Table of Contents

 

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

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

 

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

 

**For thetransition period from              to**

 

**CommissionFile Number 001-32942**

 

**EVOLUTIONPETROLEUM CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices and zip code)

 

**(713)935-0122**

(Registrant’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 the definition of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. 

 
| 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 February 17, 2009, was 26,259,147.

 

 

** **

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Table of Contents

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**TABLE OFCONTENTS**

 
| ** **                             | **Page**                                                                                                               |
|----------------------------------------|------------------------------------------------------------------------------------------------------------------------|
|                                   |                                                                                                                   |   |
| **PART I. FINANCIAL INFORMATION** |                                                                                                                   |
|                                   |                                                                                                                   |   |
| ITEM 1.                                | CONSOLIDATED  CONDENSED FINANCIAL STATEMENTS                                                                           | 3 |
|                                   |                                                                                                                   |   |
|                                   | Consolidated Balance Sheets  (unaudited) as of December 31, 2008 and June 30, 2008                           | 3 |
|                                   | Consolidated Statements of  Operations (unaudited) for the three and six months ended December 31,  2008 and 2007 | 4 |
|                                   | Consolidated Statements of Cash Flows  (unaudited) for the six months ended December 31, 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                                                            | 26 |
|                                   |                                                                                                                   |   |
| ITEM 4.                                | CONTROLS AND  PROCEDURES                                                                                               | 27 |
|                                   |                                                                                                                   |
| **PART II. OTHER  INFORMATION**   |                                                                                                                   |
|                                   |                                                                                                                   |
| ITEM  1.                               | LEGAL  PROCEEDINGS                                                                                                     | 27 |
|                                   |                                                                                                                   |   |
| ITEM  1A.                              | RISK  FACTORS                                                                                                          | 28 |
|                                   |                                                                                                                   |   |
| ITEM 2.                                | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                            | 28 |
|                                   |                                                                                                                   |   |
| ITEM 3.                                | DEFAULTS UPON  SENIOR SECURITIES                                                                                       | 28 |
|                                   |                                                                                                                   |   |
| ITEM 4.                                | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                   | 29 |
|                                   |                                                                                                                   |   |
| ITEM 5.                                | OTHER  INFORMATION                                                                                                     | 29 |
|                                   |                                                                                                                   |   |
| ITEM  6.                               | EXHIBITS                                                                                                               | 30 |
|                                   |                                                                                                                   |
| SIGNATURES                             | 31                                                                                                                     |

 

2

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Table of Contents

** **

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

 

**EvolutionPetroleum Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                           | ** ** | **December 31,  2008** | ** ** | **June 30,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                                                                                           | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Current assets                                                                                                                                                                                       |       |                        |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                                           |       | $                           | 8,514,708  |                    | $          | 11,272,280 |   |
| Certificates of  deposit                                                                                                                                                                             |       | 1,500,000                   |       | —                  |       |
| Receivables                                                                                                                                                                                          |       |                        |       |                    |       |
| Oil and natural  gas sales                                                                                                                                                                           |       | 407,775                     |       | 2,066,300               |       |
| Income tax                                                                                                                                                                                           |       | —                      |       | 478,599                 |       |
| Other                                                                                                                                                                                                |       | 159,638                     |       | 86,966                  |       |
| Income taxes  recoverable                                                                                                                                                                            |       | —                      |       | 3,625,987               |       |
| Prepaid expenses  and other current assets                                                                                                                                                           |       | 156,996                     |       | 270,938                 |       |
| Total current  assets                                                                                                                                                                                |       | 10,739,117                  |       | 17,801,070              |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Property and  equipment, net of depreciation, depletion, and amortization                                                                                                                            |       |                        |       |                    |       |
| Oil and natural  gas properties — full cost method of accounting, of which $9,467,090 at  December 31, 2008 and $7,573,507 at June 30, 2008 were excluded  from amortization)         |       | 27,496,976                  |       | 22,047,233              |       |
| Other property  and equipment                                                                                                                                                                        |       | 168,011                     |       | 161,027                 |       |
| Total property  and equipment                                                                                                                                                                        |       | 27,664,987                  |       | 22,208,260              |       |
| ** **                                                                                                                                                                                           | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Other assets,  net                                                                                                                                                                                   |       | 353,400                     |       | 356,518                 |       |
| ** **                                                                                                                                                                                           | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Total assets                                                                                                                                                                                         |       | $                           | 38,757,504 |                    | $          | 40,365,848 |   |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                        | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Current  liabilities                                                                                                                                                                                 |       |                        |       |                    |       |
| Accounts payable                                                                                                                                                                                     |       | $                           | 2,374,360  |                    | $          | 2,892,459 |   |
| Accrued expenses                                                                                                                                                                                     |       | 555,130                     |       | 805,262                 |       |
| Royalties  payable                                                                                                                                                                                   |       | 191,276                     |       | 473,327                 |       |
| Total current  liabilities                                                                                                                                                                           |       | 3,120,766                   |       | 4,171,048               |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Long term  liabilities                                                                                                                                                                               |       |                        |       |                    |       |
| Deferred income  taxes                                                                                                                                                                               |       | 2,682,921                   |       | 2,901,929               |       |
| Asset retirement  obligations                                                                                                                                                                        |       | 334,668                     |       | 215,056                 |       |
| Deferred rent                                                                                                                                                                                        |       | 75,969                      |       | 74,081                  |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Total  liabilities                                                                                                                                                                                   |       | 6,214,324                   |       | 7,362,114               |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Commitments and  contingencies (Note 11)                                                                                                                                                             |       |                        |       |                    |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Stockholders’  equity                                                                                                                                                                           |       |                        |       |                    |       |
| Common Stock;  par value $0.001; 100,000,000 shares authorized; issued 27,007,234 shares;  outstanding 26,219,034 and 26,870,439 as of December 31, 2008 and  June 30, 2008, respectively. |       | 27,007                      |       | 26,870                  |       |
| Additional  paid-in capital                                                                                                                                                                          |       | 15,465,506                  |       | 14,188,841              |       |
| Retained  earnings                                                                                                                                                                                   |       | 17,932,689                  |       | 18,788,023              |       |
|                                                                                                                                                                                                 |       | 33,425,202                  |       | 33,003,734              |       |
| Less cost of  common stock in treasury, 788,200 shares as of December 31, 2008.                                                                                                                 |       | (882,022                    | )          | —                  |       |
| Total  stockholders’ equity                                                                                                                                                                     |       | 32,543,180                  |       | 33,003,734              |       |
|                                                                                                                                                                                                 |       |                        |       |                    |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                     |       | $                           | 38,757,504 |                    | $          | 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  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                  | ** ** | **2007**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                   | ** ** | ** **                                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Crude oil                                  |       | $                                         | 407,194    |                                    | $          | 607,877 |   | $ | 1,986,264 |   | $ | 1,110,150 |   |
| Natural gas  liquids                       |       | 235,293                                   |       | 21,294                                  |       | 990,738 |   | 21,294 |   |
| Natural gas                                |       | 389,295                                   |       | 23,478                                  |       | 969,766 |   | 23,478 |   |
| Total revenues                             |       | 1,031,782                                 |       | 652,649                                 |       | 3,946,768 |   | 1,154,922 |   |
|                                       |       |                                      |       |                                    |       |   |   |   |   |
| Operating Costs                            |       |                                      |       |                                    |       |   |   |   |   |
| Lease operating  expense                   |       | 313,406                                   |       | 361,192                                 |       | 649,310 |   | 671,502 |   |
| Production taxes                           |       | 21,776                                    |       | 15,808                                  |       | 107,772 |   | 33,364 |   |
| Depreciation,  depletion and amortization  |       | 504,291                                   |       | 123,116                                 |       | 1,149,173 |   | 233,559 |   |
| Accretion of  asset retirement obligations |       | 6,124                                     |       | 4,851                                   |       | 11,861 |   | 9,546 |   |
| General and  administrative *              |       | 1,662,627                                 |       | 1,467,678                               |       | 3,127,467 |   | 2,795,996 |   |
| Total operating  costs                     |       | 2,508,224                                 |       | 1,972,645                               |       | 5,045,583 |   | 3,743,967 |   |
|                                       |       |                                      |       |                                    |       |   |   |   |   |
| Loss from  operations                      |       | (1,476,442                                | )          | (1,319,996                              | )          | (1,098,815 | ) | (2,589,045 | ) |
|                                       |       |                                      |       |                                    |       |   |   |   |   |
| Other income                               |       |                                      |       |                                    |       |   |   |   |   |
| Interest income                            |       | 17,782                                    |       | 266,740                                 |       | 91,428 |   | 607,821 |   |
| ** **                                 | ** ** | ** **                                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss before  income tax benefit        |       | (1,458,660                                | )          | (1,053,256                              | )          | (1,007,387 | ) | (1,981,224 | ) |
| ** **                                 | ** ** | ** **                                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income tax  benefit                        |       | (454,889                                  | )          | (282,399                                | )          | (152,053 | ) | (568,986 | ) |
| ** **                                 | ** ** | ** **                                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                   |       | $                                         | (1,003,771 | )                                       | $          | (770,857 | ) | $ | (855,334 | ) | $ | (1,412,238 | ) |
|                                       |       |                                      |       |                                    |       |   |   |   |   |
| Loss per common  share                     |       |                                      |       |                                    |       |   |   |   |   |
| Basic and  Diluted                         |       | $                                         | (0.04      | )                                       | $          | (0.03 | ) | $ | (0.03 | ) | $ | (0.05 | ) |
|                                       |       |                                      |       |                                    |       |   |   |   |   |
| Weighted average  number of common shares  |       |                                      |       |                                    |       |   |   |   |   |
| Basic and  Diluted                         |       | 26,351,277                                |       | 26,777,366                              |       | 26,598,473 |   | 26,776,800 |   |

