Table ofContents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2010**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from             to             **

 

**Commission File Number 001-32942**

 

**EVOLUTIONPETROLEUM CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Nevada**                                                     | ** ** | **41-1781991**                    |
|----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (IRS Employer Identification No.) |

 

**2500 CityWest Blvd., Suite 1300, Houston, Texas 77042**

(Address of principal executive offices and zip code)

 

**(713) 935-0122**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes: x No: o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes: o No: o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seethe definition of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o |   | Accelerated filer o         |
|--------------------------------|--------|----------------------------------|
|                           |   |                             |
| Non-accelerated filer o   |   | Smaller reporting company x |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.).  Yes: o No: x

 

Thenumber of shares outstanding of the registrant’s common stock, par value$0.001, as of May 14, 2010, was 27,150,278.

 

 

 

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Table ofContents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**TABLE OF CONTENTS**

 
| ** **                              | ** **                                                                                                           | **Page** |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                                                 |     |
| **PART I.  FINANCIAL INFORMATION** | 3                                                                                                                    |
|                                    |                                                                                                                 |     |
| ITEM 1.                                 | CONSOLIDATED CONDENSED  FINANCIAL STATEMENTS                                                                         | 3        |
|                                    |                                                                                                                 |     |
|                                    | Consolidated Balance Sheets (unaudited) as of  March 31, 2010 and June 30, 2009                            | 3        |
|                                    | Consolidated Statements of Operations (unaudited) for  the three and nine months ended March 31,  2010 and 2009 | 4        |
|                                    | Consolidated Statements of Cash Flows (unaudited) for  the nine months ended March 31,  2010 and 2009           | 5        |
|                                    | Notes to Consolidated Condensed Financial Statements  (unaudited)                                                    | 6        |
|                                    |                                                                                                                 |     |
| ITEM 2.                                 | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                          | 13       |
|                                    |                                                                                                                 |     |
| ITEM 3.                                 | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                          | 20       |
|                                    |                                                                                                                 |     |
| ITEM 4.                                 | CONTROLS AND  PROCEDURES                                                                                             | 21       |
|                                    |                                                                                                                 |     |
| **PART II. OTHER INFORMATION**     | 21                                                                                                                   |
|                                    |                                                                                                                 |     |
| ITEM 1.                                 | LEGAL PROCEEDINGS                                                                                                    | 21       |
|                                    |                                                                                                                 |     |
| ITEM 1A.                                | RISK FACTORS                                                                                                         | 21       |
|                                    |                                                                                                                 |     |
| ITEM 2.                                 | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                          | 21       |
|                                    |                                                                                                                 |     |
| ITEM 3.                                 | DEFAULTS  UPON SENIOR SECURITIES                                                                                     | 21       |
|                                    |                                                                                                                 |     |
| ITEM 4.                                 | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                 | 21       |
|                                    |                                                                                                                 |     |
| ITEM 5.                                 | OTHER INFORMATION                                                                                                    | 21       |
|                                    |                                                                                                                 |     |
| ITEM 6.                                 | EXHIBITS                                                                                                             | 22       |
|                                    |                                                                                                                 |     |
| SIGNATURES                              | 23                                                                                                                   |

 

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Tableof Contents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

 

**Evolution Petroleum Corporation and Subsidiaries**

**Consolidated Balance Sheets**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                                                                                                           | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                                                           | ** ** | **2010**           | ** ** | **2009**          | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                           | ** ** | ** **         | ** ** | ** **        | ** ** |
| Current assets                                                                                                                                                                                                                                                                                       |       |               |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                            |       | $                  | 3,845,942  |              | $          | 3,891,764 |   |
| Certificates of deposit                                                                                                                                                                                                                                                                              |       | 1,350,000          |       | 2,059,147         |       |
| Receivables                                                                                                                                                                                                                                                                                          |       |               |       |              |       |
| Oil and natural gas sales                                                                                                                                                                                                                                                                            |       | 617,184            |       | 532,318           |       |
| Income taxes                                                                                                                                                                                                                                                                                         |       | 25,200             |       | —            |       |
| Other                                                                                                                                                                                                                                                                                                |       | 65,041             |       | 172,314           |       |
| Income taxes recoverable                                                                                                                                                                                                                                                                             |       | —             |       | 2,055,802         |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                            |       | 201,055            |       | 162,441           |       |
| Total current assets                                                                                                                                                                                                                                                                                 |       | 6,104,422          |       | 8,873,786         |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Property and equipment, net of depreciation,  depletion, and amortization                                                                                                                                                                                                                            |       |               |       |              |       |
| Oil and natural gas properties — full-cost method  of accounting, of which $10,752,249and $9,819,465  at March 31, 2010 and June 30, 2009, respectively, were excluded  from amortization.                                                                                            |       | 29,952,146         |       | 28,751,178        |       |
| Other property and equipment                                                                                                                                                                                                                                                                         |       | 112,474            |       | 150,697           |       |
| Total property and equipment                                                                                                                                                                                                                                                                         |       | 30,064,620         |       | 28,901,875        |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Other assets                                                                                                                                                                                                                                                                                         |       | 57,335             |       | 53,162            |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Total assets                                                                                                                                                                                                                                                                                         |       | $                  | 36,226,377 |              | $          | 37,828,823 |   |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                                                       |       |               |       |              |       |
| Current liabilities                                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Accounts payable                                                                                                                                                                                                                                                                                     |       | $                  | 443,680    |              | $          | 690,639 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                  |       | 109,272            |       | 171,052           |       |
| Royalties payable                                                                                                                                                                                                                                                                                    |       | 273,016            |       | 218,477           |       |
| State taxes payable                                                                                                                                                                                                                                                                                  |       | —             |       | 157,736           |       |
| Total current liabilities                                                                                                                                                                                                                                                                            |       | 825,968            |       | 1,237,904         |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Long-term liabilities                                                                                                                                                                                                                                                                                |       |               |       |              |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                |       | 2,854,110          |       | 3,721,317         |       |
| Asset retirement obligations                                                                                                                                                                                                                                                                         |       | 780,681            |       | 664,710           |       |
| Stock bonus (Note 5)                                                                                                                                                                                                                                                                                 |       | —             |       | 370,440           |       |
| Accrued compensation                                                                                                                                                                                                                                                                                 |       | 315,000            |       | —            |       |
| Deferred rent                                                                                                                                                                                                                                                                                        |       | 80,691             |       | 77,858            |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Total liabilities                                                                                                                                                                                                                                                                                    |       | 4,856,450          |       | 6,072,229         |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Commitments  and contingencies (Note 10)                                                                                                                                                                                                                                                             |       |               |       |              |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Stockholders’ equity                                                                                                                                                                                                                                                                            |       |               |       |              |       |
| Preferred stock, par value $0.001; 5,000,000 shares  authorized; no shares issued or outstanding                                                                                                                                                                                                     |       | —             |       | —            |       |
| Common stock; par value $0.001; 100,000,000 shares  authorized; issued 27,931,101 shares and 27,318,517 shares as of  March 31, 2010 and June 30, 2009, respectively; outstanding  27,142,901 shares and 26,530,317 shares as of March 31, 2010 and  June 30, 2009, respectively |       | 27,931             |       | 27,318            |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                           |       | 17,995,874         |       | 16,424,868        |       |
| Retained earnings                                                                                                                                                                                                                                                                                    |       | 14,228,144         |       | 16,186,430        |       |
|                                                                                                                                                                                                                                                                                                 |       | 32,251,949         |       | 32,638,616        |       |
| Treasury stock, at cost, 788,200 shares as of  March 31, 2010 and June 30, 2009.                                                                                                                                                                                                           |       | (882,022           | )          | (882,022          | )          |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                                      |       | 31,369,927         |       | 31,756,594        |       |
|                                                                                                                                                                                                                                                                                                 |       |               |       |              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                      |       | $                  | 36,226,377 |              | $          | 37,828,823 |   |

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Operations**

**(unaudited)**

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **March 31,**     | ** ** | **March 31,**    | ** ** |
| ** **                                | ** ** | **2010**               | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues                                  |       |                   |       |                  |       |   |   |   |   |
| Crude oil                                 |       | $                      | 469,418    |                  | $          | 351,684 |   | $ | 1,428,915 |   | $ | 2,337,948 |   |
| Natural gas liquids                       |       | 282,400                |       | 350,891               |       | 847,923 |   | 1,341,629 |   |
| Natural gas                               |       | 539,563                |       | 461,889               |       | 1,385,872 |   | 1,431,655 |   |
| Total revenues                            |       | 1,291,381              |       | 1,164,464             |       | 3,662,710 |   | 5,111,232 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Operating Costs                           |       |                   |       |                  |       |   |   |   |   |
| Lease operating expense                   |       | 399,833                |       | 255,710               |       | 1,134,607 |   | 905,020 |   |
| Production taxes                          |       | 5,432                  |       | 29,750                |       | 40,258 |   | 137,522 |   |
| Depreciation, depletion and amortization  |       | 505,445                |       | 759,836               |       | 1,673,344 |   | 1,909,009 |   |
| Accretion of asset retirement obligations |       | 15,562                 |       | 12,591                |       | 45,100 |   | 24,452 |   |
| General and administrative *              |       | 1,194,872              |       | 1,595,402             |       | 3,701,584 |   | 4,722,869 |   |
| Total operating costs                     |       | 2,121,144              |       | 2,653,289             |       | 6,594,893 |   | 7,698,872 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Loss from operations                      |       | (829,763               | )          | (1,488,825            | )          | (2,932,183 | ) | (2,587,640 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Other income                              |       |                   |       |                  |       |   |   |   |   |
| Interest income                           |       | 18,776                 |       | 8,024                 |       | 47,785 |   | 99,452 |   |
| ** **                                |       |                   |       |                  |       |   |   |   |   |
| Net loss before income  tax benefit       |       | (810,987               | )          | (1,480,801            | )          | (2,884,398 | ) | (2,488,188 | ) |
| ** **                                |       |                   |       |                  |       |   |   |   |   |
| Income tax benefit                        |       | 259,466                |       | 444,184               |       | 926,112 |   | 596,237 |   |
| ** **                                |       |                   |       |                  |       |   |   |   |   |
| Net loss                                  |       | $                      | (551,521   | )                     | $          | (1,036,617 | ) | $ | (1,958,286 | ) | $ | (1,891,951 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Loss per common share                     |       |                   |       |                  |       |   |   |   |   |
| Basic and Diluted                         |       | $                      | (0.02      | )                     | $          | (0.04 | ) | $ | (0.07 | ) | $ | (0.07 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Weighted average number  of common shares |       |                   |       |                  |       |   |   |   |   |
| Basic and Diluted                         |       | 27,144,174             |       | 26,248,076            |       | 26,959,713 |   | 26,515,395 |   |

 

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*Generaland administrative expenses for the three month period ended March 31,2010 and 2009 included non-cash stock-based compensation expense of $384,701and $537,285, respectively. General and administrative expenses for the ninemonth period ended March 31, 2010 and 2009 included non-cash stock-basedcompensation expense of $1,201,137 and $1,645,535, respectively.

