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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended December 31, 2011

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

For the transition period from               to              

Commission File Number 001-32942

EVOLUTION PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

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

(Address of principal executive offices and zip code)

(713) 935-0122

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has 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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark 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 the registrant’s common stock, par value $0.001, as of February 6, 2012, was 27,816,963.

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EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES

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PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Evolution Petroleum Corporation and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

See accompanying unaudited notes to consolidated condensed financial statements.

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Evolution Petroleum Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

*General and administrative expenses for the three months ended December 31, 2011 and 2010 included non-cash stock-based compensation expense of $354,871 and $396,394, respectively.  For the corresponding six month period’s non-cash stock-based compensation expense was $771,566 and $750,880, respectively.

See accompanying unaudited notes to consolidated condensed financial statements.

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Evolution Petroleum Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Our supplemental disclosures of cash flow information for the six months ended December 31, 2011 and 2010 are as follows:

See accompanying unaudited notes to consolidated condensed financial statements.

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Evolution Petroleum Corporation and Subsidiaries

Unaudited Notes to Consolidated Condensed Financial Statements

Note 1 — Organization and Basis of Preparation

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

Interim Financial Statements.  The accompanying unaudited consolidated condensed 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 appropriate rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.  All adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented have been included.  The interim financial information and notes hereto should be read in conjunction with the Company’s 2011 Annual Report on Form 10-K for the fiscal year ended June 30, 2011, as filed with the SEC. The results of operations for interim periods are not necessarily indicative of results to be expected for a full fiscal year.

Principles of Consolidation and Reporting.  Our consolidated financial statements include the accounts of EPM and its wholly-owned subsidiaries: NGS Sub Corp and its wholly owned subsidiary, Tertiaire Resources Company, NGS Technologies, Inc., and Evolution Operating Co., Inc.  All significant intercompany transactions have been eliminated in consolidation. The consolidated financial statements for the prior period may include certain reclassifications that were made to conform to the current presentation.  Such reclassifications have no impact on previously reported loss or stockholders’ equity.

Use of Estimates.  The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Significant estimates include reserve quantities and estimated future cash flows associated with proved reserves, which significantly impact depletion expense and potential impairments of oil and natural gas properties, income taxes and the valuation of deferred tax assets, stock-based compensation and commitments and contingencies.  We analyze our estimates based on historical experience and various other assumptions that we believe to be reasonable. While we believe that our estimates and assumptions used in preparation of the consolidated financial statements are appropriate, actual results could differ from those estimates.

Note 2 — Property and Equipment

As of December 31, 2011 and June 30, 2011 our oil and natural gas properties and other property and equipment consisted of the following:

Unproved properties not subject to amortization includes: unevaluated acreage of $0.7 million and $2.9 million as of December 31, 2011 and June 30, 2011, respectively, of which (i) $0.7 million as of December 31, 2011 and June 30, 2011, related to our interests in the Delhi Field in Louisiana; and (ii) $6,000 and $2.2 million as of December 31, 2011 and June 30, 2011, respectively, related to Woodford Shale trend in Oklahoma.  Development of our unproved properties is expected to be completed within five years.  Our evaluation of impairment of unproved properties occurs, at a minimum, on a quarterly basis.  During the six months ended December 31, 2011, our evaluations determined that approximately $2.2 million of our unevaluated Woodford Shale trend property was impaired and accordingly was moved to the full cost pool.

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Note 3 — Joint Interest Drilling Arrangement

In July 2010, we entered into a drilling arrangement with an industry partner to drill up to five horizontal development wells in the Giddings Field in central Texas.  Our industry partner has funded $7.7 million through December 31, 2011, their portion of the approval for expenditure (“AFE’) for three wells, including a sales line.  As of December 31, 2011, $73,181 of their funding has yet to be expended with respect to those wells.  We have billed our industry partner $101,454 for operating expense recovery and costs incurred for their share of costs.  Amounts pertaining to our industry partner’s share of the joint interest drilling arrangement included in our balance sheet as of December 31, 2011, are as follows:

Note 4 — Asset Retirement Obligations

Our asset retirement obligations represent the estimated present value of the amount we will incur to plug, abandon and remediate our producing properties at the end of their productive lives in accordance with applicable laws. The following is a reconciliation of the beginning and ending asset retirement obligation for the six months ended December 31, 2011:

Note 5 — Stockholders’ Equity

Common Stock

On September 9, 2011, a contractor of the Company net exercised 20,000 stock options issued under the 2004 Stock Plan for a net issuance of 7,941 shares of our common stock.  The options were granted in March 2008 at an exercise price of $4.10 per share.

