# United States Securities and Exchange CommissionWashington, D.C. 20549

# Form 10-KSB/AAmendment No. 2

|(Mark One)                                                                                     
|-----------------------------------------------------------------------------------------------
||X|   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934     
|                                                                                               
|For the fiscal year ended December 31, 2004                                                    
|Or                                                                                             
||__|   Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|                                                                                               
|For the transition period from ___________to ___________                                       
|                                                                                               
|                                                                                               

# 

_________________

# Commission file number 001-31657

_________________

|Arena Resources, Inc.                                         
|--------------------------------------------------------------
|(Name of small business issuer in its charter)                
|                                                              
|Nevada                                                        
|(State or other jurisdiction of incorporation or organization)

|4920 South Lewis Avenue, Suite 107Tulsa, Oklahoma |  | 74105     
|------------------------------------------------- |  | ----------
|(Address of Principal Executive Offices)          |  | (Zip Code)

(918) 747-6060(Issuer'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 Registered
|------------------------- | -----------------------------------------
|Common - $0.001 Par Value | American Stock Exchange                  

Securities registered under Section 12(g) of the Exchange Act:  None

Check whether the issuer: (1) 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 |X|  No |_|

Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. |X|

State issuer's revenues for its most recent fiscal year. $8,482,130

As of March 10, 2005, the aggregate market value of the common voting stock
held by non-affiliates of the issuer, based upon the closing stock price of
$12.61 per share, was approximately $97,905,351. As of March 10, 2005, the
issuer had outstanding 10,194,304 shares of common stock ($0.001 par value).

Transitional Small Business Disclosure Format (check one): Yes |_|  No |X|

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|TABLE OF CONTENTS
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|Item 2           
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|Item 6           
|Item 7           
|Item 8           
|Item 8A          
|Item 8B          
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|Item 9           
|Item 10          
|Item 11          
|Item 12          
|Item 13          
|Item 14          

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# Explanatory Note

The
purpose of this Amendment No. 2 to the Annual Report on Form 10-KSB of Arena Resources,
Inc. (the Company) for the year ended December 31, 2004 (the Original
Form 10-KSB) is to (i) include the GAAP-based Standardized Measure of
Discounted Future Net Cash Flows in various narrative and tabular provisions where
we describe the non-GAAP concept of pre-tax present value of future net reserves
(PV-10) and explain the reason for the difference in the two measures; (ii)
reclassify certain costs which we had previously included as part of our oil and gas
production activities; (iii) disclose more fully the impact of SFAS No. 143 on our
calculation of depreciation, depletion and amortizations costs; (iv) record an adjusted
value (adjusted to market value on the date of issuance) of 40,000 shares of the
Companys common stock originally issued as a finders fee in
connection with the acquisition of property and capitalized as part of our properties
subject to amortization; and (v) to restate our financial statements to reflect the change
in how we account for compensation expenses associated with options granted to employees
under our stock option plan.

The
change in how we account for compensation expenses associated with options granted to
employees essentially results in our recognition of compensation expense related to the
discount amount of the exercise price of the option from the market price of the stock at
the date of grant over the vesting period. The discount on all options granted through
December 31, 2004 has been 15%, and the vesting period has been five years. The result of
these changes is that our general and administrative expenses (which include our current
compensation expense) have increased, with a resulting reduction in our net income after
taxes for each year we have restated our financial statements. The effect of this change
on our net income after taxes is to reduce our net income for the year ended December 31,
2003 by $139,355 (from $809,498 to $670,143), which equates to a reduction in our earnings
per share from $0.12 to $0.10 for basic earnings per share and from $0.11 to $0.09 for
diluted earnings per share, and for the year ended December 31, 2004 by $128,365 (from
$2,580,017 to $2,451,652), which equates to a reduction in our earnings per share from
$0.33 to $0.31 for basic earnings per share and from $0.30 to $0.28 for diluted earnings
per share. We direct your attention to new Note 2 to our financial statements, which
explains more fully these changes.

This
Amendment No. 2 amends and restates in its entirety the Original Form 10-KSB. This
Amendment No. 2 continues to reflect circumstances as of the date and time of the filing
of the Original Form 10-KSB and does not reflect events occurring after the filing of the
Original Form 10-KSB or modify or update any other disclosures in any way.

# Forward Looking
Statements

All
statements, other than statements of historical fact included in this Annual Report on
Form 10-KSB (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:       Description of
Business

# General

Arena
 Resources,  Inc. was  incorporated  in Nevada on August 31, 2000. Our principal
 executive  offices are located at 4920 South Lewis Avenue, Suite 107, Tulsa, Oklahoma
74105, and our telephone number is (918) 747-6060.

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

Since
our inception in August 2000, we have built our asset base and achieved growth primarily
through property acquisitions. From our inception through December 31, 2004, we have
increased our proved reserves to approximately 21.2 million Boe (barrel of oil
equivalent), through the acquisition of interests in 12 leases, which have net revenue
interests ranging from 24.5% to 81.32%. As of December 31, 2004, our estimated proved
reserves had a pre-tax PV10 (present value of future net revenues before income taxes
discounted at 10%) of approximately $302 million and a Standardized Measure of Discounted
Future Net Cash Flows of approximately $205 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 $30 million on acquisitions and capital projects during 2003 and
2004.

We
have a portfolio of oil and natural gas reserves, with approximately 92% of our proved
reserves consisting of oil and approximately 8% consisting of natural gas. Approximately
24.1% of our proved reserves are classified as proved developed producing, or
PDP. Approximately 1.7% of our proved reserves are classified as proved
developed non-producing, or PDNP, and approximately 74.2% 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. The majority of our competitors possess and
employ financial, technical and personnel resources substantially greater than ours, which
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
our financial or personnel resources permit. Our ability to acquire additional prospects
and to find and develop reserves in the future will depend on our ability to 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.

---



Current
competitive factors in the domestic oil and gas industry are unique. The actual price
range of crude oil is largely established by major international producers. Pricing for
natural gas is more regional. Because the current domestic demand for oil and gas exceeds
supply, we believe there is little risk that all current production will not be sold at
relatively fixed prices. To this extent we do not believe we are directly competitive with
other producers, nor is there any significant risk that we could not 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. However, more favorable prices
can usually be negotiated for larger quantities of oil and/or gas product. In this
respect, while we believe we have a price disadvantage when compared to larger producers,
we view our primary pricing risk to be related to a potential decline in international
prices to a level which could render our current production uneconomical.

We
are presently committed to use the services of the existing gathering companies in our
present areas of production. This 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 would be required to lay new pipeline
and/or obtain new rights of way to any lease from which we are selling production).

# 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 2004, two customers were responsible for
generating 74% or more of our total oil and natural gas sales. These two customers were
Plains Marketing, L.P., accounting for approximately 31% of total sales and Navajo
Refining Company, accounting for approximately 43% of total sales. However, we believe
that the loss of either of these customers would not materially impact our business,
because we could readily find other purchasers for our oil and gas as produced.

# 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 recently 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.

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 us or our acquired properties are
involved 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.

# Current Employees

As
of December 31, 2004, we had ten full-time employees, including one petroleum engineer.
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 2:       Description of
Property

# General Background

Since
our inception in late August 2000, we have begun to build a solid asset base and achieved
steady growth, primarily through property acquisitions, but with some exploitation
activities. From our inception through December 31, 2004, our proved reserves have grown
to 21,217,254 Boe, at an average acquisition/drilling cost of $1.60 per Boe. Many
properties contain both oil and gas reserves. In those cases, the oil and gas reserves and
the volume of oil and gas produced are converted to a common unit of measure on the basis
of their approximate relative energy content. The common unit which we use is
Barrels of oil equivalent or Boe. Acquisition and drilling costs
per Boe is calculated by dividing the net capitalized costs, computed in
accordance with applicable accounting standard, as shown under Capitalized Costs
Relating to Oil and Gas Producing Activities under Supplemental Information on Oil
and Gas Producing Activities ($33,879,101), by our reserves in Boe (21,217,254).

---



As
of December 31, 2004, our estimated proved reserves had a pre-tax PV10 value of
approximately $302 million and a Standardized Measure of Discounted Future Cash Flows of
approximately $205 million, approximately 44% of which came from properties located in New
Mexico, approximately 42% from our properties in Texas, approximately 12% from our
properties in Oklahoma and approximately 2% from our properties in Kansas. We spent
approximately $30 million on capital projects during 2003 and 2004. We expect to further
develop these properties through additional drilling. Our capital budget for 2005 is
approximately $15 million for development of existing properties. Although our focus will
be on development of our existing properties, we also intend to continue seeking
acquisition opportunities which compliment our current portfolio. We intend to fund our
development activity primarily through use of cash flow from operations and cash on hand,
while potential drawings on our credit facility and proceeds from future equity
transactions would also be available for development projects or future acquisitions. We
believe that our acquisition expertise, together with our operating experience and
efficient cost structure, provides us with the potential to continue our growth.

We
have a portfolio of oil and natural gas reserves, with approximately 92% of our proved
reserves consisting of oil and approximately 8% consisting of natural gas. Approximately
24.1% of our proved reserves are classified as proved developed producing properties.
Approximately 1.7% of our proved reserves are classified as proved developed nonproducing,
and approximately 74.2% are classified as proved undeveloped.

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, 2004.

|Geographic Area | Oil(Bbl) | Natural Gas(Mcf) | Total(Boe) | Pre-Tax PV10 Value | Standardized Measure of Discounted Future Net Cash Flows
|--------------- | -------- | ---------------- | ---------- | ------------------ | --------------------------------------------------------
|                |          |                  |            |                    |                                                         
|New Mexico      |          |                  |            | 8,659,448          |                                                         
|Texas           |          |                  |            | 7,777,328          |                                                         
|Oklahoma        |          |                  |            | 3,113,888          |                                                         
|Kansas          |          |                  |            | --                 |                                                         
|                |          |                  |            |                    |                                                         
|Total           |          |                  |            | 19,550,664         |                                                         
|                |          |                  |            |                    |                                                         

# Proved Reserves

Our
21,217,254 Boe of proved reserves, which consist of approximately 92% oil and 8% natural
gas, are summarized below as of December 31, 2004, on a net pre-tax PV10 value basis. Our
reserve estimates have not been filed with any Federal authority or agency (other than the
SEC).

---



As
of December 31, 2004, New Mexico proved reserves had a net pre-tax PV10 value of $132.9
million and Standardized Measure of Discounted Future Net Cash Flows of $90.0 million, our
proved reserves in Texas had a net pre-tax PV10 value of $127.2 million and Standardized
Measure of Discounted Future Net Cash Flows of $86.8 million, our proved reserves in
Oklahoma had a net pre-tax PV10 value of $36.6 million and a Standardized Measure of
Discounted Future Net Cash Flows of $24.7 million and our proved reserves in Kansas had a
net pre-tax PV10 value of $5.7 million and a Standardized Measure of Discounted Future Net
Cash Flows of $3.8 million.

As
of December 31, 2004, approximately 24.1% of the 21.2 million Boe of proved reserves have
been classified as proved developed producing, or PDP. Proved developed
non-producing, or PDNP, and proved undeveloped, or PUD, reserves
constitute 1.7% and 74.2%, respectively, of the proved reserves as of December 31, 2004.

Approximately
twenty-eight percent (28%) of our reserves for the year ended December 31, 2004 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.

Total
proved reserves had a net pre-tax PV10 value as of December 31, 2004 of approximately $302
million and a Standardized Measure of Discounted Future Net Cash Flows of approximately
$205 million, 18.6% or $56.1 million and $38.2, respectively, of which is associated with
the PDP reserves. An additional $4.7 million and $3.1 million, respectively, is associated
with the PDNP reserves ($60.8 million and $41.3 million, respectively, for total proved
developed reserves, or 20.1% of total proved reserves pre-tax PV10 value) and $241.6
million and $164.0 million, respectively, is associated with PUD reserves.

Our
proved reserves as of December 31, 2004 are summarized in the table below.

---



|              | Oil(Bbl)  |  | Gas(Mcf)  |  | Total(Boe) |  | % of TotalProved |  |   | Pre-taxPV10(In thousands) |  |   | Standardized Measure of Discounted Future Net Cash Flows |  |   | Future CapitalExpenditures(In thousands)
|------------- | --------- |  | --------- |  | ---------- |  | ---------------- |  | - | ------------------------- |  | - | -------------------------------------------------------- |  | - | ----------------------------------------
|New Mexico:   |           |  |           |  |            |  |                  |  |   |                           |  |   |                                                          |  |   |                                         
|PDP           | 2,273,402 |  | 2,070,556 |  | 2,618,495  |  | 12%              |  | $ | 31,268                    |  | $ | 21,218                                                   |  | $ | -                                       
|PDNP          | 326,902   |  | 250,734   |  | 368,691    |  | 2%               |  |   | 4,696                     |  |   | 3,187                                                    |  |   | -                                       
|PUD           | 6,059,144 |  | 1,844,056 |  | 6,366,487  |  | 30%              |  |   | 96,955                    |  |   | 65,792                                                   |  |   | 11,541                                  
|              |           |  |           |  |            |  |                  |  |   |                           |  |   |                                                          |  |   |                                         
|Total Proved: | 8,659,448 |  | 4,165,346 |  | 9,353,672  |  | 44%              |  | $ | 132,919                   |  | $ | 90,197                                                   |  | $ | 11,541                                  
|              |           |  |           |  |            |  |                  |  |   |                           |  |   |                                                          |  |   |                                         

|Texas:        |           |  |           |  |           |  |     |  |   |         |  |   |        |  |   |       
|------------- | --------- |  | --------- |  | --------- |  | --- |  | - | ------- |  | - | ------ |  | - | ------
|PDP           | 1,661,082 |  | 584,328   |  | 1,758,470 |  | 8%  |  | $ | 17,293  |  | $ | 11,735 |  | $ | -     
|PDNP          | -         |  | -         |  | -         |  | 0%  |  |   | -       |  |   | -      |  |   | -     
|PUD           | 6,116,246 |  | 1,620,220 |  | 6,386,283 |  | 30% |  |   | 109,980 |  |   | 74,630 |  |   | 44,684
|              |           |  |           |  |           |  |     |  |   |         |  |   |        |  |   |       
|Total Proved: | 7,777,328 |  | 2,204,548 |  | 8,144,753 |  | 38% |  | $ | 127,273 |  | $ | 86,365 |  | $ | 44,684
|              |           |  |           |  |           |  |     |  |   |         |  |   |        |  |   |       

|Oklahoma:     |           |  |         |  |           |  |     |  |   |        |  |   |        |  |   |      
|------------- | --------- |  | ------- |  | --------- |  | --- |  | - | ------ |  | - | ------ |  | - | -----
|PDP           | 459,907   |  | 168,756 |  | 488,033   |  | 3%  |  | $ | 4,731  |  | $ | 3,210  |  | $ | -    
|PDNP          | -         |  | -       |  | -         |  | 0%  |  |   | -      |  |   | -      |  |   | -    
|PUD           | 2,653,981 |  | -       |  | 2,653,981 |  | 12% |  |   | 31,853 |  |   | 21,615 |  |   | 5,375
|              |           |  |         |  |           |  |     |  |   |        |  |   |        |  |   |      
|Total Proved: | 3,113,888 |  | 168,756 |  | 3,142,014 |  | 15% |  | $ | 36,584 |  | $ | 24,825 |  | $ | 5,375
|              |           |  |         |  |           |  |     |  |   |        |  |   |        |  |   |      

|Kansas:       |   |  |           |  |         |  |    |  |   |       |  |   |       |  |   |    
|------------- | - |  | --------- |  | ------- |  | -- |  | - | ----- |  | - | ----- |  | - | ---
|PDP           | - |  | 1,540,891 |  | 256,815 |  | 1% |  | $ | 2,818 |  | $ | 1,912 |  | $ | -  
|PDNP          | - |  | -         |  | -       |  | 0% |  |   | -     |  |   | -     |  |   | -  
|PUD           | - |  | 1,920,000 |  | 320,000 |  | 2% |  |   | 2,862 |  |   | 1,942 |  |   | 375
|              |   |  |           |  |         |  |    |  |   |       |  |   |       |  |   |    
|Total Proved: | - |  | 3,460,891 |  | 576,815 |  | 3% |  | $ | 5,680 |  | $ | 3,854 |  | $ | 375
|              |   |  |           |  |         |  |    |  |   |       |  |   |       |  |   |    

|Total:        |            |  |           |  |            |  |      |  |   |         |  |   |         |  |   |       
|------------- | ---------- |  | --------- |  | ---------- |  | ---- |  | - | ------- |  | - | ------- |  | - | ------
|PDP           | 4,394,391  |  | 4,364,531 |  | 5,121,813  |  | 24%  |  | $ | 56,110  |  | $ | 38,075  |  | $ | -     
|PDNP          | 326,902    |  | 250,734   |  | 368,691    |  | 2%   |  |   | 4,696   |  |   | 3,187   |  |   | -     
|PUD           | 14,829,371 |  | 5,384,276 |  | 15,726,750 |  | 74%  |  |   | 241,650 |  |   | 163,979 |  |   | 61,975
|              |            |  |           |  |            |  |      |  |   |         |  |   |         |  |   |       
|Total Proved: | 19,550,664 |  | 9,999,541 |  | 21,217,254 |  | 100% |  | $ | 302,456 |  | $ | 205,241 |  | $ | 61,975
|              |            |  |           |  |            |  |      |  |   |         |  |   |         |  |   |       

---



# 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 to proved developed, as well as the estimated costs per year
involved in such development.

|Year | Estimated OilReservesDeveloped (Bbls) |  | Estimated GasReservesDeveloped (Mcf) |  | Total Boe  |  |   | Estimated DevelopmentCosts(1)
|---- | ------------------------------------- |  | ------------------------------------ |  | ---------- |  | - | -----------------------------
|     |                                       |  |                                      |  |            |  |   |                              
|2005 | 3,108,084                             |  | 2,159,540                            |  | 3,468,007  |  | $ | 12,406,208                   
|2006 | 6,041,222                             |  | 1,832,581                            |  | 6,346,652  |  |   | 22,620,434                   
|2007 | 4,517,791                             |  | 1,056,016                            |  | 4,693,794  |  |   | 16,532,000                   
|     |                                       |  |                                      |  |            |  |   |                              
|     | 13,667,097                            |  | 5,048,137                            |  | 14,508,453 |  | $ | 51,558,642                   
|     |                                       |  |                                      |  |            |  |   |                              

(1) The
amount shown for 2005 differs from the Capital Expenditures           budgeted as
described elsewhere in this document. The difference is the result           of Arena
owning less than 100% of the working interest in all of the properties           which
are being developed. The amount shown here and in our reserve analysis
          constitutes the portion attributable to our working interest. However, if our
          working interest partners elected not to participate in the development
planned,           we would be responsible for the full $15 million.

