UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-QSB
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE
ACT OF 1934.
For
the
quarterly period ended September 30, 2006
OR
[
] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE
ACT OF 1934
For
the
transition period ____________ to _____________
Commission
File Number 000-27862
(Exact
name of registrant as specified in charter)
Nevada
|
|
41-1781991
|
(State
or other jurisdiction
|
|
(I.R.S.
employer identification no.)
|
of
incorporation or organization)
|
|
|
820
Gessner, Suite 1340, Houston, Texas 77024
(Address
of principal executive offices and zip code)
(713)
935-0122
(Registrant's
telephone number, including area code)
Check
whether the registrant (1) filed all reports required to be filed by Section
13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past
90
days. Yes: x No: o
Check
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.). Yes: o No:x
The
number of shares outstanding of Registrant’s common stock, par value $0.001, as
of November 1, 2006, was 26,652,005.
Transitional
Small Business Disclosure Format (Check one): Yes: o No:x
EVOLUTION
PETROLEUM CORPORATION
TABLE
OF CONTENTS
PART
I. FINANCIAL
INFORMATION |
Page
Number
|
ITEM
1. FINANCIAL
STATEMENTS
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets: September 30, 2006 (unaudited) and
June 30,
2006
|
|
Condensed
Consolidated Statements of Operations (unaudited): For the three
months
ended September 30, 2006 and 2005
|
|
Condensed
Consolidated Statements of Cash Flows (unaudited): For the three
months
ended September 30, 2006 and 2005
|
|
Notes
to Condensed Consolidated Financial Statements
(unaudited)
|
6
|
|
|
|
|
ITEM
2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF
OPERATIONS
|
11
|
|
|
|
|
|
|
|
|
ITEM
3. CONTROLS
AND PROCEDURES
|
15
|
|
|
|
|
|
|
|
|
PART
II. OTHER INFORMATION
|
|
|
|
|
|
|
|
|
|
ITEM
1. LITIGATION
|
|
16
|
|
|
|
|
ITEM
6. EXHIBITS
|
|
16
|
|
|
|
|
SIGNATURES
|
|
|
17
|
Evolution
Petroleum Corporation and Subsidiaries
|
Condensed
Consolidated Balance
Sheets
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
|
Assets
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
Cash
|
|
$
|
5,977,209
|
|
$
|
9,893,547
|
|
Accounts
receivable, trade
|
|
|
350,367
|
|
|
132,371
|
|
Inventories
|
|
|
103,932
|
|
|
76,917
|
|
Prepaid
expenses
|
|
|
117,283
|
|
|
157,629
|
|
Retainers
and deposits
|
|
|
60,595
|
|
|
60,895
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
6,609,386
|
|
|
10,321,359
|
|
|
|
|
|
|
|
|
|
Cash
in qualified intermediary account for "like-kind"
exchanges
|
|
|
34,983,588
|
|
|
34,662,368
|
|
|
|
|
|
|
|
|
|
Oil
& Gas properties - full cost
|
|
|
3,939,765
|
|
|
3,878,551
|
|
Oil
& Gas properties - not amortized
|
|
|
11,556
|
|
|
52,098
|
|
Less:
accumulated depletion
|
|
|
(432,172
|
)
|
|
(371,624
|
)
|
|
|
|
|
|
|
|
|
Net
oil & gas properties
|
|
|
3,519,149
|
|
|
3,559,025
|
|
|
|
|
|
|
|
|
|
Furniture,
fixtures and equipment, at cost
|
|
|
20,041
|
|
|
16,561
|
|
Less:
accumulated depreciation
|
|
|
(9,320
|
)
|
|
(7,998
|
)
|
|
|
|
|
|
|
|
|
Net
furniture, fixtures, and equipment
|
|
|
10,721
|
|
|
8,563
|
|
|
|
|
|
|
|
|
|
Restricted
deposits
|
|
|
326,835
|
|
|
326,835
|
|
Other
assets
|
|
|
78,235
|
|
|
79,808
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
45,527,914
|
|
$
|
48,957,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
241,849
|
|
$
|
310,272
|
|
Accrued
liabilities
|
|
|
99,840
|
|
|
473,782
|
|
Income
taxes payable
|
|
|
-
|
|
|
2,978,650
|
|
Royalties
payable
|
|
|
11,092
|
|
|
47,054
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
352,781
|
|
|
3,809,758
|
|
|
|
|
|
|
|
|
|
Long
term liabilities:
|
|
|
|
|
|
|
|
Deferred
income taxes payable
|
|
|
13,101,350
|
|
|
13,101,350
|
|
Asset
retirement obligations
|
|
|
127,798
|
|
|
123,679
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
13,581,929
|
|
|
17,034,787
|
|
|
|
|
|
|
|
|
|
Common
Stock, totaling 351,333 shares subject to demand registration rights
|
|
|
790,500
|
|
|
790,500
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
Common
Stock, par value $0.001 per share; 100,000,000 shares authorized,
|
|
|
|
|
|
|
|
26,300,664
and 26,300,664, issued and outstanding as of September 30, 2006 and
|
|
|
|
|
|
|
|
June
30, 2006, respectively, net of 351,333 shares of common stock subject
to
|
|
|
|
|
|
|
|
demand
registration rights
|
|
|
26,300
|
|
|
26,300
|
|
Additional
paid-in capital
|
|
|
10,267,532
|
|
|
10,274,555
|
|
Deferred
stock based compensation
|
|
|
224,706
|
|
|
(265,167
|
)
|
Retained
earnings
|
|
|
20,636,947
|
|
|
21,096,983
|
|
|
|
|
|
|
|
|
|
Total
stockholders' equity
|
|
|
31,155,485
|
|
|
31,132,671
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders' equity
|
|
$
|
45,527,914
|
|
$
|
48,957,958
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to condensed consolidated financial
statements.
