**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM10-QSB**

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

**For thequarterly period ended March 31, 2007**

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

**For thetransition period                     to                    **

**CommissionFile Number 001-32942**

**EVOLUTION PETROLEUM CORPORATION**

(Exact name ofsmall business issuer as specified in its charter)

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

 

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

(Address ofprincipal executive offices and zip code)

**(713) 935-0122**

(Issuer’stelephone number, including area code)

**820 Gessner, Suite 1340, Houston,Texas 77024**

(Former name,former address and former fiscal year, if changed since last report)

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes:  x  No: o

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

**APPLICABLE ONLY TO ISSUERSINVOLVED IN BANKRUPTCY**

**PROCEEDINGSDURING THE PRECEDING FIVE YEARS**

Check whether the registrant filed all documents andreports required to be filed by Section 12, 13 or 15(d) of the Exchange Actafter the distribution of securities under a plan confirmed by a court.  Yes: oNo: o

**APPLICABLEONLY TO CORPORATE ISSUERS**

State the number of shares outstanding of each of theissuer’s classes of common equity, as of the latest practicable date:

The number of shares outstanding of the Registrant’scommon stock, par value $0.001, as of May 9, 2007, was 26,759,239.

Transitional Small Business Disclosure Format (Checkone):  Yes: oNo:  x

 

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**EVOLUTION PETROLEUM CORPORATION,INC.**

**TABLE OFCONTENTS**
|                                    | ** ** | **Page**                                                                                                                             |
|------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|
|                               |       |                                                                                                                                 |
| **PART I. FINANCIAL  INFORMATION** |       |                                                                                                                                 |
|                               |       |                                                                                                                                 |   |   |
| ITEM 1.                            |       | FINANCIAL  STATEMENTS                                                                                                                |   |   |
|                               |       |                                                                                                                                 |   |   |
|                               |       | Condensed Consolidated  Balance Sheets: March 31, 2007 (unaudited) and June 30, 2006                                                 |   | 3 |
|                               |       | Condensed  Consolidated Statements of Operations (unaudited): For the three and nine  months ended March 31, 2007 and 2006 |   | 4 |
|                               |       | Condensed  Consolidated Statements of Cash Flows (unaudited): For the nine months ended  March 31, 2007 and 2006                |   | 5 |
|                               |       | Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                    |   | 6 |
|                               |       |                                                                                                                                 |   |   |
| ITEM 2.                            |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS                                                                     |   | 11 |
|                               |       |                                                                                                                                 |   |   |
| ITEM 3.                            |       | CONTROLS AND  PROCEDURES                                                                                                             |   | 18 |
|                               |       |                                                                                                                                 |   |   |
| **PART II. OTHER  INFORMATION**    |       |                                                                                                                                 |
|                               |       |                                                                                                                                 |   |   |
| ITEM 1.                            |       | LEGAL PROCEEDINGS                                                                                                                    |   | 19 |
|                               |       |                                                                                                                                 |   |   |
| ITEM  6.                           |       | EXHIBITS                                                                                                                             |   | 19 |
|                               |       |                                                                                                                                 |   |   |
| SIGNATURES                         |       | 20                                                                                                                                   |

 

2

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**PART I - FINANCIAL INFORMATION**

**ITEM 1. CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**Evolution Petroleum Corporationand Subsidiaries**

**CondensedConsolidated Balance Sheets**
| ** **                                                                                                                                                                                                                                                            | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                            | ** ** | **2007**           | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                                                                                                                                            | ** ** | **(unaudited)**    | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                                                                                                            | ** ** | ** **         | ** ** | ** **        | ** ** |
| **Current Assets:**                                                                                                                                                                                                                                                   | ** ** | ** **         | ** ** | ** **        | ** ** |
| Cash and cash  equivalents                                                                                                                                                                                                                                            |       | $                  | 32,273,816 |              | $          | 9,893,547 |   |
| Accounts  receivable, trade                                                                                                                                                                                                                                           |       | 168,797            |       | 132,371           |       |
| Inventories                                                                                                                                                                                                                                                           |       | 219,518            |       | 76,917            |       |
| Prepaid expenses                                                                                                                                                                                                                                                      |       | 112,797            |       | 157,629           |       |
| Retainers and  deposits                                                                                                                                                                                                                                               |       | 106,625            |       | 60,895            |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Total current  assets                                                                                                                                                                                                                                                 |       | 32,881,553         |       | 10,321,359        |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Cash in  qualified intermediary account for “like-kind” exchanges                                                                                                                                                                                           |       | —             |       | 34,662,368        |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Oil & Gas  properties - full cost                                                                                                                                                                                                                                 |       | 4,093,446          |       | 3,878,551         |       |
| Oil & Gas  properties - not amortized                                                                                                                                                                                                                             |       | 344,989            |       | 52,098            |       |
| Less:  accumulated depletion                                                                                                                                                                                                                                          |       | (531,374           | )          | (371,624          | )          |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Net oil &  gas properties                                                                                                                                                                                                                                         |       | 3,907,061          |       | 3,559,025         |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Furniture,  fixtures and equipment, at cost                                                                                                                                                                                                                           |       | 86,874             |       | 16,561            |       |
| Less:  accumulated depreciation                                                                                                                                                                                                                                       |       | (13,041            | )          | (7,998            | )          |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Net furniture,  fixtures, and equipment                                                                                                                                                                                                                               |       | 73,833             |       | 8,563             |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Restricted  deposits                                                                                                                                                                                                                                                  |       | 301,835            |       | 326,835           |       |
| Other assets                                                                                                                                                                                                                                                          |       | 75,116             |       | 79,808            |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Total  assets**                                                                                                                                                                                                                                                     |       | $                  | 37,239,398 |              | $          | 48,957,958 |   |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                                                        | ** ** | ** **         | ** ** | ** **        | ** ** |
| **Current liabilities:**                                                                                                                                                                                                                                              | ** ** | ** **         | ** ** | ** **        | ** ** |
| Accounts payable                                                                                                                                                                                                                                                      |       | $                  | 302,839    |              | $          | 310,272 |   |
| Accrued  liabilities                                                                                                                                                                                                                                                  |       | 152,725            |       | 473,782           |       |
| Income taxes  payable                                                                                                                                                                                                                                                 |       | 4,820,000          |       | 2,978,650         |       |
| Royalties  payable                                                                                                                                                                                                                                                    |       | 6,713              |       | 47,054            |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Total current  liabilities                                                                                                                                                                                                                                            |       | 5,282,277          |       | 3,809,758         |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Long term liabilities:**                                                                                                                                                                                                                                            | ** ** | ** **         | ** ** | ** **        | ** ** |
| Deferred income  taxes payable                                                                                                                                                                                                                                        |       | —             |       | 13,101,350        |       |
| Deferred rent  payable                                                                                                                                                                                                                                                |       | 11,822             |       | —            |       |
| Asset retirement  obligations                                                                                                                                                                                                                                         |       | 136,453            |       | 123,679           |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Total  liabilities                                                                                                                                                                                                                                                    |       | 5,430,552          |       | 17,034,787        |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Common Stock, totaling 351,333  shares subject to demand registration rights**                                                                                                                                                                                      |       | 790,500            |       | 790,500           |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Stockholders’ equity:**                                                                                                                                                                                                                                        | ** ** | ** **         | ** ** | ** **        | ** ** |
| Common Stock,  par value $0.001 per share; 100,000,000 shares authorized,  26,407,906 and 26,300,664, issued and  outstanding as of March 31, 2007 and June 30, 2006, respectively, net of  351,333 shares of common stock subject to demand registration rights |       | 26,408             |       | 26,300            |       |
| Additional  paid-in capital                                                                                                                                                                                                                                           |       | 11,311,427         |       | 10,274,555        |       |
| Deferred stock  based compensation                                                                                                                                                                                                                                    |       | (80,194            | )          | (265,167          | )          |
| Retained  earnings                                                                                                                                                                                                                                                    |       | 19,760,705         |       | 21,096,983        |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                      |       | 31,018,346         |       | 31,132,671        |       |
|                                                                                                                                                                                                                                                                  |       |               |       |              |       |
| **Total liabilities and  stockholders’ equity**                                                                                                                                                                                                                  |       | $                  | 37,239,398 |              | $          | 48,957,958 |   |

 

See accompanying notes to condensed consolidated financial statements.

