**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-QSB**

** **

**x QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIESEXCHANGE ACT OF 1934.**

 

**For the quarterly period ended December 31, 2006**

 

**OR**

** **

**o TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**For thetransition period             to             **

**CommissionFile Number 000-27862**

**EVOLUTION PETROLEUM CORPORATION**

(Exact name ofregistrant as specified in charter)

| **Nevada**                         |   | **41-1781991**                        |
|------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction      |   | (I.R.S. employer  identification no.) |
| of incorporation  or organization) |   |                                  |

 

**820Gessner, Suite 1340, Houston, Texas 77024**(Address of principal executive offices and zip code)

**(713)935-0122**(Registrant’s telephone number, including area code)

Check whether the registrant (1) filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes: x     No: o

 

Check whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act.).  Yes: o   No: x

 

The number of shares outstanding of Registrant’s common stock, parvalue $0.001, as of February 12, 2007, was 26,702,006.

 

Transitional Small Business Disclosure Format (Check one):  Yes:  o   No: x

 

----

 

**EVOLUTION PETROLEUM CORPORATION,INC.**

**TABLE OFCONTENTS**
|                                    | ** ** | ** **                                                                                                                        | ** ** | **Page  Number** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| **PART I. FINANCIAL  INFORMATION** |       | 3                                                                                                                                 |       |
|                               |       |                                                                                                                              |       |             |       |
| ITEM 1.                       |       | FINANCIAL  STATEMENTS                                                                                                             |       | 3                |       |
|                               |       |                                                                                                                              |       |             |       |
|                               |       | Condensed  Consolidated Balance Sheets: December 31, 2006 (unaudited) and June 30,  2006                                |       | 3                |       |
|                               |       | Condensed  Consolidated Statements of Operations (unaudited): For the three and six  months ended December 31, 2006 and 2005 |       | 4                |       |
|                               |       | Condensed  Consolidated Statements of Cash Flows (unaudited): For the three and six  months ended December 31, 2006 and 2005 |       | 5                |       |
|                               |       | Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                 |       | 6                |       |
|                               |       |                                                                                                                              |       |             |       |
| ITEM 2.                       |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS                                                                  |       | 11               |       |
|                               |       |                                                                                                                              |       |             |       |
| ITEM 3.                       |       | CONTROLS AND  PROCEDURES                                                                                                          |       | 17               |       |
|                               |       |                                                                                                                              |       |             |       |
| **PART II. OTHER INFORMATION**     |       | 18                                                                                                                                |       |
| ** **                         |       |                                                                                                                              |       |
| ITEM 1.                            | ** ** | LITIGATION                                                                                                                        |       | 18               |       |
|                               | ** ** | ** **                                                                                                                        |       |             |       |
| ITEM 2.                            |       | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                       |       | 18               |       |
|                               | ** ** | ** **                                                                                                                        |       |             |       |
| ITEM 4.                            | ** ** | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                              |       | 18               |       |
|                               | ** ** |                                                                                                                              |       |             |       |
| ITEM 6.                            | ** ** | EXHIBITS                                                                                                                          |       | 18               |       |
| ** **                         |       |                                                                                                                              |       |             |       |
| SIGNATURES                         |       | 19                                                                                                                                |       |
|                               |       |                                                                                                                              |       |             |       |

 

2

----

**PART I - FINANCIAL INFORMATION**

**ITEM 1. CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**Evolution Petroleum Corporation and SubsidiariesCondensed Consolidated Balance Sheets**
| ** **                                                                                                                                                                                                                                                          | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                          | ** ** | **2006**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                                                                                                                                          | ** ** | **(unaudited)**       | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                                                                                                          |       |                  |       |              |       |
| **Current Assets:**                                                                                                                                                                                                                                                 |       |                  |       |              |       |
| Cash                                                                                                                                                                                                                                                                |       | $                     | 40,129,711 |              | $          | 9,893,547 |   |
| Accounts  receivable, trade                                                                                                                                                                                                                                         |       | 153,583               |       | 132,371           |       |
| Inventories                                                                                                                                                                                                                                                         |       | 177,420               |       | 76,917            |       |
| Prepaid expenses                                                                                                                                                                                                                                                    |       | 156,390               |       | 157,629           |       |
| Retainers and  deposits                                                                                                                                                                                                                                             |       | 60,595                |       | 60,895            |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Total current  assets                                                                                                                                                                                                                                               |       | 40,677,699            |       | 10,321,359        |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Cash in qualified  intermediary account for “like-kind” exchanges                                                                                                                                                                                         |       | —                |       | 34,662,368        |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Oil & Gas  properties - full cost                                                                                                                                                                                                                               |       | 4,022,938             |       | 3,878,551         |       |
| Oil & Gas  properties - not amortized                                                                                                                                                                                                                           |       | 75,441                |       | 52,098            |       |
| Less: accumulated  depletion                                                                                                                                                                                                                                        |       | (476,696              | )          | (371,624          | )          |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Net oil &  gas properties                                                                                                                                                                                                                                       |       | 3,621,683             |       | 3,559,025         |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Furniture, fixtures and  equipment, at cost                                                                                                                                                                                                                         |       | 25,624                |       | 16,561            |       |
| Less: accumulated  depreciation                                                                                                                                                                                                                                     |       | (11,147               | )          | (7,998            | )          |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Net furniture,  fixtures, and equipment                                                                                                                                                                                                                             |       | 14,477                |       | 8,563             |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Restricted deposits                                                                                                                                                                                                                                                 |       | 301,835               |       | 326,835           |       |
| Other assets                                                                                                                                                                                                                                                        |       | 76,675                |       | 79,808            |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| **Total assets**                                                                                                                                                                                                                                                    |       | $                     | 44,692,369 |              | $          | 48,957,958 |   |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                                                      |       |                  |       |              |       |
| **Current liabilities:**                                                                                                                                                                                                                                            |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                                                                                                    |       | $                     | 123,752    |              | $          | 310,272 |   |
| Accrued  liabilities                                                                                                                                                                                                                                                |       | 123,564               |       | 473,782           |       |
| Income taxes  payable                                                                                                                                                                                                                                               |       | 12,420,000            |       | 2,978,650         |       |
| Royalties  payable                                                                                                                                                                                                                                                  |       | 5,635                 |       | 47,054            |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Total current  liabilities                                                                                                                                                                                                                                          |       | 12,672,951            |       | 3,809,758         |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| **Long term liabilities:**                                                                                                                                                                                                                                          |       |                  |       |              |       |
| Deferred income  taxes payable                                                                                                                                                                                                                                      |       | —                |       | 13,101,350        |       |
| Asset retirement  obligations                                                                                                                                                                                                                                       |       | 132,055               |       | 123,679           |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Total  liabilities                                                                                                                                                                                                                                                  |       | 12,805,006            |       | 17,034,787        |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Common Stock,  totaling 351,333 shares subject to demand registration rights                                                                                                                                                                                        |       | 790,500               |       | 790,500           |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| **Stockholders’ equity:**                                                                                                                                                                                                                                      |       |                  |       |              |       |
| Common Stock,  par value $0.001 per share; 100,000,000 shares authorized, 26,350,672 and  26,300,664, issued and outstanding as of December 31, 2006 and June 30, 2006,  respectively, net of 351,333 shares of common stock subject to demand  registration rights |       | 26,350                |       | 26,300            |       |
| Additional  paid-in capital                                                                                                                                                                                                                                         |       | 10,969,785            |       | 10,274,555        |       |
| Deferred stock  compensation                                                                                                                                                                                                                                        |       | (114,562              | )          | (265,167          | )          |
| Retained  earnings                                                                                                                                                                                                                                                  |       | 20,215,290            |       | 21,096,983        |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                    |       | 31,096,863            |       | 31,132,671        |       |
|                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| **Total liabilities and  stockholders’ equity**                                                                                                                                                                                                                |       | $                     | 44,692,369 |              | $          | 48,957,958 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

