**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

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

** **

**For the quarterly period ended December31, 2007**

** **

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

** **

**For thetransition period from           to       **

**CommissionFile Number 001-32942**

**EVOLUTION PETROLEUM CORPORATION**

(Exact name of registrantas 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 ofprincipal executive offices and zip code)

**(713) 935-0122**

(Registrant’stelephone number, including area code)

Indicate by check mark whether the registrant (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes:   x  No: o

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

 

Largeaccelerated filer   ̈                    Accelerated filer   ̈                    Non-accelerated filer  x 

 

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

The number of shares outstanding of the registrant’scommon stock, par value $0.001, as of February 14, 2008, was 26,860,439.

 

 

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**TABLE OFCONTENTS**

 
|                                         | ** ** | **Page**                                                                                                                                |
|-----------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|
|                                    |       |                                                                                                                                    |
| **PART I.  FINANCIAL INFORMATION** |       |                                                                                                                                    |
|                                    |       |                                                                                                                                    |   |   |
| ITEM  1.                                |       | FINANCIAL  STATEMENTS                                                                                                                   |   | 2 |
|                                    |       |                                                                                                                                    |   |   |
|                                    |       | Consolidated  Balance Sheets as of December 31, 2007 (unaudited) and June 30,  2007                                           |   | 2 |
|                                    |       | Consolidated  Statements of Operations (unaudited) for the three and six months ended    December 31, 2007 and 2006 |   | 3 |
|                                    |       | Consolidated  Statements of Cash Flows (unaudited) for the six months ended December 31,  2007    and 2006               |   | 4 |
|                                    |       | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                       |   | 5 |
|                                    |       |                                                                                                                                    |   |   |
| ITEM 2.                                 |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                                             |   | 13 |
|                                    |       |                                                                                                                                    |   |   |
| ITEM 3.                                 |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                             |   | 20 |
|                                    |       |                                                                                                                                    |   |   |
| ITEM 4.                                 |       | CONTROLS AND  PROCEDURES                                                                                                                |                  | 20 |
|                                    |       |                                                                                                                                    |   |   |
| **PART II. OTHER  INFORMATION**    |       |                                                                                                                                    |
|                                    |       |                                                                                                                                    |   |   |
| ITEM 2.                                 |       | UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF  PROCEEDS                                                                             |   | 21 |
|                                    |       |                                                                                                                                    |   |   |
| ITEM 4.                                 |       | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                    |   | 21 |
|                                    |       |                                                                                                                                    |   |   |
| ITEM  6.                                |       | EXHIBITS                                                                                                                                |   | 22 |
|                                    |       |                                                                                                                                    |   |   |
| SIGNATURES                              |       | 23                                                                                                                                      |

 

1

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**PART I - FINANCIALINFORMATION**

 

**ITEM 1. CONSOLIDATED FINANCIALSTATEMENTS**

 

**EvolutionPetroleum Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                            | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| ** **                                                                                                                                                                            | ** ** | **(unaudited)**       | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                            | ** ** | ** **            | ** ** | ** **        | ** ** |
| Current Assets                                                                                                                                                                        |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                                                                                            |       | $                     | 21,476,116 |              | $          | 27,746,942 |   |
| Receivables                                                                                                                                                                           |       |                  |       |              |       |
| Oil and gas  sales                                                                                                                                                                    |       | 389,178               |       | 212,585           |       |
| Income tax                                                                                                                                                                            |       | 990,311               |       | 421,325           |       |
| Insurance                                                                                                                                                                             |       | 224,887               |       | —            |       |
| Other                                                                                                                                                                                 |       | 17,722                |       | —            |       |
| Prepaid expenses  and other current assets                                                                                                                                            |       | 455,405               |       | 540,666           |       |
| Total current  assets                                                                                                                                                                 |       | 23,553,619            |       | 28,921,518        |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Property and  equipment, net of depreciation, depletion, and amortization                                                                                                             |       |                  |       |              |       |
| Oil and gas  properties - full cost method of accounting                                                                                                                              |       | 11,140,416            |       | 5,459,553         |       |
| Other property  and equipment                                                                                                                                                         |       | 172,376               |       | 154,872           |       |
| Total property  and equipment                                                                                                                                                         |       | 11,312,792            |       | 5,614,425         |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Other assets,  net                                                                                                                                                                    |       | 372,069               |       | 370,049           |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Total assets                                                                                                                                                                          |       | $                     | 35,238,480 |              | $          | 34,905,992 |   |
|                                                                                                                                                                                  |       |                  |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                         |       |                  |       |              |       |
| Current  liabilities                                                                                                                                                                  |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                      |       | $                     | 1,887,719  |              | $          | 993,894 |   |
| Accrued  liabilities                                                                                                                                                                  |       | 584,921               |       | 595,833           |       |
| Royalties  payable                                                                                                                                                                    |       | 16,598                |       | 6,831             |       |
| Total current  liabilities                                                                                                                                                            |       | 2,489,238             |       | 1,596,558         |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Long term  liabilities                                                                                                                                                                |       |                  |       |              |       |
| Deferred tax  liability                                                                                                                                                               |       | 338,001               |       | 338,001           |       |
| Deferred rent                                                                                                                                                                         |       | 72,192                |       | 47,289            |       |
| Asset retirement  obligations                                                                                                                                                         |       | 150,544               |       | 140,998           |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Total  liabilities                                                                                                                                                                    |       | 3,049,975             |       | 2,122,846         |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Stockholders’  equity                                                                                                                                                            |       |                  |       |              |       |
| Common Stock,  par value $0.001, 100,000,000 shares authorized; 26,807,340 and 26,776,234  issued and outstanding as of December 31, 2007 and June 30, 2007,  respectively. |       | 26,807                |       | 26,776            |       |
| Additional paid-in  capital                                                                                                                                                           |       | 13,214,939            |       | 12,397,373        |       |
| Retained  earnings                                                                                                                                                                    |       | 18,946,759            |       | 20,358,997        |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Total  stockholders’ equity                                                                                                                                                      |       | 32,188,505            |       | 32,783,146        |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                      |       | $                     | 35,238,480 |              | $          | 34,905,992 |   |

 

See accompanyingnotes to consolidated financial statements.

 

2

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**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Operations**

**(unaudited)**

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** |
| ** **                                | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues                                  |       |                             |       |                           |       |   |   |   |   |
| Oil sales                                 |       | $                                | 629,171    |                           | $          | 426,459 |   | $ | 1,131,444 |   | $ | 895,483 |   |
| Gas sales                                 |       | 23,478                           |       | —                         |       | 23,478 |   | — |   |
| Price risk  management activities         |       | —                           |       | —                         |       | — |   | (14 | ) |
| Total revenues                            |       | 652,649                          |       | 426,459                        |       | 1,154,922 |   | 895,469 |   |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Operating Costs                           |       |                             |       |                           |       |   |   |   |   |
| Lease operating  expense                  |       | 366,043                          |       | 327,473                        |       | 681,048 |   | 651,592 |   |
| Production taxes                          |       | 15,808                           |       | (4,357                         | )          | 33,364 |   | 30,303 |   |
| Depreciation,  depletion and amortization |       | 123,115                          |       | 46,350                         |       | 233,559 |   | 108,221 |   |
| General and  administrative *             |       | 1,467,679                        |       | 960,515                        |       | 2,795,996 |   | 1,999,706 |   |
| Total operating  costs                    |       | 1,972,645                        |       | 1,329,981                      |       | 3,743,967 |   | 2,789,822 |   |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Loss from  operations                     |       | (1,319,996                       | )          | (903,522                       | )          | (2,589,045 | ) | (1,894,353 | ) |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Other income and  expense                 |       |                             |       |                           |       |   |   |   |   |
| Interest income                           |       | 266,740                          |       | 503,318                        |       | 607,821 |   | 1,034,113 |   |
| Loss on sale of  assets                   |       | —                           |       | (21,453                        | )          | — |   | (21,453 | ) |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Net loss before  income tax benefit       |       | (1,053,256                       | )          | (421,657                       | )          | (1,981,224 | ) | (881,693 | ) |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Income tax benefit                        |       | (282,399                         | )          | —                         |       | (568,986 | ) | — |   |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Net loss                                  |       | $                                | (770,857   | )                              | $          | (421,657 | ) | $ | (1,412,238 | ) | $ | (881,693 | ) |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Loss per common  share                    |       |                             |       |                           |       |   |   |   |   |
| Basic and  Diluted                        |       | $                                | (0.03      | )                              | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.03 | ) |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Weighted average  number of common shares |       |                             |       |                           |       |   |   |   |   |
| Basic and  Diluted                        |       | 26,777,366                       |       | 26,685,151                     |       | 26,776,800 |   | 26,668,575 |   |

 

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*General andadministrative expenses for the three month period ended December 31, 2007and 2006 included non cash stock-based compensation expense of $441,564 and$371,604, respectively. General and administrative expenses for the six monthperiod ended December 31, 2007 and 2006 included non cash stock-basedcompensation expense of $817,571and $861,477, respectively.

