Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **
| **x**      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
|------------|-----------------------------------------------------------------------------------|
| ** ** | **EXCHANGE  ACT OF 1934**                                                         |

** **

**For the quarterly period ended March 31, 2009**

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

** **

**For the transition period from        to      **

** **

**Commission File Number 001-32942**

** **

**EVOLUTIONPETROLEUM CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

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

(Address of principal executive offices and zip code)

** **

**(713) 935-0122**

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 and Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes:  o  No: o

 

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

 

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

 

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

 

Thenumber of shares outstanding of the registrant’s common stock, par value$0.001, as of May 14, 2009, was 26,259,147.

 

 

 

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**TABLE OF CONTENTS**

 
| **PART I.  FINANCIAL INFORMATION** |   | 3                                                                                                                    |
|-----------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------|
|                                    |   |                                                                                                                 |   |   |
| ITEM 1.                                 |   | CONSOLIDATED CONDENSED  FINANCIAL STATEMENTS                                                                         |   | 3 |
|                                    |   |                                                                                                                 |   |   |
|                                    |   | Consolidated  Balance Sheets (unaudited) as of March 31, 2009 and June 30, 2008                            |   | 3 |
|                                    |   | Consolidated Statements of Operations (unaudited) for  the three and nine months ended  March 31, 2009 and 2008 |   | 4 |
|                                    |   | Consolidated Statements of Cash Flows (unaudited) for  the nine months ended  March 31, 2009 and 2008           |   | 5 |
|                                    |   | Notes to Consolidated Condensed Financial Statements  (unaudited)                                                    |   | 6 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 2.                                 |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                          |   | 16 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 3.                                 |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                          |   | 25 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 4.                                 |   | CONTROLS AND  PROCEDURES                                                                                             |                 | 26 |
|                                    |   |                                                                                                                 |   |   |
| **PART II.  OTHER INFORMATION**    |   | 26                                                                                                                   |
|                                    |   |                                                                                                                 |   |   |
| ITEM 1.                                 |   | LEGAL PROCEEDINGS                                                                                                    |   | 26 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 1A.                                |   | RISK FACTORS                                                                                                         |   | 27 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 2.                                 |   | UNREGISTERED  SALE OF EQUITY SECURITIES AND USE OF PROCEEDS                                                          |   | 27 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 3.                                 |   | DEFAULTS  UPON SENIOR SECURITIES                                                                                     |   | 27 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 4.                                 |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                 |   | 27 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 5.                                 |   | OTHER INFORMATION                                                                                                    |   | 27 |
|                                    |   |                                                                                                                 |   |   |
| ITEM 6.                                 |   | EXHIBITS                                                                                                             |   | 28 |
|                                    |   |                                                                                                                 |   |   |
| SIGNATURES                              |   | 29                                                                                                                   |

 

2

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Table of Contents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

 

**Evolution Petroleum Corporation and Subsidiaries**

**Consolidated Balance Sheets**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                        | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                        | ** ** | **2009**           | ** ** | **2008**          | ** ** |
| **Assets**                                                                                                                                                                                        | ** ** | ** **         | ** ** | ** **        | ** ** |
| Current assets                                                                                                                                                                                    |       |               |       |              |       |
| Cash and cash  equivalents                                                                                                                                                                        |       | $                  | 4,900,219  |              | $          | 11,272,280 |   |
| Certificates of  deposit                                                                                                                                                                          |       | 1,740,944          |       | —            |       |
| Receivables                                                                                                                                                                                       |       |               |       |              |       |
| Oil and natural  gas sales                                                                                                                                                                        |       | 487,953            |       | 2,066,300         |       |
| Income taxes                                                                                                                                                                                      |       | 6,689              |       | 478,599           |       |
| Other                                                                                                                                                                                             |       | 164,243            |       | 86,966            |       |
| Income taxes  recoverable                                                                                                                                                                         |       | 1,545,922          |       | 3,625,987         |       |
| Prepaid expenses  and other current assets                                                                                                                                                        |       | 123,231            |       | 270,938           |       |
| Total current  assets                                                                                                                                                                             |       | 8,969,201          |       | 17,801,070        |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Property and  equipment, net of depreciation, depletion, and amortization                                                                                                                         |       |               |       |              |       |
| Oil and natural  gas properties — full cost method of accounting, of which $9,845,303 at  March 31, 2009 and $8,754,429 at June 30, 2008 were excluded from  amortization          |       | 28,495,507         |       | 22,047,233        |       |
| Other property  and equipment                                                                                                                                                                     |       | 159,681            |       | 161,027           |       |
| Total property  and equipment                                                                                                                                                                     |       | 28,655,188         |       | 22,208,260        |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Other assets,  net                                                                                                                                                                                |       | 356,399            |       | 356,518           |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Total assets                                                                                                                                                                                      |       | $                  | 37,980,788 |              | $          | 40,365,848 |   |
|                                                                                                                                                                                              |       |               |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                     |       |               |       |              |       |
| Current  liabilities                                                                                                                                                                              |       |               |       |              |       |
| Accounts payable                                                                                                                                                                                  |       | $                  | 629,132    |              | $          | 2,892,459 |   |
| Accrued payroll                                                                                                                                                                                   |       | 561,283            |       | 772,559           |       |
| Royalties  payable                                                                                                                                                                                |       | 208,223            |       | 473,327           |       |
| Other current  liabilities                                                                                                                                                                        |       | 67,106             |       | 32,703            |       |
| Total current  liabilities                                                                                                                                                                        |       | 1,465,744          |       | 4,171,048         |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Long term  liabilities                                                                                                                                                                            |       |               |       |              |       |
| Deferred income  taxes                                                                                                                                                                            |       | 3,791,348          |       | 2,901,929         |       |
| Asset retirement  obligations                                                                                                                                                                     |       | 602,894            |       | 215,056           |       |
| Deferred rent                                                                                                                                                                                     |       | 76,914             |       | 74,081            |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Total  liabilities                                                                                                                                                                                |       | 5,936,900          |       | 7,362,114         |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Commitments and  contingencies (Note 12)                                                                                                                                                          |       |               |       |              |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Stockholders’  equity                                                                                                                                                                        |       |               |       |              |       |
| Common stock;  par value $0.001; 100,000,000 shares authorized; issued 27,047,347 shares;  outstanding 26,259,147 and 26,870,439 as of March 31, 2009 and  June 30, 2008, respectively. |       | 27,047             |       | 26,870            |       |
| Additional  paid-in capital                                                                                                                                                                       |       | 16,002,791         |       | 14,188,841        |       |
| Retained  earnings                                                                                                                                                                                |       | 16,896,072         |       | 18,788,023        |       |
|                                                                                                                                                                                              |       | 32,925,910         |       | 33,003,734        |       |
| Treasury stock,  at cost, 788,200 shares as of March 31, 2009.                                                                                                                               |       | (882,022           | )          | —            |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Total  stockholders’ equity                                                                                                                                                                  |       | 32,043,888         |       | 33,003,734        |       |
|                                                                                                                                                                                              |       |               |       |              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                  |       | $                  | 37,980,788 |              | $          | 40,365,848 |   |

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

** Consolidated Statements of Operations**

**(unaudited)**

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **March 31,**     | ** ** | **March 31,**    | ** ** |
| ** **                                 | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues                                   |       |                   |       |                  |       |   |   |   |   |
| Crude oil                                  |       | $                      | 351,684    |                  | $          | 554,498 |   | $ | 2,337,948 |   | $ | 1,664,648 |   |
| Natural gas  liquids                       |       | 350,891                |       | 90,405                |       | 1,341,629 |   | 111,699 |   |
| Natural gas                                |       | 461,889                |       | 99,799                |       | 1,431,655 |   | 123,277 |   |
| Total revenues                             |       | 1,164,464              |       | 744,702               |       | 5,111,232 |   | 1,899,624 |   |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Operating Costs                            |       |                   |       |                  |       |   |   |   |   |
| Lease operating  expense                   |       | 255,710                |       | 300,186               |       | 905,020 |   | 971,688 |   |
| Production taxes                           |       | 29,750                 |       | 12,867                |       | 137,522 |   | 46,231 |   |
| Depreciation,  depletion and amortization  |       | 759,836                |       | 139,086               |       | 1,909,009 |   | 372,645 |   |
| Accretion of  asset retirement obligations |       | 12,591                 |       | 7,110                 |       | 24,452 |   | 16,656 |   |
| General and  administrative *              |       | 1,595,402              |       | 1,266,427             |       | 4,722,869 |   | 4,062,423 |   |
| Total operating  costs                     |       | 2,653,289              |       | 1,725,676             |       | 7,698,872 |   | 5,469,643 |   |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Loss from  operations                      |       | (1,488,825             | )          | (980,974              | )          | (2,587,640 | ) | (3,570,019 | ) |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Other income                               |       |                   |       |                  |       |   |   |   |   |
| Interest income                            |       | 8,024                  |       | 165,014               |       | 99,452 |   | 772,835 |   |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Net loss before  income tax benefit        |       | (1,480,801             | )          | (815,960              | )          | (2,488,188 | ) | (2,797,184 | ) |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Income tax  benefit                        |       | (444,184               | )          | (279,975              | )          | (596,237 | ) | (848,961 | ) |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Net loss                                   |       | $                      | (1,036,617 | )                     | $          | (535,985 | ) | $ | (1,891,951 | ) | $ | (1,948,223 | ) |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Loss per common  share                     |       |                   |       |                  |       |   |   |   |   |
| Basic and  Diluted                         |       | $                      | (0.04      | )                     | $          | (0.02 | ) | $ | (0.07 | ) | $ | (0.07 | ) |
|                                       |       |                   |       |                  |       |   |   |   |   |
| Weighted average  number of common shares  |       |                   |       |                  |       |   |   |   |   |
| Basic and  Diluted                         |       | 26,219,034             |       | 26,784,473            |       | 26,495,176 |   | 26,779,339 |   |

 

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*Generaland administrative expenses for the three month period ended March 31,2009 and 2008 included non-cash stock-based compensation expense of $537,285and $493,872, respectively.  General andadministrative expenses for the nine month period ended March 31, 2009 and2008 included non cash stock-based compensation expense of $1,645,535 and$1,311,443, respectively.