3

----

**Evolution Petroleum Corporation and SubsidiariesCondensed Consolidated Statements of Operations(unaudited)**
| ** **                                    | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenues:**                                 |       |                                                |       |                                              |       |   |   |   |   |
| Oil sales                                     |       | $                                                   | 426,459    |                                              | $          | 557,439 |   | $ | 895,483 |   | $ | 1,043,834 |   |
| Gas sales                                     |       | —                                              |       | 278,955                                           |       | — |   | 336,888 |   |
| Price risk  management activities             |       | —                                              |       | (5,458                                            | )          | (14 | ) | (6,902 | ) |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| Total revenues                                |       | 426,459                                             |       | 830,936                                           |       | 895,469 |   | 1,373,820 |   |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| **Operating Costs:**                          |       |                                                |       |                                              |       |   |   |   |   |
| Production  expenses                          |       | 327,473                                             |       | 398,686                                           |       | 651,592 |   | 862,876 |   |
| Production taxes                              |       | (4,357                                              | )          | 21,536                                            |       | 30,303 |   | 36,020 |   |
| Depreciation,  depletion and amortization     |       | 46,350                                              |       | 114,431                                           |       | 108,221 |   | 191,681 |   |
| General and  administrative *                 |       | 960,515                                             |       | 662,106                                           |       | 1,999,706 |   | 1,246,384 |   |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| Total operating  costs                        |       | 1,329,981                                           |       | 1,196,759                                         |       | 2,789,822 |   | 2,336,961 |   |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| **Loss from operations**                      |       | (903,522                                            | )          | (365,823                                          | )          | (1,894,353 | ) | (963,141 | ) |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| **Other income and expense:**                 |       |                                                |       |                                              |       |   |   |   |   |
| Interest income                               |       | 503,318                                             |       | 14,955                                            |       | 1,034,113 |   | 33,892 |   |
| Interest expense                              |       | —                                              |       | (191,016                                          | )          | — |   | (412,694 | ) |
| Gain/(loss) on  sale of assets                |       | (21,453                                             | )          | —                                            |       | (21,453 | ) | — |   |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| Total other  income and expense               |       | 481,865                                             |       | (176,061                                          | )          | 1,012,660 |   | (378,802 | ) |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| **Net loss**                                  |       | $                                                   | (421,657   | )                                                 | $          | (541,884 | ) | $ | (881,693 | ) | $ | (1,341,943 | ) |
| ** **                                    |       |                                                |       |                                              |       |   |   |   |   |
| **Net Loss per common share**                 |       |                                                |       |                                              |       |   |   |   |   |
| Basic and  Diluted                            |       | $                                                   | (0.02      | )                                                 | $          | (0.02 | ) | $ | (0.03 | ) | $ | (0.05 | ) |
|                                          |       |                                                |       |                                              |       |   |   |   |   |
| **Weighted average number of  common shares** |       |                                                |       |                                              |       |   |   |   |   |
| Basic and Diluted                             |       | 26,685,151                                          |       | 24,780,405                                        |       | 26,668,575 |   | 24,778,730 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

----

*General and administrative expenses include non cashstock compensation expense of $371,604, $156,277, $861,477 and $269,351 for thethree months ended December 31, 2006 and 2005, and the six months ended December31, 2006 and 2005, respectively.

 

4

----

**Evolution Petroleum Corporation andSubsidiaries****Condensed  Consolidated Statements of Cash Flows(unaudited)**
| ** **                                                                       | ** ** | **Six Months**     | ** ** | **Six Months**     | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **Ended December** | ** ** | **Ended December** | ** ** |
| ** **                                                                       | ** ** | **31, 2006**       | ** ** | **31, 2005**       | ** ** |
| **Cash flows from operating  activities:**                                       |       |                    |       |                    |       |
| **Net  loss**                                                                    |       | $                       | (881,693   | )                       | $          | (1,341,943 | ) |
| **Adjustments  to reconcile net loss to net cash used by operating activities:** |       |                    |       |                    |       |
| Depletion                                                                        |       | 105,072                 |       | 189,348                 |       |
| Depreciation                                                                     |       | 3,149                   |       | 2,333                   |       |
| Non-cash stock  based compensation expense                                       |       | 861,477                 |       | 269,351                 |       |
| Accretion of  asset retirement obligations                                       |       | 8,376                   |       | 14,065                  |       |
| Accretion of  debt discount and non-cash loan costs                              |       | —                  |       | 130,178                 |       |
| Other non cash  items                                                            |       | —                  |       | 50,232                  |       |
| Changes in assets and  liabilities:                                              |       |                    |       |                    |       |
| Accounts  receivable                                                             |       | (21,212                 | )          | (15,401                 | )          |
| Inventories                                                                      |       | (100,503                | )          | (232,777                | )          |
| Accounts payable                                                                 |       | (186,520                | )          | 159,772                 |       |
| Royalties  payable                                                               |       | (41,419                 | )          | 33,873                  |       |
| Accrued  liabilities                                                             |       | (350,218                | )          | (15,245                 | )          |
| Income taxes  payable                                                            |       | (3,660,000              | )          | —                  |       |
| Prepaid expenses                                                                 |       | 1,239                   |       | (48,484                 | )          |
| Net cash used by  operating activities                                           |       | (4,262,252              | )          | (804,698                | )          |
| **Cash flows from investing  activities:**                                       |       |                    |       |                    |       |
| Development of  oil and gas properties                                           |       | (222,054                | )          | (1,296,019              | )          |
| Acquisitions of  oil and gas properties                                          |       | (101,054                | )          | —                  |       |
| Proceeds from  asset sale, net                                                   |       | 155,378                 |       | —                  |       |
| Capital  expenditures for furniture, fixtures and equipment                      |       | (9,063                  | )          | (2,571                  | )          |
| Cash transferred  from qualified intermediary account                            |       | 34,662,368              |       | —                  |       |
| Retainer and  deposits                                                           |       | 25,300                  |       | (15,174                 | )          |
| Other assets                                                                     |       | 3,133                   |       | 9,993                   |       |
| Net cash  provided (used) in investing activities                                |       | 34,514,008              |       | (1,303,771              | )          |
| **Cash flow from financing  activities:**                                        |       |                    |       |                    |       |
| Payments on  notes payable                                                       |       | —                  |       | (6,754                  | )          |
| Equity and  transaction costs                                                    |       | (15,592                 | )          | —                  |       |
| Net cash used by  financing activities                                           |       | (15,592                 | )          | (6,754                  | )          |
|                                                                             |       |                    |       |                    |       |
| Net increase (decrease)  in cash and cash equivalents                            |       | 30,236,164              |       | (2,115,223              | )          |
|                                                                             |       |                    |       |                    |       |
| Cash and cash  equivalents, beginning of period                                  |       | 9,893,547               |       | 2,548,688               |       |
|                                                                             |       |                    |       |                    |       |
| Cash and cash  equivalents, end of period                                        |       | $                       | 40,129,711 |                    | $          | 433,465 |   |
|                                                                             |       |                    |       |                    |       |
| Supplemental disclosure  of cash flow information:                               |       |                    |       |                    |       |
| Interest paid                                                                    |       | $                       | —     |                    | $          | 282,516 |   |
| Income taxes paid                                                                |       | $                       | 3,660,000  |                    | $          | — |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

5

----

**EVOLUTION PETROLEUM CORPORATIONAND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

**1. Organization and Basis of Preparation**

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

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

At December 31, 2006, we conducted operations through our100% working interests in our Tullos Field Area and our non-operated interestsin our Delhi Field, all located onshore in Louisiana.  Our Tullos Field Area consists ofapproximately 155 producing wells out of 267 well bores across 599 acres ofhigh water cut primary reserve production, which we believe may be a candidatefor redevelopment using modern technology. Our non-operated interests in the 13,636 acre Delhi Field consist of a7.4% overriding and mineral royalty interest in the Delhi Holt Bryant Unit, a25% reversionary working interest in the Delhi Holt Bryant Unit, and a 25%working interest in certain other depths in the Delhi Field.  Our Delhi Holt Bryant Unit is scheduled forredevelopment using CO2 enhanced oil recovery technology.

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial information and, with theinstructions to Form 10-QSB and Item 310(b) of Regulation S-B.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the results of operations for the interim periods havebeen included. All inter-company transactions are eliminated uponconsolidation. The interim financial information and notes hereto should beread in conjunction with our 2006 Annual Report on Form 10-KSB for the yearended June 30, 2006, as filed with the Securities and Exchange Commission. Theresults of operations for interim periods are not necessarily indicative ofresults to be expected for a full fiscal year.

**2. Recent Accounting Pronouncements**

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

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

**3. Loss per Share**

Basic earnings per shareis computed by dividing net income (loss) available to common shareholders bythe weighted average number of common shares outstanding during the period.Diluted earnings per share are determined on the assumption that outstandingstock options have been converted using the average price for the period. Forpurposes of computing earnings per share in a loss year, potential commonshares have been excluded from the computation of weighted average commonshares outstanding, because their effect is antidilutive.

6

----

The following table sets forth the computation ofbasic and diluted earnings (loss) per share:
| ** **                                                             | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerator:                                                             |       |                                                |       |                                              |       |   |   |   |   |
|                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                               |       | $                                                   | (421,657   | )                                                 | $          | (541,884 | ) | $ | (881,693 | ) | $ | (1,341,943 | ) |
| Plus income impact of assumed conversions:                             |       |                                                |       |                                              |       |   |   |   |   |
| Preferred stock dividends                                              |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Interest on convertible subordinated notes                             |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
|                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                               |       | $                                                   | (421,657   | )                                                 | $          | (541,884 | ) | $ | (881,693 | ) | $ | (1,341,943 | ) |
|                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Denominator:                                                           |       | 26,685,151                                          |       | 24,780,405                                        |       | 26,668,575 |   | 24,778,730 |   |
|                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Affect of  potentially dilutive common shares:                         |       |                                                |       |                                              |       |   |   |   |   |
| Warrants                                                               |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Employee and director stock options                                    |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Convertible preferred stock                                            |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Convertible subordinated notes                                         |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Redeemable preferred stock                                             |       | N/A                                                 |       | N/A                                               |       | N/A |   | N/A |   |
| Denominator for  dilutive earnings per share - weighted average shares |       | 26,685,151                                          |       | 24,780,405                                        |       | 26,668,575 |   | 24,778,730 |   |
|                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Net Loss per  common share:                                            |       |                                                |       |                                              |       |   |   |   |   |
| Basic and  diluted                                                     |       | $                                                   | (0.02      | )                                                 | $          | (0.02 | ) | $ | (0.03 | ) | $ | (0.05 | ) |

** **

**4. Contingent Liabilities**

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

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

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

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

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

There were no newdevelopments in this case during the quarter ended December 31, 2006.

On October 11, 2006Sybil  J. Dominique, Individually, etal., filed a lawsuit in the District Court of Dallas County Texas, againstAmerada Hess Corporation and 73 other defendants, including one of oursubsidiaries, Arkla Petroleum, LLC (“Subsidiary”) alleging workplace exposureto benzene caused the death of her spouse. We were served notice of the lawsuit on October 31, 2006.  On January 5, 2007, the plaintiffs filed aNotice of Nonsuit without Prejudice, thereby dismissing us from the suit.

7

----

**5. Stock-Based Compensation**

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

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

The adoption of SFAS 123(R) resulted in stock compensationexpense for the three and six months ended December 31, 2006 of approximately$315,000 and $671,000 of the $372,000 and $861,000 of total stock compensationexpense that we recorded as general and administrative expenses in theconsolidated condensed statement of operations. This additional share-based compensation expense increased basic anddiluted loss per share by $0.01 for the three and six months ended December 31,2006 resulting in reported basic and diluted loss per share of ($0.02) and($0.03), respectively for the three and six months ended December 31,2006.   For the current period ended, wedid not recognize a tax benefit from the stock compensation expense because webelieve it is more likely than not that the related deferred tax assets, whichhave been reduced by a full valuation allowance, will not be realized.

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

For periods prior to July1, 2006, we applied the intrinsic method to our stock-based compensation awardsto our employees as set forth in Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  Under these principles,no compensation expense for stock options granted to employees is reflected innet income as long as the stock options have an exercise price equal to thequoted market price of the underlying common stock on the date of grant.

***Pro-FormaStock Compensation Expense for the Three and Six Months Ended December 31, 2005***

Thefollowing table illustrates the effect on net loss and earnings per share if wehad applied the fair value recognition provisions of SFAS 123(R) to stock-basedemployee compensation for the three and six months ended December 31, 2005.
| ** **                                                                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **December 31, 2005**  | ** ** | **December 31, 2005**      | ** ** |
| Net loss                                                                                                                        |       | $                                | (541,884   | )                                    | $          | (1,341,943 | ) |
| Add: Total stock  based employee compensation benefit reported in net loss net of related tax  effects                          |       | 73,996                           |       | 116,880                              |       |
| Deduct: Total  stock based employee compensation benefit determined under fair value of all  awards, net of related tax effects |       | (372,074                         | )          | (628,431                             | )          |
| Pro forma net  loss                                                                                                             |       | $                                | (839,962   | )                                    | $          | 1,853,494 | ) |
|                                                                                                                            |       |                             |       |                                 |       |
| Per share data:                                                                                                                 |       |                             |       |                                 |       |
| basic and  diluted, as reported                                                                                                 |       | $                                | (0.02      | )                                    | $          | (0.05 | ) |
| basic and diluted, pro  forma                                                                                                   |       | $                                | (0.03      | )                                    | $          | (0.07 | ) |

 

The fair values ofoptions and warrants granted during the three and six months ended December 31,2006 and 2005 were estimated at the date of grant using the Black-Scholesoptions pricing model assuming no dividends and with the following weightedaverage assumptions for grants in 2006 and 2005:

|                              | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **December**                     | ** ** | **December**                   | ** ** | **December** | ** ** | **December** | ** ** |
| ** **                   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average  volatility |       | 163                              | %          | 148                            | %          | 163 | % | 138 | % |
| Expected term  (in years)    |       | 6.25                             |       | 2.0                            |       | 6.25 |   | 2.7 |   |
| Risk-free rate               |       | 4.8                              | %          | 4.6                            | %          | 4.8 | % | 4.4 | % |

 

8

----

Volatilities are based onthe historical volatility of our closing common stock price.  Expected term of options and warrants grantedrepresents the period of time that options and warrants granted are expected tobe outstanding.   The risk-free rate forperiods within the contractual life of the options and warrants is based on thecomparable U.S. Treasury rates in effect at the time of each grant.

The weighted averagegrant-date fair value of options granted during the three months ended December31, 2006 and 2005 was $2.61 and $0.98, respectively.  The weighted average grant-date fair value ofoptions granted during the six months ended December 31, 2006 and 2005 was$2.61 and $0.94, respectively.  Therehave been no options or warrants exercised for the three and six months endedDecember 31, 2006 and 2005.

***Stock Options and Warrants as of the Three and Six Months EndedDecember 31, 2006***

We maintain stock optionplans under which we may grant incentive stock options and non-qualified stockoptions to officers, employees, consultants and non-employee directors.  Under our 2003 Stock Option Plan, 600,000shares of our common stock were approved to be issued or transferred to certainofficers, employees, consultants, and non-employee directors pursuant to stockbased awards granted.  No shares remainavailable for grant under the 2003 Stock Option plan.  Under our 2004 Stock Plan, a maximum of4,000,000 shares of our common stock was approved to be issued or transferredto certain officers, employees, consultants and non-employee directors pursuantto future stock based awards granted.  Asof December 31, 2006, 1,344,000 shares remain available for grant under the 2004Stock Plan.  The Company has a policy ofissuing new shares upon the exercise of stock options, awarding significantamounts of stock options to new employees and regularly awarding stock optionsto employees on an annual basis.  Stockoptions and warrants are generally granted at the market price on the date ofgrant.  The granted options and warrantshave generally vested over four years for officers and employees; generallyover two years for non-employee directors, and generally over one year for consultants.  The granted options and warrants generallyhave ten year contractual terms.