|
|
|
|
Condensed
Consolidated Statements of Operations
|
|
(unaudited)
|
|
|
|
Three
Months
Ended
September
30,
|
|
Three
Months
Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
Revenues:
|
|
|
|
|
|
Oil
sales
|
|
$
|
469,024
|
|
$
|
486,395
|
|
Gas
sales
|
|
|
-
|
|
|
57,933
|
|
Price
risk management activities
|
|
|
(14
|
)
|
|
(1,444
|
)
|
|
|
|
|
|
|
|
|
Total
revenues
|
|
|
469,010
|
|
|
542,884
|
|
|
|
|
|
|
|
|
|
Operating
Costs:
|
|
|
|
|
|
|
|
Production
expenses
|
|
|
324,119
|
|
|
464,190
|
|
Production
taxes
|
|
|
34,660
|
|
|
14,484
|
|
Depreciation,
depletion and amortization
|
|
|
61,871
|
|
|
77,250
|
|
General
and administrative (includes $489,873 and
$113,074 of non-cash stock based compensation for the three months
ended
September 30, 2006 and 2005, respectively)
|
|
|
1,039,192
|
|
|
584,278
|
|
|
|
|
|
|
|
|
|
Total
operating costs
|
|
|
1,459,842
|
|
|
1,140,202
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
|
(990,832
|
)
|
|
(597,318
|
)
|
|
|
|
|
|
|
|
|
Other
income and expenses:
|
|
|
|
|
|
|
|
Interest
income
|
|
|
530,796
|
|
|
18,937
|
|
Interest
expense
|
|
|
-
|
|
|
(221,678
|
)
|
|
|
|
|
|
|
|
|
Total
other income and expenses
|
|
|
530,796
|
|
|
(202,741
|
)
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(460,036
|
)
|
|
(800,059
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
per common share
|
|
|
|
|
|
|
|
Basic
and Diluted
|
|
$
|
(0.02
|
)
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares
|
|
|
|
|
|
|
|
Basic
and Diluted
|
|
|
26,651,999
|
|
|
24,777,056
|
|
See
accompanying notes to condensed consolidated financial statements.
Evolution
Petroleum Corporation and Subsidiaries
Condensed
Consolidated Statements of Cash Flows
(unaudited)
|
|
Three
Months
|
|
Three
Months
|
|
|
|
Ended
September 30,
|
|
Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
loss
|
|
$
|
(460,036
|
)
|
$
|
(800,059
|
)
|
Adjustments
to reconcile net loss to net cash
|
|
|
|
|
|
|
|
used
by operating activities:
|
|
|
|
|
|
|
|
Depletion
|
|
|
60,548
|
|
|
75,905
|
|
Depreciation
|
|
|
1,322
|
|
|
1,345
|
|
Non-cash
stock based compensation expense
|
|
|
489,873
|
|
|
113,074
|
|
Accretion
of asset retirement obligations
|
|
|
4,119
|
|
|
6,901
|
|
Accretion
of debt discount and non-cash loan costs
|
|
|
-
|
|
|
80,315
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(217,996
|
)
|
|
118,799
|
|
Inventories
|
|
|
(27,015
|
)
|
|
(266,719
|
)
|
Accounts
payable
|
|
|
(68,423
|
)
|
|
118,889
|
|
Royalties
payable
|
|
|
(35,962
|
)
|
|
(6,375
|
)
|
Accrued
liabilities
|
|
|
(352,592
|
)
|
|
(37,938
|
)
|
Income
taxes payable
|
|
|
(3,000,000
|
)
|
|
-
|
|
Prepaid
expenses
|
|
|
40,346
|
|
|
42,087
|
|
Net
cash used by operating activities
|
|
|
(3,565,816
|
)
|
|
(553,776
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Development
of oil and gas properties
|
|
|
(74,996
|
)
|
|
(260,301
|
)
|
Acquisitions
of oil and gas properties
|
|
|
(101,054
|
)
|
|
- |
|
Proceeds
from asset sale, net
|
|
|
155,378
|
|
|
-
|
|
Capital
expenditures for furniture, fixtures and equipment
|
|
|
(3,480
|
)
|
|
(2,571
|
)
|
Cash
in qualified intermediary account for "like-kind"
exchanges
|
|
|
(321,220
|
)
|
|
-
|
|
Retainer
and deposits
|
|
|
300
|
|
|
(1,056
|
)
|
Other
assets
|
|
|
1,573
|
|
|
2,976
|
|
Net
cash used in investing activities
|
|
|
(343,499
|
)
|
|
(260,952
|
)
|
Cash
flow from financing activities:
|
|
|
|
|
|
|
|
Payments
on notes payable
|
|
|
-
|
|
|
(6,754
|
)
|
Proceeds
from issuance of common stock
|
|
|
-
|
|
|
231
|
|
Equity
and transaction costs
|
|
|
(7,023
|
)
|
|
-
|
|
Net
cash used by financing activities
|
|
|
(7,023
|
)
|
|
(6,523
|
)
|
Net
decrease in cash and cash equivalents
|
|
|
(3,916,338
|
)
|
|
(821,251
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
9,893,547
|
|
|
2,548,688
|
|
Cash
and cash equivalents, end of period
|
|
$
|
5,977,209
|
|
$
|
1,727,437
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
Interest
paid
|
|
$
|
-
|
|
$
|
141,365
|
|
Income
taxes paid
|
|
$
|
3,000,000
|
|
$
|
-
|
|
See
accompanying notes to condensed consolidated financial statements.
EVOLUTION
PETROLEUM CORPORATION AND SUBSIDIARIES
(unaudited)
1.
Organization and Basis of Preparation
Headquartered
in Houston, Texas, Evolution Petroleum Corporation, formerly Natural Gas
Systems, Inc. (the "Company", "EPM", "we" or "us"), is a petroleum company
incorporated under the laws of the State of Nevada, engaged primarily in the
acquisition, exploitation and development of properties for the production
of
crude oil and natural gas. We acquire established oil and gas properties and
exploit them through the application of conventional and specialized technology
to increase production, ultimate recoveries, or both.
Our
stock
is traded on the American Stock Exchange (AMEX) under the ticker symbol EPM.
Prior to July 17, 2006, our stock was quoted on the OTC Bulletin Board under
the
symbol NGSY.OB. Prior to May 26, 2004, our stock was quoted on the OTC Bulletin
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 Evolution Petroleum Corporation to avoid confusion with similar names traded
on the AMEX and to better reflect our business model.
At
September 30, 2006, we conducted operations through our 100% working interests
in our Tullos Field Area and our non-operated interests in our Delhi Field,
all
located onshore in Louisiana. Our Tullos Field Area consists of 155 producing
of
267 well bores across 599 acres of high water cut primary reserve production,
which we believe may be a candidate for redevelopment using modern technology.