 

See accompanyingnotes to consolidated financial statements.

 

3

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**EvolutionPetroleum Corporation and Subsidiaries**

**Consolidated Statements of Cash Flow**

**(unaudited)**

 
| ** **                                                                                                             | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                             | ** ** | **December 31,  2007**    | ** ** | **December 31,  2006** | ** ** |
| Cash flows from  operating activities                                                                                  | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net loss                                                                                                               |       | $                              | (1,412,238 | ) | $ | (881,693 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities                                            |       |                           |       |   |   |
| Depreciation,  depletion and amortization                                                                              |       | 233,559                        |       | 108,221 |   |
| Stock-based  compensation                                                                                              |       | 817,571                        |       | 861,477 |   |
| Accretion of  asset retirement obligations                                                                             |       | 9,546                          |       | 8,376 |   |
| Changes in  operating assets and liabilities:                                                                          |       |                           |       |   |   |
| Receivables                                                                                                            |       | (988,188                       | )          | (21,212 | ) |
| Prepaid expenses  and other assets                                                                                     |       | 85,261                         |       | (99,264 | ) |
| Accounts payable  and accrued liabilities                                                                              |       | (102,658                       | )          | (536,738 | ) |
| Royalties  payable                                                                                                     |       | 9,767                          |       | (41,419 | ) |
| Deferred rent                                                                                                          |       | 24,903                         |       |   |   |
| Income tax  payable                                                                                                    |       | —                         |       | (3,660,000 | ) |
| Net cash used in  operating activities                                                                                 |       | (1,322,477                     | )          | (4,262,252 | ) |
|                                                                                                                   |       |                           |       |   |   |
| Cash flows from  investing activities                                                                                  |       |                           |       |   |   |
| Development of  oil and gas properties                                                                                 |       | (529,262                       | )          | (222,054 | ) |
| Acquisitions of  oil and gas properties                                                                                |       | (4,395,050                     | )          | (101,054 | ) |
| Proceeds from  asset sale                                                                                              |       | 31,582                         |       | 155,378 |   |
| Capital  expenditures for furniture, fixtures and equipment                                                            |       | (53,625                        | )          | (9,063 | ) |
| Cash in  qualified intermediary account for “like-kind” exchanges                                            |       | —                         |       | 34,662,368 |   |
| Retainer and  deposits                                                                                                 |       | —                         |       | 25,300 |   |
| Other assets                                                                                                           |       | (2,020                         | )          | 3,133 |   |
| Net cash (used  in) provided by investing activities                                                                   |       | (4,948,375                     | )          | 34,514,008 |   |
|                                                                                                                   |       |                           |       |   |   |
| Cash flows from  financing activities                                                                                  |       |                           |       |   |   |
| Equity and  transaction costs                                                                                          |       | —                         |       | (15,592 | ) |
| Proceeds from  issuance of restricted stock grants                                                                     |       | 26                             |       | — |   |
| Net cash  provided by (used in) financing activities                                                                   |       | 26                             |       | (15,592 | ) |
|                                                                                                                   |       |                           |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                                                                  |       | (6,270,826                     | )          | 30,236,164 |   |
|                                                                                                                   |       |                           |       |   |   |
| Cash and cash  equivalents, beginning of period                                                                        |       | 27,746,942                     |       | 9,893,547 |   |
|                                                                                                                   |       |                           |       |   |   |
| Cash and cash  equivalents, end of period                                                                              |       | $                              | 21,476,116 |   | $ | 40,129,711 |   |
|                                                                                                                   |       |                           |       |   |   |
| Supplemental  disclosure of cash flow information:                                                                     |       |                           |       |   |   |
| Income taxes  paid                                                                                                     |       | $                              | —     |   | $ | 3,660,000 |   |
| Increase in  accounts payable incurred to acquire oil and gas leasehold Interests and  develop oil and gas properties. |       | $                              | 985,571    |   | $ | — |   |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**EVOLUTIONPETROLEUM CORPORATION AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(unaudited)**

 

**Note 1 – Organization and Basis ofPreparation**

 

Headquartered in Houston, Texas, Evolution PetroleumCorporation and its subsidiaries, formerly Natural Gas Systems, Inc. (the “Company”,“EPM”, “we” or “us”), is a petroleum company incorporated under the laws of theState of Nevada, engaged primarily in the acquisition, exploitation anddevelopment of properties for the production of crude oil and natural gas.  We acquire established oil and gas propertiesand exploit them through the application of conventional and specializedtechnology to increase production, ultimate recoveries, or both.

 

Our common stock is traded on the American StockExchange (“AMEX”) under the ticker symbol EPM. Prior to July 17, 2006, our common stock was quoted on the OTCBulletin Board under the symbol NGSY.OB. Prior to May 26, 2004, our common stock was quoted on the OTCBulletin Board under the symbol RLYI.OB. Concurrently with the listing of our shares on the AMEX during July,2006, we changed our name from Natural Gas Systems, Inc. to EvolutionPetroleum Corporation to avoid confusion with similar names traded on the AMEXand to better reflect our business model.

 

At December 31, 2007, we conducted operationsthrough our 100% working interests in our Tullos Field Area and ournon-operated interests in our Delhi Field, both located onshore in Louisiana,and our 100% working interests in our Giddings field in Central Texas.  Our Tullos Field Area consists ofapproximately 156 producing wells out of 260 well bores across 599 acres ofhigh water cut primary reserve production. Our non-operated interests in the 13,636 acre Delhi Field consist of a7.4% overriding and mineral royalty interest in the Delhi Holt Bryant Unit, a25% after payout reversionary working interest in the Delhi Holt Bryant Unit,and a 25% working interest in certain other depths in the Delhi Field.  Our Delhi Holt Bryant Unit is undergoingredevelopment using CO2 enhanced oil recovery technology.  Our Giddings Field Area included provedundeveloped reserves some of which we have begun developing.

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of America (“GAAP”)with the instructions to Form 10-Q for interim financial information.  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. All inter-company transactionsare eliminated upon consolidation. The interim financial information and noteshereto should be read in conjunction with the Company’s 2007 Annual Report on Form 10-KSBfor the year ended June 30, 2007, as filed with the Securities andExchange Commission. The results of operations for interim periods are notnecessarily indicative of results to be expected for a full fiscal year.

 

**Note 2 –Recent Accounting Pronouncements**

 

***New AccountingStandards.**** *Thefollowing discloses the existence and effect of accounting standards issued butnot yet adopted by us with respect to accounting standards that may have animpact on the Company when adopted in the future.

