Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended September 30, 2008**

 

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

 

**For thetransition period from                     to                     **

 

**CommissionFile Number 001-32942**

 

**EVOLUTIONPETROLEUM CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices and zip code)

 

**(713)935-0122**

(Registrant’stelephone number, including area code)

 

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

 

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

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

 

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

 

The number of shares outstanding of the registrant’scommon stock, par value $0.001, as of November 14, 2008, was 26,917,234.

 

 

 

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Tableof Contents

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

 

**TABLE OFCONTENTS**

 
|                                         | **Page**   |
|-----------------------------------------|------------|
| ** **                              | ** ** |
| **PART I.  FINANCIAL INFORMATION** |       |
|                                    |       |   |   |
| ITEM  1.                                |       | CONSOLIDATED  CONDENSED FINANCIAL STATEMENTS |   |
|                                    |       |   |   |
|                                    |       | Consolidated Balance Sheets as of September 30,  2008 (unaudited) and June 30, 2008 | 3 |
|                                    |       | Consolidated Statements of Operations (unaudited) for  the three months ended September 30, 2008 and 2007 | 4 |
|                                    |       | Consolidated Statements of Cash Flows (unaudited) for  the three months ended September 30, 2008 and 2007 | 5 |
|                                    |       | Notes to Consolidated Condensed Financial Statements  (unaudited) | 6 |
|                                    |       |   |   |
| ITEM 2.                                 |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 16 |
|                                    |       |   |   |
| ITEM 3.                                 |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 22 |
|                                    |       |   |   |
| ITEM 4.                                 |       | CONTROLS AND  PROCEDURES | 22 |
|                                    |       |   |   |
| **PART II.  OTHER INFORMATION**    |       |
|                                    |       |   |   |
| ITEM 1.                                 |       | LEGAL PROCEEDINGS | 23 |
|                                    |       |   |   |
| ITEM  1A.                               |       | RISK  FACTORS | 24 |
|                                    |       |   |   |
| ITEM 2.                                 |       | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS | 24 |
|                                    |       |   |   |
| ITEM 3.                                 |       | DEFAULTS UPON  SENIOR SECURITIES | 24 |
|                                    |       |   |   |
| ITEM 4.                                 |       | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS | 24 |
|                                    |       |   |   |
| ITEM 5.                                 |       | OTHER INFORMATION | 24 |
|                                    |       |   |   |
| ITEM  6.                                |       | EXHIBITS | 24 |
|                                    |       |   |   |
| SIGNATURES                              | 25         |

 

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Tableof Contents

 

**PART I – FINANCIALINFORMATION**

 

**ITEM 1. CONSOLIDATED CONDENSEDFINANCIAL STATEMENTS**

 

**EvolutionPetroleum Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                             | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2008**               | ** ** | **2008**          | ** ** |
| ** **                                                                                                                                                                             | ** ** | **(Unaudited)**        | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                             |       |                   |       |              |       |
| Current Assets                                                                                                                                                                         |       |                   |       |              |       |
| Cash and cash  equivalents                                                                                                                                                             |       | $                      | 9,519,049  |              | $          | 11,272,280 |   |
| Receivables                                                                                                                                                                            |       |                   |       |              |       |
| Oil and natural  gas sales                                                                                                                                                             |       | 898,743                |       | 2,066,300         |       |
| Income tax                                                                                                                                                                             |       | 170,730                |       | 478,599           |       |
| Other                                                                                                                                                                                  |       | 129,037                |       | 86,966            |       |
| Income taxes  recoverable                                                                                                                                                              |       | 3,625,987              |       | 3,625,987         |       |
| Prepaid expenses  and other current assets                                                                                                                                             |       | 509,588                |       | 270,938           |       |
| Total current  assets                                                                                                                                                                  |       | 14,853,134             |       | 17,801,070        |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Property and  equipment, net of depreciation, depletion, and amortization                                                                                                              |       |                   |       |              |       |
| Oil and natural  gas properties – full cost method of accounting                                                                                                                  |       | 23,958,349             |       | 22,047,233        |       |
| Other property  and equipment                                                                                                                                                          |       | 176,712                |       | 161,027           |       |
| Total property  and equipment                                                                                                                                                          |       | 24,135,061             |       | 22,208,260        |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Other assets,  net                                                                                                                                                                     |       | 354,959                |       | 356,518           |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Total assets                                                                                                                                                                           |       | $                      | 39,343,154 |              | $          | 40,365,848 |   |
|                                                                                                                                                                                   |       |                   |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                          |       |                   |       |              |       |
| Current  liabilities                                                                                                                                                                   |       |                   |       |              |       |
| Accounts payable                                                                                                                                                                       |       | $                      | 1,251,951  |              | $          | 2,892,459 |   |
| Accrued expenses                                                                                                                                                                       |       | 301,041                |       | 805,262           |       |
| Royalties  payable                                                                                                                                                                     |       | 337,470                |       | 473,327           |       |
| Total current  liabilities                                                                                                                                                             |       | 1,890,462              |       | 4,171,048         |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Long term  liabilities                                                                                                                                                                 |       |                   |       |              |       |
| Deferred income  taxes                                                                                                                                                                 |       | 3,204,765              |       | 2,901,929         |       |
| Asset retirement  obligations                                                                                                                                                          |       | 328,544                |       | 215,056           |       |
| Deferred rent                                                                                                                                                                          |       | 75,025                 |       | 74,081            |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Total  liabilities                                                                                                                                                                     |       | 5,498,796              |       | 7,362,114         |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Commitments and  contingencies (Note 11)                                                                                                                                               |       |                   |       |              |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Stockholders’  equity                                                                                                                                                             |       |                   |       |              |       |
| Common Stock;  par value $0.001; 100,000,000 shares authorized; 26,917,234 and 26,870,439  issued and outstanding as of September 30, 2008 and June 30, 2008,  respectively. |       | 26,917                 |       | 26,870            |       |
| Additional  paid-in capital                                                                                                                                                            |       | 14,880,981             |       | 14,188,841        |       |
| Retained  earnings                                                                                                                                                                     |       | 18,936,460             |       | 18,788,023        |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Total  stockholders’ equity                                                                                                                                                       |       | 33,844,358             |       | 33,003,734        |       |
|                                                                                                                                                                                   |       |                   |       |              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                       |       | $                      | 39,343,154 |              | $          | 40,365,848 |   |

 

See accompanyingnotes to consolidated financial statements.

 

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**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Operations**

**(Unaudited)**

** **
| ** **                                                     | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **September 30**            | ** ** |
| ** **                                                     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues                                                       |       |                             |       |   |   |
| Crude oil                                                      |       | $                                | 1,579,070  |   | $ | 502,273 |   |
| Natural gas liquids                                            |       | 755,445                          |       | — |   |
| Natural gas                                                    |       | 580,471                          |       | — |   |
| Total revenues                                                 |       | 2,914,986                        |       | 502,273 |   |
|                                                           |       |                             |       |   |   |
| Operating Costs                                                |       |                             |       |   |   |
| Lease operating  expense                                       |       | 335,904                          |       | 310,310 |   |
| Production taxes                                               |       | 85,996                           |       | 17,556 |   |
| Depreciation,  depletion and amortization                      |       | 644,882                          |       | 110,443 |   |
| Accretion of  asset retirement obligation                      |       | 5,737                            |       | 4,695 |   |
| General and  administrative *                                  |       | 1,464,840                        |       | 1,328,318 |   |
| Total operating  costs                                         |       | 2,537,359                        |       | 1,771,322 |   |
|                                                           |       |                             |       |   |   |
| Income (loss)  from operations                                 |       | 377,627                          |       | (1,269,049 | ) |
|                                                           |       |                             |       |   |   |
| Other income  (expense)                                        |       |                             |       |   |   |
| Interest income                                                |       | 75,305                           |       | 341,081 |   |
| Other                                                          |       | (1,659                           | )          | — |   |
|                                                           |       |                             |       |   |   |
| Net income  (loss) before provision (benefit) for income taxes |       | 451,273                          |       | (927,968 | ) |
|                                                           |       |                             |       |   |   |
| Income tax  provision (benefit)                                |       | 302,836                          |       | (286,587 | ) |
|                                                           |       |                             |       |   |   |
| Net income (loss)                                              |       | $                                | 148,437    |   | $ | (641,381 | ) |
|                                                           |       |                             |       |   |   |
| Earnings (loss)  per common share                              |       |                             |       |   |   |
| Basic                                                          |       | $                                | 0.01       |   | $ | (0.02 | ) |
| Diluted                                                        |       | $                                | 0.01       |   | $ | (0.02 | ) |
|                                                           |       |                             |       |   |   |
| Weighted average  number of common shares                      |       |                             |       |   |   |
| Basic                                                          |       | 26,845,670                       |       | 26,776,234 |   |
| Diluted                                                        |       | 29,227,071                       |       | 26,776,234 |   |

 

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*General andadministrative expenses for three months ended September 30, 2008 and 2007included non-cash stock-based compensation of $523,725 and $376,007,respectively.