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Nine Months Ended****March ****31,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                       | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
| Cash flows from operating  activities                                            |       |                                        | ** ** | ** ** | ** ** |
| Net loss                                                                         |       | $                                           | (1,958,286 | ) | $ | (1,891,951 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                        |       |   |   |
| Depreciation, depletion and amortization                                         |       | 1,673,344                                   |       | 1,909,009 |   |
| Stock-based compensation                                                         |       | 1,201,137                                   |       | 1,645,535 |   |
| Accretion of asset retirement obligations                                        |       | 45,100                                      |       | 24,452 |   |
| Settlement of asset retirement obligations                                       |       | —                                      |       | (90,761 | ) |
| Deferred income taxes                                                            |       | (867,207                                    | )          | 889,419 |   |
| Accrued compensation                                                             |       | 315,000                                     |       | — |   |
| Deferred rent                                                                    |       | 2,833                                       |       | 2,833 |   |
| Other                                                                            |       | 4,678                                       |       | 4,678 |   |
| Changes in operating assets and liabilities                                      |       |                                        |       |   |   |
| Receivables from oil and natural gas sales                                       |       | (84,866                                     | )          | 1,578,347 |   |
| Receivables from income taxes and other                                          |       | 2,137,875                                   |       | 2,474,698 |   |
| Prepaid expenses and other current assets                                        |       | (38,614                                     | )          | 147,707 |   |
| Accounts payable and accrued expenses                                            |       | (121,058                                    | )          | (256,805 | ) |
| Royalties payable                                                                |       | 54,539                                      |       | (265,104 | ) |
| State taxes payable                                                              |       | (157,736                                    | )          | — |   |
| Net cash provided by operating activities                                        |       | 2,206,739                                   |       | 6,172,057 |   |
|                                                                             |       |                                        |       |   |   |
| Cash flows from investing  activities                                            |       |                                        |       |   |   |
| Development of oil and natural gas properties                                    |       | (2,767,758                                  | )          | (7,411,549 | ) |
| Acquisitions of oil and natural gas properties                                   |       | (185,141                                    | )          | (2,477,133 | ) |
| Capital expenditures for other equipment                                         |       | —                                      |       | (28,041 | ) |
| Purchases of certificates of deposit                                             |       | (1,350,000                                  | )          | (1,740,944 | ) |
| Maturities of certificates of deposit                                            |       | 2,059,147                                   |       | — |   |
| Other assets                                                                     |       | (8,851                                      | )          | (4,559 | ) |
| Net cash used in investing activities                                            |       | (2,252,603                                  | )          | (11,662,226 | ) |
|                                                                             |       |                                        |       |   |   |
| Cash flows from financing  activities                                            |       |                                        |       |   |   |
| Proceeds from the issuance of restricted common  stock                           |       | 42                                          |       | 130 |   |
| Purchase of treasury stock                                                       |       | —                                      |       | (882,022 | ) |
| Net cash provided by (used in) financing activities                              |       | 42                                          |       | (881,892 | ) |
|                                                                             |       |                                        |       |   |   |
| Net decrease in cash and cash equivalents                                        |       | (45,822                                     | )          | (6,372,061 | ) |
|                                                                             |       |                                        |       |   |   |
| Cash and cash equivalents, beginning of period                                   |       | 3,891,764                                   |       | 11,272,280 |   |
|                                                                             |       |                                        |       |   |   |
| Cash and cash equivalents, end of period                                         |       | $                                           | 3,845,942  |   | $ | 4,900,219 |   |

 

Oursupplemental disclosures of cash flow information for the nine months ended March 31,2010 and 2009 are as follows:

 
| ** **                                                                                                                        | ** ** | **Nine Months Ended****March ****31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
| Income taxes paid                                                                                                                 |       | $                                           | 251,800    |   | $ | 15,000 |   |
|                                                                                                                              |       |                                        |       |   |   |
| Income tax refunds and carry backs received                                                                                       |       | $                                           | 2,095,126  |   | $ | 4,052,631 |   |
|                                                                                                                              |       |                                        |       |   |   |
| Non-cash transactions:                                                                                                            |       |                                        |       |   |   |
| Decrease in accounts payable used to acquire oil  and natural gas leasehold interests and develop oil and natural gas  properties |       | $                                           | (187,681   | ) | $ | (2,014,933 | ) |
| Oil and natural gas properties incurred through  recognition of asset retirement obligations.                                     |       | $                                           | 70,871     |   | $ | 454,147 |   |

 

See accompanying notes to consolidated financial statements.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 1****—****Organization and Basis of Preparation**

 

***Nature of Operations.***  EvolutionPetroleum Corporation (“EPM”), including its subsidiaries (the “Company”, “we”,“our” or “us”), is an independent petroleum company headquartered in Houston,Texas and incorporated under the laws of the State of Nevada.  We are engaged primarily in the acquisition,exploitation and development of properties for the production of crude oil andnatural gas.  We acquire properties withknown oil and natural gas resources and exploit them through the application ofconventional and specialized technology to increase production, ultimaterecoveries, or both.

 

***Interim Financial Statements.***  The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and with the appropriate rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the financial position and results of operations for theinterim periods presented have been included. The interim financial information and notes hereto should be read inconjunction with the Company’s 2009 Annual Report on Form 10-K for theyear ended June 30, 2009, as filed with the SEC. The results of operationsfor interim periods are not necessarily indicative of results to be expectedfor a full fiscal year.

 

***Principles of Consolidation and Reporting.***  Our consolidated financial statements includethe accounts of EPM and its wholly-owned subsidiaries. All significantintercompany transactions have been eliminated in consolidation. Theconsolidated financial statements for the previous year include certainreclassifications that were made to conform to the current presentation.  Such reclassifications have no impact onpreviously reported income or stockholders’ equity.

 

***Use of Estimates. ***The preparationof financial statements in conformity with GAAP requires us to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe dates of the financial statements and the reported amounts of revenues andexpenses during the reporting periods. Significant estimates include reserve quantities and estimated futurecash flows associated with proved reserves, which significantly impactdepletion expense and potential impairments of oil and natural gas properties,income taxes, the amounts recoverable from the carry-back of income tax lossesand the valuation of deferred tax assets, stock-based compensation, andcommitments and contingencies.  Weanalyze our estimates based on historical experience and various otherassumptions that we believe to be reasonable. While we believe that ourestimates and assumptions used in preparation of the consolidated financialstatements are appropriate, actual results could differ from those estimates.

 

**Note 2 — Recent Accounting Pronouncements**

 

***New Accounting Standards.***  The followingdiscloses the existence and effect of accounting standards issued but not yetadopted by us with respect to accounting standards that may have an impact onthe Company when adopted in the future.

 

***Modernization of Oil and Gas Reporting.***  On December 31, 2008,the SEC released new requirements for reporting oil and gas reserves (the “ModernizationRequirements”).  The Modernization Requirements, when effective, providefor consideration of current technology in evaluating reserves, allow companiesto disclose their probable and possible reserves to investors, requirereporting of oil and gas reserves using an average price based on the prior12-month period rather than period-end prices, revise the disclosurerequirements for oil and gas operations, and revise accounting for thelimitation on capitalized costs for full cost companies.  TheModernization Requirements are effective for fiscal years ending on or after December 31,2009.  A company may not apply theModernization Requirements to disclosures in quarterly reports prior to thefirst annual report in which the revised disclosures are required.  We have not yet evaluated the effects theModernization Requirements will have on our financial statements.

 

The SEC staff issued StaffAccounting Bulletin (“SAB”) 113 (“SAB 113”), which revises portions of theguidance included in SAB Topic 12, *Oil andGas Producing Activities.* Specifically, SAB 113 revises the relevant interpretive guidance in SABTopic 12 to conform it to the Modernization Requirements.

 

On January 6, 2010, theFinancial Accounting Standards Board (“FASB”) issued Accounting StandardsUpdate 2010-03 *Extractive Activities - Oiland Gas (Topic 932): Oil and Gas Reserve Estimation and Disclosures*,an update of ASC Topic 932 *ExtractiveActivities - Oil and Gas*(“Topic932”), which substantially aligns the reserve estimation, disclosurerequirements, and definitions of Topic 932 with the disclosure requirements ofthe Modernization Requirements issued by the SEC.

