10-Q 1 form10q.htm QUARTERLY REPORT FOR PERIOD ENDED MARCH 31, 2011 Arkanova Energy Corp.: Form 10-Q - Filed by newsfilecorp.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

[ x ]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

[     ]  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 000-51612

 
____________________________________________ 
(Exact name of registrant as specified in its charter)

Nevada 68-0542002
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)  

2441 High Timbers Drive, Suite 120 The Woodlands, Texas 77380
(Address of principal executive offices) (zip code)

281.298.9555
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ x ]  No [     ]


- 2 -

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ] (Not applicable)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [     ] Accelerated filer [     ]
Non-accelerated filer [     ] Smaller reporting company [ x ]
(Do not check if a smaller reporting company)  

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

43,309,367 common shares issued and outstanding as at May 16, 2011.


- 3 -

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Our unaudited consolidated financial statements are stated in United States dollars and are prepared in accordance with United States generally accepted accounting principles.

It is the opinion of management that the unaudited consolidated interim financial statements for the quarter ended March 31, 2011 include all adjustments necessary in order to ensure that the unaudited consolidated interim financial statements are not misleading.



- 4 -
 
 
 
Arkanova Energy Corporation
Consolidated Balance Sheets
(unaudited)

    March 31,     September 30,  
    2011     2010  
             
ASSETS            
   Cash and cash equivalents $  –   $  1,656,634  
   Oil and gas receivables, net of allowance of $nil   266,927     60,183  
   Prepaid expenses and other   77,555     348,826  
   Other receivables, net of allowance of $nil and $103,000       46,381  
Total current assets   344,482     2,112,024  
Property and equipment, net of accumulated depreciation of $120,907 and $80,216   352,114     369,586  
Oil and gas properties, full cost method            
   Evaluated, net of accumulated depreciation of $15,891,474 and $15,786,820   1,202,817     2,222,570  
   Other Assets   97,000     97,000  
Total assets $  1,996,413   $  4,801,180  
             
LIABILITIES AND STOCKHOLDERS’ DEFICIT            
   Bank indebtedness $  21,874   $  –  
   Accounts payable   543,170     1,893,769  
   Accrued liabilities   378,332     739,482  
   Due to related party       794  
   Notes payable   12,343,999     12,585,963  
   Derivative liability   52,531     53,666  
Total short term liabilities   13,339,906     15,273,674  
Loans payable   30,603     50,250  
Asset retirement obligations   137,037     186,902  
Total liabilities   13,507,546     15,510,826  
             
Contingencies and commitments            
Stockholders’ Deficit            
Common Stock, $0.001 par value, 1,000,000,000 shares authorized,
43,309,367 (September 30, 2010 – 39,722,168) shares issued and outstanding
 
43,309
   
39,722
 
Additional paid-in capital   17,737,572     16,361,084  
Retained deficit   (29,292,014 )   (27,110,452 )
Total stockholders’ deficit   (11,511,133 )   (10,709,646 )
Total liabilities and stockholders’ deficit $  1,996,413   $  4,801,180  

See accompanying notes to unaudited consolidated financial statements



- 5 -
 
 
 
Arkanova Energy Corporation
Consolidated Statements of Operations
(unaudited)

    Three months     Three months     Six months     Six months  
    Ended     Ended     Ended     Ended  
    March 31,     March 31,     March 31,     March 31,  
    2011     2010     2011     2010  
Revenue                        
 Oil and gas sales $  377,151   $  269,076   $  641,950   $  570,927  
Total revenue   377,151     269,076     641,950     570,927  
                         
Expenses                        
 General and administrative expenses   402,709     370,529     1,226,126     1,248,732  
 Oil and gas production costs   461,613     333,791     1,124,073     746,080  
 Accretion expenses   3,105         7,535      
 Depletion   66,435     1,944     104,654     3,780  
Operating loss   (556,711 )   (437,188 )   (1,820,438 )   (1,427,665 )
Other income (expenses)                        
 Operator Income   13,500         13,500      
 Interest expense   (178,162 )   (193,320 )   (375,759 )   (403,191 )
 Interest income       198         1,021  
 Loss on extinguishment of debt               (480,000 )
 (Loss) gain on derivative liability   (1,472 )   (16,515 )   1,135     (18,167 )
Net loss $  (722,845 ) $  (646,825 ) $  (2,181,562 ) $  (2,328,002 )
Loss per share – basic and diluted $  (0.02 ) $  (0.02 ) $  (0.05 ) $  (0.06 )
Weighted average common shares outstanding   43,309,000     37,700,000     42,799,000     37,500,000  

See accompanying notes to unaudited consolidated financial statements



- 6 -
 
Arkanova Energy Corporation
Consolidated Statements of Cash Flows
(unaudited)

    Six months     Six months  
    Ended     Ended  
    March 31,     March 31,  
    2011     2010  
             
Operating Activities            
             
   Net loss $  (2,181,562 ) $  (2,328,002 )
             
   Adjustment to reconcile net loss to net cash used in operating activities:            
             
       Accretion   7,535      
       Depreciation   40,690     29,859  
       Depletion   104,654     3,780  
       Loss on extinguishment of debt       480,000  
       (Gain) loss on derivative liability   (1,135 )   18,167  
       Stock-based compensation   401,325     266,935  
             
   Changes in operating assets and liabilities:            
       Prepaid expenses   271,271     185,579  
       Oil and gas receivables   (160,363 )   1,355  
       Accounts payable and accrued liabilities   (1,350,599 )   (52,533 )
       Accrued interest   358,850     391,923  
       Due to related parties   (794 )   (96,414 )
             
Net Cash Used in Operating Activities   (2,510,128 )   (1,099,351 )
             
Investing Activities            
             
Purchase of equipment   (23,218 )   (40,211 )
Purchase of pipeline       (50,997 )
Proceeds on sale of oil and gas property   1,600,000      
Oil and gas property expenditures   (742,301 )   (36,778 )
             
Net Cash Provided by (Used in) Investing Activities   834,481     (127,986 )
             
Financing Activities            
             
Bank indebtedness   21,874      
Principal payments on debt   (21,611 )    
Proceeds from issuance of promissory notes       1,168,729  
Proceeds from exercise of stock options   18,750     75,000  
             
Net Cash Provided by Financing Activities   19,013     1,243,729  
             
Net Change in Cash   (1,656,634 )   16,392  
             
Cash and cash equivalents – beginning of period   1,656,634     11,022  
             
Cash and cash equivalents – end of period $  –   $  27,414  

Supplemental Cash Flow and Other Disclosures (Note 9)

See accompanying notes to unaudited consolidated financial statements



- 7 -
 
 
Arkanova Energy Corporation
Notes to Consolidated Financial Statements
(unaudited)

NOTE 1: BASIS OF PRESENTATION

Arkanova Energy Corporation (formerly Alton Ventures, Inc.) (“Arkanova” or the “Company”) was incorporated in the state of Nevada on September 6, 2001 to engage in the acquisition, exploration and development of mineral properties.

In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments, consisting of only normal recurring accruals, necessary for a fair statement of financial position, results of operations, and cash flows. The information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and the accompanying notes included in our Annual Report on Form 10-K for the year ended September 30, 2010. The accounting policies are described in the “Notes to the Consolidated Financial Statements” in the 2010 Annual Report on Form 10-K and updated, as necessary, in this Form 10-Q. The year-end consolidated balance sheet data presented for comparative purposes was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the six months ended March 31, 2011 are not necessarily indicative of the operating results for the full year or for any other subsequent interim period.

NOTE 2: GOING CONCERN

Arkanova is primarily engaged in the acquisition, exploration and development of oil and gas resource properties. Arkanova has incurred losses of $29,292,014 since inception and has a negative working capital of $12,995,424 at March 31, 2011. Management plans to raise additional capital through equity and/or debt financings. These factors raise substantial doubt regarding Arkanova’s ability to continue as a going concern.

NOTE 3: OIL AND GAS INTERESTS

Arkanova is currently participating in oil and gas exploration activities in Arkansas, Colorado and Montana. All of Arkanova’s oil and gas properties are located in the United States.

Proven and Developed Properties, Arkansas and Colorado and Montana

During the period ended March 31, 2011, the present value of the estimated future net revenue exceeds the carrying value of the evaluated oil and gas properties, therefore, no impairment is required. The carrying value of Arkanova’s evaluated oil and gas properties at March 31, 2011 was $1,202,817 (September 30, 2010 - $2,222,570).

 

(a)

On April 9, 2010, Arkanova’s subsidiary, Provident, entered into a Purchase and Sale Agreement with Knightwall Invest, Inc. (“Knightwall”). Pursuant to the agreement, Provident agreed to sell to Knightwall 30% of the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana, and the equipment, parts, machinery, fixtures and improvements located on, or used in connection with, the Unit, for a purchase price of $7,000,000 (received). The $5,500,000 received prior to September 30, 2010 was applied against the full cost pool as of September 30, 2010. The $1,500,000 received during the six months ended March 31, 2011, was applied against the full cost pool.

 

(b)

On November 22, 2010, Provident entered into an option agreement with Knightwall pursuant to which Provident granted an option to Knightwall to purchase an additional 5% working interest in the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana. The option is exercisable by Knightwall until expiry on March 31, 2011. Upon the grant of the option, Knightwall provided a $100,000 (paid) non refundable deposit, the payment of which will not be applied against the purchase price in the event the option is exercised. On March 15, 2011, Knightwall exercised the option and paid $1,500,000 to Provident on April 5, 2011. Refer to Notes 7(a) and 9(a).