# Production

Our
estimated average daily production for the month of December, 2004, is summarized below.
These tables indicate the percentage of our estimated December 2004 average daily
production of 999 Boe/d attributable to each state and to oil versus natural gas
production.

|State      |  | AverageDailyProduction |  | Oil    |  | NaturalGas
|---------- |  | ---------------------- |  | ------ |  | ----------
|New Mexico |  | 48.99%                 |  | 43.15% |  | 5.84%     
|Texas      |  | 24.40%                 |  | 22.99% |  | 1.41%     
|Oklahoma   |  | 22.21%                 |  | 20.15% |  | 2.06%     
|Kansas     |  | 4.40%                  |  | 0.00%  |  | 4.40%     
|           |  |                        |  |        |  |           
|Total      |  | 100%                   |  | 86%    |  | 14%       

---



# Summary of Oil and
Natural Gas Properties and Projects

Significant
New Mexico Operations

Seven
Rivers Queen Unit  Lea County, New Mexico. We acquired a 70.6% working interest
and a 56.48% net revenue interest in this property in May 2003. This lease was acquired
from Permian Resources Holding, Inc., an unaffiliated company, for a cash payment of
$900,000. The remaining working interest is owned by unaffiliated parties. There are
currently 43 producing wells on this lease, and we believe it can support six to eight
possible infill wells (additional wells within the spacing requirements of the unit), as
well as some untested formations in shallow sand. This lease consists of approximately
2,240 acres and is held by production.

North
Benson Queen Unit  Eddy County, New Mexico. In October 2003 we acquired a 100%
working interest and a 78.15% net revenue interest in this lease, which currently has 21
producing wells. This lease was acquired from United Resources, L.P., an unaffiliated
company, for a cash payment of $500,000. The lease covers approximately 1,800 acres, and
we currently anticipate it can support up to 23 additional wells, which are included in
our estimate of PUD. This lease is held by production.

The
North Benson Queen Unit Waterflood will require additional volumes of water to support the
waterflood expansion. A sufficient and economical source of water has been identified. A
water line of approximately four miles in length will be constructed across Bureau of Land
Management lands to transport the water to the North Benson Queen Unit. Permit
applications must be submitted to the Bureau of Land Management and are usually granted
within ninety days of application submittal. The construction of the water line should
require approximately thirty days at a cost of $250,000. The permit application will be
submitted in the second quarter 2005 with construction slated for the summer of 2005. The
development of the North Benson Queen Unit waterflood is scheduled for 2006 at estimated
costs of $5,732,000.

East
Hobbs Unit  Lea County, New Mexico. In May 2004 we acquired a 82.24% working
interest and a 67.6% net revenue interest in this lease primarily from EnerQuest Oil and
Gas, Ltd., an unaffiliated company, for a cash payment of $10,008,440. Although the
Purchase and Sales Agreement transferred the revenue and the related operating costs from
East Hobbs to us beginning March 1, 2004, Arena did not control the property interests
until May 7, 2004. As a result, the acquisition date for accounting purposes was May 7,
2004 and the operations of East Hobbs operations were included in our results of
operations from May 7, 2004. Revenues and operating costs for the months of March and
April were estimated and treated as adjustments to the purchase price. This lease covers
approximately 920 acres. At the date of acquisition, there were 20 operating oil and gas
wells. We drilled an additional six wells, all of which were successfully completed, and
washed down one other well during 2004. We believe this property can support up to six
additional wells, which are included in our estimate of PUD. This lease is held by
production.

Significant
Texas Operations

Y6 Lease
 Fisher County, Texas.We acquired a 100% working interest and an 80% net
revenue interest in this lease in June 2001. This lease was acquired from Durango
Operating Company, Inc. an unaffiliated company, for a cash payment of $750,000. There are
currently 12 producing wells on this lease. A portion of this property has been
waterflooded, and when we begin our future development operations on this property, we
plan to waterflood the remaining acreage. 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. This potential waterflood project (and the estimated $1 million cost thereof) is
included as PUD in our reserve report. This lease consists of approximately 1,697 acres
and is held by production.

---



Dodson
Lease  Montague County, Texas. We purchased a 100% working interest and an
81.25% net revenue interest in this lease in June 2002. This lease was acquired from
Nocona minerals Partnership, an unaffiliated company, for a cash payment of $200,000.
There are currently three producing wells and nine other wells on this approximately 570
acre lease, all of which is held by production.

West
San Andres Unit  Yoakum County, Texas. In October 2003 we acquired a 100%
working interest and a 79.60% net revenue interest in this lease from Permian Resources,
Inc. an unaffiliated company, for a cash payment of $500,000. The lease covers
approximately 1,200 acres, and currently has 10 producing wells. We believe it can support
up to four additional wells, which are included in our estimate of PUD. This lease is held
by production. In 2004 we contracted for the drilling of one well on this property, which
was not commenced until January 2005.

Fuhrman-Mascho
leases  Andrews County, Texas. In December 2004 we acquired a 100% working
interest and a 75% net revenue interest in these leases from four entities; Paul D.
Friemel & Assoc, Inc., Compostella Oil Company, Redco Oil & Gas Inc. and Terry N.
Stevens, Inc., all unaffiliated companies. The purchase price, including acquisition
costs, was $10,966,495 and consisted of $9,667,381 of cash paid to the sellers, $44,421 in
cash acquisition costs, 180,013 shares of the Companys common stock, valued at
$1,260,091, or $7.00 per share, and the issuance of put and call options with a net value
of $24,602. These leases cover approximately 11,300 acres. We believe it can support up to
130 additional wells, which are included in our estimate of PUD. These leases are held by
production.

Significant
Oklahoma Operations

Casey
Lease  Muskogee County, Oklahoma. The Casey Lease originally consisted of a 40%
working interest contributed by our two principal shareholders. We subsequently acquired
additional interests in this lease, so that presently we have a 94% working interest, and
an approximately 74.48% net revenue interest in the well on this property. 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.

In
May 2001, we acquired an additional 30% working interest in the lease from a group of
interest holders represented by Petro Consultants, Inc. The additional working interest
was valued at $300,000 and was acquired by the issuance of 80,000 shares of common stock
valued at $1.75 per share totaling $140,000, the assumption of a $50,000 obligation of the
seller and the issuance of a note payable for $110,000. This note was subsequently settled
through cash payments of $45,000 and the issuance of an additional 37,143 shares of common
stock valued at $1.75 per share totaling $65,000. The $50,000 liability assumed from the
seller related to the sellers previous obligation to the operator of the properties
and has been paid.

In
October 2001, we acquired an additional 24% working interest and a 21⁄2% overriding
royalty interest in the Casey lease from a group of interest holders represented by Petro
Consultants, Inc. The acquired interests were valued at $266,250 and were purchased by the
issuance of 81,857 shares of common stock valued at $1.75 per share totaling $143,250, a
cash payment of $90,000 and the issuance of a note payable for $33,000. The note was
subsequently paid.

---



The
remaining working interest in the Casey lease is owned by an unaffiliated party. This
lease consists of approximately 160 acres. In December 2003 we temporarily shut-in this
gas well. Subsequent to December 31, 2004, we sold the Casey lease to an unrelated party.

Ona
Morrow Sand Unit  Cimarron and Texas Counties, Oklahoma. We own a 100% working
interest and an 81.32% net revenue interest in this lease which has been producing since
our acquisition in July 2002. This lease was acquired from Bass Petroleum, Inc., an
unaffiliated company, for a cash payment of $735,000. This lease has approximately 2,120
acres and seven producing wells. We believe up to five additional locations may be
suitable for drilling, which are included in our estimate of our PUD. This lease is held
by production.

Eva
South Morrow Sand Unit  Texas County, Oklahoma. We own a 100% working interest
and an 85.41% net revenue interest in this lease which was also acquired in July 2002.
This lease was acquired from Ensign Operating Company, an unaffiliated company, for a cash
payment of $827,500. The lease consists of approximately 489 acres and has seven producing
wells, with a possibility for two additional wells, which have been included in our
estimate of our PUD. This lease is held by production.

Midwell,
Appleby, Smaltz and Hanes Leases  Cimarron County, Oklahoma. We own 100% of the
working interest and an 80% net revenue interest in these four leases acquired in
September 2002. All have been producing leases since the date of our acquisition. The
Midwell Appleby and Smaltz leases consist of approximately 1,640 acres with five producing
wells, and we believe there are up to three additional drilling locations on these leases.
The Hanes lease contains approximately 640 acres and four producing wells, with a
possibility of up to two additional wells, which are included in our estimate of PUD. All
of these leases are held by production.

Roy
Hanes Lease  Texas County, Oklahoma. We own a 24.5% working interest and a
21.44% net revenue interest in this lease, which is a property operated by XTO Energy,
Inc, an unaffiliated company, who also owns the remaining working interest. The interest
in this lease was acquired at the same time we acquired our interests in the Midwell,
Appleby, Smaltz and Hanes leases, and there has been production on this lease since that
time. This lease consists of approximately 640 acres, and is currently held by production.

The
Midwell, Appleby, Smaltz, Hanes and Roy Hanes leases were acquired from Burk Royalty Co.,
Ltd. R.A. Kimball Property Co., Ltd. and Kimball Family Resources, Ltd., all unaffiliated
companies. The cost of these leases was $550,179, with $100,000 paid in cash and the
balance paid through our issuance of 99,885 shares of our common stock valued at $4.00 per
share (the then current market value), and the issuance of put and call options with a net
value to the sellers of $50,639.

Significant
Kansas Operations

Koehn/Rexford
Unit  Haskell & Gray County, Kansas.This lease consists of approximately
640 acres. After entering into a farmout agreement with Bird Creek Resources, Inc., an
unaffiliated company, we drilled and completed an initial gas well on this lease. Under
the terms of this agreement, we agreed to drill one well and could drill additional wells
on the property. In exchange for each well drilled, we will be assigned 100% of the
working interest (80% of the net revenue interest) in the well and related oil and gas
until payout of all costs of drilling, equipping and operating the well. After payout, our
working interest in the wells and related oil and gas will decrease to 75% (60% of the net
revenue interest).

In
2002, we successfully drilled one well at a cost of approximately $153,000 to drill,
complete and connect to the pipeline and thus will have reached payout when we recover
this amount from production. After payout, Bird Creek Resources, Inc. will own the
remaining 25% working interest.

---



On
March 20, 2002, we entered into a joint venture agreement with Petro Consultants, Inc., to
drill and operate the well on the above-mentioned property. Under the terms of the
agreement, Petro purchased 27% of the working interest in the well for $88,200. On May 20,
2002, after the well was successfully drilled, we issued 70,000 shares of common stock
(valued at $1.26 per share) to Petro to repurchase the 27% working interest in the well.

In
February 2004, we successfully drilled one additional well on this acreage at a cost of
approximately $159,000 to drill, complete and connect to the pipeline and thus will have
reached payout when we recover this amount from production. After payout, Bird Creek
Resources, Inc. will own the remaining 25% working interest.

In
November 2004, we completed the installation of a pipeline from our Koehn lease to a
gatherer/purchased pipeline. Total cost on installation of the pipeline was approximately
$144,000. The installation of this pipeline was necessary to be able to begin producing
from our wells in that area. Production started on December 11, 2004.

Schmidt
Unit  Gray County, Kansas. During 2004 we leased an additional 640 acres
offsetting our Koehn/Rexford Unit for a total of approximately $8,582. In November 2004,
we successfully drilled one well on this acreage at a cost of approximately $183,520 to
drill, complete and connect to the pipeline. We began producing from this well on December
23, 2004.

Beals
Prospect  Comanche County, Kansas. In July 2003 we acquired a 100% working
interest and an 80.5% net revenue interest in this lease, consisting of 1,560 acres. This
lease was acquired from Bengalia Land and Cattle Company., an unaffiliated party, for a
cash payment of $60,000. During August 2003 we drilled one well on this acreage, which was
unsuccessful and was plugged and abandoned. This lease will expire in April 2006 if not
then held by production.

# Acreage

The
following table summarizes gross and net developed and undeveloped acreage at December 31,
2004 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 Acreage
|---------- | ----------------- |  | ------------------- |  | -------------
|           |                   |  |                     |  |              
|           | Gross             |  | Net                 |  | Gross        
|           |                   |  |                     |  |              
|New Mexico | 4,960             |  | 3,294               |  | --           
|Texas      | 14,767            |  | 11,251              |  | --           
|Oklahoma   | 5,689             |  | 4,242               |  | --           
|Kansas     | 1,280             |  | 1,024               |  | 1,560        
|           |                   |  |                     |  |              
|Total      | 26,696            |  | 19,811              |  | 1,560        
|           |                   |  |                     |  |              

---



# Production History

The
following table presents the historical information about our produced natural gas and oil
volumes.

|                                  | Year Ended December 31,
|--------------------------------- | -----------------------
|                                  |                        
|                                  |                        
|Oil production (Bbls)             |                        
|Natural gas production (Mcf)      |                        
|Total production (Boe)            |                        
|Daily production (Boe/d)          |                        
|Average sales price:              |                        
|Oil (per Bbl)                     | $                      
|Natural gas (per Mcf)             |                        
|Total (per Boe)                   |                        
|Average production cost (per Boe) | $                      

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.

# Productive Wells

The
following table presents our ownership at December 31, 2004, 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 Wells
|---------- | --------- |  | --------- |  | -----------
|           | Gross     |  | Net       |  | Gross      
|New Mexico | 93        |  | 60        |  | -          
|Texas      | 182       |  | 138       |  | -          
|Oklahoma   | 23        |  | 19        |  | -          
|Kansas     | -         |  | -         |  | 3          
|           |           |  |           |  |            
|Total      | 298       |  | 217       |  | 3          
|           |           |  |           |  |            

# Drilling Activity

During
2004 we completed the drilling of nine wells, completed a wash down on one well and had
contracted for the drilling of one additional well that was not commenced until January
2005. Two of the wells were drilled and completed in Gray County, Kansas, offsetting the
Koehn well that was drilled in 2002. Both of these wells were placed into production in
December 2004. The third newly drilled well is on our Dodson property in Montague County,
Texas. This well has been completed but has not yet been placed into production. The
remaining six newly drilled wells and the one washed down well are in on our East Hobbs
San Andres Unit property in Lea County, New Mexico. All seven wells were completed have
been placed into production. The well for which we had contracted for drilling that was
commenced in January 2005 is on our West San Andres Unit property in Yoakum County, Texas.
This well was drilled in January 2005 and completed in March 2005, but has not yet been
placed into production.

---



# 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 $8.94 in 2002, $8.92 in 2003 and $8.85 in 2004. These
amounts are calculated by dividing our total production costs by our total volume sold, in
Boe.

Costs
incurred for property acquisition, exploration and development activities during the years
ended December 31, 2002, 2003 and 2004 are shown below.

|                                   | For the Years Ended December 31,
|---------------------------------- | --------------------------------
|                                   |                                 
|                                   |                                 
|                                   |                                 
|Acquisition of proved properties   | $                               
|Acquisition of unproved properties |                                 
|Exploration costs                  |                                 
|Development costs                  |                                 
|                                   |                                 
|Total Costs Incurred               | $                               
|                                   |                                 

# Reserve Quantity
Information

Our
estimates of proved reserves and related valuations were based on reports prepared by Lee
Keeling and Associates, Inc., independent petroleum and geological engineers, in
accordance with the provisions of SFAS 69, Disclosures About Oil and Gas Producing
Activities. 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.

---



|                           |                               | Oil (Bbls) |           | Natural Gas(Mcf)
|-------------------------- | ----------------------------- | ---------- | --------- | ----------------
|                           |                               |            |           |                 
|Balance, December 31, 2001 | 494,823                       |            | 2,960,373
|                           | Purchase of minerals in place | 3,597,156  |           | 1,676,706       
|                           | Extensions and discoveries    | --         |           | --              
|                           | Production                    | (58,717)   |           | (46,819)        
|                           | Revisions of estimates        | 80,674     |           | (1,402,503)     
|                           |                               |            |           |                 
|                           |                               |            |           |                 
|Balance, December 31, 2002 | 4,113,936                     |            | 3,187,757
|                           | Purchase of minerals in place | 3,175,357  |           | 570,924         
|                           | Extensions and discoveries    | 18,066     |           | 229,626         
|                           | Production                    | (117,646)  |           | (67,329)        
|                           | Revisions of estimates        | (139,546)  |           | (512,224)       
|                           |                               |            |           |                 
|                           |                               |            |           |                 
|Balance, December 31, 2003 | 7,050,167                     |            | 3,408,754
|                           | Purchase of minerals in place | 8,764,087  |           | 6,431,437       
|                           | Extensions and discoveries    | -          |           | 640,000         
|                           | Production                    | (195,167)  |           | (169,002)       
|                           | Revisions of estimates        | 3,931,577  |           | (311,648)       
|                           |                               |            |           |                 
|                           |                               |            |           |                 
|Balance, December 31, 2004 | 19,550,664                    |            | 9,999,541
|                           |                               |            |           |                 

Our
proved oil and natural gas reserves are shown below.

|                  |             |  | For the Years Ended December 31,
|----------------- | ----------- |  | --------------------------------
|                  |             |  | 2002                            
|                  |             |  |                                 
|Oil (Bbls)        |             |  |                                 
|                  | Developed   |  | 750,463                         
|                  | Undeveloped |  | 3,363,473                       
|                  |             |  |                                 
|                  | Total       |  | 4,113,936                       
|                  |             |  |                                 
|                  |             |  |                                 
|Natural Gas (Mcf) |             |  |                                 
|                  | Developed   |  | 1,160,639                       
|                  | Undeveloped |  | 2,027,118                       
|                  |             |  |                                 
|                  | Total       |  | 3,187,757                       
|                  |             |  |                                 
|                  |             |  |                                 
|Total (Boe)       |             |  |                                 
|                  | Developed   |  | 943,904                         
|                  | Undeveloped |  | 3,701,326                       
|                  |             |  |                                 
|                  | Total       |  | 4,645,230                       
|                  |             |  |                                 

---



# 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 the provisions of SFAS 69. Future cash inflows were computed
by applying year-end prices to estimated future production. Future production and
development costs are computed by estimating the expenditures to be incurred in producing
and developing the proved oil and natural gas reserves at year end, based on year-end
costs and assuming continuation of existing economic conditions.

