**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2008**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT**

 

**For thetransition period from              to              **

 

**CommissionFile Number 001-32942**

 

**EVOLUTIONPETROLEUM CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices and zip code)

 

**(713)935-0122**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) filedall reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 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

 

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

 

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

 

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

 

The number of shares outstanding of the registrant’scommon stock, par value $0.001, as of May 14, 2008, was 26,860,439.

 

** **

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

 

**TABLE OFCONTENTS**

 
|                                         | ** **                                                                                                                | ** ** | **Page** |
|-----------------------------------------|---------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                    |                                                                                                                      |       |     |
| **PART I. FINANCIAL  INFORMATION** |                                                                                                                      |       |
|                                    |                                                                                                                      |       |     |
| ITEM  1.                                | CONSOLIDATED  CONDENSED FINANCIAL STATEMENTS                                                                              |       | 2        |
|                                    |                                                                                                                      |       |     |
|                                    | Consolidated  Balance Sheets as of March 31, 2008 (unaudited) and June 30, 2007                                 |       | 2        |
|                                    | Consolidated  Statements of Operations (unaudited) for the three and nine months ended  March 31, 2008 and 2007 |       | 3        |
|                                    | Consolidated  Statements of Cash Flows (unaudited) for the nine months ended March 31,  2008 and 2007                |       | 4        |
|                                    | Notes  to Consolidated Condensed Financial Statements (unaudited)                                                         |       | 5        |
|                                    |                                                                                                                      |       |     |
| ITEM 2.                                 | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                               |       | 15       |
|                                    |                                                                                                                      |       |     |
| ITEM 3.                                 | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                               |       | 22       |
|                                    |                                                                                                                      |       |     |
| ITEM 4.                                 | CONTROLS AND PROCEDURES                                                                                                   |       | 22       |
|                                    |                                                                                                                      |       |     |
| **PART II.  OTHER INFORMATION**    |                                                                                                                      |       |
|                                    |                                                                                                                      |       |     |
| ITEM  1.                                | LEGAL  PROCEEDINGS                                                                                                        |       | 23       |
|                                    |                                                                                                                      |       |     |
| ITEM 1A.                                | RISK  FACTORS                                                                                                             |       | 23       |
|                                    |                                                                                                                      |       |     |
| ITEM 2.                                 | UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF  PROCEEDS                                                               |       | 24       |
|                                    |                                                                                                                      |       |     |
| ITEM 3.                                 | DEFAULTS UPON SENIOR SECURITIES                                                                                           |       | 24       |
|                                    |                                                                                                                      |       |     |
| ITEM 4.                                 | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                       |       | 24       |
|                                    |                                                                                                                      |       |     |
| ITEM  5.                                | OTHER  INFORMATION                                                                                                        |       | 24       |
|                                    |                                                                                                                      |       |     |
| ITEM 6.                                 | EXHIBITS                                                                                                                  |       | 24       |
|                                    |                                                                                                                      |       |     |
| SIGNATURES                              |                                                                                                                      | 25         |

 

1

----

 

**PART I – FINANCIALINFORMATION**

 

**ITEM 1. CONSOLIDATED CONDENSEDFINANCIAL STATEMENTS**

 

**EvolutionPetroleum Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                         | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2008**           | ** ** | **2007**          | ** ** |
| ** **                                                                                                                                                                         | ** ** | **(unaudited)**    | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                         |       |               |       |              |       |
| Current Assets                                                                                                                                                                     |       |               |       |              |       |
| Cash and cash  equivalents                                                                                                                                                         |       | $                  | 19,875,284 |              | $          | 27,746,942 |   |
| Receivables                                                                                                                                                                        |       |               |       |              |       |
| Oil and natural  gas sales                                                                                                                                                         |       | 380,471            |       | 190,210           |       |
| Income tax                                                                                                                                                                         |       | 1,304,165          |       | 421,325           |       |
| Other                                                                                                                                                                              |       | 55,360             |       | 22,375            |       |
| Prepaid expenses  and other current assets                                                                                                                                         |       | 74,879             |       | 540,666           |       |
| Total current  assets                                                                                                                                                              |       | 21,690,159         |       | 28,921,518        |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Property and  equipment, net of depreciation, depletion, and amortization                                                                                                          |       |               |       |              |       |
| Oil and natural  gas properties – full cost method of accounting                                                                                                              |       | 14,053,812         |       | 5,459,553         |       |
| Other property and  equipment                                                                                                                                                      |       | 161,870            |       | 154,872           |       |
| Total property  and equipment                                                                                                                                                      |       | 14,215,682         |       | 5,614,425         |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Other assets,  net                                                                                                                                                                 |       | 358,077            |       | 370,049           |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Total assets                                                                                                                                                                       |       | $                  | 36,263,918 |              | $          | 34,905,992 |   |
|                                                                                                                                                                               |       |               |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                      |       |               |       |              |       |
| Current liabilities                                                                                                                                                                |       |               |       |              |       |
| Accounts payable                                                                                                                                                                   |       | $                  | 3,020,560  |              | $          | 1,064,918 |   |
| Accrued expenses                                                                                                                                                                   |       | 504,549            |       | 524,809           |       |
| Royalties  payable                                                                                                                                                                 |       | 6,572              |       | 6,831             |       |
| Total current  liabilities                                                                                                                                                         |       | 3,531,681          |       | 1,596,558         |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Long term  liabilities                                                                                                                                                             |       |               |       |              |       |
| Deferred income  tax liability                                                                                                                                                     |       | 338,001            |       | 338,001           |       |
| Deferred rent                                                                                                                                                                      |       | 73,136             |       | 47,289            |       |
| Asset retirement  obligations                                                                                                                                                      |       | 174,658            |       | 140,998           |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Total  liabilities                                                                                                                                                                 |       | 4,117,476          |       | 2,122,846         |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Stockholders’  equity                                                                                                                                                         |       |               |       |              |       |
| Common Stock,  par value $0.001, 100,000,000 shares authorized; 26,860,439 and 26,776,234  issued and outstanding as of March 31, 2008 and June 30, 2007,  respectively. |       | 26,860             |       | 26,776            |       |
| Additional  paid-in capital                                                                                                                                                        |       | 13,708,808         |       | 12,397,373        |       |
| Retained  earnings                                                                                                                                                                 |       | 18,410,774         |       | 20,358,997        |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Total stockholders’  equity                                                                                                                                                   |       | 32,146,442         |       | 32,783,146        |       |
|                                                                                                                                                                               |       |               |       |              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                   |       | $                  | 36,263,918 |              | $          | 34,905,992 |   |

 

See accompanyingnotes to consolidated condensed financial statements.

 

2

----

 

**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Operations**

**(unaudited)**

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                                | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                  |       |                             |       |                            |       |   |   |   |   |
| Oil and natural  gas liquids              |       | $                                | 644,903    |                            | $          | 462,951 |   | $ | 1,776,347 |   | $ | 1,358,433 |   |
| Natural gas                               |       | 99,799                           |       | —                          |       | 123,277 |   | — |   |
| Price risk  management activities         |       | —                           |       | —                          |       | — |   | (14 | ) |
| Total revenues                            |       | 744,702                          |       | 462,951                         |       | 1,899,624 |   | 1,358,419 |   |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Operating Costs                           |       |                             |       |                            |       |   |   |   |   |
| Lease operating  expense                  |       | 300,186                          |       | 396,010                         |       | 971,688 |   | 1,039,227 |   |
| Production taxes                          |       | 12,867                           |       | 13,957                          |       | 46,231 |   | 44,260 |   |
| Depreciation,  depletion and amortization |       | 139,086                          |       | 56,572                          |       | 372,645 |   | 164,793 |   |
| Accretion of  asset retirement obligation |       | 7,110                            |       | 4,398                           |       | 16,656 |   | 12,774 |   |
| General and  administrative *             |       | 1,266,427                        |       | 934,055                         |       | 4,062,423 |   | 2,933,761 |   |
| Total operating  costs                    |       | 1,725,676                        |       | 1,404,992                       |       | 5,469,643 |   | 4,194,815 |   |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Loss from  operations                     |       | (980,974                         | )          | (942,041                        | )          | (3,570,019 | ) | (2,836,396 | ) |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Other income  (expense)                   |       |                             |       |                            |       |   |   |   |   |
| Interest income                           |       | 165,014                          |       | 487,456                         |       | 772,835 |   | 1,521,570 |   |
| Other expense                             |       | —                           |       | —                          |       | — |   | (21,453 | ) |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Net loss before  income tax benefit       |       | (815,960                         | )          | (454,585                        | )          | (2,797,184 | ) | (1,336,279 | ) |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Income tax  benefit                       |       | (279,975                         | )          | —                          |       | (848,961 | ) | — |   |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Net loss                                  |       | $                                | (535,985   | )                               | $          | (454,585 | ) | $ | (1,948,223 | ) | $ | (1,336,279 | ) |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Loss per common  share                    |       |                             |       |                            |       |   |   |   |   |
| Basic and  Diluted                        |       | $                                | (0.02      | )                               | $          | (0.02 | ) | $ | (0.07 | ) | $ | (0.05 | ) |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Weighted average  number of common shares |       |                             |       |                            |       |   |   |   |   |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Basic and  Diluted                        |       | 26,784,473                       |       | 26,720,444                      |       | 26,779,339 |   | 26,685,612 |   |

 

----

*General andadministrative expenses for the three month periods ended March 31, 2008and 2007 included non cash stock-based compensation expense of $493,872 and$376,008, respectively.  General andadministrative expenses for the nine month periods ended March 31, 2008and 2007 included non cash stock-based compensation expense of $1,311,443 and$1,237,485, respectively.

