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

# Form 10-K

| | (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, 2006                                                    | 
| | 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.                                         
|--------------------------------------------------------------
|(Exact name of registrant as specified 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(Registrant's telephone number, including area code)
    _________________

# Securities registered under Section 12(b) of the Exchange Act:

|Title of Each Class       | Name of Each Exchange On Which Registered
|------------------------- | -----------------------------------------
|                          |                                          
|Common - $0.001 Par Value | New York Stock Exchange                  

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

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes |_|  No |X|

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes |_|  No |X|

Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Exchange Act during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X|  No |_|

---



Indicate by check mark if disclosure
of delinquent filers in response to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.

|Large accelerated filer  |_| | Accelerated filer |X| | Non-accelerated   filer |_|
|---------------------------- | --------------------- | ---------------------------

Indicate by check mark whether the
 registrant  is shell  company (as defined in Rule 12b-2 of the Act). Yes |_|  No
|X|

As of June 30, 2006, the aggregate
market value of the common voting stock held by non-affiliates of the issuer, based upon
the closing stock price of $34.29 per share, was approximately $500,690,750.

As of March 27, 2007, the issuer had
outstanding 14,821,263 shares of common stock ($0.001 par value).

---



|TABLE OF CONTENTS
|-----------------
|
|
|Item 1           
|Item 1A          
|Item 1B          
|Item 2           
|Item 3           
|Item 4           
|
|Item 5           
|Item 6           
|Item 7           
|Item 7A          
|Item 8           
|Item 9           
|Item 9A          
|Item 9B          
|
|Item 10          
|Item 11          
|Item 12          
|Item 13          
|Item 14          
|
|Item 15          

---



# Forward Looking
Statements

All
statements, other than statements of historical fact included in this Annual Report on
Form 10-K (herein, Annual Report) regarding our strategy, future operations,
financial position, estimated revenues and losses, projected costs, prospects, plans and
objectives of management are forward-looking statements. When used in this Annual Report,
the words could, believe, anticipate,
intend, estimate, expect, project and
similar expressions are intended to identify forward-looking statements, although not all
forward-looking statements contain such identifying words. All forward-looking statements
speak only as of the date of this Annual Report. You should not place undue reliance on
these forward-looking statements. Although we believe that our plans, intentions and
expectations reflected in or suggested by the forward-looking statements we make in this
Annual Report are reasonable, we can give no assurance that these plans, intentions or
expectations will be achieved. We disclose important factors that could cause our actual
results to differ materially from our expectations under Risk Factors,
Managements Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Annual Report. These cautionary statements qualify
all forward-looking statements attributable to us or persons acting on our behalf.

Unless
the context otherwise requires, references in this Annual Report to Arena,
we, us, our or ours refer to Arena
Resources, Inc.

# PART I

|Item 1: |  | Business
|------- |  | --------

# General

Arena
Resources, Inc. was incorporated in Nevada on August 31, 2000. Our principal executive
offices are located at 4920 South Lewis Avenue, Suite 107, Tulsa, Oklahoma 74105, and our
telephone number is (918) 747-6060. On or about June 1, 2007, we will be moving to our new
executive offices located at 6555 South Lewis Avenue, Tulsa, Oklahoma 74136. Our telephone
number will remain the same. Our Internet website can be found at
www.arenaresourcesinc.com. Our annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 will be available through
our Internet website as soon as reasonably practical after we electronically file such
material with, or furnish it to, the Securities and Exchange Commission.

We
are engaged in oil and natural gas acquisition, exploration, development and production,
with activities currently in Oklahoma, Texas, New Mexico and Kansas. Our focus will be on
developing our existing properties, while continuing to pursue acquisitions of oil and gas
properties with upside potential.

# Business Development

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, 2006, we have
increased our proved reserves to approximately 43.1 million Boe (barrel of oil
equivalent). As of December 31, 2006, our estimated proved reserves had a pre-tax PV10
(present value of future net revenues before income taxes discounted at 10%) of
approximately $848 million and a Standardized Measure of Discounted Future Net Cash Flows
of approximately $545 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 $162
million on acquisitions and capital projects during 2004, 2005 and 2006.

---



We
have a portfolio of oil and natural gas reserves, with approximately 84% of our proved
reserves consisting of oil and approximately 16% consisting of natural gas. Of those
reserves approximately 28% of our proved reserves are classified as proved developed
producing, or PDP, approximately 5% of our proved reserves are classified as
proved developed non-producing, or PDNP, approximately 5% are classified as
proved developed behind pipe PDBP, and approximately 62% are classified as
proved undeveloped, or PUD.

# Competitive Business
Conditions

We
operate in a highly competitive environment for acquiring properties, marketing oil and
natural gas and securing trained personnel. 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 company 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 2006, sales to one customer, Navajo Refining
Company, represented 82% of oil and gas revenues. At December 31, 2006, this customer
represented 80% of our accounts receivable. However, we believe that the loss of this
customer 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, 2006, we had fifty-two full-time employees, including twenty-three
employed by Arena Drilling Company, a wholly owned subsidiary. Our employees are not
represented by any labor union. We consider our relations with our employees to be
satisfactory and have never experienced a work stoppage or strike.

We
retain certain engineers, geologists, landmen, pumpers and other personnel on a contract
or fee basis as necessary for our operations.

|Item 1A. |  | Risk Factors
|-------- |  | ------------

The
following risks and uncertainties may affect our performance, results of operations and
trading price of our common stock.

Risks Relating to the Oil
and Natural Gas Industry and Our Business

A substantial or extended decline
in oil and natural gas prices may adversely affect our business, financial condition or
results of operations and our ability to meet our capital expenditure obligations and
financial commitments.

The
price we receive for our oil and natural gas production heavily influences our revenue,
profitability, access to capital and future rate of growth. Oil and natural gas are
commodities and, therefore, their prices are subject to wide fluctuations in response to
relatively minor changes in supply and demand. Historically, the markets for oil and
natural gas have been volatile. These markets will likely continue to be volatile in the
future. The prices we receive for our production, and the levels of our production, depend
on numerous factors beyond our control. These factors include, but are not limited to, the
following:

| |  | changes
in global supply and demand for oil and natural gas;
|- |  | ------------------------------------------------------------

| |  | the
actions of the Organization of Petroleum Exporting Countries, or OPEC;
|- |  | --------------------------------------------------------------------------

| |  | the
price and quantity of imports of foreign oil and natural gas;
|- |  | -----------------------------------------------------------------

| |  | political
conditions, including embargoes, in or affecting other oil-producing activity;
|- |  | ----------------------------------------------------------------------------------------

| |  | the
level of global oil and natural gas exploration and production activity;
|- |  | ----------------------------------------------------------------------------

| |  | the
level of global oil and natural gas inventories;
|- |  | ----------------------------------------------------

| |  | weather
conditions;
|- |  | -------------------

| |  | technological
advances affecting energy consumption; and
|- |  | --------------------------------------------------------

| |  | the
price and availability of alternative fuels.
|- |  | ------------------------------------------------

Lower
oil and natural gas prices may not only decrease our revenues on a per unit basis but also
may reduce the amount of oil and natural gas that we can produce economically. Lower
prices will also negatively impact the value of our proved reserves. A substantial or
extended decline in oil or natural gas prices may materially and adversely affect our
future business, financial condition, results of operations, liquidity or ability to
finance planned capital expenditures.

A substantial percentage of our
proven properties are undeveloped; therefore the risk associated with our success is
greater than would be the case if the majority of our properties were categorized as
proved developed producing.

Because
a substantial percentage of our proven properties are proved undeveloped (approximately
62%), or proved developed non-producing (approximately 5%), we will require significant
additional capital to develop such properties before they may become productive. Further,
because of the inherent uncertainties associated with drilling for oil and gas, some of
these properties may never be developed to the extent that they result in positive cash
flow. Even if we are successful in our development efforts, it could take several years
for a significant portion of our undeveloped properties to be converted to positive cash
flow.

---



While
our current business plan is to fund the development costs with cash flow from our other
producing properties, if such cash flow is not sufficient we may be forced to seek
alternative sources for cash, through the issuance of additional equity or debt
securities, increased borrowings or other means.

Approximately 39% of our proven
reserves depend upon secondary recovery techniques to establish production.

Approximately
thirty-nine percent (39%) of our reserves for the year ended December 31, 2006 are
associated with secondary recovery projects that are either in the initial stage of
implementation or are scheduled for implementation. We anticipate that secondary recovery
will be attempted by the use of waterflood of these reserves, and the exact project
initiation dates and, by the very nature of waterflood operations, the exact completion
dates of such projects, are uncertain. In addition, the reserves associated with these
secondary recovery projects, as with any reserves, are estimates only, as the success of
any development project, including these waterflood projects, cannot be ascertained in
advance. If we are not successful in developing a significant portion of our reserves
associated with secondary recovery methods, it could have a negative impact on our
earnings and our stock price.

Drilling for and producing oil and
natural gas are high risk activities with many uncertainties that could adversely affect
our business, financial condition or results of operations.

Our
future success will depend on the success of our exploitation, exploration, development
and production activities. Our oil and natural gas exploration and production activities
are subject to numerous risks beyond our control, including the risk that drilling will
not result in commercially viable oil or natural gas production. Our decisions to
purchase, explore, develop or otherwise exploit prospects or properties will depend in
part on the evaluation of data obtained through geophysical and geological analyses,
production data and engineering studies, the results of which are often inconclusive or
subject to varying interpretations. Please read Reserve estimates depend on
many assumptions that may turn out to be inaccurate (below) for a discussion of the
uncertainty involved in these processes. Our cost of drilling, completing and operating
wells is often uncertain before drilling commences. Overruns in budgeted expenditures are
common risks that can make a particular project uneconomical. Further, many factors may
curtail, delay or cancel drilling, including the following:

| |  | delays
imposed by or resulting from compliance with regulatory requirements;
|- |  | ----------------------------------------------------------------------------

| |  | pressure
or irregularities in geological formations;
|- |  | ----------------------------------------------------

| |  | shortages
of or delays in obtaining equipment and qualified personnel;
|- |  | ----------------------------------------------------------------------

| |  | equipment
failures or accidents;
|- |  | --------------------------------

| |  | adverse
weather conditions;
|- |  | ---------------------------

| |  | reductions
in oil and natural gas prices;
|- |  | -----------------------------------------

| |  | title
problems; and
|- |  | -------------------

| |  | limitations
in the market for oil and natural gas.
|- |  | --------------------------------------------------

If our assessments of recently
purchased properties are materially inaccurate, it could have significant impact on future
operations and earnings.

We
have aggressively expanded our base of producing properties. The successful acquisition of
producing properties requires assessments of many factors, which are inherently inexact
and may be inaccurate, including the following:

---



| |  | the
amount of recoverable reserves;
|- |  | -----------------------------------

| |  | future
oil and natural gas prices;
|- |  | ----------------------------------

| |  | estimates
of operating costs;
|- |  | -----------------------------

| |  | estimates
of future development costs;
|- |  | --------------------------------------

| |  | estimates
of the costs and timing of plugging and abandonment; and
|- |  | ------------------------------------------------------------------

| |  | potential
environmental and other liabilities.
|- |  | ----------------------------------------------

Our
assessment will not reveal all existing or potential problems, nor will it permit us to
become familiar enough with the properties to assess fully their capabilities and
deficiencies. As noted previously, we plan to undertake further development of our
properties through the use of cash flow from existing production. Therefore, a material
deviation in our assessments of these factors could result in less cash flow being
available for such purposes than we presently anticipate, which could either delay future
development operations (and delay the anticipated conversion of reserves into cash), or
cause us to seek alternative sources to finance development activities.

If oil and natural gas prices
decrease, we may be required to take write-downs of the carrying values of our oil and
natural gas properties, potentially requiring earlier than anticipated debt repayment and
negatively impacting the trading value of our securities.

Accounting
rules require that we review periodically the carrying value of our oil and natural gas
properties for possible impairment. Based on specific market factors and circumstances at
the time of prospective impairment reviews, and the continuing evaluation of development
plans, production data, economics and other factors, we may be required to write down the
carrying value of our oil and natural gas properties. Because our properties serve as
collateral for advances under our existing credit facilities, a write-down in the carrying
values of our properties could require us to repay debt earlier than we would otherwise be
required. A write-down could also constitute a non-cash charge to earnings. It is likely
the cumulative effect of a write-down could also negatively impact the trading price of
our securities.

Reserve estimates depend on many
assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve
estimates or underlying assumptions will materially affect the quantities and present
value of our reserves.

The
process of estimating oil and natural gas reserves is complex. It requires interpretations
of available technical data and many assumptions, including assumptions relating to
economic factors. Any significant inaccuracies in these interpretations or assumptions
could materially affect the estimated quantities and present value of our reported
reserves.

In
order to prepare our estimates, we must project production rates and timing of development
expenditures. We must also analyze available geological, geophysical, production and
engineering data. The extent, quality and reliability of this data can vary. The process
also requires economic assumptions about matters such as oil and natural gas prices,
drilling and operating expenses, capital expenditures, taxes and availability of funds.
Therefore, estimates of oil and natural gas reserves are inherently imprecise.

Actual
future production, oil and natural gas prices, revenues, taxes, development expenditures,
operating expenses and quantities of recoverable oil and natural gas reserves most likely
will vary from our estimates. Any significant variance could materially affect the
estimated quantities and present value of our reported reserves. In addition, we may
adjust estimates of proved reserves to reflect production history, results of exploration
and development, prevailing oil and natural gas prices and other factors, many of which
are beyond our control.

---



You
should not assume that the present value of future net revenues from our reported proved
reserves is the current market value of our estimated oil and natural gas reserves. In
accordance with SEC requirements, we generally base the estimated discounted future net
cash flows from our proved reserves on prices and costs on the date of the estimate.
Actual future prices and costs may differ materially from those used in the present value
estimate. If future values decline or costs increase it could negatively impact our
ability to finance operations, and individual properties could cease being commercially
viable, affecting our decision to continue operations on producing properties or to
attempt to develop properties. All of these factors would have a negative impact on
earnings and net income, and most likely the trading price of our securities. These
factors could also result in the acceleration of debt repayment and a reduction in our
borrowing base under our credit facilities.

Prospects that we decide to drill
may not yield oil or natural gas in commercially viable quantities.

Our
prospects are in various stages of evaluation, ranging from prospects that are currently
being drilled, to prospects that will require substantial additional seismic data
processing and interpretation. There is no way to predict in advance of drilling and
testing whether any particular prospect will yield oil or natural gas in sufficient
quantities to recover drilling or completion costs or to be economically viable. This risk
may be enhanced in our situation, due to the fact that a significant percentage (62%) of
our proved reserves is currently proved undeveloped reserves. The use of seismic data and
other technologies and the study of producing fields in the same area will not enable us
to know conclusively prior to drilling whether oil or natural gas will be present or, if
present, whether oil or natural gas will be present in commercial quantities. We cannot
assure you that the analogies we draw from available data from other wells, more fully
explored prospects or producing fields will be applicable to our drilling prospects.

We may incur substantial losses
and be subject to substantial liability claims as a result of our oil and natural gas
operations.

We
are not insured against all risks. Losses and liabilities arising from uninsured and
underinsured events could materially and adversely affect our business, financial
condition or results of operations. Our oil and natural gas exploration and production
activities are subject to all of the operating risks associated with drilling for and
producing oil and natural gas, including the possibility of:

| |  | environmental
hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas
or other pollution into the environment, including groundwater and shoreline
contamination;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | abnormally
pressured formations;
|- |  | --------------------------------

| |  | mechanical
difficulties, such as stuck oil field drilling and service tools and casing collapse;
|- |  | ------------------------------------------------------------------------------------------------

| |  | fires
and explosions;
|- |  | ---------------------

| |  | personal
injuries and death; and
|- |  | --------------------------------

| |  | natural
disasters.
|- |  | ------------------

Any
of these risks could adversely affect our ability to conduct operations or result in
substantial losses to our company. We may elect not to obtain insurance if we believe that
the cost of available insurance is excessive relative to the risks presented. In addition,
pollution and environmental risks generally are not fully insurable. If a significant
accident or other event occurs and is not fully covered by insurance, then it could
adversely affect us.

---



We are subject to complex laws
that can affect the cost, manner or feasibility of doing business.

Exploration,
development, production and sale of oil and natural gas are subject to extensive federal,
state, local and international regulation. We may be required to make large expenditures
to comply with governmental regulations. Matters subject to regulation include:

| |  | discharge
permits for drilling operations;
|- |  | ------------------------------------------

| |  | drilling
bonds;
|- |  | ---------------

| |  | reports
concerning operations;
|- |  | ------------------------------

| |  | the
spacing of wells;
|- |  | ---------------------

| |  | unitization
and pooling of properties; and
|- |  | ------------------------------------------

| |  | taxation.
|- |  | ---------

Under
these laws, we could be liable for personal injuries, property damage and other damages.
Failure to comply with these laws also may result in the suspension or termination of our
operations and subject us to administrative, civil and criminal penalties. Moreover, these
laws could change in ways that substantially increase our costs. Any such liabilities,
penalties, suspensions, terminations or regulatory changes could materially adversely
affect our financial condition and results of operations.

Our operations may incur
substantial liabilities to comply with the environmental laws and regulations.

Our
oil and natural gas operations are subject to stringent federal, state and local laws and
regulations relating to the release or disposal of materials into the environment or
otherwise relating to environmental protection. These laws and regulations may require the
acquisition of a permit before drilling commences, restrict the types, quantities and
concentration of substances that can be released into the environment in connection with
drilling and production activities, limit or prohibit drilling activities on certain lands
lying within wilderness, wetlands and other protected areas, and impose substantial
liabilities for pollution resulting from our operations. Failure to comply with these laws
and regulations may result in the assessment of administrative, civil and criminal
penalties, incurrence of investigatory or remedial obligations or the imposition of
injunctive relief. Changes in environmental laws and regulations occur frequently, and any
changes that result in more stringent or costly waste handling, storage, transport,
disposal or cleanup requirements could require us to make significant expenditures to
maintain compliance, and may otherwise have a material adverse effect on our results of
operations, competitive position or financial condition as well as the industry in
general. Under these environmental laws and regulations, we could be held strictly liable
for the removal or remediation of previously released materials or property contamination
regardless of whether we were responsible for the release or if our operations were
standard in the industry at the time they were performed.

If our indebtedness increases, it
could reduce our financial flexibility.

We
have a $150 million credit facility in place with a current borrowing base of $65 million.
As of March 27, 2007, we had $35,500,000 outstanding on our credit facility. If in the
future we further utilize this facility, the level of our indebtedness could affect our
operations in several ways, including the following:

| |  | a
significant portion of our cash flow could be used to service the indebtedness,
|- |  | ---------------------------------------------------------------------------------

| |  | a
high level of debt  would  increase  our  vulnerability  to  general  adverse  economic
 and  industry            conditions,
|- |  | -------------------------------------------------------------------------------------------------------------------------------

| |  | the
covenants contained in our credit facility limit our ability to borrow additional funds,
dispose of assets, pay dividends and make certain investments,
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

---



| |  | a
high level of debt could impair our ability to obtain additional financing in the future
for working capital, capital expenditures, acquisitions, general corporate or other
purposes.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
addition, our bank borrowing base is subject to semi-annual redeterminations. We could be
forced to repay a portion of our bank borrowings due to redeterminations of our borrowing
base. If we are forced to do so, we may not have sufficient funds to make such repayments.
If we do not have sufficient funds and are otherwise unable to negotiate renewals of our
borrowings or arrange new financing, we may have to sell significant assets. Any such sale
could have a material adverse effect on our business and financial results.