On August 31, 2011, the Board of Directors authorized the issuance of 161,861 shares of restricted common stock from the 2004 Stock Plan to all employees as a long-term incentive award.  Total unrecognized stock-based compensation expense of $1,029,436 related to the long-term incentive award will be recognized ratably over a four year period as, if and when the restricted common stock vests.

On December 5, 2011, a total of 34,245 shares of our restricted common stock was issued pursuant to the 2004 Stock Plan to five outside directors as part of their annual board compensation for calendar year 2012.  The value of the shares issued was $249,955, based on the fair market value on the date of issuance.  All issuances of our common stock were subject to vesting terms per individual stock agreements, which is one year for directors.

See Note 6.

Series A Cumulative Perpetual Preferred Stock

During the six months ended December 31, 2011, we sold 317,319 shares of our 8.5% Series A Cumulative (perpetual) Preferred Stock at a weighted average sales price of $23.80 per share, with a liquidation preference of $25.00 per share.   All shares were underwritten or sold through McNicoll Lewis & Vlak LLC (MLV), 220,000 of which were sold in an underwritten public offering and 97,319 shares of which were sold under an at-the-market sales agreement (ATM), providing aggregate net proceeds of $6,930,535 after- market discounts, underwriting fees, legal and other expenses of the offerings.  The Series A Cumulative Preferred Stock cannot be converted into our common stock and there are no sinking fund or redemption rights available to holders thereof.  Optional redemption can only be made by us on or after July 1, 2014 for the stated liquidation value of $25.00 per share plus accrued dividends, or by an acquirer under a change of control prior to such date at redemption prices ranging from $25.25 to $25.75 per share.  With respect to dividend rights and rights upon our liquidation, winding-up or dissolution, the Series A Preferred Stock ranks senior to our common shareholders, but subordinate to any of our existing and future debt.  Dividends on the Series A Cumulative Preferred Stock

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accrue and accumulate at a fixed rate of 8.5% per annum on the $25.00 per share liquidation preference, payable monthly at $0.177083 per share, as, if and when declared by our Board of Directors.

During the six months ended December 31, 2011, we paid dividends of $293,240 to holders of our Series A Preferred Stock

Note 6 — Stock-Based Incentive Plan

We have granted option awards to purchase common stock (the “Stock Options”), restricted common stock awards (“Restricted Stock”), and/or unrestricted fully vested common stock, to employees, directors, and consultants of the Company and its subsidiaries under the Natural Gas Systems Inc. 2003 Stock Plan (the “2003 Stock Plan”) and the Evolution Petroleum Corporation Amended and Restated 2004 Stock Plan (the “2004 Stock Plan” or together, the “EPM Stock Plans”).  Option awards for the purchase of 600,000 shares of common stock were issued under the 2003 Stock Plan.  The 2004 Stock Plan authorized the issuance of 5,500,000 shares of common stock with an additional 1,000,000 shares authorized by a December 5, 2011 plan amendment approved by a vote of our shareholders.  No shares are available for grant under the 2003 Stock Plan and 1,012,111 shares remain available for grant under the 2004 Stock Plan as of December 31, 2011.

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

Stock Options and Incentive Warrants

Non-cash stock-based compensation expense related to Stock Options and Incentive Warrants for the three months ended December 31, 2011 and 2010 was $59,410 and $172,728, respectively.  For the six months ended December 31, 2011, and 2010, non-cash stock-based compensation expense was $232,139 and $369,571, respectively.

There were no Stock Options granted during the six months ended December 31, 2011 and 2010.