----

*General andadministrative expenses for the three month period ended December 31, 2008and 2007 included non cash stock-based compensation expense of $584,525 and$441,564, respectively. General and administrative expenses for the six monthperiod ended December 31, 2008 and 2007 included non cash stock-based compensationexpense of $1,108,250 and $817,571, respectively.

 

See accompanyingnotes to consolidated financial statements.

 

 

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**EvolutionPetroleum Corporation and Subsidiaries**

** Consolidated Statements of Cash Flow**

**(Unaudited)**

 
| ** **                                                                                                                                  | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| Cash flows from  operating activities                                                                                                       |       |                                    |       |   |   |
| Net loss                                                                                                                                    |       | $                                       | (855,334   | ) | $ | (1,412,238 | ) |
| Adjustments to  reconcile net loss to net cash provided by(used in) operating activities:                                                   |       |                                    |       |   |   |
| Depreciation,  depletion and amortization                                                                                                   |       | 1,149,173                               |       | 233,559 |   |
| Stock-based  compensation                                                                                                                   |       | 1,108,250                               |       | 817,571 |   |
| Accretion of  asset retirement obligations                                                                                                  |       | 11,861                                  |       | 9,546 |   |
| Deferred income  taxes                                                                                                                      |       | (219,008                                | )          | — |   |
| Deferred rent                                                                                                                               |       | 1,888                                   |       | 24,903 |   |
| Changes in  operating assets and liabilities:                                                                                               |       |                                    |       |   |   |
| Receivables from  oil and natural gas sales                                                                                                 |       | 1,658,525                               |       | (176,593 | ) |
| Receivables from  income taxes and other                                                                                                    |       | 4,031,914                               |       | (811,595 | ) |
| Prepaid expenses  and other current assets                                                                                                  |       | 113,942                                 |       | 85,261 |   |
| Accounts payable  and accrued expenses                                                                                                      |       | (314,436                                | )          | (102,658 | ) |
| Royalties  payable                                                                                                                          |       | (282,051                                | )          | 9,767 |   |
| Net cash  provided by (used in) operating activities                                                                                        |       | 6,404,724                               |       | (1,322,477 | ) |
|                                                                                                                                        |       |                                    |       |   |   |
| Cash flows from  investing activities                                                                                                       |       |                                    |       |   |   |
| Development of  oil and natural gas properties                                                                                              |       | (4,723,006                              | )          | (529,262 | ) |
| Acquisitions of  oil and natural gas properties                                                                                             |       | (2,033,874                              | )          | (4,395,050 | ) |
| Proceeds from  asset sale                                                                                                                   |       | —                                  |       | 31,582 |   |
| Capital  expenditures for other equipment                                                                                                   |       | (26,602                                 | )          | (53,625 | ) |
| Purchases of  certificates of deposit                                                                                                       |       | (1,500,000                              | )          | — |   |
| Other assets                                                                                                                                |       | 3,118                                   |       | (2,020 | ) |
| Net cash used in  investing activities                                                                                                      |       | (8,280,364                              | )          | (4,948,375 | ) |
|                                                                                                                                        |       |                                    |       |   |   |
| Cash flows from  financing activities                                                                                                       |       |                                    |       |   |   |
| Proceeds from  issuance of restricted stock                                                                                                 |       | 90                                      |       | 26 |   |
| Purchase of  treasury stock                                                                                                                 |       | (882,022                                | )          | — |   |
| Net cash  provided by (used in) financing activities                                                                                        |       | (881,932                                | )          | 26 |   |
|                                                                                                                                        |       |                                    |       |   |   |
| Net decrease in  cash and cash equivalents                                                                                                  |       | (2,757,572                              | )          | (6,270,826 | ) |
|                                                                                                                                        |       |                                    |       |   |   |
| Cash and cash  equivalents, beginning of period                                                                                             |       | 11,272,280                              |       | 27,746,942 |   |
|                                                                                                                                        |       |                                    |       |   |   |
| Cash and cash  equivalents, end of period                                                                                                   |       | $                                       | 8,514,708  |   | $ | 21,476,116 |   |
|                                                                                                                                        |       |                                    |       |   |   |
| Supplemental  disclosure of cash flow information:                                                                                          |       |                                    |       |   |   |
| Income taxes  paid                                                                                                                          |       | $                                       | 15,000     |   | $ | — |   |
| Income tax  refunds and net operating loss carry-back received                                                                              |       | $                                       | 4,052,631  |   | $ | — |   |
| Non-cash  transactions:                                                                                                                     |       |                                    |       |   |   |
| Increase  (decrease) in accounts payable used to acquire oiland natural gas leasehold  interests and develop oil andnatural gas properties. |       | $                                       | (285,333   | ) | $ | 985,571 |   |
| Oil and natural  gas properties incurred through recognitionof asset retirement obligations.                                                |       | $                                       | 107,751    |   | $ | — |   |
| Common stock  issued in lieu of a portion of 2008 cash bonusaccrued 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”) andits 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.***  The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and with the appropriate rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the financial position and results of operations for theinterim periods presented have been included. The interim financial information and notes hereto should be read inconjunction with the Company’s 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.***  Ourconsolidated financial statements include the accounts of EPM and itswholly-owned subsidiaries. All significant intercompany transactions have beeneliminated in consolidation. The consolidated financial statements for theprevious year include certain reclassifications that were made to conform tothe current presentation.  Suchreclassifications have no impact on previously reported income or stockholders’equity.

 

***Use ofEstimates. ***The preparation of financial statementsin conformity with GAAP requires us to make estimates and assumptions thataffect the reported amounts of assets and liabilities at the dates of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting periods.  Significantestimates include reserve quantities and estimated future cash flows associatedwith proved reserves, which significantly impact depletion expense andpotential impairments of oil and natural gas properties, income taxes and thevaluation of deferred tax assets, stock-based compensation and commitments andcontingencies.  We analyze our estimatesbased on historical experience and various other assumptions that we believe tobe reasonable. While we believe that our estimates and assumptions used inpreparation of the consolidated financial statements are appropriate, actualresults could differ from those estimates.

 

**Note 2 —Recent Accounting Pronouncements**

 

***New AccountingStandards.***  The following discloses the existence and effect ofaccounting standards issued but not yet adopted by us with respect toaccounting standards that may have an impact on the Company when adopted in thefuture.

 

***Modernization ofOil and Gas Reporting.***  On December 31, 2008 the SEC released newrequirements for reporting oil and gas reserves.  The new disclosure requirements,when effective, provide for consideration of new technologies in evaluatingreserves, allows companies to disclose their probable and possible reserves toinvestors, requires reporting of oil and gas reserves using an average pricebased on the prior 12-month period rather than year-end prices, revises thedisclosure requirements for oil and gas operations, and revises accounting forthe limitation on capitalized costs for full cost companies.  The new rule isexpected to be effective for fiscal years ending on or after December 31,2009, although the transition may be extended. A company may not apply the new rules to disclosures in quarterlyreports prior to the first annual report in which the revised disclosures arerequired.  We have not yet evaluated theeffects the new rule will have on our financial statements.