 

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**Note 3 —****Property and Equipment**

 

Asof March 31, 2010 and June 30, 2009 our oil and natural gasproperties and other property and equipment consisted of the following:

 
| ** **                                                   | ** ** | **March 31,  2010** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Oil and natural gas properties**                           |       |                     |       |                    |       |
| Property costs subject to amortization                       |       | $                        | 23,889,255 |                    | $          | 21,985,950 |   |
| Less: Accumulated depreciation, depletion, and  amortization |       | (4,689,358               | )          | (3,054,237              | )          |
| Unproved properties not subject to amortization              |       | 10,752,249               |       | 9,819,465               |       |
| Oil and natural gas properties, net                          |       | $                        | 29,952,146 |                    | $          | 28,751,178 |   |
|                                                         |       |                     |       |                    |       |
| **Other property and equipment**                             |       |                     |       |                    |       |
| Furniture, fixtures and office equipment, at cost            |       | 260,476                  |       | 260,476                 |       |
| Less: Accumulated depreciation                               |       | (148,002                 | )          | (109,779                | )          |
| Other property and equipment, net                            |       | $                        | 112,474    |                    | $          | 150,697 |   |

 

Unprovedproperties not subject to amortization include unevaluated acreage of $6.7million and $7.5 million as of March 31, 2010 and June 30, 2009,respectively, consisting of properties in the Giddings Field in Central Texas,the Woodford Shale trend in Oklahoma, and the Lopez Field in South Texas (our “Neptuneoil project”).  Unproved properties alsoinclude $2.0 million as of March 31, 2010 and June 30, 2009, of participatinginterests through royalty and overriding royalty interests aggregating 7.4% inthe Delhi Holt Bryant Unit of the Delhi Field in Louisiana and a 25% afterpayout reversionary working interest in the Delhi Holt Bryant Unit along with a25% working interest in certain other depths in the Delhi Field.  We incurred $1.1 million and $0.3 million asof March 31, 2010 and June 30, 2009, respectively, related to thedrilling of three test wells and re-entry of four test wells on our acreage inWagoner County in Oklahoma and $1.0 million as of March 31, 2010 on twowells on our acreage in South Texas. Production testing of our wells in Oklahoma and South Texas isongoing.  Evaluation of our unprovedproperties is expected to be completed within one to five years.  Our evaluation of impairment of unprovedproperties occurs, at a minimum, on a quarterly basis.

 

**Note 4****—****Asset Retirement Obligations**

 

Ourasset retirement obligations represent the estimated present value of theamount we will incur to plug, abandon and remediate our producing properties atthe end of their productive lives in accordance with applicable laws. Thefollowing is a reconciliation of the beginning and ending asset retirementobligation for the nine months ended March 31, 2010:

 
| **Asset retirement obligations —  beginning of period** |   | $      | 664,710 |   |
|--------------------------------------------------------------|--------|--------|---------|--------|
| Liabilities incurred                                         |   | 70,871 |    |
| Accretion                                                    |   | 45,100 |    |
| **Asset retirement obligations —  end of period**       |   | $      | 780,681 |   |

 

**Note 5 — Stockholders’ Equity**

 

On September 8, 2009,the Board of Directors authorized and the Company issued 138,224 unrestrictedand fully vested shares of common stock from the 2004 Stock Plan to certainemployees for the payment of fiscal 2009 bonuses.  The value of the shares issued was $370,440,based on the fair market value on the date of issuance, or $2.68 pershare.  The amount of bonus was accruedas of June 30, 2009 and recognized as a long-term liability. On September 8,2009, when the shares were issued, the liability was reclassified tostockholders’ equity.

 

OnSeptember 8, 2009, the Board of Directors authorized and the Companyissued 324,597 shares of restricted common stock from the 2004 Stock Plan toemployees as a long-term incentive award.

 

OnOctober 27, 2009, 119,795 shares of common stock were issued through a netcashless exercise of a placement warrant. The placement warrant, which was issued to Cagan McAfee CapitalPartners, LLC (“CMCP”), a related party (See Note 8), on May 26, 2004 inconnection with a financing transaction, gave CMCP the right to purchase165,000 shares, with an exercise price of $1.00 per share (See Note 9).

 

OnNovember 10, 2009, 5,833 shares of common stock were issued through a netcashless exercise of a placement warrant. The placement warrant, issued on November 30, 2004 in connectionwith a financing transaction, gave the holder the right to purchase 10,000shares, with an exercise price of $1.50 per share (See Note 9).

 

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**Note 5 — Stockholders’ Equity**(Continued)

 

On December 9, 2009, atotal of 42,317 shares of restricted common stock were issued to four outsidedirectors as part of their board compensation for calendar year 2010.  All issuances of common stock were subject tovesting terms per individual stock agreements, which is generally one year fordirectors.

 

On February 6, 2010, atotal of 38,182 shares of restricted common stock were forfeited by anemployee.  The shares were cancelled andare available for a future grant in the 2004 Stock Plan.

 

On March 5, 2010, atotal of 20,000 shares of restricted stock were issued to a new employee aslong-term incentive compensation.  Theshares are subject to a four year vesting term.

 

**Note 6****—****Stock-Based Incentive Plan**

 

Wemay grant option awards to purchase common stock (the “Stock Options”),restricted common stock awards (“Restricted Stock”), and unrestricted and fullyvested common stock, to employees, directors, and consultants of the Company andits subsidiaries under the Natural Gas Systems Inc. 2003 Stock Plan (the “2003Stock Plan”) and the Evolution Petroleum Corporation Amended and Restated 2004Stock Plan (the “2004 Stock Plan” or together, the “EPM Stock Plans”).  Option awards for the purchase of 600,000shares of common stock were issued under the 2003 Stock Plan.  The 2004 Stock Plan authorized the issuanceof 5,500,000 shares of common stock.  Noshares are available for grant under the 2003 Stock Plan and, as of March 31,2010, 519,505 shares remain available for grant under the 2004 Stock Plan.

 

Wehave also granted common stock warrants, as authorized by the Board ofDirectors, to employees in lieu of cash bonuses or as incentive awards toreward previous service or provide incentives to individuals to acquire aproprietary interest in the Company’s success and to remain in the service ofthe Company (the “Incentive Warrants”). These Incentive Warrants have similar characteristics of the StockOptions.  A total of 1,037,500 IncentiveWarrants have been issued, with Board of Directors approval, outside of the EPMStock Plans.  We have not issuedIncentive Warrants since the listing of our shares on the NYSE Amex (formerly,the American Stock Exchange) in July 2006.

 

***Stock Options and Incentive Warrants***

 

Non-cashstock-based compensation expense related to Stock Options and IncentiveWarrants for the three months ended March 31, 2010 and 2009 was $250,154and $500,000, respectively.  Non-cashstock-based compensation expense related to Stock Options and IncentiveWarrants for the nine months ended March 31, 2010 and 2009 was $777,168and $1,445,987, respectively.

 

Therewere no Stock Options granted during the nine months ended March 31,2010.  During the nine months ended March 31,2009, we granted Stock Options to purchase 591,090 shares of common stock underthe 2004 Stock Plan with a weighted average exercise price of $4.27.  The exercise price was determined based onthe market price of the Company’s common stock on the date of grant.  The Stock Options granted during the ninemonths ended March 31, 2009 vest quarterly, on a straight line basis, overa period of four years and have a contractual life of seven years.

 

Theweighted average assumptions used to calculate the fair value of these StockOptions and the weighted average fair value of each option granted are asfollows:

 
| ** **               | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **March 31,**    | ** ** |
| ** **               | ** ** | **2010**              | ** ** | **2009** | ** ** |
| Expected volatility      |       | —                |       | 87.1 | % |
| Expected dividends       |       | —                |       | — |   |
| Expected term (in years) |       | —                |       | 4.6 |   |
| Risk-free rate           |       | —                |       | 3.10 | % |
| Fair value               |       | —                |       | $ | 2.62 |   |
|                          |            |                       |            |  |  |  |

 

Weestimated the fair value of Stock Options and Incentive Warrants issued toemployees and directors at the date of grant using the Black-Scholes-Mertonvaluation model.  The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant.  The expected term (estimated period of timeoutstanding) of Stock Options and Incentive Warrants is based on the “simplified”method of the estimated expected term for “plain vanilla” options allowed bythe SEC Staff Accounting Bulletin (“SAB”) No. 107 and SAB No. 110,and varied based on the vesting period and contractual term of the StockOptions or Incentive Warrants.   Expected volatility is based on thehistorical volatility of the Company’s closing common stock price and that ofan evaluation of a peer group of similar companies trading activity.  Wehave not declared any cash dividends on the Company’s common stock.

 

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**Note 6****—****Stock-Based Incentive Plan**(Continued)

 

Thefollowing summary presents information regarding outstanding Stock Options andIncentive Warrants as of March 31, 2010, and the changes during the period:

 
| ** **                                                               | ** ** | **Number of Stock  Options  and Incentive Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value  (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                                           | ** ** |
| Stock Options and Incentive Warrants outstanding at  July 1, 2009   |       | 5,485,820                                                                |       | $                                              | 1.83       |                                     |       |                                                                 |       |   |
|                                                                     |       |                                                                     |       |                                           |       |                                     |       |                                                                 |       |
| Granted                                                                  |       | —                                                                   |       | —                                         |       |                                     |       |                                                                 |       |
| Exercised                                                                |       | —                                                                   |       | —                                         |       |                                     |       |                                                                 |       |
| Cancelled or forfeited                                                   |       | —                                                                   |       | —                                         |       |                                     |       |                                                                 |       |
| Expired                                                                  |       | —                                                                   |       | —                                         |       |                                     |       |                                                                 |       |
|                                                                     |       |                                                                     |       |                                           |       |                                     |       |                                                                 |       |
| Stock Options and Incentive Warrants outstanding at  March 31, 2010 |       | 5,485,820                                                                |       | $                                              | 1.83       |                                     | $          | 15,403,278                                                           |       | 5.7 |   |
|                                                                     |       |                                                                     |       |                                           |       |                                     |       |                                                                 |       |
| Vested or expected to vest                                               |       | 5,485,820                                                                |       | $                                              | 1.83       |                                     | $          | 15,403,278                                                           |       | 5.7 |   |
|                                                                     |       |                                                                     |       |                                           |       |                                     |       |                                                                 |       |
| Exercisable at March 31, 2010                                       |       | 4,824,656                                                                |       | $                                              | 1.70       |                                     | $          | 14,201,490                                                           |       | 5.5 |   |

 

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(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the period ($4.64) as of March 31, 2010) and the StockOption or Incentive Warrant exercise price of in-the-money Stock Options andIncentive Warrants.

