Annual Statements Open main menu
  1. Annual Statements
  2. » Companies
  3. » ZION OIL & GAS INC
  4. » Quarter Report: 2010 September (Form 10-Q)

ZION OIL & GAS INC - Quarter Report: 2010 September (Form 10-Q)

Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
MARK ONE
 
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period ended September 30, 2010; or
 
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: 001-33228
 
ZION OIL & GAS, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
20-0065053
  (State or other jurisdiction of incorporation or organization)
   (I.R.S. Employer Identification No.)
 
6510 Abrams Rd., Suite 300
Dallas, Texas
75231
  (Address of principal executive offices)
Zip Code
 
(214) 221-4610
(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 o 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

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
 
As of November 5, 2010, Zion Oil & Gas, Inc. had outstanding 21,224,397 shares of common stock, par value $0.01 per share.
 
 
INDEX PAGE
PART 1 – FINANCIAL INFORMATION

   
Page
     
Item 1 - Financial Statements – Unaudited
    
     
Balance Sheets  - September 30, 2010 and December 31, 2009
  
1
     
Statements of Operations for the three and nine months ended September 30, 2010 and 2009 and the period from April 6, 2000 (inception) to September 30, 2010
  
2
     
Statements of Changes in Stockholders' Equity for the nine months ended September 30, 2010 and the period from April 6, 2000 (inception) to September 30, 2010
  
3
     
Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 and the period from April 6, 2000 (inception) to September 30, 2010
  
13
     
Notes to Unaudited Interim Financial Statements
  
15
     
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
  
33
     
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
  
39
     
Item 4 - Controls and Procedures
  
40
     
PART II — OTHER INFORMATION
    
     
Item 1 – Legal Proceedings
  
40
     
Item A – Risk Factors
  
40
     
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
  
41
     
Item 3 - Defaults upon Senior Securities
  
41
     
Item 4 – (Removed and Reserved)
  
41
     
Item 5 - Other Information
  
41
     
Item 6 – Exhibits
  
41
     
SIGNATURES
  
42
 
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Balance Sheets (unaudited) as of September 30, 2010 

   
September 30
    
December 31
  
    
2010
    
2009
  
    
US$ thousands
    
US$ thousands
  
Current assets
            
Cash and cash equivalents
     11,682       20,734  
Prepaid expenses and other
     700       647  
Deferred offering costs
     26       -  
Tax refunds receivable
     537       961  
Total current assets
     12,945       22,342  
                 
Unproved oil and gas properties, full cost method (see Note 2A)
     19,538       23,759  
                 
Property and equipment at cost
                
Net of accumulated depreciation of $97,200 and $82,000, at September 30, 2010 and December 31, 2009 respectively
     159       78  
                 
Other assets
                
Assets held for severance benefits
     68       46  
                 
Total assets
     32,710       46,225  
                 
Liabilities and Stockholders’ Equity
                
                 
Current liabilities
                
Accounts payable
     1,750       159  
Asset retirement obligation
     50       50  
Accrued liabilities
     678       1,915  
Deferred officers compensation
     94       477  
Total current liabilities
     2,572       2,601  
                 
Provision for severance pay
     304       185  
                 
Total liabilities
     2,876       2,786  
                 
Commitments and contingencies (see Note 6)
                
                 
Stockholders’ equity
                
Common stock, par value $.01; 50,000,000 shares authorized:    September 30, 2010 – 21,224,397 shares; December 31, 2009 – 18,706,601 shares issued and outstanding
     212       187  
Additional paid-in capital
     84,770       72,081  
Deficit accumulated in development stage
     (55,148 )     (28,829 )
Total stockholders’ equity
     29,834       43,439  
                 
Total liabilities and stockholders' equity
     32,710       46,225  
 
The accompanying notes are an integral part of the unaudited interim financial statements.
 
1
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statements of Operations (unaudited) 
 
                           
Period from
  
                            
April 6, 2000
  
    
For the three month period
    
For the nine month period
    
(inception) to
  
    
ended September 30
    
ended September 30
    
September 30
  
    
2010
    
2009
    
2010
    
2009
    
2010
  
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Revenues
     -       -       -       -       -  
                                         
General and administrative expenses
                                        
Legal and professional
     138       156       633       623       6,588  
Salaries
     651       368       2,090       1,768       10,158  
Other
     746       341       1,591       816       6,589  
Impairment of unproved oil and gas properties
     -       -       22,022       -       31,516  
Loss from operations
     (1,535 )     (865 )     (26,336 )     (3,207 )     (54,851 )
                                         
Other expense, net
                                        
Termination of initial public offering
     -       -       -       -       (527 )
Other income, net
     -       -       -       76       80  
Interest income, net
     102       48       17       66       150  
                                         
Loss before income taxes
     (1,433 )     (817 )     (26,319 )     (3,065 )     (55,148 )
Income taxes
     -       -       -       -       -  
                                         
Net loss
     (1,433 )     (817 )     (26,319 )     (3,065 )     (55,148 )
                                         
Net loss per share of common stock -  basic and diluted (in US$)
     (0.07 )     *(0.05 )     (1.36 )     *(0.23 )     *(6.34 )
                                         
Weighted-average shares outstanding – basic and diluted (in thousands)
     20,632       *15,629       19,378       *13,372       *8,694  

* Adjusted to reflect bonus element in rights offering, see note 2B.
 
The accompanying notes are an integral part of the unaudited interim financial statements.

2
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Changes in Stockholders' Equity (unaudited) 

                     
Deficit
        
                      
Additional
    
accumulated
        
    
Preferred Stock
    
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amount
    
Shares
    
Amount
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                                                         
Balances April 6, 2000
     -       -       -       -       -       -       -  
                                                         
Issued for cash ($0.001 per share)
     -       -       2,400       * -       2       -       2  
                                                         
Issuance of shares and warrants in a private offering  ($1 per share)
     -       -       100       * -       100       -       100  
                                                         
Costs associated with the issuance of shares
     -       -       -       -       (24 )     -       (24 )
                                                         
Waived interest on conversion of debt
     -       -       -       -       * -       -       * -  
                                                         
Value of warrants granted to employees
     -       -       -       -       2       -       2  
Net loss
     -       -       -       -       -       (5 )     (5 )
Balances as of December 31, 2000
     -       -       2,500       * -       80       (5 )     75  
                                                         
Issuance of shares and warrants in a private offering in January 2001 ($1 per share)
     -       -       135       * -       135       -       135  
                                                         
Issuance of shares and warrants in a private offering which closed in September 2001 ($1 per share)
     -       -       125       * -       125       -       125  
                                                         
Payment of accounts payable through issuance of shares and warrants
     -       -       40       * -       40       -       40  
                                                         
Payment of note payable through issuance of shares and warrants
     -       -       25       * -       25       -       25  
                                                         
Issuance of shares and warrants in a private offering which closed in November 2001 ($1 per share)
     -       -       175       * -       175       -       175  
                                                         
Costs associated with the issuance of shares
     -       -       -       -       (85 )     -       (85 )
Waived interest on conversion of debt
     -       -       -       -       1       -       1  
Value of warrants granted to employees
     -       -       -       -       37       -       37  
Value of warrants granted to directors and consultants
     -       -       -       -       3       -       3  
Net loss
     -       -       -       -       -       (207 )     (207 )
Balances as of December 31, 2001
     -       -       3,000       * -       536       (212 )     324  
 
*  Represents an amount less than US$ 1 thousand.
 
3
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Changes in Stockholders' Equity (unaudited)(cont’d) 

                     
Deficit
        
                      
Additional
    
accumulated
        
    
Preferred Stock
    
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amount
    
Shares
    
Amount
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Change in par value of common shares from $ 0.0001 per share to $0.01 per share
     -       -       -       30       (30 )     -       -  
                                                         
Issuance of shares and warrants in a private offering which closed in January 2002 ($1 per share)
     -       -       20       * -       20       -       20  
                                                         
Issuance of shares and warrants in a private offering which closed in November 2002 ($10 per share)
     25       * -       22       * -       254       -       254  
                                                         
Payment of accounts payable through issuance of preferred shares and warrants
     13       * -       -       -       127       -       127  
                                                         
Payment of accounts payable through issuance of common shares and warrants
     -       -       111       1       131       -       132  
                                                         
Payment of note payable through issuance of shares and warrants
     5       * -       -       -       50       -       50  
                                                         
Payment of accounts payable to employee through issuance of shares upon exercise of warrants
     -       -       400       4       76       -       80  
                                                         
Costs associated with the issuance of shares
     -       -       -       -       (160 )     -       (160 )
                                                         
Waived interest on conversion of debt
     -       -       -       -       3       -       3  
                                                         
Deferred financing costs on debt conversions / modifications
     -       -       -       -       21       -       21  
                                                         
Value of warrants granted to employees
     -       -       -       -       1       -       1  
                                                         
Value of warrants granted to directors and consultants
     -       -       -       -       13       -       13  
                                                         
Net loss
     -       -       -       -       -       (403 )     (403 )
                                                         
Balances as of December 31, 2002
     43       * -       3,553       35       1,042       (615 )     462  
 
*  Represents an amount less than US$ 1 thousand.
 
4
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Changes in Stockholders' Equity (unaudited) (cont’d)
 
                     
Deficit
        
                      
Additional
    
accumulated
        
    
Preferred Stock
    
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amount
    
Shares
    
Amount
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Issuance of shares in connection with executive employment
     -       -       50       1       49       -       50  
                                                         
Issuance of share on warrants exercise
     -       -       165       2       31       -       33  
                                                         
Issuance of dividend shares to record holders as of December 31, 2002
     4       * -       -       -       * -       -       -  
                                                         
Issuance of shares and warrants in a private offering which closed in February 2003 ($10 per share):
                                                        
for cash consideration
     10       * -       -       -       105       -       105  
for reduction of accounts payable
     5       * -       -       -       45       -       45  
                                                         
Issuance of shares and warrants as compensation for extension of $100,000 line of credit
     1       * -       -       -       10       -       10  
                                                         
Payment of account payable through issuance of shares and warrants
     * -       * -       -       -       1       -       1  
                                                         
Conversion of preferred shares to common shares in reincorporation merger
     (63 )     * -       763       7       (7 )     -       -  
                                                         
Issuance of shares in a private offering which closed in July 2003 ($3 per share):
                                                        
for cash consideration
     -       -       33       * -       99       -       99  
for reduction of accounts payable
     -       -       3       * -       9       -       9  
                                                         
Issuance of shares upon exercise of warrants:
                                                        
for cash consideration
     -       -       25       * -       25       -       25  
for reduction of accounts payable
     -       -       124       1       142       -       143  
                                                         
Issuance of shares upon exercise of warrants for cash consideration
     -       -       63       1       82       -       83  
                                                         
Payment of account payable through issuance of shares
     -       -       80       1       139       -       140  
                                                         
Costs associated with the issuance of shares
     -       -       -       -       (58 )     -       (58 )
                                                         
Value of warrants granted to employees
     -       -       -       -       47       -       47  
                                                         
Deferred financing costs on debt conversions / modifications
     -       -       -       -       (10 )     -       (10 )
                                                         
Net loss
     -       -       -       -       -       (873 )     (873 )
Balances as of December 31, 2003
     -       -       4,859       48       1,751       (1,488 )     311  
*  Represents an amount less than US$ 1 thousand.
 
