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ZN > SEC Filings for ZN > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for ZION OIL & GAS INC

Form 10-K for ZION OIL & GAS INC


6-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following discussion and analysis should be read in conjunction with Item 6, "Selected Financial Data" and our accompanying financial statements and the notes to those financial statements included elsewhere in this Annual Report. Some of our discussion is forward-looking and involve risks and uncertainties. For information regarding factors that could have a material adverse effect on our business, refer to Risk Factors under Item 1A of this Report.

Overview

Zion Oil and Gas is an initial stage oil and gas exploration company with a history of over 13 years of oil and gas exploration in Israel. We were incorporated in Florida on April 6, 2000 and reincorporated in Delaware on July 9, 2003. We completed our initial public offering in January 2007. Our common stock currently trades on the NASDAQ Global Market under the symbol "ZN".

Zion currently holds three petroleum exploration licenses, all onshore Israel, comprised of the newly granted Megiddo-Jezreel License (covering approximately 98,842 acres), the Asher-Menashe License (covering approximately 78,824 acres), and the Jordan Valley License (covering approximately 55,845 acres). Zion's total license area currently amounts to approximately 233,511 acres.

As a result of ongoing evaluation of previous and newly acquired geological and geophysical data relating to our license areas, we are re-focusing our exploration strategy with a primary emphasis on the Megiddo-Jezreel and portions of the Jordan Valley License areas. After we identify the site of our next exploratory well, we will need to begin the procedure of obtaining the needed authorizations and permits. We anticipate that the newly promulgated regulations will considerably increase the time needed to obtain all of the needed permits and authorizations from regulatory and local bodies in Israel. See the discussion under "The Onshore Petroleum Exploration Permitting Process in Israel" discussed above. Finally, prior to actually spudding our next exploratory well, we will need to contract with an appropriate rig contractor. We anticipate that we will need to raise significant funds in order to complete any exploratory well that we spud. To date, we have funded our operations through the issuance of our securities. We anticipate that we will need to raise funds through the issuance of equity securities (or securities convertible into or exchangeable for equity securities). No assurance can be provided that we will be successful in raising the needed equity on favorable terms (or at all).

To date, we have drilled four exploratory wells. While the presence of hydrocarbons was indicated while drilling certain of these wells, none of the exploratory wells that we have drilled to date have been deemed capable of producing oil or gas in commercial quantities.

At present, we have no revenues or operating income and are classified as a "development stage" company. Our ability to generate future revenues and operating cash flow will depend on the successful exploration and exploitation of our current and any future petroleum rights or the acquisition of oil and/or gas producing properties, and the volume and timing of such production. In addition, even if we are successful in producing oil and gas in commercial quantities, our results will depend upon commodity prices for oil and gas, as well as operating expenses including taxes and royalties.

Our executive offices are located at 6510 Abrams Road, Suite 300, Dallas, Texas 75231, and our telephone number is (214) 221-4610. Our field office in Israel is located at 9 Halamish Street, North Industrial Park, Caesarea 3088900, and the telephone number is +972-4-623-8500. Our website address is: www.zionoil.com.

Principal Components of our Cost Structure

Our operating and other expenses primarily consist of the following:

Impairment of Unproved Oil and Gas Properties: Impairment expense is recognized if a determination is made that a well will not be able to be commercially productive. The amounts include amounts paid in respect of the drilling operations as well as geological and geophysical costs and various amounts that were paid to Israeli regulatory authorities.

General and Administrative Expenses: Overhead, including payroll and benefits for our corporate staff, costs of managing our exploratory operations, audit and other professional fees, and legal compliance are included in general and administrative expense. General and administrative expense also includes non-cash stock-based compensation expense, investor relations related expenses, lease and insurance and related expenses.

Depreciation, Depletion, Amortization and Accretion. The systematic expensing of the capital costs incurred to explore for natural gas and oil. As a full cost company, we capitalize all costs associated with our exploration, and apportion these costs to each unit of production, if any, through depreciation, depletion and amortization expense. As we have yet to have production, the costs of abandoned wells are written off immediately versus being included in this amortization pool.


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.

Impairment of 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.

Our oil and gas properties represent an investment 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.

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 March 2013, the Company recorded a non-cash impairment charge of approximately $1,851,000 of its unproved oil and gas properties. The impairment charge is for all remaining capitalized costs of the Joseph License.