 

***Accounting for Business Combinations.***  In December 2007, the FASB issued SFAS No. 141R,*Business Combinations* (“SFAS No. 141R”),which replaces SFAS No. 141,*  Business Combinations*.  SFAS No. 141R establishes principles andrequirements for determining how an enterprise recognizes and measures the fairvalue of certain assets and liabilities acquired in a business combination,including non-controlling interests, contingent consideration, and certainacquired contingencies.  SFAS No. 141Ralso requires acquisition-related transaction expenses and restructuring costsbe expensed as incurred 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

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

period beginning on orafter December 15, 2008.  SFAS No. 141Rwould have an impact on accounting for any businesses acquired after theeffective date of this pronouncement.

 

***Accounting for Fair Value Measurements*****. **In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS No. 157”).  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in GAAP and expandsdisclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007.  The provisions of SFAS No. 157 will beapplied prospectively as of the beginning of the fiscal year in which it isinitially applied except for, among other items, a financial instrument thatwas measured at fair value at initial recognition under Statement 133 using thetransaction price in accordance with the guidance in footnote 3 of Issue 02-3prior to initial application of SFAS No. 157.  In February 2008, the FASB deferred theeffective date of SFAS No. 157 by one year for nonfinancial assets andnonfinancial liabilities that are recognized or disclosed at fair value in thefinancial statements on a nonrecurring basis and amended SFAS No. 157 toexclude SFAS No. 13, *Accounting for Leases,*and its related interpretive accounting pronouncements that address leasingtransactions.  SFAS No. 157 did nothave 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 and six months ended December 31, 2007 as though the dispositionof our properties in the Tullos Field Area occurred at October 1, 2007 andJuly 1, 2007, respectively.  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.

 

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Table of Contents

 

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 3 —Sale of Oil and Natural Gas Properties**(Continued)

 

The unaudited pro formaconsolidated financial information for the three and six months ended December 31,2007 are as follows:

 
| ** **                                           | ** ** | **Three Months Ended  December 31, 2007** | ** ** | **Six Months Ended  December 31, 2007** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | **As  Reported**                               | ** ** | **Pro  Forma**                               | ** ** | **As  Reported** | ** ** | **Pro  Forma** | ** ** |
| Oil and natural  gas revenues                        |       | $                                              | 652,649    |                                         | $          | 60,116 |   | $ | 1,154,922 |   | $ | 70,422 |   |
| Loss from  operations                                |       | (1,319,996                                     | )          | (1,425,170                                   | )          | (2,589,045 | ) | (2,743,395 | ) |
| Net loss                                             |       | (770,857                                       | )          | (847,831                                     | )          | (1,412,238 | ) | (1,522,260 | ) |
|  Loss per common share — basic and diluted |       | $                                              | (0.03      | )                                            | $          | (0.03 | ) | $ | (0.05 | ) | $ | (0.06 | ) |

 

**Note 4 —****Property and Equipment**

 

As of December 31,2008 and June 30, 2008 our oil and natural gas properties and otherproperty and equipment consisted of the following:

 
| ** **                                                   | ** ** | **December 31,  2008** | ** ** | **June 30,  2008** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **Oil and  natural gas properties**                          | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Property costs  subject to amortization                      |       | $                           | 19,791,481 |                    | $          | 15,105,766 |   |
| Less:  Accumulated depreciation, depletion, and amortization |       | (1,761,595                  | )          | (632,040                | )          |
| Unproved  properties not subject to amortization             |       | 9,467,090                   |       | 7,573,507               |       |
| Oil and natural  gas properties, net                         |       | $                           | 27,496,976 |                    | $          | 22,047,233 |   |
|                                                         |       |                        |       |                    |       |
| **Other  property and equipment**                            | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Furniture,  fixtures and office equipment, at cost           |       | 258,443                     |       | 231,841                 |       |
| Less:  Accumulated depreciation                              |       | (90,432                     | )          | (70,814                 | )          |
| Other property  and equipment, net                           |       | $                           | 168,011    |                    | $          | 161,027 |   |

 

Unproved properties not subject to amortizationincludes unevaluated acreage of $7.5 and $5.6 million as of December 31,2008 and June 30, 2008, respectively. As of December 31, 2008, this acreage consists of properties in theGiddings Field, our projects in the Woodford Shale trend in Oklahoma, and ourNeptune project in South Texas.  As of June 30,2008, the unevaluated acreage consist of properties in the Giddings Field andour projects in the Woodford Shale trend in Oklahoma.  Unproved properties also consist ofapproximately $2.0 million as of December 31, 2008 and June 30, 2008of participating interests through separately acquired royalty and overridingroyalty interests aggregating 7.4% of the Delhi Holt Bryant Unit in the DelhiField in Louisiana.  Subject to industryconditions, evaluation of these properties is expected to be completed withinthree years.  Our evaluation ofimpairment of unproved properties occurs, at a minimum, on a quarterly basis.

 

If our net oil and natural gas properties, net ofrelated deferred income taxes, exceed the present value of estimated future netcash flows based on period-end commodity prices discounted at 10 percent andplus the cost of unproved oil and natural gas properties not subject toamortization, net of related tax effects, the excess is charged to expense.  Although, we did not have a “ceiling test”impairment as of December 2008, ifprices for crude oil and natural gas decline an additional ten percent fromtheir spot price on December 31, 2008, without an equal dollar reductionin capital costs, we would expect to have a write-down of our oil and naturalgas properties of approximately $2.6 million.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 5****—****Asset Retirement Obligations**

** **

Our asset retirement obligations represent the estimated present valueof the amount we will incur to plug, abandon and remediate our producingproperties at the end of their productive lives in accordance with applicablelaws. The following is a reconciliation of the beginning and ending assetretirement obligation for the six months ended December 31, 2008:

** **
| **Asset  retirement obligations - July 1, 2008**           |   | $      | 215,056 |   |
|-----------------------------------------------------------------|--------|--------|---------|--------|
| Liabilities  incurred                                           |   | 22,480 |    |
| Accretion  expense                                              |   | 11,861 |    |
| Revisions to  previous estimates                                |   | 85,271 |    |
| **Asset  retirement obligations — December 31, 2008** |   | $      | 4,668   |   |

 

**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 elected to receive these 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.

 

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, we currently haveno plan to repurchase any more common shares.

 

On December 9, 2008, three outside directors eachreceived 30,000 shares of restricted common stock as part of a compensationplan for directors.  The same outsidedirectors each received 8,633 shares of restricted common stock as part oftheir compensation plan during the year ended June 30, 2008.  All issuances of common stock were subject tovesting terms per individual stock agreements.

 

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

 

We have granted optionawards to purchase common stock (the “Stock Options”) and restricted commonstock awards  (“Restricted Stock”) toemployees, directors, and consultants of the Company and its subsidiaries underthe Natural Gas Systems Inc. 2003 Stock Plan (the “2003 Stock Plan”) and theEvolution Petroleum Corporation Amended and Restated 2004 Stock Plan (the “2004Stock Plan” or together, the “EPM Stock Plans”).  A total of 600,000 awards to purchase anequal number of shares of common stock were issued under the 2003 StockPlan.  The 2004 Stock Plan authorized theissuance of 5,500,000 shares of common stock. There are no shares available for grant under the 2003 Stock Plan and,as of December 31, 2008, 597,974 shares remain available for grant underthe 2004 Stock Plan.

 

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 December 31, 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 monthperiod ended December 31, 2008 and 2007 was $499,994 and $403,109,respectively.  Stock-based compensationexpense related to Stock Options and Incentive Warrants for the six monthperiod ended December 31, 2008 and 2007 was $945,987 and $704,206,respectively.

 

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** **

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

** **

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

 

During the six monthsended December 31, 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 the sixmonths ended December 31, 2007, we granted Stock Options to purchase 1,335,000shares of common stock under the 2004 Stock Plan with a weighted averageexercise price of $2.43.  The exerciseprice was determined based on the market price of the Company’s common stock onthe date of grant.  The Stock Optionsgranted during the six months ended December 31, 2008 and 2007 generallyvest quarterly, on a straight line basis, over a period of four years.  The Stock Options granted during the sixmonths ended December 31, 2008 and 2007 have a contractual life of sevenand ten years, respectively.  Theweighted average assumptions used to calculate the fair value of these StockOptions and the weighted average fair value of each Stock Option granted is asfollows:

 

| ** **                   | ** ** | **Six Months Ended**  | ** ** |
|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **December 31,** | ** ** |
| ** **                   | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Expected volatility          |       | 87.1                  | %          | 94.0 | % |
| Expected  dividends          |       | —                |       | — |   |
| Expected term  (in years)    |       | 4.6                   |       | 6.1 |   |
| Risk-free rate               |       | 3.10                  | %          | 4.11 | % |
| Fair value per  Stock Option |       | $                     | 2.62       |   | $ | 1.90 |   |
|                              |            |                       |            |  |  |  |  |

 

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 the estimated expected term for “plain vanilla” options allowed bythe SEC Staff Accounting Bulletin (“SAB”) No. 107 and SAB No. 110,and varied based on the vesting period and contractual

 

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

 
| ** **                                                                  | ** ** | **Number of  Stock Options  and Incentive Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value   (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                                                                        |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| 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 December 31, 2008 |       | 6,074,590                                                           |       | $2.05                                     |       | $543,600                                       |       | 7.0                                                             |       |
|                                                                        |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Vested or  expected to vest at December 31, 2008                       |       | 6,074,590                                                           |       | $2.05                                     |       | $543,600                                       |       |                                                            |       |
|                                                                        |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Exercisable at  December 31, 2008                                      |       | 3,935,063                                                           |       | $1.59                                     |       | $543,038                                       |       | 6.6                                                             |       |

 

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the fiscal quarter ($1.20) and the Stock Option or IncentiveWarrant exercise price of in-the-money Stock Options and Incentive Warrants.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

There were no StockOptions or Incentive Warrants that were exercised during the six months ended December 31,2008 and 2007.