Our non-operated interests in the 13,636 acre Delhi Field consist of 7.4% in
overriding and mineral royalty interests in the Delhi Holt Bryant Unit, a 25%
reversionary working interest in the Delhi Holt Bryant Unit, and a 25% working
interest in certain other depths in the Delhi Field. Our Delhi Holt Bryant
Unit
is scheduled for redevelopment using CO2 enhanced oil recovery technology by
the
operator.
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America (“GAAP”) for interim financial information and, with
the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. All
adjustments (consisting of normal recurring accruals) which are, in the opinion
of management, necessary for a fair presentation of the results of operations
for the interim periods have been included. All inter-company transactions
are
eliminated upon consolidation. The interim financial information and notes
hereto should be read in conjunction with our 2006 Annual Report on Form 10-KSB
for the year ended June 30, 2006, as filed with the Securities
and Exchange Commission.
The
results of operations for interim periods are not necessarily indicative of
results to be expected for a full fiscal year.
On
July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued
FASB Interpretation No. 48 (“FIN 48”),”Accounting for Uncertainty in Income
Taxes — an interpretation of FAS 109.” FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with FASB Statement No. 109, Accounting for Income
Taxes. FIN 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. We are currently assessing the
implementation of FIN 48 and its impact on our financial
statements.
3. Acquisitions
and Sales of Properties
On
July
21, 2006, we closed the acquisition of 0.39% in additional mineral royalty
and
overriding royalty interests in the Delhi Holt Bryant Unit from an unrelated
owner.
On
September 20, 2006, we closed the purchase of a small parcel of land in Tullos,
Louisiana, which will be used as a field yard to store tangible equipment for
our Tullos Field Area.
The
$101,000 we used to acquire both of these properties was funded with monies
set
aside in our qualified intermediary (QI)
bank
account. The QI account provides us the opportunity to defer the recognition
of
taxable gain on amounts used from the QI account to acquire like-kind property
within 180 days from the date of the outgoing property sale from our Delhi
Farmout in exchange for assets identified within 45 days of such sale pursuant
to Internal Revenue Code Section 1031.
On
September 28, 2006, we completed the sale of two producing wells to the State
of
Louisiana that were located on a state highway expansion project being
constructed through the Tullos Urania Field. We received net consideration
of
approximately $155,000.
4.
Loss per Share
Basic
earnings per share is computed by dividing net income (loss) available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share are determined on the assumption that
outstanding stock options have been converted using the average price for the
period. For purposes of computing earnings per share in a loss year, potential
common shares have been excluded from the computation of weighted average common
shares outstanding, because their effect is antidilutive.
The
following table sets forth the computation of basic and diluted earnings (loss)
per share:
|
|
Three
Months
Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss applicable to common stockholders
|
|
$
|
(460,036
|
)
|
$
|
(800,059
|
)
|
Plus
income impact of assumed conversions:
|
|
|
|
|
|
|
|
Preferred
stock dividends
|
|
|
N/A
|
|
|
N/A
|
|
Interest
on convertible subordinated notes
|
|
|
N/A
|
|
|
N/A
|
|
Net
loss applicable to common stockholders plus assumed
conversions
|
|
$
|
(460,036
|
)
|
$
|
(800,059
|
)
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
26,651,999
|
|
|
24,777,056
|
|
|
|
|
|
|
|
|
|
Affect
of potentially dilutive common shares:
|
|
|
|
|
|
|
|
Warrants
|
|
|
N/A
|
|
|
N/A
|
|
Employee
and director stock options
|
|
|
N/A
|
|
|
N/A
|
|
Convertible
preferred stock
|
|
|
N/A
|
|
|
N/A
|
|
Convertible
subordinated notes
|
|
|
N/A
|
|
|
N/A
|
|
Redeemable
preferred stock
|
|
|
N/A
|
|
|
N/A
|
|
Denominator
for dilutive earnings per share - weighted average shares
|
|
|
26,651,999
|
|
|
24,777,056
|
|
|
|
|
|
|
|
|
|
Loss
per common share:
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
(0.02
|
)
|
$
|
(0.03
|
)
|
5.
Contingent Liabilities
On
November 17, 2005, a multi-plaintiff lawsuit was filed in the Fifth Judicial
District Court, Richland Parish, Louisiana, against 26 defendants, including
two
of our subsidiaries, Arkla Petroleum L.L.C. ("Arkla") and NGS Sub Corp (together
with Arkla, the "Subsidiaries"). We were served with the lawsuit in February
2006.
The
plaintiffs claim to be landowners whose property (including the soil, surface
water, and groundwater) has allegedly been contaminated by oil and gas
exploration, production and development activities conducted by the defendants
on the plaintiffs' property and adjoining land since the 1930s (including
activities by Arkla as operator of the Delhi Field subsequent to Arkla's
formation in 2002 and our acquisition of Arkla in 2003, and activities since
NGS
Sub Corp's acquisition of a 100% working interest in the Delhi Field in 2003).
The plaintiffs claim that the defendants knew of the alleged dangerous nature
of
the contamination and actively concealed it rather than remedy the problem,
and
that plaintiffs discovered such damage solely within the statute of limitations
period of one year prior to the filing of their complaint.
The
plaintiffs are seeking unspecified compensatory damages and punitive damages,
as
well as an order that the defendants restore the property and prevent further
contamination. Our ultimate exposure related to this lawsuit is not currently
determinable, but could, if adversely determined, have a material adverse effect
on our financial condition. Our costs to defend this action could also have
a
material adverse effect on our financial condition.
During
the three months ended March, 2006, we filed our response and Motion to Stay
Proceedings and Dilatory and Declinatory Exceptions with respect to this
proceeding.
During
the quarter ended June 2006, the Governor of the State of Louisiana signed
into
law new legislation addressing complaints similar to and, we believe, including
those complaints filed against us. Although the intention of the legislation
was
designed to limit plaintiff complaints and remedies by possibly deferring first
to administrative experts within the Louisiana State Departments of
Environmental Quality and Natural Resources, it is unclear at this time the
impact of such legislation.
There
were no new developments in this case during the quarter ended September 30,
2006.
On
October 11, 2006 Sybil J. Dominique, Individually, et al., filed a lawsuit
in
the District Court of Dallas, state of Texas, against Amerada Hess Corporation
and 73 other defendants, including one of our subsidiaries, Arkla Petroleum
LLC
(“Subsidiary”). We were served notice of the lawsuit on October 31,
2006.