 

****Accountingfor the Fair Value Option for Financial Assets and Financial Liabilities********.****In February 2007, the Financial Accounting Standards Board (“FASB”) issuedFASB Statement of Accounting Standards (“SFAS”) No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(“SFAS No. 159”), which permits all entities to choose, at specifiedelection dates, to measure eligible items at fair value. SFAS No. 159permits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value, and thereby mitigate volatility in reported earnings caused bymeasuring related assets and liabilities differently without having to applycomplex hedge accounting provisions. This Statement also establishespresentation and disclosure requirements designed to facilitate comparisonsbetween entities that choose different measurement attributes for similar typesof assets and liabilities. SFAS No. 159 is effective as of the beginningof an entity’s first fiscal year that begins after November 15, 2007.  We are currently evaluating the impact thatthis Statement will have on our financial statements.

 

5

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

 

***Accounting for Fair Value Measurements*.**In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements.* SFAS No. 157defines fair value, establishes a framework for measuring fair value in GAAPand expands disclosures about fair value measurements. SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007. The provisions of SFAS No. 157 will be applied prospectively as ofthe beginning of the fiscal year in which it is initially applied except for,among other items, a financial instrument that was measured at fair value atinitial recognition under Statement 133 using the transaction price inaccordance with the guidance in footnote 3 of Issue 02-3 prior to initialapplication of SFAS No. 157.  In February 2008,the FASB deferred the effective date of SFAS No. 157 by one year fornonfinancial assets and nonfinancial liabilities that are recognized ordisclosed at fair value in the financial statements on a nonrecurring basis andamended SFAS No. 157 to exclude SFAS No. 13, *Accountingfor Leases,* and it related interpretive accounting pronouncementsthat address leasing transactions. We are currently evaluating the impact thatthis Statement will have on our financial statements.

 

**Note 3 –****Property and Equipment**

 
| ** **                                                   | ** ** | **December 31,  2007** | ** ** | **June 30,   2007** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| **Oil and  gas properties**                                  |       |                        |       |                          |       |
| Proved  properties                                           |       | $                           | 7,776,886  |                          | $          | 4,187,440 |   |
| Less:  Accumulated depreciation, depletion, and amortization |       | (847,877                    | )          | (652,439                      | )          |
| Unproved  properties                                         |       | 4,211,407                   |       | 1,924,552                     |       |
| Oil and gas  properties, net                                 |       | $                           | 11,140,416 |                          | $          | 5,459,553 |   |
|                                                         |       |                        |       |                          |       |
| **Other  property and equipment**                            |       |                        |       |                          |       |
| Furniture,  fixtures and equipment, at cost                  |       | 228,830                     |       | 173,205                       |       |
| Less:  Accumulated depreciation                              |       | (56,454                     | )          | (18,333                       | )          |
| Other property  and equipment, net                           |       | $                           | 172,376    |                          | $          | 154,872 |   |

 

**Note 4 – Asset Retirement Obligations**

 

Following is a reconciliation of the beginning andending asset retirement obligation for the six month period ended December 31,2007:

 
| Asset retirement  obligation - July 1, 2007           |   | $      | 140,998 |   |
|------------------------------------------------------------|--------|--------|---------|--------|
| Liabilities  incurred                                      |   | — |    |
| Liabilities  settled                                       |   | — |    |
| Accretion                                                  |   | 9,546  |    |
| Asset retirement  obligation – December 31, 2007 |   | $      | 150,544 |   |

 

6

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**Note 5 – Stock-Based Incentive Plan**

 

Stockholders of record, as of October 15, 2007,voted at the 2007 Annual Meeting of Stockholders on December 4, 2007 toapprove amendments to the 2004 Stock Plan to increase the number of shares ofcommon stock we may authorize to issue from 4,000,000 shares to 5,500,000shares and to make certain clarifying changes and amendments as part of theapproval of the Evolution Petroleum Corporation Amended and Restated 2004 StockPlan.

 

We granted stock optionawards to purchase common stock and restricted stock to employees, directors,and consultants of the Company and its subsidiaries under the Natural GasSystems Inc. 2003 Stock Plan (the “2003 Stock Plan”) and the EvolutionPetroleum Corporation Amended and Restated 2004 Stock Plan (the “2004 StockPlan” and together, the “EPM Stock Plans”). A total of 600,000 shares were reserved for issuance under the 2003Stock Plan, of which, there are no remaining shares available for grant.  A total of 5,500,000 shares are reserved forissuance under the 2004 Stock Plan and, as of December 31, 2007, 1,415,859shares remained available for grant under the 2004 Stock Plan.

 

We have also grantedcommon stock warrants, as authorized by the Board of Directors, to employees asbonus or  incentive awards to rewardprevious service or provide incentives to individuals to acquire a proprietaryinterest in the Company and to remain in the service of the Company (the “IncentiveWarrants”).  These Incentive Warrantshave similar characteristics of stock option awards.  They have been issued, with Board ofDirectors approval, outside of the 2004 Stock Plan.

 

***IncentiveStock Options and Warrants***

 

For the three monthperiod ended December 31, 2007 and 2006, total stock based compensationexpense recognized for common stock options and Incentive Warrants was $403,109and $301,091, respectively.  Stock-basedcompensation expense related to the six month period ended December 31,2007 and 2006 was $704,206 and $684,616, respectively.

 

During the six monthperiod ended December 31, 2007, we granted options to purchase 1,335,000shares of common stock under the 2004 Stock Plan with a weighted averageexercise price of $2.43.  During the sameperiod in 2006, we granted options to purchase 150,000 shares of common stockunder the 2004 Stock Plan with a weighted average exercise price of $2.71.  The exercise price was determined based onthe market price of the Company’s common stock at the date of grant.  The stock options granted during the sixmonths ended December 31, 2007 vest over a weighted average period of 4.0years and have a contractual life of ten years. The weighted average assumptions used to calculate the fair value ofthese options and the weighted average fair value of these options are asfollows:

 
| ** **                | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **December 31,**          | ** ** |
| ** **                | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| Expected  volatility      |       | 94.0                           | %          | 96.0 | % |
| Expected  dividends       |       | —                         |       | — |   |
| Expected term  (in years) |       | 6.10                           |       | 6.10 |   |
| Risk-free rate            |       | 4.11                           | %          | 4.56 | % |
| Fair value                |       | $                              | 1.90       |   | $ | 2.15 |   |
|                           |            |                                |            |  |  |  |  |

 

We estimated the fairvalue of stock options and Incentive Warrants issued to employees and directorsunder SFAS No. 123R at the date of grant using a Black-Scholes-Mertonvaluation model.  The risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant.  The expected term (estimated period of timeoutstanding) of option grants and Incentive Warrants is based on the “simplified”method of estimated expected term for “plain vanilla” options allowed by theSEC Staff Accounting Bulletin No. 107 and 110, and varied based on thevesting period and contractual term of the stock options or IncentiveWarrants.   Expected volatility is basedon the historical volatility of the Company’s closing common stock price andthat of an evaluation of a peer group of similar companies tradingactivity.  We have not issued any cashdividends on the Company’s common stock.

 

7

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**Note 5 – Stock-Based Incentive Plan**(Continued)

 

The following summarypresents information regarding outstanding options and Incentive Warrants as ofDecember 31, 2007, and the changes during the six months then ended:

 
| ** **                                                       | ** ** | **Number of  Stock  Options  and Incentive  Warrants** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value  (1)** | ** ** | **Weighted   Average   Remaining  Contractual  Term (in   years)** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                                                             |       |                                                                       |       |                                           |       |                                     |       |                                                                                   |       |
| Options and  warrants outstanding at July 1, 2007           |       | 4,058,500                                                                  |       | $                                              | 1.53       |                                     |       |                                                                                   |       |   |
|                                                             |       |                                                                       |       |                                           |       |                                     |       |                                                                                   |       |
| Granted                                                          |       | 1,335,000                                                                  |       | $                                              | 2.43       |                                     |       |                                                                                   |       |   |
| Exercised                                                        |       | —                                                                     |       | —                                         |       |                                     |       |                                                                                   |       |
| Canceled,  forfeited, or expired                                 |       | —                                                                     |       | —                                         |       |                                     |       |                                                                                   |       |
|                                                             |       |                                                                       |       |                                           |       |                                     |       |                                                                                   |       |
| Options and  warrants outstanding at December 31, 2007 |       | 5,393,500                                                                  |       | $                                              | 1.76       |                                     | $          | 17,771,275                                                                             |       | 8.0 |   |
|                                                             |       |                                                                       |       |                                           |       |                                     |       |                                                                                   |       |
| Vested or  expected to vest at December 31, 2007            |       | 5,393,500                                                                  |       | $                                              | 1.76       |                                     | $          | 17,771,275                                                                             |       |   |   |
|                                                             |       |                                                                       |       |                                           |       |                                     |       |                                                                                   |       |
| Exercisable at  December 31, 2007                           |       | 2,861,000                                                                  |       | $                                              | 1.39       |                                     | $          | 10,497,006                                                                             |       | 7.2 |   |

 

----

(1) Based upon thedifference between the market price of our common stock on the last tradingdate of the quarter and the option or Incentive Warrant exercise price ofin-the-money options and Incentive Warrants.