For the three and sixmonths ended December 31, 2006, no warrants were granted and no warrants havebeen exercised.  As of December 31, 2006,we had 1,037,500 of warrants outstanding to officers, employees, consultantsand non-employee directors issued outside of the 2003 Stock Option Plan and the2004 Stock Plan, exclusive of warrants for capital raising services.

The following table setsforth the stock option and warrant transactions for the six months endedDecember 31, 2006:
| ** **                                             | ** ** | **Number of Options  and Warrants** | ** ** | **Weighted Average  Grant Price** | ** ** | **Aggregate  Intrinsic Value (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Options and  warrants outstanding at July 1, 2006      |       | 3,798,500                                          |       | $                                           | 1.49       |                                         |       |                                                                     |       |   |
| Granted                                                |       | 150,000                                            |       | $                                           | 2.61       |                                         |       |                                                                     |       |   |
| Exercised                                              |       | 0                                                  |       |                                        |       |                                         |       |                                                                     |       |
| Canceled, forfeited, or expired                        |       | 0                                                  |       |                                        |       |                                         |       |                                                                     |       |
|                                                   |       |                                               |       |                                        |       |                                         |       |                                                                     |       |
| Options and  warrants outstanding at December 31, 2006 |       | 3,948,500                                          |       | $                                           | 1.54       |                                         | $          | 5,675,650                                                                |       | 8.3 |   |
|                                                   |       |                                               |       |                                        |       |                                         |       |                                                                     |       |
| Options and warrants  exercisable at December 31, 2006 |       | 1,979,750                                          |       | $                                           | 1.34       |                                         | $          | 3,290,134                                                                |       | 8.1 |   |

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the quarter and the option or warrant exercise price ofin-the-money option or warrants.

A summary of the statusof our non-vested options and warrants as of December 31, 2006, and the changesduring the six months ended December 31, 2006, is presented below:

|                                 | ** ** | **Number of  Options and  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|---------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------------------|------------|
| Non-vested at  July 1, 2006     |       | 2,335,532                                      |       | $                                                            | 1.66       |   |
|                            |       |                                           |       |                                                         |       |
| Granted                         |       | 150,000                                        |       | $                                                            | 2.61       |   |
|                            |       |                                           |       |                                                         |       |
| Vested                          |       | (516,782                                       | )          |                                                         |       |
| Canceled, forfeited, or expired |       | 0                                              |       |                                                         |       |
|                            |       |                                           |       |                                                         |       |
| Non-vested at end of  period    |       | 1,968,750                                      |       | $                                                            | 1.52       |   |

 

9

----

At December 31, 2006,unrecognized stock based compensation expense related to non-vested stockoption and warrant grants totaled approximately $2.76 million.  This unrecognized expense will be amortizedon a straight-line basis over a weighted average remaining life of approximately2.54 years.

***Restricted Stock for the period ended December 31, 2006***

On October 5, 2006, wegranted 20,000 shares of restricted stock with a grant date fair value of $2.71per share to an employee.  On December14, 2006, we granted a total of 37,242 shares (or 12,414 shares to each of ourthree independent outside directors) of restricted stock with a weightedaverage grant date fair value $2.90 per share. Such restricted stock grants vest over a one-year period.  Each of the above restricted stock grants issubject to forfeiture, and cannot be sold, transferred or disposed of duringthe restriction period.  We willrecognize compensation expense over the vesting period of these shares.  During the three and six months endedDecember 31, 2006, we recognized aggregate compensation expense of $13,547 and$13,547, respectively, related to outstanding restricted stock grants.

The following table setsforth the restricted stock transactions for the six months ended December 31,2006:

|                                 | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
| Outstanding at  July 1, 2006    |       | 25,000                                 |       | $                                                  | 1.61       |   |
|                            |       |                                   |       |                                               |       |
| Granted (1)                     |       | 57,242                                 |       | $                                                  | 2.83       |   |
|                            |       |                                   |       |                                               |       |
| Vested                          |       | (30,000                                | )          | $                                                  | 2.71       |   |
| Canceled, forfeited, or expired |       | 0                                      |       |                                               |       |
|                            |       |                                   |       |                                               |       |
| Outstanding at end of  period   |       | 52,242                                 |       | $                                                  | 2.84       |   |

----

(1)   Theweighted average grant date fair value of restricted stock granted for the sixmonths ended December 31, 2006 was $2.83. The weighted average grant date fair value of restricted stock grantedfor the six months ended December 31, 2005 was $1.61.

(2)   Based upon the closing market price of ourcommon stock on the last trading date of the quarter.

At December 31, 2006,unrecognized stock compensation expense related to restricted stock totaledapproximately $149,000.  Suchunrecognized expense will be recognized as vesting occurs over a weightedaverage period of 0.9 years.

**6. Common Stock**

During the quarter ended December, 31, 2006, theCompany entered into an amended consulting agreement whereby the consultantcontinues to provide investor relations services.  For this, the company agreed to issue to theconsultant 50,000 shares of common stock, which is subject to monthly vesting,over a twelve month period.  Theeffective date of the agreement is November 1, 2006.

During the six months ended December 31, 2006, weincurred approximately $15,592 of costs related to filing registrationstatements for previous equity raised, as compared to approximately $6,800 torepay notes payable in the comparable 2005 period.

**7. Commodity Hedging and Price RiskManagement Activities**

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

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

10

----

shortfalls, the requiredbarrels are purchased at the current market price per Plains Oil Marketingprice bulletins.

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

(iii)                                                 Purchaseof a non-physical Put contract at $38.00 per barrel for 2,000 Bbls of crude oilproduction from March 2006 through February 2007.  This is accounted for as a “mark-to-market”derivative investment.  As of December2006, the market value of the Put contract was zero.

**8. Related Party Transactions**

Laird Q. Cagan, Chairman of our Board, is a ManagingDirector and co-owner of Cagan McAfee Capital Partners, LLC (“CMCP”). CMCPperforms financial advisory services to us pursuant to a written agreement,earning a monthly retainer of $5,000. In addition, Mr. Cagan, as a registeredrepresentative of Chadbourn Securities, Inc. (“Chadbourn”), has served as theCompany’s placement agent in private equity financings, typically earning cashfees equal to 8% of gross equity proceeds, declining to 4% subject to theamount of equity raised, and a fixed 4% warrant fee.  Mr. Cagan receives no additional compensationfor serving as a director or as the Chairman of our Board.

For the periods ended November 30, 2005, CMCP earned amonthly retainer of $15,000.  In December2005, we renegotiated our agreement with CMCP, and the monthly retainer fee hasdecreased from $15,000 per month to $5,000 per month effective December 1,2005. The retainer includes payment for the services of Mr. Cagan as Chairmanof our Board.   In addition, for thethree and six months ended December 31, 2005, Mr. Cagan, as a registeredrepresentative of Chadbourn Securities, Inc. (“Chadbourn”), has served as theCompany’s placement agent in private equity financings, typically earning cashfees equal to 8% of gross equity proceeds and warrants equal to 8% of theshares purchased, exercisable over seven years, net of any similar paymentsmade to third parties.

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

During our fiscal quarter ended December 31, 2006, weexpensed and paid CMCP $15,000 in monthly retainers.  There were no other earned fees by CMCP.