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 percent 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,                                             |   | 2003         |  |  |   | 2004          | 
|-------------------------------------------------------- | - | ------------ |  |  | - | ------------- | 
|                                                         |   |              |  |  |   |               | 
|Future net cash inflows                                  | $ | 218,026,254  |  |  | $ | 814,346,791   | 
|Future production costs                                  |   | (64,157,199) |  |  |   | (171,518,828) | 
|Future development costs                                 |   | (13,609,384) |  |  |   | (61,975,106)  | 
|Future income taxes                                      |   | (45,778,941) |  |  |   | (187,392,403) | 
|                                                         |   |              |  |  |   |               | 
|Future net cash flows                                    |   | 94,480,730   |  |  |   | 393,460,454   | 
|10% annual discount for estimated timing of cash flows   |   | (49,474,633) |  |  |   | (188,219,704) | 
|                                                         |   |              |  |  |   |               | 
|Standardized Measure of Discounted Future Net Cash Flows | $ | 45,006,097   |  |  | $ | 205,240,750   | 
|                                                         |   |              |  |  |   |               | 

The
changes in the standardized measure of discounted future net cash flows relating to the
proved oil and natural gas reserves are shown below.

|                                                                  | For the Years Ended December 31,
|----------------------------------------------------------------- | --------------------------------
|                                                                  |                                 
|                                                                  |                                 
|                                                                  |                                 
|Beginning of the year                                             | $                               
|Purchase of minerals in place                                     |                                 
|                                                                  |                                 
|Extensions, discoveries and improved recovery, less related costs |                                 
|Development costs incurred during the year                        |                                 
|Sales of oil and gas produced, net of production costs            |                                 
|Accretion of discount                                             |                                 
|Net change in prices and production costs                         |                                 
|Net change in estimated future development costs                  |                                 
|Revision of previous quantity estimates                           |                                 
|Revision of estimated timing of cash flows                        |                                 
|Net change in income taxes                                        |                                 
|                                                                  |                                 
|End of the Year                                                   | $                               
|                                                                  |                                 

---



# 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 26,696 gross (19,810 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, 2004, we owned interests in approximately 1,560 gross undeveloped acres
(1,256 net). We believe that our current and future cash flow will enable us to undertake
the exploitation of our properties through additional drilling activities. Our expected
capital budget for development of existing properties in 2005 is approximately $15
million.

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.
From August 2000 through December 31, 2004, we acquired 12 leases at an aggregate
acquisition and enhancement cost of approximately $33 million, representing approximately
21.2 million Boe of proved reserves. While our emphasis in 2005 and beyond is anticipated
to focus on the further development our existing properties, we will continue to look for
properties with both 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, 2004, our oil
and gas production costs per Boe averaged $8.90 and general and administrative costs
averaged $3.02 per Boe produced.

# Other Properties and
Commitments

We
currently lease our principal executive offices in Tulsa, Oklahoma. At December 31, 2004,
the lease was for approximately 2,352 square feet of office space, at an annual rental of
$20,400. Subsequent to December 31, 2004 and effective March 1, 2005, we leased an
additional 385 square feet of office space at the same location and extended the lease
through January 1, 2006. Our annual rental for 2005 will be $24,400. The current
facilities are believed adequate for our current operations.

# 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 litigation pending or
threatened.

# Item 4:       Submission of
Matters to a Vote of Security Holders

Our
annual shareholders meeting was held on December 21, 2004. The shareholders
re-elected Messrs. Stanley M. McCabe, Lloyd T. Rochford, Charles M. Crawford, Chris V.
Kemendo, Jr. and Clayton E. Woodrum as Directors with terms ending in 2005. The
shareholders further 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 1,000,000 to 1,500,000, and to provide discretionary acceleration of vesting of
options previously granted. Following is a chart reflecting the votes cast for each of the
elected directors, as well as for the amendment to the stock option plan:

---



|                         |  | Votes for |  |  |  | Votes against |  |  |  | Abstain | 
|------------------------ |  | --------- |  |  |  | ------------- |  |  |  | ------- | 
|                         |  |           |  |  |  |               |  |  |  |         | 
|Lloyd T. Rochford        |  | 5,556,002 |  |  |  | -             |  |  |  | 11,001  | 
|Stanley M. McCabe        |  | 5,556,002 |  |  |  | -             |  |  |  | 11,001  | 
|Charles M. Crawford      |  | 5,556,002 |  |  |  | -             |  |  |  | 11,001  | 
|Chris V. Kemendo, Jr.    |  | 5,545,002 |  |  |  | -             |  |  |  | 22,001  | 
|Clayton E. Woodrum       |  | 5,556,002 |  |  |  | -             |  |  |  | 11,001  | 
|                         |  |           |  |  |  |               |  |  |  |         | 
|Amendment to option plan |  | 5,473,992 |  |  |  | 93,011        |  |  |  | 438,038 | 

# PART II

|Item 5: |  | Market for
Registrants Common Stock, Related Stockholder Matters and Issuer Purchases of
Equity Securities
|------- |  | -----------------------------------------------------------------------------------------------------------

# Market for our Common
Stock

Since
April 15, 2003, our common stock has been traded on the American Stock Exchange, under the
symbol ARD. Prior to that time, our common stock traded on the OTC Bulletin
Board. The following table shows the high and low sales prices for each quarter since
listing on the American Stock Exchange, and the high and low bid prices prior to such
time, during the last two years.

|Period                                   |   | High Sale or Bid |  |  |   | Low Sale or Bid | 
|---------------------------------------- | - | ---------------- |  |  | - | --------------- | 
|1st Quarter 2003                         | $ | 4.35             |  |  | $ | 4.25            | 
|2nd Quarter 2003                         |   | 5.99             |  |  |   | 4.35            | 
|3rd Quarter 2003                         |   | 5.82             |  |  |   | 5.45            | 
|4th Quarter 2003                         |   | 6.10             |  |  |   | 5.40            | 
|                                         |   |                  |  |  |   |                 | 
|1st Quarter 2004                         | $ | 7.08             |  |  | $ | 5.85            | 
|2nd Quarter 2004                         |   | 9.65             |  |  |   | 6.98            | 
|3rd Quarter 2004                         |   | 7.46             |  |  |   | 5.98            | 
|4th Quarter 2004                         |   | 8.79             |  |  |   | 6.80            | 
|                                         |   |                  |  |  |   |                 | 
|1st Quarter 2005 (throughMarch 10, 2005) | $ | 13.40            |  |  | $ | 8.35            | 

# Record Holders

As
of March 1, 2005, there are approximately 1,481 holders of record of our common stock.
Approximately 24%, or 2,430,200 shares of the 10,194,304 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 two 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
was amended by our shareholders at our annual meeting in 2004. Information regarding this
plan and the options that have been granted under this plan may be found in this Annual
Report under Part III, Items 10 and 11.

# Recent Sales of
Unregistered Securities

Throughout
2004, we issued 78,300 shares of our common stock upon the exercise of previously issued
warrants at either $1.75 per share or $5.00 per share. These shares were issued in a
transaction not involving a public offering and were issued in reliance upon the exemption
from registration provided by Section 4(2) of the Securities Act of 1933.  The
persons to whom the shares were issued had access to full information concerning us and
represented that he acquired the shares for his own account and not for the purpose of
distribution.  The certificates for the shares contain a restrictive legend advising
that the shares may not be offered for sale, sold or otherwise transferred without having
first been registered under the 1933 Act or pursuant to an exemption from registration
under the 1933 Act. There was no underwriter involved in these transactions.

In
August 2004, we issued 25,000 shares of common stock valued at $5.99 per share and 15,000 shares of common stock valued at $6.00 per share, for a total of $239,750, as compensation
to a consultant utilized in connection with our acquisition of the East Hobbs San Andres
Unit in Eddy County, New Mexico. The shares were issued in a transaction not involving a
public offering and were issued in reliance upon the exemption from registration provided
by Section 4(2) of the Securities Act of 1933. The person to whom the shares were issued
had access to full information concerning us and represented that he acquired the shares
for his own account and not for the purpose of distribution. The certificates for the
shares contain a restrictive legend advising that the shares may not be offered for sale,
sold or otherwise transferred without having first been registered under the 1933 Act or
pursuant to an exemption from registration under the 1933 Act. There was no underwriter
involved in this transaction.

In
December 2004, we issued 30,000 shares of common stock valued at $7.00 per share, or
$210,000, as compensation to a consultant utilized in connection with our acquisition of
the Fuhrman Mascho leases in Andrews County, Texas. The shares were issued in a
transaction not involving a public offering and were issued in reliance upon the exemption
from registration provided by Section 4(2) of the Securities Act of 1933. The person to
whom the shares were issued had access to full information concerning us and represented
that he acquired the shares for his own account and not for the purpose of distribution.
The certificates for the shares contain a restrictive legend advising that the shares may
not be offered for sale, sold or otherwise transferred without having first been
registered under the 1933 Act or pursuant to an exemption from registration under the 1933
Act. There was no underwriter involved in this transaction.

# Issuer Repurchases

We
did not make any repurchases of our equity securities during the quarter ending December
31, 2004.

---



|Item 6: |  | 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 four years, we have
emphasized the acquisition of properties that provided current production and significant
upside potential through further development.

We
have increased our reserves significantly by investing approximately $25.4 million in
acquisitions and enhancements in 2004, following total capital expenditures of
approximately $4 million in 2003 and approximately $3.2 million in 2002.

Our
capital budget for 2005 is approximately $15 million for development of existing
properties. We also intend to continue seeking acquisition opportunities which compliment
our current portfolio. We intend to fund our development activity primarily through use of
cash flow from operations and cash on hand, while potential drawings on our credit
facility and proceeds from future equity transactions would also be available for
development projects or future acquisitions.

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. As we have now increased our base of proven
properties, and as oil and natural gas prices have recently significantly risen, we have
initiated our development activities.

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.
In some instances, we have been able to acquire non-operated property interests at
attractive rates of return that provided a foothold in a new area of interest or
complemented our existing operations. We intend to continue to acquire both operated and
non-operated interests to the extent we believe they satisfy our general business plan. In
addition, our willingness to acquire non-operated properties in new geographic regions may
provide us with geophysical and geologic data in some cases that leads to further
acquisitions in the same region, whether on an operated or non-operated basis.

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 sharply 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.

# Results of Operations

The
following table sets forth selected operating data for the periods indicated:

|                              |                                                     |   | For the Years Ended December 31,
|----------------------------- | --------------------------------------------------- | - | --------------------------------
|                              |                                                     |  
|                              |                                                     |   | 2002                            
|                              |                                                     |   |                                 
|Net production:               |                                                     |   |                                 
|                              | Oil (Bbls)                                          |   | 58,717                          
|                              | Natural gas (Mcf)                                   |   | 46,819                          
|                              |                                                     |   |                                 
|Net sales:                    |                                                     |   |                                 
|                              | Oil                                                 | $ | 1,532,045                       
|                              | Natural gas                                         |   | 124,992                         
|                              |                                                     |   |                                 
|Average sales price:          |                                                     |   |                                 
|                              | Oil (per Bbl)                                       | $ | 26.09                           
|                              | Natural gas (per Mcf)                               |   | 2.67                            
|                              |                                                     |   |                                 
|Production costs and expenses |                                                     |   |                                 
|                              | Lease operating expenses                            | $ | 594,863                         
|                              | Production taxes                                    |   | 117,164                         
|                              | Depreciation, depletion and    amortization expense |   | 151,197                         
|                              | General and administrative    expenses              |   | 248,018                         

Restatement of Financial
Statements to Reflect Compensation Related to Stock Option Grants

In
late 2005, following discussions with our independent auditors, we decided to restate our
financial statements for the years ended December 31, 2003 and December 31, 2004, to
reflect a change in how we account for compensation expenses associated with options
granted to employees and to record an adjusted value (adjusted to market value on the date
of issuance) of 40,000 shares of the Companys common stock which were originally
issued as a finders fee in connection with the acquisition of property and
capitalized as part of properties subject to amortization. The first change essentially
results in our recognition of compensation expense related to the discount amount of the
exercise price of the option from the market price of the stock at the date of grant over
the vesting period. The discount on all options granted through December 31, 2004 has been
15%, and the vesting period has been five years. The second change results in an
additional $35,217 in value attributable to properties subject to amortization. The result
of these changes is that general and administrative expenses (which include our current
compensation expenses) have increased, with a resulting reduction in our net income after
taxes for each year. The effect of this change on our net income after taxes is to reduce
our net income for the year ended December 31, 2003 by $139,355 (from $809,498 to
$670,143), which equates to a reduction in our earnings per share from $0.12 to $0.10 for
basic earnings per share and from $0.11 to $0.09 for diluted earnings per share, and for
the year ended December 31, 2004 by $128,365 (from $2,580,017 to $2,451,652), which
equates to a reduction in our earnings per share from $0.33 to $0.31 for basic earnings
per share and from $0.30 to $0.28 for diluted earnings per share. The comparisons reflected in the following discussions under
General and administrative expenses and Net income, reflect the
effect of such restatement. The addition of $35,217 in value attributable to properties
subject to amortization had no impact on our amortization expenses or net income as
reported for these periods.

---



Year Ended December 31,
2004 Compared to Year Ended December 31, 2003

Oil
and natural gas sales. Oil and natural gas sales revenue increased approximately $4.82
million to $8.48 million in 2004. Oil sales increased $4.42 million and natural gas sales
increased $575,000. The oil sales increase was caused by a sales volume increase of 77,470
barrels in 2004, and a 35% increase in the average realized per barrel oil price from
$29.06 in 2003 to $39.25 in 2004. 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 101,673 Mcf in 2004 and a 32% increase
in the average realized natural gas price per Mcf from $3.67 in 2003 to $4.86 in 2004.
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 $26 million of capital expenditures during 2004, of which approximately $21 million
were related to our acquisition of the East Hobbs and Fuhrman Mascho properties.

Oil
and gas production costs. Our aggregate oil and gas production costs increased from
$1,149,136 in 2003 to $1,975,835 2004, although such expenses on a Boe basis declined
slightly from $8.92 in 2003 to $8.85 in 2004. These per Boe amounts are calculated by
dividing out total production costs by our total volume sold, in Boe. This aggregate
increase was the result of having the properties acquired in 2003 in our operations for a
full year in 2004; acquiring new properties and accounting for them for a portion of the
year in 2004 and cost increases. The decline on a per Boe basis is attributable to
consolidation of resources available due to our growth.

Oil
and gas production taxes. Oil and gas production taxes as a percentage of oil and
natural gas sales were 7% during 2003 and remained steady at 7% in 2004. 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.

Depreciation,
depletion and amortization. Our depreciation, depletion and amortization expense
increased by $651,320 to $1,011,602 in 2004. The increase was a result of an increase in
the average depreciation, depletion and amortization rate from $2.79 per Boe during 2003
to $4.53 per Boe during 2004. 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 was the result of increased sales
volume and an increase in estimated future development costs.

General
and administrative expenses. General and administrative expenses increased by $96,076
to $874,850 during 2004. This increase was primarily related to increases in compensation
expense associated with an increase in personnel required to administer our growth, legal
fees of $31,150, annual listing fees of $18,700, $16,095 in fees paid to Lee Keeling for
2003 reserve reports, fees related to obtaining our credit facility and letters of credit
and directors fees.

Interest
expense. Interest expense increased $117,138 to $155,936 in 2004. The increase was due
to higher amounts of debt being outstanding during periods of the year in 2004.

Income
tax expense. Our effective tax rate was 37% during 2004 and 37% during 2003.

---



Cumulative
change in accounting principle. Effective January 1, 2003, we adopted the provisions
of SFAS No. 143, Accounting for Asset Retirement Obligations. This statement
generally applies to legal obligations associated with the retirement of long-lived assets
and requires us to recognize the fair value of asset retirement obligations in our
financial statements by capitalizing that cost as a part of the cost of the related asset.
This statement applies directly to the plug and abandonment liabilities associated with
our net working interest in well bores. The additional carrying amount is depleted over
the estimated lives of the properties. The discounted liability is based on historical
abandonment costs in specific areas and is accreted at the end of each accounting period
through charges to accretion expense. The liability is discounted using a credit-adjusted
risk-free rate of approximately 8.08%. If the obligation is settled for other than the
carrying amount, a gain or loss is recognized on settlement. Upon adoption of SFAS No.
143, we recorded an increase to our discounted abandonment liability of $236,718,
increased proved property cost by $217,878, and recognized a one-time cumulative effect
charge of $11,813 (net of a related tax effect of $7,027). The effect of adopting this
accounting principle was a $24,873 after tax decrease in net income during 2003.

Net
income. Net income increased from $670,143 for 2003 to $2,451,652 for 2004. 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.

Year Ended December 31,
2003 Compared to Year Ended December 31, 2002

Oil
and natural gas sales. Oil and natural gas sales revenue increased approximately $2
million to $3.66 million in 2003. Oil sales increased $1.89 million and natural gas sales
increased $122,000. The oil sales increase was caused by a sales volume increase of 58,929
barrels in 2003, and a 11% increase in the average realized per barrel oil price from
$26.09 in 2002 to $29.06 in 2003. 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 20,510 Mcf in 2003 and a 37% increase in
the average realized natural gas price per Mcf from $2.67 in 2002 to $3.67 in 2003. 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 $3
million of capital expenditures during 2003.

Oil
and gas production costs. Our aggregate oil and gas production costs increased from
$594,863 or $8.94 per Boe in 2002 to $1,149,136 or $8.92 per Boe in 2003, although such
expenses on a per Boe basis declined slightly from $8.94 in 2002 to $8.92 in 2003. These
per Boe amounts are calculated by dividing out total production costs by our total volume
sold, in Boe. This aggregate increase was a result of higher operating costs on properties
acquired in 2003. The decline on a per Boe basis is attributable to consolidation of
resources available due to our growth. While it is possible that this increase will
continue in the future as we acquire additional properties, because each property is
individual in its characteristics, at this time, apart from normal increases associated
with inflation in general, we cannot specifically identify this increase to be a trend.

Oil
and gas production taxes. Oil and gas production taxes as a percentage of oil and
natural gas sales were 7% during 2002 and remained steady at 7% in 2003. 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.

Depreciation,
depletion and amortization. Our depreciation, depletion and amortization expense
increased by $209,085 to $360,282 in 2003. The increase was a result of an increase in the
average depreciation, depletion and amortization rate from $2.27 per Boe during 2002 to
$2.79 per Boe during 2003. 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 was the result of increased sales
volume and an increase in estimated future development costs.