5
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Changes in Stockholders' Equity (unaudited)(cont’d) 

               
Deficit
        
          
Additional
    
accumulated
        
    
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Issuance of shares on warrants exercise
     123       1       183       -       184  
                                         
Issuance of shares and warrants in a private offering
     251       3       1,002       -       1,005  
                                         
Payment of officer salaries through issuance of shares and warrants
     46       1       184       -       185  
                                         
Payment of accounts payable to officers and consultants upon exercise of warrants
     80       1       99       -       100  
                                         
Payment of director honorariums through issuance of shares and warrants
     11       * -       45       -       45  
                                         
Payment of account payable through issuance of shares and warrants
     13       * -       50       -       50  
                                         
Payment of bridge loan through issuance of shares and warrants
     125       1       499       -       500  
                                         
Payment of bridge loan interest and commitment fee through issuance of shares and warrants
     8       * -       30       -       30  
                                         
Payment of bridge loan finders fee through issuance of shares and warrants
     2       * -       7       -       7  
                                         
Payment of service bonus through issuance of shares and warrants
     20       * -       20       -       20  
                                         
Costs associated with the issuance of shares
     -       -       (59 )     -       (59 )
                                         
Value of warrants granted to employees
     -       -       41       -       41  
                                         
Deferred financing costs on debt conversions / modifications
     -       -       30       -       30  
                                         
Net loss
     -       -       -       (1,737 )     (1,737 )
                                         
Balances as of December 31, 2004
     5,538       55       3,882       (3,225 )     712  
 
*  Represents an amount less than US$ 1 thousand.
 
6
 
 Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Changes in Stockholders' Equity (unaudited) (cont’d) 
 
               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
   
Shares
    
Amounts
    
capital
    
stage
    
Total
  
   
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Issuance of shares on warrants exercised:
                              
For cash
     493       5       872       -       877  
For payment of deferred officer salaries
     17       * -       21       -       21  
For exchange of shares of common stock
     120       1       (1 )     -       -  
                                         
Issuance of shares and warrants in a private offering that closed in March 2005:
                                        
For cash
     519       5       2,070       -       2,075  
For payment of deferred officer salaries
     10       * -       40       -       40  
For payment of accounts payable
     6       * -       25       -       25  
                                         
Issuance of shares and warrants in a private offering that closed in June 2005:
                                        
For cash
     259       3       1,292       -       1,295  
For payment of directors honoraria
     14       * -       70       -       70  
For payment of accounts payable
     3       * -       15       -       15  
                                         
Issuance of shares in a private offering that closed in October 2005:
                                        
For cash
     584       6       2,914       -       2,920  
For payment of deferred officer salaries
     40       * -       200       -       200  
For payment of accounts payable
     22       * -       110       -       110  
                                         
Issuance of shares in a private offering that closed in December 2005
     80       1       439       -       440  
                                         
Shares to be issued for services provided by director
     -       -       42       -       42  
                                         
Value of warrants and options granted to employees
     -       -       216       -       216  
                                         
Value of warrants granted to directors and consultants
     -       -       16       -       16  
                                         
 Deferred financing costs on debt conversions /modifications
     -       -       44       -       44  
                                         
Costs associated with the issuance of shares
     -       -       (275 )     -       (275 )
                                         
Net loss
     -       -       -       (1,605 )     (1,605 )
                                         
Balances as of December 31, 2005
     7,705       76       11,992       (4,830 )     7,238  
 
*  Represents an amount less than US$ 1 thousand.
 
7
 
Zion Oil & Gas, Inc.
(A Development Stage Company)

Statement of Changes in Stockholders' Equity (unaudited) (cont’d) 

               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Issuance of shares on warrants exercised:
                              
For cash
     253       3       1,151       -       1,154  
For debt
     60       1       276       -       277  
                                         
Issuance of shares and warrants in private offering closings in first quarter 2006:
                                        
For cash
     66       1       362       -       363  
For payment of accounts
                                        
Payable
     3       * -       14       -       14  
                                         
Shares issued for services provided by officer
     200       2       248       -       250  
                                         
Issuance of shares and warrants in a private offering that closed in September 2006 for cash
     23       * -       126       -       126  
                                         
Value of options granted to employees
     -       -       162       -       162  
                                         
Value of warrants granted to underwriter
     -       -       20       -       20  
                                         
Value of shares gifted to directors, employees and service providers
     -       -       147       -       147  
                                         
Costs associated with the issuance of shares
     -       -       (681 )     -       (681 )
                                         
Funds received from public offering for subscription shares:
                                        
For cash
     410       4       2,867       -       2,871  
For debt
     27       * -       188       -       188  
                                         
Net loss
     -       -       -       (2,510 )     (2,510 )
                                         
Balances as of December 31, 2006
     8,747       87       16,872       (7,340 )     9,619  
 
*  Represents an amount less than US$ 1 thousand.
 
8
 
Zion Oil & Gas, Inc.
(A Development Stage Company)

Statement of Changes in Stockholders' Equity (unaudited) (cont’d) 

               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Funds received from public offering for subscription shares:
                              
For cash
     1,336       14       9,338       -       9,352  
For debt
     33       * -       235       -       235  
                                         
Compensation in respect of shares previously issued for services provided by officer
     -       -       208       -       208  
                                         
Value of options granted to employees
     -       -       337       -       337  
                                         
Value of warrants granted to underwriter
     -       -       79       -       79  
                                         
Value of shares granted to employees
     5       *-       25       -       25  
                                         
Value of shares gifted to employees
     -       -       7       -       7  
                                         
Costs associated with the issuance of shares
     -       -       (1,027 )     -       (1,027 )
                                         
Net loss
     -       -       -       (13,047 )     (13,047 )
                                         
Balances as of December 31, 2007
     10,121       101       26,074       (20,387 )     5,788  
 
*  Represents an amount less than US$ 1 thousand.
 
9
 
Zion Oil & Gas, Inc.
(A Development Stage Company)

Statement of Changes in Stockholders' Equity (unaudited) (cont’d)

               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Funds received from Unit Offering for subscription shares:
                              
For cash
     405       4       4,040       -       4,044  
For debt
     12       *-       120       -       120  
                                         
Value of warrants granted to employees
     -       -       266       -       266  
                                         
Value of options granted to directors and consultants
     -       -       44       -       44  
                                         
Value of shares granted to employees
     4       *-       25       -       25  
                                         
Value of shares gifted to employees
     -       -       101       -       101  
                                         
Costs associated with the issuance of shares
     -       -       (815 )     -       (815 )
                                         
Net loss
     -       -       -       (4,018 )     (4,018 )
                                         
Balances as of December 31, 2008
     10,542       105       29,855       (24,405 )     5,555  
 
*  Represents an amount less than US$ 1 thousand.
 
10
 
Zion Oil & Gas, Inc.
(A Development Stage Company)

Statement of Changes in Stockholders' Equity (unaudited) (cont’d) 

               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Funds received from Unit Offering for subscription shares:
                              
For cash
     237       3       2,370       -       2,373  
For debt
     13       *-       126       -       126  
                                         
Funds received from Rights Offering
     4,200       42       20,958       -       21,000  
                                         
Funds received from Second Rights Offering
     3,600       36       17,964       -       18,000  
                                         
Funds received from warrant exercises
     59       1       414       -       415  
                                         
Underwriter warrants exercised in cashless exercise
     13       -       -       -       -  
                                         
Director warrants and options exercised in cashless exercises
     37       -       -       -       -  
                                         
Value of options granted to employees
     -       -       494       -       494  
                                         
Value of options granted to directors and consultants
     -       -       328       -       328  
                                         
Value of shares granted to consultants for services
     5       *-       46       -       46  
                                         
Value of shares gifted to employees
     -       -       4       -       4  
                                         
Costs associated with the issuance of shares
     -       -       (478 )     -       (478 )
                                         
Net loss
     -       -       -       (4,424 )     (4,424 )
                                         
Balances as of December 31, 2009
     18,706       187       72,081       (28,829 )     43,439  
 
*  Represents an amount less than US$ 1 thousand.
 
11
 
Zion Oil & Gas, Inc.
(A Development Stage Company)

Statement of Changes in Stockholders' Equity (unaudited) (cont’d) 

               
Deficit
        
         
Additional
    
accumulated
        
   
Common Stock
    
paid-in
    
in development
        
    
Shares
    
Amounts
    
capital
    
stage
    
Total
  
    
Thousands
    
US$
thousands
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
                               
Funds received from warrant exercises
     *-       *-       3       -       3  
                                         
Funds received from option exercises
     44       *-       *-       -       *-  
Funds received from Rights Offering
     2,471       25       12,331       -       12,356  
                                         
Value of shares granted to consultants for services
     3       *-       15       -       15  
                                         
Value of options granted to employees
     -       -       553       -       553  
                                         
Costs associated with the issuance of shares
     -       -       (213 )     -       (213 )
                                         
Net loss
     -       -       -       (26,319 )     (26,319 )
                                         
Balances as of September 30, 2010
     21,224       212       84,770       (55,148 )     29,834  
 
*  Represents an amount less than US$ 1 thousand.
 
The accompanying notes are an integral part of the financial statements.
 