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

The following summary presents information regarding outstanding Stock Options and Incentive Warrants as of December 31, 2011, and the changes during the fiscal year:

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(1) Based upon the difference between the market price of our common stock on the last trading date of the period ($8.05 as of December 31, 2011) and the Stock Option or Incentive Warrant exercise price of in-the-money Stock Options and Incentive Warrants.

There were 20,000 Stock Options exercised during the six months ended December 31, 2011 with an aggregate intrinsic value of $54,000.  There were 36,875 Stock Options that were exercised during the six months ended December 31, 2010, with an aggregate intrinsic value of $204,101.

A summary of the status of our unvested Stock Options and Incentive Warrants as of December 31, 2011 and the changes during the six months ended December 31, 2011, is presented below:

During the six months ended December 31, 2011 and 2010, there were 109,039 and 190,914 Stock Options and Incentive Warrants that vested with a total grant date fair value of $216,987 and $500,195, respectively.

The total unrecognized compensation cost at December 31, 2011, relating to non-vested Stock Options and Incentive Warrants was $121,912.  Such unrecognized expense is expected to be recognized over a weighted average period of 0.67 years.

Restricted Stock

Stock-based compensation expense related to Restricted Stock grants for the three months ended December 31, 2011 and 2010 was $295,461 and $223,666, respectively.  Stock-based compensation expense related to Restricted Stock grants for the six months ended December 31, 2011 and 2010 was $539,427 and $381,309, respectively.

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The following table sets forth the Restricted Stock transactions for the six months ended December 31, 2011:

At December 31, 2011, unrecognized stock compensation expense related to Restricted Stock grants totaled $2,727,533.  Such unrecognized expense will be recognized over a weighted average period of 1.85 years.

Note 7 — Income Taxes

We file a consolidated federal income tax return in the United States and various combined and separate filings in several state and local jurisdictions.

There were no unrecognized tax benefits nor any accrued interest or penalties associated with unrecognized tax benefits during the six months ended December 31, 2011.  We believe that we have appropriate support for the income tax positions taken and to be taken on the Company’s tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter. The Company’s federal and state income tax returns are open to audit under the statute of limitations for the years ending June 30, 2007 through June 30, 2011.

Our effective tax rate for any period may differ from the statutory federal rate due to our state income tax liability in Louisiana and to stock-based compensation related to qualified incentive stock option awards (“ISO awards”), a permanent tax difference for financial reporting, as these types of awards, if certain conditions are met, are not deductible for federal tax purposes.

Note 8 — Net Income (loss) Per Share

The following table sets forth the computation of basic and diluted income (loss) per share:

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

Outstanding potentially dilutive securities as of December 31, 2011 are as follows:

Outstanding potentially dilutive securities as of December 31, 2010 are as follows:

Note 9 — Commitments and Contingencies

We are subject to various claims and contingencies in the normal course of business.  In addition, from time to time, we receive communications from government or regulatory agencies concerning investigations or allegations of noncompliance with laws or regulations in jurisdiction in which we operate.  We disclose such matters if we believe it is reasonably possible that a future event or events will confirm a loss through impairment of an asset or the incurrence of a liability. We establish reserves if we believe it is probable that a future event or events will confirm a loss and we can reasonably estimate such loss.  Furthermore, we will disclose any matter that is unasserted if we consider it probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.

Lease Commitments.  We have a non-cancelable operating lease for office space that expires on August 1, 2016. Future minimum lease commitments as of December 31, 2011 under this operating lease are as follows:

Rent expense for the three months ended December 31, 2011 and 2010 was $36,808 and $36,324 respectively.  For the six months ended December 31, 2011 and 2010 rent expense was $73,617 and $72,647, respectively.

Employment Contracts.  We have entered into employment agreements with the Company’s three senior executives.  The employment contracts provide for a severance package for termination by the Company for any reason other than cause or permanent disability, or in the event of a constructive termination, that includes payment of base pay and certain medical and disability benefits from six months to a year after termination.   The total contingent obligation under the employment contracts as of December 31, 2011 is approximately $588,000.

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

This Form 10-Q and the information referenced herein contain forward-looking statements within the meaning of the Private Securities Litigations Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. 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. 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 natural gas, operating risks and other risk factors as described in our 2011 Annual Report on Form 10-K for the year ended June 30, 2011 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.

