Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                                     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|-----------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                                      |                                                                                                        |
| **For the quarterly period ended December 31, 2009** |
|                                                      |                                                                                                        |
| **o**                                                     | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF****1934** |

 

**For the transition periodfrom           to           **

 

**Commission File Number 001-32942**

 

**EVOLUTION PETROLEUM CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

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

(Address of principal executive offices and zip code)

 

**(713) 935-0122**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes:  x No: o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes: o No: o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seethe definition of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

Thenumber of shares outstanding of the registrant’s common stock, par value$0.001, as of February 12, 2010, was 27,161,083.

 

 

 

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Table ofContents

 

**EVOLUTION PETROLEUM CORPORATIONAND SUBSIDIARIES**

**TABLE OF CONTENTS**

 
| ** **                              | ** **                                                                                                            | **Page** |
|-----------------------------------------|-----------------------------------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                                                  |     |
| **PART I.  FINANCIAL INFORMATION** | 3                                                                                                                     |
|                                    |                                                                                                                  |     |
| ITEM 1.                                 | CONSOLIDATED CONDENSED  FINANCIAL STATEMENTS                                                                          | 3        |
|                                    |                                                                                                                  |     |
|                                    | Consolidated  Balance Sheets (unaudited) as of December 31, 2009 and June 30,  2009                         | 3        |
|                                    | Consolidated Statements of Operations (unaudited) for the  three and six months ended December 31, 2009 and 2008 | 4        |
|                                    | Consolidated Statements of Cash Flows (unaudited) for  the six months ended December 31, 2009 and 2008           | 5        |
|                                    | Notes  to Consolidated Condensed Financial Statements (unaudited)                                                     | 6        |
|                                    |                                                                                                                  |     |
| ITEM 2.                                 | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                           | 13       |
|                                    |                                                                                                                  |     |
| ITEM 3.                                 | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                           | 21       |
|                                    |                                                                                                                  |     |
| ITEM 4.                                 | CONTROLS AND  PROCEDURES                                                                                              | 21       |
|                                    |                                                                                                                  |     |
| **PART II. OTHER INFORMATION**     | 21                                                                                                                    |
|                                    |                                                                                                                  |     |
| ITEM 1.                                 | LEGAL PROCEEDINGS                                                                                                     | 21       |
|                                    |                                                                                                                  |     |
| ITEM 1A.                                | RISK FACTORS                                                                                                          | 21       |
|                                    |                                                                                                                  |     |
| ITEM 2.                                 | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                           | 21       |
|                                    |                                                                                                                  |     |
| ITEM 3.                                 | DEFAULTS UPON  SENIOR SECURITIES                                                                                      | 21       |
|                                    |                                                                                                                  |     |
| ITEM 4.                                 | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                  | 22       |
|                                    |                                                                                                                  |     |
| ITEM 5.                                 | OTHER INFORMATION                                                                                                     | 22       |
|                                    |                                                                                                                  |     |
| ITEM 6.                                 | EXHIBITS                                                                                                              | 22       |
|                                    |                                                                                                                  |     |
| SIGNATURES                              | 23                                                                                                                    |

 

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Table ofContents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

 

**Evolution Petroleum Corporation and Subsidiaries**

**Consolidated Balance Sheets**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                                                                                                                 | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                 | ** ** | **2009**              | ** ** | **2009**          | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                                 | ** ** | ** **            | ** ** | ** **        | ** ** |
| Current assets                                                                                                                                                                                                                                                                                             |       |                  |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                  |       | $                     | 2,312,212  |              | $          | 3,891,764 |   |
| Certificates of deposit                                                                                                                                                                                                                                                                                    |       | 1,651,835             |       | 2,059,147         |       |
| Receivables                                                                                                                                                                                                                                                                                                |       |                  |       |              |       |
| Oil and natural gas sales                                                                                                                                                                                                                                                                                  |       | 542,738               |       | 532,318           |       |
| Income taxes                                                                                                                                                                                                                                                                                               |       | 2,095,126             |       | —            |       |
| Other                                                                                                                                                                                                                                                                                                      |       | 61,245                |       | 172,314           |       |
| Income taxes recoverable                                                                                                                                                                                                                                                                                   |       | —                |       | 2,055,802         |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                  |       | 148,260               |       | 162,441           |       |
| Total current assets                                                                                                                                                                                                                                                                                       |       | 6,811,416             |       | 8,873,786         |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Property and equipment, net of depreciation,  depletion, and amortization                                                                                                                                                                                                                                  |       |                  |       |              |       |
| Oil and natural gas properties — full-cost method  of accounting, of which $11,082,567and $9,819,465  at December 31, 2009 and June 30, 2009, respectively, were excluded  from amortization                                                                                                |       | 29,801,618            |       | 28,751,178        |       |
| Other property and equipment                                                                                                                                                                                                                                                                               |       | 123,271               |       | 150,697           |       |
| Total property and equipment                                                                                                                                                                                                                                                                               |       | 29,924,889            |       | 28,901,875        |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Other assets                                                                                                                                                                                                                                                                                               |       | 53,007                |       | 53,162            |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Total assets                                                                                                                                                                                                                                                                                               |       | $                     | 36,789,312 |              | $          | 37,828,823 |   |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                                                             |       |                  |       |              |       |
| Current liabilities                                                                                                                                                                                                                                                                                        |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                                                                                                                                           |       | $                     | 747,476    |              | $          | 690,639 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                        |       | 100,028               |       | 171,052           |       |
| Royalties payable                                                                                                                                                                                                                                                                                          |       | 262,127               |       | 218,477           |       |
| State taxes payable                                                                                                                                                                                                                                                                                        |       | —                |       | 157,736           |       |
| Total current liabilities                                                                                                                                                                                                                                                                                  |       | 1,109,631             |       | 1,237,904         |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Long-term liabilities                                                                                                                                                                                                                                                                                      |       |                  |       |              |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                      |       | 3,095,161             |       | 3,721,317         |       |
| Asset retirement obligations                                                                                                                                                                                                                                                                               |       | 758,027               |       | 664,710           |       |
| Stock bonus (Note 5)                                                                                                                                                                                                                                                                                       |       | —                |       | 370,440           |       |
| Accrued compensation                                                                                                                                                                                                                                                                                       |       | 210,000               |       | —            |       |
| Deferred rent                                                                                                                                                                                                                                                                                              |       | 79,746                |       | 77,858            |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Total liabilities                                                                                                                                                                                                                                                                                          |       | 5,252,565             |       | 6,072,229         |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Commitments  and contingencies (Note 10)                                                                                                                                                                                                                                                                   |       |                  |       |              |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Stockholders’ equity                                                                                                                                                                                                                                                                                  |       |                  |       |              |       |
| Preferred stock, par value $0.001; 5,000,000 shares  authorized; no shares issued or outstanding                                                                                                                                                                                                           |       | —                |       | —            |       |
| Common stock; par value $0.001; 100,000,000 shares  authorized; issued 27,949,283 shares and 27,318,517 shares as of  December 31, 2009 and June 30, 2009, respectively; outstanding  27,161,083 shares and 26,530,317 shares as of December 31, 2009 and  June 30, 2009, respectively |       | 27,949                |       | 27,318            |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                 |       | 17,611,155            |       | 16,424,868        |       |
| Retained earnings                                                                                                                                                                                                                                                                                          |       | 14,779,665            |       | 16,186,430        |       |
|                                                                                                                                                                                                                                                                                                       |       | 32,418,769            |       | 32,638,616        |       |
| Treasury stock, at cost, 788,200 shares as of December 31,  2009 and June 30, 2009                                                                                                                                                                                                               |       | (882,022              | )          | (882,022          | )          |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                                            |       | 31,536,747            |       | 31,756,594        |       |
|                                                                                                                                                                                                                                                                                                       |       |                  |       |              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                            |       | $                     | 36,789,312 |              | $          | 37,828,823 |   |