 

See accompanyingnotes to consolidated condensed financial statements.

 

3

----

 

**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Cash Flow**

**(unaudited)**

** **
| ** **                                                                                                                             | ** ** | **Nine Months Ended  March 31** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2008**                                       | ** ** | **2007** | ** ** |
| Cash flows from  operating activities                                                                                                  | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| Net loss                                                                                                                               |       | $                                              | (1,948,223 | ) | $ | (1,336,279 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities                                                            |       |                                           |       |   |   |
| Depreciation,  depletion and amortization                                                                                              |       | 372,645                                        |       | 164,793 |   |
| Stock-based  compensation                                                                                                              |       | 1,311,443                                      |       | 1,237,485 |   |
| Accretion of  asset retirement obligations                                                                                             |       | 16,656                                         |       | 12,774 |   |
| Changes in  operating assets and liabilities:                                                                                          |       |                                           |       |   |   |
| Receivables                                                                                                                            |       | (1,106,086                                     | )          | (36,426 | ) |
| Prepaid expenses  and other assets                                                                                                     |       | 286,961                                        |       | (143,499 | ) |
| Accounts payable  and accrued expenses                                                                                                 |       | (146,399                                       | )          | (328,489 | ) |
| Royalties  payable                                                                                                                     |       | (259                                           | )          | (40,340 | ) |
| Deferred rent                                                                                                                          |       | 25,847                                         |       | 11,822 |   |
| Income tax  payable                                                                                                                    |       | —                                         |       | (11,260,000 | ) |
| Net cash used in  operating activities                                                                                                 |       | (1,187,415                                     | )          | (11,718,159 | ) |
|                                                                                                                                   |       |                                           |       |   |   |
| Cash flows from  investing activities                                                                                                  |       |                                           |       |   |   |
| Net proceeds  from the sale of the Tullos Assets                                                                                       |       | 4,420,868                                      |       | — |   |
| Proceeds from  other asset divestitures                                                                                                |       | 31,582                                         |       | 155,378 |   |
| Development of  oil and natural gas properties                                                                                         |       | (4,280,822                                     | )          | (267,245 | ) |
| Acquisitions of  oil and natural gas properties                                                                                        |       | (6,775,267                                     | )          | (395,918 | ) |
| Capital  expenditures for furniture, fixtures and equipment                                                                            |       | (79,305                                        | )          | (70,313 | ) |
| Cash in  qualified intermediary account for “like-kind” exchanges                                                            |       | —                                         |       | 34,662,368 |   |
| Other assets                                                                                                                           |       | (1,375                                         | )          | 29,692 |   |
| Net cash (used  in) provided by investing activities                                                                                   |       | (6,684,319                                     | )          | 34,113,962 |   |
|                                                                                                                                   |       |                                           |       |   |   |
| Cash flows from  financing activities                                                                                                  |       |                                           |       |   |   |
| Equity and  transaction costs                                                                                                          |       | —                                         |       | (15,591 | ) |
| Proceeds from  issuance of restricted stock grants                                                                                     |       | 76                                             |       | 57 |   |
| Net cash  provided by (used in) financing activities                                                                                   |       | 76                                             |       | (15,534 | ) |
|                                                                                                                                   |       |                                           |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                                                                                  |       | (7,871,658                                     | )          | 22,380,269 |   |
|                                                                                                                                   |       |                                           |       |   |   |
| Cash and cash  equivalents, beginning of period                                                                                        |       | 27,746,942                                     |       | 9,893,547 |   |
|                                                                                                                                   |       |                                           |       |   |   |
| Cash and cash  equivalents, end of period                                                                                              |       | $                                              | 19,875,284 |   | $ | 32,273,816 |   |
|                                                                                                                                   |       |                                           |       |   |   |
| Supplemental  disclosure of cash flow information:                                                                                     |       |                                           |       |   |   |
| Income taxes  paid                                                                                                                     |       | $                                              | 33,879     |   | $ | 11,260,000 |   |
| Increase in  accounts payable incurred to acquire oil and natural gas leasehold interests  and develop oil and natural gas properties. |       | $                                              | 2,081,781  |   | $ | — |   |

 

See accompanyingnotes to consolidated condensed financial statements.

 

4

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

**(unaudited)**

 

**Note 1****–****Organization and Basis ofPreparation**

 

***Nature ofOperations.***  EvolutionPetroleum Corporation (“EPM”) and its subsidiaries, formerly Natural GasSystems, Inc. (the “Company”, “we” or “us”), is an independent petroleumcompany headquartered in Houston, Texas and incorporated under the laws of theState of Nevada.  We are engagedprimarily in the acquisition, exploitation and development of properties forthe production of crude oil and natural gas. We acquire established oil and natural gas properties and exploit themthrough the application of conventional and specialized technology to increaseproduction, ultimate recoveries, or both.

 

Our common stock is traded on the American StockExchange (“AMEX”) under the ticker symbol EPM. Prior to July 17, 2006, our common stock was quoted on the OTCBulletin Board under the symbol NGSY.OB. Prior to May 26, 2004, our common stock was quoted on the OTCBulletin Board under the symbol RLYI.OB. Concurrently with the listing of our shares on the AMEX during July,2006, we changed our name from Natural Gas Systems, Inc. to EvolutionPetroleum Corporation to avoid confusion with similar names traded on the AMEXand to better reflect our business model.

 

***Interim FinancialStatements.***  The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) with theinstructions to Form 10-Q for interim financial information.  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 2007 Annual Report on Form 10-KSB for theyear ended June 30, 2007, as filed with the Securities and ExchangeCommission. The results of operations for interim periods are not necessarilyindicative of results to be expected for a full fiscal year.

 

***Principles ofConsolidation and Reporting.***  Ourconsolidated financial statements include the accounts of EPM and itswholly-owned subsidiaries. All significant intercompany transactions have beeneliminated in consolidation. The consolidated financial statements for theprevious period include certain reclassifications that were made to conform tothe current presentation.  Suchreclassifications have no impact on previously reported income or stockholders’equity.

 

***Use ofEstimates. ***The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities at the dates of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting periods. Estimates of proved reserves are key components of ourdepletion rate for our proved oil and natural gas properties and the full costceiling test limitation. Accordingly, our accounting estimates require exerciseof judgment. While we believe that the estimates and assumptions used inpreparation of the consolidated financial statements are appropriate, actualresults could differ from those estimates.

 

**Note 2 –Recent Accounting Pronouncements**

 

***New AccountingStandards.**** *The following discloses the existence and effect of accountingstandards issued but not yet adopted by us with respect to accounting standardsthat may have an impact on the Company when adopted in the future.

 

***Accounting for Business Combinations.***  In December 2007, theFinancial Accounting Standards Board (“FASB”) issued Statements of AccountingStandards (“SFAS”) No. 141R,*BusinessCombinations* (“SFAS No. 141R”), which replaces SFAS No. 141,*  BusinessCombinations* . SFAS 141R establishes principles and requirements fordetermining how an enterprise recognizes and measures the fair value of certainassets and liabilities acquired in a business combination, includingnon-controlling interests, contingent consideration, and certain acquiredcontingencies.  SFAS No. 141R alsorequires acquisition-related transaction expenses and restructuring costs beexpensed as incurred rather than capitalized as a component of the businesscombination.  SFAS 141R will beapplicable prospectively to business combinations for which the acquisitiondate is on or after the beginning of the first annual reporting periodbeginning on or after December 15, 2008. SFAS No. 141R would have animpact on accounting for any businesses acquired after the effective date ofthis pronouncement.

 

5

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

**(unaudited)**

 

**Note 2 –Recent Accounting Pronouncements**(Continued)

 

***Accounting for Fair Value Measurements*****. **In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS No. 157”).  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in GAAP and expandsdisclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007.  The provisions of SFAS No. 157 will beapplied prospectively as of the beginning of the fiscal year in which it isinitially applied except for, among other items, a financial instrument thatwas measured at fair value at initial recognition under Statement 133 using thetransaction price in accordance with the guidance in footnote 3 of Issue 02-3prior to initial application of SFAS No. 157.  In February 2008, the FASB deferred theeffective date of SFAS No. 157 by one year for nonfinancial assets andnonfinancial liabilities that are recognized or disclosed at fair value in thefinancial statements on a financial statements on a nonrecurring basis andamended SFAS No. 157 to exclude SFAS No. 13, *Accountingfor Leases,* and its related interpretive accounting pronouncementsthat address leasing transactions. We are currently evaluating the impact thatthis Statement will have on our financial statements.

 

****Accountingfor the Fair Value Option for Financial Assets and Financial Liabilities********.**** In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(“SFAS No. 159”), which permits all entities to choose, at specifiedelection dates, to measure eligible items at fair value.  SFAS No. 159 permits entities to chooseto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value, and therebymitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. This Statement also establishes presentation and disclosurerequirements designed to facilitate comparisons between entities that choosedifferent measurement attributes for similar types of assets andliabilities.  SFAS No. 159 iseffective as of the beginning of an entity’s first fiscal year that beginsafter November 15, 2007.  We arecurrently evaluating the impact that this Statement will have on our financialstatements.