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

Executive Overview

General

We are a petroleum company engaged primarily in the acquisition, exploitation and development of properties for the production of crude oil and natural gas, onshore in the United States. We acquire known, underdeveloped oil and natural gas resources and exploit them through the application of capital, sound engineering and modern technology to increase production, ultimate recoveries, or both.

We are focused on increasing underlying net asset values on a per share basis.  In doing so, we depend on a conservative capital structure, allowing us to maintain financial control of our assets for the benefit of our shareholders, including approximately 20% beneficially owned by all of our directors, officers and employees.

Our strategy is intended to generate scalable, low unit cost, oil-focused development and re-development opportunities that minimize or eliminate exploration risks.  These opportunities involve the application of modern technology, our own proprietary technology and our specific expertise in overlooked areas of the United States.

The assets we exploit currently fit into three types of project opportunities:

·                  Enhanced Oil Recovery (EOR),

·                  Bypassed Resources, and

·                  Unconventional Reservoir Development.

Highlights for our Second  Quarter Fiscal 2012 and Project Update

Our fiscal year is June 30.  As used below:

“Q2-12” & “current quarter” is the three months ended December 31, 2011, the company’s 2nd quarter of fiscal 2012.

“Q1-12” & “prior quarter” is the three months ended September 30, 2011, the company’s 1st quarter of fiscal 2012.

“Q2-11” & “year-ago quarter” is the three months ended December 31, 2010, the company’s 2nd quarter of fiscal 2011.

Operations

·                  Earnings to shareholders for fiscal Q2-12 increased 24% sequentially to $1.3 million from $1.0 million in the prior quarter, while increasing $1.7 million from the year-ago quarter’s $462,000 loss.  Improvements were largely driven by continued increases in top line growth.

·                  Revenues increased 20% sequentially to $4.6 million from $3.9 million in the prior quarter, while increasing 294% over the year-ago quarter’s $1.2 million.  Increased revenues were due to increases in sales volumes, particularly for crude oil, and higher liquids prices.

·      Crude oil and NGL volumes accounted for 78% of total sales volumes during Q2-12, unchanged from the prior quarter, and higher than the 65% share of sales volumes in the year-ago quarter.  Crude oil and NGL volumes increased 11% sequentially over the prior quarter and 183% over the year-ago quarter, primarily due to increasing crude oil sales from Delhi.  Natural gas volumes increased 15% sequentially from the prior quarter due to workovers at Giddings, and 50% over the year-ago quarter primarily due to additional development drilling at Giddings.

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·                  The blended product price we received in Q2-12 increased 7% sequentially to $88.84 per BOE from $83.01 in the prior fiscal quarter, while increasing 67% over the $53.32 per BOE received in the year-ago quarter.  Oil prices in the current quarter increased 8% sequentially to $112.79 per barrel and 35% over the year-ago quarter.  High absolute oil prices reflected the large proportion of sales that received favorable Louisiana Light Sweet pricing.  Similarly, NGL prices increased 9% sequentially and 26% over the year-ago quarter to $58.18 per barrel.  Meanwhile, natural gas prices decreased 18% sequentially and 9% from the year-ago quarter to $3.33 per MCF.

·                  Field margins continued to expand to $75 per BOE in fiscal Q2-12, compared to $73.12 per BOE in the prior quarter and $34 per BOE in the year-ago quarter.  The pre-tax margin improvement was driven primarily by increased crude oil volumes from our non-cost bearing interests and higher liquids prices, all on a BOE basis over both comparable periods.

Projects

We are currently active in four primary areas:  an enhanced oil recovery project in northeast Louisiana’s “Delhi Field” that is operated by an industry partner, producing horizontal wells that we generally operate in the “Giddings Field” of central Texas, producing oil wells that we operate in the “Lopez Field” of south Texas, and commercialization of our artificial lift technology (“GARP™”).

Delhi EOR Project

·                  Sales volumes at Delhi increased 13% sequentially in Q2-12 to 366 net barrels of oil per day (4,946 gross BOPD) from 326 net BOPD (4,396 gross BOPD) in the prior fiscal quarter, while increasing 438% from the year-ago quarter’s 68 net BOPD (920 gross BOPD).  Net sales to our royalty interest at Delhi are free of all cost and expense, including state severance tax until actual project payout.