3

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**Evolution Petroleum Corporationand Subsidiaries**

**CondensedConsolidated Statements of Operations**

**(unaudited)**
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                                    | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenues:**                                 | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Oil sales                                     |       | $                                | 462,951    |                            | $          | 801,036 |   | $ | 1,358,433 |   | $ | 1,844,870 |   |
| Gas sales                                     |       | —                           |       | 83,730                          |       | — |   | 420,618 |   |
| Price risk management activities              |       | —                           |       | (6,164                          | )          | (14 | ) | (13,066 | ) |
| Total revenues                                |       | 462,951                          |       | 878,602                         |       | 1,358,419 |   | 2,252,422 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |
| **Operating  Costs:**                         | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Production expenses                           |       | 400,408                          |       | 506,093                         |       | 1,052,001 |   | 1,368,967 |   |
| Production taxes                              |       | 13,957                           |       | 40,936                          |       | 44,260 |   | 76,956 |   |
| Depreciation, depletion and amortization      |       | 56,572                           |       | 132,366                         |       | 164,793 |   | 324,047 |   |
| General and administrative *                  |       | 934,055                          |       | 593,271                         |       | 2,933,761 |   | 1,839,655 |   |
| Total operating costs                         |       | 1,404,992                        |       | 1,272,666                       |       | 4,194,815 |   | 3,609,625 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |
| **Loss  from operations**                     |       | (942,041                         | )          | (394,064                        | )          | (2,836,396 | ) | (1,357,203 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
| **Other  income and expense:**                | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                               |       | 487,456                          |       | 7,626                           |       | 1,521,570 |   | 41,517 |   |
| Interest expense                              |       | —                           |       | (221,694                        | )          | — |   | (634,388 | ) |
| Gain/(loss) on sale of assets                 |       | —                           |       | —                          |       | (21,453 | ) | — |   |
| Total other income and expense                |       | 487,456                          |       | (214,068                        | )          | 1,500,117 |   | (592,871 | ) |
| **Net  Loss**                                 |       | $                                | (454,585   | )                               | $          | (608,132 | ) | $ | (1,336,279 | ) | $ | (1,950,074 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
|                                          |       |                             |       |                            |       |   |   |   |   |
| **Net  Loss per common share**                | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic and Diluted                             |       | $                                | (0.02      | )                               | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.08 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
| **Weighted  average number of common shares** | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic and  Diluted                            |       | 26,720,444                       |       | 25,309,557                      |       | 26,685,612 |   | 24,864,403 |   |

 

See accompanying notes tocondensed consolidated financial statements.

----

* Includes non-cash stock compensation expense of $376,008,$112,034, $1,237,485 and $381,385 for the three month period ended March 31,2007 and 2006, and the nine month period ended March 31, 2007 and 2006,respectively.

4

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**Evolution Petroleum Corporationand Subsidiaries**

**CondensedConsolidated Statements of Cash Flow**

**(unaudited)**
| ** **                                                                       | ** ** | **Nine Months** | ** ** | **Nine Months** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **Ended March** | ** ** | **Ended March** | ** ** |
| ** **                                                                       | ** ** | **31, 2007**    | ** ** | **31, 2006**    | ** ** |
| ** **                                                                       | ** ** | ** **           | ** ** | ** **           | ** ** |
| **Cash  flows from operating activities:**                                       | ** ** | ** **           | ** ** | ** **           | ** ** |
| **Net loss**                                                                     |       | $                    | (1,336,279 | )                    | $          | (1,950,074 | ) |
| **Adjustments to reconcile net loss to net cash used  by operating activities:** | ** ** | ** **           | ** ** | ** **           | ** ** |
| Depletion and Depreciation                                                       |       | 164,793              |       | 324,047              |       |
| Non-cash stock based compensation expense                                        |       | 1,237,485            |       | 381,385              |       |
| Accretion of asset retirement obligations                                        |       | 12,774               |       | 21,391               |       |
| Deferred rent payable                                                            |       | 11,822               |       | —               |       |
| Accretion of debt discount and non-cash loan costs                               |       | —               |       | 156,664              |       |
| Other non-cash items                                                             |       | —               |       | 34,727               |       |
| Non-cash penalty expense                                                         |       | —               |       | 240,000              |       |
| Changes in assets and liabilities:                                               |       |                 |       |                 |       |
| Accounts receivable                                                              |       | (36,426              | )          | 33,098               |       |
| Inventories                                                                      |       | (142,601             | )          | (125,755             | )          |
| Retainer and deposits                                                            |       | (45,730              | )          | —               |       |
| Accounts payable                                                                 |       | (7,433               | )          | 325,586              |       |
| Royalties payable                                                                |       | (40,340              | )          | 11,866               |       |
| Accrued liabilities                                                              |       | (321,056             | )          | (55,378              | )          |
| Income taxes and deferred income taxes payable                                   |       | (11,260,000          | )          | —               |       |
| Prepaid expenses                                                                 |       | 44,832               |       | (30,524              | )          |
| Net cash used in operating activities                                            |       | (11,718,159          | )          | (632,967             | )          |
| **Cash  flows from investing activities:**                                       | ** ** | ** **           | ** ** | ** **           | ** ** |
| Development of oil and gas properties                                            |       | (267,245             | )          | (3,082,106           | )          |
| Acquisition of oil and gas properties                                            |       | (395,918             | )          | —               |       |
| Proceeds from asset sale, net                                                    |       | 155,378              |       | —               |       |
| Capital expenditures for furniture, fixtures and  equipment                      |       | (70,313              | )          | (3,004               | )          |
| Cash transferred from qualified intermediary account                             |       | 34,662,368           |       | —               |       |
| Restricted deposits                                                              |       | 25,000               |       | 176,385              |       |
| Other assets                                                                     |       | 4,692                |       | 17,716               |       |
| Net cash provided in investing activities                                        |       | 34,113,962           |       | (2,891,009           | )          |
| **Cash  flow from financing activities:**                                        | ** ** | ** **           | ** ** | ** **           | ** ** |
| Payments on notes payable                                                        |       | —               |       | (6,754               | )          |
| Proceeds from notes payable                                                      |       | —               |       | 1,040,764            |       |
| Proceeds from issuance of common stock                                           |       | 57                   |       | —               |       |
| Deferred financing costs                                                         |       | —               |       | (22,654              | )          |
| Equity proceeds and transaction costs                                            |       | (15,591              | )          | 171,763              |       |
| Net cash provided by (used in) financing activities                              |       | (15,534              | )          | 1,183,119            |       |
| Net increase (decrease) in cash and cash equivalents                             |       | 22,380,269           |       | (2,340,857           | )          |
| Cash and cash equivalents, beginning of period                                   |       | 9,893,547            |       | 2,548,688            |       |
| Cash and cash equivalents, end of period                                         |       | $                    | 32,273,816 |                 | $          | 207,831 |   |
|                                                                             |       |                 |       |                 |       |
| Supplemental disclosure of cash flow information:                                |       |                 |       |                 |       |
| Interest paid                                                                    |       | $                    | —     |                 | $          | 443,229 |   |
| Income taxes paid                                                                |       | $                    | 11,260,000 |                 | $          | — |   |
| Non cash equity  adjustment                                                      |       | $                    | —     |                 | $          | 50,000 |   |

 

See accompanying notes to condensed consolidated financial statements.

5

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**EVOLUTION PETROLEUM CORPORATIONAND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

**1. Organization and Basis of Preparation**

Headquartered in Houston, Texas, Evolution PetroleumCorporation, formerly Natural Gas Systems, Inc. (the “Company”, “EPM”, “we” or “us”),is a petroleum company incorporated under the laws of the State of Nevada,engaged primarily in the acquisition, exploitation and development ofproperties for the production of crude oil and natural gas. We acquire establishedoil and gas properties and exploit them through the application of conventionaland specialized technology to increase production, ultimate recoveries, orboth.

Our stock is traded on the American Stock Exchange(AMEX) under the ticker symbol EPM. Prior to July 17, 2006, our stock was quoted on the OTC Bulletin Boardunder the symbol NGSY.OB.  Prior to May26, 2004, our stock was quoted on the OTC Bulletin Board under the symbolRLYI.OB.  Concurrently with the listingof our shares on the AMEX during July, 2006, we changed our name from NaturalGas Systems, Inc. to Evolution Petroleum Corporation to avoid confusion withsimilar names traded on the AMEX and to better reflect our business model.

At March 31, 2007, we conducted operations through our100% working interests in our Tullos Field Area and our non-operated interestsin our Delhi Field, all located onshore in Louisiana.  Our Tullos Field Area consists ofapproximately 155 producing wells out of 267 well bores across 599 acres ofhigh water cut primary reserve production, which we believe may be a candidatefor redevelopment using modern technology. Our non-operated interests in the 13,636 acre Delhi Field consist of a7.4% overriding and mineral royalty interest in the Delhi Holt Bryant Unit, a25% reversionary working interest in the Delhi Holt Bryant Unit, and a 25%working interest in certain other depths in the Delhi Field.  Our Delhi Holt Bryant Unit is scheduled forredevelopment using CO2 enhanced oil recovery technology.

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial information and with the instructionsto Form 10-QSB and Item 310(b) of Regulation S-B.  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 and in order to make the financial statements notmisleading have been included. All inter-company transactions are eliminatedupon consolidation. The interim financial information and notes hereto shouldbe read in conjunction with our 2006 Annual Report on Form 10-KSB for the yearended June 30, 2006, as filed with the Securities and Exchange Commission. Theresults of operations for interim periods are not necessarily indicative ofresults to be expected for a full fiscal year.

**2. Recent Accounting Pronouncements**

On July 13, 2006,the Financial Accounting Standards Board (“FASB”) issued FASB InterpretationNo. 48 (“FIN 48”),”Accounting for Uncertainty in Income Taxes — aninterpretation of FAS 109.” FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement No. 109, Accounting for IncomeTaxes. FIN 48 prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. FIN 48 is effective for fiscal years beginningafter December 15, 2006. We are currently assessing theimplementation of FIN 48 and its impact on our financial statements.