 

**Note 3 –Sale of Oil and Natural Gas Properties**

 

On March 3, 2008,NGS Sub Corp., a Delaware corporation (“NGS”), a wholly owned subsidiaryof EPM, pursuant to an Asset Purchase and Sale Agreement (the “Asset SaleAgreement”) dated February 15, 2008, completed the sale of its 100%working interest and approximately 79% average net revenue interest inproducing and shut-in crude oil wells, water disposal wells, equipment andimprovements (the “Tullos Assets”) located in the Tullos Urania, Colgrade andCrossroads Fields in LaSalle and Winn Parishes, Louisiana (the “Tullos FieldArea”).  The following table presents thetransaction and its affect on our financial statements.

 
| **Proceeds  from sale of the Tullos Assets**                                 |   | $          | 4,649,241 |   |
|------------------------------------------------------------------------------|--------|------------|-----------|--------|
| Less payout of a  carried interest arrangement                               |   | (168,106   | )         |
| Less  miscellaneous transaction costs                                        |   | (60,267    | )         |
| *Net  proceeds from sale of the Tullos Assets*                               |   | 4,420,868  |      |
| **Net  book value of Tullos Assets on March 3, 2008**                   |   |       |      |
| Asset retirement  obligation                                                 |   | 153,886    |      |
| Oil and natural  gas properties                                              |   | (1,721,990 | )         |
| Other property  and equipment                                                |   | (26,721    | )         |
| Prepaid expenses  and other current assets                                   |   | (178,826   | )         |
| Other assets                                                                 |   | (13,347    | )         |
| **Amount  credited to accumulated depreciation, depletion and amortization** |   | $          | 2,633,870 |   |

 

The Tullos Assetsrepresented approximately 18% of the Company’s total proved reserves as of March 3,2008.

 

6

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

**(unaudited)**

 

**Note 4 –****Unaudited Pro Forma ConsolidatedFinancial Information**

 

The following unauditedpro forma consolidated financial information is presented for illustrativepurposes only and presents the pro forma operating results for the Company forthe three and nine month periods ended March 31, 2008 and 2007 as thoughthe disposition of the Tullos Assets occurred at the beginning of each period.The unaudited pro forma consolidated financial information is not intended tobe indicative of the operating results that actually would have occurred if thetransaction had been consummated at the beginning of each period presented, noris the information intended to be indicative of future operating results.

 

The pro formaconsolidated financial information for the three months ended March 31, 2008and 2007 are as follows:

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007**     | ** ** |
| ** **                                      | ** ** | **As  Reported**                 | ** ** | **Pro  Forma**                   | ** ** | **As  Reported** | ** ** | **Pro  Forma** | ** ** |
| Oil and natural  gas revenues                   |       | $                                | 744,702    |                             | $          | 351,848 |   | $ | 462,951 |   | $ | 9,716 |   |
| Loss from  operations                           |       | $                                | (980,974   | )                                | $          | (1,058,901 | ) | $ | (942,041 | ) | $ | (923,349 | ) |
| Net loss                                        |       | $                                | (535,985   | )                                | $          | (583,910 | ) | $ | (454,585 | ) | $ | (437,893 | ) |
|                                            |       |                             |       |                             |       |   |   |   |   |
| Loss per common  share – basic and diluted |       | $                                | (.02       | )                                | $          | (.02 | ) | $ | (.02 | ) | $ | (.02 | ) |

 

The pro formaconsolidated financial information for the nine months ended March 31,2008 and 2007 are as follows:

 
| ** **                                      | ** ** | **Nine Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **March 31, 2008**    | ** ** | **March 31, 2007**    | ** ** |
| ** **                                      | ** ** | **As  Reported**                | ** ** | **Pro  Forma**                  | ** ** | **As  Reported** | ** ** | **Pro  Forma** | ** ** |
| Oil and natural  gas revenues                   |       | $                               | 1,899,624  |                            | $          | 422,269 |   | $ | 1,358,419 |   | $ | 28,193 |   |
| Loss from  operations                           |       | $                               | (3,570,019 | )                               | $          | (3,802,297 | ) | $ | (2,836,396 | ) | $ | (2,941,809 | ) |
| Net loss                                        |       | $                               | (1,948,223 | )                               | $          | (2,091,074 | ) | $ | (1,336,279 | ) | $ | (1,392.046 | ) |
|                                            |       |                            |       |                            |       |   |   |   |   |
| Loss per common  share – basic and diluted |       | $                               | (.07       | )                               | $          | (.08 | ) | $ | (.05 | ) | $ | (.05 | ) |

 

7

----

** **

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 5 –****Property and Equipment**

 

Oil and natural gasproperties are accounted for using the full-cost method of accounting.  All costs associated with the acquisition,exploration and development of oil and natural gas properties arecapitalized.  As of March 31, 2008and June 30, 2007 our oil and natural gas properties and other propertyand equipment consisted of the following:

 
| ** **                                                                 | ** ** | **March 31,  2008** | ** ** | **June 30,  2007** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Oil and  natural gas properties**                                        |       |                     |       |                    |       |
| Property costs  subject to amortization                                    |       | $                        | 8,609,536  |                    | $          | 4,187,440 |   |
| Less:  Accumulated depreciation, depletion, and  amortization (See Note 3) |       | (2,744,423               | )          | (652,439                | )          |
| Unproved  properties                                                       |       | 8,188,699                |       | 1,924,552               |       |
| Oil and natural  gas properties, net                                       |       | $                        | 14,053,812 |                    | $          | 5,459,553 |   |
|                                                                       |       |                     |       |                    |       |
| **Other  property and equipment**                                          |       |                     |       |                    |       |
| Furniture,  fixtures and equipment, at cost                                |       | 223,601                  |       | 173,205                 |       |
| Less:  Accumulated depreciation                                            |       | (61,731                  | )          | (18,333                 | )          |
| Other property  and equipment, net                                         |       | $                        | 161,870    |                    | $          | 154,872 |   |

 

**Note 6****–****Asset Retirement Obligations**

 

Our asset retirementobligations represent the estimated present value of the amount we will incurto plug, abandon and remediate our producing properties at the end of theirproductive lives in accordance with applicable laws. The following is areconciliation of the beginning and ending asset retirement obligation for thenine month period ended March 31, 2008:

 
| Asset retirement  obligation - July 1, 2007        |   | $        | 140,998 |   |
|---------------------------------------------------------|--------|----------|---------|--------|
| Liabilities  incurred                                   |   | 170,890  |    |
| Liabilities  settled                                    |   | —   |    |
| Liabilities sold  (See Note 3)                          |   | (153,886 | )       |
| Accretion                                               |   | 16,656   |    |
| Asset retirement  obligation – March 31, 2008 |   | $        | 174,658 |   |

 

**Note 7****–****Stock-Based Incentive Plan**

 

Stockholders of record, as of October 15, 2007,voted at the 2007 Annual Meeting of Stockholders on December 4, 2007 toapprove amendments to the 2004 Stock Plan to increase the number of shares ofcommon stock we may authorize to issue from 4,000,000 shares to 5,500,000shares and to make certain clarifying changes and amendments as part of theapproval of the Evolution Petroleum Corporation Amended and Restated 2004 StockPlan.

 

We have granted commonstock option awards to purchase common stock (the “Stock Options”) andrestricted common stock awards (“Restricted Stock”) to employees, directors,and consultants of the Company and its subsidiaries under the Natural GasSystems Inc. 2003 Stock Plan (the “2003 Stock Plan”) and the EvolutionPetroleum Corporation Amended and Restated 2004 Stock Plan (the “2004 StockPlan” and together, the “EPM Stock Plans”). A total of 510,000 shares of common stock are reserved for issuanceunder the 2003 Stock Plan, and there are no further shares available for grantunder the 2003 Stock Plan.  A total of5,500,000 shares are reserved for issuance under the 2004 Stock Plan and, as ofMarch 31, 2008 a total of 1,375,859 shares remain available for grantunder the 2004 Stock Plan.

 

8

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 7****–****Stock-Based Incentive Plan**(Continued)

 

We have also grantedcommon stock warrants, as authorized by the Board of Directors, to employees asbonus or incentive awards to reward previous service or provide incentives toindividuals to acquire a proprietary interest in the Company and to remain inthe service of the Company (the “Incentive Warrants”).  These Incentive Warrants have similarcharacteristics of the Stock Options. The Incentive Warrants have been issued, with Board of Directorsapproval, outside of the EPM Stock Plans.

 

***StockOptions and Incentive Warrants***

 

For the three monthperiods ended March 31, 2008 and 2007, total stock based compensationexpense recognized for Stock Options and Incentive Warrants was $416,143 and$301,097, respectively.  Stock-basedcompensation expense related to the nine month periods ended March 31,2008 and 2007 was $1,120,349 and $985,713, respectively.

 

During the nine monthperiod ended March 31, 2008, we granted Stock Options to purchase1,385,000 shares of common stock under the 2004 Stock Plan with a weightedaverage exercise price of $2.49.  Duringthe nine month period ended March 31, 2007, we granted Stock Options topurchase 150,000 shares of common stock under the 2004 Stock Plan with aweighted average exercise price of $2.71. The exercise price was determined based on the market price of theCompany’s common stock on the date of grant. The Stock Options granted during the nine months ended March 31,2008 vest over a weighted average period of 4.0 years and have a contractuallife of ten years.  The weighted averageassumptions used to calculate the fair value of these Stock Options and theweighted average fair value of each Stock Option granted is as follows:

 

| ** **                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **March 31,**              | ** ** |
| ** **                   | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| Expected  volatility         |       | 93.4                            | %          | 96.0 | % |
| Expected  dividends          |       | —                          |       | — |   |
| Expected term  (in years)    |       | 6.10                            |       | 6.10 |   |
| Risk-free rate               |       | 4.10                            | %          | 4.56 | % |
| Fair value per  Stock Option |       | $                               | 1.94       |   | $ | 2.15 |   |
|                              |            |                                 |            |  |  |  |  |

 

We estimated the fairvalue of Stock Options and Incentive Warrants issued to employees and directorsunder SFAS No. 123R at the date of grant using a 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 estimated expected term for “plain vanilla” options allowed by theSEC Staff Accounting Bulletin No. 107 and 110, and varied based on thevesting period and contractual term of the Stock Options or IncentiveWarrants.   Expected volatility is basedon the historical volatility of the Company’s closing common stock price andthat of an evaluation of a peer group of similar companies tradingactivity.  We have not issued any cashdividends on the Company’s common stock.