General
and administrative expenses. General and administrative expenses increased by $530,756
to $778,774 during 2003. This increase was primarily related to increases in compensation
expense associated with an increase in personnel required to administer our growth
(specifically, the addition of our in-house engineer), the amortization of the deferred
compensation associated with the outstanding stock options of $221,198, listing fees of
$56,625 paid to the American Stock Exchange, $61,280 in fees paid to a stock research
analyst, fees related to obtaining our credit facility and letters of credit and directors
fees.

---



Interest
expense. Interest expense increased $22,875 to $38,798 in 2003. The increase was due
to our debt being outstanding for the entire year in 2003, as opposed to being outstanding
for a partial year in 2002.

Income
tax expense. Our effective tax rate was 37% during 2003 and 32% during 2002. The
effective rate was higher during 2003 due to having more income subject to income tax,
higher state income tax and no benefit of operating loss carry forwards in 2003.

Cumulative
change in accounting principle. Effective January 1, 2003, we adopted the provisions
of SFAS No. 143, Accounting for Asset Retirement Obligations. This statement
generally applies to legal obligations associated with the retirement of long-lived assets
and requires us to recognize the fair value of asset retirement obligations in our
financial statements by capitalizing that cost as a part of the cost of the related asset.
This statement applies directly to the plug and abandonment liabilities associated with
our net working interest in well bores. The additional carrying amount is depleted over
the estimated lives of the properties. The discounted liability is based on historical
abandonment costs in specific areas and is accreted at the end of each accounting period
through charges to accretion expense. The liability is discounted using a credit-adjusted
risk-free rate of approximately 8.08%. If the obligation is settled for other than the
carrying amount, a gain or loss is recognized on settlement. Upon adoption of SFAS No.
143, we recorded an increase to our discounted abandonment liability of $236,718,
increased proved property cost by $217,878, and recognized a one-time cumulative effect
charge of $11,813 (net of a related tax effect of $7,027). The effect of adopting this
accounting principle was a $24,873 after tax decrease in net income during 2003.

Net
income. Net income increased from $387,049 for 2002 before preferred stock dividends,
to $670,143 for 2003. 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.

# Liquidity and Capital
Resources

Historical
Financing. We have historically funded our operations through loans from our executive
officers, our initial public offering of stock in 2001, private equity offerings of our
stock and warrants and our Secondary offering of common stock and warrants which we closed
in August 2004.

Credit
Facility. On April 14, 2004, we established a new $15,000,000 credit facility with our
principal lenders with an $8,500,000 initial borrowing base. In November 2004, we entered
into an agreement that increased the facility to $25,000,000, with an increased borrowing
base of $15,000,000. Any increases in the borrowing base are subject to written consent by
the financial institution. The interest rate is a floating rate equal to the 30, 60 or 90
day LIBOR rate plus 2.25%, currently 5.04% per annum, and is payable monthly. Annual fees
for the facility are 1/8 of one percent of the unused portion of the borrowing base.
Amounts borrowed under the revolving credit facility are due in April 2007. The revolving
credit facility is secured by our principal mineral interests. In order to obtain the
revolving credit facility, loans from two officers were subordinated to the position of
the bank. We are required under the terms of the credit facility to maintain a tangible
net worth of $12,000,000, maintain a 5-to-1 ratio of income before interest, taxes,
depreciation, depletion and amortization to interest expense and maintain a current asset
to current liability ratio of 1-to-1, not including the $2,000,000 bridge financing
arrangement discussed below. On May 7, 2004, we drew $8,008,440 under this revolving
credit facility to fund the acquisition of the East Hobbs San Andres Property interests.
During August 2004, utilizing cash flow from operations and proceeds from the recent
secondary offering of common stock and warrants, we paid $8,008,440 of principal and
related accrued interest due on the credit facility. During December 2004, we drew
$9,000,000 under this revolving credit facility to fund the acquisition of the Fuhrman
Mascho leases and $1,000,000 to help fund development activities. An additional $299,029
is reserved under the revolving credit facility as collateral for standby letters of
credit issued to various states.

---



On
April 14, 2004, we also entered into to a bridge financing arrangement for $2,000,000 from
our lender. On April 21, 2004, we borrowed $1,000,000 under the terms of the bridge
financing agreement to fund a cash deposit made on the East Hobbs San Andres Property
interests. On May 7, 2004, we borrowed an additional $1,000,000 under the terms of the
bridge financing arrangement to fund the acquisition of the East Hobbs San Andres Property
interests. The interest rate on the bridge financing arrangement is a floating rate equal
to the 30, 60 or 90 day LIBOR rate plus 2.25%, currently 3.42% per annum, and is payable
monthly. This arrangement was established for a one-time purpose to satisfy the funding
requirements of the East Hobbs San Andres Property acquisition. The original agreement
expired June 30, 2004 and was subsequently extended to July 31, 2004. The bridge financing
arrangement was guaranteed by two of the Companys officers. During August 2004,
utilizing cash flow from operations and proceeds from the recent public offering of common
stock and warrants, the Company paid $2,000,000 of principal and related accrued interest
due under the bridge financing agreement. Since repayment in August 2004, no amounts have
been outstanding on this bridge financing agreement and no new agreements have been
established to continue the bridge financing arrangement.

Cash
Flows. Our primary sources of cash have been cash flows from operations and equity
offerings. During the three years ended December 31, 2004, we generated $7,572,898 from
operating activities, financed $14,230,863 through proceeds from the sale of stock and
warrants, and $400,000 from debt obligations owed to two officers, for a total of
$22,203,761. We primarily used this cash generation to fund our capital expenditures
aggregating $31,385,738 over the three years. At December 31, 2004, we had $1,253,969 of
cash and $772,154 of working capital compared to December 31, 2003 when our cash position
was $1,076,676 and working capital was $1,268,888.

We
continually evaluate our capital needs and compare them to our capital resources. Our
budgeted capital expenditures for 2005 are approximately $15,000,000 for development of
our current properties. We expect to fund these expenditures as well as any future
property acquisitions from cash on hand, internally generated cash flow during the year
2005, proceeds from future equity transactions and from borrowings under our credit
facility, if required. 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
principal and minimum debt and lease payments for periods subsequent to December 31, 2004.

|Year  |   | Long-Term Debt |  |  |   | Lease Obligation |  |  |   | Total Cash Obligation | 
|----- | - | -------------- |  |  | - | ---------------- |  |  | - | --------------------- | 
|2005  | $ | -              |  |  | $ | 24,400           |  |  | $ | 24,400                | 
|2006  |   | 400,000        |  |  |   | -                |  |  |   | 400,000               | 
|2007  |   | 10,000,000     |  |  |   | -                |  |  |   | 10,000,000            | 
|      |   |                |  |  |   |                  |  |  |   |                       | 
|Total | $ | 10,400,000     |  |  | $ | 24,400           |  |  | $ | 10,424,400            | 
|      |   |                |  |  |   |                  |  |  |   |                       | 

---



# Off-Balance Sheet
Financing Arrangements

As
of December 31, 2004 we had no off-balance sheet financing arrangements.

# New Accounting Policies

Effective
January 1, 2003, we adopted the provisions of SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement generally applies to legal obligations
associated with the retirement of long-lived assets that result from the acquisition,
construction, development and/or the normal operation of a long-lived asset. SFAS No. 143
requires us to recognize the fair value of asset retirement obligations in our financial
statements by capitalizing that cost as a part of the cost of the related asset. In
regards to us, this statement applies directly to the plug and abandonment liabilities
associated with our net working interest in well bores. The additional carrying amount is
depleted over the estimated lives of the properties. The discounted liability is based on
historical abandonment costs in specific areas and is accreted at the end of each
accounting period through charges to accretion expense. The liability is discounted using
a credit-adjusted risk-free rate of approximately 8.08%. If the obligation is settled for
other than the carrying amount, a gain or loss is recognized on settlement. Upon adoption
of SFAS No. 143, we recorded an increase to our discounted abandonment liability of
$236,718, increased property and equipment cost by $217,878 and recognized a one-time
cumulative effect charge of $11,813 (net of a deferred tax benefit of $7,027).

The
adoption of SFAS No. 143 also affected the depreciation, depletion and amortization on an
on-going basis. The additionally capitalized amount for the discounted abandonment
liability increases the base amount used in calculating depletion. This effect was an
increase in depreciation, depletion and amortization for the years ended December 31, 2003
and 2004 of $7,459 and $10,798, respectively. The adoption of SFAS No. 143 also impacted
the way the ceiling test is calculated under the full cost accounting method used by the
Company, in that an estimation of future abandonment costs are now excluded from the
computation of the present value of estimated future net revenues for purposes of the full
cost ceiling calculation. However, these costs are now part of the base amount, so while
the way the calculation is performed has changed, the end result remains the same There
were no option impacts of the adoption of SFAS No. 143.

In
January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities. This interpretation establishes the requirement for a primary beneficiary to
consolidate certain entities in which equity investors do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated financial support from other
parties. We do not have an interest in a variable interest entity and the adoption of the
statement did not have an impact on our financial statements.

In
May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. This statement was effective for
us in July 2003. The statement requires financial instruments to be classified as
liabilities if the financial instruments are issued in the form of shares that are
mandatorily redeemable or embody an obligation to repurchase equity shares. We issued a
put option in exchange for oil and gas property interests in December 2004. The put option
was originally classified as a liability; therefore, the adoption of the statement did not
have an impact on our financial statements.

# 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.

---



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 date;
| | - |  | -------------------------------------------

| |  |  | 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 is based on estimates prepared
by Lee Keeling and Associates, 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.

---



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 on a field-by-field basis using
escalated prices to the net recorded book cost at the end of each period. 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. Different pricing assumptions or discount rates could result in a
different calculated impairment. We have never recorded any property impairments.

Income
Taxes. We provide for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, Accounting for 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.

# Effects of Inflation and
Pricing

While
we did not experience any significant increased costs during 2003 due to increased demand
for oil field products and services, this trend did not continue in 2004. 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, and this proved to be the case in
2004 as oil and gas prices rose significantly. Costs for oilfield services and materials
increased during 2004 due to higher demand as a result of the higher oil and gas prices.
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 the increased business costs will continue while the commodity prices for oil
and natural gas, and the demand for services related to production and exploration, both
remain high (from an historical context) in the near term.

# Quantitative and
Qualitative Disclosure About Market Risk

Commodity Price Risk

We
have not historically entered into derivative contracts to manage our exposure to oil and
natural gas price volatility. Normal hedging arrangements have the effect of locking in
for specified periods the prices we would receive for the volumes and commodity to which
the hedge relates. Consequently, while hedges are designed to decrease exposure to price
decreases, they also have the effect of limiting the benefit of price increases.

Interest Rate Risk

Our
current credit facility has a floating interest rate. Therefore, as a result of our draws
on this credit facility, interest rate changes will impact future results of operations
and cash flows.

---



|Item 7: |  | Financial
Statements
|------- |  | --------------------

The
financial statements and supplementary data required by this item are included at page 43.

|Item 8: |  | Changes in and
Disagreements with Accountants And Accounting and Financial Disclosure
|------- |  | -------------------------------------------------------------------------------------

None.

|Item 8A: |  | 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, 2004, 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 principal
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
that is required to be included in the reports we file or submit under the Securities
Exchange Act of 1934.

We
made no change in our internal control over financial reporting during our fiscal year
ended December 31, 2004 that has materially affected, or is reasonably likely to
materially affect our internal control over financial reporting.

|Item 8B: |  | Other
Information
|-------- |  | -----------------

None

# PART III

|Item 9: |  | Directors and
Executive Officers
|------- |  | --------------------------------

# Executive Officers and
Directors

The
following table sets forth information regarding our executive officers, certain other
officers and directors as of December 31, 2004:

|Name                  | Age | Position                                                   
|--------------------- | --- | -----------------------------------------------------------
|Lloyd T. Rochford     | 58  | President and Chief Executive Officer and Director         
|Stanley M. McCabe     | 72  | Chairman of the Board of Directors, Secretary and Treasurer
|William R. Broaddrick | 27  | Vice President and Chief Financial Officer                 
|Charles M. Crawford   | 52  | Director                                                   
|Chris V. Kemendo, Jr. | 83  | Director                                                   
|Clayton E. Woodrum    | 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
2004.

Messrs.        Rochford,
McCabe and Crawford have served as directors since our inception in           August
2000. Mr. Kemendo was first elected to the Board of Directors in February           2003
and Mr. Woodrum was initially appointed in August 2003 by the Board of
          Directors to fill a vacancy created upon the resignation of a director.

---



The
following biographies describe the business experience of our executive officers and
directors:

# Lloyd T. Rochford 
President, Chief Executive Officer and Director.

Mr.
         Rochford, 58, 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 is 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. Since July, 1997, Mr. Rochford has
primarily           devoted his time and efforts to individual oil and gas acquisition
and           development prior to his commitment to participate in Arena Resources. 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.

Stanley M. McCabe  Chairman
of the Board of Directors, Secretary and Treasurer.

Mr.
         McCabe, 72, 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.
Since           January, 1997, Mr. McCabe has been involved as an independent investor
and           developer of oil and natural gas properties. Mr. McCabe attended college
courses           at the University of Maryland, primarily in business, in 1961 and 1962.

# William R. Broaddrick
 Vice President and Chief Financial Officer.

Mr.
         Broaddrick, 27, 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.

# Charles M. Crawford
 Director

Mr.
         Crawford, 52, has for the past twenty-nine years served as an independent oil
          and gas exploration consultant to various private and public oil and gas
          companies within the United States. He has acted as a consultant to such firms
          as Texaco, Inc, Phillips Petroleum Company, Mid-Continent Energy Corp. as well
          as other regional and national companies primarily acting in the mid-continent
          area. Mr. Crawford received a Masters Degree in geology from Miami University
of           Ohio, in 1976. Mr. Crawford will serve the company on an as needed basis as
an           outside director.

---



# Chris V. Kemendo, Jr.
 Director.

Mr.
         Kemendo, 83, has from 1989 to present acted as an independent financial business
          and accounting consultant to various clients. Mr. Kemendo is currently the
          Chairman of our audit committee and compensation committee. Mr. Kemendo has 56
          years of accounting experience. Mr. Kemendo graduated from the University of
          Oklahoma and subsequently became a Certified Public Accountant. From 1947 to
          1957, Mr. Kemendo was a manager of Arthur Young & Company, in charge of
          audit departments in Kansas City, Missouri, Wichita, Kansas and Caracas,
          Venezuela. From 1957 to 1961, Mr. Kemendo served as Controller and CFO for Rio
          Arriba Drilling Company. From 1961 to 1967, he was a partner of Fox &          Company,
Certified Public Accountants. From 1967 to 1973, he served as Executive
          Vice-President and CFO of LaBarge, Inc. From 1973 to 1979, Mr. Kemendo was a
          partner at Daniel and Howard, Inc. From 1979 to 1982, he again served as a
          partner at Fox & Company (now Grant Thornton, LLP). From 1982 to 1988, Mr.
          Kemendo was Executive Vice-President and Director at Fitzgerald, DeArman &          Roberts,
Inc.

# Clayton E. Woodrum
 Director.

Mr.
         Woodrum, 64, is a Certified Public Accountant and has, from 1984 to present,
          been a principal shareholder in the accounting firm of Woodrum, Kemendo &          Cuite,
P.C., and has been an owner of Computer Data Litigation Services, LLC and           First
Capital Management, LLC. 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.           One of Mr.
Woodrums partners at Woodrum, Kemendo & Cuite, P.C., Ben           Kemendo, is
the son of Chris Kemendo, Jr.

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
2005 annual meeting of stockholders, and in each case until their respective successors
are duly elected and qualified.

None
of our directors currently serves as a director of any other company which is required to
file periodic reports under the Securities Exchange Act of 1934.

# Board Committees

Our
board of directors has established an audit committee, whose 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. The audit committee is comprised of two
independent directors, consisting of Messrs. Kemendo and Woodrum, with Mr. Kemendo acting
as the chairman. Our board of directors has determined that each member of the audit
committee qualifies as an audit committee financial expert under the rules of
the SEC adopted pursuant to requirements of the Sarbanes-Oxley Act of 2002 (see the
biographical information for each of Messrs. Kemendo and Woodrum, infra, in this
discussion of Directors and Executive Officers.) Each of Messrs. Kemendo and
Woodrum further qualifies as independent in accordance with the applicable
regulations adopted by the SEC and American Stock Exchange.

Our
board of directors has established a compensation committee, whose principal function is
to make recommendations regarding the compensation of the Companys officers. In
accordance with the rules of the American Stock Exchange (on which our shares are listed),
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. The compensation committee is comprised of two independent directors,
consisting of Messrs. Kemendo and Woodrum, with Mr. Kemendo acting as the chairman.
Compensation for all other officers is also recommended to the Board for determination, by
the compensation committee.

---



We
currently do not have a nominating committee. Instead, in accordance with the rules of the
American Stock Exchange, the independent directors (currently, Messrs. Crawford, Kemendo
and Woodrum) fulfill the role of a nominating committee. Since our inception in 2000, we
have had only six directors, five of whom continue to serve at this time. On the only
occasion when a vacancy occurred (following a resignation), the new director was
unanimously approved by the remaining directors. Therefore, the Board has not felt it
necessary to have a standing nominating committee to deal with its infrequent changes in
membership. If and when future vacancies occur, the Board would consider director nominees
recommended by shareholders, as well as director nominees recommended by a majority of the
directors who are then independent. The board does not have a formal policy regarding the
consideration of, procedures to be followed by, minimum requirements of or process for
identifying or evaluation nominees recommended by security holders.

Our
board may establish other committees from time to time to facilitate our management.

# Director Compensation

All outside
directors are currently compensated with a stipend of $500 per month plus $500 for each
directors meeting attended. No director receives a salary as a director.

# Compensation Committee
Interlocks and Insider Participation

None
of our executive officers serve as a member of the board of directors or compensation
committee of any entity that has one or more of its executive officers serving as a member
of our board of directors or compensation committee.

# 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.

# Code of Ethics

We
have adopted a code of ethics that applies to our principal executive officer, principal
financial officer and principal accounting officer or persons performing similar functions
(as well as its other employees and directors). The Company undertakes to provide any
person without charge, upon request, a copy of such code of ethics. Requests may be
directed to Arena Resources, Inc., 4920 S. Lewis Ave., Suite 107, Tulsa, Oklahoma 74105,
attention William R. Broaddrick, or by calling (918) 747-6060.