 

There were no Stock Optionsor Incentive Warrants that were exercised during the nine months ended March 31,2010 and 2009.

 

Asummary of the status of our unvested Stock Options and Incentive Warrants asof March 31, 2010 and the changes during the nine months ended March 31,2010, is presented below:

 
| ** **                      | ** ** | **Number of  Stock Options  and Incentive  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|---------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                      | ** ** | ** **                                            | ** ** | ** **                                                   | ** ** |
| Unvested at July 1, 2009   |       | 1,091,912                                             |       | $                                                            | 2.66       |   |
|                            |       |                                                  |       |                                                         |       |
| Granted                         |       | —                                                |       | $                                                            | —     |   |
|                            |       |                                                  |       |                                                         |       |
| Vested                          |       | (430,748                                              | )          | $                                                            | 2.40       |   |
|                            |       |                                                  |       |                                                         |       |
| Unvested at March 31, 2010 |       | 661,164                                               |       | $                                                            | 2.82       |   |

 

Duringthe nine months ended March 31, 2010 and 2009, there were 430,748 and764,200 Stock Options and Incentive Warrants that vested with a total grantdate fair value of $1,033,795 and $1,360,276, respectively.

 

Thetotal unrecognized compensation cost at March 31, 2010, relating tonon-vested Stock Options and Incentive Warrants was $1,282,686.  Such unrecognized expense is expected to berecognized over a weighted average period of 1.7 years.

 

***Restricted Stock***

 

Stock-basedcompensation expense related to Restricted Stock grants for the three months endedMarch 31, 2010 and 2009 was $134,547 and $37,285, respectively.  Stock-based compensation expense related toRestricted Stock grants for the nine months ended March 31, 2010 and 2009was $423,969 and $199,548, respectively.

 

OnSeptember 8, 2009, the Board of Directors authorized and the Companyissued 324,597 shares of restricted common stock from the 2004 Stock Plan toemployees as a long-term incentive award. Total unrecognized stock-based compensation expense of $869,917 relatedto the long-term incentive award will be recognized ratably over a four yearvesting period.

 

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**Note 6****—****Stock-Based Incentive Plan**(Continued)

 

On December 9, 2009, atotal of 42,317 shares of restricted common stock were issued to four outsidedirectors as part of their board compensation for calendar year 2010.  Total unrecognized stock-based compensationexpense of $167,956 related to board compensation will be recognized ratablyover a one year vesting period.  In theprevious year, a total of 130,113 shares of restricted common stock, with agrant-date fair value of $167,965, were issued to the same outside directors aspart of their board compensation for calendar year 2009, and which vested in December 2009.

 

On February 6, 2010, atotal of 38,182 shares of restricted common stock, with a grant-date fair valueof $187,965, were forfeited by an employee. The shares were cancelled and are available for a future grant under the2004 Stock Plan.

 

On March 5, 2010, atotal of 20,000 shares of restricted stock, with a grant-date fair value of$90,000, were issued to a new employee as long-term incentivecompensation.  The shares are subject toa four year vesting term.

 

Thefollowing table sets forth the Restricted Stock transactions for the ninemonths ended March 31, 2010:

 
| ** **                      | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | ** **                             | ** ** | ** **                                         | ** ** |
| Unvested at July 1, 2009   |       | 390,283                                |       | $                                                  | 3.37       |   |
|                            |       |                                   |       |                                               |       |
| Granted                         |       | 386,914                                |       | $                                                  | 2.92       |   |
|                            |       |                                   |       |                                               |       |
| Vested                          |       | (170,073                               | )          | $                                                  | 1.63       |   |
|                            |       |                                   |       |                                               |       |
| Forfeited                       |       | (38,182                                | )          | $                                                  | 4.92       |   |
| Unvested at March 31, 2010 |       | 568,942                                |       | $                                                  | 3.48       |   |

 

AtMarch 31, 2010, unrecognized stock-based compensation expense related toRestricted Stock grants totaled $1,737,189. Such unrecognized expense is expected to be recognized over a weightedaverage period of 3.2 years.

 

**Note 7****—****Income Taxes**

 

Wefile a consolidated federal income tax return in the United States and variouscombined and separate filings in several state and local jurisdictions.

 

Sincethe FASB required recognition of unrecognized tax benefits and through March 31,2010, there were no unrecognized tax benefits or accrued interest or penaltiesassociated with unrecognized tax benefits. We believe that we have appropriate support for the income tax positionstaken and to be taken on the Company’s tax returns and that the accruals fortax liabilities are adequate for all open years based on our assessment of manyfactors, including past experience and interpretations of tax law applied tothe facts of each matter. The Company’s federal and state income tax returnsare open to audit under the statute of limitations for the years ending June 30,2007 through June 30, 2009.

 

Oureffective tax rate for any period may differ from the statutory federal rate,due primarily to stock-based compensation related to qualified incentive stockoption awards (“ISO awards”), a permanent tax difference for financialreporting, as these types of awards, if certain conditions are met, are notdeductible for federal tax purposes.

 

InJanuary 2010, we received $2.1 million from the Internal Revenue Serviceas a result of the carry-back of our tax loss for the year ended June 30,2009, for income taxes paid for our year ended June 30, 2007.  Significant intangible drilling costs wereincurred during the 2009 fiscal year, of which, we elected to expenseapproximately $4.8 million for federal income tax purposes.  Under GAAP, and specifically the full-costaccounting method, intangible drilling costs are capitalized as part of oil andnatural gas properties, and depleted using the unit-of-production method.  The deduction of intangible drilling costscreated a significant difference in the income tax and book basis of our oiland natural gas properties, the most significant component of our deferredincome tax liability as of March 31, 2010 and June 30, 2009.

 

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**Note 8****—****Related Party Transactions**

 

Laird Q. Cagan, a member ofour Board of Directors, is a Managing Director and co-owner of Cagan McAfeeCapital Partners, LLC (“CMCP”).  CMCP hasperformed financial advisory services to us pursuant to a written agreementamended in December 2008.  Alsopursuant to the Agreement, Mr. Cagan, as a registered representative ofColorado Financial Services Corporation and as a partner of CMCP, could serveas our placement agent in private equity financings, wherein CMCP could earncash fees equal to 8% of gross equity proceeds, declining to 4% subject to theamount of equity raised through CMCP, and a fixed 4% warrant fee.  We have not paid placement fees to CMCP underthis agreement since May 2006.

 

Eric A. McAfee, a majorshareholder of the Company, is also a Managing Director of CMCP.

 

OnOctober 27, 2009, we issued CMCP 119,795 shares of common stock through anet cashless exercise of a placement warrant. The placement warrant, which was issued to CMCP on May 26, 2004 inconnection with a financing transaction, gave CMCP the right to purchase165,000 shares of common stock, with an exercise price of $1.00 per share (SeeNote 5).

 

**Note 9 —****Net loss Per Share**

 

The following table sets forththe computation of basic and diluted loss per share:

 
| ** **                                                        | ** ** | **Three Months Ended********March 31,** | ** ** | **Nine Months Ended********March 31,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                        | ** ** | **2010**                                     | ** ** | **2009**                                    | ** ** | **2010** | ** ** | **2009** | ** ** |
| *Numerator*                                                       |       |                                         |       |                                        |       |   |   |   |   |
| Net loss                                                          |       | $                                            | (551,521   | )                                           | $          | (1,036,617 | ) | $ | (1,958,286 | ) | $ | (1,891,951 | ) |
|                                                              |       |                                         |       |                                        |       |   |   |   |   |
| *Denominator**                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Weighted average number of common shares —basic and  diluted |       | 27,144,174                                   |       | 26,248,076                                  |       | 26,959,713 |   | 26,515,395 |   |
|                                                              |       |                                         |       |                                        |       |   |   |   |   |
| Net loss per common share — basic and diluted                |       | $                                            | (0.02      | )                                           | $          | (0.04 | ) | $ | (0.07 | ) | $ | (0.07 | ) |

 

----

* Potential dilutive commonshares are excluded from the computation of net loss per common share becausetheir effect is anti-dilutive.

