ARD Concerns over 2006 Reserve Report Confirmed
Company Announces Delay in Issuance of 2006 10K

My Concerns were validated with today's SEC filing. On March 8th I mentioned my concern about the delay in the 2006 proved reserves report when it was stated, "...Investors are left wondering why such a delay in the 2006 reserve report. Are there problems?"

Here is the narrative from the 10NT (A filing to alert the SEC that the 10K will be late):

"Arena Resources, Inc. has engaged an independent petroleum engineering consultant to aid in the preparation of the Company's estimated quantities of oil and natural gas reserves and the related discounted present value of future pre-tax cash flows and standardized measure of discounted future net cash flows therefrom ("Reserve Estimate"). The Reserve Estimate will not be completed in time to enable the Company to complete all of the disclosure required in its Annual Report on Form 10-K..."

Clearly this is a red flag. The question that needs to be asked is 'why is the reserve report late?' There is absolutely positively no excuse. GMXR was criticized for its tardy 10K reports. ARD does not get a free pass. There better be some good reasons for the problem and assurance that it will not happen again.

Maybe we should ask management to give back the stock options that were awarded for 2006 for poor performance in getting the 10K submitted on time. The jury is out until we hear from management. This just seems so uncharacteristic of a Tim Rochford company to be late on an SEC filing. The company has been perfect in on-time performance since company inception back in 2001.

I'm left wondering if Tim Rochford has some health issues/problems. Is this a reason why he created the position of COO for Phil Terry? Given the fact that Tim is so meticulous in his managment style I"m left wondering if he relinquished day to day control of the company to someone ill-prepared to handle the task as a result of some health problems.

I have no information indicating that Tim had any recent health problems but this is the only thing that I can come up with. The other scenario would be some serious problems with the Fuhrman-Masscho property as it relates to the natural declines. In the Q3'06 conference call there was mention of secondary recovery techniques being utilized on the new wells being drilled. Could this fact coupled with some large natural decline rates have painted a grim picture in the mind of the independent petroleum engineering consultant? Maybe the final results of the petroleum engineer were not to the liking of ARD management. Maybe ARD decided to take the time to get a second opinion in order to challenge the initial report? While both of these scenarios are serious they can not be dismissed by investors at this time. I would expect ARD shares to decline in trading on Monday by a significant amount.

Why Lionore Mining Ownership is so Attractive
Nickel Miner Will Capitalize on Worlwide Demand Exceeding Supply in 2007

Previously it was noted why ownership of nickel producer Lionore mining is so compelling based on superior fundamentals and extreme undervaluation. Today nickel is at another record high based on supply & demand issues. Bloomberg.com describes the problem in an article entitled, "Nickel Rises to a Record for Fourth Day as Stockpiles Plunge."

Share ownership in ARD is nowhere near as attractive as share ownership in Lionore Mining (LIM.to / LMGGF.) Right now one can purchase over 3 shares of Lionore Mining for every share of ARD sold. This is an incredible opportunity given the fact that each LIM share is at least as valuable as each ARD share based on superior fundamentals as previously described. Don't be surprised to see the ARD/LIM ratio diminish to 2 to 1 in the near future.

The Last of ARD Shares Liquidated Today
ARD Shareholder July 29, 2005 -March 8, 2007

I remember the day July 29, 2005 with clarity and excitement. It was on this day that I decided to sell my GEOI in the $14-$15 range and move it into ARD in the $13-$14 range. My decision was based on logic and simple 8th grade math. ARD was superior to GEOI in terms of fundamentals, had far more oil assets per share, better future growth prospects, better management, and was significantly undervalued. The fact that ARD shares closed today at $44.67 and GEOI closed at $5.82 proves that the average person can do very well in the market by using simple logic and 8th grade math to take advantage of short-term inefficiencies in valuation. Long-term the market tends to get valuations right.

Today I sold the last of my ARD holdings and moved them into nickel producer Lionore Mining (LIM.to.) Lionore is traded on the Toronto Stock Exchange. Lionore Mining exhibits the same characteristics that ARD did back on July 29, 2005 except that Lionore has even better fundamentals, future growth prospects and an even higher degree of undervaluation. The company is so undervalued it is absolutely ridiculous.