 

See accompanyingnotes to consolidated financial statements.

 

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**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Cash Flow**

**(Unaudited)**

** **
| ** **                                                                                                                                    | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Cash flows from  operating activities                                                                                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                                                                            |       | $                                                    | 148,437    |   | $ | (641,381 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities:                                          |       |                                                 |       |   |   |
| Depreciation,  depletion and amortization                                                                                                     |       | 644,882                                              |       | 110,443 |   |
| Stock-based  compensation                                                                                                                     |       | 523,725                                              |       | 376,007 |   |
| Accretion of  asset retirement obligations                                                                                                    |       | 5,737                                                |       | 4,695 |   |
| Deferred income  taxes                                                                                                                        |       | 302,836                                              |       | — |   |
| Deferred rent                                                                                                                                 |       | 944                                                  |       | 23,959 |   |
| Changes in  operating assets and liabilities:                                                                                                 |       |                                                 |       |   |   |
| Receivables                                                                                                                                   |       | 1,433,355                                            |       | (654,061 | ) |
| Prepaid expenses  and other current assets                                                                                                    |       | (238,650                                             | )          | 98,695 |   |
| Accounts payable  and accrued expenses                                                                                                        |       | (466,478                                             | )          | 121,992 |   |
| Royalties  payable                                                                                                                            |       | (135,857                                             | )          | 120 |   |
| Income tax  payable                                                                                                                           |       | —                                               |       | (286,587 | ) |
| Net cash provided  by (used in) operating activities                                                                                          |       | 2,218,931                                            |       | (846,118 | ) |
|                                                                                                                                          |       |                                                 |       |   |   |
| Cash flows from  investing activities                                                                                                         |       |                                                 |       |   |   |
| Development of  oil and natural gas properties                                                                                                |       | (2,836,572                                           | )          | (223,492 | ) |
| Acquisitions of  oil and natural gas properties                                                                                               |       | (1,111,640                                           | )          | (1,406,637 | ) |
| Capital  expenditures for other equipment                                                                                                     |       | (25,509                                              | )          | (21,224 | ) |
| Other assets                                                                                                                                  |       | 1,559                                                |       | 51,801 |   |
| Net cash used in  investing activities                                                                                                        |       | (3,972,162                                           | )          | (1,599,552 | ) |
|                                                                                                                                          |       |                                                 |       |   |   |
| Cash flows from  financing activities                                                                                                         |       |                                                 |       |   |   |
| Proceeds from  issuance of common stock                                                                                                       |       | —                                               |       | — |   |
| Net cash  provided by financing activities                                                                                                    |       | —                                               |       | — |   |
|                                                                                                                                          |       |                                                 |       |   |   |
| Net decrease in  cash and cash equivalents                                                                                                    |       | (1,753,231                                           | )          | (2,445,670 | ) |
|                                                                                                                                          |       |                                                 |       |   |   |
| Cash and cash  equivalents, beginning of period                                                                                               |       | 11,272,280                                           |       | 27,746,942 |   |
|                                                                                                                                          |       |                                                 |       |   |   |
| Cash and cash equivalents,  end of period                                                                                                     |       | $                                                    | 9,519,049  |   | $ | 25,301,272 |   |
|                                                                                                                                          |       |                                                 |       |   |   |
| Supplemental  disclosure of cash flow information:                                                                                            |       |                                                 |       |   |   |
| Income taxes  paid                                                                                                                            |       | $                                                    | 15,000     |   | $ | — |   |
| Income tax  refunds received                                                                                                                  |       | $                                                    | 322,869    |   | $ | — |   |
| Non-cash  transactions:                                                                                                                       |       |                                                 |       |   |   |
| Increase (decrease)  in accounts payable used to acquire oil and natural gas leasehold interests  and develop oil and natural gas properties. |       | $                                                    | (1,509,789 | ) | $ | 432,514 |   |
| Oil and natural  gas properties incurred through recognition of asset retirement obligations.                                                 |       | $                                                    | 107,751    |   | $ | — |   |
| Common stock  issued in lieu of a portion of 2008 cash bonus accrued at June 30, 2008                                                    |       | $                                                    | 168,462    |   | $ | — |   |

 

See accompanyingnotes to consolidated financial statements.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1 – Organization and Basis ofPreparation**

 

***Nature ofOperations.***  Evolution Petroleum Corporation (“EPM”)and its subsidiaries (the “Company”, “we”, “our” or “us”), is an independentpetroleum company headquartered in Houston, Texas and incorporated under thelaws of the State of Nevada.  We areengaged primarily in the acquisition, exploitation and development ofproperties for the production of crude oil and natural gas.  We acquire properties with known oil andnatural gas resources and exploit them through the application of conventionaland specialized technology to increase production, ultimate recoveries, orboth.

 

***Interim FinancialStatements.***  Theaccompanying unaudited 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 appropriate rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the financial position and results of operations for theinterim periods presented have been included. The interim financial information and notes hereto should be read inconjunction with the Company’s 2008 Annual Report on Form 10-K for theyear ended June 30, 2008, as filed with the SEC. The results of operationsfor interim periods are not necessarily indicative of results to be expectedfor a full fiscal year.

 

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

 

***Use ofEstimates. ***Thepreparation of financial statements in conformity with GAAP requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities at the dates of the financial statements and the reported amountsof revenues and expenses during the reporting periods.  Significant estimates include reserve quantitiesand estimated future cash flows associated with proved reserves, whichsignificantly impact depletion expense and potential impairments of oil andnatural gas properties, income taxes and the valuation of deferred tax assets,stock-based compensation and commitments and contingencies.  We analyze our estimates based on historicalexperience and various other assumptions that we believe to be reasonable.While we believe that our estimates and assumptions used in preparation of theconsolidated financial statements are appropriate, actual results could differfrom those estimates.

 

**Note 2 –Recent Accounting Pronouncements**

 

***New AccountingStandards.**** *Thefollowing discloses the existence and effect of accounting standards issued butnot yet adopted by us with respect to accounting standards that may have animpact on the Company when adopted in the future.

 

***Accounting for Business Combinations.***  InDecember 2007, the FASB issued SFAS No. 141R,*Business Combinations* (“SFAS No. 141R”),which replaces SFAS No. 141,*BusinessCombinations*.  SFAS No. 141Restablishes principles and requirements for determining how an enterpriserecognizes and measures the fair value of certain assets and liabilitiesacquired in a business combination, including non-controlling interests,contingent consideration, and certain acquired contingencies.  SFAS No. 141R also requiresacquisition-related transaction expenses and restructuring costs be expensed asincurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R will beapplicable prospectively to business combinations for which the acquisitiondate is on or after the beginning of the first annual reporting periodbeginning on or after December 15, 2008. SFAS No. 141R would have an impact on accounting for any businessesacquired after the effective date of this pronouncement.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

***Accounting for Fair Value Measurements*. **In September 2006, the FASB issuedSFAS No. 157,*Fair Value Measurements*(“SFAS No. 157”).  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in GAAP and expandsdisclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007.  The provisions of SFAS No. 157 will beapplied prospectively as of the beginning of the fiscal year in which it isinitially applied except for, among other items, a financial instrument thatwas measured at fair value at initial recognition under Statement 133 using thetransaction price in accordance with the guidance in footnote 3 of Issue 02-3prior to initial application of SFAS No. 157.  In February 2008, the FASB deferred theeffective date of SFAS No. 157 by one year for nonfinancial assets andnonfinancial liabilities that are recognized or disclosed at fair value in thefinancial statements on a financial statements on a nonrecurring basis andamended SFAS No. 157 to exclude SFAS No. 13, *Accountingfor Leases,* and its related interpretive accounting pronouncementsthat address leasing transactions.  SFAS No. 157did not have an impact on our financial statements when adopted on July 1,2008.  We are currently evaluating whatthe impact, if any, of SFAS No. 157 for nonfinancial assets andnonfinancial liabilities will have on our financial statements.