Unless we replace our oil and
natural gas reserves, our reserves and production will decline, which would adversely
affect our cash flows and income.

Unless
we conduct successful development, exploitation and exploration activities or acquire
properties containing proved reserves, our proved reserves will decline as those reserves
are produced. Producing oil and natural gas reservoirs generally are characterized by
declining production rates that vary depending upon reservoir characteristics and other
factors. Our future oil and natural gas reserves and production, and, therefore our cash
flow and income, are highly dependent on our success in efficiently developing and
exploiting our current reserves and economically finding or acquiring additional
recoverable reserves. If we are unable to develop, exploit, find or acquire additional
reserves to replace our current and future production, our cash flow and income will
decline as production declines, until our existing properties would be incapable of
sustaining commercial production.

# The loss of senior
management could adversely affect us.

To
a large extent, we depend on the services of our senior management. The loss of our senior
management  Stanley McCabe, our Chairman, or Tim Rochford, our Chief Executive
Officer  could have a material adverse effect on our operations. While we have
obtainedakey man life insurance policy on Mr. Rochford, any amounts that
we may recover under such policy may not adequately compensate us for the loss of the
services of Mr. Rochford. We do not have employment agreements with either Mr. McCabe or
Mr. Rochford.

The unavailability or high cost of
drilling rigs, equipment, supplies, personnel and oil field services could adversely
affect our ability to execute on a timely basis our exploration and development plans
within our budget.

With
the recent increase in the prices of oil and natural gas, we have encountered an increase
in the cost of securing drilling rigs, equipment and supplies. Shortages or the high cost
of drilling rigs, equipment, supplies and personnel are expected to continue in the
near-term. In addition, larger producers may be more likely to secure access to such
equipment by virtue of offering drilling companies more lucrative terms. If we are unable
to acquire access to such resources, or can obtain access only at higher prices, not only
would this potentially delay our ability to convert our reserves into cash flow, but could
also significantly increase the cost of producing those reserves, thereby negatively
impacting anticipated net income.

If our access to markets is
restricted, it could negatively impact our production, our income and ultimately our
ability to retain our leases.

Market
conditions or the unavailability of satisfactory oil and natural gas transportation
arrangements may hinder our access to oil and natural gas markets or delay our production.
The availability of a ready market for our oil and natural gas production depends on a
number of factors, including the demand for and supply of oil and natural gas and the
proximity of reserves to pipelines and terminal facilities. Our ability to market our
production depends in substantial part on the availability and capacity of gathering
systems, pipelines and processing facilities owned and operated by third parties. Our
failure to obtain such services on acceptable terms could materially harm our business.

---



Currently,
the majority of our production is sold to marketers and other purchasers that have access
to nearby pipeline facilities. However, as we begin to further develop our properties, we
may find production in areas with limited or no access to pipelines, thereby necessitating
delivery by other means, such as trucking, or requiring compression facilities. Such
restrictions on our ability to sell our oil or natural gas have several adverse affects,
including higher transportation costs, fewer potential purchasers (thereby potentially
resulting in a lower selling price) or, in the event we were unable to market and sustain
production from a particular lease for an extended time, possibly causing us to lose a
lease due to lack of production.

Competition in the oil and natural
gas industry is intense, which may adversely affect our ability to compete.

We
operate in a highly competitive environment for acquiring properties, marketing oil and
natural gas and securing trained personnel. Many 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. We may not be able to compete successfully in the
future in acquiring prospective reserves, developing reserves, marketing hydrocarbons,
attracting and retaining quality personnel and raising additional capital.

# Risks Relating to Our
Common Stock

# The market price of our
stock may be affected by low volume float

While
there has been a public market for our common stock on the New York Stock Exchange (and,
prior to August 31, 2006, on the American Stock Exchange), in the last twelve months the
daily trading volume, or public float, of our common stock has ranged from as
low as 67,700 shares to as high as 796,500 shares. The average volume of shares traded
during the 90 days prior to December 31, 2006 was 1,200,200 shares per week.

Additionally,
approximately 538,170 shares of our common stock are restricted shares under
Rule 144, but could be currently sold with little difficulty under the provisions of Rule
144(k). We also estimate that approximately 448,423 additional shares of common stock that
are currently restricted, will soon be capable of being resold under Rule 144.

Finally,
as of December 31, 2006 there are warrants outstanding to purchase 268,329 shares of
common stock, as well as options to purchase 1,305,000 shares of common stock (of which
options to acquire 515,000 shares are currently exercisable, with 575,000 options vesting
over the next two years, and the balance vesting over the next four and one-half years).

Substantial
sales of our common stock, including shares issued upon the exercise of outstanding
options and warrants, in the public market, or the perception that these sales could
occur, may have a depressive effect on the market price of our common stock. Such sales or
the perception of such sales could also impair our ability to raise capital or make
acquisitions through the issuance of our common stock.

---



We have no plans to pay dividends
on our common stock. You may not receive funds without selling your shares.

We
do not anticipate paying any cash dividends on our common stock in the foreseeable future.
We currently intend to retain future earnings, if any, to finance the expansion of our
business. Our future dividend policy is within the discretion of our board of directors
and will depend upon various factors, including our business, financial condition, results
of operations, capital requirements and investment opportunities. In addition, our credit
facility prohibits us from paying dividends.

Provisions under Nevada law could
delay or prevent a change in control of our company, which could adversely affect the
price of our common stock.

While
we do not believe that we currently have any provisions in our organizational documents
that could prevent or delay a change in control of our company (such as provisions calling
for a staggered board of directors, or the issuance of stock with super-majority voting
rights), the existence of some provisions under Nevada law could delay or prevent a change
in control of our company, which could adversely affect the price of our common stock.
Nevada law imposes some restrictions on mergers and other business combinations between us
and any holder of 10% or more of our outstanding common stock.

|Item 1B: |  | Unresolved Staff Comments
|-------- |  | -------------------------

None.

|Item 2: |  | Properties
|------- |  | ----------

# General Background

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, 2006, our proved reserves have grown
to 43,134,974 Boe, at an average acquisition/drilling cost of $3.75 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 ($161,638,633),
computed in accordance with applicable accounting standards, as shown under
Capitalized Costs Relating to Oil and Gas Producing Activities under
Supplemental Information on Oil and Gas Producing Activities, by our reserves in Boe
(43,134,974).

As
of December 31, 2006, our estimated proved reserves had a pre-tax PV10 value of
approximately $848 million and a Standardized Measure of Discounted Future Cash Flows of
approximately $545 million, approximately 25% of which came from properties located in New
Mexico, approximately 64% from our properties in Texas, approximately 8% from our
properties in Oklahoma and approximately 3% from our properties in Kansas. We spent
approximately $162 million on capital projects during 2004, 2005 and 2006. We expect to
further develop these properties through additional drilling. Our capital budget for 2007
is approximately $95 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.

---



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, 2006.

|Geographic Area | Oil(Bbl) | Natural Gas(Mcf) | Total(Boe) | Pre-Tax PV10 Value | Standardized Measure of Discounted Future Net Cash Flows
|--------------- | -------- | ---------------- | ---------- | ------------------ | --------------------------------------------------------
|                |          |                  |            |                    |                                                         
|New Mexico      |          |                  |            | 9,481,520          |                                                         
|Texas           |          |                  |            | 23,198,670         |                                                         
|Oklahoma        |          |                  |            | 3,384,083          |                                                         
|Kansas          |          |                  |            | -                  |                                                         
|                |          |                  |            |                    |                                                         
|Total           |          |                  |            | 36,064,273         |                                                         
|                |          |                  |            |                    |                                                         

# Proved Reserves

Our
43,134,974 Boe of proved reserves, which consist of approximately 84% oil and 16% natural
gas, are summarized below as of December 31, 2006, on a net pre-tax PV10 value and
Standardized Measure of Discounted Future Net Cash Flows basis. Our reserve estimates have
not been filed with any Federal authority or agency (other than the SEC).

As
of December 31, 2006, New Mexico proved reserves had a net pre-tax PV10 value of $215.4
million and Standardized Measure of Discounted Future Net Cash Flows of $138.4 million,
our proved reserves in Texas had a net pre-tax PV10 value of $550.5 million and
Standardized Measure of Discounted Future Net Cash Flows of $354.2 million, our proved
reserves in Oklahoma had a net pre-tax PV10 value of $71.1 million and a Standardized
Measure of Discounted Future Net Cash Flows of $45.3 million and our proved reserves in
Kansas had a net pre-tax PV10 value of $10.7 million and a Standardized Measure of
Discounted Future Net Cash Flows of $7.6 million.

As
of December 31, 2006, approximately 28% of the 43.1 million Boe of proved reserves have
been classified as proved developed producing, or PDP. Proved developed
non-producing, or PDNP reserves constitute approximately 5%, proved developed
behind-pipe PDBP reserves constitute approximately 5% and proved undeveloped,
or PUD, reserves constitute approximately 62%, of the proved reserves as of
December 31, 2006.

Approximately
thirty-nine percent (39%) of our reserves for the year ended December 31, 2006 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.

Total
proved reserves had a net pre-tax PV10 value as of December 31, 2006 of approximately $848
million and a Standardized Measure of Discounted Future Net Cash Flows of approximately
$545 million, 28.2% or $212.0 million and $136.6, respectively, of which is associated
with the PDP reserves. An additional $57.2 million and $37.0 million, respectively, is
associated with the PDNP reserves and $25.2 million and $16.2 million, respectively, is
associated with PDBP reserves ($294.4 million and $189.8 million, respectively, for total
proved developed reserves, or 38.3% of total proved reserves pre-tax PV10 value).
The remaining $553.2 million and $355.7 million, respectively, is associated with PUD
reserves.

---



Our
proved reserves as of December 31, 2006 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           | 4,203,816 |  | 5,318,472 |  | 5,090,228  |  | 12%              |  | $ | 83,502                    |  | $ | 53,626                                                   |  | $ | -                                       
|PUD           | 5,277,704 |  | 1,400,889 |  | 5,511,186  |  | 13%              |  |   | 131,942                   |  |   | 84,734                                                   |  |   | 16,412                                  
|              |           |  |           |  |            |  |                  |  |   |                           |  |   |                                                          |  |   |                                         
|Total Proved: | 9,481,520 |  | 6,719,361 |  | 10,601,414 |  | 25%              |  | $ | 215,444                   |  | $ | 138,360                                                  |  | $ | 16,412                                  
|              |           |  |           |  |            |  |                  |  |   |                           |  |   |                                                          |  |   |                                         

|Texas:        |            |  |            |  |            |  |     |  |   |         |  |   |         |  |   |        
|------------- | ---------- |  | ---------- |  | ---------- |  | --- |  | - | ------- |  | - | ------- |  | - | -------
|PDP           | 5,439,397  |  | 4,526,690  |  | 6,193,845  |  | 14% |  | $ | 118,367 |  | $ | 76,160  |  | $ | 500    
|PDNP          | 1,106,705  |  | 519,315    |  | 1,193,258  |  | 3%  |  |   | 40,157  |  |   | 25,838  |  |   | 4,337  
|PDBP          | -          |  | 13,701,830 |  | 2,283,638  |  | 5%  |  |   | 25,197  |  |   | 16,212  |  |   | 4,140  
|PUD           | 16,652,568 |  | 9,300,829  |  | 18,202,706 |  | 42% |  |   | 366,765 |  |   | 235,985 |  |   | 115,313
|              |            |  |            |  |            |  |     |  |   |         |  |   |         |  |   |        
|Total Proved: | 23,198,670 |  | 28,048,664 |  | 27,873,447 |  | 64% |  | $ | 550,486 |  | $ | 354,195 |  | $ | 124,290
|              |            |  |            |  |            |  |     |  |   |         |  |   |         |  |   |        

|Oklahoma:     |           |  |         |  |           |  |    |  |   |        |  |   |        |  |   |      
|------------- | --------- |  | ------- |  | --------- |  | -- |  | - | ------ |  | - | ------ |  | - | -----
|PDP           | 379,118   |  | 70,068  |  | 390,796   |  | 1% |  | $ | 5,827  |  | $ | 3,713  |  | $ | 500  
|PDNP          | 437,149   |  | 89,073  |  | 451,995   |  | 1% |  |   | 13,230 |  |   | 8,430  |  |   | 150  
|PUD           | 2,567,816 |  | 129,199 |  | 2,589,349 |  | 6% |  |   | 52,061 |  |   | 33,172 |  |   | 7,400
|              |           |  |         |  |           |  |    |  |   |        |  |   |        |  |   |      
|Total Proved: | 3,384,083 |  | 288,340 |  | 3,432,140 |  | 8% |  | $ | 71,118 |  | $ | 45,315 |  | $ | 8,050
|              |           |  |         |  |           |  |    |  |   |        |  |   |        |  |   |      

|Kansas:       |   |  |           |  |           |  |    |  |   |        |  |   |       |  |   |      
|------------- | - |  | --------- |  | --------- |  | -- |  | - | ------ |  | - | ----- |  | - | -----
|PDP           | - |  | 2,903,815 |  | 483,969   |  | 1% |  | $ | 4,349  |  | $ | 3,081 |  | $ | 739  
|PDNP          | - |  | 2,550,711 |  | 425,119   |  | 1% |  |   | 3,811  |  |   | 2,700 |  |   | 463  
|PUD           | - |  | 1,913,308 |  | 318,885   |  | 1% |  |   | 2,526  |  |   | 1,789 |  |   | 600  
|              |   |  |           |  |           |  |    |  |   |        |  |   |       |  |   |      
|Total Proved: | - |  | 7,367,834 |  | 1,227,973 |  | 3% |  | $ | 10,686 |  | $ | 7,570 |  | $ | 1,802
|              |   |  |           |  |           |  |    |  |   |        |  |   |       |  |   |      

|Total:        |            |  |            |  |            |  |      |  |   |         |  |   |         |  |   |        
|------------- | ---------- |  | ---------- |  | ---------- |  | ---- |  | - | ------- |  | - | ------- |  | - | -------
|PDP           | 10,022,331 |  | 12,819,045 |  | 12,158,839 |  | 28%  |  | $ | 212,045 |  | $ | 136,580 |  | $ | 1,739  
|PDNP          | 1,543,854  |  | 3,159,099  |  | 2,070,371  |  | 5%   |  |   | 57,198  |  |   | 36,968  |  |   | 4,950  
|PDBP          | -          |  | 13,701,830 |  | 2,283,638  |  | 5%   |  |   | 25,197  |  |   | 16,212  |  |   | 4,140  
|PUD           | 24,498,088 |  | 12,744,225 |  | 26,622,126 |  | 62%  |  |   | 553,294 |  |   | 355,680 |  |   | 139,725
|              |            |  |            |  |            |  |      |  |   |         |  |   |         |  |   |        
|Total Proved: | 36,064,273 |  | 42,424,199 |  | 43,134,974 |  | 100% |  | $ | 847,734 |  | $ | 545,440 |  | $ | 150,554
|              |            |  |            |  |            |  |      |  |   |         |  |   |         |  |   |        

---



# 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  |  |   | EstimatedDevelopment Costs
|---- | ------------------------------------- |  | ------------------------------------ |  | ---------- |  | - | --------------------------
|     |                                       |  |                                      |  |            |  |   |                           
|2007 | 14,730,658                            |  | 8,433,660                            |  | 16,136,267 |  | $ | 69,558,837                
|2008 | 9,383,280                             |  | 4,052,637                            |  | 10,058,719 |  |   | 65,372,000                
|2009 | 384,150                               |  | 257,928                              |  | 427,138    |  |   | 4,794,500                 
|     |                                       |  |                                      |  |            |  |   |                           
|     | 24,498,088                            |  | 12,744,225                           |  | 26,622,124 |  | $ | 139,725,337               
|     |                                       |  |                                      |  |            |  |   |                           

# Production

Our estimated  average daily production for the month of December,  2006, is summarized  below.
These tables  indicate the  percentage  of our estimated  December 2006 average daily  production of 3,700
Boe/d attributable to each state and to oil versus natural gas production.

|State      |  | AverageDailyProduction |  | Oil    |  | NaturalGas
|---------- |  | ---------------------- |  | ------ |  | ----------
|Texas      |  | 74.00%                 |  | 64.65% |  | 9.35%     
|New Mexico |  | 20.24%                 |  | 16.63% |  | 3.61%     
|Oklahoma   |  | 3.09%                  |  | 2.85%  |  | 0.24%     
|Kansas     |  | 2.67%                  |  | 0.00%  |  | 2.67%     
|           |  |                        |  |        |  |           
|Total      |  | 100%                   |  | 84.13% |  | 15.87%    

# Summary of Oil and
Natural Gas Properties and Projects

Significant New
Mexico Operations

East
Hobbs Unit  Lea County, New Mexico. In May 2004 we acquired an 82.24% working
interest and a 67.6% net revenue interest in this lease. 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. This lease covers approximately 920 acres. There are currently 34 producing
wells. We believe this property can support two additional wells, which are included in
our estimate of PUD. This lease is held by production.

---



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. The remaining working
interest is owned by unaffiliated parties. There are currently 51 producing wells on this
lease. 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. The lease covers approximately 1,800 acres, and we believe this property
can support a number of additional wells, 23 of which are included in our estimate of PUD.
This lease is held by production.

The
North Benson Queen Unit Waterflood expansion project is in progress. A water line of
approximately four miles in length has been constructed along with the associated water
storage and transfer equipment. Water injection and pumping equipment have been
constructed and water injection will begin into seven wells on the west side of the
property in April, 2007. Oil treating and storage facilities are being upgraded and will
be completed in the third quarter of 2007. The costs for the expansion and development of
the North Benson Queen Unit are estimated to be $4,450,000 in 2007. The North Benson Queen
Unit waterflood expansion project will be completed in 2008 with the drilling of
twenty-three (23) producing wells at an estimated cost of $9,200,000.

Significant
Texas Operations

Fuhrman-Mascho
leases  Andrews County, Texas. In December 2004 we acquired a 100% working
interest and a 75% net revenue interest in these leases. These leases cover approximately
11,300 acres. We believe this property can support a number of additional wells, 121 of
which are included in our estimate of PUD. These leases are held by production.

Fuhrman-Mascho
offset leases  Throughout 2005 and 2006, the Company has acquired working
interests in additional leases and leased additional acreage in and around our
Fuhrman-Mascho leases. The working interest percentages acquired range from 20% to 100%
with net revenue interest ranging from 16% to 80%. These leases cover approximately 5,960
acres. We believe this property can support a number of additional wells, 90 of which are
included in our estimate of PUD. These leases are held by production.

Y6
Lease  Fisher County, Texas.We acquired a 100% working interest and an 80% net
revenue interest in this lease in June 2001. 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 $2,700,000 cost thereof) is included as PUD in our reserve report. This
lease consists of approximately 1,697 acres and is held by production.

Significant
Oklahoma Operations

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 has approximately 2,120 acres and 12 producing
wells. We believe this property can support three additional wells, 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. The
lease consists of approximately 489 acres and has eight producing wells. We believe this
property can support 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 eight
producing wells, and we believe there are up to six additional drilling locations on these
leases. The Hanes lease contains approximately 640 acres and two producing wells. We
believe this property can support four 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.

