                
                342,485$
                24,839,439
                
                
                $
                49,112,685
                
                
                $
                21,057,843
 71
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 As of
December 31, 2009, the Company had net operating loss carry forwards for federal
income tax reporting purposes of approximately $75 million which, if unused,
will expire in 2026, 2027 and 2028.  The Company has minimum tax
credits of $1,765,774 which do not expire.
 
 The net
deferred tax liability consisted of the following:
  Deferred
      taxes:
                
                2009
                
                
                2008
                
                
                2007Deferred
      tax liabilitiesCurrent
      unrealized gain on oil derivative
                
                $
                -
                
                
                $
                6,046,508
                
                
                $
                -Property
      and equipment
                
                
                124,200,047
                
                
                
                107,316,108
                
                
                
                63,011,335Total
      deferred tax liabilities
                
                
                124,200,047
                
                
                
                113,362,616
                
                
                
                63,011,335Deferred
      tax assetsStock-based
      compensation
                
                
                5,243,557
                
                
                
                3,953,790
                
                
                
                1,808,770Minimum
      tax credit
                
                
                1,765,774
                
                
                
                967,084
                
                
                
                862,000Unrealized
      loss on oil derivative
                
                
                -
                
                
                
                -
                
                
                
                1,658,665Operating
      loss and IDC carryforwards
                
                
                8,567,917
                
                
                
                17,861,815
                
                
                
                24,785,172Total
      deferred tax assets
                
                
                15,577,248
                
                
                
                22,782,689
                
                
                
                29,114,607Net
      deferred income tax liability
                
                $
                108,622,799
                
                
                $
                90,579,927
                
                
                $
                33,896,728
 Accounting for Uncertainty in Income
Taxes   In accordance with generally accepted accounting
principles, the Company has analyzed its filing positions in all jurisdictions
where it is required to file income tax returns for the open tax years in such
jurisdictions. The Company has identified its federal income tax return and its
state income tax returns in Texas, New Mexico, Oklahoma and Kansas in which it
operates as “major” tax jurisdictions. The Company’s federal income tax returns
for the years ended December 31, 2006 through 2008 remain subject to
examination. The Company’s income tax returns in major state income tax
jurisdictions remain subject to examination for years ended December 31,
2006 through 2008, with the exception of Texas, which would also include the
year ended December 31, 2005. The Company currently believes that all
significant filing positions are highly certain and that all of its significant
income tax filing positions and deductions would be sustained upon audit.
Therefore, the Company has no significant reserves for uncertain tax positions
and no adjustments to such reserves were required by generally accepted
accounting principles. No interest or penalties have been levied against the
Company and none are anticipated, therefore interest or penalty has been
included in our provision for income taxes in the consolidated statements of
operations.
 
 NOTE
11 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
 Under
generally accepted accounting principles, the nature of a derivative instrument
must be evaluated to determine if it qualifies for hedge accounting treatment.
Instruments qualifying for hedge accounting treatment are recorded as an asset
or liability measured at fair value and subsequent changes in fair value are
recognized in equity through other comprehensive income, net of related taxes,
to the extent the hedge is effective. The Company’s derivative instrument
qualified for hedge accounting for all periods presented.  The change
in fair value of the derivative instrument was recorded to other comprehensive
income for the years ended December 31, 2007, 2008 and 2009. The cash
settlements of cash flow hedges are recorded in the operating section of the
Company’s statement of operations. Instruments not qualifying for hedge
accounting treatment are recorded in the balance sheet at fair value and changes
in fair value are recognized on the statement of operations.
 
 72
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
   
 The
statement of operations includes a realized gain on derivative instruments of
$14,884,846 for 2009 and a realized loss on derivative instruments of $4,275,330
and $932,361 for 2008 and 2007, respectively.
 