 

A summary of the statusof our unvested stock options and Incentive Warrants as of December 31,2007, and the changes during the six months ended December 31, 2007, ispresented below:

 
| ** **                       | ** ** | **Number of   Options and   Warrants** | ** ** | **Weighted   Average Grant-  Date Fair Value** | ** ** |
|----------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
|                             |       |                                                       |       |                                                               |       |
| Unvested at  July 1, 2007   |       | 1,573,125                                                  |       | $                                                                  | 1.50       |   |
|                             |       |                                                       |       |                                                               |       |
| Granted                          |       | 1,335,000                                                  |       | $                                                                  | 1.90       |   |
|                             |       |                                                       |       |                                                               |       |
| Vested                           |       | (375,625                                                   | )          | $                                                                  | 1.35       |   |
|                             |       |                                                       |       |                                                               |       |
| Canceled,  forfeited, or expired |       | —                                                     |       | —                                                             |       |
|                             |       |                                                       |       |                                                               |       |
| Unvested at end  of period       |       | 2,532,500                                                  |       | $                                                                  | 1.73       |   |

 

The total unrecognizedcompensation cost at December 31, 2007, relating to non-vested share-basedcompensation arrangements granted under the EPM Stock Plans and previouslyissued Incentive Warrants, was $4,006,561. Such unrecognized expense will be recognized as vesting occurs over aweighted average period of 3.0 years.

 

8

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**Note 5 – Stock-Based Incentive Plan**(Continued)

 

**Restricted Stock**

 

For the six months ended December 31,2007, we granted a total of 25,899 shares of restricted common stock to threeoutside directors.  All issuances ofcommon stock are subject to vesting terms per individual stock agreements.

 

During the three monthsended December 31, 2007 and 2006, we recognized compensation expense of$38,455 and $70,513, respectively, related to restricted stock grants.  During the six months ended December 31,2007 and 2006, we recognized compensation expense of $113,365 and $176,861,respectively, related to restricted stock grants.

 

The following table setsforth the restricted stock transactions for the six months ended December 31,2007:

 
| ** **                     | ** ** | **Number of   Restricted   Shares** | ** ** | **Weighted   Average  Grant-Date  Fair Value** | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------|------------|
|                           |       |                                               |       |                                                     |       |
| Unvested at  July 1, 2007 |       | 59,449                                             |       | $                                                        | 2.78       |   |
|                           |       |                                               |       |                                                     |       |
| Granted                        |       | 25,899                                             |       | 4.17                                                     |       |
|                           |       |                                               |       |                                                     |       |
| Vested                         |       | (59,449                                            | )          | 2.78                                                     |       |
|                           |       |                                               |       |                                                     |       |
| Forfeited                      |       | —                                             |       | —                                                   |       |
|                           |       |                                               |       |                                                     |       |
| Unvested at end  of period     |       | 25,899                                             |       | $                                                        | 4.17       |   |

 

At December 31,2007, unrecognized stock compensation expense related to restricted stockgrants totaled approximately $107,973. Such unrecognized expense will be recognized as vesting occurs over aweighted average period of 0.9 years.

 

**Note 6 – Commodity Hedging and Price RiskManagement Activities**

 

As of February 28,2007, all of the Company’s commodity hedging and price risk managementactivities had expired and were not renewed.

 

**Note 7 – Income Taxes**

 

*UncertainTax Positions*

 

We did not have anyunrecognized tax benefits and there was no effect on our financial condition orresults of operations as a result of implementing Interpretation No. 48 *Accounting for Uncertainty in Income Taxes-an Interpretation of FASBStatement No. 109* (“FIN48”).  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, Accountingfor Income Taxes. FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. FIN 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.

 

The amount ofunrecognized tax benefits may change in the next twelve months; however we donot expect the change to have a significant impact on the results of operationsor the financial position of the Company.

 

We file a consolidatedfederal income tax return in the United States and various combined and separatefilings in several state and local jurisdictions.   With limited exceptions, the Company is nolonger subject to U.S. Federal, state and local income tax examinations by taxauthorities for years before fiscal year ended June 30, 2004.  There is currently an Internal RevenueService (“IRS”) field examination in process for the fiscal year ended June 30,2006. The examination is in the beginning stages and no projections as to theoutcome can be made at this time.

 

9

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**Note 7 – Income Taxes**  (Continued)

 

The Company’s continuingpractice is to recognize estimated interest and penalties related to potentialunderpayment on any unrecognized tax benefits as a component of income taxexpense in the Consolidated Statement of Operations. As of the date ofadoption of FIN 48, the Company did not have any accrued interest or penaltiesassociated with any unrecognized tax benefits, nor was any interest expenserecognized during the quarter.  We do notanticipate that total unrecognized tax benefits will significantly change dueto the settlement of audits and the expiration of statute of limitations priorto December 31, 2008.

 

We account for incometaxes in accordance with SFAS No. 109,*Accounting for Income Taxes* (“SFAS 109”). SFAS No. 109requires us to recognize income tax benefits for loss carry forwards which havenot previously been recorded. The tax benefits recognized must be reducedby a valuation allowance when it is more likely than not that the deferred taxasset will not be realized.

 

In determining thecarrying value of a deferred tax asset, SFAS 109 provides for the weighing ofevidence in estimating whether and how much of a deferred tax asset may berecoverable.  We have placed a valuationallowance on certain deferred tax assets primarily inclusive of net operatinglosses (“NOL’s”) that are limited by Internal Revenue Code Section 382.   The Company had taxable income in 2006 andthus paid both federal and state income taxes. A benefit is being recognized with the intention of carrying back thecurrent year tax loss to 2006. Sufficient income is available in 2006 to fully utilize the lossescreated in the current year.  Therefore,management believes no valuation allowance is necessary on the income taxbenefit arising from the taxable loss in the current year.

 

The income tax benefitrate of 29% varies from the U.S. statutory rate primarily due to state incometaxes partially offset by disallowed compensation costs related to incentivestock options.

 

**Note 8 – Related Party Transactions**

 

Laird Q. Cagan, Chairman of our Board, is a ManagingDirector and co-owner of Cagan McAfee Capital Partners, LLC (“CMCP”). CMCPperforms financial advisory services to us pursuant to a written agreementamended in November 2005, providing for a retainer of $5,000 per month. Inaddition, Mr. Cagan, as a registered representative of ChadbournSecurities Inc. (“Chadbourn”) and a partner of CMCP, has served as the Company’splacement agent in private equity financings. Under the current agreement, CMCP may earn cash fees equal to 8% ofgross equity proceeds, declining to 4% subject to the amount of equity raised,and a fixed 4% warrant fee.  Mr. Caganreceives no additional compensation for serving as a director or as theChairman of our Board.

 

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

 

During the three and six months ended December 31,2007 and 2006 respectively, we expensed and paid CMCP $15,000 and $30,000,respectively, in quarterly retainers. There were no other earned fees by CMCP.