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).

Two
wells have been drilled on this acreage and they have not yet reached payout. They are
anticipated to reach payout during the second quarter 2007. After payout, Bird Creek
Resources, Inc. will own the remaining 25% working interest.

Schmidt
Unit  Gray County, Kansas. During 2004 and 2006 we leased 10,160 acres
offsetting our Koehn/Rexford Unit. We have drilled a total of 10 wells on this acreage,
seven of which have been successful and have been put into production. This lease is held
by production.

Syracuse
Prospect  Hamilton County, Kansas. During 2005 and 2006 we leased 21,733 acres.
These leases provide us a 100% working interest and an 81% net revenue interest. We have
drilled a total of five wells on this acreage, two of which were successful and are in the
completion phase.

Rocky
Prospect  Comanche County, Kansas. During 2005 we leased 4,160 acres. These
leases provide us a 100% working interest and an 80% net revenue interest. We have drilled
four wells on this acreage, one of which has been successful and has been put into
production.

---



# Acreage

The
following table summarizes gross and net developed and undeveloped acreage at December 31,
2006 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      | 20,927            |  | 15,871              |  | --           
|           |                   |  |                     |  |              
|Oklahoma   | 5,529             |  | 4,122               |  | --           
|           |                   |  |                     |  |              
|Kansas     | 13,040            |  | 10,432              |  | 15,787       
|           |                   |  |                     |  |              
|Total      | 44,456            |  | 33,719              |  | 15,787       
|           |                   |  |                     |  |              

# 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, 2006, 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 | 106       |  | 68        |  | -          
|Texas      | 395       |  | 298       |  | -          
|Oklahoma   | 30        |  | 25        |  | -          
|Kansas     | -         |  | -         |  | 10         
|           |           |  |           |  |            
|Total      | 531       |  | 391       |  | 10         
|           |           |  |           |  |            

# Drilling Activity

During
2006 we completed the drilling of 124 wells. Eighty-seven wells were drilled on our
Fuhrman Mascho properties in Andrews County, Texas. Nineteen wells were drilled in Lea
County, New Mexico, with fourteen on our Seven Rivers Queen property and five of them on
our East Hobbs property. Twelve wells were drilled in Kansas, four in Gray County, Kansas,
offsetting our existing wells there and nine in Hamilton and Greeley County, Kansas on
acreage acquired during 2005; the eight wells in Hamilton and Greeley Counties were
exploratory wells. Three wells were drilled in Texas County, Oklahoma, with one well on
our Eva South property and two wells on our Ona Morrow property. Three wells were drilled
on our Midwell and Hanes properties in Cimarron County, Oklahoma.

# 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 $8.85 in 2004, $7.54 in 2005 and $6.06 in 2006. 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, 2004, 2005 and 2006 are shown below.

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

(1)    
          The amount shown for 2005 for acquisition of unproved properties is net of
          proceeds received for partial working interests sold in wells drilled in Kansas.

# 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, 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 
|                           | Purchase of minerals in place | 882,460    |            | 377,179         
|                           | Extensions and discoveries    | 2,546,477  |            | 19,188,896      
|                           | Production                    | (441,995)  |            | (398,611)       
|                           | Revisions of estimates        | 2,329,583  |            | 2,815,074       
|                           |                               |            |            |                 
|                           |                               |            |            |                 
|Balance, December 31, 2005 | 24,867,189                    |            | 31,982,079
|                           | Purchase of minerals in place | 3,644,144  |            | 2,605,212       
|                           | Extensions and discoveries    | 8,952,460  |            | 10,206,642      
|                           | Production                    | (900,616)  |            | (989,991)       
|                           | Revisions of estimates        | (498,904)  |            | (1,379,743)     
|                           |                               |            |            |                 
|                           |                               |            |            |                 
|Balance, December 31, 2006 | 36,064,273                    |            | 42,424,199
|                           |                               |            |            |                 

Our
proved oil and natural gas reserves are shown below.

|                  |             |  | For the Years Ended December 31,
|----------------- | ----------- |  | --------------------------------
|                  |             |  | 2004                            
|                  |             |  |                                 
|Oil (Bbls)        |             |  |                                 
|                  | Developed   |  | 4,721,293                       
|                  | Undeveloped |  | 14,829,371                      
|                  |             |  |                                 
|                  | Total       |  | 19,550,664                      
|                  |             |  |                                 
|                  |             |  |                                 
|Natural Gas (Mcf) |             |  |                                 
|                  | Developed   |  | 4,615,265                       
|                  | Undeveloped |  | 5,384,276                       
|                  |             |  |                                 
|                  | Total       |  | 9,999,541                       
|                  |             |  |                                 
|                  |             |  |                                 
|Total (Boe)       |             |  |                                 
|                  | Developed   |  | 5,490,504                       
|                  | Undeveloped |  | 15,726,750                      
|                  |             |  |                                 
|                  | Total       |  | 21,217,254                      
|                  |             |  |                                 

---



# 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,                                             |   | 2006          |  |  |   | 2005          |  |  |   | 2004          | 
|-------------------------------------------------------- | - | ------------- |  |  | - | ------------- |  |  | - | ------------- | 
|                                                        
|Future cash flows                                        | $ | 2,206,997,329 |  |  | $ | 1,629,948,750 |  |  | $ | 814,346,791   | 
|Future production costs                                  |   | (436,830,228) |  |  |   | (281,685,991) |  |  |   | (171,518,828) | 
|Future development costs                                 |   | (150,553,635) |  |  |   | (95,765,594)  |  |  |   | (61,975,106)  | 
|Future income taxes                                      |   | (578,112,324) |  |  |   | (423,161,523) |  |  |   | (187,392,403) | 
|                                                        
|Future net cash flows                                    |   | 1,041,501,142 |  |  |   | 829,335,642   |  |  |   | 393,460,454   | 
|10% annual discount for estimated timing of cash   flows |   | (496,061,467) |  |  |   | (383,735,076) |  |  |   | (188,219,704) | 
|                                                        
|Standardized Measure of Discounted Cash Flows            | $ | 545,439,675   |  |  | $ | 445,600,566   |  |  | $ | 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,                                    |   | 2006          |  |  |   | 2005          |  |  |   | 2004         | 
|------------------------------------------------------------------- | - | ------------- |  |  | - | ------------- |  |  | - | ------------ | 
|                                                                   
|Beginning of the year                                               | $ | 445,600,566   |  |  | $ | 205,240,750   |  |  | $ | 45,006,097   | 
|Purchase of minerals in place                                       |   | 18,153,711    |  |  |   | 33,405,120    |  |  |   | 142,824,938  | 
|Extensions, discoveries and improved recovery, less   related costs |   | -             |  |  |   | 5,962,820     |  |  |   | 347,652      | 
|Development costs incurred during the year                          |   | 328,401,017   |  |  |   | 189,832,736   |  |  |   | 5,387,638    | 
|Sales of oil and gas produced, net of production costs              |   | (53,324,929)  |  |  |   | (21,991,034)  |  |  |   | (5,876,333)  | 
|Accretion of discount                                               |   | 58,727,964    |  |  |   | 28,467,073    |  |  |   | 4,882,064    | 
|Net changes in price and production costs                           |   | (106,369,988) |  |  |   | 191,917,618   |  |  |   | 74,777,221   | 
|Net change in estimated future development costs                    |   | (53,640,718)  |  |  |   | (36,307,702)  |  |  |   | (3,187,159)  | 
|Revision of previous quantity estimates                             |   | (14,276,840)  |  |  |   | 87,175,031    |  |  |   | 42,149,044   | 
|Revision of estimated timing of cash flows                          |   | (8,582,606)   |  |  |   | (111,387,288) |  |  |   | (27,509,967) | 
|Net change in income taxes                                          |   | (69,248,502)  |  |  |   | (126,714,558) |  |  |   | (73,560,445) | 
|                                                                   
|End of the Year                                                     | $ | 545,439,675   |  |  | $ | 445,600,566   |  |  | $ | 205,240,750  | 
|                                                                   

---



# 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 44,456 gross (33,720 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, 2006, we owned interests in approximately 15,787 gross undeveloped acres
(12,746 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 2007 is approximately $95
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.
While our emphasis in 2007 and beyond is anticipated to focus on the further development
of 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, 2006, our oil
and gas production costs per Boe averaged $6.06 and general and administrative costs
averaged $3.39 per Boe produced.

# Other Properties and
Commitments

We
currently lease our principal executive offices in Tulsa, Oklahoma. At December 31, 2006,
the lease was for approximately 3,224 square feet of office space, at an annual rental of
$30,000. This lease expired December 31, 2006 and is continuing on a month to month basis
at the same rate.

On
March 1, 2007, we closed the acquisition of a two story office building, and an adjoining
parcel of real estate, located on 6555 South Lewis Avenue in Tulsa, Oklahoma. This office
building has approximately 16,000 square feet, and we intend to occupy approximately
12,000 square feet to house our executive offices. The remaining 4,000 square feet are
currently under lease to an unrelated tenant. We anticipate moving into our new executive
offices in June, 2007. These 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 7, 2006. 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 2007. 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 2,000,000 to 2,500,000. The following reflects the votes cast for each matter voted
on at the annual meeting:

|                               |  | Votes for  |  |  |  | Votes against |  |  |  | Abstain | 
|------------------------------ |  | ---------- |  |  |  | ------------- |  |  |  | ------- | 
|                               |  |            |  |  |  |               |  |  |  |         | 
|Lloyd T. Rochford              |  | 12,194,756 |  |  |  | -             |  |  |  | 495,127 | 
|Stanley M. McCabe              |  | 12,032,841 |  |  |  | -             |  |  |  | 657,042 | 
|Charles M. Crawford            |  | 12,214,061 |  |  |  | -             |  |  |  | 475,822 | 
|Chris V. Kemendo, Jr.          |  | 12,106,295 |  |  |  | -             |  |  |  | 583,588 | 
|Clayton E. Woodrum             |  | 11,964,901 |  |  |  | -             |  |  |  | 724,982 | 
|                               |  |            |  |  |  |               |  |  |  |         | 
|Amendment to stock option plan |  | 5,804,600  |  |  |  | 3,025,721     |  |  |  | 28,294  | 

---



# 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
August 31, 2006, our common stock has been traded on the New York Stock Exchange, under
the symbol ARD. Prior to that dating back to April 15, 2003, our common stock
traded on the American Stock Exchange, also under the symbol ARD. The
following table shows the high and low sales prices for each quarter during the last three
years.

|Period                                   |   | High Sale |  |  |   | Low Sale | 
|---------------------------------------- | - | --------- |  |  | - | -------- | 
|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                         | $ | 15.05     |  |  | $ | 7.89     | 
|2nd Quarter 2005                         |   | 13.95     |  |  |   | 9.20     | 
|3rd Quarter 2005                         |   | 26.20     |  |  |   | 11.35    | 
|4th Quarter 2005                         |   | 29.40     |  |  |   | 19.46    | 
|                                         |   |           |  |  |   |          | 
|1st Quarter 2006                         | $ | 36.99     |  |  | $ | 25.71    | 
|2nd Quarter 2006                         |   | 38.60     |  |  |   | 25.88    | 
|3rd Quarter 2006                         |   | 41.32     |  |  |   | 26.09    | 
|4th Quarter 2006                         |   | 47.70     |  |  |   | 29.60    | 
|                                         |   |           |  |  |   |          | 
|1st Quarter 2007 (throughMarch 27, 2007) | $ | 49.42     |  |  | $ | 37.26    | 

# Record Holders

As
of March 2, 2007, there are approximately 5,116 holders of record of our common stock. As
of March 27, 2007, approximately 13%, or 1,940,300 shares of the 14,821,263 shares issued
and outstanding as of such date are held by management or affiliated parties.

# Dividend Policy

We
have not paid any dividends on our common stock during the last three years, and we do not
anticipate paying any cash dividends on our common stock in the foreseeable future. We
currently intend to retain future earnings, if any, to finance the expansion of our
business. Our future dividend policy is within the discretion of our board of directors
and will depend upon various factors, including our results of operations, financial
condition, capital requirements and investment opportunities. In addition, our credit
facility prohibits us from paying dividends.

---



# Securities Authorized
for Issuance Under Equity Compensation Plans

In
March 2003, our board of directors adopted an executive stock option plan which was
subsequently approved by our shareholders at our annual meeting in July 2003, and which
was amended by our shareholders at our annual meetings in 2004, 2005 and 2006. 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

During
the three months ended December 31, 2006, we issued 10,200 shares of our common stock as
finders fees relating to property acquisitions. 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.

# Issuer Repurchases

We
did not make any repurchases of our equity securities during the quarter ending December
31, 2006.

|Item 6: |  | Selected Financial Data
|------- |  | -----------------------

The
selected consolidated financial information set forth below is derived from our
consolidated balance sheets and statements of operations as of and for the years ended
December 31, 2006, 2005, 2004, 2003, and 2002. The data set forth below should be read in
conjunction with Managements Discussion and Analysis of Financial Condition
and Results of Operations and the consolidated financial statements and related
notes thereto included in this Annual Report.

|                                                     | For the Year Ended December 31,
|---------------------------------------------------- | -------------------------------
|                                                     |                                
|                                                     | 2006                           
|                                                     |                                
|Statement of Operations Data:                        |                                
|Revenues                                             | $                              
|Cost of revenues                                     |                                
|Depreciation, depletion and   amortization           |                                
|Accretion                                            |                                
|General and administrative                           |                                
|Net income                                           |                                
|Preferred stock dividends                            |                                
|Income (Loss) attributable to    common shareholders |                                
|                                                     |                                
|Basic income (loss) per   common share               | $                              
|Diluted income (loss) per   common share             |                                

|                                                 | As of December 31,
|------------------------------------------------ | ------------------
|                                                 |                   
|                                                 | 2006              
|                                                 |                   
|Balance Sheet Data:                              |                   
|Current assets                                   | $                 
|Oil and gas properties subject   to amortization |                   
|Total assets                                     |                   
|Total current liabilities                        |                   
|Total long-term liabilities                      |                   
|Total Stockholders Equity                        |                   

---



|Item 7: |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations
|------- |  | -------------------------------------------------------------------------------------

# Introduction

The
following discussion and analysis should be read in conjunction with our accompanying
financial statements and the notes to those financial statements included elsewhere in
this Annual Report. The following discussion includes forward-looking statements that
reflect our plans, estimates and beliefs. Our actual results could differ materially from
those discussed in these forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed below and
elsewhere in this Annual Report.

# Overview

We
are engaged in oil and natural gas acquisition, exploration and exploitation activities in
the states of Oklahoma, Texas, New Mexico and Kansas. Over the last six years, we have
emphasized the acquisition of properties that provided current production and upside
potential through further development.

We
have increased our reserves significantly by investing approximately $101.3 million in
acquisitions and enhancements in 2006, following total capital expenditures of
approximately $34.3 million in 2005 and $26 million in 2004.

Our
capital budget for 2007 is approximately $95 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 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,
|----------------------------- | --------------------------------------------------- | - | --------------------------------
|                              |                                                     |  
|                              |                                                     |   | 2004                            
|                              |                                                     |   |                                 
|Net production:               |                                                     |   |                                 
|                              | Oil (Bbls)                                          |   | 195,166                         
|                              | Natural gas (Mcf)                                   |   | 169,002                         
|                              |                                                     |   |                                 
|Net sales:                    |                                                     |   |                                 
|                              | Oil                                                 | $ | 7,661,006                       
|                              | Natural gas                                         |   | 821,124                         
|                              |                                                     |   |                                 
|Average sales price:          |                                                     |   |                                 
|                              | Oil (per Bbl)                                       | $ | 39.25                           
|                              | Natural gas (per Mcf)                               |   | 4.86                            
|                              |                                                     |   |                                 
|Production costs and expenses |                                                     |   |                                 
|                              | Oil and gas production costs                        | $ | 1,975,835                       
|                              | Production taxes                                    |   | 629,703                         
|                              | Depreciation, depletion and    amortization expense |   | 1,011,602                       
|                              | Accretion expense                                   |   | 53,729                          
|                              | General and administrative    expenses              |   | 874,850                         

---



Year Ended December 31,
2006 Compared to Year Ended December 31, 2005

Oil
and natural gas sales. Oil and natural gas sales revenue increased approximately
$33.92 million to $59.76 million in 2006. Oil sales increased $30.20 million and natural
gas sales increased $3.72 million. The oil sales increase was caused by a sales volume
increase of 458,619 barrels in 2006, and a 13% increase in the average realized per barrel
oil price from $52.41 in 2005 to $59.26 in 2006. 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 591,380 Mcf in 2006 partially
offset by a 4% decrease in the average realized natural gas price per Mcf from $6.72 in
2005 to $6.46 in 2006. These per Mcf amounts are calculated by dividing revenue from gas
sales by the volume of gas sold, in Mcf. The volume increase for crude oil and natural gas
primarily resulted from development of our existing properties in 2006.

Oil
and gas production costs. Our aggregate oil and gas production costs increased from
$3,832,486 in 2005 to $6,453,831, although such expenses on a Boe basis declined from
$7.54 in 2005 to $6.06 in 2006. These per Boe amounts are calculated by dividing our total
production costs by our total volume sold, in Boe. This aggregate increase was the result
of the drilling of new wells in 2006 and cost increases. The decline on a per Boe basis is
attributable to an increase in volume as a result of our development and 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 7.51% during 2005 and decreased to 5.87% in 2006. 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 $5,118,595 to $7,900,099 in 2006. The increase was a result of an increase in
the average depreciation, depletion and amortization rate from $5.47 per Boe during 2005
to $7.41 per Boe during 2006. 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
$2,257,719 to $3,617,309 during 2006. This increase was primarily related to increases in
compensation expense associated with an increase in personnel required to administer our
growth and compensation expense related to the companys option plan as a result of
adoption of FASB 123(R).

Other
Financing expense. Other financing expense was $785,598 in 2006, compared to $597,773
in 2005. The increase is a result of the stock price being higher on the date of the
expense in 2006 than it was on the date of the expense in 2005.

Interest
expense. Interest expense decreased $104,791 to $124,833 in 2006. The decrease was due
to lower amounts of debt being outstanding during periods of the year in 2006 as well as
partial offset by interest income received on excess cash on hand during parts of the
year.

Income
tax expense. Our effective tax rate was 38% during 2006 and 37% during 2005.

Net
income. Net income increased from $9,460,683 for 2005 to $23,267,968 for 2006. The
primary reasons for this increase include higher crude oil prices between periods and an
increase in volumes sold, partially offset by lower natural gas prices between periods and
higher oil and gas production costs, oil and gas production taxes and general and
administrative expenses due to our growth.

---



Year Ended December 31,
2005 Compared to Year Ended December 31, 2004

Oil
and natural gas sales. Oil and natural gas sales revenue increased approximately
$17.36 million to $25.84 million in 2005. Oil sales increased $15.50 million and natural
gas sales increased $1.86 million. The oil sales increase was caused by a sales volume
increase of 246,829 barrels in 2005, and a 34% increase in the average realized per barrel
oil price from $39.25 in 2004 to $52.41 in 2005. 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 229,609 Mcf in 2005 and a 38%
increase in the average realized natural gas price per Mcf from $4.86 in 2004 to $6.72 in
2005. 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 acquisitions made in 2004 and development of our existing properties in
2005.