**9. Asset Retirement Obligations**

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

The reconciliation of the beginning and ending assetretirement obligation for the period ending December 31, 2006 is as follows:

| Asset retirement obligation  at June 30, 2006     |   | $      | 123,679 |   |
|---------------------------------------------------|--------|--------|---------|--------|
| Liabilities  incurred                             |   | — |    |
| Liabilities  settled                              |   | — |    |
| Accretion  expense                                |   | 8,376  |    |
| Asset retirement  obligation at December 31, 2006 |   | $      | 132,055 |   |

 

**ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OR PLAN OF OPERATIONS**

 *This Form 10-QSB and the information referenced herein containforward-looking statements. The words “plan,” “expect,” “project,” “estimate,” “assume,”“believe,” “anticipate,” “intend,” “budget,” “forecast,” “predict” and othersimilar expressions 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. We use the terms, “EPM,” “Company,”“we,” “us” and “our” to refer to Evolution Petroleum Corporation.*  *When considering any forward-looking statement, you should keep in mindthe risk factors that could cause our actual results to differ materially fromthose contained in any forward-looking statement. Important factors that couldcause actual results to differ materially from those in the forward-lookingstatements herein include the timing and extent of changes in commodity prices foroil and gas, operating risks and other risk factors as described in our 2006Annual Report on Form 10-KSB as filed with the Securities and ExchangeCommission. Furthermore, the assumptions that support our forward-lookingstatements are based upon information that is currently available and issubject to change. We specifically disclaim all responsibility to publiclyupdate any information contained in a forward-looking statement or anyforward-looking statement in its entirety and therefore disclaim any resultingliability for potentially related damages. All forward-looking statementsattributable to Evolution Petroleum Corporation are expressly qualified intheir entirety by this cautionary statement.*

11

----

**Business**

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

At December 31, 2006, we conducted operations throughour 100% working interests in our Tullos Field Area and our non-operatedinterests in our Delhi Field, all located onshore in Louisiana.  Our Tullos Field Area consists ofapproximately 155 producing wells out of 267 well bores across 599 acres, with highwater cut primary reserve production that we believe may be a candidate forredevelopment using modern technology. Our non-operated interests in the 13,636 acre Delhi Field consist of a7.4% overriding and mineral royalty interest in the Delhi Holt Bryant Unit, a25% reversionary working interest in the Delhi Holt Bryant Unit, and a 25%working interest in certain other depths in the Delhi Field.  Our Delhi Holt Bryant Unit is scheduled forredevelopment using CO2 enhanced oil recovery technology by the operator.

We are focused on an overall strategy of acquiringcontrolling working interests in oil and gas resources within establishedfields and redeveloping those fields through the application of capital andtechnology to convert the oil and gas resources into profitable producingreserves. Our strategy is intended to generate scalable developmentopportunities at normally pressured depths, exhibiting relatively lowcompletion risk, generally longer and more predictable production lives, lessexpenditures on infrastructure and lower operational risks. Within this overallstrategy, we have established three specific business initiatives:

I               Enhanced oil recovery (EOR) usingmiscible and immiscible gas flooding;

II             Technology based redevelopment ofmature oil and gas fields to recover bypassed resources; and

III            Unconventional gas reservoirdevelopment using modern stimulation and completion technologies.

In June 2006 we completed a major milestone inexecuting our EOR Initiative I.  At thattime, we closed the sale of part of our interests in our Delhi Field in theform of a farmout (the **“Delhi Farmout”**).  As previously reported, terms of the DelhiFarmout include:

·                  We received $50million in pre-tax cash at closing.

·                  We conveyed 100%of the working interests in the Delhi Holt Bryant Unit to Denbury Resources,retaining a 25% back-in working interest after a $200 million simple payout,excluding capital expenditures.

·                  We retainedseparate override and mineral royalty interests equal to approximately 7.4% onall future production from the Delhi Holt Bryant Unit.

·                  We retained a25% working interest in certain other depths in the Delhi Field.

·                  We received acommitment by Denbury Resources to install a CO2 enhanced oil recovery project,at Denbury’s sole capital cost and expense, subject to financial penalties ofup to $36 million for Denbury’s failure to expend $100 million over six andone-half years, with yearly cumulative benchmarks beginning with the periodending December 31, 2007.

We are currently engagedin reviewing or implementing additional development opportunities in all threeinitiatives.

12

----

**Summary Results**

***FinancialUpdate***

*** ***

Financially, we are a markedly strongercompany at December 31, 2006, as compared to one year earlier.

At December 31, 2006, our working capital,predominately cash, was approximately $28 million and we were debt free. This compares to approximately $0.6million of working capital and $3 million of long-term notes payable, net ofdiscount, at December 31, 2005.

As a proxy for cash flow from operations, EBTDA(Earnings before taxes, depletion, depreciation, amortization and othernon-cash charges excluding deferred income taxes) is dramatically improved. EBTDAis a non-GAAP measure which includes the effect of our net interest income forsome periods and net interest expense for other periods, as reconciled to GAAPand explained further at the end of this Item II below.

EBTDA was approximately $96,000 during thesix months ended December 31, 2006, as compared to approximately $(686,000) inthe comparable 2005 period.  Theimprovement was due mostly to earnings from our $40+ million in short terminvestments, combined with an approximate $413,000 reduction in interestexpense during the current six month period, as compared to the comparable 2005period.

Our net loss decreased 34% for the six months endedDecember 31, 2006, as compared to the comparable 2005 period.

For the six months ended December 31, 2006, our netloss was approximately $882,000, of which approximately $862,000 was due tonon-cash stock compensation expense recorded in accordance with SFAS123(R).  For the six months endedDecember 31, 2005, our net loss was approximately $1,342,000, of whichapproximately $269,000 was due to non-cash stock compensation expense recordedunder APB 25.

All of these improvements are a direct result of theDelhi Farmout we completed in June 2006, despite the associated near term lossof our Delhi oil and gas production resulting from the Delhi Farmout and highernon-cash stock compensation expense due to our July 1, 2006 adoption ofSFAS 123(R).

Concerning the $35 million of partialproceeds we received from the Delhi Farmout to fund a Qualified Intermediaryaccount (“QI”) for possible like-kind exchanges in June 2006, we usedapproximately $579,000 to purchase additional properties, mostly consisting ofDelhi Holt-Brant royalty interests. Based on the other like-kind properties we were limited to purchasingthrough the QI account, we ultimately decided to pursue other properties andprojects outside of this tax deferred structure.  We believe this decision will provide ahigher return to our shareholders, despite forgoing a tax deferral.  As required by law, we closed the QI accountwithin 180 days from its inception, withdrawing approximately $35.3 millionduring December, 2006, inclusive of approximately $844,000 of interest earnedthereon. 

Lookingahead, in the short term we can expect that our cash flow from operations andEBTDA will be adversely affected by reduced interest income on approximately$12.4 million scheduled to be remitted for income tax payments related to theDelhi Farmout over the next few months, cash expended in acquiring and developingnew producing sources through our ongoing projects, and developmentexpenditures aimed at improving our Tullos Field area production.  We anticipate that these adverse impactsshould be increasingly offset by revenues from our new projects as, if and whenthey become operational. 

***OperationalUpdate***

Concerning future production opportunitiesfrom our planned CO2-EOR project at our 13,626 acre Delhi Holt Bryant Unit, the operator has advised us they are currently engaged in obtaining right-of-ways andpipeline route surveys.  Further, we are advised that pipeline constructionis scheduled to begin in late 2007, and CO2 injection is now projected to beginin the second quarter of 2008.  We view this as a positive development.

Concerning our Tullos Field Areaoperations, we have experienced a 13% loss in production during the six monthsended December 31, 2006, compared to the 2005 comparable period.  This was mostly due to threesaltwater disposal wells being temporarily shut down, including one for highwater caused by heavy rain in the area. Production losses were exacerbated by the diversion of our onlyavailable service rig from repair and maintenance activities to our capitalprogram to install additional saltwater disposal capacity to assist futureproduction.