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Operations**

**(unaudited)**

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**  | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **December 31,**  | ** ** | **December 31,** | ** ** |
| ** **                                | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues                                  |       |                   |       |                  |       |   |   |   |   |
| Crude oil                                 |       | $                      | 456,375    |                  | $          | 407,194 |   | $ | 959,497 |   | $ | 1,986,264 |   |
| Natural gas liquids                       |       | 280,212                |       | 235,293               |       | 565,523 |   | 990,738 |   |
| Natural gas                               |       | 464,715                |       | 389,295               |       | 846,309 |   | 969,766 |   |
| Total revenues                            |       | 1,201,302              |       | 1,031,782             |       | 2,371,329 |   | 3,946,768 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Operating Costs                           |       |                   |       |                  |       |   |   |   |   |
| Lease operating expense                   |       | 369,928                |       | 313,406               |       | 734,774 |   | 649,310 |   |
| Production taxes                          |       | 16,459                 |       | 21,776                |       | 34,826 |   | 107,772 |   |
| Depreciation, depletion and amortization  |       | 550,142                |       | 504,291               |       | 1,167,899 |   | 1,149,173 |   |
| Accretion of asset retirement obligations |       | 15,200                 |       | 6,124                 |       | 29,538 |   | 11,861 |   |
| General and administrative *              |       | 1,253,596              |       | 1,662,627             |       | 2,506,712 |   | 3,127,467 |   |
| Total operating costs                     |       | 2,205,325              |       | 2,508,224             |       | 4,473,749 |   | 5,045,583 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Loss from operations                      |       | (1,004,023             | )          | (1,476,442            | )          | (2,102,420 | ) | (1,098,815 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Other income                              |       |                   |       |                  |       |   |   |   |   |
| Interest income                           |       | 13,785                 |       | 17,782                |       | 29,009 |   | 91,428 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Net loss before income  tax benefit       |       | (990,238               | )          | (1,458,660            | )          | (2,073,411 | ) | (1,007,387 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Income tax benefit                        |       | 288,298                |       | 454,889               |       | 666,646 |   | 152,053 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Net loss                                  |       | $                      | (701,940   | )                     | $          | (1,003,771 | ) | $ | (1,406,765 | ) | $ | (855,334) |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Loss per common share                     |       |                   |       |                  |       |   |   |   |   |
| Basic and Diluted                         |       | $                      | (0.03      | )                     | $          | (0.04 | ) | $ | (0.05 | ) | $ | (0.03 | ) |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Weighted average number  of common shares |       |                   |       |                  |       |   |   |   |   |
| Basic and Diluted                         |       | 27,092,954             |       | 26,399,988            |       | 26,869,488 |   | 26,646,149 |   |

 

----

*Generaland administrative expenses for the three month period ended December 31,2009 and 2008 included non-cash stock-based compensation expense of $424,800and $584,525, respectively. General and administrative expenses for the sixmonth period ended December 31, 2009 and 2008 included non-cashstock-based compensation expense of $816,436 and $1,108,250, respectively.

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Six Months Ended********December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                       | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| Cash flows from operating  activities                                            |       |                                          | ** ** | ** ** | ** ** |
| Net loss                                                                         |       | $                                             | (1,406,765 | ) | $ | (855,334 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                          |       |   |   |
| Depreciation, depletion and amortization                                         |       | 1,167,899                                     |       | 1,149,173 |   |
| Stock-based compensation                                                         |       | 816,436                                       |       | 1,108,250 |   |
| Accretion of asset retirement obligations                                        |       | 29,538                                        |       | 11,861 |   |
| Deferred income taxes                                                            |       | (626,156                                      | )          | (219,008 | ) |
| Deferred rent                                                                    |       | 1,888                                         |       | 1,888 |   |
| Other                                                                            |       | 213,118                                       |       | 3,118 |   |
| Changes in operating assets and liabilities                                      |       |                                          |       |   |   |
| Receivables from oil and natural gas sales                                       |       | (10,420                                       | )          | 1,658,525 |   |
| Receivables from income taxes and other                                          |       | 71,745                                        |       | 4,031,914 |   |
| Prepaid expenses and other current assets                                        |       | 14,181                                        |       | 113,942 |   |
| Accounts payable and accrued expenses                                            |       | 139,474                                       |       | (314,436 | ) |
| Royalties payable                                                                |       | 43,650                                        |       | (282,051 | ) |
| State taxes payable                                                              |       | (157,736                                      | )          | — |   |
| Net cash provided by operating activities                                        |       | 296,852                                       |       | 6,407,842 |   |
|                                                                             |       |                                          |       |   |   |
| Cash flows from investing  activities                                            |       |                                          |       |   |   |
| Development of oil and natural gas properties                                    |       | (2,222,654                                    | )          | (4,723,006 | ) |
| Acquisitions of oil and natural gas properties                                   |       | (58,141                                       | )          | (2,033,874 | ) |
| Capital expenditures for other equipment                                         |       | —                                        |       | (26,602 | ) |
| Purchases of certificates of deposit                                             |       | (1,350,000                                    | )          | (1,500,000 | ) |
| Maturities of certificates of deposit                                            |       | 1,757,312                                     |       | — |   |
| Other assets                                                                     |       | (2,963                                        | )          | — |   |
| Net cash used in investing activities                                            |       | (1,876,446                                    | )          | (8,283,482 | ) |
|                                                                             |       |                                          |       |   |   |
| Cash flows from financing  activities                                            |       |                                          |       |   |   |
| Proceeds from the issuance of restricted common  stock                           |       | 42                                            |       | 90 |   |
| Purchase of treasury stock                                                       |       | —                                        |       | (882,022 | ) |
| Net cash provided by (used in) financing activities                              |       | 42                                            |       | (881,932 | ) |
|                                                                             |       |                                          |       |   |   |
| Net decrease in cash and cash equivalents                                        |       | (1,579,552                                    | )          | (2,757,572 | ) |
|                                                                             |       |                                          |       |   |   |
| Cash and cash equivalents, beginning of period                                   |       | 3,891,764                                     |       | 11,272,280 |   |
|                                                                             |       |                                          |       |   |   |
| Cash and cash equivalents, end of period                                         |       | $                                             | 2,312,212  |   | $ | 8,514,708 |   |

 

Oursupplemental disclosures of cash flow information for the six months ended December 31,2009 and 2008 are as follows:

 
| ** **                                                                                                                        | ** ** | **Six Months Ended********December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2009**                                                | ** ** | **2008** | ** ** |
| ** **                                                                                                                        | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Income taxes paid                                                                                                                 |       | $                                                       | 166,015    |   | $ | 15,000 |   |
|                                                                                                                              |       |                                                    |       |   |   |
| Income tax refunds and carry backs received                                                                                       |       | $                                                       | —     |   | $ | 4,052,631 |   |
|                                                                                                                              |       |                                                    |       |   |   |
| Non-cash transactions:                                                                                                            |       |                                                    |       |   |   |
| Decrease in accounts payable used to acquire oil  and natural gas leasehold interests and develop oil and natural gas  properties |       | $                                                       | (153,661   | ) | $ | (285,333 | ) |
| Oil and natural gas properties incurred through  recognition of asset retirementobligations                                       |       | $                                                       | 63,779     |   | $ | 107,751 |   |
| Common stock issued in lieu of a portion of 2008  cash bonus accrued as a short-term liability at June 30, 2008              |       | $                                                       | —     |   | $ | 168,462 |   |

 

See accompanying notes to consolidated financial statements.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 1****—****Organization and Basis of Preparation**

 

***Nature of Operations.***  EvolutionPetroleum Corporation (“EPM”), including its subsidiaries (the “Company”, “we”,“our” or “us”), is an independent petroleum company headquartered in Houston,Texas and incorporated under the laws of the State of Nevada.  We are engaged primarily in the acquisition,exploitation and development of properties for the production of crude oil andnatural gas.  We acquire properties withknown oil and natural gas resources and exploit them through the application ofconventional and specialized technology to increase production, ultimaterecoveries, or both.

 

***Interim Financial Statements.***  The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) for interimfinancial information and with the appropriate rules and regulations ofthe Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States have been condensed oromitted pursuant to such rules and regulations.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the financial position and results of operations for theinterim periods presented have been included. The interim financial information and notes hereto should be read inconjunction with the Company’s 2009 Annual Report on Form 10-K for theyear ended June 30, 2009, as filed with the SEC. The results of operationsfor interim periods are not necessarily indicative of results to be expectedfor a full fiscal year.

 

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

 

***Use of Estimates. ***The preparationof financial statements in conformity with GAAP requires us to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe dates of the financial statements and the reported amounts of revenues andexpenses during the reporting periods. Significant estimates include reserve quantities and estimated futurecash flows associated with proved reserves, which significantly impactdepletion expense and potential impairments of oil and natural gas properties,income taxes, the amounts recoverable from the carry-back of income tax lossesand the valuation of deferred tax assets, stock-based compensation, andcommitments and contingencies.  Weanalyze our estimates based on historical experience and various otherassumptions that we believe to be reasonable. While we believe that ourestimates and assumptions used in preparation of the consolidated financialstatements are appropriate, actual results could differ from those estimates.

 

**Note 2 — Recent Accounting Pronouncements**

 

***New Accounting Standards.***  The followingdiscloses the existence and effect of accounting standards issued but not yetadopted by us with respect to accounting standards that may have an impact onthe Company when adopted in the future.

 

***Modernization of Oil and Gas Reporting.***  On December 31, 2008,the SEC released new requirements for reporting oil and gas reserves (the “ModernizationRequirements”).  The Modernization Requirements, when effective, providefor consideration of current technology in evaluating reserves, allow companiesto disclose their probable and possible reserves to investors, requirereporting of oil and gas reserves using an average price based on the prior12-month period rather than period-end prices, revise the disclosurerequirements for oil and gas operations, and revise accounting for thelimitation on capitalized costs for full cost companies.  TheModernization Requirements are expected to be effective for fiscal years endingon or after December 31, 2009.  Acompany may not apply the Modernization Requirements to disclosures inquarterly reports prior to the first annual report in which the reviseddisclosures are required.  We have notyet evaluated the effects the Modernization Requirements will have on ourfinancial statements.