In September 2006, theSecurities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”)No. 108. This Bulletin provides the Staff’s views on the consideration ofthe effects of prior year misstatements in quantifying current yearmisstatements for the purpose of a materiality assessment. The guidance in SABNo. 108 is effective for financial statements of fiscal years ending afterNovember 15, 2006. Adoption of this guidance is not expected to materiallyimpact our financial statements.

**3. Net Loss per Share**

Basic earnings (loss) pershare is computed by dividing net income (loss) available to common shareholdersby the weighted average number of common shares outstanding during the period.Diluted earnings (loss) per share are determined on the assumption thatoutstanding stock options have been converted using the average price for theperiod. For purposes of computing earnings (loss) per share in a loss year,potential common shares have been excluded from the computation of weightedaverage common shares outstanding, because their effect is antidilutive.

6

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The following table sets forth the computation ofbasic and diluted earnings (loss) per share:
| ** **                                                             | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                             | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Numerator:                                                             |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss, as  reported                                                 |       | $                                                    | (454,585   | )                                                   | $          | (608,132 | ) | $ | (1,336,279 | ) | $ | (1,950,074 | ) |
| Plus income impact of assumed conversions:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Preferred stock dividends                                              |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Interest on convertible subordinated notes                             |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss  applicable to common stockholders plus assumed conversions   |       | $                                                    | (454,585   | )                                                   | $          | (608,132 | ) | $ | (1,336,279 | ) | $ | (1,950,074 | ) |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Denominator:                                                           |       | 26,720,444                                           |       | 25,039,557                                          |       | 26,685,612 |   | 24,864,403 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Affect of  potentially dilutive common shares:                         |       |                                                 |       |                                                |       |   |   |   |   |
| Warrants                                                               |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Employee and director stock options                                    |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Convertible preferred stock                                            |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Convertible subordinated notes                                         |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Redeemable preferred stock                                             |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Denominator for  dilutive earnings per share - weighted average shares |       | 26,720,444                                           |       | 25,039,557                                          |       | 26,685,612 |   | 24,864,403 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net Loss per  common share:                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and  diluted                                                     |       | $                                                    | (0.02      | )                                                   | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.08 | ) |

 

**4. Contingent Liabilities**

On November 17, 2005, a multi-plaintiff lawsuit wasfiled in the Fifth Judicial District Court, Richland Parish, Louisiana, against26 defendants, including two of our subsidiaries, Arkla Petroleum L.L.C. (“Arkla”)and NGS Sub Corp (together with Arkla, the “Subsidiaries”). We were served withthe lawsuit in February 2006.

The plaintiffs claim to be landowners whose property(including the soil, surface water, and groundwater) has allegedly beencontaminated by oil and gas exploration, production and development activitiesconducted by the defendants on the plaintiffs’ property and adjoining landsince the 1930s (including activities by Arkla as operator of the Delhi Fieldsubsequent to Arkla’s formation in 2002 and our acquisition of Arkla in 2003,and activities since NGS Sub Corp’s acquisition of a 100% working interest inthe Delhi Field in 2003). The plaintiffs claim that the defendants knew of thealleged dangerous nature of the contamination and actively concealed it ratherthan remedy the problem, and that plaintiffs discovered such damage solelywithin the statute of limitations period of one year prior to the filing oftheir complaint.

The plaintiffs are seeking unspecified compensatorydamages and punitive damages, as well as an order that the defendants restorethe property and prevent further contamination. Our ultimate exposure relatedto this lawsuit is not currently determinable, but could, if adverselydetermined, have a material adverse effect on our financial condition. Ourcosts to defend this action could also have a material adverse effect on ourfinancial condition.

During the three monthsended March 31, 2006, we filed our response and Motion to Stay Proceedings andDilatory and Declinatory Exceptions with respect to this proceeding.

During the quarter endedJune 30, 2006, the Governor of the State of Louisiana signed into law newlegislation addressing complaints similar to and, we believe, including thosecomplaints filed against us. Although the intention of the legislation wasdesigned to limit plaintiff complaints and remedies by possibly deferring firstto administrative experts within the Louisiana State Departments ofEnvironmental Quality and Natural Resources, it is unclear at this time theimpact of such legislation.

There were no newdevelopments in this case during the quarter ended March 31, 2007.

On October 11, 2006Sybil  J. Dominique, Individually, etal., filed a lawsuit in the District Court of Dallas County Texas, againstAmerada Hess Corporation and 73 other defendants, including one of oursubsidiaries, Arkla Petroleum, LLC (“Subsidiary”) alleging workplace exposureto benzene caused the death of her spouse. On January 5, 2007, the plaintiffs filed a Notice of Nonsuit withoutPrejudice, thereby dismissing us from the suit.

7

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**5. Stock-Based Compensation**

***Adoption of SFAS 123(R)***

Effective July 1, 2006, we adopted the fair value recognitionprovisions of Statement of Financial Accounting Standard 123(R) “*Share-Based Payment”* (“SFAS 123(R)”) usingthe modified prospective transition method. In addition, the Securities andExchange Commission issued Staff Accounting Bulletin No. 107 “*Share-Based Payment*” (“SAB 107”) in March2005, which provides supplemental SFAS 123(R) application guidance based on theviews of the SEC. Under the modified prospective transition method,compensation cost recognized in the three and nine months ended March 31, 2007includes: (a) compensation cost for all share-based payments granted priorto, but not yet vested as of July 1, 2006, based on the grant date fair valueestimated in accordance with the original provisions of SFAS No. 123, and(b) compensation cost for all share-based payments granted beginning July1, 2006, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). In accordance with the modified prospective transitionmethod, results for prior periods have not been restated.

The adoption of SFAS 123(R) resulted in stockcompensation expense for the three and nine months ended March 31, 2007 ofapproximately $376,000 and $1,238,000, respectively.   Stock compensation expense is recorded asgeneral and administrative expenses in the consolidated condensed statement ofoperations.  This additional share-basedcompensation expense increased basic and diluted loss per share by $0.01 and$0.05, respectively for the three and nine months ended March 31, 2007.  For the nine month period ended March 31,2007, we did not recognize a tax benefit from the stock compensation expensebecause we believe it is more likely than not that the related deferred taxassets, which have been reduced by a full valuation allowance, will not berealized.

For the three months ended March 31, 2007, there wereno stock options granted.

We usethe Black-Scholes option-pricing model to estimate option fair values. Theoption-pricing model requires a number of assumptions, of which the mostsignificant are, expected stock price volatility, the expected pre-vestingforfeiture rate and the expected option term (the amount of time from the grantdate until the options are exercised or expire). For stock options issuedsubsequent to our adoption of 123(R), expected volatility, pre-vestingforfeitures and option term will be calculated using SAB 107 guidance.

Forperiods prior to July 1, 2006, we applied the intrinsic method to ourstock-based compensation awards to our employees and directors as set forth inAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations.  Under these principles, no compensationexpense for stock options granted to employees is reflected in net income aslong as the stock options have an exercise price equal to the quoted marketprice of the underlying common stock on the date of grant.

***Pro-FormaStock Compensation Expense for the Three and Nine Months Ended March 31, 2006***

The followingtable illustrates the effect on net loss and earnings per share if we hadapplied the fair value recognition provisions of SFAS 123(R) to stock-basedemployee compensation for the three and nine months ended March 31, 2006.
|                                                                                                     | ** ** | **Three Months**         | ** ** | **Nine Months **    | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                                          | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** |
| ** **                                                                                          | ** ** | **2006**                      | ** ** | **2006**                      | ** ** |
| Net loss, as  reported                                                                              |       | $                             | (608,132   | )                             | $          | (1,950,074 | ) |
| Add: Total stock  based employee compensation benefit reported in net loss                          |       | 27,328                        |       | 144,208                       |       |
| Deduct: Total  stock based employee compensation benefit determined under fair value of all  awards |       | (567,826                      | )          | (1,196,257                    | )          |
| Pro forma net  loss                                                                                 |       | $                             | (1,148,630 | )                             | $          | (3,002,123 | ) |
|                                                                                                |       |                          |       |                          |       |
| Per share data:                                                                                     |       |                          |       |                          |       |
| Basic and  diluted, as reported                                                                     |       | $                             | (0.02      | )                             | $          | (0.08 | ) |
| Basic and diluted, pro  forma                                                                       |       | $                             | (0.05      | )                             | $          | (0.12 | ) |

 

The fair values ofoptions and warrants granted during the three and nine months ended March 31,2007 and 2006 were estimated at the date of grant using the Black-Scholesoptions pricing model assuming no dividends and with the following weightedaverage assumptions for grants in 2007 and 2006:
|                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **March 31**                | ** ** | **March 31**               | ** ** |
| ** **                   | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted average  volatility |       | —                           |       | 150                             | %          | 163 | % | 147 | % |
| Expected term  (in years)    |       | —                           |       | 4.0                             |       | 6.25 |   | 3.6 |   |
| Risk-free rate               |       | —                           |       | 4.5                             | %          | 4.8 | % | 4.5 | % |

 

Volatilities are based onthe historical volatility of our closing common stock price.  Expected term of options and warrants grantedrepresents the period of time that options and warrants granted are expected tobe outstanding.   The risk-free rate forperiods within the contractual life of the options and warrants is based on thecomparable U.S. Treasury rates in effect at the time of each grant. The weightedaverage grant-date fair value of options granted during the three months endedMarch 31, 2006 was $1.24.  The weightedaverage grant-date fair value of options granted during the nine months endedMarch 31, 2007 and 2006 was $2.61 and $1.15, respectively.  There have been no options or warrantsexercised for the three and nine months ended March 31, 2007 and 2006.