Also at Tullos, we have recently implemented anInitiative II capital program aimed at capturing bypassed oil reserves in thisfield.  Our initial test is expected totake place during March of this year. Should this test prove successful, the production technology we areusing could be applicable throughout our Tullos Field area, in addition to manyother fields with similar high water cut reservoirs. 

Looking forward, we continue to focus our staff andthe cash proceeds we received from our Delhi Farmout toward identifying,acquiring and executing additional oil and gas development projects fittingwithin our Initiatives I-III described in the Business section above.  AtDecember 31, 2006, we had at least $28 million of un-levered after-tax cashresources to fund these initiatives and our working capital needs.  It isour intention to commit most of these cash resources to “seed” new projectsthrough a “proof of concept” stage, followed by outside financing in the formof insulated project financing to complete each development stage.

**Results of Operations**

***Three months ended December 31,2006 compared to three months ended December 31, 2005***

The following table sets forth certain financialinformation with respect to our oil and gas operations:
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                                     | ** ** | **December 31,**            | ** ** | ** ** | ** ** | ** **   | ** ** |
| ** **                                     | ** ** | **2006**                         | ** ** | **2005**   | ** ** | **Variance** | ** ** | **% change** | ** ** |
| **Sales Volumes, net to EPM:**                 | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (Bbl)                                      |       | 6,080                            |       | 11,828     |       | (5,748       | )          | -49 | % |
| Gas (Mcf)                                      |       | 0                                |       | 23,977     |       | (23,977      | )          | -100 | % |
| Oil and Gas (Boe)                              |       | 6,080                            |       | 15,824     |       | (9,744       | )          | -62 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| **Revenue data (a):**                          | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil revenue                                    |       | $                                | 426,459    |       | $          | 551,981      |       | $ | (125,522 | ) | -23 | % |
| Gas revenue                                    |       | 0                                |       | 278,955    |       | (278,955     | )          | -100 | % |
| Total oil and gas  revenues                    |       | $                                | 426,459    |       | $          | 830,936      |       | $ | (404,477 | ) | -49 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| **Average prices (a):**                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (per Bbl)                                  |       | $                                | 70.14      |       | $          | 46.67        |       | $ | 23.47 |   | 50 | % |
| Gas (per Mcf)                                  |       | 0                                |       | 11.63      |       | (11.63       | )          | -100 | % |
| Oil and Gas (per Boe)                          |       | 70.14                            |       | 52.51      |       | 17.63        |       | 34 | % |
|                                           |       |                             |       |       |       |         |       |   |   |
| **Expenses (per Boe)**                         | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating  expenses and production taxes |       | $                                | 53.14      |       | $          | 26.56        |       | $ | 26.59 |   | 100 | % |
| Depletion expense on  oil and gas properties   |       | 7.65                             |       | 7.10       |       | 0.55         |       | 8 | % |

----

(a) Includesthe cash settlement of hedging contracts

13

----

Net Loss. For the three monthsended December 31, 2006, we reported a net loss of approximately $422,000 or$0.02 loss per share on total oil and gas revenues of approximately $427,000,as compared to a net loss of $542,000 or $0.02 loss per share on total oil andgas revenues of $831,000 for the three months ended December 31, 2005.  The improvement in our net loss isattributable primarily to approximately $503,000 of interest income earned andno interest expense charged in the current quarter, versus approximately$15,000 of interest income earned and $191,000 of interest expense charged inthe comparable quarter of the prior year. Offsetting income were lower oil revenues of approximately $404,000 andhigher operating costs (includes production expenses, production taxes,depletion expense and general and administrative costs) of approximately$133,000, all of which are explained in greater detail below.  In addition, for the period ended December31, 2006, a loss on sale of asset (Delhi Field) was recorded for approximately$21,500 for the settlement of a sales and use tax audit.

Sales Volumes. Oil salesvolumes, net to our interest, for the three months ended December 31, 2006decreased 49% to 6,080 Bbls, compared to 11,828 Bbls for the three months endedDecember 31, 2005.  The decrease in oilsales volumes is primarily due to a loss of production from the Delhi Farmout,in addition to decreases in production from the Tullos Field area byapproximately 19%.

Net natural gas volumes sold for the three monthsended December 31, 2006 were zero due to the Delhi Farmout, as compared to23,977 Mcfs for the three months ended December 31, 2005.

On a BOE basis, total sales volumes decreased 62% inthe current quarter when compared to the prior year quarter.

Production. Oil productionvaries from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Networking interest oil production for the three months ended December 31, 2006decreased 45% to 6,542 Bbls, compared to 11,860 Bbls for the three months endedDecember 31, 2005.  This is primarily dueto the loss of production from the Delhi Farmout.  Net natural gas production for the threemonths ended December 31, 2006 decreased 100% to zero, compared to 23,977 Mcfsfor the three months ended December 31, 2005, again due to the Delhi Farmout.

Oil and Gas Revenues. Revenuespresented in the table above and discussed herein represent revenue from salesof our oil and natural gas production volumes, net to our interest.  Production sold under fixed price deliverycontracts, which have been designated for the normal purchase and saleexemption under SFAS 133, are also included in these amounts.  Realized prices may differ from market pricesin effect during the periods, depending on when the fixed delivery contract wasexecuted.

Oil and gas revenues decreased 49% for the threemonths ended December 31, 2006, compared to the same period in 2005, as aresult of a 62% decrease in sales volumes (on a BOE basis) due primarily to thesale Delhi Farmout and slight decreases to sales in the Tullos Field area.  Offsetting the decrease in revenues was a 50%increase in net realized oil prices from approximately $47 per barrel toapproximately $70 per barrel.

Lease Operating Expenses (including productionseverance taxes). Lease operating expenses for thethree months ended December 31, 2006 decreased approximately 23% from thecomparable 2005 period. The decrease in operating expenses in 2006 is primarilyattributable to fewer operated wells due to the Delhi Farmout.  On a BOE basis, lease operating expensesincreased during the quarter by 100% over the comparable 2005 quarter,primarily due to lower oil production at Tullos Field area due to requiredworkovers on saltwater disposal wells and unusually high workover costs onthose saltwater disposal wells as well as the sale of the Delhi production thathad a lower LOE per barrel. In the current quarter, production in the TullosArea was reduced due to three saltwater disposal wells temporarily shut down,including one for high water caused by heavy rain in the area.  The prior quarter’s high rate per BOE was dueto uncharacteristically high workover costs and a corresponding reduction inproduction volumes at our Delhi Field.

General and Administrative Expenses (G&A). Generaland administrative expenses were up 45% to approximately $960,000 for the threemonths ended December 31, 2006, compared to approximately $662,000 for thethree months ended December 31, 2006. Higher non-cash stock compensation expense, and to a lesser extentincreases to salary & wages for a new employee, accounted for the majorityof the increase to G&A expenses in the current quarter.  Non-cash stock compensation expense wasapproximately $372,000 and $156,000 for the 2006 and 2005 three month periods,respectively.

14

----

Depreciation, Depletion & Amortization Expense(DD&A). DD&A expense decreased approximately$68,000 to approximately $46,000 for the three months ended December 31, 2006from $114,000 for the same period in 2005. The decrease is primarily due to a lower depletion expense as a resultof a 62% decrease in sales volumes (on a BOE basis) due to the Delhi Farmoutand decreases to oil sales at Tullos Field area, offset by slight increases inthe average depletion rate from $7.10 to $7.65 per BOE.

Interest Income. Interestincome for the three months ended December 31, 2006 increased approximately$488,000 to approximately $503,000, compared to approximately $15,000 for thethree months ended December 31, 2005. The increase in interest income is primarily due to higher interestearned on higher available cash balances of approximately $40 million in thecurrent quarter, as compared to cash of less than $500,000 in the priorcomparable quarter.

