**U.S.
                SECURITIES AND EXCHANGE COMMISSION**
              **Washington,
                D.C. 20549**
              **Form
                10-KSB**





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





[
      ]
      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: 0-25455**






**Lexington
      Resources, Inc.**


**(Name
      of small business issuer in its charter)**





**Nevada**
            **88-0365453****(State
                or other jurisdiction of incorporation**
              **or
                organization)**
            **(I.R.S.
                Employer Identification No.)******
            ******7473
                West Lake Mead Road, Las Vegas, Nevada 89128**
              **(Address
                of principal executive offices)******
            ******(702)
                382-5139**
              **(Issuer’s
                telephone number)******
            ******Securities
                registered pursuant to Section**
              **12(b)
                of the Act:**
            **Name
                of each exchange on which**
              **registered:****None******
            ******Securities
                registered pursuant to Section 12(g) of the
                Act:****Common
                Stock, $0.000025 par value****(Title
                of Class)**




Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act. [ ]






Indicate
      by checkmark whether the issuer: (1) has filed all reports required to be filed
      by Section 13 or 15(d) of the Exchange Act during the past 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[  ]


1




Indicate
      by checkmark if no disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of issuer’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-KSB or any amendment
      to
      this Form 10-KSB [ X ]






Indicate
      by checkmark whether the registrant is a shell company (as defined in Rule
      12b-2
      of the Exchange Act). Yes [ ] No [X]






State
      issuer's revenues for its most recent fiscal year (ended December 31, 2006):
      $2,336,941






State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliate shareholders by reference to the price at which the common
      equity was sold, or the average bid and asked prices of such common equity,
      as
      of a specified date within the past 60 days: May 1, 2007: US $
      3,204,402.63






**Applicable
      Only to Issuer Involved in Bankruptcy Proceedings During the Preceding Five
      Years**.


N/A






Indicate
      by checkmark whether the issuer has filed all documents and reports required
      to
      be filed by Section 12, 13 and 15(d) of the Securities Exchange Act of 1934
      after the distribution of securities under a plan confirmed by a court. Yes[
      ]
      No[ ]






**Applicable
      Only to Corporate Registrants**




Indicate
                the number of shares outstanding of each of the issuer’s classes of common
                stock, as of the most practicable date:
              
              Class
            Outstanding
                as of May 1, 2007Common
                Stock, $0.00025 par value
            38,766,270




**Documents
      Incorporated By Reference**






List
      hereunder the following documents if incorporated by reference and the Part
      of
      the Form 10-KSB (e.g., Part I, Part II, etc.) into which the document is
      incorporated: (1) any annual report to security holders; (2) any proxy or
      information statement; and (3) any prospectus filed pursuant to Rule 424(b)
      or
      (c) of the Securities Act of 1933 “Securities Act”). The listed documents should
      be clearly described for identification purposes (e.g. annual report to security
      holders for fiscal year ended December 24, 1980).




None.






Transitional
      Small Business Disclosure Format (Check one): Yes [ ] No [X]




2















**LEXINGTON
      RESOURCES, INC.**





**FORM
      10-KSB**





**FORM
        10-KSB**
 
 Item
                  1.
              Description
                  of Business.
              4Item
                  2.
              Description
                  of Property.
              33Item
                  3.
              Legal
                  Proceedings.
              33Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders.
              33Item
                  5.
              Market
                  for Common Equity and Related Stockholder Matters.
              33Item
                  6.
              Management’s
                  Discussion and Analysis or Plan of Operation.
              38Item
                  7.
              Financial
                  Statements.
              48Item
                  8.
              Changes
                  In and Disagreements With Accountants on Accounting and Financial
                  Disclosure.
              74Item
                  8A.
              Controls
                  and Procedures.
              74Item
                  8B
              Other
                  Information.
              75Item
                  9.
              Directors,
                  Executive Officers, Promoters, Control Persons and Corporate Governance;
                  Compliance With Section 16(a) of the Exchange Act.
              76Item
                  10.
              Executive
                  Compensation.
              78Item
                  11.
              Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters.
              80Item
                  12.
              Certain
                  Relationships and Related Transactions and Director
                  Independenace
              83Item
                  13.
              Exhibits.
              85Item
                  14.
              Principal
                  Accountant Fees and Services.
              86












3











**FORWARD
      LOOKING STATEMENTS**





Statements
      made in this Form 10-KSB that are not historical or current facts are
      "forward-looking statements" made pursuant to the safe harbor provisions of
      Section 27A of the Securities Act of 1933 (the "Act") and Section 21E of the
      Securities Exchange Act of 1934. These statements often can be identified by
      the
      use of terms such as "may," "will," "expect," "believe," "anticipate,"
      "estimate," "approximate" or "continue," or the negative thereof. We intend
      that
      such forward-looking statements be subject to the safe harbors for such
      statements. We wish to caution readers not to place undue reliance on any such
      forward-looking statements, which speak only as of the date made. Any
      forward-looking statements represent management's best judgment as to what
      may
      occur in the future. However, forward-looking statements are subject to risks,
      uncertainties and important factors beyond our control that could cause actual
      results and events to differ materially from historical results of operations
      and events and those presently anticipated or projected. We disclaim any
      obligation subsequently to revise any forward-looking statements to reflect
      events or circumstances after the date of such statement or to reflect the
      occurrence of anticipated or unanticipated events.





**Available
      Information**





Lexington
      Resources, Inc. files annual, quarterly, current reports, proxy statements,
      and
      other information with the Securities and Exchange Commission (the
“Commission”). You may read and copy documents referred to in this Annual Report
      on Form 10-KSB that have been filed with the Commission at the Commission’s
      Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. You may obtain
      information on the operation of the Public Reference Room by calling the
      Commission at 1-800-SEC-0330. You can also obtain copies of our Commission
      filings by going to the Commission’s website at http://www.sec.gov.








**PART
      I**





**ITEM
      1. DESCRIPTION OF BUSINESS**





**BUSINESS
      DEVELOPMENT**





Lexington
      Resources, Inc. was incorporated under the laws of the State of Nevada in 1996
      under the name "All Wrapped Up, Inc." During 1997, we changed our name to
      Intergold Corporation and were engaged in the business of exploration of gold
      and precious metals in the United States. On November 19, 2003, Intergold
      Corporation, Lexington Oil & Gas Ltd. Co. LLC, an Oklahoma limited liability
      company ("Lexington"), and the shareholders of Lexington (the "Lexington
      Shareholders"), entered into a share exchange agreement (the "Share Exchange
      Agreement"). In accordance with the terms of the Share Exchange Agreement:
      (i)
      Lexington became our wholly-owned subsidiary; (ii) we changed our name to
      "Lexington Resources, Inc." and our trading symbol to "LXRS"; and (iii) our
      sole
      business operations commenced as a natural resource exploration company engaging
      in the acquisition and development of oil and natural gas properties in the
      United States. On November 20, 2003, we filed an amendment to our articles
      of
      incorporation changing our name to "Lexington Resources, Inc."





This
      acquisition has been accounted for as a reverse acquisition with Lexington
      being
      treated as the accounting parent and Lexington Resources, Inc., the legal
      parent, being treated as the accounting subsidiary. Accordingly, our
      consolidated results of operations include those of Lexington for the period
      from its inception on September 29, 2003 and those of Lexington Resources,
      Inc.
      since the date of the reverse acquisition. Please note that throughout this
      report, and unless otherwise noted, the words “we,” “our,” “us,” or the
“Company” refer to Lexington Resources, Inc.







4


**CURRENT
        BUSINESS OPERATIONS**
  **General**




We
      are a
      natural resource exploration and production company currently engaged in the
      exploration, acquisition and development of oil and gas properties in the United
      States. As of December 31, 2006, we had an aggregate of approximately 5,358
      gross developed acres, 3,351 net unldeveloped acres and 4,798 gross undeveloped
      acres, 2,524 net developed acres pursuant to leases and/or concessions.




Our
      material mineral properties, which are discussed more fully below in - “Oil and
      Gas Properties”, are as follows as at December 31, 2006. In all developed
      acreage, Paluca Petroleum, Inc. receives a 10% carried interest of our working
      interest pursuant to a management agreement with one of our directors.




·
            Wagnon
                Lease in Pittsburg County, Oklahoma. We have a 53.95% working interest
                and
                a 40.4625% net revenue interest in 590.2 gross acres. As of the date
                of
                this Annual Report, the Kellster 1-2, Kyndal 2-2, Bryce 3-2 and Caleigh
                4-2 wells are all in production.





·
            Coal
                Creek Prospect in Hughes and Pittsburg Counties, Oklahoma. We have
                a 47.5%
                working interest and a minimum 37.525% net revenue interest in 1,024
                net
                mineral acres as of December 31, 2006. The Lex 1-34 and Brumbaugh
                1-10
                wells are in production, in which we have a 43.5% working interest
                and
                34.4% NRI and 18.88% working interest and 14.92% NRI, respectively.
                The
                Ellis 1-15 well, in which we have a 44% working interest, is not
                completed. Paluca Petroleum, Inc. receives a 10% carried interest
                of our
                working interest pursuant to a farm-out agreement.






·
            Panther
                Creek Prospect in Hughes County, Oklahoma. The Poe 1-29 well is a
                non-operated producing interest of Lexington, in which our 165 net
                mineral
                acres equates to a 25.78% working interest and 20.95% net revenue
                interest.






·
            South
                Lamar Prospect in Hughes County, Oklahoma. We have a 45% working
                interest
                in 955 net mineral acres. The Peyton 1-25 (35.99% NRI) and the Nicole
                1-23
                (34.23% NRI) are completed and are both flowing gas, and the Dylan
                Peyton
                1-24H (36.21% NRI) is in the completion
                stage.






·
            H-9
                Prospect in Hughes County, Oklahoma. We have a 50% leasehold interest
                and
                a 39.625% net revenue interest in 712 net mineral acres. The Gates
                1-19
                and 2-19, which were drilled by Orion Exploration, are completed
                and in
                production. We participate 50/50 with Dylan Peyton LLC in an 11.33%
                working interest and a 8.98% net revenue interest in those wells.
                The Gray
                1-22 has been drilled with Dylan Peyton LLC and we have a 41.16%
                working
                interest and 32.62% net revenue interest. As of the date of this
                Annual
                Report, the well is flowing but requires fracturing.






·
            Middle
                Creek Prospect in Hughes County, Oklahoma. There are two minimal
                producing
                gas wells, the Betsey 1-23 and the Fix 1-14, that existed at the
                time of
                purchase in which we have a 45% working interest and a 31.5% net
                revenue
                interest in 320 net mineral acres. As of the date of this Annual
                Report,
                there has been no new development on the property.






·
            Barnett
                Pathway Prospect - Undeveloped acreage. In Jack County, Texas, we
                have a
                100% working interest and 70% net revenue interest in 1,115 net mineral
                acres. The interest in Jack County is in the Barnett Shale and includes
                deep rights. In Hood County, Texas, we have an additional 459 acres
                in
                which we have a 100% working interest and a 72.5% net revenue interest.
                On
                February 26, 2007, the Company sold its interest in its Hood County,
                Texas
                leases to Initial Energy Services, LLC of
                Texas




5




·
            Barnett
                Pathway Prospect - Developed acreage. The Martin 1H well in Parker
                County,
                Texas, has completed the drilling phase and fracturing and is now
                in
                production. We have a 90% working interest and a 63% net revenue
                interest
                in this well. In Palo Pinto County, Texas, we have a 90% working
                interest
                and 63% net revenue interest in 1,211 net mineral acres. There are
                no
                depth limitations in our interest in Palo Pinto County. The Gilbert
                #1H
                has been drilled in Palo Pinto County and is shut in pending resolution
                of
                water infiltration and the setup of compressor equipment to aid gas
                flows
                into a small diameter higher pressure pipeline. A Marble Falls zone
                above
                the Barnett Shale target represents an alternative or commingled
                production opportunity for the Gilbert #1H.We
                also have a non-operating 9% working interest and a 6.3% net revenue
                interest in the Paradise Park 1H well which was acquired through
                our
                drilling contract work. As of the date of this Annual Report, the
                well has
                been fractured, stimulated and fitted with production equipment and
                compressor and is in production. Total developed gross acreage is
                1,152
                net mineral acres.






·
            Geneva
                Prospect in Tarrant County, Texas. We have a 90% working interest
                and a
                63% net revenue interest in 312 acres. As of the date of this Annual
                Report, the Oliver Unit 1H well is shut in pending resolution of
                water
                infiltration.






·
            Comanche
                County Prospect in Comanche County, Texas. On March 3, 2006, effective
                January 31, 2006, the Company entered into an exploration agreement
                with
                Dylan-Peyton, LLC to jointly develop approximately 5,670 acres of
                Barnett
                Shale and shallow gas targets in Comanche County, Texas (the “Comanche
                County Exploration Agreement”). The property will be developed on a 50/50
                equal working interest basis.  The Company’s subsidiary, Oak Hills
                will become the operator of the project.  The Company will pay
                approximately $1,225,500 for its 50% working interest in the new
                acreage
                through a combination of $575,000 in cash (paid during the period)
                and
                approximately $650,500 of carried drilling costs in the first Comanche
                Barnett Shale test well required to be drilled on or before September
                1,
                2006.  The test well commenced drilling on September 1, 2006 and the
                Company is currently evaluating the final costs associated with drilling
                in order to determine the total amounts owing. The Company is currently
                in
                negotiations and reconciliation of expenditures relating to the Joint
                Exploration Agreement in Comanche County, Texas.




**Acquisition
      of Oak Hills Drilling and Operating International, Inc**






On
      September 23, 2005, we entered into an agreement in principle (the "Agreement")
      to acquire 100% of the total issued and outstanding shares of Oak Hills Drilling
      and Operating International Inc. (“Oak Hills”). The Agreement was subject to
      certain conditions precedent including but not limited to: (i) the prior receipt
      by us of a valuation acceptable to the independent members of our Board of
      Directors that determined the underlying value of the assets of Oak Hills;
      (ii)
      the prior audit of Oak Hills; and (iii) mutual due diligence. During December
      2005, we obtained an independent third party valuation by James B. Matthews
      of
      the underlying assets of Oak Hills.




On
      January 23, 2006, we entered into a definitive share exchange agreement (the
      "Oak Hills Share Exchange Agreement") with Oak Hills. Oak Hills Drilling and
      Operating LLC, the wholly-owned subsidiary of Oak Hills (“Oak Hills Drilling
& Operating”), and each of the shareholders of Oak Hills (the "Oak Hills
      Shareholders"), pursuant to which the Oak Hills Shareholders agreed to sell
      to
      us the total issued and outstanding shares of Oak Hills and by virtue of the
      same its wholly owned subsidiary, Oak Hills, in consideration of the issuance
      by
      us to the Oak Hills Shareholders of an aggregate of 6,000,000 shares of our
      restricted common stock at a price of approximately $0.64 per share. See "
      -
      Material Agreements", “Item 5. Market for Common Equity and Related Stockholder
      Matters” and “Item 12. Certain Relationships and Related Transactions and
      Director Compensation.”




6




Oak
      Hills
      is our designated oil and gas operator for our well and property interests
      located in the Barnett Shale, and Texas Project leases. Oak Hills is a full
      service well drilling, operating and completion company and until recently
      owned
      a 10,000 foot operating depth Wilson Giant triple mechanical drilling rig
      outfitted with both triplex and duplex mud pumps. Oak Hills has a well workover
      rig, trucks, dozer, backhoe, trailers and well and pipeline completion
      equipment. Oak Hills operates wells for private clients in addition to us on
      a
      contractual basis. Oak Hills employs approximately five to ten people. Fiscal
      year 2005 was Oak Hills' first year of substantial operations since acquiring
      the Wilson Giant drilling rig in late 2004. Oak Hills spent the latter quarter
      of 2004 and the first quarter of 2005 rebuilding and updating its Wilson Giant
      drilling rig. Oak Hills operated the drilling rig from April 2005 until its
      sale
      in January 2007, drilling horizontal Barnett Shale wells in the Dallas/Ft.
      Worth
      Basin as a third party contractor, for our Oliver, Martin, and Gilbert well
      interests, and most recently, for us on our Comanche County Lease in Comanche
      County, Texas under joint exploration with Dylan Peyton, LLC.






**Dylan
      Peyton Exploration Agreements**






**Arkoma
      Basin Exploration Agreement**






Lexington
      Oil & Gas entered into an exploration agreement and operating agreement
      dated effective January 31, 2006 (the "Arkoma Basin Exploration Agreement"),
      with Dylan Peyton. Pursuant to the terms and provisions of the Arkoma Basin
      Exploration Agreement: (i) we agreed with Dylan Peyton to conduct joint
      exploration and development operations, including the drilling of exploratory
      or
      development wells for the discovery of and for the production of oil and/or
      gas
      on certain of our leasehold interests located in the Arkoma Basin in McIntosh
      and Hughes Counties, Oklahoma; (ii) Avatar Energy LLC, an affiliate of Dylan
      Peyton, became the operator of the initial test well and any test well drilled
      under the terms of the Arkoma Basin Exploration Agreement; (iii) Lexington
      Oil
      and Gas assigned to Dylan Peyton an undivided 50% interest in all the leaseholds
      in Coal Creek, South Lamar, Middlecreek, and H-9 Prospects; and (iv) Dylan
      Peyton paid to Lexington Oil and Gas $575,000 in consideration of the
      assignments.






**Comanche
      County Barnett Shale Exploration Agreement**






Lexington
      Oil & Gas entered into an exploration agreement and operating agreement
      dated effective January 31, 2006 (the "Comanche County Barnett Shale Exploration
      Agreement"), with Dylan Peyton. Pursuant to the terms and provisions of the
      Comanche County Barnett Shale Exploration Agreement: (i) we agreed with Dylan
      Peyton to conduct joint exploration and development operations, including the
      drilling of exploratory or development wells for the discovery of and for the
      production of oil and/or gas on certain leasehold interests owned by Dylan
      Peyton located in the Barnett Shale and shallow gas targets in Comanche County,
      Texas; (ii) Oak Hills shall be the operator of the project; and (iii) Lexington
      Oil & Gas will pay to Dylan Peyton approximately $1,225,500 for a 50%
      working interest in approximately 5,670 acres of new acreage located in Comanche
      County, Texas through a combination of $575,000 in cash and approximately
      $650,500 of carried drilling costs in the first test well. In September of
      2006,
      we began drilling the Petta 1 horizontal Barnett Shale well in Comanche, County,
      Texas. The well will be analyzed with a view towards possible completion once
      pipeline infrastructure in the area is further developed. Our other Barnett
      shale acreage in the Barnett Pathway Prospect or the Geneva Prospect does not
      form part of Comanche County Barnett Shale Exploration Agreement.




On
      October 2, 2006, we entered into a convertible debt set-off agreement (the
      “Convertible Debt Agreement”) with Dylan Peyton LLC, a Texas limited liability
      company (“Dylan Peyton"), relating to amounts due and owing to Dylan Peyton by
      Oak Hills from fractures and completion of certain coal bed methane gas wells.
      Pursuant to the terms and provisions of the Convertible Debt Agreement: (i)
      Oak
      Hills sold to Ada Energy Services LLC ("AES") certain of its assets, including
      two Wilson 600 duplex pumps for an aggregate consideration of $120,000 as a
      set-off for the debt due and owing to Dylan Peyton; (ii) Oak Hills had 120
      days
      to pay the amount of $120,000 due and owing to Dylan Peyton to re-purchase
      the
      two Wilson pumps from AES for $120,000 plus the cost of any work done on them
      other than repairs made for damages caused by AES' usage of the pumps; (iii)
      Oak
      Hills made a payment of $20,000 to Avatar Energy relating to the completion
      and
      fracture job on the Gray Well #1H-22 and the fracture job on the Dylan Peyton
      well #1-23; and (iv) in the event Oak Hills did not re-purchase the Wilson
      pumps
      for $120,000 within the 120 days, the sale of the pumps would constitute full
      and complete settlement of the $120,000 due and owing Dylan Peyton.




7




On
      January 27, 2007, the Company extinguished its obligations under the convertible
      debt set-off agreement with Dylan Peyton, LLC by repaying $120,000 to Ada Energy
      Services and reclaiming its pledged collateral (two Wilson 600 duplex pumps).







On
      January 27, 2007, the Company sold its two Wilson 600 duplex pumps to Innovative
      Energy Services for $125,000.




**Disposition
      of Oak Hills Drilling Rig**






During
      the fourth quarter of 2006, we considered monetizing certain of our assets
      and
      those of Oak Hills in order to decrease liabilities and overhead incurred by
      us
      on a consolidated basis from previous capital expenditures and a lack of current
      debt and equity resources made available to us. In this respect, we actively
      solicited offers from unaffiliated third parties for the purchase of certain
      assets of Oak Hills, inclusive of Oak Hills' Wilson Giant single draw works
      drilling rig and related equipment (collectively, the "Drilling Rig"). At the
      same time, we also requested an independent evaluation report regarding
      valuation of the Drilling Rig in order to substantiate the consideration to
      be
      offered.




On
      January 2, 2007, our Board of Directors authorized and approved the execution
      by
      Oak Hills of an agreement dated December 29, 2006 with Innovative Energy
      Services ("IES") pertaining to the sale and purchase of the Drilling Rig. In
      accordance with the terms of this agreement: (i) IES paid to Oak Hills an
      aggregate amount of $3,100,000; and (ii) Oak Hills delivered title to the
      Drilling Rig to IES. In connection with this subsequent sale of equipment,
      as at
      December 31, 2006, the Company adjusted the carrying value of the Drilling
      Rig
      to its estimated recoverable amount resulting in an impairment of the carrying
      value totaling $1,572,723. This Agreement was completed, and the net proceeds
      were received effective January 5, 2007.





**OIL
      AND GAS PROPERTIES**




As
      of
      December 31, 2006, we maintained an aggregate of approximately 5,358 gross
      developed acres and 4,798 gross undeveloped acres pursuant to leases and/or
      concessions as described below. Of that acreage, we maintain approximately
      3,766
      gross developed acres and 1,857 gross undeveloped acres in the Arkoma Basin
      in
      the State of Oklahoma and approximately 1,592 gross developed acres and 2,941
      gross undeveloped acres in the Barnett Shale play in North Texas.






**Wagnon
      Lease**




In
      November 2003, we purchased an 80% working interest and a 60.56% net revenue
      interest in approximately 590 gross acres of a gas lease located on the Wagnon
      Lease in Pittsburg County, Oklahoma (the "Wagnon Lease"). The gas lease was
      acquired from Oak Hills Energy, Inc. ("Oak Hills Energy"), which acquired the
      lease pursuant to a farm-out agreement with Quinton Rental & Repair
      Services, Inc. (the "Wagnon Farm-Out Agreement"). Our interest relating to
      the
      Wagnon Property is subject to farm-out agreements equating to a total 20%
      working interest between Paluca Petroleum, Inc. ("Paluca"), an affiliate of
      one
      of our directors, Douglas Humphreys, as well as Oak Hills Energy, and the lessee
      of the Wagnon Property.




As
      of the
      date of this Annual Report, we have drilled, completed, and put four coal bed
      methane gas wells into production on this prospect, the Kellster #1-5, the
      Kyndal #2-2, the Bryce #3-2, and the Calleigh #4-2. The Kellster #1-5 was
      drilled to a depth of approximately 2,400 feet vertically and 2,200 feet
      horizontally and has been producing since the middle of February
      2004.




The
      Kyndal #2-2 was completed in June 2004 to a depth of approximately 2,400 feet
      vertically and 2,200 feet horizontally and is located in close proximity to
      the
      Kellster #1-5 well. The Kyndal #2-2 well feeds directly into the existing
      pipeline and compressor station infrastructure located on the Wagnon
      Lease.




The
      Bryce
      #3-2 was completed in August 2004 and is in production. The Bryce #3-2 well
      is
      also located in close proximity to the Kellster #1-5 well. Completion of
      drilling of the Bryce #3-2 well resulted in vertical depths of approximately
      2,400 feet with an approximate 2,000 foot horizontally drilled section utilizing
      drilling protocols similar to those previously utilized in the drilling of
      the
      Kellster #1-5 and Kyndal #2-2 wells.




8




The
      last
      well drilled on the Wagnon Prospect was completed on April 2, 2005 when the
      Calleigh #4-2 commenced production. The Calleigh #4-2 well resulted in vertical
      depths of approximately 2,600 feet with an approximate 1,800 foot horizontally
      drilled section.




We
      previously entered into funding agreements for the Kellster #1-5, Kyndal #2-2,
      Bryce #3-2, and Calleigh #4-2 wells (collectively, the "Funding Agreements").
      Pursuant to the Funding Agreements, private investors were provided with an
      80%
      working interest and a 60.56% net revenue interest in the wells until their
      respective invested capital in each well was repaid, after which time the
      private investors were to revert to an aggregate 20.1% working interest and
      a
      12.17% net revenue interest. Oak Hills Energy, the original driller and operator
      of the wells, would "back-in" to a reversionary 6.7% working interest after
      the
      working interest capital was repaid and Lexington Oil & Gas would "back-in"
      to a reversionary 53.95% working interest. Pursuant to the further terms and
      provisions of the Funding Agreements, all wells drilled on the Wagnon Lease
      carry royalty interests totaling 25% to landowners and property interest holders
      and carried working interests of 5% to a landowner, as well as a 10% carried
      working interest to Paluca. Paluca also owns a non-carried working interest
      of
      5% as part of capital participation funding provided by Paluca. During fiscal
      year 2005, we received the total required funding of $1,485,000 under the
      Funding Agreements for drilling and completion of the four horizontal coal
      bed
      methane gas wells on the Wagnon Property. As of September 19, 2005, we had
      repaid the funding investors the balance of their unpaid capital, which totaled
      $1,180,915 as of December 31, 2004, to acquire our back-in 53.95% working
      interest and 40.4625% net revenue interest in the four wells developed on the
      Wagnon lease under the Funding Agreements. Therefore, as of the date of this
      Annual Report, our back-in working interest of 53.95% (40.4625% net revenue
      interest) in each of the four wells on the Wagnon Property has vested and the
      private investors have reverted to an aggregate 20.1% working interest and
      a
      12.17% net revenue interest.






**Coal
      Creek Prospect**




During
      fiscal year 2004, we obtained an option to purchase an undivided 95% interest
      in
      approximately 2,500 net leasehold acres in five sections located in Hughes
      and
      Pittsburg Counties, State of Oklahoma (the "Coal Creek Prospect"). On March
      12,
      2004, we entered into a lease originally expiring in August 2006 for
      approximately 1,324 gross acres in the Coal Creek Gas Prospect pursuant to
      which
      we had an undivided 95% working interest and a minimum 79% net revenue interest.
      On May 20, 2004, we entered into a lease originally expiring in August 2006,
      pursuant to which we acquired an additional 372 acres of the Coal Creek Prospect
      with a minimum 95% working interest and a 78% net revenue interest. Two wells
      have been drilled on these properties, and as such, pursuant to the provisions
      of these leases, these leases will remain in effect until one year after the
      wells stop producing. On August 20, 2004, we entered into a two-year lease
      pursuant to which we acquired an additional 23 acres of the Coal Creek Prospect
      with a minimum 95% working interest and a 79% net revenue interest. In
      accordance with the terms and provisions of a consulting agreement with Douglas
      Humphreys, one of our directors (the "Consulting Agreement"), we assigned to
      Paluca as an earned carried interest 10% of our working interest as a carried
      working interest in each well to be drilled on the Coal Creek Gas Prospect
      that
      has been completed and is in production. See "Item 10. Executive Compensation"
      and "Item 12. Certain Relationships and Related Transactions and Director
      Independence".




Our
      non-producing inventory of leases in the Coal Creek Prospect is now subject
      to
      the 50/50 joint exploration agreement with Dylan Peyton LLC, thereby reducing
      our working interest and net revenue interest accordingly to a 47.5% working
      interest and a 39-39.5% net revenue interestI. Our indirect subsidiary, Oak
      Hills, will be utilized for well completion and service as well as geological
      and engineering work associated with joint exploration. Dylan Peyton LLC is
      the
      operator of new wells drilled in the Arkoma Basin, OK on assigned acreage
      subject to the joint exploration agreement. See " - Material Agreements".




As
      of
      December 31, 2006, the total acreage acquired less expired acreage in the Coal
      Creek Gas Prospect is approximately 1,024 gross developed acres and 360 gross
      undeveloped acres. Certain other leases may terminate in accordance with their
      terms.




9




On
      March
      31, 2005, we began drilling the first well on the Coal Creek Prospect, the
      Lex
      #1-34, of which we have a 45% working interest. The Lex #1-34 well has been
      completed and is currently in production. The Lex #1-34 well was drilled to
      a
      depth of approximately 3,200 vertical feet and approximately 2,000 horizontal
      feet.




On
      April
      15, 2005, we began drilling a second well on the Coal Creek Project, the
      Brumbaugh #1-10 well, of which we have a 19.8% working interest. The Brumbaugh
      #1-10 well has been completed and began production in May 2005. The Brumbaugh
      #1-10 was drilled to a vertical depth of 3,350 feet and a horizontal lateral
      section of 2,350 feet.




On
      May
      31, 2005, we began drilling a third coal bed methane well on the Coal Creek
      Prospect, the Ellis #1-15, of which we have an 88% working interest. Drilling
      of
      this well encountered a shallow "Bartlesville Sand" zone that produced a
      significant gas flair upon testing of the zone. The zone was logged, underwent
      economic and geological study to assess commercial potential of the new, non-CBM
      gas zone, and we attempted completion in the Bartlesville Sand zone without
      success due to intrusion of water from a salt water disposal well. As a result,
      we evaluated the completion of the well in the originally targeted, Hartshorne
      CBM gas zone that we believe was unaffected by the intrusion of water. As of
      the
      date of this Annual Report, we have determined to re-complete the horizontal
      section of the Ellis #1-15 in accordance with contractual arrangements with
      Dylan Peyton at a future date. See " - Material Agreements". Pursuant to further
      arrangements with Dylan Peyton, we now participate 50/50 with Dylan Peyton
      in
      the 88% interest and 69.49% net revenue interest in this well.






**Panther
      Creek Prospect**




On
      March
      12, 2004, we entered into a three year lease for approximately 292 gross acres
      located in five separate sections in the Panther Creek coal bed methane gas
      prospect located in Hughes County, State of Oklahoma (the "Panther Creek
      Prospect"). We had a 100% working interest and an approximate 81% net revenue
      interest in the acreage acquired in the Panther Creek Prospect. As at December
      31, 2006, we have interests in approximately 165 gross developed acres and
      35
      gross undeveloped acres with 92 acres terminated under the terms of these
      leases.




Part
      of
      the acreage in this lease has been subject to three division pooling orders
      by
      Newfield Exploration Mid-Continent, Inc. ("Newfield"), for three wells to be
      drilled and operated by Newfield in which Lexington had originally elected
      to
      participate. Our working interest in the first of the three wells to be drilled
      was proportionate to our Panther Creek lease ownership in the first of three
      areas pooled by Newfield. Our working interest in the well we elected to
      participate in was 25.78% (20.95% NRI).




Newfield
      has proceeded with the drilling and completion of one of the wells in which
      we
      have leased acreage and in which we elected to participate. The vertical well
      targeted a Woodford Shale gas zone, the POE 1-29, commenced drilling on February
      9, 2005, and began producing on March 21, 2005. Based on results of the POE
      1-29
      and increased revised estimated costs to complete a further horizontal well
      proposed by Newfield, we have not elected to participate in any further wells
      operated by Newfield on the Panther Creek Prospect.






**South
      Lamar Prospect**




On
      April
      22, 2004, we entered into a two-year lease agreement to acquire a 100% working
      interest and a 78.5% net revenue interest in 960 gross undeveloped acres to
      develop coal bed methane gas wells in Hughes County, State of Oklahoma (the
      "South Lamar Prospect"). On July 26, 2004, we acquired a further 183.98 gross
      acres in the South Lamar Prospect pursuant to which we held a 100% working
      interest and a 79% net revenue interest. We previously prepared the drill site
      for the first proposed coal bed methane Hartshorne Coal targeted gas well on
      this prospect, the Goodson #1-24 well. Subsequently, we decided not to proceed
      with the drilling of the planned "Goodson #1-24" pending reassessment of costs
      and techniques utilized to drill and complete wells. Various well drilling
      and
      completion related cost reduction techniques were evaluated by our management.




This
      property is now subject to the 50/50 joint exploration agreement with Dylan
      Peyton, thereby reducing our working interest and net revenue interest
      accordingly to a 45% working interest and a 35.99% net revenue interest. Our
      indirect subsidiary, Oak Hills, is being utilized for well completion and
      service as well as geological and engineering work associated with joint
      exploration while Dylan Peyton is the operator. See " - Material Agreements".




10




Our
      further exploration targeted a vertical well to test Hartshorne Coal, and
      shallow gas sands on a portion of this prospect in addition to horizontal CBM
      gas wells, using two drilling rigs provided by Dylan Peyton on both vertical
      and
      horizontal targets utilizing the smaller, more cost effective drilling equipment
      on the shallower vertical well. In conjunction with the terms of the Consulting
      Agreement, 10% of our interest will be assigned to Douglas Humphreys or his
      designate. As of the date of this Annual Report, the Peyton 1-25 (35.99% net
      revenue interest), Nicole 1-23H (34.23% net revenue interest), and Dylan Peyton
      1-24H (36.21% net revenue interest) wells are completed and are flowing minor
      amounts of gas. As at December 31, 2006, we have interests in approximately
      960
      gross developed acres and 0 gross undeveloped acres with 184 acres terminated
      under the terms of these leases.






**H-9
      Prospect**




On
      June
      29, 2004, we entered into an option agreement to purchase a leasehold interest
      and a net revenue interest in approximately 4,600 net leasehold acres located
      in
      approximately 38 sections of the H-9 Prospect in Hughes and McIntosh Counties,
      Oklahoma (the "H-9 Prospect"). On July 29, 2004, we entered into three to
      four-year lease agreements to acquire an undivided 100% leasehold interest
      and a
      79.25% net revenue interest in the 4,600 gross leasehold acres on the H-9
      Prospect. On July 19, 2004, we entered into another three-year lease to acquire
      a 100% leasehold interest and a 78.25% net revenue interest in an additional
      320
      gross acres of gas target drillable acreage on the H-9 Prospect.




We
      have
      contributed our undeveloped inventory of leases in the H-9 Prospect to jointly
      develop gas-producing wells with Dylan Peyton on a 50/50 equal working interest
      basis, thereby reducing our working interest and net revenue interest
      accordingly to a 50% working interest and a 39% net revenue interest. Our
      subsidiary, Oak Hills, will be utilized for well completion and service as
      well
      as geological and engineering work associated with joint exploration while
      Dylan
      Peyton is the operator. See " - Material Agreements".




We
      elected to participate in a non-operated interest in the Gates 1-19 well, which
      was drilled by Orion Exploration. As of the date of this Annual Report, the
      well
      is completed and is now in production. We participated 50/50 with Dylan Peyton
      in a 11.33% working interest and a 8.98% net revenue interest in this well.
      We
      also elected to participate in a further well being drilled by Orion Exploration
      named the Gates 2-19 with similar working and net revenue interests. As of
      the
      date of this Annual Report, the Gates 2-19 well has been completed by Orion
      Exploration and is now in production. We participated 50/50 with Dylan Peyton
      in
      a 11.33% working interest and a 8.98% net revenue interest in this further
      well
      drilled by Orion Exploration.




Dylan
      Peyton drilled and put into minor production a further well named the Grey
      1-22
      horizontal CBM gas well on the H-9 Prospect. We participated 50/50 with Dylan
      Peyton in a 41.16% working interest and 32.62% net revenue interest in this
      well. As of the date of this Annual Report, Dylan Peyton is planning to drill
      a
      further horizontal CBM well on this prospect. As of the date of this Annual
      Report, the well is flowing but requires fracturing. As at December 31, 2006,
      we
      have interests in approximately 712 gross developed acres and 1,462 gross
      undeveloped acres with 2,746 acres terminated under the terms of these
      leases.