8

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***StockOptions and Warrants as of the Three and Nine Months Ended March 31, 2007***

We maintain stock optionplans under which we may grant incentive stock options and non-qualified stockoptions to officers, employees, consultants and non-employee directors.  Under our 2003 Stock Option Plan, 600,000shares of our common stock were approved to be issued or transferred to certainofficers, employees, consultants, and non-employee directors pursuant to stockbased awards granted.  No shares remainavailable for grant under the 2003 Stock Option Plan.  Under our 2004 Stock Plan, a maximum of4,000,000 shares of our common stock was approved to be issued or transferredto certain officers, employees, consultants and non-employee directors pursuantto future stock based awards granted.  Asof March 31, 2007, 1,286,758 shares remain available for grant under the 2004Stock Plan.  The Company has a policy ofissuing new shares upon the exercise of stock options, awarding significantamounts of stock options to new employees and regularly awarding stock optionsto employees on an annual basis.  Stockoptions and warrants are generally granted at the market price on the date ofgrant.  The granted options and warrantshave generally vested over four years for officers and employees, generallyover two years for non-employee directors, and generally over one year forconsultants.  The granted options and warrantsgenerally have ten year contractual terms.

For the three and ninemonths ended March 31, 2007, no warrants were granted and no warrants have beenexercised.  As of March 31, 2007, we had1,037,500 of warrants outstanding to officers, employees, consultants andnon-employee directors issued outside of the 2003 Stock Option Plan and the2004 Stock Plan, exclusive of warrants for capital raising services.

The following table setsforth the stock option and warrant transactions for the nine months ended March31, 2007:
|                                                     | ** ** | **Number of Options  and Warrants** | ** ** | **Weighted Average  Grant Price** | ** ** | **Aggregate  Intrinsic Value   (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                                                |       |                                               |       |                                        |       |                                           |       |                                                            |       |
| Options and  warrants outstanding at July 1, 2006   |       | 3,798,500                                          |       | $                                           | 1.49       |                                           |       |                                                            |       |   |
|                                                |       |                                               |       |                                        |       |                                           |       |                                                            |       |
| Granted                                             |       | 150,000                                            |       | $                                           | 2.61       |                                           |       |                                                            |       |   |
| Exercised                                           |       | 0                                                  |       |                                        |       |                                           |       |                                                            |       |
| Canceled, forfeited, or expired                     |       | 0                                                  |       |                                        |       |                                           |       |                                                            |       |
|                                                |       |                                               |       |                                        |       |                                           |       |                                                            |       |
| Options and  warrants outstanding at March 31, 2007 |       | 3,948,500                                          |       | $                                           | 1.54       |                                           | $          | 4,000,810                                                       |       | 8.0 |   |
|                                                |       |                                               |       |                                        |       |                                           |       |                                                            |       |
| Options and warrants  exercisable at March 31, 2007 |       | 2,122,250                                          |       | $                                           | 1.34       |                                           | $          | 2,579,079                                                       |       | 7.9 |   |

 

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(1) Based upon thedifference between the market price of our common stock on the last tradingdate of the quarter and the option or warrant exercise price of in-the-moneyoptions or warrants.

A summary of the statusof our non-vested options and warrants as of March 31, 2007, and the changesduring the nine months ended March 31, 2007, is presented below:
|                                 | ** ** | **Number of  Options and  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|---------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                            |       |                                           |       |                                                         |       |
| Non-vested at  July 1, 2006     |       | 2,335,532                                      |       | $                                                            | 1.66       |   |
|                            |       |                                           |       |                                                         |       |
| Granted                         |       | 150,000                                        |       | $                                                            | 2.61       |   |
|                            |       |                                           |       |                                                         |       |
| Vested                          |       | (678,032                                       | )          |                                                         |       |
| Canceled, forfeited, or expired |       | 0                                              |       |                                                         |       |
|                            |       |                                           |       |                                                         |       |
| Non-vested at end of  period    |       | 1,807,500                                      |       | $                                                            | 1.53       |   |

 

At March 31, 2007,unrecognized stock based compensation expense related to non-vested stockoption and warrant grants totaled approximately $2.5 million.  This unrecognized expense will be amortizedon a straight-line basis per grant over a weighted average remaining life ofapproximately 2.3 years.

***RestrictedStock for the period ended March 31, 2007***

For the three monthsended March 31, 2007, no new restricted stock awards were granted.  However, the Company issued 57,242 shares ofcommon stock pursuant to the stock grants described in the next paragraph.   We recognize compensation expense over thevesting period of these shares.  Duringthe three and nine months ended March 31, 2007, we recognized aggregatecompensation expense of $40,543 and $54,090, respectively, related to theseoutstanding restricted stock grants.

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On October 5, 2006, wegranted 20,000 shares of restricted stock with a grant date fair value of $2.71per share to a new employee as a sign on bonus. On December 14, 2006, we granted a total of 37,242 shares (or 12,414shares to each of our three independent outside directors) of restricted stockwith a weighted average grant date fair value $2.90 per share.  Such restricted stock grants vest over aone-year period.  Each of the aboverestricted stock grants is subject to forfeiture, and cannot be sold,transferred or disposed of during the restriction period.  We recognize compensation expense over thevesting period of these shares.

The following table setsforth the restricted stock transactions for the nine months ended March 31,2007:
|                                 | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                            |       |                                   |       |                                               |       |
| Outstanding at  July 1, 2006    |       | 25,000                                 |       | $                                                  | 1.61       |   |
|                            |       |                                   |       |                                               |       |
| Granted (1)                     |       | 57,242                                 |       | $                                                  | 2.83       |   |
|                            |       |                                   |       |                                               |       |
| Vested                          |       | (44,310                                | )          |                                               |       |
| Canceled, forfeited, or expired |       | 0                                      |       |                                               |       |
|                            |       |                                   |       |                                               |       |
| Outstanding at end of  period   |       | 37,932                                 |       | $                                                  | 2.85       |   |

 

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(1) The weighted averagegrant date fair value of restricted stock granted for the nine months endedMarch 31, 2007 was $2.83.  The weightedaverage grant date fair value of restricted stock granted for the nine monthsended December 31, 2005 was $1.61.

At March 31, 2007,unrecognized stock compensation expense related to restricted stock totaledapproximately $108,000.  Suchunrecognized expense will be recognized as vesting occurs over a weightedaverage period of 0.7 years.

**6.  CommonStock**

During the quarter ended March 31, 2007, we issued20,000 shares of common stock to an employee as part of an incentivecompensation package for employment. Also, three outside directors each received 12,414 shares of commonstock as part of a revised compensation plan for directors.  All issuances of common stock are subject tovesting terms per individual stock agreements.

During the quarter ended December, 31, 2006, weentered into an amended consulting agreement whereby the consultant continuesto provide investor relations services. For this, the Company agreed to issue to the consultant 50,000 shares ofcommon stock, which is subject to monthly vesting, over a twelve month period.  The effective date of the agreement isNovember 1, 2006.

As a result of theprivate placement of 351,333 of our common shares at $2.25 during fiscal 2006,we became subject to a registration rights agreement requiring us to use ourreasonable efforts to register these shares subsequent to the demand of 40% ofthe holders of such stock.  Such demandcannot become effective, however, until the price of our common stock exceedsat least $14.23 per share, which has not occurred.  There are no specified damages for ourfailure to register, nor a specified timetable for obtaining such registration,except that the registration shall be undertaken by us as soon as practicableand shall stay effective for 120 days, or if such registration statement is onForm S-3 and provides for sales of securities from time to time pursuant toRule 415 under the Securities Exchange Act of 1934, for up to one year.  The demand registration rights will terminatewhen a holder is able to sell all its shares during any three month periodunder Rule 144, which we believe should occur sometime between the first andsecond anniversary dates from the June 10, 2006 closing of the offering.  Based on the terms of this registrationrights agreement, we have recorded the $790,500 of proceeds as temporaryequity.

**7.  CommodityHedging and Price Risk Management Activities**

Pursuant to the terms of our previous credit facility,we entered into financial instruments covering approximately 50% of ourexpected oil and gas production from proved developed producing properties on atwo year rolling basis.  We used reservereport data prepared by W. D. Von Gonten & Co., our independent petroleumengineering firm, to estimate our future production for hedging purposes.  As we may elect under FAS 133, Accounting forDerivative Instruments and Hedging Activities, we have designated our physicaldelivery contracts as normal delivery sale contracts.  For the oil price floors (the “Puts”) wepurchased, we have not fulfilled the documentation requirements of FAS133.  As a result, the Put contracts are “marked-to-market”,with the unrealized gain or loss reflected in our statement of operations.  Since July 31, 2005, we had the followingfinancial instruments in place:

(i)                                                       2,100Bbls of oil to be delivered monthly from March 2005 through February 2006 toPlains Oil Marketing LLC, at $48.35 per barrel, plus or minus changes in basisbetween: (a) the arithmetic daily average of the prompt month “Light SweetCrude Oil” contract reported by the New York Mercantile Exchange, and (b)Louisiana field posted price. This is accounted for as a normal delivery salescontract.  This contract was extended forthe months of March 2006 through May 2006 for 70 Bbls of oil per day at a fixedprice of $52.55 per barrel of oil, and extended again for the months of June 2006through August 2006 for 90 Bbls of oil per day at a fixed price $63.45 perbarrel of oil.  Lastly, on January 27,2006 we extended our crude oil contracts with Plains Oil Marketing, LLC for anadditional six months, covering the

10

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periods September 2006 through February 2007.  The contract requires us to deliver 90 Bblsof oil per day, in exchange for a fixed price of $69.30 per Bbl, plus or minusNYMEX to posted field price basis risk. In the case of production shortfalls, the required barrels are purchasedat the current market price per Plains Oil Marketing price bulletins.