 

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

 

On March 3, 2008,NGS Sub Corp., a Delaware corporation wholly owned by EPM (“NGS Sub”),pursuant to an Asset Purchase and Sale Agreement (the “Asset Sale Agreement”)dated February 15, 2008, completed the sale of its 100% working interestand approximately 79% average net revenue interest in producing and shut-incrude oil wells, water disposal wells, equipment and improvements located inthe Tullos Urania, Colgrade and Crossroads Fields in LaSalle and Winn Parishes,Louisiana (the “Tullos Field Area”).  Thefollowing table presents the transaction and its affect on our financialstatements.

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

 

The following unauditedpro forma consolidated financial information is presented for illustrativepurposes only and presents the pro forma operating results for the Company forthe three months ended September 30, 2007 as though the disposition of ourproperties in the Tullos Field Area occurred at July 1, 2007. Theunaudited pro forma consolidated financial information is not intended to beindicative of the operating results that actually would have occurred if thetransaction had been consummated at the beginning of the period presented, noris the information intended to be indicative of future operating results.

 

The unaudited pro formaconsolidated financial information for the three months ended September 30,2007 is as follows:

 
|                                            |       | **Three Months Ended** |       |
|-------------------------------------------------|------------|----------------------------------|------------|
|                                            |       | **September 30, 2007** |       |
| ** **                                      | ** ** | **As Reported**             | ** ** | **Pro Forma** | ** ** |
| Oil and natural  gas revenues                   |       | $                                | 502,273    |   | $ | 10,306 |   |
| Loss from  operations                           |       | $                                | (1,269,049 | ) | $ | (1,318,938 | ) |
| Net loss                                        |       | $                                | (641,381   | ) | $ | (675,863 | ) |
| Loss per common  share – basic and diluted |       | $                                | (0.02      | ) | $ | (0.03 | ) |

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 4 –****Property and Equipment**

 

As of September 30,2008 and June 30, 2008 our oil and natural gas properties and otherproperty and equipment consisted of the following:

 
| ** **                                                   | ** ** | **September 30,  2008** | ** ** | **June 30,  2008** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| **Oil and  natural gas properties**                          | ** ** | ** **                   | ** ** | ** **              | ** ** |
| Property costs  subject to amortization                      |       | $                            | 16,539,004 |                    | $          | 15,105,766 |   |
| Less:  Accumulated depreciation, depletion, and amortization |       | (1,267,098                   | )          | (632,040                | )          |
| Unproved  properties not subject to amortization             |       | 8,686,443                    |       | 7,573,507               |       |
| Oil and natural  gas properties, net                         |       | $                            | 23,958,349 |                    | $          | 22,047,233 |   |
|                                                         |       |                         |       |                    |       |
| **Other  property and equipment**                            | ** ** | ** **                   | ** ** | ** **              | ** ** |
| Furniture,  fixtures and equipment, at cost                  |       | 257,350                      |       | 231,841                 |       |
| Less:  Accumulated depreciation                              |       | (80,638                      | )          | (70,814                 | )          |
| Other property  and equipment, net                           |       | $                            | 176,712    |                    | $          | 161,027 |   |

 

**Note 5 – Asset Retirement Obligations**

 

Our asset retirementobligations represent the estimated present value of the amount we will incurto plug, abandon and remediate our producing properties at the end of theirproductive lives in accordance with applicable laws. The following is areconciliation of the beginning and ending asset retirement obligation for thethree months ended September 30, 2008:

 
| **Asset  retirement obligations - July 1, 2008**            |   | $      | 215,056 |   |
|------------------------------------------------------------------|--------|--------|---------|--------|
| Liabilities  incurred                                            |   | 22,480 |    |
| Accretion  expense                                               |   | 5,737  |    |
| Revisions to  previous estimates                                 |   | 85,271 |    |
| **Asset retirement  obligations — September 30, 2008** |   | $      | 328,544 |   |

 

**Note 6 – Stockholders’ Equity**

 

On August 19, 2008,the Board of Directors authorized the issuance of 46,795 shares of common stockto certain employees who requested to receive the shares in lieu of a portionof their fiscal 2008 cash bonus.  Thevalue of the shares issued was $168,462, based on the fair market value on thedate of issuance.

 

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

 

We have granted optionawards to purchase common stock (the “Stock Options”) and restricted commonstock awards (“Restricted Stock”) to employees, directors, and consultants ofthe Company and its subsidiaries under the Natural Gas Systems Inc. 2003 StockPlan (the “2003 Stock Plan”) and the Evolution Petroleum Corporation Amendedand Restated 2004 Stock Plan (the “2004 Stock Plan” or together, the “EPM StockPlans”).  A total of 600,000 awards topurchase an equal number of shares of common stock were issued under the 2003Stock Plan.  The 2004 Stock Planauthorized the issuance of 5,500,000 shares of common stock.  There are no shares available for grant underthe 2003 Stock Plan and, as of September 30, 2008, 687,974 shares remainavailable for grant under the 2004 Stock Plan.

 

8

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Tableof Contents

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

We have also grantedcommon stock warrants, as authorized by the Board of Directors, to employees inlieu of cash bonuses or as incentive awards to reward previous service orprovide incentives to individuals to acquire a proprietary interest in theCompany’s success and to remain in the service of the Company (the “IncentiveWarrants”).  These Incentive Warrantshave similar characteristics of the Stock Options.  A total of 1,037,500 Incentive Warrants havebeen issued, through September 30, 2008, with Board of Directors approval,outside of the EPM Stock Plans.

 

***StockOptions and Incentive Warrants***

 

Stock-based compensationexpense related to Stock Options and Incentive Warrants for the three monthsended September 30, 2008 and 2007 was $445,993 and $301,097, respectively.

 

During the three monthsended September 30, 2008, we granted Stock Options to purchase 591,090shares of common stock under the 2004 Stock Plan with a weighted averageexercise price of $4.27.  During thethree months ended September 30, 2007, we granted Stock Options topurchase 1,135,000 shares of common stock under the 2004 Stock Plan with aweighted average exercise price of $2.21. The exercise price was determined based on the market price of theCompany’s common stock on the date of grant. The Stock Options granted during the three months ended September 30,2008 and 2007 generally vest quarterly, on a straight line basis, over a periodof four years.  The Stock Options grantedduring the three months ended September 30, 2008 and 2007 have a contractuallife of seven and ten years, respectively. The weighted average assumptions used to calculate the fair value ofthese Stock Options and the weighted average fair value of each Stock Optiongranted is as follows:

 
| ** **                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------|------------|------------------------|------------|
| ** **                   | ** ** | **September 30,** | ** ** |
| ** **                   | ** ** | **2008**               | ** ** | **2007** | ** ** |
| Expected  volatility         |       | 87.1                   | %          | 93.6 | % |
| Expected  dividends          |       | —                 |       | — |   |
| Expected term  (in years)    |       | 4.6                    |       | 6.1 |   |
| Risk-free rate               |       | 3.10                   | %          | 4.14 | % |
| Fair value per  Stock Option |       | $                      | 2.62       |   | $ | 1.74 |   |
|                              |            |                        |            |  |  |  |  |

 

We estimated the fairvalue of Stock Options and Incentive Warrants issued to employees and directorsunder SFAS No. 123R at the date of grant using a Black-Scholes-Mertonvaluation model.  The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant.  The expected term (estimated period of timeoutstanding) of Stock Options and Incentive Warrants is based on the “simplified”method of estimated expected term for “plain vanilla” options allowed by theSEC Staff Accounting Bulletin (“SAB”) No. 107 and SAB No. 110, andvaried based on the vesting period and contractual term of the Stock Options orIncentive Warrants.   Expected volatilityis based on the historical volatility of the Company’s closing common stockprice and that of an evaluation of a peer group of similar companies trading activity.  We have not declared any cash dividends onthe Company’s common stock.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

The following summarypresents information regarding outstanding Stock Options and Incentive Warrantsas of September 30, 2008, and the changes during the three months thenended:

 
| ** **                                                                   | ** ** | **Number of Stock Options  and Incentive Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value   (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                                                                         |       |                                                               |       |                                      |       |                                      |       |                                                            |       |
| Stock Options  and Incentive Warrants outstanding at July 1, 2008       |       | 5,483,500                                                          |       | $                                         | 1.81       |                                      |       |                                                            |       |   |
|                                                                         |       |                                                               |       |                                      |       |                                      |       |                                                            |       |
| Granted                                                                      |       | 591,090                                                            |       | $                                         | 4.27       |                                      |       |                                                            |       |   |
| Exercised                                                                    |       | —                                                             |       | —                                    |       |                                      |       |                                                            |       |
| Canceled,  forfeited, or expired                                             |       | —                                                             |       | —                                    |       |                                      |       |                                                            |       |
|                                                                         |       |                                                               |       |                                      |       |                                      |       |                                                            |       |
| Stock Options  and Incentive Warrants outstanding at September 30, 2008 |       | 6,074,590                                                          |       | $                                         | 2.05       |                                      | $          | 7,076,875                                                       |       | 7.2 |   |
|                                                                         |       |                                                               |       |                                      |       |                                      |       |                                                            |       |
| Vested or  expected to vest at September 30, 2008                       |       | 6,074,590                                                          |       | $                                         | 2.05       |                                      | $          | 7,076,875                                                       |       | 7.2 |   |
|                                                                         |       |                                                               |       |                                      |       |                                      |       |                                                            |       |
| Exercisable at  September 30, 2008                                      |       | 3,709,125                                                          |       | $                                         | 1.56       |                                      | $          | 5,565,181                                                       |       | 6.8 |   |

 

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the fiscal quarter ($3.05) and the Stock Option or IncentiveWarrant exercise price of in-the-money Stock Options and Incentive Warrants.

