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EPM > SEC Filings for EPM > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for EVOLUTION PETROLEUM CORP

Form 10-Q for EVOLUTION PETROLEUM CORP


12-May-2014

Quarterly Report


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

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto contained herein and in our Annual Report on Form 10-K for the year ended June 30, 2013 (the "Form 10-K"), along with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Form 10-K. Any terms used but not defined herein have the same meaning given to them in the Form 10-K.

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 (the "Securities Act") 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 2013 Annual Report on Form 10-K for the year ended June 30, 2013 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 engaged primarily in the development of incremental oil and gas reserves within known oil and gas resources for our shareholders and customers utilizing conventional and proprietary technology.

We particularly focus 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 a substantial ownership by our directors, officers and staff. By policy, every employee and director maintains a beneficial ownership of our common stock.

Our strategy is intended to fully participate in growing the value of our Delhi asset and maximize the value realized by our shareholders from that asset while aggressively commercializing our patented GARP® technology for recovering incremental oil and gas reserves in mature fields.

We are funding our base fiscal 2014 development plan from working capital, with any increases to the base plan funded out of working capital and net cash flows from our properties.

Highlights for our Third Quarter Fiscal 2014 and Project Update

"Q3-14" & "current quarter" is the three months ended March 31, 2014, the company's 3rd quarter of fiscal 2014.

"Q2-14" & "prior quarter" is the three months ended December 31, 2013, the company's 2nd quarter of fiscal 2014.

"Q3-13" & "year-ago quarter" is the three months ended March 31, 2013, the company's 3rd quarter of fiscal 2013.

Operations

† For Q3-14, we returned to profitability with net income of $0.8 million, impacted by a one-time charge of $0.6 million for the retirement of our previous CFO, compared to net loss of $0.6 million in the prior quarter and net income of $2.2 million in the year-ago quarter. The current quarter's earnings increase was primarily due to the prior quarter's $1.3 million restructuring charge and $0.8 million of non-recurring charges. The decrease from the year-ago quarter is primarily due to lower oil revenue and higher G&A, including the one-time $0.6 million charge, partially offset by lower LOE and income taxes.


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† Current quarter revenue of $4.3 million was flat sequentially and a decrease of 28% from $6.0 million in the year-ago quarter. The decrease from the year-ago quarter is primarily due to lower Delhi revenue driven by lower volumes and prices, as well as the fiscal 2013 divestment of Giddings properties and Q2-14 divestment of Lopez properties, offset by increased GARP® production.

† Black oil volumes accounted for 96% of total volumes and 99% of revenues during Q3-14, compared sequentially to 96% of volume and 99% of revenues in the prior quarter, while the year-ago quarter's oil volume was 95% of volume and 99% of revenue. Delhi oil volumes decreased 4% from the prior quarter and decreased 19% compared to the year-ago quarter. The sequential decrease in Delhi production primarily reflects two fewer production days, resulting in daily volumes being essentially flat compared to the previous quarter.

† The blended oil, NGL and natural gas product price we received in Q3-14 increased 6% sequentially to $99.03 per BOE from $93.66 in the prior quarter, and decreased 8% from $106.67 in the year-ago quarter. Current quarter oil prices increased 5% sequentially to $101.65 and decreased 9% compared to the year-ago quarter. Our average oil price reflects the large proportion of sales from Delhi that received favorable Louisiana Light Sweet pricing. The current quarter's price spread to WTI was 4%, compared to 2% sequentially and 13% in the year-ago quarter. NGL price increased 27% sequentially and 23% from the year-ago quarter to $38.88, while natural gas price increased 52% sequentially and 43% compared to the year-ago quarter to $4.87.

† A one-time charge of $0.6 million was recorded in the current quarter related to the February retirement of our previous CFO. This charge to G&A included $0.2 million of non-cash stock compensation expense and $0.4 million for payments to be made over the next year for salary, cash incentive and benefits.

† $1.0 million of proceeds were received during the current quarter from stock option exercises.