 

See accompanying notes to consolidated financial statements.

 

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**Evolution Petroleum Corporation and Subsidiaries**

** Consolidated Statements of Cash Flow**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Cash flows from  operating activities                                                      | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                     | (1,891,951 | ) | $ | (1,948,223 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                  |       |   |   |
| Depreciation,  depletion and amortization                                                  |       | 1,909,009                             |       | 372,645 |   |
| Stock-based  compensation                                                                  |       | 1,645,535                             |       | 1,311,443 |   |
| Accretion of  asset retirement obligations                                                 |       | 24,452                                |       | 16,656 |   |
| Settlement of  asset retirement obligations                                                |       | (90,761                               | )          | — |   |
| Deferred income  taxes                                                                     |       | 889,419                               |       | — |   |
| Deferred rent                                                                              |       | 2,833                                 |       | 25,847 |   |
| Changes in  operating assets and liabilities:                                              |       |                                  |       |   |   |
| Receivables from  oil and natural gas sales                                                |       | 1,578,347                             |       | (190,261 | ) |
| Receivables from  income taxes and other                                                   |       | 2,474,698                             |       | (915,825 | ) |
| Prepaid expenses  and other current assets                                                 |       | 147,707                               |       | 286,961 |   |
| Accounts payable  and accrued expenses                                                     |       | (256,805                              | )          | (146,399 | ) |
| Royalties  payable                                                                         |       | (265,104                              | )          | (259 | ) |
| Net cash  provided by (used in) operating activities                                       |       | 6,167,379                             |       | (1,187,415 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from  investing activities                                                      |       |                                  |       |   |   |
| Net proceeds  from the sale of the Tullos Assets                                           |       | —                                |       | 4,420,868 |   |
| Proceeds from  other asset sales                                                           |       | —                                |       | 31,582 |   |
| Development of  oil and natural gas properties                                             |       | (7,411,549                            | )          | (4,109,932 | ) |
| Acquisitions of  oil and natural gas properties                                            |       | (2,477,133                            | )          | (6,946,157 | ) |
| Capital  expenditures for other equipment                                                  |       | (28,041                               | )          | (79,305 | ) |
| Purchases of  certificates of deposit                                                      |       | (1,740,944                            | )          | — |   |
| Other assets                                                                               |       | 119                                   |       | (1,375 | ) |
| Net cash used in  investing activities                                                     |       | (11,657,548                           | )          | (6,684,319 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from  financing activities                                                      |       |                                  |       |   |   |
| Proceeds from  issuance of restricted stock                                                |       | 130                                   |       | 76 |   |
| Purchase of  treasury stock                                                                |       | (882,022                              | )          | — |   |
| Net cash  provided by (used in) financing activities                                       |       | (881,892                              | )          | 76 |   |
|                                                                                       |       |                                  |       |   |   |
| Net decrease in  cash and cash equivalents                                                 |       | (6,372,061                            | )          | (7,871,658 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash and cash  equivalents, beginning of period                                            |       | 11,272,280                            |       | 27,746,942 |   |
|                                                                                       |       |                                  |       |   |   |
| Cash and cash  equivalents, end of period                                                  |       | $                                     | 4,900,219  |   | $ | 19,875,284 |   |
|                                                                                       |       |                                  |       |   |   |

 

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 2008 Annual Report on Form 10-K for theyear ended June 30, 2008, as filed with the SEC. The results of operationsfor interim periods are not necessarily indicative of results to be expectedfor a full fiscal year.

 

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

 

***Use of Estimates. ***The preparationof financial statements in conformity with GAAP requires us to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe dates of the financial statements and the reported amounts of revenues andexpenses during the reporting periods. Significant estimates include reserve quantities and estimated futurecash flows associated with proved reserves, which significantly impactdepletion expense and potential impairments of oil and natural gas properties,income taxes 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 — Recent Accounting Pronouncements**

 

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

 

***Modernization of Oil and Gas Reporting.***  On December 31, 2008 theSEC released new requirements for reporting oil and gas reserves.  The newdisclosure requirements, when effective, provide for consideration of newtechnologies in evaluating reserves, allows companies to disclose theirprobable and possible reserves to investors, requires reporting of oil and gasreserves using an average price based on the prior 12-month period rather thanyear-end prices, revises the disclosure requirements for oil and gasoperations, and revises accounting for the limitation on capitalized costs forfull cost companies.  The new rule is expected to be effective forfiscal years ending on or after December 31, 2009, although the transitionmay be extended.  A company may not applythe new rules to disclosures in quarterly reports prior to the firstannual report in which the revised disclosures are required.  We have not yet evaluated the effects the newrule will have on our financial statements.

 

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

***Accounting for Business Combinations.***  In December 2007,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141R,*Business Combinations* (“SFAS No. 141R”),which replaces SFAS No. 141,*  Business Combinations*.  SFAS No. 141R establishes principles andrequirements for determining how an enterprise recognizes and measures the fairvalue of certain assets and liabilities acquired in a business combination,including non-controlling interests, contingent consideration, and certainacquired contingencies.  SFAS No. 141Ralso requires acquisition-related transaction expenses and restructuring costsbe expensed as incurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R will beapplicable prospectively to business combinations for which the acquisitiondate is on or after the beginning of the first annual reporting periodbeginning on or after December 15, 2008. SFAS No. 141R would have an impact on accounting for any businessesacquired after the effective date of this pronouncement.

 

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

 

***Accounting for Earnings Per Share.***  In June 2008, the FASB issued StaffPosition No. EITF 03-6-1, *DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities*(“FSP No. EITF 03-6-1”).  FSP No. EITF03-6-1 addresses whether instruments granted in share-based paymenttransactions are participating securities prior to vesting and, therefore, needto be included in the earnings allocation in computing earnings per share underthe two-class method described in FASB Statement No. 128, *Earnings Per Share*.  FSP No. EITF03-6-1 is effective for fiscal years, and interim periods within those fiscalyears, beginning after December 15, 2008; early adoption is notpermitted.  The adoption of FSP No. EITF 03-6-1 will be effective forus for interim and annual periods ending after July 1, 2009.  We are currently evaluating what the impact,if any, of FSP No. EITF 03-6-1 will have on our earnings per share.

 

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

 

OnMarch 3, 2008, NGS Sub Corp., a Delaware corporation wholly owned byEPM (“NGS Sub”), pursuant to an Asset Purchase and Sale Agreement (the “AssetSale Agreement”) dated February 15, 2008, completed the sale of its 100%working interest and approximately 79% average net revenue interest inproducing and shut-in crude oil wells, water disposal wells, equipment andimprovements (the “Tullos Assets”) located in the Tullos Urania, Colgrade andCrossroads Fields in LaSalle and Winn Parishes, Louisiana (the “Tullos FieldArea”).  The following table presents thetransaction and its affect on our financial statements.

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

 

7

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

Thefollowing unaudited pro forma consolidated financial information is presentedfor illustrative purposes only and presents the pro forma operating results forthe Company for the three and nine months ended March 31, 2008 as thoughthe disposition of our properties in the Tullos Field Area occurred on July 1,2007.  The unaudited pro formaconsolidated financial information is not intended to be indicative of theoperating results that actually would have occurred if the transaction had beenconsummated at the beginning of the period presented, nor is the informationintended to be indicative of future operating results.

 

Theunaudited pro forma consolidated financial information for the three and ninemonth period ended March 31, 2008 are as follows:

 
| ** **                                      | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **March 31, 2008** | ** ** | **March 31, 2008** | ** ** |
| ** **                                      | ** ** | **As  Reported**        | ** ** | **Pro  Forma**          | ** ** | **As  Reported** | ** ** | **Pro  Forma** | ** ** |
| Oil and natural  gas revenues                   |       | $                       | 744,702    |                    | $          | 351,884 |   | $ | 1,899,624 |   | $ | 422,306 |   |
| Loss from  operations                           |       | (980,974                | )          | (1,058,866              | )          | (3,570,019 | ) | (3,802,261 | ) |
| Net loss                                        |       | (535,985                | )          | (587,150                | )          | (1,948,223 | ) | (2,109,979 | ) |
|                                            |       |                    |       |                    |       |   |   |   |   |
| Loss per common  share — basic and diluted |       | $                       | (0.02      | )                       | $          | (0.02 | ) | $ | (0.07 | ) | $ | (0.08 | ) |

 

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

 

We utilize the full costmethod of accounting for costs related to the development and acquisition ofoil and natural gas reserves.  Under thismethod, all such costs (productive and nonproductive), including salaries,benefits and other internal costs directly attributable to these activities arecapitalized and amortized on an aggregate basis over the estimated lives of theproperties using the units-of-production method. These capitalized costs, lessaccumulated amortization and related deferred income taxes (the “NetCapitalized Costs”), are subject to a “ceiling test” that limits such costs tothe aggregate of the present value of future net revenues attributable toproved oil and natural gas reserves discounted at 10 percent (the “StandardizedMeasure”) plus the cost of properties not being amortized (pursuant to Reg. S-XRule 4-10 (c)(3)(ii)), plus the lower of cost or estimated fair value ofunproven properties included in the costs being amortized, and net of relatedincome taxes (the “Ceiling”).  Any costsin excess of the Ceiling are written off as a non-cash expense.  The expense may not be reversed in futureperiods, even though higher oil and natural gas prices may subsequentlyincrease the Ceiling.  Full costcompanies must use the prices in effect at the end of each fiscal quarter, withconsideration of price changes only to the extent of contractual arrangements,to calculate the Standardized Measure. Favorable price changes subsequent to the balance sheet date and priorto the release of financial statements may be considered to avoid animpairment.  The Ceiling determined withthe Standardized Measure of our proved reserves, calculated based upon March 31,2009 quoted market prices ($3.37 per MMBtu for Houston Ship Channel natural gasand $49.66 per barrel for NYMEX oil, adjusted for market differentials), exceededour Net Capitalized Costs by approximately $180,000, or less than 1% of our netoil and natural gas property costs. However, due to the increases in crude oil and natural gas pricessubsequent to March 31, 2009, our Ceiling has increased over and above ourNet Capitalized Costs, and as such, we did not have an impairment of our oiland natural gas properties as of March 31, 2009.