 

There were no StockOptions or Incentive Warrants that were exercised during the three months endedSeptember 30, 2008 and 2007.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

A summary of the statusof our unvested Stock Options and Incentive Warrants as of September 30,2008 and the changes during the three months ended September 30, 2008 and2007, is presented below:

 
| ** **                           | ** ** | **Number of  Stock Options  and Incentive  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                 |       |                                                  |       |                                                         |       |
| Unvested at  July 1, 2007       |       | 1,573,125                                             |       | $                                                            | 1.50       |   |
|                                 |       |                                                  |       |                                                         |       |
| Granted                              |       | 1,135,000                                             |       | $                                                            | 1.73       |   |
|                                 |       |                                                  |       |                                                         |       |
| Vested                               |       | (170,625                                              | )          | $                                                            | 1.39       |   |
|                                 |       |                                                  |       |                                                         |       |
| Canceled,  forfeited, or expired     |       | —                                                |       | —                                                       |       |
|                                 |       |                                                  |       |                                                         |       |
| Unvested at  September 30, 2007 |       | 2,537,500                                             |       | $                                                            | 1.61       |   |
|                                 |       |                                                  |       |                                                         |       |
| Unvested at  July 1, 2008       |       | 2,003,437                                             |       | $                                                            | 1.83       |   |
|                                 |       |                                                  |       |                                                         |       |
| Granted                              |       | 591,090                                               |       | $                                                            | 2.62       |   |
|                                 |       |                                                  |       |                                                         |       |
| Vested                               |       | (229,062                                              | )          | $                                                            | 1.70       |   |
|                                 |       |                                                  |       |                                                         |       |
| Canceled, forfeited,  or expired     |       | —                                                |       | —                                                       |       |
|                                 |       |                                                  |       |                                                         |       |
| Unvested at  September 30, 2008 |       | 2,365,465                                             |       | $                                                            | 2.04       |   |

 

The total unrecognizedcompensation cost at September 30, 2008, relating to non-vestedshare-based compensation arrangements granted under the EPM Stock Plans andIncentive Warrants was $4,651,821.  Suchunrecognized expense is expected to be recognized over a weighted averageperiod of 3.0 years.

 

**Restricted Stock**

 

For the three monthsended September 30, 2008 and 2007, there were no grants of restrictedstock.  All issuances of common stock aresubject to vesting terms per individual Restricted Stock agreements.

 

During the three monthsended September 30, 2008 and 2007, we recognized compensation expense of$77,732 and $74,910, respectively, related to Restricted Stock grants.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

The following table setsforth the restricted stock transactions for the three months ended September 30,2008 and 2007:

 
| ** **                           | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                                 |       |                                   |       |                                               |       |
| Unvested at July 1,  2007       |       | 59,449                                 |       | $                                                  | 2.78       |   |
|                                 |       |                                   |       |                                               |       |
| Granted                              |       | —                                 |       | —                                             |       |
|                                 |       |                                   |       |                                               |       |
| Vested                               |       | (21,808                                | )          | $                                                  | 2.81       |   |
|                                 |       |                                   |       |                                               |       |
| Forfeited                            |       | —                                 |       | —                                             |       |
|                                 |       |                                   |       |                                               |       |
| Unvested at  September 30, 2007 |       | 37,641                                 |       | 2.77                                               |       |
|                                 |       |                                   |       |                                               |       |
| Unvested at  July 1, 2008       |       | 50,898                                 |       | $                                                  | 4.11       |   |
|                                 |       |                                   |       |                                               |       |
| Granted                              |       | —                                 |       | —                                             |       |
|                                 |       |                                   |       |                                               |       |
| Vested                               |       | (12,501                                | )          | 4.06                                               |       |
|                                 |       |                                   |       |                                               |       |
| Forfeited                            |       | —                                 |       | —                                             |       |
|                                 |       |                                   |       |                                               |       |
| Unvested at  September 30, 2008 |       | 38,397                                 |       | 4.13                                               |       |

 

At September 30,2008, unrecognized stock compensation expense related to Restricted Stockgrants totaled $77,731.  Suchunrecognized expense will be recognized over a weighted average period of 0.23years.

 

**Note 8 – Income Taxes**

 

We file a consolidatedfederal income tax return in the United States and various combined andseparate filings in several state and local jurisdictions.

 

There were nounrecognized tax benefits nor any accrued interest or penalties associated withunrecognized tax benefits as of the date of adoption of FIN 48 and through September 30,2008.

 

Our effective tax ratewas a provision of 67% and a benefit of 31% for the three months ended September 30,2008 and 2007, respectively.  The primaryreconciling item of our income tax provision (benefit) at the statutory federalrate to our actual income tax provision (benefit) is the expense of stock-basedcompensation related to our qualified incentive stock option awards (“ISOAwards”).  We expensed $396,394 and$213,551 for the three months ended September 30, 2008 and 2007,respectively, related to ISO Awards.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 9 – Related Party Transactions**

 

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

 

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

 

During the three months ended September 30, 2008and 2007, we expensed and paid CMCP $15,000 through monthly retainers of$5,000.  There were no other earned feesby CMCP during the three months ended September 30, 2008 and 2007.

 

**Note 10 –****Earnings (loss) Per Share (“EPS”)**

 

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

 
| ** **                                                                                          | ** **   | **Three Months Ended  September 30** | ** **   |
|-----------------------------------------------------------------------------------------------------|--------------|-------------------------------------------|--------------|
| ** **                                                                                          | ** **   | **2008**                                  | ** **   | **2007** | ** ** |
| ***Numerator  used in basic and diluted EPS***                                                      | *** *** | *** ***                              | *** *** | *** *** | *** *** |
| Net income  (loss)                                                                                  |         | $                                         | 148,437      |   | $ | (641,381 | ) |
|                                                                                                |         |                                      |         |   |   |
| ***Denominator***                                                                                   | *** *** | *** ***                              | *** *** | *** *** | *** *** |
| Weighted average  number of common shares used in basic EPS                                         |         | 26,845,670                                |         | 26,776,234 |   |
| * *                                                                                            | * *     | * *                                  | * *     | * * | * * |
| Effect of  dilutive securities:                                                                     |         |                                      |         |   |   |
| Common stock  warrants issued in connection with equity and financing Transactions                  |         | 269,699                                   |         | — |   |
| Stock Options  and Incentive Warrants                                                               |         | 2,092,263                                 |         | — |   |
| Non-vested  Restricted Stock                                                                        |         | 19,439                                    |         | — |   |
| Total weighted  average dilutive securities                                                         |         | 2,381,401                                 |         | — |   |
|                                                                                                |         |                                      |         |   |   |
| Weighted average  number of common shares and dilutive potential common shares used in diluted  EPS |         | 29,227,071                                |         | 26,776,234 |   |
|                                                                                                |         |                                      |         |   |   |
| Basic EPS                                                                                           |         | $                                         | 0.01         |   | $ | (0.02 | ) |
| Diluted EPS                                                                                         |         | $                                         | 0.01         |   | $ | (0.02 | ) |

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 10 –****Earnings (loss) Per Share (“EPS”)**(Continued)

 

Total potentiallydilutive securities outstanding as of September 30, 2008 are as follows:

 
| **Outstanding Potentially Dilutive Securities**                     | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  September 30,  2008** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                               |       |                                       |       |                                              |       |
| Common stock  warrants issued in connection with equity and financing Transactions |       | $                                          | 1.40       |                                              | 401,058    |   |
| Stock Options  and Incentive Warrants                                              |       | $                                          | 2.05       |                                              | 6,074,590  |   |
| Non-vested  Restricted Stock                                                       |       | N/A                                        |       | 38,397                                            |       |
|                                                                               |       |                                       |       | 6,514,045                                         |       |

 

**Note11 – Commitments and Contingencies**

 

***Environmental clean-up.***  On August 3, 2007, we were advised of anoil spill in the Tullos Field near one of our leases. At the request of fieldagents of the Louisiana Department of Environmental Quality and theEnvironmental Protection Agency (“EPA”), we agreed to commence a clean-upoperation that was completed by the end of August 2007. A detailedanalysis of the oil in the spill compared to the Company’s produced oil wasconducted by an EPA approved laboratory. We believe that the oil in the spill did not originate from ouroperations, supported by the formal findings of the laboratory.  We received insurance reimbursements of$484,197 in October 2007 and $217,668 in March 2008.  These reimbursements covered all of ouractual cleanup costs except a $5,000 insurance deductible and excluding ourlegal fees, in-house administrative costs, and any possible EPA expensereimbursements and fines that might be billed.