Delhi EOR Project

† Production in our Delhi enhanced oil recovery project of 457 BOPD net to our 7.4% royalty interest (6,172 gross BOPD) was essentially flat compared to the previous quarter and a decrease of 19% from the year-ago quarter. The decrease from the year ago quarter was due to the continuing production impact of the remediation work during the second half of calendar 2013 in response to a June 2013 fluids release event. As part of the remediation, the operator temporarily suspended CO2 injection in the southwestern portion of the field near the discovered fluid release in order to reduce reservoir pressure to stop further releases and allow re-entry of the previously plugged well(s) believed to be the source of the fluids release. This reduction in CO2 injection volumes that "drives" tertiary oil production temporarily reduced production in that area. Recently, the operator announced that remediation work had been completed and incremental CO2 injection resumed, although CO2 injection in the area directly impacted by the well believed to be the source of the fluids release has been replaced with water injection, a conventional secondary recovery technique. At this time, we do not know how much of the production rate decrease will be restored or the impact on future production and reserves due to the operator's revised development plan.

The operator recently announced that the field was back to normal operations and that it planned net development capital expenditures during calendar 2014 totaling $40 million. The operator further announced its plan to begin constructing a gas processing plant to recover methane and natural gas liquids from the recycle gas stream with first operations in 2015.

The temporary decline in production combined with the remediation expense has delayed the reversion of our 24% working interest to later in calendar 2014, excluding the effect of any indemnity of, or compensation to, us or the payout account by the operator, or the receipt of any insurance reimbursements. To date, the operator has not agreed to our interpretation of the application of the indemnity and their 2006 assumption of environmental liabilities and obligations, and we have filed a lawsuit against the operator seeking, among other things, declaration of the validity of the 2006 agreements that include the indemnity and recovery of damages and attorney's fees. The lawsuit asserts various breaches of the 2006 purchase and sale agreements and operating agreements between us and the operator including improperly charging our payout account for the cost of its remediation work, failure to timely assign us our reversionary working interest due to un-allowed charges to the deemed payout account, failure to indemnify us for damages associated with reductions in production due to the environmental event in June 2013, charging our payout account $43.8 million through March 31, 2014 for the cost of the processing plant as an operating cost and not a capital cost, charging over $2.4 million of plugging and abandonment cost as operating expense and not as capital, and failure to offer us our pro


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rata share of acquisitions made by the operator within the area of mutual interest. The Operator subsequently filed counterclaims.

Our working interest reversion, when it occurs, will more than triple our revenue interest from 7.4% to approximately 26.5%, while our cost bearing interest will increase from 0% to 23.9%.

† Realized oil prices at Delhi increased 5% sequentially and decreased 10% from the year-ago quarter to $102 per BO. Realized prices were $97 per BO in the previous quarter and $111 per BO in the year-ago quarter.

† The operator has stated its intention to begin work in 2014 on a plant to recover methane and natural gas liquids from the recycle gas stream with completion in calendar 2015; the plant would have a broader recovery of liquids and an earlier start date than projected in our June 30, 2013 reserve report. The plant is expected to have a positive impact on reserves, offset by any impact of the June 2013 fluids release. Proved oil reserves net to our interest are 74% developed and probable reserves are 48% developed as of June 30, 2013, based on our independent engineer's report as filed in our 2013 Form 10-K.

GARP® (Gas Assisted Rod Pump)

† We entered into an agreement during the quarter with a large independent operator to install GARP® in ten wells in the Giddings Field. The operator has the option to terminate the second five installations based on uneconomic performance in the first five installations. We will pay for the intangible costs of installation and a portion of required new tubing, and the operator will provide the leases and wells fully equipped for pumped operations as well as the balance of required new equipment. We will earn a fee equal to twenty-five percent of the field cash profits from the wells. The operator has a substantial portfolio of similar candidates for installation of GARP® that could be added to our agreement in the future.

† Subsequent to the end of the quarter and following our work with the customer to design the implementation of GARP® in the targeted wells, the operator has begun installing GARP® in the first five wells.