12
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Cash Flows (unaudited) 

               
Period from
  
          
April 6, 2000
  
    
For the nine month
    
(inception) to
  
    
period ended September 30
    
September 30
  
    
2010
    
2009
    
2010
  
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Cash flows from operating activities
                  
Net loss
     (26,319 )     (3,065 )     (55,148 )
Adjustments required to reconcile net loss to net cash used in operating activities:
                        
Depreciation
     24       12       112  
Officer, director and other fees, paid via common stock
     15       4       2,330  
Cost of options or warrants issued to employees, directors & others
     553       764       2,659  
Interest paid through issuance of common stock
     -       -       17  
Write-off of costs associated with public offering
     -       -       507  
Loss on disposal of equipment
     -       -       4  
Impairment of unproved oil and gas properties
     22,022       -       31,516  
Asset retirement obligation
     -       -       50  
Change in assets and liabilities, net:
                        
Decrease in inventories
     -       -       150  
Prepaid expenses and other
     (53 )     66       (700 )
Increase in deferred offering costs
     (26 )     (22 )     (26 )
Tax refunds receivable
     424       (620 )     (537 )
Provision for severance pay, net
     98       28       237  
Accounts payable
     1,591       (60 )     2,398  
Accrued liabilities
     (1,237 )     920       678  
Increase (decrease) in deferred officers' compensation
     (383 )     (1,231 )     334  
Net cash used in operating activities
     (3,291 )     (3,204 )     (15,419 )
                         
Cash flows from investing activities
                        
Acquisition of property and equipment
     (104 )     (4 )     (272 )
Investment in unproved oil and gas properties
     (17,800 )     (10,915 )     (51,203 )
Net cash used in investing activities
     (17,904 )     (10,919 )     (51,475 )
                         
Cash flows from financing activities
                        
Deferred financing costs on debt conversions and modification
     -       -       89  
Loan proceeds – related party
     -       -       259  
Loan principal repayments – related party
     -       -       (259 )
Loan proceeds – other
     -       -       500  
Proceeds from sale of stock
     12,356       23,784       81,963  
Costs associated with the issuance of shares
     (213 )     (365 )      (3,976 )
Net cash provided by financing activities
     12,143       23,419       78,576  
                         
Net increase (decrease) in cash and cash equivalents
     (9,052 )     9,296       11,682  
Cash and cash equivalents – beginning of period
     20,734       1,726       -  
Cash and cash equivalents– end of period
     11,682       11,022       11,682  
 
13
 
Zion Oil & Gas, Inc.
(A Development Stage Company)
Statement of Cash Flows (unaudited) (cont'd) 

               
Period from
  
                
April 6, 2000
  
    
For the nine month
    
(inception) to
  
    
period ended September 30
    
September 30
  
    
2010
    
2009
    
2010
  
    
US$ thousands
    
US$ thousands
    
US$ thousands
  
Supplemental information
                  
                   
Cash paid for interest
     14       4       78  
Cash paid for income taxes
     -       -       -  
                         
Non-cash investing and financing activities:
                        
                         
Payment of accounts payable through  issuance of common stock
     -       6       575  
Payment of accounts payable through  issuance of note payable
     -       -       35  
Financing costs paid through issuance of common stock
     -       -       25  
Increase in accounts payable for financing costs
     -       -       382  
Waived interest on debt conversions
     -       -       4  
Shares issued for debt conversion
     -       120       940  
Value of warrants and options granted to directors and consultants
             328       405  
Value of warrants and options granted to employees
             436       1,544  
Value of warrants granted to underwriters
     -       -       99  
Value of shares gifted to directors, employees and service providers
     -       4       259  
Deferred financing costs
     -       -       85  
Transfer of inventory to oil and gas properties
     -       -       150  
 
The accompanying notes are an integral part of the unaudited interim financial statements.
 
14
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 

Note 1 - Nature of Operations and Basis of Presentation

A.
Nature of Operations

Effective July 9, 2003, Zion Oil & Gas, Inc., a Florida corporation (“Zion Florida”) was merged into its wholly owned Delaware subsidiary, Zion Oil & Gas, Inc. (sometimes referred to herein as “Zion,” or the “Company,”), the purpose of which was solely to reincorporate from Florida to Delaware in anticipation of a public offering.  Upon the reincorporation, all the outstanding shares of common stock in Zion Florida were converted into common stock, par value $0.01 (the “Common Stock”), of the Company on a one-to-one basis and all the outstanding shares of preferred stock in Zion Florida were converted into Common Stock of the Company at the ratio of twelve shares of common stock for each share of preferred stock.  All of the outstanding warrants and options of Zion Florida were converted into equivalent warrants and options of the Company.

The Company currently holds two petroleum exploration licenses and one preliminary exclusive petroleum exploration permit with priority rights under the Israeli Petroleum Law, 5712-1952 (the “Petroleum Law”). Zion’s petroleum rights extend from the Mediterranean at Caesarea across the Carmel Mountains to Megiddo and through to the Jordan River immediately south of the Sea of Galilee.  Zion’s total petroleum exploration rights area is approximately 327,100 acres.  Below is a summary of the licenses and the permit.

Licenses

(1) The “Asher-Menashe License” covers an area of approximately 78,824 acres located on the Israeli coastal plain and the Mt. Carmel range between Caesarea in the south and Haifa in the north. The Asher-Menashe License had an initial three-year term that ran from June 10, 2007 through June 9, 2010, and as of May 17, 2010, has been extended for an additional one-year period ending June 9, 2011.  At the option of the Israeli Petroleum Commissioner, the Asher-Menashe License may be extended for additional one-year periods up to 2014, as provided by the Petroleum Law. The Asher-Menashe License was issued following the Company's successful completion of the work program under the 121,000 acre Asher Permit, originally granted to the Company effective August 1, 2005, in the course of which the Company developed three leads.  Under the terms of the Asher-Menashe License, as extended, the Company is to (i) sign an agreement with an appropriate geological services provider to acquire at least 30 kilometers of 2D seismic by August 1, 2010, (ii) commence the seismic survey by October 1, 2010, (iii) process and integrate the results of the new seismic survey with existing seismic lines and file a report with the Israeli Petroleum Commissioner by February 1, 2011, (iv) identify a new drilling prospect in the Asher-Menashe License area by April 1, 2011 and (v) sign a drilling contract to drill to the Permian geological layer by May 1, 2011 and complete such drilling during 2011. The areas covered by the Asher-Menashe License include the Elijah-3 well. Approximately 32 kilometers of 2D seismic data was acquired in June 2010 and is currently being processed, by a geophysical consultant in the United States, into usable graphic imagery that will then be interpreted by the Company’s geologists in their search for future drilling prospects.  The processing and interpretation of this data is expected to be finalized by December 2010.
 
15
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 1 - Nature of Operations and Basis of Presentation (cont’d)
A.  Nature of Operations (cont’d)

(2) The “Joseph License” covers approximately 83,272 acres on the Israeli coastal plain south of the Asher-Menashe License between Caesarea in the north and Netanya in the south.  The Joseph License had an initial three-year term that ran from October 11, 2007 through October 10, 2010 and, as of April 22, 2010, has been extended for an additional one-year period ending October 10, 2011.  The Joseph License may be extended for additional one-year periods up to 2014, as provided by the Petroleum Law.  The area covered by the Company’s Joseph License covers approximately 85% of the area subject to the 98,100 acre Ma’anit-Joseph License which had been held by the Company until it was formally surrendered on June 22, 2007 in accordance with the provisions of the Petroleum Law following the abandonment of the Ma’anit #1 well, drilled by the Company.  The areas covered by the Joseph License include the Ma’anit structure, on which the Company drilled the Ma’anit #1 and Ma’anit-Rehoboth #2 wells, and on which the Company is currently drilling the Ma'anit-Joseph #3 well.  Under the terms of the Joseph License, as extended, the Company is to (i) submit to the Israeli Petroleum Commissioner a report as to the production testing of Zion’s Ma’anit-Rehoboth #2 well by October 1, 2010 and (ii) start drilling, by January 1, 2011, a well to the Permian geological layer.  A report relating to the production testing of the Company’s Ma’anit-Rehoboth #2 well was timely submitted to the Israeli Petroleum Commissioner.  Between May 2009 and October 2009, the Company drilled the Ma’anit-Rehoboth #2 well to a depth of approximately 5,460 meters (17,913 feet).  In April 2010, the Company conducted production tests on several zones of interest identified during the drilling of the Ma’anit-Rehoboth #2 well.  The productions tests indicated that commercial quantities of hydrocarbons were not present in the Ma’anit-Rehoboth #2 well.  Work on this well was subsequently suspended and an impairment charge was recognized during the quarter ended June 30, 2010.  (See Note 2A).

In August 2010, the Company submitted a production testing report regarding the Ma’anit-Rehoboth #2 well to the Israeli Petroleum Commissioner and on August 26, 2010, the Company commenced drilling operations on its Ma’anit-Joseph #3 well, at a location near to the Ma'anit-Rehoboth #2 well.  The drilling of the Ma'anit-Joseph #3 well is planned to test the Permian geological formation and drilling operations on this well are expected to last approximately six months.  As of November 4, 2010, the drilling of the Ma'anit-Joseph #3 well reached a depth of approximately 2,220 meters (7,283 feet).

In the event of a discovery on either of the licenses held, Zion will be entitled to convert the relevant portions of the license to a 30-year production lease, extendable to 50 years, subject to compliance with a field development work program and production.

Permit

In August 2009, Zion was awarded a preliminary exclusive petroleum exploration permit (the “Issachar-Zebulun Permit”) on approximately 165,000 acres onshore Israel.  The Issachar-Zebulun Permit is adjacent to and to the east of the Company's Asher-Menashe License and is in the area that was formerly within Issachar’s and Zebulun’s ancient biblical tribal areas.
 
16
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 

Note 1 - Nature of Operations and Basis of Presentation (cont’d)
A.  Nature of Operations (cont’d)

The Issachar-Zebulun Permit allows the Company to conduct, on an exclusive basis through February 23, 2011, preliminary investigations to ascertain the prospects for discovering petroleum in the area covered by the permit.  Unlike a license area, where test drilling may take place, no test drilling is allowed on a permit area.

The Company contracted with the Geophysical Institute in Israel (“GII”) on May 20, 2010 to acquire 32 kilometers of field seismic on its Issachar-Zebulun Permit.  In June 2010, field acquisition of seismic was successfully completed and it is anticipated that, by December 2010, the collected data will be processed and interpreted for use in the Company's geologic model of the area.

Drilling Activities

In 2005, in accordance with terms of the Ma’anit-Joseph License, the Company drilled the Ma’anit #1 well on the Ma’anit prospect. Drilling breaks and shows of hydrocarbons were recorded from approximately 12,000 feet to the total depth of approximately 15,500 feet. Due to mechanical problems that prevented the Company from isolating highly conductive water bearing zones from the tighter hydrocarbon bearing formations, the shows were never successfully tested. Despite the encouraging, but inconclusive results, the Company determined that the well was incapable of producing oil and/or gas in commercial quantities.  As a result, the well was abandoned in June 2007, following analysis of the results of the remedial workover operations conducted between April and June 2007. (See Note 2A).

In May 2009, the Company commenced drilling the Ma’anit-Rehoboth #2 well to a depth of approximately 5,460 meters (17,913 feet), utilizing a 2,000 horsepower drilling rig and rig crews. The Company completed drilling and logging the well in September 2009. During the drilling of this well, the Company reported that it had positive indications that the well contained hydrocarbon bearing zones and identified several such ‘zones of interest'.  In December 2009, using a workover rig, swabbing and preliminary completion testing took place. During the preliminary completion testing, small quantities of crude oil were produced, but further testing procedures were required to determine whether the Company made a discovery of a hydrocarbon reservoir and, if so, whether it is commercially viable.  Production testing of the Ma’anit-Rehoboth #2 well commenced in February 2010.  In April 2010, following the completion of the production testing procedures, the Company determined that commercial quantities of hydrocarbons were not present in the Ma'anit-Rehoboth #2 well.  The Company accordingly suspended drilling operations on the Ma’anit-Rehoboth #2 well and took an impairment charge during the quarter ended June 30, 2010. (See Note 2A).

On October 20, 2009, the Company commenced drilling the Elijah #3 well on the Asher-Menashe License. The Company targeted the Elijah #3 well to be drilled toward the Triassic geological formation.  The Company also planned to continue drilling to the Permian geological formation, down to a total depth below 5,182 meters (17,000 feet).  As of January 15, 2010, the Company drilled the Elijah #3 well to a depth of 10,938 feet (3,334 meters).  In early February 2010, the Company temporarily suspended drilling operations in the well following unsuccessful efforts to retrieve a stuck pipe.  The 32 kilometers of additional field seismic data (in Zion’s Asher-Menashe License area) completed in June 2010 is being analyzed to resolve certain questions regarding the geology of the area surrounding the Elijah #3 well.  The subsequent processing of this seismic is anticipated to be completed by the end of 2010.
 