- 8 -

NOTE 4: NOTES PAYABLE

(a)

On April 17, 2008, Arkanova received $300,000 and issued a promissory note. Under the terms of the promissory note, the amount was unsecured, accrued interest at 10% per annum, and was due on April 16, 2009. At April 16, 2009, accrued interest of $30,000 was recorded. On April 17, 2009, this note was modified whereby the maturity date was extended to April 17, 2010 and the accrued interest on the note at the date of modification was added to the principal balance for a modified principal amount outstanding of $330,000. On April 17, 2010, Arkanova paid interest of $33,000 to the note holder and extended the maturity date to July 17, 2010. On July 17, 2010, Arkanova repaid principal amount of $30,000 and interest of $8,250 and extended the maturity date to October 17, 2010.On October 17, 2010, Arkanova paid interest of $7,500 to the note holder and extended the maturity date to January 17, 2011. On January 17, 2011, Arkanova paid interest of $7,500 to the note holder and further extended the maturity date to April 17, 2011. On April 17, 2011, Arkanova further extended the maturity date to July 17, 2011. Arkanova evaluated the application of ASC 470-50, Modifications and Extinguishments and ASC 470-60, Troubled Debt Restructurings by Debtors and concluded that the revised terms constituted a debt modification, rather than a debt extinguishment or troubled debt restructuring. The promissory note bears interest at 10% per annum, is due on demand at any time after July 17, 2011 and may be secured against Arkanova’s oil, gas and mineral leases in Phillips and Monroe County, Arkansas, and any wells located on acreage covered by such leases that are owned and operated by Arkanova, right-of-ways and easements and Arkanova’s share of production obtained from such wells, if any. The promissory note may be prepaid in whole or in part at any time prior to July 17, 2011 without penalty. In the event that Arkanova completes a subsequent debt or equity financing of $5,000,000 or more prior to July 17, 2011, Arkanova is obligated to repay the promissory note, plus accrued interest, from the proceeds of the financing. In the event that Arkanova defaults on the promissory note, and unless such default is waived in writing by the holder, the holder may consider the promissory note immediately due and payable without presentment, demand, protest or notice of any kind. Under such circumstances, interest shall accrue on the principal amount from the date of default at the rate of 16% per annum, or the maximum rate allowed by applicable law, whichever is lower.

   
(b)

On October 1, 2009, our subsidiary borrowed $1,168,729 and consolidated its outstanding promissory note balances into one promissory note in the principal amount for $12,000,000. The loan also adds accrued interest of $818,771 to this principal amount. The note bears interest at 6% per annum, is due on September 30, 2011, and is secured by our guarantee and also a pledge of our wholly owned subsidiary, Provident. Interest is payable 10 days after maturity in our common shares. The number of shares payable will be determined by dividing $1,440,000 by the average stock price over the 15 business day period immediately preceding the date on which the promissory note matures. On October 22, 2010, Arkanova issued 2,634,150 shares of common stock with a fair value of $720,000 to Aton Select Funds Limited as an interest payment on the promissory note of $12,000,000. (Refer to Note 5(b)).

   

As further consideration for this new loan, Arkanova issued the note holder 821,918 common shares with a fair value of $240,000 during the fiscal year ended September 30, 2010. On October 26, 2010, Arkanova issued an additional 878,049 common shares with a fair value of $240,000 (refer to Note 5(c)). Arkanova evaluated the application of ASC 470-50and ASC 470-60 by Debtors and determined the debt modification was substantial and qualified as a debt extinguishment. The additional stock due was valued at $480,000 and was expensed as a loss on extinguishment of debt during the quarter ended December 31, 2009.

NOTE 5: COMMON STOCK

Common stock

a)

On October 22, 2010, Arkanova issued 75,000 common shares upon the exercise of 75,000 stock options by one of the employees at an exercise price of $0.25 per common share for gross proceeds of $18,750.

   
b)

On October 26, 2010, Arkanova issued 2,634,150 shares of common stock with a fair value of $720,000 to Aton Select Funds Limited as an interest payment on the promissory note of $12,000,000. Refer to Note 4(b).

   
c)

On October 26, 2010, Arkanova issued 878,049 shares of common stock to Aton Select Funds Limited as further consideration for loan obtained from Aton Select Funds Limited. Refer to Note 4(b).

Stock Options

On April 25, 2007, Arkanova adopted a stock option plan named the 2007 Stock Option Plan (the “Plan”), the purpose of which is to attract and retain the best available personnel and to provide incentives to employees, officers, directors and consultants, all in an effort to promote the success of Arkanova. Prior to the grant of options under the 2007 Stock Option Plan, there were 5,000,000 shares of Arkanova’s common stock available for issuance under the plan.


- 9 -

During the six months ended March 31, 2011, Arkanova granted 1,725,000 stock options, exercisable at $0.25 per share and expire on October 8, 2015. The weighted average grant date fair value of stock options granted during the six months ended March 31, 2011 was $0.25.

During the six months ended March 31, 2011, 75,000 of stock options were exercised. During the six months ended March 31, 2011 and 2010, Arkanova recorded stock-based compensation of $401,325 and $266,935, respectively, as general and administrative expense.

A summary of Arkanova’s stock option activity is as follows:

          Weighted Average     Weighted Average     Aggregate  
    Number of     Exercise Price     Remaining     Intrinsic Value  
    Options       Contractual Term    
Outstanding, September 30, 2010   3,303,333     0.38     3.27        
Granted   1,725,000     0.25              
Exercised   (75,000 )   0.25              
Outstanding, March 31, 2011   4,953,333     0.33     3.36     256,167  
Exercisable, March 31, 2011   4,953,333     0.33     3.36     256,167  

The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:

    Six months  
    ended  
    March 31,  
    2011  
       
Expected dividend yield   0.00%  
Expected volatility   214%  
Expected life (in years)   2.50  
Risk-free interest rate   0.45%  

A summary of the status of the Company’s non-vested stock options as of March 31, 2011, and changes during the six month period ended March 31, 2011, is presented below:

          Weighted Average  
    Number of     Grant Date  
Non-vested options   options     Fair Value  
         
             
Non-vested at September 30, 2010   125,000     0.28  
             
Granted   1,725,000     0.23  
Vested   (1,850,000 )   0.23  
             
Non-vested at March 31, 2011        

At March 31, 2011, there was $nil of unrecognized compensation costs related to non-vested share-based compensation arrangements granted under the Plan. There was $256,167 intrinsic value associated with the outstanding options at March 31, 2011.

NOTE 6: DERIVATIVE INSTRUMENTS

In June 2008, the FASB ratified ASC 815-15, Derivatives and Hedging – Embedded Derivatives (“ASC 815-15”). ASC 815-15, specifies that a contract that would otherwise meet the definition of a derivative, but is both (a) indexed to its own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. ASC 815-15 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock, including evaluating the instrument’s contingent exercise and settlement provisions, and thus able to qualify for the ASC 815-15 scope exception. It also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. ASC 815-15 is effective for the first annual reporting period beginning after December 15, 2008 and early adoption is prohibited.

The impact of ASC 815-15 for the period ending March 31, 2011 resulted in a decrease in the derivative liability of $1,135 with a corresponding income of $1,135 on derivative instruments. The fair value of the derivative liability was $52,531 at March 31, 2011.


- 10 -

The fair values of the warrants on March 31, 2011 and September 30, 2010 were estimated using the following assumptions:

    March 31, 2011     September 30, 2010  
Expected volatility   177%     214%  
Expected term   2.00 years     2.50 years  
Risk free rate   0.80%     0.64%  
Expected dividends        
Fair value $  52,531   $  53,666  

Assets and liabilities measured at fair value on a recurring basis were presented on the Company's consolidated balance sheet as of March 31, 2011 as follows:

    Fair Value Measurements Using        
    Quoted Price in     Significant              
    Active Markets     Other     Significant        
    for Identical     Observable     Unobservable     Balance as of  
    Instruments     Inputs     Inputs     March 31,  
    (Level 1)   (Level 2)   (Level 3)   2011  
Liabilities:                        
Derivative Liabilities $  –   $  –   $  52,531   $  52,531  
                         
Total liabilities measured at fair value $  –   $  –   $  52,531   $  52,531  

NOTE 7: COMMITMENTS

See Note 4.

(a)

On April 9, 2010, Arkanova’s subsidiary, Provident, entered into a Purchase and Sale Agreement with Knightwall Invest, Inc. Pursuant to the agreement, Provident agreed to sell to Knightwall 30% of the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana, and the equipment, parts, machinery, fixtures and improvements located on, or used in connection with, the Unit, for a purchase price of $7,000,000 (the “Purchase Price”).

   

The Purchase Price is payable in installments, with the initial payment of $1,500,000 being due on or before April 9, 2010 (received), a second payment of $2,000,000 being due on June 8, 2010 (received on July 2, 2010), a third payment of $2,000,000 ($369,365 of which Knightwall is entitled to apply to the payment in full of loan being due on July 8, 2010 (received on August 3, 2010), and the remaining $1,500,000 was paid on November 23, 2010 completing the sale.