 

The SEC staff issued StaffAccounting Bulletin (“SAB”) 113 (“SAB 113”), which revises portions of theguidance included in SAB Topic 12, *Oil andGas Producing Activities.* Specifically, SAB 113 revises the relevant interpretive guidance in SABTopic 12 to conform it to the Modernization Requirements.

 

On January 6, 2010, theFinancial Accounting Standards Board (“FASB”) issued Accounting StandardsUpdate 2010-03 *Extractive Activities - Oiland Gas (Topic 932): Oil and Gas Reserve Estimation and Disclosures*,an update of ASC Topic 932 *ExtractiveActivities - Oil and Gas*(“Topic932”), which substantially aligns the reserve estimation, disclosurerequirements, and definitions of Topic 932 with the disclosure requirements ofthe Modernization Requirements issued by the SEC.

 

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**Note 3 —****Property and Equipment**

 

Asof December 31, 2009 and June 30, 2009 our oil and natural gasproperties and other property and equipment consisted of the following:

 
| ** **                                                   | ** ** | **December 31,  2009** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **Oil  and natural gas properties**                          |       |                        |       |                    |       |
| Property costs subject to amortization                       |       | $                           | 22,913,761 |                    | $          | 21,985,950 |   |
| Less: Accumulated depreciation, depletion, and  amortization |       | (4,194,710                  | )          | (3,054,237              | )          |
| Unproved properties not subject to amortization              |       | 11,082,567                  |       | 9,819,465               |       |
| Oil and natural gas properties, net                          |       | $                           | 29,801,618 |                    | $          | 28,751,178 |   |
|                                                         |       |                        |       |                    |       |
| **Other property and equipment**                             |       |                        |       |                    |       |
| Furniture, fixtures and office equipment, at cost            |       | 260,476                     |       | 260,476                 |       |
| Less: Accumulated depreciation                               |       | (137,205                    | )          | (109,779                | )          |
| Other property and equipment, net                            |       | $                           | 123,271    |                    | $          | 150,697 |   |

 

Unprovedproperties not subject to amortization include unevaluated acreage of $7.5million as of December 31, 2009 and June 30, 2009, consisting ofproperties in the Giddings Field in Central Texas, the Woodford Shale trend inOklahoma, and the Lopez Field in South Texas (our “Neptune oil project”).  Unproved properties also include $2.0 millionas of December 31, 2009 and June 30, 2009, of participating intereststhrough royalty and overriding royalty interests aggregating 7.4% in the DelhiHolt Bryant Unit of the Delhi Field in Louisiana and a 25% after payoutreversionary working interest in the Delhi Holt Bryant Unit along with a 25%working interest in certain other depths in the Delhi Field.  We incurred $1.0 million and $0.3 million asof December 31, 2009 and June 30, 2009, respectively, related to thedrilling of three test wells and re-entry of four test wells on our acreage inWagoner County in Oklahoma and $0.6 million as of December 31, 2009 on twowells in our acreage in South Texas. Production testing of our wells in Oklahoma and South Texas isongoing.  Evaluation of our unprovedproperties is expected to be completed within one to five years.  Our evaluation of impairment of unprovedproperties occurs, at a minimum, on a quarterly basis.

 

**Note 4****—****Asset Retirement Obligations**

 

Ourasset retirement obligations represent the estimated present value of theamount we will incur to plug, abandon and remediate our producing properties atthe end of their productive lives in accordance with applicable laws. Thefollowing is a reconciliation of the beginning and ending asset retirementobligation for the six months ended December 31, 2009:

 
| **Asset retirement obligations —  beginning of period** |   | $      | 664,710 |   |
|--------------------------------------------------------------|--------|--------|---------|--------|
| Liabilities incurred                                         |   | 63,779 |    |
| Accretion                                                    |   | 29,538 |    |
| **Asset retirement obligations —  end of period**       |   | $      | 758,027 |   |

 

**Note 5 — Stockholders’ Equity**

 

On September 8, 2009,the Board of Directors authorized and the Company issued 138,224 unrestrictedand fully vested shares of common stock from the 2004 Stock Plan to certainemployees for the payment of fiscal 2009 bonuses.  The value of the shares issued was $370,440,based on the fair market value on the date of issuance, or $2.68 pershare.  The amount of bonus was accruedas of June 30, 2009 and recognized as a long-term liability. On September 8,2009, when the shares were issued, the liability was reclassified tostockholders’ equity.

 

OnSeptember 8, 2009, the Board of Directors authorized and the Companyissued 324,597 shares of restricted common stock from the 2004 Stock Plan toemployees as a long-term incentive award.

 

OnOctober 27, 2009, 119,795 shares of common stock were issued through a netcashless exercise of a placement warrant. The placement warrant, which was issued to Cagan McAfee CapitalPartners, LLC (“CMCP”), a related party (See Note 8), on May 26, 2004 inconnection with a financing transaction, gave CMCP the right to purchase165,000 shares, with an exercise price of $1.00 per share (See Note 9).

 

OnNovember 10, 2009, 5,833 shares of common stock were issued through a netcashless exercise of a placement warrant. The placement warrant, issued on November 30, 2004 in connectionwith a financing transaction, gave the holder the right to purchase 10,000shares, with an exercise price of $1.50 per share (See Note 9).

 

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**Note 5— Stockholders’ Equity** (Continued)

 

On December 9, 2009, atotal of 42,317 shares of restricted common stock was issued to four outsidedirectors as part of their board compensation for calendar year 2010.  All issuances of common stock were subject tovesting terms per individual stock agreements, which is generally one year fordirectors.

 

**Note 6****—****Stock-Based Incentive Plan**

 

Wemay grant option awards to purchase common stock (the “Stock Options”),restricted common stock awards (“Restricted Stock”), and unrestricted and fullyvested common stock, to employees, directors, and consultants of the Companyand its subsidiaries under the Natural Gas Systems Inc. 2003 Stock Plan (the “2003Stock Plan”) and the Evolution Petroleum Corporation Amended and Restated 2004Stock Plan (the “2004 Stock Plan” or together, the “EPM Stock Plans”).  Option awards for the purchase of 600,000shares of common stock were issued under the 2003 Stock Plan.  The 2004 Stock Plan authorized the issuanceof 5,500,000 shares of common stock.  Noshares are available for grant under the 2003 Stock Plan and, as of December 31,2009, 501,323 shares remain available for grant under the 2004 Stock Plan.

 

Wehave also granted common stock warrants, as authorized by the Board ofDirectors, to employees in lieu of cash bonuses or as incentive awards toreward previous service or provide incentives to individuals to acquire aproprietary interest in the Company’s success and to remain in the service ofthe Company (the “Incentive Warrants”). These Incentive Warrants have similar characteristics of the StockOptions.  A total of 1,037,500 IncentiveWarrants have been issued, with Board of Directors approval, outside of the EPMStock Plans.  We have not issuedIncentive Warrants since the listing of our shares on the NYSE Amex (formerly,the American Stock Exchange) in July 2006.

 

***Stock Options and Incentive Warrants***

 

Non-cashstock-based compensation expense related to Stock Options and IncentiveWarrants for the three months ended December 31, 2009 and 2008 was$261,762 and $499,994, respectively. Non-cash stock-based compensation expense related to Stock Options andIncentive Warrants for the six months ended December 31, 2009 and 2008 was$527,014 and $945,987, respectively.

 

Therewere no Stock Options granted during the six months ended December 31,2009.  During the six months ended December 31,2008, we granted Stock Options to purchase 591,090 shares of common stock underthe 2004 Stock Plan with a weighted average exercise price of $4.27.  The exercise price was determined based onthe market price of the Company’s common stock on the date of grant.  The Stock Options granted during the sixmonths ended December 31, 2008 vest quarterly, on a straight line basis,over a period of four years and have a contractual life of seven years.

 

Theweighted average assumptions used to calculate the fair value of these StockOptions and the weighted average fair value of each option granted are asfollows:

 
| ** **               | ** ** | **Six Months Ended**  | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **December 31,** | ** ** |
| ** **               | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Expected volatility      |       | —                |       | 87.1 | % |
| Expected dividends       |       | —                |       | — |   |
| Expected term (in years) |       | —                |       | 4.6 |   |
| Risk-free rate           |       | —                |       | 3.10 | % |
| Fair value               |       | —                |       | $ | 2.62 |   |
|                          |            |                       |            |  |  |  |

 

Weestimated the fair value of Stock Options and Incentive Warrants issued toemployees and directors at the date of grant using the Black-Scholes-Mertonvaluation model.  The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant.  The expected term (estimated period of timeoutstanding) of Stock Options and Incentive Warrants is based on the“simplified” method of the estimated expected term for “plain vanilla” optionsallowed by the SEC Staff Accounting Bulletin (“SAB”) No. 107 and SAB No. 110,and varied based on the vesting period and contractual term of the StockOptions or Incentive Warrants.   Expected volatility is based on thehistorical volatility of the Company’s closing common stock price and that ofan evaluation of a peer group of similar companies trading activity.  Wehave not declared any cash dividends on the Company’s common stock.