---



|Item 10: |  | Executive
Compensation
|-------- |  | ----------------------

The
following table sets forth information concerning the compensation paid by us for the
three most recent fiscal years to our chief executive officer and our other two executive
officers.

Summary Compensation Table

|                                                             |      | Annual Compensation | Long-Term Compensation Awards
|------------------------------------------------------------ | ---- | ------------------- | -----------------------------
|                                                             |      |                     |                              
|Name and Principal Position                                  | Year | Salary(1)           | Bonus                        
|                                                             |      |                     |                              
|Lloyd T. RochfordPresident and Chief Executive Officer       | 2002 | $ 36,000            | $            -               
|                                                             | 2003 | $ 36,000            | $            -               
|                                                             | 2004 | $ 36,000            | $            -               
|                                                             |      |                     |                              
|Stanley M. McCabeChairman of the Board                       | 2002 | $ 36,000            | $            -               
|                                                             | 2003 | $ 36,000            | $            -               
|                                                             | 2004 | $ 36,000            | $            -               
|                                                             |      |                     |                              
|William R. BroaddrickVice President, Chief Financial Officer | 2002 | $ 45,000            | $    6,000                   
|                                                             | 2003 | $ 47,927            | $            -               
|                                                             | 2004 | $ 51,500            | $    4,167                   

(1)    
          Mr. Broaddricks salary for 2003 reflects a raise that occurred in mid-year
          to increase his annual salary to $50,000. Mr. Broaddricks salary for 2004
          reflects a raise that occurred during the year to increase his annual salary to
          $54,000. There are no current plans to change any officers salary from
          their level at December 31, 2004.(2)    
          The fair value of the options is estimated on the dates granted using the
          Black-Scholes option pricing model with the following weighted average
          assumptions: dividend yield of 0%; expected volatility of 36.2%; risk-free
          interest rate of 2.9% and expected lives of 5.0 years. The weighted average
          remaining contractual life of the options at December 31, 2004 was 3.8 years.

# Employee Benefit Plans

Equity
Incentive Plan. 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 further amended by our shareholders at our annual meeting in December 2004.
The executive stock option plan is intended to promote continuity of management and to
provide increased incentive and personal interest in our welfare by those key employees
who are primarily responsible for shaping and carrying out our long-range plans and
securing our continued growth and financial success. In addition, by encouraging stock
ownership by directors who are not our employees, the executive stock option plan is
intended to attract and retain qualified directors.

The
plan is administered by Messrs. Rochford and McCabe, and they have the authority to select
the key employees and non-employee directors to be participants in the plan, to determine
the awards to be granted to participants and the number of shares covered by such awards,
to set the terms and conditions of such awards and to establish, amend or waive rules for
the administration of the plan.

Any
of our key employees, including any of our executive officers or directors, is eligible to
be granted awards by plan administrators. The plan authorizes the grant of stock options
to key employees, all of which have been non-qualified stock options. Our non-employee
directors are only eligible to be granted non-qualified stock options under the plan.

---



The
plan provides that up to a total of 1,500,000 shares of common stock, subject to
adjustment to reflect stock dividends and other capital changes, are available for
granting of awards under the executive stock option plan. 1,000,000 of the shares
available for grant under the plan have been reserved for issuance pursuant to options
granted during 2003. No options to acquire shares were granted under the plan in 2004.

The
following table provides information regarding option exercises and fiscal year-end option
values calculated by determining the difference between the closing price of our common
stock at December 31, 2004 and the exercise price of the options.

|Name                  | SharesAcquiredonExercise | ValueRealized($) | Number of UnexercisedSecurities UnderlyingOptions/SARs at FY-End(#)Exercisable/Unexercisable | Value of UnexercisableIn-The-MoneyOptions/SARs at FY-End($) Exercisable/Unexercisable
|--------------------- | ------------------------ | ---------------- | -------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------
|                      |                          |                  |                                                                                              |                                                                                      
|Lloyd T. Rochford     | 0                        | 0                | 25,000/100,000                                                                               | $120,000/$480,000                                                                    
|Stanley M. McCabe     | 0                        | 0                | 25,000/100,000                                                                               | $120,000/$480,000                                                                    
|William R. Broaddrick | 0                        | 0                | 50,000/200,000                                                                               | $240,000/$960,000                                                                    
|Charles M. Crawford   | 0                        | 0                | 10,000/40,000                                                                                | $48,000/$192,000                                                                     
|Chris V. Kemendo, Jr. | 0                        | 0                | 10,000/40,000                                                                                | $48,000/$192,000                                                                     
|Clayton E. Woodrum    | 0                        | 0                | 10,000/40,000                                                                                | $37,000/$148,000                                                                     
|Phillip W. Terry      | 0                        | 0                | 50,000/200,000                                                                               | $240,000/$960,000                                                                    
|Raymond H. Estep      | 0                        | 0                | 20,000/80,000                                                                                | $96,000/$384,000                                                                     

The following table sets forth
information concerning our executive stock option plan as of December 31, 2004.

|                                                         | Number ofsecurities to beissued uponexercise ofoutstandingoptions | Weighted-averageexercise priceof outstandingoptions | Number of securitiesremaining available forfuture issuance undercompensation plans(excluding securities incolumn (a))
|-------------------------------------------------------- | ----------------------------------------------------------------- | --------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------
|                                                         |                                                                   |                                                     |                                                                                                                      
|                                                         | (a)                                                               | (b)                                                 | (c)                                                                                                                  
|Equity compensationplans approved bysecurity holders     | 1,000,000                                                         | 3.76                                                | 500,000                                                                                                              
|                                                         |                                                                   |                                                     |                                                                                                                      
|Equity compensationplans not approved bysecurity holders | -                                                                 | -                                                   | -                                                                                                                    
|                                                         |                                                                   |                                                     |                                                                                                                      
|Total                                                    | 1,000,000                                                         | 3.76                                                | 500,000                                                                                                              
|                                                         |                                                                   |                                                     |                                                                                                                      

---



|Item 11: |  | Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- |  | ----------------------------------------------------------------------------------------------

The
following table sets forth, as March 10, 2005, information regarding the beneficial
ownership of our common stock: (i) by each of our directors and executive officers; (ii)
by all directors and executive officers as a group; and (iii) by all persons known to us
to own 5% or more of our outstanding shares of common stock. 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 Owned
|------------------------------------ |  | -----------------------------------------
|                                     | 
|
|                                     |  |                                          
|Lloyd T. Rochford                    |  | 1,262,600 (1)                            
|Stanley M. McCabe                    |  | 1,263,000 (2)                            
|William R. Broaddrick                |  | 104,500 (3)                              
|Charles M. Crawford                  |  | 20,000 (4)                               
|Chris V. Kemendo, Jr                 |  | 20,100 (5)                               
|Clayton E. Woodrum                   |  | 10,000 (6)                               
|                                     |  |                                          
|All directors and executive officers |  | 2,680,200 (7)                            
|                                     |  |                                          

|(1) |  | Includes
25,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 25,000 shares issuable upon the exercise of
stock                     options that are exercisable within 60 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes
25,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 25,000 shares issuable upon the exercise of
stock                     options that are exercisable within 60 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Includes
50,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 50,000 shares issuable upon the exercise of
stock                     options that are exercisable within 60 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Includes
10,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 10,000 shares issuable upon the exercise of
stock                     options that are exercisable within 60 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Includes
10,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 10,000 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.
|--- |  | ----------------------------------------------------------------------------------------------------------------------

|(7) |  | Includes
130,000 shares issuable upon the exercise of stock options that are
                    currently exercisable and 120,000 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%
|- |  | -----------------------------------------------

---



Percentage
ownership calculations for any stockholder listed above are based on 10,194,304 shares of
our common stock outstanding as of March 10, 2005.

|Item 12: |  | Certain
Relationships and Related Transactions
|-------- |  | ----------------------------------------------

The
initial capital assets that were contributed to us were provided by Messrs. Rochford and
McCabe. In contributing these assets to us in September 2000, no independent determination
was made regarding the value of the oil and gas properties and related interests
contributed in exchange for stock. In exchange for the initial 1,300,000 shares of common
stock issued to each of Messrs. Rochford and McCabe, each contributed $33,695 in cash and
a carried working interest obligation with future development costs estimated by an
independent oil and gas engineer of approximately $134,000. Of the cash contributed,
$61,174 was used to acquire our three initial leases. The estimated future development
costs were accounted for as a receivable from Messrs. Rochford and McCabe. Total actual
costs incurred by them in relation to the carried working interest were $121,274. The
difference of $12,726 was charged against additional paid in capital.

In
July 2002, we borrowed $200,000 from each of Messrs. Rochford and McCabe, which debts are
evidenced by notes payable which mature on January 1, 2006. The notes bear interest at a
rate of 10% per annum, and are secured by our assets (although such notes are subordinate
to our credit facility with our primary commercial lender).

In
2001 and 2002 we acquired certain lease interests and had other business dealings with
Petro Consultants, Inc. One of the principals of Petro Consultants, Inc., Mr. Robert J.
Morley, was appointed our Vice President of Investor Relations in July 2002 and served as
a member of the Board of Directors from February 2003, until his resignation of all
positions as an officer and director in August 2003. Therefore, any transactions involving
Petro Consultant between July 2002 and August 2003 could be deemed to have been entered
into with an affiliate. Because we anticipated that we may continue to
transact business with Petro Consultants, to avoid future issues that might arise due to
such affiliation, Mr. Morley resigned his position as an officer and member of our board
and forfeited all stock options (none of which had vested) which he had been granted by
reason of his position as a board member.

|Item 13: |  | Exhibits
|-------- |  | --------

# Exhibit Index:

|3.1 |  | Articles
of Incorporation of Arena Resources, Inc. (i)
|--- |  | ------------------------------------------------------

|3.2 |  | By-Laws
of Arena Resources, Inc. (i)
|--- |  | ------------------------------------

|10.1 |  | Business
Loan Agreement, dated as of April 14, 2004, among Arena Resources, Inc. and MidFirst
Bank, N.A. (ii)
|---- |  | -------------------------------------------------------------------------------------------------------------

|10.2 |  | Business
Loan Agreement, dated as of May 7, 2004, among Arena Resources, Inc. and MidFirst Bank,
N.A. (ii)
|---- |  | ----------------------------------------------------------------------------------------------------------

|10.3 |  | Business
Loan Agreement, dated as of November 16, 2004, among Arena Resources, Inc. and MidFirst
Bank, N.A. (iii)
|---- |  | -----------------------------------------------------------------------------------------------------------------

|10.4 |  | East
Hobbs Purchase and Sales Agreement Dated April 22, 2004 (ii)
|---- |  | -----------------------------------------------------------------

|10.5 |  | Fuhrman-Mascho
Purchase and Sales Agreements Dated December 1, 2004 (iii)
|---- |  | -------------------------------------------------------------------------

---



|23 |  | Consent
of Lee Keeling and Associates, Inc., Independent Petroleum Engineers
|-- |  | ----------------------------------------------------------------------------

|31.1 |  | Certification
of CEO
|---- |  | --------------------

|31.2 |  | Certification
of CFO
|---- |  | --------------------

|32.1 |  | Section
1350 Certification - CEO
|---- |  | --------------------------------

|32.2 |  | Section
1350 Certification - CFO
|---- |  | --------------------------------

(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 exhibits to Arena Resources, Inc.s
          From 8-K filed May 18, 2004.

(iii)  
          Incorporated herein by reference to the exhibits to Arena Resources Form
          10-KSB filed March 17, 2005.

|Item 14: |  | Principal
Accountant Fees and Services
|-------- |  | --------------------------------------

The
firm of Hansen, Barnett & Maxwell, (HBM) has served as the Companys
independent auditors since 2000. The Board of Directors selected HBM as the independent
auditors of the Company for the fiscal year ending December 31, 2004, and the Audit
Committee has selected HBM to serve in the same capacity for the fiscal year ending
December 31, 2005. 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 $37,000 and $25,521 for professional
services rendered for the audit of the Companys financial statements for the years
ended December 31, 2004 and 2003, respectively, and its reviews of the Companys
financial statements included in its Form 10-QSBs for the first three quarters of
2004 and 2003.

Audit
Related Fees. In 2004, HBM was paid $78,998 for its services in connection with the
review of the Companys registration statement on Form SB-2 (which was filed with the
SEC in 2004) and for the audit of the Fuhrman-Mascho property acquisition, and which are
not included in the audit fees identified above).

Tax
Fees. HBM billed the Company an aggregate of $3,000 and $750 for professional services
rendered for tax compliance, tax advice and tax planning for the years ended December 31,
2004 and 2003.

All
Other Fees.  No other fees were billed by HBM to the Company during 2004 or 2003.

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.

---



# 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:                    
| |                        
| |                        
| |                        
| |                        
| | Date: February 15, 2006
| |                        
| |                        
| | By:                    
| |                        
| |                        
| |                        
| |                        
| | Date: February 15, 2006
| |                        
| |                        
| | By:                    
| |                        
| |                        
| |                        
| |                        
| | Date: February 15, 2006

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.

| | By:                     | /s/  Lloyd T. Rochford
| | ----------------------- | ----------------------
| |                         |                       
| |                         | Mr. Lloyd T. Rochford 
| |                         | Director              
| |                         |                       
| | Date: February 15, 2006
| |                         |                       
| |                         |                       
| | By:                     | /s/ Stanley McCabe    
| |                         |                       
| |                         | Mr. Stanley McCabe    
| |                         | Director              
| |                         |                       
| | Date: February 15, 2006

---



| | By:                     | /s/  Charles Crawford     
| | ----------------------- | --------------------------
| |                         |                           
| |                         | Mr. Charles Crawford      
| |                         | Director                  
| |                         |                           
| | Date: February 15, 2006
| |                         |                           
| |                         |                           
| | By:                     | /s/  Chris V. Kemendo, Jr.
| |                         |                           
| |                         | Mr. Chris V. Kemendo, Jr. 
| |                         | Director                  
| |                         |                           
| | Date: February 15, 2006
| |                         |                           
| |                         |                           
| | By:                     | /s/  Clayton E. Woodrum   
| |                         |                           
| |                         | Mr. Clayton E. Woodrum    
| |                         | Director                  
| |                         |                           
| | Date: February 15, 2006

---



# ARENA RESOURCES, INC.

# INDEX TO FINANCIAL
STATEMENTS



|                                                                                  | Page
|--------------------------------------------------------------------------------- | ----
|Report of Independent Registered Public Accounting Firm                           | 44  
|Balance Sheets - December 31, 2004 and 2003                                       | 45  
|Statements of Operations for the Years Ended December 31, 2004 and 2003           | 46  
|Statements of Stockholders' Equity for the Years Ended December 31, 2003 and 2004 | 47  
|Statements of Cash Flows for the Years Ended December 31, 2004 and 2003           | 48  
|Notes to Financial Statements                                                     | 50  
|Supplemental Information on Oil and Gas Producing Activities                      | 64  

---



|HANSEN, BARNETT &
MAXWELL     | 
|----------------------------- | 
|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               | 

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and the
StockholdersArena Resources, Inc.

We have audited the accompanying
balance sheets of Arena Resources, Inc. as of December 31, 2004 and 2003, and the related
statements of operations, stockholders equity, and cash flows for the years then
ended. 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 audits 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 that 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 financial
position of Arena Resources, Inc. as of December 31, 2004 and 2003, and the results of its
operations and its cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 6 to the
financial statements, the Company changed its method of recognizing asset retirement
obligations in 2003. As discussed in Note 2, the accompanying financial statements have
been restated to correct the valuation of common stock and stock options.

| | HANSEN, BARNETT &
MAXWELL
| | -------------------------

Salt Lake City, Utah
January 14, 2005, except for Note 2As
to which the date is December 21, 2005

---



ARENA RESOURCES, INC.
BALANCE SHEETS (As Restated - Note 2)

|December 31,                                                                                                                        |   | 2004        |  |   | 2003     
|----------------------------------------------------------------------------------------------------------------------------------- | - | ----------- |  | - | ---------
|                                                                                                                                   
|ASSETS                                                                                                                              |   |             |  |   |          
|Current Assets                                                                                                                      |   |             |  |   |          
|Cash                                                                                                                                | $ | 1,253,969   |  | $ | 1,076,676
|Account receivable                                                                                                                  |   | 1,149,513   |  |   | 388,910  
|Joint interest billing receivable                                                                                                   |   | 61,805      |  |   | -        
|Short-term investments                                                                                                              |   | -           |  |   | 25,234   
|Prepaid expenses                                                                                                                    |   | 33,136      |  |   | 28,935   
|                                                                                                                                   
|Total Current Assets                                                                                                                |   | 2,498,423   |  |   | 1,519,755
|                                                                                                                                   
|Property and Equipment, Using Full Cost Accounting                                                                                  |   |             |  |   |          
|Oil and gas properties subject to amortization                                                                                      |   | 34,457,137  |  |   | 8,463,400
|Drilling advances                                                                                                                   |   | 900,000     |  |   | 351,000  
|Equipment                                                                                                                           |   | 26,687      |  |   | 48,480   
|Office equipment                                                                                                                    |   | 60,401      |  |   | 18,978   
|                                                                                                                                   
|Total Property and Equipment                                                                                                        |   | 35,444,225  |  |   | 8,881,858
|Less:  Accumulated depreciation and amortization                                                                                    |   | (1,565,124) |  |   | (559,229)
|                                                                                                                                   
|Net Property and Equipment                                                                                                          |   | 33,879,101  |  |   | 8,322,629
|                                                                                                                                   
|Deferred Offering Costs                                                                                                             |   | -           |  |   | 130,872  
|                                                                                                                                   
|Total Assets                                                                                                                        | $ | 36,377,524  |  | $ | 9,973,256
|                                                                                                                                   
|                                                                                                                                    |   |             |  |   |          
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                |   |             |  |   |          
|Current Liabilities                                                                                                                 |   |             |  |   |          
|Accounts payable                                                                                                                    | $ | 1,805,865   |  | $ | 229,522  
|Accrued liabilities                                                                                                                 |   | 34,800      |  |   | 18,440   
|Put option                                                                                                                          |   | -           |  |   | 2,905    
|                                                                                                                                   
|Total Current Liabilities                                                                                                           |   | 1,840,665   |  |   | 250,867  
|                                                                                                                                   
|Long-Term Liabilities                                                                                                               |   |             |  |   |          
|Notes payable                                                                                                                       |   | 10,000,000  |  |   | -        
|Notes payable to related parties                                                                                                    |   | 400,000     |  |   | 400,000  
|Put option                                                                                                                          |   | 95,033      |  |   | -        
|Asset retirement liability                                                                                                          |   | 1,267,993   |  |   | 607,200  
|Deferred income taxes                                                                                                               |   | 1,971,990   |  |   | 574,916  
|                                                                                                                                   
|Total Long-Term Liabilities                                                                                                         |   | 13,735,016  |  |   | 1,582,116
|                                                                                                                                   
|Stockholders' Equity                                                                                                                |   |             |  |   |          
|Preferred 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;    
9,132,910 shares and 7,162,097 shares outstanding, respectively |   | 9,133       |  |   | 7,162    
|Additional paid-in capital                                                                                                          |   | 15,258,352  |  |   | 6,994,925
|Options and warrants outstanding                                                                                                    |   | 3,213,159   |  |   | 1,473,164
|Deferred compensation                                                                                                               |   | (234,277)   |  |   | (438,802)
|Retained earnings                                                                                                                   |   | 2,555,476   |  |   | 103,824  
|                                                                                                                                   
|Total Stockholders' Equity                                                                                                          |   | 20,801,843  |  |   | 8,140,273
|                                                                                                                                   
|Total Liabilities and Stockholders' Equity                                                                                          | $ | 36,377,524  |  | $ | 9,973,256
|                                                                                                                                   