 

A summary of the status ofour unvested Stock Options and Incentive Warrants as of December 31, 2008and the changes during the six months ended December 31, 2008 and 2007, ispresented 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                             |       | 1,335,000                                           |       | $                                                            | 1.90       |   |
|                                |       |                                                |       |                                                         |       |
| Vested                              |       | (375,625                                            | )          | $                                                            | 1.35       |   |
|                                |       |                                                |       |                                                         |       |
| Canceled,  forfeited, or expired    |       | —                                              |       | —                                                       |       |
|                                |       |                                                |       |                                                         |       |
| Unvested at  December 31, 2007 |       | 2,532,500                                           |       | $                                                            | 1.73       |   |
|                                |       |                                                |       |                                                         |       |
| Unvested at July 1,  2008      |       | 2,003,437                                           |       | $                                                            | 1.83       |   |
|                                |       |                                                |       |                                                         |       |
| Granted                             |       | 591,090                                             |       | $                                                            | 2.62       |   |
|                                |       |                                                |       |                                                         |       |
| Vested                              |       | (455,000                                            | )          | $                                                            | 1.69       |   |
|                                |       |                                                |       |                                                         |       |
| Canceled,  forfeited, or expired    |       | —                                              |       | —                                                       |       |
|                                |       |                                                |       |                                                         |       |
| Unvested at  December 31, 2008 |       | 2,139,527                                           |       | $                                                            | 2.08       |   |

 

The total unrecognizedcompensation cost at December 31, 2008, relating to non-vested share-basedcompensation arrangements granted under the EPM Stock Plans and IncentiveWarrants was $4,151,838.  Suchunrecognized expense is expected to be recognized over a weighted averageperiod of 2.8 years.

 

**Restricted Stock**

 

For the six months ended December 31,2008 and 2007, we issued 90,000 and 25,899 shares of restricted common stock,respectively, to three outside directors. All issuances of common stock are subject to vesting terms perindividual stock agreements.

 

Stock-based compensationexpense related to Restricted Stock grants for the three month period ended December 31,2008 and 2007 was $84,531 and $38,455, respectively.  Stock-based compensation expense related toRestricted Stock grants for the six month period ended December 31, 2008and 2007 was $162,263 and $113,365, respectively.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

The following table setsforth the Restricted Stock transactions for the six months ended December 31,2008 and 2007:

 
| ** **                          | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                                |       |                                   |       |                                               |       |
| Unvested at  July 1, 2007      |       | 59,449                                 |       | $                                                  | 2.78       |   |
|                                |       |                                   |       |                                               |       |
| Granted                             |       | 25,899                                 |       | $                                                  | 4.17       |   |
|                                |       |                                   |       |                                               |       |
| Vested                              |       | (59,449                                | )          | $                                                  | 2.78       |   |
|                                |       |                                   |       |                                               |       |
| Forfeited                           |       | —                                 |       | —                                             |       |
|                                |       |                                   |       |                                               |       |
| Unvested at  December 31, 2007 |       | 25,899                                 |       | $                                                  | 4.17       |   |
|                                |       |                                   |       |                                               |       |
| Unvested at  July 1, 2008      |       | 50,898                                 |       | $                                                  | 4.11       |   |
|                                |       |                                   |       |                                               |       |
| Granted                             |       | 90,000                                 |       | $                                                  | 1.20       |   |
|                                |       |                                   |       |                                               |       |
| Vested                              |       | (50,898                                | )          | $                                                  | 4.11       |   |
|                                |       |                                   |       |                                               |       |
| Forfeited                           |       | —                                 |       | —                                             |       |
|                                |       |                                   |       |                                               |       |
| Unvested at  December 31, 2008 |       | 90,000                                 |       | $                                                  | 1.20       |   |

 

At December 31,2008, unrecognized stock compensation expense related to Restricted Stockgrants totaled $101,110.  Suchunrecognized expense will be recognized over a weighted average period of 0.9years.

 

**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 December 31,2008.

 

We recognized a taxbenefit of 31% and 27% for the three months ended December 31, 2008 and2007, respectively, and a tax benefit of 15% and 29% for the six months ended December 31,2008 and 2007, respectively.  The primaryreconciling item of our income tax benefit at the statutory federal rate to oureffective income tax benefit is stock-based compensation related to ourqualified incentive stock option awards.

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 9****—****Related Party Transactions**

 

Laird Q. Cagan, a member of our Board of Directors, isa Managing Director and co-owner of Cagan McAfee Capital Partners, LLC (“CMCP”).CMCP has performed financial advisory services to us pursuant to a writtenagreement amended in November 2005 (the “Agreement”), providing for aretainer of $5,000 per month.  Alsopursuant to the Agreement, Mr. Cagan, as a registered representative ofChadbourn Securities Inc. (“Chadbourn”) and as a partner of CMCP could serve asour placement agent in private equity financings, wherein CMCP could earn cashfees equal to 8% of gross equity proceeds, declining to 4% subject to theamount of equity raised through CMCP, and a fixed 4% warrant fee.  During the term of the Agreement , Mr. Caganreceived no compensation for serving as a director or as the Chairman of ourBoard of Directors.  Effective December31, 2008, the Agreement was modified to remove the monthly retainer and Mr. Caganwas re-elected as a director of our Board with remuneration consistent withother outside directors of our Board.

 

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

 

During the three and six months ended December 31,2008 and 2007, we expensed and paid CMCP $15,000 and $30,000, respectively,through monthly retainers of $5,000. There were no other earned fees by CMCP during these periods.

 

See also Note 6 for equity transactions with relatedparties.

 

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

 

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

 
| ** **                                                         | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                         | ** ** | **2008**                                  | ** ** | **2007**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| *Numerator*                                                        | * *   | * *                                  | * *   | * *                                | * *   | * * | * * | * * | * * |
| Net loss                                                           |       | $                                         | (1,003,771 | )                                       | $          | (770,857 | ) | $ | (855,334 | ) | $ | (1,412,238 | ) |
|                                                               |       |                                      |       |                                    |       |   |   |   |   |
| *Denominator*                                                      | * *   | * *                                  | * *   | * *                                | * *   | * * | * * | * * | * * |
| Weighted average  number of common shares — basic and diluted |       | 26,351,277                                |       | 26,777,366                              |       | 26,598,473 |   | 26,776,800 |   |
|                                                               |       |                                      |       |                                    |       |   |   |   |   |
| Net Loss per  common share — basic and diluted                |       | $                                         | (0.04      | )                                       | $          | (0.03 | ) | $ | (0.03 | ) | $ | (0.05 | ) |

 

Total potentiallydilutive securities outstanding as of December 31, 2008 are as follows:

 
| **Outstanding Potential Dilutive Securities**                                      | ** ** | **Weighted   Average  Exercise Price** | ** ** | **Outstanding at December 31, 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                                         |       | 90,000                                    |       |
|                                                                               |       |                                        |       | 6,565,648                                 |       |

 

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** **

**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note11 — Commitments and Contingencies**

 

***Environmental clean-up.*** On August 3, 2007, we were advised of an oil spill in the TullosField near one of our leases. At the request of field agents of the LouisianaDepartment of Environmental Quality and the Environmental Protection Agency (“EPA”),we agreed to commence a clean-up operation that was completed by the end of August 2007.A detailed analysis of the oil in the spill compared to the Company’s producedoil was conducted by an EPA approved laboratory.  We believe that the oil in the spill did notoriginate from our operations, supported by the formal findings of thelaboratory.  We received insurancereimbursements 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 theoil spill.  In August we paid thefine under a settlement with the EPA where we agreed to pay the $5,500 finewith no admission of liability.  We havealso received a bill from the United States Coast Guard of approximately$76,000 for expense reimbursement.  Webelieve this claim 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. If ultimately paid, we believe that such reimbursements arecovered by our insurance.