 

9

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 7****–****Stock-Based Incentive Plan**(Continued)

 

The following summarypresents information regarding outstanding Stock Options and Incentive Warrantsas of March 31, 2008, and the changes during the nine months then ended:

 
| ** **                                                          | ** ** | **Number of Stock  Options  and Incentive  Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value  (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|
|                                                                |       |                                                                 |       |                                           |       |                                     |       |                                                                 |       |
| Options and  Incentive Warrants  outstanding at July 1, 2007   |       | 4,058,500                                                            |       | $                                              | 1.53       |                                     |       |                                                                 |       |   |
|                                                                |       |                                                                 |       |                                           |       |                                     |       |                                                                 |       |
| Granted                                                             |       | 1,385,000                                                            |       | $                                              | 2.49       |                                     |       |                                                                 |       |   |
| Exercised                                                           |       | —                                                               |       | —                                         |       |                                     |       |                                                                 |       |
| Canceled,  forfeited, or expired                                    |       | —                                                               |       | —                                         |       |                                     |       |                                                                 |       |
|                                                                |       |                                                                 |       |                                           |       |                                     |       |                                                                 |       |
| Options and  Incentive Warrants  outstanding at March 31, 2008 |       | 5,443,500                                                            |       | $                                              | 1.78       |                                     | $          | 15,097,025                                                           |       | 7.8 |   |
|                                                                |       |                                                                 |       |                                           |       |                                     |       |                                                                 |       |
| Vested or  expected to vest at March 31, 2008                  |       | 5,443,500                                                            |       | $                                              | 1.78       |                                     | $          | 15,097,025                                                           |       |   |   |
|                                                                |       |                                                                 |       |                                           |       |                                     |       |                                                                 |       |
| Exercisable at  March 31, 2008                                 |       | 3,142,250                                                            |       | $                                              | 1.44       |                                     | $          | 9,765,294                                                            |       | 7.1 |   |

 

----

(1) Based upon thedifference between the market price of our common stock on the last tradingdate of the quarter and the Stock Option or Incentive Warrant exercise price ofin-the-money Stock Options and Incentive Warrants.

 

A summary of the statusof our unvested Stock Options and Incentive Warrants as of March 31, 2008,and the changes during the nine months ended March 31, 2008, is presentedbelow:

 
| ** **                       | ** ** | **Number of  Options and  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|----------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                             |       |                                           |       |                                                         |       |
| Unvested at  July 1, 2007   |       | 1,573,125                                      |       | $                                                            | 1.50       |   |
|                             |       |                                           |       |                                                         |       |
| Granted                          |       | 1,385,000                                      |       | $                                                            | 1.94       |   |
|                             |       |                                           |       |                                                         |       |
| Vested                           |       | (656,875                                       | )          | $                                                            | 1.46       |   |
|                             |       |                                           |       |                                                         |       |
| Canceled,  forfeited, or expired |       | —                                         |       | —                                                       |       |
|                             |       |                                           |       |                                                         |       |
| Unvested at end  of period       |       | 2,301,250                                      |       | $                                                            | 1.78       |   |

 

The total unrecognizedcompensation cost at March 31, 2008, relating to non-vested share-basedcompensation arrangements granted under the EPM Stock Plans and IncentiveWarrants was $3,747,895.  Suchunrecognized expense will be recognized over a weighted average period of 2.9years.

 

**Restricted Stock**

 

For the nine months endedMarch 31, 2008, we granted a total of 75,899 shares of Restricted Stock tothree outside directors and a consultant. All issuances of common stock are subject to vesting terms perindividual Restricted Stock agreements.

 

10

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 7****–****Stock-Based Incentive Plan**(Continued)

 

During the three monthsended March 31, 2008 and 2007, we recognized compensation expense of$77,729 and $74,911, respectively, related to Restricted Stock grants.  During the nine months ended March 31,2008 and 2007, we recognized compensation expense of $191,094 and $251,772,respectively, related to Restricted Stock grants.

 

The following table setsforth the restricted stock transactions for the nine months ended March 31,2008:

 
| ** **                     | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                           |       |                                   |       |                                               |       |
| Unvested at  July 1, 2007 |       | 59,449                                 |       | $                                                  | 2.78       |   |
|                           |       |                                   |       |                                               |       |
| Granted                        |       | 75,899                                 |       | 4.10                                               |       |
|                           |       |                                   |       |                                               |       |
| Vested                         |       | (71,949                                | )          | 3.00                                               |       |
|                           |       |                                   |       |                                               |       |
| Forfeited                      |       | —                                 |       | —                                             |       |
|                           |       |                                   |       |                                               |       |
| Unvested at end  of period     |       | 63,399                                 |       | $                                                  | 4.10       |   |

 

At March 31, 2008,unrecognized stock compensation expense related to Restricted Stock grantstotaled $233,194.  Such unrecognizedexpense will be recognized over a weighted average period of 0.7 years.

 

**Note 8****–****Commodity Hedging and Price RiskManagement Activities**

 

As of February 28,2007, all of our commodity hedging and price risk management activities hadexpired and were not renewed.

 

**Note 9****–****Income Taxes**

 

We file a consolidatedfederal income tax return in the United States and various combined andseparate filings in several state and local jurisdictions.  There is currently an Internal RevenueService (“IRS”) field examination in process for the fiscal year ended June 30,2006.  No estimate as to the outcome ofthe IRS field examination can be made at this time.

 

We adopted FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes – an interpretation of SFAS No. 109*, (“FIN 48”),effective July 1, 2007.  The adoption of FIN 48 did not have aneffect on our consolidated financial statements.  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, *Accounting for IncomeTaxes*.  FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  FIN 48 also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition.

 

There were nounrecognized tax benefits as of the date of adoption.  There are nounrecognized tax benefits that if recognized would affect our tax rate.  The Company’s practice is to recognizeestimated interest and penalties related to potential underpayment onunrecognized tax benefits as a component of income tax expense in theConsolidated Statement of Operations. As of the date of adoption of FIN48, the Company did not have any accrued interest or penalties associated withany unrecognized tax benefits, nor was any interest expense recognized for thenine months ended March 31, 2008. We cannot predict whether total unrecognized tax benefits willsignificantly change due to the settlement of the current IRS field examinationor possible future examinations.

 

11

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 9****–****Income Taxes**(Continued)

 

We account for incometaxes in accordance with SFAS No. 109,*Accounting for Income Taxes* (“SFAS No. 109”). SFAS No. 109requires us to recognize income tax benefits for loss carry forwards which havenot previously been recorded. The tax benefits recognized must be reducedby a valuation allowance when it is more likely than not that the deferred taxasset will not be realized.

 

In determining thecarrying value of a deferred tax asset, SFAS 109 provides for the weighing ofevidence in estimating whether and how much of a deferred tax asset may berecoverable.  We have placed a valuationallowance on certain deferred tax assets primarily inclusive of net operatinglosses (“NOL’s”) that are limited by Internal Revenue Code Section 382.   The Company had taxable income in 2006 and2007 and thus paid both federal and state income taxes.  A benefit is being recognized with theintention of carrying any current year tax loss back to 2006.  We believe sufficient taxable income isavailable in 2006 and 2007 to fully utilize the losses created in the currentyear.  Therefore, management believes novaluation allowance is necessary on the income tax benefit arising from thetaxable loss in the current year.

 

The income tax benefitrate varies from the U.S. statutory rate primarily due to state income taxespartially offset by disallowed compensation costs related to incentive stockoptions.

 

**Note 10****–****Related Party Transactions**

 

Laird Q. Cagan, Chairman of our Board of Directors, isa Managing Director and co-owner of Cagan McAfee Capital Partners, LLC (“CMCP”).CMCP performs financial advisory services to us pursuant to a written agreementamended in November 2005, providing for a retainer of $5,000 permonth.  In addition, Mr. Cagan, as aregistered representative of Chadbourn Securities Inc. (“Chadbourn”) and apartner of CMCP, has served as the Company’s placement agent in private equityfinancings.  Under the current agreement,CMCP may earn cash fees equal to 8% of gross equity proceeds, declining to 4%subject to the amount of equity raised through CMCP, and a fixed 4% warrantfee.  Mr. Cagan receives noadditional compensation for serving as a director or as the Chairman of ourBoard of Directors.

 

Eric A. McAfee, a major shareholder of the Company, isalso a Managing Director of CMCP.

 

During the three and nine months ended March 31,2008 and 2007 respectively, we expensed and paid CMCP $15,000 and $45,000,respectively, in quarterly retainers. There were no other earned fees by CMCP during the three and nine monthsended March 31, 2008 and 2007.

 

**Note 11 –****Net Loss per Share**

 

Basic and diluted loss per share are computed bydividing net loss available to common shareholders by the weighted averagenumber of common shares outstanding during the period.  For purposes of computing diluted loss pershare, potential common shares have been excluded from the computation ofweighted average common shares outstanding, because their effect isantidilutive.