Interest Expense. Due to therepayment of all of our debt in May 2006, interest expense for the three monthsended December 31, 2006 decreased to zero from approximately $191,000 for thethree months ended December 31, 2005.

***Six months ended December 31,2006 compared to six months ended December 31, 2005***

The following table sets forth certain financialinformation with respect to our oil and gas operations:
| ** **                                     | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|------------|------------|--------------|------------|
| ** **                                     | ** ** | **December 31,**          | ** ** | ** ** | ** ** | ** **   | ** ** |
| ** **                                     | ** ** | **2006**                       | ** ** | **2005**   | ** ** | **Variance** | ** ** | **% change** | ** ** |
| **Sales  Volumes, net to EPM:**                | ** ** | ** **                     | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (Bbl)                                      |       | 13,775                         |       | 20,794     |       | (7,019       | )          | -34 | % |
| Gas (Mcf)                                      |       | 0                              |       | 33,827     |       | (33,827      | )          | -100 | % |
| Oil and Gas  (Boe)                             |       | 13,775                         |       | 26,432     |       | (12,657      | )          | -48 | % |
|                                           |       |                           |       |       |       |         |       |   |   |
| **Revenue  data (a):**                         | ** ** | ** **                     | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil revenue                                    |       | $                              | 895,469    |       | $          | 1,036,932    |       | $ | (141,463 | ) | -14 | % |
| Gas revenue                                    |       | 0                              |       | 336,888    |       | (336,888     | )          | -100 | % |
| Total oil and  gas revenues                    |       | $                              | 895,469    |       | $          | 1,373,820    |       | $ | (478,351 | ) | -35 | % |
|                                           |       |                           |       |       |       |         |       |   |   |
| **Average  prices (a):**                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Oil (per Bbl)                                  |       | $                              | 65.01      |       | $          | 49.87        |       | $ | 15.14 |   | 30 | % |
| Gas (per Mcf)                                  |       | 0                              |       | 9.96       |       | (9.96        | )          | -100 | % |
| Oil and Gas (per  Boe)                         |       | 65.01                          |       | 51.98      |       | 13.03        |       | 25 | % |
|                                           |       |                           |       |       |       |         |       |   |   |
| **Expenses  (per Boe)**                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating  expenses and production taxes |       | $                              | 49.50      |       | $          | 34.01        |       | $ | 15.49 |   | 46 | % |
| Depletion  expense on oil and gas properties   |       | 7.69                           |       | 7.16       |       | 0.53         |       | 7 | % |

----

(a) Includes thecash settlement of hedging contracts

Net Loss. For the six monthsended December 31, 2006, we reported a net loss of approximately $882,000 or$0.03 loss per share on total oil and gas revenues of approximately $895,000,as compared to a net loss of $1,342,000 or $0.05 loss per share on total oiland gas revenues of $1,374,000 for the six months ended December 31, 2005.  The improvement in our net loss isattributable primarily to approximately $1,034,000 of interest income earnedand no interest expensed charged in the current quarter, versus approximately$34,000 of interest income earned and $413,000 of interest expense charged inthe comparable period of the prior year. Offsetting income were lower oil and gas revenues of approximately$479,000 and higher operating costs (includes production expenses, productiontaxes, depletion expense and general and administrative costs) of approximately$453,000, all of which are explained in greater detail below.  In addition, for the period ended December31, 2006, a loss on sale of asset (Delhi Field) was recorded for approximately$21,500 for the settlement of a sales and use tax audit.

Sales Volumes. Oil salesvolumes, net to our interest, for the six months ended December 31, 2006decreased 34% to 13,775 Bbls, compared 

15

----

to 20,794 Bbls for the six months ended December 31,2005.  The decrease in oil sales volumesis primarily due to a loss of production from the Delhi Farmout, in addition todecreases in oil production from the Tullos Field area by approximately 13%.

Net natural gas volumes sold for the six months endedDecember 31, 2006 were zero due to the Delhi Farmout, as compared to 33,827Mcfs for the six months ended December 31, 2005.

On a BOE basis, total sales volumes decreased 48% inthe current period when compared to the prior year period.

Production. Oil productionvaries from oil sales volumes by changes in crude oil inventories, which arenot carried on our balance sheet.  Networking interest oil production for the six months ended December 31, 2006decreased 13% to 14,144 Bbls, compared to 16,195 Bbls for the six months endedDecember 31, 2005.  This is primarily dueto the loss of production from the Delhi Farmout.  Net natural gas production for the six monthsended December 31, 2006 decreased 100% to zero, compared to 33,827 Mcfs for thesix months ended December 31, 2005, again due to the Delhi Farmout.

Oil and Gas Revenues. Revenuespresented in the table above and discussed herein represent revenue from salesof our oil and natural gas production volumes, net to our interest.  Production sold under fixed price deliverycontracts, which have been designated for the normal purchase and saleexemption under SFAS 133, are also included in these amounts.  Realized prices may differ from market pricesin effect during the periods, depending on when the fixed delivery contract wasexecuted.

Oil and gas revenues decreased 35% for the six monthsended December 31, 2006, compared to the same period in 2005, as a result of a48% decrease in sales volumes (on a BOE basis) due primarily to the DelhiFarmout and decreases to sales in the Tullos Field area.  Offsetting the decrease in revenues was a 30%increase in net realized oil prices from approximately $50 per barrel toapproximately $65 per barrel for the six months ended December 31, 2006.

Lease Operating Expenses (including productionseverance taxes). Lease operating expenses for the sixmonths ended December 31, 2006 decreased approximately 24% from the comparable2005 period. The decrease in operating expenses in 2006 is primarilyattributable to fewer operated wells due to the Delhi Farmout.  On a BOE basis, lease operating expensesincreased during the period by approximately 46% over the comparable 2005period, primarily due to lower oil production at Tullos Field area due torequired workovers on saltwater disposal wells and unusually high workovercosts on those saltwater disposal wells as well as the sale of the Delhiproduction that had a lower LOE per barrel.  In the current period, production in the Tullos Area was reduced due tothree saltwater disposal wells temporarily shut down, including one for highwater caused by heavy rain in the area and the diversion of our only availableservice rig and crew from repair and maintenance to our capital program.  The prior quarter’s high rate per BOE was dueto uncharacteristically high workover costs and a corresponding reduction inproduction volumes at our Delhi Field.

General and Administrative Expenses (G&A). Generaland administrative expenses increased approximately 60% to approximately$2,000,000 for the six months ended December 31, 2006, compared toapproximately $1,246,000 for the six months ended December 31, 2006.  Higher non-cash stock compensation expenseand increases to salary & wages for annual bonuses plus a new employee hireaccounted for the majority of the increase to G&A expenses in theperiod.  Non-cash stock compensationexpense was approximately $861,000 and $269,000 for the 2006 and 2005 six monthperiods, respectively.

Depreciation, Depletion & Amortization Expense(DD&A). DD&A expense decreased approximately$84,000 to approximately $108,000 for the six months ended December 31, 2006from $192,000 for the same period in 2005. The decrease is primarily due to a lower depletion expense as a resultof a 48% decrease in sales volumes (on a BOE basis) due to the Delhi Farmoutand decreases to oil sales at Tullos Field area, offset by slight increases inthe average depletion rate from $7.16 to $7.69 per BOE.

Interest Income. Interestincome for the six months ended December 31, 2006 increased approximately$1,000,000 to approximately $1,034,000, compared to approximately $34,000 forthe six months ended December 31, 2005. The increase in interest income is primarily due to higher interestincome earned on higher available cash balances of approximately $40 million inthe current period, as compared to cash of less than $500,000 in the priorcomparable period.

Interest Expense. Due to therepayment of all of our debt in May 2006, interest expense for the six monthsended December 31, 2006 decreased to zero from approximately $413,000 for thesix months ended December 31, 2005.