In December 2013, the Company recorded a non-cash impairment charge of approximately $1,438,000 of its unproved oil and gas properties. The impairment charge is for all remaining capitalized costs of the Asher-Menashe License and the results of the Elijah #3 well re-entry operations. Impairments on both licenses are due principally to a decision to prioritize available financial resources and focus Zion's efforts on the Megiddo-Jezreel and portions of the Jordan Valley License areas.

Following the conclusion of the re-entry operations into the Elijah #3 well and related geological and geophysical testing in the third-fourth quarters of 2012, we recorded in the quarter ended December 31, 2012 a non-cash impairment charge of $1,965,000 to our unproved oil and gas properties, comprised of $1,913,000 in respect of the Elijah #3 re-entry well operations and $52,000 in respect of the withdrawal of the three applications for petroleum exploration rights originally submitted in 2011.

Following the impairment charges noted above, the total net book value of our unproved oil and gas properties under the full cost method is $2,446,000 at December 31, 2013.


Currency Utilized

Although our oil & gas properties and our principal operations are in Israel, we report all our transactions in United States dollars. Certain dollar amounts in the financial statements may represent the dollar equivalent of other currencies.

Valuation of Deferred 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.

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.

RESULTS OF OPERATIONS

The following table sets forth our Statements of Operations data for the years ended December 31 (all data is in thousands of USD):

                                                   2013         2012
General and administrative expenses:

Legal and professional                              1,065        1,188

Salaries                                            2,553        3,890

Other                                               2,216        3,310

  Impairment of unproved oil and gas properties     3,289        1,965
Total General and administrative expenses           9,123       10,353

Other (income) expense, net                          (46)         (59)

Net loss                                            9,077       10,294

FOR THE YEAR ENDED DECEMBER 31, 2013 COMPARED TO DECEMBER 31, 2012

Revenue. We currently have no revenue generating operations as we are still a development stage company.

General and administrative expenses. General and administrative expenses for the year ended December 31, 2013 were $9,123,000 compared to $10,353,000 for the year ended December 31, 2012. The decrease in general and administrative expenses in 2013 compared to 2012 is primarily attributable to a deliberate effort to run the Company more efficiently, resulting in reduced costs in salaries and other expenses. Legal and professional fees for 2013 were $1,065,000 compared to $1,188,000 for 2012. The decrease in legal and professional fees is primarily attributable to the decreased utilization of legal services resulting from the decrease in operational activity in 2013. Salary expenses for the year ended December 31, 2013 were $2,553,000 compared to $3,890,000 for the year ended December 31, 2012. The decrease in salary expenses in 2013 compared to 2012 is primarily attributable to a lesser salary cost due to a reduction in workforce coupled with a lesser non-cash expense recorded in connection with stock option grants that were awarded during 2013, 2012 and 2011. Other general and administrative expenses for the year ended December 31, 2013 were $2,216,000 compared to $3,310,000 for the year ended December 31, 2012. Other general and administrative expenses are comprised of non-compensation and non-professional expenses incurred. The decrease in other general and administrative expenses in 2013 compared to 2012 is primarily attributable to decreased marketing and investor relations related expenses and operational expenses. Impairment of unproved oil and gas properties expenses for the year ended December 31, 2013 were $3,289,000 compared to $1,965,000 for the year ended December 31, 2012. The increase in impairment of unproved oil and gas properties expenses in 2013 compared to 2012 is attributable to the impairment charge of $3,289,000 recorded during the year ended December 31, 2013 in respect of all remaining capitalized costs of the Joseph and Asher - Menashe Licenses and the Elijah #3 re-entry operations, in comparison to the impairment charge of $1,965,000 recorded during the year ended December 31, 2012 in respect the Elijah #3 well re-entry.


Other (income) expense, net. Other (income) expense, net for the year ended December 31, 2013 was ($46,000) compared to ($59,000) for the year ended December 31, 2012.

Net Loss. Net loss for the year ended December 31, 2013 was $9,077,000 compared to $10,294,000 for the year ended December 31, 2012.

Liquidity and Capital Resources

Liquidity is a measure of a company's ability to meet potential cash requirements. As discussed above, we have historically met our capital requirements through the issuance of common stock (or securities convertible into common stock) as well as proceeds from the exercise of warrants and options to purchase common equity.

At December 31, 2013, we had approximately $10,414,000 in cash and cash equivalents compared to $14,983,000 at December 31, 2012. Our working capital (current assets minus current liabilities) was $10,045,000 at December 31, 2013 and $13,409,000 at December 31, 2012.