 

On May 5, 2008, we received a letter from the EPAproposing a $5,500 fine related to the oil spill.  In August we paid the fine under asettlement with the EPA where we agreed to pay the $5,500 fine with noadmission of liability.  We have alsoreceived a bill from the United States Coast Guard of approximately $70,000 forexpense reimbursement.  We believe thisclaim is not supported by independent investigation.  As of the date of this filing, we haverequested further verification from the United States Coast Guard to supporttheir claim.

 

***Litigation.***  The Company is subject to various lawsuitsand other claims in the normal course of business.  In addition, from time to time, we receivecommunications from government or regulatory agencies concerning investigationsor allegations of noncompliance with laws or regulations in jurisdiction inwhich we operate.  We establish reservesfor specific liabilities in connection with regulatory and legal actions thatwe deem to be probable and estimable.  Noamounts have been accrued in our financial statements with respect to any legalor regulatory matters as we believe the matters have a remote chance ofresulting in a significant judgment.

 

In July 2008, a multi-plaintiff lawsuit was filedin the twenty-eighth Judicial District Court, Lasalle Parish, Louisiana,against 15 defendants, including Four Star Development Corporation, a formerindirect wholly owned subsidiary of the Company, which was sold on March 3,2008, as part of our sale of the Tullos Field Area.  Plaintiffs claim that the defendants’ oil andnatural gas exploration, development and production activities on theirproperties have caused soil and ground water contamination as a result of therelease of hydrocarbons and drilling fluids. Plaintiffs seek damages fortesting, clean-up and remediation of the properties as well as diminution intheir value and mental anguish and emotional distress to the individualplaintiffs, unjust enrichment and punitive damages for alleged concealment ofongoing activities.  At this time, we arenot a party to the litigation and are unable to determine the exposure, if any,to the Company.

 

In November 2005, amulti-plaintiff lawsuit was filed in the Fifth Judicial District Court,Richland Parish, Louisiana, against 18 defendants including NGS Sub Corp. andArkla Petroleum LLC, the Company’s direct and indirect wholly ownedsubsidiaries (the “Subsidiaries”), as working interest owners/operators ofvarious oil and natural gas leases in the Delhi Field.  Plaintiffs claim that the defendants’ oil andnatural gas exploration, development and production activities on theirproperties have caused soil and ground water contamination as a result of therelease of hydrocarbons and drilling fluids. Plaintiffs seek damages fortesting, clean-up and remediation of the properties as well as diminution intheir value and mental anguish to the individual plaintiffs, unjust enrichmentand punitive damages for alleged concealment of ongoing activities.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note11 – Commitments and Contingencies** (Continued)

 

Defendants have answeredPlaintiffs’ suit denying all claims.****Trial is set before a jury inRichland Parish for July 13, 2009. We intend to vigorously contest all of Plaintiffs’ claims.  The case is currently in discovery, and, atthis time, we are unable to predict the outcome of the litigation.

 

***Lease Commitments.***  We have a non-cancelable operating lease foroffice space that expires on August 1, 2016. Future minimum leasecommitments as of September 30, 2008 under this operating lease are asfollows:

 
| **Year ended September 30,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2009                                        |       | $          | 138,089    |   |
| 2010                                        |       | 138,089    |       |
| 2011                                        |       | 141,576    |       |
| 2012                                        |       | 159,011    |       |
| 2013                                        |       | 159,011    |       |
| Thereafter                                  |       | 450,531    |       |
| Total                                       |       | $          | 1,186,307  |   |

 

Rent expense for thethree months ended September 30, 2008 and 2007 was $35,466.

 

***EmploymentContracts.***  We haveentered into employment agreements with the Company’s three seniorexecutives.  The employment contractsprovide for a severance package for termination by the Company for any reasonother than cause or permanent disability, that includes payment of base pay andcertain medical and disability benefits from six months to a year aftertermination.   The total contingentobligation under the employment contracts as of September 30, 2008 isapproximately $499,000.

 

**Note 12 – Subsequent Events**

 

On October 30, 2008, we repurchased 788,200shares of common stock at an average price of $1.10 per share, plusapproximately $15,000 of transaction costs, from an unaffiliated accreditedinvestor.  At this time, the company hasno plan to repurchase any more common shares.

 

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

 

*This Form 10-Q and theinformation referenced herein contain forward-looking statements within themeaning of the Private Securities Litigations Reform Act of 1995, Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,”“anticipate,” “intend,” “budget,” “forecast,” “predict” and other similarexpressions are intended to identify forward-looking statements. Thesestatements appear in a number of places and include statements regarding ourplans, beliefs or current expectations, including the plans, beliefs andexpectations of our officers and directors.* *When considering any forward-looking statement, you should keep in mindthe risk factors that could cause our actual results to differ materially fromthose contained in any forward-looking statement. Important factors that couldcause actual results to differ materially from those in the forward-lookingstatements herein include the timing and extent of changes in commodity pricesfor oil and natural gas, operating risks and other risk factors as described inour 2008 Annual Report on Form 10-K for the year ended June 30, 2008as filed with the Securities and Exchange Commission. Furthermore, theassumptions that support our forward-looking statements are based uponinformation that is currently available and is subject to change. Wespecifically disclaim all responsibility to publicly update any informationcontained in a forward-looking statement or any forward-looking statement inits entirety and therefore disclaim any resulting liability for potentiallyrelated damages. All forward-looking statements attributable to EvolutionPetroleum Corporation are expressly qualified in their entirety by thiscautionary statement.*

 

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

 

**Executive Overview**

 

*General*

 

We are a petroleum company engaged primarily in theacquisition, exploitation and development of properties for the production ofcrude oil and natural gas. We acquire known, underdeveloped oil and natural gasresources and exploit them through the application of capital and technology toincrease production, ultimate recoveries, or both.

 

Our strategy is intended to generate scalabledevelopment opportunities at normally pressured depths, exhibiting relativelylow completion risk, generally longer and more predictable production lives,less expenditures on infrastructure and lower operational risks.

 

Within this overall strategy, we pursue three specificinitiatives:

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

 

Our most significant asset is within our EORInitiative in the 13,636 acre Delhi Field, located in northeast Louisiana.  Our non-operated interests consist of 7.4% inoverriding and mineral royalty interests and a 25% after pay-out reversionaryworking interest in the Delhi Field Holt Bryant Unit, along with a 25% workinginterest in certain other depths in the Delhi Field resulting from the Farmoutwe completed on June 12, 2006 with Denbury Onshore LLC, a subsidiary ofDenbury Resources Inc. (“Denbury”) (the “Delhi Farmout”).  The Holt Bryant Unit is currently being redevelopedby the operator, Denbury, using CO2 enhanced oil recovery technologyand a dedicated portion of Denbury’s proved CO2 reserves in theJackson Dome, approximately 100 miles east of Delhi. Injection of CO2is expected to begin during the first half of calendar 2009, followed byprojected increases in oil production on or about late calendar 2009.

 

Since our closing of the Delhi Farmout, we havefocused on developing projects in our other initiatives, particularly throughconventional redevelopment of bypassed resources in the Giddings Field usinghorizontal drilling methods, and the leasing of unconventional gas shaleprojects in the Woodford Shale Trend in Oklahoma.  Conceptually, our plan going forward can beillustrated as follows:

 

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As indicated by the above chart, (volumes arerepresentative and not to scale), we are funding our current development projectsin the Giddings Field and leasing and development in our gas shale projectswith our working capital resources.  Weexpect that net cash flows from our properties in the Giddings Field, ourcurrent cash resources and cash flows from the Delhi Project will be used tofund our gas shale projects and other new projects.