**Middlecreek
      Prospect**




On
      May
      24, 2004, we entered into an agreement to acquire an undivided 100% working
      interest and a 70% net revenue interest in 320 gross leasehold acres located
      in
      two sections in the Middlecreek Prospect located in Hughes County, Oklahoma
      (the
      "Middlecreek Prospect"). Rights to drill all geological zones are included
      and
      primary gas targets include the Caney shale and Hartshorne coal zones with
      further possibilities in the Booch, Stuart and Savannah zones. The Middlecreek
      Prospect includes a 2,000 foot gas pipeline and pipeline right of way. There
      are
      two minimal producing gas wells, the Betsey 1-23 and the Fix 1-14, that existed
      at the time of purchase in which we had a 90% working interest and a 63% net
      revenue interest. There has been no new development on the
      property.




We
      have
      contributed our undeveloped inventory of leases in the Coal Creek Prospect
      to
      jointly develop gas-producing wells with Dylan Peyton on a 50/50 equal working
      interest basis, thereby reducing our working interest and net revenue interest
      accordingly to a 45% working interest and a 31.5% net revenue interest. Our
      subsidiary, Oak Hills, will be utilized for well completion and service as
      well
      as geological and engineering work associated with joint exploration while
      Dylan
      Peyton is the operator. See " - Material Agreements". As at December 31, 2006,
      we have interests in approximately 320 gross developed acres and 0 gross
      undeveloped acres.




11






**Barnett
      Pathway Prospect**




On
      June
      2, 2005, as amended July 14, 2005, we entered into a definitive agreement with
      a
      Texas-based limited partnership (the "Barnett Agreement"), regarding a gas
      well
      horizontal drilling venture in the Jack, Wise, and Palo Pinto Counties in the
      State of Texas (the "Barnett Pathway Prospect"). Pursuant to the terms and
      provisions of the Barnett Agreement: (i) we will be able to acquire a working
      interest of between 75% to 100% in the wells to be drilled on the Barnett Shale
      Project with net revenue interests ranging from 70% to 72.5%, and to increase
      the initial acreage up to approximately 3,600 net leasehold acres; (ii) we
      paid
      a non-refundable deposit of $100,000 and the balance of the funds on August
      19,
      2005, which $100,000 deposit shall be credited against the total purchase price
      to be paid by us for the working interest in up to 3,687 net leasehold acres;
      (iii) we will pay our pro-rata share of net leasehold acres we acquire; (iv)
      in
      the event we purchase the maximum 100% working interest, we will receive a
      minimum 70 to 72.5% net revenue interest on the leases without any carried
      interest to the Texas limited partnership, with the remaining net revenue
      interest to be reserved as an overriding royalty interest for the Texas limited
      partnership; (v) in the event we purchase a 75% working interest, we will
      receive a 56.25% net revenue interest on the leases and we will carry for the
      Texas limited partnership a 10% working interest in the drilling, completion
      and
      equipping of the pipeline on all wells drilled on the acreage purchased by
      us;
      (vi) we will be responsible for our pro-rata share of acreage costs; and (vii)
      our contract operator, Oak Hills, will be the operator for the project.




On
      September 25, 2005, we acquired our first lease in the Barnett Pathway Prospect.
      We acquired approximately 2,325 net leasehold acres for $1,107,000. On January
      5, 2006, we acquired an additional three leases comprising approximately 601
      net
      leasehold acres for $439,000. The acquisition of the additional 601 net
      leasehold acres provides us with a 100% working interest and a 72.5% net revenue
      interest.




During
      the second quarter of fiscal year 2006, we began drilling the Martin 1H
      horizontal Barnett Shale well in Parker County, Texas. As of the date of this
      Annual Report, we have completed the drilling and fracturing phases of
      development and the well is now in production. We have a 90% working interest
      and a 63% net revenue interest in this well.




Late
      in
      the second quarter of fiscal year 2006, we began drilling the Gilbert 1H
      horizontal Barnett Shale well in Palo Pinto County, Texas. We have a 90% working
      interest and a 63% net revenue interest in this well. As of the date of this
      Annual Report, we have completed the drilling and fracturing phases of
      development but the well is not in production. The well is shut in pending
      resolution of water infiltration and the setup of compressor equipment to aid
      gas flows into a small diameter higher pressure pipeline. A Marble Falls zone
      above the Barnett Shale target represents an alternative or commingled
      production opportunity.




We
      also
      have a 9% working interest and 6.3% net revenue interest in the non-operated
      Paradise Park 1H well located in Parker County that Oak Hills drilled on third
      party contract during the second quarter of fiscal year 2006. As of the date
      of
      this Annual Report, the well has been drilled and fractured, stimulated and
      fitted with production equipment and compressor and is in production.






**Geneva
      Prospect**




On
      December 5, 2005, we entered into an asset purchase agreement with Geneva Energy
      Corp., a Nevada corporation ("Geneva"), and Lexington (the "Asset Purchase
      Agreement"). In accordance with the terms and provisions of the Asset Purchase
      Agreement, we purchased a 100% working interest and a 70% net revenue interest
      in and to certain petroleum and natural gas rights on approximately 312 acres
      located in Tarrant County, Texas (the "Tarrant Prospect"), for an aggregate
      consideration of $779,798. We currently have a 90% working interest and a 63%
      net revenue interest in the Tarrant Prospect.




The
      recent acquisitions increase our total Barnett Shale targeted lease inventory
      to
      a total of 3,238 net mineral acres diversified in Hood, Parker, Tarrant, Palo
      Pinto, and Jack Counties, all with access to existing pipeline networks. On
      February 26, 2007, we sold approximately 499 acres of Barnett Shale targeted
      exploration leases located in Hood County, TX resulting in net proceeds of
      approximately $379,000.


12




During
      the first quarter of fiscal year 2006, through Oak Hills, we completed the
      drilling portion of a horizontal Barnett Shale gas well named the Oliver Unit
      1H. Subsequently the Oliver Unit 1H was completed to a total depth of 9,300
      feet. As of the date of this Annual Report, the Oliver Unit 1H well is shut
      in
      pending resolution of water infiltration.






**Comanche
      County Prospect**




On
      March
      3, 2006, effective January 31, 2006, we acquired a 50% working interest in
      approximately 5,670 acres of Barnett Shale and shallow gas targets. As of the
      date of this Annual Report, we do not know what our exact net revenue interest
      in this property will be, but anticipate it to be in the range of 75% and expect
      it will vary on a lease by lease basis. As of the date of this Annual Report,
      we
      have received title to 1,368 acres. The property will be developed on a 50/50
      equal working basis with Dylan Peyton. We will pay approximately $1,225,500
      for
      its 50% working interest in the new acreage through a combination of $575,000
      in
      cash (paid during the period) and approximately $650,500 of carried drilling
      costs in the first Comanche Barnett Shale test well required to be drilled
      on or
      before September 2006.  The test well (“Petta-1”) commenced drilling on
      September 1, 2006 and we are currently evaluating the final costs associated
      with drilling in order to determine the total amounts owing. It is estimated
      that the total amount owing for the acreage will be approximately $1,225,500,
      resulting in no additional amount remaining to be paid after deducting the
      original payment of $575,000 and the carried drilling costs estimated to be
      $650,500. We are currently in negotiations and reconciliation of expenditures
      relating to the Joint Exploration Agreement in Comanche County, Texas. The
      Petta-1 well will be analyzed with a view toward the possible completion once
      pipeline infrastructure in the area is further developed.






**Drilling
      Activity**




As
      of the
      date of this Annual Report, the following table sets forth the results of our
      gas drilling activity:




**Gross
                Wells**
            **Net
                Wells**Total
            Producing
            Dry
            Total
            Producing
            Dry20
            15
            0
            9.
                35
            6.61
            0




**Production
      Information**




During
      years ended 2003 and previous, we had no oil and gas production.




**Net
      Production, Average Sales Price and Average Production
      Costs**






The
      table
      below sets forth the net quantities of gas production (net of all royalties,
      overriding royalties and production due to others) attributable to us for fiscal
      year ended December 31, 2006, and the average sales prices, average production
      costs and direct lifting costs per unit of production.


**For
                Fiscal Year Ended December 31, 2006**Net
                production (Mcf)
            153,971Average
                Sales price (per Mcf)*
            $4.94Average
                Production Cost (per Mcf)**
            $3.11




*
        Includes deductions for transportation, marketing costs, compressor surcharge
        and BTU factor.
  **Includes
        direct lifting costs, which are comprised of labor, repairs and maintenance,
        materials and supplies, workover costs, insurance and property, gathering,
        compression, marketing and severance taxes


13






The
      table
      below sets forth the net quantities of gas production (net of all royalties,
      overriding royalties and production due to others) attributable to us for fiscal
      year ended December 31, 2005, and the average sales prices, average production
      costs and direct lifting costs per unit of production.




**For
                Fiscal Year Ended December 31, 2005**Net
                production (Mcf)
            130,942Average
                Sales price (per Mcf)*
            $5.30Average
                Production Cost (per Mcf)**
            $1.63




*Includes
      deductions for transportation, marketing costs, compressor surcharge and BTU
      factor.




**Includes
      direct lifting costs, which are comprised of labor, repairs and maintenance,
      materials and supplies, workover costs, insurance and property, gathering,
      compression, marketing and severance taxes.






**Gross
      and Net Productive Gas Wells, Developed Acreage**






**Productive
      Wells and Developed Acres**






As
      of the
      date of this Annual Report, the tables below set forth our leasehold interest
      in
      productive and shut-in gas wells, and in developed acres:




**Prospect**
            **Gross****(1)**
            **Net****(2)**Wagnon
            4
            2.13Panther
            1
            0.25Coal
                Creek
            3
            1.06Geneva
            1
            0.90Barnett
                Pathway
            3
            1.89H-9
            2
            0.38South
                Lamar
              
              Middle
                Creek
              
              Comanche
              
              Paradise
                Park
            3
              
              2
              
              1
              
              1
            1.35
              
              0.90
              
              0.45
              
              0.04Total
            20
            9.35




(1) A gross
      well is a well in which a working interest is owned. The number of gross wells
      is the total number of wells in which a working interest is owned.




(2) A net
      well is deemed to exist when the sum of fractional ownership working interest
      in
      gross wells equals one. The number of net wells is the sum of the fractional
      working interests owned in gross wells expressed as whole numbers and fractions
      thereof.




14


**Developed
                Acreage Table****(1)****Prospect**
            **Gross****(2)**
            **Net****(3)**Wagnon
            590
            313.9Panther
            165
            38.3Coal
                Creek
            1,024
            591.7Middle
                Creek
            320
            248.6South
                Lamar
            955
            429.7Geneva
                lease
            312
            280.8Barnett
                Pathway
            1,280
            1,152.0H-9
            712
            295.8Total
            5,358
            3,351.0




(1)
      Consists of acres spaced or assignable to productive wells.




(2)
      A
      gross acre is an acre in which a working interest is owned. The number of gross
      acres is the total number of acres in which a working interest is
      owned.




(3)
      A net
      acre is deemed to exist when the sum of fractional ownership working interests
      in gross acres equals one. The number of net acres is the sum of the fractional
      working interests owned in gross acres expressed as whole numbers and fractions
      thereof.






**Undeveloped
      Acreage**




As
      of the
      date of this Annual Report, the table below sets forth our leasehold interest
      in
      undeveloped acreage:




**Prospect**
            **Gross**
            **Net***Panther
            35
            31.5Coal
                Creek
            360
            162.0H-9
            1,462
            601.7Barnett-Pathway
            1,573
            1,113.0Comanche
                County
            1,368
            615.6Total
            4,798
            2,524







15




**Gas
      Delivery Commitments**




We
      have
      no gas delivery commitments. Lexington contracts with Unimark LLC and through
      its operator, Oak Hills, with Williams Arkoma Gathering Company, LLC, Devon
      Gas
      Services LP and Hughes Gas System LLC to sell gas produced.






**Drilling
      Commitments**




As
      of the
      date of this Annual Report, we are not committed to drilling any
      wells.






**Reserve
      Information**




On
      January 6, 2006, we obtained an independent reserves and economic evaluation
      report regarding our holdings as of December 31, 2005 (the "January 2006
      Reserves and Economic Evaluation Report"). The January 2006 Reserves and
      Economic Evaluation Report was prepared by Pinnacle Energy Services, LLC
      ("Pinnacle") of Oklahoma City, Oklahoma.




After
      the
      January 2006 Reserves and Economic Evaluation Report was prepared, we entered
      into two Joint Exploration Agreements with Dylan Peyton LLC whereby we obtained
      certain interests and assigned certain interests, as described below under
      "Material Agreements--Arkoma Basin Exploration Agreement" and "--Comanche County
      Barnett Shale Exploration Agreement." We requested Pinnacle to prepare a new
      independent report as of July 1, 2006 to include these and other changes.
      Pinnacle prepared a "Mid-Year 2006 Reserves and Economic Evaluation Report"
      on
      August 7, 2006, and finalized this report on September 23, 2006. The Mid-Year
      2006 Reserves and Economic Evaluation Report provides a summary of the proven
      results regarding our interests in eleven proven developed producing (PDP)
      wells, seven proven non-producing (PNP) wells and ten proven undeveloped (PUD)
      wells as of July 1, 2006. The Mid-Year 2006 Reserves and Economic Evaluation
      Report supersedes the January 2006 Reserves and Economic Evaluation Report,
      but
      does not include well completions, leases expired or acquired, or additional
      property or lease developments after July 1, 2006.




The
      remaining paragraphs of this "Reserve Information" section closely track the
      information provided in the Executive Summary of the Mid-Year 2006 Reserves
      and
      Economic Evaluation Report, redacted to remove information with respect to
      "non-proven" reserves:




Pinnacle
      evaluated several producing and non-producing assets of Lexington as of July
      1,
      2006. Included in the assets are ten (10) producing wells in the Arkoma Basin
      of
      Eastern Oklahoma, multiple non-producing and undeveloped wells, approximately
      3,655 acres of undeveloped leasehold in Hughes and McIntosh Counties in Eastern
      Oklahoma, approximately 4,607 acres of undeveloped leasehold in six north Texas
      counties of Hood, Jack, Palo Pinto, Parker, Johnson, and Tarrant.




16




The
      Arkoma undeveloped leasehold is located in fifty (50) sections located in seven
      townships between 4N-11E to 9N-14E. The leasehold is primarily limited to the
      Hartshorne and shallower intervals and is generally in an active and
      multi-horizon production area. Eight leases comprise the North Texas (Fort
      Worth
      Basin) leasehold which is primarily for Barnett Shale (horizontal) development,
      but also has other uphole secondary targets such as the Marble Falls and
      Conglomerate formations. A portion of the acreage is nearby commercial activity,
      while most of the acreage is in areas of likely future activity.




The
      economic evaluation was performed using a flat natural gas pricing forecast
      of
      $7.50/mcf, adjusted $0.75/Mcf for basis differential. A summary of the proven
      results are as below (volumes in MMcf, values in M$),




**Asset**
            **Gross
                Rem'g Oil**
            **Gross
                Rem'g Gas**
            **Net
                Rem'g Oil**
            **Net
                Rem'g Gas**
            **Net
                Cashflow**
            **Before
                Income Tax at**
              
              **Discounted
                10% Present Worth**PDP
                wells
            0.92
            3,487
            0.6
            637
            3,140
            2,200PNP
                wells
            13.7
            3,084
            3.4
            900
            3,514
            2,355PUD
                wells
            10.6
            4,732
            6.7
            1,707
            5,780
            2,859**Total
                Proven**
            **25.2**
            **11,303**
            **10.7**
            **3,244**
            **12,434**
            **7,414**Non-Proven
            XXX
            XXX
            XXX
            XXX
            XXX
            XXXGrand
                Total
            XXX
            XXX
            XXX
            XXX
            XXX
            XXX




Note:
      The
      information in this Note is not contained in the Executive Summary of the
      Mid-Year 2006 Reserves and Economic Evaluation Report, but is included here
      by
      us to help provide a context to the information contained in such Report and
      set
      forth herein. Total net remaining gas of 3.24 BCF of gas in the Mid-Year 2006
      Reserves and Economic Evaluation Report compares to 7.59 BCF of gas in the
      January 2006 Reserves and Economic Evaluation Report. The significant revisions
      to the previous estimates pertain primarily to Barnett Shale area reserves
      that
      were downgraded in either valuation or from PUD to possible category reserves.
      Specifically, the changes are as follows:






·
            offsetting
                well data relating to our Riley Barnett Shale Lease for three PUDS
                provided at year-end 2005 were downgraded to possible category resulting
                in a decrease of 2.7 BCFG; this information came from offsetting
                production data differences at the two time intervals (wells in area
                previously flowing well are no longer doing so at the same or normal
                decline rates); and






·
            our
                Oliver well 1 and Oliver 2 PUD and Martin 1 wells were downgraded
                from
                production and preproduction data from well developments undertaken
                in the
                interval resulting in a net decrease of 2.2 BCFG.




In
      addition to these downgrades, changes to new wells on line and changes to values
      of wells from updates during the interval accounted for a net increase of .630
      BCFG, bringing the total net remaining gas estimate in the Mid-Year 2006
      Reserves and Economic Evaluation Report to 3.24 BCF.




In
      addition, different price assumptions were utilized in the January 2006 Reserves
      and Economic Evaluation Report ($8.20 net) and the Mid-Year 2006 Reserves and
      Economic Evaluation Report ($6.75 net). The different price assumptions,
      combined with the lower net remaining gas estimate in the Mid-Year 2006 Reserves
      and Economic Evaluation Report, resulted in significant changes in the reported
      discounted 10% present worth values of the reserves. Discounted 10% present
      worth of the reserves in the January 2006 Reserves and Economic Evaluation
      Report was $20,472,000, which was revised downward to $7,414,000 in the Mid-Year
      2006 Reserves and Economic Evaluation Report.




17




Operating
      expense data was provided and estimated by us and average monthly costs of
      approximately $1,000 per well per month were applied to the Oklahoma producing
      wells, held constant. Capital costs for new horizontal Hartshorne wells was
      estimated at $550,000 per well. For the undeveloped Texas assets, operating
      expenses of $3,500 per well per month were applied to account for water,
      compression, and other monthly expenses. Capital expenses for drilling,
      completing, and equipping a horizontal Barnett Shale well was estimated to
      be
      $2,500,000.






**Field/Reservoir
      Comments**




Monthly
      and daily production data was used with analogy declines to forecast future
      production. In addition to the Proven Producing properties, seven (7) Proven
      Non-Producing (PNP) cases were included in the evaluation. These wells are
      in
      the process of being completed or are waiting on pipeline connection. Ten (10)
      Proven Undeveloped (PUD) locations were also identified for future drilling,
      offsetting existing tested and producing wells. Only one Non-proven (Probable)
      well was forecasted for the Arkoma properties, while eighteen non-proven wells
      were forecasted in the Forth Worth Basin for Barnett Shale. Additional drilling
      and work will be performed to determine how many more wells can be identified
      and forecasted.




Much
      of
      the undeveloped leasehold in Oklahoma is adjacent to or contains wells producing
      from Booch, Cromwell, Gilcrease, Bartlesville, Hartshorne sands, and other
      intervals. Most but not all of the leasehold is limited to depths ranging from
      the surface to the base of the Hartshorne Coal. Expirations occurred in varying
      months of 2006 and will continue to occur in 2007. Additional mapping and
      reservoir evaluation is ongoing to identify additional wells to be drilled.
      The
      undeveloped value of these wells will likely increase the value significantly
      above the current valuation using the $/acre method.




Barnett
      Shale development on the Texas leasehold began in 2006 and was scheduled to
      continue at the rate of approximately 6-10 wells per year. Horizontal drilling
      has enhanced the Barnett shale potential significantly, with XXX reserves
      common. Approximately 1/4 of the leasehold is adjacent or nearby commercially
      producing Barnett shale producers. The remaining 3/4ths of the leasehold is
      in
      the areas identified as likely productive but has not been developed to the
      extent of other areas. We put this project on hold at the end of 2006 due to
      insufficient funds. We will need to raise additional capital before proceeding
      with this program.






**Disclosure
      of Reserve Information**




We
      have
      not filed any estimates of total proved net oil or gas reserves with, or
      included such information in reports to, any federal authority or agency other
      than the Securities and Exchange Commission on our Registration Statement on
      Form SB-2, our Form 10-KSB for fiscal years ended December 31, 2006 and 2005,
      and our Form 8-K dated February 1, 2006 (information from the January 2006
      Reserves and Economic Evaluation Report) and our Form 8-K dated September 28,
      2006 (information from the Mid-Year 2006 Reserves and Economic Evaluation
      Report).






**Reserve
      Quantity Information for Fiscal Year Ended December 31,
      2006**




Oil
              December
                31, 2006
            Gas
                - mcf
              December
                31, 2006Proved
                developed and undeveloped reserves:
              Beginning
                of period
            -
            12,477,000Extensions
                and discoveries
            --
            (9,233,000)Production
            --
            (153,972)Sales
                of minerals in place
            --
            --End
                of period
            --
            3,090,028Proved
                developed reserves:
              Beginning
                of period
              End
                of period
            --
              --
            1,618,000
              1,243,000Oil
                and gas applicable to long-term supply agreements with government
                or
                authorities in which the enterprise acts as a producer:
              Proved
                reserves - beginning of period
              Received
                during the period
            --
              --
            1,618,000
              (9,398,160)




**Standardized
      Measure of Discounted Future Net Cash Flows and Changes
      Therein**






18






**Relating
      to Proved Oil and Gas Reserves as of December 31, 2006**




December
                31, 2006
              TotalFuture
                cash inflows
            $
                20,990,000Future
                production and development costs
            $
                (8,556,000)Future
                income tax expense
            --Future
                net cash flows 10% annual discount
              for
                estimated timing of cash flows
            $
                (5,020,000)Standardized
                measure of discounted future net cash flows
            $
                7,414,000Sales
                and transfers of oil and gas produced, net of production
                costs
            $
                (373,220)Net
                changes in prices and production costs
            --Extensions,
                discoveries and improved recovery, less related costs
            --Development
                costs incurred during the period
            $
                10,321,714


**MATERIAL
      AGREEMENTS**




**Oak
      Hills Share Exchange Agreement**




On
      January 23, 2006, we entered into the definitive Oak Hills Share Exchange
      Agreement with Oak Hills, Oak Hills Drilling & Operating, and each of the
      Oak Hills Shareholders. Pursuant to the terms and provisions of the Oak Hills
      Share Exchange Agreement, the Oak Hills Shareholders agreed to sell to us the
      total issued and outstanding shares of Oak Hills in consideration of the
      issuance by us to the Oak Hills Shareholders of an aggregate of 6,000,000 shares
      of restricted common stock at a price of approximately $0.637645 per share.
      The
      per share consideration was calculated by reference to the fair market value
      of
      the assets of Oak Hills obtained from the independent third party valuation,
      and
      management's further calculation of net tangible value inclusive of all other
      balance sheet assets, current, and long-term liabilities of the acquired
      companies resulting in the shares issued as consideration, with such shares
      issued at a 6.3% discount to the trading value of our stock as at December
      22-23, 2005, the transaction valuation date.




19






As
      a
      consequence of the Oak Hills Share Exchange Agreement, we acquired Oak Hills
      as
      a wholly-owned subsidiary and we also indirectly acquired Oak Hills Drilling
      & Operating, as a wholly-owned subsidiary of Oak Hills.




**Asset
      Sale Agreements**




During
      the fourth quarter of 2006, management considered monetizing certain of our
      assets and those of Oak Hills in order to decrease liabilities and overhead
      incurred by us on a consolidated basis from previous capital expenditures and
      a
      lack of current debt and equity resources made available to us.





On
      January 2, 2007, our Board of Directors authorized and approved the execution
      by
      Oak Hills of an agreement dated December 29, 2006 with Innovative Energy
      Services pertaining to the sale of our Drilling Rig. In accordance with the
      Agreement, Innovative Energy Services paid to Oak Hills an aggregate amount
      of
      $3,100,000 for the Drilling Rig and related equipment.





On
      January 27, 2007, we extinguished our obligations under the convertible debt
      set-off agreement with Dylan Peyton by repaying $120,000 to Ada Energy Services
      and reclaiming our pledged collateral (two Wilson 600 duplex pumps).





On
      January 27, 2007, we sold our two Wilson 600 duplex pumps to Innovative Energy
      Services for $125,000.





On
      February 26, 2007, we sold approximately 499 acres of Barnett Shale targeted
      exploration leases located in Hood County TX resulting in net proceeds of
      approximately $379,000.




**Dylan
      Peyton Exploration Agreements**




**Arkoma
      Basin Exploration Agreement**




Lexington
      Oil & Gas entered into an exploration agreement and operating agreement
      dated effective January 31, 2006 (the "Arkoma Basin Exploration Agreement"),
      with Dylan Peyton. Pursuant to the terms and provisions of the Arkoma Basin
      Exploration Agreement: (i) we agreed with Dylan Peyton to conduct joint
      exploration and development operations, including the drilling of exploratory
      or
      development wells for the discovery of and for the production of oil and/or
      gas
      on certain of our leasehold interests located in the Arkoma Basin in McIntosh
      and Hughes Counties, Oklahoma; (ii) Avatar Energy LLC, an affiliate of Dylan
      Peyton, became the operator of the initial test well and any test well drilled
      under the terms of the Arkoma Basin Exploration Agreement; (iii) Lexington
      Oil
      and Gas assigned to Dylan Peyton an undivided 50% interest in all the Company’s
      undeveloped acreage interest in leaseholds in Coal Creek, South Lamar,
      Middlecreek, and H-9 Prospects; and (iv) Dylan Peyton paid to Lexington Oil
      and
      Gas $575,000 in consideration of the assignment.






**Comanche
      County Barnett Shale Exploration Agreement**




Lexington
      Oil & Gas entered into an exploration agreement and operating agreement
      dated effective January 31, 2006 (the "Comanche County Barnett Shale Exploration
      Agreement"), with Dylan Peyton. Pursuant to the terms and provisions of the
      Comanche County Barnett Shale Exploration Agreement: (i) we agreed with Dylan
      Peyton to conduct joint exploration and development operations, including the
      drilling of exploratory or development wells for the discovery of and for the
      production of oil and/or gas on certain leasehold interests owned by Dylan
      Peyton located in the Barnett Shale and shallow gas targets in Comanche County,
      Texas; (ii) Oak Hills shall be the operator of the project; and (iii) Lexington
      Oil & Gas will pay to Dylan Peyton approximately $1,225,500 for a 50%
      working interest in approximately 5,670 acres of new acreage located in Comanche
      County, Texas through a combination of $575,000 in cash and approximately
      $650,500 of carried drilling costs in the first test well. In September of
      2006,
      we began drilling the Petta 1 horizontal Barnett Shale well in Comanche, County,
      Texas. The well will be analyzed with a view towards possible completion once
      pipeline infrastructure in the area is further developed. Our other Barnett
      shale acreage in the Barnett Pathway Prospect or the Geneva Prospect does not
      form part of Comanche County Barnett Shale Exploration Agreement.




20






**EurXchange
      Consulting Ltd.**






We
      entered into a consulting agreement dated February 15, 2006 (the "EurXchange
      Consulting Agreement"), with EurXchange Consulting Ltd., a Canadian corporation
      ("EurXchange"). Pursuant to the terms and provisions of the EurXchange
      Consulting Agreement: (i) EurXchange agreed to render to us consulting services
      including, but not limited to, translations of webpage, business plan and new
      releases into German, establishment of communication during European business
      hours, chat line coordination, web portal presence through Wallstreet Online,
      production and distribution of a MIDAS research report and a penny stock report,
      presentation of roadshows, production of certain mailers, and establishment
      of a
      Stock Hotline telephone line; (ii) we will pay to EurXchange a cash retainer
      in
      the aggregate amount of 293,000 EUR, with the first installment of 153,000
      EUR
      due on date of execution of the EurXchange Consulting Agreement and the second
      and third installment of 70,000 EUR payable on April 15, 2006 and May 15, 2006,
      respectively; and (iii) we issued to EurXchange an aggregate of 400,000 shares
      of our restricted common stock. See "Item 5. Market for Common Equity and
      Related Stockholder Matters.”




**COAL
      BED METHANE GAS**





Natural
      gas consists primarily of methane, which is produced when organic material
      is
      physically turned into coal under extreme geologic conditions. When the coal
      and
      methane conversion process occurs such that the resultant coal is saturated
      with
      water and methane is trapped within the coal, the result is "coal bed methane."
      Water permeates coal beds and the water pressure traps the gas within the coal.
      Because coal has a large and complex internal surface area, it can store volumes
      of gas six or seven time as much as a conventional nature gas reservoir of
      equal
      rock volume. Coal bed methane is kept in place usually by the presence of water.
      Thus the production of coal bed methane in many cases requires the dewatering
      of
      the coal gas to be extracted. Therefore, in a coal bed gas well, water is
      produced in large volumes especially in the early stages of production. As
      the
      amount of water in the coal decreases, gas production increases.





The
      Barnett Shale in the Fort Worth Basin in North Texas has grown from a
      sub-economic, unconventional natural gas play to the largest onshore U.S. gas
      producing area with predictions that it may become the most prolific domestic
      onshore play.





**COMPETITION**





We
      operate in a highly competitive industry, competing with major oil and gas
      companies, independent producers and institutional and individual investors,
      which are actively seeking oil and gas properties throughout the world together
      with the equipment, labor and materials required to operate properties. Most
      of
      our competitors have financial resources, staffs and facilities substantially
      greater than ours. The principal area of competition is encountered in the
      financial ability to acquire good acreage positions and drill wells to explore
      for oil and gas, then, if warranted, drill production wells and install
      production equipment. Competition for the acquisition of oil and gas wells
      is
      intense with many oil and gas properties and or leases or concessions available
      in a competitive bidding process in which we may lack technological information
      or expertise available to other bidders. Therefore, we may not be successful
      in
      acquiring and developing profitable properties in the face of this competition.
      No assurance can be given that a sufficient number of suitable oil and gas
      wells
      will be available for acquisition and development.





**GOVERNMENT
      REGULATION**





**General**





The
      production and sale of oil and gas are subject to various federal, state and
      local governmental regulations, which may be changed from time to time in
      response to economic or political conditions and can have a significant impact
      upon overall operations. Matters subject to regulation include discharge permits
      for drilling operations, drilling bonds, reports concerning operations, the
      spacing of wells, unitization and pooling of properties, taxation, abandonment
      and restoration and environmental protection. These laws and regulations are
      under constant review for amendment or expansion. From time to time, regulatory
      agencies have imposed price controls and limitations on production by
      restricting the rate of flow of oil and gas wells below actual production
      capacity in order to conserve supplies of oil and gas. Changes in these
      regulations could require us to expend significant resources to comply with
      new
      laws or regulations or changes to current requirements and could have a material
      adverse effect on us.


21







**Oil
      and Gas Regulation**





The
      governmental laws and regulations which could have a material impact on the
      oil
      and gas exploration and production industry are as follows:





**Drilling
      and Production**





Our
      operations are subject to various types of regulation at federal, state, local
      and Native American tribal levels. These types of regulation include requiring
      permits for the drilling of wells, drilling bonds and reports concerning
      operations. Most states, and some counties, municipalities and Native American
      tribes, in which we operate also regulate one or more of the following: (i)
      the
      location of wells; (ii) the method of drilling and casing wells; (iii) the
      rates
      of production or “allowables”; (iv) the surface use and restoration of
      properties upon which wells are drilled and other third parties; (v) the
      plugging and abandoning of wells; and (vi) notice to surface owners and
      other third parties.





State
      laws regulate the size and shape of drilling and spacing units or pro-ration
      units governing the pooling of oil and natural gas properties. Some states
      allow
      forced pooling or integration of tracts to facilitate exploration while other
      states rely on voluntary pooling of lands and leases. In some instances, forced
      pooling or unitization may be implemented by third parties and may reduce our
      interest in the unitized properties. In addition, state conservation laws
      establish maximum rates of production from oil and natural gas wells, generally
      prohibit the venting or flaring of natural gas and impose requirements regarding
      the ratability of production. These laws and regulations may limit the amount
      of
      natural gas and oil we can produce from our wells or limit the number of wells
      or the locations at which we can drill. 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.





**Natural
      Gas Sales Transportation**





Historically,
      federal legislation and regulatory controls have affected the price of the
      natural gas we produce and the manner in which we market our production. The
      Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the
      transportation and sale for resale of natural gas in interstate commerce by
      natural gas companies under the Natural Gas Act of 1938 and the Natural Gas
      Policy Act of 1978.





FERC
      also
      regulates interstate natural gas transportation rates and service conditions,
      which affects the marketing of natural gas that we produce, as well as the
      revenues we receive for sales of our natural gas. Commencing in 1985, FERC
      promulgated a series of orders, regulations and rule makings that significantly
      fostered competition in the business of transporting and marketing gas. Today,
      interstate pipeline companies are required to provide nondiscriminatory
      transportation services to producers, marketers and other shippers, regardless
      of whether such shippers are affiliated with an interstate pipeline company.
      Under FERC’s current regulatory regime, transmission services must be provided
      on an open-access, non-discriminatory basis at cost-based rates or at
      market-based rates if the transportation market at issue is sufficiently
      competitive.





**Mineral
      Act**





The
      Mineral Leasing Act of 1920 ("Mineral Act") prohibits direct or indirect
      ownership of any interest in federal onshore oil and gas leases by a foreign
      citizen of a country that denies "similar or like privileges" to citizens of
      the
      United States. Such restrictions on citizens of a "non-reciprocal" country
      include ownership or holding or controlling stock in a corporation that holds
      a
      federal onshore oil and gas lease. If this restriction is violated, the
      corporation's lease can be canceled in a proceeding instituted by the United
      States Attorney General. Although the regulations of the Bureau of Land
      Management (which administers the Mineral Act) provide for agency designations
      of non-reciprocal countries, there are presently no such designations in effect.


22


**Environmental
      Regulation**





Our
      activities will be subject to existing federal, state and local laws and
      regulations governing environmental quality and pollution control. Our
      operations will be subject to stringent environmental regulation by state and
      federal authorities including the Environmental Protection Agency ("EPA").
      Such
      regulation can increase the cost of such activities. In most instances, the
      regulatory requirements relate to water and air pollution control
      measures.





**Waste
      Disposal**





The
      Resource Conservation and Recovery Act (“RCRA”), and comparable state statutes,
      affect oil and gas exploration and production activities by imposing regulations
      on the generation, transportation, treatment, storage, disposal and cleanup
      of
“hazardous wastes” and on the disposal of non-hazardous wastes. Under the
      auspices of the EPA, the individual states administer some or all of the
      provisions of RCRA, sometimes in conjunction with their own, more stringent
      requirements. Drilling fluids, produced waters, and most of the other wastes
      associated with the exploration, development, and production of crude oil,
      natural gas, or geothermal energy constitute “solid wastes”, which are regulated
      under the less stringent non-hazardous waste provisions, but there is no
      guarantee that the EPA or the individual states will not adopt more stringent
      requirements for the handling of non-hazardous wastes or categorize some
      non-hazardous wastes as hazardous for future regulation.





**Comprehensive
      Environmental Response, Compensation and Liability Act**





The
      federal Comprehensive Environmental Response, Compensation and Liability Act
      ("CERCLA") imposes joint and several liability for costs of investigation and
      remediation and for natural resource damages, without regard to fault or the
      legality of the original conduct, on certain classes of persons with respect
      to
      the release into the environment of substances designated under CERCLA as
      hazardous substances ("Hazardous Substances"). These classes of persons or
      potentially responsible parties include the current and certain past owners
      and
      operators of a facility or property where there is or has been a release or
      threat of release of a Hazardous Substance and persons who disposed of or
      arranged for the disposal of the Hazardous Substances found at such a facility.
      CERCLA also authorizes the EPA and, in some cases, third parties to take actions
      in response to threats to the public health or the environment and to seek
      to
      recover the costs of such action. Although CERCLA generally exempts petroleum
      from the definition of Hazardous Substances in the course operations, we may
      in
      the future generate wastes that fall within CERCLA's definition of Hazardous
      Substances. We may also in the future become an owner of facilities on which
      Hazardous Substances have been released by previous owners or operators. We
      may
      in the future be responsible under CERCLA for all or part of the costs to clean
      up facilities or property at which such substances have been released and for
      natural resource damages.





**Air
      Emissions**





Our
      operations are subject to local, state and federal regulations for the control
      of emissions of air pollution. Major sources of air pollutants are subject
      to
      more stringent, federally imposed permitting requirements. Administrative
      enforcement actions for failure to comply strictly with air pollution
      regulations or permits are generally resolved by payment of monetary fines
      and
      correction of any identified deficiencies. Alternatively, regulatory agencies
      could require us to forego construction, modification or operation of certain
      air emission sources.