Oil
and gas production costs. Our aggregate oil and gas production costs increased from
$1,975,835 in 2004 to $3,832,486, although such expenses on a Boe basis declined from
$8.85 in 2004 to $7.54 in 2005. These per Boe amounts are calculated by dividing our total
production costs by our total volume sold, in Boe. This aggregate increase was the result
of having the properties acquired in 2004 in our operations for a full year in 2005, and
the drilling of new wells in 2005 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 7.42% during 2004 and increased to 7.51% in 2005. 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 $1,769,902 to $2,781,504 in 2005. The increase was a result of an increase in
the average depreciation, depletion and amortization rate from $4.53 per Boe during 2004
to $5.47 per Boe during 2005. 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 $490,740
to $1,365,590 during 2005. This increase was primarily related to increases in
compensation expense associated with an increase in personnel required to administer our
growth.

Other
Financing expense. Other financing expense was $597,773 in 2005, compared to $0 in
2004. The increase is a result of the offering that occurred in 2005.

Interest
expense. Interest expense increased $73,688 to $229,624 in 2005. The increase was due
to higher amounts of debt being outstanding during periods of the year in 2005.

Income
tax expense. Our effective tax rate was 37% during 2005 and 37% during 2004.

Net
income. Net income increased from $2,451,652 for 2004 to $9,460,683 for 2005. 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 and private equity offerings of our stock and warrants in 2005 and 2006 and our
secondary offering of common stock and warrants which we closed in August 2004.

Credit
Facility. On April 14, 2004, the Company established a credit facility with our
principal lenders. In April 2005, the Company entered into an agreement that increased its
credit facility to $50,000,000, with an increased borrowing base of $35,000,000. The
interest rate was a floating rate equal to the 30, 60 or 90 day LIBOR rate plus 2.25%, and
is payable monthly. Amounts borrowed under the revolving credit facility are due in May
2009. The revolving credit facility is secured by the Companys principal mineral
interests. The bank credit facility is subject to borrowing base availability, which is
redetermined semiannually based on the banks estimates of the future net cash flows
of our oil and natural gas properties. 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.

In April 2006, the Company entered
into a new credit agreement increasing the Companys credit facility to $150,000,000
with a $65,000,000 borrowing base. Additionally, this new agreement adjusted the interest
rate to be equal to the 30, 60 or 90 day LIBOR rate plus 2%, removed the requirement to
maintain a tangible net worth but added a requirement to a rolling four quarter basis of a
maximum leverage ratio of no more than 2.5-to-1. All other conditions of the credit
facility remained the same. At December 31, 2006, $19,300,000 was outstanding under this
credit facility, with an additional $527,500 reserved under the revolving credit facility
as collateral for standby letters of credit issued to various states.

Cash
Flows. Our primary sources of cash have been cash flows from operations and equity
offerings. During the three years ended December 31, 2006, we generated $73,929,685 from
operating activities, financed $66,728,119 through proceeds from the sale of stock and
warrants and exercise of warrants and options and financed a net $19,300,000 from our
outstanding credit facility. We primarily used this cash generation to fund our capital
expenditures and development aggregating $137,044,529 over the three years. At December 31,
2006, we had cash on hand of $4,919,984 and a working capital deficit of $321,525,
compared to December 31, 2005 when our cash was $4,317,114 and working capital of
$1,083,664.

We
continually evaluate our capital needs and compare them to our capital resources. Our
budgeted capital expenditures for 2007 are approximately $95,000,000 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
2007, 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. With the exception of the credit facility and notes to
officers, the Company had no future estimated principal and minimum debt and lease
payments for periods subsequent to December 31, 2006.

# Off-Balance Sheet
Financing Arrangements

As
of December 31, 2006 we had no off-balance sheet financing arrangements.

---



# New Accounting Policies

In July 2006,
the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxesan Interpretation of FASB Statement No. 109 (FIN 48).
FIN 48 changes the accounting for uncertainty in income taxes recognized in an
entitys financial statements in accordance with SFAS No. 109, Accounting
for Income Taxes, and prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. Additionally, FIN 48 provides guidance on subsequent
derecognition of tax positions, financial statement classification, recognition of
interest and penalties, accounting in interim periods, and disclosure and transition
requirements. FIN 48 is effective for the Companys fiscal year beginning
January 1, 2007, with early adoption permitted. The Company is in the process of
evaluating FIN 48 but does not believe that its implementation will have a material effect
on the Companys financial position or results of operation in any period.

In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (FAS 157). FAS 157 defines
fair value as used in numerous accounting pronouncements, establishes a framework for
measuring fair value in accordance with generally accepted accounting principles and
expands disclosure requirements related to the use of fair value measures in financial
statements. FAS 157 will be effective for our financial statements for the fiscal year
beginning January 1, 2008; however, earlier application is encouraged. We are
currently evaluating the timing of adoption and the impact that adoption might have on our
financial position or results of operations.

# 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 data;
|- |  | -------------------------------------------

| |  | the
interpretation of that data;
|- |  | --------------------------------

| |  | the
accuracy of various mandated economic assumptions; and
|- |  | ----------------------------------------------------------

| |  | the
judgments of the persons preparing the estimates.
|- |  | -----------------------------------------------------

Our
proved reserve information included in this Annual Report 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

As
in 2005, we did experience continued increases in costs during 2006 due to increased
demand for oil field products and services. 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 2006 as oil and
gas prices rose significantly. Costs for oilfield services and materials increased during
2006 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.

|Item 7A |  | 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 8: |  | Financial Statements and Supplementary Data
|------- |  | -------------------------------------------

The
financial statements and supplementary data required by this item are included at page 55.

|Item 9: |  | Changes in and Disagreements with Accountants And Accounting and Financial Disclosure
|------- |  | -------------------------------------------------------------------------------------

None.

|Item 9A: |  | Controls and Procedures
|-------- |  | -----------------------

Evaluation
of Disclosure Controls and Procedures.

We
maintain controls and procedures designed to ensure that information required to be
disclosed in the reports that we file or submit under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission. As of the end of the fiscal
year ended December 31, 2006, 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
in a timely manner that is required to be included in the reports we file or submit under
the Securities Exchange Act of 1934.

---



Managements
Annual Report on Internal Control Over Financial Reporting.

Our
management is responsible for establishing and maintaining adequate internal controls over
financial reporting. Our internal control system was designed to provide reasonable
assurance to our management and Board of Directors regarding the preparation and fair
presentation of published financial statements.

All
internal control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can provide only reasonable
assurance with respect to financial statement preparation and presentation.

In
making our assessment of internal control over financial reporting, our management used
the criteria issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control  Integrated Framework. Based on our
assessment, we believe that, as of December 31, 2006, our internal control over financial
reporting is effective based on those criteria.

Hansen,
Barnett & Maxwell, P.C., our independent registered public accounting firm, has issued
an attestation report on managements assessment of Arenas internal control
over financial reporting.

Date: March 29, 2007

| | /s/
Lloyd T. Rochford
                                                                       Chief Executive
Officer
| | --------------------------------------------------------------------------------------------------------------------

| | /s/
William R. Broaddrick
                                                                       Chief Financial
Officer
| | ------------------------------------------------------------------------------------------------------------------------

|HANSEN,
BARNETT & MAXWELL, P.C.                                                                                                                                                                                                                                                                                             |                                                                       
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------
|A Professional Corporation
            CERTIFIED PUBLIC ACCOUNTANTS
                         AND
                BUSINESS CONSULTANTS
              5 Triad Center, Suite 750
            Salt Lake City, UT 84180-1128
                Phone: (801) 532-2200
                 Fax: (801) 532-7944
         www.hbmcpas.com | Registered with the Public Company
         Accounting Oversight Board

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors and Stockholdersof Arena Resources, Inc.

We have audited managements
assessment, included in the accompanying Managements Annual Report on Internal
Control Over Financial Reporting,that Arena Resources, Inc. maintained effective
internal control over financial reporting as of December 31, 2006, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Arena
Resources, Inc.s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness of the companys
internal control over financial reporting based on our audit.

---



We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A companys internal control
over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements.

Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

In our opinion, managements
assessment that Arena Resources, Inc. maintained effective internal control over financial
reporting as of December 31, 2006 is fairly stated, in all material respects, based
on the COSO criteria. Also, in our opinion, Arena Resources, Inc. maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2006, based on the COSO criteria.

We have also audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Arena Resources, Inc. as of December 31, 2006 and
2005, and the related consolidated statements of operations, stockholders equity and
cash flows for each of the three years in the period ended December 31, 2006 of Arena
Resources, Inc. and our report dated March 29, 2007 expressed an unqualified opinion
thereon.

| | /s/ HANSEN,
BARNETT & MAXWELL, P.C.
| | -----------------------------------

Salt Lake City, UtahMarch 29, 2007

Changes
in Internal Control Over Financial Reporting

We made no change in our internal
control over financial reporting during our fourth quarter of 2006 that has materially
affected, or is reasonably likely to materially affect our internal control over financial
reporting.

|Item 9B: |  | Other Information
|-------- |  | -----------------

None

---



# PART III

|Item 10: |  | Directors, Executive Officers and Corporate Governance
|-------- |  | ------------------------------------------------------

# Executive Officers and
Directors

The
following table sets forth information regarding our executive officers, certain other
officers and directors as of December 31, 2006:

|Name                  | Age | Position                                                   
|--------------------- | --- | -----------------------------------------------------------
|Lloyd T. Rochford     | 60  | President and Chief Executive Officer and Director         
|Stanley M. McCabe     | 74  | Chairman of the Board of Directors, Secretary and Treasurer
|William R. Broaddrick | 29  | Vice President and Chief Financial Officer                 
|Charles M. Crawford   | 54  | Director                                                   
|Chris V. Kemendo, Jr. | 85  | Director                                                   
|Clayton E. Woodrum    | 66  | 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
2006.

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, 60, has been active as an individual consultant and entrepreneur in
          the oil and gas industry since 1973. In this capacity, he has primarily been
          engaged in the organization and funding of private oil and gas drilling and
          completion projects and ventures within the mid-continent region of the United
          States. In 1990 Mr. Rochford was co-founder, director and CEO of a public
          company known as Magnum Petroleum, Inc. (Magnum) which was listed on the New
          York Stock Exchange. Subsequently, Magnum acquired Hunter Resources, Inc. in
          August, 1995. Mr. Rochford served as Chairman of the Board of the combined
          companies from August, 1995 to June, 1997. From July, 1997 until he committed
to           participate in Arena Resources, Mr. Rochford had primarily devoted his time
and           efforts to individual oil and gas acquisition and development. In 1982, Mr.
          Rochford was co-founder of Dana Niguel Bank, a publicly held California bank
          operation and served as a director until 1994. Mr. Rochford attended various
          college level courses in business from 1967 to 1970 in California.

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

Mr.
         McCabe, 74, served from 1979 to 1989, as Chairman and CEO of Stanton Energy,
          Inc., a Tulsa, Oklahoma natural resource company specializing in contract
          drilling and operation of oil and gas wells. In 1990, Mr. McCabe also became a
          co-founder and subsequently an officer and director of Magnum Petroleum, Inc.,
          along with Mr. Rochford as previously discussed. Subsequently, Mr. McCabe
served           as a director of Magnum Hunter Resources, Inc., through December, 1996.
From           January, 1997, until he committed to participate in Arena Resources, Mr.
McCabe           had primarily devoted his time and efforts to individual oil and gas
acquisition           and development. Mr. McCabe attended college courses at the
University of           Maryland, primarily in business, in 1961 and 1962.

---



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

Mr.
         Broaddrick, 29, 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, 54, 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, passed away on January 5, 2007. From 1989 until his death, Mr. Kemendo
          acted as an independent financial business and accounting consultant to various
          clients. Mr. Kemendo had 57 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, 66, is a Certified Public Accountant and has, from 1984 to present,
          been a principal shareholder in the accounting firm of Woodrum, Kemendo, Tate
          & Cuite, P.L.L.C., and has been an owner of Computer Data Litigation
          Services, LLC and First Capital Management, LLC. Mr. Woodrum is currently the
          Chairman of our audit committee and compensation committee. From 1965 to 1975,
          Mr. Woodrum was employed by Peat, Marwick, Mitchell & Co., serving as
          partner in charge of the tax department during the final two years. From 1975
to           1980 he served as CFO for BancOklahoma Corp. and Bank of Oklahoma. From 1980
to           1984 Mr. Woodrum served as a partner in charge of the tax department at
Peat,           Marwick, Mitchell & Co. One of Mr. Woodrums partners at
Woodrum,           Kemendo, Tate & Cuite, P.L.L.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
2007 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.

# New Board and Officer
Appointments Subsequent to December 31, 2006.

On
January 5, 2007, Chris V. Kemendo, Jr., passed away after a brief illness. As discussed in
more detail below, as an independent director of the Company, Mr. Kemendo had
served as a member of our Audit Committee, Compensation Committee and Nominating and
Corporate Governance Committee.

Pursuant
to the authority granted to the Board of Directors by the Companys Bylaws, effective
January 9, 2007, the remaining directors unanimously appointed Mr. Anthony B. Petrelli to
fill the vacancy in the Board of Directors created by Mr. Kemendos death. Mr.
Petrelli is currently Senior Vice President of Neidiger Tucker Bruner, Inc., which firm
served as one of the lead underwriters in the Companys secondary registration of its
common stock in August of 2004.

On
February 1, the Board of Directors announced that Phillip Terry has been appointed to the
newly created office of President and Chief Operating Officer. Tim Rochford
has retained the position of Chief Executive Officer of the Company. Also, the
Board of Directors appointed William Parsons to the newly created position of Vice
President and Manager of Investor Relations.

Mr.
         Terry, 59, joined the Company in April 2003, and since that time he has been in
          charge of all engineering and field operations. Immediately prior to joining
the           Company, Mr. Terry owned and operated an independent petroleum engineering
          consulting firm. The Company was one of his clients. In 2001 and 2002, Mr.
Terry           was Vice President of Drilling and Production for Bird Creek Resources,
Inc. Mr.           Terry received his Bachelor of Science degree in Mechanical
Engineering from           Oklahoma State University in 1970, and is a registered
Professional Petroleum           Engineer with over 34 years experience in engineering,
production, drilling,           completions, reservoir engineering, property evaluations
and corporate           management in the oil and gas industry.

As
President and Chief Operating Officer, Mr. Terry is responsible for the day-to-day
management of the operational business and affairs of the Company. Mr. Terry reports
directly to Mr. Rochford who, as Chief Executive Officer, will continue to be responsible
for the overall supervision of the policy, direction and control of the Company.

Mr.
         Parsons, 58, has since 1992 served as President of K M Financial, Inc., a
          Scottsdale, Arizona based consulting, marketing and investment relations firm
          which specializes in providing these services to companies whose stock has
          recently become publicly-traded. The Company has been a client of K M
Financial,           Inc. since the Companys formation, and for this reason, Mr.
Parsons is           intimately familiar with all aspects of the Companys
operations, and also           has extensive experience in investor and market
communications associated with           the securities markets.

# Board Committees

Our
Board of Directors has established an Audit Committee, a Compensation Committee and a
Nominating and Corporate Governance Committee, the composition and responsibilities of
which are briefly described below.

---



The
Audit Committees principal functions are to assist the board in monitoring the
integrity of our financial statements, the independent auditors qualifications and
independence, the performance of our independent auditors and our compliance with legal
and regulatory requirements. The Audit Committee has the sole authority to retain and
terminate our independent auditors and to approve the compensation paid to our independent
auditors. The Audit Committee is also responsible for overseeing our internal audit
function. During 2006, the Audit Committee was comprised of our three independent
directors, Messrs. Kemendo, Woodrum and Crawford, with Mr. Woodrum acting as the chairman.
Our Board of Directors determined that both Messrs. Kemendo and Woodrum qualified as
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, Woodrum and Crawford further qualified
as independent in accordance with the applicable regulations adopted by the
SEC and Section 303A.02 of the New York Stock Exchange Corporate Governance Standards.
Upon the death of Mr. Kemendo in January 2007, the board appointed Mr. Petrelli to fill
the position left vacant on the Audit Committee. The Board of Directors has determined
that Mr. Petrelli qualifies as independent in accordance with the applicable
regulations adopted by the SEC and Section 303A.02 of the New York Stock Exchange
Corporate Governance Standards.

The
Compensation Committees principal function is to make recommendations regarding the
compensation of the Companys officers. In accordance with the rules of the New York
Stock Exchange (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. Compensation for all other officers
is also recommended to the Board for determination, by the Compensation Committee. During
2006, the Compensation Committee was comprised of our three independent directors, Messrs.
Kemendo, Woodrum and Crawford, with Mr. Woodrum acting as the chairman. Upon the death of
Mr. Kemendo in January 2007, the Board appointed Mr. Petrelli to fill the position left
vacant on the Compensation Committee.

The Nominating and Corporate Governance Committees principal functions are to
(a) identify and recommend qualified candidates to the board of directors for nomination
as members of the Board and its committees, and (b) develop and recommend to the Board
corporate governance principles applicable to the Company. During 2006, the committee was
comprised of Messrs. Kemendo, Woodrum and Crawford, our three independent directors, with
Mr. Woodrum acting as Chairman. Upon the death of Mr. Kemendo in January 2007, the Board
appointed Mr. Petrelli to fill the position left vacant on the Nominating and Corporate
Governance Committee.

There
has been no material changes to the procedures by which security holders may recommend
nominees to our board of directors.

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

# Code of Ethics

We
have adopted a code of ethics 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.

# 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.

---



|Item  11: |  | Executive Compensation
|--------- |  | ----------------------

# Compensation Discussion
& Analysis

This
section contains a discussion of the material elements of compensation awarded to, earned
by or paid to our principal executive and principal financial officers, and our other
three most highly compensated executive officers and employees. These individuals are
referred to as the (Named Officers) in this Annual Report on Form 10-K.

Our
current executive compensation programs are determined and approved by our Compensation
Committee, after consideration of recommendations by our Chairman of the Board and our
Chief Executive Officer, as to the other Named Officers. None of the Named Officers are
members of the Compensation Committee. The Compensation Committee has the direct
responsibility and authority to review and approve the Companys goals and objectives
relative to the compensation of the Named Officers, and to determine and approve (either
as a committee or with the other members of the Companys Board of Directors who
qualify as independent directors under applicable guidelines adopted by the
New York Stock Exchange) the compensation levels of the Named Officers.

Our
current executive compensation programs are intended to achieve two objectives. The
primary objective is to enhance the profitability of the Company, and thus shareholder
value. The second objective is to attract, motivate, reward and retain employees,
including executive personnel, who contribute to the long-term success of the Company. As
described in more detail below, the material elements of our current executive
compensation program for Named Officers include a base salary, discretionary annual
bonuses and discretionary stock options grants.