 

***Litigation.*** The Company is subject to various lawsuits and other claims in thenormal course of business.  In addition,from time to time, we receive communications from government or regulatoryagencies concerning investigations or allegations of noncompliance with laws orregulations in jurisdiction in which we operate.  We establish reserves for specificliabilities in connection with regulatory and legal actions that we deem to beprobable and estimable.  No amounts havebeen accrued in our financial statements with respect to any legal orregulatory matters as we believe the matters have a remote chance of resultingin 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 at this time to determine theexposure, 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 are vigorously contesting 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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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

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

 

| **For the twelve months ended December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|------------|------------|
| 2009                                              |       | $          | 138,089    |   |
| 2010                                              |       | 138,089    |       |
| 2011                                              |       | 146,806    |       |
| 2012                                              |       | 159,011    |       |
| 2013                                              |       | 159,011    |       |
| Thereafter                                        |       | 410,779    |       |
| Total                                             |       | $          | 1,151,785  |   |

 

Rent expense for thethree months ended December 31, 2008 and 2007 was 35,466.  Rent expense for the six months ended December 31,2008 and 2007 was 70,933.

 

***EmploymentContracts.***  We have entered into employment agreementswith the Company’s three senior executives. The employment contracts provide for a severance package for terminationby the Company for any reason other than cause or permanent disability, or inthe event of a constructive termination, that includes payment of base pay andcertain medical and disability benefits from six months to a year aftertermination.   The total contingentobligation under the employment contracts as of December 31, 2008 isapproximately $499,000.

 

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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 anyforward-looking statement, you should keep in mind the risk factors that couldcause our actual results to differ materially from those contained in anyforward-looking statement. Important factors that could cause actual results todiffer materially from those in the forward-looking statements herein includethe timing and extent of changes in commodity prices for oil and natural gas,operating risks and other risk factors as described in our 2008 Annual Reporton Form 10-K for the year ended June 30, 2008 as filed with theSecurities and Exchange Commission. Furthermore, the assumptions that supportour forward-looking statements are based upon information that is currentlyavailable and is subject to change. We specifically disclaim all responsibilityto publicly update any information contained in a forward-looking statement orany forward-looking statement in its entirety and therefore disclaim anyresulting liability for potentially related damages. All forward-lookingstatements attributable to Evolution Petroleum Corporation are expresslyqualified in their entirety by this cautionary statement.*

 

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

 

**Executive Overview**

 

*General*

 

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  resources 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 beingredeveloped by the operator, Denbury, using CO2 enhanced oil recovery technology and adedicated portion of Denbury’s proved CO2 reserves in the Jackson Dome, locatedapproximately 100 miles east of Delhi. According to public presentations released by Denbury, injection of CO2 is expected tobegin during the first half of calendar 2009, followed by projected increasesin oil production 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 developmentprojects in the Giddings Field and leasing and development activities in ourgas shale projects with our working capital resources.  We expect that net cash flows from ourproperties in the Giddings Field, our current cash resources and cash flowsfrom the Delhi Project will be used to fund our gas shale projects and othernew projects.

 

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.  Our focus is on the following value-addedactivities, including (i) project identification and leasing of reservesthat we believe will be categorized as proved undeveloped, and (ii) selectivedrilling activities to move existing reserves into the proved category.

 

*Highlights for our Second Quarter Fiscal Year 2009*

 

·                  **The redeployment of our proceedsfrom the sale of our properties in the Tullos Field Area into the GiddingsField continues to generate positive results**

 

***Salesvolumes increased 228% during our second quarter in fiscal year 2009 vs. oursecond quarter in fiscal year 2008. ***Our increase in sales volumes for thequarter were solely attributable to our production in the Giddings Field.  Our properties in the Tullos Field Area,which were sold on March 3, 2008, accounted for approximately 85% of totalsales volumes for the three months ended December 31, 2007.

 

***Welowered per barrel lifting costs by 72% during our most recent quarter vs. theprior year quarter, while depletion increased approximately $6 per BOE.*******Lifting costs (lease operating and severance tax, on acombined per unit of sales basis) were $12.54 per BOE during the quarter ended December 31,2008, which included only production from our properties in the GiddingsField.  During the quarter ended December 31,2007, where our production was primarily from our properties in the TullosField Area, lifting costs averaged $44.63 per Bbl of crude oil.  Due to additions of higher valued, highercost reserves at the Giddings Field during the period, our depletion rate rosefrom $13.29 to $19.07 per BOE.

 

·                  **We remained financially strong**

 

***Weended the quarter with $10.0  million ofcash and cash equivalents and short-term certificates of deposit and $7.6million of working capital, compared to $11.3 million of cash and cashequivalents and $13.6 million of working capital  at June 30, 2008.***  We incurred $6.6 million in capitalexpenditures for oil and natural gas leasehold and development costs during thesix months ended December 31, 2008.

 

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***Weprotected our short-term investments during difficult credit market conditions.*** We have continually avoided structurally enhanced investment securities,auction rate securities and other higher risk credit instruments.  Instead, we relied upon lower yielding U.S.Government Agency money market funds until July 2008, when we shifted allof our cash equivalents into short-term U.S. Treasury money market funds.  During the most recent quarter, we redeployedsome of our cash and cash equivalents into certificates of deposit that maturewithin a year and that are fully insured by the FDIC.

 

***We  repurchased 788,200 shares of our commonshares at an average price of $1.10 per share, plus transaction costs, from anunaffiliated accredited investor. ***We believe the acquisition of our sharesat these levels is highly accretive to existing shareholder value based on ourinternal calculations of the net present value of our proved and unprovedassets.  At this time, we currently haveno plan to repurchase any more common shares.

 

***Weare still debt free, and expect to remain so during fiscal 2009.***

 

*Looking Forward in 2009*

 

·                  **We will focus our efforts on increasing underlying value per share byconverting unproved resources to proved reserves**.

 

***Increasedproduction from two re-entry wells beginning in our third fiscal quarter2009. ***The first fiscal 2009 Giddings Field re-entrywell, the Hilton Yeagua #1, was recently completed and placed onto productionduring mid-January 2009.  A secondre-entry well, the Pearson #1, began drilling in late December 2008 andwas completed and placed on production in late January 2009.  As of early February, the two wells wereproducing at a combined rate of 580 boepd, and we own a 100% working interestand approximately 79% revenue interest in the two wells. Wells of this type inthe Giddings Field  generally exhibithigh initial decline rates, however, the initial production rates were higherthan projected

 

***Completionof the CO******2****** pipeline to Delhi and initiationofCO2  injection is expected in thesecond calendar quarter of 2009 (source: public presentations by Operator).***

 

***Productionfrom Delhi expected in calendar 2009. ***First oil production is expected to beginwithin six months following first injection of CO2, or sometime in latecalendar 2009. We believe that production response in the Delhi Field resultingfrom the injection of CO2 will lead to substantial net proved reserves.

 

***Weexpect to initiate pilot drilling within our shallow Woodford Shale projects.***Current plans for fiscal 2009 include thedrilling of up to five vertical wells to depths of about 1500’ to utilize airdrilling to develop what we believe will be substantial low cost gas reserves.

 

***Weexpect to initiate pilot drilling within our Neptune heavy oil project in SouthTexas. ***We recently completed the leasing ofapproximately 1500 net acres where we intend to drill infill wells within anexisting moderately heavy oil field.  Theinfill, or downspaced, wells have already been proved in expected reserves byanother operator and we expect to apply our specialized completion technologyto enhance recovery.

 

·                  **Further declines of oiland****natural****gas prices could resultin a significant impairment****of****our full-cost pool.**

 

***The current recessionary economic environment has resulted in lowerdemand for oil and natural gas, resulting in severely declining************commodityprices, while the decline in oilfield capital costs has lagged.***  If prices for crude oil and natural gasdecline an additional ten percent from their spot price on December 31,2008, without an equal dollar reduction in capital costs, we would expect tohave a write-down of our oil and natural gas properties of approximately $2.6million.

 

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**Liquidity and Capital Resources**

 

Our primary liquidity needs are to fund strategicproperty acquisitions, our drilling program, and general and administrativecosts.   As disclosed in our quarterlyreport on Form 10-Q for the quarter ended September 30, 2008, werevised our 2009 capital expenditures budget for fiscal 2009 (the “Revised 2009Plan”), reducing the overall program by more than half to less than $10million.  Due to our substantial workingcapital, cash flows from producing properties, no debt and no near termexpiring leases, we believe we have the ability to fund or further adjust ourcapital expenditure budget to capture select opportunities that may arise forthe benefit of our shareholders, without the need of additional financing.  Therefore, we believe that our currentsources of liquidity are sufficient to fund our ongoing cash requirements.