(ii)                                                  100Mcfd of natural gas at a fixed price of $6.21, delivered through our DelhiField sales tap into Gulf South’s pipeline, for the account of Texla fordeliveries from March 2005 to May 2006. This is accounted for as a normal delivery sales contract.

(iii)                                               Purchaseof a non-physical Put contract at $38.00 per barrel for 2,000 Bbls of crude oilproduction from March 2006 through February 2007.  This is accounted for as a “mark-to-market”derivative investment.

As of February 28, 2007, all of the Company’scommodity hedging and price risk management activities had expired and were notrenewed.

**8. Related Party Transactions**

Laird Q. Cagan, Chairman of our Board, is a ManagingDirector and co-owner of Cagan McAfee Capital Partners, LLC (“CMCP”). CMCPperforms financial advisory services to us pursuant to a written agreementamended in November 2005, providing for a retainer of $5,000 per month. Inaddition, Mr. Cagan, as a registered representative of Chadbourn SecuritiesInc. (“Chadbourn”) and a partner of CMCP, has served as the Company’s placementagent in private equity financings. Under the current agreement, CMCP may earn cash fees equal to 8% ofgross equity proceeds, declining to 4% subject to the amount of equity raised,and a fixed 4% warrant fee.  Mr. Caganreceives no additional compensation for serving as a director or as theChairman of our Board.

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

During the three months ended March 31, 2007, weexpensed and paid CMCP $15,000 in monthly retainers.  There were no other earned fees by CMCP.

During the nine months ended March 31, 2007, weexpensed and paid CMCP $45,000 in monthly retainers.  There were no other earned fees by CMCP.

**9.  AssetRetirement Obligations**

SFAS No. 143, “*Accounting for Asset Retirement Obligations*,” (“SFAS 143”)provides accounting requirements for retirement obligations associated withtangible long-lived assets, including: 1) the timing of liability recognition;2) initial measurement of the liability; 3) allocation of asset retirement costto expense; 4) subsequent measurement of the liability; and 5) financialstatement disclosures. SFAS 143 requires that an asset retirement cost shouldbe capitalized as part of the cost of the related long-lived asset andsubsequently allocated to expense using a systematic and rational method.

The reconciliation of the beginning and ending assetretirement obligation for the period ending March 31, 2007 is as follows:
| Asset retirement obligation  at June 30, 2006  |   | $      | 123,679 |   |
|------------------------------------------------|--------|--------|---------|--------|
| Liabilities  incurred                          |   | — |    |
| Liabilities  settled                           |   | — |    |
| Accretion  expense                             |   | 12,774 |    |
| Asset retirement  obligation at March 31, 2007 |   | $      | 136,453 |   |

 

**ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS**

*This Form 10-QSB and theinformation referenced herein contain forward-looking statements. The words “plan,”“expect,” “project,” “estimate,” “assume,” “believe,” “anticipate,” “intend,” “budget,”“forecast,” “predict” and other similar expressions are intended to identifyforward-looking statements. These statements appear in a number of places andinclude statements regarding our plans, beliefs or current expectations,including the plans, beliefs and expectations of our officers and directors. Weuse the terms, “EPM,” “Company,” “we,” “us” and “our” to refer to EvolutionPetroleum Corporation.*  *Whenconsidering any forward-looking statement, you should keep in mind the riskfactors that could cause our actual results to differ materially from thosecontained in any forward-looking statement. Important factors that could causeactual results to differ materially from those in the forward-lookingstatements herein include the timing and extent of changes in commodity pricesfor oil and gas, operating risks and other risk factors as described in our2006 Annual Report on Form 10-KSB for the year ended June 30, 2006 asfiled with the Securities and Exchange Commission. Furthermore, the assumptionsthat support our forward-looking statements are based upon information that iscurrently available and is subject to change. We specifically disclaim allresponsibility to publicly update any information contained in aforward-looking statement or any forward-looking statement in its entirety andtherefore disclaim any resulting liability for potentially related damages. Allforward-looking statements attributable to Evolution Petroleum Corporation areexpressly qualified in their entirety by this cautionary statement.*

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**Critical Accounting Policies**

Except as noted below, our 2006 Annual Report on Form10-KSB describes the accounting policies that we believe are critical to thereporting of our financial position and operating results and that requiremanagement’s most difficult, subjective or complex judgments.

At March 31, 2007, Management believes that 1)estimates for Asset Retirement Obligations are not critical accounting polices,due to their insignificance to our overall financial position, 2) estimates forthe Fair Value of Debt and Equity Transactions are not critical accountingpolices, since they are not subject to wide valuation differences and no suchtransactions currently exist in our balance sheet, and 3) the italicizedinsertion to the following will add additional clarity to our critical policyfor the full cost method of accounting: “Under the rules of the Securities andExchange Commission (“SEC”) for the full cost method of accounting, the netcarrying value of oil and natural gas properties is limited to the sum of thepresent value (10% discount rate) of the estimated future net cash flows fromproved reserves, *net of estimated future expenditures to beincurred in developing and producing the proved reserves*, based oncurrent prices as of the balance sheet date, and excluding future cash outflowsassociated with setting asset retirement obligations, plus the lower of cost orestimated fair market value of unproved properties adjusted for related incometax effects.”

This Quarterly Report on Form 10-QSB should be read inconjunction with the discussion contained in our 2006 Annual Report on Form10-KSB regarding these critical accounting policies.

**Business**

Evolution Petroleum Corporation, formerly Natural GasSystems, Inc., is a petroleum company engaged primarily in the acquisition,exploitation and development of properties for the production of crude oil andnatural gas. We acquire established oil and gas properties and exploit themthrough the application of conventional and specialized technology to increaseproduction, ultimate recoveries, or both.

At March 31, 2007, we conducted operations through our100% working interests in the Tullos Field Area and our non-operated interestsin the Delhi Field, all located onshore in Louisiana.  The Tullos Field Area consists ofapproximately 155 producing wells out of 267 well bores across approximately599 acres with high water-cut oil production that we believe may be a candidatefor redevelopment using modern technology. Our non-operated interests in the 13,636 acre Delhi Field consist of a7.4% overriding and mineral royalty interests in the Delhi Field Holt BryantUnit, a 25% reversionary working interest in the Delhi Field Holt Bryant Unit,and a 25% working interest in certain other depths in the Delhi Field.  Our Holt Bryant Unit is scheduled forredevelopment using CO2 enhanced oil recovery technology by the operator.

We are focused on an overall strategy of acquiringcontrolling working interests in oil and gas resources within establishedfields and redeveloping those fields through the application of capital andtechnology to convert a portion of the oil and gas resources into profitableproducing reserves. Our strategy is intended to generate scalable developmentopportunities at normally pressured depths, exhibiting relatively lowcompletion risk, generally longer and more predictable production lives, lessexpenditures on infrastructure and lower operational risks.

Within this overall strategy, we have establishedthree specific business initiatives:
|        | I      |   | Enhanced oil recovery (EOR) using miscible and  immiscible gas flooding;                        |
|--------|--------|--------|-------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                            |
|   | II     |   | Technology based redevelopment of mature oil and gas  fields to recover bypassed resources; and |
|   |   |   |                                                                                            |
|   | III    |   | Unconventional gas reservoir development using  modern stimulation and completion technologies. |

 

Having reached a major milestone in executing on ourEOR Initiative I with the June 2006 closing of our Delhi Farmout, we arecurrently engaged in implementing additional development opportunities acrossour three initiatives, as more fully described below.

**Summary Results**

***Financial Summary***

As has been evident over the last three quarters, wecontinue to be a markedly stronger company as compared to one year earlier.

At March 31, 2007, ourworking capital, predominately cash & cash equivalents, was approximately$28 million and we continued to be debt free. This compares to negative working capital of $3.9 million at March 31,2006, which included approximately $3.8 million of short-term debt net of a$1.2 million capitalized discount for warrants issued to the lender.

As a proxy for cash flow from operations to fundcapital programs, EBDDA (Earnings before, depletion, depreciation,amortization, non-cash stock compensation expense and other non-cash charges)is dramatically improved.  EBDDA is anon-GAAP measure which includes the effect of our net interest income, netinterest expense and income tax expense across comparable periods, asreconciled to GAAP and explained further at the end of this Item 2 below.

EBDDA was approximately $91,000 for the nine monthsended March 31, 2007, as compared to approximately $(792,000) in the comparable2006 period.  The improvement was duemostly to interest earned from our approximately $40 million in average shortterm investments, combined with an approximate $634,000 reduction in interestexpense during the current nine month period, as compared to the comparable2006 period.