·                  Field development and facility installations at Delhi exceeded calendar 2011’s field plan.  As originally planned for calendar 2011 by Denbury as operator, a third test site was installed, 39 wells were completed and an oil production response was achieved from the newly installed site.  As an expansion to the 2011 plan, field development was accelerated through the completion of 11 additional wells associated with the newly installed third test site, while 9 wells associated with the planned fourth test site were completed awaiting that test site’s construction that began in December 2011.

·                  According to the operator, produced oil gravity suggests a highly miscible flood and potentially better sweep efficiency, both of which point to potentially improved ultimate recoveries over the reserve report dated June 30, 2011.  Produced oil gravity has remained relatively constant in the 41-45 degree gravity range, suggesting high miscibility and higher ultimate recoveries at Delhi.  Alternatively, low miscibility is indicated by increasing produced oil gravities over time.

·                  New production techniques were added in 2011 to increase field performance. During 2011, a plan was implemented by the operator to re-inject produced water back into the producing reservoir in lieu of a separate reservoir.  Nine injection wells have been drilled down-dip to help maintain reservoir pressure in place of purchased CO2 volumes.    Since purchased CO2 cost is a major factor in the economics of our projects, reduced CO2 purchases increase profitability.

·                  Delhi crude oil sales continued to benefit from Louisiana Light Sweet pricing (LLS), averaging 22% higher than WTI prices during Q2-12.  The $115 per barrel average price we received at Delhi in Q2-12 was $21 higher than the $94 daily average spot price for WTI delivered at Cushing. We believe that a material premium for Delhi’s oil may continue over the near term, subject to market factors.

GARP™ (Gas Assisted Rod Pump)

Two GARP™ commercialization demonstrations with industry partners are underway.  As reported last quarter, we expected to install GARP demonstrations with each of two industry partners by calendar year-end.   The first application was

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successfully installed and placed onto production on December 2, 2011.  Production testing is ongoing; however, initial rates are positive and suggest that the technology has not only extended the life of the previously marginal well and leases for many years, but has potentially added 10-25% more reserves thereby achieving or exceeding our stated goals.

Due to our ongoing field activity, our second commercial demonstration is about one month behind schedule. Installation work is now underway.

In both demonstration agreements, we are paying the cost of the technology installation and are operating the wells, in return for an equity ownership equal to a 50% net profits interest in the first well and a 99% before payout and 76% after payout working interest in the second well.

Giddings Field (Central Texas)

Production increased at Giddings due to well workovers and drilling completions, but further drilling is being adversely impacted by low natural gas prices.  Sales volumes at Giddings increased 13% sequentially from the prior quarter to 198 BOE per day, mostly due to successful well workovers, and 15% over the year-ago quarter due to 0.6 new nets wells (3 gross) being brought online in fiscal Q2-11 and Q3-11. With remaining PUDs averaging approximately 50% oil and NGLs, we believe more attractive opportunities are available for capital investment while we explore various options to maximize our Giddings asset values.

Lopez Field (South Texas)

We continued our testing of high fluid production rates and corresponding high water re-injection rate in the Lopez Field. Obtaining consistent high re-injection rates continues to be an operational challenge and we are working closely with service companies on the best solution.

Based on the success of our high fluid rate production test, we drilled two new producer wells and two salt water injection wells. Initial results suggest that the projected oil cut in the produced fluid is sufficiently attractive and we are working to put all four wells on line. We expect to continue drilling operations in Lopez during the remainder of fiscal 2012.

Woodford Shale (Oklahoma)

Despite our success in the western portion of our Wagoner County leasehold and our first vertical test well in our Haskell County leasehold, continued low natural gas prices have led us to keep these projects on hold, while considering other options, including a sale of the leases.

Expansion Projects

We are actively considering and reviewing new oil development projects for redeployment of expected current and future levels of cash flows from Delhi.  These projects include those generated by other companies that meet certain criteria: high oil content; within Texas, Oklahoma, Kansas, New Mexico or Louisiana; reasonable well costs and within our expertise.