   

On November 22, 2010, Provident entered into an option agreement with Knightwall pursuant to which Provident granted an option to Knightwall to purchase an additional 5% working interest in the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana. The option is exercisable by Knightwall until expiry on March 31, 2011. Upon the grant of the option, Knightwall provided a $100,000 (paid) non refundable deposit, the payment of which will not be applied against the purchase price in the event the option is exercised. On March 15, 2011, Knightwall exercised the option and paid $1,500,000 to Provident on April 5, 2011. Refer to Note 9(a).

   
(b)

The Company, as an owner or lessee and operator of oil and gas properties, is subject to various federal, state and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, the Company may be directed to suspend or cease operations in the affected area. The Company maintains insurance coverage, which it believes is customary in the industry, although the Company is not fully insured against all environmental risks. The Company is not aware of any environmental claims existing as of March 31, 2011, which have not been provided for, covered by insurance or otherwise have a material impact on its financial position or results of operations. There can be no assurance, however, that current regulatory requirements will not change, or past noncompliance with environmental laws will not be discovered on the Company’s properties.

   
(c)

On October 17, 2010, Arkanova extended the maturity date on the $300,000 promissory note due to Global Project Finance AG to January 17, 2011. On January 17, 2011, Arkanova further extended the maturity date to April 17, 2011. On April 17, 2011, Arkanova further extended the maturity date to July 17, 2011. The amount was unsecured, with an accrued interest at 10% per annum. Refer to Note 4(a) and Note 9(b).

   
(d)

On December 15, 2010, the Company entered into a lease agreement for a period of six months at the rate of $6,500 per month.



- 11 -

NOTE 8: ASSET RETIREMENT OBLIGATION

Changes in Arkanova’s asset retirement obligations were as follows:

    Six months     Year ended  
    ended March 31,     September 30,  
    2011     2010  
Asset retirement obligations, beginning of period $  186,902   $  –  
Revision due to property sales   (57,400 )    
Revisions in estimated liabilities       155,316  
Abandonment costs        
Accretion expense   7,535     31,586  
Asset retirement obligations, end of period $  137,037   $  186,902  

On April 20, 2010, Arkanova entered into an escrow agreement that has been established for the purpose of assuring maintenance and administration of a performance bond which secures certain plugging and abandonment obligations assumed by Arkanova in the acquisition of oil and gas properties during the year ended September 30, 2009. At September 30, 2010, the amount of the escrow account totaled $250,000 shown as prepaid expenses and other.

During the six months ended March 31, 2011, the Company reduced the asset retirement obligations by $56,071 due to the sale of 30% of the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana. Refer to Note 7(a).

NOTE 9: SUPPLEMENTAL CASH FLOW AND OTHER DISCLOSURES

    Six months     Six months  
    Ended     Ended  
    March 31,     March 31,  
    2011     2010  
Supplemental Disclosures:            
             
   Interest paid $  15,000   $  –  
   Income taxes paid $  –   $  –  
             
Noncash Financing and Investing Activities            
   Accounts payable related to capital expenditures $  –   $  55,310  
   Cumulative effect of change in accounting principal $  –   $  59,546  
   Shares issued to extinguish liability $  960,000   $  –  
   Asset retirement obligation revision $ 57,400   $  –  

NOTE 10: SUBSEQUENT EVENTS

Pursuant to ASC 855, we have evaluated all events or transactions that occurred through the date of issuance of the unaudited consolidated financial statements. During this period we did not have any material recognizable subsequent events, except as disclosed below.

(a)

On April 5, 2011, Provident received a payment of $1,500,000 from Knightwall upon the exercise of the option to acquire an additional 5% working interest in the leasehold interests comprising Provident’s Two Medicine Cut Bank Sand Unit in Pondera and Glacier Counties, Montana. Refer to Note 7(a).

   
(b)

On April 17, 2011, Arkanova extended the maturity date on the $300,000 promissory note due to Global Project Finance AG to July 17, 2011. The amount was unsecured, with an accrued interest at 10% per annum. Refer to Note 4(a).



- 12 -

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

This quarterly report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks in the section entitled “Risk Factors”, that may cause our company’s or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

Our unaudited consolidated interim financial statements are stated in United States dollars and are prepared in accordance with United States generally accepted accounting principles. The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes that appear elsewhere in this quarterly report.

In this quarterly report, unless otherwise specified, all references to “common shares” refer to the shares of our common stock and the terms “we”, “us”, “our” and “Arkanova” mean Arkanova Energy Corporation.

Results of Operations for the Three and Six Months Ended March 31, 2011

The following summary of our results of operations should be read in conjunction with our unaudited consolidated interim financial statements for the three and six months ended March 31, 2011 which are included herein:

    Three Months     Three Months     Six Months     Six Months  
    Ended     Ended     Ended     Ended  
    March 31, 2011     March 31, 2010     March 31, 2011     March 31, 2010  
                         
Revenue $  377,151   $  269,076   $  641,950   $  570,927  
Expenses $  (933,862 ) $  (706,264 ) $  (2,462,388 ) $  (1,998,592 )
Net Loss $  (722,845 ) $  $(646,825 ) $  (2,181,562 ) $  (2,328,002 )

Revenues

During the three months ended March 31, 2011, we generated $377,151 in revenue as compared to revenues of $269,076 during the three months ended March 31, 2010. During the six months ended March 31, 2011, we generated $641,950 in revenue as compared to revenue of $570,927 during the six months ended March 31, 2010. The increase in revenues during the three and six months ended March 31, 2011 is a result of increasing oil prices and increased oil production. The revenue during the three months and six months ended March 31, 2011 was expected to have been greater if it was not for our main battery being shut down for a total of 29 days for renovation. Our main battery is now fully operational and in good working condition.

Expenses

Expenses increased during the three months ended March 31, 2011 to $933,862 as compared to $706,264 during the three months ended March 31, 2010. The increase is largely as a result of increased general and administrative expenses which were $402,709 for the three months ended March 31, 2011 and $370,529 for the three months ended March 31, 2010. The main components of our general and administrative expenses during the three months ended March 31, 2011 included employment compensation expenses of $163,777, stock based compensation of $4,299, professional and audit fees of $56,813, and other general and administrative expenses of $177,820. The three months ended March 31, 2011 also resulted in oil and gas production costs of $461,613 and depletion expenses of $66,435, as compared to oil and gas production costs of $333,791 and depletion expenses of $1,944 for the three months ended March 31, 2010.


- 13 -

Expenses substantially increased during the six months ended March 31, 2011 to $2,462,388 as compared to $1,998,592 during the six months ended March 31, 2010. The increase is largely as a result of increased general and administrative expenses which were $1,226,126 for the six months ended March 31, 2011 and $1,248,732 for the six months ended March 31, 2010. The main components of our general and administrative expenses during the six months ended March 31, 2011 included employment compensation expenses of $408,299, stock based compensation of $401,325, professional and audit fees of $100,553, and other general and administrative expenses of $315,949. The six months ended March 31, 2011 also resulted in oil and gas production costs of $1,124,073 and depletion expenses of $104,654, as compared to oil and gas production costs of $746,080 and depletion expenses of $3,780 for the six months ended March 31, 2010. The increase is mainly because of our continuing commitment to upgrade, renovate, reactivate wells and construct the necessary facilities to increase production and revenues.

Interest Expense

Interest expense decreased during the six months ended March 31, 2011 to $375,759 as compared to $403,191 during the six months ended March 31, 2010.

Loss on extinguishment of debt

During the six months ended March 31, 2011, we did not incur any loss due to the early extinguishment of debt as compared to $480,000 during the six months ended March 31, 2010.

Liquidity and Capital Resources

Working Capital

    At March 31,     At September 30,  
    2011     2010  
Current assets $  344,482   $  2,112,024  
Current liabilities $  13,339,906   $  15,273,674  
Working capital (deficiency) $  (12,995,424 ) $  (13,161,650 )

We had cash and cash equivalents of $nil and a working capital deficiency of $12,995,424 as at March 31, 2011 compared to cash and cash equivalents of $1,656,634 and a working capital deficiency of $13,161,650 as of September 30, 2010. In addition to funds required to eliminate our working capital deficiency, we anticipate that we will require approximately $3,700,000 for operating expenses during the next twelve months as set out below.

Estimated Expenses for the Next Twelve Month Period   
  $    
Exploration & Operating Costs      
             Drilling Costs $  5,000,000  
             Employee and Consultant Compensation $  900,000  
             Professional Fees $  300,000  
             General and Administrative Expenses $  500,000  
Total $  6,700,000  

Our company’s principal cash requirements are for new infield well drilling development and current well reactivations. We anticipate such expenses will rise as we proceed to determine the feasibility of developing our current or future property interests.


- 14 -

Our company’s cash and cash equivalents will not be sufficient to meet our working capital requirements for the next twelve month period. We estimate that we will require approximately $6,700,000 over the next twelve month period to fund our plan of operations. Our company plans to raise the capital required to satisfy our immediate short-term needs and additional capital required to meet our estimated funding requirements for the next twelve months primarily through the private placement of our equity securities. There is no assurance that our company will be able to obtain further funds required for our continued working capital requirements. The ability of our company to meet our financial liabilities and commitments is primarily dependent upon the continued financial support of our directors and shareholders, the continued issuance of equity to new shareholders, and our ability to achieve and maintain profitable operations.

There is substantial doubt about our ability to continue as a going concern as the continuation of our business is dependent upon obtaining further long-term financing, successful exploration of our property interests, the identification of reserves sufficient enough to warrant development, successful development of our property interests and, finally, achieving a profitable level of operations. The issuance of additional equity securities by us could result in a significant dilution in the equity interests of our current stockholders. Obtaining commercial loans, assuming those loans would be available, will increase our liabilities and future cash commitments.