**Liquidity and Capital Resources**

As of December 31, 2006, we had approximately $40million of unrestricted cash, inclusive of approximately $34.7 million of cashthat was transferred from the qualified intermediary (**“QI”**)account that was previously set up for possible Internal Revenue Code Section1031 “like-kind exchanges”.  Thistransfer occurred in mid December, shortly after the expiration of the 1031period.  In the quarter ended December31, 2006, we used approximately $62,000 of 1031 “like-kind exchanges” funds topurchase tangible equipment.  Of the $12.4million tax liability associated with the final disbursement from the QIaccount, 75% and 25% of this amount will be deposited with the U. S. Treasuryon March 15, 2007 and June 15, 2007, respectively.  On a pro forma basis, following payment ofour estimated federal income tax liability, our unrestricted cash position asof February 12, 2007 is approximately $28 million.

At December 31, 2006 we had approximately $28 millionof positive working capital, as compared to $0.6 million of positive working capital

16

----

at December 31, 2005. Our working capital at December 31, 2006 included approximately $34.7million of cash we withdrew from the QI account and the $12.4 million ofcurrent tax liability associated with such receipt.

Cash flow used by our operating activities was $4.3million for the six months ended December 31, 2006, as compared to $0.8 millionused during the comparable period ended December 31, 2005.  The primary expenditure in the 2006 periodwas a $3 million estimated federal income tax payment and a $0.66 millionestimated state income tax payment to cover our prior fiscal year and the firstquarter estimate for fiscal 2007.

Cash flow used by investing activities wasapproximately $148,000 for the six months ended December 31, 2006, net of approximately$34.7 million of cash transferred from the qualified intermediary account,which was closed in December 2006 due to the expiration of the “like-kindexchange” window. Approximately $185,000 was received for the sale of twoTullos Field Area wells to the State of Louisiana, offset by approximately$30,000 in legal fees to close the transaction. Approximately $101,000 was used to acquire additional royalty andoverriding royalty interests in the Delhi Holt Bryant Unit and a small parcelof land to be used as a field office in Tullos, Louisiana, and $222,000 wasused to develop our oil and gas properties. In the prior fiscal comparable period we used approximately $1.3 millionto develop our properties, primarily related to the Development drillingprogram at our Delhi Field.

During the six months ended December 31, 2006, weincurred approximately $15,592 of costs related to filing registrationstatements for previous equity raising matters, as compared to approximately$6,800 to repay notes payable in the comparable 2005 period.

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

**Off Balance Sheet Arrangements**

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

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

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

(iii)                                                 Purchaseof a non-physical Put contract at $38.00 per barrel for 2,000 Bbls of crude oilproduction from March 2006 through February 2007.  This is accounted for as a “mark-to-market”derivative investment.  As of December2006, the market value of the Put contract was zero.

**Non-GAAP Financial Measures**

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

**Earnings before tax, depreciationand amortization**

Earnings before tax,depreciation and amortization, EBTDA, is a Non-GAAP financial measure. Webelieve EBTDA is relevant because it is a proxy for cash generated byoperations to fund our available capital programs, while taking into accountthe significant (i) non cash charges in our income statement, mostly due tonon-cash stock compensation expense (ii) net interest income generated in someperiods, versus net interest expense incurred in other periods and (iii)non-taxable income in some periods versus tax liabilities arising from gain onsale of assets in other periods. EBTDA should not be considered in isolationfrom or as a substitute for net income, as an indication of operatingperformance or cash flows from operating activities or as a measure ofliquidity. EBTDA and as we calculate it, may not be comparable to EBTDAmeasures reported by other companies. In addition, EBTDA does not representfunds available for discretionary use.  Areconciliation of our consolidated net income to EBTDA is as follows:

RECONCILIATION TO GAAPINFORMATION 
| ** **                                                                                        | ** ** | **Six Months Ended  December 31, 2006** | ** ** | **Six Months Ended  December 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Net Loss (GAAP)                                                                                   |       | $                                                           | (881,693   | )                                                           | $          | (1,341,943 | ) |
| Depreciation, depletion,  amortization and other non-cash charges excluding deferred income taxes |       | 978,074                                                     |       | 655,507                                                     |       |
| Income Tax  expense                                                                               |       | 0                                                           |       | 0                                                           |       |
| Earnings before  tax, depreciation and amortization (Non-GAAP)                                    |       | $                                                           | 96,381     |                                                        | $          | (686,436 | ) |
|                                                                                              |       |                                                        |       |                                                        |       |

 

 

**ITEM 3. CONTROLS AND PROCEDURES**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and that such information is accumulated and communicated to this company’smanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule13a-15(b), we carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including our Chief ExecutiveOfficer and the Company’s Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of the end ofthe quarter covered by this report. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective in ensuring that the information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms.

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

17

----

**PART II - OTHER INFORMATION**

**ITEM 1.  LITIGATION**

On October 11, 2006Sybil  J. Dominique, Individually, etal., filed a lawsuit in the District Court of Dallas County Texas, againstAmerada Hess Corporation and 73 other defendants, including one of oursubsidiaries, Arkla Petroleum, LLC (“Subsidiary”) alleging workplace exposureto benzene caused the death of her spouse. We were served notice of the lawsuit on October 31, 2006.  On January 5, 2007, the plaintiffs filed aNotice of Nonsuit without Prejudice, thereby dismissing us from the suit.

**ITEM 2. UNREGISTEREDSALE OF EQUITY SECURITIES AND USE OF PROCEEDS**

During the quarter ended December, 31, 2006, theCompany entered into an amended consulting agreement with Liviakis FinancialCommunications, Inc. whereby the consultant continues to provide investorrelations services for the Company.  Forthis, the Company agreed to issue to the consultant an aggregate of 50,000shares of common stock, which is subject to monthly vesting, over a twelvemonth period.  The effective date of theagreement is November 1, 2006.  TheCompany issued the shares in reliance on the exemption afforded by Section 4(2)under the Securities Act of 1933, as amended, based on representations,warranties and agreements made by the consultant in the consulting agreement.

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

The following matters were submitted to a vote ofsecurity holders during Evolution Petroleum’s Annual Meeting of Stockholdersheld on December 6, 2006:

1.               Election ofDirectors — The following nominees were elected to serve as Directors ofEvolution Petroleum Corporation until the 2007 Annual Meeting of Stockholders:

|                    | ** ** | **Votes Cast For** | ** ** | **Votes Withheld** | ** ** |
|--------------------|------------|------------------------------|------------|-------------------------|------------|
| Laird Q. Cagan     |       | 17,174,885                   |       | 29,028                  |       |
| E. J. DiPaolo      |       | 16,926,688                   |       | 454,642                 |       |
| William E.  Dozier |       | 16,926,695                   |       | 454,635                 |       |
| Robert S. Herlin   |       | 17,174,885                   |       | 31,028                  |       |
| Gene G. Stoever    |       | 16,919,688                   |       | 461,642                 |       |

 

No other person received any votes.

2.               Ratification of theappointment of Hein & Associates LLP, as independent accountants of theCompany for the fiscal year ending June 30, 2007.  The voting was as follows:

| For        | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 16,678,774 |       | 524,528     |       | 1,500       |       |

 

I**TEM 6.EXHIBITS**

A.           Exhibits

10.1                           ThirdAmendment to Consulting Agreement between Liviakis Financial Communications,Inc. and Evolution Petroleum dated November 14, 2006.

31.1                           Certificationof Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) underthe Securities Exchange Act of 1934, as amended.

31.2                           Certificationof Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) underthe Securities Exchange Act of 1934, as amended.

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

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

 

18

----

**SIGNATURES**

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

**EVOLUTION PETROLEUM CORPORATION**

(Registrant)

 
| Date:  February 14, 2007 | By:    | /s/ STERLING H. MCDONALD                    |
|--------------------------|--------|---------------------------------------------|
|                     |   | Sterling H. McDonald                        |
|                     |   | Chief Financial  Officer                    |
|                     |   | Principal  Financial and Accounting Officer |

 

 

19

----