**Clean
      Water Act**





The
      Clean
      Water Act ("CWA") imposes restrictions and strict controls regarding the
      discharge of wastes, including produced waters and other oil and natural gas
      wastes, into waters of the United States, a term broadly defined. Permits must
      be obtained to discharge pollutants into federal waters. The CWA provides for
      civil, criminal and administrative penalties for unauthorized discharges of
      oil,
      hazardous substances and other pollutants. It imposes substantial potential
      liability for the costs of removal or remediation associated with discharges
      of
      oil or hazardous substances. State laws governing discharges to water also
      provide varying civil, criminal and administrative penalties and impose
      liabilities in the case of a discharge of petroleum or it derivatives, or other
      hazardous substances, into state waters. In addition, the EPA has promulgated
      regulations that may require us to obtain permits to discharge storm water
      runoff. In the event of an unauthorized discharge of wastes, we may be liable
      for penalties and costs.




Management
      believes that we are in substantial
      compliance with current applicable environmental laws and regulations.


23




**RESEARCH
      AND DEVELOPMENT ACTIVITIES**





No
      research and development expenditures have been incurred, either on our account
      or sponsored by customers, during the past three years.





**EMPLOYEES**





We
      do not
      employ any persons on a full-time or on a part-time basis. Grant Atkins is
      our
      President and Chief Executive Officer and Douglas Humphreys is the Drilling
      Operations Manager of Lexington Oil & Gas. These individuals are primarily
      responsible for all our day-to-day operations. Other services are provided
      by
      outsourcing, consultant, and special purpose contracts. Our current designated
      drilling contractor and well operator is Oak Hills.





**RISK
      FACTORS**





An
      investment in our common stock involves a number of very significant risks.
      You
      should carefully consider the following risks and uncertainties in addition
      to
      other information in evaluating our company and its business before purchasing
      shares of our common stock. Our business, operating results and financial
      condition could be seriously harmed due to any of the following risks. The
      risks
      described below are all of the material risks that we are currently aware of
      that are facing our company. Additional risks not presently known to us may
      also
      impair our business operations. You could lose all or part of your investment
      due to any of these risks.





**Risks
      Related to Our Business**





**Our
      business is difficult to evaluate because we have a limited operating
      history.**





In
      considering whether to invest in our common stock, you should consider that
      there is only limited historical financial and operating information available
      on which to base your evaluation of our performance. Our inception as an oil
      and
      gas exploration company was November 2003 and, as a result, we have a limited
      operating history.





**We
      have a history of operating losses and there can be no assurances we will be
      profitable in the future** .





We
      have a history of operating losses, expect to continue to incur losses, and
      may
      never be profitable, and we must be considered to be in the development stage.
      Further, we have been dependent on sales of our equity securities and debt
      financing to meet our cash requirements. We have incurred losses totaling
      approximately $10,576,849 for fiscal year ended December 31, 2006. As of
      December 31, 2006, we had a working capital deficit of $8,234,830. Further,
      we
      do not expect positive cash flow from operations in the near term. There is
      no
      assurance that actual cash requirements will not exceed our estimates. In
      particular, additional capital may be required in the event that: (i) the costs
      to acquire additional leases are more than we currently anticipate; (ii)
      drilling and completion costs for additional wells increase beyond our
      expectations; or (iii) we encounter greater costs associated with general and
      administrative expenses or offering costs.





Our
      development of and participation in an increasingly larger number of oil and
      gas
      prospects has required and will continue to require substantial capital
      expenditures. The uncertainty and factors described throughout this section
      may
      impede our ability to economically find, develop, exploit, and acquire natural
      gas and oil reserves. As a result, we may not be able to achieve or sustain
      profitability or positive cash flows from operating activities in the future.





**We
      have received a going concern opinion from our independent auditors report
      accompanying our December 31, 2006 and 2005 consolidated financial
      statements.**





The
      independent registered independent accounting firm's report
      accompanying our December 31, 2006 and 2005 consolidated financial statements
      contains an explanatory paragraph expressing substantial doubt about our ability
      to continue as a going concern. The consolidated financial statements have
      been
      prepared “assuming that the Company will continue as a going concern,” which
      contemplates that we will realize our assets and satisfy our liabilities and
      commitments in the ordinary course of business. Our ability to continue as
      a
      going concern is dependent on raising additional capital to fund our operations
      and ultimately on generating future profitable operations. There can be no
      assurance that we will be able to raise sufficient additional capital or
      eventually have positive cash flow from operations to address all of our cash
      flow needs. If we are not able to find alternative sources of cash or generate
      positive cash flow from operations, our business and shareholders will be
      materially and adversely affected.


24





**We
      will require additional funding in the future.**





Based
      upon our historical losses from operations, we will require additional funding
      in the future. If we cannot obtain capital through financings or otherwise,
      our
      ability to execute our development plans and achieve production levels will
      be
      greatly limited. Our current development plans require us to make capital
      expenditures for the exploration and development of our oil and natural gas
      properties. Historically, we have funded our operations through the issuance
      of
      equity and short-term debt financing arrangements. We may not
      be able to obtain additional financing on favorable terms, if at all .
      Our
      future cash flows and the availability of financing will be subject to a number
      of variables, including potential production and the market prices of oil and
      natural gas. Further, debt financing could lead to a diversion of cash flow
      to
      satisfy debt-servicing obligations and create restrictions on business
      operations. If we
      are unable to raise additional funds, it would have a material adverse effect
      upon our operations.





**Our
      acquisitions may not be successful.**





As
      part
      of our growth strategy, we intend to acquire additional oil and gas production
      properties. Such acquisitions may pose substantial risks to our business,
      financial condition, and results of operations. In pursuing acquisitions, we
      will compete with other companies, many of which have greater financial and
      other resources to acquire attractive properties. Even if we are successful
      in
      acquiring additional properties, some of the properties may not produce revenues
      at anticipated levels or failure to conduct drilling on prospects within
      specified time periods may cause the forfeiture of the lease in that prospect.
      There can be no assurance that we will be able to successfully integrate
      acquired properties, which could result in substantial costs and delays or
      other
      operational, technical, or financial problems. Further, acquisitions could
      disrupt ongoing business operations. If any of these events occur, it would
      have
      a material adverse effect upon our operations and results from
      operations.




**Our
      exploratory and development drilling and production operations may not be
      successful.**





We
      intend
      to drill additional wells and continue production operations on our current
      wells. There can be no assurance that our future drilling activities will be
      successful, and we cannot be sure that our overall drilling success rate or
      our
      production operations within a particular area will not decline. We may not
      recover all or any portion of our capital investment in the wells or the
      underlying leaseholds. Unsuccessful drilling activities would have a material
      adverse effect upon our results of operations and financial condition. The
      cost
      of drilling, completing, and operating wells is often uncertain, and a number
      of
      factors can delay or prevent drilling operations including: (i) unexpected
      drilling conditions; (ii) pressure or irregularities in formation; (iii)
      equipment failures or accidents; (iv) adverse weather conditions; and (iv)
      shortages or delays in availability of drilling rigs and delivery of equipment.





Further,
      the coal beds in the Arkoma Basin in the State of Oklahoma from which we produce
      methane gas frequently contain water, which may hamper our ability to produce
      gas in commercial quantities. The amount of coal bed methane that can be
      commercially produced depends upon the coal quality, the original gas content
      of
      the coal seam, the thickness of the seam, the reservoir pressure, the rate
      at
      which gas is released from the coal, and the existence of any natural fractures
      through which the gas can flow to the well bore. However, coal beds frequently
      contain water that must be removed in order for the gas to detach from the
      coal
      and flow to the well bore. The average life of a coal bed well is only five
      to
      six years. Our ability to remove and dispose of sufficient quantities of water
      from the coal seam will determine whether or not we can produce coal bed methane
      in commercial quantities.




In
      addition, there is a risk of a failure during our drilling for natural gas
      in
      the Barnett Shale in the State of Texas. The reason for failure in the Barnett
      Shale Play is spacing and depth which are essential in producing from this
      zone.
      A fine layer of obsidian covers the Ellenberger zone which must be watched
      and
      avoided in the core areas. If, during our horizontal drilling, one of the
      fractures goes into the Ellenberger Zone which is below the Barnett Shale then
      all of the gas will follow the path of least resistance and follow into the
      Ellenberger zone which is an underground ocean itself and the well will not
      be
      successful.




25







**A
      decline in the price of our common stock could affect our ability to raise
      further working capital and adversely impact our
      operations.**





A
      decline
      in the price of our common stock could result in a reduction in the liquidity
      of
      our common stock and a reduction in our ability to raise additional capital
      for
      our operations. Because our operations to date have been principally financed
      through the sale of equity securities, a decline in the price of our common
      stock could have an adverse effect upon our liquidity and our continued
      operations. A reduction in our ability to raise equity capital in the future
      would have a material adverse effect upon our business plan and operations,
      including our ability to continue our current operations. If our stock price
      declines, we may not be able to raise additional capital or generate funds
      from
      operations sufficient to meet our obligations.





**We
      are a new entrant into the oil and gas industry without profitable operating
      history and only have proved developed producing future net revenue of
      $2,200,000 at a 10% discounted present worth.**





Since
      September 29, 2003 (inception), our activities have been limited to
      organizational efforts, obtaining working capital and acquiring and developing
      a
      very limited number of properties. As a result, there is limited information
      regarding production or revenue generation. Further, a Reserve and Economic
      Evaluation initially prepared on August 7, 2006 and finalized on September
      23,
      2006 by Pinnacle Energy Services, LLC (based on evaluation of our assets as
      of
      July 1, 2006), shows proven developed producing future net revenue of $2,200,000
      (before income taxes) at a 10% discounted present worth. As a result, our future
      revenues may be limited.





Our
      prospects are still in the development stage, and estimates made at this time
      by
      our contracted independent reservoir engineer as to proved or probable oil
      and
      natural gas reserves cannot be guaranteed that sufficient reserves will be
      maintained or new reserves discovered for production. Although several wells
      have been drilled to date and several others are nearing completion, the absence
      of a sustained production history provides risk regarding independent reserve
      estimates. Property lease positions in other locations that have been purchased
      by us are unproved, having little to no production, which prevents our engineers
      from assigning any proved or probable reserves to these other
      properties.




**No
      assurance of the accuracy of the estimates of oil and gas
      reserves** .





We
      have
      obtained a report on the estimated reserves. Reserve estimates are based upon
      various assumptions, including assumptions relating to oil and gas prices,
      drilling and operating expenses, production levels, capital expenditures, taxes
      and availability of funds. No one can measure underground accumulations of
      oil
      and natural gas in an exact way. As a result, estimated quantities of proved
      reserves, projections of future production rates, and the timing of development
      expenditures may be incorrect. Any significant variance from these assumptions
      to actual figures could greatly affect our estimates of reserves, the
      economically recoverable quantities of oil and natural gas attributable to
      any
      particular group of properties, the classifications of reserves based on risk
      of
      recovery, and estimates of the future net cash flows.





Further,
      the present value of future net cash flows from our proved reserves is not
      necessarily the same as the current market value of our estimated oil and
      natural gas reserves. Actual future net cash flows from our oil and natural
      gas
      properties also will be affected by factors such as: (i) actual prices we
      receive for oil and natural gas; (ii) the amount and timing of actual
      production; (iii) the amount and timing of operating costs incurred; (iv) supply
      of and demand for oil and natural gas; and (v) changes in governmental
      regulations or taxation.





The
      timing of both our production and our incurrence of expenses in connection
      with
      the development and production of oil and natural gas properties will affect
      the
      timing of actual future net cash flows from proved reserves, and thus their
      actual present value. In addition, the 10% discount factor used when calculating
      discounted future net cash flows may not be the most appropriate discount factor
      based on interest rates in effect from time to time and risks associated with
      us
      or the oil and natural gas industry in general. Actual future production, oil
      and gas prices, revenues, taxes, development expenditures, operating expenses
      and quantities of recoverable oil and gas reserves will most likely vary from
      those estimates and any significant variance could have a material adverse
      effect on our future results from operations.


26







**Unless
      we replace our oil and natural gas reserves, our reserves and production will
      decline, which would adversely affect our business, financial condition and
      results of operations.**





Producing
      oil and natural gas reservoirs generally are characterized by declining
      production rates that vary depending upon reservoir characteristics and other
      factors. Thus, 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. We may not be able to
      develop, find or acquire additional reserves to replace our current and future
      production at acceptable costs.





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





We
      describe some of our current prospects in this Annual Report. Our prospects
      are
      in various stages of evaluation, ranging from a prospect that is ready to drill
      to a prospect that will require substantial additional seismic data processing
      and interpretation. However, 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 and testing whether natural gas or oil will
      be
      present or, if present, whether natural gas or oil will be present in sufficient
      quantities to recover drilling or completion costs or to be economically viable.
      If we drill additional wells that we identify as dry holes in our current and
      future prospects, our drilling success rate may decline and materially harm
      our
      business. In sum, the cost of drilling, completing and operating any wells
      is
      often uncertain and new wells may not be productive.





**We
      are substantially dependent on properties located in the Arkoma Basin, which
      causes our risk to be concentrated.**





All
      of
      our producing wells and leases are located in the Arkoma Basin in the State
      of
      Oklahoma. As a result, we may be disproportionately exposed to the impact of
      delays or interruptions of production from these wells caused by significant
      governmental regulation, transportation capacity constraints, curtailment of
      production or interruption of transportation of natural gas produced from the
      wells in this basin.





**Properties
      that we buy may not produce as projected and we may be unable to determine
      reserve potential, identify liabilities associated with the properties or obtain
      protection from sellers against them.**





One
      of
      our growth strategies is to capitalize on opportunistic acquisitions of oil
      and
      natural gas reserves. However, our reviews of acquired properties are inherently
      incomplete because it generally is not feasible to review in depth every
      individual property involved in each acquisition. A detailed review of records
      and properties may not necessarily reveal existing or potential problems, nor
      will it permit a buyer to become sufficiently familiar with the properties
      to
      assess fully their deficiencies and potential. Further, environmental problems,
      such as ground water contamination, are not necessarily observable even when
      an
      inspection is undertaken. Acquiring properties with liabilities would have
      a
      material adverse effect upon our results of operations.





**The
      potential profitability of oil and gas ventures depends upon factors beyond
      our
      control.**





The
      potential profitability of oil and gas properties is dependent upon many factors
      beyond our control. For instance, world prices and markets for oil and gas
      are
      unpredictable, highly volatile, potentially subject to governmental fixing,
      pegging, controls, or any combination of these and other factors, and respond
      to
      changes in domestic, international, political, social, and economic
      environments. Additionally, due to worldwide economic uncertainty, the
      availability and cost of funds for production and other expenses have become
      increasingly difficult, if not impossible, to project. These and other changes
      and events may materially affect our financial performance.







27


Adverse
      weather conditions can also hinder drilling operations. A productive well may
      become uneconomic in the event water or other deleterious substances are
      encountered which impair or prevent the production of oil and/or gas from
      the well. In addition, production from any well may be unmarketable if it is
      impregnated with water or other deleterious substances. The marketability of
      oil
      and gas, which may be acquired or discovered will be affected by numerous
      factors beyond our control. These factors include, but are not limited to,
      the
      proximity and capacity of oil and gas pipelines and processing equipment, market
      fluctuations of prices, taxes, royalties, land tenure, allowable production
      and
      environmental protection. These factors cannot be accurately predicted and
      the
      combination of these factors may result in us not receiving an adequate return
      on our invested capital.





**We
      are dependent upon transportation and storage services provided by third
      parties.**





We
      will
      be dependent on the transportation and storage services offered by various
      interstate and intrastate pipeline companies for the delivery and sale of our
      gas supplies. Both the performance of transportation and storage services by
      interstate pipelines and the rates charged for such services are subject to
      the
      jurisdiction of the Federal Energy Regulatory Commission or state regulatory
      agencies. An inability to obtain transportation and/or storage services at
      competitive rates could hinder our processing and marketing operations and/or
      affect our sales margins.





**Our
      results of operations are dependent upon market prices for oil and natural
      gas,
      which fluctuate widely and are beyond our control.**





Our
      revenue, profitability, and cash flow depend upon the prices and demand for
      oil
      and natural gas. The markets for these commodities are very volatile and even
      relatively modest drops in prices can significantly affect our financial results
      and impede our growth. Prices received also will affect the amount of future
      cash flow available for capital expenditures and may affect our ability to
      raise
      additional capital. Lower prices may also affect the amount of natural gas
      and
      oil that can be economically produced from reserves either discovered or
      acquired.





Factors
      that can cause price fluctuations include: (i) the level of consumer product
      demand; (ii) weather conditions; (iii) domestic and foreign governmental
      regulations; (iv) the price and availability of alternative fuels; (v) technical
      advances affecting energy consumption; (vi) proximity and capacity of oil and
      gas pipelines and other transportation facilities; (vii) political conditions
      in
      natural gas and oil producing regions; (viii) the domestic and foreign supply
      of
      natural gas and oil; (ix) the ability of members of Organization of Petroleum
      Exporting Countries to agree to and maintain oil price and production controls;
      (x) the price of foreign imports; and (xi) overall domestic and global economic
      conditions.





The
      availability of a ready market for our oil and gas depends upon numerous factors
      beyond our control, including the extent of domestic production and importation
      of oil and gas, the relative status of the domestic and international economies,
      the proximity of our properties to gas gathering systems, the capacity of those
      systems, the marketing of other competitive fuels, fluctuations in seasonal
      demand and governmental regulation of production, refining, transportation
      and
      pricing of oil, natural gas and other fuels.





**The
      oil and gas industry in which we operate involves many operating risks that
      can
      cause substantial losses** *.*





Our
      drilling activities are subject to many risks, including the risk that we will
      not discover commercially productive reservoirs. Drilling for oil and natural
      gas can be unprofitable, not only from dry holes, but from productive wells
      that
      do not produce sufficient revenues to return a profit. In addition, our drilling
      and producing operations may be curtailed, delayed or canceled as a result
      of
      other factors, including: (i) fires; (ii) explosions; (iii) blow-outs and
      surface cratering; (iv) uncontrollable flows of underground natural gas, oil,
      or
      formation water; (v) natural disasters; (vi) facility and equipment failures;
      (vii) title problems; (viii) shortages or delivery delays of equipment and
      services; (ix) abnormal pressure formations; and (x) environmental hazards
      such
      as natural gas leaks, oil spills, pipeline ruptures and discharges of toxic
      gases.





If
      any of
      these events occur, we could incur substantial losses as a result of (i) injury
      or loss of life; (ii) severe damage to and destruction of property, natural
      resources or equipment; (iii) pollution and other environmental damage; (iv)
      clean-up responsibilities; (v) regulatory investigation and penalties; (vi)
      suspension of our operations; or (vii) repairs necessary to resume
      operations.


28


If
      we
      were to experience any of these problems, it could affect well bores, gathering
      systems and processing facilities, any one of which could adversely affect
      our
      ability to conduct operations. We may be affected by any of these events more
      than larger companies, since we have limited working capital. We currently
      maintain $2 million of liability insurance on bodily injury per year, for up
      to
      25 wells, which includes coverage for pollution, environmental damage and
      chemical spills. However, for some risks, we may elect not to obtain insurance
      if we believe 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, it could adversely affect operations. Moreover,
      we
      cannot provide assurance that we will be able to maintain adequate insurance
      in
      the future at rates considered reasonable.





**The
      oil and gas industry is highly competitive and there is no assurance that we
      will be successful in acquiring the leases** *.*





The
      oil
      and natural gas industry is intensely competitive, and we compete with other
      companies that have greater resources. Many of these companies not only explore
      for and produce oil and natural gas, but also carry on refining operations
      and
      market petroleum and other products on a regional, national or worldwide basis.
      These companies may be able to pay more for productive oil and natural gas
      properties and exploratory prospects or define, evaluate, bid for and purchase
      a
      greater number of properties and prospects than our financial or human resources
      permit. In addition, these companies may have a greater ability to continue
      exploration activities during periods of low oil and natural gas market prices.
      Our larger competitors may be able to absorb the burden of present and future
      federal, state, local and other laws and regulations more easily than we can,
      which would adversely affect our competitive position. Our ability to acquire
      additional properties and to discover reserves in the future will be dependent
      upon our ability to evaluate and select suitable properties and to consummate
      transactions in a highly competitive environment. In addition, because we have
      fewer financial and human resources than many companies in our industry, we
      may
      be at a disadvantage in bidding for exploratory prospects and producing oil
      and
      natural gas properties.





**There
      can be no assurance we will be able to obtain drilling equipment to meet our
      drilling requirements.**





There
      is
      currently a high demand for drilling equipment. We have experienced delays
      in
      the past in obtaining drilling rigs. While our exploration agreement with Dylan
      Peyton LLC has given us access to drill rigs to develop our properties, we
      may
      still encounter limitations with respect to drilling equipment. There can be
      no
      assurance that we will be able to obtain the requisite drilling equipment to
      meet our planned drilling initiatives according to our timetable. In the event
      that we are unable to obtain drilling equipment to conduct our exploration
      operations, it could have a material adverse effect upon our business and our
      results of operations.





**The
      marketability of natural resources will be affected by numerous factors beyond
      our control which may result in us not receiving an adequate return on invested
      capital to be profitable or viable.**





The
      marketability of natural resources which may be acquired or discovered by us
      will be affected by numerous factors beyond our control. These factors include
      market fluctuations in oil and gas pricing and demand, the proximity and
      capacity of natural resource markets and processing equipment, governmental
      regulations, land tenure, land use, regulation concerning the importing and
      exporting of oil and gas and environmental protection regulations. The exact
      effect of these factors cannot be accurately predicted, but the combination
      of
      these factors may result in us not receiving an adequate return on invested
      capital to be profitable or viable.





**Oil
      and gas operations are subject to comprehensive regulation which may cause
      substantial delays or require capital outlays in excess of those anticipated
      causing an adverse effect on our company.**





Oil
      and
      gas operations are subject to federal, state, and local laws relating to the
      protection of the environment, including laws regulating removal of natural
      resources from the ground and the discharge of materials into the environment.
      Oil and gas operations are also subject to federal, state, and local laws and
      regulations which seek to maintain health and safety standards by regulating
      the
      design and use of drilling methods and equipment. Various permits from
      government bodies are required for drilling operations to be conducted; no
      assurance can be given that such permits will be received. Environmental
      standards imposed by federal, provincial, or local authorities may be changed
      and any such changes may have material adverse effects on our activities.
      Moreover, compliance with such laws may cause substantial delays or require
      capital outlays in excess of those anticipated, thus causing an adverse effect
      on us. Additionally, we may be subject to liability for pollution or other
      environmental damages which we may elect not to insure against due to
      prohibitive premium costs and other reasons. To date we have not been required
      to spend material amounts on compliance with environmental regulations. However,
      we may be required to do so in future and this may affect our ability to expand
      or maintain our operations.


29





**Exploration
      and production activities are subject to certain environmental regulations
      which
      may prevent or delay the commencement or continuance of our
      operations.**





In
      general, our exploration and production activities are subject to certain
      federal, state and local laws and regulations relating to environmental quality
      and pollution control. Such laws and regulations increase the costs of these
      activities and may prevent or delay the commencement or continuance of a given
      operation. Compliance with these laws and regulations has not had a material
      effect on our operations or financial condition to date. Specifically, we are
      subject to legislation regarding emissions into the environment, water
      discharges and storage and disposition of hazardous wastes. In addition,
      legislation has been enacted which requires well and facility sites to be
      abandoned and reclaimed to the satisfaction of state authorities. However,
      such
      laws and regulations are frequently changed and we are unable to predict the
      ultimate cost of compliance. Generally, environmental requirements do not appear
      to affect us any differently or to any greater or lesser extent than other
      companies in the industry.





We
      believe that our operations comply, in all material respects, with all
      applicable environmental regulations. However, we are not fully insured against
      all possible environmental risks.





**Any
      change to government regulation/administrative practices may have a negative
      impact on our ability to operate and our profitability.**





The
      laws,
      regulations, policies or current administrative practices of any government
      body, organization or regulatory agency in the United States or any other
      jurisdiction, may be changed, applied or interpreted in a manner which will
      fundamentally alter our ability to carry on business. The actions, policies
      or
      regulations, or changes thereto, of any government body or regulatory agency,
      or
      other special interest groups, may have a detrimental effect on us. Any or
      all
      of these situations may have a negative impact on our ability to operate and/or
      our profitably.





**We
      may be unable to retain key employees or consultants or recruit additional
      qualified personnel.**





Our
      extremely limited personnel means that we would be required to spend significant
      sums of money to locate and train new employees in the event any of our
      employees resign or terminate their employment with us for any reason. Due
      to
      our limited operating history and financial resources, we are entirely dependent
      on the continued service of Grant Atkins, Chief Executive Officer and Douglas
      Humphreys, Drilling Operations Manager of Lexington Oil & Gas. Further, we
      do not have key man life insurance on either of these individuals. We may not
      have the financial resources to hire a replacement if one or both of our
      officers were to die. The loss of service of either of these employees could
      therefore significantly and adversely affect our operations.





**Our
      officers and directors may be subject to conflicts of
      interest.**





Our
      officers and directors serve only part time and are subject to conflicts of
      interest. Each of our executive officers and directors serves only on a part
      time basis. Each devotes part of his working time to other business endeavors,
      much time to devote to our affairs, as well as what business opportunities
      should be presented to the company. Such conflicts include deciding how much
      time to devote to our affairs, as well as what business opportunities should
      be
      presented to the company. Because of these relationships, our officers and
      directors will be subject to conflicts of interest.





**Risks
      Related to Our Common Stock**





Sales
      of
      a substantial number of shares of our common stock into the public market by
      certain stockholders may result in significant downward pressure on the price
      of
      our common stock and could affect your ability to realize the current trading
      price of our common stock.


30


As
      of the
      date of this Annual Report, we have 38,766,270 shares of our common stock issued
      and outstanding. Of the total number of issued and outstanding shares of common
      stock, certain stockholders will be able to resell up to 13,868,000 pursuant
      to
      a registration statement filed on Form SB-2 under the Securities Act of 1933,
      as
      amended (the “Securities Act”) with the Securities and Exchange Commission,
      which was declared effective approximately November 30, 2005 (the “2005
      Registration Statement”). Pursuant to the 2005 Registration Statement: (i)
      233,000 shares of common stock underlying certain common stock purchase warrants
      issuable at an exercise price of $3.00; (ii) 200,000 shares of our common stock;
      (iii) up to 10,255,000 shares of common stock underlying certain secured
      convertible notes; (iv) 586,000 shares of common stock underlying a finders
      warrants issuable at an exercise price of $1.00 per share were registered;
      and
      (v) 2,930,000 shares of common stock underlying Class B common stock purchase
      warrants issuable at an exercise price of $1.00 per share were registered,
      which, if exercised, would have an adverse effect on the price of our common
      stock. A further 2,680,000 Class B common stock warrants issuable at an exercise
      price of $1.00 per share were registered and expired according to their terms.
      As a result of the 2005 Registration Statement, an aggregate of 13,868,000
      shares of our common stock were available for immediate resale, which could
      have
      an adverse effect on the price of our common stock. To the extent stockholders
      exercised the warrants and resold the shares of common stock issued to them
      upon
      such exercise (subject to applicable securities law restrictions), the price
      of
      our common stock may decrease due to the additional shares of common stock
      in
      the market.




In
      addition, on July 2, 2006, we filed a registration statement on Form SB-2 (the
      “2006 Registration Statement”) under the Securities Act to register an aggregate
      of 16,065,000 shares of our common stock as follows: (i) 8,415,000 shares of
      our
      common stock issued; and (ii) 7,650,000 shares of common stock underlying
      certain common stock purchase warrants issuable at an exercise price of $1.25
      per share. As of the date of this Annual Report, the 2006 Registration Statement
      has not been declared effective. When declared effective and the shares are
      registered, the 7,650,000 shares of common stock issued would be available
      for
      immediate resale and if sold would have an adverse effect on the price of our
      common stock. The 7,650,000 shares of common stock underlying the common stock
      purchase warrants would be registered and which, if exercised, would have an
      adverse effect on the price of our common stock. To the extent stockholders
      exercised the warrants and resold the shares of common stock issued to them
      upon
      such exercise (subject to applicable securities law restrictions), the price
      of
      our common stock may decrease due to the additional shares of common stock
      in
      the market. See “Item 5. Market for Common Equity and Related Stockholder
      Matters.”




As
      of the
      date of this Annual Report, there are 24,649,251 outstanding shares of our
      common stock that are restricted securities as that term is defined in Rule
      144
      under the Securities Act. Although the Securities Act and Rule 144 place certain
      prohibitions on the sale of restricted securities, restricted securities may
      be
      sold into the public market under certain conditions. Further, as of December
      31, 2006, there are an aggregate of 1,285,000 Stock Options and 11,399,000
      Warrants outstanding.





Any
      significant downward pressure on the price of our common stock as the selling
      stockholders sell their shares of our common stock could encourage short sales
      by the selling stockholders or others. Any such short sales could place further
      downward pressure on the price of our common stock.


**The
      trading price of our common stock on the OTC Bulletin Board has been and may
      continue to fluctuate significantly and stockholders may have difficulty
      reselling their shares.**





Our
      common stock has traded as low as $0.10 and as high as $7.46 (adjusted for
      pre
      split share prices on a 3 new shares for 1 old share effected January 28, 2004).
      In addition to volatility associated with Bulletin Board securities in general,
      the value of your investment could decline due to the impact of any of the
      following factors upon the market price of our common stock: (i) changes in
      the
      world wide price for oil or natural gas; (ii) disappointing results from our
      discovery or development efforts; (iii) failure to meet our revenue or profit
      goals or operating budget; (iv) decline in demand for our common stock; (v)
      downward revisions in securities analysts' estimates or changes in general
      market conditions; (vi) technological innovations by competitors or in competing
      technologies; (vii) lack of funding generated for operations; (viii) investor
      perception of our industry or our prospects; and (ix) general economic
      trends.


31





In
      addition, stock markets have experienced price and volume fluctuations and
      the
      market prices of securities have been highly volatile. These fluctuations are
      often unrelated to operating performance and may adversely affect the market
      price of our common stock. As a result, investors may be unable to sell their
      shares at a fair price and you may lose all or part of your
      investment.





**One
      of our shareholders may exercise voting power of more than 15% of our common
      stock.**





As
      of the
      date of this Annual Report, Orient Exploration, Inc. (“Orient Exploration”) owns
      6,000,000 shares of our common stock, or 15.48% of our outstanding common stock
      and is one of our largest shareholders. Due to its stock ownership, Orient
      Exploration may be in a position to effect control to elect our Board of
      Directors and, therefore, to affect the control our business and affairs
      including certain significant corporate actions such as acquisitions, the sale
      or purchase of assets, and the issuance and sale of our securities. Further,
      Orient Exploration may be able to prevent or cause a change in control. We
      also
      may be prevented from entering into transactions that could be beneficial to
      us
      without Orient Exploration’s consent. The interest of our largest shareholders
      may differ from the interests of other shareholders.





**Additional
      issuances of equity securities may result in dilution to our existing
      stockholders** .





Our
      Articles of Incorporation authorize the issuance of 200,000,000 shares of common
      stock and 75,000,000 shares of preferred stock. The Board of Directors has
      the
      authority to issue additional shares of our capital stock to provide additional
      financing in the future and the issuance of any such shares may result in a
      reduction of the book value or market price of the outstanding shares of our
      common stock. If we do issue any such additional shares, such issuance also
      will
      cause a reduction in the proportionate ownership and voting power of all other
      stockholders. As a result of such dilution, if you acquire shares of our common
      stock, your proportionate ownership interest and voting power could be
      decreased. Further, any such issuances could result in a change of
      control.





**Possible
      Issuance of Preferred Stock.**





We
      are
      authorized to issue up to 75,000,000 shares of preferred stock. The preferred
      stock may be issued in one or more series, the terms of which may be determined
      at the time of issuance by the board of directors, without further action by
      shareholders, and may include voting rights, preferences as to dividends and
      liquidation, conversion and redemption rights and sinking fund provisions as
      determined by the board of directors. Although we have no present plans to
      issue
      any shares of preferred stock, the issuance of preferred stock in the future
      could adversely affect the rights of the holders of common stock and reduce
      the
      value of the common stock.





**Our
      common stock is classified as a "penny stock" under SEC rules which limits
      the
      market for our common stock.**





Because
      our stock is not traded on a stock exchange or on the NASDAQ National Market
      or
      the NASDAQ Small Cap Market, and because the market price of the common stock
      is
      less than $5 per share, the common stock is classified as a "penny stock."
      Our
      stock has not traded above $5 per share since June 28, 2004. SEC Rule 15g-9
      under the Exchange Act imposes additional sales practice requirements on
      broker-dealers that recommend the purchase or sale of penny stocks to persons
      other than those who qualify as an "established customer" or an "accredited
      investor." This includes the requirement that a broker-dealer must make a
      determination that investments in penny stocks are suitable for the customer
      and
      must make special disclosures to the customers concerning the risk of penny
      stocks. Many broker-dealers decline to participate in penny stock transactions
      because of the extra requirements imposed on penny stock transactions.
      Application of the penny stock rules to our common stock reduces the market
      liquidity of our shares, which in turn affects the ability of holders of our
      common stock to resell the shares they purchase, and they may not be able to
      resell at prices at or above the prices they paid.




**A
          majority of our directors and officers are outside the United States, with
          the
          result that it may be difficult for investors to enforce within the United
          States any judgments obtained against us or any of our directors or
          officers.**
  A
          majority of our directors and officers are nationals and/or residents of
          countries other than the United States, and all or a substantial portion
          of such
          persons' assets are located outside the United States. As a result, it
          may be
          difficult for investors to effect service of process on our directors or
          officers, or enforce within the United States or Canada any judgments obtained
          against us or our officers or directors, including judgments predicated
          upon the
          civil liability provisions of the securities laws of the United States
          or any
          state thereof. Consequently, you may be effectively prevented from pursuing
          remedies under U.S. federal securities laws against them. In addition,
          investors
          may not be able to commence an action in a Canadian court predicated upon
          the
          civil liability provisions of the securities laws of the United States.
          The
          foregoing risks also apply to those experts identified in this prospectus
          that
          are not residents of the United States.
  **Nevada
        law and our Articles of Incorporation may protect our directors from certain
        types of lawsuits.** ****





32









Nevada
      law provides that our officers and directors will not be liable to us or our
      stockholders for monetary damages for all but certain types of conduct as
      officers and directors. Our Bylaws permit us broad indemnification powers to
      all
      persons against all damages incurred in connection with our business to the
      fullest extent provided or allowed by law. The exculpation provisions may have
      the effect of preventing stockholders from recovering damages against our
      officers and directors caused by their negligence, poor judgment or other
      circumstances. The indemnification provisions may require us to use our limited
      assets to defend our officers and directors against claims, including claims
      arising out of their negligence, poor judgment, or other
      circumstances.




**ITEM
      2. DESCRIPTION OF PROPERTIES**





We
      lease
      our principal office space located at 7473 West Lake Mead Road, Las Vegas,
      Nevada 89128. We currently utilize office space, warehouse, and fenced yard,
      located at 225 Kingsberry Road, Holdenville, Oklahoma 74848. We intend to lease
      this space in the future from Douglas Humphreys or an affiliated entity on
      terms
      no less favorable than those that may be obtained from third
      parties.





**ITEM
      3. LEGAL PROCEEDINGS**





Management
      is not aware of any legal proceedings contemplated by any governmental authority
      or any other party involving us or our properties. As of the date of this Annual
      Report, no director, officer or affiliate is (i) a party adverse to us in any
      legal proceeding, or (ii) has an adverse interest to us in any legal
      proceedings. Management is aware of the following legal proceedings pending
      or
      other actions that have been threatened against us or our
      properties:





During
      the fourth quarter and to the date of the audit report, the Company has received
      six law suits from creditors of the Company for the payment of services and
      goods totaling approximately $785,445, one contractual mediation request from
      a
      creditor for the payment of services and goods totaling approximately $111,994,
      nine well liens for the payment of services and goods totaling approximately
      $333,771, and eighteen demand letters for the payment of services and goods
      totaling approximately $520,554 pursuant to expenditures incurred in the
      development of oil and gas assets on the Company’s leasehold interests. All such
      amounts have been accrued for, as applicable, as of December 31,
      2006.