The
Company believes that each element of the executive compensation program helps to achieve
one or both of the compensation objectives outlined above. The table below lists each
material element of our executive compensation program and the compensation objective or
objectives that it is designed to achieve.

|Compensation Element                      | Compensation Objectives Attempted to be Achieved                                                                                                                                                                     
|----------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                          |                                                                                                                                                                                                                      
|Base Salary                               | Attract and retain qualified executive's
                                                       Motivate and reward executives performance                                                                           
|                                          |                                                                                                                                                                                                                      
|Bonus Compensation                        | Motivate and reward executive's performance
                                                       Enhance  profitability  of  Company  and  shareholder
                                                       value
|                                          |                                                                                                                                                                                                                      
|Equity-Based Compensation  stock options | Enhance profitability of Company and shareholder value
by aligning long-term incentives with shareholders long-term interests                                                                                       

As
illustrated by the table above base salary is primarily intended to attract and retain
qualified executives. This is the element of the Companys current executive
compensation program where the value of the benefit in any given year is not wholly
dependent on performance. Base salaries are intended to attract and retain qualified
executives as well as being linked to performance by rewarding and/or motivating
executives. Base salaries are reviewed annually and take into account: experience and
retention considerations; past performance; improvement in historical performance;
anticipated future potential performance; and other issues specific to the individual
executive.

---



There
are specific elements of the current executive compensation program that are designed to
reward performance and enhance profitability and shareholder value, and therefore the
value of these benefits is based on performance. The Companys discretionary annual
bonus plan is primarily intended to motivate and reward Named Officers performance
to achieve specific strategies and operating objectives, as well as improved financial
performance.

The
salaries and bonuses of Messrs. McCabe and Rochford have, at their insistence, been
historically lower than salaries and bonuses of comparable executives of peer companies.
With respect to other executive officers of the Company, the Compensation Committee, with
input from both Messrs. McCabe and Rochford, considers the salaries of comparable
executives of peer companies for which such information is publicly available. The
Compensation Committee believes that bonuses and equity compensation should fluctuate with
the Companys success in achieving financial, operating and strategic goals. The
Committees philosophy is that the Company should continue to use long-term
compensation such as stock options to align shareholder and executives interests and
should allocate a portion of long-term compensation to the entire executive compensation
package.

The
Company has never retained an outside consultant in establishing its compensation program
or in establishing any specific compensation for an executive officer.

# Current Executive
Compensation Program Elements

# Base Salaries

Similar
to most companies within the industry, our policy is to pay Named Officers base
salaries in cash. With the exception of the base salaries paid to Messrs. McCabe and
Rochford noted above, a significant portion of the executive compensation package is
through base salaries. Effective August 1, 2006, the Compensation Committee increased
salaries for Named Officers by an aggregate of $39,000 resulting in the following
individual base salaries for the Named Officers: Stanley McCabe  $36,000, Lloyd T.
Rochford  $36,000, William R. Broaddrick  $75,000, Phillip Terry 
$120,000 and H. D. Haston  $70,000. In approving these salary increases, the
Committee took into account factors including, peer group comparisons available to the
Committee, each executives individual experience and increased responsibilities and
improved performance for the Company.

# Annual Bonuses

In
the past, the Company has not had a formal policy regarding bonuses, and payment of
bonuses has been purely discretionary and is largely based on the recommendations of the
Chairman of the Board and the Chief Executive Officer (except as to themselves). In the
recent past, annual bonuses have been established as a percentage of each employees
base salary. The Compensation Committee may reduce or increase the size of the payout for
each individual Named Officer at their discretion. Cash bonuses were declared and paid out
in December of 2006 for two of the Named Officers. Cash bonuses are not a significant
portion of the executive compensation package. The annual discretionary bonus is reported
in the Bonus column of the Summary Compensation Table for each
Named Officer.

# Perquisites

The
Company currently provides a vehicle allowance for some of its employees, including two of
the Named Officers. Perquisites are reported in the All Other Compensation
column of the Summary Compensation Table for each Named Officer, if
applicable.

---



# Equity-Based Compensation

It
is our policy is that the Named Officers long-term compensation should be directly
linked to enhancing profitability and value provided to shareholders of the Companys
common stock. Accordingly, the Compensation Committee, (upon the recommendation of Messrs.
McCabe and Rochford, with respect to grants of options other than to themselves) grants
equity awards under the Companys stock option plan designed to link an increase in
shareholder value to compensation. All of the Named Officers equity-based
compensation opportunity for 2006 was awarded in the form of the Companys
non-qualified stock options. Stock option grants are valued using the Black-Scholes Model
in accordance with SFAS 123 (R) and are calculated as a part of the executive compensation
package for the year based on the amount of requisite service period served. Non-qualified
stock options for Named Officers and other key employees generally vest ratably over 5
years. The Compensation Committee believes that these awards encourage Named Officers to
continue to use their best professional skills and to retain Named Officers for longer
terms.

Grants
are determined for Named Officers based on his or her performance in the prior year, his
or her expected future contribution to the performance of the Company, and other
competitive data on grant values of peer companies. Awards may be granted to new key
employees or Named Officers on hire date. Other grant date determinations are made by the
Compensation Committee, which is based upon the date the Committee met and proper
communication was made to the Named Officer or key employee as defined in the definition
of grant date by SFAS 123 (R). Exercise prices are equal to the value of the
Companys stock on the close of business on the determined grant date. The Company
has no program or practice to coordinate timing of grants with release of material,
nonpublic information.

The
aggregate amount as determined under SFAS 123(R) recognized for purposes of our financial
statements for 2006 with respect to outstanding options granted to the Named Officers is
shown in the Summary Compensation Table below. The grant date fair value of
the option awarded to the Named Officers in 2006 as determined under SFAS 123 (R) for
purposes of our financial statements is shown in the Grants of Plan-Based
Awards table below. The Grants of Plan-Based Awards table below provides
additional detail regarding the options granted to Named Officers in 2006, including the
vesting and other terms that apply to the options.

# Compensation
Committees Report on Executive Compensation (1)

| | Among
the duties imposed on our Compensation Committee under its charter, is the direct
responsibility and authority to review and approve the Companys goals and objectives
relevant to the compensation of the Companys Chief Executive Officer and other
executive officers, to evaluate the performance of such officers in accordance with the
policies and principles established by the Compensation committee and to determine and
approve, either as a Committee, or (as directed by the Board) with the other
independent Board members (as defined by the New York Stock Exchange listing
standards), the compensation level of the Chief Executive Officer and the other executive
officers. During 2006 the Compensation Committee was composed of the three non-employee
Directors named at the end of this report each of whom is independent as
defined by the New York Stock Exchange listing standards.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Compensation Committee has reviewed and discussed with management the disclosures
contained in the Compensation Discussion and Analysis section of this Item 11. Based upon
this review and our discussions, the Arena Resources, Inc. Compensation Committee
recommended to its Board of Directors that the Compensation Discussion and Analysis
section be included in this annual report on Form 10-K.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



| | Compensation
Committee of the Board of Directors          Clayton E. Woodrum (Chair)          Charles
M. Crawford
| | -----------------------------------------------------------------------------------------------------------------

| | (1)              SEC filings sometimes incorporate information by reference. This
          means the Company is referring you to information that has previously been filed
          with the SEC, and that this information should be considered as part of the
          filing you are reading. Unless the Company specifically states otherwise, this
          Compensation Committee Report shall not be deemed to be incorporated by
          reference and shall not constitute soliciting material or otherwise be
          considered filed under the Securities Act of 1933 as amended, or the Securities
          Exchange act of 1934, as amended.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Compensation
Committees Interlocks and Insider Participation

The
Compensation Committee members whose names appear above were committee members during all
of 2006. The other member of the Compensation Committee during 2006, Mr. Chris V. Kemendo,
Jr. passed away on January 5, 2007, and was, therefore, unable to participate in the
preparation of the Compensation Committees Report on Executive Compensation. No
member of the Compensation Committee is or has been a former or current Named Officer of
the Company or had any relationships requiring disclosure by the Company under the
SECs rules requiring disclosure of certain relationships and related-party
transactions. None of our Named Officers identified herein served as a director or a
member of a compensation committee (or other committee serving an equivalent function) of
any other entity.

# Compensation of Named
Officers

The
Summary Compensation Table set forth below should be read in connection with
the tables and narrative descriptions that follow. The Grants of Plan-Based
Awards table, and the description of the material terms of the nonqualified options
granted in 2006 that follows it, provides information regarding the long-term equity
incentives awarded to Named Officers in 2006 that are also reported in the Summary
Compensation Table. The Outstanding Equity Awards at Fiscal Year End
Table and Option Exercises and Stock Vested Table provide further
information on the Named Officers potential realizable value and actual value
realized with respect to their equity awards.

The
Company does not have any pension plans, non-qualified deferred compensation plans or
severance, retirement, termination, constructive termination or change in control
arrangements for any of its Named Officers for the year ended December 31, 2006.

---



# Summary Compensation Table

|                                                                |  |      |  |            |         |           |  |                       |  |                                |         |           |  |        |  |  |        
|--------------------------------------------------------------- |  | ---- |  | ---------- | ------- | --------- |  | --------------------- |  | ------------------------------ | ------- | --------- |  | ------ |  |  | -------
|Name and Principal Position                                     |  | Year |  | Salary ($) |         | Bonus ($) |  | Option Awards (1) ($) |  | All Other Compensation (2) ($) |         | Total ($)
|                                                                |  |      |  |            |         |           |  |                       |  |                                |         |          
|Lloyd T. Rochford, Presidentand Chief Executive Officer         |  | 2006 |  |            | 36,000  |           |  | -                     |  |                                | -       |           |  | -      |  |  | 36,000 
|                                                                |  |      |  |            |         |           |  |                       |  |                                |        
|Stanley McCabe,Chairman of the Board                            |  | 2006 |  |            | 36,000  |           |  | -                     |  |                                | -       |           |  | -      |  |  | 36,000 
|                                                                |  |      |  |            |         |           |  |                       |  |                                |        
|William R. Broaddrick,Vice President and ChiefFinancial Officer |  | 2006 |  |            | 65,666  |           |  | -                     |  |                                | -       |           |  | -      |  |  | 65,666 
|                                                                |  |      |  |            |         |           |  |                       |  |                                |        
|Phillip W. Terry,Manager of Operations                          |  | 2006 |  |            | 106,583 |           |  | 12,000                |  |                                | -       |           |  | 12,000 |  |  | 130,583
|                                                                |  |      |  |            |         |           |  |                       |  |                                |        
|H. D. Haston,General Manager, Arena Drilling Company            |  | 2006 |  |            | 86,500  |           |  | 10,000                |  |                                | 876,618 |           |  | 20,400 |  |  | 993,518

(1)          See
discussion of assumptions made in valuing these awards in the notes to the
          companys financial statements.(2) All Other Compensation was cash
paid as           vehicle allowances.

The
Company awards stock incentives to key employees and the Named Officers either on the
initial date of employment or due to performance incentives throughout the year. The 2006
grants to Named Officers are reported in the table below.

|Grants of Plan-Based Awards
|---------------------------
|                           
|Name                       
|                           
|H. D. Haston               

(1)          See
discussion of assumptions made in valuing these awards in the notes to the
          companys financial statements

Named
Officers are not separately entitled to receive dividend equivalent rights with respect to
each stock option. Each nonqualified stock option award described in the Grants of
Plan-Based Awards Table above expires six-months following the fifth anniversary of
its associated grant date and vests in equal installments over the course of five years.

---



|Outstanding Equity Awards  
|---------------------------
|                           
|                           
|Name and Principal Position
|                           
|Lloyd T. Rochford          
|                           
|                           
|Stanley McCabe             
|                           
|                           
|William R. Broaddrick      
|                           
|Phillip W. Terry           
|                           
|H. D. Haston               

The
following table presents information regarding the exercise of stock options by Named
Officers during 2006.

|Option Exercises and Stock Vesting
|----------------------------------
|                                  
|                                  
|                                  
|Name                              
|William R. Broaddrick             
|Phillip W. Terry                  
|Raymond H. Estep                  
|Clayton E. Woodrum                
|Charles M. Crawford               
|Chris V. Kemendo, Jr.             

# Director Compensation

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

The
Company made a grant of options in 2003 to its directors, at which time Messrs. Kemendo,
Woodrum and Crawford received 50,000 non-qualified stock options each that vest ratably
over five years. The Company made a grant of options in 2005 to its directors at which
time Messrs. Woodrum and Crawford received an additional 12,500 options and Mr. Kemendo
received an additional 25,000 options.

|Director Compensation Table
|---------------------------
|                           
|                           
|Name                       
|                           
|Clayton E. Woodrum         
|Charles M. Crawford        
|Chris V. Kemendo, Jr.      

(1)          There
were 52,500 options outstanding to this Director at December 31, 2006.  

(2)
          There were 52,500 options outstanding to this Director at December 31, 2006.

(3)
          There were 65,000 options outstanding to this Director at December 31, 2006.

---



The following table sets forth
information concerning our executive stock option plan as of December 31, 2006.

|                                                           | Number of securitiesto be issued uponexercise of
outstanding options | Weighted-averageexercise price ofoutstanding options | Number of securities
                                        remaining available for
                                        future issuance undercompensation plans(excluding
securities incolumn (a))
|---------------------------------------------------------- | -------------------------------------------------------------------- | ---------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                           |                                                                      |                                                      |                                                                                                                                                                                                        
|                                                           | (a)                                                                  | (b)                                                  | (c)                                                                                                                                                                                                    
|                                                           |                                                                      |                                                      |                                                                                                                                                                                                        
|Equity compensation plans approved by security holders     | 1,305,000                                                            | 6.65                                                 | 1,025,000                                                                                                                                                                                              
|                                                           |                                                                      |                                                      |                                                                                                                                                                                                        
|Equity compensation plans not approved by security holders | -                                                                    | -                                                    | -                                                                                                                                                                                                      
|                                                           |                                                                      |                                                      |                                                                                                                                                                                                        
|Total                                                      | 1,305,000                                                            | 6.65                                                 | 1,025,000                                                                                                                                                                                              
|                                                           |                                                                      |                                                      |                                                                                                                                                                                                        

|Item 12: |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
|-------- |  | ----------------------------------------------------------------------------------------------

The
following table sets forth, as March 27, 2007, 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                    |  | 997,700 (1)                              
|Stanley M. McCabe                    |  | 798,000 (2)                              
|William R. Broaddrick                |  | 104,500 (3)                              
|Charles M. Crawford                  |  | 25,000 (4)                               
|Chris V. Kemendo, Jr.                |  | 40,100 (5)                               
|Clayton E. Woodrum                   |  | 35,000 (6)                               
|                                     |  |                                          
|All directors and executive officers |  | 2,000,300 (7)                            
|                                     |  |                                          

---



|(1) |  | Includes
125,000 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
125,000 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
15,000 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
25,000 shares issuable upon the exercise of stock options that are           currently
exercisable and 15,000 shares issuable upon the exercise of stock           options that
are exercisable within 60 days.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Includes
25,000 shares issuable upon the exercise of stock options that are           currently
exercisable and 10,000 shares issuable upon exercise of stock options           that are
exercisable within 60 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Includes
365,000 shares issuable upon the exercise of stock options that are           currently
exercisable and 135,,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 14,821,263 shares of
our common stock outstanding as of March 27, 2007.

|Item  13: |  | Certain Relationships and Related Transactions, and Director Independence
|--------- |  | -------------------------------------------------------------------------

In
July 2002, we borrowed $200,000 from each of Messrs. Rochford and McCabe, which debts are
evidenced by notes payable which mature on January 1, 2008. 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).

As
discussed under Item 10 of this Form 10-K, the Board of Directors has determined that in
2006 Messrs. Kemendo, Crawford and Woodrum were each independent directors
within the meaning of Section 303A.00 of the New York Stock Exchange Listed Company
Manual. None of our independent directors falls within any of the categories of persons
who would not be independent as described in Section 303A.00(b) of the New York Stock
Exchange rules. Because the Board of Directors believes it is not possible to anticipate
or provide for all circumstances that might give rise to conflicts of interest or that
might bear on the materiality of a relationship between a director and the Company, the
Board has not established specific objective criteria, apart from the criteria set forth
in the New York Stock Exchange rules, to determine independence. In addition
to such criteria, in making the determination of independence, the Board of
Directors considers such other matters including (i) the business and non-business
relationships that each independent director has or may have had with the Company and its
other Directors and executive officers, (ii) the stock ownership in the Company held by
each such Director, (iii) the existence of any familial relationships with any executive
officer or Director of the Company, and (iv) any other relevant factors which could cause
any such Director to not exercise his independent judgment.

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

The
firm of Hansen, Barnett & Maxwell, P.C., (HBM) has served as the
Companys independent auditors since 2000. The Audit Committee selected HBM as the
independent auditors of the Company for the fiscal year ending December 31, 2006, and the
Audit Committee has selected HBM to serve in the same capacity for the fiscal year ending
December 31, 2007. 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 $95,870 and $75,000 for professional
services rendered for the audit of the Companys financial statements for the years
ended December 31, 2006 and 2005, respectively, and its reviews of the Companys
financial statements included in its Form 10-Qs for the first three quarters of 2006
and, 2005.

Audit
Related Fees. HBM billed the Company $17,320 and $5,000 for the years ended December
31, 2006 and 2005, respectively, for its services in connection with the review of the
Companys registration statement on Form S-3, which was originally filed with the SEC
in 2005 and was amended in 2006.

Tax
Fees. HBM billed the Company an aggregate of $5,000 and $5,000 for professional
services rendered for tax compliance, tax advice and tax planning for the years ended
December 31, 2006 and 2005.

All
Other Fees.  No other fees were billed by HBM to the Company during 2006 and 2005.

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.

|Item 15: |  | Exhibits
|-------- |  | --------

|(a) |  | Financial
Statements     See Index to Financial Statements on page 50
|--- |  | ---------------------------------------------------------------------

|(b) |  | Exhibits
|--- |  | --------

|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)
|---- |  | -------------------------------------------------------------------------

|21 |  | Subsidiaries of the Registrant
|-- |  | ------------------------------

|23.1 |  | Consent
of Lee Keeling and Associates, Inc., Independent Petroleum Engineers
|---- |  | ----------------------------------------------------------------------------

|23.2 |  | Consent
of Hansen, Barnett & Maxwell, P.C., Independent
|---- |  | -------------------------------------------------------

|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.

---



# 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:  March 30, 2007  
| |                        
| | By:                    
| |                        
| |                        
| |                        
| | Date:    March 30, 2007
| |                        
| | By:                    
| |                        
| |                        
| |                        
| | Date:    March 30, 2007

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.

| | /s/  Lloyd T. Rochford 
| | -----------------------
| | Mr. Lloyd T. Rochford  
| | Director               
| |                        
| | Date: March 30, 2007   
| |                        
| | /s/  Stanley McCabe    
| | Mr. Stanley McCabe     
| | Director               
| |                        
| | Date:    March 30, 2007
| |                        
| | /s/  Charles Crawford  
| | Mr. Charles Crawford   
| | Director               
| |                        
| | Date:    March 30, 2007

---



| | /s/  Clayton E. Woodrum
| | -----------------------
| | Mr. Clayton E. Woodrum 
| | Director               
| |                        
| | Date: March 30, 2007   
| |                        
| | /s/ Anthony B. Petrelli
| | Mr. Anthony B. Petrelli
| | Director               
| |                        
| | Date: March 30, 2007   

---



# ARENA RESOURCES, INC.

# INDEX TO FINANCIAL
STATEMENTS

|                                                             | Page
|------------------------------------------------------------ | ----
|Report of Independent Registered Public Accounting Firm      | 56  
|Balance Sheets                                               | 57  
|Statements of Operations                                     | 58  
|Statements of Stockholders' Equity                           | 59  
|Statements of Cash Flows                                     | 60  
|Notes to Financial Statements                                | 62  
|Supplemental Information on Oil and Gas Producing Activities | 76  

---



|HANSEN,
BARNETT & MAXWELL, P.C.                                                                                                                                                                                                                                                                                             |                                                                       
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------
|A Professional Corporation
            CERTIFIED PUBLIC ACCOUNTANTS
                         AND
                BUSINESS CONSULTANTS
              5 Triad Center, Suite 750
            Salt Lake City, UT 84180-1128
                Phone: (801) 532-2200
                 Fax: (801) 532-7944
         www.hbmcpas.com | Registered with the Public Company
         Accounting Oversight Board

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Stockholdersof Arena Resources, Inc.