 

Totaloutstanding potentially dilutive securities as of March 31, 2010 are asfollows:

 
| **Outstanding  Potential Dilutive Securities**                                     | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  March 31, 2010** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
|                                                                               |       |                                  |       |                                    |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                     | 1.90       |                                    | 171,308    |   |
| Stock Options and Incentive Warrants                                               |       | $                                     | 1.83       |                                    | 5,485,820  |   |
| Total                                                                              |       | $                                     | 1.83       |                                    | 5,657,128  |   |

 

Totaloutstanding potentially dilutive securities as of March 31, 2009 are asfollows:

 
| **Outstanding  Potential Dilutive Securities**                                     | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at March 31, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
|                                                                               |       |                                  |       |                                   |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                     | 1.40       |                                   | 401,058    |   |
| Stock Options and Incentive Warrants                                               |       | $                                     | 2.05       |                                   | 6,074,590  |   |
| Total                                                                              |       | $                                     | 2.01       |                                   | 6,475,648  |   |

 

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**Note 10 — Commitments and Contingencies**

 

Weare subject to various claims and contingencies in the normal course ofbusiness.  In addition, from time totime, we receive communications from government or regulatory agenciesconcerning investigations or allegations of noncompliance with laws orregulations in jurisdiction in which we operate.  We disclose such matters if we believe it isreasonably possible that a future event or events will confirm a loss throughimpairment of an asset or the incurrence of a liability. We establish reservesif we believe it is probable that a future event or events will confirm a lossand we can reasonably estimate such loss. Furthermore, we will disclose any matter that is unasserted if weconsider it probable that a claim will be asserted and there is a reasonablepossibility that the outcome will be unfavorable.

 

***Lease Commitments.***  We have a non-cancelable operating lease foroffice space that expires on August 1, 2016. Future minimum leasecommitments as of March 31, 2010 under this operating lease are asfollows:

 
| **For the year ended March 31,** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|
| 2011                                  |       | $          | 138,089    |   |
| 2012                                  |       | 152,037    |       |
| 2013                                  |       | 159,011    |       |
| 2014                                  |       | 159,011    |       |
| 2015                                  |       | 159,011    |       |
| Thereafter                            |       | 212,015    |       |
| Total                                 |       | $          | 979,174    |   |

 

Rentexpense for the three months ended March 31, 2010 and 2009 was 36,324 and39,232, respectively.  Rent expense forthe nine months ended March 31, 2010 and 2009 was 115,286 and 110,165,respectively.

 

***Employment Contracts.***  We have entered into employment agreementswith the Company’s three senior executives. The employment contracts provide for a severance package for terminationby the Company for any reason other than cause or permanent disability, or inthe event of a constructive termination, that includes payment of base pay andcertain medical and disability benefits from six months to a year aftertermination.   The total contingentobligation under the employment contracts as of March 31, 2010 isapproximately $499,000.

 

**Note 11****—****Subsequent Events**

 

Effectiveas of April 14, 2010, 4,913 shares of common stock were issued to anon-affiliate through a net cashless exercise of a placement warrant based onthe closing sale price of the Company’s common stock on the day beforeexercise.  The placement warrant, issuedon June 22, 2006 in connection with a financing transaction, gave theholder the right to purchase 8,000 shares, with an exercise price of $2.25 pershare (See Note 9).

 

Effective as of April 16,2010, 2,464 shares of common stock were issued to a non-affiliate through a netcashless exercise of a placement warrant based on the closing sale price of theCompany’s common stock on the day before exercise.  The placement warrant, issued on June 22,2006 in connection with a financing transaction, gave the holder the right topurchase 4,000 shares, with an exercise price of $2.25 per share (See Note 9).

 

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

 

Thefollowing is Management’s Discussion and Analysis (“MD&A”) of our financialposition and operating results during the periods included in the accompanyingunaudited consolidated condensed financial statements. This discussion shouldbe read in conjunction with the accompanying unaudited consolidated condensedfinancial statements and related notes thereto, included elsewhere in thisQuarterly Report on Form 10-Q and should further be read in conjunctionwith our Annual Report on Form 10-K for the year ended June 30, 2009.

 

**Forward-LookingInformation**

 

ThisForm 10-Q and the information referenced herein contain forward-lookingstatements within the meaning of the Private Securities Litigations Reform Actof 1995, Section 27A of the Securities Act of 1933 and Section 21E ofthe Securities Exchange Act of 1934. The words “plan,” “expect,” “project,” “estimate,”“assume,” “believe,” “anticipate,” “intend,” “budget,” “forecast,” “predict”and other similar expressions are intended to identify forward-lookingstatements. These statements appear in a number of places and includestatements regarding our plans, beliefs or current expectations, including theplans, beliefs and expectations of our officers and directors. Whenconsidering any forward-looking statement, you should keep in mind the riskfactors that could cause our actual results to differ materially from thosecontained in any forward-looking statement. Important factors that could causeactual results to differ materially from those in the forward-lookingstatements herein include the timing and extent of changes in commodity pricesfor oil and natural gas, operating risks and other risk factors as described inour 2009 Annual Report on Form 10-K for the year ended June 30, 2009as filed with the Securities and Exchange Commission. Furthermore, theassumptions that support our forward-looking statements are based uponinformation that is currently available and is subject to change. Wespecifically disclaim all responsibility to publicly update any informationcontained in a forward-looking statement or any forward-looking statement inits entirety and therefore disclaim any resulting liability for potentiallyrelated damages. All forward-looking statements attributable to EvolutionPetroleum Corporation are expressly qualified in their entirety by thiscautionary statement.  We use the terms, “EPM,”“Company,” “we,” “us” and “our” to refer to Evolution Petroleum Corporation.

 

**General Overview**

 

We are a petroleum companyengaged primarily in the acquisition, exploitation and development ofproperties for the production of crude oil and natural gas. We originateproject development concepts, capture such opportunities through theacquisition of known, underdeveloped oil and natural gas resources and exploitthem through the application of capital and technology to increase production,ultimate recoveries, or both.

 

Our strategy is intended togenerate scalable development opportunities at normally pressured depths,exhibiting relatively low completion risk, generally longer and morepredictable production lives, less expenditures on infrastructure and loweroperational risks.

 

Within this overall strategy,we pursue three specific initiatives:

 

I                    Enhanced oil recovery(“EOR”), using miscible and immiscible gas flooding;

 

II        Conventionalredevelopment of bypassed primary resources within mature oil and natural gasfields utilizing modern technology and our expertise; and

 

III            Unconventional gas resourcedevelopment, using modern stimulation and completion technologies.

 

Ourmost significant asset is our EOR project in the 13,636 acre Delhi Field,located in northeast Louisiana.  Ourinterests consist of 7.4% in overriding and mineral royalty interests, a 25%after pay-out reversionary working interest (20% revenue interest) in the DelhiField Holt Bryant Unit, and a 25% working interest (20% revenue interest) incertain other depths in the Delhi Field, resulting from the Farmout wecompleted on June 12, 2006, with Denbury Onshore LLC, a subsidiary ofDenbury Resources Inc. (the “Operator”) (the “Delhi Farmout”).  The Holt Bryant Unit is currently beingredeveloped by the Operator, using CO2 enhanced oilrecovery technology and a dedicated portion of the Operator’s proved CO2 reserves in the Jackson Dome, locatedapproximately 100 miles east of Delhi. Following several years of development by the Operator, CO2 injection had begun at the Delhi Field in November 2009,followed by initial oil production in March 2010.

 

Since our closing of theDelhi Farmout, we have focused on developing projects in our other initiativesthrough conventional redevelopment of oil and rich gas in the Giddings Fieldusing horizontal drilling, development of gas resources in the shallow portionof the Woodford and Caney Shale Trend in Eastern Oklahoma, development ofpotential oil reserves in the mature Lopez Field within our Neptune oil projectin South Texas and development of our proprietary artificial lift technologyintended to extend the life of horizontal wells with oil or associated waterproduction.

 

Ourlong-term strategy and primary focus continue to be on increasing share valuethrough the identification and acquisition of resources and conversion of thoseresources into proved reserves through our expertise and technology.

 

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*Highlights for our Third Quarter2010*

 

***Projects***

 

·**                ****Firstoil production flowed at our Delhi EOR project in March 2010, ahead ofrecent schedule. **As previouslyreported, we had expected first oil production would begin by mid-calendar2010, following the initiation of CO2 injection lastNovember. For March 2010, the operator reported 7,359 gross barrels ofsales at Delhi, covering two weeks of active production from only the firstthree producer wells in the initial injection pattern. Denbury is continuingits multi-year roll out of the project by adding additional producer andinjector wells and associated facilities in the field, thereby increasing ourexpected production through the 7.4% of royalty interests we hold throughoutthe EOR project’s life. The increasing field production is also graduallyreducing the remaining portion of the deemed $200 million payout, based onDenbury’s receipt of field revenues less direct field operating expense, atwhich point we receive a 25% working interest and an incremental 20% revenueinterest (increasing our revenue interest to 27.4%). We continue to bear nocapital expenditures or operating costs until such payout occurs, after whichwe begin paying our 25% share of future costs.

 

·**                ****Commercializationof our artificial lift technology continues. **Our installed technology continues to operate in the Giddings Field anddemonstrate its applicability, although the test well was shut-inextensively for compressor repairs during the quarter.  We are continuingdiscussions with a third party to apply our technology to their marginal,uneconomic or shut-in wells.

 

·                 **Electricpower became operational at our Neptune oil project, but first production wasdelayed due to water injection well repairs. **Drilling of our first two producer wells in the Lopez Field in SouthTexas has been completed, but first testing was delayed due to delays inobtaining access to electric power service. Once remedied, production testing began, and was then further delayeddue to injection rate issues in the well re-entered for use as a waterinjection well.  At the end of thequarter, operations necessary to increase injection capacity and allow thestartup of production testing were in process. As previously reported, we had expected test production to begin in FQ3,which we have now moved to FQ4.  We hold1,710 net acres with the potential for up to 111 additional drilling locations,of which four locations have been assigned by our outside reservoir engineer asproved.