The
lawsuit alleges that Gary Dominique’s death from Acute Myelogenous Leukemia was
related to his workplace exposure to benzene. The plaintiffs are seeking
unspecified damages. The lawsuit does not give details of the time or place
of
the alleged benzene exposure and we currently have no knowledge of this alleged
exposure or any other facts surrounding this case.
6.
Stock-Based Compensation
Adoption
of SFAS 123(R)
Effective
July 1, 2006, we adopted the fair value recognition provisions of Statement
of
Financial Accounting Standard 123(R) “Share-Based
Payment”
(“SFAS
123(R)”) using
the
modified prospective transition method. In
addition, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 “Share-Based
Payment”
(“SAB
107”) in March 2005, which provides supplemental SFAS 123(R) application
guidance based on the views of the SEC. Under
the
modified prospective transition method, compensation cost recognized in the
three month period ended September 30, 2006 includes: (a) compensation cost
for all share-based payments granted prior to, but not yet vested as of July
1,
2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, and (b) compensation cost for all
share-based payments granted beginning July 1, 2006, based on the grant date
fair value estimated in accordance with the provisions of SFAS 123(R). In
accordance with the modified prospective transition method, results for prior
periods have not been restated.
The
adoption of SFAS
123(R) resulted in stock compensation expense for the three month period ended
September 30, 2006 of approximately $356,000 of the $490,000 total stock
compensation expense which we recorded as general and administrative expenses
in
the consolidated
condensed statement of operations. This
additional share-based compensation expense increased basic and diluted loss
per
share by $0.01 for the quarter resulting in reported
basic and diluted loss per share of ($0.02) for the quarter.
We did
not recognize a tax benefit from the stock compensation expense because we
believe it is more likely than not that the related deferred tax assets, which
have been reduced by a full valuation allowance, will not be
realized.
We
use
the Black-Scholes option-pricing model to estimate option fair values. The
option-pricing model requires a number of assumptions, of which the most
significant are, expected stock price volatility, the expected pre-vesting
forfeiture rate and the expected option term (the amount of time from the grant
date until the options are exercised or expire). For stock options issued
subsequent to our adoption of 123(R), expected volatility, pre-vesting
forfeitures and option term will be calculated using SAB 107 guidance.
For
periods prior to July 1, 2006, we applied the intrinsic method to our
stock-based compensation awards to our employees as set forth in Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to
Employees,” and related interpretations. Under these principles, no compensation
expense for stock options granted to employees is reflected in net income as
long as the stock options have an exercise price equal to the quoted market
price of the underlying common stock on the date of grant.
Pro-Forma
Stock Compensation Expense for the Three Month Period Ended September 30,
2005
The
following table illustrates the effect on net loss and earnings per share if
we
had applied the fair value recognition provisions of SFAS 123(R) to stock-based
employee compensation for the three months ended September 30,
2005.
|
|
Three
Months
Ended
September
30,
2005
|
|
Net
loss available to common shareholders, as reported
|
|
$
|
(800,059
|
)
|
Add:
Total stock based employee compensation benefit reported in net loss,
net
of related tax effects
|
|
|
42,884
|
|
Deduct:
Total stock based employee compensation benefit determined under
fair
value of all awards, net of related tax effects
|
|
|
(256,357
|
)
|
Pro
forma net loss
|
|
$
|
(1,013,532
|
)
|
|
|
|
|
|
Per
share data:
|
|
|
|
|
basic
and diluted, as reported
|
|
$
|
(0.03
|
)
|
basic
and diluted, pro forma
|
|
$
|
(0.04
|
)
|
Stock
Options and Warrants as of the Three Month Period Ended September 30,
2006
We
maintain stock option plans under which we may grant incentive stock options
and
non-qualified stock options to officers, employees, consultants and non-employee
directors. Under our 2003 Stock Option Plan, 600,000 shares of our common stock
were approved to be issued or transferred to certain officers, employees,
consultants, and non-employee directors pursuant to stock based awards granted.
As of September 30, 2006, no shares remain available for grant under this plan.
Under our 2004 Stock Plan, a maximum of 4,000,000 shares of our common stock
was
approved to be issued or transferred to certain officers, employees, consultants
and non-employee directors pursuant to stock based awards granted. As of
September 30, 2006, 1,494,000 shares remain available for grant under the 2004
Stock Plan. The Company has a policy of issuing new shares upon the exercise
of
stock options.
As
of
September 30, 2006, we also had 1,037,500 of warrants outstanding to officers,
employees, consultants and non-employee directors issued outside of the 2003
Stock Option Plan and the 2004 Stock Plan, exclusive of warrants for capital
raising services.
Stock
options and warrants are generally granted at the market price on the date
of
grant. However, in 2003 we granted two awards “in-the-money”, and in 2005 we
replaced those with two awards “out-of-the money” in order to avail ourselves of
a safe harbor provision regarding Internal Revenue Code Section 409A. The
granted options and warrants have generally vested over four years for officers
and employees; generally over two years for non-employee directors, and
generally over one year for consultants. The granted options and warrants
generally have ten year contractual terms.
For
the
three months ended September 30, 2006, we did not grant any stock option awards,
nor were there any stock options exercised. The fair value of options granted
during the fiscal year ending June 30, 2006 were estimated at the date of grant
using the Black-Scholes options pricing model with the following assumptions:
stock price volatility of 132% to 159%; risk free interest rate of 4.30% to
4.87%; zero dividend yield; and an expected life of 1 to 4 years.
The
following table sets forth the stock option and warrant transactions for the
three months ended September 30, 2006 and the fiscal year ended June 30,
2006:
|
|
Number
of Options and Warrants
|
|
Weighted
Average Grant Price
|
|
Aggregate
Intrinsic Value (1)
|
|
Weighted
Average Remaining Contractual Term (in years)
|
|
Options/warrants
outstanding at July 1, 2005
|
|
|
2,487,500
|
|
$
|
1.38
|
|
|
|
|
|
|
|
Granted
|
|
|
1,311,000
|
|
$
|
1.70
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
-
|
|
|
|
|
|
|
|
Canceled,
forfeited, or expired
|
|
|
0
|
|
|
-
|
|
|
|
|
|
|
|
Options/warrants
outstanding at June 30, 2006
|
|
|
3,798,500
|
|
$
|
1.49
|
|
|
|
|
|
|
|
Granted
|
|
|
0
|
|
|
-
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
-
|
|
|
|
|
|
|
|
Canceled,
forfeited, or expired
|
|
|
0
|
|
|
-
|
|
|
|
|
|
|
|
Options/warrants
outstanding at September 30, 2006
|
|
|
3,798,500
|
|
$
|
1.49
|
|
$
|
5,213,065
|
|
|
8.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options/warrants
exercisable at September 30, 2006
|
|
|
1,746,625
|
|
$
|
1.33
|
|
$
|
2,727,084
|
|
|
8.4
|
|
____________
(1)
Based
upon the difference between the market price of our common stock on the last
trading date of the quarter and the option or warrant exercise price of
in-the-money option or warrants.
A
summary
of the status of our non-vested options and warrants as of September 30, 2006,
and the changes during the three months ended September 30, 2006, is presented
below:
Non-vested
Stock Options and Warrants
|
|
Number
of Options and Warrants
|
|
Weighted
Grant-Date Fair Value
|
|
Non-vested
at July 1, 2006
|
|
|
2,335,532
|
|
$
|
1.66
|
|
Granted
|
|
|
0
|
|
|
|
|
Vested
|
|
|
(283,657
|
)
|
|
|
|
Canceled,
forfeited, or expired
|
|
|
0
|
|
|
|
|
Non-vested
at September 30, 2006
|
|
|
2,051,875
|
|
$
|
1.69
|
|
At
September 30, 2006, unrecognized stock based compensation expense related to
non-vested stock option and warrant grants totaled approximately $2.67 million.
This unrecognized expense will be amortized on a straight-line basis over a
weighted average remaining life of approximately 2.8 years.
Pursuant
to the terms of our previous credit facility, we entered into financial
instruments covering approximately 50% of our expected oil and gas production
from proved developed producing properties on a two year rolling basis. We
used
reserve report data prepared by W. D. Von Gonten & Co., our independent
petroleum engineering firm, to estimate our future production for hedging
purposes. As we may elect under FAS 133, Accounting for Derivative Instruments
and Hedging Activities, we have designated our physical delivery contracts
as
normal delivery sale contracts. For the oil price floors (the “Puts”) we
purchased, we have not fulfilled the documentation requirements of FAS 133.
As a
result, the Put contracts are “marked-to-market”, with the unrealized gain or
loss reflected in our statement of operations. Since July 31, 2005, we had
the
following financial instruments in place:
(i) |
2,100
Bbls of oil to be delivered monthly from March 2005 through February
2006
to Plains Oil Marketing LLC, at $48.35 per barrel, plus or minus
changes
in basis between: (a) the arithmetic daily average of the prompt
month
“Light Sweet Crude Oil” contract reported by the New York Mercantile
Exchange, and (b) Louisiana field posted price. This is accounted
for as a
normal delivery sales contract. This contract was extended for the
months
of March 2006 through May 2006 for 70 Bbls of oil per day at a fixed
price
of $52.55 per barrel of oil, and extended again for the months of
June
2006 through August 2006 for 90 Bbls of oil per day at a fixed price
$63.45 per barrel of oil. Lastly, on January 27, 2006 we extended
our
crude oil contracts with Plains Oil Marketing, LLC for an additional
six
months, covering the periods September 2006 through February 2007.
The
contract requires us to deliver 90 Bbls of oil per day, in exchange
for a
fixed price of $69.30 per Bbl, plus or minus NYMEX to posted field
price
basis risk.
|
(ii) |
100
Mcfd of natural gas at a fixed price of $6.21, delivered through
our Delhi
Field sales tap into Gulf South’s pipeline, for the account of Texla for
deliveries from March 2005 to May 2006. This is accounted for as
a normal
delivery sales contract.
|
(iii) |
Purchase
of a non-physical Put contract at $38.00 per barrel for 2,000 Bbls
of
crude oil production from March 2006 through February 2007. This
is
accounted for as a “mark-to-market” derivative investment. For the three
months ended September 30, 2006, $14 was expensed to reflect the
changes
in the market value of the Put from June 30, 2006 to September 30,
2006.
|
8.
Related Party Transactions
Laird
Q.
Cagan, Chairman of our Board, is a Managing Director and co-owner of Cagan
McAfee Capital Partners, LLC ("CMCP"). CMCP performs financial advisory services
to us pursuant to a written agreement, earning a monthly retainer of $5,000.
In
addition, Mr. Cagan, as a registered representative of Chadbourn Securities,
Inc. (“Chadbourn”), has served as the Company’s placement agent in private
equity financings, typically earning cash fees equal to 8% of gross equity
proceeds, declining to 4% subject to the amount of equity raised, and a fixed
4%
warrant fee. Mr. Cagan receives no additional compensation for serving as a
director or as the Chairman of our Board.
Eric
A.
McAfee, a major shareholder of the Company is also a Managing Director of CMCP.
During
the fiscal quarter ended September 30, 2006, we expensed and paid CMCP $15,000
in monthly retainers.
9.
Asset Retirement Obligations
SFAS
No.
143, “Accounting
for Asset Retirement Obligations,”
(“SFAS
143”) provides accounting requirements for retirement obligations associated
with tangible long-lived assets, including: 1) the timing of liability
recognition; 2) initial measurement of the liability; 3) allocation of asset
retirement cost to expense; 4) subsequent measurement of the liability; and
5)
financial statement disclosures. SFAS 143 requires that an asset retirement
cost
should be capitalized as part of the cost of the related long-lived asset and
subsequently allocated to expense using a systematic and rational
method.
The
reconciliation of the beginning and ending asset retirement obligation for
the
period ending September 30, 2006 is as follows:
Asset
retirement obligation at June 30, 2006
|
|
$
|
123,679
|
|
Liabilities
incurred
|
|
|
-
|
|
Liabilities
settled
|
|
|
-
|
|
Accretion
expense
|
|
|
4,119
|
|
Asset
retirement obligation at September 30, 2006
|
|
$
|
127,798
|
|
|
|
|
|
|
This
Form 10-QSB and the information referenced herein contain forward-looking
statements. The words “plan,” “expect,” “project,” “estimate,” “assume,”
“believe,” “anticipate,” “intend,” “budget,” “forecast,” “predict” and other
similar expressions are intended to identify forward-looking statements. These
statements appear in a number of places and include statements regarding our
plans, beliefs or current expectations, including the plans, beliefs and
expectations of our officers and directors. We use the terms, “EPM,” “Company,”
“we,” “us” and “our” to refer to Evolution Petroleum
Corporation. When
considering any forward-looking statement, you should keep in mind the risk
factors that could cause our actual results to differ materially from those
contained in any forward-looking statement. Important factors that could cause
actual results to differ materially from those in the forward-looking statements
herein include the timing and extent of changes in commodity prices for oil
and
gas, operating risks and other risk factors as described in our 2006 Annual
Report on Form 10-KSB as filed with the Securities and Exchange Commission.