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





During
      fiscal year ended December 31, 2006, no matters were submitted to our
      stockholders for approval.




**ITEM
          5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS**
  **MARKET
          FOR COMMON EQUITY**
 Shares
        of
        our common stock are traded on the OTC Bulletin Board under the symbol "LXRS"
        and on the Frankfurt and Berlin stock exchanges under the symbol "LXR"; WKN:
        AOBKLP. The market for our common stock is limited, and can be volatile.
        The
        following table sets forth the high and low sales prices relating to our
        common
        stock on a quarterly basis for the last two fiscal years as quoted by the
        NASDAQ. These quotations reflect inter-dealer prices without retail mark-up,
        mark-down, or commissions, and may not reflect actual transactions.
 
 **Quarter
                  Ended**
              **High
                  Bid**
              **Low
                  Bid**December
                  31, 2006
              $0.81
              $0.25September
                  30, 2006
              $1.06
              $0.77June
                  30, 2006
              $1.62
              $0.85March
                  31, 2006
              $1.21
              $0.67December
                  31, 2005
              $0.89
              $0.81September
                  30, 2005
              $1.75
              $1.25June
                  30, 2005
              $1.89
              $1.15March
                  31, 2005
              $2.20
              $1.25
 
 As
        of
        April 2, 2007, we had 152 shareholders of record, which does not include
        shareholders whose shares are held in street or nominee names. We believe
        that
        there are approximately 3,000 beneficial owners of our common
        stock.





33




**DIVIDEND
      POLICY**




No
      dividends have ever been declared by the Board of Directors on our common stock.
      Our losses do not currently indicate the ability to pay any cash dividends,
      and
      we do not indicate the intention of paying cash dividends either on our common
      stock in the foreseeable future. There are no restrictions in our articles
      of
      incorporation or by-laws that prevent us from declaring dividends. The Nevada
      Revised Statutes, however, do prohibit us from declaring dividends where, after
      giving effect to the distribution of the dividend, we would not be able to
      pay
      our debts as they become due in the usual course of business or our total assets
      would be less than the sum of our total liabilities plus the amount that would
      be needed to satisfy the rights of stockholders who have preferential rights
      superior to those receiving the distribution.




**SECURITIES
      AUTHORIZED FOR ISSUANCE UNDER COMPENSATION PLANS**




We
      have
      one equity compensation plan, the Lexington Resources Inc. current "Stock Option
      Plan". The table set forth below presents the securities authorized for issuance
      with respect to the Stock Option Plan under which equity securities are
      authorized for issuance as of December 31, 2006:






**Equity
      Compensation Plan Information**




**Plan
                Category**
            **Number
                of Securities to be Issued Upon exercise of Outstanding Options,
                warrants
                and Rights**
              **(a)**
            **Weighted-Average
                Exercise Price of Outstanding Options, warrants and
                Rights**
              **(b)**
            **Number
                of Securities Remaining Available for Future Issuance Under Equity
                Compensation Plans (excluding column (a))**
              **(c)****Equity
                Compensation Plans**
              **Approved
                by Security Holders**Stock
                Options
            50,000
            $0.167
            n/a5,000
            1.00
            n/a380,000
            3.00
            n/a850,000
            1.25
            6,215,000Total
                Stock Options
            1,285,000**Equity
                Compensation Plans not**
              **Approved
                by Security Holders**Warrants
            233,000
            $3.00
            02,930,000
            $1.00
            0586,000
            $1.00
            07,650,000
            $1.25
            0Total
                warrants
            11,399,000Total
            12,684,000






34




**LEXINGTON
      RESOURCES INC. STOCK OPTION PLAN**






On
      August
      7, 2003, our Board of Directors unanimously approved and adopted a Stock Option
      Plan. The purpose of the Stock Option Plan is to advance our interests and
      the
      interests of the shareholders by affording our key personnel an opportunity
      for
      investment in the Company and the incentive advantages inherent in stock
      ownership in the Company. Pursuant to the provisions of the Stock Option Plan,
      stock options will be granted only to our key personnel, generally defined
      as a
      person designated by the board of directors upon whose judgment, initiative
      and
      efforts we may rely including any director, officer, employee or
      consultant.




The
      Stock
      Option Plan is administered by our Board of Directors, which shall determine:
      (i) the persons to be granted stock options under the Stock Option Plan; (ii)
      the number of shares subject to each option, the exercise price of each stock
      option; and (iii) whether the stock option shall be exercisable at any time
      during the option period of 10 years or whether the stock option shall be
      exercisable in installments or by vesting only.




The
      Stock
      Option Plan originally provided authorization to our Board of Directors to
      grant
      stock options to purchase a total number of shares of our common stock, not
      to
      exceed 1,000,000 shares as at the date of adoption by our Board of Directors
      of
      the Stock Option Plan. Effective December 31, 2003, our Board of Directors
      amended the Stock Option Plan to increase the total number of shares of common
      stock to be purchased pursuant to exercise of stock options to 4,000,000.
      Effective July 2, 2004, our Board of Directors amended the Stock Option Plan
      to
      increase the total number of shares of common stock to be purchased pursuant
      to
      exercise of stock options to 5,000,000. Effective August 19, 2005, our Board
      of
      Directors further amended the Stock Option Plan to increase the total number
      of
      share of common stock to be purchased pursuant to exercise of stock options
      to
      7,500,000.




During
      April 2004, we registered 500,000 stock options pursuant to a registration
      statement on Form S-8 which was filed with the Securities and Exchange
      Commission. During February 2006, we registered 500,000 stock options pursuant
      to a registration statement on Form S-8 which was filed with the Securities
      and
      Exchange Commission. During March 2006, we registered 1,150,000 stock options
      pursuant to registration statement on Form S-8 filed with the Securities and
      Exchange Commission.




At
      the
      time a stock option is granted under the Stock Option Plan, our Board of
      Directors shall fix and determine the exercise price at which our shares of
      common stock may be acquired; provided, however, that any such exercise price
      shall not be less than that permitted under the rules and policies of any stock
      exchange or over-the-counter market which is applicable to us.




In
      the
      event an optionee who is our director or officer ceases to serve in that
      position, any stock option held by such optionee generally may be exercisable
      within up to 90 calendar days after the effective date that his position ceases,
      and after such 90-day period any unexercised stock option shall expire. In
      the
      event an optionee who is our employee or consultant ceases to be employed by
      us,
      any stock option held by such optionee generally may be exercisable within
      up to
      60 calendar days (or up to 30 calendar days where the optionee provided only
      investor relations services to us) after the effective date that his employment
      ceases, and after such 60- or 30-day period any unexercised stock option shall
      expire.


35








The
      Board
      of Directors shall determine the acceptable form of consideration for exercising
      a stock option, including the method of payment. Such consideration may consist
      entirely of: (i) cash; (ii) check; (iii) promissory note; (iv) other shares
      which (A) in the case of shares acquired upon exercise of a stock option, have
      been owned by the optionee for more than six months on the date of surrender,
      and (B) have a fair market value on the date of surrender equal to the aggregate
      exercise price of the shares as to which said stock option shall be exercised;
      (v) consideration received by us under a cashless exercise program implemented
      by us in connection with the Stock Option Plan; (vi) a reduction in the amount
      of any of our liability to the optionee; (vii) such other consideration and
      method of payment for the issuance of shares to the extent permitted by
      applicable laws; or (viii) any combination of the foregoing methods of payment.
      Notwithstanding the foregoing, any method of payment other than in case may
      be
      used only with the consent of our board of directors or if and to the extent
      so
      provided in an agreement.




As
      of the
      date of this Annual Report, an aggregate of 1,285,000 stock options have been
      granted, which remain outstanding and exercisable. We did not grant any Stock
      Options during fiscal year ended December 31, 2006.




**COMMON
      STOCK PURCHASE WARRANTS**




As
      of the
      date of this Annual Report, there are an aggregate of 11,399,000 common stock
      purchase warrants issued and outstanding. During fiscal year ended December
      31,
      2006, we issued an aggregate 7,650,000 common stock purchase warrants. The
      warrants to purchase shares of common stock and the shares of common stock
      underlying the warrants were issued in a private placement by us during fiscal
      year 2006. On August 31, 2006, we issued the 7,650,000 warrants to acquire
      up to
      7,650,000 shares of our common stock at an exercise price of $1.25 per share
      for
      the period commencing upon the date of issuance of the warrant and ending on
      the
      day which is the earlier of (i) 18 months from the date of issuance of the
      warrants and (ii) 12 months from the effective date of our proposed registration
      statement. Both the warrant shares and the common shares issued pursuant to
      the
      private placement offering are proposed for registration under the 1933
      Securities Act. See “ — Recent Sales of Unregistered Securities.”





Pursuant
      to the terms of the 2006 Registration Statement, an aggregate of 16,065,000
      shares of common stock underlying certain common stock purchase warrants
      described above will be registered. As of the date of this Annual Report, the
      Registration Statement has not become effective.





**RECENT
      SALES OF UNREGISTERED SECURITIES**





As
      of the
      date of this Annual Report and during fiscal year ended December 31, 2006,
      to
      provide capital, we sold stock in private placement offerings, issued stock
      in
      exchange for our debts or pursuant to contractual agreements as set forth
      below.





**Private
      Placement Offering**





During
      fiscal year ended December 31, 2006, we completed a private placement pursuant
      to which we issued an aggregate of 7,650,000 Units at a subscription price
      of
      U.S. $1.00 per Unit for total gross proceeds of $7,650,000. Each Unit is
      comprised of one common share and one non-transferable common stock purchase
      warrant ("Warrant"). Each resulting Warrant entitles the subscriber to purchase
      an additional share of our common stock (“Warrant Share”) at a price of $1.25
      per share for the period commencing upon the date of issuance of the Units
      and
      ending on the day which is the earlier of (i) 18 months from the date of
      issuance of the Units and (ii) 12 months from the effective date of our proposed
      registration statement. Both the Warrant Shares and the common shares issued
      pursuant to the private placement offering are to be proposed for registration
      under the United States Securities Act of 1933, as amended. We paid finders
      fees
      of 5% of the gross cash proceeds received under the private placement offering
      and 10% restricted common shares on the gross units issued, with such restricted
      shares carrying piggy back registration rights.


36




The
      per
      share price of the offering was arbitrarily determined by our Board of Directors
      based upon analysis of certain factors including, but not limited to, stage
      of
      development, industry status, investment climate, perceived investment risks,
      our assets, and net estimated worth. We issued Units to investors who were
      either a U.S. resident- or a non-U.S. resident. The investors executed
      subscription agreements and acknowledged that the securities to be issued have
      not been registered under the Securities Act, that they understood the economic
      risk of an investment in the securities, and that they had the opportunity
      to
      ask questions of and receive answers from our management concerning any and
      all
      matters related to acquisition of the securities.





Effective
      July 3, 2006, we filed the 2006 Registration Statement under the 1933 Securities
      Act to register 8,415,000 shares of common stock issued and the 7,650,000 shares
      of common stock underlying the Warrants. The 2006 Registration Statement was
      not
      declared effective before financial penalties were due pursuant to registration
      timing. Penalties accrued and unpaid to December 31, 2006 aggregate $419,671.
      As
      of the date of this Annual Report, we continue to incur 1% of $7,450,000 raised
      per month of delay until the 2006 Registration Statement is declared effective
      by the Securities and Exchange Commission.




**CONVERSION
      OF NOTES**





During
      fiscal year ended December 31, 2006, we issued an aggregate of 3,423,747 shares
      of our common stock in connection with the conversion of the Convertible Notes.
      An aggregate of $3,390,122 in principal and $33,625 in interest in the
      Convertible Notes was converted into the 3,423,747 shares of our common stock
      at
      a conversion price of $1.00 per share. We issued the shares of common stock
      in
      reliance upon Section 4(2) of the Securities Act.





**EXERCISE
      OF SERIES B WARRANTS**





During
      fiscal year ended December 31, 2006, we have issued an aggregate of 250,000
      shares of our common stock in connection with the exercise of Series B Warrants
      at $1.00 per Series B Warrant for aggregate proceeds of $250,000. The Series
      B
      Warrants were originally issued as part of a secured convertible note unit
      offering and the shares of common stock underlying the warrants were registered
      under the Securities Act pursuant to a registration statement on Form
      SB-2.




**STOCK
      OPTIONS**





During
      fiscal year ended December 31, 2006, we issued an aggregate of 1,150,000 shares
      of our common stock pursuant to the exercise of a total of 1,150,000 Stock
      Options, which were exercised at $1.25 per share for aggregate proceeds of
      $1,437,500. In addition, 500,000 share options issued during 2005 were exercised
      during 2006 at $1.00 per share for aggregate proceeds of $500,000.





**OAK
      HILLS SHARE EXCHANGE AGREEMENT**





On
      January 23, 2006, we issued an aggregate of 6,000,000 shares of our restricted
      common stock to the shareholders of Oak Hills International, Inc. at a price
      of
      approximately $0.637645 per share in accordance with the terms and provisions
      of
      the Oak Hills Share Exchange Agreement. The per share consideration was
      calculated by reference to the of the assets of Oak Hills obtained from the
      independent third party valuation, and management’s further calculation of net
      tangible value inclusive of all other balance sheet assets, current, and
      long-term liabilities of the acquired companies resulting in the shares issued
      as consideration, with such shares issued at a 6.3% discount to the trading
      value of our stock as at December 22-23, 2005, the transaction valuation date.
      The shares were issued pursuant to an exemption from registration under Section
      4(2) of the 1933 Securities Act. In addition, we also negotiated favorable
      terms
      on long term debt that formed part of the acquisition deferring payment of
      interest and principle for a period of two years. Oak Hills had outstanding
      promissory notes totaling $1,295,261, which accrue interest at 9% per annum
      and
      required no payments of interest or principal until the end of a two year term
      ending January 22, 2008. The security underlying the promissory notes was sold
      in January 2007. On January 26, 2007, we repaid an aggregate of $1,523,736
      of
      principal and interest to four debt holders of Oak Hills which had a secured
      interest in our drilling rig that was sold on January 2, 2007.


37




**EURXCHANGE
      CONSULTING LTD.**





On
      February 15, 2006, we issued an aggregate of 400,000 shares of our restricted
      common stock in accordance with the terms and provisions of the EurXchange
      Consulting Agreement. Pursuant to the terms and provisions of the EurXchange
      Consulting Agreement, we issued to EurXchange an aggregate of 400,000 shares
      of
      our restricted common stock. The shares were issued pursuant to an exemption
      from registration under Section 4(2) of the 1933 Securities Act.





**ITEM
      6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**




The
      summarized consolidated financial data set forth in the tables below and
      discussed in this section should be read in conjunction with our consolidated
      financial statements and related notes for fiscal years ended December 31,
      2005
      and 2006, which financial statements are included elsewhere in this Annual
      Report.











**For
                Fiscal Year Ended December 31, 2006**
              **(audited)**
            **For
                Fiscal Year Ended**
              **December
                31, 2005**
              **(audited)****Revenues**Oil
                and Gas RevenueOil
                and Gas revenues
            $
                761,656
            $
                693,860Drilling
                revenues
            1,575,285
            -0-**Total
                Revenues**
            $
                2,336,941
            $
                693,860**Operating
                Expenses**Operating
                costs and taxes
            $
                474,696
            $
                213,377Rig
                well and pulling unit expense
            905,148
            -0-Salaries,
                wages and related personnel costs
            847,300
            -0-Depreciation,
                depletion and amortization
            1,209,969
            259,609General
                and administrative
            2,520,652
            864,964Consulting
                - stock-based
            -0-
            1,913,991Impairment
                of other equipment
            1,600,000Impairment
                of oil and gas properties
            2,150,000Investor
                relations and promotion
            2,238,575
            1,205,743**Net
                Loss From Operations**
            $
                (9,609,399)
            $
                (3,763,824)Interest
                and finance fees
            (3,255,450)
            (4,775,039)Derivative
                liability gain
            2,288,000
            -0-**Net
                Loss**
            $
                (10,576,849)
            $
                (8,538,863)





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS**





**Results
      of Operation**





**For
      Fiscal Year Ended December 31, 2006 Compared to Fiscal Year Ended** **December
      31, 2005**





Our
      net
      loss during fiscal year ended December 31, 2006 was approximately $ (10,576,849)
      compared to $ (8,538,863) for fiscal year ended December 31, 2005 (an increase
      of $2,037,986).







38


During
      fiscal year ended December 31, 2006, we generated $2,336,941 in gross revenue
      compared to $693,860 in gross revenue generated during fiscal year ended
      December 31, 2005 (an increase of $1,643,081), resulting primarily fromwell
      drilling and services revenues generated by our subsidiary, Oak Hills Drilling
      and Operating, LLC. Prices from natural gas averaged $4.94 per mcf (net of
      marketing and transportation costs) during fiscal year ended December 31, 2006
      compared to $5.30 per mcf for fiscal year ended December 31, 2005. Volume of
      gas
      sold for fiscal year ended December 31, 2006 was approximately 153,971 mcf
      up
      from approximately 130,942 mcf from fiscal year ended December 31, 2005.
      Increased volume was due to new wells coming into production, however, increases
      were moderated by the decline in production from older wells and an increase
      in
      average production costs increasing from $1.63 per mcf in 2005 to $3.11 per
      mcf
      in 2006.





During
      fiscal year ended December 31, 2006, we incurred operating expenses in the
      aggregate amount of $11,946,340 compared to $4,457,684 incurred during fiscal
      year ended December 31, 2005 (an increase of $7,488,656). The operating expenses
      incurred during fiscal year ended December 31, 2006 consisted of: (i) operating
      costs and taxes of $474,696 (2005: $213,377); (ii) depreciation, depletion
      and
      amortization of $1,209,969 (2005: $259,609); (iii) general and administrative
      of
      $2,520,652 (2005: $864,964); (iv) investor relations and promotion of $2,238,575
      (2005: $1,205,743); (v) drilling rig, well and pulling unit expense of $905,148
      (2005: $0); (vi) salaries, wages and related of $847,300 (2005: $0); (vii)
      impairment of other equipment of $1,600,000 (2005: $0); (viii) impairment of
      oil
      and gas properties of $2,150,000 (2005: $0); and (ix) stock based
      compensation of $-0- (2005: $1,913,991). The increase in operating expenses
      incurred during fiscal year ended December 31, 2006 compared to fiscal year
      ended December 31, 2005 resulted primarily from the increase in operating
      expenditures relating to the Company’s acquired subsidiary interest, Oak Hills
      Drilling and Operating, LLC, an increase in the scale and scope of well drilling
      operations and related capital expenditure, an increase in overall general
      administration, and an increase in investor relations and promotion relating
      to
      investor awareness programs. Increases were also the result of impairment to
      oil
      and gas property interests and impairment from the sale of the drilling rig
      previously owned by Oak Hills.




Of
      the
      $11,946,340 incurred as operating expenses during fiscal year ended December
      31,
      2006, an aggregate of $120,000 was incurred in fees payable to International
      Market Trend (“IMT”) for amounts due and owing for operational, administrative
      and consulting services rendered during fiscal year ended December 31, 2006.
      On
      November 10, 2003, we entered into a consulting agreement with IMT (the
“Consulting Agreement”), whereby IMT performs a wide range of management,
      administrative, financial, and business development services for us. On August
      19, 2005, we granted to IMT an aggregate of 1,150,000 stock options exercisable
      at $1.25 per share for a period of five years and on March 1, 2006, the stock
      options were re-assigned from IMT to two consultants of IMT under identical
      terms and conditions of the original grant in connection with business
      development services rendered to us.





Of
      the
      $11,946,340 incurred as operating expenses during fiscal year ended December
      31,
      2006: (i) an aggregate of $300,000 was incurred to our officers/directors for
      management fees. Furthermore, an additional $90,000 was incurred to Mr.
      Humphreys, who is also the sole officer and director of Oak Hills, as
      compensation during fiscal year ended December 31, 2006. In addition, Oak Hills
      incurred $42,000 to Mr. Humphreys and a relative of this director for rent
      on
      our field offices in Oklahoma. As at December 31, 2006, $73,916 is owed to
      us
      from Mr. Humphreyes and/or affiliates of Mr. Humphreyes for costs incurred
      in
      connection with certain well interests. Subsequent to December 31, 2006, we
      have
      received $46,922 of this amount due and owing. This director has previously
      been
      assigned a 10% carried working interest in each well successfully drilled on
      the
      Wagnon lease, as partial compensation for his involvement in obtaining and
      facilitating the execution of the Farm-Out Agreement and to compensate for
      his
      services relating to operation and completion of wells to be located on the
      Wagnon lease, and has also been provided the right to purchase up to an
      additional 5% working interest of the Company’s total interest in all wells
      drilled by the Company on its properties provided that funds for this
      participation are paid prior to the commencement of drilling of said wells.
      During 2006, compensation was recorded in connection with the costs of this
      carried working interest totaling $652,300. See “Item 10 - Executive
      Compensation.”





Our
      net
      loss from operations during fiscal year ended December 31, 2006 also includes
      $3,255,450 related to interest and finance fees and a gain of $2,288,000 related
      to the decrease in the fair value of derivative liability, and together with
      operating expenses results in a net loss of ($10,576,849). Included in interest
      and finance fees are non-cash amounts totaling $2,939,917 relating to the
      amortization of a convertible debt discount, deferred finance costs, and the
      fair value resulting from the re-pricing of certain warrants. The increase
      in
      net loss during fiscal year ended December 31, 2006 compared to fiscal year
      ended December 31, 2005 is attributable primarily to the increase in operating
      expenditures relating to the Company’s acquired subsidiary interest, Oak Hills
      Drilling and Operating, LLC, an increase in the scale and scope of well drilling
      operations and related capital expenditure, an increase in overall general
      administration, and an increasing investor relations and promotion relating
      to
      investor awareness programs. Increases were also the result of impairment to
      oil
      and gas property interests and impairment from the sale of the drilling rig
      previously owned by Oak Hills but were offset by the gain realized on the
      decrease in the fair value of the derivative liability. Our net loss during
      fiscal year ended December 31, 2006 was ($10,576,849) or ($0.31) per share
      compared to a net loss of ($8,538,863) or ($0.49) per share for fiscal year
      ended December 31, 2005. The weighted average number of shares outstanding
      was
      17,470,971 for the year ended December 31, 2005 compared to 33,918,870
      at December 31, 2006.


39







**LIQUIDITY
      AND CAPITAL RESOURCES**





Our
      financial statements have been prepared assuming that we will continue as a
      going concern and, accordingly, do not include adjustments relating to the
      recoverability and realization of assets and classification of liabilities
      that
      might be necessary should we be unable to continue in operation.





For
      the
      year ended December 31, 2006, our current assets were $1,628,327 and our current
      liabilities were $9,863,157, resulting in a working capital deficit of
      $8,234,830. As at fiscal year ended December 31, 2006, current assets were
      comprised of: (i) $86,241 in cash and cash equivalents; (ii) $1,425,450 in
      accounts receivable; (iii) $73,916 in amounts due from related parties; (iv)
      $39,803 in current portion of deferred finance fees; and (vii) $2,917 in prepaid
      expenses and other. As at fiscal year ended December 31, 2006, current
      liabilities were comprised of: (i) $8,404,178 in accounts payable and accrued
      liabilities; (ii) $615,824 in current portion of convertible notes and accrued
      interest; (iii) $640,274 in promissory note and other short term advances;
      and
      (iv) $202,881 in amounts due to related parties. See “ - Material Commitments.”





For
      the year ended December 31, 2006, our total assets were $18,432,644
      comprised of: (i) $1,628,327 in current assets; (ii) $2,767,225 in assets held
      for sale; (iii) $8,408,510 in carrying value of proved oil and gas properties
      (net of accumulated depletion); (iii) $5,049,858 in carrying value of unproved
      oil and gas properties; and (iv) $578,724 in other fixed assets (net of
      accumulated depreciation). The increase in total assets during fiscal year
      ended
      December 31, 2006 from fiscal year ended December 31, 2005 was primarily due
      to
      the increase in carrying value of proved and unproved oil and gas properties
      from well drilling and leasehold related capital expenditures.





For
      the year ended December 31, 2006, our total liabilities were $12,697,947
      comprised of: (i) $9,863,157 in current liabilities; (ii) $1,538,829 in
      derivative liability; and (iii) $1,295,961 in long term debt. The increase
      in
      total liabilities during fiscal year ended December 31, 2006 from fiscal year
      ended December 31, 2005 was primarily due to the increase in accounts payable
      from well drilling and leasehold related capital expenditures, and increases
      from long term debt and derivative liability.





Stockholders’
      equity increased from $3,006,058 for December 31, 2005 to $5,734,697 for
      December 31, 2006.




We
      have
      not generated positive cash flows from operating activities. For the fiscal
      year
      ended December 31, 2006, net cash flow used in operating activities was
      ($4,941,033) compared to net cash flow used in operating activities of
      ($1,428,552) for fiscal year ended December 31, 2005. Net cash flow used in
      operating activities during fiscal year ended December 31, 2006 consisted
      primarily of a net loss of ($10,576,849) adjusted by $2,939,917 relating to
      non-cash interest and finance fee expenses, ($2,288,000) relating to a non-cash
      gain on derivative liabilities, $1,600,000 relating to impairment of equipment,
      $2,150,000 relating to impairment of oil and gas properties, $515,921 in
      depreciation, $694,048 in oil and gas depletion, and $262,500 in non-cash
      expenses.





During
      fiscal year ended December 31, 2006, net cash flow used in investing activities
      was ($4,077,287) compared to net cash flow used in investing activities of
      ($3,510,559) for fiscal year ended December 31, 2005. Net cash flow used in
      investing activities during fiscal year ended December 31, 2006 was primarily
      the result of ($3,845,864) in oil and gas property expenditures relating to
      our
      oil and gas properties and ($350,967) relating to the purchase of equipment,
      offset by $119,544 of cash acquired on acquisition of Oak Hills.





During
      fiscal year ended December 31, 2006, net cash flow from financing activities
      was
      $8,584,229 compared to net cash flow from financing activities of $5,133,150
      for
      fiscal year ended December 31, 2005. Net cash flow from financing activities
      during fiscal year ended December 31, 2006 pertained primarily to $9,426,250
      received as proceeds from the sales of shares of our common stock, ($763,735)
      in
      convertible note repayments, and ($222,423) in long term debt
      repayments.


40


**PLAN
      OF OPERATION**




During
      fiscal year ended December 31, 2006, we completed a private placement pursuant
      to which we issued an aggregate of 7,650,000 Units at a subscription price
      of
      U.S. $1.00 per Unit for total gross proceeds of $7,650,000; with each Unit
      being
      comprised of one common share and one non-transferable common stock purchase
      Warrant. Each resulting Warrant entitles the subscriber to purchase an
      additional share of our common stock ("Warrant Share") at a price of $1.25
      per
      share for the period commencing upon the date of issuance of the Units and
      ending on the day which is the earlier of (i) 18 months from the date of
      issuance of the Units and (ii) 12 months from the effective date of our proposed
      registration statement. Both the Warrant Shares and the common shares issued
      pursuant to the private placement offering are to be proposed for registration
      under the 1933 Securities Act. We paid finders fees of 5% of the gross cash
      proceeds received under the private placement offering and 10% restricted common
      shares on the gross units issued, with such restricted shares carrying piggy
      back registration rights.






Effective
      July 3, 2006, we filed the 2006 Registration Statement under the 1933 Securities
      Act to register the 8,415,000 common shares issued and 7,650,000 common shares
      underlying the Warrants. The 2006 Registration Statement was not declared
      effective before financial penalties were due pursuant to registration timing.
      Penalties accrued and unpaid to December 31, 2006 aggregate $419,671. As of
      the
      date of this Annual Report, we continue to incur 1.5% of $7,450,000 raised
      per
      month of delay until the 2006 Registration Statement is declared effective
      by
      the Securities and Exchange Commission.






Existing
      working capital, further advances and possible debt instruments, warrant
      exercises, further private placements, monetization of existing assets, and
      anticipated cash flow are expected to be adequate to fund our operations over
      the next two months. We have no lines of credit or other bank financing
      arrangements. Generally, we have financed operations to date through the
      proceeds of the private placement of equity and debt securities. In connection
      with our business plan, management will delay additional increases in operating
      expenses and capital expenditures relating to: (i) oil and gas operating
      properties; (ii) drilling initiatives; and (iii) property acquisitions. We
      intend to utilize our best efforts to settle current finance accounts payables
      and liabilities with further issuances of securities, debt and or advances,
      monetization of existing assets, and revenues from operations. We will need
      to
      raise additional capital and increase revenues to meet both short term and
      long-term operating requirements.






During
      the fourth quarter of 2006 and to the date of the audit report, the Company
      has
      received six law suits from creditors of the Company for the payment of services
      and goods totaling approximately $785,445, one contractual mediation request
      from a creditor for the payment of services and goods totaling approximately
      $111,994, nine well liens for the payment of services and goods totaling
      approximately $333,771, and eighteen demand letters for the payment of services
      and goods totaling approximately $520,554 pursuant to expenditures incurred
      in
      the development of oil and gas assets on the Company’s leasehold interests. All
      amounts owing in connection with these law suits, mediation requests, well
      liens
      and demand letters have been accrued, as applicable, as of December 31, 2006.
      Additional issuances of equity or convertible debt securities will result in
      dilution to our current shareholders. Further, such securities might have
      rights, preferences or privileges senior to our common stock. Additional
      financing may not be available upon acceptable terms, or at all. If adequate
      funds are not available or are not available on acceptable terms, we may not
      be
      able to take advantage of prospective new business endeavors or opportunities,
      which could significantly and materially restrict our business
      operations.






The
      report of the independent registered public accounting firms that accompanies
      our December 31, 2006 and  2005 consolidated financial statements contains
      an explanatory paragraph expressing substantial doubt about our ability to
      continue as a going concern. The consolidated financial statements have been
      prepared "assuming that we will continue as a going concern," which contemplates
      that we will realize our assets and satisfy our liabilities and commitments
      in
      the ordinary course of business.






41




**MATERIAL
        COMMITMENTS**
   **Secured
        Convertible Notes**


During
      2007, a material commitment for us relates to the repayment of secured
      convertible debenture holders of the outstanding amounts of principal and
      interest accruing at 8% per annum. The secured convertible debt principal
      outstanding was $723,461 plus accrued interest of $9,100 as at December 31,
      2006. During fiscal year ended December 31, 2006, we paid a total of $188,783
      in
      interest, repaid an aggregate of $763,735 of principal, converted a total of
      $3,390,122 of principal and $33,626 of interest into shares of our common stock
      at a price of $1.00 per share under the terms of the convertible note
      agreements. As at December 31, 2006, we had convertible debt principal
      outstanding of $700,457 and $22,373 of accrued interest.






As
      at
      December 31, 2006, the remaining amounts of principal and interest due and
      owing
      under the convertible note agreements totaling $7,22,830 was payable in eight
      monthly principal and interest payments in either cash or shares of our common
      stock at the rate of $1.00 per share (the "Fixed Conversion Price") beginning
      on
      or about December 17, 2005 if our share price is trading above $1.00 per share
      at the date of payment. Commencing on the fourth month anniversary of the
      closing date of the issue of the Convertible Notes (September 16, 2005 and
      October 11, 2005), and on the first day or each month thereafter, the
      Convertible Notes must be repaid in cash in amount equal to 5% of the principal
      amount of the Notes together with all accrued interest due and payable up to
      the
      repayment date. If our shares are trading at less than $1.00 per share at the
      date of repayment, then we may repay outstanding monthly principal and interest
      in either cash or shares in our capital at a different rate than the Fixed
      Conversion Price. If the volume weighted average share price (the "VWAP") of
      the
      five trading days prior to a monthly payment date is less than the Fixed
      Conversion Price, then we may pay the monthly amount in cash or registered
      shares of our common stock at 75% of the VWAP for the five trading days prior
      to
      the monthly payment date. As of the date of this Annual Report, required monthly
      payments of principle and interest are approximately $95,172 monthly; however,
      as set forth below, we have elected to redeem the notes by making the payments
      described in the following paragraph. The holders of the Convertible Notes
      had a
      secured first interest in the assets of Lexington Oil and Gas Ltd.
      Co.






On
      December 27, 2006, we wrote to the holders of these notes to advise them that
      we
      had decided to exercise our redemption right under the notes by paying to the
      note holders the sum of money equal to 120% of the principal amount to be
      redeemed, together with accrued but unpaid interest. The redemption date was
      January 26, 2007, and the following amounts were due to the following note
      holders as of such date:




**Principal**
              **Amount
                Due on Dec. 16, 2006**
              ($)
            **Current**
              **Interest**
              **Rate**
              (%pa)
            **Days
                to**
              **Jan.
                26, 2007**
              (#)
            **Interest**
              **Owing**
              ($)
            **Sub-Total**
              ($)
            **20%
                Prepayment Penalty**
              ($)
            **Redemption
                Amount payable**
              **Jan.
                26, 2007**
              ($)**Alpha
                Capital Aktiengesellschaft**
            126,276.48
            8
            42
            1,162.44
            127,438.92
            25,487.78
            **152,926.70****Enable
                Opportunity Partners LP**
            21,450.82
            8
            42
            197.46
            21,648.28
            4,329.65
            **25,977.93****Enable
                Growth Partners LP**
            96,995.72
            8
            42
            892.89
            97,888.61
            19,577.72
            **117,466.33****Double
                U Master Fund LP**
            175,746.18
            8
            42
            1,617.83
            177,364.01
            35,472.80
            **212,836.81****RHP
                Mater Fund Ltd.**
            226,479.45
            15
            42
            3,909.10
            230,388.55
            46,077.71
            **276,466.26****Notzer
                Chesed Corp.**
            76,512.45
            15
            42
            1,320.63
            77,833.08
            15,566.62
            **93,399.70**Totals:
            $723,461.10
            
            
            $9,100.35
            $732,561.45
            $146,512.28
            $879,073.73






42




**Promissory
      Note**




During
      2007, a material commitment for us relates to an unsecured promissory note
      from
      one of our shareholders aggregating $600,000 (the "Promissory Note"). The
      provisions of the Promissory Note are:(i) two-year term with interest at the
      rate of 10% per annum; and (ii) interest to be paid on a quarterly basis with
      the principal to be repaid on or before the due date of the Promissory Note.
      As
      at December 31, 2006, there is $40,274 of accrued and unpaid interest on this
      loan.






**Oak
      Hills Debt**




During
      2007, a material commitment for us on behalf of Oak Hills relates to outstanding
      promissory notes totaling $1,295,261, which accrues interest at 9% per annum,
      and require no payments of interest or principal until the end of a two-year
      term ending January 22, 2008. The promissory notes are owed to certain former
      shareholders of Oak Hills and are secured against the assets of Oak Hills.
      During fiscal year ended December 31, 2006, we accrued $106,730 of interest
      on
      these loans resulting in $226,136 in accumulated accrued interest due and owing.
      On January 26, 2007, the $1,295,961 in promissory notes and accrued interest
      of
      $227,775 was repaid in full pursuant to contractual obligation relating to
      the
      sale of equipment securing these notes.




**Capital
      Expenditure Related Accounts Payable**




As
      of the
      date of this Annual Report, Oak Hills has incurred capital expenditures relating
      to the drilling and completion of various wells and for the development of
      our
      various lease interests in Oklahoma and Texas. As a consequence of well
      performance, gas price volatility, and the lack of availability of debt and
      equity sources on commercially acceptable terms to us, our trade payables have
      increased to $5,907,204 as at December 31, 2006. We will continue to review
      available sources of debt and equity to satisfy these debts, and will also
      review the monetization of various of our assets as an alternative source of
      capital.






**Lease
      Acquisition Expenditures - Comanche County, Texas**




On
      March
      3, 2006, effective January 31, 2006, we entered into the Comanche County Barnett
      Shale Exploration Agreement to jointly acquire and develop approximately 5,670
      acres of Barnett Shale and shallow gas targets in Comanche County, Texas. The
      Company will pay approximately $1,225,500 for its 50% working interest in the
      new acreage through a combination of $575,000 in cash (paid during the period)
      and approximately $650,500 of carried drilling costs in the first Comanche
      Barnett Shale test well required to be drilled on or before September 1,
      2006.  The test well commenced drilling on September 1, 2006 and we are
      currently evaluating the final costs associated with drilling in order to
      determine the total amounts owing. The Company is currently in negotiations
      and
      reconciliation of expenditures relating to the Joint Exploration Agreement
      in
      Comanche County, Texas.