 

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**Note 6****—****Stock-Based Incentive Plan**(Continued)

 

Thefollowing summary presents information regarding outstanding Stock Options andIncentive Warrants as of December 31, 2009, and the changes during theperiod:

 
| ** **                                                                  | ** ** | **Number of Stock  Options  and Incentive Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value  (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | ** **                                                          | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                                           | ** ** |
| Stock Options and Incentive Warrants outstanding at  July 1, 2009      |       | 5,485,820                                                           |       | $                                              | 1.83       |                                     |       |                                                                 |       |   |
|                                                                        |       |                                                                |       |                                           |       |                                     |       |                                                                 |       |
| Granted                                                                     |       | —                                                              |       | —                                         |       |                                     |       |                                                                 |       |
| Exercised                                                                   |       | —                                                              |       | —                                         |       |                                     |       |                                                                 |       |
| Cancelled or forfeited                                                      |       | —                                                              |       | —                                         |       |                                     |       |                                                                 |       |
| Expired                                                                     |       | —                                                              |       | —                                         |       |                                     |       |                                                                 |       |
|                                                                        |       |                                                                |       |                                           |       |                                     |       |                                                                 |       |
| Stock Options and Incentive Warrants outstanding at  December 31, 2009 |       | 5,485,820                                                           |       | $                                              | 1.83       |                                     | $          | 13,944,050                                                           |       | 5.9 |   |
|                                                                        |       |                                                                |       |                                           |       |                                     |       |                                                                 |       |
| Vested or expected to vest                                                  |       | 5,485,820                                                           |       | $                                              | 1.83       |                                     | $          | 13,944,050                                                           |       | 5.9 |   |
|                                                                        |       |                                                                |       |                                           |       |                                     |       |                                                                 |       |
| Exercisable at December 31, 2009                                       |       | 4,675,447                                                           |       | $                                              | 1.67       |                                     | $          | 12,640,049                                                           |       | 5.7 |   |

 

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the period ($4.37 as of December 31, 2009) and the StockOption or Incentive Warrant exercise price of in-the-money Stock Options andIncentive Warrants.

 

There were no Stock Optionsor Incentive Warrants that were exercised during the six months ended December 31,2009 and 2008.

 

Asummary of the status of our unvested Stock Options and Incentive Warrants asof December 31, 2009 and the changes during the six months ended December 31,2009, is presented below:

 
| ** **                         | ** ** | **Number of  Stock Options  and Incentive  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                         | ** ** | ** **                                            | ** ** | ** **                                                   | ** ** |
| Unvested at July 1, 2009      |       | 1,091,912                                             |       | $                                                            | 2.66       |   |
|                               |       |                                                  |       |                                                         |       |
| Granted                            |       | —                                                |       | $                                                            | —     |   |
|                               |       |                                                  |       |                                                         |       |
| Vested                             |       | (281,539                                              | )          | $                                                            | 2.34       |   |
|                               |       |                                                  |       |                                                         |       |
| Unvested at December 31, 2009 |       | 810,373                                               |       | $                                                            | 2.77       |   |

 

Duringthe six months ended December 31, 2009 and 2008, there were 281,539 and455,000 Stock Options and Incentive Warrants that vested with a total grantdate fair value of $658,801 and $768,950, respectively.

 

Thetotal unrecognized compensation cost at December 31, 2009, relating tonon-vested Stock Options and Incentive Warrants was $1,532,839.  Such unrecognized expense is expected to berecognized over a weighted average period of 1.9 years.

 

***Restricted Stock***

 

Stock-basedcompensation expense related to Restricted Stock grants for the three monthsended December 31, 2009 and 2008 was $163,038 and $84,531,respectively.  Stock-based compensationexpense related to Restricted Stock grants for the six months ended December 31,2009 and 2008 was $289,422 and $162,263, respectively.

 

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**Note 6****—****Stock-Based Incentive Plan**(Continued)

 

OnSeptember 8, 2009, the Board of Directors authorized and the Companyissued 324,597 shares of restricted common stock from the 2004 Stock Plan toemployees as a long-term incentive award. Total unrecognized stock-based compensation expense of $869,917 relatedto the long-term incentive award will be recognized ratably over a four yearvesting period.

 

On December 9, 2009, atotal of 42,317 shares of restricted common stock was issued to four outsidedirectors as part of their board compensation for calendar year 2010.  Total unrecognized stock-based compensationexpense of $167,956 related to board compensation will be recognized ratablyover a one year vesting period.  In theprevious year, a total of 130,113 shares of restricted common stock was issuedto the same outside directors as part of their board compensation for calendaryear 2009, and which vested in December 2010.

 

Thefollowing table sets forth the Restricted Stock transactions for the six monthsended December 31, 2009:

 
| ** **                         | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | ** **                             | ** ** | ** **                                         | ** ** |
| Unvested at July 1, 2009      |       | 390,283                                |       | $                                                  | 3.37       |   |
|                               |       |                                   |       |                                               |       |
| Granted                            |       | 366,914                                |       | $                                                  | 2.83       |   |
|                               |       |                                   |       |                                               |       |
| Vested                             |       | (150,401                               | )          | $                                                  | 3.30       |   |
|                               |       |                                   |       |                                               |       |
| Unvested at December 31, 2009 |       | 606,796                                |       | $                                                  | 3.06       |   |

 

AtDecember 31, 2009, unrecognized stock-based compensation expense relatedto Restricted Stock grants totaled $1,969,701.  Such unrecognized expense is expected to berecognized over a weighted average period of 3.4 years.

 

**Note 7****—****Income Taxes**

 

Wefile a consolidated federal income tax return in the United States and variouscombined and separate filings in several state and local jurisdictions.

 

Sincethe FASB required recognition of unrecognized tax benefits and through December 31,2009, there were no unrecognized tax benefits or accrued interest or penaltiesassociated with unrecognized tax benefits. We believe that we have appropriate support for the income tax positionstaken and to be taken on the Company’s tax returns and that the accruals fortax liabilities are adequate for all open years based on our assessment of manyfactors, including past experience and interpretations of tax law applied tothe facts of each matter. The Company’s federal and state income tax returnsare open to audit under the statute of limitations for the years ending June 30,2007 through June 30, 2009.

 

Oureffective tax rate for any period may differ from the statutory federal rate,due primarily to stock-based compensation related to qualified incentive stockoption awards (“ISO awards”), a permanent tax difference for financialreporting, as these types of awards, if certain conditions are met, are notdeductible for federal tax purposes.

 

InJanuary 2010, we received $2.1 million from the Internal Revenue Serviceas a result of the carry-back of our tax loss for the year ended June 30,2009, for income taxes paid for our year ended June 30, 2007.  Significant intangible drilling costs wereincurred during the 2009 fiscal year, of which, we elected to expenseapproximately $4.8 million for federal income tax purposes.  Under GAAP, and specifically the full-costaccounting method, intangible drilling costs are capitalized as part of oil andnatural gas properties, and depleted using the unit-of-production method.  The deduction of intangible drilling costscreated a significant difference in the income tax and book basis of our oiland natural gas properties, the most significant component of our deferredincome tax liability as of December 31, 2009 and June 30, 2009.

 

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**Note 8****—****Related Party Transactions**

 

Laird Q. Cagan, a member ofour Board of Directors, is a Managing Director and co-owner of Cagan McAfeeCapital Partners, LLC (“CMCP”).  CMCP hasperformed financial advisory services to us pursuant to a written agreementamended in November 2005 (the “Agreement”), providing for a retainer of$5,000 per month.  Also pursuant to theAgreement, Mr. Cagan, as a registered representative of Colorado FinancialServices Corporation and as a partner of CMCP, could serve as our placementagent in private equity financings, wherein CMCP could earn cash fees equal to8% of gross equity proceeds, declining to 4% subject to the amount of equityraised through CMCP, and a fixed 4% warrant fee.  We have not paid placement fees to CMCP underthis agreement since May 2006. During the term of the Agreement, Mr. Cagan received nocompensation for serving as a director or as the Chairman of our Board ofDirectors.   Effective December 31,2008, the Agreement was modified to remove the monthly retainer and Mr. Caganwas re-elected as a director of our Board with remuneration consistent withother outside directors of our Board. During the three months ended September 30, 2008, we expensed andpaid CMCP $15,000 through monthly retainers of $5,000.  There were no other transactions with CMCP,except for the exercise of stock warrants during the six months ended December 31,2009 (See Note 5).

 

Eric A. McAfee, a majorshareholder of the Company, is also a Managing Director of CMCP.

 

**Note 9 —****Net loss Per Share**

 

The following table setsforth the computation of basic and diluted loss per share:

 
| ** **                                                        | ** ** | **Three Months Ended********December 31,** | ** ** | **Six Months Ended********December 31,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| *Numerator*                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                                                          |       | $                                               | (701,940   | )                                             | $          | (1,003,771 | ) | $ | (1,406,765 | ) | $ | (855,334 | ) |
|                                                              |       |                                            |       |                                          |       |   |   |   |   |
| *Denominator**                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average number of common shares —basic and  diluted |       | 27,092,954                                      |       | 26,399,988                                    |       | 26,869,488 |   | 26,646,149 |   |
|                                                              |       |                                            |       |                                          |       |   |   |   |   |
| Net loss per common share — basic and diluted                |       | $                                               | (0.03      | )                                             | $          | (0.04 | ) | $ | (0.05 | ) | $ | (0.03 | ) |

 

----

* Potential dilutive commonshares are excluded from the computation of net loss per common shares becausetheir effect will always be anti-dilutive.

 

Totaloutstanding potentially dilutive securities as of December 31, 2009 are asfollows:

 
| **Outstanding  Potential Dilutive Securities**                                     | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  December 31, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|
|                                                                               |       |                                  |       |                                       |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                     | 1.89       |                                       | 173,058    |   |
| Stock Options and Incentive Warrants                                               |       | $                                     | 1.83       |                                       | 5,485,820  |   |
| Total                                                                              |       | $                                     | 1.83       |                                       | 5,658,878  |   |

 

Totaloutstanding potentially dilutive securities as of December 31, 2008 are asfollows:

 
| **Outstanding  Potential Dilutive Securities**                                     | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  December 31, 2008** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|
|                                                                               |       |                                  |       |                                       |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                     | 1.40       |                                       | 401,058    |   |
| Stock Options and Incentive Warrants                                               |       | $                                     | 2.05       |                                       | 6,074,590  |   |
| Total                                                                              |       | $                                     | 2.01       |                                       | 6,475,648  |   |

 

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**Note 10 — Commitments and Contingencies**

 

Weare subject to various claims and contingencies in the normal course ofbusiness.  In addition, from time to time,we receive communications from government or regulatory agencies concerninginvestigations or allegations of noncompliance with laws or regulations injurisdiction in which we operate.  Wedisclose such matters if we believe it is reasonably possible that a futureevent or events will confirm a loss through impairment of an asset or theincurrence of a liability. We establish reserves if we believe it is probablethat a future event or events will confirm a loss and we can reasonablyestimate such loss.  Furthermore, we willdisclose any matter that is unasserted if we consider it probable that a claimwill be asserted and there is a reasonable possibility that the outcome will beunfavorable.  As of December 31,2009, and subsequently through the date these financial statements were issued,no claim or unasserted claim existed that required an accrual or disclosure.

 

***Lease Commitments.***  We have a non-cancelable operating lease foroffice space that expires on August 1, 2016. Future minimum lease commitmentsas of December 31, 2009 under this operating lease are as follows:

 
| **For the year ended December 31,** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|
| 2010                                     |       | $          | 138,089    |   |
| 2011                                     |       | 146,806    |       |
| 2012                                     |       | 159,011    |       |
| 2013                                     |       | 159,011    |       |
| 2014                                     |       | 159,011    |       |
| Thereafter                               |       | 251,767    |       |
| Total                                    |       | $          | 1,013,695  |   |

 

Rentexpense for the three months ended December 31, 2009 and 2008 was 39,232and 35,466, respectively.  Rent expensefor the six months ended December 31, 2009 and 2008 was 78,962 and 70,933,respectively.

 

***Employment Contracts.***  We have entered into employment agreementswith the Company’s three senior executives. The employment contracts provide for a severance package for terminationby the Company for any reason other than cause or permanent disability, or inthe event of a constructive termination, that includes payment of base pay andcertain medical and disability benefits from six months to a year aftertermination.   The total contingentobligation under the employment contracts as of December 31, 2009 isapproximately $499,000.

 

**Note 11****—****Subsequent Events**

 

ThroughFebruary 12, 2010, the date these financial statements were issued, therewere no significant subsequent events that would require disclosure oradjustment to the financial statements.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

Thefollowing is Management’s Discussion and Analysis (“MD&A”) of our financialposition and operating results during the periods included in the accompanyingunaudited consolidated financial statements. This discussion should be read inconjunction with the accompanying unaudited consolidated financial statementsand related notes thereto, included elsewhere in this Quarterly Report on Form 10-Qand should further be read in conjunction with our Annual Report on Form 10-Kfor the year ended June 30, 2009.

 

**Forward-Looking Information**

 

This Form 10-Q and theinformation referenced herein contain forward-looking statements within themeaning of the Private Securities Litigations Reform Act of 1995, Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,”“anticipate,” “intend,” “budget,” “forecast,” “predict” and other similarexpressions are intended to identify forward-looking statements. Thesestatements appear in a number of places and include statements regarding ourplans, beliefs or current expectations, including the plans, beliefs andexpectations of our officers and directors. When considering anyforward-looking statement, you should keep in mind the risk factors that couldcause our actual results to differ materially from those contained in anyforward-looking statement. Important factors that could cause actual results todiffer materially from those in the forward-looking statements herein includethe timing and extent of changes in commodity prices for oil and natural gas,operating risks and other risk factors as described in our 2009 Annual Reporton Form 10-K for the year ended June 30, 2009 as filed with theSecurities and Exchange Commission. Furthermore, the assumptions that supportour forward-looking statements are based upon information that is currentlyavailable and is subject to change. We specifically disclaim all responsibilityto publicly update any information contained in a forward-looking statement orany forward-looking statement in its entirety and therefore disclaim anyresulting liability for potentially related damages. All forward-lookingstatements attributable to Evolution Petroleum Corporation are expresslyqualified in their entirety by this cautionary statement.  We use the terms, “EPM,” “Company,” “we,” “us”and “our” to refer to Evolution Petroleum Corporation.

 

**General Overview**

 

We are a petroleum companyengaged primarily in the acquisition, exploitation and development ofproperties for the production of crude oil and natural gas. We originateproject development concepts, capture such opportunities through theacquisition of known, underdeveloped oil and natural gas resources and exploitthem through the application of capital and technology to increase production,ultimate recoveries, or both.

 

Our strategy is intended togenerate scalable development opportunities at normally pressured depths,exhibiting relatively low completion risk, generally longer and morepredictable production lives, less expenditures on infrastructure and loweroperational risks.

 

Within this overall strategy,we pursue three specific initiatives:

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

 

Ourmost significant asset is our EOR project in the 13,636 acre Delhi Field,located in northeast Louisiana.  Ourinterests consist of 7.4% in overriding and mineral royalty interests, a 25%after pay-out reversionary working interest (20% revenue interest) in the DelhiField Holt Bryant Unit, and a 25% working interest (20% revenue interest) incertain other depths in the Delhi Field, resulting from the Farmout wecompleted on June 12, 2006, with Denbury Onshore LLC, a subsidiary ofDenbury Resources Inc. (the “Operator”) (the “Delhi Farmout”).  The Holt Bryant Unit is currently beingredeveloped by the Operator, using CO2 enhanced oilrecovery technology and a dedicated portion of the Operator’s proved CO2 reserves in the Jackson Dome, locatedapproximately 100 miles east of Delhi. On November 12, 2009, the Operator announced that CO2 injection had begun at the Delhi Field andthat an initial oil production response was expected by mid-year calendar 2010.

 

Since our closing of theDelhi Farmout, we have focused on developing projects in our other initiativesthrough conventional redevelopment of oil and rich gas in the Giddings Fieldusing horizontal drilling, development of gas resources in the shallow portionof the Woodford and Caney Shale Trend in Eastern Oklahoma, development ofpotential oil reserves in the mature Lopez Field within our Neptune oil projectin South Texas and development of our proprietary artificial lift technologyintended to extend the life of horizontal wells with oil or associated waterproduction.

 

Ourlong-term strategy and primary focus continue to be on increasing share valuethrough the identification and acquisition of resources and conversion of thoseresources into proved reserves through our expertise and technology.

 

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*Highlights for our SecondQuarter 2010*

 

***Projects***

 

·**                ****CO****2**** injection began at Delhi during this fiscalquarter.**  As previouslyreported, the Delhi operator announced that CO2 injection hadbegun on November 12, 2009, and that they expected first oil production tobegin by mid-calendar 2010.

 

·**                ****Fieldtesting of our proprietary lift technology continues to be successful atGiddings. **We installed the first field application of our lifttechnology last June in the Donella #1 and the well appears to be capableof economic production, although it was shut-in for compressor repairs at theend of the quarter.  We recently installed a partial application of thelift technology to another producing well at Giddings, the Williams #1, duringa normal workover, and the combination of the technology and installation of arod pump have substantially enhanced production. We also are in early stagediscussions with third parties to potentially apply our technology to their marginal,uneconomic or shut-in wells.

 

·                 **We are adding a water injection well to ourNeptune oil project. **We havecompleted the drilling of the first two producer wells in the Lopez Field inSouth Texas within our Neptune oil project and are currently re-enteringanother well to convert to water injection. We are also working to obtain electric power in the field, and expect tobe able to begin production testing in the third fiscal quarter of 2010.  We hold 1,710 net acres with the potentialfor up to 111 additional drilling locations, of which four locations have beenassigned by our outside reservoir engineer as proved.