Furthermore, the assumptions that support our forward-looking statements are
based upon information that is currently available and is subject to change.
We
specifically disclaim all responsibility to publicly update any information
contained in a forward-looking statement or any forward-looking statement in
its
entirety and therefore disclaim any resulting liability for potentially related
damages. All forward-looking statements attributable to Evolution Petroleum
Corporation are expressly qualified in their entirety by this cautionary
statement.
Overview
Evolution
Petroleum Corporation, formerly Natural Gas Systems, Inc.,
is a
petroleum company engaged primarily in the acquisition, exploitation and
development of properties for the production of crude oil and natural gas.
We
acquire established oil and gas properties and exploit them through the
application of conventional and specialized technology to increase production,
ultimate recoveries, or both.
At
September 30, 2006, we conducted operations through our 100% working interests
in our Tullos Field Area and our non-operated interests in our Delhi Field,
all
located onshore in Louisiana. Our Tullos Field Area consists of approximately
155 producing of 267 well bores across 599 acres, of high water cut primary
reserve production which we believe may be a candidate for redevelopment using
modern technology. Our non-operated interests in the 13,636 acre Delhi Field
consist of 7.4% in overriding and mineral royalty interests in the Delhi Holt
Bryant Unit, a 25% reversionary working interest in the Delhi Holt Bryant Unit,
and a 25% working interest in certain other depths in the Delhi Field. Our
Delhi
Holt Bryant Unit is scheduled for redevelopment using CO2 enhanced oil recovery
technology by the operator.
We
are
focused on an overall strategy of acquiring controlling working interests in
oil
and gas resources within established fields and redeveloping those fields
through the application of capital and technology to convert the oil and gas
resources into profitable producing reserves. Within this overall strategy,
we
have established three specific business initiatives:
|
I |
Enhanced
oil recovery (EOR) projects in mature oil
reservoirs;
|
|
II |
Redevelopment
of mature oil and gas fields using modern and/or proprietary technology;
and
|
|
III |
Development
of low permeability resource plays using modern stimulation and completion
technologies, including horizontal
drilling.
|
Our
strategy is designed to generate scalable development opportunities at normally
pressured depths, exhibiting relatively low completion risk, generally longer
and more predictable production lives, less expenditures on infrastructure
and
lower operational risks. We believe that the benefits of this approach include:
· |
Reduced
exposure to the risk of whether resources are
present;
|
· |
Reduced
capital expenditures per net BOE for infrastructure, such as roads,
water
handling facilities and pipelines;
|
· |
Large
inventory of development opportunities, which provides a more predictable
future stream of drilling activity and production, as well as potentially
reducing risks from short-term oil and gas price
volatility;
|
· |
Reduced
operational risks and costs associated with lower pressures and lower
temperatures; and
|
· |
Control
of operations, development timing and technology
selection.
|
In
June
2006 we completed a major milestone in executing our EOR Initiative I. At that
time, we closed the sale of part of our interests in our Delhi Field in the
form
of a farmout (the “Delhi
Farmout”).
As
previously reported, terms of the Delhi Farmout include:
· |
We
received $50 million in cash at
closing.
|
· |
We
conveyed 100% of the working interests in the Delhi Holt Bryant Unit
to
Denbury Resources, retaining a 25% back-in working interest after
a $200
million simple payout, excluding capital
expenditures.
|
· |
We
retained separate override and mineral royalty interests equal to
7.4% on
all future production from the Delhi Holt Bryant
Unit.
|
· |
We
retained a 25% working interest in certain other depths in the Delhi
Field.
|
· |
We
received a commitment by Denbury Resources to install a CO2 enhanced
oil
recovery project, at Denbury’s sole capital cost and expense, subject to
financial penalties of up to $36 million for Denbury’s failure to expend
$100 million over six and one-half years, with yearly cumulative
benchmarks beginning with the period ending December 31, 2007.
|
We
are
currently studying additional development opportunities as follows:
· |
Initiative
II opportunities related to our Tullos
Field.
|
· |
Initiative
III coal bed methane opportunities related to our Delhi
Field.
|
· |
A
number of additional projects spanning these Initiatives.
|
Critical
Accounting Policies
Our
2006
Annual Report on Form 10-KSB describes the accounting policies that we believe
are critical to the reporting of our financial position and operating results
and that require management’s most difficult, subjective or complex judgments.
This
Quarterly Report on Form 10-QSB should be read in conjunction with the
discussion contained in our 2006 Annual Report on Form 10-KSB regarding these
critical accounting policies.
Results
of Operations
Summary
Our
net
loss decreased 42%, to approximately $460,000 for the three months ended
September 30, 2006, as compared to a net loss of approximately $800,000 for
the
three months ended September 30, 2005. Non-cash stock compensation expense
of
approximately $490,000 contributed to the current quarter loss, as compared
to
approximately $113,000 of non-cash stock compensation expense in comparable
2005
period.
We
increased our operating revenue and other income sources by 78% to approximately
$1 million in the three months ended September 30, 2006, approximately $469,000
of which came from oil and gas revenues and approximately $531,000 of which
came
from interest income on our money market investments. This compares to
approximately $562,000 of operating revenue and other income sources for the
three months ended September 30, 2005, approximately $543,000 of which came
from
oil and gas revenues and approximately $19,000 of which came from interest
income on our money market investments.
Our
total
operating costs increased 28% over the prior year’s fiscal quarter, from
approximately $1.14 million to approximately $1.46 million. Specifically, our
general and administrative expenses increased 78%, primarily due to higher
non-cash stock compensation expense due to the adoption of SFAS 123(R) in
the current quarter. Lease operating expense for the current quarter declined
by
approximately 30% from the comparable 2005 period. The decrease in lease
operating expenses in 2006 is primarily due to fewer operated wells due to
the
Delhi Farmout, compared to the prior year, offset by general overall increases
in the industry for materials and services.
Due
to
the repayment of all of our debt, interest expense declined 100% from
approximately $222,000 in the prior year’s quarter to zero in the current
quarter.