 

10

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**Note 9 –****Net Loss per Share**

 

Basic and diluted loss per share are computed bydividing net loss available to common shareholders by the weighted averagenumber of common shares outstanding during the period.  For purposes of computing diluted loss pershare, potential common shares have been excluded from the computation ofweighted average common shares outstanding, because their effect is antidilutive.

 

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

 
| ** **                                                    | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| *Numerator*                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                      |       | $                                                   | (770,857   | )                                                 | $          | (421,657 | ) | $ | (1,412,238 | ) | $ | (881,693 | ) |
|                                                          |       |                                                |       |                                              |       |   |   |   |   |
| *Denominator*                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  number of common shares - basic and diluted |       | 26,777,366                                          |       | 26,685,151                                        |       | 26,776,800 |   | 26,668,575 |   |
|                                                          |       |                                                |       |                                              |       |   |   |   |   |
| Net Loss per  common share – basic and diluted           |       | $                                                   | (0.03      | )                                                 | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.03 | ) |

 

**Note10 – 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, and this is supported by the formal findings of thelaboratory.  We also believe that most ofthe approximately $700,000 of estimated costs to be incurred in the cleanup,before adjustment following audit, will be covered by insurance orreimbursement from the relevant government oil spill funds.  We received insurance proceeds of $484,197 inOctober 2007.  Furthermore, we haverecorded an insurance receivable of $224,887 for costs incurred through December 31,2007.  Clean up costs that aren’t coveredby insurance are expensed as incurred.

 

***Litigation.***  In November 2005, a multi-plaintifflawsuit was filed in the Fifth Judicial District Court, Richland Parish, Louisiana,against 18 defendants including NGS Sub Corp. and Arkla Petroleum LLC, theCompany’s wholly owned subsidiaries (the “Subsidiaries”), as working interestowners/operators of various oil and gas leases in the Delhi Field. Plaintiffsclaim that the defendants’ oil and 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 to the individual plaintiffs,unjust enrichment and punitive damages for alleged concealment of ongoingactivities.

 

Certain exceptions filedby the defendants are still under consideration by the court.  Discovery has begun and the allegations ofplaintiffs’ suit are so vague that the specifics of their claims cannot bedetermined yet with certainty. Accordingly, the court has ordered the plaintiffs to file their claims withspecificity.  Trial is set before a juryin Richland Parish for the first two weeks of September 2008.

 

Management intends tocontest plaintiffs’ claims vigorously. The plaintiffs have not produced any evidence of specific damage totheir lands by defendants’ oil and gas operations.  While the Delhi Field has been in productionfor over fifty years, we believe that no contamination of significance occurredduring the Subsidiaries’ period of ownership of the Delhi operating interestsand Arkla Petroleum LLC as operator of said interests, beginning with ouracquisitions of each in 2003 and ending with the our disposition of the Delhioperating interests in 2006.  We believethat our liability exposure results largely through any potential contractualindemnity of prior working interest owners. Until such time as the specifics of plaintiffs’ claims are identifiedthrough the discovery process, and particularly any evidence of actualcontamination of soil or groundwater, the amount of any judgment that might berendered cannot be determined with accuracy.

 

11

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**Note 10 – Commitments andContingencies**(Continued)

 

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

 

***Lease Commitments.***  We have a non-cancelable operating lease foroffice space that expires on August 1, 2016. Future minimum lease commitmentsas of December 31, 2007 under this operating lease are as follows:

 
| **Twelve months ending December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|
| 2008                                                      |       | $          | 138,089    |   |
| 2009                                                      |       | 138,089    |       |
| 2010                                                      |       | 138,089    |       |
| 2011                                                      |       | 146,806    |       |
| 2012                                                      |       | 159,012    |       |
| Thereafter                                                |       | 569,790    |       |
| Total                                                     |       | $          | 1,289,875  |   |

 

Rent expense for thethree months ended December 31, 2007 and 2006 was $35,466 and $10,730,respectively.  Rent expense for the six months ended December 31,2007 and 2006 was $70,933 and $21,461, respectively.

 

***EmploymentContracts.***  We haveentered into employment agreements with the Company’s three seniorexecutives.  The employment contractsprovide for a severance package for termination by the Company for any reasonother than cause or permanent disability, that includes payment of base pay andcertain medical and disability benefits from six months to a year aftertermination.   The total obligation underthe employment contracts as of December 31, 2007 is approximately$450,000.

 

***InternalRevenue Service Examination.***  We file a consolidated federal income taxreturn in the United States and various combined and separate filings inseveral state and local jurisdictions.  With limited exceptions, the Company is no longer subject to U.S.Federal, state and local income tax examinations by tax authorities for yearsbefore fiscal year ending June 30, 2004. There is currently an IRS examination in process for the fiscal yearended June 30, 2006. The examination is in the beginning stages and noprojections as to the outcome can be made at this time.

 

**Note11 – Subsequent Events**

 

On February 12,2008, we entered into a consulting agreement with the Liviakis FinancialCommunications, which expires December 31, 2008, Inc. to provideinvestor relations services for the Company. In exchange for these services,the Company issued 50,000 shares of common stock, which is subject to monthlyvesting, over the term of the agreement.

 

12

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**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

*This Form 10-Q and theinformation referenced herein contain forward-looking statements within themeaning of the Private Securities Litigations Reform Act of 1995, Section 27Aof the Securities Act of 1933 and Section 21E of the Securities Exchange Act of1934 . The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,” “anticipate,”“intend,” “budget,” “forecast,” “predict” and other similar expressions areintended to identify forward-looking statements. These statements appear in anumber of places and include statements regarding our plans, beliefs or currentexpectations, including the plans, beliefs and expectations of our officers anddirectors.* *When considering anyforward-looking statement, you should keep in mind the risk factors that couldcause our actual results to differ materially from those contained in anyforward-looking statement. Important factors that could cause actual results todiffer materially from those in the forward-looking statements herein includethe timing and extent of changes in commodity prices for oil and gas, operatingrisks and other risk factors as described in our 2007 Annual Report on Form 10-KSBfor the year ended June 30, 2007 as filed with the Securities and ExchangeCommission. Furthermore, the assumptions that support our forward-lookingstatements are based upon information that is currently available and issubject to change. We specifically disclaim all responsibility to publiclyupdate any information contained in a forward-looking statement or anyforward-looking statement in its entirety and therefore disclaim any resultingliability for potentially related damages. All forward-looking statementsattributable to Evolution Petroleum Corporation are expressly qualified intheir entirety by this cautionary statement.*

 

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

 

**Critical Accounting Policies**

 

Our 2007 Annual Report onForm 10-KSB describes the accounting policies that we believe are criticalto the reporting of our financial position and operating results and thatrequire management’s most difficult, subjective or complex judgments.

 

This Quarterly Report on Form 10-Q should be readin conjunction with the discussion contained in our 2007 Annual Report on Form 10-KSBregarding these critical accounting policies.

 

**Executive Overview**

 

*General*

 

Evolution Petroleum Corporation, formerly Natural GasSystems, Inc., is a petroleum company engaged primarily in theacquisition, exploitation and development of properties for the production ofcrude oil and natural gas. We acquire established oil and gas properties andexploit them through the application of conventional and specialized technologyto increase production, ultimate recoveries, or both.

 

We are focused on an overall strategy of acquiringcontrolling working interests in oil and gas resources within establishedfields and redeveloping those fields through the application of capital andtechnology to convert a portion of the oil and gas resources into profitableproducing reserves. Our strategy is intended to generate scalable developmentopportunities at normally pressured depths, exhibiting relatively lowcompletion risk, generally longer and more predictable production lives, lessexpenditures on infrastructure and lower operational risks.