 

*Highlights for our First Quarter 2009*

 

·                  **The redeployment of our proceeds from the sale of our properties in theTullos Field Area into the Giddings Field continues to generate positiveresults**

 

***Wereported positive earnings from operations for the three months ended September 30,2008***.  During thethree months ended September 30, 2008, operating income was $377,627 andnet income before income taxes was $451,273. This compares to an operating loss of $1,269,049 and a net loss beforeincome taxes of $927,968 for the three months ended September 30,2007.  (Non-cash stock based compensationof $523,725 and $376,008, for the three months ended September 30, 2008and 2007, respectively, are included in these results.)

 

***Salesvolumes increased 385% during our first quarter in fiscal year 2009 vs. ourfirst quarter in fiscal year 2008. ***Ourincrease in sales volumes for the quarter were solely attributable to ourproduction in the Giddings Field.  Ourproperties in the Tullos Field Area, which were sold on March 3, 2008,accounted for approximately 98% of total sales volumes for the three monthsended September 30, 2007.

 

***Welowered per barrel lifting costs by 73% during our most recent quarter vs. theprior year quarter, while depletion increased approximately $6 per BOE.***Lifting costs (lease operating and severance tax, on a combined per unit ofsales basis) were $12.22 per BOE during the quarter ended September 30,2008, which included only production from our properties in the GiddingsField.  During the quarter ended September 30,2007, where primarily all our production was from our properties in the TullosField Area, lifting costs averaged $44.55 per Bbl of crude oil.  Due to additions of higher valued, highercost reserves at the Giddings field during the period, our depletion rate rosefrom $13.11 to $18.63 per BOE.

 

·                  **We remained financiallystrong**

 

***Weended the quarter with $12.9 million of working capital, little changed from$13.6 million at June 30, 2008.***  At September 30, 2008, our workingcapital consisted of $14.3 million of cash and near cash, consisting of $9.5million of cash and cash equivalents, $3.6 million of recoverable income taxesand $1.2 million in receivables from oil and natural gas sales, income taxesand other.  The $3.6 million of recoverableincome taxes is due to our estimated income tax refund from the carry-back ofour fiscal 2008 taxable loss to our tax years ended June 30, 2006 and2007.  Our 2008 tax loss was significantdue to the deduction of Intangible Drilling Costs incurred in fiscal 2008.  We expect to file our 2008 Corporation IncomeTax Return as well as the application for refund in mid November.

 

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***We protected our short-terminvestments during difficult credit market conditions.***  We have continually avoided structurallyenhanced investment securities, auction rate securities and other higher riskcredit instruments.  Instead, we reliedupon lower yielding U.S. Government Agency money market funds until July 2008,when we shifted all of our cash equivalents into short-term U.S. Treasury moneymarket funds.

 

***We are still debt free, andexpect to remain so during fiscal 2009.***

 

*Looking Forward in 2009*

 

·                  **We reduced our fiscal 2009 capital expenditures budget.**

 

***We expect to fund our fiscal 2009capital expenditures budget entirely from our working capital and operatingcash flow.* **Due inpart to uncertainties caused by the recent turmoil in the financial markets andthe decline in the price of oil and natural gas, we reduced our fiscal 2009capital expenditure budget by approximately 50% to less than $10 million (the “Revised2009 Plan”), as discussed in the “Liquidity and Capital Resources” section thatfollows.  We believe preserving ourresources could allow us to take advantage of opportunities that may arise fromthe continued disruptions in the financial markets.

 

·                  **We are more focused on extending our trend of increasing underlying pershare value.**

 

***Our Revised 2009 Plan, althoughsmaller to maintain our liquidity, is now more focused on adding provedreserves instead of converting proved reserves to production.*** We are placing more emphasis on proved reserveadditions and increasing value per share, and less emphasis this fiscal year onconverting drilling locations to producing wells.  Our capital expenditures are now focused moreon lease acquisitions and initial pilot drilling of expected proved reserves inour new Texas project and the drilling of relatively inexpensive wells in ourproperties in the Woodford Shale Trend in Oklahoma, in the expectation ofestablishing proved reserves, as described in the “Liquidity and CapitalResources” section that follows.

 

***We recently repurchased 788,200shares of our common shares at an average price of $1.10 per share, plustransaction costs, from an unaffiliated accredited investor. ***We believe theacquisition of our shares at these levels is highly accretive to existingshareholder value.  Although it’s not ourcurrent intention to repurchase more shares at this time, we will keep thatoption open.

 

We expect revenues to increase in our second quarter fiscal 2009 as comparedto our second quarter fiscal 2008, but will decline sequentially compared toour first quarter fiscal 2009.

 

·      **We expectrevenues to increase in our second quarter fiscal 2009 as compared to oursecond quarter fiscal 2008, but will decline sequentially compared to our firstquarter fiscal 2009.**

 

**Liquidity and Capital Resources**

 

At September 30,2008, our working capital, predominately cash and cash equivalents, wasapproximately $12.9 million and we continued to be debt free.  This compares to working capital ofapproximately $13.6 million at June 30, 2008.  Of the $0.7 million decrease in workingcapital since June 2008, cash of approximately $4.0 million was used forinvesting activities, primarily for development activities in the GiddingsField and leasehold acquisition costs in the Giddings Field and our WoodfordShale projects in Oklahoma, offset by cash of approximately $2.2 millionprovided by operations and an increase of approximately $1.1 million in netoperating assets.

 

Cash flows provided byoperating activities for the three months ended September 30, 2008 wasapproximately $2.2 million.  Cash flowsprovided by operations includes cash proceeds of approximately $3.9 millionfrom oil and natural gas production primarily from our properties in theGiddings Field, net cash proceeds of approximately $0.4 million from interest incomeand income tax refunds, offset by approximately $2.1 million of cash paymentsfor operating activities, including lease operating expenses, production taxes,and salaries and wages.  This compares toapproximately $0.8 million of cash used in operations for the three monthsended September 30, 2007, which includes approximately $0.6 million ofcash proceeds from oil production primarily from our properties in the TullosField Area, which we sold on March 3, 2008, cash proceeds from interest incomeof approximately $0.3 million, offset by approximately $1.7 million of cashpayments for operating activities, including lease operating expenses,production taxes, and salaries and wages.

 

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Cash flows used ininvesting activities totaled approximately $4.0 million during the three monthsended September 30, 2008.  Thiscompared to approximately $1.6 million used in investing activities for thethree months ended September 30, 2007. During the current period approximately $3.9 million of cash was usedfor investments to acquire and develop oil and natural gas property interests,which includes net payments on accounts payable of approximately $1.5 millionfrom June 30, 2008 relating to expenditures for oil and natural gasproperties.

 

There were no cash flowsfrom financing activities during the three months ended September 30, 2008and 2007.

 

We incurred approximately$2.5 million in capital expenditures for oil and natural gas leasehold anddevelopment costs during the three months ended September 30, 2008, whichincludes approximately $0.1 million related to costs incurred due to therecognition of asset retirement obligations. Of the $2.5 million, $1.1 millionwas incurred for leasehold acquisitions and approximately $1.4 million wasincurred for development activities.  Forthe three months ended September 30, 2007, we incurred approximately $2.1million in capital expenditures for oil and natural gas leasehold anddevelopment costs, with the majority being used for leasehold acquisitions.

 

Due in part touncertainties caused by the recent turmoil in the financial markets and thedecline in the price of oil and natural gas, we have revised our capitalexpenditure budget for fiscal 2009 (the “Revised 2009 Plan”), reducing theoverall program from $19 million to less than $10 million.  Our previous capital budget, as disclosed inour 2008 annual report on Form 10-K, was approximately $19 million ofincreased development activities and diminished incremental leasing in theGiddings Field and in our gas shale projects in Oklahoma, with approximately$16 million dedicated to development drilling and the balance to leaseholdacquisitions.

 

Our long term strategyand primary focus continue to be on increasing share value through theidentification and acquisition of resources and conversion of those resourcesinto proved reserves through our expertise and technology.  Due to current market conditions, we haveshifted the Revised 2009 Plan more towards higher value-added activities in (i) projectidentification and leasing of reserves that we believe will be categorized asproved undeveloped, (ii) drilling to move existing reserves into theproved category, and (iii) selective repurchase of common shares.