Looking
forward, we are focusing the cash we received from our Delhi Farmout and our
staff on identifying, acquiring and executing additional oil and gas development
projects fitting within our Initiatives I-III described in the Overview section
above. At September 30, 2006, we had at least $28 million in after-tax
cash resources to fund these initiatives and our working capital needs. It
is our intention to commit most of these cash resources to “seed” new projects
through a “proof of concept” stage, followed by outside financing to complete
each development stage (See financing explanation in our Liquidity and Capital
Resources section below).
Our
Delhi
Farmout has resulted in an immediate reduction in our net production and net
revenues effective June 1, 2006. This reduction was only partially
reflected in the current quarter, and subsequent quarters will bear the full
adverse effect until we
are
able to transition into new producing projects, successfully complete our Tullos
Area redevelopment activities and/or begin accruing production from our Delhi
CO2 project.
Three
months ended September 30, 2006 compared to three months ended September 30,
2005
The
following table sets forth certain financial information with respect to our
oil
and gas operations.
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
Variance
|
|
%
change
|
|
Sales
Volumes, net to EPM:
|
|
|
|
|
|
|
|
|
|
Oil
(Bbl)
|
|
|
7,694
|
|
|
8,966
|
|
|
(1,272
|
)
|
|
-14
|
%
|
Gas
(Mcf)
|
|
|
0
|
|
|
9,852
|
|
|
(9,852
|
)
|
|
-100
|
%
|
Oil
and Gas (Boe)
|
|
|
7,694
|
|
|
10,608
|
|
|
(2,914
|
)
|
|
-27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
data (a):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
revenue
|
|
$
|
469,010
|
|
$
|
484,951
|
|
$
|
(15,941
|
)
|
|
-3
|
%
|
Gas
revenue
|
|
|
0
|
|
|
57,933
|
|
|
(57,933
|
)
|
|
-100
|
%
|
Total
oil and gas revenues
|
|
$
|
469,010
|
|
$
|
542,884
|
|
$
|
(73,874
|
)
|
|
-14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
prices (a):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(per Bbl)
|
|
$
|
60.95
|
|
$
|
54.09
|
|
$
|
6.86
|
|
|
13
|
%
|
Gas
(per Mcf)
|
|
|
0
|
|
|
5.88
|
|
|
(5.88
|
)
|
|
-100
|
%
|
Oil
and Gas (per Boe)
|
|
$
|
60.95
|
|
$
|
51.18
|
|
$
|
9.77
|
|
|
19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
(per Boe)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
operating expenses and production taxes
|
|
$
|
46.63
|
|
$
|
45.12
|
|
$
|
1.51
|
|
|
3
|
%
|
Depletion
expense on oil and gas properties
|
|
$
|
7.87
|
|
$
|
7.16
|
|
$
|
0.71
|
|
|
10
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
____________
(a)
Includes the cash settlement of hedging contracts
Net
Loss.
For the
three months ended September 30, 2006, we reported a net loss of $460,036
or
$0.02 loss per share on total revenues of $469,010, as compared to a net
loss of
$800,059 or $0.03 loss per share on total revenues of $542,884 for the three
months ended September 30, 2005. The decrease in our net loss is attributable
primarily to approximately $531,000 of interest income earned and no interest
expensed charged in the current quarter, versus approximately $19,000 of
interest income earned and $222,000 of interest expense charged in the
comparable quarter of the prior year. This is offset by slightly lower revenues
and higher general and administrative costs in 2006, explained in greater
detail
below.
Sales
Volumes.
Oil
sales volumes, net to our interest, for the three months ended September 30,
2006 decreased 14% to 7,694 Bbls, compared to 8,966 Bbls for the three months
ended September 30, 2005. The decrease in oil sales volumes is primarily due
to
a loss of production from the Delhi Farmout.
Net
natural gas volumes sold for the three months ended September 30, 2006 were
zero
due to the Delhi Farmout, as compared to 9,852 Mcfs for the three months ended
September 30, 2005.
On
a BOE
basis, total sales volumes decreased 27% in the current quarter when compared
to
the prior year quarter.
Production.
Oil
production varies from oil sales volumes by changes in crude oil inventories,
which are not carried on our balance sheet. Net working interest oil production
for the three months ended September 30, 2006 decreased 29% to 7,602 Bbls,
compared to 10,639 Bbls for the three months ended September 30, 2005. This
is
primarily due to the loss of production from the Delhi Farmout. Net natural
gas
production for the three months ended September 30, 2006 decreased 100% to
zero,
compared to 9,852 Mcfs for the three months ended September 30, 2005, again
due
to the Delhi Farmout.
Oil
and Gas Revenues.
Revenues
presented in the table above and discussed herein represent revenue from sales
of our oil and natural gas production volumes, net to our interest. Production
sold under fixed price delivery contracts, which have been designated for the
normal purchase and sale exemption under SFAS 133, are also included in these
amounts. Realized prices may differ from market prices in effect during the
periods, depending on when the fixed delivery contract was executed.
Oil
and
gas revenues decreased 14% for the three month period ended September 30, 2006,
compared to the same period in 2005, as a result of a 27% decrease in sales
volumes (on a BOE basis) due primarily to the sale Delhi Farmout. Offsetting
the
decrease in revenues was a 13% increase in net realized oil prices from
approximately $54 per barrel to approximately $61 per barrel.
Lease
Operating Expenses.
Lease
operating expenses for the three months ended September 30, 2006 decreased
approximately 30% from the comparable 2005 period. The decrease in operating
expenses in 2006 is primarily attributable to fewer operated wells due to the
Delhi Farmout. On a BOE basis, lease operating expenses increased during the
quarter by 3% over the prior quarter. In the current quarter, production in
the
Tullos Area was reduced due to the diversion of our only available service
rig
and crew from repair and maintenance to our capital program. The prior quarter’s
high rate per BOE was due to uncharacteristically high workover costs and a
corresponding reduction in production volumes at our Delhi Field.
General
and Administrative Expenses.
General
and administrative expenses were up 78% to $1,040,000 for the three months
ended
September 30, 2006, compared to approximately $584,000 for the three months
ended September 30, 2005. Higher non-cash stock compensation expense accounted
for approximately 83% of the 78% increase, and the AMEX listing fee accounted
for approximately 16% of the 78% increase. Our remaining general and
administrative expense remains high due significant expenses associated with
a
being a public registrant, including expenses for audited financial statements,
SEC counsel, Director and Officers insurance, outside director fees and other
related costs.