As of December 31, 2013, the Company provided bank guarantees to various governmental bodies (approximately $1,143,000) and others (approximately $109,000) in respect of its drilling operation in the aggregate amount of approximately $1,252,000. The restricted cash in the Company's bank account represents those guarantees and is in interest-bearing deposits.

During the year ended December 31, 2013, cash used in operating activities totaled $4,648,000. Cash provided by financing activities during the year ended December 31, 2013 was $2,479,000 and is attributable to proceeds received from the DSPP (the "Plan") which offers investors the ability to purchase units and shares of our common stock directly from us. Net cash used in investing activities such as unproved oil and gas properties, other assets and restricted bank deposits was $2,400,000 for the year ended December 31, 2013.

We expect to incur additional significant expenditures to further our exploration programs. We estimate that, when we are not actively drilling a well, our expenditures are approximately $494,000 per month excluding exploratory operational activities. However, when we become engaged in active drilling operations, we estimate an additional minimum expenditure of approximately $2,500,000 per month. The above estimates are subject to change. Management believes that our existing cash balance will be sufficient to finance our plan of operations through March 31, 2015. However, there are factors that can adversely impact our ability to fund our operating needs through such date, including (without limitation), unexpected or unforeseen cost overruns in planned non-drilling exploratory work (e.g., seismic acquisition, drilling and environmental permit acquisition costs, etc.) in existing and newly sought license areas and the costs associated with extended delays in undertaking the required exploratory work, which is typical of what we have experienced in the past, or plugging and abandonment activities. We are considering various alternatives with respect to raising additional capital but to date have made no specific plans or arrangements, except for the launch in March 2013 of the DSPP. We expect that when we seek to raise additional capital it will be through the sale of equity securities, debt or other financing arrangements. Due in part to our lack of any oil and natural gas reserves, there can be no assurance this capital will be available and if it is not, we may be forced to substantially curtail or cease exploration and development expenditures.


Dividend Reinvestment and Direct Stock Purchase Plan

On March 27, 2013, the Company filed with the SEC the prospectus supplement dated as of March 27, 2013 and accompanying base prospectus (collectively, the "Prospectus") relating to the Company's Dividend Reinvestment and Direct Stock Purchase Plan (the "DSPP"). The Prospectus forms a part of the Company's current Registration Statement on Form S-3.

Under the Prospectus, the Company is offering (a) shares of common stock and (b) through February 28, 2014, units of the Company's securities with each unit comprised of (i) one share of common stock and (ii) a warrant to purchase an additional share of the Company's common stock at an exercise price of $2.00 per share for five years. The securities are being offered by the Company in accordance with the terms of the DSPP as described in the Prospectus.

On August 26, 2013, the Company extended the expiration date for the Unit program under its DSPP to November 29, 2013.

On November 25, 2013, the Company extended the expiration date for the Unit program under its DSPP to February 28, 2014.

On February 21, 2014, the Company extended the expiration date for the Unit program under its DSPP to June 30, 2014. The extensions were made, in part, to allow interested investors to utilize a new and more convenient electronic enrollment procedure with the TeleCheck Internet Check Acceptance service as a payment method.

As of December 31, 2013, the Company and its registered agent, Registrar and Transfer Company ("RTC"), had collected approximately $2,478,000 from the DSPP. As a result, the Company issued a total of 1,099,486 shares of its common stock, comprised of 790,975 units (unit comprised of (i) one share of common stock and
(ii) a warrant) and 308,511 shares.

Tabular Disclosure of Contractual Obligations

The following summarizes our contractual financial obligations for continuing
operations at December 31, 2013 and the effect such obligations are expected to
have on our liquidity and cash flow in future periods.

                                            Payment due by period (in Thousands of USD)
                           2014           2015          2016          2017         Thereafter        Total
Exploration Related
Commitments                  2,012              -             -             -                -         2,012

Operating Leases               335            304           174           171              186         1,170

Employment Agreements        1,073             -             -             -                -          1,073

Total                        3,420            304           174           171              186         4,255

Off-Balance Sheet Arrangements

We do not currently use any off-balance sheet arrangements to enhance our liquidity or capital resource position, or for any other purpose.

Recently Issued Accounting Pronouncements

During 2013, there were no recently issued accounting pronouncements which were issued and which have relevancy to our business.

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