We have audited the accompanying
consolidated balance sheets of Arena Resources, Inc. and subsidiaries as of December 31,
2006 and 2005, and the related consolidated statements of operations, stockholders
equity, and cash flows for each of the three years in the period ended December 31, 2006.
These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We
believe our audits provide a reasonable basis for our opinion.

In our opinion, the financial
statements referred to above present fairly, in all material respects, the consolidated
financial position of Arena Resources, Inc. and subsidiaries as of December 31, 2006 and
2005, and the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 1 to the
consolidated financial statements, the Company adopted Statement of Financial Accounting
Standards No. 123R, Share-Based Payment, effective January 1, 2006.

We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of Arena Resources, Inc.s internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 29, 2007 expressed an unqualified opinion
thereon.

| | /s/ HANSEN,
BARNETT & MAXWELL, P.C.
| | -----------------------------------

Salt Lake City, UtahMarch 29, 2007

---



ARENA RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS

|December 31,                                                                                                                          | December 31,2006 |              |  | December 31,2005
|------------------------------------------------------------------------------------------------------------------------------------- | ---------------- | ------------ |  | ----------------
|                                                                                                                                     
|ASSETS                                                                                                                                |                  |              |  |                 
|Current Assets                                                                                                                        |                  |              |  |                 
|Cash                                                                                                                                  | $                | 4,919,984    |  | $               
|Accounts receivable                                                                                                                   |                  | 6,702,677    |  |                 
|Joint interest billing receivable                                                                                                     |                  | 2,949,099    |  |                 
|Prepaid expenses                                                                                                                      |                  | 102,585      |  |                 
|                                                                                                                                     
|Total Current Assets                                                                                                                  |                  | 14,674,345   |  |                 
|                                                                                                                                     
|Property and Equipment                                                                                                                |                  |              |  |                 
|Oil and gas properties subject to amortization, Using Full Cost Accounting                                                            |                  | 171,708,200  |  |                 
|Equipment                                                                                                                             |                  | 59,332       |  |                 
|Drilling rig                                                                                                                          |                  | 1,996,899    |  |                 
|Office equipment                                                                                                                      |                  | 120,929      |  |                 
|                                                                                                                                     
|Total Property and Equipment                                                                                                          |                  | 173,885,360  |  |                 
|Less:  Accumulated depreciation and amortization                                                                                      |                  | (12,246,727) |  |                 
|                                                                                                                                     
|Net Property and Equipment                                                                                                            |                  | 161,638,633  |  |                 
|                                                                                                                                     
|Total Assets                                                                                                                          | $                | 176,312,978  |  | $               
|                                                                                                                                     
|                                                                                                                                      |                  |              |  |                 
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                  |                  |              |  |                 
|Current Liabilities                                                                                                                   |                  |              |  |                 
|Accounts payable                                                                                                                      | $                | 14,367,252   |  | $               
|Income taxes payable                                                                                                                  |                  | -            |  |                 
|Accrued liabilities                                                                                                                   |                  | 628,618      |  |                 
|                                                                                                                                     
|Total Current Liabilities                                                                                                             |                  | 14,995,870   |  |                 
|                                                                                                                                     
|Long-Term Liabilities                                                                                                                 |                  |              |  |                 
|Notes payable                                                                                                                         |                  | 19,300,000   |  |                 
|Notes payable to related parties                                                                                                      |                  | 400,000      |  |                 
|Asset retirement liability                                                                                                            |                  | 2,250,332    |  |                 
|Deferred income taxes                                                                                                                 |                  | 19,322,724   |  |                 
|                                                                                                                                     
|Total Long-Term Liabilities                                                                                                           |                  | 41,273,056   |  |                 
|                                                                                                                                     
|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;    
14,668,787 shares and 13,099,702 shares outstanding, respectively |                  | 14,669       |  |                 
|Additional paid-in capital                                                                                                            |                  | 81,872,268   |  |                 
|Options and warrants outstanding                                                                                                      |                  | 2,872,988    |  |                 
|Deferred compensation                                                                                                                 |                  | -            |  |                 
|Retained earnings                                                                                                                     |                  | 35,284,127   |  |                 
|                                                                                                                                     
|Total Stockholders' Equity                                                                                                            |                  | 120,044,052  |  |                 
|                                                                                                                                     
|Total Liabilities and Stockholders' Equity                                                                                            | $                | 176,312,978  |  | $               
|                                                                                                                                     

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

---



ARENA RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

|For the years ended December 31,              |   | 2006         |  |   | 2005        |  |   | 2004       
|--------------------------------------------- | - | ------------ |  | - | ----------- |  | - | -----------
|                                             
|Oil and Gas Revenues                          | $ | 59,760,117   |  | $ | 25,843,077  |  | $ | 8,482,130  
|                                             
|Costs and Operating Expenses                  |   |              |  |   |             |  |   |            
|Oil and gas production costs                  |   | 6,453,831    |  |   | 3,832,486   |  |   | 1,975,835  
|Oil and gas production taxes                  |   | 3,506,347    |  |   | 1,939,739   |  |   | 629,703    
|Depreciation, depletion and amortization      |   | 7,900,099    |  |   | 2,781,504   |  |   | 1,011,602  
|Accretion expense                             |   | 127,132      |  |   | 102,585     |  |   | 53,729     
|General and administrative expense            |   | 3,617,309    |  |   | 1,365,590   |  |   | 874,850    
|                                             
|Total Costs and Operating Expenses            |   | 21,604,718   |  |   | 10,021,904  |  |   | 4,545,719  
|                                             
|Other Income (Expense)                        |   |              |  |   |             |  |   |            
|Gain from change in fair value of put options |   | -            |  |   | 95,033      |  |   | 68,251     
|Other financing expense                       |   | (785,598)    |  |   | (597,773)   |  |   | -          
|Interest (expense)                            |   | (124,833)    |  |   | (229,624)   |  |   | (155,936)  
|                                             
|Net Other Income (Expense)                    |   | (910,431)    |  |   | (732,364)   |  |   | (87,685)   
|                                             
|Income Before Provision for Income Taxes      |   | 37,244,968   |  |   | 15,088,809  |  |   | 3,848,726  
|                                              |   |              |  |   |             |  |   |            
|Provision for Income Taxes                    |   | (13,977,000) |  |   | (5,628,126) |  |   | (1,397,074)
|                                             
|Net Income                                    | $ | 23,267,968   |  | $ | 9,460,683   |  | $ | 2,451,652  
|                                             
|                                              |   |              |  |   |             |  |   |            
|Basic Net Income Per Common Share             | $ | 1.65         |  | $ | 0.85        |  | $ | 0.31       
|Diluted Net Income Per Common Share           |   | 1.55         |  |   | 0.75        |  |   | 0.28       
|                                             

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

---



ARENA RESOURCES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006

|                                                                                                                                                                                                | Common Stock |   |            |   |                |   |                     |   |                      |   |                 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | - | ---------- | - | -------------- | - | ------------------- | - | -------------------- | - | ----------------
|                                                                                                                                                                                                |              |   | Additional |   | Options and    |   |                     |   |                      |   | Total           
|                                                                                                                                                                                                | Shares       |   | Amount     |   | Paid-inCapital |   | WarrantsOutstanding |   | DeferredCompensation |   | RetainedEarnings
|                                                                                                                                                                                               
|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, net                                                                                                                                                                          | 1,667,500    |   | 1,668      |   | 6,469,225      |   | 1,781,791           |   | -                    |   | -               
|Issuance of common stock in propertyacquisitions, 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       
|Warrants exercised for cash, net                                                                                                                                                                | 2,971,273    |   | 2,971      |   | 20,194,042     |   | (2,322,392)         |   | -                    |   | -               
|Expiration of warrants                                                                                                                                                                          | -            |   | -          |   | 4,733          |   | (4,733)             |   | -                    |   | -               
|Issuance of common stock in                                                                                                                                                                     |              |   |            |   |                |   |                     |   |                      |   |                 
|property acquisition                                                                                                                                                                            | 25,000       |   | 25         |   | 340,625        |   | -                   |   | -                    |   | -               
|Issuance for cash, net                                                                                                                                                                          | 970,874      |   | 971        |   | 9,535,967      |   | -                   |   | -                    |   | -               
|Issuance of warrants for services relating to private offering                                                                                                                                  | -            |   | -          |   | -              |   | 597,773             |   | -                    |   | -               
|Cancellation of stock issued in
     property acquisition                                                                                                                                       | (355)        |   | -          |   | (2,485)        |   | -                   |   | -                    |   | -               
|Amortization of deferred compensation                                                                                                                                                           | -            |   | -          |   | -              |   | -                   |   | 118,732              |   | -               
|Net income                                                                                                                                                                                      | -            |   | -          |   | -              |   | -                   |   | -                    |   | 9,460,683       
|                                                                                                                                                                                               
|Balance December 31, 2005                                                                                                                                                                       | 13,099,702   |   | 13,100     |   | 45,331,234     |   | 1,483,807           |   | (115,545)            |   | 12,016,159      
|Issuance of common stock in
     property acquisition                                                                                                                                           | 131,000      |   | 131        |   | 3,752,755      |   | -                   |   | -                    |   | -               
|Issuance of common stock as part of
     drilling rig acquisition                                                                                                                               | 6,200        |   | 6          |   | 181,034        |   | -                   |   | -                    |   | -               
|Warrants exercised for cash, net                                                                                                                                                                | 50,000       |   | 50         |   | 165,850        |   | (15,900)            |   | -                    |   | -               
|Warrants exercised using cashless
     exercise provision                                                                                                                                       | 61,885       |   | 62         |   | 49,621         |   | (49,683)            |   | -                    |   | -               
|Option exercised for cash                                                                                                                                                                       | 170,000      |   | 170        |   | 752,230        |   | (112,400)           |   | -                    |   | -               
|Issuance for cash, net                                                                                                                                                                          | 1,150,000    |   | 1,150      |   | 29,787,729     |   | -                   |   | -                    |   | -               
|Tax impact of option exercises                                                                                                                                                                  | -            |   | -          |   | 1,851,815      |   | -                   |   | -                    |   | -               
|Issuance of warrants for services                                                                                                                           -
     relating to private offering | -            |   | -          |   | -              |   | 785,598             |   | -                    |   | -               
|Expense related to vesting stock
     based compensation                                                                                                                                        | -            |   | -          |   | -              |   | 897,111             |   | -                    |   | -               
|Elimination of deferred compensation                                                                                                                                                            | -            |   | -          |   | -              |   | (115,545)           |   | 115,545              |   | -               
|Net income                                                                                                                                                                                      | -            |   | -          |   | -              |   | -                   |   | -                    |   | 23,267,968      
|                                                                                                                                                                                               
|Balance December 31, 2006                                                                                                                                                                       | 14,668,787   | $ | 14,669     | $ | 81,872,268     | $ | 2,872,988           | $ | -                    | $ | 35,284,127      

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

---



ARENA RESOURCES, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS

|For the years ended December 31,                                                        |   | 2006         |  |   | 2005         |  |   | 2004        
|--------------------------------------------------------------------------------------- | - | ------------ |  | - | ------------ |  | - | ------------
|                                                                                       
|Cash Flows From Operating Activities                                                    |   |              |  |   |              |  |   |             
|Net income                                                                              | $ | 23,267,968   |  | $ | 9,460,683    |  | $ | 2,451,652   
|Adjustments to reconcile net income to net cash       provided by operating activities: |   |              |  |   |              |  |   |             
|Warrants issued for financing expense                                                   |   | 785,598      |  |   | 597,773      |  |   | -           
|Depreciation, depletion and amortization                                                |   | 7,900,099    |  |   | 2,781,504    |  |   | 1,011,602   
|Provision for income taxes                                                              |   | 13,977,000   |  |   | 5,628,126    |  |   | 1,397,074   
|Gain from change in fair value of put option                                            |   | -            |  |   | (95,033)     |  |   | (68,251)    
|Loss on sale of equipment                                                               |   | -            |  |   | -            |  |   | 5,586       
|Share based compensation                                                                |   | 897,111      |  |   | 118,732      |  |   | 204,525     
|Accretion of asset retirement obligation                                                |   | 127,132      |  |   | 102,585      |  |   | 83,730      
|Changes in assets and liabilities:                                                      |   |              |  |   |              |  |   |             
|Accounts and joint interest receivable                                                  |   | (6,330,466)  |  |   | (2,109,992)  |  |   | (656,864)   
|Other changes in deferred income taxes                                                  |   | (320,058)    |  |   | (82,521)     |  |   | -           
|Prepaid expenses                                                                        |   | (67,149)     |  |   | (2,300)      |  |   | (4,201)     
|Excess tax benefits from share-based payment           arrangements                     |   | (1,851,815)  |  |   | -            |  |   | -           
|Accounts payable and accrued liabilities                                                |   | 8,729,479    |  |   | 4,419,545    |  |   | 1,570,831   
|                                                                                       
|Net Cash Provided by Operating Activities                                               |   | 47,114,899   |  |   | 20,819,102   |  |   | 5,995,684   
|                                                                                       
|Cash Flows from Investing Activities                                                    |   |              |  |   |              |  |   |             
|Proceeds from sale of property and equipment                                            |   | -            |  |   | 735,000      |  |   | 10,500      
|Cash payments on purchase of East Hobbs                                                 |   | -            |  |   | -            |  |   | (1,028,000) 
|Cash payments on purchase of Fuhrman Mascho properties                                  |   | -            |  |   | -            |  |   | (711,802)   
|Purchase and development of oil and gas properties                                      |   | (97,576,774) |  |   | (34,665,614) |  |   | (4,802,141) 
|Maturity of long term investment                                                        |   | -            |  |   | -            |  |   | 25,234      
|Purchase of machinery and office equipment                                              |   | (672,130)    |  |   | (1,236,902)  |  |   | (41,423)    
|                                                                                       
|Net Cash Used in Investing Activities                                                   |   | (98,248,904) |  |   | (35,167,516) |  |   | (6,547,632) 
|                                                                                       
|Cash Flows From Financing Activities                                                    |   |              |  |   |              |  |   |             
|Proceeds from issuance of common stock and warrants,       net of offering costs        |   | 29,788,879   |  |   | 9,536,938    |  |   | 8,383,557   
|Proceeds from exercise of warrants, net of offering costs                               |   | 150,000      |  |   | 17,874,621   |  |   | 354,124     
|Proceeds from exercise of options                                                       |   | 640,000      |  |   | -            |  |   | -           
|Excess tax benefits from share-based payment arrangements                               |   | 1,851,815    |  |   | -            |  |   | -           
|Funds received and held for call options                                                |   | 1,272,093    |  |   | -            |  |   | -           
|Funds paid from funds held for call options                                             |   | (1,265,912)  |  |   | -            |  |   | -           
|Issuance of notes payable                                                               |   | 30,300,000   |  |   | -            |  |   | 2,000,000   
|Payment of notes payable                                                                |   | (11,000,000) |  |   | (10,000,000) |  |   | (10,008,440)
|                                                                                       
|Net Cash Provided by Financing Activities                                               |   | 51,736,875   |  |   | 17,411,559   |  |   | 729,241     
|                                                                                       
|Net Increase in Cash                                                                    |   | 602,870      |  |   | 3,063,145    |  |   | 177,293     
|                                                                                        |   |              |  |   |              |  |   |             
|Cash at Beginning of Period                                                             |   | 4,317,114    |  |   | 1,253,969    |  |   | 1,076,676   
|                                                                                       
|Cash at End of Period                                                                   | $ | 4,919,984    |  | $ | 4,317,114    |  | $ | 1,253,969   
|                                                                                       

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

---



ARENA RESOURCES, INC.
STATEMENTS OF CASH
FLOWS (CONTINUED)

|For the years ended December 31,                                                   |   | 2006      |  |   | 2005    |  |   | 2004       
|---------------------------------------------------------------------------------- | - | --------- |  | - | ------- |  | - | -----------
|                                                                                  
|Supplemental Cash Flow Information                                                 |   |           |  |   |         |  |   |            
|Cash paid for income taxes                                                         | $ | 329,986   |  | $ | 82,521  |  | $ | -          
|Cash paid for interest                                                             | $ | 240,815   |  | $ | 199,624 |  | $ | 158,950    
|                                                                                  
|Non-Cash Investing and Financing Activities                                        |   |           |  |   |         |  |   |            
|Common stock issued for properties                                                 | $ | 3,933,926 |  | $ | 340,650 |  | $ | 34,500     
|Asset retirement obligation incurred in property       acquisition and development |   | 607,853   |  |   | 144,769 |  |   | 570,029    
|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 CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1 
ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of
Operations Arena Resources, Inc.
(the Company) is a Nevada corporation that owns
interests in oil and gas properties located in Oklahoma, Texas, Kansas and New Mexico. The
Company is engaged primarily in the acquisition, exploration and development of oil and
gas properties and the production and sale of oil and gas. In 2006, the Company formed two
wholly owned subsidiaries, Arena Drilling Co. and ARD Production Company. Arena Drilling
Co. was formed to oversee the operation of the Companys drilling rig that began
operating in May 2006. ARD Production was formed to hold LZS Corporation, an acquisition
the Company made in November 2006. The accompanying statements of operations and cash
flows include the operations of the above subsidiaries from the date of
acquisition/formation.

Use of Estimates
 The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Changes in the
future estimated oil and natural gas reserves or the estimated future cash flows
attributable to the reserves that are utilized for impairment analysis could have a
significant impact on the future results of operations.

Fair Values of Financial
Instruments  The carrying amounts reported in the balance sheets for
accounts receivable, accounts payable, and accrued liabilities approximate fair value
because of the immediate or short-term maturity of these financial instruments. The
carrying amounts reported for notes payable and long-term debt approximate fair value
because the underlying instruments are at interest rates which approximate current market
rates.

Consolidation
 The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

Concentration of Credit Risk
and Accounts Receivable  Financial instruments that potentially
subject the Company to a concentration of credit risk consist principally of cash and
accounts receivable. The Company places its cash with a high credit quality financial
institution. Substantially all of the Companys accounts receivable is from
purchasers of oil and gas. Oil and gas sales are generally unsecured. The Company has not
had any significant credit losses in the past and believes its accounts receivable are
fully collectable. Accordingly, no allowance for doubtful accounts has been provided. The
Company also has a joint interest billing receivable. Joint interest billing receivables
are collateralized by the pro rata revenue attributable to the joint interest holders and
further by the interest itself.

Cash  The
Company considers all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.

Oil and Gas
Properties  The Company uses the full cost method of accounting for
oil and gas properties. Under this method, all costs associated with acquisition,
exploration, and development of oil and gas properties are capitalized. Costs capitalized
include acquisition costs, geological and geophysical expenditures, lease rentals on
undeveloped properties and costs of drilling and equipping productive and non-productive
wells. Drilling costs include directly related overhead costs. Capitalized costs are
categorized either as being subject to amortization or not subject to amortization.

The Company records a liability in
the period in which an asset retirement obligation (ARO) is incurred, in an
amount equal to the discounted estimated fair value of the obligation that is capitalized.
Thereafter this liability is accreted up to the final retirement cost. The Companys
AROs relate to future plugging and abandonment expenses of its oil and gas
properties and related facilities disposal.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

All capitalized costs of oil and gas
properties, including the estimated future costs to develop proved reserves and estimated
future costs to plug and abandon wells and costs of site restoration, 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.
Following is a table showing our total depletion and amortization and depletion per
barrel-of-oil-equivalent rate, by year for the years ended December 31, 2006, 2005 and
2004.

|                                                   | For the Years Ended December 31,
|-------------------------------------------------- | --------------------------------
|                                                   |                                 
|                                                   |                                 
|Depletion                                          | $                               
|Depletion rate, per barrel-of-oil-equivalent (BOE) | $                               

In addition, capitalized costs less
accumulated amortization and related deferred income taxes shall not exceed an amount (the
full cost ceiling) equal to the sum of:

1)          the
present value of estimated future net revenues 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; 2) plus the cost of properties not being amortized; 3) plus the
          lower of cost or estimated fair value of unproven properties included in the
          costs being amortized; 4) less income tax effects related to differences
between           the book and tax basis of the properties.

Support and Office
Equipment  Depreciation of support and office equipment is computed
using the straight-line method over the estimated useful lives of the assets which are
currently five to seven years. Depreciation expense was $25,864, $22,659 and $13,908 for
the years ended December 31, 2006, 2005 and 2004, respectively. Additionally, with the
completed acquisition of our drilling rig in 2006, we had depreciation on the rig of
$133,125 in 2006.

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. 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.

Income Taxes
 Provisions for income taxes are based on taxes payable or refundable for the
current year and deferred taxes. Deferred taxes are provided on differences between the
tax bases of assets and liabilities and their reported amounts in the financial
statements, and tax carry forwards. Deferred tax assets and liabilities are included in
the financial statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes.

Earnings Per Share Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the year. Diluted earnings per
share are calculated to give effect to potentially issuable dilutive common shares.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Major Customers
 During the year ended December 31, 2006, sales to one customer represented 82% of
total sales, respectively. At December 31, 2006, this customer made up 80% of accounts
receivable. During the year ended December 31, 2005, sales to two customers represented
72% and 12% of total sales, respectively. At December 31, 2005, these two customers made
up 77% and 8% of accounts receivable, respectively. 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. The loss of any of the foregoing customers would not have a material adverse
affect on the Company as there is an available market for its crude oil and natural gas
production from other purchasers.

Stock-Based Employee
Compensation  The Company has outstanding stock options
to directors and employees, which are described more fully in Note 8. Effective January 1,
2006, the Company adopted Statements of Financial Standards 123R, Share-Based
Payment (SFAS 123R), using the modified prospective method. SFAS 123R requires the
recognition of the cost of employee services received in exchange for an award of equity
instruments in the financial statements and is measured based on the grant date fair value
of the award. SFAS 123R also requires the stock option compensation expense to be
recognized over the period during which an employee is required to provide service in
exchange for the award (the vesting period). Prior to our adopting SFAS 123R, the Company
accounted for stock-based compensation plans under Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees (APB
25). Under APB 25, no compensation expense is recorded when the terms of the award
are fixed and the exercise price of the employee stock option equals or exceeds the fair
value of the underlying stock on the date of grant. The Company's net income decreased by
$552,323, or $0.04 per share, in 2006 due to the adoption of SFAS 123R.

Stock-based
employee compensation incurred for the years ended December 31, 2006, 2005 and 2004 was
$897,111, $118,732 and $204,525, respectively.

Prior to January 1, 2006, the Company
determined the value of stock-based compensation arrangements under the provisions of APB
Opinion No. 25 Accounting for Stock Issued to Employees and made pro forma
disclosures required under SFAS No. 123, Accounting for Stock-Based
Compensation. Had compensation expense for stock option grants been determined based
on the fair value at the grant dates consistent with the method prescribed in SFAS No. 123,
the Companys net income and net income per share would have been adjusted to the pro
forma amounts below for the years ended December 31, 2005 and 2004:

|For the Years Ended December 31,                                                                     |   | 2005      |  |   | 2004      |  |  | 
|---------------------------------------------------------------------------------------------------- | - | --------- |  | - | --------- |  |  | 
|                                                                                                    
|Net income, as reported                                                                              | $ | 9,460,683 |  | $ | 2,451,652 |  |  | 
|Add:   Stock based employee compensation expense
     included                                       |   |           |  |   |           |  |  | 
|in net income, net of related tax effects                                                            |   | 74,444    |  |   | 128,365   |  |  | 
|Deduct:  Total stock-based employee compensation expense                                             |   |           |  |   |           |  |  | 
|determined under the fair value based
     method for all         awards, net of related tax effects |   | (555,051) |  |   | (345,068) |  |  | 
|                                                                                                    
|Pro Forma Net Income                                                                                 | $ | 8,980,076 |  | $ | 2,234,949 |  |  | 
|                                                                                                    
|Income Per Common Share                                                                              |   |           |  |   |           |  |  | 
|Basic, as reported                                                                                   | $ | 0.85      |  | $ | 0.31      |  |  | 
|Basic, pro forma                                                                                     |   | 0.80      |  |   | 0.28      |  |  | 
|                                                                                                     |   |           |  |   |           |  |  | 
|Diluted, as reported                                                                                 | $ | 0.75      |  | $ | 0.28      |  |  | 
|Diluted, pro forma                                                                                   |   | 0.71      |  |   | 0.26      |  |  | 
|                                                                                                    

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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.

Recent Accounting
Pronouncements  In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of tax positions taken
or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure, and
transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, and
the Company is still evaluating the effects of adopting this standard, but does not expect
it to have a material effect on the Companys consolidated financial statements.

In September 2006, the FASB issued
SFAS No. 157, Fair Value Measurements (SFAS No. 157). This statement
establishes a framework for fair value measurements in financial statements by providing a
single definition of fair value. This standard provides guidance on the methods used to
estimate fair value and increases disclosures about estimate of fair value. SFAS No. 157
is effective for fiscal years beginning after November 15, 2007 and is generally applied
prospectively. The Company is currently evaluating the impact of this statement on its
consolidated financial statements.

In September 2006, the Securities
Exchange Commission issued Staff Accounting Bulletin No. 108
(SAB No. 108). SAB No. 108 addresses how the effects of
prior year uncorrected misstatements should be considered when quantifying misstatements
in current year financial statements. SAB No. 108 requires companies to quantify
misstatements using a balance sheet and income statement approach and to evaluate whether
either approach results in quantifying an error that is material in light of relevant
quantitative and qualitative factors. When the effect of initial adoption is material,
companies will record the effect as a cumulative effect adjustment to beginning of year
retained earnings and disclose the nature and amount of each individual error being
corrected in the cumulative adjustment. SAB No. 108 will be effective beginning
January 1, 2007 and it is anticipated that the initial adoption of
SAB No. 108 will not have a material impact on the Companys financial
statements.

# NOTE 2  EARNINGS
PER SHARE INFORMATION

|For the Years Ended December 31,                   |   | 2006       |  |   | 2005       |  |   | 2004     
|-------------------------------------------------- | - | ---------- |  | - | ---------- |  | - | ---------
|                                                  
|Net Income                                         | $ | 23,267,968 |  | $ | 9,460,683  |  | $ | 2,451,652
|                                                  
|Basic Weighted-Average Common Shares Outstanding   |   | 14,066,540 |  |   | 11,164,070 |  |   | 7,873,213
|Effect of dilutive securities                      |   |            |  |   |            |  |   |          
|Warrants                                           |   | 244,261    |  |   | 838,773    |  |   | 524,173  
|Stock options                                      |   | 713,953    |  |   | 597,263    |  |   | 296,792  
|                                                  
|Diluted Weighted-Average Common Shares Outstanding |   | 15,024,754 |  |   | 12,600,106 |  |   | 8,694,178
|                                                  
|Basic Income Per Common Share                      |   |            |  |   |            |  |   |          
|Net income                                         |   | 1.65       |  |   | 0.85       |  |   | 0.31     
|                                                   |   |            |  |   |            |  |   |          
|Diluted Income Per Common Share                    |   |            |  |   |            |  |   |          
|Net Income                                         |   | 1.55       |  |   | 0.75       |  |   | 0.28     
|                                                  

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 3 
ACQUISITION OF OIL AND GAS PROPERTIES

East Hobbs 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
40,000 shares of common stock valued at $239,750, or $5.99 per share.

Furhman-Mascho 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, the
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
149,658 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
149,658 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 149,658 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 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:

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|For the Year Ended December 31,                                   |             | 2004       |  |  | 
|----------------------------------------------------------------- | ----------- | ---------- |  |  | 
|                                                                 
|                                                                  | (Unaudited)
|Oil and Gas Revenues                                              | $           | 11,493,181 |  |  | 
|Income from Operations Before Cumulative Effect of Change in      |             |            |  |  | 
|Accounting Principle                                              |             | 2,833,800  |  |  | 
|Net Income                                                        |             | 2,833,800  |  |  | 
|                                                                 
|Basic Income Per Common Share                                     |             |            |  |  | 
|Income before cumulative effect of change in accounting principle | $           | 0.36       |  |  | 
|Net income                                                        |             | 0.36       |  |  | 
|Basic Income Per Common Share                                     |             |            |  |  | 
|Income before cumulative effect of change in accounting principle | $           | 0.33       |  |  | 
|Net income                                                        |             | 0.33       |  |  | 
|                                                                 

The full year of operations from both
of these properties was included in our operating statement for the years ended December,
31, 2006 and 2005.

Other Acquisitions
 During 2005, the Company acquired working interests in leases near
its Fuhrman Mascho properties acquired in 2004. The working interests acquired ranged from
20.2% to 100%, and the net revenue interest ranged from 16.1% to 79.2%. Total acquisition
costs, included 5,000 shares of restricted common stock valued at $15.81 per share, or
$79,050, and cash of $1,327,538. The pro forma impact of this acquisition was not material
to the Companys historical results of operations.

During 2005, the Company acquired the
lease rights to a total of 19,840 acres in Hamilton and Greeley Counties, Kansas. Total
acquisition cost was $574,546, which included 20,000 shares of restricted common stock
valued at $13.08 per share, or $261,600, and cash of $312,946. Subsequent to the
acquisition of these leases, the Company sold a partial working interest in four wells the
Company drilled and a right of first refusal on wells drilled offsetting those wells.
Total funds received for these working interests were $735,000. These funds received were
accounted for as an offset to capitalized costs. In February 2006, the Company issued
120,800 shares of the Companys stock, valued at $3,326,832, or $27.54 per share, to
re-acquire the interests sold.

During 2006, the Company acquired
working interests in leases near its Fuhrman Mascho properties acquired in 2004. The
working interests acquired ranged from 72.5% to 100%, and the net revenue interests ranged
from 55% to 80%. As a part of these acquisitions, the Company acquired the entire LZS
Corporation. Total acquisition costs of $6,293,368, included 10,200 shares of restricted
common stock valued at $41.77 per share, or $426,054 and cash of $5,867,314.

During 2006, the Company acquired
15,573 acres of lease rights at a total cost of $543,350 in various locations.

# NOTE 4  OIL AND
GAS PRODUCING ACTIVITIES

Set forth below is certain
information regarding the aggregate capitalized costs of oil and gas properties and costs
incurred by the Company for its oil and gas property acquisitions, development and
exploration activities:

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# Capitalized Costs
Relating to Oil and Gas Producing Activities

|December 31,                                              |   | 2006         |  |   | 2005        |  |   | 2004       
|--------------------------------------------------------- | - | ------------ |  | - | ----------- |  | - | -----------
|                                                         
|Unproved oil and gas properties                           | $ | 5,099,974    |  | $ | 692,783     |  | $ | 388,581    
|Proved oil and gas properties                             |   | 166,608,226  |  |   | 69,077,903  |  |   | 34,068,557 
|Drilling advances on uncompleted projects                 |   | -            |  |   | -           |  |   | 900,000    
|Acquisition of drilling rig                               |   | 1,996,899    |  |   | 1,191,126   |  |   | -          
|Support and office equipment                              |   | 180,261      |  |   | 132,863     |  |   | 87,087     
|                                                         
|Total capitalized costs                                   |   | 173,885,360  |  |   | 71,094,675  |  |   | 35,444,225 
|Less accumulated depletion, depreciation and amortization |   | (12,246,727) |  |   | (4,346,628) |  |   | (1,565,124)
|                                                         
|Net Capitalized Costs                                     | $ | 161,638,633  |  | $ | 66,748,047  |  | $ | 33,879,101 
|                                                         

# Costs Incurred in Oil
and Gas Producing Activities

|For the Years Ended December 31,                                          |   | 2006        |  |   | 2005       |  |   | 2004      
|------------------------------------------------------------------------- | - | ----------- |  | - | ---------- |  | - | ----------
|                                                                         
|Acquisition of proved properties                                          |   | 7,122,176   |  |   | 1,406,588  |  |   | 21,706,166
|Acquisition of unproved properties (net of proceeds   from property sale) |   | 3,282,635   |  |   | (160,454)  |  |   | 43,082    
|Exploration costs                                                         |   | 1,124,556   |  |   | 464,656    |  |   | 216,805   
|Development costs                                                         |   | 89,797,285  |  |   | 32,557,989 |  |   | 4,027,754 
|                                                                         
|Total Costs Incurred                                                      | $ | 101,326,652 |  | $ | 34,268,779 |  | $ | 25,993,807
|                                                                         

# NOTE 5  NOTES
PAYABLE AND PUT OPTION

Notes Payable On April 14, 2004, the Company established a
credit facility with its principal lenders.  In April 2005, the Company entered into an agreement that
increased its credit facility to $50,000,000, with an increased borrowing base of $35,000,000.  The
interest rate was a floating rate equal to the 30, 60 or 90 day LIBOR rate plus 2.25%, and is payable
monthly.  Amounts borrowed under the revolving credit facility are due in May 2009.  The revolving
credit facility is secured by the Companys principal mineral interests.  The bank credit facility is
subject to borrowing base availability, which is redetermined semiannually based on the banks estimates
of the future net cash flows of our oil and natural gas properties.  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, with current assets
including unused amounts under the note payable.

In April 2006, the Company entered
into a new credit agreement increasing the Companys credit facility to $150,000,000
with a $65,000,000 borrowing base. Additionally, this new agreement adjusted the interest
rate to be equal to the 30, 60 or 90 day LIBOR rate plus 2%, removed the requirement to
maintain a tangible net worth but added a requirement to a rolling four quarter basis of a
maximum leverage ratio of no more than 2.5-to-1. All other conditions of the credit
facility remained the same. At December 31, 2006, $19,300,000 was outstanding under this
credit facility, with an additional $527,500 reserved under the revolving credit facility
as collateral for standby letters of credit issued to various states.

We were in compliance with all
covenants required by our credit facility as of December 31, 2006.

Notes Payable to Related Parties
In 2002, the Board of Directors authorized the Company to borrow up
to $500,000 from its officers. During 2002, the Company borrowed $400,000 from two of its
officers. The related notes payable bear interest at 10% per annum. The notes are secured
by all mineral interests, rights and equipment of the Company but have been subordinated
to the bank revolving credit facility mentioned above. The Board of Directors and the
officers agreed to extend the notes to January 1, 2008, 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 December 31, 2006 and 2005.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Put Option 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 sellers had
the right until December 1, 2006, to require the Company to repurchase the 149,658 common
shares at $7.00 per share. The put option is a derivative and as such, the liability was
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. This put option expired
unexercised in December 2006.

# NOTE 6  ASSET
RETIREMENT OBLIGATION

A reconciliation of the asset
retirement obligation for the years ended December 31, 2004, 2005 and 2006 is as follows:

|                           | 
|-------------------------- | 
|Balance, January 1, 2004   | 
|Liabilities incurred       | 
|Accretion expense          | 
|                          
|Balance, December 31, 2004 | 
|                          
|Liabilities incurred       | 
|Accretion expense          | 
|                          
|Balance, December 31, 2005 | 
|                          
|Liabilities incurred       | 
|Accretion expense          | 
|                          
|Balance, December 31, 2006 | 
|                          

# 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 Issued in
Offerings  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 totaling $1,919,066. 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 warrants 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. Net proceeds from
the offering totaled $8,252,684. These proceeds were allocated as follows: $6,470,893 were
allocated to the common stock issued to investors, $1,781,791 were allocated to the
warrants. The warrants had a fair value of $2,803,473 or $1.43 per share, which was
determined by the Black-Scholes option pricing model using the following assumptions:
volatility of 33.3%, risk-free interest rate of 3.2%, dividend yield of 0% and life of 4.0
years.

In July 2005, the Company issued
970,874 shares of common stock, valued at $10,000,000, or $10.30 per share, in a private
placement. As of December 31, 2005, the Company had paid $463,062 in related offering
costs. As a part of the negotiation process related to the terms of the private placement,
the Company also assigned to certain of the investors call options to purchase 149,658
shares of its common stock at $8.50 per share. The call options were granted in connection
with the issuance of shares of the Companys common stock, as partial consideration
for its purchase of interests in the Furhman-Mascho lease. The call terms in the option
agreements provide the Company with the right to repurchase the shares issued in the
Furhman-Mascho transaction at a price of $8.50 per share, at any time prior to November 1,
2006. The option agreements further provide the stockholders who received shares in that
transaction the right to require the Company to repurchase its stock from them at a price
of $7.00 per share (the public trading price of the common stock at the time of the
Furhman-Mascho transaction) for a period of thirty days following November 1, 2006.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

The proceeds from the offering have
been allocated to the common stock issued and the call options transferred based on their
relative fair values and resulted in allocating $9,033,291 to the 970,874 shares of common
stock and $503,647 to the 149,658 call options. The market value of the common stock on
July 11, 2005 was $12.02 per share. The fair value of the call options was $4.35 per share
determined by the Black-Scholes option pricing model using the following assumptions:
volatility of 38.3%, risk-free interest rate of 3.6%, dividend yield of 0% and life of 1.0
years.

In May 2006, the Company issued
1,150,000 shares of common stock in a private placement for $32,246,000. The Company paid
$2,457,121 in offering costs and underwriters fees resulting in net proceeds from
the offering of $29,788,879. As part of the agreement, the Company agreed to register
these shares which was completed in July 2006.

Common Stock Issued from
Warrant Exercises  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.

During the year ended December 31,
2005, warrant holders exercised 187,800 warrants with an exercise price of $1.75 per
share, 1,117,123 warrants with an exercise price of $5.00 per share, 1,665,350 warrants
with an exercise price of $7.32 per share and 1,000 warrants with an exercise price of
$9.00 per share for $18,113,627. The Company paid $239,006 in costs related to the call of
a portion of those warrants.