**2006
      Registration Statement Penalties**




On
      July
      3, 2006, we filed the 2006 Registration Statement to register the 8,415,000
      common shares issued and 7,650,000 common shares underlying the Warrants. The
      2006 Registration Statement was not declared effective before financial
      penalties were due pursuant to registration timing. Penalties accrued and unpaid
      to December 31, 2006 aggregate $419,671. As of the date of this Annual Report,
      we continue to incur 1.5% of $7,450,000 raised per month of delay until the
      registration statement is declared effective by the Securities and Exchange
      Commission.




43




**Mineral
      Property Liens**






As
      of the
      date of this Annual Report, the following liens or claims have been made against
      our mineral properties:






·
            January
                12, 2007 Notice of Claim of Lien by Red River Well Service, Ltd.,
                notifying us of a lien filed in Vol. 1332, Page 93 of the real property
                records of Palo Pinto County, Texas, in the amount of $84,841.19,
                with
                respect to materials/services furnished in connection with the Gilbert
                property.






·
            January
                12, 2007 Notice of Claim of Lien by Red River Well Service, Ltd.,
                notifying us of a lien filed in Book 2383, Page 1843 of the real
                property
                records of Parker County, Texas, in the amount of $62,635.30, with
                respect
                to materials/services furnished in connection with the Martin Cantrell
                property.






·
            January
                10, 2007 Petition for Suit on Sworn Account by Oil Field Service
                Company,
                Inc., filed in the District Court of Palo Pinto County, Texas, seeking
                judgment in the amount of $20,643.33, plus interest and attorney's
                fees,
                with respect to materials/services furnished in connection with one
                of our
                mineral properties.






·
            December
                28, 2006 Notice of Mechanic's and Materialmen's Liens to be filed
                in Palo
                Pinto and Comanche Counties, Texas, by Well Management Partners,
                LLC, in
                an aggregate amount of $57,966.50, with respect to materials/services
                furnished in connection with the Gilbert and Petta
                properties.






·
            December
                13, 2006 Notice of Demand for Payment by Coil Tubing Services, LLC,
                in the
                amount of $58,194.32, plus attorney's fees, with respect to
                materials/services furnished in connection with one of our mineral
                properties.






·
            December
                4, 2006 Notice of Intent to File Liens by Ulterra Drilling Technologies,
                LP, in Parker and Palo Pinto Counties, Texas, in an aggregate amount
                of
                $49,919.54, with respect to materials/services furnished in connection
                with the Martin Cantrell and Gilbert
                properties.






·
            November
                27, 2006 Statement of Lien and Affidavit by Sun West Mud Company,
                Inc.,
                filed in Parker County, Texas, in the amount of $25,069.06, plus
                interest,
                with respect to materials/services furnished in connection with the
                Martin
                Cantrell lease.






·
            Cude
                Oilfield Contractors Inc. and Cude Energy Services Inc. (collectively,
                the
                "lienholders"), recorded mineral property liens to secure payment
                in
                connection with amounts owed to the lienholders totaling $589,407
                relating
                to labor, materials and services provided by the lienholders on certain
                of
                our drilling sites located in Texas. The properties subject to the
                liens
                include the Olive Lease in Tarrant County, the Martin Cantrell Lease
                in
                Parker County and the Gilbert Lease in Palo Pinto County. Subsequently,
                on
                or about December 1, 2006, the lienholders filed suit in each of
                Tarrant,
                Parker and Palo Pinto Counties, Texas, in connection with such claims.






**PURCHASE
      OF SIGNIFICANT EQUIPMENT**






We
      do not
      intend to purchase any significant equipment during the next twelve
      months.






**CRITICAL
      ACCOUNTING POLICIES**




**Basis
      of accounting**





The
      accounts are maintained and the consolidated financial statements have been
      prepared using the accrual basis of accounting in accordance with accounting
      principles generally accepted in the United States of America.







44




Principles of Consolidation


The
      consolidated financial statements include the accounts of the Company and its
      wholly-owned subsidiaries, Lexington and Oak Hills. Lexington was acquired
      by
      reverse acquisition on November 19, 2003 and Oak Hills was acquired January
      23,
      2006. All significant inter-company transactions and account balances have
      been
      eliminated upon consolidation.





Our
      financial position, results of operations and cash flows include those of the
      Company and Lexington for all periods presented and those of Oak Hills since
      January 23, 2006, being the date of the acquisition.




**Accounts
      Receivable**





The
        Company performs ongoing credit evaluations of its customers’ financial
        condition and extends credit to virtually all of its customers on an
        uncollateralized basis. . Accounts receivable are stated at the historical
        carrying amount net of allowances for uncollectible accounts. The Company
        establishes an allowance for uncollectible accounts based on specific customer
        collection issues the Company has identified. Uncollectible accounts receivable
        are written off when a settlement is reached for an amount less than the
        outstanding historical balance or when the Company has determined the balance
        will not be collected.


**Oil
      and Gas Properties**





We
      follow
      the full cost method of accounting for its oil and gas operations whereby all
      costs related to the acquisition of methane, petroleum, and natural gas
      interests are capitalized. Under this method, all productive and nonproductive
      costs incurred in connection with the exploration for and development of oil
      and
      gas reserves are capitalized. Such costs include land and lease acquisition
      costs, annual carrying charges of non-producing properties, geological and
      geophysical costs, costs of drilling and equipping productive and non-productive
      wells, and direct exploration salaries and related benefits. Proceeds from
      the
      disposal of oil and gas properties are recorded as a reduction of the related
      capitalized costs without recognition of a gain or loss unless the disposal
      would result in a change of 20 percent or more in the depletion rate. We
      currently operate solely in the U.S.A.





Depletion
      of proved oil and gas properties is computed on the units-of-production method
      based upon estimates of proved reserves, as determined by independent
      consultants, with oil and gas being converted to a common unit of measure based
      on their relative energy content.





The
      costs
      of acquisition and exploration of unproved oil and gas properties, including
      any
      related capitalized interest expense, are not subject to depletion, but are
      assessed for impairment either individually or on an aggregated basis. The
      costs
      of certain unevaluated leasehold acreage are also not subject to depletion.
      Costs not subject to depletion are periodically assessed for possible impairment
      or reductions in value. Any impairment in value is included in the amortization
      base and amortized prospectively, subject to the ceiling test described
      below.




We
      apply
      a ceiling test to capitalized costs which limits such costs to the aggregate
      of
      the estimated present value, using a ten percent discount rate of the estimated
      future net revenues from production of proven reserves at year end market prices
      less future production, administrative, financing, site restoration, and income
      tax costs plus the lower of cost or estimated market value of unproved
      properties. If capitalized costs are determined to exceed estimated future
      net
      revenues, a write-down of carrying value is charged to depletion in the
      period.





**Property
      and other equipment**





Property
      and other equipment are stated at cost. Depreciation is computed using
      straight-line method over the estimated useful lives of the assets for financial
      reporting purposes. Drilling rigs and related equipment have estimated useful
      lives of ten years. Automobiles, trucks, other equipment, software, furniture,
      fixtures and office equipment have estimated useful lives of five years.
      Expenditures for major renewals and betterments that extend the useful lives
      are
      capitalized. Expenditures for normal maintenance and repairs are expensed as
      incurred. The cost of assets sold or abandoned and the related accumulated
      depreciation are eliminated from the accounts and any gains or losses are
      charged or credited in the accompanying consolidated statement of operations
      of
      the respective period.




**Asset
        Retirement Obligations**
 
 We
        have
        adopted the provisions of Statement of Financial Accounting Standards (“SFAS”)
        No. 143, *Accounting
        for Asset Retirement Obligations* .
        SFAS
        No. 143 requires the fair value of a liability for an asset retirement
        obligation to be recognized in the period in which it is incurred if a
        reasonable estimate of fair value can be made. The associated asset retirement
        costs are capitalized as part of the carrying amount of the related oil and
        gas
        properties. As of December 31, 2006, management has determined that there
        are no
        material asset retirement obligations.
 
 **Impairment
        of Long-Lived Assets**
 
 We
        review
        our long-term assets for impairment in accordance with SFAS No. 144, *Accounting
        for the Impairment or Disposal of Long-Lived Assets* .
        SFAS
        No. 144 requires that, when events or circumstances indicate that the carrying
        amount of an asset may not be recoverable, we should determine if impairment
        of
        value exists. If the estimated undiscounted future net cash flows are less
        than
        the carrying amount of the assets, an impairment exists and an impairment
        loss
        must be calculated and recorded. If an impairment exists, the impairment
        loss is
        calculated based on the excess of the carrying amount of the asset over the
        asset’s fair value. Any impairment loss is treated as a permanent reduction in
        the carrying value of the assets. During 2006, we recorded impairments of
        certain of our oil and gas properties and other equipment.  45


**Earnings
      (Loss) Per Share**





We
      compute loss per share in accordance with SFAS No. 128, *Earnings
      per Share* which
      requires presentation of both basic and diluted earnings per share on the face
      of the statement of operations. Basic loss per share is computed by dividing
      net
      loss available to common shareholders by the weighted average number of
      outstanding common shares during the period. Diluted loss per share gives effect
      to all dilutive potential common shares outstanding during the period including
      stock options and warrants using the treasury method. Dilutive loss per share
      excludes all potential common shares if their effect is anti-dilutive.





**Revenue
      Recognition**





Oil
      and
      natural gas revenues are recorded using the sales method, whereby we recognize
      oil and natural gas revenue based on the amount of oil and gas sold to
      purchasers, when title passes, the amount is determinable and collection is
      reasonably assured. Actual sales of gas are based on sales, net of the
      associated volume charges for processing fees and for costs associated with
      delivery, transportation, marketing, and royalties in accordance with industry
      standards. Operating costs and taxes are recognized in the same period in which
      revenue is earned.





We
      enter
      into contracts with customers whereby related drilling and service revenues
      are
      earned and recognized on a per-day basis as services are rendered when
      collectibility is deemed probable.





**Financial
      Instruments**





The
      fair
      values of cash and cash equivalents, accounts receivable, accounts payable,
      accrued liabilities, promissory notes and convertible notes were
      estimated to approximate their carrying values due to the immediate or
      short-term maturity of these financial instruments. Our current and planned
      operations are located in the States of Oklahoma and Texas, in the United
      States, and as a result we are not subject to significant exposure to market
      risks from changes in foreign currency rates.




Our
      financial instruments that are exposed to concentrations of credit risk consist
      primarily of cash and cash equivalents and accounts receivable. Our cash and
      cash equivalents are held at a major U.S. based financial institution. We manage
      and control market and credit risk through established formal internal control
      procedures, which are reviewed on an ongoing basis.




Use
        of
        Estimates
 
 The
        preparation of these financial statements requires the use of certain estimates
        by management in determining our assets, liabilities, revenues and expenses.
        Actual results could differ from such estimates. Depreciation, depletion
        and
        amortization of oil and gas properties and the impairment of oil and gas
        properties are determined using estimates of oil and gas reserves. There
        are
        numerous uncertainties in estimating the quantity of reserves and in projecting
        the future rates of production and timing of development expenditures, including
        future costs to dismantle, dispose, plug, and restore our properties. Oil
        and
        gas reserve engineering must be recognized as a subjective process of estimating
        underground accumulations of oil and gas that cannot be measured in an exact
        way. Proved reserves of oil and natural gas are estimated quantities that
        geological and engineering data demonstrate with reasonable certainty to
        be
        recoverable in the future from known reservoirs under existing
        conditions.
 
 **Income
        taxes**
 
 We
        follow
        the liability method of accounting for income taxes. Under this method, deferred
        tax assets and liabilities are recognized for the future tax consequences
        attributable to differences between the financial statement carrying amounts
        of
        existing assets and liabilities and their respective tax balances. Deferred
        tax
        assets and liabilities are measured using enacted or substantially enacted
        tax
        rates expected to apply to the taxable income in the years in which those
        differences are expected to be recovered or settled. The effect on deferred
        tax
        assets and liabilities of a change in tax rates is recognized in income in
        the
        period that includes the date of enactment or substantial enactment. A valuation
        allowance is provided for deferred tax assets if it is more likely than not
        that
        we will not realize the future benefit, or if future deductibility is
        uncertain.
 
 **Cash
        and cash equivalents**
 
 We
        consider all highly liquid instruments with an original maturity of three
        months
        or less at the time of issuance to be cash equivalents.


46


**Stock
      Based Compensation**





On
      January 1, 2006, we adopted the fair value recognition provisions of SFAS No.
      123(R), *Share-Based
      Payment,* (“SFAS
      123R”). Prior to January 1, 2006, we accounted for share-based payments under
      the recognition and measurement provisions of APB Opinion No. 25, *Accounting
      for Stock Issued to Employees* (“APB
      25”), and related Interpretations, as permitted by SFAS No. 123, *Accounting
      for Stock-Based Compensation* (“SFAS
      123”). In accordance with APB 25, no compensation cost was required to be
      recognized for options granted that had an exercise price equal to the market
      value of the underlying common stock on the date of grant.





We
      adopted SFAS 123R using the modified-prospective-transition method. Under this
      method, compensation cost recognized for the year ended December 31, 2006
      includes: a) compensation cost for all share-based payments granted prior to,
      but not yet vested as of December 31, 2005, based on the grant-date fair value
      estimated in accordance with the original provisions of SFAS 123, and b)
      compensation cost for all share-based payments granted subsequent to December
      31, 2005, based on the grant-date fair value estimated in accordance with the
      provisions of SFAS 123R. In addition, deferred stock compensation related to
      non-vested options is required to be eliminated against additional paid-in
      capital upon adoption of SFAS 123R. The results for the prior periods have
      not
      been restated.





All
      previously granted stock options had fully vested as at December 31, 2005 and
      during the year ended December 31, 2006, we did not grant any new stock options
      or modify any previously existing stock options. Accordingly, our results of
      operations for the year ended December 31, 2006 were no different than if we
      had
      not adopted SFAS 123R. As a result, no  disclosure of the impact of
      adopting SFAS 123R has been provided. The following table illustrates the effect
      on net loss and net loss per share had we applied the fair value recognition
      provisions of SFAS No. 123 to stock-based compensation for the comparative
      year
      ended December 31, 2005:





Year
                ended
              December
                31, 2005Net
                loss
            
            As
                reported
            
            $
                (8,538,863)SFAS
                No. 123 compensation expense
            
            Pro-forma
            
            (841,307)Net
                loss
            
            Pro-forma
            
            $
                (9,374,170)Basic
                and diluted net loss per share
            
            Pro-forma
            
            $
                (0.54)





**Recent
      Accounting Pronouncements**





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurement* ("SFAS
      157"). The Statement provides guidance for using fair value to measure assets
      and liabilities. The Statement also expands disclosures about the extent to
      which companies measure assets and liabilities at fair value, the information
      used to measure fair value, and the effect of fair value measurement on
      earnings. This Statement applies under other accounting pronouncements that
      require or permit fair value measurements. This Statement does not expand the
      use of fair value measurements in any new circumstances. Under this Statement,
      fair value refers to the price that would be received to sell an asset or paid
      to transfer a liability in an orderly transaction between market participants
      in
      the market in which the entity transacts. SFAS 157 is effective for the Company
      for fair value measurements and disclosures made by us in our fiscal year
      beginning on January 1, 2008. The adoption of SFAS 157 is not expected to have
      a
      material impact on our financial position, results of operations or cash
      flows.





In
      September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* .
      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. SAB
      No.
      108 was effective for our fiscal year ended December 31, 2006.  The
      adoption of SAB 108 did not have a material impact on our current or previously
      reported financial position, results of operations or cash flows.





In
      July
      2006, the FASB issued Interpretation (“FIN”) No. 48, *Accounting
      for Uncertainty in Income Taxes - an interpretation of SFAS No.
      109* .
      FIN No.
      48 clarifies the accounting for uncertainty in income taxes recognized in an
      entity’s financial statements in accordance with SFAS No. 109 and prescribes a
      recognition threshold and measurement attribute for financial statement
      disclosure of tax positions taken or expected to be taken on a tax return.
      Additionally, FIN No. 48 provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure and
      transition. FIN No. 48 is effective for fiscal years beginning after December
      15, 2006, with early adoption permitted. We are currently evaluating the impact,
      if any, that FIN 48 will have on our financial position, results of operations
      or cash flows.





In
      December 2006, the FASB issued FSP EITF 00-19-02, *Accounting
      for Registration Payment Arrangements* (“FSP
      00-19-2”) which addresses accounting for registration payment arrangements. FSP
      00-19-2 specifies that the contingent obligation to make future payments or
      otherwise transfer consideration under a registration payment arrangement,
      whether issued as a separate agreement or included as a provision of a financial
      instrument or other agreement, should be separately recognized and measured
      in
      accordance with FASB Statement No. 5, *Accounting
      for Contingencies* .
      FSP
      00-19-2 further clarifies that a financial instrument subject to a registration
      payment arrangement should be accounted for in accordance with other applicable
      generally accepted accounting principles without regard to the contingent
      obligation to transfer consideration pursuant to the registration payment
      arrangement. For registration payment arrangements and financial instruments
      subject to those arrangements that were entered into prior to the issuance
      of
      EITF 00-19-2, this guidance is effective for financial statements issued for
      fiscal years beginning after December 15, 2006 and interim periods within those
      fiscal years. We have not yet determined the impact that the adoption of FSP
      00-19-2 will have on our financial
      position, results of operations or cash flows .


47


**ITEM
        7. FINANCIAL STATEMENTS**
   **LEXINGTON
          RESOURCES, INC.**
 
 
 **CONSOLIDATED**  **FINANCIAL
          STATEMENTS**
 
 
 **DECEMBER
          31, 2006 and 2005**
      Report
                of Independent Registered Public Accounting Firm dated May 17,
                2007.
              49Report of Independent Registered Public
                Accounting Firm dated March 27, 2006.
              50Consolidated
                Balance Sheets as at December 31, 2006 and December 31, 2005.
              51Consolidated
                Statements of Operations for Fiscal Year Ended December 31, 2006
                and
                Fiscal Year Ended December 31, 2005.
              52Consolidated
                Statement of Stockholders’ Equity for the Period From December 31,
                2004 through Year Ended December 31, 2006.
              53-
                  54Consolidated
                Statements of Cash Flows for Fiscal Year Ended December 31, 2006
                and
                Fiscal Year Ended December 31, 2005.
              55Notes
                to Consolidated Financial Statements.
              56






48
  **REPORT
          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 To
          the
          Board of Directors and Stockholders
 Lexington
          Resources, Inc.
 
 
 We
          have
          audited the accompanying consolidated balance sheet of Lexington Resources,
          Inc.
          and subsidiaries, as of December 31, 2006 and the related consolidated
          statements of operations, changes in stockholders’ equity, and cash flows for
          the year then ended. These financial statements are the responsibility
          of the
          Company’s management. Our responsibility is to express an opinion on these
          financial statements based on our 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 the
          financial
          statements are free of material misstatement. The Company is not required
          to
          have, nor were we engaged to perform, an audit of its internal control
          over
          financial reporting. An audit includes consideration of internal control
          over
          financial reporting as a basis for designing audit procedures that are
          appropriate in the circumstances, but not for the purpose of expressing
          an
          opinion on the effectiveness of the Company's internal control over financial
          reporting. Accordingly, we express no such opinion. An audit also includes
          examining, on a test basis, evidence supporting the amounts and disclosures
          in
          the financial statements, assessing the accounting principles used and
          significant estimates made by management, as well as evaluating the overall
          financial statement presentation. We believe that our audit provides a
          reasonable basis for our opinion.
 
 In
          our
          opinion, the consolidated financial statements referred to above present
          fairly,
          in all material respects, the consolidated financial position of Lexington
          Resources, Inc. and subsidiaries as of December 31, 2006 and the consolidated
          results of their operations and their cash flows for the year then ended,
          in
          conformity with accounting principles generally accepted in the United
          States of
          America.
 
 The
          accompanying consolidated financial statements have been prepared assuming
          that
          the Company will continue as a going concern. As discussed in Note 1 to
          the
          consolidated financial statements, the Company has had recurring losses
          from
          operations, a net working capital deficiency and accumulated deficit that
          raises
          substantial doubt about its ability to continue as a going concern. Management’s
          plans in regard to these matters are also described in Note 1. These conditions
          raise substantial doubt about the Company’s ability to continue as a going
          concern. These consolidated financial statements do not include any adjustments
          to reflect the possible future effects on the recoverability and classification
          of assets or the amounts and classification of liabilities that may result
          from
          the outcome of this uncertainty.
 
 */s/
          Whitley Penn LLP*
 
 Dallas,
          Texas
 May
          17,
          2007
 
 
 
 
  49
  **REPORT
          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 To
          the
          Stockholders and Board of Directors of Lexington Resources, Inc.
 
 We
          have
          audited the consolidated balance sheets of Lexington Resources, Inc. as
          at
          December 31, 2005 and the consolidated statement of operations, stockholders’
equity and cash flows for the year then ended. These financial statements
          are
          the responsibility of the Company's management. Our responsibility is to
          express
          an opinion on these financial statements based on our 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 an audit to obtain reasonable assurance whether the financial
          statements are free of material misstatement. The Company is not required
          to
          have, nor were we engaged to perform, an audit of its internal control
          over
          financial reporting. Our audit included consideration of internal control
          over
          financial reporting as a basis for designing audit procedures that are
          appropriate in the circumstances, but not for the purpose of expressing
          an
          opinion on the effectiveness of the Company’s internal control over financial
          reporting. Accordingly, we express no such opinion. An audit also includes
          examining, on a test basis, evidence supporting the amounts and disclosures
          in
          the financial statements. An audit also includes assessing the accounting
          principles used and significant estimates made by management, as well as
          evaluating the overall financial statement presentation. We believe that
          our
          audit provides a reasonable basis for our opinion.
 
 In
          our
          opinion, these consolidated financial statements present fairly, in all
          material
          respects, the financial position of the Company as at December 31, 2005
          and the
          results of its operations and its cash flows and the changes in stockholders’
equity for the year then ended in conformity with accounting principles
          generally accepted in the United States of America.
 
 The
          accompanying financial statements have been prepared assuming that the
          Company
          will continue as a going concern. As discussed in Note 1 to the financial
          statements, to date the Company has reported significant losses since
          inception from
          operations and requires additional funds to meet its obligations and fund
          the
          costs of its operations. These factors raise substantial doubt about the
          Company’s ability to continue as a going concern. Management’s plans in this
          regard are described in Note 1. The financial statements do not include
          any
          adjustments that might result from the outcome of this uncertainty.
 
 
 
 *“Dale
          Matheson Carr-Hilton LaBonte”*
 
 
 CHARTERED
          ACCOUNTANTS
 
 
 Vancouver,
          Canada
 March
          27,
          2006
    50
 **LEXINGTON
          RESOURCES, INC.**
 
 **CONSOLIDATED
          BALANCE SHEETS**
 
 December
                    31,
                  2006
                
                
                December
                    31,
                  2005**ASSETS****CURRENT
                    ASSETS**Cash
                    and cash equivalents
                
                $
                86,241
                
                $
                520,332Accounts
                    receivable, net of allowance for doubtful accounts $177,367
                    (2005-$0)
                
                
                1,425,450
                
                
                184,546Due
                    from related parties (Note 8)
                
                
                73,916
                
                
                -Prepaid
                    expenses and other
                
                
                2,917
                
                
                -Current
                    portion of deferred finance fees (Note 6)
                
                
                39,803
                
                
                401,7151,628,327
                
                
                1,106,593**DEFERRED
                    FINANCE FEES**(Note
                    6)
                
                
                -
                
                
                267,810**ASSETS
                    HELD FOR SALE**(Note 5)
                
                
                2,767,225
                
                
                -**PROPERTY
                    AND EQUIPMENT**(Note 4)Oil
                    and gas properties - full cost method of accountingProved,
                    net of accumulated depletion $1,114,985 (2005 - $420,937)
                
                
                8,408,510
                
                
                2,329,448Unproved
                
                
                5,049,858
                
                
                4,000,02413,458,368
                
                
                6,329,472Other
                    equipment, net of accumulated depreciation of $235,858 (2005
                    -
                    $1,328)
                
                
                578,724
                
                
                2,16714,037,092
                
                
                6,331,639$
                18,432,644
                
                $
                7,706,042**LIABILITIES
                    AND STOCKHOLDERS’ EQUITY****CURRENT
                    LIABILITIES**Accounts
                    payable and accrued liabilities
                
                $
                8,404,178
                
                $
                936,265Due
                    to related parties (Note 8)
                
                
                202,881
                
                
                -Promissory
                    note and other short term advances (Note 6)
                
                
                640,274
                
                
                601,973Current
                    portion of convertible notes and accrued interest (Note 6)
                
                
                615,824
                
                
                1,940,7819,863,157
                
                
                3,479,019**CONVERTIBLE
                    NOTES**(Note
                    6)
                
                
                -
                
                
                1,220,965**LONG
                    TERM DEBT**(Note
                    6)
                
                
                1,295,961
                
                
                -**DERIVATIVE
                    LIABILITY**(Note
                    7)
                
                
                1,538,829
                
                
                -12,697,947
                
                
                4,699,984**CONTINGENCIES
                    AND COMMITMENTS**(Notes 1, 4, 6 & 8)**STOCKHOLDERS’
                    EQUITY**(Note
                    7)Common
                    stock $.00025 par value: 200,000,000 shares authorizedPreferred
                    stock, $.001 par value: 75,000,000 shares authorizedIssued
                    and outstanding:38,766,270
                    common shares (December 31, 2005 - 18,627,523)
                
                
                10,611
                
                
                5,575Additionalpaid-in
                    capital
                
                
                30,398,613
                
                
                16,297,665Common
                    stock purchase warrants
                
                
                2,009,340
                
                
                2,809,836Accumulated
                    deficit
                
                
                (26,683,867
                )
                
                (16,107,018
                )5,734,697
                
                
                3,006,058$
                18,432,644
                
                $
                7,706,042
 
 The
          accompanying notes are an integral part of these consolidated financial
          statements.  51
 **LEXINGTON
          RESOURCES, INC.**
 
 **CONSOLIDATED
          STATEMENTS OF OPERATIONS**
 
 **FOR
          THE YEARS ENDED DECEMBER 31, 2006 AND 2005**
 
 2006
                
                
                2005**REVENUES**Oil
                    and gas revenue
                
                $
                761,656
                
                $
                693,860Drilling
                    and service revenue
                
                
                1,575,285
                
                
                -2,336,941
                
                
                693,860**OPERATING
                    EXPENSES**Operating
                    costs and taxes
                
                
                474,696
                
                
                213,377Rig,
                    well and pulling unit expense
                
                
                905,148
                
                
                -Salaries,
                    wages and related
                
                
                847,300
                
                
                -Depreciation,
                    depletion and amortization
                
                
                1,209,969
                
                
                259,609General
                    and administrative
                
                
                2,520,652
                
                
                864,964Consulting
                    - stock-based
                
                
                -
                
                
                1,913,991Impairment
                    of other equipment (Note 5)
                
                
                1,600,000
                
                
                -Impairment
                    of oil and gas properties (Note 4)
                
                
                2,150,000
                
                
                -Investor
                    relations and promotion
                
                
                2,238,575
                
                
                1,205,74311,946,340
                
                
                4,457,684**NET
                    LOSS FROM OPERATIONS**
                
                
                (9,609,399
                )
                
                (3,763,824
                )**INTEREST
                    AND FINANCE FEES**(Note 6)
                
                
                (3,255,450
                )
                
                (4,775,039
                )**GAIN
                    ON DERIVATIVE LIABILITY**(Note
                    7)
                
                
                2,288,000
                
                
                -**NET
                    LOSS FOR THE YEAR**
                
                $
                (10,576,849
                )
                $
                (8,538,863
                )
 
 
 
 **BASIC
                    AND FULLY DILUTED NET LOSS PER SHARE**
                
                $
                (0.31
                )
                $
                (0.49
                )**WEIGHTED
                    AVERAGE COMMON SHARES OUTSTANDING**
                
                
                33,918,870
                
                
                17,470,971
 
 
  
 
 
 
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
 
  52
   **LEXINGTON
          RESOURCES, INC.**
 
 **CONSOLIDATED
          STATEMENT OF STOCKHOLDERS’ EQUITY**
 
 **FOR
          THE YEARS ENDED DECEMBER 31, 2006 AND 2005**
 
 Common
                    stock
                
                Additional
                    Paid-In
                
                
                Common
                    Stock Purchase
                
                
                AccumulatedShares
                
                
                Amount
                
                
                Capital
                
                
                Warrants
                
                
                Deficit
                
                
                TotalBalance,
                    December 31, 2004, carried forward
                
                
                16,999,038
                
                $
                4,250
                
                $
                8,947,604
                
                $
                301,815
                
                $
                (7,568,155
                )
                $
                1,685,514Common
                    stock purchase warrants exercised between Feb 2, 2005
                  and
                    Mar. 31, 2005 at $1.68 per share
                
                
                278,014
                
                
                70
                
                
                510,090
                
                
                (43,096
                )
                
                -
                
                
                467,064Fees
                    paid regarding warrants exercised between Feb. 2 and Mar. 31,
                    2005
                
                
                -
                
                
                -
                
                
                (12,433
                )
                
                -
                
                
                -
                
                
                (12,433
                )Common
                    stock purchase warrants exercised on
                  April
                    1 and 18, 2005 at $1.68 per share
                
                
                26,353
                
                
                6
                
                
                48,351
                
                
                (4,085
                )
                
                -
                
                
                44,272Fees
                    paid regarding warrants exercised on April 1 and 18, 2005
                
                
                -
                
                
                -
                
                
                (2,940
                )
                
                -
                
                
                -
                
                
                (2,940
                )Options
                    exercised May 11, 2005 at $0.16667 per share
                
                
                100,000
                
                
                25
                
                
                16,642
                
                
                -
                
                
                -
                
                
                16,667Fair
                    value of 233,000 warrants attached to May 31, 2005
                  promissory
                    notes
                
                
                -
                
                
                -
                
                
                -
                
                
                286,664
                
                
                -
                
                
                286,664Issuance
                    of common stock at $1.31 per share as finder’s fee
                  on
                    convertible notes
                
                
                200,000
                
                
                200
                
                
                261,800
                
                
                -
                
                
                -
                
                
                262,000Stock
                    based compensation
                
                
                -
                
                
                -
                
                
                1,913,991
                
                
                -
                
                
                -
                
                
                1,913,991Discount
                    on Convertible Notes and issuance of
                  Class
                    A& B warrants
                
                
                -
                
                
                -
                
                
                3,336,828
                
                
                2,523,172
                
                
                -
                
                
                5,860,000Conversion
                    of Convertible Notes to common stock at $1.00 per share
                  between
                    Nov. 30 and Dec 20, 2005 )
                
                
                1,024,118
                
                
                1,024
                
                
                1,023,098
                
                
                -
                
                
                -
                
                
                1,024,122Common
                    stock purchase warrants expired
                
                
                -
                
                
                -
                
                
                254,634
                
                
                (254,634
                )
                
                -
                
                
                -Net
                    loss year ended December 31, 2005
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (8,538,863
                )
                
                (8,538,863
                )Balance,
                    December 31, 2005
                
                
                18,627,523
                
                $
                5,575
                
                $
                16,297,665
                
                $
                2,809,836
                
                $
                (16,107,018
                )
                $
                3,006,058
 
 
 
 
 
 
 
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
  53
  **LEXINGTON
          RESOURCES, INC.**
 
 **CONSOLIDATED
          STATEMENT OF STOCKHOLDERS’ EQUITY**
 
 **FOR
          THE YEARS ENDED DECEMBER 31, 2006 AND 2005**
 
 Common
                      stock
                
                Additional
                    Paid-In
                
                
                Common
                    Stock Purchase
                
                
                AccumulatedShares
                
                
                Amount
                
                
                Capital
                
                
                Warrants
                
                
                Deficit
                
                
                TotalBalance,
                    December 31, 2005, carried forward
                
                18,627,523
                
                $
                5,575
                
                $
                16,297,665
                
                $
                2,809,836
                
                $
                (16,107,018
                )
                $
                3,006,058Issued
                    on acquisition of Oak Hills (Note 3)
                
                6,000,000
                
                
                1,500
                
                
                3,822,690
                
                
                -
                
                
                -
                
                
                3,824,190Issued
                    on exercise of stock options at $1.00 per share - March 13,
                    2006
                
                500,000
                
                
                125
                
                
                499,875
                
                
                -
                
                
                -
                
                
                500,000Issued
                    on exercise of stock options at $1.25 per share - March 21,
                    2006
                
                1,150,000
                
                
                288
                
                
                1,437,212
                
                
                -
                
                
                -
                
                
                1,437,500Conversion
                    of Convertible Notes to common stock at $1.00 per share
                  Between
                    February 21, 2006 and May 16, 2006 (Note 7)
                
                3,423,747
                
                
                856
                
                
                3,422,892
                
                
                -
                
                
                -
                
                
                3,423,748Issued
                    for services at $0.75 per share
                
                400,000
                
                
                100
                
                
                299,900
                
                
                -
                
                
                -
                
                
                300,000Deferred
                    compensation component of shares issued for services
                
                -
                
                
                -
                
                
                (300,000
                )
                
                -
                
                
                -
                
                
                (300,000
                )Issued
                    for private placement at $1.00 per share,
                  net
                    of cash finders’ fees of $411,250
                
                7,650,000
                
                
                1,913
                
                
                7,124,837
                
                
                112,000
                
                
                -
                
                
                7,238,750Issued
                    as finders’ fees on private placement
                
                765,000
                
                191
                
                
                (191
                )
                
                -
                
                
                -
                
                
                -Reallocation
                    of derivative component of private placement financing (Note
                    7)
                
                -
                
                
                -
                
                
                (4,246,500
                )
                
                -
                
                
                -
                
                
                (4,246,500
                )Issued
                    on exercise of warrants at $1.00 per share
                
                250,000
                
                
                63
                
                
                249,937
                
                
                -
                
                
                -
                
                
                250,000Finance
                    cost on repricing of warrants (Note 7)
                
                -
                
                
                -
                
                
                -
                
                
                615,300
                
                
                -
                
                
                615,300Reallocated
                    on exercise of common stock purchase warrants
                
                -
                
                
                -
                
                
                130,358
                
                
                (130,358
                )
                
                -
                
                
                -Reallocated
                    on expiration of common stock purchase warrants
                
                -
                
                
                -
                
                
                1,397,438
                
                
                (1,397,438
                )
                
                -
                
                
                -Amortization
                    of deferred compensation
                
                -
                
                
                -
                
                
                262,500
                
                
                -
                
                
                -
                
                
                262,500Net
                    loss year ended December 31, 2006
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (10,576,849
                )
                
                (10,576,849
                )Balance,
                    December 31, 2006
                
                38,766,270
                
                $
                10,611
                
                $
                30,398,613
                
                $
                2,009,340
                
                $
                (26,683,867
                )
                $
                5,734,697
 
 
 
 
 
 
 
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
 
  54
   **LEXINGTON
          RESOURCES, INC.**
 
 **CONSOLIDATED
          STATEMENTS OF CASH FLOWS**
 
 **FOR
          THE YEARS ENDED DECEMBER 31, 2006 AND 2005**
  2006
                
                
                2005**CASH
                    FLOWS FROM OPERATING ACTIVITIES**Net
                    loss for the year
                
                $
                (10,576,849
                )
                $
                (8,538,863
                )Adjustments
                    to reconcile net loss to net cash used in operating
                    activities:Stock-based
                    compensation
                
                
                -
                
                
                1,913,991Non-cash
                    expenses
                
                
                262,500
                
                
                160,708Oil
                    and gas depletion
                
                
                694,048
                
                
                259,609Depreciation
                
                
                515,921
                
                
                830Non-cash
                    interest and finance fees (Note 6)
                
                
                2,939,917
                
                
                4,614,238Impairment
                    of other equipment
                
                
                1,600,000
                
                
                -Impairment
                    of oil and gas properties
                
                
                2,150,000
                
                
                -Gain
                    on derivative liability
                
                
                (2,288,000
                )
                
                -Changes
                    in working capital assets and liabilities:Accounts
                    receivable
                
                
                (439,395
                )
                
                (47,973
                )Prepaid
                    expenses and other
                
                
                17,532
                
                
                -Accounts
                    payable
                
                
                198,326
                
                
                97,601Accrued
                    liabilities
                
                
                (15,033
                )
                
                111,307**NET
                    CASH FLOWS USED IN OPERATING ACTIVITIES**
                
                
                (4,941,033
                )
                
                (1,428,552
                )**CASH
                    FLOWS FROM INVESTING ACTIVITIES**Purchases
                    of equipment
                
                
                (350,967
                )
                
                -Additions
                    to oil and gas properties
                
                
                (3,845,864
                )
                
                (3,510,559
                )Cash
                    acquired on acquisition of Oak Hills, net of transaction
                    costs
                
                
                119,544
                
                
                -**NET
                    CASH FLOWS USED IN INVESTING ACTIVITIES**
                
                
                (4,077,287
                )
                
                (3,510,559
                )**CASH
                    FLOWS FROM FINANCING ACTIVITIES**Drilling
                    obligation payments
                
                
                -
                
                
                (1,180,915
                )Advances
                    from (to) related parties
                
                
                144,137
                
                
                -Convertible
                    note advances (repayments)
                
                
                (763,735
                )
                
                5,201,435Promissory
                    notes
                
                
                -
                
                
                600,000Long
                    term debt repayments
                
                
                (222,423
                )
                
                -Proceeds
                    on sale of common stock
                
                
                9,426,250
                
                
                512,630**NET
                    CASH FLOWS PROVIDED BY FINANCING ACTIVITIES**
                
                
                8,584,229
                
                
                5,133,150**INCREASE
                    (DECREASE) IN CASH AND CASH EQUIVALENTS**
                
                
                (434,091
                )
                
                194,039**CASH
                    AND CASH EQUIVALENTS, BEGINNING OF YEAR**
                
                
                520,332
                
                
                326,293**CASH
                    AND CASH EQUIVALENTS, END OF YEAR**
                
                $
                86,241
                
                $
                520,332
 
 
 **SUPPLEMENTAL
          CASH FLOW INFORMATION** (Note
          9).
 
 
 
 
 
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
  55
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  NOTE
          1:  NATURE
          OF
          CONTINUED OPERATIONS AND BASIS OF PRESENTATION
 
 Lexington
          Resources, Inc., a Nevada corporation, and its wholly owned subsidiary
          Lexington
          Oil & Gas Ltd. Co., an Oklahoma Limited Liability Corporation (“Lexington”),
          were organized for the purposes of the acquisition and development of oil
          and
          natural gas properties in the United States, concentrating on unconventional
          gas
          production initiatives that include coal bed methane gas acquisitions and
          developments in the Arkoma Basin in the State of Oklahoma as well as Barnett
          Shale targeted acquisitions and developments in the Dallas Fort Worth Basin
          in
          the State of Texas.
 