For the nine months ended March 31, 2007, our net lossdecreased 31% from the comparable prior period to approximately $1.3 million,of which approximately $1.2 million was due to non-cash stock compensationexpense recorded in accordance with SFAS 123(R).  For the nine months ended March 31, 2006, ournet loss was approximately $2 million, of which approximately $381,000 was dueto non-cash stock compensation expense recorded under APB 25.

All of these improvements are a direct result of theDelhi Farmout that we completed in June 2006, net of the associated loss of ourDelhi oil and gas production.

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Looking ahead, in theshort term we can expect that our cash flow from operations and EBDDA will beadversely affected by reduced interest income on approximately $11.3 million ofcash balances we have already remitted for income tax payments, andapproximately $4.8 million we expect to remit on June 15, 2007 for income taxpayments related to the Delhi Farmout, up to $6 million of  expenditures we have budgeted to acquireleasehold interests in our seven new projects currently underway, anddevelopment expenditures to bring these projects to fruition.  We anticipate that these adverse impactsshould be increasingly offset by revenues from our new projects as, if and whenthey become operational.

***Operational Summary***

The operator of our Initiative I CO2-EOR project inthe 13,626 acre Delhi Holt Bryant Unit has publicly announced that they expectCO2 injection will begin in 2008.  Wecontinue to view the operator’s announcements as positive developments for ourshareholders.

As reported to you in our last fiscal quarter, wecontinue to focus our personnel and approximately $28 million of unrestrictedcash resources (net of $4.8 million of income taxes payable at March 31, 2007)on additional Initiative I, II and III projects, seven of which are currentlyunderway.  Of these projects, fivequalify as Initiative II - Bypassed Resource plays and two qualify asInitiative III — Unconventional Gas Resource plays.

Leasing in four of our five Initiative II BypassedResource plays has been in motion since December 2006.  We already own the fifth Initiative IIproject in our Tullos Urania Field Area. Leasing in our two Initiative III Unconventional Gas Resource plays didnot begin until after March 31, 2007, and therefore are not reflected in ourresults.

During our current fiscal year, we have expendedapproximately $295,000 on leasehold acquisition costs related to these newprojects, about 90% of which occurred in the quarter ended March 31, 2007.  Over 90% of these leasehold costs wereexpended on Initiative II projects, as our Initiative III projects were onlyrecently approved by our Board of Directors for leasing.  Since all of our Initiative II projects areadjacent to current or past offsetting production, we are targeting specificwell site locations, which we believe may provide us the opportunity to acquireproved or high quality unproved resources upon leasing the parcels necessary toestablish each drilling unit.  It is ourintention to begin a development drilling program on this acreage around theend of this calendar year, with the objective of adding proved producingreserves to fill in the period prior to our expected Delhi EOR productionramp-up.

Concerning the Initiative II Bypassed Resource projectunderway at our Tullos Urania Field Area, we attempted a re-entry into anexisting well during March 2007 to test a production/completion method which webelieve could have wide applicability to increasing production and ultimaterecoveries for heavy oil reservoirs overlying large volumes of water.  The age and condition of the well casing werenot adequate to allow a useful test of the technology; therefore, we haveelected to test the technology on a newly drilled well prior to calendar yearend.  If successful, we see broadapplication for this method across other oil fields exhibiting similarformation and production characteristics, in addition to its application to theTullos Urania Area property we already own.

In late April our Board authorized us to proceed withleasehold acquisitions of two Initiative III - Unconventional Gas Resourceplays.  In contrast to our currentInitiative II – Bypassed Resource plays, these projects require the acquisitionof large, fairly contiguous land parcels containing the targeted reservoir rockthat is an extension of, but not adjacent to or offsetting, existing production.  Consequently, we expect the development ofthese properties will require more time to develop than the Initiative IIprojects currently underway.

With respect to new Initiative I – EOR plays, wecontinue to screen projects for acquisition.

As previously forecast, BOE sales have declined in thecurrent period.  For the nine monthsended March 31, 2007, BOE sales declined 51%, as compared to the comparable2006 period.  This was due mostly toproduction lost through the Delhi Farmout, as we had expected for the nearterm.  Production at our Tullos UraniaField Area also declined 14% during this period, primarily due to threesaltwater disposal wells temporarily shut-in for casing leaks or high watercaused by heavy rain in the area, as well as the diversion of our onlyavailable service rig and crew from repair and maintenance to our capitalprogram.

Over the past six months, we have begun expanding ouroperating team to carry out our emerging development drilling projects.  To accommodate this growth and future growth,in March 2007 we leased approximately 8,000 square feet of corporate officespace for nine years under a sublease. The terms of the sublease include rent at about 65% of the currentmarket rate for direct lease property in the same building, located in theEnergy Corridor.

Looking forward, we continue to focus our staff andour significant cash resources on executing the Initiative I, II and IIIprojects described above.  It remains ourintention to commit most of these cash resources to “seed” these new projectsthrough a “proof of concept” stage, followed by outside financing in the formof insulated project financing to complete each development stage with minimalshareholder dilution.

13

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**Results of Operations**

***Three months ended March 31, 2007compared to three months ended March 31, 2006***

The following table sets forth certain financialinformation with respect to our oil and gas operations:
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                     | ** ** | **2007**                         | ** ** | **2006**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales Volumes, net to EPM:**                 | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (Bbl)                                      |       | 7,164                            |       | 14,496     |       | (7,332       | )          | -51 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| Gas (Mcf)                                      |       | —                           |       | 10,003     |       | (10,003      | )          | -100 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| Oil and Gas (Boe)                              |       | 7,164                            |       | 16,163     |       | (8,999       | )          | -56 | % |
|                                           |       |                             |       |       |       | —       |       |   |   |
| **Revenue data (a):**                          |       |                             |       |       |       | —       |       |   |   |
| ** **                                     |       |                             |       |       |       |         |       |   |   |
| Oil revenue                                    |       | $                                | 462,951    |       | $          | 794,872      |       | $ | (331,921 | ) | -42 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| Gas revenue                                    |       | —                           |       | 83,730     |       | (83,730      | )          | -100 | % |
| Total oil and gas  revenues                    |       | $                                | 462,951    |       | $          | 878,602      |       | $ | (415,651 | ) | -47 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| **Average prices (a):**                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (per Bbl)                                  |       | $                                | 64.62      |       | $          | 54.83        |       | $ | 9.79 |   | 18 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| Gas (per Mcf)                                  |       | —                           |       | 8.37       |       | (8.37        | )          | -100 | % |
| Oil and Gas (per Boe)                          |       | $                                | 64.62      |       | $          | 54.36        |       | $ | 10.26 |   | 19 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| **Expenses (per Boe)**                         | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating  expenses and production taxes |       | $                                | 57.84      |       | $          | 33.84        |       | $ | 24.00 |   | 71 | % |
| Depletion expense on oil and gas properties    |       | $                                | 7.81       |       | $          | 8.12         |       | $ | (0.31 | ) | -4 | % |

 

----

(a) Includes thecash settlement of hedging contracts

Net Loss. For the three months endedMarch 31, 2007, we reported a net loss of approximately $455,000 or $0.02 lossper share on total oil and gas revenues of approximately $463,000, as comparedto a net loss of $608,000 or $0.02 loss per share on total oil and gas revenuesof $879,000 for the three months ended March 31, 2006.  The improvement in our net loss isattributable primarily to approximately $488,000 of interest income earned andno interest expense charged in the current quarter, versus approximately $8,000of interest income earned and $222,000 of interest expense charged in thecomparable quarter of the prior year. Offsetting income were lower oil and gas revenues primarily due to theDelhi Farmout and higher operating costs (includes production expenses,production taxes, depletion expense and general and administrative costs) ofapproximately $132,000, all of which are explained in greater detail below.

Sales Volumes.  Oil sales volumes, net to our interest, forthe three months ended March 31, 2007 decreased 51% to 7,164 Bbls, compared to14,496 Bbls for the three months ended March 31, 2006.  The decrease in oil sales volumes isprimarily due to a loss of production from the Delhi Farmout, in addition todecreases in production from the Tullos Field area by approximately 18%.

Net natural gas volumes sold for the three monthsended March 31, 2007 were zero due to the Delhi Farmout, as compared to 10,003Mcfs for the three months ended March 31, 2006.

On a BOE basis, total sales volumes decreased 56% inthe current quarter when compared to the prior year quarter.

Production.  Oil production varies from oil sales volumesby changes in crude oil inventories, which are not carried on our balancesheet.  Net working interest oilproduction for the three months ended March 31, 2007 decreased 52% to 6,610Bbls, compared to 13,890 Bbls for the three months ended March 31, 2006.  This was primarily due to the loss ofproduction from the Delhi Farmout.  Netnatural gas production for the three months ended March 31, 2007 decreased 100%to zero, compared to 10,003 Mcfs for the three months ended March 31, 2006,again due to the Delhi Farmout.

Oil and Gas Revenues.  Revenues presented in the table above anddiscussed herein represent revenue from sales of our oil 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 gas revenues decreased 47% for the threemonths ended March 31, 2007, compared to the same period in 2006, as a resultof a 56% decrease in sales volumes (on a BOE basis) due primarily to the DelhiFarmout and a slight decrease in sales in the Tullos Field area.  Offsetting the decrease in revenues was an18% increase in net realized oil prices from approximately $55 per barrel toapproximately $65 per barrel.