17
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 1 - Nature of Operations and Basis of Presentation (cont’d)
A.  Nature of Operations (cont’d)

On August 26, 2010, the Company commenced drilling operations on its Ma’anit-Joseph #3 well, at a location near to the Ma'anit-Rehoboth #2 well.  The drilling of the Ma'anit-Joseph #3 well is planned to test the Permian geological formation and drilling operations on this well are expected to last approximately six months.  As of November 4, 2010, the well has been drilled to an estimated depth of 2,220 meters (7,283 feet).

The drilling rig and crew utilized in the Ma’anit-Rehoboth #2 well, the Elijah #3 well and the Ma’anit-Joseph #3 well are owned and operated by Aladdin Middle East Ltd. (“Aladdin”), a Turkish based drilling rig operator. (See Note 6I).

Operations in Israel are conducted through a branch office. The Asher-Menashe License, the Joseph License and the Issachar-Zebulun Permit are held directly in the name of the Company.

At present it is expected that, other than investment income, any and all future income will be derived from Israeli based operations.

B.      Basis of Presentation

The unaudited interim financial statements have been prepared on a going concern basis, which contemplates realization of assets and liquidation of liabilities in the ordinary course of business. Since the Company is in the development stage, it has limited capital resources, no revenue, and a loss from operations. The appropriateness of using the going concern basis is dependent upon the Company's ability to obtain additional financing or equity capital to finance its current operations and, ultimately, to realize profitable operations.

The accompanying unaudited interim financial statements were prepared in accordance with accounting principles generally accepted in the United States for the preparation of interim financial statements and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles used in annual financial statements. All adjustments, which are, in the opinion of management, of a normal recurring nature and are necessary for a fair presentation of the interim financial statements, have been included. Nevertheless, these financial statements should be read in conjunction with the financial statements and related notes included in the Company's annual financial statements for the year ended December 31, 2009.  The results of operations for the period ended September 30, 2010 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.
 
18
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 2 - Summary of Significant Accounting Policies

A.       Oil and Gas Properties and Impairment

The Company follows the full-cost method of accounting for oil and gas properties.  Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including directly related overhead costs, are capitalized.

All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized by the unit-of-production method using estimates of proved reserves.  Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is included in income from continuing operations before income taxes and the adjusted carrying amount of the unproved properties is amortized by the unit-of-production method.

The Company’s oil and gas property represents investments in unproved properties.  These costs are excluded from the amortized cost pool until proved reserves are found or until it is determined that the costs are impaired.  All costs excluded are reviewed at least quarterly to determine if impairment has occurred.  The amount of any impairment is charged to expense since a reserve base has not yet been established.  A further impairment requiring a charge to expense may be indicated through evaluation of drilling results, relinquishing drilling rights or other information.

An abandonment of properties is accounted for as an adjustment to capitalized costs. The net capitalized costs are subject to a “ceiling test,” which limits such costs to the aggregate of the estimated present value of future net revenues from proved reserves discounted at ten percent based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. The recoverability of amounts capitalized for oil and gas properties is dependent upon the identification of economically recoverable reserves, together with obtaining the necessary financing to exploit such reserves and the achievement of profitable operations.

In June 2007, following the analysis of the results of the testing of the Company’s Ma’anit #1 well workover and an evaluation of the mechanical condition of the well, the Company determined that the well was incapable of producing oil and/or gas in commercial quantities. As a result of the unsuccessful Ma’anit #1 well and formal relinquishment of the Ma’anit-Joseph License, the Company recorded in June 2007 an impairment charge of $9,494,000 to its unproved oil and gas properties.

As planned, the Company used the Ma’anit #1 wellbore, down to approximately 3,000 meters (9,842 feet), as the upper part of the wellbore for the Ma’anit-Rehoboth #2 well.  This well was directionally drilled from that point to penetrate the middle and the lower Triassic geological formation.  The Company drilled this well to a depth of 5,460 meters (17,913 feet). In April 2010, following production and other testing, management concluded that commercial quantities of hydrocarbons were not present in the Ma'anit-Rehoboth # 2 well.
 
19
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 2 - Summary of Significant Accounting Policies (cont’d)
A. Oil and Gas Properties and Impairment (cont’d)

Accordingly, the Company recorded a non-cash impairment charge of $22,022,000 in the quarter ended June 30, 2010 to its unproved oil and gas properties.

The Company’s ability to maintain present operations is dependent on two petroleum exploration licenses and one petroleum exploration permit: (a) The Joseph License, in respect of which two wells have been drilled and a third well, the Ma’anit-Joseph #3 well, is currently being drilled; (b) the Asher-Menashe License, in respect of which drilling operations have been temporarily suspended on the Elijah #3 well pending the processing and interpretation of additional seismic data (expected by December 2010); and (c) the Issachar-Zebulun Permit, in respect of which a work program to interpret and process seismic data (which was obtained in June 2010) is currently underway with the results expected by December 2010.

The Company has no economically recoverable reserves and no amortization base. Excluding the impairment charges discussed above in the aggregate amount of $22,022,000 recorded in the quarter ended June 30, 2010, the Company’s unproved oil and gas properties consist of capitalized exploration costs of $19,538,000 at September 30, 2010.

Unproved oil and gas properties, under the full cost method, are comprised as follows:

   
September 30
2010
    
December 31
2009
  
    
US$ thousands
    
US$ thousands
  
Excluded from amortization base:
            
Drilling operations, completion costs and other related costs
   $ 15,389     $ 20,823  
Capitalized salary costs
     587       1,003  
Legal costs, license fees and other preparation costs
     2,612       922  
Other costs
      950       1,011  
                 
    $ 19,538     $ 23,759  

Impairment of unproved oil and gas properties comprised as follows:
 
   
For the nine month period ended
        
    
September 30
2010
    
September 30
2009
    
Period from April 6,
2000 (inception) to
September 30, 2010
  
    
US$
thousands
    
US$
thousands
    
US$ thousands
  
                   
Drilling operations, completion costs and other related costs
   $ 20,419       -     $ 28,378  
Capitalized salary costs
     620       -       1,303  
Legal costs and license fees
     -       -       509  
Other costs
     983       -       1,326  
     $ 22,022       -     $ 31,516  
 
20
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 2 - Summary of Significant Accounting Policies (cont’d)
B.  Net Loss per Share Data

Diluted net loss per share is the same as basic net loss per share as the inclusion of 1,015,261 and 1,020,153, common stock equivalents in the third quarter of 2010 and 2009, respectively, would be anti-dilutive.

Due to the new common stock shares that were issued in connection with the Second Rights Offering during December 2009, the weighted average shares outstanding was adjusted by a factor of 1.037 which, in turn, adjusted the earnings per share calculations for the bonus element associated with the Second Rights Offering shares, as prescribed by ASC 260-10, “Earnings Per Share”.

C. 
Recently Adopted Accounting Pronouncement

SEC Final Rule - Modernization of Oil and Gas Reporting / Accounting Standards Update (ASU) 2010-03 – Oil and Gas Reserve Estimation and Disclosures

In December 2008, the SEC published authoritative guidance as the Final Rule “Modernization of Oil and Gas Reporting” and in January 2010, ASU 2010-03 was issued in order to align the oil and gas reserve estimation and disclosure requirements of Extractive Activities – Oil and Gas (Topic 932) with the requirements in the SEC’s final rule.  The new guidance permits the use of new technologies to determine proved reserves if those technologies have been demonstrated to lead to reliable conclusions about reserves volumes.  The new requirements also will allow companies to disclose their probable and possible reserves to investors.  In addition, the new disclosure requirements require companies to, among other things:  (a) report the independence and qualifications of its reserves preparer or auditor; (b) file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and (c) report oil and gas reserves using an average price based upon the prior 12-month period rather than period-end prices.  The use of the new proved reserve definitions and average prices in developing the Company’s reserve estimates will affect future impairment and depletion calculations.

The new disclosure requirements are effective for annual reports on Form 10-K for fiscal years ending on or after December 31, 2009.  A company may not apply the new rules to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required.  Since the Company does not yet have any proved reserves, the adoption of this Final Rule has had no material effect on the Company’s disclosures, financial position or results of operations.

Note 3 – Fair Value of Financial Instruments

The Company’s financial assets and liabilities consist of cash and cash equivalents and trade payables and also consist of accrued liabilities and deferred compensation.  The carrying amount of these financial instruments approximate fair value.  Assets held for severance benefits are recorded at their current cash redemption value.
 
21
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010 
 
Note 4 - Stockholders’ Equity

A.  Fourth Rights Offering

On January 28, 2010, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission with respect to a shelf offering. The registration statement, as subsequently amended on March 26, 2010, was declared effective on April 16, 2010 (the “Shelf Registration Statement”).

Utilizing the Shelf Registration Statement, in October 2010, the Company launched a rights offering to raise approximately $19 million (the “Fourth Rights Offering”).  Under the pending Fourth Rights Offering, the Company distributed to each holder of record as of close of business on September 28, 2010, at no charge, .18 of a subscription right for each share held as of such date (i.e., EIGHTEEN subscription rights for each ONE HUNDRED shares).  Each whole subscription right entitles the stockholder to purchase one unit (a “Unit”) at the purchase price of $5.00 per Unit, with each Unit consisting of (a) one (1) share of Common Stock, and (b) one (1) warrant to purchase an additional share of the Company’s Common Stock at an exercise price of $4.00 per share (a “Warrant). The rights offering is scheduled to terminate on November 15, 2010, subject to the Company’s right to extend the offering.  No assurance can be provided that the Company will be able to raise significant funds from the rights offering. (See Note 7).

B.  Third Rights Offering

Utilizing the Shelf Registration Statement, in May 2010, the Company launched a rights offering to raise up to $50 million (the “Third Rights Offering”).   Under the Third Rights Offering, the Company distributed to each holder of record as of the close of business on
 
22
 
Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 4 - Stockholders’ Equity (cont’d)
B.  Third Rights Offering (cont’d)
May 6, 2010, at no charge, .5 of a subscription right for each share held as of such date (i.e., one subscription right for each two shares). Each whole subscription right entitled the stockholder to purchase one share of common stock at the purchase price of $5.00 per share. Shareholders who exercised their rights in full were entitled to purchase additional shares pursuant to an over-subscription right to the extent holders did not fully subscribe for their basic subscription rights. The Third Rights Offering, originally scheduled to terminate on June 30, 2010, was extended to July 15, 2010, whereupon it expired.  In total, in connection with the Third Rights Offering, the Company received subscriptions for a total of 2,471,117 shares, resulting in gross proceeds of $12,355,585.  After deducting $213,000 in offering costs, the Company received net proceeds of $12,142,585.