 

Within this overall strategy, we pursue three specificinitiatives:

 
|        | I      |   | Enhanced oil recovery (EOR), using miscible and  immiscible gas flooding;                        |
|--------|--------|--------|--------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                             |
|   | II     |   | Bypassed primary resource development, within mature  oil and gas fields; and                    |
|   |   |   |                                                                                             |
|   | III    |   | Unconventional gas reservoir development, using  modern stimulation and completion technologies. |

 

13

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Our Initiative I EOR project at the 13,636 acre DelhiField, located in northeast Louisiana, is currently our most strategicasset.  These non-operated interestsconsist of 7.4% in overriding and mineral royalty interests in the Delhi FieldHolt Bryant Unit, a 25% after pay-out reversionary working interest in theDelhi Field Holt Bryant Unit, and a 25% working interest in certain otherdepths in the Delhi Field.  The HoltBryant Unit is being redeveloped by the operator, Denbury Resources, using CO2enhanced oil recovery technology, with CO2 injection expected by the operatorin calendar 2008, followed by projected increases in oil production beginningin calendar 2009.  Since we are not theoperator of the Delhi Field, we have no control of the timing or the success offield operations.  Since our closing ofthe Delhi CO2 Farmout, we have been focused on bringing Initiative II BypassedResource projects, Initiative III Unconventional Gas Resource projects and newInitiative I EOR projects to the forefront. Conceptually, our plan going forward can be illustrated as follows:

 

As indicated by the above chart, we are funding ourBypassed Resource projects with our cash resources. We expect that net cashflows from these projects, our current cash resources and cash flows from DelhiCO2 project will be used to fund our Unconventional Gas Initiative and newprojects spanning all of our initiatives.

 

*First and Second Fiscal Quarter2008 Highlights*

 

Our progress during the six months ended December 31,2007 includes:

 

·                  Initial drillingoperations in our Bypassed Resource projects, which began in December 2007;

 

·                  Development ofour operational infrastructure and vendor network to support a continuousdrilling program;

 

·                  Additionalleasehold acquisitions of proved undeveloped reserves within our Bypassed Resourceprojects; and

 

·                  Additionalacquisitions of unproved leasehold acreage within our Bypassed Resource andUnconventional Gas Development projects.

 

At December 31, 2007, weconducted operations through our 100% working interests in our Tullos Field Areaand our non-operated interests in our Delhi Field, both located on shore inLouisiana, and our 100% working interests in our Giddings field in CentralTexas. As of January 31, 2008, we have acquired approximately 13,000 grossand net acres within our Unconventional Gas Resource Initiative and 11,500gross and net acres within our Bypassed Resource Initiative.

 

14

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**Liquidity and Capital Resources**

 

At December 31,2007, our working capital, predominately cash and cash equivalents, wasapproximately $21.1 million, and we continued to be debt free.  This compares to working capital ofapproximately $27.3 million at June 30, 2007.  Of the $6.2 million decrease in workingcapital, $5.9 million was used for capital expenditures on oil and gasleasehold and development costs.

 

For the six months ended December 31,2007, approximately $1.3 million was used in operations primarily throughchanges in working capital.  Thiscompares to approximately $4.3 million used in operations for the six monthsended in 2006, which includes $3.7 million used to extinguish income taxespayable.

 

Cash flows used ininvesting activities totaled approximately $4.9 million during the six monthsended December 31, 2007 This compared to approximately $34.5 millionprovided by investing activities for the comparable six months of 2006.  During the six months ended December 31,2006, $34.7 million was received by us from a qualified intermediary accountinto our operating account and approximately $0.2 million of cash was used forinvestments to acquire and develop oil and gas property interests.  During the six months ended December 31,2007 approximately $4.9 million of cash was used for investments to acquire anddevelop oil and gas property interests, which does not include approximately$1.0 million in oil and gas expenditures remaining unpaid and carried in accountspayable as of December 31, 2007.

 

Cash flows from financingactivities during the six months ended December 31, 2007, included cashproceeds received with issuance of restricted stock grants to three independentdirectors.  During the same period in2006, we incurred approximately $15,592 of costs related to filing registrationstatements for previous equity raising matters.

 

We expect our capitalexpenditures will increase substantially during fiscal year 2008, due tocontinued leasing and the execution of a development drilling program withinour Bypassed Resource Initiative, and continued leasing in our UnconventionalGas Initiative. Based on our current plans, we expect capital expenditures toexceed $15 million during fiscal 2008, with $8.5 million dedicated todevelopment drilling and the balance to leasehold acquisitions.  We believe our working capital is sufficientto fund this drilling program.

 

15

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**Results of Operations**

 

***Three months ended December 31,2007 compared to three months ended December 31, 2006***

 

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

 
| ** **                                         | ** ** | **Three Months Ended  December 31** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                         | ** ** | ** **                                         | ** ** | ** ** | **%**      | ** **   |
| ** **                                         | ** ** | **2007**                                           | ** ** | **2006**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                               |       |                                               |       |       |       |         |       |   |   |
| **Sales  Volumes, net to Evolution:**              |       |                                               |       |       |       |         |       |   |   |
|                                               |       |                                               |       |       |       |         |       |   |   |
| Oil (Bbl)                                          |       | 7,315                                              |       | 6,080      |       | 1,235        |       | 21 | % |
|                                               |       |                                               |       |       |       |         |       |   |   |
| Gas (Mcf)                                          |       | 3,617                                              |       | —     |       | 3,617        |       | — |   |
|                                               |       |                                               |       |       |       |         |       |   |   |
| Oil and Gas  (Boe)                                 |       | 7,918                                              |       | 6,080      |       | 1,838        |       | 31 | % |
|                                               |       |                                               |       |       |       |         |       |   |   |
| **Revenue  data (a):**                             |       |                                               |       |       |       |         |       |   |   |
|                                               |       |                                               |       |       |       |         |       |   |   |
| Oil revenues                                       |       | $                                                  | 629,171    |       | $          | 426,459      |       | $ | 202,712 |   | 48 | % |
|                                               |       |                                               |       |       |       |         |       |   |   |
| Gas revenues                                       |       | 23,478                                             |       | —     |       | 23,478       |       | — |   |
| Total oil and  gas revenues                        |       | $                                                  | 652,649    |       | $          | 426,459      |       | $ | 226,190 |   | 53 | % |
|                                               |       |                                               |       |       |       |         |       |   |   |
| **Average  prices (a):**                           |       |                                               |       |       |       |         |       |   |   |
| Oil (per Bbl)                                      |       | $                                                  | 86.01      |       | $          | 70.14        |       | $ | 15.87 |   | 23 | % |
| Gas (per Mcf)                                      |       | 6.49                                               |       | —     |       | 6.49         |       | — |   |
| Oil and Gas (per  Boe)                             |       | $                                                  | 82.43      |       | $          | 70.14        |       | $ | 12.29 |   | 18 | % |
|                                               |       |                                               |       |       |       |         |       |   |   |
| **Expenses  (per Boe)**                            |       |                                               |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes (b) |       | $                                                  | 46.39      |       | $          | 53.14        |       | $ | (6.75 | ) | 13 | % |
| Depletion  expense on oil and gas properties       |       | $                                                  | 13.30      |       | $          | 7.65         |       | $ | 5.65 |   | 74 | % |

 

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(a)          Includes the cash settlement of hedgingcontracts in the prior year

 

(b)         Excludes non-recurring oil spill expenses inthe current period of $14,532

 

Net Loss. For the three months endedDecember 31, 2007, we reported a net loss of  $770,857, or $0.03 loss per share (which,included approximately $0.6 million of non-cash charges related to stock basedcompensation and depreciation, depletion, and amortization), on total oil andgas revenues of $652,649, as compared to a net loss of $421,657, or $0.02 lossper share (which, included approximately $0.4 million of non-cash chargesrelated to stock based compensation and depreciation, depletion, andamortization), on total oil and gas revenues of $426,459 for the three monthsended December 31, 2006.  Theincrease to our net loss is primarily attributable to increases in general andadministrative expenses of $507,164, primarily related to increased staff costsnecessary to initiate our ten well drilling program and higher administrative costs,a decrease in interest income earned of $236,578, offset by an income taxbenefit of $282,399 in the quarter ended December 31, 2007 as compared tono income tax benefit in the 2006 quarter. Additional details of the components of net loss are explained ingreater detail below.

