Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended September 30, 2010**

 

**o**                   **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from              to            **

 

**Commission File Number 001-32942**

 

**EVOLUTION PETROLEUM CORPORATION**

(Exactname 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)

 

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

 

Indicate by check mark whetherthe registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes: o No: o

 

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

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.). Yes: o No: x

 

Thenumber of shares outstanding of the registrant’s common stock, par value$0.001, as of November 12, 2010, was 27,446,519.

 

 

 

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**TABLE OF CONTENTS**

 
| ** **                              | ** **                                                                                                      | **Page** |
|-----------------------------------------|-----------------------------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                                            |     |
| **PART I.  FINANCIAL INFORMATION** |                                                                                                            | 3        |
|                                    |                                                                                                            |     |
| ITEM 1.                                 | CONSOLIDATED  CONDENSED FINANCIAL STATEMENTS                                                                    |     | 3 |
|                                    |                                                                                                            |     |   |
|                                    | Consolidated  Balance Sheets (unaudited) as of September 30, 2010 and June 30,  2010                  |     | 3 |
|                                    | Consolidated Statements of Operations (unaudited) for  the three months ended September 30, 2010 and 2009  |     | 4 |
|                                    | Consolidated  Statements of Cash Flows (unaudited) for the three months ended  September 30, 2010 and 2009 |     | 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                                                     |     | 18 |
|                                    |                                                                                                            |     |   |
| ITEM 4.                                 | CONTROLS AND  PROCEDURES                                                                                        |     | 19 |
|                                    |                                                                                                            |     |   |
| **PART II. OTHER  INFORMATION**    |                                                                                                            | 20       |
|                                    |                                                                                                            |     |   |
| ITEM 1.                                 | LEGAL PROCEEDINGS                                                                                               |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 1A.                                | RISK FACTORS                                                                                                    |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 2.                                 | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                     |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 3.                                 | DEFAULTS  UPON SENIOR SECURITIES                                                                                |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 4.                                 | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                            |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 5.                                 | OTHER INFORMATION                                                                                               |     | 20 |
|                                    |                                                                                                            |     |   |
| ITEM 6.                                 | EXHIBITS                                                                                                        |     | 21 |
|                                    |                                                                                                            |     |   |
| SIGNATURES                              |                                                                                                            | 22       |

 

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**PART I — FINANCIALINFORMATION**

 

**ITEM 1. CONSOLIDATED****CONDENSED****FINANCIAL STATEMENTS**

 

**Evolution Petroleum Corporation and Subsidiaries**

**Consolidated Balance Sheets**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                         | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                         | ** ** | **2010**               | ** ** | **2010**          | ** ** |
| **Assets**                                                                                                                                                                                                         |       |                   | ** ** | ** **        | ** ** |
| Current assets                                                                                                                                                                                                     |       |                   |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                          |       | $                      | 3,495,420  |              | $          | 3,138,259 |   |
| Certificates of deposit                                                                                                                                                                                            |       | 250,000                |       | 1,350,000         |       |
| Restricted cash from joint venture partner                                                                                                                                                                         |       | 3,477,802              |       | —            |       |
| Receivables                                                                                                                                                                                                        |       |                   |       |              |       |
| Oil and natural gas sales                                                                                                                                                                                          |       | 426,020                |       | 536,366           |       |
| Income taxes                                                                                                                                                                                                       |       | 25,200                 |       | 25,200            |       |
| Other                                                                                                                                                                                                              |       | 293,578                |       | 147,059           |       |
| Income taxes recoverable                                                                                                                                                                                           |       | 716,973                |       | 716,973           |       |
| Prepaid expenses and other current assets                                                                                                                                                                          |       | 287,259                |       | 315,494           |       |
| Total current assets                                                                                                                                                                                               |       | 8,972,252              |       | 6,229,351         |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Property and equipment, net of depreciation,  depletion, and amortization                                                                                                                                          |       |                   |       |              |       |
| Oil and natural gas properties — full-cost method  of accounting, of which $8,238,300and $7,851,068 at September 30, 2010  and June 30, 2010, respectively, were excluded from amortization.        |       | 31,372,884             |       | 30,803,061        |       |
| Other property and equipment                                                                                                                                                                                       |       | 93,171                 |       | 101,998           |       |
| Total property and equipment                                                                                                                                                                                       |       | 31,466,055             |       | 30,905,059        |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Other assets                                                                                                                                                                                                       |       | 35,117                 |       | 60,665            |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Total assets                                                                                                                                                                                                       |       | $                      | 40,473,424 |              | $          | 37,195,075 |   |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                     |       |                   |       |              |       |
| Current liabilities                                                                                                                                                                                                |       |                   |       |              |       |
| Accounts payable                                                                                                                                                                                                   |       | $                      | 1,834,616  |              | $          | 678,609 |   |
| Joint interest advances                                                                                                                                                                                            |       | 2,267,717              |       | —            |       |
| Accrued payroll                                                                                                                                                                                                    |       | 33,217                 |       | 75,692            |       |
| Royalties payable                                                                                                                                                                                                  |       | 203,070                |       | 221,062           |       |
| State taxes payable                                                                                                                                                                                                |       | 202,334                |       | 202,334           |       |
| Other current liabilities                                                                                                                                                                                          |       | 127,151                |       | 110,002           |       |
| Total current liabilities                                                                                                                                                                                          |       | 4,668,105              |       | 1,287,699         |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Long term liabilities                                                                                                                                                                                              |       |                   |       |              |       |
| Deferred income taxes                                                                                                                                                                                              |       | 2,787,893              |       | 2,949,880         |       |
| Asset retirement obligations                                                                                                                                                                                       |       | 827,950                |       | 811,635           |       |
| Accrued compensation                                                                                                                                                                                               |       | 157,500                |       | —            |       |
| Stock-based compensation                                                                                                                                                                                           |       | —                 |       | 587,033           |       |
| Deferred rent                                                                                                                                                                                                      |       | 82,579                 |       | 81,635            |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Total liabilities                                                                                                                                                                                                  |       | 8,524,027              |       | 5,717,882         |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Commitments  and contingencies (Note 9)                                                                                                                                                                            |       |                   |       |              |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| 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 28,229,874 shares;outstanding 27,441,674 shares and  27,061,376 shares as of September 30, 2010 and June 30, 2010,  respectively. |       | 28,229                 |       | 27,849            |       |
| Additional paid-in capital                                                                                                                                                                                         |       | 19,489,801             |       | 18,532,643        |       |
| Retained earnings                                                                                                                                                                                                  |       | 13,313,389             |       | 13,798,723        |       |
|                                                                                                                                                                                                               |       | 32,831,419             |       | 32,359,215        |       |
| Treasury stock, at cost, 788,200 shares as of  September 30, 2010 and June 30, 2010.                                                                                                                     |       | (882,022               | )          | (882,022          | )          |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Total stockholders’ equity                                                                                                                                                                                    |       | 31,949,397             |       | 31,477,193        |       |
|                                                                                                                                                                                                               |       |                   |       |              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                    |       | $                      | 40,473,424 |              | $          | 37,195,075 |   |