 

·                 **We initiated production testing in our Oklahomagas shale project. **  During the quarter, we hydraulicallyfractured a vertical test well in the Woodford Shale and a vertical test wellin the Caney Shale in our Wagoner County project.  To date, the Caney well has consistentlyproduced water free at a low gas rate, confirming that the Caney Shale cancontribute commercial gas volumes as an add-on to our Woodford production.Initial test production in the Woodford formation was promising, both in gasand water rates, but we are unable to produce this well currently until thewater disposal well is deepened to handle the water rate.  This work is underway and we expect to beproduction testing the Woodford during our third fiscal quarter.

 

***Operations***

 

·                 **Sales volumes increased 22% and product pricesdeclined 5%, resulting in a 16% increase in revenues during our second quarterof fiscal 2010 compared to our second quarter of fiscal 2009.* ***Essentially 100%of our production for the three months ended December 31, 2009 and 2008was attributable to our properties in the Giddings Field.  Declines in crude oil and NGL production weremore than offset by an increase in natural gas production.  A 29% decline in natural gas prices and ahigher gas component in the commodity mix of our sales volumes were partiallyoffset by a 30% increase in oil and NGL prices. Natural gas accounted for 58% of our volumes sold during the currentperiod compared to 42% for the same period in fiscal 2009.  During the three months ended December 31,2009, the average price we received was $38.46 per BOE, as compared to $40.29per BOE during the three months ended December 31, 2008.

 

·                 **Ourproduction declines generally have flattened, although net production wasimpacted by downtime to install our artificial lift technology on the Williams#1 and what we believe to be continued constrained production at theHilton-Yegua #1 due to a likely obstruction in the horizontal section of thewell.  **Net production during the quarter averaged approximately340 net BOE per day, compared to a quarterly rate of 380 net BOE per day and278 net BOE per day for the three months ended September 30, 2009 and December 31,2008, respectively.  In particular, our best well, the Pearson #1, hasstabilized at a productive gross rate of approximately 1.2 MMCFE per day aftereleven months of production.

 

·                 **Our field costs have stabilized.**  During the three months ended December 31,2009, lifting costs (lease operating expense and production taxes, on acombined per unit of sales basis) were $12.37 and our depletion rate was $17.27per BOE, equaling a field income break-even point of $29.64 per BOE.  This compares to lifting costs of $10.95 anda depletion rate of $17.17 per BOE, equaling a field income break-even point of$28.12 per BOE, during the quarter ended September 30, 2009 and liftingcosts of $13.09 and a depletion rate of $19.31 per BOE, equaling a field incomebreak-even point of $32.40 per BOE for the quarter ended December 31,2008.

 

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***Finances***

 

·                 **We endedour 2****nd**** quarter of fiscal 2010 with $5.7 million ofworking capital, compared to $7.6 million at June 30, 2009. **At December 31, 2009,working capital included $4.0 million of cash, cash equivalents and short-termcertificates of deposit, and $2.1 million of income taxes recoverable fromfederal taxes paid for our year ended June 30, 2007, as a result of acarry-back of our tax loss for the year ended June 30, 2009.  We received payment for the $2.1 millionreceivable from the Internal Revenue Service in January 2010.  The $1.9 million reduction in our workingcapital since June 30, 2009, was due to investments of $2.1 million in oiland natural gas properties.

 

·**                ****Cashflows from operations provided for our general and administrative expenses andfunded a portion of our capital expenditures. **Our decrease in working capital since the beginning of our 2010 fiscalyear was due entirely to capital spending on our oil and gas projects.  Cash flows from operations were $296,852during the six months ended December 31, 2009.

 

·**                ****G&Aexpense was reduced 25% and 20% during the three and six months ended December 31,2009, respectively, as compared to the respective periods in the prior fiscalyear. **Inaddition to reduced non-cash stock-based compensation expense, we have reducedour staff and legal costs during the year.

 

·                 **Weremained debt free.** All of our expenditures were funded solely byworking capital and we ended the quarter with no funded debt.

 

*Looking forward*

 

Wecontinue to focus on:

 

***Selective low cost testing and development of our portfolio properties.***

 

·                 **Upgradeour shallow multi-pay shale gas reserves.**  Continue ourproduction testing in the Oklahoma shallow Woodford and Caney gas shales todemonstrate production rates, decline curves and ultimate recovery in order tomove this project into full scale development. Market conditions permitting, we also plan to re-enter a well in ourmid-depth project in Haskell County, OK to begin testing the Woodford and CaneyShale reservoirs between 4,000’ and 5,000’ depth.

 

·                 **Continueto pursue commercial joint ventures utilizing our proprietary artificial lifttechnology.**

 

·**                ****Establishproduction in our Neptune oil project**.  We expect to begin first production in twoproducing wells in our 100% owned Neptune oil project in South Texas during ourthird fiscal quarter, with the goals of upgrading potential reserves and addingoil production.

 

·                 **Conductworkovers in Giddings as justified to add net production to cover our overhead.**

 

·                 **Developjoint venture(s) to drill or monetize undeveloped locations at Giddings.**  We are considering these options toaccelerate the drilling of our proved and unproved drilling locations, subjectto stable natural gas, oil and NGL prices.

 

***Continued progress in ourDelhi EOR project****.*

 

·                 **Firstoil production at Delhi is expected by the Operator by mid-calendar 2010.**

 

·                 **Establishproved reserves at Delhi.** Under current SEC rules, proved reservescannot be assigned to our Delhi EOR property until the first EOR oil productionresponse, projected by the Operator to occur by mid-year calendar 2010.Alternatively, the SEC’s “Modernization” rules that are scheduled tobecome effective for us on June 30, 2010, state that reservoir engineerscan consider other relevant factors in assigning proved reserves to EORprojects, including current technology, the results of field pilot tests andEOR projects in geologically comparable fields, all of which we believe arecharacteristics of the EOR project at Delhi.

 

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***Continued conservativefinancial management.***

 

·                 **Emphasizelong-term share value over near-term earnings.**

 

·                 **Retainfinancial strength, flexibility and liquidity to assure we obtain proper valueof our core assets.**

 

·                 **Useinternally generated funds and our working capital for fiscal 2010 capitalplan,**while considering joint ventures, project financing, asset redeploymentsand/or appropriate use of our common stock to fund growth through additionaldevelopment of our core projects and new projects.

 

**Liquidityand Capital Resources**

 

Forthe current fiscal year, we expect to finance our budgeted oil and gasactivities through our working capital and our cash flow from operatingactivities.

 

AtDecember 31, 2009, our working capital was $5.7 million and we continuedto be debt free.  This compares toworking capital of $7.6 million at June 30, 2009.  The $1.9 million decrease in working capitalsince June 30, 2009, was due primarily to investments of $2.1 million inoil and natural gas properties (not including $0.1 million incurred related torecognition of asset retirement obligations). Of the $2.1 million of incurred capital expenditures during the sixmonths ended December 31, 2009, $0.1 million was for leaseholdacquisitions and $2.0 million was for development activities.  Development activities were in the GiddingsField in Texas, our Neptune oil project in South Texas, and our gas shaleproject in Eastern Oklahoma.

 

***Cash Flows from Operating Activities***

 

Cashflows provided by operating activities for the six months ended December 31,2009 were $0.3 million.  Cash flowsprovided by operations include cash receipts of $2.4 million from oil andnatural gas sales, primarily from our properties in the Giddings Field,partially offset by $1.9 million of cash payments for operating expenses,including lease operating expenses, production taxes, and salaries and wages,and payment of $0.2 million in state income taxes.  In comparison, cash flows provided byoperating activities for the six months ended December 31, 2008 were $6.4million, which included cash proceeds of $5.3 million from oil and natural gasproduction primarily from our properties in the Giddings Field, cash proceedsof $0.1 million from interest income, cash proceeds of $4.1 million from incometax refunds, primarily from our 2008 tax year net operating loss carry-back,offset by $3.1 million of cash payments for operating expenses, including leaseoperating expenses, production taxes, and salaries and wages.

 

***Cash Flows from Investing Activities***

 

Cashpaid for oil and gas capital expenditures during the six months ended December 31,2009 and 2008, was $2.3 million and $6.8 million, respectively, which includesnet payments on accounts payable of $0.2 million and $0.3 million relating toprior period expenditures for oil and natural gas properties.

 

Wepurchased $1.4 million and $1.5 million in short-term certificates of depositduring the six months ended December 31, 2009 and 2008, respectively.   During the six months ended December 31,2009, $1.8 million of certificates of deposit matured.

 

***Cash Flows from Financing Activities***

 

There were no significantcash flows from financing activities during the six months ended December 31,2009.  On October 30, 2008, werepurchased 788,200 shares of common stock at an average price of $1.10 pershare plus $0.02 in transaction costs from an unaffiliated accredited investor.

 

***Capital Budget***

 

Wepreviously reported in our annual report for the fiscal year ended June 30,2009, that we expect capital expenditures of approximately $3.0 million duringfiscal year 2010.  As of December 31,2009, we have incurred $2.1 million for capital expenditures related to our oiland gas activities. Due to our positive working capital, cash flows fromproducing properties and no debt, we believe that our current sources ofliquidity are sufficient to fund our budget.

 

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**Resultsof Operations**

 

*Three months ended December 31,2009 and 2008*

 

The following table setsforth certain financial information with respect to our oil and natural gasoperations:

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **December 31**   | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2009**               | ** ** | **2008**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales Volumes, net to the  Company:**                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 6,128                  |       | 7,098      |       | (970         | )          | (14 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 6,891                  |       | 7,682      |       | (791         | )          | (10 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas (Mcf)                                        |       | 109,316                |       | 64,973     |       | 44,343       |       | 68 | % |
| Crude oil, NGLs and natural gas (BOE)                    |       | 31,238                 |       | 25,609     |       | 5,629        |       | 22 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Revenue data:**                                        |       |                   |       |       |       |         |       |   |   |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Crude oil                                                |       | $                      | 456,375    |       | $          | 407,194      |       | $ | 49,181 |   | 12 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs                                                     |       | 280,212                |       | 235,293    |       | 44,919       |       | 19 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas                                              |       | 464,715                |       | 389,295    |       | 75,420       |       | 19 | % |
| Total revenues                                           |       | $                      | 1,201,302  |       | $          | 1,031,782    |       | $ | 169,520 |   | 16 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Average price:**                                       | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (per Bbl)                                      |       | $                      | 74.47      |       | $          | 57.37        |       | $ | 17.10 |   | 30 | % |
| NGLs (per Bbl)                                           |       | 40.66                  |       | 30.63      |       | 10.03        |       | 33 | % |
| Natural gas (per Mcf)                                    |       | 4.25                   |       | 5.99       |       | (1.74        | )          | (29 | )% |
| Crude oil, NGLs and natural gas (per BOE)                |       | $                      | 38.46      |       | $          | 40.29        |       | $ | (1.83 | ) | (5 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating expenses and production taxes            |       | $                      | 12.37      |       | $          | 13.09        |       | $ | (0.72 | ) | (6 | )% |
| Depletion expense on oil and natural gas properties  (a) |       | $                      | 17.27      |       | $          | 19.31        |       | $ | (2.04 | ) | (11 | )% |

 

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(a)          Excludesdepreciation of office equipment, furniture and fixtures and other equipment of$10,799 and $9,794, for the three months ended December 31, 2009 and 2008,respectively.

 

Netloss.  For the three months ended December 31,2009, we reported a net loss of $701,940 or $0.03 loss per share (whichincludes $424,800 of non-cash stock-based compensation expense) on total oiland natural gas revenues of $1,201,302. This compares to a net loss of $1,003,771, or $0.04 per share (whichincludes $584,525 of non-cash stock-based compensation expense) on total oiland natural gas revenues of $1,031,782 for the three months ended December 31,2008.  An increase in our revenues of$169,520 and a decrease in operating expenses of $302,899 were partially offsetby a slight decrease in interest income and a decrease of $166,591 in ourincome tax benefit.  Additional detailsof the components of net loss are explained in greater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the three months ended December 31, 2009increased 22% to 31,238 BOE, compared to 25,609 BOE for the three months December 31,2008.  Our sales volumes for the threemonths ended December 31, 2009 and 2008 were primarily from our propertiesin the Giddings Field in Texas.  Salesvolumes of natural gas increased 68%, while sales volumes of crude oil and NGLsdecreased 12% compared to the three months ended December 31, 2008.

 

PetroleumRevenues.  Crude oil,NGLs and natural gas revenues for the three months ended December 31, 2009increased 16% from the three months ended December 31, 2008.  The increase was due to a 22% increase insales volumes, partially offset by a 5% decline in the weighted-average pricereceived per BOE, from $40 per BOE for the three months ended December 31,2008 to $38 per BOE for the three months ended December 31, 2009.

 

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LeaseOperating Expenses (including production severance taxes).  Lease operating expenses and production taxesfor the three months ended December 31, 2009 increased 15% compared to thethree months ended December 31, 2008, primarily due to the additions ofthree producing wells and ad valorem taxes assessed in calendar year 2009.  Lease operating expense and production taxesper barrel of oil equivalent decreased 6% from $13.09 per BOE during the threemonths ended December 31, 2008, to $12.37 per BOE during the three monthsended December 31, 2009.  Productiontaxes comprise $0.53 per BOE for the period ended December 31, 2009compared to $0.85 in the same period of the prior year.

 

General and AdministrativeExpenses (“G&A”). G&A expenses decreased 25% to $1.3 million for the three monthsended December 31, 2009, compared to $1.7 million for the three monthsended December 31, 2008.  Thereduction was due to a decrease in non-cash stock-based compensation expense,which was $424,800 (34% of total G&A) and $584,525 (35% of total G&A)for the three months ended December 31, 2009 and 2008, respectively, a 28%reduction in personnel costs, due to a reduction in staff and estimated annualbonus payments, and a reduction of legal fees of approximately $115,000 due tothe settlement of the Delhi litigation in July 2009.  Non-cash stock-based compensation is anintegral part of total staff compensation utilized to recruit quality stafffrom other, more established companies and, as a result, will likely continueto be a significant component of our G&A costs.

 

Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A increased by 9% to $550,142 for thethree months ended December 31, 2009, compared to $504,291 for the threemonths ended December 31, 2008.  Theincrease is primarily due to a 22% increase in net sales volumes, partiallyoffset by a lower depletion rate ($17.27 vs. $19.31) per BOE, as a result ofthe reduction in projected capital expenditures associated with our provedundeveloped locations in our properties in the Giddings Field.

 

Interest Income.  Interest income for the three months ended December 31,2009 decreased $3,997 to $13,785, compared to $17,782 for the three monthsended December 31, 2008.  Thedecrease in interest income is due to much lower short-term investment balancesaveraging $4.5 million during the three months ended December 31, 2009, ascompared to short-term investment balances averaging $9.8 million during thethree months ended December 31, 2008. We redeployed cash during the end of calendar year 2008 to higheryielding certificates of deposit, which partially offset the loss of interestincome from a much lower invested balance. The lower balances were primarily due to investments in our oil andnatural gas properties during the prior twelve months.

 

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*Sixmonths ended December 31, 2009 and 2008*

 

The following table setsforth certain financial information with respect to our oil and natural gasoperations:

 
| ** **                                               | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **December 31** | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2009**             | ** ** | **2008**   | ** ** | **Variance** | ** ** | **change** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales Volumes, net to the  Company:**                  | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 13,698               |       | 19,933     |       | (6,235       | )          | (31 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 15,762               |       | 18,745     |       | (2,983       | )          | (16 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| Natural gas (Mcf)                                        |       | 220,696              |       | 126,119    |       | 94,577       |       | 75 | % |
| Crude oil, NGLs and natural gas (BOE)                    |       | 66,243               |       | 59,698     |       | 6,545        |       | 11 | % |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Revenue data:**                                        |       |                 |       |       |       |         |       |   |   |
|                                                     |       |                 |       |       |       |         |       |   |   |
| Crude oil                                                |       | $                    | 959,497    |       | $          | 1,986,264    |       | $ | (1,026,767 | ) | (52 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| NGLs                                                     |       | 565,523              |       | 990,738    |       | (425,215     | )          | (43 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| Natural gas                                              |       | 846,309              |       | 969,766    |       | (123,457     | )          | (13 | )% |
| Total revenues                                           |       | $                    | 2,371,329  |       | $          | 3,946,768    |       | $ | (1,575,439 | ) | (40 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Average price:**                                       | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (per Bbl)                                      |       | $                    | 70.05      |       | $          | 99.65        |       | $ | (29.60 | ) | (30 | )% |
| NGLs (per Bbl)                                           |       | 35.88                |       | 52.85      |       | (16.97       | )          | (32 | )% |
| Natural gas (per Mcf)                                    |       | 3.83                 |       | 7.69       |       | (3.86        | )          | (50 | )% |
| Crude oil, NGLs and natural gas (per BOE)                |       | $                    | 35.80      |       | $          | 66.11        |       | $ | (30.31 | ) | (46 | )% |
|                                                     |       |                 |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                   | ** ** | ** **           | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating expenses and production taxes            |       | $                    | 11.62      |       | $          | 12.68        |       | $ | (1.06 | ) | (8 | )% |
| Depletion expense on oil and natural gas properties  (a) |       | $                    | 17.22      |       | $          | 18.92        |       | $ | (1.70 | ) | (9 | )% |

 

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(a)          Excludesdepreciation of office equipment, furniture and fixtures, and other of $24,293and $19,618, for the six months ended December 31, 2009 and 2008,respectively.