14

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Lease Operating Expenses (including productionseverance taxes). Lease operating expenses for the three months ended March 31, 2007decreased approximately 24% from the comparable 2006 period. The decrease inoperating expenses in 2007 is primarily attributable to fewer operated wellsdue to the Delhi Farmout.  On a BOEbasis, lease operating expenses increased during the quarter by 71% over thecomparable 2006 quarter, primarily due to lower oil production at Tullos Fieldarea resulting from required workovers on saltwater disposal wells andunusually high workover costs on those saltwater disposal wells as well as thesale of the Delhi production that had a lower LOE per barrel. In the currentquarter, production in the Tullos Area was reduced due to three saltwaterdisposal wells temporarily shut down for casing leaks and high water caused byheavy rain in the area.  The priorquarter’s high rate per BOE was due to uncharacteristically high workover costsand a corresponding reduction in production volumes at our Delhi Field.

General and Administrative Expenses (G&A).  General and administrative expenses were up57% to approximately $934,000 for the three months ended March 31, 2007,compared to approximately $593,000 for the three months ended March 31, 2006.  Higher non-cash stock compensation expense,and to a lesser extent, increases to salary & wages for a new employee,accounted for the majority of the increase to G&A expenses in the currentquarter.  Non-cash stock compensationexpense was approximately $376,000 and $112,000 for the 2007 and 2006 threemonth periods, respectively.

Depreciation, Depletion & Amortization Expense(DD&A).  DD&Aexpense decreased approximately $76,000 to approximately $57,000 for the threemonths ended March 31, 2007 from $132,000 for the same period in 2006.  The decrease is primarily due to a lowerdepletion expense as a result of a 56% decrease in sales volumes (on a BOEbasis) due to the Delhi Farmout and decreases to oil sales at Tullos Field areaand a slight decrease in the average depletion rate from $8.12 to $7.81per BOE.

Interest Income. Interest income forthe three months ended March 31, 2007 increased approximately $480,000 toapproximately $488,000, compared to approximately $8,000 for the three monthsended March 31, 2006.  The increase ininterest income is primarily due to higher interest earned on higher availablecash balances of approximately $40,000,000 during most of the current quarter,as compared to average cash of approximately $248,000 in the prior comparablequarter.

Interest Expense. Due to therepayment of all of our debt in May 2006, interest expense for the three monthsended March 31, 2007 decreased to zero from approximately $222,000 for thethree months ended March 31, 2006.

***Nine months ended March 31, 2007compared to nine months ended March 31, 2006***

The following table sets forth certain financialinformation with respect to our oil and gas operations:
| ** **                                     | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|------------|------------|--------------|------------|
| ** **                                     | ** ** | **March 31,**              | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                     | ** ** | **2007**                        | ** ** | **2006**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales  Volumes, net to EPM:**                | ** ** | ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (Bbl)                                      |       | 20,939                          |       | 35,277     |       | (14,338      | )          | -41 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Gas (Mcf)                                      |       | —                          |       | 43,962     |       | (43,962      | )          | -100 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Oil and Gas  (Boe)                             |       | 20,939                          |       | 42,604     |       | (21,665      | )          | -51 | % |
|                                           |       |                            |       |       |       | —       |       |   |   |
| **Revenue  data (a):**                         |       |                            |       |       |       | —       |       |   |   |
| Oil revenue                                    |       | $                               | 1,358,419  |       | $          | 1,831,804    |       | $ | (473,385 | ) | -26 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Gas revenue                                    |       | —                          |       | 420,618    |       | (420,618     | )          | -100 | % |
| Total oil and  gas revenues                    |       | $                               | 1,358,419  |       | $          | 2,252,422    |       | $ | (894,003 | ) | -40 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| **Average  prices (a):**                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (per Bbl)                                  |       | $                               | 64.88      |       | $          | 51.93        |       | $ | 12.95 |   | 25 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Gas (per Mcf)                                  |       | —                          |       | 9.57       |       | (9.57        | )          | -100 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Oil and Gas (per  Boe)                         |       | $                               | 64.88      |       | $          | 52.87        |       | $ | 12.01 |   | 23 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| **Expenses  (per Boe)**                        | ** ** | ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating  expenses and production taxes |       | $                               | 52.35      |       | $          | 33.94        |       | $ | 18.42 |   | 54 | % |
|                                           |       |                            |       |       |       |         |       |   |   |
| Depletion expense on  oil and gas properties   |       | $                               | 7.73       |       | $          | 7.52         |       | $ | 0.21 |   | 3 | % |

 

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(a) Includes the cashsettlement of hedging contracts

 

15

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Net Loss. For the nine months endedMarch 31, 2007, we reported a net loss of approximately $1,336,000 or $0.05loss per share on total oil and gas revenues of approximately $1,358,000, ascompared to a net loss of $1,950,000 or $0.08 loss per share on total oil andgas revenues of $2,252,000 for the nine months ended March 31, 2006.  The improvement in our net loss isattributable primarily to approximately $1,522,000 of interest income earnedand no interest expensed charged in the current quarter, versus approximately$42,000 of interest income earned and $634,000 of interest expense charged inthe comparable period of the prior year. Offsetting income were lower oil and gas revenues of approximately$894,000 and higher operating costs (includes production expenses, productiontaxes, depletion expense and general and administrative costs) of approximately$585,000, all of which are explained in greater detail below.  In addition, for the nine month period endedMarch 31, 2007, a loss on sale of asset (Delhi Field) was recorded forapproximately $21,500 for the settlement of a sales and use tax audit.

Sales Volumes.  Oil sales volumes, net to our interest, forthe nine months ended March 31, 2007 decreased 41% to 20,939 Bbls, compared to35,277 Bbls for the nine months ended March 31, 2006.  The decrease in oil sales volumes isprimarily due to a loss of production from the Delhi Farmout, in addition todecreases in oil production from the Tullos Field area by approximately 14%.

Net natural gas volumes sold for the nine months endedMarch 31, 2007 were zero due to the Delhi Farmout, as compared to 43,962 Mcfsfor the nine months ended March 31, 2006.

On a BOE basis, total sales volumes decreased 51% inthe current period when compared to the prior year period.

Production.  Oil production varies from oil sales volumesby changes in crude oil inventories, which are not carried on our balancesheet.  Net working interest oilproduction for the nine months ended March 31, 2007 decreased 43%% to 20,754Bbls, compared to 36,390 Bbls for the nine months ended March 31, 2006.  This is primarily due to the loss ofproduction from the Delhi Farmout.  Netnatural gas production for the nine months ended March 31, 2007 decreased 100%to zero, compared to 43,962 Mcfs for the nine months ended March 31, 2006,again due to the Delhi Farmout.

Oil and Gas Revenues.  Revenues presented in the table above anddiscussed herein represent revenue from sales of our oil 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 gas revenues decreased 40% for the nine monthsended March 31, 2007, compared to the same period in 2006, as a result of a 51%decrease in sales volumes (on a BOE basis) due primarily to the Delhi Farmoutand decreases to sales in the Tullos Field area.  Offsetting the decrease in revenues was a 25%increase in net realized oil prices from approximately $52 per barrel toapproximately $65 per barrel for the nine months ended March 31, 2007.

Lease Operating Expenses (including productionseverance taxes). Lease operating expenses for the nine months ended March 31, 2007decreased approximately 24% from the comparable 2006 period. The decrease inoperating expenses is primarily attributable to fewer operated wells due to theDelhi Farmout.  On a BOE basis, leaseoperating expenses increased during the period by approximately 54% over thecomparable 2006 period, primarily due to lower oil production at Tullos Fieldarea due to required workovers on saltwater disposal wells and unusually highworkover costs on those saltwater disposal wells as well as the sale of theDelhi production that had a lower LOE per barrel.   In the current period, production in theTullos Area was reduced due to three saltwater disposal wells temporarily shutdown for high water caused by heavy rain in the area as well as the diversionof our only available service rig and crew from repair and maintenance to ourcapital program.  The prior quarter’shigh rate per BOE was due to uncharacteristically high workover costs and acorresponding reduction in production volumes at our Delhi Field.

General and Administrative Expenses (G&A).  General and administrative expenses increasedapproximately 59% to approximately $2,934,000 for the nine months ended March31, 2007, compared to approximately $1,840,000 for the nine months ended March31, 2006.  Higher non-cash stockcompensation expense and increases to salary & wages for annual bonuses,plus a new employee hire, accounted for the majority of the increase to G&Aexpenses in the period.  Non-cash stockcompensation expense was approximately $1,238,000 and $381,000 for the 2007 and2006 nine month periods, respectively.

Depreciation, Depletion & Amortization Expense(DD&A).  DD&Aexpense decreased approximately $159,000 to approximately $165,000 for the ninemonths ended March 31, 2007 from $324,000 for the same period in 2006.  The decrease is primarily due to a lowerdepletion expense as a result of a 51% decrease in sales volumes (on a BOEbasis) due to the Delhi Farmout and decreases to oil sales at Tullos Fieldarea, offset by slight increases in the average depletion rate from $7.52 to$7.73 per BOE.