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Operations**

**(Unaudited)**

** **
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **September 30,**           | ** ** |
| ** **                                | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Revenues                                  |       |                             |       |   |   |
| Crude oil                                 |       | $                                | 648,218    |   | $ | 503,122 |   |
| Natural gas liquids                       |       | 209,918                          |       | 285,311 |   |
| Natural gas                               |       | 310,960                          |       | 381,594 |   |
| Total revenues                            |       | 1,169,096                        |       | 1,170,027 |   |
|                                      |       |                             |       |   |   |
| Operating Costs                           |       |                             |       |   |   |
| Lease operating expenses                  |       | 354,581                          |       | 364,846 |   |
| Production taxes                          |       | 14,703                           |       | 18,367 |   |
| Depreciation, depletion and amortization  |       | 124,018                          |       | 617,757 |   |
| Accretion of asset retirement obligations |       | 16,315                           |       | 14,338 |   |
| General and administrative expenses *     |       | 1,307,567                        |       | 1,253,116 |   |
| Total operating costs                     |       | 1,817,184                        |       | 2,268,424 |   |
|                                      |       |                             |       |   |   |
| Loss from operations                      |       | (648,088                         | )          | (1,098,397 | ) |
|                                      |       |                             |       |   |   |
| Other income                              |       |                             |       |   |   |
| Interest income                           |       | 7,767                            |       | 15,224 |   |
|                                      |       |                             |       |   |   |
| Net loss before income  tax benefit       |       | (640,321                         | )          | (1,083,173 | ) |
|                                      |       |                             |       |   |   |
| Income tax benefit                        |       | 154,987                          |       | 378,348 |   |
|                                      |       |                             |       |   |   |
| Net loss                                  |       | $                                | (485,334   | ) | $ | (704,825 | ) |
|                                      |       |                             |       |   |   |
| Loss per common share                     |       |                             |       |   |   |
| Basic and Diluted                         |       | $                                | (0.02      | ) | $ | (0.03 | ) |
|                                      |       |                             |       |   |   |
| Weighted average number  of common shares |       |                             |       |   |   |
| Basic and diluted                         |       | 27,160,723                       |       | 26,646,022 |   |

 

----

*Generaland administrative expenses for the three months ended September 30, 2010and 2009 included non-cash stock-based compensation expense of $354,486 and$391,636, respectively.

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Three Months Ended********September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2010**                                                   | ** ** | **2009** | ** ** |
| Cash flows from  operating activities                                            | ** ** | ** **                                                 | ** ** | ** ** | ** ** |
| Net loss                                                                         |       | $                                                          | (485,334   | ) | $ | (704,825 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                                       |       |   |   |
| Depreciation, depletion and amortization                                         |       | 124,018                                                    |       | 617,757 |   |
| Stock-based compensation                                                         |       | 354,486                                                    |       | 391,636 |   |
| Accretion of asset retirement obligations                                        |       | 16,315                                                     |       | 14,338 |   |
| Deferred income taxes                                                            |       | (161,987                                                   | )          | (339,522 | ) |
| Accrued compensation                                                             |       | 157,500                                                    |       | 105,000 |   |
| Deferred rent                                                                    |       | 944                                                        |       | 944 |   |
| Other                                                                            |       | 32,080                                                     |       | 1,559 |   |
| Changes in operating assets and liabilities                                      |       |                                                       |       |   |   |
| Receivables from oil and natural gas sales                                       |       | 110,346                                                    |       | 22,255 |   |
| Receivables from income taxes and other                                          |       | 84,807                                                     |       | 33,378 |   |
| Prepaid expenses and other current assets                                        |       | 28,235                                                     |       | 41,751 |   |
| Accounts payable and accrued expenses                                            |       | (78,652                                                    | )          | 107,600 |   |
| Royalties payable                                                                |       | (17,992                                                    | )          | 35,342 |   |
| Net cash provided by operating activities                                        |       | 164,766                                                    |       | 327,213 |   |
|                                                                             |       |                                                       |       |   |   |
| Cash flows from  investing activities                                            |       |                                                       |       |   |   |
| Development of oil and natural gas properties                                    |       | (431,492                                                   | )          | (1,090,298 | ) |
| Acquisitions of oil and natural gas properties                                   |       | (485,600                                                   | )          | (45,190 | ) |
| Maturities of certificates of deposit                                            |       | 1,100,000                                                  |       | — |   |
| Purchases of certificates of deposit                                             |       | —                                                     |       | (107,212 | ) |
| Other assets                                                                     |       | (6,532                                                     | )          | (2,963 | ) |
| Net cash provided by (used in) investing  activities                             |       | 176,376                                                    |       | (1,245,663 | ) |
|                                                                             |       |                                                       |       |   |   |
| Cash flows from  financing activities                                            |       |                                                       |       |   |   |
| Proceeds from the exercise of stock options                                      |       | 16,019                                                     |       | — |   |
| Net cash provided by financing activities                                        |       | 16,019                                                     |       | — |   |
|                                                                             |       |                                                       |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                            |       | 357,161                                                    |       | (918,450 | ) |
|                                                                             |       |                                                       |       |   |   |
| Cash and cash equivalents, beginning of period                                   |       | 3,138,259                                                  |       | 3,891,764 |   |
|                                                                             |       |                                                       |       |   |   |
| Cash and cash equivalents, end of period                                         |       | $                                                          | 3,495,420  |   | $ | 2,973,314 |   |