 

Netloss.  For the six months ended December 31,2009, we reported a net loss of $1,406,765, or $0.05 per share (which includes$816,436 of non-cash stock-based compensation expense) on total oil and naturalgas revenues of $2,371,329.  Thiscompares to a net loss of $855,334, or $0.03 per share (which includes$1,108,250 of non-cash stock-based compensation expense) on total oil andnatural gas revenues of $3,946,768 for the six months ended December 31,2008.  A decrease in our revenues of$1,575,439 and a decrease in interest income of $62,419 were partially offsetby decreases in operating costs of $571,834, and an increase in our income taxbenefit of $514,593.  Additional detailsof the components of net loss are explained in greater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the six months ended December 31, 2009increased 11% to 66,243 BOE, compared to 59,698 BOE for the six months December 31,2008.  Our sales volumes for the sixmonths ended December 31, 2009 and 2008 were primarily from our propertiesin the Giddings Field in Texas. Production of natural gas increased 75%, while production of crude oiland NGLs decreased 24% compared to the six months ended December 31, 2008.

 

PetroleumRevenues.  Crude oil,NGLs and natural gas revenues for the six months ended December 31, 2009decreased 40% from the six months ended December 31, 2008.  This was due to a 46% decline in the averageprice received per BOE, from $66 per BOE for the six months ended December 31,2008 to $36 per BOE for the six months ended December 31, 2009.

 

LeaseOperating Expenses (including production severance taxes).  Lease operating expenses and production taxesfor the six months ended December 31, 2009 increased 2% compared to thesix months ended December 31, 2008, despite the addition of threeproducing wells.  Lease operating expenseand production taxes per barrel of oil equivalent decreased 8% from $12.68 perBOE during the six months ended December 31, 2008, to $11.62 per BOEduring the six months ended December 31, 2009.  The decrease is primarily attributable to adecrease in production taxes.  Productiontaxes were $0.53 per BOE for the six months ended December 31, 2009compared to $1.81 per BOE the same period in the prior fiscal year.

 

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General and AdministrativeExpenses (“G&A”). G&A expenses decreased 20% to $2.5 million for the six months ended December 31,2009, compared to $3.1 million for the six months ended December 31,2008.  The reduction was due to adecrease in non-cash stock-based compensation expense, which was $816,436 (33%of total G&A) and $1,108,250 (35% of total G&A) for the six months endedDecember 31, 2009 and 2008, respectively, a 22% reduction in personnelcosts, due to a reduction in staff and estimated annual bonus payments, and areduction of legal fees of approximately $77,000 due to the settlement of theDelhi litigation in July 2009. Non-cash stock-based compensation is an integral part of total staffcompensation utilized to recruit quality staff from other, more establishedcompanies and, as a result, will likely continue to be a significant componentof our G&A costs.

 

Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A increased by 2% to $1,167,899 forthe six months ended December 31, 2009, compared to $1,149,173 for the sixmonths ended December 31, 2008.  Theincrease is primarily due to an 11% increase in net sales volumes, partiallyoffset by a lower depletion rate ($17.22 vs. $18.92) per BOE, as a result ofthe reduction in projected capital expenditures associated with our provedundeveloped locations in our properties in the Giddings Field.

 

Interest Income.  Interest income for the six months ended December 31,2009 decreased $62,419 to $29,009, compared to $91,428 for the six months endedDecember 31, 2008.  The decrease ininterest income is due to much lower short-term investment balances averaging$5.0 million during the six months ended December 31, 2009, as compared toshort-term investment balances averaging $10.3 million during the six monthsended December 31, 2008.  Weredeployed cash during the end of calendar 2008 to higher yielding certificatesof deposit, which partially offset the loss of interest income from a muchlower invested balance.  The lowerbalances were primarily due to investments in our oil and natural gasproperties during the prior twelve months.

 

Inflation.  Although the general inflationrate in the United States, as measured by the Consumer Price Index and theProducer Price Index, has been relatively low in recent years, the oil and gasindustry has experienced unusually volatile price movements in commodityprices, vendor goods and oilfield services. With the general rise in the price of oil and natural gas products overtwo of the last three fiscal years, increased prices for drilling and oilfieldservices, oilfield equipment, tubulars, labor, expertise and other services, havealso increased, thereby escalating our lease operating expenses and our capitalexpenditures.  Most recently, we haveseen a substantial decline in both petroleum product prices and drilling andoilfield services costs.  However,product prices, operating costs and development costs may not always move intandem.

 

KnownTrends and Uncertainties. General worldwide economic conditions have deteriorated due to creditconditions impacted by the sub-prime mortgage turmoil and otherfactors.  Concerns over uncertain future economic growth areaffecting numerous industries, companies, as well as consumers, which hasresulted in reduced demand for crude oil and natural gas.  If demanddecreases in the future, it may put downward pressure on crude oil and naturalgas prices, thereby lowering our revenues and working capital going forward.

 

Seasonality.  Our business is generally not seasonal,except for certain rare instances when weather conditions may adversely affectaccess to our properties or delivery of our petroleum products.  Although we do not generally modify ourproduction for changes in market demand, we do experience seasonality in theproduct prices we receive, generally based on higher demand for natural gas inthe summer and winter and higher demand for downstream oil products during thesummer driving season.

 

**OffBalance Sheet Arrangements**

 

TheCompany has no off-balance sheet arrangements to report during the secondquarter ending December 31, 2009.

 

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**ITEM 3.**** ****QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

Informationabout market risks for the three months ended December 31, 2009, did notchange materially from the disclosures in Item 7A. of our Annual Report on Form 10-Kfor the year ended June 30, 2009 except as noted below.  As such, the information contained hereinshould be read in conjunction with the related disclosures in our Annual Reporton Form 10-K for the year ended June 30, 2009.

 

*Interest Rate Risk*

 

Weare exposed to changes in interest rates. Changes in interest rates affect theinterest earned on our cash and cash equivalents.  Under our current policies, we do not useinterest rate derivative instruments to manage exposure to interest ratechanges.

 

*Commodity Price Risk*

 

Ourrevenues, profitability and future growth depend substantially on prevailingprices for oil and natural gas. Prices also affect the amount of cash flow availablefor capital expenditures and our ability to borrow and raise additionalcapital, as, if and when needed. Lower prices may also reduce the amount of oiland natural gas that we can economically produce.  Although our current production base may not besufficient enough to effectively allow hedging, we may periodically usederivative instruments to hedge our commodity price risk. We may hedge aportion of our projected oil and natural gas production through a variety offinancial and physical arrangements intended to support oil and natural gasprices at targeted levels and to manage our exposure to price fluctuations. Wemay use futures contracts, swaps and fixed price physical contracts to hedgeour commodity prices. Realized gains and losses from our price risk managementactivities are recognized in oil and natural gas sales when the associatedproduction occurs. We presently do not hold or issue derivative instruments forhedging or speculative purposes.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to this Company’s management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow for timelydecisions regarding required disclosure.

 

As required by Securities andExchange Commission Rule 13a-15(b), we carried out an evaluation, underthe supervision and with the participation of the Company’s management,including our Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(c) and15d-15(e)) as of the end of the quarter covered by this report.  In designing and evaluating our disclosurecontrols and procedures, our management recognizes that controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving desired control objectives.  Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that as of December 31, 2009our disclosure controls and procedures are effective in ensuring that theinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission rules andforms.

 

During the quarter ended December 31,2009 there has been no change in our internal control over financial reportingthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II- OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

None.

 

**ITEM 1A. RISK FACTORS**

 

Seerisk factors set forth in the Company’s Annual Report on Form 10-K for theyear ended June 30, 2009.

 

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

 

None.

 

**ITEM****3. DEFAULTS UPON SENIOR SECURITIES**

 

Notapplicable.

 

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

 

The following items werepresented for approval to stockholders of record on October 23, 2009 atthe Company’s annual meeting of stockholders which was held on December 9,2009 in Houston, Texas:

 

1.               Election ofDirectors:  The following nominees wereelected to serve as Directors of Evolution Petroleum Corporation until the 2009annual meeting of stockholders, or until their successors are elected andqualified:

 
| ** **       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|------------------|------------|------------|------------|--------------|------------|
| ** **       | ** ** | ** ** | ** ** | ** **   | ** ** |
| Laird Q. Cagan   |       | 20,859,897 |       | 570,071      |       |
| E. J. DiPaolo    |       | 19,564,956 |       | 1,865,012    |       |
| William Dozier   |       | 19,626,412 |       | 1,803,556    |       |
| Robert S. Herlin |       | 19,995,593 |       | 1,434,375    |       |
| Kelly W. Loyd    |       | 21,389,856 |       | 40,112       |       |
| Gene Stoever     |       | 19,623,843 |       | 1,806,125    |       |

 

No other person received any votes.

 

2.               Ratification ofHein & Associates LLP, as independent registered public accountingfirm of the Company for the fiscal year ending June 30, 2010.  The voting was as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 21,312,449 |       | 20,197      |       | 46,275      |       |

 

All matters received therequired number of votes for approval.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

**ITE****M 6.EXHIBITS**

 

A.           Exhibits

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

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

**EVOLUTION PETROLEUM CORPORATION**

(Registrant)

 

 
| Date:  February 12, 2010 | By:    |   | /s/ STERLING H. MCDONALD                    |
|-------------------------------|--------|--------|---------------------------------------------|
|                          |   |   | Sterling H. McDonald                        |
|                          |   |   | Vice-President and Chief  Financial Officer |
|                          |   |   | Principal Financial and  Accounting Officer |

 

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