 
C.
2005 Stock Option Plan

In January 2010, the Company’s Board agreed to and approved the following option award grants under the 2005 Stock Option Plan: (a) to one employee for the purchase of 20,000 shares of common stock at an exercise price of $0.01 per share through January 31, 2020 (b) to one employee for the purchase of 40,000 shares of common stock at an exercise price of $0.01 per share through December 3, 2017 (c) to one employee for the purchase of 25,000 shares of common stock at an exercise price of $7.15 per share through December 31, 2014 (d) to one employee for the purchase of 12,000 shares of common stock at an exercise price of $7.15 per share through December 31, 2014.  Each of the above grants vest in four equal tranches on March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010, and will be charged according to the vesting periods on a straight line basis.

In January 2010, the Company’s Board agreed to and approved an option award grant under the 2005 Stock Option Plan to one employee pursuant to which such employee is to be awarded, at the end of each quarter, fully vested options exercisable through January 31, 2020 at a per share exercise price of $0.01, to purchase such number of shares of the Company Common Stock as shall equal $12,500 divided by the closing price on the last trading day of the calendar quarter of the Company’s publicly traded share of Common Stock, but in no event at a per share price of less than $5.00.  Pursuant thereto, the employee received a first quarter award to purchase 2,022 shares of common stock, a second quarter option award to purchase 2,481 shares of common stock and a third quarter option award to purchase 2,414 shares of common stock.  The expenses are amortized based on the vesting periods, posting appropriate amounts each quarter.

 
D.
Fair Value of Warrants and Options

The Company has reserved 1,516,679 shares of common stock as of September 30, 2010 for the exercise of warrants and options to employees and non-employees, of which 1,015,261 are outstanding. These warrants and options have been excluded from earnings per share calculations because they are anti-dilutive at September 30, 2010 and 2009 and the period from April 6, 2000 (inception) to September 30, 2010. These warrants and options could potentially dilute basic earnings per share in future years. The warrants and options exercise prices and expiration dates are as follows:

 
23
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 4 - Stockholders’ Equity (cont’d)
 
D.
Fair Value of Warrants and Options  (cont’d)

   
Exercise
    
Number of
  
Expiration
  
Warrants or
   
price
    
shares
  
Date
  
Options
   
US$
              
To non-employees
                  
      8.25       58,000  
June 16, 2012
  
Options
To employees and directors
                
      5.00       66,667  
December 31, 2010
  
Options
      8.25       50,000  
June 16, 2012
  
Options
      7.97       50,000  
December 31, 2014
  
Options
      7.15       37,000  
December 31, 2014
  
Options
      0.01       120,000  
December 3, 2017
  
Options
      0.01       26,915  
January 31, 2020
  
Options
To investors
                      
      7.00       606,679  
January 31, 2012
  
Warrants
      6.07 *     1,015,261        

*  Weighted Average

The warrant and option transactions since April 6, 2000 (inception) are shown in the table below:
   
Number of
    
Weighted Average
  
   
shares
    
exercise price
  
         
US$
  
             
Granted from April 6, 2000 (inception) to December 31, 2008 to:
            
Employees, officers and directors
     1,884,818       1.76  
Underwriters (in connection with IPO)
     46,621       8.75  
Private placement investors and others
     1,105,492       2.84  
Investors in Follow On Public Offering
     416,404       7.00  
Expired/Cancelled
     (705,684 )     2.61  
Exercised
     (1,984,077 )     1.59  
Outstanding, December 31, 2008
     763,574       4.52  
                 
Granted to:
                
Employees, officers and directors
     202,000       6.55  
Investors in Follow On Public Offering
     249,939       7.00  
Expired/Cancelled
     (40,000 )     5.22  
                 
Exercised
     (180,810 )     6.62  
Outstanding, December 31, 2009
     994,703       6.14  
                 
Granted to:
                
Employees, officers and directors
     103,915       2.55  
Exercised
     (44,357 )     0.08  
Expired/Cancelled
     (39,000 )     5.87  
Outstanding, September 30, 2010
     1,015,261       6.04  

 
24
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 4 - Stockholders’ Equity (cont’d)
D.
Fair Value of Warrants and Options  (cont’d)

The following table summarizes information about stock warrants and options outstanding as of September 30, 2010:

Shares underlying outstanding
    
Shares underlying outstanding
  
warrants and options (nonvested)
    
warrants and options (all fully vested)
  
         
Weighted
                      
Weighted
      
         
average
    
Weighted
                
average
    
Weighted
         
remaining
    
Average
    
Range of
          
remaining
    
Average
Range of
  
Number
    
contractual
    
Exercise
    
exercise
    
Number
    
contractual
    
exercise
exercise price
  
outstanding
    
life (years)
    
price
    
price
    
Outstanding
    
Life (years)
    
price
US$
              
US$
    
US$
                
US$
0.01
     10,000       7.18       0.01       0.01       110,000       7.18       0.01  
0.01
     5,000       9.34       0.01       0.01       21,915       9.34       0.01  
-
     -       -       -       5.00       66,667       0.25       5.00  
                              7.00       606,679       1.34       7.00  
                                                         
7.15
     9,250       4.25       7.15       7.15       27,750       4.25       7.15  
7.97
     30,000       4.25       7.97       7.97       20,000       4.25       7.97  
-
     -       -       -       8.25       108,000       1.71       8.25  
0.01-7.97
     54,250               4.41       0.01-8.25       961,011               6.07  

Granted to employees

The following table sets forth information about the weighted-average fair value of options granted to employees and directors during the nine month period ended September 30, 2010 and 2009, and the period from April 6, 2000 (inception) to September 30, 2010, using the Black Scholes option-pricing model and the weighted-average assumptions used for such grants:

   
For the nine month period
    
Period from April 6,
  
   
ended September 30,
    
2000 (inception) to
  
   
2010
    
2009
    
September 30, 2010
  
   
US$
    
US$
    
US$
  
Weighted-average fair value of underlying stock at grant date
     6.45       7.71       3.00 – 7.71  
Dividend yields
     -       -       -  
Expected volatility
     71-79 %     59.0 – 71.0 %     28.2% - 79 %
Risk-free interest rates
     2.38-3.84 %     1.79 – 2.47 %     1.79% - 5.15 %
                         
Expected lives
     2.19-4.88       1.5 – 4.81    
1.74 – 4.88 years
  
                         
Weighted-average grant date fair
value
     2.80-6.51       4.93       0.76 - 6.51  

 
25
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 4 - Stockholders’ Equity (cont’d)
D.
Fair Value of Warrants and Options (cont’d)
Granted to non-employees

The following table sets forth information about the weighted-average fair value of options granted to non-employees during the nine month periods ended September 30, 2010 and 2009 and the period from April 6, 2000 (inception) to September 30, 2010, using the Black Scholes option-pricing model and the weighted-average assumptions used for such grants:

   
For the nine month period
    
Period from April 6,
  
   
ended September 30,
    
2000 (inception) to
  
   
2010
    
2009
    
September 30, 2010
  
   
US$
    
US$
    
US$
  
Weighted-average fair value of underlying stock at grant date
     -       8.23       1.00 – 8.75  
Dividend yields
     -       -       -  
Expected volatility
     -       71 %     32.2% - 99.8 % 
Risk-free interest rates
     -       1.79 %     2.8% - 5.50 % 
Contractual lives
     -       3.00    
0.56 – 3.17 years
  
Weighted-average grant date fair value
     -       3.91       0.68 – 2.74  

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options.

The expected life represents the weighted average period of time that options granted are expected to be outstanding. The expected life of the options granted to employees and directors during 2009 and 2010 is calculated based on the Simplified Method as allowed under Staff Accounting Bulletin No. 110 (“SAB 110”), giving consideration to the contractual term of the options and their vesting schedules, as the Company does not have sufficient historical exercise data at this time. The expected life of the option granted to non-employees equals their contractual term.  In the case of an extension of the option life, the calculation was made on the basis of the extended life.

Prior to 2008, due to the lack of sufficient history of the Company’s stock volatility, the Company estimated its own expected stock volatility based on the historic volatility for other oil exploration companies.  Beginning in 2008 and continuing through September 30, 2010, the Company’s stock volatility is based on actual trading of the Company’s stock.

E.
Compensation Cost for Warrant and Option Issuances

The compensation cost of warrant and option issuances recognized for the three and nine month periods ended September 30, 2010 and 2009 and from April 6, 2000 (inception) to September 30, 2010 amounted to $106,000, $553,000, $82,000, $764,000 and $2,659,000, respectively.

 
26
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 4 - Stockholders’ Equity (cont’d)
E.           Compensation Cost for Warrant and Option Issuances (cont’d)

As of September 30, 2010, there was $77,000 of unrecognized compensation cost, related to nonvested stock options granted under the Company’s various stock option plans. That cost is expected to be recognized as follows:

   
US$
thousands
  
       
October 1 -  December 31, 2010
     48  
For the year ended December 31, 2011
     27  
For the year ended December 31, 2012
     2  
      77  

 
F.
Warrant Descriptions

Through the balance sheet date the Company issued ten different series of warrants to employees, non-employees and investors. The price and the expiration dates are as follows:

   
Period of Grant
  
US$
  
Expiration Date
             
A Warrants
  
January 2001 – December 2001
     1.00  
January 31, 2005
B Warrants
  
November 2001 – February 2003
     1.50  
January 31, 2005
C Warrants
  
July 2003 – March 2004
     3.00  
December 31, 2005
$3.00 Warrants
  
June 2004 – August 2004
     3.00  
December 31, 2006
D Warrants
  
September 2004 – April 2005
     4.00  
December 31, 2006
E Warrants
  
September 2004 – June 2005
     5.00  
December 31, 2006
F and FF Warrants
  
October 2005
     5.00  
* December 31, 2008
G Warrants
  
December 2005 – January 2006
     5.50  
December 31, 2008
H Warrants
  
December 2006 –May 2007
     8.75  
September 26, 2009
Unit Warrants
  
October 2008 – December 2008
     7.00  
January 31, 2012
*  Subsequently extended to December 31, 2009 for some of this class of warrants

Other than price and date details, all of the warrants, except for the Unit Warrants, were issued on the same conditions, except that the F, FF and G Warrants were not exercisable before July 1, 2007, on which date the Company had the right to extend for up to six months (which right was not exercised by the Company), and H warrants were not exercisable before November 25, 2007, which was six months following the final closing date of the Initial Public Offering.  The Unit Warrants were issued as a component of a Unit that consisted of one share of common stock and one warrant during the Company’s Follow On Public Offering.  On February 9, 2009, the Unit split into its two components.  The warrant became exercisable as of February 9, 2009.

 
G.
Gift Shares

During the second quarter of 2009, two persons who are employees of the Company received a total of 400 shares from one of the executive officers.  The related value of $4,000 was charged to the statement of operations and credited as additional paid in capital.

 
27
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 5 - Related Party Transactions

The Company had $94,000 of deferred officers’ compensation at September 30, 2010 which represents payables to officers of the Company.  The prior balance through June 30, 2010 of $246,000 was paid in full on August 2, 2010. Such officers have committed to defer payments of these sums through 2010.  (See Note 6F).