 

8

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 4 —****Property and Equipment** (Continued)

 

Asof March 31, 2009 and June 30, 2008 our oil and natural gasproperties and other property and equipment consisted of the following:

 
| ** **                                                   | ** ** | **March 31,  2009** | ** ** | **June 30,  2008** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Oil and  natural gas properties**                          |       |                     |       |                    |       |
| Property costs  subject to amortization                      |       | $                        | 21,161,866 |                    | $          | 13,924,844 |   |
| Less:  Accumulated depreciation, depletion, and amortization |       | (2,511,662               | )          | (632,040                | )          |
| Unproved  properties not subject to amortization             |       | 9,845,303                |       | 8,754,429               |       |
| Oil and natural  gas properties, net                         |       | $                        | 28,495,507 |                    | $          | 22,047,233 |   |
|                                                         |       |                     |       |                    |       |
| **Other  property and equipment**                            |       |                     |       |                    |       |
| Furniture,  fixtures and office equipment, at cost           |       | 259,882                  |       | 231,841                 |       |
| Less:  Accumulated depreciation                              |       | (100,201                 | )          | (70,814                 | )          |
| Other property  and equipment, net                           |       | $                        | 159,681    |                    | $          | 161,027 |   |

 

Unproved properties notsubject to amortization includes unevaluated acreage of $7.8 and $6.8 millionas of March 31, 2009 and June 30, 2008, respectively.  As of March 31, 2009, this acreageconsists of properties in the Giddings Field, our projects in the WoodfordShale trend in Oklahoma, and our Neptune project in South Texas.  As of June 30, 2008, the unevaluatedacreage consisted of properties in the Giddings Field and our projects in theWoodford Shale trend in Oklahoma. Unproved properties also include approximately $2.0 million as of March 31,2009 and June 30, 2008 of participating interests through separatelyacquired royalty and overriding royalty interests aggregating 7.4% of the DelhiHolt Bryant Unit in the Delhi Field in Louisiana.  Subject to industry conditions, evaluation ofthese properties is expected to be completed within three years.  Our evaluation of impairment of unprovedproperties occurs, at a minimum, on a quarterly basis.

 

The following table providesa summary of costs that are not being amortized as of March 31, 2009, bythe fiscal year in which the costs were incurred:

 
| ** **                                | ** ** | ** ** | ** **      | **During the**        | ** ** | ** **                              | ** ** |
|-------------------------------------------|------------|------------|-----------------|-----------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | ** ** | ** **      | **Nine Months Ended** | ** ** | **During the Year Ended June 30,** | ** ** |
| ** **                                | ** ** | ** ** | ** **      | **March 31,**         | ** ** | ** **                              | ** ** | ** ** | ** ** | **2006 and** | ** ** |
| **Costs excluded from amortization**      | ** ** | **Total**  | ** **      | **2009**              | ** ** | **2008**                                | ** ** | **2007** | ** ** | **Prior** | ** ** |
|                                      |       |       |            |                  |       |                                    |       |   |   |   |   |
| Leasehold  acquisition costs              |       | $          | 7,890,926       |                  | $          | 1,452,174                               |       | $ | 5,495,568 |   | $ | 943,184 |   | $ | — |   |
| Royalty and  overriding royalty interests |       | 1,954,377  |            | 3,636                 |       | —                                  |       | 966,794 |   | 983,947 |   |
|                                      |       | $          |  9,845,303 |                  | $          | 1,455,810                               |       | $ | 5,495,568 |   | $ | 1,909,978 |   | $ | 983,947 |   |

 

**Note 5****—****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 nine months ended March 31, 2009:

 
| **Asset  retirement obligations - July 1, 2008**        |   | $       | 215,056 |   |
|--------------------------------------------------------------|--------|---------|---------|--------|
| Liabilities  incurred                                        |   | 185,770 |    |
| Liabilities  settled                                         |   | (90,761 | )       |
| Accretion  expense                                           |   | 24,452  |    |
| Revisions to  previous estimates                             |   | 268,377 |    |
| **Asset  retirement obligations — March 31, 2009** |   | $       | 602,894 |   |

 

9

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 6 — Stockholders’ Equity**

 

OnAugust 19, 2008, the Board of Directors authorized the issuance of 46,795shares of common stock to certain employees who elected to receive these sharesin lieu of a portion of their fiscal 2008 cash bonus.  The value of the shares issued was $168,462,based on the fair market value on the date of issuance, or $3.60 pershare.  See Note 7.

 

On October 30, 2008, werepurchased 788,200 shares of common stock at an average price of $1.10 pershare, plus approximately $15,000 of transaction costs, from an unaffiliatedaccredited investor.  At this time, wecurrently have no plan to repurchase any more common shares.

 

On December 9, 2008,three outside directors each received 30,000 shares of restricted common stock,with a per share price of $1.20, as part of a compensation plan for outsidedirectors.  The same outside directorseach received 8,633 shares of restricted common stock, with a per share priceof $4.17, as part of their compensation plan during the calendar year2008.  All issuances of common stock weresubject to vesting terms per individual stock agreements, which is generallyone year for directors.

 

On January 16 and February 10,2009, we issued 24,324 and 15,789 shares of restricted common stock,respectively, to Mr. Cagan as compensation for his services as a director,in lieu of the $5,000 monthly advisor fee previously paid to CMCP.   The 15,789 share award was elected by Mr. Caganin lieu of cash retainers and fees for his board service during calendar2009.   These issuances of common stockare subject to vesting terms per the individual stock agreements, which isgenerally one year for directors.

 

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

 

Wehave granted option awards to purchase common stock (the “Stock Options”) andrestricted common stock awards  (“RestrictedStock”) to employees, directors, and consultants of the Company and itssubsidiaries 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. There are no shares available for grant under the 2003 Stock Plan and,as of March 31, 2009, 557,861 shares remain available for grant under the2004 Stock Plan.

 

Wehave also granted common stock warrants, as authorized by the Board of Directors,to employees in lieu of cash bonuses or as incentive awards to reward previousservice or provide incentives to individuals to acquire a proprietary interestin the Company’s success and to remain in the service of the Company (the “IncentiveWarrants”).  These Incentive Warrantshave similar characteristics of the Stock Options.  A total of 1,037,500 Incentive Warrants havebeen issued, with Board of Directors approval, outside of the EPM Stock Plans.

 

OnAugust 19, 2008, the Board of Directors authorized the issuance of 46,795shares of common stock from the 2004 Stock Plan to certain employees whoelected to receive these shares in lieu of a portion of their fiscal 2008 cashbonus.  The value of the shares issuedwas $168,462, based on the fair market value on the date of issuance, or $3.60per share.

 

***Stock Options and Incentive Warrants***

 

Non-cashstock-based compensation expense related to Stock Options and IncentiveWarrants for the three month period ended March 31, 2009 and 2008 was$500,000 and $416,143, respectively. Non-cash stock-based compensation expense related to Stock Options andIncentive Warrants for the nine month period ended March 31, 2009 and 2008was $1,445,987 and $1,120,349, respectively.

 

Duringthe nine months ended March 31, 2009, we granted Stock Options to purchase591,090 shares of common stock under the 2004 Stock Plan with a weightedaverage exercise price of $4.27.  Duringthe nine months ended March 31, 2008, we granted Stock Options to purchase1,385,000 shares of common stock under the 2004 Stock Plan with a weightedaverage exercise price of $2.49.  Theexercise price was determined based on the market price of the Company’s commonstock on the date of grant.  The StockOptions granted during the nine months ended March 31, 2009 and 2008generally vest quarterly, on a straight line basis, over a period of fouryears.  The Stock Options granted duringthe nine months ended March 31, 2009 and 2008 have a contractual life ofseven and ten years, respectively.  Theweighted average assumptions used to calculate the fair value of these StockOptions and the weighted average fair value of the Stock Options granted are asfollows:

 

10

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

| ** **                                                 | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **March 31,**    | ** ** |
| ** **                                                 | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Expected volatility                                        |       | 87.1                  | %          | 93.4 | % |
| Expected  dividends                                        |       | —                |       | — |   |
| Expected term  (in years)                                  |       | 4.6                   |       | 6.1 |   |
| Risk-free rate                                             |       | 3.10                  | %          | 4.10 | % |
| Weighted-average  grant date fair value of options granted |       | $                     | 2.62       |   | $ | 1.94 |   |
|                                                            |            |                       |            |  |  |  |  |

 

Weestimated the fair value of Stock Options and Incentive Warrants issued toemployees and directors under SFAS No. 123R at the date of grant using aBlack-Scholes-Merton valuation model. The risk-free rate is based on the U.S. Treasury yield curve in effectat the time of grant.  The expected term(estimated period of time outstanding) of Stock Options and Incentive Warrantsis based on the “simplified” method of the estimated expected term for “plainvanilla” options allowed by the SEC Staff Accounting Bulletin (“SAB”) No. 107and SAB No. 110, and varied based on the vesting period and contractualterm of the Stock Options or Incentive Warrants.   Expectedvolatility is based on the historical volatility of the Company’s closingcommon stock price and that of an evaluation of a peer group of similarcompanies trading activity.  We have not declared any cash dividends onthe Company’s common stock.

 

Thefollowing summary presents information regarding outstanding Stock Options andIncentive Warrants as of March 31, 2009, and the changes during the ninemonths then ended:

 
| ** **                                                               | ** ** | **Number of  Stock Options  and Incentive Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value   (1)** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in  years)** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                                                                     |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Stock Options  and Incentive Warrants outstanding at July 1, 2008   |       | 5,483,500                                                           |       | $                                         | 1.81       |                                           |       |                                                            |       |   |
|                                                                     |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Granted                                                                  |       | 591,090                                                             |       | $                                         | 4.27       |                                           |       |                                                            |       |   |
| Exercised                                                                |       | —                                                              |       | —                                    |       |                                           |       |                                                            |       |
| Canceled,  forfeited, or expired                                         |       | —                                                              |       | —                                    |       |                                           |       |                                                            |       |
|                                                                     |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Stock Options  and Incentive Warrants outstanding at March 31, 2009 |       | 6,074,590                                                           |       | $                                         | 2.05       |                                           | $          | 1,789,330                                                       |       | 6.7 |   |
|                                                                     |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Vested or  expected to vest at March 31, 2009                       |       | 6,074,590                                                           |       | $                                         | 2.05       |                                           | $          | 1,789,330                                                       |       | 6.7 |   |
|                                                                     |       |                                                                |       |                                      |       |                                           |       |                                                            |       |
| Exercisable at  March 31, 2009                                      |       | 4,244,263                                                           |       | $                                         | 1.66       |                                           | $          | 1,702,874                                                       |       | 6.4 |   |

 

----

(1) Basedupon the difference between the market price of our common stock on the lasttrading date of the period ($1.88 as of March 31, 2009) and the StockOption or Incentive Warrant exercise price of in-the-money Stock Options andIncentive Warrants.