† The first three of the current commercial GARP® installations continue to perform as expected. The fourth installation, the Appelt, has experienced the same fines production that caused pump plugging problems prior to installation of GARP®, and the high operating cost associated with repeatedly cleaning out the fines has offset the increased production due to our GARP® installation.

† Our GARP® technology was awarded the 43rd annual E&P Special Meritorius Award for Engineering Innovation for 2014. The presentation of the award was made recently at the Offshore Technology Conference in Houston, and the award recognized the technology's innovation, suitability as a practical solution and potential for improving efficiency and profitability.

Projects - Non-Core Assets

Mississippi Lime

† Testing has been completed in the recompleted Sneath well, in which we plugged off production from the first 2/3rds of the horizontal lateral that is lowest in section in order to test production from a structurally higher portion of the reservoir. Results suggest that the recompletion was unsuccessful in completely shutting off water from the lower section of the horizontal section, thus we cannot prove or disprove the production model. At this time, no further development is under consideration and we are evaluating our options for this asset including divestment.


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Looking Forward

† $0.1 million of cash proceeds from the exercise of ISO's will be recorded in FQ4-14. In April, an officer exercised 50,000 stock options.

† We expect to achieve first production during Q4-14 from the first group of GARP® installations under the contract announced in Q3-14.

† Financial results will not be burdened by restructuring and related nonrecurring charges.

† Dividends paid to common and preferred shareholders through our year ending June 30, 2014 will be reported as return of capital and not as taxable dividends to the recipient.

Liquidity and Capital Resources

At March 31, 2014, our working capital was $24.2 million, compared to working capital of $24.8 million at June 30, 2013. The $0.6 million decrease in working capital since June 30, 2013 was due primarily to payment of $6.5 million of common stock dividends paid during our second and third fiscal quarters and increased current liabilities reflecting one-time accruals for restructuring charges and a retirement obligation, mostly offset by cash flows from operating activities, exercises of stock options and warrants, and lower accounts payable and accrued compensation.

Cash Flows from Operating Activities

For the nine months ended March 31, 2014, cash flows provided by operating activities were $5.7 million, reflecting $5.4 million provided by operations before $0.2 million provided by other working capital changes. Of the $5.4 million provided before working capital changes, $2.0 million was due to net income, which includes $1.3 million of restructuring and $0.6 million of retirement obligation charges, and $3.4 million was attributable to non-cash expenses.

For the nine months ended March 31, 2013, cash flows provided by operating activities were $9.1 million, reflecting $9.6 million provided by operations before $0.5 million was used in working capital. Of the $9.6 million provided before working capital changes, $5.5 million was due to net income, $2.1 million from non-cash expenses and $2.0 million from deferred income taxes.

The decrease in cash flow from operations for the nine months ended March 31, 2014 as compared to the nine months ended March 31, 2013 was due primarily to $2.6 million of lower revenue reflecting reduced Delhi Field production due to the fluids release together with $1.4 million of current year non-recurring items and a $1.3 million restructuring charge.

Cash Flows from Investing Activities

Cash paid for oil and gas capital expenditures during the nine months ended March 31, 2014 was $1.0 million. Development activities were about equally divided between GARP® wells in Giddings and the Sneath and Hendrickson wells completed in the Mississippi Lime during the prior year. We received approximately $542,000 of proceeds from asset sales, including $400,000 from the prior quarter sale of our South Texas properties, and $250,000 of cash from the maturity of a certificate of deposit.

Cash paid for oil and gas capital expenditures during the nine months ended March 31, 2013 was $4.4 million. Development activities were predominantly in the Mississippi Lime, where one salt water disposal well and two producer wells were completed. In Giddings, expenditures were centered on installing GARP® on a fourth commercial demonstration well. An inflow of $3.1 million was received for proceeds from the sales of a portion of our Giddings exploration and production properties. In December 2012, an expiring $0.25 million CD was rolled over beginning a new annual term.

Oil and gas capital expenditures incurred, but not yet paid, were $0.8 million and $3.9 million, respectively, for the nine months ended March 31, 2014 and 2013. These amounts can be reconciled to cash capital expenditures on their respective cash flow statements by adjusting them for changes in accounts payable and amounts owed to joint venture partners for capital expenditures as represented in the supplemental information.