At December 2009, deferred officers’ compensation was $477,000, which amount was paid during the first quarter of 2010.

In January 2009 two of the Company’s then senior officers purchased Units in the Follow On Public Offering through the non-cash conversion of amounts then owed to them in respect of deferred salaries and other payments in the aggregate amount of $140,000.

Note 6 - Commitments and Contingencies
A.
Environmental Matters

The Company is engaged in oil and gas exploration and production and may become subject to certain liabilities as they relate to environmental cleanup of well sites or other environmental restoration procedures as they relate to the drilling of oil and gas wells or the operation thereof.

The Company currently estimates that environmental clean up/restoration of the well sites will be approximately $50,000.  Although the timing of such payment is uncertain a provision has been made and is included in the oil and gas properties.  No other environmental claims have been made, nor is the Company aware of any contingent demands relating thereto. Liabilities for expenditures are recorded when environmental assessment and/or remediation is probable and the timing and costs can be reasonably estimated.

B.
Royalty Commitments

The Company is obligated, according to the Petroleum Law, to pay royalties to the Government of Israel on the gross production of oil and gas from the oil and gas properties of the Company located in Israel (except those reserves serving to operate the wells and related equipment and facilities). The royalty rate stated in the Petroleum Law is 12.5% of the produced reserves.  At September 30, 2010 and December 31, 2009, the Company did not have any outstanding obligation with respect to royalty payments, since it is at the “exploration stage” and, to this date, no proved reserves have been found.    In April 2010 the Israeli Ministry of Finance announced that it has appointed a committee that will examine Israel’s tax policy regarding oil and gas resources in Israel, including the royalty rate to be paid to the Government of Israel.

C.
Long-term Incentive Plan

The Company may initiate the establishment of a long-term management incentive plan for key employees whereby a 1.5% overriding royalty or equivalent interest in the Asher-Menashe License and Joseph License and such other oil and gas exploration and development rights as may in the future be acquired by the Company would be assigned to key employees.  As the plan has not been established as of September 30, 2010 or December 31, 2009, the Company did not have any outstanding obligation in respect of the plan.

 
28
 

Zion Oil & Gas Inc
(A Development Stage Company)
Notes to the Unaudited Interim Financial Statements as of September 30, 2010
 
Note 6 - Commitments and Contingencies (cont’d)

D.
Charitable Foundations

The Company has established two charitable foundations, one in Israel and one in Switzerland, for the purpose of supporting charitable projects and other charities in Israel, the United States and internationally. A 3% overriding royalty in the Company's current Israeli oil and gas interests has been assigned to each charitable organization (6% overriding interest in the aggregate).  At September 30, 2010 or December 31, 2009, the Company did not have any outstanding obligation in respect of the charitable foundations, since it is at the “exploration stage” and, to this date, no proved reserves have been found.

E. 
Surface Rights of Drilling Operations

The surface rights to the drill sites from which the Company drilled the Ma’anit #1 and Ma’anit-Rehoboth #2 wells and is currently drilling the Ma’anit-Joseph #3 well, are held under long-term lease by Kibbutz Ma’anit (the “Kibbutz”) with the Israel Lands Authority.

The necessary permission, to use the drill site for the Ma’anit Joseph #3 well to conduct petroleum exploration operations, has been granted to the Company by the Kibbutz, in consideration for a fee of approximately $50,000 for the period up to October 10, 2010 and $5,000 for each year thereafter.

The surface rights to the drill site from which the Company drilled the Elijah #3 well are held under long-term lease by Kibbutz Ein Carmel with the Israel Lands Authority. The necessary permission, to enter and use the drill site to conduct petroleum operations on the Elijah #3 well, was granted to the Company by Kibbutz Ein Carmel through July 20, 2015 in consideration for a one-time fee of approximately $145,000,

Permission of the Israel Lands Authority for the use of the surface rights is also required. The consent for Ma'anit-Rehoboth #2 and Elijah #3 were obtained, but such consents formally expired on August 13, 2010 with respect to Ma'anit-Rehoboth #2 well and on October 11, 2010 with respect to Elijah #3 well. The Company is in the process of obtaining an extension to the consent for Ma'anit-Rehoboth #2 well and for the Elijah #3 well.

The Israel Lands Authority has granted formal consent for the use of the surface with regard to the Ma'anit-Joseph #3 well; the expiration date of the consent is August 3, 2012.

F.
Payments to executives and deferral of compensation

Under existing compensation agreements, the Company is committed to pay certain of its executive officers and other employees an aggregate amount of $1,439,000 on an annual basis.  Most of these officers and employees have agreed to continue to defer a portion of their pay during 2010 (See Note 5).  During the nine month period ended September 30, 2010, $543,000 of amounts previously deferred was paid to executives and employees.

 
29
 

Note 6 - Commitments and Contingencies (cont’d)

G.
Lease Commitments

The Company leases approximately 3,600 square feet of office space in Dallas, Texas under a lease which expires on October 31, 2011. The monthly rent was $4,000 during the twelve-month period ending October 31, 2008, $4,500 during the twelve-month period ending October 31, 2009, $4,600 for the twelve-month period ending October 31, 2010 and will be $4,700 during the twelve-month period ending October 31, 2011.

During July 2005, the Company entered into a rental agreement for approximately 3,165 square feet of office space in the industrial area of Caesarea, Israel. The rental was for a six-month period commencing August 1, 2005 with two additional three-month option periods at a monthly rental cost of $3,000. The Company subsequently extended the rental agreement through January 31, 2009, and then exercised the option to extend the lease for two additional periods of six months each (through January 31, 2010).  The Company subsequently entered into two additional six-month extensions.  The monthly rental cost during this extended period continues at $3,000.

In March 2010, the Company leased approximately 500 square feet of office space in State College, Pennsylvania for its President and Chief Operating Officer.  The initial lease is for 12 months, expiring at the end of February 2011.  The monthly rental amount is $525.

The future minimum lease payments as of September 30, 2010 are as follows:

   
US$
 thousands
  
       
2010
     29  
2011
     57  
      86  

H.
Contract with Geophysical Institute of Israel

On January 31, 2010, in connection with planned seismic, magnetic and gravimetric surveys on the Issachar-Zebulun permit area, the Company entered into another agreement with GII to acquire necessary data.  On May 14, 2010, the Company entered into an amended agreement with GII to obtain additional seismic data in the Company’s Asher Menashe License from the area surrounding the Elijah #3 well.  The agreement, as amended, provides for a 64-kilometer program, subject to increase or decrease by the Company, with approximately 32 kilometers to be acquired on the Issachar-Zebulun Permit and another 32 kilometers to be acquired on the Asher Menashe License.  The agreement, as amended, provides for the survey to be performed by GII on a per kilometer basis at a rate of NIS 44,000 (approximately $11,430) per kilometer.   An initial amount of NIS 150,000 (approximately US $39,000) was paid upon signing of the initial agreement.  Additional amounts of (i) NIS 100,000 (approximately US $26,000) and (ii) a prepayment of NIS 1,000,000 (approximately US $260,000) were paid in connection with the signing of the amended agreement.

 
30
 

Note 6 - Commitments and Contingencies (cont’d)

 
I.
Drilling Contract and Memorandum of Understanding

On September 12, 2008, the Company entered into a drilling contract with Aladdin Middle East Ltd. pursuant to which Aladdin shipped into Israel its 2,000 horsepower rig for use in the drilling contemplated by the Company’s business plan. The rig arrived in Israel, cleared customs in April 2009 and was used to drill the Ma’anit-Rehoboth #2 well and subsequently the Elijah #3 well. The contract provided for the wells to be drilled on a daywork basis with payment to Aladdin at the rate of $28,500 per drilling day, and other scheduled rates for non-operating days. The contract originally provided for mobilization and de-mobilization fees of $675,000 each. The Company paid Aladdin $475,000 on account of mobilization fees, which are included in the well cost. Subsequent amendments provided that the remaining $200,000 payment was to be offset against the amount paid by the Company for the drilling and no additional cash outlay was due upon mobilization. The contract, as further amended, provided for a demobilization fee of $550,000, but also provided that, in the event that Aladdin enters into a drilling contract with another operator in Israel, then the demobilization fee will be reduced if and to the extent that Aladdin receives funds from such other operator. As security for these and related fees, the contract, as amended, called for the Company to provide a letter of credit to Aladdin in the amount of $550,000.

However, in April 2009, the parties further amended the contract to eliminate the letter of credit requirement.  In exchange, the Company provided Aladdin with a cash advance in the amount of $300,000 that was to be offset against future payments to Aladdin under the contract.  The contract was again amended, in December 2009, and the Company paid to Aladdin an additional $250,000 cash advance in exchange for the Company being released of its obligation to pay the $550,000 demobilization fee.  Aladdin continues to be bound to reimburse the Company with respect to any demobilization fee it may receive from another operator.

In May 2010, the contract was further amended. Under the terms of the May 2010 amendment, Aladdin and the Company extended the term of the agreement to cover the drilling of the Company’s planned Ma’anit-Joseph #3 well to a depth of 5,900 meters.  In addition, the agreement was further amended in order to transfer to Aladdin the obligation to pay certain taxes that may be owed.  Also under the May 2010 amendment, Aladdin agreed to reimburse the Company for certain insurance premiums incurred by the Company.  The amendment also memorialized an advance, previously remitted by the Company to Aladdin, in an amount of $750,000 and provided that the amount of the advance would be offset against future Aladdin invoices.

During the year ended December 31, 2009 and through September 30, 2010, the Company made payments of $12,300,000 to Aladdin after the deduction of $935,000 for reimbursement of the drill pipe expenditures, $212,000 for reimbursement of expenses paid by the Company on Aladdin’s behalf and $750,000 for reimbursement of a cash advance previously provided by the Company to Aladdin.  The Company has also paid $355,000 to Aladdin for corporate taxes due by Aladdin and paid an advance payment of $550,000 for payment of the demobilization fee, which amount is classified as a prepayment.  The Company remains entitled to a reimbursement or credit of the $550,000 demobilization fee in the event the rig is not moved from Israel.


 
31
 

Note 6 - Commitments and Contingencies (cont’d)

 
I.
Drilling Contract and Memorandum of Understanding (cont’d)

On April 9, 2010, the Company and Aladdin, signed a Memorandum of Understanding which outlines plans to establish a subsidiary, tentatively named Zion Drilling, Inc., for the purpose of purchasing and operating Aladdin’s 2,000 horsepower drilling rig (currently located at Zion's Ma'anit-Rehoboth #2 wellsite, in Israel).  The planned subsidiary, which would be 51% owned by the Company and 49% by Aladdin, is to purchase Aladdin’s drilling rig for an initial payment of $7 million and a series of $1 million additional payments that are anticipated to coincide with the planned drilling of seven additional wells in Israel during the next few years. The funds for the purchase of the rig are to be provided by the Company. The Company plans with Aladdin are subject to a number of events, including satisfactory completion of due diligence, the raising of sufficient capital and the negotiation and execution of definitive agreements relating to the establishment of Zion Drilling, Inc.