 On
          January 23, 2006, the Company acquired 100% of the shares of Oak Hills
          Drilling
          and Operating International, Inc., and its wholly owned operating subsidiary,
          Oak Hills Drilling and Operating LLC (“Oak Hills”). The purpose of the
          acquisition of Oak Hills was to enable the Company to improve scheduling
          of
          property development, to decrease costs associated with drilling and completing
          wells, and to increase the Company's control over its oil and gas leasehold
          developments by utilizing Oak Hills’ in house drilling and completion teams for
          its property exploration initiatives and gas well development
          programs.
 
 Commencing
          in the fourth quarter of 2006, management of the Company considered monetizing
          certain of the Company's assets and those of Oak Hills in order to decrease
          liabilities and overhead incurred by the Company in connection with previous
          capital expenditures and as a result of a lack of current debt and equity
          resources made available to the Company. On January 2, 2007, the Board
          of
          Directors of the Company authorized and approved the execution by Oak Hills
          of
          an agreement dated December 29, 2006 with Innovative Energy Services for
          the
          sale of the Company’s Drilling Rig. In accordance with the Agreement, Innovative
          Energy Services paid to Oak Hills an aggregate amount of $3,100,000 for
          the
          Drilling Rig and certain related equipment (Refer to Note 5).
 
 **Going
          Concern**
 The
          consolidated financial statements have been prepared on the basis of a
          going
          concern which contemplates the realization of assets and the satisfaction
          of
          liabilities in the normal course of business. The Company has a working
          capital
          deficiency of $8,234,830 at December 31, 2006, has incurred losses since
          inception of $26,683,867 and further losses are anticipated in the development
          of its oil and gas properties raising substantial doubt as to the Company’s
          ability to continue as a going concern. The ability of the Company to continue
          as a going concern is dependent on raising additional capital to fund ongoing
          losses and property development and ultimately on generating future profitable
          operations. The Company will continue to fund operations with advances
          and debt
          instruments, as well as further equity placements.
 
 Additional
          issuances of equity or convertible debt securities will result in dilution
          to
          our current shareholders. Further, such securities might have rights,
          preferences or privileges senior to our common stock. Additional financing
          may
          not be available upon acceptable terms, or at all. If adequate funds are
          not
          available or are not available on acceptable terms, we may not be able
          to take
          advantage of prospective new business endeavors or opportunities, which
          could
          significantly and materially restrict our business operations.
 
 During 2006
          the Company completed a private placement of shares at $1.00
          per shares for gross proceeds of $7,650,000 as described in Note
          6.
 
 
 **NOTE
          2:**  **SUMMARY
          OF SIGNIFICANT ACCOUNTING POLICIES**
 
 **(a)**  **Basis
          of accounting**
 The
          accounts are maintained and the consolidated financial statements have
          been
          prepared using the accrual basis of accounting in accordance with accounting
          principles generally accepted in the United States of America.
 
 **(b)**  **Principles
          of Consolidation**
 The
          consolidated financial statements include the accounts of the Company and
          its
          wholly-owned subsidiaries, Lexington and Oak Hills. Lexington was acquired
          by
          reverse acquisition on November 19, 2003 and Oak Hills was acquired January
          23,
          2006 (refer to Note 3). All significant inter-company transactions and
          account
          balances have been eliminated upon consolidation.
 
 The
          Company’s financial position, results of operations and cash flows include those
          of the Company and Lexington for all periods presented and those of Oak
          Hills
          since January 23, 2006, being the date of the acquisition.
  56
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          2:**  **SUMMARY
          OF SIGNIFICANT ACCOUNTING POLICIES (continued)**
 
 **(c)**  **Accounts
          Receivable**
 The
          Company performs ongoing credit evaluations of its customers’ financial
          condition and extends credit to virtually all of its customers on an
          uncollateralized basis.  Accounts receivable are stated at the historical
          carrying amount net of allowances for uncollectible accounts. The Company
          establishes an allowance for uncollectible accounts based on specific customer
          collection issues the Company has identified. Uncollectible accounts receivable
          are written off when a settlement is reached for an amount less than the
          outstanding historical balance or when the Company has determined the balance
          will not be collected.
 
 **(d)**  **Oil
          and Gas Properties**
 The
          Company follows the full cost method of accounting for its oil and gas
          operations whereby all costs related to the acquisition of methane, petroleum,
          and natural gas interests are capitalized. Under this method, all productive
          and
          nonproductive costs incurred in connection with the exploration for and
          development of oil and gas reserves are capitalized. Such costs include
          land and
          lease acquisition costs, annual carrying charges of non-producing properties,
          geological and geophysical costs, costs of drilling and equipping productive
          and
          non-productive wells, and direct exploration salaries and related benefits.
          Proceeds from the disposal of oil and gas properties are recorded as a
          reduction
          of the related capitalized costs without recognition of a gain or loss
          unless
          the disposal would result in a change of 20 percent or more in the depletion
          rate. The Company currently operates solely in the U.S.A.
 
 Depletion
          of proved oil and gas properties is computed on the units-of-production
          method
          based upon estimates of proved reserves, as determined by independent
          consultants, with oil and gas being converted to a common unit of measure
          based
          on their relative energy content.
 
 The
          costs
          of acquisition and exploration of unproved oil and gas properties, including
          any
          related capitalized interest expense, are not subject to depletion, but
          are
          assessed for impairment either individually or on an aggregated basis.
          The costs
          of certain unevaluated leasehold acreage are also not subject to depletion.
          Costs not subject to depletion are periodically assessed for possible impairment
          or reductions in value. Any impairment in value is included in the amortization
          base and amortized prospectively, subject to the ceiling test described
          below.
  The
          Company applies a ceiling test to capitalized costs which limits such costs
          to
          the aggregate of the estimated present value, using a ten percent discount
          rate
          of the estimated future net revenues from production of proven reserves
          at year
          end market prices less future production, administrative, financing, site
          restoration, and income tax costs plus the lower of cost or estimated market
          value of unproved properties. If capitalized costs are determined to exceed
          estimated future net revenues, a write-down of carrying value is charged
          to
          depletion in the period.
 
 **(e)**  **Property
          and other equipment**
 Property
          and other equipment are stated at cost. Depreciation is computed using
          straight-line method over the estimated useful lives of the assets for
          financial
          reporting purposes. Drilling rigs and related equipment have estimated
          useful
          lives of ten years. Automobiles, trucks, other equipment, software, furniture,
          fixtures and office equipment have estimated useful lives of five years.
          Expenditures for major renewals and betterments that extend the useful
          lives are
          capitalized. Expenditures for normal maintenance and repairs are expensed
          as
          incurred. The cost of assets sold or abandoned and the related accumulated
          depreciation are eliminated from the accounts and any gains or losses are
          charged or credited in the accompanying consolidated statement of operations
          of
          the respective period.
 
 **(f)**  **Asset
          Retirement Obligations**
 The
          Company has adopted the provisions of Statement of Financial Accounting
          Standards (“SFAS”) No. 143, *Accounting
          for Asset Retirement Obligations* .
          SFAS
          No. 143 requires the fair value of a liability for an asset retirement
          obligation to be recognized in the period in which it is incurred if a
          reasonable estimate of fair value can be made. The associated asset retirement
          costs are capitalized as part of the carrying amount of the related oil
          and gas
          properties. As of December 31, 2006, management has determined that there
          are no
          material asset retirement obligations.
  57
  **NOTE
          2:**  **SUMMARY
          OF SIGNIFICANT ACCOUNTING POLICIES (continued)**
 
 **(g)**  **Impairment
          of Long-Lived Assets**
 The
          Company reviews its long-term assets for impairment in accordance with
          SFAS No.
          144, *Accounting
          for the Impairment or Disposal of Long-Lived Assets* .
          SFAS
          No. 144 requires that, when events or circumstances indicate that the carrying
          amount of an asset may not be recoverable, the Company should determine
          if
          impairment of value exists. If the estimated undiscounted future net cash
          flows
          are less than the carrying amount of the assets, an impairment exists and
          an
          impairment loss must be calculated and recorded. If an impairment exists,
          the
          impairment loss is calculated based on the excess of the carrying amount
          of the
          asset over the asset’s fair value. Any impairment loss is treated as a permanent
          reduction in the carrying value of the assets. During 2006, the Company
          recorded
          impairments of certain of its oil and gas properties and other equipment
          as
          described in Notes 4 and 5.
 
 **(h)**  **Earnings
          (Loss) Per Share**
 The
          Company computes loss per share in accordance with SFAS No. 128, *Earnings
          per Share s* which
          requires presentation of both basic and diluted earnings per share on the
          face
          of the statement of operations. Basic loss per share is computed by dividing
          net
          loss available to common shareholders by the weighted average number of
          outstanding common shares during the period. Diluted loss per share gives
          effect
          to all dilutive potential common shares outstanding during the period including
          stock options and warrants using the treasury method. Dilutive loss per
          share
          excludes all potential common shares if their effect is anti-dilutive.
 
 **(i)**  **Revenue
          Recognition**
 Oil
          and
          natural gas revenues are recorded using the sales method, whereby the Company
          recognizes oil and natural gas revenue based on the amount of oil and gas
          sold
          to purchasers, when title passes, the amount is determinable and collection
          is
          reasonably assured. Actual sales of gas are based on sales, net of the
          associated volume charges for processing fees and for costs associated
          with
          delivery, transportation, marketing, and royalties in accordance with industry
          standards. Operating costs and taxes are recognized in the same period
          in which
          revenue is earned.
 
 The
          Company enters into contracts with customers whereby related drilling and
          service revenues are earned and recognized on a per-day basis as services
          are
          rendered when collectibility is deemed probable.
 
 **(j)**  **Financial
          Instruments**
 The
          fair
          values of cash and cash equivalents, accounts receivable, accounts payable,
          accrued liabilities, promissory notes and convertible notes were
          estimated to approximate their carrying values due to the immediate or
          short-term maturity of these financial instruments. The Company’s current and
          planned operations are located in the States of Oklahoma and Texas, in
          the
          United States, and as a result the Company is not subject to significant
          exposure to market risks from changes in foreign currency rates.
  The
          Company's financial instruments that are exposed to concentrations of credit
          risk consist primarily of cash and cash equivalents and accounts receivable.
          The
          Company's cash and cash equivalents are held at a major U.S. based financial
          institution. The Company manages and controls market and credit risk through
          established formal internal control procedures, which are reviewed on an
          ongoing
          basis.
 
 The
          Company sells its gas to only two customers as there is currently insufficient
          production for multiple purchasers. The Company manages and controls this
          situation by ensuring it only deals with gas purchasers that are reputable
          and
          are well established.
 
 **(k)**  **Use
          of Estimates**
 The
          preparation of these financial statements requires the use of certain estimates
          by management in determining the Company's assets, liabilities, revenues
          and
          expenses. Actual results could differ from such estimates. Depreciation,
          depletion and amortization of oil and gas properties and the impairment
          of oil
          and gas properties are determined using estimates of oil and gas reserves.
          There
          are numerous uncertainties in estimating the quantity of reserves and in
          projecting the future rates of production and timing of development
          expenditures, including future costs to dismantle, dispose, plug, and restore
          the Company's properties. Oil and gas reserve engineering must be recognized
          as
          a subjective process of estimating underground accumulations of oil and
          gas that
          cannot be measured in an exact way. Proved reserves of oil and natural
          gas are
          estimated quantities that geological and engineering data demonstrate with
          reasonable certainty to be recoverable in the future from known reservoirs
          under
          existing conditions.
 
  58
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  NOTE
          2:  SUMMARY
          OF SIGNIFICANT ACCOUNTING POLICIES (continued)
 
 **(l)**  **Income
          taxes**
 Income
          taxes are accounted for asset and liability method of SFAS
          #109, Accounting for Income Taxes. Under this method, deferred tax
          assets and liabilities are recognized for the future tax consequences
          attributable to differences between the financial statement carrying amounts
          of
          existing assets and liabilities and their respective tax balances. Deferred
          tax
          assets and liabilities are measured using enacted or substantially enacted
          tax
          rates expected to apply to the taxable income in the years in which those
          differences are expected to be recovered or settled. The effect on deferred
          tax
          assets and liabilities of a change in tax rates is
 recognized
          in income in the period that includes the date of enactment or substantial
          enactment. A valuation allowance is provided for deferred tax assets if
          it is
          more likely than not that the Company will not realize the future benefit,
          or if
          future deductibility is uncertain.
 
 **(m)**  **Cash
          and cash equivalents**
 The
          Company considers all highly liquid instruments with an original maturity
          of
          three months or less at the time of issuance to be cash
          equivalents.
 
 **(n)**  **Stock
          Based Compensation**
 On
          January 1, 2006, the Company adopted the fair value recognition provisions
          of
          SFAS No. 123(R), *Share-Based
          Payment,* (“SFAS
          123R”). Prior to January 1, 2006, the Company accounted for share-based payments
          under the recognition and measurement provisions of APB Opinion No. 25, *Accounting
          for Stock Issued to Employees* (“APB
          25”), and related Interpretations, as permitted by SFAS No. 123, *Accounting
          for Stock-Based Compensation* (“SFAS
          123”). In accordance with APB 25, no compensation cost was required to be
          recognized for options granted that had an exercise price equal to the
          market
          value of the underlying common stock on the date of grant.
 
 The
          Company adopted SFAS 123R using the modified-prospective-transition method.
          Under this method, compensation cost recognized for the year ended December
          31,
          2006 includes: a) compensation cost for all share-based payments granted
          prior
          to, but not yet vested as of December 31, 2005, based on the grant-date
          fair
          value estimated in accordance with the original provisions of SFAS 123,
          and b)
          compensation cost for all share-based payments granted subsequent to December
          31, 2005, based on the grant-date fair value estimated in accordance with
          the
          provisions of SFAS 123R. In addition, deferred stock compensation related
          to
          non-vested options is required to be eliminated against additional paid-in
          capital upon adoption of SFAS 123R. The results for the prior periods have
          not
          been restated.
 
 All
          previously granted stock options had fully vested as at December 31, 2005
          and
          during the year ended December 31, 2006, the Company did not grant any
          new stock
          options or modify any previously existing stock options. Accordingly, the
          Company’s results of operations for the year ended December 31, 2006 were no
          different than if the Company had not adopted SFAS 123R. As a result, no
          disclosure of the impact of adopting SFAS 123R has been provided. The following
          table illustrates the effect on net loss and net loss per share had the
          Company
          applied the fair value recognition provisions of SFAS No. 123 to stock-based
          compensation for the comparative year ended December 31, 2005:
 
 Year
                    ended
                  December
                    31, 2005Net
                    loss
                
                
                As
                    reported
                
                $
                (8,538,863
                )SFAS
                    No. 123 compensation expense
                
                
                Pro-forma
                
                
                (841,307
                )Net
                    loss
                
                
                Pro-forma
                
                $
                (9,380,170
                )Basic
                    and diluted net loss per share
                
                
                Pro-forma
                
                $
                (0.54
                )
 
 
 
 
 
 
  59
  **NOTE
          2:**  **SUMMARY
          OF SIGNIFICANT ACCOUNTING POLICIES (continued)**
 
 **(o)**  **Recent
          Accounting Pronouncements**
 
 In
          September 2006, the FASB issued SFAS No. 157, *Fair
          Value Measurement* ("SFAS
          157"). The Statement provides guidance for using fair value to measure
          assets
          and liabilities. The Statement also expands disclosures about the extent
          to
          which companies measure assets and liabilities at fair value, the information
          used to measure fair value, and the effect of fair value measurement on
          earnings. This Statement applies under other accounting pronouncements
          that
          require or permit fair value measurements. This Statement does not expand
          the
          use of fair value measurements in any new circumstances. Under this Statement,
          fair value refers to the price that would be received to sell an asset
          or paid
          to transfer a liability in an orderly transaction between market participants
          in
          the market in which the entity transacts. SFAS 157 is effective for the
          Company
          for fair value measurements and disclosures made by the Company in its
          fiscal
          year beginning on January 1, 2008. The adoption of SFAS 157 is not expected
          to
          have a material impact on the Company’s financial position, results of
          operations or cash flows.
 
 In
          September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Considering
          the Effects of Prior Year Misstatements when Quantifying Misstatements
          in
          Current Year Financial Statements* .
          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. SAB
          No.
          108 was effective for the Company’s year ended December 31, 2006.  The
          adoption of SAB 108 did not have a material impact on the Company’s current or
          previously reported financial position, results of operations or cash flows.
 
 In
          July
          2006, the FASB issued Interpretation (“FIN”) No. 48, *Accounting
          for Uncertainty in Income Taxes - an interpretation of SFAS No.
          109* .
          FIN No.
          48 clarifies the accounting for uncertainty in income taxes recognized
          in an
          entity’s financial statements in accordance with SFAS No. 109 and prescribes a
          recognition threshold and measurement attribute for financial statement
          disclosure of tax positions taken or expected to be taken on a tax return.
          Additionally, FIN No. 48 provides guidance on derecognition, classification,
          interest and penalties, accounting in interim periods, disclosure and
          transition. FIN No. 48 is effective for fiscal years beginning after December
          15, 2006, with early adoption permitted. The Company is currently evaluating
          the
          impact, if any, that FIN 48 will have on its financial position, results
          of
          operations or cash flows.
 
 In
          December 2006, the FASB issued FSP EITF 00-19-02, *Accounting
          for Registration Payment Arrangements* (“FSP
          00-19-2”) which addresses accounting for registration payment arrangements. FSP
          00-19-2 specifies that the contingent obligation to make future payments
          or
          otherwise transfer consideration under a registration payment arrangement,
          whether issued as a separate agreement or included as a provision of a
          financial
          instrument or other agreement, should be separately recognized and measured
          in
          accordance with FASB Statement No. 5, *Accounting
          for Contingencies* .
          FSP
          00-19-2 further clarifies that a financial instrument subject to a registration
          payment arrangement should be accounted for in accordance with other applicable
          generally accepted accounting principles without regard to the contingent
          obligation to transfer consideration pursuant to the registration payment
          arrangement. For registration payment arrangements and financial instruments
          subject to those arrangements that were entered into prior to the issuance
          of
          EITF 00-19-2, this guidance is effective for financial statements issued
          for
          fiscal years beginning after December 15, 2006 and interim periods within
          those
          fiscal years. The Company has not yet determined the impact that the adoption
          of
          FSP 00-19-2 will have on its financial
          position, results of operations or cash flows .
 
 
 
 
 
  60
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          3:**  **ACQUISITION
          OF OAK HILLS DRILLING AND OPERATING INTERNATIONAL,
          INC.**
 
 On
          January 23, 2006, the Company acquired 100% of the shares of Oak Hills
          Drilling
          and Operating International, Inc., and its wholly owned operating subsidiary,
          Oak Hills. The companies were acquired from the existing shareholders for
          an
          aggregate of 6,000,000 restricted shares of the Company’s common stock. The
          assets of Oak Hills were independently valued at approximately $5.85 million
          and
          management of the Company determined a net tangible fair value of approximately
          $3.82 million as the basis for the total number of common shares issued
          at a
          price per share of $0.637. As of the acquisition date, Oak Hills had secured
          promissory notes totaling $1.28 million owed to certain of the Oak Hills
          vendors. The $1.28 million in promissory notes accrue interest at 9% per
          annum,
          and require no payments of interest or principal until the end of a two
          year
          term ending January 22, 2008.
 
 The
          purpose of the acquisition of Oak Hills was to enable the Company to improve
          scheduling of property development, to decrease costs associated with drilling
          and completing wells, and to increase the Company's control over its oil
          and gas
          leasehold developments by utilizing Oak Hills’ in house drilling and completion
          teams for its property exploration initiatives and gas well development
          programs.
 
 Prior
          to
          the acquisition of Oak Hills, there were 18,627,523 shares of common stock
          of
          the Company outstanding. Accordingly, the pre-acquisition shareholders
          of the
          Company owned approximately 76% of the post-acquisition issued and outstanding
          shares of the Company’s common stock. As a result, this business combination has
          been accounted for using the purchase method with the Company being the
          acquirer.
 
 The
          fair
          value of the assets acquired and liabilities assumed effective January
          23, 2006
          are as follows:
 Current
                    assets
                
                $
                    1,024,458Property,
                    plant and equipment
                
                5,228,736Current
                    liabilities
                
                (842,836)Due
                    to related parties
                
                
                (1,280,789
                )Long
                    term debt
                
                
                (222,423
                )$
                3,907,146
 
 Consideration
                    paid-
                    6,000,000 common shares at $0.6374 per share
                
                $
                    3,824,190-
                    transaction costs
                
                
                82,956$
                3,907,146
 
 The
          results of operations and cash flows presented include those of the Company
          for
          all periods presented and those of Oak Hills for the period from January
          23,
          2006 to December 31, 2006.
 
 The
          following unaudited pro forma information for the years ended December
          31, 2006
          and 2005 presents the pro forma results of operations as if the acquisition
          had
          occurred as of January 1, 2006 and January 1, 2005, respectively. The pro
          forma
          information presented is not necessarily indicative of what would have
          occurred
          had the acquisition been made as of January 1, 2006 and 2005, nor is it
          necessarily indicative of future results of operations. The following pro
          forma
          amounts give effect to appropriate adjustments for an increase in depreciation,
          additional intercompany profit elimination and an increase in weighted
          average
          shares outstanding.
 
 For
                    the Year Ended December 31,2006
                
                
                2005Revenues
                
                $
                2,683,574
                
                $
                3,742,410Net
                    loss
                
                $
                (10,552,777
                )
                $
                (9,053,358
                )Net
                    loss per share - basic and diluted
                
                $
                (0.31
                )
                $
                (0.39
                )Weighted
                    average shares outstanding
                
                
                34,280,514
                
                
                23,470,971
  61
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          4:**  **PROPERTY
          AND EQUIPMENT**
 
 Property
          and equipment includes the following:
 December
                    31,
                
                December
                    31,2006
                
                2005**Oil
                    and gas properties:**Proved,
                    subject to depletion
                
                $
                    11,673,495
                
                $
                    2,750,385Unproved,
                    not subject to depletion
                
                5,049,858
                
                4,000,024Accumulated
                    depletion
                
                
                (1,114,985
                )
                
                (420,937
                )Impairment
                    provision
                
                
                (2,150,000
                )
                
                -Net
                    oil and gas properties
                
                
                13,458,368
                
                
                6,329,472Other
                    equipment
                
                
                841,859
                
                
                3,495Accumulated
                    depreciation
                
                
                (235,858
                )
                
                (1,328
                )Impairment
                    provision
                
                
                (27,277
                )
                
                -Net
                    other property and equipment
                
                
                578,724
                
                
                2,167Property
                    and equipment, net of accumulated depreciation and
                    depletion
                
                $
                14,037,092
                
                $
                6,331,639
 
 For
          the
          year ended December 31, 2006 estimated future development costs totaling
          $3,686,000 were included in costs subject to amortization for the purposes
          of
          determining depletion for the year.
 
 Total
          depletion expense per unit of production for the year ended December 31,
          2006
          was $4.51 per mcf (2005 - $1.04).
 
 The
          Company's oil and gas activities are currently conducted in the United
          States.
          During the year ended December 31, 2006, the Company completed the following
          transactions related to its oil and gas activities:
 
 **Acquisition
          of Oak Hills Drilling and Operating International, Inc.**
 On
          January 23, 2006, the Company completed the acquisition of Oak Hills as
          described in Note 3.
 
 **Joint
          Exploration Agreement - Arkoma Basin, Oklahoma**
 On
          March
          3, 2006, effective January 31, 2006, the Company entered into an exploration
          agreement with Dylan Peyton, LLC (“Dylan”) of Dallas, Texas to jointly develop
          Lexington’s Arkoma Basin leases located in Hughes and MacIntosh Counties in the
          State of Oklahoma (the “Arkoma Basin Exploration Agreement”).  The
          properties will be developed on a 50/50 equal working interest basis.  An
          affiliate to Dylan, named Avatar Energy, LLC, will become the operator
          for the
          project supplying at least one drilling rig to the project.  The Company
          has assigned 50% of its undeveloped leasehold interests in Oklahoma in
          exchange
          for cash proceeds of $575,000 which equates to approximately 50% of the
          Company’s originally incurred leasing costs.  Assignments to 50% of the
          Company’s undeveloped leasehold interests in Coal Creek, South Lamar, Middle
          Creek, and H-9 Prospects have been effected to Dylan.  Well bores and
          acreage relating to previously drilled and completed wells by the Company
          will
          not form part of any assignments under the Arkoma Basin Exploration Agreement.
          Proceeds from this disposal were recorded as a reduction of the capitalized
          costs without recognition of a gain or loss as the disposal did not result
          in a
          change of 20 percent or more in the Company’s depletion rate.
 
 **Joint
          Exploration Agreement - Comanche County, Texas**
 On
          March
          3, 2006, effective January 31, 2006, the Company entered into an exploration
          agreement with Dylan to jointly develop approximately 5,000 acres of Barnett
          Shale and shallow gas targets in Comanche County, Texas (the “Comanche County
          Exploration Agreement”). The property will be developed on a 50/50 equal working
          interest basis.  The Company’s subsidiary, Oak Hills will become the
          operator of the project.  The Company will pay approximately $1,225,500 for
          its 50% working interest in the new acreage through a combination of $575,000
          in
          cash (paid during the period) and approximately $650,500 of carried drilling
          costs in the first Comanche Barnett Shale test well required to be drilled
          on or
          before September 2006.  The test well commenced drilling on September 1,
          2006 and the Company is currently evaluating the final costs associated
          with
          drilling in order to determine the total amounts owing. It is estimated
          that the
          total amount owing for the acreage will be approximately $1,225,500, resulting
          in no additional amount to be paid after deducting the original payment
          of
          $575,000 and the carried drilling costs estimated to be $650,500. The Company
          is
          currently in negotiations and reconciliation of expenditures relating to
          the
          Joint Exploration Agreement in Comanche County, Texas.
 
  62
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          4:**  **PROPERTY
          AND EQUIPMENT (continued)**
 
 During
          2006, the Company’s leases relating the H-9 Prospect acreage lapsed according to
          their terms resulting in an impairment to the carrying value of unamortized
          property of $331,963. In accordance with the provisions of full cost accounting,
          the Company transferred this carrying value into its cost pool subject
          to
          amortization. Also during the year, certain other acreage leases were allowed
          to
          lapse, however, these expiries did not result in any property
          impairments.
 
 On
          October 2, 2006, the Company entered into a convertible debt set-off agreement
          with Dylan (the “Convertible Debt Agreement”), relating to amounts due and owing
          to Dylan from fractures and completion of certain coal bed methane gas
          wells.
          Pursuant to the terms and provisions of the Convertible Debt Agreement:
          (i) Oak
          Hills sold to Ada Energy Services LLC (“AES”) certain of its assets, including
          two Wilson 600 duplex pumps for an aggregate consideration of $120,000
          as a
          set-off for the debt due and owing to Dylan; (ii) Oak Hills had 120 days
          to pay
          the amount of $120,000 due and owing to Dylan to re-purchase the two Wilson
          pumps from AES for $120,000 plus the cost of any work done on them other
          than
          repairs made for damages caused by AES’ usage of the pumps; (iii) Oak Hills made
          a payment of $20,000 to Avatar Energy relating to the completion and fracture
          job on the Gray Well #1H-22 and the fracture job on the Dylan Well #1-23;
          and
          (iv) in the event Oak Hills does not re-purchase the Wilson pumps for $120,000
          within the 120 days, the sale of the pumps will constitute full and complete
          settlement of the $120,000 due and owing Dylan. On January 27, 2007, the
          Company
          extinguished its obligations under the convertible debt set-off agreement
          with
          Dylan by repaying $120,000 to Ada Energy Services and reclaiming its pledged
          collateral (two Wilson 600 duplex pumps). Accordingly, as at December 31,
          2006,
          the Company off-set the amount owing to Dylan against the carrying value
          of the
          pumps with the residual carrying value being included in the Rig and related
          equipment impairment provision as described in Note 5.
 
 The
          following is a summary of the transactions involving the Company’s unproven
          properties not subject to depletion:
 
 Acquisition
                  Costs
                
                
                Development
                  Costs
                
                
                TotalBalance,
                    December 31, 2004
                
                $
                -
                
                $
                1,419,447
                
                $
                1,419,447Incurred
                    during the year
                
                
                2,327,230
                
                
                309,347
                
                
                2,636,577Reallocated
                    to proven and subject to depletion
                
                
                -
                
                
                (56,000
                )
                
                (56,000
                )Balance,
                    December 31, 2005
                
                
                2,327,230
                
                
                1,672,794
                
                
                4,000,024Incurred
                    during the year
                
                
                72,000
                
                
                2,013,524
                
                
                2,085,524Reallocated
                    to proven and subject to depletion
                
                
                (331,963
                )
                
                (703,727
                )
                
                (1,035,690
                )Balance,
                    December 31, 2006
                
                $
                2,067,267
                
                $
                2,982,591
                
                $
                5,049,858
 
 
 **NOTE
          5:**  **ASSETS
          HELD FOR SALE**
 
 On
          January 2, 2007, the Company authorized and approved the execution by Oak
          Hills
          of an agreement dated December 29, 2006 with Innovative Energy Services
          pertaining to the sale of the Company’s drilling rig and related equipment. In
          accordance with the Agreement, Innovative Energy Services paid to Oak Hills
          a
          gross aggregate amount of $3,100,000 for the drilling dig and related equipment.
          The Agreement further required the Company to make certain lease buy out
          payments on the equipment totaling $332,775. These assets have been reclassified
          to assets held for sale at their net recoverable amount of $2,767,225 resulting
          in an impairment of the carrying value of these assets totaling $1,572,723
          being
          recorded during the period. This Agreement was completed, and the net proceeds
          received effective January 5, 2007.
 
  63
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          6:**  **LONG
          TERM DEBT, SHORT TERM DEBT AND OTHER ADVANCES**
 
 During
          the year ended December 31, 2006, the Company had the following activity
          in
          connection with long term debt, short term debt and other advances:
 
 **Promissory
          note**
 On
          December 20, 2005, the Company obtained an unsecured loan by way of promissory
          note from a shareholder of the Company totaling $600,000. The term of the
          loan
          is for two years with interest calculated at 10% per annum. Interest is
          to be
          paid on a quarterly basis with the principal to be repaid on or before
          the two
          year loan period. As of December 31, 2006, $40,274 (December 31, 2005 -
          $1,973)
          of accrued interest remains unpaid on this loan. Subject to available funds,
          the
          Company intends to repay this loan during the next 12 months and accordingly
          it
          has been classified as a current liability.
 
 **Long
          term debt**
 As
          at the
          date of the Oak Hills acquisition, Oak Hills had outstanding notes payable
          to
          financial institutions totaling $222,423 secured by certain assets of Oak
          Hills
          with interest rates ranging from 6.25% to 11.5% and maturing through October
          2010. Subsequent to the acquisition of Oak Hills, the balance of these
          loans
          have been repaid and the security has been released.
 
 As
          at the
          date of the Oak Hills acquisition, Oak Hills had outstanding promissory
          notes
          totaling $1,295,961 which accrue interest at 9% per annum, and require
          no
          payments of interest or principal until the end of a two year term ending
          January 22, 2008. These promissory notes are owed to certain former shareholders
          of Oak Hills, being vendors in the Oak Hills acquisition described in Note
          3 and
          are secured against the assets of Oak Hills. During the year ended December
          31,
          2006, the Company accrued $106,730 of interest on these loans resulting
          in
          $226,136 of accrued interest owing which has been included in accounts
          payable.
 
 On
          January 26, 2007, the $1,295,961 in promissory notes and accrued interest
          of
          $227,775 was repaid in full pursuant to the sale of equipment securing
          these
          notes (Refer to note 12).
 
 **Other
          short term advances**
 During
          the first quarter of 2006, the Company received an advance from a shareholder
          of
          the Company of $500,000. This amount was unsecured, non-interest bearing
          and
          without specific terms of repayment. During the year, this amount was applied
          towards subscriptions in connection with the Company’s private placement. (Refer
          to Note 7).
 
 **Secured
          convertible notes**
 As
          at
          December 31, 2005, the Company had secured convertible debt principal
          outstanding of $4,854,314 less an unamortized discount of $1,801,901 resulting
          in a net carrying value of $3,052,413 of which $1,831,448 plus accrued
          interest
          of $109,333 was recorded as a current liability. The convertible notes
          are due
          September 15, 2007 and bear interest at a rate of 8% per annum. The repayment
          of
          the notes has been guaranteed by Lexington supported by a collateral security
          agreement covering all the assets of Lexington. During the year ended December
          31, 2006, the Company paid a total of $188,783 of interest, repaid a total
          of
          $763,735 of principal, and converted a total of $3,390,122 of principal
          and
          $33,626 of interest into common shares of the Company at a price of $1.00
          per
          share under the provisions of the Convertible Note agreements. Also during
          the
          year, the Company recorded non-cash finance fees totaling $1,694,895 relating
          to
          the amortization of the discount on both converted and unconverted notes
          and
          $629,722 relating to the amortization of deferred issuance costs. As at
          December
          31, 2006, the Company had convertible debt principal outstanding of $700,457
          less an unamortized discount of $107,006 resulting in a net carrying value
          of
          $593,451 which, in addition to $22,373 of accrued interest, has been recorded
          as
          a current liability. On January 26, 2007, the Company repaid all outstanding
          convertible promissory notes principal of $700,457, accrued interest of
          $32,105,
          and a 20% penalty repayment amount of $146,512 for an aggregate amount
          of
          $879,074 to the remaining convertible note holders who had a secured interest
          on
          the assets of Lexington. (Refer to Note 7).
 
 
 **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY**
 
 The
          authorized capital of the Company consists of 200,000,000 voting common
          shares
          with $0.00025 par value, and 75,000,000 non-voting preferred shares with
          $0.001
          par value.
 