 

Therewere no Stock Options or Incentive Warrants that were exercised during the ninemonths ended March 31, 2009 and 2008.

 

11

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Table of Contents

 

**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

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

 
| ** **                       | ** ** | **Number of   Stock Options  and Incentive  Warrants** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|----------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                             |       |                                                   |       |                                                         |       |
| Unvested at  July 1, 2008   |       | 2,003,437                                              |       | $                                                            | 1.83       |   |
|                             |       |                                                   |       |                                                         |       |
| Granted                          |       | 591,090                                                |       | $                                                            | 2.62       |   |
|                             |       |                                                   |       |                                                         |       |
| Vested                           |       | (764,200                                               | )          | $                                                            | 1.78       |   |
|                             |       |                                                   |       |                                                         |       |
| Forfeited                        |       | —                                                 |       | —                                                       |       |
|                             |       |                                                   |       |                                                         |       |
| Unvested at March 31,  2009 |       | 1,830,327                                              |       | $                                                            | 2.13       |   |

 

Thetotal unrecognized compensation cost at March 31, 2009, relating tonon-vested share-based compensation arrangements granted under the EPM StockPlans and Incentive Warrants was $3,651,844. Such unrecognized expense is expected to be recognized over a weightedaverage period of 2.6 years. Unrecognized compensation related to non-vested share-based compensationarrangements are not adjusted for a decline in the underlying stock pricesubsequent to the date of the award.

 

**RestrictedStock**

 

Forthe nine months ended March 31, 2009, we issued 130,113 shares of restrictedcommon stock to certain members of our board of directors.

 

Forthe nine months ended March 31, 2008, we issued 25,899 and 50,000 shares ofrestricted common stock to certain members of our board of directors and aconsultant, respectively.

 

Stock-basedcompensation expense related to Restricted Stock grants for the three monthperiod ended March 31, 2009 and 2008 was $37,285 and $77,729,respectively.  Stock-based compensationexpense related to Restricted Stock grants for the nine month period ended March 31,2009 and 2008 was $199,548 and $191,094, respectively.

 

Thefollowing table sets forth the Restricted Stock transactions for the ninemonths ended March 31, 2009:

 
| ** **                       | ** ** | **Number of  Restricted  Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|
|                             |       |                                   |       |                                               |       |
| Unvested at  July 1, 2008   |       | 50,898                                 |       | $                                                  | 4.11       |   |
|                             |       |                                   |       |                                               |       |
| Granted                          |       | 130,113                                |       | $                                                  | 1.29       |   |
|                             |       |                                   |       |                                               |       |
| Vested                           |       | (50,898                                | )          | $                                                  | 4.11       |   |
|                             |       |                                   |       |                                               |       |
| Forfeited                        |       | —                                 |       | —                                             |       |
|                             |       |                                   |       |                                               |       |
| Unvested at  March 31, 2009 |       | 130,113                                |       | $                                                  | 1.29       |   |

 

AtMarch 31, 2009, unrecognized stock compensation expense related toRestricted Stock grants totaled $123,783. Such unrecognized expense will be recognized over a weighted averageperiod of 0.8 years.

 

12

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 8 —Supplemental Disclosure of Cash Flow Information**

 

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

 
| ** **                                                                                                                                    | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                    | ** ** | **March 31,**    | ** ** |
| ** **                                                                                                                                    | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Income taxes  paid:                                                                                                                           |       | $                     | 15,000     |   | $ | 33,879 |   |
|                                                                                                                                          |       |                  |       |   |   |
| Income tax  refunds and net operating loss carry-back received:                                                                               |       | $                     | 4,052,631  |   | — |   |
|                                                                                                                                          |       |                  |       |   |   |
| Non-cash  transactions:                                                                                                                       |       |                  |       |   |   |
| Increase  (decrease) in accounts payable used to acquire oil and natural gas leasehold  interests and develop oil and natural gas properties: |       | $                     | (2,014,933 | ) | $ | 2,081,781 |   |
| Oil and natural  gas properties incurred through recognition of asset retirement obligations:                                                 |       | $                     | 454,147    |   | $ | 170,890 |   |
| Common stock  issued in lieu of a portion of 2008 cash bonus accrued at June 30, 2008:                                                   |       | $                     | 168,462    |   | $ | — |   |

 

**Note 9****—****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 as of the date of adoption of FIN 48and through March 31, 2009.

 

Werecognized a tax benefit of 30% and 34% for the three months ended March 31,2009 and 2008, respectively, and a tax benefit of 24% and 30% for the ninemonths ended March 31, 2009 and 2008, respectively.  Stock-based compensation expense related toour qualified incentive stock option awards is our most significant permanentdifference in reconciling our income tax benefit at the statutory federal rateto our effective income tax benefit.

 

Asof March 31, 2009, we expect to recover approximately $1.5 million infederal and state income taxes paid during the tax year ended June 30,2007, arising from an estimated carry-back of income tax losses incurred duringthe nine months ended March 31, 2009. Significant intangible drilling costs were incurred during the 2009fiscal year, which we will elect to deduct for federal and state income taxpurposes.  Under GAAP and specificallythe full cost accounting method, intangible drilling costs are capitalized aspart of oil and natural gas properties, and depleted using theunit-of-production method.  The deductionof intangible drilling costs creates a significant difference in the income taxand book basis of our oil and natural gas properties and resulted in anincrease in our net deferred tax liability, from $2.9 million as of June 30,2008, to $3.8 million as of March 31, 2009.

 

**Note 10****—****Related Party Transactions**

 

Laird Q. Cagan, a member ofour Board of Directors, is a Managing Director and co-owner of Cagan McAfeeCapital Partners, LLC (“CMCP”). CMCP has performed financial advisory servicesto us pursuant to a written agreement amended in November 2005 (the “Agreement”),providing for a retainer of $5,000 per month. Also pursuant to the Agreement, Mr. Cagan, as a registeredrepresentative of Chadbourn Securities Inc. (“Chadbourn”) and as a partner ofCMCP could serve as our placement agent in private equity financings, whereinCMCP could earn cash fees equal to 8% of gross equity proceeds, declining to 4%subject to the amount of equity raised through CMCP, and a fixed 4% warrantfee.  During the term of the Agreement , Mr. Caganreceived no compensation for serving as a director or as the Chairman of ourBoard of Directors.   Effective December 31,2008, the Agreement was modified to remove the monthly retainer and Mr. Caganwas re-elected as a director of our Board with remuneration consistent withother outside directors of our Board.

 

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

 

13

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 10****—****Related Party Transactions**(Continued)

 

During the three months endedMarch 31, 2009 we did not pay CMCP any fee related to the Agreement.  During the nine months ended March 31,2009, we expensed and paid $30,000, through monthly retainers of $5,000 throughDecember 31, 2008.  During the threeand nine months ended March 31, 2008, we expensed and paid CMCP $15,000and $45,000, respectively, through monthly retainers of $5,000.  There were no other earned fees by CMCPduring these periods.

 

See also Note 6 for equitytransactions with related parties.

 

**Note 11 —****Earnings (loss) Per Share (“EPS”)**

 

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

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                         | ** ** | **2009**                               | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| *Numerator*                                                        |       |                                   |       |                                  |       |   |   |   |   |
| Net loss                                                           |       | $                                      | (1,036,617 | )                                     | $          | (535,985 | ) | $ | (1,891,951 | ) | $ | (1,948,223 | ) |
|                                                               |       |                                   |       |                                  |       |   |   |   |   |
| *Denominator*                                                      |       |                                   |       |                                  |       |   |   |   |   |
| Weighted average  number of common shares — basic and diluted |       | 26,219,034                             |       | 26,784,473                            |       | 26,495,176 |   | 26,779,339 |   |
|                                                               |       |                                   |       |                                  |       |   |   |   |   |
| Net loss per  common share — basic and diluted                |       | $                                      | (0.04      | )                                     | $          | (0.02 | ) | $ | (0.07 | ) | $ | (0.07 | ) |

 

Totalpotentially dilutive securities outstanding as of March 31, 2009 are asfollows:

 
| **Outstanding Potential Dilutive Securities**                                      | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Outstanding at  March 31, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
|                                                                               |       |                                  |       |                                    |       |
| Common stock  warrants issued in connection with equity and financing transactions |       | $                                     | 1.40       |                                    | 401,058    |   |
| Stock Options  and Incentive Warrants                                              |       | $                                     | 2.05       |                                    | 6,074,590  |   |
|                                                                               |       |                                  |       | 6,475,648                               |       |

 

**Note 12 — Commitments and Contingencies**

 

***Environmental clean-up.***  On August 3, 2007, we were advised of anoil spill in the Tullos Field near one of our leases. At the request of fieldagents of the Louisiana Department of Environmental Quality and theEnvironmental Protection Agency (“EPA”), we agreed to commence a clean-upoperation that was completed by the end of August 2007. A detailedanalysis of the oil in the spill compared to the Company’s produced oil wasconducted by an EPA approved laboratory. We believe that the oil in the spill did not originate from ouroperations, supported by the formal findings of the laboratory.  We received insurance reimbursements of$484,197 in October 2007, $217,668 in March 2008, and $75,514 in February 2009.  These reimbursements covered all of ouractual cleanup costs except a $5,000 insurance deductible and excluding ourlegal fees, in-house administrative costs, and any possible EPA expensereimbursements and fines that might be billed. As of March 31, 2009, we believe all matters related to this oilspill have been settled, with the exception of an invoice from the UnitedStates Coast Guard for approximately $20,000 for penalties and interest, whichwe believe is unsupported and plan to appeal.

 

14

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**EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 12 — Commitments and Contingencies**(Continued)

 

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

 

In July 2008, amulti-plaintiff lawsuit was filed in the twenty-eighth Judicial District Court,Lasalle Parish, Louisiana, against 15 defendants, including Four StarDevelopment Corporation, a former indirect wholly owned subsidiary of theCompany, which was sold on March 3, 2008, as part of our sale of theTullos Field Area.  Plaintiffs claim thatthe defendants’ oil and natural gas exploration, development and productionactivities on their properties have caused soil and ground water contaminationas a result of the release of hydrocarbons and drilling fluids. Plaintiffs seekdamages for testing, clean-up and remediation of the properties as well asdiminution in their value and mental anguish and emotional distress to theindividual plaintiffs, unjust enrichment and punitive damages for allegedconcealment of ongoing activities.  Atthis time, we are not a party to the litigation and are unable at this time todetermine the exposure, if any, to the Company.

 

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

 

Defendantshave answered Plaintiffs’ suit denying all claims.****Trial is setbefore a jury in Richland Parish for July 13, 2009.  We are vigorously contesting all ofPlaintiffs’ claims.  The case iscurrently in discovery and, at this time, we are unable to predict the outcome.

 

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

 

**For thetwelve months ended March 31,**

 

| 2010       |   | $       | 138,089   |   |
|------------|--------|---------|-----------|--------|
| 2011       |   | 138,089 |      |
| 2012       |   | 152,037 |      |
| 2013       |   | 159,011 |      |
| 2014       |   | 159,011 |      |
| Thereafter |   | 371,026 |      |
| Total      |   | $       | 1,117,263 |   |

 

Rentexpense for the three months ended March 31, 2009 and 2008 was $39,232 and$35,466, respectively.  Rent expense forthe nine months ended March 31, 2009 and 2008 was $110,165 and $106,399,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 March 31, 2009 isapproximately $499,000.

 

15

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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 2008 Annual Report on Form 10-K for the year ended June 30, 2008as filed with the Securities and Exchange Commission. Furthermore, theassumptions that support our forward-looking statements are based uponinformation that is currently available and is subject to change. Wespecifically disclaim all responsibility to publicly update any informationcontained in a forward-looking statement or any forward-looking statement inits entirety and therefore disclaim any resulting liability for potentiallyrelated damages. All forward-looking statements attributable to EvolutionPetroleum Corporation are expressly qualified in their entirety by thiscautionary statement.*

 

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

 

**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. We acquire known,underdeveloped oil and natural gas resources and exploit them through theapplication of capital and technology to increase production, ultimaterecoveries, or both.

 

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

 

Within this overall strategy,we pursue three specific initiatives:

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

 

Our most significant asset iswithin our EOR Initiative in the 13,636 acre Delhi Field, located in northeastLouisiana.  Our non-operated interestsconsist of 7.4% in overriding and mineral royalty interests and a 25% afterpay-out reversionary working interest in the Delhi Field Holt Bryant Unit,along with a 25% working interest in certain other depths in the Delhi Fieldresulting from the Farmout we completed on June 12, 2006 with DenburyOnshore LLC, a subsidiary of Denbury Resources Inc. (“Denbury”) (the “DelhiFarmout”).  The Holt Bryant Unit iscurrently being redeveloped by the operator, Denbury, using CO2 enhanced oil recovery technology and adedicated portion of Denbury’s proved CO2 reserves inthe Jackson Dome, located approximately 100 miles east of Delhi.  According to public presentations released byDenbury, injection of CO2 is expected to begin in the third quarter ofcalendar 2009, followed by projected increases in oil production about early2010.

 

Since our closing of theDelhi Farmout, we have focused on developing projects in our other initiatives,particularly through conventional redevelopment of bypassed resources in theGiddings Field using horizontal drilling methods, the leasing of unconventionalgas shale projects in the Woodford Shale Trend in Oklahoma and the leasing ofNeptune, a heavy oil project in S. Texas. Conceptually, our plan going forward can be illustrated as follows:

 

16

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As indicated by the abovechart, (volumes are representative and not to scale), we are funding ourdevelopment projects in the Giddings Field and leasing and development activitiesin our gas shale projects from our working capital resources.  We expect that net cash flows from ourproperties in the Giddings Field, our current cash resources and cash flowsfrom the Delhi Project will be used to fund full development our gas shaleprojects and other new projects.  We mayutilize project financing in the future for both Giddings and our gas shaleprojects.

 

Ourlong term strategy and primary focus continue to be on increasing share valuethrough the identification and acquisition of resources and conversion of thoseresources into proved reserves through our expertise and technology.  Near term, our focus is on (i) projectidentification and leasing of reserves that we believe will be categorized asproved undeveloped, and (ii) selective drilling activities to moveexisting reserves into the proved category. We are emphasizing long term share value maintenance and growth overnear term earnings during the current period of low commodity prices.

 

*Highlights for our Third QuarterFiscal Year 2009*

 

·                 **The CO2Pipeline to our Delhi Field has been completed.**  On May 5, 2009, the operator reportedthat the 78 mile Delta Pipeline from Tinsley Field to our Delhi Field has beencompleted, tested and CO2 fill into the pipeline has begun.

 

·                 **Theredeployment of our proceeds from the sale of our properties in the TullosField Area into the Giddings Field continues to generate positive results.**

 

***Sales volumes increased 346% during our third quarter in fiscal year2009 versus our third quarter in fiscal year 2008. ***Our increase in sales volumesfor the quarter were solely attributable to our production in the GiddingsField.  Our properties in the TullosField Area, which were sold on March 3, 2008, accounted for approximately45% of total sales volumes for the three months ended March 31, 2008.  Production during March 2009 averaged482 gross (386 net) BOE per day, despite two key wells producing for onlytwo-thirds of the month.

 

17

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***We completed two new re-entry wells in the third fiscal quarter of2009. ***The first fiscal2009 Giddings Field re-entry well, the Hilton Yegua #1, was completed andplaced on production during mid-January 2009.  A second re-entry well, the Pearson #1, wascompleted and placed on production in late January 2009.  We own a 100% working interest andapproximately 79% revenue interest in the two wells.

 

***We lowered our field income break-even point by 58%.***  During the quarter ended March 31, 2009,lifting costs (lease operating and severance tax, on a combined per unit ofsales basis) were $6.88 and depletion rates were $17.57 per BOE at our GiddingsField, equaling a field income break-even point of $24.45 per BOE.  This compares to lifting costs of $44.63 anda depletion rate of $13.29 per BOE, equaling a field income break-even point of$57.92 per BOE for the last full fiscal quarter of production prior todivestiture in early March 2008.

 

·                 **Theproduct prices we received declined 65% year over year and declined 31%sequentially. **During the quarterended March 31, 2009, we received $27.27 per BOE, as compared to $77.82per BOE during the three months ended March 31, 2008, and $39.78 per BOEduring the three months ended December 31, 2008.

 

·                 **Weremained financially strong.**

 

***We ended the quarter with $7.5 million of working capital, compared to$7.6 million at December 31, 2008 and $13.6 million at June 30,2008. ***At March 31,2009, working capital included $6.6 million of cash and cash equivalents, andshort-term certificates of deposit, and $1.5 million of recoverable incometaxes arising from current year tax losses being carried back to a prior taxyear.*** *** We incurred $8.3 million in capitalexpenditures for oil and natural gas leasehold and development costs during thenine months ended March 31, 2009, which was funded by workingcapital.  We continue to have no short orlong term funded debt other than our payables incurred in the ordinary courseof business.

 

***We protected our short-term investments during difficult credit marketconditions.***  We havecontinually avoided structurally enhanced investment securities, auction ratesecurities and other higher risk credit instruments.  Instead, we relied upon lower yielding U.S.Government Agency money market funds through July 2008, when we shiftedall of our cash equivalents into short-term U.S. Treasury money marketfunds.  During the second quarter offiscal 2009, we redeployed some of our cash and cash equivalents intocertificates of deposit that mature within a year and that are fully insured bythe FDIC.

 

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

 

*Looking Forward in 2009*

 

·                 **We willmaintain our focus on increasing underlying value per share by convertingunproved resources to proved reserves**.

 

***Our Delhi CO***2*** project is nearing production:***

 

·                 CO2 pipeline fill will continue through the secondcalendar quarter of 2009.

 

·                 Finalcommissioning of the pipeline is expected in June 2009.

 

·                 A rig will bemobilized for additional field work in the second calendar quarter of 2009.

 

·                 CO2  reservoir injection is scheduled for thesummer of 2009.

 

·                 The CO2 processing facility is scheduled to beoperational in the fourth calendar quarter of 2009.

 

·                 First oilproduction is expected to begin within six months following first fieldinjection of CO2 , or sometime around early calendar 2010.  We believe that production response in theDelhi Field resulting from the injection of CO2 will lead to asubstantial addition to our net proved reserves.

 

18

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***We expect to initiate pilot drilling within our shallow Woodford Shaleprojects.***Current plans for fiscal 2009 include the drilling orre-entry of up to three vertical wells to depths of about 1,500 feet to utilizeair drilling to develop what we believe will be substantial low cost gasreserves.

 

***We expect to initiate development drilling within our Neptune heavy oilproject in South Texas. ***We completed theleasing of approximately 1,500 net acres where we intend to drill infill (ordownspaced) wells within an existing moderately heavy oil field.  Production in this field by another operatorhas established proved reserves on infill spacing.  We also expect to apply our specializedcompletion technology to further enhance recovery.

 

***Further declines of oil and natural gas prices could result in asignificant impairment******of******our full-cost pool.***Thecurrent recessionary economic environment has resulted in lower demand for oiland natural gas, resulting in volatile commodity price.  Commodityprices at March 31, 2009 ($3.37 per MMBtu for Houston Ship Channel naturalgas and $49.66 per barrel for NYMEX oil, adjusted for market differentials),would have caused an impairment of our oil and natural gas properties ofapproximately $180,000, or less than 1% of our net oil and natural gas propertycosts.  However, due to the increases incrude oil and natural gas prices subsequent to March 31, 2009, we did notrecognize and impairment of our oil and natural gas properties as of March 31,2009.  Our depletion rate decreased from $19.56 per barrel to $17.57 per barrelduring the three months ended March 31, 2009 due to revision of estimatedfuture development costs associated with our proved undeveloped reserves.  Natural gas prices at the wellhead declinedfrom $5.23 per mcf in December 2008 to $3.25 per mcf in March 2009,offset partially by the increase in received oil price from $40.06 to $44.71per barrel.  Receipts per BOE declineddramatically during the quarter, offset in part by continuing declines in oilfield service and drilling costs.  Priceshave improved subsequent to March 31, 2009 as of early May 2009.

 

·                 **Reductionsin General and Administrative Costs**

 

***We expect a 10% reduction in our fully burdenedpayroll expenses starting in mid- fourth quarter of fiscal 2009.***** **During April 2009, wereduced our headcount by two full time employees and one contractor, bringingour staff to eleven full-time employees and two contractors.  We are also reviewing all recurring costs andoperations for potential savings.

 

**Liquidityand Capital Resources**

 

Our primary liquidity needsare to fund strategic property acquisitions, our drilling program, andoperating costs.   As disclosed in ourquarterly report on Form 10-Q for the quarter ended September 30,2008, we revised our 2009 capital expenditures budget for fiscal 2009 (the “Revised2009 Plan”), reducing the overall program by more than half to less than $10million.  Due to our positive workingcapital, cash flows from producing properties, no debt and no near termexpiring leases, we believe we have the ability to fund or further adjust ourcapital expenditure budget to capture select opportunities that may arise forthe benefit of our shareholders, without the need of additional financing.  Therefore, we believe that our currentsources of liquidity are sufficient to fund our ongoing cash requirements.

 

AtMarch 31, 2009, our working capital was $7.5 million and we continued tobe debt free.  This compares to workingcapital of $13.6 million at June 30, 2008. The decrease in working capital of $6.1 million since June 2008 wasdue to cash of $9.9 million used for investing activities, primarily forinvestments in oil and natural gas properties, cash used of  $0.9 million to repurchase our common stock,a decrease of $4.2 million in receivables and other current assets, primarilyfrom the collection of oil and gas receivables and income tax receivables,partially offset by cash of $6.2 million provided by operations and a decreaseof $2.7 million in current liabilities, primarily due to payments made onaccounts payable for costs incurred for our drilling program.

 

Cashflows provided by operating activities for the nine months ended March 31,2009 were $6.2 million.  Cash flowsprovided by operations includes cash proceeds of $6.4 million from oil andnatural gas production primarily from our properties in the Giddings Field,cash proceeds of $0.1 million from interest income, cash proceeds of $4.1million from income tax refunds, primarily from our 2008 tax year net operatingloss carry-back, offset by cash payments of $0.1 million for settlingliabilities associated with our asset retirement obligations and $4.3 millionof cash payments for operating activities, including lease operating expenses,production taxes, and salaries and wages. This compares to $1.2 million of cash used in operations for the ninemonths ended March 31, 2008, which includes $1.7 million of cash proceedsfrom oil and natural gas production primarily from our properties in the TullosField Area, which we sold on March 3, 2008, and cash proceeds frominterest income of $0.8 million, offset by $3.7 million of cash payments foroperating activities, including lease operating expenses, production taxes, andsalaries and wages.

 

19

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Cashflows used in investing activities totaled $11.7 million during the nine monthsended March 31, 2009, which includes the purchase of short-termcertificates of deposit of $1.8 million. Our remaining investing activities of $9.9 million were primarily fordevelopment activities in the Giddings Field and leasehold acquisition costs inthe Giddings Field, our Woodford Shale projects in Oklahoma and our Neptuneproject in South Texas.  The $9.9 millionincludes net payments on accounts payable of $2.0 million from June 30,2008, relating to expenditures for oil and natural gas properties incurred inthe prior fiscal period, thus $7.9 million of cash was used for oil and gasproperties incurred during this fiscal year. During the nine months ended March 31, 2008, approximately $11.1million of cash was used for investments to acquire and develop oil and naturalgas property interests and other property and equipment, primarily forinvestments in oil and natural gas properties at the Giddings Field, and doesnot include approximately $2.1 million net increase in accounts payable from July 1,2007 through March 31, 2008, relating to expenditures on oil and naturalgas properties.  The sale of the TullosAssets partially offset our development and acquisition activities by providingnet proceeds of approximately $4.4 million for the nine months ended March 31,2008.

 

Cash flows used in financingactivities for the nine months ended March 31, 2009 were $0.9million.  On October 30, 2008, werepurchased 788,200 shares of common stock at an average price of $1.10 pershare, plus approximately $15,000 of transaction costs, from an unaffiliatedaccredited investor.  Cash flows fromfinancing activities for the nine months ended March 31, 2008 wereinsignificant.

 

Weincurred $8.3 million of capital expenditures for oil and natural gas leaseholdand development costs during the nine months ended March 31, 2009, whichincludes $0.4 million related to the recognition of asset retirementobligations.  Of the $8.3 million, $2.2million was incurred for leasehold acquisitions and $6.1 million was incurredfor development activities.  Developmentactivities were in the Giddings Field and leasehold acquisition costs were forproperties in the Giddings Field, our Woodford Shale projects in Oklahoma andour Neptune project in South Texas.  Weincurred approximately $13.3 million in capital expenditures for oil andnatural gas leasehold and development costs during the nine months ended March 31,2008, which includes $0.2 million related to the recognition of assetretirement obligations.  Of the $13.3million, $6.6 million was incurred for leasehold acquisitions and $6.7 millionfor development costs, primarily in the Giddings Field.

 

Sinceour wells in the Giddings Field tend to produce a large portion of theirreserves relatively quickly, and due to continued economic uncertainty, webelieve that it is in our shareholders’ best interests, and consistent with ourfocus on increasing share value, to slow the development of our properties inthe Giddings Field until expectations of higher commodity prices may berealized.  Our Revised 2009 Plan providedfor drilling up to three re-entry wells in the Giddings Field, which is areduction from the previous ten well re-entry plan, subject to future changesin commodity prices and market conditions. The first fiscal 2009 Giddings Field re-entry well, the Hilton Yegua #1,was completed and placed on production in mid-January 2009.  A second re-entry well, the Pearson #1, begandrilling in late December 2008 and was completed and placed on productionby late January 2009.  We own a 100%working interest and approximately 79% revenue interest in the two wells.

 

Additionally,during the fourth quarter of our fiscal year 2009, we are planning initial testdrilling or re-entry of up to three low-cost vertical wells within our shallowWoodford Shale project in Oklahoma.  Itis our intention to potentially quantify and convert that potential resourceinto higher graded reserves.  Similarly,we expect to initiate drilling of low cost development wells in our new SouthTexas project beginning the summer of 2009, subject to the price of crude oil,with the expectation of potentially establishing additional proved reserves ofmoderately heavy oil associated with water at shallow depths.

 

20

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**Resultsof Operations**

 

*Three months ended March 31,2009 compared with the three months ended March  31, 2008*

 

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

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **March 31**      | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                               | ** ** | **2009**               | ** ** | **2008**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Production  Volumes, net to the Company:**             |       |                   |       |       |       |         |       |   |   |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Crude oil (Bbl)                                          |       | 8,953                  |       | 6,540      |       | 2,413        |       | 37 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas  liquids (“NGLs”) (Bbl)            |       | 15,091                 |       | 1,606      |       | 13,485       |       | 840 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                       |       | 112,176                |       | 12,287     |       | 99,889       |       | 813 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 42,740                 |       | 10,194     |       | 32,546       |       | 319 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Sales  Volumes, net to the Company:**                  |       |                   |       |       |       |         |       |   |   |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Crude oil (Bbl)                                          |       | 8,911                  |       | 5,915      |       | 2,996        |       | 51 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs (Bbl)                                               |       | 15,091                 |       | 1,606      |       | 13,485       |       | 840 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas  (Mcf)                                       |       | 112,176                |       | 12,287     |       | 99,889       |       | 813 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |       | 42,698                 |       | 9,569      |       | 33,129       |       | 346 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Revenue  data:**                                       |       |                   |       |       |       |         |       |   |   |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Crude oil                                                |       | $                      | 351,684    |       | $          | 554,498      |       | $ | (202,814 | ) | (37 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| NGLs                                                     |       | 350,891                |       | 90,405     |       | 260,486      |       | 288 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| Natural gas                                              |       | 461,889                |       | 99,799     |       | 362,090      |       | 363 | % |
| Total revenues                                           |       | $                      | 1,164,464  |       | $          | 744,702      |       | $ | 419,762 |   | 56 | % |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Average  price:**                                      |       |                   |       |       |       |         |       |   |   |
| Crude oil (per  Bbl)                                     |       | $                      | 39.47      |       | $          | 93.74        |       | $ | (54.27 | ) | (58 | )% |
| NGLs (per Bbl)                                           |       | 23.25                  |       | 56.29      |       | (33.04       | )          | (59 | )% |
| Natural gas (per  Mcf)                                   |       | 4.12                   |       | 8.12       |       | (4.00        | )          | (49 | )% |
| Crude oil, NGLs  and natural gas (per BOE)               |       | $                      | 27.27      |       | $          | 77.82        |       | $ | (50.55 | ) | (65 | )% |
|                                                     |       |                   |       |       |       |         |       |   |   |
| **Expenses  (per BOE)**                                  |       |                   |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes           |       | $                      | 6.88       |       | $          | 32.72        |       | $ | (25.84 | ) | (79 | )% |
| Depletion  expense on oil and natural gas properties (a) |       | $                      | 17.57      |       | $          | 13.55        |       | $ | 4.02 |   | 30 | % |

 

----

(a)          Excludesdepreciation of furniture and fixtures of $9,769 and $9,465, for the threemonths ended March 31, 2009 and 2008, respectively.

 

 

Net loss.  For the three months ended March 31,2009, we reported a net loss of $1,036,617, or $0.04 loss per share (whichincludes $1.3 million of non-cash charges related to stock-based compensation,depreciation, depletion, and amortization, and accretion on asset retirementobligations) on total oil and natural gas revenues of $1,164,464.  This compares to a net loss of $535,985, or$0.02 loss per share (which included approximately $0.6 million of non-cashcharges related to stock based compensation, depreciation, depletion, andamortization, and accretion on asset retirement liabilities), on total oil andnatural gas revenues of $744,702 for the three months ended March 31,2008.  The increase in loss isattributable to an increase in operating costs of  $927,613 (primarily related to an increase innon-cash charges as noted above), a decrease in interest income of $156,990,offset by an increase in revenues of $419,762 and an increase in our income taxbenefit of $164,209.  Additional detailsof the components of net loss are explained in greater detail below.

 

21

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Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the three months ended March 31, 2009increased 346% to 42,698 BOE, compared to 9,569 BOE for the three months ended March 31,2008.  The increase in sales volumes isdue to production of crude oil, NGLs and natural gas from our properties in theGiddings Field.  Our properties in theTullos Field Area, which were sold on March 3, 2008, accounted for 45% oftotal sales volumes for the three months ended March 31, 2008.

 

Production.  Oil production will vary from oil salesvolumes by changes in crude oil inventories, which are included in total provedreserves.  Crude oil, NGLs and naturalgas production for the three months ended March 31, 2009 increased 319% to42,740 BOE, compared to 10,194 BOE for the three months ended March 31,2008.  The increase is due to crude oil,NGLs and natural gas production from our properties in the Giddings Field.  Production from our properties in the TullosField Area, which were sold on March 3, 2008, accounted for 48% ofproduction for the three months ended March 31, 2008.

 

Oil,NGLs and Natural Gas Revenues.  Crude oil, NGLs and natural gas revenues forthe three months ended March 31, 2009 increased 56% from the comparablequarter in the previous fiscal year. This was due to an increase in sales volumes of crude oil, NGLs, andnatural gas during the three months ended March 31, 2009 from ourproperties in the Giddings Field, whereas our sales volumes from our propertiesin the Giddings Field during the three months ended March 31, 2008,accounted for 55% of total net production sold. Increased production was substantially offset by a 65% decline in theaverage price received per BOE, from $78 per BOE for the three months ended March 31,2008 to $27 per BOE for the three months ended March 31, 2009.  Our properties in the Giddings Fieldgenerated almost 100% of our revenues for the three months ended March 31,2009.  Oil revenues from our propertiesin the Tullos Field Area, which was sold in March 2008, accounted for 53%of total revenues for the three months March 31, 2008.

 

Lease Operating Expenses(including production severance taxes).  Lease operating expenses and production taxesfor the three months ended March 31, 2009 decreased approximately 9% fromthe comparable quarter in the prior fiscal year.    Fewer higher producing wells in the GiddingsField compared to numerous lower producing wells in the Tullos Field Area arecontributing more efficient operations and decreasing lease operating costs,which is partially offset by higher production taxes in the Giddings Field ascompared to the Tullos Field Area where 48% of our production was during theprevious period.  The higher productiontaxes are due to higher revenues in our Texas properties compared to ourproduction from our Louisiana properties in the comparable quarter in theprevious fiscal year, even after adjusting for the Texas limited severance taxholiday on wells restored to production. On a BOE basis, lease operating expenses (including production severancetaxes) decreased by 79% over the comparable three month period in the priorfiscal year, due to the reasons discussed above.

 

General and AdministrativeExpenses (“G&A”). G&A expenses increased 26% to $1.6 million for the three monthsended March 31, 2009, compared to $1.3 million for the three months ended March 31,2008.  A large portion of the increase inG&A is due to the completion of the Giddings drilling program in early February 2009,whereas a portion of the salary costs of engineers and other employees, thatwere directly associated and capitalized with the drilling program, arecurrently being charged to G&A.  Forthe three months ended March 31, 2009 and 2008, these costs totaled$36,906 and $245,931, respectively, an increase in G&A of $209,025.  Also contributing to the increase wasnon-cash stock-based compensation of $537,285 (34% of total G&A) and $493,872 (39% of total G&A) forthe three months ended March 31, 2009 and 2008, respectively.  Non-cash stock-based compensation is anintegral part of total staff compensation utilized to recruit quality stafffrom other, more established companies. A third major contributor to the increase is legal expense associatedwith the Delhi litigation in the amount of $146,962 for the quarter ended March 31,2009.

 

Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A increased by $620,750 to $759,836for the three months ended March 31, 2009, compared to $139,086 for thethree months ended March 31, 2008. The increase is primarily due to a higher depletion rate ($17.57 vs.$13.55) per BOE and a 346% increase in sales volumes.  The increase in the depletion rate is due tothe higher development cost of PUDs in the Giddings Field that we added inamount far in excess of the volume of lower cost PDP’s in our properties in theTullos Field Area, which we sold in March 2008.  Proved reserves in the Giddings Fieldtypically are higher cost, but higher valued, compared to the long life, highoperating cost proved reserves in the Tullos Field Area.

 

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Interest Income.  Interest income for the three months ended March 31,2009 decreased $156,990 to $8,024, compared to $165,014 for the three monthsended March 31, 2008.  The decreasein interest income is due to lower available cash balances, includingcertificates of deposit, averaging $8.3 million during the three months ended March 31,2009, as compared to cash balances averaging $20.7 million during the threemonths ended March 31, 2008, combined with a lower interest rateenvironment during the three months ended March 31, 2009.  The lower cash balance is primarily due tocash used to pay for additions to our oil and natural gas properties.

 

*Ninemonths ended March 31, 2009 compared with the nine months ended March 31,2008*

 

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

 
|                                                     |   | **Nine Months Ended** |       |     |       |         |       |
|----------------------------------------------------------|--------|-----------------------|------------|----------|------------|--------------|------------|
|                                                     |   | **March 31**     |       |     |       | **%**        |       |
|                                                     |   | **2009**              | ** ** | **2008** | ** ** | **Variance** | ** ** | **change** |   |
|                                                     |   |                  |       |     |       |         |       |   |   |
| **Production  Volumes, net to the Company:**             |   |                  |       |     |       |         |       |   |   |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Crude oil and  natural gas liquids (Bbl)                 |   | 29,008                |       | 20,382   |       | 8,626        |       | 42 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Natural gas  liquids (“NGLs”) (Bbl)            |   | 33,836                |       | 1,993    |       | 31,843       |       | 1,598 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Natural gas  (Mcf)                                       |   | 240,251               |       | 15,904   |       | 224,347      |       | 1,411 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |   | 102,886               |       | 25,026   |       | 77,860       |       | 311 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| **Sales  Volumes, net to the Company:**                  |   |                  |       |     |       |         |       |   |   |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Crude oil (Bbl)                                          |   | 28,844                |       | 19,875   |       | 8,969        |       | 45 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| NGLs (Bbl)                                               |   | 33,836                |       | 1,993    |       | 31,843       |       | 1,598 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Natural gas  (Mcf)                                       |   | 240,251               |       | 15,904   |       | 224,347      |       | 1,411 | % |
| Crude oil, NGLs  and natural gas (BOE)                   |   | 102,722               |       | 24,519   |       | 78,203       |       | 319 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| **Revenue  data:**                                       |   |                  |       |     |       |         |       |   |   |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Crude oil                                                |   | $                     | 2,337,948  |     | $          | 1,664,648    |       | $ | 673,300 |   | 40 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| NGLs                                                     |   | 1,341,629             |       | 111,699  |       | 1,229,930    |       | 1101 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| Natural gas                                              |   | 1,431,655             |       | 123,277  |       | 1,308,378    |       | 1061 | % |
| Total revenues                                           |   | $                     | 5,111,232  |     | $          | 1,899,624    |       | $ | 3,211,608 |   | 169 | % |
|                                                     |   |                  |       |     |       |         |       |   |   |
| **Average  price:**                                      |   |                  |       |     |       |         |       |   |   |
| Crude oil (per  Bbl)                                     |   | $                     | 81.05      |     | $          | 83.76        |       | $ | (2.71 | ) | (3 | )% |
| NGLs (per Bbl)                                           |   | 39.65                 |       | 56.05    |       | (16.40       | )          | (29 | )% |
| Natural gas (per  Mcf)                                   |   | 5.96                  |       | 7.75     |       | (1.79        | )          | (23 | )% |
| Crude oil, NGLs  and natural gas (per BOE)               |   | $                     | 49.76      |     | $          | 77.48        |       | $ | (27.72 | ) | (36 | )% |
|                                                     |   |                  |       |     |       |         |       |   |   |
| **Expenses  (per BOE)**                                  |   |                  |       |     |       |         |       |   |   |
| Lease operating  expenses and production taxes (a)       |   | $                     | 10.08      |     | $          | 40.07        |       | $ | (29.99 | ) | (75 | )% |
| Depletion  expense on oil and natural gas properties (b) |   | $                     | 18.30      |     | $          | 13.34        |       | $ | 4.96 |   | 37 | % |

 

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(b)         Excludesnon-recurring expenses related to the oil spill in the Tullos Field Area of$7,418 and $35,417, for the nine months ended March 31, 2009 and 2008,respectively.

(c)          Excludesdepreciation of furniture and fixtures of $29,387 and $45,586, for the ninemonths ended March 31, 2009 and 2008, respectively.

 

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Net loss.  For the nine months ended March 31, 2009,we reported a net loss of $1,891,951, or $0.07 in loss per share (whichincludes $3.6 million of non-cash charges related to stock-based compensation,depreciation, depletion, and amortization, and accretion on asset retirementobligations) on total oil and natural gas revenues of $5,111,232.  This compares to a net loss of $1,948,223, or$0.07 loss per share (which, included approximately $1.7 million of non-cashcharges related to stock based compensation, depreciation, depletion, andamortization, and accretion on asset retirement obligations), on total oil andnatural gas revenues of $1,899,624 for the nine months ended March 31,2008.  An increase in our revenues of$3,211,608 was offset by increases in operating costs of $2,229,229 (primarilyrelated to an increase in non-cash charges as noted above), a decrease ininterest income of $673,383, and a decrease in our income tax benefit of$252,724.  Additional details of thecomponents of net loss are explained in greater detail below.

 

Sales Volumes.  Crude oil, NGLs, and natural gas salesvolumes, net to our interest, for the nine months ended March 31, 2009increased 319% to 102,722 BOE, compared to 24,519 BOE for the nine months endedMarch 31, 2008.  The increase insales volumes is due to production of crude oil, NGLs and natural gas from ourproperties in the Giddings Field.  Ourproperties in the Tullos Field Area, which were sold on March 3, 2008,accounted for 73% of total sales volumes for the nine months ended March 31,2008.