 

At December 31,2008, our working capital was $7.6 million and we continued to be debtfree.  This compares to working capitalof $13.6 million at June 30, 2008. The decrease in working capital of $6.0 million since June 2008 wasdue to cash of $6.8 million used for investing activities, primarily forinvestments in oil and natural gas properties, cash used of  $0.9 million to repurchase our common stock,a decrease of $5.8 million in receivables and other current assets, primarilyfrom the collection of income tax receivables, partially offset by cash of $6.4million provided by operations and a decrease of $1.1 million in currentliabilities.

 

Cash flows provided byoperating activities for the six months ended December 31, 2008 were $6.4million.  Cash flows provided byoperations includes cash proceeds of $5.3 million from oil and natural gasproduction primarily from our properties in the Giddings Field, cash proceedsof $0.1 million from interest income, cash proceeds of $4.1 million from incometax refunds, primarily from our 2008 tax year net operating loss carry-back,offset by $3.1 million of cash payments for operating activities, includinglease operating expenses, production taxes, and salaries and wages.  This compares to $1.3 million of cash used inoperations for the six months ended December 31, 2007, which includes $0.9million of cash proceeds from oil and natural gas production primarily from ourproperties in the Tullos Field Area, which we sold on March 3, 2008, cashproceeds from interest income of $0.6 million, offset by $2.8 million of cashpayments for operating activities, including lease operating expenses,production taxes, and salaries and wages.

 

Cash flows used in investingactivities totaled $8.3 million during the six months ended December 31,2008, and notwithstanding the purchase of certificates of deposit of $1.5million with maturities no greater than twelve months, our investing activitieswere primarily for development activities in the Giddings Field and leaseholdacquisition costs in the Giddings Field, our Woodford Shale projects inOklahoma and our Neptune project in South Texas.  Our cash flows from investing activitiesincludes net payments on accounts payable of $0.3 million from June 30,2008, relating to expenditures for oil and natural gas properties.  This compared to $4.9 million used ininvesting activities for the six months ended December 31, 2007, primarilyfor investments in oil and natural gas properties at the Giddings Field.

 

Cash flows used in financing activities for the sixmonths ended December 31, 2008 were $0.9 million.  On October 30, 2008, we repurchased788,200 shares 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. Cash flows from financing activities for the six months ended December 31,2007 were insignificant.

 

We incurred $6.6 millionin capital expenditures for oil and natural gas leasehold and development costsduring the six months ended December 31, 2008, which includes $0.1 millionrelated to costs incurred due to the recognition of asset retirement obligations.Of the $6.6 million, $2.0 million was incurred for leasehold acquisitions and$4.6 million was incurred for development activities.  For the six months ended December 31,2007, we incurred $5.9 million in capital expenditures (which includes a netincrease in accounts payable of $1.0 million from June 30, 2007 related tocapital expenditures) for oil and natural gas leasehold and development costs,primarily leasehold acquisitions in the Giddings Field.

 

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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 fiscal 2009 Giddings Field re-entrywell, the Hilton Yeagua #1, was recently completed and placed onto productionduring mid-January 2009.  A secondre-entry well, the Pearson #1, began drilling in late December 2008 andwas completed and placed on production in late January 2009.  As of early February, the two wells wereproducing at a combined rate of 580 boepd, and we own a 100% working interestand approximately 78-80% revenue interest in the two wells.

 

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.  Similarly, we expect todrill up to three low cost wells in our new Texas project, with the expectationof potentially establishing additional proved reserves of moderately heavy oilassociated with water at shallow depths.

 

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**Results of Operations**

 

*Three months ended December 31, 2008 comparedwith the three months ended December 31, 2007*

 

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

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **December 31**   | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2008**               | ** ** | **2007**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Production  Volumes, net to the Company:**             | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 7,346                  |       | 6,481      |       | 865          |       | 13 | % |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Natural gas  liquids (“NGLs”) (Bbl)            |       | 7,682                  |       | 388        |       | 7,294        |       | 1,880 | % |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Natural gas  (Mcf)                                       |       | 66,929                 |       | 3,617      |       | 63,312       |       | 1,750 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 26,183                 |       | 7,472      |       | 18,711       |       | 250 | % |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales  Volumes, net to the Company:**                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 7,098                  |       | 6,927      |       | 171          |       | 2 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 7,682                  |       | 388        |       | 7,294        |       | 1,880 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                       |       | 66,929                 |       | 3,617      |       | 63,312       |       | 1,750 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 25,935                 |       | 7,918      |       | 18,017       |       | 228 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Revenue  data:**                                       | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil                                                |       | $                      | 407,194    |       | $          | 607,877      |       | $ | (200,683 | ) | (33 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs                                                     |       | 235,293                |       | 21,294     |       | 213,999      |       | 1,005 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas                                              |       | 389,295                |       | 23,478     |       | 365,817      |       | 1,558 | % |
| Total revenues                                           |       | $                      | 1,031,782  |       | $          | 652,649      |       | $ | 379,133 |   | 58 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Average  price:**                                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (per  Bbl)                                     |       | $                      | 57.37      |       | $          | 87.75        |       | $ | (30.38 | ) | (35 | )% |
| NGLs (per Bbl)                                           |       | 30.63                  |       | 54.88      |       | (24.25       | )          | (44 | )% |
| Natural gas (per  Mcf)                                   |       | 5.82                   |       | 6.49       |       | (0.67        | )          | (10 | )% |
| Crude oil, NGLs  and natural gas (per BOE)               |       | $                      | 39.78      |       | $          | 82.43        |       | $ | (42.65 | ) | (52 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Expenses  (per BOE)**                                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating  expenses and production taxes (a)       |       | $                      | 12.54      |       | $          | 44.63        |       | $ | (32.09 | ) | (72 | )% |
| Depletion  expense on oil and natural gas properties (b) |       | $                      | 19.07      |       | $          | 13.29        |       | $ | 5.78 |   | 43 | % |

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(a)          Excludesnon-recurring expenses related to the oil spill in the Tullos Field Area of$10,000 and $23,591 for the three months ended December 31, 2008 and 2007,respectively.

 

(b)         Excludesdepreciation of furniture and fixtures of $9,794 and $17,870, for the threemonths ended December 31, 2008 and 2007, respectively.

 

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Net income (loss). For the three months ended December 31, 2008, wereported a net loss of $1,003,771, or $0.04 loss per share (which includes $1.1million of non-cash charges related to stock-based compensation, depreciation,depletion, and amortization, and accretion on asset retirement obligations) ontotal oil and natural gas revenues of $1,031,782.  This compares to a net loss of $770,857, or$0.03 loss per share (which includes $0.6 million of non-cash charges relatedto stock-based compensation, depreciation, depletion, and amortization, andaccretion on asset retirement obligations) on total oil and natural gasrevenues of $652,649 for the three months ended December 31, 2007.  The increase in loss is attributable to anincrease depreciation, depletion and amortization of $381,175, and an increasein general and administrative expenses of $194,949, a decrease in interestincome of $248,958, offset by an increase in revenues of $379,133, a decreasein lease operating expense and production taxes of $41,818, an increase in ourincome tax benefit of $172,490.  Additionaldetails of the components of net loss are explained in greater detail below.

 

Sales Volumes.  Crude oil,NGLs, and natural gas sales volumes, net to our interest, for the three monthsended December 31, 2008 increased 228% to 25,935 BOE, compared to 7,918BOE for the three months ended December 31, 2007.  The increase in sales volumes is due toproduction of crude oil, NGLs and natural gas from our properties in theGiddings Field.  Our properties in theTullos Field Area, which were sold on March 3, 2008, accounted for 85% oftotal sales volumes for the three months ended December 31, 2007.

 

Production.  Oil productionwill vary from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Crudeoil, NGLs and natural gas production for the three months ended December 31,2008 increased 250% to 26,183 BOE, compared to 7,472 BOE for the three monthsended December 31, 2007.  Theincrease is due to crude oil, NGLs and natural gas production from ourproperties in the Giddings Field. Production from our properties in the Tullos Field Area, which were soldon March 3, 2008, accounted for 84% of production for the three monthsended December 31, 2007.