 

Our supplemental disclosures of cash flowinformation for the three months ended September 30, 2010 and 2009 are asfollows:

 
| ** **                                                                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                         | ** ** | **September 30,**           | ** ** |
| ** **                                                                                                                         | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Income  taxes paid                                                                                                                 |       | $                                | 7,000      |   | $ | — |   |
|                                                                                                                               |       |                             |       |   |   |
| Non-cash  transactions                                                                                                             |       |                             |       |   |   |
| Assignment  of oil and gas leases recognized in other receivables                                                                  |       | $                                | 231,326    |   | $ | — |   |
| Decrease  in accounts payable used to acquire oil and natural gas leasehold interests  and develop oil and natural gas properties: |       | $                                | (752       | ) | $ | (21,561 | ) |
| Oil  and natural gas properties incurred through recognition of asset retirement  obligations:                                     |       | $                                | —     |   | $ | 58,779 |   |

 

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”) and its subsidiaries (the “Company”, “we”, “our”or “us”), is an independent petroleum company headquartered in Houston, Texasand 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 consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and with the appropriate rules andregulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  All adjustments (consisting of normalrecurring accruals) which are, in the opinion of management, necessary for afair presentation of the financial position and results of operations for theinterim periods presented have been included. The interim financial information and notes hereto should be read inconjunction with the Company’s 2010 Annual Report on Form 10-K for theyear ended June 30, 2010, 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: NGS Sub Corp and itswholly owned subsidiary, Tertiaire Resources Company, NGS Technologies, Inc.,and Evolution Operating Corp.  Allsignificant intercompany transactions have been eliminated in consolidation.The consolidated 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 and the valuation of deferred tax assets, stock-based compensationand commitments 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 —****Property and Equipment**

 

Asof September 30, 2010 and June 30, 2010 our oil and natural gasproperties and other property and equipment consisted of the following:

 
| ** **                                                   | ** ** | **September 30,********2010** | ** ** | **June 30,  2010** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------|------------|-------------------------|------------|
| **Oil and natural gas properties**                           |       |                               |       |                    |       |
| Property costs subject to amortization                       |       | $                                  | 28,073,423 |                    | $          | 27,775,641 |   |
| Less: Accumulated depreciation, depletion, and  amortization |       | (4,938,839                         | )          | (4,823,648              | )          |
| Unproved properties not subject to amortization              |       | 8,238,300                          |       | 7,851,068               |       |
| Oil and natural gas properties, net                          |       | $                                  | 31,372,884 |                    | $          | 30,803,061 |   |
|                                                         |       |                               |       |                    |       |
| **Other property and equipment**                             |       |                               |       |                    |       |
| Furniture, fixtures and office equipment, at cost            |       | 260,476                            |       | 260,476                 |       |
| Less: Accumulated depreciation                               |       | (167,305                           | )          | (158,478                | )          |
| Other property and equipment, net                            |       | $                                  | 93,171     |                    | $          | 101,998 |   |

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 2 —****Property and Equipment**(Continued)

 

Unprovedproperties not subject to amortization includes unevaluated acreage of $6.3 and$6.0 million as of September 30, 2010 and June 30, 2010,respectively, consisting of properties in the Giddings Field in Central Texas,the Woodford Shale trend in Oklahoma, and the Lopez Field in South Texas (our “NeptuneOil Project”).    Unproved propertiesalso includes $0.7 million as of September 30, 2010 and June 30,2010, of participating interests through royalty and overriding royaltyinterests aggregating 7.4% in the Delhi Holt Bryant Unit of the Delhi Field inLouisiana and a 23.9% after payout reversionary working interest in the DelhiHolt Bryant Unit along with a 23.9% working interest in certain other depths inthe Delhi Field.  Unproved propertiesalso includes $1.2 million as of September 30, 2010 and June 30,2010, related to the drilling of three test wells and re-entry of four testwells on our acreage in Wagoner County in Oklahoma.  Production testing of our wells in Oklahomais ongoing.  Development 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 3****—****Joint Venture Drilling Arrangement**

 

Wereceived $4,095,855 from an industry partner under a joint venture drillingarrangement.  As of September 30,2010, capital expenditures of $1,828,138 were incurred related to the jointventure partner’s proportionate share of the arrangement.  Amounts pertaining to our joint venturepartner’s share of the drilling arrangement included in our balance sheet as ofSeptember 30, 2010 are as follows:

 
| Restricted cash from joint venture partner |   | $          | 3,477,802 |   |
|--------------------------------------------|--------|------------|-----------|--------|
| Accounts payable                           |   | (1,210,085 | )         |
| Joint venture advances                     |   | $          | 2,267,717 |   |

 

**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 three months ended September 30, 2010:

 
| Asset retirement obligations — beginning of period |   | $      | 811,635 |   |
|---------------------------------------------------------|--------|--------|---------|--------|
| Accretion                                               |   | 16,315 |    |
| Asset retirement obligations — end of period       |   | $      | 827,950 |   |

 

**Note 5 — Stockholders’ Equity**

 

On July 2, 2010, anemployee of the Company exercised 6,875 stock options granted in 2007 at anexercise price of $2.33 per share. See Note 6.

 

On July 2, 2010, atotal of 4,215 shares of restricted common stock were forfeited by anemployee.  Total unrecognized  stock-based compensation expense related tothe shares was $11,621.  The shares werecancelled and are available for a future grant in the 2004 Stock Plan.  See Note 6.

 

On August 9, 2010, atotal of 30,233 shares of restricted stock were issued to a new employee aslong-term incentive compensation.  Thevalue of the shares issued was $156,000, based on the fair market value on thedate of issuance.  The shares are subjectto a four year vesting term.  See Note 6.

 

OnSeptember 10, 2010, the Board of Directors authorized and the Companyissued 106,927 shares of common stock from the 2004 Stock Plan to certainemployees for the payment of fiscal 2010 bonuses.  The value of the shares issued were $587,033,based on the fair market value on the date of issuance, or $5.49 per share.  The amount of bonus was accrued as of June 30,2010, and recognized as a long term liability. On September 10, 2010, the liability was reclassified to additionalpaid-in capital.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

OnSeptember 10, 2010, the Board of Directors authorized and the Companyissued 240,478 shares of restricted common stock from the 2004 Stock Plan tocertain employees as a long-term incentive award.  Total unrecognized stock-based compensationexpense of $1,320,224 related to the long-term incentive award will be recognizedratably over a four year period as the restricted common stock vests.  See Note 6.