The driving forces that led me to begin a quest to search for another company was the reality of slowing future production growth, revenues, net income and EPS. This concern was underscored when ARD appointed Phil Terry as Chief Operating Officer with a salary of $160,000. The creation of this new management position was in my mind the beginning of increased bureaucracy and higher costs and the end of the darling lean mean low cost company that I had grown to love. On top of that my analysis has indicated Q4'06 earnings of $0.36. The Wallstreet consensus is for $0.46. I expect up to a 21% miss in earnings. Certainly my number is conservative. In any case there is no way ARD will meet or exceed the consensus of $0.46 based on production of 325,000 BOE.

I don't believe the 2006 reserve report will surprise anybody. It is expected that they should increase by at least 40.2%. A miss would cause investor disappointment. Investors are left wondering why such a delay in the 2006 reserve report. Are there problems?

I believe investors have their heart set on commercial oil production in Kansas. Everyone is holding their breath on the results of the joint venture exploratory well that has been drilled on the Syracuse property in Kansas. If there is no oil then that will only cause disappointment.

One issue that has flagged my attention on the cashflow statement is the fact that even with all the capex spending the last 2 years cashflow from operating activities are still nowhere close to funding 100% of the capex program for 2007. The latest 10Q reveals $2 going out the door for every $1 that comes in the door. Compare the cashflow from operations of $30 million vs. Cashflow used in investing activites of $62 million. (See page 6 of 10Q.) This is not a good cashflow model.

Lionore Mining is the opposite. It has over $2.50 of cashflow from operations for every $1 of cashflow used in investing activities. (See page 5 of financial statement.)

My analysis indicates that LIM will earn $3.20 U.S. in FY2007. ARD is forecast to earn $2.58 by Wallstreet analysts. I feel the $2.50 range is reasonable. Based on ARD share price of $44.67 you could by 3.21 shares of LIM. If you decided to buy the 3.21 shares of LIM instead of the 1 share of ARD you would have earnings power of:

3.21 (shares) X $3.20 (2007 EPS projection) = $10.28.

In other words a $44.67 investment in LIM would yield $10.28 in EPS for 2007. The same investment in ARD would only yield 2007 EPS of $2.58. To put it bluntly, you are getting nearly 4X the earnings in LIM than by owning ARD. This is based on $15 a pound nickel. Currently nickel is worth over $20 a pound.

LIM has a stronger balance sheet, better cashflow and current assets exceed total liabilities. (Ben Graham would be proud!) The company has a demonstrated record of increasing production year after year. Given the fact that LIM takes in over 2.5 times as much as it spends (cashflow from operations vs. cashflow invested in capex and keeping the company running) there are no concerns about secondary offerings, issuance of preferred stock or going deep into debt. The same can not be said about ARD given the fact that its most recent cashflow statement shows over $2 spent for every $1 coming in from operations.

To top it all off LIM has a forward P/E of 4.4 in comparison to that of 17 for ARD. What we have in LIM is a company with better fundamentals, better future prospects, capable management, and extreme undervaluation. LIM should have a forward P/E at least double the current 4.4. This would yield 8.8 and yet nearly half of what the forward P/E is for ARD. (LIM really deserves a forward P/E at least as high as ARD. So you can see the high degree of undervaluation.)

In conclusion, there were events at ARD that got me looking for other investment opportunities. It was LIM's combination of superior fundamentals and incredible undervaluation that forced me to sell 100% of my ARD holdings and put them into LIM. I have been adding LIM (LMGGF) for a number of weeks. My low buy point was in the $9 range on LMGGF. Today LMGGF closed at $13.82.

I will continue to follow ARD. Since the last of my ARD shares were sold today I felt compelled to explain the reasons for doing so.

Sincerely,
Dok

Note: U.S. citizens can purchase the shares of Lionore Mining via the exchange symbol LMGFF. This is essentially LIM.to except that it is traded in U.S. dollars instead of Canadian dollars. Here is a link to the Lionore Mining website. There is also a wealth of information online about nickel.

Investor Email: Are there Problems with ARD?
Write to me at Doktor_Stocks@yahoo.com

XXXX from xxx@charter.net wrote:
Dok It sounds like you are down on ARD, as is the price of ARD. Something must have changed your mind rather quickly, like the CEO selling somestock. Any other ideas? My email is xxx@charter.net. I am just a simple investor trying to make money.....Thanks in advance for your thoughts.

XXXX,
Its not that I"m necessarily down on ARD. Rather the reason I sold 26% of my ARD holdings was due to the fact that I have found a company with stellar fundamentals that is significantly undervalued in relation to intrinsic value. So basically the fundamentals are superior to that of ARD. Also the other company has a gap between current share price and intrinsic value that is greater than that of ARD. In other words this other company is where ARD was back in 2005 in terms of attractiveness.

Keep in mind that up to this point of 26% of my ARD portfolio being sold I held a very concentrated position in ARD. By shifting some assets out of ARD and into the other company I was not only able to capture some better fundamentals and with a larger degree of undervaluation but I was also able to diversify. This is something I've always wanted to do but not at the expense of investing in a company with inferior fundamentals, future growth or current share price discount to intrinsic value.

On the other hand there have been some events at ARD that have pushed me to search for other investment opportunities. These events include the eventual slowing in future production growth, the creation of a $160,000 a year senior management position (increased G&A), challenges with production in Q4 (there were valid excuses), Tim Rochford selling a major portion of his common shares in 2007 and lack of clarity on status of exploratory well on the Syracuse property in Kansas.

Also I have certain expectations in order to maintain my high degree of investment in ARD going forward. These include but are not limited to the following:

1. Oil in Kansas. Lack of commercial oil production in Kansas would not make me happy. Given the massive acreage in Kansas I would like to start seeing some production from this region. This would also serve to take some of the load off the shoulders of the production at the Fuhrman-Mascho.

2. Q4'06 EPS of at least $0.36. This is a conservative estimate. If ARD comes in below this figure then you know there are some problems with rising costs. Rising costs that I consider to be significant will not be tolerated.

3. Proved Reserves Report for 2006 that has Year over Year growth of at least 40.2%. Anything less than 40.2% growth in proved reserves is an example of actual results coming in below expectations based on information provided by Tim in the previous quarterly conference calls. This report is crucial. It is an indicator as to your piece of the asset pie. The larger the numbers the larger your piece of the pie.

With everything said I still maintain a massive position in ARD. I have a higher percentage of my net worth in ARD than does Tim Rochford or Stan McCabe assuming they take their stock sales and diversify into other investment opportunities. Make no mistake about it: There is no better investment opportunity in the E&P sector right now that has a better combination of superior fundamentals and discount to intrinsic value than ARD.

I still believe in the concept of peak oil. ARD is the most efficient investment vehicle to capitalize on rising future oil prices.

However, we still need to keep our fingers on the pulse of ARD. We need to constantly pay attention to fundamentals and share price discount to fair value. When fundamentals deteriorate and/or share price exceeds fair value then one really needs to have a plan of action. In other words you need to have an idea where to move investment dollars. I currently have a plan with my nickel producing company. I will reveal the name of this nickel producer at or before the release of Q4'06 results. At that time I will discuss the company in more detail.

Until then, sit back and try not to let the volatility of today's markets bother you.

Dok

Why my ARD Share Count was Reduced 26% Today
Various Reasons Contributed to Decision; Diversification and More Attractive Investment Opportunity Played Key Role to Sell

Arena Resources' ratio of capex to cashflow from operating activities, EPS per dollar invested and the likely decline in future production growth were three primary factors that contributed to my decision to sell over a quarter of my ARD shares today. Such a sale never would have occurred in the absence of another more attractive investment opportunity.

The other company I moved the proceeds into was just far too undervalued based on the tremendous earnings power per dollar invested (topping that of ARD), cashflow from operating activities in excess of capex by a significant margin (unlike ARD) and production growth that is more secure without the great challenges of the natural declines that occur in mature oil fields such as the Fuhrman-Mascho.

The new company I invested in does not produce oil. It produces a commodity that has the same worldwide supply/demand issues that exist with that of oil. The peak oil problem will have the effect of increasing future demand for this non hydrocarbon as governments seek solutions to rising oil prices by investing in alternative fuels such as ethanol (stainless steel requirements) and hybrid vehicles (nicad batteries.) Both stainless steel and nicad batteries are only two of countless applications that consume a commodity the new company produces.

One should not construe my portfolio rebalancing as a result of glaring red flags at ARD. The more proper assessment would be that the other opportunity currently presents a more significant discount to intrinsic value than does ARD.

Going forward I do have certain expectations for ARD. Failure to meet or exceed my expectations would result in the possibility of future ARD liquidation. The expectations are as follows:

1. Oil in Kansas: The absence of commercial oil production associated with the deep test on the Syracuse in light of the Phil Terry promotion to COO at a salary of $160,000 a year would be a red flag. Only in the presence of oil in Kansas should Phil Terry have been hired. Lack of oil in Kansas noted in FY06 C.C. would yield a red flag.

2. EPS coming in at or Above $0.36: An EPS disappointment below my conservative estimate of $0.36 would yield another red flag. This would be a sign of a cost structure that is rising faster than expected.

3. Proved Reserve Growth of at Least 40.2%: Anything less than a 40.2% increase in year end proved reserves to 42,362,535 BOE for FY2006 would be considered a disappointment. This would constitute another possible red flag.

Even in the absence of potential red flags as mentioned above, a sound business decision could mandate the further decrease of ARD ownership and increase the ownership of the new company. The new company I have moved funds into as mentioned above is a producer of the base metal nickel. Here is the price history of the commodity. This company comprises the second company in my portfolio. After the release of ARD Q4'06 results this company will be revealed.

ARD CEO Tim Rochford Sells 200,000 Common Shares
Two Day Transaction Size is Record for CEO; Represents First Time CEO has Sold Shares Prior to Release of Reserve Report

The CEO share sale on February 1-2 may seem bearish at first glance due to the number of shares sold. After all, this is the largest block of shares that he has sold in a two day span going back to the birth of the company in 2001. In fact, this is the largest share sale by the CEO in any 30 day span. In 2006 Rochford sold 140,000 shares in a period between September 18 and October 4th. However, one needs to understand that the timing of the share sale is extremely bullish.

Timing of Share Sale is Bullish

This is the first time in the history of the company that CEO Tim Rochford has sold shares prior to the Reserve Report announcement. This is also the first time that Tim has sold shares prior to the release of the operational results of the fourth quarter and full year. Certainly Tim would be subjecting himself to a potential SEC investigation if he sold his shares with either a disappointing reserves report or operational results.

We already know operationally the company produced approximately 325,000 BOE in Q4'06. This is below guidance. However, there were valid reasons for the shortfall in production which will ultimately be reflected in the fourth quarter revenues, net income and EPS. One should expect good news as it relates to the year-end reserve report. Expect at least a 40.2% increase in proved reserves over the previous year.

One should also expect to hear good news as it relates to the Syracuse Project in southwest Kansas with the joint venture partner. Specifically don't be surprised if Tim announces the presence of commercial oil production on this project in association with the St.Louis formation. Expect the partnership to reveal initial development plans. This increased activity in Kansas and the likely presence of oil bearing hydrocarbons fits perfectly with Tim's decision to give the day to day operational control to the newly appointed President and Chief Operating Officer, Phil Terry. The creation of this $160,000 a year position is further proof of the likelihood oil has been found in Kansas. This amount is more than the combined salaries of CEO Rochford, Chairman McCabe and CFO Broaddrick in 2006. Tim is a low cost man. He couldn't justify creating a new $160,000 upper level management position in the absence of significant growth going forward.

Below is a chart indicating ARD CEO Tim Rochford's common stock sales by year. The chart below tells the story of Tim's investment in Arena. The first four years of the company's existence he did not sell a single share nor profit from his investment of time and money. This is especially true given the fact that his annual salary has been no greater than $36,000 a year. Only since 2005 has ARD CEO Tim Rochford finally realized some return on his investment by virtue of his sales of common stock.

The chart below indicates that Tim's holdings are declining over time. The sales of common stock are partially being offset by increases in stock options. The picture below indicates that Tim has not decreased his position significantly in ARD shares and stock options when taken in aggregate. Certainly stock options are comprising a larger percentage of Tim's ARD portfolio.

In summary, Tim is finally beginning to see some return on his investment in Arena Resources. The size of the latest common stock sales should not be viewed as bearish. Instead the timing of these share sales should be clear indication of good things to come. His ownership in the company has not decreased significantly even with the common stock sales as a result of stock option awards. Additionally the appointment of Phil Terry as the new President and Chief Operating Officer at a salary of $160,000 a year is further proof of significant drilling opportunities not only in the Permian Basin but also as they relate to the very probable presence of oil bearing hydrocarbons in the Syracuse Project's St.Louis Formation.

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