 

Oil, NGLs and Natural GasRevenues.  Crude oil, NGLs and natural gas revenues forthe three months ended December 31, 2008 increased 58% from the comparablequarter in the previous fiscal year. This was due to increased sales of NGLs and natural gas during the threemonths ended December 31, 2008 in our properties in the Giddings Field,whereas we had very little production in our properties in the Giddings Fieldduring the three months ended December 31, 2007.  Increased production was offset by a 35%decrease in our average price of a Bbl of oil, from $88 per Bbl for the threemonths ended December 31, 2007 to $57 per Bbl for the three months ended December 31,2008.  Our properties in the GiddingsField generated approximately 100% of our revenues for the three months ended December 31,2008.  Oil revenues from our propertiesin the Tullos Field Area, which was sold in March 2008, accounted for 91%of total revenues for the three months December 31, 2007.

 

Lease Operating Expenses (including productionseverance taxes).  Lease operating expenses and production taxesfor the three months ended December 31, 2008 decreased approximately 14%from the comparable quarter in the prior fiscal year. Fewer higher producingwells in the Giddings Field compared to numerous lower producing wells in theTullos Field Area are contributing more efficient operations and decreasinglease operating costs, which is partially offset by higher production taxes inthe Giddings Field as compared to the Tullos Field Area where the majority ofour production was during the previous period. The higher production taxes are due to higher revenues and a higher taxrate in our Texas properties compared to our production from our Louisianaproperties in the comparable quarter in the previous fiscal year, even afteradjusting for the Texas limited severance tax holiday on wells restored toproduction.  On a BOE basis, leaseoperating expenses (including production severance taxes) decreased by 72% overthe comparable three month period in the prior fiscal year, due to higher salesvolumes at Giddings in the current period as compared to lower sales volumes atthe Tullos Field in the comparable prior year period.

 

General and Administrative Expenses (“G&A”). G&A expenses increased 13% to $1.7 million for the three monthsended December 31, 2008, compared to $1.5 million for the three months endedDecember 31, 2007.  Higher overallcompensation expenses for estimated bonuses and new hires, and includingnon-cash stock-based compensation, accounted for the majority of theincrease.  New hires are primarilyassociated with the build up of our infrastructure to accommodate ouroperations in the Giddings Field. Non-cash stock-based compensation expense was $584,525 (35% of totalG&A) and $441,564 (30% of total G&A) for the three months ended December 31,2008 and 2007, respectively.  Non-cashstock-based compensation is an integral part of total staff compensation utilized to recruit quality staff fromother, more established companies.

 

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Depreciation, Depletion & AmortizationExpense (“DD&A”).  DD&A expense increased by$381,175 to $504,291 for the three months ended December 31, 2008,compared to $123,116 for the three months ended December 31, 2007.  The increase is primarily due to a higherdepletion rate ($19 vs. $13) per BOE and a 228% increase in sales volumes.  The increase in the depletion rate is due tothe higher development cost of PUDs in the Giddings Field that we added inamount far in excess of the volume of lower cost PDP’s in our properties in theTullos 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.  Interestincome for the three months ended December 31, 2008 decreased $248,958 to$17,782, compared to $266,740 for the three months ended December 31,2007.  The decrease in interest income isdue to lower available cash balances averaging $8.9 million during the threemonths ended December 31, 2008, as compared to cash balances averaging$23.2 million during the three months ended December 31, 2007, combinedwith a lower interest rate environment during the three months ended December 31,2008.  The lower cash balance isprimarily due to cash used to pay for additions to our oil and natural gasproperties.

 

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*Six months ended December 31,2008 compared with the six months ended December 31, 2007*

 

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

 
| ** **                                               | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **December 31** | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2008**             | ** ** | **2007**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Production  Volumes, net to the Company:**             | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil and  natural gas liquids (Bbl)                 |       | 20,055               |       | 13,841     |       | 6,214        |       | 45 | % |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Natural gas  liquids (“NGLs”) (Bbl)            |       | 18,745               |       | 388        |       | 18,357       |       | 4,731 | % |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Natural gas  (Mcf)                                       |       | 128,075              |       | 3,617      |       | 124,458      |       | 3,441 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 60,146               |       | 14,832     |       | 45,314       |       | 306 | % |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales  Volumes, net to the Company:**                  | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 19,933               |       | 13,961     |       | 5,972        |       | 43 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 18,745               |       | 388        |       | 18,357       |       | 4,731 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                       |       | 128,075              |       | 3,617      |       | 124,458      |       | 3,441 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 60,024               |       | 14,952     |       | 45,072       |       | 301 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Revenue  data:**                                       | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil                                                |       | $                    | 1,986,264  |       | $          | 1,110,150    |       | $ | 876,114 |   | 79 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| NGLs                                                     |       | 990,738              |       | 21,294     |       | 969,444      |       | 4,553 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| Natural gas                                              |       | 969,766              |       | 23,478     |       | 946,288      |       | 4,031 | % |
| Total revenues                                           |       | $                    | 3,946,768  |       | $          | 1,154,922    |       | $ | 2,791,846 |   | 242 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Average  price:**                                      | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (per  Bbl)                                     |       | $                    | 99.65      |       | $          | 79.52        |       | $ | 20.13 |   | 25 | % |
| NGLs (per Bbl)                                           |       | 52.85                |       | 54.88      |       | (2.03        | )          | (4 | )% |
| Natural gas (per  Mcf)                                   |       | 7.57                 |       | 6.49       |       | 1.08         |       | 17 | % |
| Crude oil, NGLs  and natural gas (per BOE)               |       | $                    | 65.75      |       | $          | 77.24        |       | $ | (11.49 | ) | (15 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Expenses  (per BOE)**                                  |       |                 |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes (a)       |       | $                    | 12.35      |       | $          | 44.59        |       | $ | (32.24 | ) | (72 | )% |
| Depletion  expense on oil and natural gas properties (b) |       | $                    | 18.82      |       | $          | 13.20        |       | $ | 5.62 |   | 43 | % |

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(c)          Excludesnon-recurring expenses related to the oil spill in the Tullos Field Area of$15,500 and $38,123, for the six months ended December 31, 2008 and 2007,respectively.

 

(d)         Excludesdepreciation of furniture and fixtures of $19,618 and $36,121, for the sixmonths ended December 31, 2008 and 2007, respectively.

 

Net income (loss). For the six months ended December 31, 2008, wereported a net loss of $855,334, or $0.03 in loss per share (which includes$2.3 million of non-cash charges related to stock-based compensation,depreciation, depletion, and amortization, and accretion on asset retirementobligations) on total oil and natural gas revenues of $3,946,768.  This compares to a net loss of $1,412,238, or$0.05 loss per share (which includes $1.1 million of non-cash charges relatedto stock-based compensation, depreciation, depletion, and amortization, andaccretion on asset retirement obligations) on total oil and natural gasrevenues of $1,154,922 for the six months ended December 31, 2007.  The decrease in our net loss is primarilyattributable to an increase in revenues of $2,791,846, partially offset byincreases in lease operating expense and production taxes of $52,216, anincrease in depreciation, depletion and amortization of $915,614, an increase ingeneral and administrative expenses of $331,471 and a decrease in interestincome earned of $516,393.  Additionaldetails of the components of net loss are explained in greater detail below.

 

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Sales Volumes.  Crude oil,NGLs, and natural gas sales volumes, net to our interest, for the six monthsended December 31, 2008 increased 301% to 60,024 BOE, compared to 14,952BOE for the six months ended December 31, 2007.  The increase in sales volumes is due toproduction of crude oil, NGLs and natural gas from our properties in theGiddings Field.  Our properties in theTullos Field Area, which were sold on March 3, 2008, accounted for 91% oftotal sales volumes for the six months ended December 31, 2007.

 

Production.  Oil productionwill vary from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Crudeoil, NGLs and natural gas production for the six months ended December 31,2008 increased 306% to 60,146 BOE, compared to 14,832 BOE for the six monthsended December 31, 2007.  Theincrease is due to crude oil, NGLs and natural gas production from ourproperties in the Giddings Field. Production from our properties in the Tullos Field Area, which were soldon March 3, 2008, accounted for 91% of production for the six months endedDecember 31, 2007.

 

Oil, NGLs and Natural GasRevenues.  Crude oil, NGLs and natural gas revenues forthe six months ended December 31, 2008 increased 242% from the comparableperiod in the previous fiscal year.  Thiswas due to a 25% increase in our average price of a Bbl of oil, from $80 perBbl for the six months ended December 31, 2007 to $100 per Bbl for the sixmonths ended December 31, 2008, along with sales of NGLs and natural gasduring the six months ended December 31, 2008, whereas there were verylittle sales of NGLs and natural gas during the six months ended December 31,2007.  Our properties in the GiddingsField generated approximately 100% our revenues for the six months ended December 31,2008.  Oil revenues from our propertiesin the Tullos Field Area, which was sold in March 2008, accounted for 94%of total revenues for the six months ended December 31, 2007.

 

Lease Operating Expenses (including productionseverance taxes).  Lease operating expenses and production taxesfor the six months ended December 31, 2008 increased approximately 7% fromthe comparable six month period in the prior fiscal year.    The increase for the six months ended December 31,2008 is 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 period in the previous fiscal year, even after adjusting for theTexas limited severance tax holiday on wells restored to production.  The higher production taxes was partiallyoffset by a decrease in lease operating costs, due to fewer higher producingwells in the Giddings Field compared to numerous lower producing wells in theTullos Field Area.  On a BOE basis, leaseoperating expenses (including production severance taxes) decreased by 72% overthe comparable six month period in the prior fiscal year, due to higher salesvolumes at Giddings in the current period as compared to lower sales volumes atthe Tullos Field in the comparable prior year period.

 

General and Administrative Expenses (“G&A”). G&A expenses increased 12% to $3.1 million for the six months ended December 31,2008, compared to $2.8 million for the six months ended December 31,2007.  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 accommodate our operations in the Giddings Field.  Non-cash stock-based compensation expense was$1,108,250 (35% of total G&A) and $817,571 (29% of total G&A) for thesix months ended December 31, 2008 and 2007, respectively.  Non-cash stock-based compensation is anintegral part  of total staffcompensation utilized to recruit quality staff from other, more establishedcompanies.

 

Depreciation, Depletion & AmortizationExpense (“DD&A”).  DD&A expense increased by$915,614 to $1,149,173 for the six months ended December 31, 2008,compared to $233,559 for the six months ended December 31, 2007.  The increase is primarily due to a higherdepletion rate ($19 vs. $13) per BOE and a 301% increase in sales volumes.  The increase in the depletion rate is due tothe higher development cost of PUDs in the Giddings Field that we added inamount far in excess of the volume of lower cost PDP’s in our properties in theTullos 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.  Interestincome for the six months ended December 31, 2008 decreased $516,393 to$91,428, compared to $607,821 for the six months ended December 31,2007.  The decrease in interest income isdue to lower available cash balances averaging $9.6 million during the sixmonths ended December 31, 2008, as compared to cash balances averaging$24.8 million during the six months ended December 31, 2007, combined witha lower interest rate environment during the six months ended December 31,2008.  The lower cash balance isprimarily due to cash used to pay for additions to our oil and natural gasproperties.

 

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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.  With the general rise in theprice of oil and natural gas products over the last three years, increasedprices for drilling and oilfield services, oilfield equipment, tubulars, labor,expertise and other services, have also increased, thereby escalating our leaseoperating expenses and our capital expenditures.  Most recently, we have seen a precipitousdecline in both petroleum product prices, drilling and oilfield services,although product prices, operating costs and development costs may not alwaysmove in tandem.  Such declines as of December 31,2008 are reflected in our ceiling test calculations.

 

Known Trends andUncertainties.  General worldwide economic conditions havedeteriorated due to credit conditions impacted by the sub-prime mortgageturmoil and other factors.  Concerns over slower or decliningeconomic growth are affecting numerous industries, companies, as well asconsumers, which has resulted in reduced demand for crude oil and naturalgas.  If demand continues to decrease in the future, it may continueto put downward pressure on crude oil and natural gas prices, thereby loweringour revenues and working capital going forward.

 

Seasonality. Our business is generally not seasonal, except for certain rareinstances when weather conditions may adversely affect access to our propertiesor delivery of our petroleum products. Although we do not generally modify our production for changes in marketdemand, we do experience seasonality in the product prices we receive,generally based on higher demand for natural gas in the summer and winter andhigher demand for downstream oil products during the summer driving season.

 

**Off Balance Sheet Arrangements**

 

The Company has nooff-balance sheet arrangements to report during the second quarter ending December 31,2008.

 

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

 

Information about marketrisks for the three months ended December 31, 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 presently do nothold or issue derivative instruments for hedging or speculative purposes.

 

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**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.

 

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 December 31, 2008our 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 December 31, 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 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 $484,197in 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 theoil spill.  In August we paid thefine under a settlement with the EPA where we agreed to pay the $5,500 finewith no admission of liability.  We havealso received a bill from the United States Coast Guard of approximately$76,000 for expense reimbursement.  Webelieve this claim 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. If ultimately paid, we believe that such reimbursements arecovered by our insurance.

 

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 at this time to determine theexposure, if any, to the Company.

 

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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 are vigorously contesting all of Plaintiffs’ claims.  The case is currently in discovery and, atthis time, we are unable to predict the outcome of the litigation.

 

**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, there 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.**

 

Thecurrent recessionary economic environment has resulted in lower demand for oiland natural gas, resulting in a decline of commodity prices.  If the current recessionary environmentcontinues we will continue to have low demand for petroleum products, lowerrealized prices and increased operating losses. These factors will negatively impact our operations and may limit ourgrowth.

 

**ITEM 2. UNREGISTERED SALE OFEQUITY SECURITIES AND USE OF PROCEEDS**
| **Period**            | ** ** | **(a) Total Number of  Shares (or Units)  Purchased** | ** ** | **(b) Average  Price Paid  per Share (or Unit)** | ** ** | **(c) Total Number of  Shares (or Units)  Purchased as Part of  Publicly Announced  Plans or Programs** | ** ** | **(d) Maximum  Number (or  Approximate  Dollar Value) of  Shares (or Units)  that May Yet Be  Purchased Under  the Plans or  Programs** |
|-----------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|
| October 30, 2008 |       | **(1)**  788,200                                      |       | $                                                     | 1.12       |                                                                                                              | —     |                                                                                                                                              | — |
|                       |            |                                                            |            |                                                       |            |                                                                                                                   |            |                                                                                                                                                   |  |

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(1) Therepurchase was from an unaffiliated accredited investor through a negotiatedtransaction.

 

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

 

Not applicable.

 

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

 

The following items were presented for approval tostockholders of record on October 24, 2008 at the Company’s annual meetingof stockholders which was held on December 9, 2008 in Houston, Texas:

 

1.               Election of Directors: The following nominees were elected to serve as Directors of EvolutionPetroleum Corporation until the 2009 annual meeting of stockholders, or untiltheir successors are elected and qualified:

 

| ** **       | ** ** | **For**    | ** ** | **Withheld** |
|------------------|------------|------------|------------|--------------|
| Laird Q. Cagan   |       | 23,916,795 |       | 138,826      |
| E. J. DiPaolo    |       | 23,889,770 |       | 165,851      |
| William Dozier   |       | 23,970,483 |       | 85,138       |
| Robert S. Herlin |       | 23,970,483 |       | 85,138       |
| Kelly W. Loyd    |       | 23,970,483 |       | 85,138       |
| Gene Stoever     |       | 23,970,470 |       | 85,151       |

 

No other personreceived any votes.

 

2.               Ratification of Hein & Associates LLP, asindependent registered public accounting firm of the Company for the fiscalyear ending June 30, 2009.  Thevoting was as follows:

 

| **For**    | ** ** | **Against** | ** ** | **Withheld** |
|------------|------------|-------------|------------|--------------|
| 23,883,702 |       | 167,878     |       | 4,041        |

 

All matters received the required number of votes forapproval.

 

**ITEM5. OTHER INFORMATION**

 

(a)  EffectiveDecember 31, 2008, the Company and Laird Q. Cagan, a member of our Boardof Directors, agreed to modify that certain letter agreement dated February 13, 2006 between the Company andCagan McAfee Capital Partners, LLC to eliminate the cash advisory services feeof $5,000 per month.  In conjunction withthis modification, the Company agreed to provide remuneration to Mr. Caganconsistent with that provided to the other outside members of our Board ofDirectors.

 

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**ITEM 6. EXHIBITS**

 

A.           Exhibits

 
| 10.1   |   | Form of Indemnification Agreement between  Evolution Petroleum Corporation. and each of its directors and officers.  (Incorporated by reference to Exhibit 10.1of the Company’s  Form 8-K, filed September 22, 2006) |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                          |
| 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: February 17, 2009 |   | By:    | /s/ STERLING H. MCDONALD                   |
|--------|------------------------------|--------|--------|--------------------------------------------|
|   |                         |   |   | Sterling H. McDonald                       |
|   |                         |   |   | Vice-President and Chief Financial Officer |
|   |                         |   |   |                                       | Principal Financial and Accounting |
|   |                         |   |   |                                       | Officer |

 

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