 

**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 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 ofSeptember 30, 2010, 241,109 shares remain available for grant under the2004 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 September 30, 2010 and 2009 was$196,843 and $265,252, respectively.

 

Therewere no Stock Options granted during the three months ended September 30,2010 and 2009.

 

Weestimated the fair value of Stock Options and Incentive Warrants issued toemployees and directors at the date of grant using a Black-Scholes-Mertonvaluation model.  The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant.  The expected term (estimated period of timeoutstanding) of Stock Options and Incentive Warrants is based on the “simplified”method of the estimated expected term for “plain vanilla” options allowed bythe SEC Staff Accounting Bulletin (“SAB”) No. 107 and SAB No. 110,and varied based on the vesting period and contractual 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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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

Thefollowing summary presents information regarding outstanding Stock Options andIncentive Warrants as of September 30, 2010, and the changes during thefiscal year:

 
| ** **                                                                   | ** ** | **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, 2010       |       | 5,482,820                                                                      |       | $                                              | 1.83       |                                     |       |                                                                 |       |   |
|                                                                         |       |                                                                           |       |                                           |       |                                     |       |                                                                 |       |
| Granted                                                                      |       | —                                                                         |       | —                                         |       |                                     |       |                                                                 |       |
| Exercised                                                                    |       | (6,875                                                                         | )          | $                                              | 2.33       |                                     |       |                                                                 |       |   |
| Cancelled or forfeited                                                       |       | (3,125                                                                         | )          | $                                              | 2.33       |                                     |       |                                                                 |       |   |
| Expired                                                                      |       | —                                                                         |       | —                                         |       |                                     |       |                                                                 |       |
|                                                                         |       |                                                                           |       |                                           |       |                                     |       |                                                                 |       |
| Stock Options and Incentive Warrants outstanding  at September 30, 2010 |       | 5,472,820                                                                      |       | $                                              | 1.83       |                                     | $          | 22,867,322                                                           |       | 5.2 |   |
|                                                                         |       |                                                                           |       |                                           |       |                                     |       |                                                                 |       |
| Vested or expected to vest at September 30,  2010                       |       | 5,472,820                                                                      |       | $                                              | 1.83       |                                     | $          | 22,867,322                                                           |       | 5.2 |   |
|                                                                         |       |                                                                           |       |                                           |       |                                     |       |                                                                 |       |
| Exercisable at September 30, 2010                                       |       | 5,018,820                                                                      |       | $                                              | 1.73       |                                     | $          | 21,463,558                                                           |       | 5.1 |   |

 

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the period ($6.01 as of September 30, 2010) and the StockOption or Incentive Warrant exercise price of in-the-money Stock Options andIncentive Warrants.

 

There were 6,875 StockOptions exercised during the three months ended September 30, 2010 with anaggregate intrinsic value of $17,531. There were no Stock Options or Incentive Warrants that were exercisedduring the three months ended September 30, 2009.

 

Asummary of the status of our unvested Stock Options and Incentive Warrants asof September 30, 2010 and the changes during the three months ended September 30,2010, is presented below:

 
| ** **                          | ** ** | **Number of  Stock Options********and Incentive  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                |       |                                                                       |       |                                                         |       |
| Unvested at July 1, 2010       |       | 552,582                                                                    |       | $                                                            | 2.04       |   |
|                                |       |                                                                       |       |                                                         |       |
| Granted                             |       | —                                                                     |       | —                                                       |       |
|                                |       |                                                                       |       |                                                         |       |
| Vested                              |       | (95,457                                                                    | )          | $                                                            | 1.96       |   |
|                                |       |                                                                       |       |                                                         |       |
| Forfeited                           |       | (3,125                                                                     | )          | $                                                            | 1.83       |   |
|                                |       |                                                                       |       |                                                         |       |
| Unvested at September 30, 2010 |       | 454,000                                                                    |       | $                                                            | 2.06       |   |

 

Duringthe three months ended September 30, 2010 and 2009, there were 95,457 and144,833 Stock Options and Incentive Warrants that vested with a total grantdate fair value of $187,096 and $260,699, respectively.

 

Thetotal unrecognized compensation cost at September 30, 2010, relating tonon-vested Stock Options and Incentive Warrants was $872,232.  Such unrecognized expense is expected to berecognized over a weighted average period of 1.3 years.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

***Restricted Stock***

 

Stock-basedcompensation expense related to Restricted Stock grants for the three monthsended September 30, 2010 and 2009 was $157,643 and $126,384, respectively.

 

Thefollowing table sets forth the Restricted Stock transactions for the year endedSeptember 30, 2010:

 
| ** **                          | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                                |       |                                   |       |                                               |       |
| Unvested at July 1, 2010       |       | 403,159                                |       | $                                                  | 3.15       |   |
|                                |       |                                   |       |                                               |       |
| Granted                             |       | 270,711                                |       | $                                                  | 5.45       |   |
|                                |       |                                   |       |                                               |       |
| Vested                              |       | (29,234                                | )          | $                                                  | 3.11       |   |
|                                |       |                                   |       |                                               |       |
| Forfeited                           |       | (4,215                                 | )          | $                                                  | 3.11       |   |
|                                |       |                                   |       |                                               |       |
| Unvested at September 30, 2010 |       | 640,421                                |       | $                                                  | 4.12       |   |

 

AtSeptember 30, 2010, unrecognized stock compensation expense related toRestricted Stock grants totaled $2,453,813. Such unrecognized expense will be recognized over a weighted averageperiod of 3.5 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.

 

Therewere no unrecognized tax benefits nor any accrued interest or penaltiesassociated with unrecognized tax benefits during the three months ended September 30,2010.  We believe that we haveappropriate support for the income tax positions taken and to be taken on the Company’stax returns and that the accruals for tax liabilities are adequate for all openyears based on our assessment of many factors including past experience andinterpretations of tax law applied to the facts of each matter. The Company’sfederal and state income tax returns are open to audit under the statute oflimitations for the years ending June 30, 2008 through June 30, 2010.

 

Weexpect to recover approximately $0.7 million in federal income taxes paidduring the tax year ended June 30, 2007, as a result of the carry-back ofour 2010 income tax loss.  Significantintangible drilling costs were incurred during the 2010 fiscal year, of which,we elected to expense approximately $1.3 million for federal income taxpurposes.  Under GAAP intangible drillingcosts are capitalized as part of oil and natural gas properties, and depletedusing the unit-of-production method.  Thededuction of intangible drilling costs created a significant difference in theincome tax and book basis of our oil and natural gas properties, the mostsignificant component of our net deferred income tax liability as of September 30,2010 and June 30, 2010.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 8 —****Netloss Per Share**

 

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

 
| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| *Numerator*                                                        |       |                                                 |       |   |   |
| Net loss                                                           |       | $                                                    | (485,334   | ) | $ | (704,825 | ) |
|                                                               |       |                                                 |       |   |   |
| *Denominator*                                                      |       |                                                 |       |   |   |
| Weighted average number of common shares – basic  and diluted |       | 27,160,723                                           |       | 26,646,022 |   |
|                                                               |       |                                                 |       |   |   |
| Net loss per common share – basic and diluted                 |       | $                                                    | (0.02      | ) | $ | (0.03 | ) |

 

Outstandingpotentially dilutive securities as of September 30, 2010 are as follows:

 
| **Outstanding Potential Dilutive Securities**                       | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  September 30,  2010** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                               |       |                                       |       |                                              |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                          | 1.87       |                                              | 159,308    |   |
| Stock Options and Incentive Warrants                                               |       | $                                          | 1.83       |                                              | 5,472,820  |   |
| Total                                                                              |       | $                                          | 1.83       |                                              | 5,632,128  |   |

 

Outstandingpotentially dilutive securities as of September 30, 2009 are as follows:

 
| **Outstanding Potential Dilutive Securities**                       | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  September 30,  2009** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                               |       |                                       |       |                                              |       |
| Common stock warrants issued in connection with  equity and financing transactions |       | $                                          | 1.46       |                                              | 348,058    |   |
| Stock Options and Incentive Warrants                                               |       | $                                          | 1.83       |                                              | 5,485,820  |   |
| Total                                                                              |       | $                                          | 1.81       |                                              | 5,833,878  |   |

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note9 — Commitments and Contingencies**

 

Weare subject to various claims and contingencies in the normal course ofbusiness.  In addition, from time totime, we receive communications from government or regulatory agenciesconcerning investigations or allegations of noncompliance with laws orregulations in jurisdiction in which we operate.  We disclose such matters if we believe it isreasonably possible that a future event or events will confirm a loss through impairmentof an asset or the incurrence of a liability. We establish reserves if webelieve it is probable that a future event or events will confirm a loss and wecan reasonably estimate such loss. Furthermore, we will disclose any matter that is unasserted if weconsider it probable that a claim will be asserted and there is a reasonablepossibility that the outcome will be unfavorable.

 

***Lease Commitments.***  We have a non-cancelable operating lease foroffice space that expires on August 1, 2016. Future minimum leasecommitments as of September 30, 2010 under this operating lease are asfollows:

 
| **For the twelve months ended September 30,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|
| 2012                                                                        |       | $          | 141,576    |   |
| 2013                                                                        |       | 159,011    |       |
| 2014                                                                        |       | 159,011    |       |
| 2015                                                                        |       | 159,011    |       |
| 2016                                                                        |       | 159,011    |       |
| Thereafter                                                                  |       | 132,509    |       |
| Total                                                                       |       | $          | 910,129    |   |

 

Rentexpense for the three months ended September 30, 2010 and 2009 was $36,323and $39,730, 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 September 30, 2010 isapproximately $524,000.

 

**Note 10****—****Subsequent Events**

 

On October 1, 2010, atotal of 4,845 shares of restricted stock were issued to a new employee aslong-term incentive compensation.  Thevalue of the shares issued was $29,118, based on the fair market value on thedate of issuance.  The shares are subjectto a four year vesting term.

 

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

 

*This Form 10-Qand the information referenced herein contain forward-looking statements withinthe meaning 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.* *Whenconsidering any forward-looking statement, you should keep in mind the riskfactors that could cause our actual results to differ materially from thosecontained in any forward-looking statement. Important factors that could causeactual results to differ materially from those in the forward-lookingstatements herein include the timing and extent of changes in commodity pricesfor oil and natural gas, operating risks and other risk factors as described inour 2010 Annual Report on Form 10-K for the year ended June 30, 2010as filed with the Securities and Exchange Commission. Furthermore, theassumptions that support our forward-looking statements are based uponinformation that is currently available and is subject to change. Wespecifically disclaim all responsibility to publicly update any informationcontained in a forward-looking statement or any forward-looking statement inits entirety and therefore disclaim any resulting liability for potentiallyrelated damages. All forward-looking statements attributable to EvolutionPetroleum Corporation are expressly qualified in their entirety by thiscautionary statement.*

 

*We usethe terms, “EPM,” “Company,” “we,” “us” and “our” to refer to Evolution PetroleumCorporation.*

 

**Executive Overview**

 

*General*

 

We are a petroleum companyengaged primarily in the acquisition, exploitation and development ofproperties for the production of crude oil and natural gas, onshore in theUnited States. We acquire known, underdeveloped oil and natural gas resourcesand exploit them through the application of capital, sound engineering andmodern technology to increase production, ultimate recoveries, or both.

 

Weare focused on increasing underlying asset values on a per share basis.  In doing so, we depend on a conservativecapital structure, allowing us to maintain control of our assets for thebenefit of our shareholders, including approximately 20% beneficially owned byall of our employees.

 

Our strategy is intended togenerate scalable, low unit cost, development and re-development opportunitiesthat minimize or eliminate exploration risks. These opportunities involve the application of modern technology, ourown proprietary technology and our specific expertise in overlooked areas ofthe United States.

 

Theassets we exploit currently fit into three types of project opportunities:

 

·                  Enhanced Oil Recovery (EOR),

 

·                  Bypassed Primary Resources, and

 

·                  Unconventional Shale Gas Development.

 

We expect to fund our fiscal2011 development plan from working capital and net cash flows from ourproperties in the Giddings and Delhi Fields, although we also may utilizeappropriate financing or noncore asset sales to fund additional developmentabove our 2011 development plan.

 

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*Highlights for our First Quarter2011 and Project Update*

 

***Projects***

 

·                  **Roll out of the CO****2**** EOR project at Delhi has continued.** Denbury, the operator, has continued the fieldinstallation of phases II and III of the CO2 EOR project, production from which is notexpected until sometime in calendar 2011. Production from phase I during thequarter was temporarily constrained by a flow line problem.  This caused oil production to be restrictedfor certain wells while the problem was diagnosed, other flow lines inspected,and replacements lines ordered.  We view this as a short term delay insubstantially ramping up phase I oil production from our royalty interestsduring the coming year. In the meantime, CO2 injection has continued at plannedrates.

 

·                  **Developmentdrilling at Giddings resumed during the quarter.  We drilled and completed one well and begandrilling on a second well under our recently completed Joint DevelopmentAgreement.**  Immediatelyfollowing the close of our recently completed fiscal year, we entered into ajoint development agreement (“JDA”) with an industry partner to develop up tofive of our eighteen proved and two probable drilling locations at Giddings.The JDA provides that we operate the drilling of two commitment wells on ourproved locations in the Giddings Field, with the potential to add up to threeoption wells as elected by our partner. Under the terms of the JDA, we receive a 10% carried working interest inrecognition of our costs to date, retain a 10% cost bearing working interestfor our cash participation, and retain a 22.5% back-in working interest on eachwell drilled on our partner’s 80% working interest following a simple two wellbasket payout and well-by-well simple pay-out on the subsequent wells (bringingour after-payout working interest to 38%). The leases carry approximately 80% net revenue interest to the 100%working interest.

 

Thefirst location, the Supak-Brinkman-1H in Burleson County, was a re-entryoperation to add a single Austin Chalk lateral to an existing wellbore.  We began operations in late August, 2010 andreached total depth at the end of September. Completion operations are underway by first producing back a portion ofthe water lost to the formation during drilling. At June 30, 2010, ouroutside engineers had assigned to the 100% working interest approximately164,000 net BOE of proved reserves.

 

Followingrig-down of the Supak-Brinkman, we mobilized and rigged up on the second JDAlocation, the Dodd in northern Grimes County, to complete two 4,000’ opposinglaterals into the Georgetown formation. The gross AFE for this new grass rootswell is $2.9 million plus pipeline connection costs, of which we will bear 10%of the costs. At June 30, 2010, our outside engineers assigned 244,000 netBOE of reserves to the 100% working interest, split evenly between proved andprobable reserve categories.

 

Ourshare of expected net capital expenditures for the JDA program is $1.2 million,assuming all five wells are drilled.  Weare also exploring opportunities to enter into a second joint venture todevelop additional drilling locations, which would require an increase in ourcapital subject to the terms of such joint venture.

 

·                  **Increasedour Woodford Shale test activity.**  We initiated activities of the first of up totwo more test wells at our shallow 1,500’ depth Woodford acreage block inWagoner County, OK during fiscal 2011 to add to our knowledge base.  Separately, in our mid-depth Haskell County,OK, Woodford Shale leasehold, we initiated activities to re-enter two verticalwells to begin testing completions in the Woodford between 4,000’ and 6,000’depth.  We intend to use the informationgained to attract candidates for joint venture development.

 

·                  **Pursuingcommercial joint ventures utilizing our proprietary artificial lift technology.**  Based on tests results at Giddings, webelieve our technology could re-establish production in many wells throughoutGiddings and other fields developed with horizontal wells where liquids areassociated with their production.  We arecurrently negotiating with a major producer at Giddings, and have entered intodiscussions with a second producer, to provide our lift technology with theintent of gaining an interest in the newly re-established production.  We also plan on approaching other producersduring fiscal 2011 for potential applications both within and outside ofGiddings.

 

·                  **Continuedtesting of our Neptune Oil Project in South Texas**.  Following receipt of a state permit for ourwater injection well, we plan to continue testing the Garcia #1 producer in theMirando Sand and re-enter up to two additional producer wells to complete ourtest program.

 

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**·****      Exercised lease options and renew otherleases.**We continue to exercise lease options and renewother leases to maintain high value drilling locations at Giddings and corepositions in our leasehold in Oklahoma, as well as provide funds for forcedpooling associated with producing Woodford wells in Oklahoma.

 

***Operations***

 

·                  **Salesvolumes decreased 27% in the first quarter of fiscal 2011 versus our firstquarter of fiscal 2010. **Our decrease insales volumes for the year was solely attributable to our normal productiondecline in the Giddings Field.  Salesvolumes for our properties in the Giddings field decreased 40% as compared tothe three months ended September 30, 2009. The decrease was partially offset by oil production from our interestsin Delhi of 4,558 bbls during the three months ended September 30, 2010compared to 27 bbls during the three months ended September 30, 2009.

 

·                  **Ourdepletion rate decreased 74% to less than $5 per BOE compared to our 1****st**** quarter of fiscal 2010.**  Our depletion rate for the three months endedSeptember 30, 2010 was $4.50 per BOE, compared to $17.17 for the threemonths ended September 30, 2009.  Thedecrease in our depletion rate was due to the addition of 9.4 million barrelsof proved oil reserves at Delhi, while associated legacy capital costs of only$1.2 million ($0.13 of costs per incremental barrel) were transferred to ourfull cost pool.

 

·                  **Theproduct prices we received increased 37% during our first quarter of fiscal2011 versus our first quarter of fiscal 2010. **During the three months ended September 30, 2010, the averageprice we received was $45.63 per BOE, as compared to $33.43 per BOE during thethree months ended September 30, 2009. Received oil price increased from $66.46 to $74.36 per barrel, gas pricefrom $3.43 to $4.38 per mcf, and natural gas liquid price from $32.16 to $41.41per barrel.

 

***Finances***

 

·                  **Weended our first quarter with $4.3 million of working capital, compared to $4.9million at June 30, 2010. **At September 30,2010, working capital included $3.7 million of cash, cash equivalents andshort-term certificates of deposit and $0.7 million of recoverable income taxesarising from current year tax losses carried back to a prior tax year.*** *** The $0.6 million reduction in our workingcapital since June 30, 2010 was due primarily to investments of $0.9million in oil and natural gas properties, offset by an asset sale of $0.2million and positive cash flow generated from our oil and gas properties.  The asset sale included one lower valuedproved undeveloped location as of June 30, 2010.

 

·                  **Cashflows from operations covered our general and administrative expenses andfunded a portion of our capital expenditures. **Cash flows from operations were $158 thousand during the three monthsended September 30, 2010.

 

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

 

**Liquidityand Capital Resources**

 

AtSeptember 30, 2010, our working capital was $4.3 million and we continuedto be debt free.  This compares toworking capital of $4.9 million at June 30, 2010.  The $0.6 million decrease in working capitalsince June 30, 2010, was due primarily to investments of $0.9 million inoil and natural gas properties, offset by an asset sale of $0.2 million and cashflows from operations.  Of the $0.9million of capital expenditures incurred during the three months ended September 30,2010, $462 thousand was for leasehold acquisitions and $455 thousand was fordevelopment activities.  Developmentactivities were in the Giddings Field in Texas, our Neptune Oil Project in theLopez Field in South Texas, and our gas shale project in Eastern Oklahoma.

 

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***Cash Flows from Operating Activities***

 

Cashflows provided by operating activities for the three months endedSeptember 30, 2010 were $0.2 million. Cash flows provided by operations include cash receipts of $1.3 millionfrom oil and natural gas sales from our properties in the Giddings Field andour interests in the Delhi Field, less cash payments for operating expenses of$1.1 million, including lease operating expenses, production taxes, salariesand wages.

 

Cashflows provided by operating activities for the three months endedSeptember 30, 2009 were $0.3 million. Cash flows provided by operations include cash receipts of $1.2 millionfrom oil and natural gas sales primarily from our properties in the GiddingsField.  Sources of cash were offset by$0.9 million of cash payments for operating activities, including leaseoperating expenses, production taxes, salaries and other general administrativeexpenses.

 

***Cash Flows from Investing Activities***

 

Cashpaid for oil and gas capital expenditures during the three months ended September 30,2010 and 2009, was $0.9 million and $1.1 million, respectively, which includesnet payments on accounts payable of nil and $0.1 million, respectively,relating to prior period expenditures for oil and natural gas properties.

 

Duringthe three months ended September 30, 2010, $1.0 million of certificates ofdeposit matured.  During the three monthsended September 30, 2009, $0.1 million of short-term certificates ofdeposit were purchased.

 

***Cash Flows from Financing Activities***

 

During the three monthsended September 30, 2010, we received $16 thousand due to the exercise of6,875 stock options with an exercise price of $2.33 per share.  There were no cash flows from financingactivities during the three months ended September 30, 2009.

 

***Capital Budget***

 

Ourapproved fiscal 2011 Plan provides for capital expenditures of approximately$4.0 million.  We expect to fund ourfiscal 2011 Plan with internally generated funds, our working capital andpursuant to the JDA we signed in July 2010.  Increases in our activity level over theplanned operations will be funded from joint ventures, project financing,selective divestments of noncore assets or potentially from minor equityofferings at attractive stock valuations when capital market conditionsimprove.

 

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** **

**Resultsof Operations**

 

*Three months endedSeptember 30, 2010 and 2009*

 

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

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **September 30**            | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2010**                         | ** ** | **2009**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Sales Volumes, net to the  Company:**                  | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
|                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (Bbl)                                          |       | 8,717                            |       | 7,570      |       | 1,147        |       | 15 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 5,069                            |       | 8,871      |       | (3,802       | )          | (43 | )% |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural gas (Mcf)                                        |       | 71,010                           |       | 111,380    |       | (40,370      | )          | (36 | )% |
| Crude oil, NGLs and natural gas (BOE)                    |       | 25,621                           |       | 35,004     |       | (9,383       | )          | (27 | )% |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Revenue data:**                                        |       |                             |       |       |       |         |       |   |   |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Crude oil                                                |       | $                                | 648,218    |       | $          | 503,122      |       | $ | 145,096 |   | 29 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| NGLs                                                     |       | 209,918                          |       | 285,311    |       | (75,393      | )          | (26 | )% |
|                                                     |       |                             |       |       |       |         |       |   |   |
| Natural gas                                              |       | 310,960                          |       | 381,594    |       | (70,634      | )          | (19 | )% |
| Total revenues                                           |       | $                                | 1,169,096  |       | $          | 1,170,027    |       | $ | (931 | ) | (0 | )% |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Average price:**                                       | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Crude oil (per Bbl)                                      |       | $                                | 74.36      |       | $          | 66.46        |       | $ | 7.90 |   | 12 | % |
| NGLs (per Bbl)                                           |       | 41.41                            |       | 32.16      |       | 9.25         |       | 29 | % |
| Natural gas (per Mcf)                                    |       | 4.38                             |       | 3.43       |       | 0.95         |       | 28 | % |
| Crude oil, NGLs and natural gas (per BOE)                |       | $                                | 45.63      |       | $          | 33.43        |       | $ | 12.20 |   | 37 | % |
|                                                     |       |                             |       |       |       |         |       |   |   |
| **Expenses (per BOE)**                                   | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** |
| Lease operating expenses and production taxes            |       | $                                | 14.41      |       | $          | 10.95        |       | $ | 3.46 |   | 32 | % |
| Depletion expense on oil and natural gas  properties (a) |       | $                                | 4.50       |       | $          | 17.17        |       | $ | (12.67 | ) | (74 | )% |

 

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(a)          Excludesdepreciation of office equipment, furniture and fixtures, and other of $8,827and $16,627, for the three months ended September 30, 2010 and 2009,respectively.

 

Netloss.  For the three months endedSeptember 30, 2010, we reported a net loss of $485,334, or $0.02 loss pershare (which includes $354,486 of non-cash stock-based compensation expense) ontotal oil and natural gas revenues of $1,169,096.  This compares to a net loss of $704,825, or$0.03 per share (which includes $391,636 of non-cash stock-based compensationexpense) on total oil and natural gas revenues of $1,170,027 for the threemonths ended September 30, 2009.  Thedecrease in net loss was primarily due to a decrease in total operatingexpenses of $451,240, offset by a reduction of our income tax benefit from$154,987 for the three months ended September 30, 2010 compared to abenefit of $378,348 for the three months ended September 30, 2009.  Additional details of the components of netloss are explained in greater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the three months ended decreased 27% from35,004 BOE for the three months ended September 30, 2009 to 25,621 for thethree months ended September 30, 2010. Our crude oil sales volumes for the three months ended September 30,2010 included 4,558 bbls from our interests in Delhi and 4,159 bbls from ourproperties in the Giddings Field.  Ourcrude oil sales volumes for the three months ended September 30, 2009included 27 bbls from our interests in Delhi and 7,543 bbls from our propertiesin the Giddings Field.  Our NGL andnatural gas volumes for the three months ended September 30, 2010 and 2009were from our properties in the Giddings Field.

 

Overall sales volumes fromour properties in the Giddings Field has decreased 40% from the three monthsended September 30, 2009 due to normal decline.

 

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PetroleumRevenues.  Crude oil,NGLs and natural gas revenues for the three months ended September 30,2010 remained flat compared to the three months ended September 30,2008.  This was due to a 37% increase inthe average price received per BOE, from $33 per BOE for the three months endedSeptember 30, 2009 to $46 per BOE for the three months ended September 30,2010, offset by a 27% decline in volumes.

 

LeaseOperating Expenses (including production severance taxes).  Lease operating expenses and production taxesfor the three months ended September 30, 2010 decreased 4% compared to thethree months ended September 30, 2009. A significant reduction in saltwater disposal costs, due to our Pearsonsalt water disposal well, was partially offset by increased workovercosts.  Lease operating expense andproduction taxes per barrel of oil equivalent increased 32% from $11 per BOEduring the three months ended September 30, 2009, to $14 per BOE duringthe three months ended September 30, 2010.

 

General and AdministrativeExpenses (“G&A”). G&A expenses increased 4% to $1.31 million for the three monthsended September 30, 2010, compared to $1.25 million for the three monthsended September 30, 2009.  Theincrease was due to greater personnel costs associated with an increase inestimated 2011 bonuses and a one time recruiting charge for the hiring of areplacement field engineer, offset by a decrease in legal fees and stock basedcompensation.  Stock-based compensationwas $354,486 (27% of total G&A) for the three months ended September 30,2010, compared with and $391,636 (31% of total G&A) for the three monthsended September 30, 2009.  Non-cashstock-based compensation is an integral part of total staff compensationutilized to recruit quality staff from other, more established companies and,as a result, will likely continue to be a significant component of our G&Acosts.

 

Depreciation,Depletion & Amortization Expense (“DD&A”).  DD&A decreased by 80% to $124,018 for thethree months ended September 30, 2010, compared to $617,757 for the threemonths ended September 30, 2009. The decrease is due to a lower depletion rate ($4.50 vs. $17.17) perBOE, as a result of the addition of 9.4 million proved oil reserves at Delhiwith associated legacy costs of only $1.2 million transferred to our full costpool.

 

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. Prices for drilling and oilfield services, oilfield equipment, tubulars,labor, expertise and other services greatly impact our lease operating expensesand our capital expenditures.  Duringfiscal 2009 and into fiscal 2010, we saw a substantial decline in both petroleumproduct prices and drilling and oilfield services costs from prior years,followed more recently by moderate increases in oil price, materials andservices, offset by a substantial decrease in natural gas price.  Product prices, operating costs and developmentcosts may not always move in tandem.

 

KnownTrends and Uncertainties. While general worldwide economic conditions have improved, they continueto be uncertain and volatile.  Concerns over uncertain futureeconomic growth are affecting numerous industries, companies, as well asconsumers, which impact demand for crude oil and natural gas.  Ifdemand decreases in the future, it may put downward pressure on crude oil andnatural gas prices, thereby lowering our revenues and working capital going forward.

 

Seasonality.  Our business is generally not directlyseasonal, except for 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, driven by summer cooling and driving, winterheating, and extremes in seasonal weather including hurricanes that maysubstantially affect oil and natural gas production and imports.

 

**OffBalance Sheet Arrangements**

 

TheCompany has no off-balance sheet arrangements to report during the firstquarter ending September 30, 2010.

 

**ITEM 3.**** QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISKS**

 

Informationabout market risks for the three months ended September 30, 2010, did notchange materially from the disclosures in Item 7A. of our Annual Report on Form 10-Kfor the year ended June 30, 2010 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, 2010.

 

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*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 flowavailable for capital expenditures and our ability to borrow and raiseadditional capital, as, if and when needed. Lower prices may also reduce theamount of oil and natural gas that we can economically produce.  Although our current production base may notbe sufficient 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 gas pricesat targeted levels and to manage our exposure to price fluctuations. We may usefutures contracts, swaps and fixed price physical contracts to hedge ourcommodity 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 Securitiesand Exchange Commission Rule 13a-15(b), we carried out an evaluation,under the supervision and with the participation of the Company’s management,including our Chief Executive Officer, Chief Financial and Chief AccountingOfficers, 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, Chief Financial and Chief Accounting Officers concluded that as of September 30,2010 our disclosure controls and procedures are effective in ensuring that theinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission rules andforms.

 

During the quarter ended September 30,2010 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.

 

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**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, 2010.

 

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

 

None.

 

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

 

Notapplicable.

 

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

 

None.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

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**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)

 

 
|   |   | By:    | /s/  STERLING H. MCDONALD                   |
|--------|--------|--------|---------------------------------------------|
|   |   |   | Sterling  H. McDonald                       |
|   |   |   | Vice-President  and Chief Financial Officer |
|   |   |   | Principal Financial Officer                 |
|   |   |   |                                        |
|   |   |   |                                        |
|   |   | By:    | /s/  GREG S. GOODALE                        |
|   |   |   | Greg  S. Goodale                            |
|   |   |   | Chief  Accounting Officer                   |
|   |   |   | Principal Accounting Officer                |

 

Date:November 15, 2010

 

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