Due to the uncertainty of our ability to meet our current operating and capital expenses, in their report on our audited consolidated financial statements for the period ended September 30, 2010, our independent auditors included an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our statements contain additional note disclosures describing the circumstances that lead to this disclosure by our independent auditors.

Outstanding Promissory Notes

On October 1, 2009, our subsidiary entered into a Loan Consolidation Agreement to consolidate its outstanding promissory notes. We requested an additional loan in the amount of $1,168,729 to be consolidated into one new promissory note in the principal amount of $12,000,000. Pursuant to the terms and conditions of the agreement, the new loan provided for the consolidation and cancellation of the former notes and the additional loan amount. Interest of $818,771 on the former notes was consolidated to the new principal amount of $12,000,000. The promissory note bears interest at 6% per annum, is due on September 30, 2011, and is secured by a pledge of all of our subsidiary’s interest in its wholly-owned subsidiary, Provident Energy. Interest on the promissory note is payable 10 days after maturity in shares of our company’s common stock. The number of shares payable as interest will be determined by dividing $1,440,000 by the average stock price over the 15 business day period immediately preceding the date on which the promissory note matures.

As inducement to the note holder to provide the additional loan of $1,168,729, our subsidiary agreed to cause our company to issue 821,918 shares of common stock to the note holder. In addition, we agreed to issue $240,000 worth of shares of common stock to the note holder on the first anniversary of the execution of the Note Purchase Agreement. The new note is secured by a pledge of all the membership interest of Provident Energy and a guarantee of indebtedness by our company.

Our subsidiary also agreed to cause our company to issue an additional 900,000 shares of common stock to the lender following the execution of the Loan Consolidation Agreement, in accordance with our company’s heretofore unfulfilled obligation under Section 3 of the Note Purchase Agreement relating to the $9,000,000 note. We issued the 900,000 shares on May 27, 2010.

On October 22, 2010, we issued 2,634,150 shares of common stock with a fair value of $720,000 to Aton Select Funds Limited as an interest payment on the promissory note and on October 26, 2010, we issued an additional 878,049 common shares with a fair value of $240,000.

Lease Acquisition Costs

We have recorded or paid for 31,258 oil and gas lease acreage of the approximately 50,000 acres in the Phillips, Monroe and Desha counties in Arkansas that we intended to acquire. We anticipate approximately $5,600,000 to be the amount to acquire the balance of this acreage during the next twelve month period. It remains uncertain that we will acquire the remainder of this acreage. The decision to purchase the Arkansas acreage was made by prior management.


- 15 -

Drilling, Remediation and Seismic Costs

We estimate that our exploration and development costs on our property interests will be approximately $5,000,000 during the next twelve months, which will include drilling and, if warranted, completion costs for one horizontal well that has already been drilled to the Bakken. We will need to obtain additional equity funding, and possibly additional debt funding as well, in order to be able to obtain the needed funds. Alternatively, we may be required to farmout a working interest in some of our acreage to a third party. There is no guarantee that we will be able to raise sufficient additional capital or alternatively that we will be able to negotiate a farmout arrangement on terms acceptable to us.

Estimated Timeline of Exploration Activity on Property

Date Objective
January, 2011 Drilled the MAX 1 – 2817 vertical test the Bakken and completed horizontal drill in Cut Bank.
September, 2011 Commence drilling the Cut Bank horizontal well (MAX 2- Bakken or Cut Bank Warrior horizontal well). A possible Alberta Bakken test on our well # 5993

Employee and Consultant Compensation

Given the early stage of our development and exploration properties, we intend to continue to outsource our professional and personnel requirements by retaining consultants on an as needed basis. We estimate that our consultant and related professional compensation expenses for the next twelve month period will be approximately $900,000. As of September 30, 2010, we had seven employees, including Pierre Mulacek and Reginald Denny. We pay Mr. Mulacek an annual salary of $240,000 and Mr. Denny an annual salary of $190,000. On February 9, 2010, we entered into an executive employment agreement with Lance Nelson to appoint him as field operations manager of our company. Pursuant to the terms of the agreement, we agreed to pay Mr. Nelson an annual salary of $120,000 plus a discretionary performance based bonus as determined by our board of directors. Mr. Nelson replaced Mr. Cook who resigned as our chief operations officer on October 20, 2009 and his executive employment agreement terminated. Mr. Nelson’s employment contract expired on February 9, 2011 and was not renewed. We intend to contract his services when needed.

Professional Fees

We expect to incur on-going legal, accounting and audit expenses to comply with our reporting responsibilities as a public company under the United States Securities Exchange Act of 1934, as amended, in addition to general legal fees for oil and gas and general corporate matters. We estimate our legal and accounting expenses for the next twelve months to be approximately $300,000.

General and Administrative Expenses

We anticipate spending $500,000 on general and administrative costs in the next twelve month period. These costs primarily consist of expenses such as lease payments, office supplies, insurance, travel, office expenses, etc.

Cash Used In Operating Activities

Operating activities used cash of $2,510,128 during the six months ended March 31, 2011 as compared to $1,099,351 during the six months ended March 31, 2010.


- 16 -

Cash from Investing Activities

Investing activities provided cash of $834,481 during the six months ended March 31, 2011 as compared to investing activities using cash of $127,986 during the six months ended March 31, 2010.

Cash from Financing Activities

Financing activities provided cash of $19,013 during the six months ended March 31, 2011 as compared to financing activities providing cash of $1,243,729 during the six months ended March 31, 2010.

Capital Expenditures

As of May 16, 2011, our company did not have any material commitments for capital expenditures.

Off-Balance Sheet Arrangements

We have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, allowance for doubtful accounts, inventory reserves and income taxes. These policies require that we make estimates in the preparation of our financial statements as of a given date.

Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

Going Concern

Due to the uncertainty of our ability to meet our current operating and capital expenses, in their report on the annual financial statements for the year ended September 30, 2010 and period ended March 31, 2011, our independent auditors included an explanatory paragraph regarding concerns about our ability to continue as a going concern. Our financial statements contain additional note disclosures describing the circumstances that lead to this disclosure by our independent auditors.

There is substantial doubt about our ability to continue as a going concern as the continuation of our business is dependent upon obtaining further financing. The issuance of additional equity securities by us could result in a significant dilution in the equity interests of our current stockholders. Commercial loans, assuming those loans would be available, will increase our liabilities and future cash commitments.

There are no assurances that we will be able to obtain further funds required for our continued operations or for our entry into the petroleum exploration and development industry. We are pursuing various financing alternatives to meet our immediate and long-term financial requirements. There can be no assurance that additional financing will be available to us when needed or, if available, that it can be obtained on commercially reasonable terms. If we are not able to obtain the additional financing on a timely basis, we will not be able to meet our other obligations as they become due.


- 17 -

Use of Estimates

The preparation of consolidated financial statements in accordance with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses in the reporting period. Our company regularly evaluates estimates and assumptions related to useful life and recoverability of long-lived assets, stock-based compensation expense, deferred income tax asset valuations and loss contingencies. Our company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by our company may differ materially and adversely from our company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Cash and Cash Equivalents

For purposes of the statement of cash flows, we consider all highly liquid instruments with maturity of three months or less at the time of issuance to be cash equivalents.

Foreign Currency Transactions

Our company’s functional and reporting currency is the United States dollar. Monetary assets and liabilities denominated in foreign currencies are translated into United States dollars at rates of exchange in effect at the balance sheet date in accordance with ASC 830, Foreign Currency Translation Matters. Non-monetary assets, liabilities and items recorded in income arising from transactions denominated in foreign currencies are translated at rates of exchange in effect at the date of the transaction. Foreign currency transactions are primarily undertaken in Canadian dollars. Our company has not, to the date of these financials statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

Basic and Diluted Net Income (Loss) Per Share

Our company computes net income (loss) per share in accordance with ASC 260, Earnings per Share which requires presentation of both basic and diluted earnings per share (EPS) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period including convertible debt, stock options, and warrants, using the treasury stock method, and convertible securities, using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive. We had net losses as of March 31, 2011 and 2010, so the diluted EPS excluded all dilutive potential shares in the diluted EPS because there effect is anti-dilutive.

Financial Instruments

Our company’s financial instruments consist of cash and cash equivalents, oil and gas receivables, other receivables, accounts payable and accrued liabilities, due to related party, deferred proceeds, loans payable and notes payable Pursuant to ASC 820, Fair Value Measurements and Disclosures and ASC 825, Financial Instruments, fair value of assets and liabilities measured on a recurring basis include cash equivalents determined based on “Level 1” inputs, which consist of quoted prices in active markets for identical assets. Loans payable and notes payable are valued based on “Level 2” inputs, consisting of quoted prices in less active markets. We believe that the recorded values of all of the other financial instruments approximate their current fair values because of their nature and respective maturity dates or durations.


- 18 -

Oil and Gas Properties

Our company utilizes the full-cost method of accounting for petroleum and natural gas properties. Under this method, our company capitalizes all costs associated with acquisition, exploration and development of oil and natural gas reserves, including leasehold acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties and costs of drilling of productive and non-productive wells into the full cost pool on a country by country basis. As of March 31, 2011, we had properties with proven reserves. When our company obtains proven oil and gas reserves, capitalized costs, including estimated future costs to develop the reserves proved and estimated abandonment costs, net of salvage, will be depleted on the units-of-production method using estimates of proved reserves. The costs of unproved properties are not amortized until it is determined whether or not proved reserves can be assigned to the properties. Our company assesses the property at least annually to ascertain whether impairment has occurred. In assessing impairment our company considers factors such as historical experience and other data such as primary lease terms of the property, average holding periods of unproved property, and geographic and geologic data. During the three months ended March 31, 2011 and 2010, no impairment was recorded.

Revenue Recognition

Our company recognizes oil and gas revenue when production is sold at a fixed or determinable price, persuasive evidence of an arrangement exists, delivery has occurred and title has transferred, and collectability is reasonably assured.

Asset Retirement Obligations

Our company accounts for asset retirement obligations in accordance with ASC 410-20, Asset Retirement Obligations. ASC 410-20 requires us to record the fair value of an asset retirement obligation as a liability in the period in which it incurs an obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. Asset retirement obligations consists of estimated final well closure and associated ground reclamation costs to be incurred by our company in the future once the economical life of its oil and gas wells are reached. The estimated fair value of the asset retirement obligation is based on the current cost escalated at an inflation rate and discounted at a credit adjusted risk-free rate. This liability is capitalized as part of the cost of the related asset and amortized over its useful life. The liability accretes until our company settles the obligation.

Accounting for Derivative Instruments

ASC 815-24 (formerly SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”), requires all derivatives to be recorded on the balance sheet at fair value. Our company’s derivatives are separately valued and accounted for on the balance sheet. Fair values for securities traded in the open market and derivatives are based on quoted market prices. Where market prices are not readily available, fair values are determined using market based pricing models incorporating readily observable market data and requiring judgment and estimates.

The pricing model we used for determining fair values of our derivatives is the Black-Scholes option-pricing model. Valuations derived from this model are subject to ongoing internal and external verification and review. The model uses market-sourced inputs such as interest rates, exchange rates and option volatilities. Selection of these inputs involves management’s judgment and may impact net income.

Long-lived Assets

In accordance with ASC 360, Property, Plant and Equipment, the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances that may suggest impairment. We recognize impairment when the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Impairment losses, if any, are measured as the excess of the carrying amount of the asset over its estimated fair value.


- 19 -

Concentration of Risk

Our company maintains its cash accounts in a commercial bank located in Texas, United States. Our company’s cash accounts are uninsured and insured business checking accounts and deposits maintained in U.S. dollars. As at March 31, 2011, we have not engaged in any transactions that would be considered derivative instruments on hedging activities.

Comprehensive Loss

ASC 220, Comprehensive Income establishes standards for the reporting and display of comprehensive loss and its components in the financial statements. As at December 31, 2010 and 2009, we have no items that represent comprehensive loss and, therefore, has not included a schedule of comprehensive loss in the financial statements.

Income Taxes

Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. Our company has adopted ASC 740, Income Taxes as of its inception. Pursuant to ASC 740, we are required to compute tax asset benefits for net operating losses carried forward. The potential benefits of net operating losses have not been recognized in these financial statements because our company cannot be assured it is more likely than not it will utilize the net operating losses carried forward in future years.

Stock-based Compensation

Our company records stock-based compensation in accordance with ASC 718, Compensation – Stock Based Compensation and ASC 505, Equity Based Payments to Non-Employees, using the fair value method. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. Equity instruments issued to employees and the cost of the services received as consideration are measured and recognized based on the fair value of the equity instruments issued.

Recent Accounting Pronouncements

On December 31, 2008, the SEC published the final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the petroleum resource management system, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include changes to the pricing used to estimate reserves utilizing a 12-month average price rather than a single day spot price which eliminates the ability to utilize subsequent prices to the end of a reporting period when the full cost ceiling was exceeded and subsequent pricing exceeds pricing at the end of a reporting period, the ability to include non-traditional resources in reserves, the use of new technology for determining reserves, and permitting disclosure of probable and possible reserves. The SEC will require companies to comply with the amended disclosure requirements for registration statements filed after January 1, 2010, and for annual reports on Form 10- K for fiscal years ending on or after December 15, 2009. Early adoption is not permitted. The adoption of this accounting policy did not have a material impact on our company’s financial statements.

Our company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations.

Risk Factors

Much of the information included in this quarterly report includes or is based upon estimates, projections or other forward looking statements. Such forward looking statements include any projections and estimates made by us and our management in connection with our business operations. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect our current judgment regarding the direction of our business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein.


- 20 -

Such estimates, projections or other forward looking statements involve various risks and uncertainties as outlined below. We caution the reader that important factors in some cases have affected and, in the future, could materially affect actual results and cause actual results to differ materially from the results expressed in any such estimates, projections or other forward looking statements.

Risks Relating To Our Business And The Oil And Gas Industry

We have a history of losses and this trend may continue and may negatively impact our ability to achieve our business objectives.

We have experienced net losses since inception, and expect to continue to incur substantial losses for the foreseeable future. Our accumulated deficit was $29,292,014 as at March 31, 2011. We may not be able to generate significant revenues in the future and our company has incurred increased operating expenses following the recent commencement of production. As a result, our management expects our business to continue to experience negative cash flow for the foreseeable future and cannot predict when, if ever, our business might become profitable. We will need to raise additional funds, and such funds may not be available on commercially acceptable terms, if at all. If we are unable to raise funds on acceptable terms, we may not be able to execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements. This may seriously harm our business, financial condition and results of operations.

We have a limited operating history, which may hinder our ability to successfully meet our objectives.

We have a limited operating history upon which to base an evaluation of our current business and future prospects. We have only recently commenced production and we do not have an established history of operating producing properties or locating and developing properties that have oil and gas reserves. As a result, the revenue and income potential of our business is unproven. In addition, because of our limited operating history, we have limited insight into trends that may emerge and affect our business. Errors may be made in predicting and reacting to relevant business trends and we will be subject to the risks, uncertainties and difficulties frequently encountered by early-stage companies in evolving markets. We may not be able to successfully address any or all of these risks and uncertainties. Failure to adequately do so could cause our business, results of operations and financial condition to suffer.

Our operations and proposed exploration activities will require significant capital expenditures for which we may not have sufficient funding and if we do obtain additional financing, our existing shareholders may suffer substantial dilution.

We intend to make capital expenditures far in excess of our existing capital resources to develop, acquire and explore oil and gas properties. We intend to rely on funds from operations and external sources of financing to meet our capital requirements to continue acquiring, exploring and developing oil and gas properties and to otherwise implement our business plan. We plan to obtain additional funding through the debt and equity markets, but we can offer no assurance that we will be able to obtain additional funding when it is required or that it will be available to us on commercially acceptable terms, if at all. In addition, any additional equity financing may involve substantial dilution to our then existing shareholders.

The successful implementation of our business plan is subject to risks inherent in the oil and gas business, which if not adequately managed could result in additional losses.

Our oil and gas operations are subject to the economic risks typically associated with exploration and development activities, including the necessity of making significant expenditures to locate and acquire properties and to drill exploratory wells. In addition, the availability of drilling rigs and the cost and timing of drilling, completing and, if warranted, operating wells is often uncertain. In conducting exploration and development activities, the presence of unanticipated pressure or irregularities in formations, miscalculations or accidents may cause our exploration, development and, if warranted, production activities to be unsuccessful. This could result in a total loss of our investment in a particular well. If exploration efforts are unsuccessful in establishing proved reserves and exploration activities cease, the amounts accumulated as unproved costs will be charged against earnings as impairments.


- 21 -

In addition, market conditions or the unavailability of satisfactory oil and gas transportation arrangements may hinder our access to oil and gas markets and delay our production. The availability of a ready market for our prospective oil and gas production depends on a number of factors, including the demand for and supply of oil and gas and the proximity of reserves to pipelines and other facilities. Our ability to market such production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities, in most cases owned and operated by third parties. Our failure to obtain such services on acceptable terms could materially harm our business. We may be required to shut in wells for lack of a market or a significant reduction in the price of oil or gas or because of inadequacy or unavailability of pipelines or gathering system capacity. If that occurs, we would be unable to realize revenue from those wells until arrangements are made to deliver such production to market.

Our future performance is dependent upon our ability to identify, acquire and develop oil and gas properties, the failure of which could result in under use of capital and losses.

Our future performance depends upon our ability to identify, acquire and develop additional oil and gas reserves that are economically recoverable. Our success will depend upon our ability to acquire working and revenue interests in properties upon which oil and gas reserves are ultimately discovered in commercial quantities, and our ability to develop prospects that contain proven oil and gas reserves to the point of production. Without successful acquisition and exploration activities, we will not be able to develop additional oil and gas reserves or generate revenues. We cannot provide you with any assurance that we will be able to identify and acquire additional oil and gas reserves on acceptable terms, or that oil and gas deposits will be discovered in sufficient quantities to enable us to recover our exploration and development costs or sustain our business.

The successful acquisition and development of oil and gas properties requires an assessment of recoverable reserves, future oil and gas prices and operating costs, potential environmental and other liabilities, and other factors. Such assessments are necessarily inexact and their accuracy inherently uncertain. In addition, no assurance can be given that our exploration and development activities will result in the discovery of additional reserves. Our operations may be curtailed, delayed or canceled as a result of lack of adequate capital and other factors, such as lack of availability of rigs and other equipment, title problems, weather, compliance with governmental regulations or price controls, mechanical difficulties, or unusual or unexpected formations, pressures and or work interruptions. In addition, the costs of exploitation and development may materially exceed our initial estimates.

We have a very small management team and the loss of any member of our team may prevent us from implementing our business plan in a timely manner.

We have two executive officers and a limited number of additional consultants upon whom our success largely depends. Although we do maintain key person life insurance policies on our executive officers or consultants, the loss of such personnel could seriously harm our business, financial condition and results of operations, and we may not be able to recruit personnel to replace our executive officers or consultants in a timely manner, or at all, on acceptable terms.

Future growth could strain our personnel and infrastructure resources, and if we are unable to implement appropriate controls and procedures to manage our growth, we may not be able to successfully implement our business plan.

We expect to experience rapid growth in our operations, which will place a significant strain on our management, administrative, operational and financial infrastructure. Our future success will depend in part upon the ability of our management to manage growth effectively. This may require us to hire and train additional personnel to manage our expanding operations. In addition, we must continue to improve our operational, financial and management controls and our reporting systems and procedures. If we fail to successfully manage our growth, we may be unable to execute upon our business plan.


- 22 -

Market conditions or operation impediments may hinder our access to natural gas and oil markets or delay our production.

The marketability of production from our properties depends in part upon the availability, proximity and capacity of pipelines, natural gas gathering systems and processing facilities. This dependence is heightened where this infrastructure is less developed. Therefore, if drilling results are positive in certain areas of our oil and gas properties, a new gathering system would need to be built to handle the potential volume of gas produced. We might be required to shut in wells, at least temporarily, for lack of a market or because of the inadequacy or unavailability of transportation facilities. If that were to occur, we would be unable to realize revenue from those wells until arrangements were made to deliver production to market.

Our ability to produce and market natural gas and oil is affected and also may be harmed by:

  • the lack of pipeline transmission facilities or carrying capacity;

  • government regulation of natural gas and oil production;

  • government transportation, tax and energy policies;

  • changes in supply and demand; and

  • general economic conditions.

We might incur additional debt in order to fund our exploration and development activities, which would continue to reduce our financial flexibility and could have a material adverse effect on our business, financial condition or results of operations.

If we incur indebtedness, the ability to meet our debt obligations and reduce our level of indebtedness depends on future performance. General economic conditions, oil and gas prices and financial, business and other factors affect our operations and future performance. Many of these factors are beyond our control. We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our current or future debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt. Factors that will affect our ability to raise cash through an offering of our capital stock or a refinancing of our debt include financial market conditions, the value of our assets and performance at the time we need capital. We cannot assure you that we will have sufficient funds to make such payments. If we do not have sufficient funds and are otherwise unable to negotiate renewals of our borrowings or arrange new financing, we might have to sell significant assets. Any such sale could have a material adverse effect on our business and financial results.

Our properties in Arkansas, Colorado and Montana and/or future properties might not produce, and we might not be able to determine reserve potential, identify liabilities associated with the properties or obtain protection from sellers against them, which could cause us to incur losses.

Although we have reviewed and evaluated our properties in Arkansas, Colorado and Montana in a manner consistent with industry practices, such review and evaluation might not necessarily reveal all existing or potential problems. This is also true for any future acquisitions made by us. Inspections may not always be performed on every well, and environmental problems, such as groundwater contamination, are not necessarily observable even when an inspection is undertaken. Even when problems are identified, a seller may be unwilling or unable to provide effective contractual protection against all or part of those problems, and we may assume environmental and other risks and liabilities in connection with the acquired properties.

We are subject to ongoing obligations under our Acquisition and Development Agreement.

Under the terms of our Acquisition and Development Agreement, as modified by an agreement dated May 21, 2007, we will have to pay approximately an additional $5,600,000 to acquire the remainder of the acreage which we have committed to acquire, unless we elect to pay a majority of the costs with shares of our common stock at $1.25 per share. In addition, we are required to drill five additional wells within 24 months, from the date upon which Arkanova Delaware makes the last of the lease bonus payments as required in the agreement. We do not anticipate paying the final lease payment until the balance of the leases are delivered which at this time is not known when this may occur. We expect that the total cost of these wells, together with a seismic program, will require approximately $5,600,000 in additional capital. We will need to obtain additional equity funding, and possibly additional debt funding as well, in order to be able to obtain these funds. Alternatively, we may be required to farmout a working interest in some of our acreage to a third party. There is no guarantee that we will be able to raise sufficient additional capital or alternatively that we will be able to negotiate a farmout arrangement on terms acceptable to us. In addition, while we anticipate that David Griffin will be able to deliver the mineral rights for all 50,000 acres which we have contracted for, we have no guarantee that he will be able to do so. We are also evaluating the possible sale and expiration of said leases in order to concentrate our resources on the producing Montana property.


- 23 -

If we or our operators fail to maintain adequate insurance, our business could be materially and adversely affected.

Our operations are subject to risks inherent in the oil and gas industry, such as blowouts, cratering, explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution, earthquakes and other environmental risks. These risks could result in substantial losses due to injury and loss of life, severe damage to and destruction of property and equipment, pollution and other environmental damage, and suspension of operations. We could be liable for environmental damages caused by previous property owners. As a result, substantial liabilities to third parties or governmental entities may be incurred, the payment of which could have a material adverse effect on our financial condition and results of operations.

Any prospective drilling contractor or operator which we hire will be required to maintain insurance of various types to cover our operations with policy limits and retention liability customary in the industry. We also have acquired our own insurance coverage for such prospects. The occurrence of a significant adverse event on such prospects that is not fully covered by insurance could result in the loss of all or part of our investment in a particular prospect which could have a material adverse effect on our financial condition and results of operations.

The oil and gas industry is highly competitive, and we may not have sufficient resources to compete effectively.

The oil and gas industry is highly competitive. We compete with oil and natural gas companies and other individual producers and operators, many of which have longer operating histories and substantially greater financial and other resources than we do, as well as companies in other industries supplying energy, fuel and other needs to consumers. Our larger competitors, by reason of their size and relative financial strength, can more easily access capital markets than we can and may enjoy a competitive advantage in the recruitment of qualified personnel. They may be able to absorb the burden of any changes in laws and regulation in the jurisdictions in which we do business and handle longer periods of reduced prices for oil and gas more easily than we can. Our competitors may be able to pay more for oil and gas leases and properties and may be able to define, evaluate, bid for and purchase a greater number of leases and properties than we can. Further, these companies may enjoy technological advantages and may be able to implement new technologies more rapidly than we can. Our ability to acquire additional properties in the future will depend upon our ability to conduct efficient operations, evaluate and select suitable properties, implement advanced technologies and consummate transactions in a highly competitive environment.

Complying with environmental and other government regulations could be costly and could negatively impact our production.

Our business is governed by numerous laws and regulations at various levels of government. These laws and regulations govern the operation and maintenance of our facilities, the discharge of materials into the environment and other environmental protection issues. Such laws and regulations may, among other potential consequences, require that we acquire permits before commencing drilling and restrict the substances that can be released into the environment with drilling and production activities.

Under these laws and regulations, we could be liable for personal injury, clean-up costs and other environmental and property damages, as well as administrative, civil and criminal penalties. Prior to commencement of drilling operations, we may secure limited insurance coverage for sudden and accidental environmental damages as well as environmental damage that occurs over time. However, we do not believe that insurance coverage for the full potential liability of environmental damages is available at a reasonable cost. Accordingly, we could be liable, or could be required to cease production on properties, if environmental damage occurs.


- 24 -

The costs of complying with environmental laws and regulations in the future may harm our business. Furthermore, future changes in environmental laws and regulations could result in stricter standards and enforcement, larger fines and liability, and increased capital expenditures and operating costs, any of which could have a material adverse effect on our financial condition or results of operations.

Shortages of rigs, equipment, supplies and personnel could delay or otherwise adversely affect our cost of operations or our ability to operate according to our business plans.

If drilling activity increases in eastern Arkansas, Colorado, Montana or the southern United States generally, a shortage of drilling and completion rigs, field equipment and qualified personnel could develop. The demand for and wage rates of qualified drilling rig crews generally rise in response to the increasing number of active rigs in service and could increase sharply in the event of a shortage. Shortages of drilling and completion rigs, field equipment or qualified personnel could delay, restrict or curtail our exploration and development operations, which could in turn harm our operating results.

We will be required to replace, maintain or expand our reserves in order to prevent our reserves and production from declining, which would adversely affect cash flows and income.

In general, production from natural gas and oil properties declines over time as reserves are depleted, with the rate of decline depending on reservoir characteristics. If we are not successful in our exploration and development activities, our proved reserves will decline as reserves are produced. Our future natural gas and oil production is highly dependent upon our ability to economically find, develop or acquire reserves in commercial quantities.

To the extent cash flow from operations is reduced, either by a decrease in prevailing prices for natural gas and oil or an increase in exploration and development costs, and external sources of capital become limited or unavailable, our ability to make the necessary capital investment to maintain or expand our asset base of natural gas and oil reserves would be impaired. Even with sufficient available capital, our future exploration and development activities may not result in additional proved reserves, and we might not be able to drill productive wells at acceptable costs.

The geographic concentration of all of our other properties in eastern Arkansas, Colorado and Montana subjects us to an increased risk of loss of revenue or curtailment of production from factors affecting those areas.

The geographic concentration of all of our leasehold interests in Phillips, Monroe and Deshea Counties, Arkansas, Lone Mesa State Park, Colorado and Pondera and Glacier Counties, Montana means that our properties could be affected by the same event should the region experience:

  • severe weather;

  • delays or decreases in production, the availability of equipment, facilities or services;

  • delays or decreases in the availability of capacity to transport, gather or process production; or

  • changes in the regulatory environment.

The oil and gas exploration and production industry historically is a cyclical industry and market fluctuations in the prices of oil and gas could adversely affect our business.

Prices for oil and gas tend to fluctuate significantly in response to factors beyond our control. These factors include:

  • weather conditions in the United States and wherever our property interests are located;

  • economic conditions, including demand for petroleum-based products, in the United States wherever our property interests are located;

  • actions by OPEC, the Organization of Petroleum Exporting Countries;

  • political instability in the Middle East and other major oil and gas producing regions;


- 25 -

  • governmental regulations, both domestic and foreign;

  • domestic and foreign tax policy;

  • the pace adopted by foreign governments for the exploration, development, and production of their national reserves;

  • the price of foreign imports of oil and gas;

  • the cost of exploring for, producing and delivering oil and gas;

  • the discovery rate of new oil and gas reserves;

  • the rate of decline of existing and new oil and gas reserves;

  • available pipeline and other oil and gas transportation capacity;

  • the ability of oil and gas companies to raise capital;

  • the overall supply and demand for oil and gas; and

  • the availability of alternate fuel sources.

Changes in commodity prices may significantly affect our capital resources, liquidity and expected operating results. Price changes will directly affect revenues and can indirectly impact expected production by changing the amount of funds available to reinvest in exploration and development activities. Reductions in oil and gas prices not only reduce revenues and profits, but could also reduce the quantities of reserves that are commercially recoverable. Significant declines in prices could result in non-cash charges to earnings due to impairment.

Changes in commodity prices may also significantly affect our ability to estimate the value of producing properties for acquisition and divestiture and often cause disruption in the market for oil and gas producing properties, as buyers and sellers have difficulty agreeing on the value of the properties. Price volatility also makes it difficult to budget for and project the return on acquisitions and the exploration and development of projects. We expect that commodity prices will continue to fluctuate significantly in the future.

Our ability to produce oil and gas from our properties may be adversely affected by a number of factors outside of our control which may result in a material adverse effect on our business, financial condition or results of operations.

The business of exploring for and producing oil and gas involves a substantial risk of investment loss. Drilling oil and gas wells involves the risk that the wells may be unproductive or that, although productive, the wells may not produce oil or gas in economic quantities. Other hazards, such as unusual or unexpected geological formations, pressures, fires, blowouts, loss of circulation of drilling fluids or other conditions may substantially delay or prevent completion of any well. Adverse weather conditions can also hinder drilling operations. A productive well may become uneconomic if water or other deleterious substances are encountered that impair or prevent the production of oil or gas from the well. In addition, production from any well may be unmarketable if it is impregnated with water or other deleterious substances. There can be no assurance that oil and gas will be produced from the properties in which we have interests. In addition, the marketability of oil and gas that may be acquired or discovered may be influenced by numerous factors beyond our control. These factors include the proximity and capacity of oil and gas, gathering systems, pipelines and processing equipment, market fluctuations in oil and gas prices, taxes, royalties, land tenure, allowable production and environmental protection. We cannot predict how these factors may affect our business.

We may be unable to retain our leases and working interests in our leases, which would result in significant financial losses to our company.

Our properties are held under oil and gas leases. If we fail to meet the specific requirements of each lease, such lease may terminate or expire. We cannot assure you that any of the obligations required to maintain each lease will be met. The termination or expiration of our leases may harm our business. Our property interests will terminate unless we fulfill certain obligations under the terms of our leases and other agreements related to such properties. If we are unable to satisfy these conditions on a timely basis, we may lose our rights in these properties. The termination of our interests in these properties may harm our business. In addition, we will need significant funds to meet capital requirements for the exploration activities that we intend to conduct on our properties.


- 26 -

Title deficiencies could render our leases worthless which could have adverse effects on our financial condition or results of operations.

The existence of a material title deficiency can render a lease worthless and can result in a large expense to our business. It is our practice in acquiring oil and gas leases or undivided interests in oil and gas leases to forego the expense of retaining lawyers to examine the title to the oil or gas interest to be placed under lease or already placed under lease. Instead, we rely upon the judgment of oil and gas landmen who perform the field work in examining records in the appropriate governmental office before attempting to place under lease a specific oil or gas interest. This is customary practice in the oil and gas industry. However, we do not anticipate that we, or the person or company acting as operator of the wells located on the properties that we currently lease or may lease in the future, will obtain counsel to examine title to the lease until the well is about to be drilled. As a result, we may be unaware of deficiencies in the marketability of the title to the lease. Such deficiencies may render the lease worthless.

Our disclosure controls and procedures and internal control over financial reporting were not effective, which may cause our financial reporting to be unreliable and lead to misinformation being disseminated to the public.

Our management evaluated our disclosure controls and procedures as of March 31, 2011 and concluded that as of that date, our disclosure controls and procedures were not effective. In addition, our management evaluated our internal control over financial reporting as of March 31, 2011 and concluded that that there was a material weakness in our internal control over financial reporting as of that date and that our internal control over financial reporting was not effective as of that date. A material weakness is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis.

We have not yet remediated this material weakness and we believe that our disclosure controls and procedures and internal control over financial reporting continue to be ineffective. Until the issue is corrected, our ability to report financial results or other information required to be disclosed on a timely and accurate basis may be adversely affected and our financial reporting may continue to be unreliable, which could result in additional misinformation being disseminated to the public. Investors relying upon this misinformation may make an uninformed investment decision.

Risks Relating To Our Common Stock

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

A prolonged 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 capital. Because a significant portion of our operations have been and will be financed through the sale of equity securities, a decline in the price of our common stock could be especially detrimental to our liquidity and our operations. Such reductions may force us to reallocate funds from other planned uses and may have a significant negative effect on our business plan and operations, including our ability to develop new properties and continue our current operations. If our stock price declines, we can offer no assurance that we will be able to raise additional capital or generate funds from operations sufficient to meet our obligations. If we are unable to raise sufficient capital in the future, we may not be able to have the resources to continue our normal operations.

The market price for our common stock may also be affected by our ability to meet or exceed expectations of analysts or investors. Any failure to meet these expectations, even if minor, may have a material adverse effect on the market price of our common stock.


- 27 -

If we issue additional shares in the future, it will result in the dilution of our existing shareholders.

Our articles of incorporation, as amended, authorizes the issuance of up to 1,000,000,000 shares of common stock with a par value of $0.001. Our board of directors may choose to issue some or all of such shares to acquire one or more businesses or to provide additional financing in the future. The issuance of any such shares will result in a reduction of the book value and market price of the outstanding shares of our common stock. If we issue any such additional shares, such issuance will cause a reduction in the proportionate ownership and voting power of all current shareholders. Further, such issuance may result in a change of control of our corporation.

Trading of our stock may be restricted by the Securities Exchange Commission’s penny stock regulations, which may limit a stockholder’s ability to buy and sell our stock.

The Securities and Exchange Commission has adopted regulations which generally define “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the Securities and Exchange Commission, which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.

The Financial Industry Regulatory Authority, or FINRA, has adopted sales practice requirements which may also limit a stockholder’s ability to buy and sell our stock.

In addition to the “penny stock” rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.

Our common stock is illiquid and the price of our common stock may be negatively impacted by factors which are unrelated to our operations.

Our common stock currently trades on a limited basis on the OTC Bulletin Board. Trading of our stock through the OTC Bulletin Board is frequently thin and highly volatile. There is no assurance that a sufficient market will develop in our stock, in which case it could be difficult for shareholders to sell their stock. The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of our competitors, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.


- 28 -

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not Applicable.

Item 4. Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our president and chief executive officer (who is acting as our principal executive officer) and our chief financial officer (who is acting as our principal financial officer and principal accounting officer) to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of March 31, 2011, the end of the three month period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our president and chief executive officer (who is acting as our principal executive officer) and our chief financial officer (who is acting as our principal financial officer and principal accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our president and chief executive officer (who is acting as our chief executive officer) and our chief financial officer (who is acting as our principal financial officer and principal accounting officer) concluded that our disclosure controls and procedures were ineffective as of the end of the period covered by this quarterly report.

After conducting an evaluation under the Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission, our company determined that our internal control over financial reporting was not effective as of September 30, 2010 due to three material weaknesses that were indentified in our annual report on Form 10-K for the fiscal year ended September 30, 2010. During the quarter ended December 31, 2010, we rectified the following two material weaknesses: (i) lack of accounting staff with sufficient U.S. GAAP expertise; and (ii) significant audit adjustments discovered by our independent registered public accounting firm. With respect to the first material weakness, we have increased the frequency of review and the services provided by an outside accounting firm with certified public accountant members. With respect to the second material weakness, there were no material adjustments identified from our independent public accounting firm for the period ended December 31, 2010 and our company has implemented additional procedures to reduce the potential for fututure adjustments that may be a result of accounting errors. However, due to the small size of our company and our limited personnel, we continue to have insufficient segregation of duties in our finance and accounting function. Our company anticipates hiring additional personnel to segregate such duties when operations warrant.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

Except as disclosed below, we know of no material, active or pending legal proceedings against our company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.

Provident Energy of Montana, LLC and Arkanova Energy Corporation vs. Billie Eustice

On October 20, 2010, we and our subsidiary, Provident Energy of Montana, LLC, initiated a lawsuit against Billie Eustice in the Circuit Court of Tulsa County, Oklahoma.


- 29 -

Factual Allegations

Provident Energy was bought by our company in its entirety from a former corporation owned by Billie Eustice and the Gary Little Trust. In that share acquisition, we acquired Provident Energy as a wholly owned subsidiary and obtained the rights to existing leases and production on approximately 10,000 acres in Montana. After the sale was completed, Provident Energy learned of violations of the Migratory Bird Treaty Act which had occurred on the property the month before the closing date of the sale. Although Billie Eustice had direct knowledge of the incident, she failed to disclose the information to us. She also signed a seller’s certificate acknowledging that no incidents had occurred on the property prior to the sale which would have materially altered the value of the property that had not already been disclosed to us.

As a consequence of the violations, Provident Energy had to plead guilty to a federal class B misdemeanor and incurred fines and penalties in addition to being put on 18-months probation.

In addition to this claim, we and Provident Energy have also asserted that Billie Eustice committed fraud and conversion in withdrawing monies from the account of Provident Energy after the sale of the company and in representing herself as an agent of Provident Energy after the sale in order to acquire royalty interest which she was not authorized to do. Provident Energy had a one year consulting agreement with Billie Eustace wherein she was to provide consulting services to Provident Energy in exchange for a $1,500,000.00 consulting fee that was paid up front as part of the consideration for the company less a $250,000.00 retention for remediation and clean up of a spill disclosed prior to closing. Provident Energy's costs far exceeded the $250,000 retention.

We and Provident Energy seek rescission of the consulting agreement with Billie Eustace, the divesting of any royalty interests she fraudulently obtained for herself, and reimbursement and indemnity of all damages incurred as a result of her fraud and conversion.

Relief Sought

We and Provident Energy are asking for all amounts expended for clean up, remediation, fines, attorneys fees, and any loss of opportunity or profit attributable to the undisclosed "spill" resulting the death of birds covered by the Migratory Bird Treaty Act, rescission of the consulting agreement, damages in the amounts of all profits derived from royalty interests fraudulently obtained by Billie Eustace, $134,000.00 as the amount of Provident Energy’s funds converted by Eustace to her own personal bank account, attorneys fees, pre and post-judgment interests, and court costs.

Item 1A. Risk Factors

Not Applicable

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. (Removed and Reserved)

None.

Item 5. Other Information.

None.


- 30 -

Item 6. Exhibits.

(3)

Articles of Incorporation and Bylaws

3.1

Articles of Incorporation (incorporated by reference from our Registration Statement on Form SB-2 filed on August 19, 2004)

3.2

Bylaws (incorporated by reference from our Registration Statement on Form SB-2 filed on August 19, 2004)

3.3

Articles of Merger filed with the Secretary of State of Nevada on October 17, 2006 (incorporated by reference from our Current Report on Form 8-K filed on November 1, 2006)

3.4

Certificate of Change filed with the Secretary of State of Nevada on October 17, 2006 (incorporated by reference from our Current Report on Form 8-K filed on November 1, 2006)

(4)

Instrument Defining the Rights of Holders

4.1

Debenture with John Thomas Bridge & Opportunity Fund (incorporated by reference from our Current Report on Form 8-K filed on March 26, 2008)

(10)

Material Contracts

10.1

10% Promissory Note dated July 14, 2008 issued by our company to Aton Select Fund Limited in the principal amount of $375,000 (incorporated by reference from our Quarterly Report on Form 10-QSB filed on August 14, 2008)

10.2

Stock Purchase Agreement dated August 21, 2008, by and between Billie J. Eustice and the Gary L. Little Trust, as Sellers, and Arkanova Acquisition Corporation (incorporated by reference from our Current Report on Form 8-K filed on August 25, 2008)

10.3

Form of Note Purchase Agreement dated September 3, 2008 between our company and an unaffiliated lender (incorporated by reference from our Current Report on Form 8-K/A filed on December 10, 2008)

10.4

First Amendment to Stock Purchase Agreement dated October 3, 2008, by and between Billie J. Eustice and the Gary L. Little Trust, as Sellers, and Arkanova Acquisition Corporation (incorporated by reference from our Current Report on Form 8-K filed on October 6, 2008)

10.5

Amended and Restated Stock Option Agreement dated November 14, 2008 with Reginald Denny (incorporated by reference from our Current Report on Form 8-K filed on November 20, 2008)

10.6

Employment Agreement dated October 18, 2008 between our company and Reginald Denny (incorporated by reference from our Quarterly Report on Form 10-Q filed on February 23, 2009)

10.7

Employment Agreement dated October 18, 2008 between our company and Pierre Mulacek (incorporated by reference from our Quarterly Report on Form 10-Q filed on February 23, 2009)

10.8

Note Purchase Agreement dated April 17, 2009 between our company and Global Project Finance AG (incorporated by reference from our Current Report on Form 8-K filed on May 13, 2009)

10.9

Promissory Note dated April 17, 2009 issued by our company to Global Project Finance AG (incorporated by reference from our Current Report on Form 8-K filed on May 13, 2009)

10.10

Note Purchase Agreement dated April 29, 2009 between our company and Aton Select Fund Limited (incorporated by reference from our Current Report on Form 8-K filed on May 13, 2009)

10.11

Promissory Note dated April 29, 2009 issued by our company to Aton Select Fund Limited (incorporated by reference from our Current Report on Form 8-K filed on May 13, 2009)

10.12

Loan Consolidation Agreement dated as of October 1, 2009, between Arkanova Acquisition Corporation and Aton Select Funds Limited (incorporated by reference from our Current Report on Form 8-K filed on October 7, 2009)

10.14

Note Purchase Agreement dated as of October 1, 2009, between Arkanova Acquisition Corporation and Aton Select Funds Limited (incorporated by reference from our Current Report on Form 8-K filed on October 7, 2009)



- 31 -

10.15

Promissory Note dated October 1, 2009, of Arkanova Acquisition Corporation (incorporated by reference from our Current Report on Form 8-K filed on October 7, 2009)

10.16

Stock Option Agreement dated October 14, 2009 with Pierre Mulacek (incorporated by reference from our Current Report on Form 8-K filed on October 19, 2009)

10.17

Stock Option Agreement dated October 14, 2009 with Erich Hofer (incorporated by reference from our Current Report on Form 8-K filed on October 19, 2009)

10.18

Stock Option Agreement dated October 14, 2009 with Reginald Denny (incorporated by reference from our Current Report on Form 8-K filed on October 19, 2009)

10.19

Purchase and Sale Agreement dated April 9, 2010, by and between Provident Energy Associates of Montana, LLC, as Seller, and Knightwall Invest, Inc., as Buyer (incorporated by reference from our Current Report on Form 8-K filed on April 12, 2010)

10.20

Executive Employment Agreement dated July 17, 2010 with Pierre Mulacek (incorporated by reference from our Current Report on Form 8-K filed on July 22, 2010)

10.21

Executive Employment Agreement dated July 17, 2010 with Reginald Denny (incorporated by reference from our Current Report on Form 8-K filed on July 22, 2010)

10.22

Note Purchase Agreement dated as of the 17th day of July, 2010, between our company and Global Project Finance AG (incorporated by reference from our Quarterly Report on Form 10-Q filed on August 13, 2010)

10.23

Stock Option Agreement dated October 8, 2010 with Pierre Mulacek (incorporated by reference from our Current Report on Form 8-K filed on October 14, 2010)

10.24

Stock Option Agreement dated October 8, 2010 with Reginald Denny (incorporated by reference from our Current Report on Form 8-K filed on October 14, 2010)

10.25

Stock Option Agreement dated October 8, 2010 with Erich Hofer (incorporated by reference from our Current Report on Form 8-K filed on October 14, 2010)

10.26

Option Agreement dated November 22, 2010 between Provident Energy Associates of Montana, LLC and Knightwall Invest, Inc. (incorporated by reference from our Current Report on Form 8-K filed on November 26, 2010)

(21)

Subsidiaries

21.1


Arkanova Development LLC (Nevada Limited Liability Company)
Arkanova Acquisition Corporation (Delaware)
Prism Corporation (Oklahoma)
Provident Energy of Montana, LLC (Montana Limited Liability Company)

(31)

Section 302 Certification

31.1*

Section 302 Certification under Sarbanes-Oxley Act of 2002 of Pierre Mulacek

31.2*

Section 302 Certification under Sarbanes-Oxley Act of 2002 of Reginald Denny

(32)

Section 906 Certification

32.1*

Section 906 Certification under Sarbanes-Oxley Act of 2002

(99)

Additional Exhibits

99.1

Report of Gustavson Associates dated December 28, 2010 on Montana Properties (incorporated by reference from our Annual Report on Form 10-K filed on January 12, 2011)

*Filed herewith


- 32 -

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ARKANOVA ENERGY CORPORATION

/s/ Pierre Mulacek  
By: Pierre Mulacek  
President, Chief Executive Officer,  
Secretary, Treasurer and Director  
(Principal Executive Officer)  
Dated: May 16, 2011  
   
   
   
/s/ Reginald Denny  
By: Reginald Denny  
Chief Financial Officer  
(Principal Financial Officer and  
Principal Accounting Officer)  
Dated: May 16, 2011