Interest Income. Interest income forthe nine months ended March 31, 2007 increased approximately $1,480,000 toapproximately $1,522,000 compared to approximately $42,000 for the nine monthsended March 31, 2006.  The increase in interestincome is primarily due to higher interest income earned on higher availablecash balances of approximately $40,000,000 in the current period, as comparedto cash averaging approximately $1,000,000 in the prior comparable period.

Interest Expense. Due to therepayment of all of our debt in May 2006, interest expense for the nine monthsended March 31, 2007 decreased to

16

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zero from approximately $634,000 for the nine monthsended March 31, 2006.

**Liquidity and Capital Resources**

At March 31, 2007, we had approximately $27.6 millionof positive working capital, as compared to $3.9 million of negative workingcapital at March 31, 2006.  Our workingcapital at March 31, 2007 includes approximately $32 million of cash equivalentsand approximately $4.8 million of remaining tax liabilities arising from theDelhi Farmout.

Cash flow used by our operating activities for thenine months ended March 31, 2007 was $11.7 million, as compared to $0.6 millionused during the comparable period ended March 31, 2006.  Of the $11.7 million used in the current ninemonth period, $11.3 million was used to pay estimated federal and state incometax deposits related to the $50 million of proceeds we received from the DelhiFarmout in June 2006.

Cash flow used by investing activities for the ninemonths ended March 31, 2007 was approximately $0.5 million, net ofapproximately $34.7 million of cash transferred from the qualified intermediaryaccount, which was closed in December 2006 due to the expiration of the “like-kindexchange” window as required by the Revenue Service. Approximately $185,000 wasreceived for the sale of two Tullos Field Area wells to the State of Louisiana,offset by approximately $30,000 in legal fees to close the transaction.  Approximately $396,000 was used to acquirenew leases, acquire additional royalty and overriding royalty interests in theDelhi Holt Bryant Unit, acquire a small parcel of land to be used as a fieldoffice in Tullos, Louisiana and for land broker fees, while approximately$267,000 was used to develop our oil and gas properties.  In the prior fiscal comparable period we usedapproximately $3.1 million to develop our properties, primarily related to the2005 Development Drilling Program at our Delhi Field.

Cash flow used by financing activities for the ninemonths ended March 31, 2007, was approximately $16,000 for costs related tofiling registration statements for previous equity raising matters.  This compared to cash flow provided byfinancing activities totaling approximately $1.2 million in the comparable 2006period, the majority of which represented proceeds from the exercise ofwarrants issued with our debt.

Going forward, we plan on using the majority of ourafter-tax cash resources to “seed” new development projects within ourInitiatives I-III outlined in the Overview section above.  It is currently our intention to bring theseprojects through a proof of concept phase, followed by raising some form ofinsulated project financing specific to each project.

**Off Balance Sheet Arrangements**

Pursuant to the terms of our previous credit facility,we entered into financial instruments covering approximately 50% of ourexpected oil and gas production from proved developed producing properties on atwo year rolling basis.  We used reservereport data prepared by W. D. Von Gonten & Co., our independent petroleumengineering firm, to estimate our future production for hedging purposes.  As we may elect under FAS 133, Accounting forDerivative Instruments and Hedging Activities, we have designated our physicaldelivery contracts as normal delivery sale contracts.  For the oil price floors (the “Puts”) wepurchased, we have not fulfilled the documentation requirements of FAS133.  As a result, the Put contracts are “marked-to-market”,with the unrealized gain or loss reflected in our statement of operations.  Since July 31, 2005, we had the followingfinancial instruments in place:

(i)                                                     2,100Bbls of oil to be delivered monthly from March 2005 through February 2006 toPlains Oil Marketing LLC, at $48.35 per barrel, plus or minus changes in basisbetween: (a) the arithmetic daily average of the prompt month “Light SweetCrude Oil” contract reported by the New York Mercantile Exchange, and (b)Louisiana field posted price. This is accounted for as a normal delivery salescontract.  This contract was extended forthe months of March 2006 through May 2006 for 70 Bbls of oil per day at a fixedprice of $52.55 per barrel of oil, and extended again for the months of June2006 through August 2006 for 90 Bbls of oil per day at a fixed price $63.45 perbarrel of oil.  Lastly, on January 27,2006 we extended our crude oil contracts with Plains Oil Marketing, LLC for anadditional six months, covering the periods September 2006 through February2007.  The contract requires us todeliver 90 Bbls of oil per day, in exchange for a fixed price of $69.30 perBbl, plus or minus NYMEX to posted field price basis risk.  In the case of production shortfalls, therequired barrels are purchased at the current market price per Plains OilMarketing price bulletins.

(ii)                                                  100Mcfd of natural gas at a fixed price of $6.21, delivered through our DelhiField sales tap into Gulf South’s pipeline, for the account of Texla fordeliveries from March 2005 to May 2006. This is accounted for as a normal delivery sales contract.

(iii)                                               Purchaseof a non-physical Put contract at $38.00 per barrel for 2,000 Bbls of crude oilproduction from March 2006 through February 2007.  This is accounted for as a “mark-to-market”derivative investment.  As of February28, 2007, the market value of the Put contract was zero.

As of February 28, 2007, all of the Company’scommodity hedging and price risk management activities have expired and havenot been renewed.

17

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**Non-GAAP Financial Measures**

The United StatesSecurities and Exchange Commission has adopted disclosure requirements forpublic companies concerning Non-GAAP financial measures. GAAP refers togenerally accepted accounting principles. We must reconcile the non-GAAP financialmeasure to related GAAP information.

**Earnings before depletion,depreciation, amortization, non-cash stock compensation expense and othernon-cash charges (EBDDA)**

Earnings before,depletion, depreciation, amortization, non-cash stock compensation expense andother non-cash charges, EBDDA, is a non-GAAP financial measure. We believe EBDDAis relevant because it is a proxy for cash generated by operations to fund ourcapital programs, while taking into account the significant (i) non-cashcharges in our income statement, mostly due to non-cash stock compensationexpense (ii) net interest income generated in some periods, versus net interestexpense incurred in other periods and (iii) non-taxable income in some periodsversus tax liabilities arising from gains on the sale of assets in otherperiods.  EBDDA should not be consideredin isolation from or as a substitute for net income, as an indication ofoperating performance or as a measure of liquidity. EBDDA, as we calculate it,may not be comparable to EBDDA measures reported by other companies. EBDDA isnot the same measure as EBITDA (Earnings before interest, tax, depreciation andamortization). Whereas EBDDA, as we calculate it, retains interest income,interest expense and income tax expense in earnings, EBITDA typically excludesthese items from earnings. A reconciliation of our consolidated net income to EBDDAis as follows:

RECONCILIATION TO GAAPINFORMATION
|                                                                    | ** ** | **Nine Months Ended  March 31, 2007** | ** ** | **Nine Months Ended  March 31, 2006** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net Loss (GAAP)                                                    |       | $                                                         | (1,336,279 | )                                                         | $          | (1,950,074 | ) |
| Depreciation,  depletion, amortization, and other non-cash charges |       | 189,389                                                   |       | 776,829                                                   |       |
| Non-cash stock  compensation expense                               |       | 1,237,485                                                 |       | 381,385                                                   |       |
| EBDDA (Non-GAAP)                                                   |       | $                                                         | 90,595     |                                                      | $          | (791,860 | ) |

 

**ITEM 3. 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. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule13a-15(b), we carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including our Chief ExecutiveOfficer and the Company’s Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of the end ofthe quarter 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.

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**PART II - OTHER INFORMATION**

**ITEM 1.  LEGAL PROCEEDINGS**

On October 11, 2006 SybilJ. Dominique, Individually, et al., filed a lawsuit in the District Court ofDallas County Texas, against Amerada Hess Corporation and 73 other defendants,including one of our subsidiaries, Arkla Petroleum, LLC (“Subsidiary”) allegingworkplace exposure to benzene caused the death of her spouse.  On January 5, 2007, the plaintiffs filed aNotice of Nonsuit without Prejudice, thereby dismissing us from the suit.

**ITEM 6. EXHIBITS**

A.           Exhibits
|        | 4.1    | Natural Gas Systems, Inc. 2003 Stock Plan Adopted on  September 25, 2003 (Incorporated by reference to Exhibit 4.1 of the Company’s  Registration Statement on Form S-8 filed on January 24, 2007). |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                     |
|   | 4.2    | Natural Gas Systems, Inc. 2004 Stock Plan  (Incorporated by reference to Exhibit A of the Company’s Information  Statement on Schedule 14C filed on August 9, 2004).                                |
|   |   |                                                                                                                                                                                                     |
|   | 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.                                   |

 

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**SIGNATURES**

In accordance with the requirements of the SecuritiesExchange Act of 1934, the registrant caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

**EVOLUTION PETROLEUM CORPORATION**

(Registrant)
|        | Date: May 15, 2007 |   | By:    | /s/ STERLING H. MCDONALD |                               |
|--------|--------------------|--------|--------|--------------------------|------------------------------------|
|   |               |   |   | Sterling H.  McDonald    |
|   |               |   |   | Chief Financial  Officer |
|   |               |   |   |                     | Principal Financial and Accounting |
|   |               |   |   |                     | Officer                            |
|        |                    |        |        |                          |                                    |  |

 

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