 

12

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note 11 –****Net Loss per Share**(Continued)

 

The following table sets forth the computation ofbasic and diluted loss per share:

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                         | ** ** | **2008**                                         | ** ** | **2007**                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| *Numerator*                                                        |       |                                             |       |                                            |       |   |   |   |   |
| Net loss                                                           |       | $                                                | (535,985   | )                                               | $          | (454,585 | ) | $ | (1,948,223 | ) | $ | (1,336,279 | ) |
|                                                               |       |                                             |       |                                            |       |   |   |   |   |
| *Denominator*                                                      |       |                                             |       |                                            |       |   |   |   |   |
| Weighted average  number of common shares – basic and diluted |       | 26,784,473                                       |       | 26,720,444                                      |       | 26,779,339 |   | 26,685,612 |   |
|                                                               |       |                                             |       |                                            |       |   |   |   |   |
| Net Loss per  common share – basic and diluted                |       | $                                                | (0.02      | )                                               | $          | (0.02 | ) | $ | (0.07 | ) | $ | (0.05 | ) |

 

**Note12 – Commitments and Contingencies**

 

***Environmental clean-up.*** On August 3, 2007, we were advised of an oil spill in the TullosField near one of our leases. At the request of field agents of the LouisianaDepartment of Environmental Quality and the Environmental Protection Agency (“EPA”),we agreed to commence a clean-up operation that was completed by the end of August 2007.A detailed analysis of the oil in the spill compared to the Company’s producedoil was conducted by an EPA approved laboratory.  We believe that the oil in the spill did notoriginate from our operations, supported by the formal findings of thelaboratory.  We received an initialinsurance reimbursement of $484,197 in October 2007 and a final insurancereimbursement of $217,668 in March 2008. These reimbursements covered all of our actual cleanup costs except a$5,000 insurance deductible and excluding our legal fees, in-houseadministrative costs, and any possible EPA expense reimbursements and finesthat might be billed.

 

On May 5, 2008, we received a letter from the EPAproposing a $5,500 fine related to the oil spill, which we believe is notsupported by independent investigation. As of the date of this filing , we have not responded to the EPAproposal.

 

***Litigation.*** In November 2005, a multi-plaintiff lawsuit was filed in the FifthJudicial District Court, Richland Parish, Louisiana, against 18 defendantsincluding NGS Sub Corp. and Arkla Petroleum LLC, the Company’s wholly ownedsubsidiaries (the “Subsidiaries”), as working interest owners/operators ofvarious oil and natural gas leases in the Delhi Field. Plaintiffs claim thatthe defendants’ oil and natural gas exploration, development and productionactivities on their properties have caused soil and ground water contaminationas a result of the release of hydrocarbons and drilling fluids. Plaintiffs seekdamages for testing, clean-up and remediation of the properties as well asdiminution in their value and mental anguish to the individual plaintiffs, unjustenrichment and punitive damages for alleged concealment of ongoing activities.

 

Certain exceptions filedby the defendants are still under consideration by the court.  Discovery has begun and the allegations ofplaintiffs’ suit are so vague that the specifics of their claims cannot bedetermined yet with certainty. Accordingly, the court has ordered the plaintiffs to file their claimswith specificity.  Trial is set before a juryin Richland Parish for July of 2009.

 

We intend to contestplaintiffs’ claims vigorously.  Theplaintiffs have not produced any evidence of specific damage to their lands bydefendants’ oil and natural gas operations. While the Delhi Field has been in production for over fifty years, webelieve that no contamination of significance occurred during our period ofownership.  We believe that our liabilityexposure results largely through any potential contractual indemnity of priorworking interest owners.

 

During the quarter ended June 2006,new legislation was passed and signed in Louisiana addressing complaintssimilar to and including those filed against Delhi operators and workinginterest owners.  Although the intention of the legislation was toposition the Louisiana Department of Environmental Quality and Natural Resourcesto determine the existence and extent of any environmental damages, the sourceof liability and necessary remediation plan and cost, and to ensure that anycompensatory payments be used to remediate damages, it is unclear at this timewhether such legislation will be applied.

 

13

----

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

**Note12 – Commitments and Contingencies**(Continued)

 

***Lease Commitments.***  We have anon-cancelable operating lease for office space that expires on August 1,2016. Future minimum lease commitments as of March 31, 2008 under thisoperating lease are as follows:

 

| **Twelve  months ending March 31,** |   |    |      |
|------------------------------------------|--------|---------|-----------|
| 2009                                     |   | $       | 138,089   |   |
| 2010                                     |   | 138,089 |      |
| 2011                                     |   | 138,089 |      |
| 2012                                     |   | 152,037 |      |
| 2013                                     |   | 159,012 |      |
| Thereafter                               |   | 530,037 |      |
| Total                                    |   | $       | 1,255,353 |   |

 

Rent expense for thethree months ended March 31, 2008 and 2007 was $35,466 and $22,552,respectively.  Rent expense for the nine months ended March 31,2008 and 2007 was $106,399 and $44,013, respectively.

 

***EmploymentContracts.***  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, thatincludes payment of base pay and certain medical and disability benefits fromsix months to a year after termination.  The total contingent obligation under the employment contracts as of March 31,2008 is approximately $450,000.

 

***InternalRevenue Service Examination.***  We file aconsolidated federal income tax return in the United States and variouscombined and separate filings in several state and local jurisdictions.   With limited exceptions, the Company is nolonger subject to U.S. Federal, state and local income tax examinations by taxauthorities for years before fiscal year ending June 30, 2005.  There is currently an Internal RevenueService (“IRS”) field examination in process for the fiscal year ended June 30,2006.  No estimate as to the outcome ofthe IRS field examination can be made at this time.

 

14

----

 

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*This Form 10-Q and theinformation referenced herein contain forward-looking statements within themeaning of the Private Securities Litigations Reform Act of 1995, Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,”“anticipate,” “intend,” “budget,” “forecast,” “predict” and other similarexpressions are intended to identify forward-looking statements. Thesestatements appear in a number of places and include statements regarding ourplans, beliefs or current expectations, including the plans, beliefs andexpectations of our officers and directors.* *When considering anyforward-looking statement, you should keep in mind the risk factors that couldcause our actual results to differ materially from those contained in anyforward-looking statement. Important factors that could cause actual results todiffer materially from those in the forward-looking statements herein includethe timing and extent of changes in commodity prices for oil and natural gas,operating risks and other risk factors as described in our 2007 Annual Reporton Form 10-KSB for the year ended June 30, 2007 as filed with theSecurities and Exchange Commission. Furthermore, the assumptions that supportour forward-looking statements are based upon information that is currentlyavailable and is subject to change. We specifically disclaim all responsibilityto publicly update any information contained in a forward-looking statement orany forward-looking statement in its entirety and therefore disclaim anyresulting liability for potentially related damages. All forward-lookingstatements attributable to Evolution Petroleum Corporation are expresslyqualified in their entirety by this cautionary statement.*

 

*We use the terms, “EPM,” “Company,”“we,” “us” and “our” to refer to Evolution Petroleum Corporation.*

 

**Executive Overview**

 

*General*

 

Evolution Petroleum Corporation, formerly Natural GasSystems, Inc., is a petroleum company engaged primarily in theacquisition, exploitation and development of properties for the production ofcrude oil and natural gas. We acquire known oil and natural gas resources andexploit them through the application of conventional and specialized technologyto increase production, ultimate recoveries, or both.

 

We are focused on an overall strategy of acquiringcontrolling working interests in oil and natural gas resources withinestablished fields and redeveloping those fields through the application ofcapital and technology to convert a portion of the oil and natural gasresources into profitable producing reserves. 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 specificinitiatives:

 
| I      |   | Enhanced oil recovery (“EOR”), using miscible and  immiscible gas flooding;                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                  |
| II     |   | Conventional redevelopment of bypassed primary  resource within mature oil and natural gas fields utilizing modern technology  and our expertise; and |
|   |   |                                                                                                                                                  |
| III    |   | Unconventional gas resource development, using  modern stimulation and completion technologies.                                                       |

 

15

----

 

Our most strategic asset is within our EOR Initiativeat the 13,636 acre Delhi Field, located in northeast Louisiana.  Our non-operated interests consist of 7.4% inoverriding and mineral royalty interests and a 25% after pay-out reversionaryworking interest in the Delhi Field Holt Bryant Unit, along with a 25% workinginterest in certain other depths in the Delhi Field.  The Holt Bryant Unit is currently beingredeveloped by the operator, Denbury Resources, using CO2 enhanced oilrecovery technology and a dedicated portion of Denbury’s proved CO2 reserves in theJackson Dome, approximately 90 miles east of Delhi. Injection of CO2 is expected tobegin by late calendar 2008 or early calendar 2009, followed by projectedincreases in oil production beginning in calendar 2009.

 

Since our closing of the Delhi Farmout, we have beenfocused on developing projects in our other initiatives, particularly throughconventional redevelopment of bypassed resources in the Giddings Field ofCentral Texas using horizontal drilling methods,  and unconventional gas shale developmentprojects in the Woodford Shale Trend in Oklahoma.  Conceptually, our plan going forward can beillustrated as follows:

 

 

As indicated by the above chart, we are funding ourcurrent development projects in the Giddings Field with our current workingcapital resources.  We expect that netcash flows from these projects, our current cash resources and cash flows fromthe Delhi CO2 EOR project will be used to fund ourUnconventional Gas Initiative and other new projects.