Note 7 - Subsequent Events

In October 2010, the Company launched a rights offering to raise approximately $19 million (the “Fourth Rights Offering”). Under the pending Fourth Rights Offering, the Company distributed to each holder of record as of close of business on September 28, 2010, at no charge, .18 of a subscription right for each share held as of such date (i.e., EIGHTEEN subscription rights for each ONE HUNDRED shares).  Each whole subscription right entitles the stockholder to purchase one unit (a “Unit”) at the purchase price of $5.00 per Unit, with each Unit consisting of (a) one (1) share of Common Stock, and (b) one (1) warrant to purchase an additional share of the Company’s Common Stock at an exercise price of $4.00 per share (a “Warrant).  The Warrant is exercisable for a two (2) year period beginning after the expiration of the rights offering. The Fourth Rights Offering is scheduled to terminate on November 15, 2010, subject to the Company’s right to extend the offering.  The rights are non-transferable. No assurance can be provided that the Company will be able to raise significant funds from the Fourth Rights Offering.

 
32
 

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

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR UNAUDITED INTERIM FINANCIAL STATEMENTS AND THE RELATED NOTES TO THOSE STATEMENTS INCLUDED IN THIS FORM 10-Q. SOME OF OUR DISCUSSION IS FORWARD-LOOKING AND INVOLVES RISKS AND UNCERTAINTIES. FOR INFORMATION REGARDING RISK FACTORS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, REFER TO THE DISCUSSION OF RISK FACTORS IN DESCRIPTION OF BUSINESS SECTION OF OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2009 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

Forward-Looking Statements

Certain statements made in this discussion are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may materially differ from actual results.

Forward-looking statements can be identified by terminology such as “may”, “should”, “expects”, “intends”, “anticipates”, “believes”, “estimates”, “predicts”, or “continue” or the negative of these terms or other comparable terminology and include, without limitation, statements regarding:
 
 
·
exploration, development, and drilling plans;
 
·
future general and administrative expenses;
 
·
future exploration;
 
·
future geophysical and geological data;
 
·
growth strategies;
 
·
new prospects and drilling locations;
 
·
future capital expenditures;
 
·
sufficiency of working capital;
 
·
plans regarding and ability to raise additional capital;
 
·
drilling plans;
 
·
timing or results of any wells;
 
·
interpretation and results of seismic surveys or seismic data;
 
·
permit, license and lease rights;
 
·
legislative and regulatory initiatives, their potential results and effects; and
 
·
any other statements regarding future operations, financial results, opportunities, growth, business plans, and strategies.
 
Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We undertake no duty to update any forward-looking statements after the date of this report to conform such statements to actual results.

 
33
 

Overview
 
Zion Oil is an initial stage oil and gas exploration company with a history of over ten years of oil and gas exploration in Israel. We have no revenues or operating income and we are classified as an "exploration stage" company. The Company currently holds two petroleum exploration licenses, named by the Company, the “Joseph License” and the “Asher-Menashe License” and one preliminary exclusive petroleum exploration permit, named by the Company, the "Issachar-Zebulun” permit. Zion’s total petroleum exploration area is approximately 327,100 acres.

The Joseph License and Asher-Menashe License areas, as well as the Issachar-Zebulun permit area, are contiguous in a similar geologic environment. They are located on a continuous regional high associated with the basement to a Paleozoic Age structure (approximately 280 million years old) that runs parallel to the current coast of Israel primarily onshore, from just off of Haifa to south of Tel Aviv. The regional high is evidenced by gravimetric anomalies in both license areas. This structure and other geologic elements common to both areas, including particularly the Triassic Age (approximately 205-245 million years ago) Ma'anit structure that extends from the Joseph License area into the Asher-Menashe License area, lend themselves to an integrated exploratory program (and, if successful, may lend themselves to an integrated development program).

To date, we have completed drilling two exploratory wells in the Joseph License area and are in the process of drilling one exploratory well in the Asher Menashe License Area and another exploratory well in the Joseph License area. The first exploratory well, named the Ma’anit #1 well, was drilled to a depth of 15,842 feet (4,829 meters) to the Triassic formation with encouraging but inconclusive results. However, notwithstanding these results, due to the mechanical condition of the well-bore, we determined that the well was incapable of producing oil and/or gas in commercial quantities and, consequently, in June 2007 we abandoned the well. In 2009, we drilled an additional well (the Ma’anit-Rehoboth #2 well), ‘directionally’ to a depth of 17,913 feet (5,460 meters). The purpose of the Ma’anit-Rehoboth #2 well was both to appraise the apparent findings of the Ma’anit #1 in the Triassic (at a depth of between approximately 12,000 and 15,400 feet) and to test the deeper Permian horizons at a depth of between approximately (16,000 and 18,000 feet). The well penetrated a number of geologic formations that have been preliminarily deemed to have hydrocarbon potential and, during the drilling, we retrieved a small quantity of crude oil. In February 2010, we began completions/testing of the Ma’anit-Rehoboth #2 well. In April 2010, following the completion of testing procedures, we determined that commercial quantities of hydrocarbons were not present in the Ma'anit-Rehoboth #2 well and, accordingly, we suspended drilling operations in that well. In connection with this decision, we recognized a non-cash impairment charge to our unproved oil and gas properties for the quarter ended June 30, 2010.
 
In October 2009, utilizing the 2,000 horsepower drilling rig used to drill Zion’s Ma’anit-Rehoboth #2 well, we commenced drilling an additional well (the Elijah #3 well), within the Asher-Menashe License area, toward the Triassic geological formation, which is expected below approximately 10,000 feet (3,048 meters). As of January 15, 2010, we drilled to a depth of 10,938 feet (3,334 meters). In early February 2010, we temporarily suspended drilling operations in the well following our unsuccessful efforts to retrieve a stuck pipe pending further analysis of the situation. The Company has recently acquired approximately 32 kilometers of additional field seismic data that will hopefully help to resolve certain questions regarding the geology of the area surrounding the Elijah #3 well.

 
34
 

As the Ma'anit-Rehoboth #2 well did not reach the Permian geological formation beneath the Joseph license area, we are currently drilling a subsequent well, named by us the "Ma'anit-Joseph #3 well" at a location near to the Ma'anit-Rehoboth #2 well. The drilling of the Ma'anit-Joseph #3 well is planned to test the Permian geological formation and drilling operations on this well are expected to last approximately six months. As of November 4, 2010, the drilling of the Ma'anit-Joseph #3 well has reached a depth of approximately 2,220 meters (7,823 feet).

Going Concern Basis

Our unaudited interim financial statements for the period ended September 30, 2010 have been prepared on a going concern basis, which contemplates realization of assets and liquidation of liabilities in the ordinary course of business. Since we are in the development stage, we have limited capital resources, no revenue, and a loss from operations. The appropriateness of using the going concern basis is dependent upon our ability to obtain additional financing or equity capital and, ultimately, to achieve profitable operations. The uncertainty of these conditions in the past has raised substantial doubt about our ability to continue as a going concern. The unaudited financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
Critical Accounting Policies

Management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expense during the reporting period.

We have identified the accounting principles which we believe are most critical to the reported financial status by considering accounting policies that involve the most complex of subjective decisions or assessment.

Accounting for Oil and Gas Properties

We follow the full-cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including directly related overhead costs, are capitalized.

All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is included in income from continuing operations before income taxes and the adjusted carrying amount of the unproved properties is amortized on the unit-of-production method.

The Company’s oil and gas property represents an investment in unproved properties and two major development projects on that property. These costs are excluded from the amortized cost pool until proved reserves are found or until it is determined that the costs are impaired. All costs excluded are reviewed at least quarterly to determine if impairment has occurred. The amount of any impairment is charged to expense since a reserve base has not yet been established. A further impairment requiring a charge to expense may be indicated through evaluation of drilling results, relinquishing drilling rights or other information.
 
35

Abandonment of properties is accounted for as adjustments to capitalized costs. The net capitalized costs are subject to a “ceiling test” which limits such costs to the aggregate of the estimated present value of future net revenues from proved reserves discounted at ten percent based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. The recoverability of amounts capitalized for oil and gas properties is dependent upon the identification of economically recoverable reserves, together with obtaining the necessary financing to exploit such reserves and the achievement of profitable operations.

In June 2007, following the analysis of the results of the testing of the Company’s Ma’anit #1 well workover and an evaluation of the mechanical condition of the well, the Company determined that the well was incapable of producing oil and/or gas in commercial quantities. In order to optimize drilling operations on the Company’s planned Ma’anit-Rehoboth #2 well, the Company ceased operations on the Ma’anit #1 well and, as required by the Petroleum Law, formally relinquished the Ma’anit-Joseph License. Immediately after the relinquishment of the Ma’anit-Joseph License, the Company filed an application with the Petroleum Commissioner for a petroleum exploration license, the Joseph License, covering approximately 83,272 acres of the original Ma’anit-Joseph License including the Ma’anit structure on which the Ma’anit #1 well was drilled, which license was subsequently granted on October 11, 2007. As a result of the abandonment of the Ma’anit #1 well and formal relinquishment of the Ma’anit-Joseph License, the Company recorded in June 2007 an impairment of $9,494,000 to its unproved oil and gas properties.

 As planned, the Company used the Ma’anit #1 wellbore, down to approximately 9,842 feet (3,000 meters), as the upper part of the wellbore for the Ma’anit-Rehoboth #2 well. This well was directionally drilled from that point to penetrate the middle and the lower Triassic. The Company drilled this well to a depth of 17,913 feet (5,460 meters) and, after initial testing of the lower open hole section of the well using a workover rig, in December 2009, conducted further testing of the well in 2010. Subsequent to drilling the Ma’anit-Rehoboth #2 well and after analysis of all the data collected, we identified several ‘zones of interest' warranting further investigation. In February 2010, we began completion and production testing of the Ma’anit-Rehoboth #2 well. In April 2010, following the completion of our testing procedures, we determined that commercial quantities of hydrocarbons were not present in the Ma'anit-Rehoboth #2 well and have accordingly suspended drilling operations in that well. As a result, we recorded a non-cash impairment charge of $22,022,000 to our unproved oil and gas properties for the quarter ending June 30, 2010.
 
Financial Statements in United States Dollars

Although both our properties and our principal operations are in Israel, we report all our transactions in United States dollars. Certain of the dollar amounts in the financial statements may represent the dollar equivalent of other currencies.
 
Accounting for Income Taxes

We record a valuation allowance to reduce our deferred tax asset to the amount that we believe, is likely to be realized in the future. In assessing the need for the valuation allowance we have considered not only future taxable income but also feasible and prudent tax planning strategies. In the event that we were to determine that it would be likely that we would, in the future, realize our deferred tax assets in excess of the net recorded amount, an adjustment to the deferred tax asset would be made. In the period that such a determination was made, the adjustment to the deferred tax asset would produce an increase in our net income.
 
36
 
We do not participate in, nor have we created, any off-balance sheet special purpose entities or other off-balance sheet financing. In addition, we do not enter into any derivative financial instruments.