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Cash Flows from Financing Activities

In the nine months ended March 31, 2014, we used $5.3 million in cash for financing activities, including cash inflows of $3.2 million from stock option exercise proceeds and $0.1 million of windfall tax benefits, offset by cash outflows of $6.5 million for common dividends, $0.5 million for preferred dividends and $1.6 million for treasury stock purchases related to incentive stock warrant and stock option exercises and restricted stock vestings.

In the nine months ended March 31, 2013, we paid preferred dividends of $0.5 million.

Capital Budget

We expect to fund all of our remaining fiscal 2014 Capital Plan, the total of which is uncertain at this time, with our $24.2 million of working capital on hand at March 31, 2014 and internally generated funds from operations. Our current capital budget for the balance of 2014 includes the potential of up to $10 million of development expenditures at Delhi, subject to the actual reversion date of our working interest and the timing of capital expenditures by the operator during calendar 2014. Our GARP® business is expected to require up to approximately $1 million during the balance of 2014, depending upon the timing of our customer's approval for and execution of the second five installations, as well as any other installations under any new agreement. No capital is currently allocated for the Mississippian Lime assets.

Capital Outlook for FY15

With reversion of our 23.9% working interest in Delhi expected to occur during FY15, we expect to begin funding our share of capital expenditures upon reversion. Although not yet established, the capital budget for Delhi for calendar 2015 is estimated to be approximately $12-20 million, thus our capital budget for fiscal 2015 may approach $22-30 million, depending upon the timing of expenditures by the operator and reversion date. Capital expenditures in our GARP® activities are expected to be less than $5 million for 2015. Funding for all capital expenditures is expected to be met from current working capital and cash flows from operations. In addition, we have access to a $5 million unsecured revolver and are in discussions to convert the revolver to a senior secured credit with up to $30 million of capacity, primarily to provide a standby source of liquidity to meet future lump sum capital expenditures at Delhi.

Results of Operations

Three month period ended March 31, 2014 and 2013

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

                                          Three Months Ended
                                              March 31,                                %
                                         2014           2013          Variance       Change

Sales Volumes, net to the Company:

Crude oil (Bbl.)                           42,108         53,699         (11,591 )     (21.6 )%

NGLs (Bbl.)                                   764            857             (93 )     (10.9 )%

Natural gas (Mcf)                           5,532         10,743          (5,211 )     (48.5 )%
Crude oil, NGLs and natural gas
(BOE)                                      43,794         56,347         (12,553 )     (22.3 )%

Revenue data:

Crude oil                             $ 4,280,355    $ 5,947,015    $ (1,666,660 )     (28.0 )%

NGLs                                       29,701         27,067           2,634         9.7 %

Natural gas                                26,950         36,485          (9,535 )     (26.1 )%
Total revenues                        $ 4,337,006    $ 6,010,567    $ (1,673,561 )     (27.8 )%

Average price:
Crude oil (per Bbl.)                  $    101.65    $    110.75    $      (9.10 )      (8.2 )%
NGLs (per Bbl.)                             38.88          31.58            7.30        23.1 %
Natural gas (per Mcf)                        4.87           3.40            1.47        43.2 %
Crude oil, NGLs and natural gas
(per BOE)                             $     99.03    $    106.67    $      (7.64 )      (7.2 )%

Expenses (per BOE)
Lease operating expenses              $      7.89    $      9.32    $      (1.43 )     (15.3 )%
Production taxes                      $      0.19    $      0.25    $      (0.06 )     (24.0 )%
Depletion expense on oil and
natural gas properties (a)            $      6.90    $      4.81    $       2.09        43.5 %


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(a) Excludes depreciation of office equipment, furniture and fixtures, and other assets of $9,732 and $10,305, for the three months ended March 31, 2014 and 2013, respectively.