 

*Highlights for the nine months ended March 31,2008*

 

·                  **We high-graded our production and reserve base within our Bypassed ResourceInitiative**

 

***We completed the sale of ourTullos Assets.***  On March 3, 2008, we completed the saleof our Tullos Assets for gross cash proceeds of approximately $4.6million.  While only producing about 100gross and 79 net barrels of oil production per day from over 150 producingwells, Tullos required a disproportionate amount of staff effort and vendorservices, thereby adversely affecting our ability to develop other projectsutilizing our expertise and working capital. Furthermore, we believe the potential upside at Tullos was substantiallyless than that offered in our other projects then underway, particularly theGiddings Field drilling program, where the Tullos cash proceeds would beexpected to yield a much higher return. Last, we had completed the testing of our completion technologyutilizing the one well we drilled in Tullos and determined that the potentialof that technology would be best realized in other fields.

 

***We initiated our developmentdrilling program in the Giddings Field of Central Texas. ***In late 2007, we initiated an $8.5 millionredevelopment drilling program in the Giddings Field, targeted to the AustinChalk and Georgetown formations. Initially composed of ten re-entries, we subsequently revised theprogram to six wells, with an aggregate horizontal footage similar to theinitial ten well program.  This drillingis expected to be completed by fiscal year end. As of March 31, three of the wells had been drilled, completed andplaced on production.  By May 7,2008, a fourth well was drilled and placed on production and two more wells beingdrilled.  All four completed wells arenow producing.

 

16

----

 

As is normal in redevelopment of naturally fracturedreservoirs, the horizontal holes penetrated one or more partially depletedfractures that absorbed water from our drilling fluid.  When put on production, we must first flowback a portion of this lost water in order to allow full production rates ofoil and gas.  We believe our oil and gasrates are constrained until sufficient water has been recovered.  To date, results of the drilling program areconsistent with our expectations and we continue to move forward in our programof converting existing proved undeveloped locations to producing well status,while also adding to our inventory of proved undeveloped locations throughleasing.

 

***We have added net production,while continuing to increase our revenues and proved reserves. ***Our production has increased 50% and 18% during therespective three and nine month periods ended March 31, 2008, compared tothe same periods of fiscal 2007, despite the sale of production from our TullosAssets effective March 3, 2008. Despite the constrained rates from our first drilled wells, we havesubstantially increased our net production of oil and gas.  The first well began production in lateFebruary, and two more wells came on in mid March, leaving March withaverage net production of 103 Bbls/D and 391MCF/D or a total of 168 BOEPD.  In May, a fourth well was placed onproduction.  Furthermore, we continued toacquire leases in the Giddings Field that we believe will result in a similaraddition of proved undeveloped reserves subsequent to our last report date of November 1,2007.

 

·                  **The Delhi EOR-CO2 Project is Proceeding**

 

Denbury Resources, the operator of the Delhi Field’sHolt Bryant Unit, recently announced a capital expenditure budget of $80million for the completion of the CO2 supply pipeline to Delhi and related fieldactivities for 2008. Denbury has also reported to us that a similar level ofexpenditures were incurred through December 2007, and have publiclyreported that the supply line should be completed and flowing by the end ofcalendar 2008 or early 2009.  Although wedon’t control the operations, we expect that oil production response will occurwithin months of first injection and that the field oil production rate willsteadily increase beginning in 2009.  Wehave no capital expenditure requirements related to the ongoing CO2-EOR development at Delhi Field, although we retainour separate 7.4% overriding and mineral royalty interests and 25% reversionaryinterest after payout.

 

·                  **We continue to advance our Unconventional Gas shale projects**

 

We continue to add acreage in our two Woodford Shaleprojects in Oklahoma and now own approximately 15,800 gross and net acresthere.  We believe that the balance ofour targeted 25,000 net acres is either committed to us, is in negotiation oris otherwise obtainable at reasonable cost.

 

**Liquidity and Capital Resources**

 

At March 31, 2008,our working capital, predominately cash and cash equivalents, was approximately$18.2 million and we continued to be debt free. This compares to working capital of approximately $27.3 million at June 30,2007.  Of the $9.1 million decrease inworking capital since June 2007, $13.2 million was used for capitalexpenditures on oil and natural gas leasehold and development costs and otherproperty and equipment and $1.2 million was used in operations, offset by netproceeds from the sale of the Tullos Assets of approximately $4.4 million andincreases of $0.8 million in net operating assets.

 

For the nine months endedMarch 31, 2008, approximately $1.2 million was used in operations.  This compares to approximately $11.8 millionused in operations for the nine months ended March 31, 2007, whichincludes approximately $11.3 million used to extinguish income taxes payable.

 

Cash flows used ininvesting activities totaled approximately $6.7 million during the nine monthsended March 31, 2008.  This comparedto approximately $34.1 million provided by investing activities for thecomparable nine months ended March 31, 2007. During the nine months ended March 31, 2008 approximately $11.1million of cash was used for investments to acquire and develop oil and naturalgas property interests and other property and equipment, which does not includeapproximately $2.1 million net change in accounts payable from July 1,2007, relating to expenditures on oil and natural gas properties.  The sale of the Tullos Assets partiallyoffset our development and acquisition activities by providing net proceeds ofapproximately $4.4 million.  During thenine months ended March 31, 2007, we received $34.7 million from thequalified intermediary account representing unspent 1031 exchange funds fromthe Delhi Farmout, partially offset by approximately $0.7 million of cash usedfor investments to acquire and develop oil and natural gas property interests.

 

17

----

 

There were no significantcash flows from financing activities during the nine months ended March 31,2008 and 2007.

 

We incurred approximately$13.1 million in capital expenditures for oil and natural gas leasehold anddevelopment costs during the nine months ended March 31, 2008.  We expect our capital expenditures for oiland natural gas leasehold and development costs to continue during theremainder of fiscal year 2008 related to continued leasing, the completion ofour initial development drilling program in the Giddings Field and continuedleasing in our gas shale projects in Oklahoma. Based on our current plans, we expect capital expenditures to exceed $18million during fiscal 2008, with $10.5 million dedicated to developmentdrilling and the balance to leasehold acquisitions.  We believe our working capital is sufficientto fund this drilling program.

 

**Results of Operations**

 

*Three months ended March 31, 2008 compared tothree months ended March 31, 2007*

 

The following table sets forth certain financialinformation with respect to our oil and natural gas operations:

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                         | ** ** | **March 31**                | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                                         | ** ** | **2008**                         | ** ** | **2007**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                                               |       |                             |       |       |       |         |       |   |   |
| **Production  Volumes, net to the Company:**                       |       |                             |       |       |       |         |       |   |   |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (Bbl)                                 |       | 8,146                            |       | 6,800      |       | 1,346        |       | 20 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                                 |       | 12,287                           |       | —     |       | 12,287       |       | — |   |
| Oil and natural  gas (Barrels of oil equivalent (“BOE”)) |       | 10,194                           |       | 6,800      |       | 3,394        |       | 50 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| **Sales  Volumes, net to the Company:**                            |       |                             |       |       |       |         |       |   |   |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (Bbl)                                 |       | 7,521                            |       | 7,164      |       | 357          |       | 5 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                                 |       | 12,287                           |       | —     |       | 12,287       |       | — |   |
| Oil and natural  gas (BOE)                                         |       | 9,569                            |       | 7,164      |       | 2,405        |       | 34 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| **Revenue  data (a):**                                             |       |                             |       |       |       |         |       |   |   |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Oil and natural  gas liquids                                       |       | $                                | 644,903    |       | $          | 462,951      |       | $ | 181,952 |   | 39 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| Natural gas                                                        |       | 99,799                           |       | —     |       | 99,799       |       | — |   |
| Total oil and  natural gas revenues                                |       | $                                | 744,702    |       | $          | 462,951      |       | $ | 281,751 |   | 61 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| **Average  prices (a):**                                           |       |                             |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (per Bbl)                             |       | $                                | 85.75      |       | $          | 64.62        |       | $ | 21.13 |   | 33 | % |
| Natural gas (per  Mcf)                                             |       | 8.12                             |       | —     |       | 8.12         |       | — |   |
| Oil and natural  gas (per BOE)                                     |       | $                                | 77.82      |       | $          | 64.62        |       | $ | 13.20 |   | 20 | % |
|                                                               |       |                             |       |       |       |         |       |   |   |
| **Expenses  (per BOE)**                                            |       |                             |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes                     |       | $                                | 32.72      |       | $          | 57.74        |       | $ | (25.02 | ) | 43 | % |
| Depletion  expense on oil and natural gas properties               |       | $                                | 13.55      |       | $          | 7.81         |       | $ | 5.74 |   | 73 | % |

 

----

(a)          Includes thecash settlement of hedging contracts in the prior year

 

18

----

 

Net Loss. For the three months ended March 31, 2008, wereported a net loss of $535,985, or $0.02 loss per share (which includedapproximately $0.6 million of non-cash charges related to stock basedcompensation, depreciation, depletion, and amortization, and accretion on assetretirement liabilities), on total oil and natural gas revenues of $744,702, ascompared to a net loss of $454,585, or $0.02 loss per share (which includedapproximately $0.4 million of non-cash charges related to stock basedcompensation, depreciation, depletion, and amortization, and accretion on assetretirement liabilities), on total oil and natural gas revenues of $462,951 forthe three months ended March 31, 2007. The increase to our net loss is primarily attributable to increases ingeneral and administrative expenses of $332,372, primarily related to increasedstaff costs necessary to initiate our drilling program and higheradministrative costs, a decrease in interest income earned of $322,442, offsetby an income tax benefit of $279,975 in the quarter ended March 31, 2008as compared to no income tax benefit in the quarter ended March 31,2007.  Additional details of thecomponents of net loss are explained in greater detail below.

 

Sales Volumes  Oil andnatural gas sales volumes, net to our interest, for the three months ended March 31,2008 increased 34% to 9,569 BOE, compared to 7,164 BOE for the three monthsended March 31, 2007.  The increasein oil and natural gas sales volumes is due primarily to new production of oiland natural gas in our Giddings Field as compared to the three month periodended March 31, 2007.  Of the 9,569BOE sold during the three months ended March 31, 2008, the Tullos FieldArea, which was sold on March 3, 2008, accounted for approximately 4,340BOE or approximately 45% of total sales volumes.  For the three months ended March 31,2007, the Tullos Field Area accounted for 6,975 BOE or approximately 97% oftotal sales volumes.

 

Production.  Oil productionwill vary from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Oiland natural gas production for the three months ended March 31, 2008increased 50% to 10,194 BOE, compared to 6,800 BOE for the three months ended March 31,2007.  The increase is primarily due tooil and natural gas production from our Giddings Field.  Production from the Tullos Field Area, whichwas sold on March 3, 2008, accounted for approximately 48% of productionfor the three months ended March 31, 2008 compared to approximately 97%for the three months ended March 31, 2007. Production from wells drilled and completed in our Giddings Field duringthe three months ended March 31, 2008 was constrained due to flow back ofdrill water lost to the formations during drilling.

 

Oil and Natural Gas Revenues. Revenues presented in the table above and discussed herein representrevenue from sales of our oil, natural gas liquids (“NGLs”) and natural gasproduction volumes, net to our interest. Production sold under fixed price delivery contracts, which have beendesignated for the normal purchase and sale exemption under SFAS 133, are alsoincluded in these amounts.  Realizedprices may differ from market prices in effect during the periods, depending onwhen the fixed delivery contract was executed.

 

Oil and natural gas revenues increased 61% for thethree months ended March 31, 2008, compared to the three months ended March 31,2007, as a result of a 20% increase in the price of a BOE, from $64.62 per BOEto $77.82 per BOE, and a 34% increase in sales volumes as described above.  The average sales price increase includes theeffect of current quarter sales being 87% oil and NGLs, as compared to 100% oilin the prior quarter.  Oil and naturalgas revenues from our Tullos Field Area was approximately $392,854, orapproximately 53% of total revenues for the three months ended March 31,2008, compared to $453,235, or approximately 98% of total revenues for thethree months ended March 31, 2007.

 

Lease Operating Expenses (including productionseverance taxes).  Lease operating expenses for the three monthsended March 31, 2008 decreased approximately 24% from the three monthsended March 31, 2007. The overall decrease in lease operating expenses in2008 is primarily attributable to lower field expenses in our Giddings Field ascompared to the Tullos Field Area and inclusion of only two months of fieldexpenses from the Tullos Field Area.  Ona BOE basis, lease operating expenses decreased by 43% over the comparable 2007quarter, primarily due to an increase in sales volumes and lower field costs inthe Giddings Field compared to the Tullos Area.

 

General and Administrative Expenses (“G&A”). G&A expenses increased 36% to approximately $1.3 million for thethree months ended March 31, 2008, compared to approximately $0.9 millionfor the three months ended March 31, 2007. Higher overall compensation expenses for estimated accrued bonuses(whereas we did not accrue for bonuses in the prior comparable period) and newhires accounted for the majority of the increase.  New hires are associated with building up ourinfrastructure to execute the planned drilling program. Non-cash stockcompensation expense was $493,872 and $376,008 for the three months ended March 31,2008 and 2007, respectively.

 

19

----

 

Depreciation, Depletion & AmortizationExpense (“DD&A”).  DD&A expense increased$82,514 to $139,086 for the three months ended March 31, 2008 from $56,572for the same period in 2007.  Theincrease is primarily due to a higher depletion rate ($14 vs. $8) perbarrel.  The increase in depletion is dueto the higher cost of Proved Undeveloped reserves at our Giddings Field addedto our lower cost Proved Developed Producing reserves from our Tullos FieldArea, which we sold in March 2008.

 

Interest Income.  Interestincome for the three months ended March 31, 2008 decreased $322,442 to$165,014, compared to $487,456 for the three months ended March 31,2007.  The decrease in interest income isdue to lower available cash balances averaging approximately $20.7 millionduring most of the current quarter, as compared to cash balances averagingapproximately $36.2 million in the comparable prior year quarter, combined witha lower interest rate environment during the three months ended March 31,2008.  The lower cash balance is mostlydue to cash used to relieve income taxes payable arising from the $50 millionwe received from the Delhi Farmout and for additions to our oil and natural gasproperties.

 

*Nine months ended March 31, 2008 compared tonine months ended March 31, 2007*

 

The following table sets forth certain financialinformation with respect to our oil and natural gas operations:

 
| ** **                                           | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|--------------|------------|
| ** **                                           | ** ** | **March 31**               | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                           | ** ** | **2008**                        | ** ** | **2007**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                                 |       |                            |       |       |       |         |       |   |   |
| **Production  Volumes, net to the Company**          |       |                            |       |       |       |         |       |   |   |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (Bbl)                   |       | 22,375                          |       | 21,231     |       | 1,144        |       | 5 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                   |       | 15,904                          |       | —     |       | 15,904       |       | — |   |
| Oil and natural  gas (BOE)                           |       | 25,026                          |       | 21,231     |       | 3,795        |       | 18 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| **Sales  Volumes, net to the Company:**              |       |                            |       |       |       |         |       |   |   |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (Bbl)                   |       | 21,868                          |       | 20,939     |       | 929          |       | 4 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                   |       | 15,904                          |       | —     |       | 15,904       |       | — |   |
| Oil and natural  gas (BOE)                           |       | 24,519                          |       | 20,939     |       | 3,580        |       | 17 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| **Revenue  data (a):**                               |       |                            |       |       |       |         |       |   |   |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Oil and natural  gas liquids                         |       | $                               | 1,776,347  |       | $          | 1,358,419    |       | $ | 417,928 |   | 31 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| Natural gas                                          |       | 123,277                         |       | —     |       | 123,277      |       | — |   |
| Total oil and  natural gas revenues                  |       | $                               | 1,899,624  |       | $          | 1,358,419    |       | $ | 541,205 |   | 40 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| **Average  prices (a):**                             |       |                            |       |       |       |         |       |   |   |
| Oil and natural  gas liquids (per Bbl)               |       | $                               | 81.23      |       | $          | 64.88        |       | $ | 16.35 |   | 25 | % |
| Natural gas (per  Mcf)                               |       | 7.75                            |       | —     |       | —       |       | — |   |
| Oil and Natural  Gas (per BOE)                       |       | $                               | 77.48      |       | $          | 64.88        |       | $ | 12.60 |   | 19 | % |
|                                                 |       |                            |       |       |       |         |       |   |   |
| **Expenses  (per BOE)**                              |       |                            |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes (b)   |       | $                               | 40.07      |       | $          | 52.35        |       | $ | (12.28 | ) | 23 | % |
| Depletion  expense on oil and natural gas properties |       | $                               | 13.34      |       | $          | 7.73         |       | $ | 5.61 |   | 73 | % |

 

----

(a)          Includes thecash settlement of hedging contracts in the prior year

 

(b)         Excludesnon-recurring oil spill expenses in the current period of $35,417

 

20

----

 

Net Loss. For the nine months ended March 31, 2008, wereported a net loss of $1,948,223, or $0.07 loss per share (which, includedapproximately $1.7 million of non-cash charges related to stock basedcompensation, depreciation, depletion, and amortization, and accretion on assetretirement obligations), on total oil and natural gas revenues of $1,899,624,as compared to a net loss of $1,336,279, or $0.05 loss per share (which,included approximately $1.4 million of non-cash charges related to stock basedcompensation, depreciation, depletion, and amortization, and accretion on assetretirement obligations), on total oil and natural gas revenues of $1,358,419for the nine months ended March 31, 2007. The increase in our net loss is primarily attributable to increases toGeneral and Administrative expenses of $1,128,662 as described below and adecrease in interest income earned of $748,735, offset by an income tax benefitof $848,961 in the nine months ended March 31, 2008 as compared to noincome tax benefit in the nine months ended March 31, 2007.  Additional details of the components of netloss are explained in greater detail below.

 

Sales Volumes.  Oil andnatural gas sales volumes, net to our interest, for the nine months ended March 31,2008 increased 17% to 24,519 BOE, compared to 20,939 BOE for the nine monthsended March 31, 2007.  The increasein oil and natural gas sales volumes is due primarily to production of oil andnatural gas in Texas as compared to none for the three month period ended March 31,2007.  Of the 24,519 BOE sold during thenine months ended March 31, 2008, the Tullos Field Area, which was sold onMarch 3, 2008, accounted for approximately 17,995 BOE or approximately 73%of total sales volumes.  For the ninemonths ended March 31, 2007, the Tullos Field Area accounted for 20,290BOE or approximately 97% of total sales volumes.

 

Production.  Oil productionwill vary from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Oiland natural gas production for the nine months ended March 31, 2008increased 18% to 25,026 BOE, compared to 21,231 BOE for the nine months ended March 31,2007.  The increase is primarily due tooil and natural gas production from our Giddings Field.  Production from the Tullos Field Area, whichwas sold on March 3, 2008, accounted for approximately 73% of productionfor the nine months ended March 31, 2008 compared to approximately 98% forthe nine months ended March 31, 2007. Production from wells drilled and completed in our Giddings Field duringthe three months ended March 31, 2008 was constrained due to flow back ofdrill water lost to the formations during drilling.