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

---



ARENA RESOURCES, INC.
STATEMENTS OF OPERATIONS (As Restated - Note 2)

|For the Years Ended December 31,                           |   | 2004        |  |   | 2003     
|---------------------------------------------------------- | - | ----------- |  | - | ---------
|                                                          
|Oil and Gas Revenues                                       | $ | 8,482,130   |  | $ | 3,665,477
|                                                          
|Costs and Operating Expenses                               |   |             |  |   |          
|Oil and gas production costs                               |   | 1,975,835   |  |   | 1,149,136
|Oil and gas production taxes                               |   | 629,703     |  |   | 269,563  
|Depreciation, depletion and amortization                   |   | 1,011,602   |  |   | 360,282  
|General and administrative expense                         |   | 874,850     |  |   | 778,774  
|                                                          
|Total Costs and Operating Expenses                         |   | 4,491,990   |  |   | 2,557,755
|                                                          
|Other Income (Expense)                                     |   |             |  |   |          
|Gain from change in fair value of put options              |   | 68,251      |  |   | 47,699   
|Accretion expense                                          |   | (53,729)    |  |   | (32,212) 
|Interest expense                                           |   | (155,936)   |  |   | (38,798) 
|                                                          
|Net Other Income (Expense)                                 |   | (141,414)   |  |   | (23,311) 
|                                                          
|Income Before Provision for Income Taxes and Cumulative    |   |             |  |   |          
|Effect of  Change in Accounting Principle                  |   | 3,848,726   |  |   | 1,084,411
|                                                           |   |             |  |   |          
|Provision for Deferred Income Taxes                        |   | (1,397,074) |  |   | (402,455)
|                                                          
|Income Before Cumulative Effect of Change                  |   |             |  |   |          
|in Accounting Principle                                    |   | 2,451,652   |  |   | 681,956  
|                                                           |   |             |  |   |          
|Cumulative Effect of Change in Accounting Principle        |   | -           |  |   | (11,813) 
|                                                          
|Net Income                                                 | $ | 2,451,652   |  | $ | 670,143  
|                                                          
|Basic Earnings Per Share                                   |   |             |  |   |          
|Before cumulative effect of change in accounting principle | $ | 0.31        |  | $ | 0.10     
|Net Income                                                 |   | 0.31        |  |   | 0.10     
|Diluted Earnings Per Share                                 |   |             |  |   |          
|Before cumulative effect of change in accounting principle | $ | 0.28        |  | $ | 0.09     
|Net Income                                                 |   | 0.28        |  |   | 0.09     
|                                                          

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

---



ARENA RESOURCES, INC.
STATEMENTS OF STOCKHOLDERS EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2004 (As Restated - Note 2)

|                                                | Common Stock |   |            |   |                |   |                     |   |                      |   |                 
|----------------------------------------------- | ------------ | - | ---------- | - | -------------- | - | ------------------- | - | -------------------- | - | ----------------
|                                                |              |   | Additional |   | Options and    |   |                     |   |                      |   | Total           
|                                                | Shares       |   | Amount     |   | Paid-InCapital |   | WarrantsOutstanding |   | DeferredCompensation |   | RetainedEarnings
|                                               
|Balance, December 31, 2002                      | 6,282,056    | $ | 6,282      | $ | 5,287,189      | $ | 382,040             | $ | -                    | $ | (566,319)       
|Issuance for cash                               | 790,294      |   | 790        |   | 1,274,256      |   | 436,154             |   | -                    |   | -               
|Issuance of employee stock options              | -            |   | -          |   | -              |   | 660,000             |   | (660,000)            |   | -               
|Issuance of warrants as consulting fee          |              |   |            |   |                |   |                     |   |                      |   |                 
|for 2002 offering                               | -            |   | -          |   | (15,922)       |   | 15,922              |   | -                    |   | -               
|Cancellation of shares for extension            |              |   |            |   |                |   |                     |   |                      |   |                 
|of lock up                                      | (500)        |   | -          |   | -              |   | -                   |   | -                    |   | -               
|Issuance of common stock for services           | 13,847       |   | 14         |   | 75,026         |   | -                   |   | -                    |   | -               
|Warrants exercised                              | 19,400       |   | 19         |   | 54,883         |   | (20,952)            |   | -                    |   | -               
|Issuance of common stock                        |              |   |            |   |                |   |                     |   |                      |   |                 
|in property acquisitions                        | 57,000       |   | 57         |   | 319,493        |   | -                   |   | -                    |   | -               
|Amortization of deferred compensation           | -            |   | -          |   | -              |   | -                   |   | 221,198              |   | -               
|Net income                                      | -            |   | -          |   | -              |   | -                   |   | -                    |   | 670,143         
|                                               
|Balance, December 31, 2003                      | 7,162,097    |   | 7,162      |   | 6,994,925      |   | 1,473,164           |   | (438,802)            |   | 103,824         
|Warrants exercised                              | 78,300       |   | 78         |   | 395,843        |   | (41,796)            |   | -                    |   | -               
|Issuance for cash                               | 1,667,500    |   | 1,668      |   | 6,469,225      |   | 1,781,791           |   | -                    |   | -               
|Issuance of common stock in property            |              |   |            |   |                |   |                     |   |                      |   |                 
|acquisitions, net of call option
      received | 225,013      |   | 225        |   | 1,398,359      |   | -                   |   | -                    |   | -               
|Amortization of deferred compensation           | -            |   | -          |   | -              |   | -                   |   | 204,525              |   | -               
|Net income                                      | -            |   | -          |   | -              |   | -                   |   | -                    |   | 2,451,652       
|                                               
|Balance, December 31, 2004                      | 9,132,910    | $ | 9,133      | $ | 15,258,352     | $ | 3,213,159           | $ | (234,277)            | $ | 2,555,476       
|                                               

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

---



ARENA RESOURCES, INC.
STATEMENTS OF CASH FLOWS (As Restated - Note 2)

|For the Years Ended December 31                                                   |   | 2004         |  |   | 2003       
|--------------------------------------------------------------------------------- | - | ------------ |  | - | -----------
|                                                                                 
|Cash Flows From Operating Activities                                              |   |              |  |   |            
|Net income                                                                        | $ | 2,451,652    |  | $ | 670,143    
|Adjustments to reconcile net income to net cash provided by operating activities: |   |              |  |   |            
|Shares issued for services                                                        |   | -            |  |   | 75,040     
|Depreciation, depletion and amortization                                          |   | 1,011,602    |  |   | 360,282    
|Gain from change in fair value of put option                                      |   | (68,251)     |  |   | (47,699)   
|Cumulative effect of change in accounting principle                               |   | -            |  |   | 11,813     
|Loss on sale of equipment                                                         |   | 5,586        |  |   | -          
|Amortization of deferred compensation                                             |   | 204,525      |  |   | 221,198    
|Accretion of discounted asset retirement liability and note payable               |   | 83,730       |  |   | 32,212     
|Changes in assets and liabilities:                                                |   |              |  |   |            
|Accounts receivable                                                               |   | (656,864)    |  |   | (119,474)  
|Prepaid expenses                                                                  |   | (4,201)      |  |   | (27,807)   
|Accounts payable and accrued liabilities                                          |   | 1,570,831    |  |   | 74,787     
|Deferred income taxes                                                             |   | 1,397,074    |  |   | 402,455    
|                                                                                 
|Net Cash Provided by Operating Activities                                         |   | 5,995,684    |  |   | 1,652,950  
|                                                                                 
|Cash Flows from Investing Activities                                              |   |              |  |   |            
|Proceeds from sale of equipment                                                   |   | 10,500       |  |   | -          
|Cash payments on purchase of East Hobbs property                                  |   | (1,028,000)  |  |   | -          
|Cash payments on purchase of Furhman-Mascho property                              |   | (711,802)    |  |   | -          
|Purchase and development of oil and gas properties                                |   | (4,802,141)  |  |   | (3,050,558)
|Purchase of property, plant & equipment                                           |   | -            |  |   | (26,686)   
|Maturity of long-term investment                                                  |   | 25,234       |  |   | 51,268     
|Purchase of office equipment                                                      |   | (41,423)     |  |   | (4,306)    
|                                                                                 
|Net Cash Used in Investing Activities                                             |   | (6,547,632)  |  |   | (3,030,282)
|                                                                                 
|Cash Flows From Financing Activities                                              |   |              |  |   |            
|Proceeds from issuance of common stock and warrants, net of offering costs        |   | 8,383,557    |  |   | 1,580,328  
|Proceeds from exercise of warrants                                                |   | 354,124      |  |   | 33,950     
|Issuance of note payable                                                          |   | 2,000,000    |  |   | -          
|Payment of notes payable                                                          |   | (10,008,440) |  |   | -          
|Collection of common stock subscription receivable                                |   | -            |  |   | 157,500    
|Payment of accrued dividends to preferred stockholders                            |   | -            |  |   | (114,685)  
|                                                                                 
|Net Cash Provided by Financing Activities                                         |   | 729,241      |  |   | 1,657,093  
|                                                                                 
|Net Increase in Cash                                                              |   | 177,293      |  |   | 279,761    
|                                                                                  |   |              |  |   |            
|Cash at Beginning of Year                                                         |   | 1,076,676    |  |   | 796,915    
|                                                                                 
|Cash at End of Year                                                               | $ | 1,253,969    |  | $ | 1,076,676  
|                                                                                 

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

---



ARENA RESOURCES, INC.
STATEMENTS OF CASH FLOWS (CONTINUED) (As Restated - Note 2)

|For the Years Ended December 31                              |   | 2004        |  |   | 2003   
|------------------------------------------------------------ | - | ----------- |  | - | -------
|                                                            
|Supplemental Cash Flow Information                           |   |             |  |   |        
|Cash paid for interest                                       | $ | 158,950     |  | $ | 38,798 
|                                                            
|Non-Cash Investing and Financing Activities                  |   |             |  |   |        
|Common stock issued for properties                           | $ | 34,500      |  | $ | 319,550
|Asset retirement obligation incurred in property acquisition |   | -           |  |   | 338,271
|                                                            
|East Hobbs property was acquired as follows:                 |   |             |  |   |        
|Fair value of assets acquired                                | $ | 10,354,964  |  |   |        
|Liabilities assumed                                          |   | (78,654)    |  |   |        
|Notes payable incurred                                       |   | (9,008,440) |  |   |        
|Common stock issued                                          |   | (239,870)   |  |   |        
|                                                            
|Cash paid                                                    | $ | 1,028,000   |  |   |        
|                                                            
|Fuhrman-Mascho property was acquired as follows:             |   |             |  |   |        
|Fair value of assets acquired                                | $ | 11,479,742  |  |   |        
|Liabilities assumed                                          |   | (513,247)   |  |   |        
|Note payable incurred, net of $30,000 unamortized discount   |   | (8,970,000) |  |   |        
|Put options issued                                           |   | (160,379)   |  |   |        
|Common stock issued                                          |   | (1,260,091) |  |   |        
|Call options received                                        |   | 135,777     |  |   |        
|                                                            
|Cash paid                                                    | $ | 711,802     |  |   |        
|                                                            

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

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS
DECEMBER 31, 2004 AND
2003

# 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.

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.

Cash  The
Company had deposits with a bank that are $1,153,969 in excess of federally insured limits
at December 31, 2004.

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.

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, 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 or until
impairment occurs. 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.
Depletion and amortization expense for the year ended December 31, 2004, was $997,694,
based on depletion at the rate of $4.47 per barrel-of-oil-equivalent and for the year
ended December 31, 2003, was $360,282, based on depletion at the rate of $2.79 per
barrel-of-oil-equivalent.

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: the present value of estimated future net revenues
computed by applying current prices of oil and gas reserves to estimated future production
of proved oil and gas reserves, less estimated future expenditures (based on current
costs) to be incurred in developing and producing the proved reserves computed using a
discount factor of ten percent and assuming continuation of existing economic conditions;
plus the cost of properties not being amortized; plus the lower of cost or estimated fair
value of unproven properties included in the costs being amortized; less income tax
effects related to differences between the book and tax basis of the properties.

Support and Office
Equipment  Depreciation of support and office equipment is computed
using the straight-line method over the estimated useful lifes of the assets which are
currently five to seven years. Depreciation expense was $13,908 and $9,950 for the years
ended December 31, 2004 and 2003, respectively.

Income Taxes
 Provisions for income taxes are based on taxes payable or refundable for the
current year and deferred taxes on temporary differences between the amount of taxable
income and pretax financial income and between the tax bases of assets and liabilities and
their reported amounts in the financial statements. 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.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS
DECEMBER 31, 2004 AND
2003

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 is calculated to give effect to potentially issuable dilutive common shares.

Major Customers
 During the year ended December 31, 2004, sales to two customers represented 43% and
31% of total sales, respectively. At December 31, 2004, these two customers made up 43%
and 22% of accounts receivable, respectively. During the year ended December 31, 2003,
sales to three customers represented 51%, 19% and 11% of total sales, respectively. At
December 31, 2003, these three customers made up 46%, 16% and 17% of accounts receivable,
respectively.

Stock-Based EmployeeCompensation  On April 1, 2003 and on August 12, 2003, the Company
issued stock options to directors and employees, which are described more fully in Note 8.
The Company applies the recognition and measurement principles of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its stock-based compensation awards to employees. The
Company recognized compensation expense relating to those stock options of $204,525 and
$221,198 for the years ended December 31, 2004 and 2003, respectively.

Alternately, Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (SFAS
No. 123), allows companies to recognize compensation expense over the related service
period based on the grant date fair value of the stock option awards. The following table
illustrates the effect on net income and basic and diluted earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation:

|For the Years Ended December 31,                                             |   | 2004      |  |   | 2003     
|---------------------------------------------------------------------------- | - | --------- |  | - | ---------
|                                                                            
|Net income, as reported                                                      | $ | 2,451,652 |  | $ | 670,143  
|Add: Stock based employee compensation included in net income, net           |   |           |  |   |          
|of related tax effects                                                       |   | 128,365   |  |   | 139,355  
|Deduct: Total stock-based employee compensation expense determined under the |   |           |  |   |          
|fair value based method for all awards, net of related tax effects           |   | (345,068) |  |   | (372,935)
|                                                                            
|Pro Forma Net Income                                                         | $ | 2,234,949 |  | $ | 436,563  
|                                                                            
|Income Per Common Share                                                      |   |           |  |   |          
|Basic, as reported                                                           | $ | 0.31      |  | $ | 0.10     
|Basic, pro forma                                                             |   | 0.28      |  |   | 0.06     
|                                                                             |   |           |  |   |          
|Diluted, as reported                                                         |   | 0.28      |  |   | 0.09     
|Diluted, pro forma                                                           |   | 0.26      |  |   | 0.06     
|                                                                            

The pro forma estimated after-tax
stock-based compensation expense under SFAS 123 for the years ending December 31, 2005,
2006 and 2007 relating to options outstanding at December 31, 2004, will be approximately
$128,000, $75,000 and $37,000, respectively. These amounts will change as the result of
stock options granted on January 1, 2005 and will be recognized in the results of
operations beginning July 1, 2005 upon adoption of Statement 123(R), as discussed below.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

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 SFAS No. 123,
Accounting for Stock-Based Compensation. Under SFAS No. 123, 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.

Cumulative Effect of Change in
Accounting Principle  The Company adopted SFAS No. 143,
Accounting for Asset Retirement Obligations, on January 1, 2003. In accordance with
the transition provisions of SFAS No. 143, on that date the Company recorded asset
retirement costs and liabilities and recorded an adjustment for the cumulative effect on
prior years of adopting SFAS No. 143 in the amount of $11,813 as a reduction in
earnings, which had no effect on basic or diluted earnings per share.

Recent Accounting
Pronouncements  In January 2003, the FASB issued Interpretation No.
46, Consolidation of Variable Interest Entities. This interpretation establishes
the requirement for a primary beneficiary to consolidate certain entities in which equity
investors do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The Company does not have an interest
in a variable interest entity and the adoption of the statement did not have an impact on
the Companys financial statements.

In May 2003, the FASB issued SFAS No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This statement was effective for the Company in July 2003. The
statement requires financial instruments to be classified as liabilities if the financial
instruments are issued in the form of shares that are mandatorily redeemable or embody an
obligation to repurchase equity shares. The Company has issued put options in exchange for
oil and gas property interests that have been classified as a liability; therefore, the
adoption of the statement did not have an impact on the Companys financial
statements.

In December 2004, the FASB issued
Statement No. 123 (Revised 2004), Share-Based Payment (Statement
123(R)). Statement 123(R) revises Statement No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees. Statement 123(R) requires companies to recognize the cost of employee
services received in exchange for stock options and awards of equity instruments based on
the grant-date fair value of such options and awards. The Company is required to adopt
Statement 123(R) on a prospective basis beginning on July 1, 2005, which will result in
the recognition of the remaining unrecognized stock-based compensation computed on a fair
value basis over the remaining vesting period. The effect of adopting Statement 123(R)
will result in recognition of $87,000 of additional after-tax compensation during the year
ending December 31, 2005 from options outstanding at December 31, 2004.

In December 2004, the FASB issued
SFAS Statement No. 153, Exchanges of Non-monetary Assetsan amendment of APB
Opinion No. 29. This Statement amends APB Opinion 29 to eliminate the exception for
non-monetary exchanges of similar productive assets and replaces it with a general
exception for exchanges of non-monetary assets that do not have commercial substance. A
non-monetary exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The Statement will be
effective in January 2006. The Company does not expect that the adoption of Statement 153
will have a material impact on its financial statements.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

# NOTE 2 
RESTATEMENT OF FINANCIAL STATEMENTS

During 2003, the Company granted
nonqualified stock options to directors and employees to purchase 1,000,000 shares of
common stock. The exercise price was 85% of the market value of the Companys common
stock on the dates issued and the options vest over a five-year period. In reliance upon
FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, the Company considered the 15% discount from the market price of the
Companys common stock to be reasonable in determining the fair value of the common
stock and determined that the time permitted for exercise of the stock options was limited
to a reasonable period; therefore, the Company did not recognize any stock-based
compensation from the grant of these stock options. However, the Company has recently
reevaluated its conclusion with regard to the time permitted for exercise of the stock
options and has determined that the five year vesting period is not a reasonable period.
As a result, the discount from market value is stock-based compensation. As further
discussed in Note 8, the stock-based compensation is being recognized over the five-year
vesting period of the options.

In addition, the Company recently
determined that it did not recognize 40,000 shares of common stock that were issued as a
finders fee at their fair value during 2004. The fair value of the common stock has
been determined by the market value of the Companys common stock on the date the
shares were issued. The fair value of the finders fee was capitalized as part of the
acquisition of oil and gas properties subject to amortization.

The Company has restated its 2004 and
2003 financial statements for the effects of these adjustments. As a result of the
restatement, the Company recognized additional compensation expense of $204,525 and
$221,198 during the years ended December 31, 2004 and 2003, respectively. The cost of oil
and gas properties subject to amortization was increased by $35,217 at December 31, 2004
and stockholders equity was increased by $193,220 and $81,843 at December 31, 2004
and $2003, respectively. The following tables summarize the effect of the restatement on
the 2004 and 2003 financial statements:

|                                                                                                   | As Previously Reported |           | Effect of Restatement |   | As Restated
|-------------------------------------------------------------------------------------------------- | ---------------------- | --------- | --------------------- | - | -----------
|                                                                                                  
|For the Year Ended December 31, 2004                                                               |                        |           |                       |   |            
|General and administrative expense                                                                 | $                      | 670,325   |                       | $ | 204,525    
|Income before provision for income taxes                                                           |                        | 4,053,251 |                       |   | (204,525)  
|Provision for deferred income taxes                                                                |                        | 1,473,234 |                       |   | (76,160)   
|Net income                                                                                         |                        | 2,580,017 |                       |   | (128,365)  
|Basic earnings per common share                                                                    |                        | 0.33      |                       |   | (0.02)     
|Diluted earnings per common share                                                                  |                        | 0.30      |                       |   | (0.02)     
|                                                                                                   |                        |           |                       |   |            
|For the Year Ended December 31, 2003                                                               |                        |           |                       |   |            
|General and administrative expense                                                                 | $                      | 557,576   |                       | $ | 221,198    
|Income before provision for income taxes and cumulative   effect of change in accounting principle |                        | 1,305,609 |                       |   | (221,198)  
|Provision for deferred income taxes                                                                |                        | 484,298   |                       |   | (81,843)   
|Income before cumulative effect of change in   accounting principle                                |                        | 821,311   |                       |   | (139,355)  
|Net income                                                                                         |                        | 809,498   |                       |   | (139,355)  
|Basic earnings per common share                                                                    |                        | 0.12      |                       |   | (0.02)     
|Diluted earnings per common share                                                                  |                        | 0.11      |                       |   | (0.02)     

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

|                                 | As Previously Reported |            | Effect of Restatement |   | As Restated
|-------------------------------- | ---------------------- | ---------- | --------------------- | - | -----------
|                                
|As of December 31, 2004          |                        |            |                       |   |            
|Property and equipment, net      | $                      | 33,843,884 |                       | $ | 35,217     
|Total assets                     |                        | 36,342,307 |                       |   | 35,217     
|Deferred income taxes            |                        | 2,129,993  |                       |   | (158,003)  
|Total long-term liabilities      |                        | 13,893,019 |                       |   | (158,003)  
|Additional paid-in capital       |                        | 15,223,135 |                       |   | 35,217     
|Options and warrants outstanding |                        | 2,553,159  |                       |   | 660,000    
|Deferred compensation            |                        | -          |                       |   | (234,277)  
|Retained earnings                |                        | 2,823,196  |                       |   | (267,720)  
|Total stockholders' equity       |                        | 20,608,623 |                       |   | 193,220    
|                                 |                        |            |                       |   |            
|As of December 31, 2003          |                        |            |                       |   |            
|Deferred income taxes            | $                      | 656,759    |                       | $ | (81,843)   
|Total long-term liabilities      |                        | 1,663,959  |                       |   | (81,843)   
|Options and warrants outstanding |                        | 813,164    |                       |   | 660,000    
|Deferred compensation            |                        | -          |                       |   | (438,802)  
|Retained earnings                |                        | 243,179    |                       |   | (139,355)  
|Total stockholders' equity       |                        | 8,058,430  |                       |   | 81,843     

# NOTE 3  EARNING
PER SHARE INFORMATION

|For the Years Ended December 31,                                  |   | 2004      |  |   | 2003     
|----------------------------------------------------------------- | - | --------- |  | - | ---------
|                                                                 
|Income before cumulative effect of change in accounting principle | $ | 2,451,652 |  | $ | 681,956  
|Cumulative effect of change in accounting principle               |   | -         |  |   | (11,813) 
|                                                                 
|Net Income                                                        | $ | 2,451,652 |  | $ | 670,143  
|                                                                 
|Basic Weighted-Average Common Shares Outstanding                  |   | 7,873,213 |  |   | 6,759,858
|Effect of dilutive securities                                     |   |           |  |   |          
|Warrants                                                          |   | 524,173   |  |   | 231,476  
|Stock options                                                     |   | 296,792   |  |   | 250,342  
|                                                                 
|Diluted Weighted-Average Common Shares Outstanding                |   | 8,694,178 |  |   | 7,241,676
|                                                                 
|Basic Earnings Per Share                                          |   |           |  |   |          
|Income before cumulative effect of change in accounting principle | $ | 0.31      |  | $ | 0.10     
|Net income                                                        |   | 0.31      |  |   | 0.10     
|Diluted Earnings Per Share                                        |   |           |  |   |          
|Income before cumulative effect of change in accounting principle | $ | 0.28      |  | $ | 0.09     
|Net Income                                                        |   | 0.28      |  |   | 0.09     
|                                                                 

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

# NOTE 4 
ACQUISITION OF OIL AND GAS PROPERTIES

On May 7, 2004, the Company acquired
an 82.24% working interest, 67.60% net revenue interest, in the East Hobbs San Andres
Property mineral lease (East Hobbs) located in Lea County, New Mexico.
Although the Purchase and Sales Agreement transferred the revenue and the related
operating costs from East Hobbs to Arena beginning March 1, 2004, Arena did not control
the property interests until May 7, 2004. As a result, the acquisition date for accounting
purposes was May 7, 2004 and the East Hobbs operations have been included in the
results of operations of Arena from May 7, 2004. Revenues and operating costs for the
months of March and April were treated as adjustments to the purchase price.

At the date of acquisition, East
Hobbs was comprised of 21 operating oil and gas wells that were unitized into one lease
prior to the acquisition. The Company purchased East Hobbs for its current production and
cash flow, as well as for the drilling and secondary recovery opportunities from the
property. The Company paid $10,008,440 to the sellers, including $9,008,440 paid directly
from borrowings under a credit facility and a bridge financing from a bank described more
fully in Note 5 . In addition, the Company paid acquisition costs of $28,000 and issued
15,000 shares of common stock valued at $90,000, or $6.00 per share, and 25,000 shares of
common stock valued at $149,750, or $5.99 per share, as a finders fee on the East
Hobbs San Andres Property acquisition. The total acquisition cost was allocated to the
assets acquired and the liabilities assumed as follows:

|Accounts receivable                            | $ | 165,544    |  |  | 
|---------------------------------------------- | - | ---------- |  |  | 
|Oil and gas properties subject to amortization |   | 10,189,480 |  |  | 
|                                              
|Total Assets                                   |   | 10,355,024 |  |  | 
|                                              
|Accounts payable                               |   | (21,872)   |  |  | 
|Asset retirement obligation                    |   | (56,782)   |  |  | 
|                                              
|Total Liabilities Assumed                      |   | (78,654)   |  |  | 
|                                              
|Net Assets Acquired                            | $ | 10,276,370 |  |  | 
|                                              

On November 18, 2004, Arena
Resources, Inc. entered into a binding letter of intent to acquire 100% of the working
interest, 75% of the net revenue interest, of the Fuhrman-Mascho Property mineral leases
under the terms of Asset Purchase Agreements (the Agreements). Under the terms
of the Agreements, the sellers transferred effective control of the property to the
Company on December 1, 2004 without restrictions. Accordingly, the acquisition date was
December 1, 2004. The results of operations of the Fuhrman-Mascho property have been
included in the results of operations of the Company from December 1, 2004.

At the date of acquisition,
Fuhrman-Mascho property consisted of 84 leases with a total of 174 operating oil and gas
wells. The Company purchased Fuhrman-Mascho for its current production and cash flow, as
well as for the drilling and development opportunities from the property. On December 20,
2004, the Company made cash payments to the sellers of $9,667,381, issued the sellers
150,013 shares of common stock valued at $1,050,091 or $7.00 per share based on the market
value of the common stock over the 2-day period before and after November 18, 2004, issued
the sellers put options entitling the sellers to demand that the Company reacquire the
150,013 shares of common stock at $7.00 per share from November 1, 2006 through November
30, 2006, valued at $160,379 using the Black-Scholes option pricing model, and received
call options from the sellers entitling the Company to reacquire the 150,013 shares of
common stock at $8.50 per share from the date issued through November 1, 2006 and valued
at $135,777 using the Black-Scholes option pricing model. In addition, the Company paid
acquisition costs of $44,421 and issued 30,000 shares of common stock as a consulting and
finders fee, valued at $210,000, or $7.00 per share. The consideration paid or
issued on December 20, 2004 was discounted to December 1, 2004 at 5% and resulted in
recognition of an unamortized discount of $30,000 at December 1, 2004. The acquisition was
funded through the use of cash on hand and a credit facility secured from the
Companys principal lender. The acquisition cost was allocated to the assets acquired
and the liabilities assumed as follows:

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

|Oil and gas properties subject to amortization | $ | 11,479,742 |  |  | 
|---------------------------------------------- | - | ---------- |  |  | 
|Asset retirement obligation                    |   | (513,247)  |  |  | 
|Net Assets Acquired                            | $ | 10,966,495 |  |  | 
|                                              

The following unaudited pro forma
information is presented to reflect the operations of the Company as if the acquisitions
of the East Hobbs and the Fuhrman-Mascho properties had been completed on January 1, 2004
and 2003, respectively:

|For the Years Ended December 31,                                  |             | 2004       |  |   | 2003     
|----------------------------------------------------------------- | ----------- | ---------- |  | - | ---------
|                                                                 
|                                                                  | (Unaudited)
|Oil and Gas Revenues                                              | $           | 11,493,181 |  | $ | 7,885,740
|Income from Operations Before Cumulative Effect of Change in      |             |            |  |   |          
|Accounting Principle                                              |             | 2,833,800  |  |   | 1,037,061
|Net Income                                                        |             | 2,833,800  |  |   | 1,025,248
|                                                                 
|Basic Income Per Common Share                                     |             |            |  |   |          
|Income before cumulative effect of change in accounting principle | $           | 0.36       |  | $ | 0.15     
|Net income                                                        |             | 0.36       |  |   | 0.15     
|Basic Income Per Common Share                                     |             |            |  |   |          
|Income before cumulative effect of change in accounting principle | $           | 0.33       |  | $ | 0.14     
|Net income                                                        |             | 0.33       |  |   | 0.14     
|                                                                 

On October 28, 2004, the Company
issued 5,000 shares of common stock to an unrelated party as a finders fee in
connection with the purchase of a 70% interest in the Gibralter well in Mississippi. The
shares were valued at $34,500, or $6.90 per share, based on the market value of the common
stock on the date issued. Arena paid $214,507 of the costs to drill the exploratory well
in exchange for the jointly-operated working interest in the well.

# NOTE 5  NOTES
PAYABLE AND PUT OPTION

In February 2003 the Company
established a $10,000,000 revolving credit facility with an initial borrowing base of
$2,000,000. In December 2003, the Company entered into an agreement that increased the
facility to $20,000,000, with an increased borrowing base of $4,000,000. On April 14,
2004, the Company changed financial institutions and thereby canceled this credit
facility.

On April 14, 2004, the Company
established a new $15,000,000 credit facility from a bank with an $8,500,000 initial
borrowing base. In November2004, the Company entered into an agreement that increased the
facility to $25,000,000, with an increased borrowing base of $15,000,000. Any increases in
the borrowing base are subject to written consent by the financial institution. The
interest rate is a floating rate equal to the 30, 60 or 90 day LIBOR rate plus 2.25%,
currently 5.26% per annum, and is payable monthly. Annual fees for the facility are 1/8 of
one percent of the unused portion of the borrowing base. Amounts borrowed under the
revolving credit facility are due in April 2007. The revolving credit facility is secured
by the Companys principal mineral interests. In order to obtain the revolving credit
facility, loans from two officers were subordinated to the position of the bank. The
Company is required under the terms of the credit facility to maintain a tangible net
worth of $12,000,000, maintain a 5-to-1 ratio of income before interest, taxes,
depreciation, depletion and amortization to interest expense and maintain a current asset
to current liability ratio of 1-to-1, not including the $2,000,000 bridge financing
arrangement discussed below. On May 7, 2004, the Company drew $8,008,440 under this
revolving credit facility to fund the acquisition of the East Hobbs San Andres Property
interests. During August 2004, utilizing cash flow from operations and proceeds from the
recent secondary offering of common stock and warrants, the Company paid $8,008,440 of
principal and related accrued interest due on the credit facility. During December 2004,
the Company drew $9,000,000 under this revolving credit facility to fund the acquisition
of the Fuhrman Mascho leases and $1,000,000 to help fund development activities. An
additional $299,029 is reserved under the revolving credit facility as collateral for
standby letters of credit issued to various states.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

On April 14, 2004, the Company also
entered into to a bridge financing arrangement for $2,000,000 from a bank. On April 21,
2004, the Company borrowed $1,000,000 under the terms of the bridge financing agreement to
fund a cash deposit made on the East Hobbs San Andres Property interests. On May 7, 2004,
the Company borrowed an additional $1,000,000 under the terms of the bridge financing
arrangement to fund the acquisition of the East Hobbs San Andres Property interests. The
interest rate on the bridge financing arrangement is a floating rate equal to the 30, 60
or 90 day LIBOR rate plus 2.25%, currently 5.26% per annum, and is payable monthly. This
arrangement was established for a one-time purpose to satisfy the funding requirements of
the East Hobbs San Andres Property acquisition. The original agreement expired June 30,
2004 and was subsequently extended to July 31, 2004. The bridge financing arrangement was
guaranteed by two of the Companys officers. During August 2004, utilizing cash flow
from operations and proceeds from the recent public offering of common stock and warrants,
the Company paid $2,000,000 of principal and related accrued interest due under the bridge
financing agreement. There are no amounts outstanding on this bridge financing agreement.
No new agreements have been established to continue the bridge financing arrangement.

On July 1, 2002, the Board of
Directors authorized the Company to borrow up to $500,000 from its officers. On July 26,
2002, the Company borrowed $400,000 from two of its officers. The related notes payable
bear interest at 10% per annum payable monthly with principal and interest due December
31, 2002. The notes are secured by all mineral interests, rights and equipment of the
Company but have been subordinated to the bank revolving credit facility. The Board of
Directors and the officers agreed to extend the notes to January 1, 2006, under the same
terms as the original notes. Based on the borrowing rates available to the Company for
bank loans, the fair value of the notes payable to officers was $400,000 at both December
31, 2004 and 2003.

The Company granted a put option in
connection with the acquisition of oil and gas properties in December 2004. Under the
terms of the put option, the seller has the right until December 1, 2006, to require the
Company to repurchase the 150,013 common shares at $7.00 per share. The put option is a
derivative and as such, the liability has been revalued to its fair value at each balance
sheet date with adjustments to fair value being recognized as gain on change in fair value
of put options. At December 31, 2004, the fair value of the liability was $160,379,
calculated using the Black-Scholes option pricing model with the following assumptions: 3%
risk-free interest rate; 33% volatility; 2 years expected life; and 0% dividend yield.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

# NOTE 6  ASSET
RETIREMENT OBLIGATION

Effective January 1, 2003, the
Company adopted SFAS No. 143, Accounting for Asset Retirement Obligations,
which requires entities to record the fair value of a liability for an asset retirement
obligation when it is incurred which, for the Company, is typically when an oil or gas
well is drilled or purchased. The standard applies to legal obligations associated with
the retirement of long-lived assets that result from the acquisition, construction,
development or normal use of the asset. The Companys asset retirement obligations
relate primarily to the obligation to plug and abandon oil and gas wells and support wells
at the conclusion of their useful lives.

SFAS No. 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in the period
in which it is incurred, if a reasonable estimate of fair value can be made. When the
liability is initially recorded, the related cost is capitalized by increasing the
carrying amount of the related oil and gas property. Over time, the liability is accreted
upward for the change in its present value each period until the obligation is settled.
The initial capitalized cost is amortized as a component of oil and gas properties as
described in Note 1.

At January 1, 2003, the
implementation of SFAS No. 143 resulted in a net increase in property and equipment
of $217,878. Liabilities increased by $236,718, which represents the establishment of an
asset retirement obligation liability. The cumulative effect on prior years of the change
in accounting principle of $11,813, net of $7,027 of related tax effects, was
recorded in the first quarter of 2003 as a reduction in earnings. The effect of adopting
this accounting principle was a $24,873 after-tax decrease in net income during the year
ended December 31, 2003.

The adoption of SFAS No. 143 will
affect amortization of oil and gas properties on an on-going basis. The increase in oil
and gas properties is being amortized as the related oil and gas reserves are produced,
and resulted in an increase in depreciation, depletion and amortization for the years
ended December 31, 2004 and 2003 of $10,798 and $7,459, respectively. The adoption of SFAS
No. 143 also impacted the computation of the ceiling test for the carrying value of oil
and gas properties. The ceiling test has changed to include the estimated asset retirement
costs in the cost of oil and gas properties and exclude future abandonment costs from the
computation of the present value of estimated future net revenues. This change only had a
nominal effect on the Companys ceiling test computation at December 31, 2004 and
2003.

The reconciliation of the asset
retirement obligation for the years ended December 31, 2003 and 2004 is as follows:

|Balance, January 1, 2003   | $ | 236,718   |  |  | 
|-------------------------- | - | --------- |  |  | 
|Liabilities incurred       |   | 338,270   |  |  | 
|Accretion expense          |   | 32,212    |  |  | 
|                          
|Balance, December 31, 2003 |   | 607,200   |  |  | 
|Liabilities incurred       |   | 607,063   |  |  | 
|Accretion expense          |   | 53,730    |  |  | 
|                           |   |           |  |  | 
|Balance, December 31, 2004 | $ | 1,267,993 |  |  | 
|                          

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

# NOTE 7 
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
 On August 22, 2002, the Company initiated a $3,000,000 private placement offering
of the Companys common stock at $2.50 per share with a detachable warrant
exercisable at $5.00 per share through September 30, 2005. Through December 31, 2002, the
Company had issued 286,000 shares of common stock and warrants under the terms of the
private placement offering for gross proceeds of $715,000 before cash offering costs of
$112,864 and were allocated to the common stock issued and the warrants based upon their
relative fair value. Accordingly, $493,821 was allocated to the 286,000 shares of common
stock, and $108,315 was allocated to the 286,000 warrants. Although the amount allocated
to the warrants was less than their fair value, the fair value of the warrants was
$278,015 determined using the Black-Scholes option pricing model with the following
assumptions: risk free interest rate of 1.8%, expected dividend yield of 0%, volatility of
36.5%, and expected lives of 2.8 years.

From January 1, 2003 to July 15,
2003, the Company issued 790,294 shares of common stock and 790,294 warrants for
$1,711,200 in net cash proceeds (net of cash offering costs of $264,535). In addition,
105,196 warrants exercisable at $5.00 per share through September 30, 2005 were issued to
placement agents. The net proceeds received were allocated to the common stock and the
warrants based upon their relative fair values, with $1,275,046 allocated to the common
stock and $436,154 allocated to the warrants. The fair value of the warrants issued was
$1,192,626, or $1.37 per warrant, which was determined using the Black-Scholes option
pricing model with the following weighted-average assumptions: risk-free interest rate of
1.32%, expected dividend yield of 0%, volatility of 34.7% and an expected life of 2.21
years.

In addition, during the year ended
December 31, 2003, Arena issued 2,433 additional warrants, with the same terms to
placement agents, and 50,000 additional warrants exercisable at $3.00 per share through
July 15, 2006, as consulting fees, relating to the shares of common stock and warrants
issued during 2002. During the year ended December 31, 2003, $15,922 of the proceeds from
the 2002 cash offering proceeds were allocated to the additional warrants, based upon
their relative fair value. The offering closed July 15, 2003. The Company issued a total
of 1,076,294 units of common stock and warrants to investors under the offering for
$2,313,336 in net cash proceeds (net of cash offering costs of $377,399) and issued
157,629 warrants as consulting fees and for services to placement agents. During the year
ended December 31, 2003, warrant holders exercised 19,400 warrants with an exercise price
of $1.75 for $33,950. Additionally, in 2003 the Company issued 70,947 shares of common
stock for services, which the Company valued at an aggregate total of $394,590, or $5.57
per share. The Company capitalized as part of oil and gas properties $319,550 and the
remaining $75,040 was charged to expense.

In August 2004, the Company completed
a public offering of common stock and warrants as a unit at $6.10 per unit before
underwriters discount and offering costs. The Company issued 1,667,500 shares of
common stock and 1,667,500 warrants to purchase common stock at $7.32 per share, through
August 9, 2008. In addition, the Company issued options to the underwriters to purchase
145,000 shares of common stock at $9.00 per share and 145,000 warrants at $0.165 per
warrant, which entitles them to purchase 145,000 shares of common stock at $7.32.

During the year ended December 31,
2004, warrant holders exercised 66,800 warrants with an exercise price of $5.00 per share
and 11,500 warrants with an exercise price of $1.75 per share for $354,125. Additionally,
in 2004 the Company issued 75,000 shares of common stock for services, which the Company
valued at an aggregate of $449,053, or $5.99 per share. The Company capitalized as part of
oil and gas properties the full $449,053.

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

Stock purchase warrants issued and
exercised during the years ended December 31, 2004 and 2003 are summarized as follows:

|                                     | 2004      |                                 | 2003
|------------------------------------ | --------- | ------------------------------- | ----
|                                     |           |                                 |     
|                                     | Warrants  | Weighted-Average Exercise Price |     
|                                    
|Outstanding at beginning of the year | 1,435,723 | $4.47                           |     
|Issued                               | 1,957,500 | $7.46                           |     
|Exercised                            | (78,300)  | $4.52                           |     
|                                    
|Outstanding at End of Year           | 3,314,923 | $6.23                           |     
|                                    

Stock purchase warrants outstanding
at December 31, 2004 are as follows:

|WarrantsOutstanding | Exercise Price | Weighted-AverageRemainingContractual Life
|------------------- | -------------- | -----------------------------------------
|                   
|190,300             | $1.75          | 0.5  years                               
|50,000              | 3.00           | 1.7                                      
|1,117,123           | 5.00           | 0.7                                      
|1,667,500           | 7.32           | 3.6                                      
|145,000             | 9.00           | 4.6                                      
|145,000             | 7.49           | 4.6                                      
|                   
|3,314,923           |                |                                          
|                   

The
Company values any shares of stock issued to non-employees at their fair value at the date
the recipient has rendered services or otherwise earned the shares.

Call Option
 The Company received a call option in December 2004 in connection with the purchase
of oil and gas properties. The option permits the Company to repurchase 150,013 shares of
its common stock at $8.50 per share through November 1, 2006. The call option is
exercisable at the Companys discretion and was recorded as a reduction of additional
paid-in capital based on its fair value of $135,777 on the date received. The fair value
of the call option was determined using the Black-Scholes option pricing model with the
following assumptions: 3% risk-free interest rate; 34% expected volatility; two year
expected life and 0% dividend yield. The call option is part of permanent equity and will
not be revalued.

# NOTE 8  EMPLOYEE
STOCK OPTIONS

On April 1, 2003 and on August 12,
2003, the Company granted nonqualified stock options to directors and employees to
purchase 1,000,000 shares and 50,000 shares of common stock at $3.70 per share and $4.80
per share through April 1, 2008 and August 12, 2008, respectively. Effective July 31,
2003, 50,000 of the options with an exercise price of $3.70 per share were forfeited. The
options vest at the rate of 20% each year over five years beginning one year from the date
granted. The exercise price was 85% of the market value of the Companys common stock
on the dates issued. The Company recognizes compensation expense related to the 15%
discount amount of the exercise price from the market price of the stock at the date of
grant over the five year vesting period of the options. The Company recognized
compensation expense for the years ended December 31, 2003 and 2004 of $221,198 and
$204,525, respectively. A summary of the status of the stock options as of December 31,
2004 and changes during the year then ended is as follows:

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

|                                      | Options   |  | Weighted-Average Exercise Price
|------------------------------------- | --------- |  | -------------------------------
|                                     
|2003                                  |           |  |                                
|Options granted                       | 1,050,000 |  | $3.75                          
|                                      |           |  |                                
|Options forfeited                     | (50,000)  |  | 3.70                           
|                                     
|Options outstanding December 31, 2003 | 1,000,000 |  | $3.76                          
|Options outstanding December 31, 2004 | 1,000,000 |  | $3.76                          
|                                     
|Options exercisable December 31, 2004 | 200,000   |  | $3.76                          
|                                     

The fair value of the options granted
during 2003, net of forfeitures, was $1,862,864, or $1.86 per share, and was estimated on
the dates granted using the Black-Scholes option-pricing model with the following
weighted-average assumptions: dividend yield of 0% percent, expected volatility of 36.2%,
risk-free interest rate of 2.9% and expected lives of 5.0 years. The weighted-average
remaining contractual life of the stock options at December 31, 2004 was 3.2 years.

# NOTE 9  RELATED
PARTY TRANSACTIONS

In July 2002, the Company borrowed
$400,000 from two of its officers under the terms of secured, 10% promissory notes, as
more fully described in Note 5 .

# NOTE 10 
COMMITMENTS

Operating Leases
Effective January 1, 2004, the Company entered into a two-year extension to
an existing operating lease agreement for office space. Under terms of the lease, the
Company pays $1,700 per month through December 31, 2005. However, subsequent to December
31, 2004 and effective March 1, 2005, the Company leased an additional 385 square feet of
office space at the same location. The Company incurred lease expense of $20,400 for the
year ended December 31, 2004. The future minimum lease payments under the operating lease
agreement as of December 31, 2004 consist of $24,400 due during the year ending December
31, 2005.

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 $299,029 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.

# NOTE 11  INCOME
TAXES

The provision for income taxes
consisted of the following:

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

|For the Years Ended December 31,                        |   | 2004      |  |   | 2003    
|------------------------------------------------------- | - | --------- |  | - | --------
|                                                       
|Current before benefit of operating loss carry forwards | $ | -         |  | $ | 83,686  
|Current benefit of operating loss carry forwards        |   | -         |  |   | (83,686)
|Deferred                                                |   | 1,397,074 |  |   | 402,455 
|                                                       
|Provision for Income Taxes                              | $ | 1,397,074 |  | $ | 402,455 
|                                                       

The following is a reconciliation of
income taxes computed using the U.S. federal statutory rate to the provision for income
taxes:

|For the Years Ended December 31,    |   | 2004      |  |   | 2003    
|----------------------------------- | - | --------- |  | - | --------
|                                   
|Tax at federal statutory rate (34%) | $ | 1,308,567 |  | $ | 368,700 
|Income not subject to tax           |   | (24,493)  |  |   | (17,364)
|State tax, net of federal benefit   |   | 127,008   |  |   | 51,120  
|Effect of lower effective tax rates |   | (14,008)  |  |   | -       
|                                   
|Provision for Income Taxes          | $ | 1,397,074 |  | $ | 402,455 
|                                   

As of December 31, 2004, the Company
had net operating loss carry forwards for federal income tax reporting purposes of $73,118
which, if unused, will expire in 2022 and 2024. The net deferred tax liability consisted
of the following:

|December 31,                   |   | 2004      |  |   | 2003   
|------------------------------ | - | --------- |  | - | -------
|                              
|Deferred tax liabilities       |   |           |  |   |        
|Depreciation                   | $ | 13,092    |  | $ | 41,152 
|Intangible drilling costs      |   | 2,291,116 |  |   | 648,126
|Asset retirement costs         |   | 380,736   |  |   | 208,690
|                              
|Total deferred tax liabilities |   | 2,684,944 |  |   | 897,968
|                              
|Deferred tax assets            |   |           |  |   |        
|Depletion and amortization     |   | 95,077    |  |   | -      
|Asset retirement obligation    |   | 426,628   |  |   | 226,486
|Stock-based compensation       |   | 158,003   |  |   | 81,843 
|Operating loss carryforwards   |   | 33,246    |  |   | 14,723 
|                              
|Total deferred tax assets      |   | 712,954   |  |   | 323,052
|                              
|Net Deferred Income Taxes      | $ | 1,971,990 |  | $ | 574,916
|                              

---



# ARENA RESOURCES, INC. 

NOTES TO FINANCIAL
STATEMENTS 

DECEMBER 31, 2004 AND
2003

# NOTE 12 
SUBSEQUENT EVENTS (UNAUDITED)

Subsequent to December 31, 2004,
warrants to acquire 1,061,394 shares of common stock have been exercised. Using the
proceeds from the exercise of the warrants, the Company paid $5,000,000 on its outstanding
line of credit, reducing the amount outstanding to $5,000,000.

Subsequent to December 31, 2004, the
Company sold its interest in the Casey lease to an unrelated party for a nominal amount.

On January 1, 2005, the Company
granted nonqualified stock options to directors and employees to purchase 375,000 shares
of common stock at $8.30 per share through July 1, 2010. The options The pro forma
stock-based employee compensation expense determined under the fair value method for these
options, net of related tax effects, for the year ending December 31, 2005 would be
$323,126. The effect of adopting FASB Statement No. 123(R) on the stock-based compensation
from these stock options will result in recognition of $161,563 of additional after-tax
compensation during the year ending December 31, 2005.

---



# ARENA RESOURCES, INC. 
SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES(Unaudited)

Capitalized Costs Relating to Oil
and Gas Producing Activities

|December 31,                                   |   | 2004        |  |   | 2003     
|---------------------------------------------- | - | ----------- |  | - | ---------
|                                              
|Unproved oil and gas properties                | $ | 388,581     |  | $ | 128,694  
|Proved oil and gas properties                  |   | 34,068,557  |  |   | 8,334,706
|Drilling advances on uncompleted projects      |   | 900,000     |  |   | 351,000  
|Support and office equipment                   |   | 87,087      |  |   | 67,458   
|                                              
|Total capitalized costs                        |   | 35,444,225  |  |   | 8,881,858
|Less accumulated depreciation and amortization |   | (1,565,124) |  |   | (559,229)
|                                              
|Net Capitalized Costs                          | $ | 33,879,101  |  | $ | 8,322,629
|                                              

Costs Incurred in Oil and Gas Producing Activities

|For the Years Ended December 31,   |   | 2004       |  |   | 2003     
|---------------------------------- | - | ---------- |  | - | ---------
|                                  
|Acquisition of proved properties   |   | 21,706,166 |  |   | 2,692,039
|Acquisition of unproved properties |   | 43,082     |  |   | 147,000  
|Exploration costs                  |   | 216,805    |  |   | 326,410  
|Development costs                  |   | 4,027,754  |  |   | 849,864  
|                                  
|Total Costs Incurred               | $ | 25,993,807 |  | $ | 4,015,313
|                                  

Results of Operations from Oil and
Gas Producing Activities The Companys results of operations from oil and
gas producing activities exclude interest expense, accretion expense, gain from change in
fair value of put options and the cumulative effect of change in accounting principle.
Income taxes are based on statutory tax rates, reflecting allowable deductions.

|For the Years Ended December 31,                       |   | 2004        |  |   | 2003       
|------------------------------------------------------ | - | ----------- |  | - | -----------
|                                                      
|Oil and gas revenues                                   | $ | 8,482,130   |  | $ | 3,665,477  
|Production costs                                       |   | (1,975,835) |  |   | (1,149,136)
|Production taxes                                       |   | (629,703)   |  |   | (269,563)  
|Depreciation and amortization                          |   | (1,011,602) |  |   | (360,282)  
|Operating expenses of oil and gas producing activities |   | (313,953)   |  |   | (221,498)  
|                                                      
|Results of operations before income taxes              |   | 4,551,037   |  |   | 1,664,998  
|Provision for income taxes                             |   | (1,683,884) |  |   | (616,049)  
|                                                      
|Results of Oil and Gas Producing Operations            | $ | 2,867,153   |  | $ | 1,048,949  
|                                                      

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.

---



# ARENA RESOURCES, INC. 
SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES(Unaudited)

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 year-end prices of 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.

|For the Years Ended December 31,          | 2004       |           | 2003
|----------------------------------------- | ---------- | --------- | ----
|                                          |            |           |     
|                                          | Oil (1)    | Gas (1)   |     
|                                          |           
|Proved Developed and Undeveloped Reserves |            |           |     
|Beginning of year                         | 7,050,167  | 3,408,754 |     
|Purchases of minerals in place            | 8,764,087  | 6,431,437 |     
|Improved recovery and development         | -          | 640,000   |     
|Production                                | (195,167)  | (169,002) |     
|Revision of previous estimate             | 3,931,577  | (311,648) |     
|                                         
|End of year                               | 19,550,664 | 9,999,541 |     
|                                         
|Proved Developed at end of year           | 4,721,293  | 4,615,265 |     
|                                         

1Oil reserves are stated in barrels; gas reserves are stated in
thousand cubic feet.

Standard Measure of Discounted Cash
Flows

|December 31,                                           |   | 2004          |  |   | 2003        
|------------------------------------------------------ | - | ------------- |  | - | ------------
|                                                      
|Future cash flows                                      | $ | 814,346,791   |  | $ | 218,026,254 
|Future production costs                                |   | (171,518,828) |  |   | (64,157,199)
|Future development costs                               |   | (61,975,106)  |  |   | (13,609,384)
|Future income taxes                                    |   | (187,392,403) |  |   | (45,778,941)
|                                                      
|Future net cash flows                                  |   | 393,460,454   |  |   | 94,480,730  
|10% annual discount for estimated timing of cash flows |   | (188,219,704) |  |   | (49,474,633)
|                                                      
|Standardized Measure of Discounted Cash Flows          | $ | 205,240,750   |  | $ | 45,006,097  
|                                                      

---



# ARENA RESOURCES, INC. 
SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES(Unaudited)

# Changes in Standardized Measure
of Discounted Future Net Cash Flows

|For the Years Ended December 31,                                  |   | 2004         |  |   | 2003       
|----------------------------------------------------------------- | - | ------------ |  | - | -----------
|                                                                 
|Beginning of the year                                             | $ | 45,006,097   |  | $ | 27,997,824 
|Purchase of minerals in place                                     |   | 142,824,938  |  |   | 21,333,720 
|Extensions, discoveries and improved recovery, less related costs |   | 347,652      |  |   | 691,469    
|Development costs incurred during the year                        |   | 5,387,638    |  |   | 320,102    
|Sales of oil and gas produced, net of production costs            |   | (5,876,333)  |  |   | (2,302,405)
|Accretion of discount                                             |   | 4,882,064    |  |   | 3,012,793  
|Net changes in price and production costs                         |   | 74,777,221   |  |   | 8,222,075  
|Net change in estimated future development costs                  |   | (3,187,159)  |  |   | 39,219     
|Revision of previous quantity estimates                           |   | 42,149,044   |  |   | (53,098)   
|Revision of estimated timing of cash flows                        |   | (27,509,967) |  |   | (5,468,732)
|Net change in income taxes                                        |   | (73,560,445) |  |   | (8,786,870)
|                                                                 
|End of the Year                                                   | $ | 205,240,750  |  | $ | 45,006,097 
|                                                                 

---