Net Income Available to Common Shareholders. For the three months ended March 31, 2014, we earned net income of $0.8 million or $0.02 per diluted share, (which includes a pre-tax $0.6 million non-recurring charge for a retirement obligation) on total oil and natural gas revenues of $4.3 million. The current quarter's non-cash stock compensation expense was $444,981 of which $203,861 related to the accelerated vesting of equity awards under the retirement arrangement. This compares to the year ago net income of $2,228,467, or $0.07 per diluted share, (which includes $392,433 of non-cash stock-based compensation expense) on total oil and natural gas revenues of $6,010,567. Decreased revenues and higher general and administrative expense were partially offset by lower lease operating expenses and income tax expense.

Sales Volumes. Crude oil, NGLs, and natural gas sales volumes, net to our interest, for the three months ended March 31, 2014 decreased 22% to 43,794 BOE's compared to 56,347 BOE's for the year-ago quarter. This 12,553 volume decrease primarily reflects lower Delhi Field volumes, lower Giddings Field volumes due to sale of properties in fiscal 2013 and the absence of Lopez field volumes (sold in December 2013). Our crude oil sales volumes for the current quarter of 42,108 barrels include 41,137 from our interests in Delhi and 966 barrels from the Giddings field. Our crude oil sales volumes for the year-ago quarter of 53,699 barrels included 50,951 barrels from our interests in Delhi, 1,264 barrels at Giddings, 1,218 barrels at Lopez and 266 barrels at the Mississippi Lime. Our NGL volumes for the three months ended March 31, 2014 declined 11% to 764 barrels compared to 857 barrels in the year-ago-quarter. Current quarter natural gas volumes, virtually all produced at Giddings, decreased 49% to 5,532 mcf from 10,743 mcf in the year-ago quarter. Both NGL and natural gas volumes were impacted by the Giddings sales.

Petroleum Revenues. Crude oil, NGLs and natural gas revenues decreased $1.7 million to $4.3 million for the current quarter, a 28% decrease from $6.0 million in the year-ago quarter due to a 22% volume decline together with a 7% lower price per BOE. Prices per BOE were $99.03 and $106.67, respectively, for the current and year-ago quarters.

Lease Operating Expenses (including ad valorem and production severance taxes). Lease operating expenses and production taxes for the current quarter decreased $185,691, or 34%, to $353,629 compared to the year-ago quarter. Expenses were approximately $106,000 lower due to the Lopez Field sale, $35,000 lower at our Mississippi Lime properties, and $44,000 lower in the Giddings Field where the impact of fiscal 2013 divestitures was partially offset by higher expenses at GARP® wells. Lease operating expense and production tax per barrel of oil equivalent decreased 16% from $9.57 per BOE during year-ago quarter to $8.08 per BOE during current quarter.

General and Administrative Expenses ("G&A"). G&A expenses increased $0.5 million, or 30%, to $2.3 million during the three months ended March 31, 2014 from $1.8 million in the year-ago quarter primarily due to a $0.6 million non-recurring charge related to the retirement of the Company's vice president and chief financial officer. The charge consisted of $0.2 million of stock compensation from the accelerated vesting of equity awards, $0.3 million for future payments of salary and benefits and $0.1 million for cash incentive bonus. Stock-based compensation was $444,981 (19% of total G&A) for the current quarter compared to $392,433 (22% of total G&A) for the year-ago quarter.

Depreciation, Depletion & Amortization Expense ("DD&A"). DD&A increased 11% to $311,815 for the three months ended March 31, 2014, compared to $281,306 for the year-ago quarter. This change was principally due to a 40% increase in depletion rate from $4.81 per BOE in the year-ago quarter to $6.72 in the current quarter partially offset by a 22% decline in volume as described above. Much of the higher depletion rate is due to higher future capital expenditures at Delhi associated with increased reserves reflected in our June 30, 2013 reserve report.


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Nine month period ended March 31, 2014 and 2013

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

                                              Nine Months Ended
                                                  March 31,                              %
                                             2014           2013         Variance     Change

Sales Volumes, net to the Company:

Crude oil (Bbl.)                              128,853        145,051        (16,198 )   (11.2 )%

NGLs (Bbl.)                                     2,408          6,616         (4,208 )   (63.6 )%
. . .
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