 

Oil and Natural Gas Revenues. Revenues presented in the table above and discussed herein representrevenue from sales of our oil and natural gas production volumes, net to ourinterest.  Production sold under fixedprice delivery contracts, which have been designated for the normal purchaseand sale exemption under SFAS 133, are also included in these amounts.  Realized prices may differ from market pricesin effect during the periods, depending on when the fixed delivery contract wasexecuted.

 

Oil and natural gas revenues increased 40% for thenine months ended March 31, 2008, compared to the same period in 2007, asa result of a 19% increase in the price of a BOE, from $65 per BOE to $77 perBOE, and a 17% increase in sales volumes as described above.  Oil and natural gas revenues from our TullosField Area was approximately $1,477,355, or approximately 78% of totalrevenues, for the nine months ended March 31, 2008, compared to$1,330,226, or approximately 98% of total revenues, for the nine months ended March 31,2007.

 

Lease Operating Expenses (including productionseverance taxes).  Lease operating expenses for the nine monthsended March 31, 2008 decreased approximately 6% from the comparable 2007period. The overall decrease in lease operating expenses in 2008 is primarilyattributable to lower field expenses in our Giddings Field as compared to theTullos Field Area and the inclusion of only eight months of field expense dueto the sale of the Tullos Assets in early March 2008.  On a BOE basis, lease operating expensesdecreased by 23% over the comparable 2007 period.

 

General and Administrative Expenses (G&A). G&A expenses increased 38% to approximately $4.1million for the ninemonths ended March 31, 2008, compared to approximately $2.9 million forthe nine months ended March 31, 2007. Higher overall compensation expenses for estimated accrued bonuses(whereas we did not accrue for bonuses in the prior comparable period) and newhires accounted for the majority of the increase.  New hires are associated with building up ourinfrastructure to execute the planned drilling program. Non-cash stockcompensation expense was $1,311,443 and $1,237,485 for the nine months ended March 31,2008 and 2007, respectively.

 

Depreciation, Depletion & AmortizationExpense (DD&A).  DD&A expense increased $207,852 to$372,645 for the nine months ended March 31, 2008 from $164,793 for thesame period in 2007.  The increase isprimarily due to a higher depletion rate ($13 vs. $8) per barrel.  The increase in depletion is due to thehigher cost of PUDs at our Giddings Field that we added to our lower cost PDP’sfrom our Tullos Field Area, which we sold in March 2008.

 

21

----

 

Interest Income.  Interestincome for the nine months ended March 31, 2008 decreased $748,735 to$772,835, compared to $1,521,570 for the nine months ended March 31,2007.  The decrease in interest income isdue to lower available cash balances averaging approximately $23.8 millionduring the nine months ended March 31, 2008, as compared to cash balancesaveraging approximately $38.4 million during the nine months ended March 31,2007, combined with a lower interest rate environment during the nine monthsended March 31, 2008.  The lowercash balance is mostly due to cash used to relieve income taxes payable arisingfrom the $50 million we received from the Delhi Farmout and for additions toour oil and natural gas properties.

 

**Off Balance Sheet Arrangements**

 

*Hedging Activities*

 

As of February 28,2007, all of our commodity hedging and price risk management activities hadexpired and were not renewed.

 

*ContractualObligations*

 

Information about contractualobligations at March 31, 2008 did not change materially from thedisclosures in our Annual Report on Form 10-KSB for the year ended June 30,2007.

 

**ITEM 3.**** ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISKS**

 

*InterestRate Risk*

 

We are exposed to changesin interest rates. Changes in interest rates affect the interest earned on ourcash and cash equivalents.  Under ourcurrent policies, we do not use interest rate derivative instruments to manageexposure to interest rate changes.

 

*CommodityPrice Risk*

 

Our revenues,profitability and future growth depend substantially on prevailing prices foroil and natural gas. Prices also affect the amount of cash flow available forcapital expenditures and our ability to borrow and raise additional capital,as, if and when needed. Lower prices may also reduce the amount of oil andnatural gas that we can economically produce. 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 associatedproduction occurs. We do not hold or issue derivative instruments for speculativepurposes.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and that such information is accumulated and communicated to this Company’smanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow for timely decisions regarding required disclosure.

 

22

----

 

As required by Securities and Exchange Commission Rule 13a-15(b),we carried out an evaluation, under the supervision and with the participationof the Company’s management, including our Chief Executive Officer and theCompany’s Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of thequarter covered by this report. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective in ensuring that the information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms.

 

There has been no change in our internal control overfinancial reporting during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

In November 2005, amulti-plaintiff lawsuit was filed in the Fifth Judicial District Court,Richland Parish, Louisiana, against 18 defendants including NGS Sub Corp. andArkla Petroleum LLC, the Company’s wholly owned subsidiaries (the “Subsidiaries”),as working interest owners/operators of various oil and natural gas leases inthe Delhi Field.  Plaintiffs claim thatthe defendants’ oil and natural gas exploration, development and productionactivities on their properties have caused soil and ground water contaminationas a result of the release of hydrocarbons and drilling fluids. Plaintiffs seekdamages for testing, clean-up and remediation of the properties as well asdiminution in their value and mental anguish to the individual plaintiffs,unjust enrichment and punitive damages for alleged concealment of ongoingactivities.  Certain exceptions filed bythe defendants are still under consideration by the court.  Discovery has begun and the allegations ofplaintiffs’ suit are so vague that the specifics of their claims cannot bedetermined yet with certainty. Accordingly, the court has ordered the plaintiffs to file their claimswith specificity.  Trial is set before ajury in Richland Parish for July of 2009. Management intends to contest plaintiffs’ claims vigorously.  The plaintiffs have not produced any evidenceof specific damage to their lands by defendants’ oil and natural gasoperations.  While the Delhi Field hasbeen in production for over fifty years, we believe that no contamination ofsignificance occurred during our period of ownership.  We believe that our liability exposureresults largely through any potential contractual indemnity of prior workinginterest owners.  During the quarterended June 2006, new legislation was passed and signed in Louisianaaddressing complaints similar to and including those filed against Delhioperators and working interest owners.  Although the intention of thelegislation was to position the Louisiana Department of Environmental Qualityand Natural Resources to determine the existence and extent of anyenvironmental damages, the source of liability and necessary remediation planand cost, and to ensure that any compensatory payments be used to remediatedamages, it is unclear at this time whether such legislation will be applied.

 

**ITEM 1A. RISK FACTORS**

 

Our Annual Report on Form 10-KSBfor the year ended June 30, 2007 includes a detailed discussion of ourrisk factors. There have been no material changes to the risk factorspreviously disclosed in our Annual Report on Form 10-KSB for the yearended June 30, 2007, except for the following related to the sale of ourTullos Assets.  The information presentedbelow updates and should be read in conjunction with the risk factors andinformation disclosed in our Annual Report on Form 10-KSB for the yearended June 30, 2007.

 

**If we are not successful inreplacing the production and revenues lost from the sale of our Tullos Assets,we will suffer a material adverse effect.**

 

Effective March 3,2008, we sold 100% of our working interest in our Tullos Field Area forapproximately $4.6 million.  Our TullosAssets yielded approximately 80 net barrels of oil per day,  representing substantially all of ourproduction and revenues at the time of the closing of the sale on March 3,2008.  Although we have since redeployedour assets to new operations, namely in the Giddings Field in Central Texas andhave had some initial success in such operations, our continued success isdependent upon replacing the production lost when we sold our Tullos Assets, ina field which we have not had significant operating history.    If we are unable to replace the lostproduction and revenues by success in the Giddings Field and other operations,our financial results will be materially and adversely affected.

 

23

----

 

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

 

On February 12,2008, we entered into a consulting agreement with the Liviakis FinancialCommunications, which expires December 31, 2008, to provide investorrelations services for the Company. In exchange for these services, the Companyissued 50,000 shares of common stock to Liviakis Financial Communications,which is subject to monthly vesting, over the term of the agreement.  The Company relied on an exemption fromregistration under Section 4 (2) of the Securities Act of 1933, asamended.  Liviakis FinancialCommunications is an accredited investor as defined in Regulation D, Rule 501(a) ofthe Securities Act of 1933.

 

**ITEM****3. DEFAULTS UPON SENIORSECURITIES**

 

Not applicable.

 

**ITEM****4. SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**ITEM5. OTHER INFORMATION**

 

Not applicable.

 

**ITEM 6. EXHIBITS**

 

A.           Exhibits

 
| 10.1   |   | Asset Purchase and Sale Agreement                                                                                                                                                               |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                            |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934, as amended.                              |
|   |   |                                                                                                                                                                                            |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934, as amended.                              |
|   |   |                                                                                                                                                                                            |
| 32.1   |   | Certification of Chief Executive Officer pursuant  Rule 13a-14(b) or Rule 15d-14(b) under the Securities  Exchange Act of 1934, as amended and 18 U.S.C. Section 1350. |
|   |   |                                                                                                                                                                                            |
| 32.2   |   | Certification of Chief Financial Officer pursuant  Rule 13a-14(b) or Rule 15d-14(b) under the Securities  Exchange Act of 1934, as amended and 18 U.S.C. Section 1350. |

 

24

----

 

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

**EVOLUTIONPETROLEUM CORPORATION**

(Registrant)

 

 
| Date: May 14, 2008 | By:    | /s/ STERLING H. MCDONALD                   |
|-------------------------|--------|--------------------------------------------|
|                    |   | Sterling H. McDonald                       |
|                    |   | Vice-President and Chief Financial Officer |
|                    |   | Principal  Financial and Accounting        |
|                    |   | Officer                                    |

 

25

----