During the year ended December 31,
2006, the Company issued 50,000 shares of common stock upon the exercise of warrants for
proceeds of $150,000, or $3.00 per share. Additionally, during the year ended December 31,
2006, the Company issued 61,885 shares of common stock in a cashless exercise of 75,462
warrants with an exercise price of $9.00 per share and 3,461 warrants with an exercise
price of $7.49 per share.

Other Issuances of Common Stock In February 2006, the Company issued 6,200 shares of restricted
common stock, valued at $181,040, or $29.20 per share, as part of the cost of a drilling
rig that the Company acquired, which was placed in service in April 2006.

Additionally, during the year ended
December 31, 2006, the Company issued 170,000 shares of common stock upon the exercise of
options for proceeds of $640,000, or an average of $3.76 per share. As a result of these
exercises, the Company will realize an additional tax benefit in the amount of $1,851,815,
which was recorded against additional paid-in capital.

Warrants Issued
 In connection with the July 2005 private placement, the Company committed to use
its best efforts to register the shares with the SEC. The Company was unable to affect the
registration within the allotted time and was required to issue 29,126 warrants on
December 28, 2005. The exercise price of these warrants is $10.30 and the warrants expire
December 28, 2010. The Company recognized an expense for the fair value of these warrants
of $597,773 from the issuance of these warrants. The fair value of the warrants was
determined using the Black-Scholes option pricing model with the following assumptions:
4.32% risk-free interest rate; 43.44% expected volatility; five year expected life and 0%
dividend yield.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

The Company continued to be unable to
affect the registration within a month from the end of the original allotted time and was
required to issue an additional 29,126 warrants in January 2006. The exercise price of
these warrants is $10.30 and the warrants expire in January 2011. The Company recognized
an expense equal to the fair value of these warrants of $785,598 as a result of this
issuance. The fair value of the warrants was determined using the Black-Scholes option
pricing model with the following assumptions: 4.44% risk-free interest rate; 43.42%
expected volatility; five year expected life and 0% dividend yield.

Stock purchase warrants issued and
exercised during the years ended December 31, 2006, 2005 and 2004 are summarized as
follows:

|                                     | 2006      |                                 | 2005 |             | 2004                           
|------------------------------------ | --------- | ------------------------------- | ---- | ----------- | -------------------------------
|                                     |           |                                 |      |             |                                
|                                     | Warrants  | Weighted-Average Exercise Price |      | Warrants    | Weighted-Average Exercise Price
|                                    
|Outstanding at beginning of the year | 368,126   | $  7.69                         |      | 3,314,923   | $  4.47                        
|Issued                               | 29,126    | $10.30                          |      | 29,126      | $10.30                         
|Expired                              | -         | $        -                      |      | (4,650)     | $  4.33                        
|Exercised                            | (128,923) | $  6.63                         |      | (2,971,273) | $  6.10                        
|                                    
|Outstanding at end of year           | 268,329   | $  8.49                         |      | 368,126     | $  7.69                        
|                                    

Stock purchase warrants outstanding
at December 31, 2006 are as follows:

|WarrantsOutstanding | Exercise Price | Weighted-AverageRemainingContractual Life
|------------------- | -------------- | -----------------------------------------
|                    |                |                                          
|141,539             | $  7.49        | 1.6                                      
|68,538              | 9.00           | 1.6                                      
|58,252              | 10.30          | 4.0                                      
|                   
|268,329             |                |                                          
|                   

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 149,658 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. This call option was assigned to certain of the investors involved in the
Companys private placement offering during 2005.

# NOTE 8  EMPLOYEE
STOCK OPTIONS

In March 2003, our board of directors
adopted a non-qualified 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 meetings in 2004, 2005 and 2006. The amendments effectively increased the
number of shares available under the plan to 2,500,000. There are 1,025,000 options still
available for grant at December 31, 2006.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

In January 2005 and October 2005, the
Company granted nonqualified stock options to directors and employees to purchase 375,000
shares and 50,000 shares of common stock at $8.30 and $20.85, respectively.

In April 2006, the Company issued
50,000 options with an original exercise price of $34.43 per share under the
Companys stock option plan. In June 2006, the Company amended these options to have
an exercise price of $27.40. The original fair value of the options was $778,357,
calculated using the Black-Scholes option-pricing model with the following weighted
average assumptions: dividend yield of 0%, expected volatility of 43.62%, risk-free
interest rate of 4.92%, and expected lives of 5 years. As a result of the amendment the
fair value increased by $98,260, calculated using the Black-Scholes option-pricing model
with the following weighted average assumptions: dividend yield of 0%, expected volatility
of 44.27%, risk-free interest rate of 5.03%, and expected lives of 5 years.

All granted options vest at the rate
of 20% each year over five years beginning one year from the date granted. A summary of
the status of the stock options as of December 31, 2006 and changes during the years ended
December 31, 2006, 2005 and 2004 is as follows:

|                                                               | 2006      | 2005 | 2004                           
|-------------------------------------------------------------- | --------- | ---- | -------------------------------
|                                                               |           |      |                                
|                                                               | Options   |      | Weighted-Average Exercise Price
|                                                              
|Outstanding at beginning of the year                           | 1,425,000 |      | $  5.55                        
|Issued                                                         | 50,000    |      | 27.40                          
|Exercised                                                      | (170,000) |      | 3.76                           
|                                                              
|Outstanding at end of year                                     | 1,305,000 |      | 6.62                           
|                                                              
|Exercisable at end of  year                                    | 515,000   |      | $  4.75                        
|                                                              
|Weighted average fair value of options granted during the year |           |      | $17.53                         
|                                                              

The following are the
weighted-average assumptions used for options granted during the years ended December 31,
2006 and 2005, with no options issued in 2004:

|                        |  | 2006    |  |  | 2005    |  |  | 
|----------------------- |  | ------- |  |  | ------- |  |  | 
|                        |  |         |  |  |        
|Risk free interest rate |  | 4.92%   |  |  | 3.73%   |  |  | 
|Expected life           |  | 5 Years |  |  | 5 Years |  |  | 
|Dividend yield          |  | -       |  |  | -       |  |  | 
|Volatility              |  | 44%     |  |  | 32%     |  |  | 

The expected life of stock options
represents the period of time that the stock options granted are expected to be
outstanding based on historical exercise trends. The expected volatility is based on the
historical price volatility of our common stock. The risk-free interest rate represents
the U.S. Treasury bill rate for the expected life of the related stock options. The
dividend yield represents our anticipated cash dividend over the expected life of the
stock options.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

As  of December 31, 2006, there was  approximately
$1,205,536 of  unrecognized  compensation  cost related to stock  options that will be  recognized  over a
weighted  average  period of 2.44 years.  The  aggregate  intrinsic  value of options  expected to vest at
December 31, 2006 was $47,096,550.  The aggregate  intrinsic value of options  exercisable at December 31,
2006 was  $19,551,650.  The year end  intrinsic  value is based on a December  31, 2006  closing  price of
$42.71.  The 170,000 options exercised during 2006 had an intrinsic value of $5,075,600.

The following table summarizes
information related to the Company's stock options outstanding at December 31, 2006:

|               |           |                    | Options Outstanding |                                                        |        
|-------------- | --------- | ------------------ | ------------------- | ------------------------------------------------------ | -------
|               |           |                    |                     |                                                        |        
|Exercise price |           | Number Outstanding |                     | Weighted-Average Remaining Contractual Life (in years) |        
|              
|$              | 3.70      |                    | 790,000             |                                                        | 1.8    
|$              | 4.80      |                    | 40,000              |                                                        | 2.2    
|$              | 8.30      |                    | 375,000             |                                                        | 3.5    
|$              | 20.85     |                    | 50,000              |                                                        | 4.3    
|$              | 27.40     |                    | 50,000              |                                                        | 5.0    
|              
|               | 1,305,000 |                    | 2.5                 |                                                        | 515,000
|              

# 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

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 $527,500 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

At    December   31,   2006,   the   Company   had
alternative  minimum  income tax of $304,000,  but had made  sufficient  estimated  tax payments as to not
have a year end taxes payable.  The provision for income taxes consisted of the following:

|Provision for income taxes |  | 2006       |  |  | 2005      |  |  | 2004     
|-------------------------- |  | ---------- |  |  | --------- |  |  | ---------
|                           | 
|Current                    |  | 304,000    |  |  | 365,606   |  |  | -        
|Deferred                   |  | 13,673,000 |  |  | 5,262,520 |  |  | 1,397,074
|                           | 
|                           |  | 13,977,000 |  |  | 5,628,126 |  |  | 1,397,074
|                           | 

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

|Rate Reconciliation                          |  | 2006       |  |  | 2005      |  |  | 2004     
|-------------------------------------------- |  | ---------- |  |  | --------- |  |  | ---------
|                                             | 
|Tax at federal statutory rate (34%)          |  | 12,663,000 |  |  | 5,130,195 |  |  | 1,308,567
|Non-deductible expenses (non-taxable income) |  | 27,000     |  |  | -         |  |  | (24,493) 
|State tax, net of federal benefit            |  | 1,229,000  |  |  | 497,931   |  |  | 127,008  
|Other                                        |  | 58,000     |  |  | -         |  |  | (14,008) 
|                                             | 
|                                             |  | 13,977,000 |  |  | 5,628,126 |  |  | 1,397,074
|                                             | 

As of December 31, 2006, the Company
had net operating loss and IDC carry forwards for federal income tax reporting purposes of
$46,342,000 which, if unused, will expire in 2022, 2025 and 2026. The Company is subject
to Alternative Minimum Tax (AMT) as a result of the deferred income that
results from the regular tax treatment of intangible drilling costs. The AMT liability
creates a deferred tax asset that can be used to offset any future tax liability from
regular Federal income tax. The $346,744 minimum tax credit has an unlimited carryover
period.

The net deferred tax liability
consisted of the following:

|Deferred taxes:                      |  | 2006       |  |  | 2005       |  |  | 2004     
|------------------------------------ |  | ---------- |  |  | ---------- |  |  | ---------
|                                     | 
|Deferred tax liabilities             |  |            |  |  |            |  |  |          
|Property and equipment               |  | 37,448,700 |  |  | 11,102,307 |  |  | 2,163,239
|                                     | 
|Total deferred tax liabilities       |  | 37,448,700 |  |  | 11,102,307 |  |  | 2,163,239
|                                     | 
|Deferred tax assets                  |  |            |  |  |            |  |  |          
|Stock-based compensation             |  | 493,775    |  |  | 203,078    |  |  | 158,003  
|Minimum tax credit                   |  | 346,744    |  |  | 401,109    |  |  | -        
|Operating loss and IDC carryforwards |  | 17,285,457 |  |  | 3,310,511  |  |  | 33,246   
|                                     | 
|Total deferred tax assets            |  | 18,125,976 |  |  | 3,914,698  |  |  | 191,249  
|                                     | 
|Net deferred income taxes            |  | 19,322,724 |  |  | 7,187,609  |  |  | 1,971,990
|                                     | 

# NOTE 12 
SUBSEQUENT EVENTS (UNAUDITED)

Subsequent to December 31, 2006, the
Company issued 125,000 shares of common stock from the exercise of 125,000 options with an
exercise price of $3.70 per share, resulting in proceeds to the Company of $462,500.

Subsequent to December 31, 2006, the
Company accelerated the vesting of 10,000 options. These shares would have vested on April
1, 2007. The Company will recognize the remaining fair value of $1,145 as an expense in
the first quarter of 2007.

Subsequent to December 31, 2006, the
Company issued 350,000 nonqualified options to officers and directors of the Company. Of
the options issued, 50,000 have an exercise price of $37.35 and the remaining 300,000 have
an exercise price of $38.46.

Subsequent to December 31, 2006, the
Company issued 27,476 shares of common stock from the exercise of 27,476 warrants, 10,000
of which had an exercise price of $9.00 per share and 17,476 with an exercise price of
$10.30 per share, resulting in proceeds to the Company of $270,003.

---



# ARENA RESOURCES, INC. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Subsequent to December 31, 2006, the
Company has borrowed an additional $16,200,000 on its credit facility described in Note 5.

Subsequent to December 31, 2006, the
Company purchased a two story building, and an adjoining parcel of real estate, in Tulsa,
Oklahoma to serve as our executive offices, for a cash payment of $1,900,000.

# NOTE 13  QUARTERLY
FINANCIAL DATA (UNAUDITED)

Quarterly
financial information is presented in the following summary:

|                             | 2004              
|---------------------------- | ------------------
|                             |                   
|                             | Three Months Ended
|                             |                   
|                             |                   
|                             |                   
|Revenues                     | $                 
|Operating Income             |                   
|Net Income                   |                   
|Basic Net Income Per Share   | $                 
|Diluted Net Income Per Share |                   

|                             | 2005              
|---------------------------- | ------------------
|                             |                   
|                             | Three Months Ended
|                             |                   
|                             |                   
|                             |                   
|Revenues                     | $                 
|Operating Income             |                   
|Net Income                   |                   
|Basic Net Income Per Share   | $                 
|Diluted Net Income Per Share |                   

|                             | 2006              
|---------------------------- | ------------------
|                             |                   
|                             | Three Months Ended
|                             |                   
|                             |                   
|                             |                   
|Revenues                     | $                 
|Operating Income             |                   
|Net Income                   |                   
|Basic Net Income Per Share   | $                 
|Diluted Net Income Per Share |                   

The
net income per share information above will not match the income statement due to
rounding.

# NOTE 14 
SIGNIFICANT FOURTH QUARTER ADJUSTMENTS

There were no material fourth quarter
adjustments or accounting changes.

---



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

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

|For the Years Ended December 31,                             |   | 2006         |  |   | 2005        |  |   | 2004       
|------------------------------------------------------------ | - | ------------ |  | - | ----------- |  | - | -----------
|                                                            
|Oil and gas revenues                                         | $ | 59,760,117   |  | $ | 25,843,077  |  | $ | 8,482,130  
|Production costs                                             |   | (6,453,830)  |  |   | (3,832,487) |  |   | (1,975,835)
|Production taxes                                             |   | (3,506,347)  |  |   | (1,939,739) |  |   | (629,703)  
|Depreciation, depletion, amortization and accretion          |   | (8,027,231)  |  |   | (2,884,089) |  |   | (1,011,602)
|General and administrative (exclusive of corporate overhead) |   | (894,499)    |  |   | (613,762)   |  |   | (313,953)  
|                                                            
|Results of operations before income taxes                    |   | 40,878,210   |  |   | 16,573,000  |  |   | 4,551,037  
|Provision for income taxes                                   |   | (15,124,938) |  |   | (6,132,010) |  |   | (1,683,884)
|                                                            
|Results of Oil and Gas Producing Operations                  | $ | 25,753,272   |  | $ | 10,440,990  |  | $ | 2,867,153  
|                                                            

Reserve Quantities Information
 The following estimates of proved and proved developed reserve quantities and
related standardized measure of discounted net cash flow are estimates only, and do not
purport to reflect realizable values or fair market values of the Companys reserves.
The Company emphasizes that reserve estimates are inherently imprecise and that estimates
of new discoveries are more imprecise than those of producing oil and gas properties.
Accordingly, these estimates are expected to change as future information becomes
available. All of the Companys reserves are located in the United States of America.

Proved reserves are estimated
reserves of crude oil (including condensate and natural gas liquids) and natural gas that
geological and engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating conditions.
Proved developed reserves are those expected to be recovered through existing wells,
equipment and methods.

The standardized measure of
discounted future net cash flows is computed by applying 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,          | 2006       |             | 2005 |            | 2004      
|----------------------------------------- | ---------- | ----------- | ---- | ---------- | ----------
|                                          |            |             |      |            |           
|                                          | Oil (1)    | Gas (1)     |      | Oil (1)    | Gas (1)   
|                                          |           
|Proved Developed and Undeveloped Reserves
|Beginning of year                         | 24,867,189 | 31,982,079  |      | 19,550,664 | 9,999,541 
|Purchases of minerals in place            | 3,644,144  | 2,605,212   |      | 882,460    | 377,179   
|Improved recovery and development         | 8,952,460  | 10,206,642  |      | 2,546,477  | 19,188,896
|Production                                | (900,616)  | (989,991)   |      | (441,995)  | (398,611) 
|Revision of previous estimate             | (498,904)  | (1,379,743) |      | 2,329,583  | 2,815,074 
|                                         
|End of year                               | 36,064,273 | 42,424,199  |      | 24,867,189 | 31,982,079
|                                         
|Proved Developed at end of year           | 11,566,186 | 29,679,976  |      | 7,885,115  | 22,480,279
|                                         

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

---



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

Standardized Measure of Discounted Cash Flows

|December 31,                                           |   | 2006          |  |   | 2005          |  |   | 2004         
|------------------------------------------------------ | - | ------------- |  | - | ------------- |  | - | -------------
|                                                      
|Future cash flows                                      | $ | 2,206,997,329 |  | $ | 1,629,948,750 |  | $ | 814,346,791  
|Future production costs                                |   | (436,830,228) |  |   | (281,685,991) |  |   | (171,518,828)
|Future development costs                               |   | (150,553,635) |  |   | (95,765,594)  |  |   | (61,975,106) 
|Future income taxes                                    |   | (578,112,324) |  |   | (423,161,523) |  |   | (187,392,403)
|                                                      
|Future net cash flows                                  |   | 1,041,501,142 |  |   | 829,335,642   |  |   | 393,460,454  
|10% annual discount for estimated timing of cash flows |   | (496,061,467) |  |   | (383,735,076) |  |   | (188,219,704)
|                                                      
|Standardized Measure of Discounted Cash Flows          | $ | 545,439,675   |  | $ | 445,600,566   |  | $ | 205,240,750  
|                                                      

# Changes in Standardized Measure of Discounted Future Net Cash Flows

|For the Years Ended December 31,                                    |   | 2006          |  |   | 2005          |  |   | 2004        
|------------------------------------------------------------------- | - | ------------- |  | - | ------------- |  | - | ------------
|                                                                   
|Beginning of the year                                               | $ | 445,600,566   |  | $ | 205,240,750   |  | $ | 45,006,097  
|Purchase of minerals in place                                       |   | 18,153,711    |  |   | 33,405,120    |  |   | 142,824,938 
|Extensions, discoveries and improved recovery,   less related costs |   | -             |  |   | 5,962,820     |  |   | 347,652     
|Development costs incurred during the year                          |   | 328,401,017   |  |   | 189,832,736   |  |   | 5,387,638   
|Sales of oil and gas produced, net of production    costs           |   | (53,324,929)  |  |   | (21,991,034)  |  |   | (5,876,333) 
|Accretion of discount                                               |   | 58,727,964    |  |   | 28,467,073    |  |   | 4,882,064   
|Net changes in price and production costs                           |   | (106,369,988) |  |   | 191,917,618   |  |   | 74,777,221  
|Net change in estimated future development costs                    |   | (53,640,718)  |  |   | (36,307,702)  |  |   | (3,187,159) 
|Revision of previous quantity estimates                             |   | (14,276,840)  |  |   | 87,175,031    |  |   | 42,149,044  
|Revision of estimated timing of cash flows                          |   | (8,582,606)   |  |   | (111,387,288) |  |   | (27,509,967)
|Net change in income taxes                                          |   | (69,248,502)  |  |   | (126,714,558) |  |   | (73,560,445)
|                                                                   
|End of the Year                                                     | $ | 545,439,675   |  | $ | 445,600,566   |  | $ | 205,240,750 
|                                                                   

---