Asset Retirement Obligation

We record a liability for asset retirement obligation at fair value in the period in which it is incurred and a corresponding increase in the carrying amount of the related long lived assets.

Liquidity and Capital Resources

We believe that our currently available cash resources will be sufficient to enable us to meet our operating requirements in carrying out our plans through December 2010. We will need to raise additional funds to maintain operations beyond that date and in order to realize our business plan, including establishing Zion Drilling, Inc. We will need to raise funds by attracting additional investment in our company or additional parties to join our drilling operations. We have no commitments for any such financing or participation and no assurance can be provided that we will be successful in attracting any such investment.
 
In October 2010, we launched a rights offering to raise approximately $19 million (the “Fourth Rights Offering”) from the sale of Units (as defined below). Under the pending Fourth Rights Offering, the Company distributed to each holder of record as of close of business on September 28, 2010, at no charge, .18 of a subscription right for each share held as of such date (i.e., EIGHTEEN subscription rights for each ONE HUNDRED shares). Each whole subscription right entitles the stockholder to purchase one unit (a “Unit”) at the purchase price of $5.00 per Unit, with each Unit consisting of (a) one (1) share of Common Stock, and (b) one (1) warrant to purchase an additional share of our Common Stock at an exercise price of $4.00 per share (a “Warrant). The Warrant is exercisable for a two (2) year period beginning after the expiration of the rights offering. The Fourth Rights Offering is scheduled to terminate on November 15, 2010, subject to the Company’s right to extend the offering. The rights are non-transferable. The pending rights offering is being conducted via an existing effective shelf registration statement on Form S-3 that was declared effective on April 16, 2010. No assurance can be provided that the Company will be able to raise significant funds from the Fourth Rights Offering.

Our working capital (current assets minus current liabilities) was $10,373,000 at September 30, 2010 and $19,741,000 at December 31, 2009. The decrease in working capital is primarily attributable to drilling-related expenditures.
 
During the nine months ended September 30, 2010, we recorded expenses paid, relating to the Third Rights Offering, in the amount of $213,000. Net cash provided from financing activities was $12,143,000 during the nine month period ended September 30, 2010 compared to net cash provided of $23,419,000 during the nine month period ended September 30, 2009. The difference is attributable to proceeds received from a rights offering that closed during the period ended June 30, 2009. Net cash used for investment in the Company's unproved oil and gas properties was $17,800,000 for the nine months ended September 30, 2010 and $10,915,000 for the nine-month period ended September 30, 2009; these amounts were primarily drilling related expenditures.
 
37
 
On September 30, 2010, we had cash and cash equivalents in the amount of $11,682,000, compared to $20,734,000 at December 31, 2009. On November 4, 2010, we had cash and cash equivalents in the amount of $8,582,000. The decrease in cash resources from December 31, 2009 compared to September 30, 2010 is primarily attributable to drilling costs related to the Company’s Ma’anit Joseph # 3 well. The decrease in cash resources as of November 4, 2010 compared to September 30, 2010 is primarily attributable to drillings costs related to the Company’s Ma’anit Joseph # 3 well.

To date, we have funded our operations primarily through the issuance of our securities. Our recent financings are discussed below.

Between October 24, 2008 and January 9, 2009, we raised from a follow-on public offering gross proceeds of $6,663,000 from the sale of units of our securities, of which $240,000 was for debt conversion. Each unit offered in the follow-on offering consisted of (i) one share of common stock, par value $.01 per share and (ii) one warrant to purchase one share of common stock at a per share exercise price equal to $7.00. We utilized the amounts raised in the follow on public offering to commence drilling the above referenced Ma’anit Rehoboth #2 well.
 
In June 2009, we raised gross proceeds of $21 million from a rights offering to common stockholders of up to 4.2 million shares of our common stock. The rights offering was fully subscribed, resulting in our distribution of all of the 4.2 million shares that were offered.
 
In November 2009, we raised an additional $18 million from a follow-on rights offering to common stockholders of up to 3.6 million shares of our common stock. The rights offering was fully subscribed, resulting in our distribution of all of the 3.6 million shares that were offered.
 
In July 2010, we raised approximately $12.4 million from our Third Rights Offering resulting in our distribution of approximately 2.47 million shares of our common stock.
 
Results of Operations
 
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009

Revenue. We have no revenue generating operations as we are still an exploration stage company.

 
38
 

General and administrative expenses. General and administrative expenses were $1,535,000 and $26,336,000 for the three and nine month periods ended September 30, 2010, respectively, compared to $865,000 and $3,207,000, respectively, for the three and nine month periods ended September 30, 2009. The increase in general and administrative expenses during the three month period ended September 30, 2010 compared to the corresponding period in 2009 is primarily attributable to increased salary expenses as well as increased travel and marketing costs. The increase in general and administrative expenses during the nine month period ended September 30, 2010 compared to the corresponding period in 2009 is primarily attributable to the impairment charge of $22,022,000 recorded during the three months ended June 30, 2010 in respect of the Ma’anit-Rehoboth #2 well. Legal and other professional fees were $138,000 and $633,000 for the three and nine month periods ended September 30, 2010, respectively, compared to $156,000 and $623,000, respectively, for the three and nine month periods ended September 30, 2009. The decrease in legal and other professional fees during the three months ended September 30, 2010 compared to the corresponding period in 2009 is primarily attributable to additional legal fees incurred in the third quarter of 2009. The increase in legal and professional fees during the nine months ended September 30, 2010 compared to the corresponding period in 2009 is primarily attributable to accounting fees incurred in connection with Sarbanes Oxley compliance efforts. Salary expenses were $651,000 and $2,090,000 for the three and nine month periods ended September 30, 2010 compared to $368,000 and $1,768,000 for the three and nine months period ended September 30, 2009. The increase in salary expenses during each of the three and nine month periods ended September 30, 2010 compared to the corresponding periods in 2009 is related to expense recognition of option grants recognized during the third quarter of 2010 and the hiring of additional staff and management. Other general and administrative expenses were $746,000 and $1,591,000 for the three and nine month periods ended September 30, 2010 compared to $341,000 and $816,000 for the three and nine month periods ended September 30, 2009. The increase in other general and administrative expenses during each of the three and nine month periods ended September 30, 2010 as compared to the corresponding periods in 2009 is attributable to increased investor relations and marketing efforts and increased travel costs.
 
Interest income, net. Interest income, net was $102,000 and $17,000 for the three and nine-month periods ended September 30, 2010 as compared to $48,000 and $66,000 for the three and nine months ended September 30, 2009. The increase in interest income during the three months ended September 30, 2010 compared to the corresponding period in 2009 was due to a significant currency exchange gain. The decrease in interest income during the nine months ended September 30, 2010 compared to the corresponding period in 2009 is attributable to a significant currency exchange loss in the second quarter of 2010. Interest expense for these periods was negligible.

Net Loss. Net loss was $1,433,000 and $26,319,000 for the three and nine-month periods ended September 30, 2010 compared to $817,000 and $3,065,000 for the three and nine month periods ended September 30, 2009. The increase in net loss during the three months ended September 30, 2010 compared to the corresponding periods in 2009 is primarily attributable to the increased general and administrative expenses noted above, namely increased salary, marketing and travel costs. The increase in net loss during the nine months ended September 30, 2010 compared to the corresponding periods in 2009 is primarily attributable to the impairment charges recorded in respect of the Ma’anit-Rehoboth #2 well.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices and/or equity prices. In the normal course of doing business, we are exposed to the risks associated with foreign currency exchange rates and changes in interest rates.
 
Foreign Currency Exchange Rate Risks. A portion of our expenses, primarily labor expenses and certain supplier contracts, are nominated in New Israeli Shekels “NIS”. As a result, we have significant exposure to the risk of fluctuating exchange rates with the US Dollar, our primary reporting currency. The recent weakness of the US Dollar in the international markets has been equally reflected against NIS and this may continue in the future. Since December 31, 2008, 2007 and 2006, to the current date, the US Dollar has devalued by approximately 1%, 2% and 11% respectively against the NIS. Continuing devaluation of the US dollar against the NIS will result in higher operating costs from NIS denominated expenses. We do not currently hedge against currency exchange rate risks.

 
39
 
 
Interest Rate Risk. Our exposure to market risk relates to our cash and investments. We maintain an investment portfolio of short term bank deposits and money market funds. The securities in our investment portfolio are not leveraged, and are, due to their very short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that a change in market interest rates would have a significant negative impact on the value of our investment portfolio except for reduced income in a low interest rate environment. At September 30, 2010, we had cash, cash equivalents and marketable securities of approximately $11,682,000. The weighted average annual interest rate related to our cash and cash equivalents for the nine months ended September 30, 2010 was approximately 1%.
 
The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in short-term bank deposits and money market funds that may invest in high quality debt instruments.

ITEM 4.
CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission. As of September 30, 2010, our chief executive officer and our chief financial officer conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based on this evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2010.

During the quarter ended September 30, 2010, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.

PART II—OTHER INFORMATION

ITEM 1.
LEGAL PROCEEDINGS

None.

ITEM 1A.
RISK FACTORS
 
During the quarter ended September 30, 2010, there were no material changes to the risk factors previously reported in our Annual Report on Form 10-K for the year ended December 31, 2009, other than the following.

 
40
 

Our future operations may be adversely affected by changes in Israel’s current tax policy with respect to oil and gas resources.

Under Israeli law, we are required to pay royalties to the Government of Israel on the gross production of any oil and gas that we may discover in Israel. The current royalty rate to which we are subject is 12.5% of the produced reserves. To date, no proved reserves have yet been discovered on our license areas, and therefore we have not had any outstanding obligation with respect to royalty payments.
 
In April 2010, the Israeli Ministry of Finance announced that it has appointed a committee to study Israel’s tax policy regarding oil and gas resources in Israel, as well as the possibility of an increase in taxes and/or royalties.

If increases in royalties or other taxes on any oil or gas production are enacted and we discover any oil or gas on our license areas, then we would need to pay royalties and/or taxes at a higher rate than the rate we are currently subject to. Any such developments could also negatively impact our future drilling activities. Since no changes to the current royalty/tax structure have been enacted, we do not know the ultimate impact that any such developments may have on our future net income and/or cash flows.

ITEM 2.
UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.
(REMOVED AND RESERVED)

ITEM 5.
OTHER INFORMATION

None.

ITEM 6.
EXHIBITS
 
Exhibit Index:

31.1
  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 under the Exchange Act
     
31.2
  
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 under the Exchange Act
     
32.1
  
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished only).
     
32.2
  
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished only).

 
41
 

SIGNATURES

Pursuant to 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.

ZION OIL & GAS, INC.
    
(Registrant)
    
     
By:
/s/ Richard J. Rinberg
  
By:
/s/ Kent S. Siegel
 
Richard J. Rinberg
Chief Executive Officer
(Principal Executive Officer)
    
Kent S. Siegel,Senior Vice-President and Chief Financial
Officer
(Principal Financial Officer)
Date:
November 8, 2010
  
Date:
November 8, 2010

 
42