 

Sales Volumes  Oil and gas sales volumes, net to ourinterest, for the three months ended December 31, 2007 increased 31% to7,918 barrels of oil equivalent, compared to 6,080 BOE for the three monthsended December 31, 2006.  Theincrease in oil and gas sales volumes is due primarily to first production ofoil and natural gas in Texas as compared to the three month period ended December 31,2006 and the sale of excess oil inventory in the Tullos Field Area notpreviously saleable. The initial oil and gas production in Texas occurredduring re-entry operations of wells in preparation for drilling.

 

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Production.  Oil production varies from oil sales volumesby changes in crude oil inventories, which are not carried on our balancesheet.  Net working interest oil and gasproduction for the three months ended December 31, 2007 increased 7% to6,987 Bbls, compared to 6,542 Bbls for the three months ended December 31,2006.  The increase is primarily due to oiland natural gas production from our first well in Texas, offset by lowerproduction in Tullos due to the lack of field services during the quarter.

 

Oil and Gas Revenues.  Revenues presented in the table above anddiscussed herein represent revenue from sales of our oil and natural gasproduction volumes, net to our interest. Production sold under fixed price delivery contracts, which have beendesignated for the normal purchase and sale exemption under SFAS 133, are alsoincluded in these amounts.  Realized pricesmay differ from market prices in effect during the periods, depending on whenthe fixed delivery contract was executed.

 

Oil and gas revenues increased 53% for the threemonths ended December 31, 2007, compared to the same period in 2006, as aresult of a 18% increase in the price of a barrel of oil equivalent (“BOE”),from $70 per BOE to $82 per BOE, and a 31% increase in sales volumes asdescribed above.  The average sales priceincrease includes the effect of current quarter sales being 85% oil compared to100% in the prior quarter.

 

Lease Operating Expenses (including productionseverance taxes). Lease operating expenses for the three months ended December 31,2007 increased approximately 12% from the comparable 2006 period. The overallincrease in lease operating expenses in 2007 is primarily attributable tohigher field expenses in our Tullos Field. On a BOE basis, lease operating expenses decreased by 13% over thecomparable 2006 quarter, primarily due to an increase in sales volumes.

 

General and Administrative Expenses (G&A).  G&A expenses increased 53% toapproximately $1.5 million for the three months ended December 31, 2007,compared to approximately $1 million for the three months ended December 31,2006.  Higher overall compensation expensesfor estimated accrued bonuses (whereas we did not accrue for bonuses in theprior comparable period) and new hires accounted for the majority of theincrease, in addition to increases to franchise taxes owed for the State ofTexas.  New hires are associated withbuilding up our infrastructure to execute the planned drilling program.Non-cash stock compensation expense was $441,564 and $371,604 for the threemonths ended December 31, 2007 and 2006, respectively.

 

Depreciation, Depletion & Amortization Expense(DD&A).  DD&Aexpense increased $77,765 to $123,115 for the three months ended December 31,2007 from $46,350 for the same period in 2006. The increase is primarily due to a higher depletion rate ($13 vs. $8)per barrel.  The increase in depletion isdue to the higher cost of Proved Undeveloped reserves at our Giddings fieldadded to our lower cost Proved Developed Producing reserves from our TullosField Area.

 

Interest Income.  Interest income for the three months ended December 31,2007 decreased $236,578 to $266,740, compared to $503,318 for the three monthsended December 31, 2006.  Thedecrease in interest income is primarily due to lower available cash balancesaveraging approximately $23.4 million during most of the current quarter, ascompared to cash balances averaging approximately $40 million in the comparableprior year quarter.  The lower cashbalance is due to cash used to relieve income taxes payable arising from the$50 million we received from the Delhi Farmout and for additions to our oil andgas properties.

 

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***Six months ended December 31,2007 compared to six months ended December 31, 2006***

 

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

 
| ** **                                         | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|------------|------------|--------------|------------|
| ** **                                         | ** ** | **December 31**           | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                         | ** ** | **2007**                       | ** ** | **2006**   | ** ** | **Variance** | ** ** | **change** | ** ** |
|                                               |       |                           |       |       |       |         |       |   |   |
| **Sales  Volumes, net to Evolution:**              |       |                           |       |       |       |         |       |   |   |
|                                               |       |                           |       |       |       |         |       |   |   |
| Oil (Bbl)                                          |       | 14,349                         |       | 13,775     |       | 574          |       | 5 | % |
|                                               |       |                           |       |       |       |         |       |   |   |
| Gas (Mcf)                                          |       | 3,617                          |       | —     |       | 3,617        |       | — |   |
| Oil and Gas  (Boe)                                 |       | 14,952                         |       | 13,775     |       | 1,177        |       | 9 | % |
|                                               |       |                           |       |       |       |         |       |   |   |
| **Revenue  data (a):**                             |       |                           |       |       |       |         |       |   |   |
|                                               |       |                           |       |       |       |         |       |   |   |
| Oil revenues                                       |       | $                              | 1,131,444  |       | $          | 895,469      |       | $ | 235,975 |   | 27 | % |
|                                               |       |                           |       |       |       |         |       |   |   |
| Gas revenues                                       |       | 23,478                         |       | —     |       | 23,478       |       | — |   |
| Total oil and  gas revenues                        |       | $                              | 1,154,922  |       | $          | 895,469      |       | $ | 259,453 |   | 29 | % |
|                                               |       |                           |       |       |       |         |       |   |   |
| **Average  prices (a):**                           |       |                           |       |       |       |         |       |   |   |
| Oil (per Bbl)                                      |       | $                              | 78.86      |       | $          | 65.01        |       | $ | 13.85 |   | 23 | % |
| Gas (per Mcf)                                      |       | 6.50                           |       | —     |       | 6.50         |       | — |   |
| Oil and Gas (per  Boe)                             |       | $                              | 77.25      |       | $          | 65.01        |       | $ | 12.24 |   | 19 | % |
|                                               |       |                           |       |       |       |         |       |   |   |
| **Expenses  (per Boe)**                            |       |                           |       |       |       |         |       |   |   |
| Lease operating  expenses and production taxes (b) |       | $                              | 45.23      |       | $          | 49.50        |       | $ | (4.27 | ) | 9 | % |
| Depletion  expense on oil and gas properties       |       | $                              | 13.21      |       | $          | 7.69         |       | $ | 5.52 |   | 72 | % |

 

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(c)          Includes the cash settlement of hedgingcontracts in the prior year

 

(d)         Excludes non-recurring oil spill expenses inthe current period of $38,123

 

Net Loss. For the six months ended December 31,2007, we reported a net loss of $1,412,238, or $0.05 loss per share (which,included approximately $1.1 million of non-cash charges related to stock basedcompensation and depreciation, depletion, and amortization), on total oil andgas revenues of $1,154,922, as compared to a net loss of $881,693, or $0.03loss per share (which, included approximately $1.0 million of non-cash chargesrelated to stock based compensation and depreciation, depletion, andamortization), on total oil and gas revenues of $895,469 for the six monthsended December 31, 2006.  Theincrease to our net loss is primarily attributable to increases to General andAdministrative expenses of $796,290 as described below and a decrease ininterest income earned of $426,292, offset by an income tax benefit of $568,986in the six months ended December 31, 2007 as compared to no income taxbenefit in the six months ended December 31, 2006.  Additional details of the components of netloss are explained in greater detail below.

 

Sales Volumes.  Oil and gas sales volumes, net to ourinterest, for the six months ended December 31, 2007 increased 9% to 14,952BOE, compared to 13,775 BOE for the six months ended December 31,2006.  The increase in oil and gas salesvolumes is due primarily to first production oil and natural gas in Texas ascompared to the three month period ended December 31, 2006 and the sale ofexcess oil inventory in the Tullos Field Area not previously saleable.