 

Since our wells in theGiddings Field tend to produce a large portion of their reserves relativelyquickly, we believe that it is in our shareholders’ best interests to slow thedevelopment of our properties in the Giddings Field until expectations ofhigher commodity prices may be realized. Our Revised 2009 Plan provides for drilling up to three re-entry wellsin the Giddings Field, which is a reduction from the previous ten well re-entryplan, subject to future changes in commodity prices and market conditions.  The first Giddings Field re-entry well isexpected to be drilled in November 2008.

 

Additionally, initialtest drilling of up to five low-cost vertical wells is planned within ourshallow Woodford Shale project in Oklahoma. It is our intention to potentially quantify and convert that potentialresource into proved and probable reserves, with possible further provedextensions from these wells if the SEC implements its proposed new rules onproved reserves in “continuous formations”. Similarly, we expect to drill up to three low cost wells in our newTexas project, with the expectation of potentially establishing proved reservesof moderately heavy oil associated with water at shallow depths.

 

Due to our substantialworking capital, no debt and no near term expiring leases, we believe we havethe ability to adjust our capital expenditure budget to capture selectopportunities that may arise for the benefit of our shareholders.  As an example, extreme stock marketvolatility provided us with an opportunity to repurchase our common shares at afavorable price that, we believe, increases shareholder value.  Thus, on October 30, 2008 we completed ablock repurchase of 788,200 of our common shares from an unaffiliatedinstitution at an average price of $1.10 per share, plus approximately $15,000in transaction fees.  At this time, wehave no current plan to conduct any additional repurchases of our commonshares.

 

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**Results of Operations**

 

*Three months ended September 30, 2008 comparedwith the three months ended September 30, 2007*

 

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

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **September 30**            | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2008**                         | ** ** | **2007**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Production Volumes, net to the Company:**              |       |                             |       |       |       |         |       |   |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Crude  oil and natural gas liquids (Bbl)                 |       | 12,709                           |       | 7,360      |       | 5,349        |       | 73 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural  gas liquids (“NGLs”) (Bbl)            |       | 11,063                           |       | —     |       | 11,063       |       | — |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural  gas (Mcf)                                       |       | 61,146                           |       | —     |       | 61,146       |       | — |   |
| Crude  oil, NGLs and natural gas (BOE)                   |       | 33,963                           |       | 7,360      |       | 26,603       |       | 361 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Sales Volumes, net to the Company:**                   |       |                             |       |       |       |         |       |   |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Crude  oil (Bbl)                                         |       | 12,835                           |       | 7,034      |       | 5,801        |       | 82 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| NGLs  (Bbl)                                              |       | 11,063                           |       | —     |       | 11,063       |       | — |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural  gas (Mcf)                                       |       | 61,146                           |       | —     |       | 61,146       |       | — |   |
| Crude  oil, NGLs and natural gas (BOE)                   |       | 34,089                           |       | 7,034      |       | 27,055       |       | 385 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Revenue data:**                                        |       |                             |       |       |       |         |       |   |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Crude  oil                                               |       | $                                | 1,579,070  |       | $          | 502,273      |       | $ | 1,076,797 |   | 214 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| NGLs                                                     |       | 755,445                          |       | —     |       | 755,445      |       | — |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural  gas                                             |       | 580,471                          |       | —     |       | 580,471      |       | — |   |
| Total  revenues                                          |       | $                                | 2,914,986  |       | $          | 502,273      |       | $ | 2,412,713 |   | 480 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Average prices:**                                      |       |                             |       |       |       |         |       |   |   |
| Crude  oil (per Bbl)                                     |       | $                                | 123.03     |       | $          | 71.41        |       | $ | 51.62 |   | 72 | % |
| NGLs  (per Bbl)                                          |       | 68.29                            |       | —     |       | —       |       | — |   |
| Natural  gas (per Mcf)                                   |       | 9.49                             |       | —     |       | —       |       | — |   |
| Crude  oil, NGLs and natural gas (per BOE)               |       | $                                | 85.51      |       | $          | 71.41        |       | $ | 14.10 |   | 20 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                   |       |                             |       |       |       |         |       |   |   |
| Lease  operating expenses and production taxes (a)       |       | $                                | 12.22      |       | $          | 44.55        |       | $ | (32.33 | ) | (73 | )% |
| Depletion  expense on oil and natural gas properties (b) |       | $                                | 18.63      |       | $          | 13.11        |       | $ | 5.52 |   | 42 | % |

 

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(a)          Excludes non-recurring expenses related to theoil spill in the Tullos Field Area of $5,500 and $14,532, for the three monthsended September 30, 2008 and 2007, respectively.

(b)         Excludes depreciation of furniture andfixtures of $9,824 and $18,251, for the three months ended September 30,2008 and 2007, respectively.

 

Net income (loss). For the threemonths ended September 30, 2008, we reported net income of $148,437, or$0.01 in earnings per share (which includes approximately $1.2 million ofnon-cash charges related to stock-based compensation, depreciation, depletion,and amortization, and accretion on asset retirement obligations) on total oiland natural gas revenues of $2,914,986. This compares to a net loss of $641,381, or $0.02 loss per share (whichincludes approximately $0.5 million of non-cash charges related to stock-basedcompensation, depreciation, depletion, and amortization, and accretion on assetretirement obligations) on total oil and natural gas revenues of $502,273 forthe three months ended September 30, 2007. The increase in earnings is primarily attributable to an increase inrevenues of $2,412,713, partially offset by increases in lease operatingexpense and production taxes of $94,034, an increase in depreciation, depletionand amortization of $534,438, an increase in general and administrativeexpenses of $136,523 and a decrease in interest income earned of $265,776.  Additional details of the components of netloss are explained in greater detail below.

 

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Sales Volumes.  Crude oil, natural gas liquids, and naturalgas sales volumes, net to our interest, for the three months ended September 30,2008 increased 385% to 34,089 BOE, compared to 7,034 BOE for the three monthsended September 30, 2007.  Theincrease in sales volumes is due to production of crude oil, NGLs and naturalgas from our properties in the Giddings Field. Our properties in the Tullos Field Area, which were sold on March 3,2008, accounted for approximately 98% of total sales volumes for the threemonths ended September 30, 2007.

 

Production.  Oil production will vary from oil salesvolumes by changes in crude oil inventories, which are not carried on ourbalance sheet.  Crude oil, NGL andnatural gas production for the three months ended September 30, 2008increased 361% to 33,963 BOE,compared to 7,360 Bbls of crude oil for the three months ended September 30,2007.  The increase is due to oil, NGLand natural gas production from our properties in the Giddings Field.  Production from our properties in the TullosField Area, which were sold on March 3, 2008, accounted for approximately99% of production for the three months ended September 30, 2007.

 

Oil, NGL and Natural GasRevenues.  Crude oil,NGL and natural gas revenues for the three months ended September 30, 2008increased 480% from the comparable quarter in the previous fiscal year.  This was due to a 72% increase in our averageprice of a Bbl of oil, from $71 per Bbl to $123 per Bbl, along with sales ofNGLs and natural gas during the three months ended September 30, 2008,whereas there were no sales of NGLs and natural gas during the three monthsended September 30, 2007.  Ourproperties in the Giddings Field generated approximately 100% our revenues forthe three months ended September 30, 2008. Oil revenues from our properties in the Tullos Field Area, which wassold in March 2008, accounted for approximately 98% of total revenues forthe three months September 30, 2007.

 

Lease Operating Expenses (including productionseverance taxes). Lease operating expenses and production taxes for the three months endedSeptember 30, 2008 increased approximately 29% from the comparable threemonth period in the prior fiscal year.   The increase for the three months ended September 30, 2008 isprimarily attributable to higher production taxes in the Giddings Field ascompared to the Tullos Field Area where the majority of our production wasduring the previous period.  The higherproduction taxes are due to higher revenues and a higher tax rate in our Texasproperties compared to our production from our Louisiana properties in thecomparable quarter in the previous fiscal year. On a BOE basis, lease operatingexpenses (including production severance taxes) decreased by 73% over thecomparable three month period in the prior fiscal year, due to higher salesvolumes.

 

General and Administrative Expenses (“G&A”).  G&A expenses increased 10% toapproximately $1.5 million for the three months ended September 30, 2008,compared to approximately $1.3 million for the three months ended September 30,2007.  Higher overall compensationexpenses for estimated bonuses and new hires, and including non-cashstock-based compensation, accounted for the majority of the increase.  New hires are associated with a build up ofour infrastructure to execute our drilling program in the Giddings Field.  Non-cash stock-based compensation expense was$523,725 (36% of total G&A) and $376,008 (28% of total G&A) for thethree months ended September 30, 2008 and 2007, respectively.