 

Production.  Oil production will vary from oil salesvolumes by changes in crude oil inventories, which are included in total provedreserves.  Crude oil, NGLs and naturalgas production for the nine months ended March 31, 2009 increased 311% to102,886 BOE, compared to 25,026 BOE for the nine months ended March 31,2008.  The increase is due to crude oil,NGLs and natural gas production from our properties in the Giddings Field.  Production from our properties in the TullosField Area, which were sold on March 3, 2008, accounted for 73% ofproduction for the nine months ended March 31, 2008.

 

Oil,NGLs and Natural Gas Revenues.  Crude oil, NGLs and natural gas revenues forthe nine months ended March 31, 2009 increased 169% from the nine monthsended March 31, 2008.  This was dueto an increase in sales volumes of crude oil, NGLs, and natural gas during thenine months ended March 31, 2009 from our properties in the GiddingsField, whereas our sales volumes from our properties in the Giddings Fieldduring the nine months ended March 31, 2008, accounted for 27% of totalnet production sold.  Increasedproduction was substantially offset by a 36% decline in the average pricereceived per BOE, from $77 per BOE for the nine months ended March 31,2008 to $50 per BOE for the nine months ended March 31, 2009.  Our properties in the Giddings Fieldgenerated almost 100% of our revenues for the nine months ended March 31,2009.  Oil revenues from our propertiesin the Tullos Field Area, which was sold in March 2008, accounted for 78%of total revenues for the nine months March 31, 2008.

 

Lease Operating Expenses(including production severance taxes).  Lease operating expenses and production taxesfor the nine months ended March 31, 2009 increased approximately 2% fromthe comparable nine month period in the prior fiscal year.  The increase for the nine months ended March 31,2009 is attributable to higher production taxes in the Giddings Field ascompared to the Tullos Field Area where the majority of our production wasduring the previous period.  The higherproduction taxes are due to higher revenues in our Texas properties compared toour production from our Louisiana properties in the comparable period in theprevious fiscal year, even after adjusting for the Texas limited severance taxholiday on wells restored to production. The higher production taxes was partially offset by a decrease in leaseoperating costs, due to fewer higher producing wells in the Giddings Fieldcompared to numerous lower producing wells in the Tullos Field Area.  On a BOE basis, lease operating expenses(including production severance taxes) decreased by 75% over the comparablenine month period in the prior fiscal year, due to increased production atGiddings in the current period as compared to our properties in the TullosField Area in the comparable prior year period.

 

General and AdministrativeExpenses (“G&A”). G&A expenses increased 16% to $4.7 million for the nine months endedMarch 31, 2009, compared to $4.1 million for the nine months ended March 31,2008.  Higher overall compensationexpenses for new hires, and including non-cash stock-based compensation,accounted for the majority of the increase. New hires were associated with a build up of our infrastructure toaccommodate our operations in the Giddings Field.  Non-cash stock-based compensation expense was$1,645,535 (35% of total G&A) and $1,311,443 (32% of total G&A) for thenine months ended March 31, 2009 and 2008, respectively.  Non-cash stock-based compensation is anintegral part of total staff compensation utilized to recruit quality staff fromother, more established companies.  Alsocontributing to the increase is legal expense associated with the Delhilitigation in the amount of $254,401 for the nine months ended March 31,2009.

 

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Depreciation, Depletion &Amortization Expense (“DD&A”).  DD&A increased by $1,536,364 to$1,909,009 for the nine months ended March 31, 2009, compared to $372,645for the nine months ended March 31, 2008. The increase is primarily due to a higher depletion rate ($18.30 vs.$13.34) per BOE and a 319% increase in sales volumes.  The increase in the depletion rate is due tothe higher development cost of PUDs in the Giddings Field that we added inamount far in excess of the volume of lower cost PDP’s in our properties in theTullos Field Area, which we sold in March 2008.  Proved reserves in the Giddings Fieldtypically are higher cost, but higher valued, compared to the long life, highoperating cost proved reserves in the Tullos Field Area.

 

Interest Income.  Interest income for the nine months ended March 31,2009 decreased $673,383 to $99,452, compared to $772,835 for the nine monthsended March 31, 2008.  The decreasein interest income is due to lower available cash balances averaging $9.4million during the nine months ended March 31, 2009, as compared to cashbalances averaging $23.8 million during the nine months ended March 31,2008, combined with a lower interest rate environment during the nine monthsended March 31, 2009.  The lowercash balance is primarily due to cash used to pay for additions to our oil andnatural gas properties.

 

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 high price increases.  With the general rise in the price of oil andnatural gas products over the last three years, increased prices for drillingand oilfield services, oilfield equipment, tubulars, labor, expertise and otherservices, have also increased, thereby escalating our lease operating expensesand our capital expenditures.  Mostrecently, we have seen a precipitous decline in both petroleum product prices,drilling and oilfield services, although product prices, operating costs anddevelopment costs may not always move in tandem.  Such declines as of March 31, 2009 arereflected in our ceiling test calculations.

 

KnownTrends and Uncertainties. General worldwide economic conditions have deteriorated due to creditconditions impacted by the sub-prime mortgage turmoil and otherfactors.  Concerns over slower or declining economic growth areaffecting numerous industries, companies, as well as consumers, which hasresulted in reduced demand for crude oil and natural gas.  If demandcontinues to decrease in the future, it may continue to put downward pressureon crude oil and natural gas prices, thereby lowering our revenues and workingcapital going forward.

 

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

 

**OffBalance Sheet Arrangements**

 

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

 

 

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

 

Informationabout market risks for the three months ended March 31, 2009, did notchange materially from the disclosures in Item 7A. of our Annual Report on Form 10-Kfor the year ended June 30, 2008 except as noted below.  As such, the information contained hereinshould be read in conjunction with the related disclosures in our Annual Reporton Form 10-K for the year ended June 30, 2008.

 

*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.

 

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*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 gasprices at targeted levels and to manage our exposure to price fluctuations. Wemay use futures contracts, swaps and fixed price physical contracts to hedgeour commodity prices. Realized gains and losses from our price risk managementactivities are recognized in oil and natural gas sales when the associatedproduction occurs. We presently do not hold or issue derivative instruments forhedging or speculative purposes.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

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

 

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

 

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

 

 

**PART II- OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

On August 3, 2007, wewere advised of an oil spill in the Tullos Field near one of our leases. At therequest of field agents of the Louisiana Department of Environmental Qualityand the Environmental Protection Agency (“EPA”), we agreed to commence aclean-up operation that was completed by the end of August 2007. A detailedanalysis of the oil in the spill compared to the Company’s produced oil wasconducted by an EPA approved laboratory. We believe that the oil in the spill did not originate from ouroperations, supported by the formal findings of the laboratory.  We received insurance reimbursements of$484,197 in October 2007, $217,668 in March 2008, and $75,514 in February 2009.  These reimbursements covered all of ouractual cleanup costs except a $5,000 insurance deductible and excluding ourlegal fees, in-house administrative costs, and any possible EPA expensereimbursements and fines that might be billed. As of March 31, 2009, we believe all matters related to this oilspill have been settled, with the exception of an invoice from the UnitedStates Coast Guard for approximately $20,000 for penalties and interest, whichwe believe is unsupported, and plan to appeal.

 

26

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In July 2008, amulti-plaintiff lawsuit was filed in the twenty-eighth Judicial District Court,Lasalle Parish, Louisiana, against 15 defendants, including Four StarDevelopment Corporation, a former indirect wholly owned subsidiary of theCompany, which was sold on March 3, 2008, as part of our sale of theTullos Field Area.  Plaintiffs claim thatthe defendants’ oil and natural gas exploration, development and productionactivities on their properties have caused soil and ground water contaminationas a result of the release of hydrocarbons and drilling fluids. Plaintiffs seekdamages for testing, clean-up and remediation of the properties as well asdiminution in their value and mental anguish and emotional distress to theindividual plaintiffs, unjust enrichment and punitive damages for allegedconcealment of ongoing activities.  Atthis time, we are not a party to the litigation and are unable at this time todetermine the exposure, if any, to the Company.

 

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

 

Defendantshave answered Plaintiffs’ suit denying all claims.****Trial is setbefore a jury in Richland Parish for July 13, 2009.  We are vigorously contesting all ofPlaintiffs’ claims.  The case iscurrently in discovery and, at this time, we are unable to predict the outcome.

 

 

**ITEM 1A. RISK FACTORS**

 

Seerisk factors set forth in the Company’s Annual Report on Form 10-K for theyear ended June 30, 2008 and subsequent updates in the Company’s quarterlyreports on Form 10-Q for the periods ended September 30, 2008 and December 31,2008.

 

 

**ITEM 2.UNREGISTERED SALE OF EQUITY 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**

 

OnFebruary 1, 2009, we entered into a gas purchase and sale agreement, throughour wholly owned subsidiary Evolution Operating Co., Inc., with Copano FieldServices/Upper Gulf Coast, L.P. (the “Buyer”), whereas the Buyer will purchase100% of the gas delivered from certain wells in the Giddings Field owned by usat 91% of the IF HSC Index.  The primaryterm of this gas purchase and sale agreement is through March 1, 2014, andwill continue from month to month thereafter unless terminated by either partyupon by 30 days written notice.  Theforegoing description of this agreement is qualified in its entirety byreference to the agreement, which is attached hereto as Exhibit 10.1.

 

27

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

 

A.           Exhibits

 
| 10.1   | Gas Purchase and Sale Agreement Between Copano Field  Services/Upper Gulf Coast, L.P. (“Buyer”) and Evolution Operating  Co., Inc. (“Seller”)                          |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                            |
| 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. |

 

28

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**SIGNATURES**

 

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

 

**EVOLUTION PETROLEUM CORPORATION**

(Registrant)

 

 
|   | Date: May 15, 2009 | By:    | /s/ STERLING H. MCDONALD |
|--------|-------------------------|--------|--------------------------|
|   |                    |   |                     | Sterling H. McDonald |
|   |                    |   |                     | Vice-President and Chief Financial Officer |
|   |                    |   |                     |   | Principal Financial and Accounting |
|   |                    |   |                     |   | Officer |

 

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