 

Production.  Oil production varies from oil sales volumesby changes in crude oil inventories, which are not carried on our balancesheet.  Net working interest oil and gasproduction for the six months ended December 31, 2007 decreased slightlyto 14,132 BOE, compared to 14,144 BOE for the six months ended December 31,2006.  This was primarily due to adecrease in oil production in our Tullos Field Area, offset by production fromour Texas field. The initial oil and gas production in Texas occurred duringre-entry operations of wells in preparation for drilling.

 

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Oil and Gas Revenues.  Revenues presented in the table above anddiscussed herein represent revenue from sales of our oil and natural gasproduction volumes, net to our interest. Production sold under fixed price delivery contracts, which have beendesignated for the normal purchase and sale exemption under SFAS 133, are alsoincluded in these amounts.  Realizedprices may differ from market prices in effect during the periods, depending onwhen the fixed delivery contract was executed.

 

Oil and gas revenues increased 29% for the six monthsended December 31, 2007, compared to the same period in 2006, as a resultof a 19% increase in the price of a barrel of oil equivalent (“BOE”), from $65per BOE to $77 per BOE, and a 9% increase in sales volumes as described above.

 

Lease Operating Expenses (including production severancetaxes).  Leaseoperating expenses for the six months ended December 31, 2007 increasedapproximately 5% from the comparable 2006 period. The overall increase in leaseoperating expenses in 2007 is primarily attributable to higher field expensesin our Tullos Field.  On a BOE basis,lease operating expenses decreased by 9% over the comparable 2006 period.

 

General and Administrative Expenses (G&A).  G&A expenses increased 40% toapproximately $2.8 million for the six months ended December 31, 2007, comparedto approximately $2 million for the six months ended December 31,2006.  Higher overall compensationexpenses for estimated accrued bonuses (whereas we did not accrue for bonusesin the prior comparable period) and new hires accounted for the majority of theincrease, in addition to increases in Franchise taxes owed to the State ofTexas.  New hires are associated withbuilding up our infrastructure to execute the planned drilling program.Non-cash stock compensation expense was $817,571 and $861,477 for the sixmonths ended December 31, 2007 and 2006, respectively.

 

Depreciation, Depletion & AmortizationExpense (DD&A). DD&A expense increased $125,338 to $233,559 for the six months endedDecember 31, 2007 from $108,221 for the same period in 2006.  The increase is primarily due to a higherDD&A rate ($13 vs. $8) per barrel. The increase in depletion is due to the higher cost of PUDs at ourGiddings field that we added to our lower cost PDP’s from our Tullos FieldArea.

 

Interest Income.  Interest income for the six months ended December 31,2007 decreased $426,292 to $607,821, compared to $1,034,113 for the six monthsended December 31, 2006.  Thedecrease in interest income is primarily due to lower available cash balancesaveraging approximately $24.6 million during the six months ended December 31,2007, as compared to cash balances averaging approximately $42.3 million in thecomparable prior year quarter.  The lowercash balance is due to cash used to relieve income taxes payable arising fromthe $50 million we received from the Delhi Farmout and for additions to our oiland gas properties.

 

**Off Balance Sheet Arrangements**

 

As of February 28,2007, all of the Company’s commodity hedging and price risk managementactivities had expired and were not renewed.

 

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

 

*InterestRate Risk*

 

We are exposed to changesin interest rates. Changes in interest rates affect the interest earned on our cashand cash equivalents.  Under our currentpolicies, we do not use interest rate derivative instruments to manage exposureto interest rate changes.

 

*CommodityPrice Risk*

 

Our revenues,profitability and future growth depend substantially on prevailing prices foroil and gas. Prices also affect the amount of cash flow available for capitalexpenditures and our ability to borrow and raise additional capital. Lowerprices may also reduce the amount of oil and gas that we can economicallyproduce. We may periodically use derivative instruments to hedge our commodityprice risk. We may hedge a portion of our projected oil and gas productionthrough a variety of financial and physical arrangements intended to supportoil and gas prices at targeted levels and to manage our exposure to pricefluctuations. We may use futures contracts, swaps and fixed price physicalcontracts to hedge our commodity prices. Realized gains and losses from ourprice risk management activities are recognized in oil and gas sales when theassociated production occurs. We do not hold or issue derivative instrumentsfor speculative purposes.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and that such information is accumulated and communicated to this Company’smanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow for timely decisions regarding required disclosure.

 

As required by Securities and Exchange Commission Rule 13a-15(b),we carried out an evaluation, under the supervision and with the participationof the Company’s management, including our Chief Executive Officer and theCompany’s Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of thequarter covered by this report. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective in ensuring that the information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms.

 

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

 

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**PART II - OTHER INFORMATION**

 

**ITEM 2. UNREGISTERED SALE OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

On February 12,2008, we entered into a consulting agreement with the Liviakis FinancialCommunications, which expires December 31, 2008, Inc. to provideinvestor relations services for the Company. In exchange for these services,the Company issued 50,000 shares of common stock, which is subject to monthlyvesting, over the term of the agreement. The Company relied on an exemption from registration under Section 21(2) ofthe Securities Act of 1933, as amended. Liviakis Financial Communications is an accredited investor as definedin Regulation D, Rule 501(a).

 

**ITEM 4. SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

The following matters were submitted to a vote ofsecurity holders during Evolution Petroleum’s Annual Meeting of Stockholdersheld on December 4, 2007:

 

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

 
| ** **         | ** ** | **Votes Cast For** | ** ** | **Votes Withheld** | ** ** |
|--------------------|------------|------------------------------|------------|-------------------------|------------|
| Laird Q. Cagan     |       | 22,437,481                   |       | 190,900                 |       |
| E. J. DiPaolo      |       | 21,244,665                   |       | 1,383,716               |       |
| William E.  Dozier |       | 22,560,251                   |       | 68,130                  |       |
| Robert S. Herlin   |       | 22,447,968                   |       | 180,413                 |       |
| Gene G. Stoever    |       | 22,460,251                   |       | 168,130                 |       |

 

No other personreceived any votes.

 

2.               Approval of theamendment and restatement of the 2004 Stock Plan.  The voting was as follows:

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** | ** ** |
|------------|------------|-------------|------------|-------------|------------|---------------------------|------------|
| 14,680,327 |       | 3,731,995   |       | 14,221      |       | 4,201,838                 |       |

 

3.               Ratification of theappointment of Hein & Associates LLP, as independent accountants ofthe Company for the fiscal year ending June 30, 2008.  The voting was as follows:

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 22,426,558 |       | 198,568     |       | 3,255       |       |

 

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**ITEM 6. EXHIBITS**

 

A.           Exhibits

 
|        | 10.1   | Evolution Petroleum Corporation Amended and Restated  2004 Stock Plan (incorporated by reference to the Company’s Definitive Proxy  Statement filed on Form 14A filed on October 29, 2007). |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                       |
|   | 31.1   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934, as amended.                                         |
|   |   |                                                                                                                                                                                                       |
|   | 31.2   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934, as amended.                                         |
|   |   |                                                                                                                                                                                                       |
|   | 32.1   | Certification of Chief Executive Officer pursuant Rule 13a-14(b) or  Rule 15d-14(b) under the Securities Exchange Act of 1934, as  amended and 18 U.S.C. Section 1350.            |
|   |   |                                                                                                                                                                                                       |
|   | 32.2   | Certification of Chief Financial Officer pursuant Rule 13a-14(b) or  Rule 15d-14(b) under the Securities Exchange Act of 1934, as  amended and 18 U.S.C. Section 1350.            |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

**EVOLUTIONPETROLEUM CORPORATION**

(Registrant)

 

 
|        | Date: February 14, 2008 |   | By:    | /s/ STERLING H. MCDONALD                    |                               |
|--------|------------------------------|--------|--------|---------------------------------------------|------------------------------------|
|   |                         |   |   | Sterling H.  McDonald                       |
|   |                         |   |   | Vice-President  and Chief Financial Officer |
|   |                         |   |   |                                        | Principal Financial and Accounting |
|   |                         |   |   |                                        | Officer                            |
|        |                              |        |        |                                             |                                    |  |

 

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