 As of
December 31, 2009, the Company had entered into the following costless collar
contracts accounted for as a cash flow hedge:
 
 Commodity
              Remaining
      Period
              
              Volume
      (Bbls)
              
              
              Floor
              
              
              CeilingWTI
      Crude Oil
              January
      2010 - December 2010
              
              
              730,000
              
              
              $
              65.00
              
              
              $
              93.00WTI
      Crude Oil
              January
      2010 - December 2010
              
              
              365,000
              
              
              $
              70.00
              
              
              $
              92.85Commodity
              Remaining
      Period
              
              Volume
      (MMBTU)
              
              
              Floor
              
              
              CeilingEl
      Paso Permian Gas
              January
      2010 - December 2010
              
              
              1,825,000
              
              
              $
              4.00
              
              
              $
              7.87
 
 There
were no hedges in effect as of December 31, 2009, therefore the Company did not
record an asset or a liability.  The fair value of the 2010 hedges is
zero as of December 31, 2009, as the relative price curve for the index prices
used is between the floor and the ceiling.
 
 NOTE
12 – FAIR VALUE MEASUREMENTS
 
 Generally
accepted accounting principles establish a fair value hierarchy that prioritizes
the inputs used to measure fair value. The hierarchy gives the highest priority
to quoted prices in active markets for identical assets or liabilities (Level 1
measurement) and the lowest priority to unobservable inputs (Level 3
measurement). The Company’s fair value balances are based on the observability
of those inputs. The three levels of the fair value hierarchy are as
follows:
 
 •
              
              Level
      1 — Quoted prices in active markets for identical assets or liabilities
      that the Company has the ability to access. Active markets are those in
      which transactions for the asset or liability occur in sufficient
      frequency and volume to provide pricing information on an ongoing
      basis.  The Company does not have any fair value balances
      classified as Level 1.•
              
              Level
      2 — Inputs other than quoted prices in active markets included in Level 1,
      that are either directly or indirectly observable. These inputs are either
      directly observable in the marketplace or indirectly observable through
      corroboration with market data for substantially the full contractual term
      of the asset or liability being measured. The Company’s Level 2 items
      consist of a costless collar.•
              
              Level
      3 — Includes inputs that are not observable for which there is little, if
      any, market activity for the asset or liability being measured. These
      inputs reflect management’s best estimate of the assumptions market
      participants would use in determining fair value. Level 3 would include
      instruments valued using industry standard pricing models and other
      valuation methods that utilize unobservable pricing inputs that are
      significant to the overall fair value. The Company does not have any fair
      value balances classified as Level
3.
 
 73
 
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 In
valuing certain contracts, the inputs used to measure fair value may fall into
different levels of the fair value hierarchy. For disclosure purposes, assets
and liabilities are classified in their entirety in the fair value hierarchy
level based on the lowest level of input that is significant to the overall fair
value measurement. Our assessment of the significance of a particular input to
the fair value measurement requires judgment and may affect the placement within
the fair value hierarchy levels.
 
 The fair
value of all hedge instruments was zero as of December 31, 2009, therefore the
Company does not have either an asset or a liability recorded in connection with
those instruments.
 
 NOTE
13 –EMPLOYEES’ BENEFIT PLANS
 
 The
Company’s employees are eligible to participate in a 401(k) plan after attaining
the age of 21. Participants may defer up to 100% of eligible compensation. The
Company matches participant contributions dollar for dollar up to 6% of
participant compensation not exceeding $16,500 per employee ($22,000 for those
over 50, choosing to catch-up). For the year ended December 31, 2009, 2008 and
2007, the Company made contributions to the plan totaling 290,695, $311,825 and
$68,743, respectively.
 
 NOTE
14 – QUARTERLY FINANCIAL DATA (UNAUDITED)
 
 Quarterly
financial information is presented in the following summary:
 
 2007Three
      Months EndedMarch
      31
              
              
              June
      30
              
              
              September
      30
              
              
              December
      31Revenues
              
              $
              16,651,301
              
              
              $
              21,620,299
              
              
              $
              26,731,699
              
              
              $
              35,086,399Operating
      Income
              
              
              9,395,863
              
              
              
              13,283,378
              
              
              
              17,661,615
              
              
              
              15,685,456Net
      Income
              
              
              5,707,890
              
              
              
              7,899,378
              
              
              
              11,403,777
              
              
              
              9,430,894Basic
      Net Income Per Share
              
              $
              0.19
              
              
              $
              0.26
              
              
              $
              0.33
              
              
              $
              0.28Diluted
      Net Income Per Share
              
              
              0.18
              
              
              
              0.24
              
              
              
              0.32
              
              
              
              0.26
   2008Three
      Months EndedMarch
      31
              
              
              June
      30
              
              
              September
      30
              
              
              December
      31Revenues
              
              $
              45,312,392
              
              
              $
              62,159,281
              
              
              $
              68,412,686
              
              
              $
              32,974,286Operating
      Income
              
              
              29,650,936
              
              
              
              39,637,781
              
              
              
              42,188,778
              
              
              
              21,097,908Net
      Income
              
              
              18,318,395
              
              
              
              24,794,349
              
              
              
              26,922,966
              
              
              
              13,581,491Basic
      Net Income Per Share
              
              $
              0.52
              
              
              $
              0.69
              
              
              $
              0.71
              
              
              $
              0.36Diluted
      Net Income Per Share
              
              
              0.51
              
              
              
              0.67
              
              
              
              0.69
              
              
              
              0.35
   2009Three
      Months EndedMarch
      31
              
              
              June
      30
              
              
              September
      30
              
              
              December
      31Revenues
              
              $
              20,193,160
              
              
              $
              27,636,695
              
              
              $
              36,060,878
              
              
              $
              42,350,044Operating
      Income
              
              
              9,998,248
              
              
              
              22,702,454
              
              
              
              18,954,179
              
              
              
              14,649,746Net
      Income
              
              
              6,465,449
              
              
              
              14,436,065
              
              
              
              12,113,026
              
              
              
              9,279,639Basic
      Net Income Per Share
              
              $
              0.17
              
              
              $
              0.38
              
              
              $
              0.32
              
              
              $
              0.24Diluted
      Net Income Per Share
              
              
              0.17
              
              
              
              0.37
              
              
              
              0.31
              
              
              
              0.24
  The net
income per share information above will not match the income statement due to
rounding.
 74
 ARENA
RESOURCES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
15 – SIGNIFICANT FOURTH QUARTER ADJUSTMENTS
 
 There
were no material fourth quarter adjustments or accounting changes.
 
 NOTE
16 – SUBSEQUENT EVENTS
 
 Subsequent
to December 31, 2009, the Company issued a total of 75,000 shares of stock
pursuant to the restricted stock award plan.  These shares were valued
based on the market price of the shares of $45.05 on the date of grant of
January 6, 2010.  These shares will vest 50% per year for two years
and the fair value of these shares will be expensed over that
period.
 
 We have
evaluated subsequent events after the balance sheet date of December 31, 2009
through the time of filing with the SEC on March 1, 2010, which is the date the
financial statements were issued.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  75
 ARENA
RESOURCES, INC.
 SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
 (Unaudited)
  Results of Operations from Oil and
Gas Producing Activities– The Company’s results of operations from oil
and gas producing activities exclude interest expense, gain from change in fair
value of put options, and other financing expense.  Income taxes are
based on statutory tax rates, reflecting allowable deductions.
 
 For
      the Years Ended December 31,
                
                2009
                
                
                2008
                
                
                2007Oil
      and gas revenues
                
                $
                126,240,777
                
                
                $
                208,858,645
                
                
                $
                100,089,698Production
      costs
                
                
                (15,543,461
                )
                
                
                (17,833,144
                )
                
                
                (11,500,461
                )Production
      taxes
                
                
                (6,455,585
                )
                
                
                (10,518,370
                )
                
                
                (5,655,877
                )Realized
      loss on oil derivative
                
                
                14,884,846
                
                
                
                (4,275,330
                )
                
                
                (932,361
                )Depreciation,
      depletion, amortization and accretion
                
                
                (39,368,567
                )
                
                
                (30,099,196
                )
                
                
                (18,158,966
                )General
      and administrative (exclusive of corporate overhead)
                
                
                (3,804,383
                )
                
                
                (3,034,525
                )
                
                
                (3,011,753
                )Results
      of operations before income taxes
                
                
                75,953,627
                
                
                
                143,098,080
                
                
                
                60,830,280Provision
      for income taxes
                
                
                (28,102,842
                )
                
                
                (52,946,290
                )
                
                
                (22,507,204
                )Results
      of Oil and Gas Producing Operations
                
                $
                47,850,785
                
                
                $
                90,151,790
                
                
                $
                38,323,076
 
 Recent SEC and FASB Rule-Making
Activity --In December 2008, the SEC announced that it had approved
revisions designed to modernize the oil and gas company reserves reporting
requirements. See Note 1 Organization and Summary of Significant Accounting
Policies – New Accounting Policies. We adopted the rules effective December 31,
2009 and the rule changes, including those related to pricing and technology,
are included in our reserves estimates.  The new rule does not allow
for prior-year reserve information to be restated, so all information related to
periods prior to 2009 is presented consistent with prior SEC rules for the
estimation of proved reserves.
 
 In
addition, in January 2010 the FASB issued Accounting Standards Update 2010-03,
"Oil and Gas Reserve Estimation and Disclosures", to provide consistency with
the SEC rules. See Note 1 Organization and Summary of Significant Accounting
Policies – New Accounting Policies.
 
 Reserve Quantities Information
– The following estimates of proved and proved developed reserve quantities and
related standardized measure of discounted net cash flow are estimates only, and
do not purport to reflect realizable values or fair market values of the
Company’s reserves.  The Company emphasizes that reserve estimates are
inherently imprecise and that estimates of new discoveries are more imprecise
than those of producing oil and gas properties.  Accordingly, these
estimates are expected to change as future information becomes
available.  All of the Company’s reserves are located in the United
States of America.
 
 Proved
reserves are estimated reserves of crude oil (including condensate and natural
gas liquids) and natural gas that geological and engineering data demonstrate
with reasonable certainty to be recoverable in future years from known
reservoirs under existing economic and operating conditions.  Proved
developed reserves are those expected to be recovered through existing wells,
equipment and methods.
 
 The
standardized measure of discounted future net cash flows is computed by applying
the price according to the SEC guidelines for oil and gas to the estimated
future production of proved oil and gas reserves, less estimated future
expenditures (based on year-end costs) to be incurred in developing and
producing the proved reserves, less estimated future income tax expenses (based
on year-end statutory tax rates) to be incurred on pretax net cash flows less
tax basis of the properties and available credits, and assuming continuation of
existing economic conditions.  The estimated future net cash flows are
then discounted using a rate of 10 percent per year to reflect the estimated
timing of the future cash flows.
 
 76
  ARENA
RESOURCES, INC.
 SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
 (Unaudited)
 For the Years
      Ended December
      31,
                
                2009
                
                
                2008
                
                
                2007Oil (1)
                
                
                Gas (1)
                
                
                Oil (1)
                
                
                Gas (1)
                
                
                Oil (1)
                
                
                Gas (1)Proved
      Developed and Undeveloped ReservesBeginning
      of year
                
                
                55,845,257
                
                
                
                58,804,662
                
                
                
                47,413,322
                
                
                
                48,074,962
                
                
                
                36,064,273
                
                
                
                42,424,199Purchases
      of minerals in place
                
                
                1,589,141
                
                
                
                2,791,611
                
                
                
                3,638,095
                
                
                
                2,364,908
                
                
                
                7,021,972
                
                
                
                4,330,246Improved
      recovery and extensions
                
                
                14,360,492
                
                
                
                13,605,184
                
                
                
                9,547,981
                
                
                
                11,391,853
                
                
                
                6,016,660
                
                
                
                6,852,346Production
                
                
                (2,004,498
                )
                
                
                (2,172,790
                )
                
                
                (2,018,335
                )
                
                
                (1,911,713
                )
                
                
                (1,316,023
                )
                
                
                (1,503,611
                )Revision
      of previous estimate
                
                
                (10,074,880
                )
                
                
                (15,813,979
                )
                
                
                (2,735,806
                )
                
                
                (1,115,348
                )
                
                
                (373,560
                )
                
                
                (4,028,218
                )End
      of year
                
                
                59,715,512
                
                
                
                57,214,688
                
                
                
                55,845,257
                
                
                
                58,804,662
                
                
                
                47,413,322
                
                
                
                48,074,962Proved
      Developed at end of year
                
                
                21,144,906
                
                
                
                28,302,469
                
                
                
                20,231,477
                
                
                
                28,659,033
                
                
                
                14,951,794
                
                
                
                30,783,255
 1Oil reserves
are stated in barrels; gas reserves are stated in thousand cubic
feet.
  Standardized
      Measure of Discounted Cash FlowsDecember
      31,
              
              2009
              
              
              2008
              
              
              2007Future
      cash flows
              
              $
              3,721,873,750
              
              
              $
              2,391,888,946
              
              
              $
              4,634,645,500Future
      production costs
              
              
              (902,963,847
              )
              
              
              (716,121,604
              )
              
              
              (790,284,047
              )Future
      development costs
              
              
              (543,022,875
              )
              
              
              (330,672,457
              )
              
              
              (321,485,125
              )Future
      income taxes
              
              
              (746,548,080
              )
              
              
              (394,800,287
              )
              
              
              (1,254,982,170
              )Future
      net cash flows
              
              
              1,529,338,948
              
              
              
              950,294,598
              
              
              
              2,267,894,15810%
      annual discount for estimated timing of cash flows
              
              
              (775,105,191
              )
              
              
              (489,607,688
              )
              
              
              (991,727,804
              )Standardized
      Measure of Discounted Cash Flows
              
              $
              754,233,757
              
              
              $
              460,686,910
              
              
              $
              1,276,166,354




Changes
      in Standardized Measure of Discounted Future Net Cash
Flows2009
              
              
              2008
              
              
              2007Beginning
      of the year
              
              $
              460,686,910
              
              
              $
              1,276,166,354
              
              
              $
              545,439,675Purchase
      of minerals in place
              
              
              28,329,307
              
              
              
              41,597,736
              
              
              
              325,058,027Extensions,
      discoveries and improved recovery, less related costs
              
              
              253,485,559
              
              
              
              129,110,323
              
              
              
              297,610,301Development
      costs incurred during the year
              
              
              107,237,470
              
              
              
              190,631,820
              
              
              
              113,109,335Sales
      of oil and gas produced, net of production costs
              
              
              (110,697,316
              )
              
              
              (190,374,853
              )
              
              
              (82,949,751
              )Accretion
      of discount
              
              
              48,058,341
              
              
              
              131,684,244
              
              
              
              69,291,660Net
      changes in price and production costs
              
              
              619,543,318
              
              
              
              (1,526,963,575
              )
              
              
              592,749,069Net
      change in estimated future development costs
              
              
              6,550,757
              
              
              
              (22,637,628
              )
              
              
              (111,175,136
              )Revision
      of previous quantity estimates
              
              
              (447,110,784
              )
              
              
              293,723,576
              
              
              
              (7,424,163
              )Revision
      of estimated timing of cash flows
              
              
              (35,543,586
              )
              
              
              (409,158,356
              )
              
              
              (62,546,312
              )Net
      change in income taxes
              
              
              (176,306,219
              )
              
              
              546,907,269
              
              
              
              (402,996,351
              )End
      of the Year
              
              $
              754,233,757
              
              
              $
              460,686,910
              
              
              $
              1,276,166,354






77