 

·                 **Testproduction began in our shallow Oklahoma gas shale project. **  In late February we began steady-stateproduction from our vertical Woodford Shale test well in Wagoner County,Oklahoma.  As expected, production hassteadily increased from an initial low rate as we have dewatered the localizedarea of the reservoir.  At the end ofMarch, production stood at 40 mcf and 500+ barrels of water per day, and by theend of April, gas production had not only exceeded our targeted peak rate of80mcfd with continued decline in water production, but the gas rate continuesto steadily increase.  At this time, weare unable to predict the final peak gas rate in this well.  These results are encouraging and consistentwith Antrim Shale production characteristics, wherein the dewatering processrelieves the hydrostatic formation pressure to allow increasing gas rates,typically followed by a long slow decline curve.  While one test well result does notnecessarily imply similar results in future wells to be drilled on our leases,we are encouraged in that our Wagoner County leases are bracketed by our testwell on the west side of our lease block and a substantial number of producingWoodford Shale wells operated by others just outside the east side of our leaseblock.  As previously reported, in aseparate test well we also performed a brief production test of the Caney Shalefollowing a light frac of a vertical well in the same prospect area. The testconfirmed a water free, low gas rate as a potential add-on to our Woodfordproduction. Currently, production in this well has been shut-in, waiting on asecond, much larger frac before further testing.

 

·                  **GiddingsField production continues at a flatter decline rate, while we considerdevelopment options**. We performed several workovers at Giddings duringF3Q to help optimize future production. With blended product prices somewhat improving, mostly driven by higherliquids prices, we began to solicit and consider proposals for acceleratingdevelopment of our 21 proved undeveloped locations at Giddings, as furtherdescribed in the “Looking forward” section below.

 

***Operations***

 

·                 **Salesvolumes decreased 33%, while product prices increased 65%, resulting in an 11%increase in revenues during our third quarter of fiscal 2010 compared to ourthird quarter of fiscal 2009.* ***The decline in our sales andproduction were mostly due to the initial steep decline rate in the HiltonYegua #1 in the Giddings Field that was completed and placed on productionduring January 2009.  This wellpeaked during the quarter ended March 31, 2009 at 254 BOE per day,compared to average production of 27 BOE per day during the quarter ended March 31,2010.  The decline may be a result of apossible obstruction in the horizontal section of the wellbore early-on in thelife of the well.  Overall, natural gasaccounted for 57% of our volumes sold during the current period compared to 44%for the same period in fiscal 2009 due to the better than expected results inthe Pearson well that was completed in January 2009.  The average price we received was $44.98 perBOE during the three months ended March 31, 2010, as compared to $27.27per BOE during the three months ended March 31, 2009.

 

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·      **Production rates have flattened in general, withannualized decline rates slowing to under 10% since the quarter ended June 30,2009. **Net production duringthe quarter averaged approximately 319 net BOE per day, compared to a quarterlyrate of 340 net BOE per day for the quarter ended December 31, 2009, 344net BOE per day for the quarter ended June 30, 2009 and 474 net BOE perday for the quarter ended March 31, 2009, respectively.  Inparticular, our best well, the Pearson #1, still produced at a gross rate ofapproximately 1.05 MMCFE per day for the month of April, 2010 after fifteenmonths of production.

 

·                 **Ourfield breakeven point remains low.**  During the three months ended March 31,2010, lifting costs (lease operating expense and production taxes, on acombined per unit of sales basis) were $14.12 and our depletion rate was $17.23per BOE, equaling a field income break-even point of $31.35 per BOE.  This compares to lifting costs of $12.37 andour depletion rate was $17.27, equaling a field income break-even point of $29.64per BOE, during the quarter ended December 31, 2009. The increase inlifting costs during the quarter was due in material part to unusually highworkover activity at Giddings.

 

***Finances***

 

·                 **We endedour 3****rd**** quarter of fiscal 2010 with $5.3 million ofworking capital, compared to $7.6 million at June 30, 2009. **The $2.3 million reduction inour working capital since June 30, 2009, was due to investments of $2.8million in oil and natural gas properties, offset by positive cash flowgenerated from our oil and gas properties.

 

·**                ****Cashflows from operations provided for our general and administrative expenses andfunded a portion of our capital expenditures. **Our decrease in working capital since the beginning of our 2010 fiscalyear was due almost entirely to capital spending on our oil and gasprojects.  Cash flows from operationswere $2.2 million during the nine months ended March 31, 2010, whichincludes $2.1 million received in January from the Internal RevenueService as a result of a carry-back of our tax loss for the year ended June 30,2009 and net payments on working capital of $0.3 million.

 

·**                ****G&Aexpense was reduced 25% and 22% during the three and nine months ended March 31,2010, respectively, as compared to the respective periods in the prior fiscalyear. **Inaddition to reduced non-cash stock-based compensation expense, we have reducedour staff and legal costs during the year.

 

·                 **Weremained debt free.** All of our expenditures were funded solely byworking capital and we ended the quarter with no funded debt.

 

*Looking forward*

 

Wecontinue to focus on:

 

***Continued progress in ourDelhi EOR project****.*

 

·              **We expect continuing productionincreases at Delhi over the next few years. **Although we don’t control the operations of our Delhi EOR project, weexpect Delhi production to steadily increase to a peak rate of about 10,000gross barrels per day in the next 5 to 8 years as Denbury continues to expandthe project.  Following a deemed payout,expected to occur in about 4 years, subject to oil prices and actual productionlevels being realized in line with our outside reserve report, we would own 27.4%of gross production, over one-fourth of which would bear no operating expense.

 

·              **Establish proved reserves atDelhi.** Under current SEC rules, provedreserves cannot be assigned to our Delhi EOR property before the first EOR oilproduction response.  The SEC’s “Modernization”rules that become effective for us on June 30, 2010, state thatreservoir engineers can consider relevant factors other than production inassigning proved reserves to EOR projects, including current technology, theresults of field pilot tests and EOR projects in geologically comparablefields, all of which we believe are characteristics of the EOR project atDelhi.  Since an oil production responsehas occurred, we expect to be able to categorize a significant amount of provedreserves at Delhi under both sets of rules.

 

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***Selective low cost testing and development of our portfolio properties.***

 

·                 **Upgradeour shallow multi-pay shale gas reserves.**  We will continueour production testing in the Oklahoma shallow Woodford and Caney gas shales todemonstrate peak production rates, decline curves and estimated ultimaterecovery in order to move this project into full scale development.  We also plan to re-enter a well in our mid-depthproject in Haskell County, OK to begin testing the Woodford Shale reservoirbetween 4,000’ and 5,000’ depth.

 

·                 **Continueto pursue commercial joint ventures utilizing our proprietary artificial lifttechnology.**

 

·**                ****Establishproduction in our Neptune oil project**.  We expect to begin first production in twoproducing wells in our 100% owned Neptune oil project in South Texas during ourfourth fiscal quarter, with the goals of upgrading potential reserves andadding oil production.

 

·                 **Conductworkovers in Giddings as justified to maintain net production to cover ouroverhead.**

 

·                 **Developjoint venture(s) to drill or monetize undeveloped locations at Giddings.**  We are considering options to accelerate thedrilling of our proved and unproved drilling locations, subject to natural gas,oil and NGL prices.

 

***Continued conservativefinancial management.***

 

·                 **Emphasizelong-term share value over near-term earnings.**

 

·                 **Retainfinancial strength, flexibility and liquidity to assure we obtain proper valuefor our core assets.**

 

·                 **Useinternally generated funds and our working capital for continued developmentand testing,**while considering joint ventures, project financing,asset redeployments and/or appropriate modest use of our common stock to fundgrowth through additional development of our core projects and new projects.

 

**Liquidityand Capital Resources**

 

Forthe current fiscal year, we expect to finance our budgeted oil and gasactivities through our working capital and our cash flows from operatingactivities.

 

AtMarch 31, 2010, our working capital was $5.3 million and we continued tobe debt free.  This compares to workingcapital of $7.6 million at June 30, 2009. The $2.3 million decrease in working capital since June 30, 2009,was due primarily to investments of $2.8 million in oil and natural gasproperties (not including $0.1 million incurred related to recognition of assetretirement obligations).  Of the $2.8million of incurred capital expenditures during the nine months ended March 31,2010, $0.2 million was for leasehold acquisitions and $2.6 million was fordevelopment activities.  Developmentactivities were in the Giddings Field in Texas, our Neptune oil project inSouth Texas, and our gas shale project in Eastern Oklahoma.

 

***Cash Flows from Operating Activities***

 

Cashflows provided by operating activities for the nine months ended March 31,2010 were $2.2 million.  Cash flowsprovided by operations include cash receipts of $3.6 million from oil andnatural gas sales, primarily from our properties in the Giddings Field, cashreceipts of $2.1 million from the Internal Revenue Service due to our 2009 taxyear net operating loss carry-back, and interest received of $0.1 million.  Total cash received of $5.8 million waspartially offset by $3.3 million of cash payments for operating expenses,including lease operating expenses, production taxes, and salaries and wages,and payment of $0.3 million in state income taxes.

 

Cashflows provided by operating activities for the nine months ended March 31,2009 were $6.2 million, which included cash receipts of $6.4 million from oiland natural gas production primarily from our properties in the Giddings Field,interest received of $0.1 million, cash receipts of $4.1 million from theInternal Revenue Service, primarily from our 2008 tax year net operating losscarry-back, offset by cash payments of $0.1 million for settling liabilitiesassociated with our asset retirement obligations and $4.3 million of cashpayments for operating activities, including lease operating expenses,production taxes, and salaries and wages.

 

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***Cash Flows from Investing Activities***

 

Cashpaid for oil and gas capital expenditures during the nine months ended March 31,2010 and 2009, was $3.0 million and $9.9 million, respectively, which includesnet payments on accounts payable of $0.2 million and $2.0 million,respectively, relating to prior period expenditures for oil and natural gasproperties.