 

Depreciation, Depletion & AmortizationExpense (“DD&A”). DD&A expense increased by $534,438 to $644,882 for the three monthsended September 30, 2008, compared to $110,444 for the three months ended September 30,2007.  The increase is primarily due to ahigher depletion rate ($19 vs. $13) per BOE and a 385% increase in salesvolumes.  The increase in the depletionrate is due to the higher development cost of PUDs in the Giddings Field thatwe added in amount far in excess of the volume of lower cost PDP’s in ourproperties in the Tullos Field Area, which we sold in March 2008.  Proved reserves in the Giddings Fieldtypically are higher cost, but higher valued, compared to the long life, highoperating cost proved reserves in the Tullos Field Area.

 

Interest Income.  Interest income for the three months ended September 30,2008 decreased $265,776 to $75,305, compared to $341,081 for the three monthsended September 30, 2007.  The decreasein interest income is due to lower available cash balances averagingapproximately $10.0 million during the three months ended September 30,2008, as compared to cash balances averaging approximately $26.1 million duringthe three months ended September 30, 2007, combined with a lower interestrate environment during the three months ended September 30, 2008.  The lower cash balance is primarily due tocash used to pay for additions to our oil and natural gas properties.

 

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Inflation. Although the general inflation rate in the United States, as measured bythe Consumer Price Index and the Producer Price Index, has been relatively lowin recent years, the oil and gas industry has experienced unusually high priceincreases for oilfield equipment, tubulars, labor, expertise and services forthe three months ended September 30, 2008 and 2007.  The prices we received for our productsduring this period also increased dramatically and more than offset the impactof higher costs on our results of operations.

 

Known Trends andUncertainties.  Generalworldwide economic conditions have deteriorated due to credit conditionsimpacted by the sub-prime mortgage turmoil and otherfactors.  Concerns over slower or declining economic growth areaffecting numerous industries, companies, as well as consumers, which hasresulted in reduced demand for crude oil and natural gas.  If demandcontinues to decrease in the future it may continue to put downward pressure oncrude oil and natural gas prices. Decreasing oil and natural gas prices will likely result in lowerrevenues and capital resources during the second quarter of fiscal year 2009,as compared to the first quarter of fiscal 2009.

 

Seasonality.  Our business is generally not seasonal,except for certain rare instances when weather conditions may adversely affectaccess to our properties.  Although we donot generally modify our production for changes in market demand, we doexperience seasonality in the product prices we receive, generally based onhigher demand for natural gas in the summer and winter and higher demand fordownstream oil products during the summer driving season.

 

**Off Balance Sheet Arrangements**

 

The Company has nooff-balance sheet arrangements to report during the first quarter ending September 30,2008.

 

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

 

Information about marketrisks for the three months ended September 30, 2008, did not changematerially from the disclosures in Item 7A. of our Annual Report on Form 10-Kfor the year ended June 30, 2008 except as noted below.  As such, the information contained hereinshould be read in conjunction with the related disclosures in our Annual Reporton Form 10-K for the year ended June 30, 2008.

 

*InterestRate Risk*

 

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

 

*CommodityPrice Risk*

 

Our revenues,profitability and future growth depend substantially on prevailing prices foroil and natural gas. Prices also affect the amount of cash flow available forcapital expenditures and our ability to borrow and raise additional capital,as, if and when needed. Lower prices may also reduce the amount of oil andnatural gas that we can economically produce. Although our current production base may not be sufficient enough toeffectively allow hedging, we may periodically use derivative instruments tohedge our commodity price risk. We may hedge a portion of our projected oil andnatural gas production through a variety of financial and physical arrangementsintended to support oil and natural gas prices at targeted levels and to manageour exposure to price fluctuations. We may use futures contracts, swaps andfixed price physical contracts to hedge our commodity prices. Realized gainsand losses from our price risk management activities are recognized in oil andnatural gas sales when the associated production occurs. We do not hold orissue derivative instruments for speculative purposes.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

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

 

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As required by Securities and Exchange Commission Rule 13a-15(b),we carried out an evaluation, under the supervision and with the participationof the Company’s management, including our Chief Executive Officer and theCompany’s Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Exchange ActRules 13a-15(c) and 15d-15(e)) as of the end of the quarter coveredby this report.  In designing andevaluating our disclosure controls and procedures, our management recognizesthat controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving desired control objectives.  Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that as of September 30,2008 our disclosure controls and procedures are effective in ensuring that theinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission rules andforms.

 

During the quarter ended September 30, 2008 therehas been no change in our internal control over financial reporting that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

On August 3, 2007, we were advised of an oilspill in the Tullos Field Area near one of our leases. At the request of fieldagents of the Louisiana Department of Environmental Quality and theEnvironmental Protection Agency (“EPA”), we agreed to commence a clean-upoperation that was completed by the end of August 2007. A detailedanalysis of the oil in the spill compared to the Company’s produced oil wasconducted by an EPA approved laboratory. We believe that the oil in the spill did not originate from ouroperations, supported by the formal findings of the laboratory.  We received insurance reimbursements of$484,197 in October 2007 and $217,668 in March 2008.  These reimbursements covered all of ouractual cleanup costs except a $5,000 insurance deductible and excluding ourlegal fees, in-house administrative costs, and any possible EPA expensereimbursements and fines that might be billed. On May 5, 2008, we received a letter from the EPA proposing a  $5,500 fine related to the oil spill.  We have also received a bill from the UnitedStates Coast Guard of approximately $70,000 for expense reimbursement.  We believe these claims are not supported byindependent investigation.  As of thedate of this filing, we have requested further verification from the UnitedStates Coast Guard to support their claims, and have entered into a settlementwith the EPA where we have agreed to pay the $5,500 fine with no admission ofliability.

 

In July 2008, a multi-plaintiff lawsuit was filedin the twenty-eighth Judicial District Court, Lasalle Parish, Louisiana,against 15 defendants, including Four Star Development Corporation, a formerindirect wholly owned subsidiary of the Company, which was sold on March 3,2008, as part of our sale of the Tullos Field Area.  Plaintiffs claim that the defendants’ oil andnatural gas exploration, development and production activities on theirproperties have caused soil and ground water contamination as a result of therelease of hydrocarbons and drilling fluids. Plaintiffs seek damages fortesting, clean-up and remediation of the properties as well as diminution intheir value and mental anguish and emotional distress to the individualplaintiffs, unjust enrichment and punitive damages for alleged concealment ofongoing activities.  At this time, we arenot a party to the litigation and are unable to determine the exposure, if any,to the Company.

 

In November 2005, amulti-plaintiff lawsuit was filed in the Fifth Judicial District Court,Richland Parish, Louisiana, against 18 defendants including NGS Sub Corp. andArkla Petroleum LLC, the Company’s direct and indirect wholly ownedsubsidiaries (the “Subsidiaries”), as working interest owners/operators ofvarious oil and natural gas leases in the Delhi Field.  Plaintiffs claim that the defendants’ oil andnatural gas exploration, development and production activities on theirproperties have caused soil and ground water contamination as a result of therelease of hydrocarbons and drilling fluids. Plaintiffs seek damages fortesting, clean-up and remediation of the properties as well as diminution intheir value and mental anguish to the individual plaintiffs, unjust enrichmentand punitive damages for alleged concealment of ongoing activities.

 

Defendants have answeredPlaintiffs’ suit denying all claims.****Trial is set before a jury inRichland Parish for July 13, 2009. We intend to vigorously contest all of Plaintiffs’ claims.  The case is currently in discovery, and, atthis time, we are unable to predict the outcome of the litigation.

 

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**ITEM 1A. RISK FACTORS**

 

The following is anupdate of the risk factors set forth in the Company’s Annual Report on Form 10-Kfor the year ended June 30, 2008. Other than set forth below, thee have been no material changes in ourrisk factors from the information provided in Item 1A. Risk Factors in the Form 10-K.

 

**We couldbe adversely affected by a recession in the United States or global economy.**

 

Arecessionary economic environment could result in lower demand for oil andnatural gas and may also result in less capital available to fund futuregrowth.  These factors could negativelyimpact our profitability or limit our growth.

 

**ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 

None.

 

**ITEM3. DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

**ITEM5. OTHER INFORMATION**

 

None.

 

**ITEM 6.EXHIBITS**

 

A.           Exhibits

 
|        | 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**

 

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

 

**EVOLUTIONPETROLEUM CORPORATION**

(Registrant)

 

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

 

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