 
  64
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY (continued)**
 
 **Common
          Stock Issuances -year ended December 31, 2006**
 The
          Company entered into a one year consulting contract with a third party
          contractor, to provide financial and investor public relations and related
          matters in Germany. In connection with this agreement the Company issued
          400,000
          restricted shares of the Company’s common stock with a fair value of $300,000
          and agreed to pay approximately $353,000 (EUR $293,000) over the term of
          the
          agreement. The $300,000 was initially recorded as a deferred compensation
          equity
          item of which $262,500 was expensed during the year.
 
 During
          the year, 1,150,000 stock options were re-assigned from International Market
          Trend, Inc. (“IMT”) to two consultants of IMT in connection with business
          development services provided by IMT and the consultants to the Company.
          The
          options are exercisable at $1.25 per share for a term of 5 years and replaced
          1,150,000 options previously granted to IMT which were concurrently cancelled.
          The exercise prices, terms and conditions of the new options issued were
          identical to those of the stock options cancelled. As these options were
          a
          reissuance of the original options and not a modification or replacement
          of the
          original option, the Company has not remeasured the fair value of the options
          at
          the reissuance date.
 
 A
          total
          of 1,650,000 shares of common stock were issued on the exercise of options
          (500,000 at $1.00 per share and 1,150,000 at $1.25 per share) for cash
          proceeds
          of $1,937,500. All shares issued were previously registered on Form
          S-8.
 
 The
          Company issued 6,000,000 restricted shares of common stock in connection
          with
          the acquisition of Oak Hills as described in Note 3.
 
 The
          Company issued 3,423,747 shares of common stock on conversion of a total
          of
          $3,423,748 of convertible note principal and accrued interest amounts as
          described in Note 6.
 
 A
          total
          of 250,000 shares of common stock were issued on the exercise of Series
          B
          warrants at $1.00 per share for cash proceeds of $250,000. The Series A
          and
          Series B warrants were originally issued as part of the secured convertible
          note
          unit offering and the shares of common stock underlying the warrants were
          registered by way of a Registration Statement on Form SB-2. The Series
          A and
          Series B warrants were originally issued at exercise prices of $1.50 per
          share
          and $1.25 per share, respectively. Under the original terms of the warrants,
          the
          exercise prices were subject to change under certain conditions relating
          to a
          subsequent financing. As a result of the private placement completed during
          the
          year, the Series A and Series B warrants were all repriced to $1.00 per
          share.
          During the year, the Company recorded a non-cash finance cost of $615,300
          being
          the estimated fair value increase in the warrants resulting from the price
          reduction described above.
 
 During
          the year, the Company completed a private placement pursuant to which the
          Company issued an aggregate of 7,650,000 units ("Unit") of the Company’s
          securities at a subscription price of U.S. $1.00 per Unit for total gross
          proceeds of $7,650,000; with each Unit being comprised of one common share
          and
          one non-transferable common stock purchase warrant ("Warrant"). Each resulting
          Warrant entitles the subscriber to purchase an additional common share
          (“Warrant
          Share”) of the Company at a price of $1.25 per share for the period commencing
          upon the date of issuance of the Units by the Company and ending on the
          day
          which is the earlier of (i) 18 months from the date of issuance of the
          Units and
          (ii) 12 months from the effective date of the Company’s proposed registration
          statement. Both the Warrant Shares and the common shares issued pursuant
          to the
          private placement offering are to be proposed for registration under the
          United
          States Securities Act of 1933, as amended. The Company paid finders fees
          of 5%
          of the gross cash proceeds received under the private placement offering
          and 10%
          restricted common shares on the gross units issued, with such restricted
          shares
          carrying piggy back registration rights. Of the total Units sold, 7,450,000
          are
          subject to potential damages relating to the registration requirement.
          Effective
          July 3, 2006, the Company filed a Form SB-2 Registration Statement under
          the
          United States Securities Act of 1933, as amended, to register the 8,415,000
          common shares issued and 7,650,000 common shares underlying the common
          stock
          purchase warrants. This registration statement was not declared effective
          before
          financial penalties were due pursuant to registration timing. Penalties
          accrued
          and unpaid to December 31, 2006 total $419,671 and have been included in
          accounts payable and accrued liabilities. The Company continues to incur
          1.5% of
          $7,450,000 raised per month of delay until the Registration Statement is
          declared effective.
 
 The
          Company accounted for the various components of the private placement
          transaction using the provisions of SFAS No. 133 *Accounting
          for Derivative Instruments and Hedging Activities* ;
          EITF
          Issue No. 00-19 *Accounting
          for Derivative Financial instruments Indexed to, and Potentially Settled
          in a
          Company’s Own Stock* ;
          EITF
          Issue No. 05-4 *The
          Effect of Liquidated Damages Clause on Freestanding Financial Instruments
          Subject to Issue No. 00-19* and
          related amendments and guidance.
  65
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY (continued)**
 
 The
          following table summarizes the initial allocation of the proceeds from
          the
          private placement:
 Gross
                    proceeds
                
                $
                7,650,000Fair
                    value of warrants subject to registration damages
                
                
                (4,172,000
                )Estimated
                    fair value of liquidated damages on common shares and
                    warrants
                
                
                (74,500
                )Share
                    issuance costs
                
                
                (411,250
                )Proceeds
                    allocated to equity components
                
                $
                2,992,250Allocated
                    as follows:Common
                    shares
                
                $
                2,880,250Warrants
                    not subject to registration damages
                
                
                112,000$
                2,992,250
 
 **Private
          placement warrants**
 The
          fair
          value of the Warrants at inception was estimated to be $4,284,000 and has
          been
          allocated between warrants subject to damages (derivative liability) and
          warrants not subject to damages (equity) as outlined above. The fair value
          of
          the warrants at inception was estimated using the Black-Scholes option-pricing
          model with the following assumptions: expected warrant life of 1.33 years,
          risk-free interest rate of 4.81%, dividend yield of 0% and expected volatility
          of 77%.
 
 **Liquidated
          damages related to common stock and warrants issued to investors in the
          private
          placement**
 The
          Company determined that the warrants and related liquidated damages provisions
          associated with the common stock issuable upon exercise of the warrants
          did not
          meet the criteria for equity accounting under EITF 00-19. Further, the
          Company
          determined that the liquidated damages provision related to the common
          stock
          issued is an embedded derivative under SFAS No. 133.
  As
          at
          issuance of the shares and warrants, the fair value of the warrants was
          estimated to be $4,172,000 using the Black-Scholes option-pricing model
          as
          described above. The fair value of the liquidated damages on the common
          stock
          and warrants at issuance was estimated to be $74,500. This estimate was
          based on
          the probability of non-registration over time and the damages related thereto.
          The total fair value of the combined warrants and liquidated damages was
          $4,246,500 at issuance of the shares and warrants and was recorded as a
          derivative liability which will be revalued each quarter until the liquidated
          damages provisions expire. Changes in the fair value estimate over this
          period
          will be recorded in the consolidated statement of operations.
 
 As
          at
          December 31, 2006, the fair value of the warrants was estimated to be $36,500
          using the Black-Scholes option-pricing model with the following assumptions:
          expected warrant life of .83 years, risk-free interest rate of 5%, dividend
          yield of 0% and expected volatility of 89%. As at December 31, 2006, the
          fair
          value of the liquidated damages on the common stock and warrants was estimated
          to be $1,922,000. As at December 31, 2006, the combined derivative liability
          had
          a carrying value of $1,958,500. During the year ended December 31, 2006,
          the
          company recorded a gain of $2,288,000 on the change in the carrying value
          of the
          derivative liability resulting primarily from a decline in the price of
          the
          Company’s common stock of approximately 82%.
 
 The
          carrying value of the derivative liability is summarized as
          follows:
 
 Derivative
                    liability:Fair
                    value of warrants subject to registration damages
                
                $
                4,172,000Estimated
                    fair value of liquidated damages on common shares and
                    warrants
                
                
                74,500Balance
                    as at issuance of the shares and warrants
                
                
                4,246,500Change
                    in fair value for the year ended December 31, 2006
                
                
                (2,288,000
                )Less:
                    actual damages accrued to December 31, 2006
                
                
                (419,671
                )Derivative
                    liability, December 31, 2006
                
                $
                1,538,829
 
 
  66
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY (continued)**
 
 Allocated
                    as follows:Fair
                    value of warrants subject to registration damages
                
                $
                    36,500Estimated
                    fair value of liquidated damages on common shares and
                    warrants
                
                1,922,000Less:
                    actual damages accrued to December 31, 2006
                
                (419,671)$
                    1,538,829
 
 **Common
          Stock Issuances -year ended December 31, 2005**
 On
          July
          21, 2005 the Company issued 200,000 restricted common shares to C.K. Cooper
          & Co., relating to a termination and settlement agreement regarding debt
          financing by the Company. The fair value of these shares at the date of
          issuance
          was estimated to be $262,000 which was recorded as an increase in equity
          and a
          charge to deferred finance fees which was expensed during 2005 on repayment
          of
          the promissory notes. The shares were registered for resale pursuant to
          contractual obligations.
 
 A
          total
          of 304,367 shares of common stock were issued on the exercise of share
          purchase
          warrants at $1.68 per purchase warrant for proceeds of $495,964, net of
          brokers’
fees of $15,373 in accordance with the Company’s agreements with the
          broker.
 
 A
          total
          of 100,000 shares of common stock were issued on the exercise of options
          at
          $0.16667 per share for cash proceeds of $16,667. All shares issued were
          previously registered on Form S-8.
 
 The
          Company issued 1,024,118 shares of common stock on conversion of a total
          of
          $1,024,122 of convertible note principal and accrued interest amounts as
          described in Note 6.
 **Share
          Purchase Warrants**
 A
          summary
          of the Company’s stock purchase warrants as of December 31, 2006 and 2005, and
          changes during the years then ended is presented below:
 
 Number
                    of Warrants
                
                
                Weighted
                    average exercise price
                  per
                    share
                
                
                Weighted
                    average remaining contractual life (in years)$Balance,
                    December 31, 2004
                
                
                1,947,039
                
                
                2.02
                
                
                0.60Issued
                    during the year
                
                
                6,679,000
                
                
                1.07Exercised
                    during the year
                
                
                (304,367
                )
                
                1.68Expired
                    during the year
                
                
                (1,642,672
                )
                
                2.08Balance
                    at December 31, 2005
                
                
                6,679,000
                
                
                1.07
                
                
                2.09Issued
                    during the year
                
                
                7,650,000
                
                
                1.25Exercised
                    during the year
                
                
                (250,000
                )
                
                1.00Expired
                    during the year
                
                
                (2,680,000
                )
                
                1.00Balance
                    at December 31, 2006
                
                
                11,399,000
                
                
                1.21
                
                
                1.11
 
 The
          Series A and Series B warrants were originally issued as part of the secured
          convertible note unit offering at exercise prices of $1.50 per share and
          $1.25
          per share, respectively were subject to exercise price changes under certain
          conditions relating to a subsequent financing. As a result of the private
          placement completed during the year, the Series A and Series B warrants
          were all
          repriced to $1.00 per share. During the year, the Company recorded a non-cash
          finance cost of $615,300 being the estimated fair value increase in the
          warrants
          resulting from the price reduction described above. The table above has
          been
          restated, as required, to give effect to these price changes.
 
 During
          the 2006 the Company reclassified from common stock purchase warrants to
          additional paid in capital, $130,358 (2005 - $47,181) on the exercise of
          warrants and $1,397,438 (2005- $254,634) on the expiration of
          warrants.
  67
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY (continued)**
 
 **Stock
          Options**
 The
          Company has stock options outstanding to certain employees, officers, directors
          and consultants of the Company and its subsidiaries. The Company’s Stock Option
          Plan (the “Plan”), most recently amended and approved by the board of directors
          on August 19, 2005, was effective August 7, 2003 for the purpose of advancing
          the interests of the Company and its stockholders. The Plan allows for
          the
          granting of options to key employees, officers, directors and consultants
          of the
          Company for terms not to exceed 10 years and at prices and vesting conditions
          to
          be determined by the board of directors. The Plan also allows for the granting
          of Incentive Stock Options that must be granted at no less than grant date
          market price of the Company’s common stock.
 
 The
          Plan
          allows for a total of 7,500,000 options outstanding of which 1,285,000
          were
          outstanding as at December 31, 2006 (2005 - 2,935,000; 2004 - 535,000)
          resulting
          in options available for grant of 6,215,000 as at December 31, 2006 (2005
          -
          4,565,000; 2004 - 6,965,000). To date, all options granted under the Plan
          have
          been immediately vested and exercisable, and accordingly, there is no
          unrecognized stock based compensation expense as at December 31, 2006 or
          2005.
 
 As
          at
          December 31, 2006, the Company had no stock options outstanding for which
          the
          exercise price was lower than the market value of the Company’s common stock. As
          at December 31, 2005, the Company had 50,000 stock options outstanding
          for which
          the exercise price was lower than the market value of the Company’s common stock
          with an estimated intrinsic value of $32,165.
 
 The
          total
          estimated intrinsic value of options exercised during 2006 was 19,100 (2005
          -
          $113,330). During 2006, no options were granted (2005 - $2,600,000). The
          weighted average grant date fair value of the options granted during 2005
          was
          $1.06. Of the options granted during 2005, the fair value of 850,000 options
          granted with a weighted average grant date fair value of $0.99 was disclosed
          on
          a pro forma basis in Note 2 (n) the fair value of the remaining 1,750,000
          options granted with a weighted average grant date fair value of $1.09
          was
          charged to operations.
 
 During
          2005, the Company granted a total of 2,600,000 options to certain officers,
          directors and consultants of the Company. These options vested immediately
          and
          can be exercised for periods ending between February 1, 2010 and August
          19, 2010
          at prices ranging from $1.00 to $1.25. The fair value of the options granted
          during 2005 was estimated to be $2,755,298 of which $1,913,991 was expensed
          during 2005 and $841,307 was disclosed on a pro-forma basis in Note 2.
          Management determined the fair value of stock options granted during 2005
          using
          the Black-Scholes option pricing model using the following weighted average
          assumptions: expected option life of 5.00 years, risk-free interest rate
          of
          3.0%, dividend yield of 0% and expected volatility of 162%.
 
 A
          summary
          of the Company’s stock option activity for the years ended December 31, 2006 and
          2005 is as follows:
 
 Number
                    of options
                
                
                Weighted
                    average exercise price
                  per
                    share
                
                
                Weighted
                    average remaining contractual life (in years)$Balance,
                    December 31, 2004
                
                
                535,000
                
                
                2.19
                
                
                4.17Granted
                    during the year
                
                
                2,600,000
                
                
                1.16Cancelled
                    during the year
                
                
                (100,000
                )
                
                0.50Exercised
                    during the year
                
                
                (100,000
                )
                
                0.17Balance,
                    December 31, 2005
                
                
                2,935,000
                
                
                1.42
                
                
                4.33Granted
                    during the year
                
                
                -
                
                
                -Cancelled
                    during the year
                
                
                -
                
                
                -Exercised
                    during the year
                
                
                (1,650,000
                )
                
                1.17Outstanding
                    at December 31, 2006
                
                
                1,285,000
                
                
                1.72
                
                
                3.16
 
  68
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          7:**  **STOCKHOLDERS'
          EQUITY (continued)**
 
 **Stock
          Options (continued)**
 
 A
          summary
          of information about stock options as at December 31, 2006 is as
          follows:
 
 Exercise
                    Price
                
                
                Number
                    of options outstanding and exercisable
                
                
                Weighted
                    average remaining contractual life (in years
                )$0.167
                
                
                50,000
                
                
                1.88$1.00
                
                
                5,000
                
                
                2.09$1.25
                
                
                850,000
                
                
                3.64$3.00
                
                
                380,000
                
                
                2.281,285,000
 
 A
          summary
          of information about stock options as at December 31, 2005 is as
          follows:
 
 Exercise
                    Price
                
                Number
                    of options outstanding and exercisable
                
                Weighted
                    average remaining contractual life (in years)$0.167
                
                
                50,000
                
                
                2.88$1.00
                
                
                505,000
                
                
                4.08$1.25
                
                
                2,000,000
                
                
                4.64$3.00
                
                
                380,000
                
                
                3.282,935,000
 
 
 **NOTE
          8:**  **RELATED
          PARTY TRANSACTIONS**
 
 The
          Company previously entered into a one year contract with IMT on November
          10,
          2003, a private company that performs a wide range of management,
          administrative, financial, and business development services to the Company.
          The
          contract has been renewed annually. During the year, the Company incurred
          $120,000 (2005 - $120,000) in fees to IMT.
 
 During
          2006 the Company incurred (a) $180,000 to its officers for management fees
          (2005
          - $179,150), (b) $127,543 to an officer and director for legal and other
          expense
          reimbursements and (c) $60,000 in fees to a director (2005 -
          $65,000).
 
 As
          at
          December 31, 2006,  the Company owes $202,881 (2005 - $NIL) to these
          related parties.
 
 During
          2006, the Company incurred $90,000 in fees to the sole officer and director
          of
          Oak Hills who is also a director of the Company. In addition, Oak Hills
          incurred
          $42,000 to this director and a relative of this director for rent on the
          Company’s field offices in Oklahoma. This director has previously been assigned
          a 10% carried working interest in each well successfully drilled on the
          Wagnon
          lease, as partial compensation for his involvement in obtaining and facilitating
          the execution of the Farm-Out Agreement and to compensate for his services
          relating to operation and completion of wells to be located on the Wagnon
          lease,
          and has also been provided the right to purchase up to an additional 5%
          working
          interest of the Company’s total interest in all wells drilled by the Company on
          its properties provided that funds for this participation are paid prior
          to the
          commencement of drilling of said wells. During 2006, compensation was recorded
          in connection with the costs of this carried working interest totaling
          $652,300.
          As at December 31, 3006, a total of $73,916 is owed to the Company from
          this
          director and / or affiliates of this director for costs incurred in connection
          with certain well interests.
 
 On
          January 1, 2005, the Company appointed Oak Hills as its elected operator
          for
          wells on its Wagnon Lease, and for further drilling to be conducted by
          the
          Company. During 2006 the Company acquired Oak Hills who continues to act as
          operator.
  69
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          8:**  **RELATED
          PARTY TRANSACTIONS (continued)**
 
 During
          2005 and 2006, the Company provided drilling and related services to Liberty
          Energy, Corp. (“Liberty”), a private company with a director in common with the
          Company. During 2006, as a result of an inability to obtain funding based
          on
          unsatisfactory initial drilling results, Liberty allowed its leases to
          lapse.
          Accordingly, during 2006, the Company recorded an impairment of amounts
          owing
          from Liberty for the drilling and related services totaling
          $107,807.
 
 Refer
          to
          Notes 3 and 4.
 
 
 **NOTE
          9:**  **SUPPLEMENTAL
          DISCLOSURE WITH RESPECT TO CASH FLOWS**
 
 Year
                    ended December 31,2006
                
                
                2005Cash
                    paid during the period for:Interest
                
                $
                210,482
                
                $
                158,828Income
                    taxes
                
                $
                -
                
                $
                -Non-cash
                    investing and financing:Accrued
                    and unpaid property additions
                
                $
                6,127,080
                
                $
                449,137
 
 
 **NOTE
          10:**  **INCOME
          TAXES**
 
 As
          of
          December 31, 2006, the Company had net operating loss carry forwards of
          approximately $29,079,000 that may be available to reduce future years’ taxable
          income and will expire, if not utilized, between the years 2007 and 2026.
          Availability of loss usage is subject to change of ownership limitations
          under
          Internal Revenue Code 382. Future tax benefits which may arise as a result
          of
          these losses have not been recognized in these financial statements, as
          their
          realization is determined not likely to occur and accordingly, the Company
          has
          recorded a valuation allowance for the deferred tax asset relating to these
          tax
          loss carry forwards.
 
 The
          Company evaluates its valuation allowance requirements on an annual basis
          based
          on projected future operations. When circumstances change and this causes
          a
          change in management’s judgment about the recoverability of future tax assets,
          the impact of the change on the valuation allowance is generally reflected
          in
          current income.
 
 The
          Company’s actual income tax provisions differ from the expected amounts
          determined by applying the appropriate combined effective tax rate to the
          Company’s net income before taxes. The significant components of these
          differences are as follows:
 Year
                    ended December 31, 2006
                
                
                Year
                    ended December 31, 2005Net
                    loss for the year
                
                $
                (10,576,849
                )
                $
                (8,538,863
                )Combined
                    corporate tax rate
                
                
                37
                %
                
                41
                %Expected
                    corporate tax recovery
                
                
                3,913,400
                
                
                3,500,900Increase
                    (decrease) resulting from:Non
                    deductible items and other permanent differences
                
                
                (1,215,300
                )
                
                (2,571,600
                )Tax
                    rate changes and assessement of NOL carry forward
                
                
                2,656,200
                
                
                -Valuation
                    allowance for the year
                
                
                (5,354,300
                )
                
                (929,300
                )Provision
                    for income taxes
                
                $
                -
                
                $
                -
 
  70
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          10:**  **INCOME
          TAXES (continued)**
 
 The
          tax
          effects of temporary differences that give rise to the Company’s future tax
          assets (liabilities) are as follows:
 
 2006
                
                2005Net
                    operating losses carried forward
                
                $
                10,759,300
                
                
                2,819,000Other
                    equipment
                
                
                (10,200
                )
                
                -Bad
                  debt allowance
                
                
                65,600Oil
                    and gas properties
                
                
                (2,641,500)
                
                
                -8,173,200
                
                
                2,819,000Less:
                    valuation allowance
                
                
                (8,173,200
                )
                
                (2,819,000
                )Net
                    future tax assets
                
                $
                -
                
                $
                -
 
 
 **NOTE
          11:**  **CONCENTRATIONS**
 
 **Revenue**
 For
            the
            year ended December 31, 2006, the Company had 4 customers that accounted
            for
            27%, 19%, 18% and 14% of total revenue.  For the year ended December 31,
            2005, the Company had 3 customers that accounted for 54%, 16% and 10%
            of total
            revenue.  .
 
 **Accounts
            Receivable**
 As
            of
            December 31, 2006, the Company had 3 customers that accounted for 55%,
            19% and
            12% of the total accounts receivable balance.  As of December 31, 2005, the
            Company had 3 customers that accounted for 42%, 15% and 14% of the total
            accounts receivable balance.
   **NOTE
          12:**  **SUBSEQUENT
          EVENTS**
 
 On
          January 2, 2007, the Company authorized and approved the execution by Oak
          Hills
          of an agreement dated December 29, 2006 with Innovative Energy Services
          pertaining to the sale of the Company’s drilling rig. In accordance with the
          Agreement, Innovative Energy Services paid to Oak Hills a gross aggregate
          amount
          of $3,100,000 for the Drilling Rig and related equipment. (See Note
          5)
 
 On
          January 26, 2007, the Company repaid all outstanding convertible promissory
          notes principal of $723,461, accrued interest of $9,100 and penalty repayment
          amounts of $146,512, in the aggregate amount of $879,073 to the remaining
          convertible note holders that had a secured interest on the assets of the
          Lexington.
 
 On
          January 26, 2007, the Company repaid an aggregate of $1,523,736 of principal
          and
          interest to four debt holders of Oak Hills which had a secured interest
          in the
          Company’s drilling rig that was sold on January 2, 2007.
 
 On
          January 27, 2007, the Company sold its two Wilson 600 duplex pumps to an
          unrelated party for $125,000. (See Note 4)
 
 On
          February 26, 2007, the Company sold approximately 499 acres of Barnett
          Shale
          targeted exploration leases located in Hood County TX resulting in net
          proceeds
          of approximately $379,000.
 
 To
          the
          date of the audit report, the Company has received six law suits from creditors
          of the Company for the payment of services and goods totaling approximately
          $785,445, one contractual mediation request from a creditor for the payment
          of
          services and goods totaling approximately $111,994, nine well liens for
          the
          payment of services and goods totaling approximately $333,771, and eighteen
          demand letters for the payment of services and goods totaling approximately
          $520,554 pursuant to expenditures incurred in the development of oil and
          gas
          assets on the Company’s leasehold interests. All amounts owing in connection
          with these law suits, mediation requests, well liens and demand letters
          have
          been accrued, as applicable, as of December 31, 2006.
 
  71
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          13:**  **DISCLOSURES
          ABOUT OIL AND GAS PRODUCING ACTIVITIES (unaudited)**
 
 All
          of
          the Company’s Oil and Gas activities are conducted in the United States of
          America.
 
 **Capitalized
                    Costs Relating to Oil and Gas Producing Activities
                    at:****December
                    31, 2006**
                
                
                **December
                    31, 2005**Unproved
                    oil and gas properties
                
                $
                5,049,858
                
                $
                4,000,024Proved
                    oil and gas
                
                
                11,673,495
                
                
                2,750,385Accumulated
                    depreciation, depletion, amortization
                  and
                    valuation allowances
                
                
                (3,264,985
                )
                
                (420,937
                )Net
                    capitalized costs
                
                $
                13,458,368
                
                $
                6,329,472
 
 
 **Costs
                    Incurred in Oil and Gas Property Acquisition, Exploration and
                    Development
                    Activities For the Year Ended:****December
                    31, 2006**
                
                
                **December
                    31, 2005**Acquisition
                    Properties-
                    Proved
                
                $
                -
                
                $
                --
                    Unproved
                
                $
                72,000
                
                $
                2,327,230Exploration
                    costs
                
                $
                -
                
                $
                -Development
                    costs
                
                $
                9,900,944
                
                $
                1,693,175
 
 **Results
                    of Operations for Producing Activities For the Year
                    Ended:****December
                    31, 2006**
                
                **December
                    31, 2005**Revenues-
                    Sales
                
                $
                    761,656
                
                $
                    693,860-
                    Transfers
                
                
                -
                
                
                -Totals
                
                
                761,656
                
                
                693,860Production
                    Costs
                
                
                (474,696
                )
                
                (213,377
                )Depreciation,
                    depletion, amortization, and valuation provisions
                
                
                (2,844,048
                )
                
                (259,609
                )Income
                    tax expense
                
                
                -
                
                
                -Results
                    of operations from producing activities
                  (excluding
                    corporate overhead and interest costs)
                
                $
                (2,557,088
                )
                $
                220,874
 
 
  72
 
 **LEXINGTON
            RESOURCES, INC.**
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **DECEMBER
            31, 2006 AND 2005**
  **NOTE
          13:**  **DISCLOSURES
          ABOUT OIL AND GAS PRODUCING ACTIVITIES (unaudited)
          (continued)**
 
 **Reserve
                    Quantity Information For the Year Ended:****Oil**
                  **December
                    31, 2006**
                
                
                **Oil**
                  **December
                    31, 2005**
                
                
                **Gas
                    - mcf**
                  **December
                    31, 2006**
                
                
                **Gas
                    - mcf**
                  **December
                    31, 2005****Proved
                    developed and undeveloped reserves:**Beginning
                    of year
                
                
                -
                
                
                -
                
                
                12,477,000
                
                
                1,350,903Extensions
                    and discoveries
                
                
                -
                
                
                -
                
                
                (9,233,000
                )
                
                11,375,856Production
                
                
                -
                
                
                -
                
                
                (153,972
                )
                
                (249,759
                )Sales
                    of minerals in place
                
                
                -
                
                
                -
                
                
                -
                
                
                -End
                    of year
                
                
                -
                
                
                -
                
                
                3,090,028
                
                
                12,477,000**Proved
                    developed reserves:**Beginning
                    of year
                
                
                -
                
                
                -
                
                
                1,618,000
                
                
                1,176,008End
                    of year
                
                
                -
                
                
                -
                
                
                1,243,000
                
                
                1,618,000Oil
                    and gas applicable to long-term supply agreements with government
                    or
                    authorities in which the enterprise acts as a producer:Proved
                    reserves - beginning of year
                
                
                -
                
                
                -
                
                
                12,477,000
                
                
                1,350,903Change during
                    the year
                
                
                -
                
                
                -
                
                
                (9,398,160
                )
                
                11,126,097
 
 
 **Standardized
                    Measure of Discounted Future Net Cash Flows**
                  **and
                    Changes Therein Relating to Proved Oil and Gas
                    Reserves****December
                    31, 2006**
                
                
                **December
                    31, 2005**Future
                    cash inflows
                
                $
                20,990,000
                
                $
                60,228,000Future
                    production and development costs
                
                
                (8,556,000
                )
                
                (22,723,000
                )Future
                    income tax expense
                
                
                -
                
                
                -Future
                    net cash flows 10% annual discount
                  for
                    estimated timing of cash flows
                
                
                (5,020,000
                )
                
                (17,033,000
                )Standardized
                    measure of discounted future net cash flows
                
                $
                7,414,000
                
                $
                20,472,000Sales
                    and transfers of oil and gas produced, net of production
                    costs
                
                $
                (407,088
                )
                $
                220,874Net
                    changes in prices and production costs
                
                $
                -
                
                $
                -Extensions,
                    discoveries and improved recovery, less related costs
                
                $
                -
                
                $
                -Development
                    costs incurred during the year
                
                $
                9,900,944
                
                $
                1,693,175
 73







**ITEM
      8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**




On
      April
      13, 2006, our Board of Directors approved and authorized the termination of
      the
      services of Dale Matheson Carr-Hilton LaBonte Chartered Accountants ("DMCL")
      as
      our independent registered public accounting firm. The termination of the
      services of DMCL was a result of communication between us and DMCL and the
      subsequent decision by our Board of Directors that it would be in our best
      interests to effect a change in auditors in order to address the needs of a
      small business development company with growing operations located in Oklahoma
      and Texas. During our two most recent fiscal years and any subsequent interim
      period preceding the resignation of DMCL, there were no disagreements with
      DMCL
      which were not resolved on any matter concerning accounting principles or
      practices, financial statement disclosure, or auditing scope or procedure,
      which
      disagreements, if not resolved to the satisfaction of DMCL, would have caused
      DMCL to make reference to the subject matter of the disagreements in connection
      with its reports. The report of DMCL for fiscal years ended December 31, 2005
      and 2004 indicated the following:




"The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 1 to the financial
      statements, to date the Company has reported significant losses since inception
      from operations and requires additional funds to meet its obligations and fund
      the costs of its operations. These factors raise substantial doubt about the
      Company's ability to continue as a going concern. Management's plans in this
      regard are described in Note 1. The financial statements do not include any
      adjustments that might result from the outcome of this
      uncertainty".




Except
      as
      described in the immediately preceding paragraph, the report of DMCL did not
      contain an adverse opinion or a disclaimer of opinion, and was not qualified
      or
      modified as to uncertainty, audit scope, or accounting principles.




On
      April
      13, 2006, our Board of Directors approved and authorized the engagement of
      the
      services of Whitley Penn LLP ("WP"), as independent registered public accounting
      firm for the Company. The address and telephone/facsimile numbers for WP are
      as
      follows: 5420 LBJ Freeway, Suite 1440, Dallas, Texas 75240, telephone no.
      972-392-6600 and facsimile no. 972-392-6601.




We
      did
      not previously contact WP prior to its engagement regarding application of
      accounting principles to a specific completed or contemplated transaction,
      or
      the type of audit opinion that might be rendered on our financial statements,
      and neither written nor oral advice was sought by us from WP prior to its
      engagement regarding an important factor considered by us in reaching a decision
      as to the accounting, auditing or financial reporting issue.




**ITEM
      8A. CONTROLS AND PROCEDURES**





**FINANCIAL
      DISCLOSURE CONTROLS AND PROCEDURES**





An
      evaluation was conducted under the supervision and with the participation of
      our
      management, including Grant Atkins, our Chief Executive Officer (“CEO”) and
      Norman MacKinnon, our Chief Financial Officer (“CFO”), of the effectiveness of
      the design and operation of our disclosure controls and procedures as of
      December 31, 2006. Based on that evaluation, Messrs. Atkins and MacKinnon
      concluded that our disclosure controls and procedures were effective as of
      such
      date to ensure that information required to be disclosed in the reports that
      we
      file or submit under the Exchange Act, is recorded, processed, summarized and
      reported within the time periods specified in SEC rules and forms. Such officers
      also confirmed that there was no change in our internal control over financial
      reporting during the year ended December 31, 2006 that has materially affected,
      or is reasonably likely to materially affect, our internal control over
      financial reporting.


74







**Audit
      Committee Report**





Our
      Board
      of Directors has established an audit committee. The members of the audit
      committee are Mr. Steven Jewett, Mr. Doug Humphreys, and Mr. Norman MacKinnon.
      One of the three members of the audit committee are “independent” within the
      meaning of Rule 10A-3 under the Exchange Act and are financial experts. The
      audit committee was organized in April 2004 and operates under a written charter
      adopted by the Board of Directors. See “Item 9. Directors, Executive Officers,
      Promoters and Control Persons; Compliance with Section 16(a) of the Exchange
      Act
      - Committees of the Board of Directors.”





The
      audit
      committee has reviewed and discussed with management our audited financial
      statements as of and for fiscal year ended December 31, 2006. The audit
      committee has also discussed with Whitley Penn the matters required to be
      discussed by Statement on Auditing Standards No. 61, Communication with Audit
      Committees, as amended, by the Auditing Standards Board of the American
      Institute of Certified Public Accountants. The audit committee has received
      and
      reviewed the written disclosures and the letter from Whitley Penn required
      by
      Independence Standards Board Standard No. 1, Independence Discussions with
      Audit
      Committees, as amended, and has discussed with Whitley Penn their
      independence.





Based
      on
      the reviews and discussions referred to above, the audit committee has
      recommended to the Board of Directors that the audited financial statements
      referred to above be included in our Annual Report on Form 10-KSB for fiscal
      year ended December 31, 2006 filed with the Securities and Exchange
      Commission.





**Ethics
      Committee**





Our
      Board
      of Directors has established an ethics committee. The member of our ethics
      committee is Mr. Grant Atkins, Mr. Douglas Humphreyes, and Mr. Steve Jewett.
      The
      ethics committee was organized in February 2005 and operates under a code of
      business conduct and ethics policy (the “Code”) adopted by the Board of
      Directors. See “Item 9. Directors, Executive Officers, Promoters and Control
      Persons; Compliance with Section 16(a) of the Exchange Act - Committees of
      the
      Board of Directors.”





Our
      Board
      of Directors adopted the Code for our directors and officers. This Code is
      intended to describe our core values and beliefs and to provide the foundation
      for all business conduct. The Code is further intended to focus our board of
      directors and each director and officer on areas of ethical risk, provide
      guidance to directors and officers to help them recognize and deal with ethical
      issues, provide mechanisms to report unethical conduct, and help foster a
      culture of honesty and accountability. Our guidelines for conducting business
      are consistent with the highest standards of business ethics. Each director
      and
      officer must comply with the letter and spirit of this Code.





Upon
      request, we shall provide to any person without charge a copy of the Code.
      Any
      such requests should be directed to Mr. Grant Atkins, President, 7473 West
      Lake
      Mead Road, Las Vegas, Nevada 89128.




**ITEM
      8B. OTHER INFORMATION**





Not
      applicable.








75


**ITEM
        9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH
        SECTION 16(a) OF THE EXCHANGE ACT**
 
 **IDENTIFICATION
        OF DIRECTORS AND EXECUTIVE OFFICERS**
 
 All
        of
        our directors hold office until the next annual general meeting of the
        shareholders or until their successors are elected and qualified. Our officers
        are appointed by our board of directors and hold office until their earlier
        death, retirement, resignation or removal.


As
      of the
      date of this Annual Report our directors and executive officers, their ages,
      positions held are as follows:





**Name**
            **Age**
            **Position
                with the Company**Grant
                R. Atkins
            46
            President,
                Chief Executive Officer, Chairman, Principal Executive Officer and
                a
                directorDouglas
                Humphreys
            54
            DirectorNorman
                J. R. MacKinnon
            71
            Director,
                Secretary, Treasurer and Chief Financial OfficerSteve
                Jewett
            68
            DirectorGino
                Cicci (resigned May 2, 2007)
            70
            Director




The
      following describes the business experience of each of our directors and
      executive officers, including other directorships held in reporting companies:






**Grant
      R. Atkins** .
      Grant
      R. Atkins has been our Chief Executive Officer since July 2003, our President
      since 2001 and our Secretary and a director since September 1998. For the past
      ten years, Mr. Atkins has been self-employed and has acted as a financial and
      project coordination consultant to clients in government and private industry.
      He has extensive multi-industry experience in the fields of finance,
      administration and business development. From 1998 to March 31, 2004, Mr. Atkins
      provided consulting services through Investor Communications International,
      Inc.
      to a number of private and public companies, including us. Mr. Atkins received
      a
      Bachelor of Commerce degree from the University of British Columbia. Mr. Atkins
      is a director of Derminsonics, Inc., which is quoted on the OTC Bulletin Board.
      Mr. Atkins is not a director or officer of any other U.S. reporting
      company.




**Douglas
      Humphreys** .
      Douglas
      Humphreys has been a director since April 30, 2004 and is a member of our audit
      committee. Mr. Humphreys is also a manager of Oak Hills, one of our wholly-owned
      subsidiaries. Mr. Humphreys has been Operations Manager of Lexington Oil &
Gas since November 2003 and an oil and gas consultant to Paluca Petroleum,
      Inc.
      since 1995. Mr. Humphreys is also an officer, director and sole shareholder
      of
      Paluca Petroleum, Inc. and has been a director of GHB Farms, Inc. Mr. Humphreys
      received his Bachelor of Science degree in Business and Geology from Southwest
      Oklahoma State University. Mr. Humphreys has been active in the industry for
      over 30 years, mostly in his home state of Oklahoma and in the surrounding
      oil
      and gas rich regions of the mid continent. His industry knowledge comes from
      hands-on experience helping to build several oil and gas producing companies
      to
      prominence. Mr. Humphreys is not a director or officer of any other U.S.
      reporting company.




**Norman
      J. R. MacKinnon** .
      Norman
      J. R. MacKinnon has been a director since April 30, 2004 and is a member of
      our
      audit committee. Mr. MacKinnon is a Chartered Accountant and has been the
      principal of NJR MacKinnon, CA since 1984. Mr. MacKinnon received his degree
      as
      a Chartered Accountant from the Institute of Chartered Accountants of British
      Columbia. Mr. MacKinnon is not a director or officer of any other U.S. reporting
      company. Mr. MacKinnon became our Secretary, Treasurer and Chief Financial
      Officer on January 3, 2007, replacing Vaughn Barbon, who resigned as of such
      date.




**Steve
      Jewett** .
      Steve
      Jewett has been a director since April 30, 2004. Since 1978, Mr. Jewett has
      been
      the owner of Stephen Jewett - Chartered Accountants. During his career, Mr.
      Jewett was auditor of several public companies. Mr. Jewett received his degree
      as a Chartered Accountant from the Institute of Chartered Accountants of British
      Columbia and is the audit committee's financial expert. Mr. Jewett is a
      currently a director of each of Morgan Creek Energy Corp. and Geneva Gold Corp.,
      and was until mid-last year a director of Uranium Energy Corp.; each of which
      is
      quoted on the OTC Bulletin Board. Mr. Jewett is not a director or officer of
      any
      other U.S. reporting company.










76


**Gino
      Cicci**(resigned
      May 2, 2007). Gino Cicci has been a director since June 12, 2006. During the
      past five years, Mr. Cicci has been active within the oil and gas industry
      and
      has been engaged in providing consulting services to the


Company.
      In past years, he has been associated with junior companies that have drilled
      oil and gas in Alberta and Texas. He has also been engaged in companies that
      have explored various regions in the United State and Canada for precious
      metals. Mr. Cicci has a broad experience and knowledge of junior markets and
      will be an asset to us during our various phases of growth. Mr. Cicci is not
      a
      director or officer of any other U.S. reporting company.






**Term
      of Office**




All
      of
      our directors hold office until the next annual general meeting of the
      shareholders or until their successors are elected and qualified. Our officers
      are appointed by our board of directors and hold office until their earlier
      death, retirement, resignation or removal.






**Significant
      Employees**




There
      are
      no other significant employees.




**Involvement
      in Certain Legal Proceedings**





During
      the past five years, none of our directors, executive officers or persons that
      may be deemed promoters is or have been involved in any legal proceeding
      concerning (i) any bankruptcy petition filed by or against any business of
      which
      such person was a general partner or executive officer either at the time of
      the
      bankruptcy or within two years prior to that time; (ii) any conviction in a
      criminal proceeding or being subject to a pending criminal proceeding (excluding
      traffic violations and other minor offenses); (iii) being subject to any order,
      judgment or decree, not subsequently reversed, suspended, or vacated, of any
      court of competent jurisdiction permanently or temporarily enjoining, barring,
      suspending or otherwise limiting involvement in any type of business, securities
      or banking activity; or (iv) being found by a court, the Securities and Exchange
      Commission or the Commodity Futures Trading Commission to have violated a
      federal or state securities or commodities law (and the judgment has not been
      reversed, suspended or vacated).





**COMMITTEES
      OF THE BOARD OF DIRECTORS**





**Audit
      Committee**





As
      of the
      date of this Annual Report, Messrs. Humphreys, Jewett and MacKinnon have been
      appointed as members to our audit committee. Two of the three members are
“independent” within the meaning of Rule 10A-3 under the Exchange Act and are in
      addition financial experts. The audit committee operates under a written charter
      adopted by the Board of Directors on February 2, 2004.





The
      audit
      committee's primary function is to provide advice with respect to our financial
      matters and to assist the Board of Directors in fulfilling its oversight
      responsibilities regarding finance, accounting, and legal compliance. The audit
      committee's primary duties and responsibilities will be to: (i) serve as an
      independent and objective party to monitor our financial reporting process
      and
      internal control system; (ii) review and appraise the audit efforts of our
      independent accountants; (iii) evaluate our quarterly financial performance
      as
      well as our compliance with laws and regulations; (iv) oversee management's
      establishment and enforcement of financial policies and business practices;
      and
      (v) provide an open avenue of communication among the independent accountants,
      management and the Board of Directors.





**Ethics
      Committee**





Our
      Board
      of Directors has established an ethics committee. The members of the ethics
      committee are Mr. Grant Atkins, Mr. Douglas Humphreys, and Mr. Steve Jewett.
      The
      ethics committee was organized in February 2005 and operates under a code of
      business conduct and ethics policy (the “Code”) adopted by the Board of
      Directors.





The
      Code
      was adopted for our directors and officers. The Code is intended to describe
      our
      core values and beliefs and to provide the foundation for all business conduct.
      The Code is further intended to focus our Board of Directors and each director
      and officer on areas of ethical risk, provide guidance to directors and officers
      to help them recognize and deal with ethical issues, provide mechanisms to
      report unethical conduct, and help foster a culture of honesty and
      accountability. Our guidelines for conducting business are consistent with
      the
      highest standards of business ethics. Each director and officer must comply
      with
      the letter and spirit of this Code.


77




**COMPLIANCE
      WITH SECTION 16(a) OF THE EXCHANGE ACT**





Section
      16(a) of the Exchange Act requires our directors and officers, and the persons
      who beneficially own more than ten percent of our common stock, to file reports
      of ownership and changes in ownership with the Securities and Exchange
      Commission. Copies of all filed reports are required to be furnished to us
      pursuant to Rule 16a-3 promulgated under the Exchange Act. Based solely on
      the
      reports received by us and on the representations of the reporting persons,
      we
      believe that these persons have complied with all applicable filing requirements
      during the fiscal year ended December 31, 2006.





**ITEM
      10. EXECUTIVE COMPENSATION**




Except
      as
      described below, none of our directors or officers received an annual salary
      and
      bonus that exceeded $100,000 during fiscal year ended December 31, 2006. Our
      officers and directors may be reimbursed for any out-of-pocket expenses incurred
      by them on our behalf. We presently have no pension, health, annuity, insurance,
      profit sharing or similar benefit plans. The following table sets forth the
      compensation received by Grant R. Atkins, Vaughn Barbon (who resigned as our
      Chief Financial Officer effective as of January 3, 2007), and Douglas Humphreys
      (the “Named Executive Officers”) during fiscal year ended December 31, 2006. Mr.
      Atkins and Mr. Barbon previously derived remuneration from us directly and
      through Investor Communications International, Inc., which previously provided
      a
      wide range of management, financial and administrative services to us.




**SUMMARY
      COMPENSATION TABLE**




**Name
                and Principal Position**
            **Year**
            **Salary**
              
              
              **($)**
            **Bonus**
              
              
              **($)**
            **Stock
                Awards**
              
              
              **($)**
            **Option
                Awards**
              **($)**
            **Non-Equity
                Incentive Plan Compensation**
              
              **($)**
            **Non-Qualified
                Deferred Compensation Earnings**
              
              **($)**
            **All
                Other Compensation**
              
              
              **($)**
            **Total**
              
              
              **($)**Grant
                Atkins, President and CEO
            2006
            $145,000
                (1)
            -0-
            -0-
            -0-
            ---
            ---
            ---
            $145,000Vaughn
                Barbon, Chief Financial Officer and Treasurer
            2006
            $60,000
                (1)
            -0-
            -0-
            -0-
            ---
            ---
            ---
            $60,000Douglas
                Humphreys, Drilling Operations Manager
            2006
            $784,300
                (2)
            -0-
            -0-
            -0-
            ---
            ---
            ---
            $690,772









(1)
      These
      amounts represent fees paid by us to the Named Executive Officers during the
      past year pursuant to various employment and consulting services agreements,
      as
      between us and the Named Executive Officers, which are more
      particularly described in this Annual Report. See “Item 10. Executive
      Compensation - Employment and Consulting Agreements.”


(2)
        Of
        this amount, $652,300 was incurred in accordance with the terms and provisions
        of the Consulting Agreement and the carried working interest in our wells
        held
        by Mr. Humphreys, $42,000 was incurred as a result of monthly rental payments
        of
        $3,500 for the office space in Oklahoma, and $90,000 was incurred by Oak
        Hills.


78







**STOCK
      OPTIONS/SAW GRANTS IN FISCAL YEAR ENDED DECEMBER 31, 2006**





The
      following table sets forth information as at December 31, 2006 relating to
      options that have been granted to the Named Executive Officers:













**OUTSTANDING
                EQUITY AWARDS AT FISCAL YEAR-END**OPTION
                AWARDS
            STOCK
                AWARDSName
            Number
                of Securities Underlying Unexercised Options
              Exercisable
              (#)
            Number
                of Securities Underlying Unexercised Options
              Unexercisable
              (#)
            Equity
                Incentive Plan Awards: Number of Securities Underlying Unexercised
                Unearned Options
              (#)
            Option
                Exercise Price
              ($)
            Option
                Expiration Date
            Number
                of Shares or Units of Stock That Have Not Vested
              (#)
            Market
                Value of Shares or Units of Stock That Have Not Vested
              ($)
            Equity
                Incentive Plan Awards: Number of Unearned Shares, Units or Other
                Rights
                That Have Not Vested
              (#)
            Equity
                Incentive Plan Awards: Market or Payout Value of Unearned Shares,
                Units or
                Other Rights That Have Not Vested
              (#)Grant
                Atkins, Chief Executive Officer/President
            -0-
            -0-
            -0-
            --
            ---
            ---
            ---
            -0-
            -0-Vaughn
                Barbon, prior Chief Financial Officer/Treasurer
            -0-
            -0-
            -0-
            --
            --
            --
            --
            -0-
            -0-Douglas
                Humphreys, Drilling Operations Manager
            -0-
            -0-
            -0-
            --
            --
            --
            --
            -0-
            -0-





The
      following table sets forth information relating to compensation paid to our
      directors in 2006:





**DIRECTOR
      COMPENSATION TABLE**




Name
            Fees
              Earned
                or
              Paid
                in
              Cash
              ($)
            Stock
              Awards
              ($)
            Option
              Awards
              ($)
            Non-Equity
              Incentive
              Plan
              Compensation
              ($)
            Change
                in
              Pension
              Value
                and
              Nonqualified
              Deferred
              Compensation
              Earnings
              ($)
            All
              Other
              Compensation
              ($)
            Total
              ($)Grant
                Atkins
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-Douglas
                Humphreys
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-Steve
                Jewett
            $60,000
                (1)
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-Norman
                MacKinnon
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-Gino
                Cicci
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-
            -0-





(1)
      Paid
      as compensation for Mr. Jewett’s role as chairman of the Audit
      Committee.









79


**EMPLOYMENT
      AND CONSULTING AGREEMENTS**





**Consulting
      Agreement**




On
      July
      12, 2004, we entered into a consulting agreement (the "Consulting Agreement")
      with Lexington Oil & Gas and Douglas Humphreys. Pursuant to the Consulting
      Agreement, Mr. Humphreys will assist in overseeing the drilling operations
      and
      the completion and management of our wells. Mr. Humphreys compensation pursuant
      to the terms and provisions of the Consulting Agreement will be: (i) $7,500
      per
      month effective April 1, 2004, (ii) the assignment of up to 10% carried working
      interest of Lexington's interest in every well drilled on all properties held
      by
      us, including the Wagnon Lease (during fiscal year 2004 we recorded additional
      compensation expense to Mr. Humphreys of $117,030 being the estimated value
      of
      his 10% carried interest in our wells developed as at December 31, 2004); (iii)
      the right to purchase up to an additional 5% working interest of Lexington's
      interest in all wells drilled by us on our properties provided that funds for
      this participation are paid prior to the commencement of drilling of said wells;
      and (iv) grant of 200,000 stock options to purchase shares of our common stock
      at an exercise price of $3.00 per share (which were granted July, 2004). The
      Consulting Agreement can be terminated at any time with ninety days written
      notice by either party.




**COMPENSATION
      OF DIRECTORS**





Generally,
      our directors do not receive salaries or fees for serving as directors, nor
      do
      they receive any compensation for attending meetings of the board of directors.
      Directors are entitled to reimbursement of expenses incurred in attending
      meetings. In addition, our directors are entitled to participate in our stock
      option plan. During fiscal year ended December 31, 2006, we paid Steve Jewett
      $60,000 in connection with his service as the chairman of the audit committee.





**ITEM
      11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS**




The
      following table sets forth certain information with respect to the beneficial
      ownership of our common stock by each stockholder known by us to be the
      beneficial owner of more than 5% of our common stock and by each of our current
      directors and executive officers. Each person has sole voting and investment
      power with respect to the shares of common stock, except as otherwise indicated.
      Beneficial ownership consists of a direct interest in the shares of common
      stock, except as otherwise indicated. As of the date of this Annual Report,
      there are 38,766,270 shares of common stock issued and outstanding.




80


**Name
                and Address of Beneficial Owner****(1)**
            **Number
                of Shares Owned****(1)**
            **Percentage
                of Class****(1)****Directors
                and Officers:**Grant
                R. Atkins
              7473
                West Lake Mead Road
              Las
                Vegas, Nevada 89128
            350,000(2)
            0.90%Douglas
                Humphreys
              7473
                West Lake Mead Road
              Las
                Vegas, Nevada 89128
            2,250,000(3)
            5.80%Norman
                J. R. MacKinnon
              7473
                West Lake Mead Road
              Las
                Vegas, Nevada 89128
            27,500(4)
            0.07%Steve
                Jewett
              7473
                West Lake Mead Road
              Las
                Vegas, Nevada 89128
            27,500(5)
            0.07%Gino
                Cicci
              7473
                West Lake Mead Road
              Las
                Vegas, Nevada 89128
            Nil
            NilAll
                executive officers and directors as a group (5 persons)(6)
            2,655,000
            6.84%**Major
                Shareholders:**Orient
                Explorations Ltd.
              P.O.
                Box 97 Leeward Highway,
              Provinciales
                Turks & Caicos Islands
            6,000,000(7)
            15.48%Longfellow
                Industries (B.C.) Ltd.
              612
                - 618 West 45thAvenue
              Vancouver,
                B.C. Canada, V5Z 4R7
            3,000,000(8)
            7.74%Alexander
                Cox
              760
                Terminal Avenue
              Vancouver,
                B.C., Canada, V6A 2M5
            5,155,134(9)
            13.30%Newport
                Capital Corp.
              Rennweg
                28, Zurich, Switzerland, CH-8001
            2,185,364(10)
            5.64%Eastern
                Capital Corp.
              P.O.
                Box 97
              Leeward
                Hwy, Provinciales,
              Turks
                & Caicos Islands
            2,110,000(11)
            5.44%Touradji
                Deep Rock Master Fund, Ltd.
              Spectrum
                GFA, P.O. 10243 APO, Anchorage Center, 2ndFloor, George Town, Grand Cayman, Cayman Islands, BWI
            2,400,000(12)
            6.19%Touradji
                Global Resources Master Fund, Ltd.
              Spectrum
                GFA, P.O. 10243 APO, Anchorage Center, 2ndFloor, George Town, Grand Cayman, Cayman Islands, BWI
            3,600,000(13)
            9.29%




81


1.
            Under
                Rule 13d-3, a beneficial owner of a security includes any person
                who,
                directly or indirectly, through any contract, arrangement, understanding,
                relationship, or otherwise has or shares: (i) voting power, which
                includes
                the power to vote, or to direct the voting of shares; and (ii) investment
                power, which includes the power to dispose or direct the disposition
                of
                shares. Certain shares may be deemed to be beneficially owned by
                more than
                one person (if, for example, persons share the power to vote or the
                power
                to dispose of the shares). In addition, shares are deemed to be
                beneficially owned by a person if the person has the right to acquire
                the
                shares (for example, upon exercise of an option) within 60 days of
                the
                date as of which the information is provided. In computing the percentage
                ownership of any person, the amount of shares outstanding is deemed
                to
                include the amount of shares beneficially owned by such person (and
                only
                such person) by reason of these acquisition rights. As a result,
                the
                percentage of outstanding shares of any person as shown in this table
                does
                not necessarily reflect the person's actual ownership or voting power
                with
                respect to the number of shares of common stock actually outstanding
                as of
                the date of this Annual Report. As of the date of this Annual Report,
                there are 38,766,270 shares issued and outstanding.






2.
            This
                figure includes 350,000 shares which may be acquired on the exercise
                of
                Stock Options exercisable within 60 days of the date hereof.






3.
            This
                figure includes 750,000 shares which may be acquired on the exercise
                of
                Stock Options exercisable within 60 days of the date hereof.






4.
            This
                figure includes 27,500 shares which may be acquired on the exercise
                of
                Stock Options exercisable within 60 days of the date hereof.






5.
            This
                figure includes 27,500 shares which may be acquired on the exercise
                of
                Stock Options exercisable within 60 days of the date hereof.






6.
            This
                figure includes 1,155,000 shares which may be acquired on the exercise
                of
                Stock Options exercisable within 60 days of the date hereof.






7.
            The
                sole shareholder of Orient Explorations Ltd. is Canopus Limited for
                Meridian Trust. The sole director of Orient Explorations Ltd. is
                Cockburn
                Directors, Ltd. Mr. Dempsey, as the authorized representative of
                Cockburn
                Directors Ltd., has the sole exclusive voting and disposition rights
                regarding shares of common stock.






8.
            The
                sole shareholder of Longfellow Industries (B.C.) Ltd. is Irene V.
                Cox. The
                directors of Longfellow Industries (B.C.) Ltd. are Irene V. Cox,
                Catherine
                S. Lambert and William A. Cox. The Board of Directors of Longfellow
                Industries (B.C.) Ltd. has the sole exclusive voting and disposition
                rights regarding shares of common stock. Our Board of Directors was
                advised that a private transaction not involving a public sale occurred
                effective as of February 18, 2005 between Orient Explorations Ltd.
                and
                Longfellow Industries (B.C.) Ltd. Pursuant to the terms and provisions
                of
                the private transaction, Orient Explorations Ltd. sold 3,000,000
                shares of
                our restricted common stock it held of record to Longfellow Industries
                (B.C.) Ltd. at par value $0.00025 for an aggregate consideration
                of
                approximately $750.00 in cash. At the time of the transaction, Orient
                Explorations Ltd. was deemed to be an affiliate of us. Our Board
                of
                Directors is unaware of any arrangement or understanding among the
                members
                of Orient Explorations Ltd. and Longfellow Industries (B.C.) Ltd.
                with
                respect to election of our directors or other matters.






9.
            Alexander
                Cox is the holder of record of 2,155,134 shares of our common stock.
                In
                addition, Longfellow Industries (B.C.) Ltd. is the holder of record
                of
                3,000,000 shares of our common stock. The sole shareholder of Longfellow
                Industries (B.C.) is Irene V. Cox, the wife of Alexander Cox.




82




10.
            This
                figure includes 1,782,114 shares and 113,000 warrants (immediately
                exercisable for one share each) held of record by Newport Capital
                Corp. We
                are informed that the Board of Directors of Newport Capital Corp.
                has
                delegated to Brent Pierce, one of its directors and officers, sole
                voting
                and dispositive power with respect to the shares of common stock
                owned by
                Newport Capital Corp. In addition, this figure includes (i) 5,250
                shares
                held of record by Brent Pierce, (ii) 45,000 shares held of record
                by Dana
                Pierce, Brent Pierce's wife, (iii) 222,500 shares held of record
                by Parc
                Place Investments AG, and (iv) 17,500 shares held of record by Spartan
                Asset Group. We are informed that Brent Pierce shares dispositive
                and
                voting power with respect to the shares owned by Parc Place Investments
                AG
                and Spartan Asset Group in his capacity as an officer and director
                of
                these entities.






11.
            This
                figure includes 1,055,000 shares which may be acquired on the exercise
                of
                warrants exercisable within 60 days of the date hereof.






12.
            This
                figure includes 1,200,000 shares which may be acquired on the exercise
                of
                warrants exercisable within 60 days of the date hereof.






13.
            This
                figure includes 1,800,000 shares which may be acquired on the exercise
                of
                warrants exercisable within 60 days of the date hereof.






**Changes
      in Control**






We
      are
      unaware of any contract, or other arrangement or provision, the operation of
      which may at a subsequent date result in a change of control of our
      company.




**ITEM
      12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR COMPENSATION**




Except
      for the transactions described below, none of our directors, officers or
      principal stockholders, nor any associate or affiliate of the foregoing, have
      any interest, direct or indirect, in any transaction from May 1, 2004 to the
      date of this Annual Report, or in any proposed transactions, which has
      materially affected or will materially affect us. As they relate to the certain
      relationships and related transactions discussed below, Douglas Humphreys,
      one
      of our directors, is the sole officer, director and shareholder of Paluca
      Petroleum, Inc. Douglas Humphreys is also an officer and director of Oak Hills
      and a previous owner of a 25% shareholding in Oak Hills International until
      January 21, 2006. He is currently a director and officer of Oak Hills
      International.






**OAK
      HILLS INTERNATIONAL**






On
      January 26, 2006, we entered into the Oak Hills Share Exchange Agreement. For
      a
      complete description, see "Description of Business and Properties". On November
      9, 2004, we entered into an agreement with Oak Hills to drill a ten well program
      and on January 1, 2005, we appointed Oak Hills as our elected operator for
      wells
      on our Wagnon Lease and for further drilling to be conducted by us. Douglas
      Humphreys, a director of our company, is also an officer and director of Oak
      Hills and a previous owner of a 25% shareholding in Oak Hills International
      until January 21, 2006. He is currently also a director and officer of Oak
      Hills
      International.






**SADDLEBAG
      OILFIELD SERVICES**






Saddlebag
      Oilfield Services ("Saddlebag") has provided completion services to Oak Hills
      Energy, Lexington's previous designated operator during 2004 for Lexington
      wells, Kellster #1-5, Kyndal #2-2, and Bryce #3-2 during 2004 and incurred
      direct expenses on behalf of Lexington. Mr. Humphreys is a director of Saddlebag
      and Pam Humphreys, Mr. Humphrey's wife, is the president of Saddlebag. During
      the 2004 fiscal year, Oak Hills Energy, Inc. paid Saddlebag a total of $44,567
      for completion work on the three wells previously mentioned. The work included
      setting up the surface equipment, swabbing the well to initiate production,
      laying pipeline, setting up fences, compressor hookups and other related
      services. During the 2005 fiscal year, Oak Hills was the operator and developer
      of wells for Lexington and made no payments to Saddlebag on behalf of
      Lexington.




83




**PALUCA
      PETROLEUM INC.**






On
      July
      19, 2004, we were assigned 320 gross acres of leases in the H-9 Prospect from
      Paluca Petroleum, Inc. who had entered into a farm-out agreement with Faith
      Production, LLC dated July 19, 2004 for the acquisition of this property. Paluca
      Petroleum,. Inc. served only as an intermediary and received no consideration
      in
      connection with this transaction.




On
      April
      22, 2004, we acquired from Paluca Petroleum, Inc. three sections of farm-out
      acreage to develop coal bed methane gas wells in Hughes County, State of
      Oklahoma (the "South Lamar Farm-out") for $120,000 and on July 14, 2004, we
      acquired an additional 184 gross acres in this Prospect from Paluca Petroleum,
      Inc. for approximately $13,800. The acreage was purchased originally by Paluca
      Petroleum, Inc. for approximately $100,000, and the exchange of certain other
      equipment.






**Paluca
      Agreement**




On
      January 21, 2004, we entered into the Paluca Agreement with Lexington Oil &
Gas, Paluca Petroleum, Inc. and Douglas Humphreys. Pursuant to the terms and
      provisions of the Paluca Agreement: (i) we assigned to Mr. Humphreys a 10%
      carried working interest in every well drilled by us on the Wagnon Lease; (ii)
      we agreed to allow Humphreys to participate up to an additional 5% working
      interest in every well drilled by us on the Wagnon Lease; (iii) Mr. Humphreys
      agreed to waive any and all other claims, debts or obligations owed to him
      by us
      or Lexington Oil & Gas, (iv) we agreed to transfer to Paluca certain assets
      previously acquired by us (which included working interests and net revenue
      interests in certain oil and gas leases located on the Doc Cole Property, the
      Atwood Booch Sand Property, the Jeneva Property and the Sasakwa Gilcrease Sand
      Property, as previously disclosed in prior filings).




On
      January 21, 2004, Orient Explorations, Inc. and Douglas Humphreys entered into
      an agreement (the "Humphreys/Orient Agreement"). Pursuant to the terms and
      provisions of the Humphreys/Orient Agreement, Mr. Humphreys agreed to transfer
      750,000 shares of our restricted common stock held of record by Humphreys to
      Orient Explorations Inc. for $10.






**ORIENT
      EXPLORATIONS LTD.**




On
      February 18, 2005, Orient Explorations Ltd. and Longfellow Industries (B.C.)
      Ltd. entered into a stock purchase agreement pursuant to which Orient
      Explorations Ltd. sold 3,000,000 shares of our restricted common stock to
      Longfellow Industries (B.C.) Ltd. for aggregate consideration of approximately
      $750.00 in cash.






**OFFICERS/DIRECTORS**




On
      August
      19, 2005, we granted to: (i) Norman J. R. MacKinnon 25,000 stock options to
      acquire shares of our common stock; (ii) Grant R. Atkins 250,000 stock options
      to acquire shares of our common stock (who is also paid $10,000 monthly as
      part
      of remuneration for his duties as our President); (iii) Vaughn Barbon (our
      former Chief Financial Officer, who resigned effective as of January 3, 2007)
      50,000 stock options to acquire shares of our common stock (who was also paid
      up
      to $5,000 monthly as part of remuneration for his duties as our Chief Financial
      Officer; and (iv) Steve Jewett 25,000 stock options to acquire shares of our
      common stock (who was also paid $60,000 and $65,000, respectively, during fiscal
      years ended December 31, 2006 and 2005 for his services as chairman of our
      Audit
      Committee).




We
      did
      not grant any Stock Options to our officers/directors during fiscal year ended
      December 31, 2006.




On
      July
      12, 2004, we entered into the Consulting Agreement with Lexington Oil & Gas
      and Douglas Humphreys. Pursuant to the Consulting Agreement, Mr. Humphreys
      or
      Paluca Petroleum, Inc. is paid $7,500 per month by us and receives 10% of
      Lexington's working interest as a carried working interest in any well drilled
      and completed by us. On August 19, 2005, we granted Doug Humphreys 500,000
      stock options to acquire shares of our common stock. During fiscal year ended
      December 31, 2006, we recorded additional compensation expense to Mr. Humphreys
      of $652,300 (2005 - $160,708) being the estimated value of his 10% carried
      interest in our well interests that were successfully developed in the fiscal
      period. We incurred and paid $90,000 to Mr. Humphreys during fiscal year ended
      December 31, 2006 pursuant to provisions of the Consulting Agreement.




84




**FINANCIAL
      CONSULTING AGREEMENT**




On
      November 10, 2003, we entered into a financial consulting services agreement
      (the "Financial Consulting Agreement") with IMT. Pursuant to the terms and
      provisions of the Financial Consulting Agreement: (i) IMT performed a wide
      range
      of management, administrative, financial, business development, and consulting
      services for us: (ii) we granted IMT and/or its designates or employees 950,000
      pre-forward stock split stock options to purchase shares of our common stock
      at
      an exercise price of $0.50 per share; and (iii) we agreed to a contracted rate
      of $10,000 per month.. Of the 1,000,000 stock options granted on February 2,
      2004, 895,000 pre-forward stock split stock options were granted to IMT or
      its
      designates. The Financial Consulting Agreement was for a term of twelve months
      and expired on November 10, 2004, with subsequent renewal of the contract on
      a
      month to month basis thereafter.




On
      February 1, 2005, we granted to IMT 600,000 stock options to acquire shares
      of
      our common stock. On August 19, 2005, we granted to IMT 1,150,000 stock options
      to acquire shares of our common stock, which have been returned by IMT to us
      and
      were subsequently re-assigned to two consultants of IMT on March 1, 2006.
      We incurred $120,000 in fees to IMT for fiscal years ended December 31, 2006
      and
      2005, respectively.






**ITEM
      13. EXHIBITS**




The
      following exhibits are filed with this Annual Report on Form 10-KSB:




**Exhibit
                Number**
            **Description
                of Exhibit**2.1
            Share
                Exchange Agreement dated November 19, 2003(1)3.1
            Articles
                of Incorporation(4)3.2
            Bylaws
                incorporated by reference to Exhibit 3.1 filed on Form 8-K dated
                October
                1, 2004(2)5.1
            Opinion
                and consent of Lang Michener LLP as to legality of securities being
                registered(10)10.1
            Wagnon
                Farm-Out Agreement dated December 5, 2004(3)10.2
            South
                Lamar Farm-Out Agreement #1 dated April 21, 2004(3)10.3
            Assignment
                of South Lamar Farmouts(3)10.4
            South
                Lamar Farm-Out Agreement #2 dated April 21, 2004(3)10.5
            South
                Lamar Farm-Out Agreement #3 dated April 21, 2004(3)10.6
            SISM
                Research & Investment Services Agreement dated June of
                2005(5)10.7
            Douglas
                Humphreys Consultation Agreement dated July 12, 2004(3)10.8
            Oak
                Hills Drilling and Operating, LLC Drilling Agreement dated November
                8,
                2004(3)10.9
            Form
                of Securities Purchase Agreement in connection with private placement
                of
                units(4)10.10
            South
                Lamar Farm-Out Agreement #4 dated July 14, 2004(3)10.11
            Settlement
                Agreement with C.K. Cooper & Company, Inc. dated July 26,
                2005(6)10.12
            Exploration
                Agreement between Lexington Oil & Gas Ltd. Co. and Rylan Peyton, LLC
                dated January 31, 2006(7)10.13
            Consulting
                Agreement between Lexington Resources Inc. and EurXchange Consulting
                Ltd.
                dated February 15, 2006(7)10.14
            Exploration
                Agreement between Lexington Oil & Gas Ltd. and Dylan Peyton, LLC dated
                January 31, 2006, together with Comanche County assignment(7)10.15
            Share
                Exchange Agreement between Lexington Resources Inc., Oak Hills Drilling
                and Operating International, Inc., Oak Hills Drilling and Operating,
                LLC
                and shareholders of Oak Hills Drilling and Operating International,
                Inc.
                dated January 20, 2006(8)10.16
            Agreement
                between Lexington Resources Inc. and Pathway Investment LP dated
                July 14,
                2005(7)10.17
            Stock
                Option Plan of Lexington Resources, Inc. dated February 2,
                2004(4)10.18
            Lexington
                Resources, Inc. Amended Stock Option Plan(5)10.19
            Form
                of $1.00 Unit Private Placement Subscription Agreement in connection
                with
                the private placement of units(10)10.20
            Financial
                Consulting Services Agreement between Lexington Resources Inc. and
                International Market Trend AG dated November 10, 2003(11)10.21
            Agreement
                dated December 29, 2006 between Oak Hills Drilling and Operating
                LLC and
                Innovative Energy Services(12)16.1
            Letter
                on change in Certifying Accountant from Dale Matheson Carr-Hilton
                LaBonte
                Chartered Accountants dated April 20, 2006(9)21.1
            List
                of Subsidiaries(10)23.3
            Consent
                of Pinnacle Energy Services, LLC with respect to year-end 2005
                report(13)23.4
            Consent
                of Pinnacle Energy Services, LLC with respect to mid-year 2006
                report(14)31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a)
                of the
                Securities Exchange Act.31.2
            Certification
                of the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a)
                of
                the Securities Exchange Act33.3
            Certification
                of Chief Executive Officer and Chief Financial officer Under Section
                1350
                as Adopted Pursuant to Section 906 of the Sarbane-Oxley Act.




85




1.
            Incorporated
                by reference to Exhibit 4.1 of the Company's Form 10-KSB filed with
                the
                SEC on April 7, 2004 (SEC File No. 000-25455).




2.
            Incorporated
                by reference to Exhibit 3.1 of the Company's Form 8-K filed with
                the SEC
                on October 1, 2004 (SEC File No. 000-25455).




3.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on December
                15, 2004 (SEC File No. 333-121301), and incorporated herein by this
                reference.




4.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on January
                19, 2005 (SEC File No. 333-121301), and incorporated herein by this
                reference.




5.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on October
                17, 2005 (SEC File No. 333-129068), and incorporated herein by this
                reference.




6.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on November
                18, 2005 (SEC File No. 333-129068), and incorporated herein by this
                reference.




7.
            Filed
                as an Exhibit to the Company's Form 10-KSB, filed with the SEC on
                March
                31, 2006 (SEC File No. 000-25455), and incorporated herein by this
                reference.




8.
            Filed
                as an Exhibit to the Company's Form 8-K filed with the SEC on January
                24,
                2006 (SEC File No. 000-25455) and incorporated herein by this reference.




9.
            Filed
                as an Exhibit to the Company's Form 8-K filed with the SEC on April
                21,
                2006 (SEC File No. 000-25455) and incorporated herein by this reference.




10.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on July
                3,
                2006 (SEC File No. 333-135576), and incorporated herein by this reference.




11.
            Filed
                as an Exhibit to the Company's Form 10-KSB, filed with the SEC on
                April 7,
                2004 (SEC File No. 000-25455) and incorporated herein by this reference.




12.
            Filed
                as an Exhibit to the Company's Form 8-K filed with the SEC on January
                10,
                2007 (SEC File No. 000-25455) and incorporated herein by this reference.




13.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on July
                3,
                2006 (SEC File No. 333-135576), and incorporated herein by this reference.




14.
            Filed
                as an Exhibit to the Company's Form SB-2, filed with the SEC on October
                3,
                2006 (SEC File No. 333-135576), and incorporated herein by this reference.




**ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES**





During
      fiscal year ended December 31, 2006, we incurred approximately $167,000 in
      fees
      to our  independent registered public accounting firm for
      professional services rendered in connection with the audit of our financial
      statements for fiscal year ended December 31, 2006 and for the review of our
      financial statements for the quarters ended March 31, 2006, June 30, 2006 and
      September 30, 2006.





During
      fiscal year ended December 31, 2005, we incurred approximately $65,000 in fees
      to our  independent registered public accounting firm for
      professional services rendered in connection with the audit of our financial
      statements for fiscal year ended December 31, 2005 and for the review of our
      financial statements for the quarters ended March 31, 2005, June 30, 2005 and
      September 30, 2005.




During
      fiscal year ended December 31, 2006, we did not incur any other fees for
      professional services rendered by our  independent registered public
      accounting firm for all other non-audit services which may include, but is
      not limited to, tax-related services, actuarial services or valuation
      services.












86




**SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly authorized.










LEXINGTON
              RESOURCES, INC.Dated:
              May 17, 2007
            By:
            /s/ GRANT
              ATKINSGrant
              Atkins, President/Chief Executive Officer


Dated:
              May 17, 2007
            By:
            /s/ NORMAN
              MACKINNONNorman
              MacKinnon, Treasurer/Chief Financial
              Officer

















87