Depletion
Expense.
Depletion expense decreased $15,357 to $60,548 for the three months ended
September 30, 2006 from $75,905 for the same period in 2005. The decrease is
primarily due to a 27% decrease in sales volumes (on a BOE basis) due to the
Delhi Farmout.
Interest
Income.
Interest income for the three months ended September 30, 2006 increased
approximately $512,000 to approximately $531,000, compared to approximately
$19,000 for the three months ended September 30, 2005. The increase in interest
income is primarily due to higher interest earned on higher available cash
balances of approximately $41 million in the current quarter, as compared to
cash of approximately $1.7 million in the prior comparable quarter.
Interest
Expense.
Due to
the repayment of all of our debt in June 2006, interest expense for the three
months ended September 30, 2006 decreased to zero from approximately $222,000
for the three months ended September 30, 2005.
Liquidity
and Capital Resources
As
of
September 30, 2006, we had approximately $6 million of unrestricted cash and
approximately $35 million of cash held in a qualified intermediary (“QI”)
account
for possible Internal Revenue Code Section 1031 “like-kind exchanges”, all of
which is available to us at any time. The QI account provides us the opportunity
to defer the recognition of taxable gain on amounts used from the QI account
to
acquire like-kind property within 180 days from the date of the outgoing
property sale from our Delhi Farmout (being December 9, 2006) for assets
identified within 45 days of such sale. Concurrent with the closing of the
Delhi
Farmout, we established the QI account with $35 million of the $50 million
of
proceeds we received from Denbury at closing, approximately $521,000 of which
has been used to acquire like-kind property on or prior to September 30, 2006
(partially offset by approximately $418,000 of interest income earned in the
current quarter). In the event that we choose to withdraw any funds from the
qualified intermediary account to fund non like-kind exchanges, or fail to
use
all of the funds prior to December 9, 2006, all of the funds remaining or
disbursed from the QI account will become subject to immediate gain for tax
purposes, although all gain for financial purposes was recorded during our
year
ended June 30, 2006.
At
September 30, 2006 we had $6.3 million of positive working capital, as compared
to $1.8 million of positive working capital at September 30, 2005. Our working
capital at September 30, 2006 does not include the $35 million of cash deposited
in the QI account for possible like-kind exchanges, or the $13.1 million of
deferred tax liability associated with such cash receipt deferral, as they
are
recorded as non-current assets and liabilities, respectively.
Cash
flow
used by our operating activities was $3.6 million for the three months ended
September 30, 2006, as compared to $0.6 million used during the fiscal quarter
ended September 30, 2005. The primary expenditure in the 2006 period was a
$3
million estimated federal income tax payment to cover our prior fiscal year
and
the first quarter estimate for fiscal 2007.
Cash
flow
used by investing activities was approximately $344,000 for the three months
ended September 30, 2006. Approximately $185,000 was received for the sale
of
two Tullos Field Area wells to the State of Louisiana, offset by approximately
$30,000 in legal fees to close the transaction. Approximately $101,000 was
used
to acquire additional royalty and overriding royalty interests in the Delhi
Holt
Bryant Unit and a small parcel of land to be used as a field office in Tullos,
Louisiana, and $75,000 was used to develop our oil and gas properties. In the
prior fiscal comparable quarter we used approximately $260,000 to develop our
properties.
During
the three months ended September 30, 2006, we incurred approximately $7,000
of
transaction costs used for financing activities, as compared to approximately
$7,000 to repay notes payable in the comparable 2005 quarter.
The
Delhi
Farmout (closed in the prior quarter) has allowed us to:
o
Strengthen our balance sheet to fund new development projects in accordance
with
our business plan to exploit known petroleum resources;
o
Participate in a major enhanced oil recovery project without our incurring
further capital expenditures or scaled up operations; and
o
Repay
all of our funded debt in the prior quarter.
Going
forward, we plan on using the majority of our after-tax cash resources to “seed”
new development projects within our Initiatives I-III outlined in the Overview
section above. It is currently our intention to bring these projects through
a
proof of concept phase, followed by raising some form of insulated project
financing specific to each project.
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms and that such information
is accumulated and communicated to this company’s management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship
of
possible controls and procedures.
As
required by Securities and Exchange Commission Rule 13a-15(b), we carried out
an
evaluation, under the supervision and with the participation of the Company’s
management, including our Chief Executive Officer and the Company’s Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the quarter covered by
this
report. Based on the foregoing, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective
in
ensuring that the information required to be disclosed in our reports filed
or
submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission
rules and forms.
There
has
been no change in our internal control over financial reporting during our
most
recent fiscal quarter that has materially affected, or is reasonably likely
to
materially affect, our internal control over financial reporting.
ITEM
1. LITIGATION
On
October 11, 2006 Sybil J. Dominique, Individually, et al., filed a lawsuit
in
the District Court of Dallas, state of Texas, against Amerada Hess Corporation
and 73 other defendants, including one of our subsidiaries, Arkla Petroleum
LLC
(“Subsidiary”). We were served notice of the lawsuit on October 31,
2006.
The
lawsuit alleges that Gary Dominique’s death from Acute Myelogenous Leukemia was
related to his workplace exposure to benzene. The plaintiffs are seeking
unspecified damages. The lawsuit does not give details of the time or place
of
the alleged benzene exposure and we currently have no knowledge of this alleged
exposure or any other facts surrounding this case.
ITEM
6. EXHIBITS
|
31.1 |
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of 1934, as
amended.
|
|
31.2 |
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of 1934, as
amended.
|
|
32.1 |
Certification
of Chief Executive Officer pursuant Rule 13a-14(b) or Rule 15d-14(b)
under
the Securities Exchange Act of 1934, as amended and 18 U.S.C. Section
1350.
|
|
32.2 |
Certification
of Chief Financial Officer pursuant Rule 13a-14(b) or Rule 15d-14(b)
under
the Securities Exchange Act of 1934, as amended and 18 U.S.C. Section
1350.
|
In
accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
EVOLUTION
PETROLEUM CORPORATION
(Registrant)
|
|
|
|
|
Date: November
13, 2006 |
By: |
/s/ STERLING
H. MCDONALD |
|
Sterling H. McDonald
Chief Financial Officer
Principal
Financial and Accounting Officer
|
|
|