 

Wepurchased $1.4 million and $1.7 million in short-term certificates of depositduring the nine months ended March 31, 2010 and 2009, respectively.   During the nine months ended March 31,2010, $2.1 million of certificates of deposit matured.

 

***Cash Flows from Financing Activities***

 

There were no significantcash flows from financing activities during the nine months ended March 31,2010.  During the previous nine monthperiod, on October 30, 2008, we repurchased 788,200 shares of common stockat an average price of $1.10 per share plus $0.02 in transaction costs from anunaffiliated accredited investor.

 

***Capital Budget***

 

Wepreviously reported in our annual report for the fiscal year ended June 30,2009, that we expected capital expenditures of approximately $3.0 millionduring fiscal year 2010.  As of March 31,2010, we had incurred $2.8 million for capital expenditures related to our oiland gas activities. Due to our positive working capital, cash flows fromproducing properties and no debt, we believe that our current sources ofliquidity are sufficient to fund our budget.

 

**Resultsof Operations**

 

*Three months ended March 31,2010 and 2009*

 

The following table setsforth certain financial information with respect to our oil and natural gasoperations:

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **March 31**      | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2010**               | ** ** | **2009**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   |       | ** ** |   |
| **Sales Volumes, net to the  Company:**                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   |       | ** ** |   |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   |       | ** ** |   |
| Crude oil (Bbl)                                          |       | 6,083                  |       | 8,911      |       | (2,828       | )          | (32 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 6,217                  |       | 15,091     |       | (8,874       | )          | (59 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas (Mcf)                                        |       | 98,458                 |       | 112,176    |       | (13,718      | )          | (12 | )% |
| Crude oil, NGLs and natural gas (BOE)                    |       | 28,710                 |       | 42,698     |       | (13,988      | )          | (33 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Revenue data:**                                        |       |                   |       |       |       |         |       |   |   |
| ** **                                               |       |                   |       |       |       |         |       |   |   |
| Crude oil                                                |       | $                      | 469,418    |       | $          | 351,684      |       | $ | 117,734 |   | 33 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs                                                     |       | 282,400                |       | 350,891    |       | (68,491      | )          | (20 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas                                              |       | 539,563                |       | 461,889    |       | 77,674       |       | 17 | % |
| Total revenues                                           |       | $                      | 1,291,381  |       | $          | 1,164,464    |       | $ | 126,917 |   | 11 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Average price:**                                       | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   |       | ** ** |   |
| Crude oil (per Bbl)                                      |       | $                      | 77.17      |       | $          | 39.47        |       | $ | 37.70 |   | 96 | % |
| NGLs (per Bbl)                                           |       | 45.42                  |       | 23.25      |       | 22.17        |       | 95 | % |
| Natural gas (per Mcf)                                    |       | 5.48                   |       | 4.12       |       | 1.36         |       | 33 | % |
| Crude oil, NGLs and natural gas (per BOE)                |       | $                      | 44.98      |       | $          | 27.27        |       | $ | 17.71 |   | 65 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   |       | ** ** |   |
| Lease operating expenses and production taxes            |       | $                      | 14.12      |       | $          | 6.69         |       | $ | 7.43 |   | 111 | % |
| Depletion expense on oil and natural gas properties  (a) |       | $                      | 17.23      |       | $          | 17.57        |       | $ | (0.34 | ) | (2 | )% |

 

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(a)          Excludesdepreciation of furniture and fixtures of $10,797 and $9,769, for the threemonths ended March 31, 2010 and 2009, respectively.

 

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Netloss.  For the three months ended March 31,2010, we reported a net loss of $551,521 or $0.02 loss per share (whichincludes $384,701 of non-cash stock-based compensation expense) on total oiland natural gas revenues of $1,291,381. This compares to a net loss of $1,036,617, or $0.04 per share (whichincludes $537,285 of non-cash stock-based compensation expense) on total oiland natural gas revenues of $1,164,464 for the three months ended March 31,2009.  An increase in our revenues of$126,917 and a decrease in operating expenses of $532,145 were partially offsetby a decrease of $184,718 in our income tax benefit.  Additional details of the components of netloss are explained in greater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the three months ended March 31, 2010decreased 33% to 28,710 BOE, compared to 42,698 BOE for the three months ended March 31,2009.  Our sales volumes for the threemonths ended March 31, 2010 included 559 Bbls of oil from Delhi and 28,151BOE from our properties in the Giddings Field in Texas.  Our sales volumes for the three months ended March 31,2009 were primarily from our properties in the Giddings Field in Texas.  Sales volumes of natural gas decreased 12%,while sales volumes of crude oil and NGLs decreased 49% compared to the threemonths ended March 31, 2009.

 

During January of 2009,we completed and placed on production the Hilton Yegua #1.  This well produced at peak production duringthe three months ended March 31, 2009.

 

Werecorded approximately $43,000 of revenue from first EOR oil production in our Delhi enhanced oil recovery project that began in thelast two weeks of March 2010.

 

PetroleumRevenues.  Crude oil,NGLs and natural gas revenues for the three months ended March 31, 2010increased 11% from the three months ended March 31, 2009.  The increase was due to a 65% increase in theaverage price received per BOE of $27 for the three months ended March 31,2009 to $45 per BOE for the three months ended March 31, 2010, partiallyoffset by a 33% decrease in sales volumes.

 

LeaseOperating Expenses (including production severance taxes).  Lease operating expenses and production taxesfor the three months ended March 31, 2010 increased 42% compared to thethree months ended March 31, 2009, primarily due to the additions of threeproducing wells and ad valorem taxes assessed in calendar year 2009.  Lease operating expense and production taxesper barrel of oil equivalent increased 111% from $6.69 per BOE during the threemonths ended March 31, 2009, to $14.12 per BOE during the three monthsended March 31, 2010.  Leaseoperating expense per BOE for the three months ended March 31, 2009 washeavily influenced by the initial high rate of production from the Hilton Yegua#1 completed in January 2009.

 

General and AdministrativeExpenses (“G&A”). G&A expenses decreased 25% to $1.2 million for the three monthsended March 31, 2010, compared to $1.6 million for the three months ended March 31,2009.  The reduction was due, primarily,to a decrease in non-cash stock-based compensation expense, which was $384,701(32% of total G&A) and $537,285 (34% of total G&A) for the three monthsended March 31, 2010 and 2009, respectively, and a reduction of legal feesof approximately $158,000 due to the settlement of the Delhi litigation in July 2009.  Non-cash stock-based compensation is anintegral part of total staff compensation utilized to recruit quality stafffrom other, more established companies and, as a result, will likely continueto be a significant component of our G&A costs.

 

Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A decreased by 33% to $505,445 for thethree months ended March 31, 2010, compared to $759,836 for the threemonths ended March 31, 2009.  Thedecrease is due to a 33% reduction in net sales volumes.

 

Interest Income.  Interest income for the three months ended March 31,2010 increased $10,752 to $18,776, compared to $8,024 for the three monthsended March 31, 2009.  We receivedinterest of $9,925 from the Internal Revenue Service in January 2010related to the carry back of our 2009 tax loss. The average daily balances of short term certificates of deposit remainedconsistent with the same period in the previous fiscal year.

 

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*Ninemonths ended March 31, 2010 and 2009*

 

The following table setsforth certain financial information with respect to our oil and natural gasoperations:

 
| ** **                                              | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|------------|------------|--------------|------------|
| ** **                                              | ** ** | **March 31**     | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                              | ** ** | **2010**              | ** ** | **2009**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                              | ** ** | ** **            | ** ** | ** ** | ** ** | ** **   | ** ** |   | ** ** |
| **Sales Volumes, net to the Company:**                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** **   | ** ** |   | ** ** |
| ** **                                              | ** ** | ** **            | ** ** | ** ** | ** ** | ** **   | ** ** |   | ** ** |
| Crude oil (Bbl)                                         |       | 19,781                |       | 28,844     |       | (9,063       | )          | (31 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| NGLs (Bbl)                                              |       | 21,979                |       | 33,836     |       | (11,857      | )          | (35 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| Natural gas (Mcf)                                       |       | 319,154               |       | 238,295    |       | 80,859       |       | 34 | % |
| Crude oil, NGLs and natural gas (BOE)                   |       | 94,952                |       | 102,396    |       | (7,444       | )          | (7 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| **Revenue data:**                                       |       |                  |       |       |       |         |       |   |   |
| ** **                                              |       |                  |       |       |       |         |       |   |   |
| Crude oil                                               |       | $                     | 1,428,915  |       | $          | 2,337,948    |       | $ | (909,033 | ) | (39 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| NGLs                                                    |       | 847,923               |       | 1,341,629  |       | (493,706     | )          | (37 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| Natural gas                                             |       | 1,385,872             |       | 1,431,655  |       | (45,783      | )          | (3 | )% |
| Total revenues                                          |       | $                     | 3,662,710  |       | $          | 5,111,232    |       | $ | (1,448,522 | ) | (28 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| **Average price:**                                      | ** ** | ** **            | ** ** | ** ** | ** ** | ** **   | ** ** |   | ** ** |
| Crude oil (per Bbl)                                     |       | $                     | 72.24      |       | $          | 81.05        |       | $ | (8.81 | ) | (11 | )% |
| NGLs (per Bbl)                                          |       | 38.58                 |       | 39.65      |       | (1.07        | )          | (3 | )% |
| Natural gas (per Mcf)                                   |       | 4.34                  |       | 6.01       |       | (1.67        | )          | (28 | )% |
| Crude oil, NGLs and natural gas (per BOE)               |       | $                     | 38.57      |       | $          | 49.92        |       | $ | (11.35 | ) | (23 | )% |
|                                                    |       |                  |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** **   | ** ** |   | ** ** |
| Lease operating expenses and production taxes           |       | $                     | 12.37      |       | $          | 10.18        |       | $ | 2.19 |   | 22 | % |
| Depletion expense on oil and natural gas properties (a) |       | $                     | 17.22      |       | $          | 18.36        |       | $ | (1.14 | ) | (6 | )% |

 

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(a)          Excludesdepreciation of furniture and fixtures of $38,223 and $29,387, for the ninemonths ended March 31, 2010 and 2009, respectively.

 

Net loss.  For the nine months ended March 31, 2010,we reported a net loss of $1,958,286 or $0.07 loss per share (which includes$1,201,137 of non-cash stock-based compensation) on total oil and natural gasrevenues of $3,662,710.  This compares toa net loss of $1,891,951, or $0.07 loss per share (which, included $1,645,535of non-cash stock-based compensation), on total oil and natural gas revenues of$5,111,232 for the nine months ended March 31, 2009.  A decrease in revenues of $1,448,522 waspartially offset by decrease in operating costs of $1,103,979, and an increasein our income tax benefit of $329,875. Additional details of the components of net loss are explained ingreater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the nine months ended March 31, 2010decreased 7% to 94,952 BOE, compared to 102,396 BOE for the nine months ended March 31,2009.  Our sales volumes for the ninemonths ended March 31, 2010 included 611 Bbls of oil from Delhi and 94,341BOE from our properties in the Giddings Field in Texas.  Our sales volumes for the nine months ended March 31,2009 were primarily from our properties in the Giddings Field in Texas.  Production of natural gas increased 34%, whileproduction of crude oil and NGLs decreased 33% compared to the nine monthsended March 31, 2009.

 

During January of 2009,we completed and placed on production the Hilton Yegua #1.  This wells produced at peak production duringthe nine months ended March 31, 2009.

 

Werecorded approximately $43,000 of revenue from first EOR oil production in our Delhi enhanced oil recovery project that began in thelast two weeks of March 2010.

 

PetroleumRevenues.  Crude oil,NGLs and natural gas revenues for the nine months ended March 31, 2010decreased 28% from the nine months ended March 31, 2009.  This was due to a 23% decline in the averageprice received per BOE, from $50 per BOE for the nine months ended March 31,2009 to $39 per BOE for the nine months ended March 31, 2010.

 

LeaseOperating Expenses (including production severance taxes).  Lease operating expenses and production taxesfor the nine months ended March 31, 2010 increased 13% compared to thenine months ended March 31, 2009, primarily due to the additions of threeproducing wells.  Lease operating expenseand production taxes per barrel of oil equivalent increased 22% from $10.18 perBOE during the nine months ended March 31, 2009, to $12.37 per BOE duringthe nine months ended March 31, 2010.

 

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General and AdministrativeExpenses (“G&A”). G&A expenses decreased 22% to $3.7 million for the nine months endedMarch 31, 2010, compared to $4.7 million for the nine months ended March 31,2009.  The reduction was due to adecrease in non-cash stock-based compensation expense, which was $1,201,137(32% of total G&A) and $1,645,535 (35% of total G&A) for the nine monthsended March 31, 2010 and 2009, respectively, an 8% reduction in personnelcosts, due to a reduction in staff and estimated annual bonus payments, and areduction of legal fees of approximately $236,000 due to the settlement of theDelhi litigation in July 2009. Non-cash stock-based compensation is an integral part of total staffcompensation utilized to recruit quality staff from other, more establishedcompanies and, as a result, will likely continue to be a significant componentof our G&A costs.

 

Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A decreased by 12% to $1,673,344 forthe nine months ended March 31, 2010, compared to $1,909,009 for the ninemonths ended March 31, 2009.  Thedecrease is primarily due to a 7% decrease in net sales volumes, and a lowerdepletion rate ($17.22 vs. $18.36) per BOE, as a result of the reduction inprojected capital expenditures associated with our proved undeveloped locationsin our properties in the Giddings Field.

 

Interest Income.  Interest income for the nine months ended March 31,2010 decreased $51,667 to $47,785, compared to $99,452 for the nine monthsended March 31, 2009.  The decreasein interest income is due to lower average daily balances of cash and shortterm certificates of deposit and a reduction in market interest rates receivedon invested cash.

 

Inflation.  Although the general inflationrate in the United States, as measured by the Consumer Price Index and theProducer Price Index, has been relatively low in recent years, the oil and gasindustry has experienced unusually volatile price movements in commodityprices, vendor goods and oilfield services. Prices for drilling and oilfield services, oilfield equipment, tubulars,labor, expertise and other services greatly impact our lease operating expensesand our capital expenditures.  Duringfiscal 2009 and into early fiscal 2010, we have seen a substantial decline inboth petroleum product prices and drilling and oilfield services costs from prioryears, followed more recently by some increases in products and services.  Product prices, operating costs anddevelopment costs may not always move in tandem.

 

KnownTrends and Uncertainties. General worldwide economic conditions have deteriorated due to creditconditions impacted by the sub-prime mortgage turmoil and otherfactors.  Concerns over uncertain future economic growth areaffecting numerous industries, companies, as well as consumers, which hasresulted in reduced demand for crude oil and natural gas.  If demanddecreases in the future, it may put downward pressure on crude oil and naturalgas prices, thereby lowering our revenues and working capital going forward.

 

Seasonality.  Our business is generally not seasonal,except for instances when weather conditions may adversely affect access to ourproperties or delivery of our petroleum products.  Although we do not generally modify ourproduction for changes in market demand, we do experience seasonality in theproduct prices we receive, generally based on higher demand for natural gas inthe summer and winter and higher demand for downstream oil products during thesummer driving season.

 

**OffBalance Sheet Arrangements**

 

TheCompany has no off-balance sheet arrangements to report during the thirdquarter ending March 31, 2010.

 

**ITEM 3.**** ****QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

Informationabout market risks for the three months ended March 31, 2010, did notchange materially from the disclosures in Item 7A. of our Annual Report on Form 10-Kfor the year ended June 30, 2009 except as noted below.  As such, the information contained hereinshould be read in conjunction with the related disclosures in our Annual Reporton Form 10-K for the year ended June 30, 2009.

 

*Interest Rate Risk*

 

Weare exposed to changes in interest rates. Changes in interest rates affect theinterest earned on our cash and cash equivalents.  Under our current policies, we do not useinterest rate derivative instruments to manage exposure to interest ratechanges.

 

*Commodity Price Risk*

 

Ourrevenues, profitability and future growth depend substantially on prevailingprices for oil and natural gas. Prices also affect the amount of cash flowavailable for capital expenditures and our ability to borrow and raiseadditional capital, as, if and when needed. Lower prices may also reduce theamount of oil and natural gas that we can economically produce.  Although our current production base may notbe sufficient enough to effectively allow hedging, we may periodically usederivative instruments to hedge our commodity price risk. We may hedge aportion of our projected oil and natural gas production through a variety offinancial and physical arrangements intended to support oil and natural gasprices at targeted levels and to manage our exposure to price fluctuations. Wemay use futures contracts, swaps and fixed price physical contracts to hedgeour commodity prices. Realized gains and losses from our price risk managementactivities are recognized in oil and natural gas sales when the associated productionoccurs. We presently do not hold or issue derivative instruments for hedging orspeculative purposes.

 

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**ITEM 4.CONTROLS AND PROCEDURES**

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to this Company’s management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow for timely decisionsregarding required disclosure.

 

As required by Securities andExchange Commission Rule 13a-15(b), we carried out an evaluation, underthe supervision and with the participation of the Company’s management,including our Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(c) and15d-15(e)) as of the end of the quarter covered by this report.  In designing and evaluating our disclosurecontrols and procedures, our management recognizes that controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving desired control objectives.  Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that as of March 31, 2010our disclosure controls and procedures are effective in ensuring that theinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission rules andforms.

 

During the quarter ended March 31,2010 there has been no change in our internal control over financial reportingthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II- OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

None.

 

**ITEM 1A. RISK FACTORS**

 

Seerisk factors set forth in the Company’s Annual Report on Form 10-K for theyear ended June 30, 2009.

 

**ITEM 2.UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM****3. DEFAULTS UPON SENIOR SECURITIES**

 

Notapplicable.

 

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

 

None.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

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**ITE****M 6.EXHIBITS**

 

A.           Exhibits

 

31.1                      Certification of Chief Executive Officerpursuant to Rule 13a-14(a) or Rule 15d-14(a) under theSecurities Exchange Act of 1934, as amended.

 

31.2                      Certification of Chief Financial Officerpursuant to Rule 13a-14(a) or Rule 15d-14(a) under theSecurities Exchange Act of 1934, as amended.

 

32.1                      Certification of Chief Executive Officerpursuant Rule 13a-14(b) or Rule 15d-14(b) under theSecurities Exchange Act of 1934, as amended and 18 U.S.C. Section 1350.

 

32.2                      Certification of Chief Financial Officerpursuant Rule 13a-14(b) or Rule 15d-14(b) under theSecurities Exchange Act of 1934, as amended and 18 U.S.C. Section 1350.

 

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**SIGNATURES**

 

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

 

**EVOLUTION PETROLEUM CORPORATION**

(Registrant)

 
|   |                    |   |   |   |                                        |
|--------|-------------------------|--------|--------|--------|---------------------------------------------|
|   | Date: May 14, 2010 |   |   | By:    | /s/ STERLING H. MCDONALD                    |
|   |                    |   |   |   | Sterling H. McDonald                        |
|   |                    |   |   |   | Vice-President and Chief  Financial Officer |
|   |                    |   |   |   | Principal Financial and Accounting          |
|   |                    |   |   |   | Officer                                     |

 

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