Finances

·                  Our working capital increased to $13.9 million compared to $12.2 million at September 30, 2011.  The increase was due both to net operational cash flows and a small issuance of our Series A perpetual non-convertible Preferred Stock.

·                  We suspended At-the-Market sales of our Series A Preferred Stock in October, pending further investment opportunities.  During the current quarter, we issued 35,064 shares raising $876,000 in net proceeds after a 3% sales commission.  As previously reported, we believe access to this non-convertible perpetual security is a complement to our low risk financing philosophy of remaining debt free, while providing an expandable platform to raise funds as needed to bridge new petroleum investments.

·                  We remained debt free and in financial control of our assets.

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Liquidity and Capital Resources

At December 31, 2011, our working capital was $13.9 million, compared to working capital of $4.1 million at June 30, 2011.  The $9.8 million increase in working capital since June 30, 2011 was due primarily to $6.9 million of net proceeds from sales of our 8.5% Series “A” perpetual non-convertible preferred stock and $5.1 million provided by operations before changes in working capital, partially offset by $1.5 million invested in oil and natural gas properties and the payment of $0.3 million of preferred stock dividends.

Cash Flows from Operating Activities

For the six months ended December 31, 2011, cash flows provided by operating activities were $4.3 million, reflecting $5.1 million provided by operations before $0.8 million was used in working capital.  Of the $5.1 million provided, $2.6 million was attributable to accrued net income, $1.2 million from non-cash expenses and $1.3 million from deferred income taxes.

For the six months ended December 31, 2010, $19,007 of cash flows was used by operating activities, reflecting $0.1 million provided by operations which was more than offset by $0.1 million used in working capital.  Of the $0.1 million provided before working capital changes, the $1.3 million provided by non-cash expenses was almost offset by the $0.9 million net loss and $0.3 million used by deferred income tax payable.

Cash Flows from Investing Activities

Cash paid for oil and gas capital expenditures during the six months ended December 31, 2011 and 2010, was $1.5 million and $2.0 million, respectively.  Of the capital expenditures expended during the six months ended December 31, 2011, $0.2 million was for leasehold acquisitions and $1.3 million was for development activities.  Development activities included a workover on the Dodd well in Grimes County and the drilling of four new wells at Lopez Field in South Texas.

As presented in the supplemental cash flow information on the consolidated statements of cash flows, the changes in accounts payable for capital expenditures during the six months ended December 31, 2011 and 2010 were increases of $0.5 million and $0.3 million, respectively.  Taking both cash and accrued capital expenditures together, total capital expenditures incurred were $2.0 million and $2.3 million, respectively, during the six months ended December 31, 2011 and 2010.  These amounts can be reconciled to balance sheet changes for oil and gas properties when amortization expense for the respective periods is taken in account and, for the 2010 period, proceeds of $0.200 million for the asset sale.

During the six months ended December 31, 2011, an expiring $0.250 million CD was rolled over commencing a new annual term.   During the six months ended December 31, 2010, $1.1 million of certificates of deposit matured.

Cash Flows from Financing Activities

During the six months ended December 31, 2011, we received $6.9 million of net proceeds from the issuance of 317,319 shares of our 8.5% Series A perpetual preferred stock after all offering costs and we paid $0.3 million of dividends thereon.

During the six months ended December 31, 2010, we received $16 thousand due to the exercise of 6,875 stock options with an exercise price of $2.33 per share.

Capital Budget

During the first six months of fiscal 2012, we have incurred approximately $2 million of capital expenditures. Our approved fiscal 2012 Base Plan provides for capital expenditures of $4 million to as much as $12 million, which can be fully funded from our existing working capital of $13.9 million at December 31, 2011.  We expect to fund any increases over the fiscal 2012 Base Plan out of working capital, internally generated funds from operations, joint ventures, project financing, selective divestments of noncore assets or other appropriate financings, including possible additional issuances of our Series A perpetual non-convertible preferred stock.

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Table of Contents

Results of Operations

Three month period ended December 31, 2011 and 2010

The following table sets forth certain financial information with respect to our oil and natural gas operations: