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

A.

Nature of Operations (cont’d)

 

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).

 

Operations in Israel are conducted through a branch office. The Asher-Menashe License and Joseph License 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 operations.

B.

Management Presentation and Liquidity

On February 17, 2004, a registration statement filed by the Company with the Securities and Exchange Commission was declared effective to offer 7,000,000 shares of the Company’s common stock to the public. The minimum offering requirement of $6,500 thousand was not subscribed by the offering termination date of August 30, 2004. As a result, no securities were sold to the public, all escrow subscription funds that had been received pursuant to the offering were sent back to the subscribers by the escrow agent, and the Company removed from registration the 7,000,000 shares of the Company’s common stock.

Between September 2004 and through September 2006, the Company raised capital through debt and private offerings and the exercise of outstanding warrants. During 2006, $1,934 thousand was raised in private equity financings and warrant exercises, as described below.

 

On January 25, 2006 the Company filed a registration statement for a public offering on a “best efforts” basis (the “Public Offering”) of between 350,000 and 2,000,000 shares of common stock at $7.00 per share with a minimum offering requirement of $2,450 thousand (350,000 shares) and a maximum of $14,000 thousand (2,000,000 shares). The registration statement was declared effective by the Securities and Exchange Commission on September 26, 2006. On December 29, 2006, the Company completed the first closing of its Public Offering in which it accepted subscriptions in the amount of $3,059 thousand in consideration of the issuance of 436,907 shares of common stock. Between January 1, 2007 and May 25, 2007, the Company completed additional closings in which it accepted additional subscriptions for 1,369,428 shares of its common stock in the amount of $9,587 thousand bringing the total amount raised in the Public Offering through its termination following the May 25, 2007 closing to $12,645 thousand.

14

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

B.

Management Presentation and Liquidity (cont’d)

On February 1, 2008, the Company filed a registration statement with the Securities and Exchange Commission (the “2008 Registration Statement”) in connection with a public offering of 2,500,000 units (the “Units) consisting of one share of the Company’s common stock and one common share purchase warrant (exercisable at $7 per share), with each Unit priced at $10 (the “Unit Offering”). The Unit Offering has a minimum closing requirement of $3,250,000 (325,000 units) (the “Minimum Unit Offering”). On April 22, 2008, the Company filed Amendment No. 1 to the 2008 Registration Statement and on May 2, 2008, filed Amendment No. 2 to the 2008 Registration Statement. The 2008 Registration Statement was declared effective on May 14, 2008. Under the terms of the Unit Offering, an initial closing will be scheduled as soon as possible following the acceptance of subscriptions in the amount of the Minimum Unit Offering, which must be a date no later than August 12, 2008 (which date may be extended by up to 60 days). The Unit Offering will remain open until the earlier to occur of (i) November 10, 2008 (which date may be extended by up to 60 days), (ii) the date on which 2,500,000 Units have been subscribed and accepted, and (iii) such date as announced by the Company on no less than two trading days’ prior notice (See Note 6).

 

We believe that additional funds will be required for us to carry out our plan of operations through December 31, 2008 as the funds currently available to us will not be sufficient. To carry out our plan of operations, we must complete the Minimum Unit Offering in sufficient time to commence the drilling of the Ma’anit-Rehoboth #2 prior to the end of August 2008, and the deferring officers and employees must continue to defer the monies due them and continue to accept partial payment of their currently due salaries.

In the opinion of management, all adjustments considered necessary for a fair presentation of financial position, results of operations, and changes in financial position have been included. See Note 2A for a discussion of the Company’s recording an impairment of unproved oil and gas properties following the cessation of operations on the Ma’anit #1 well and the formal relinquishment of the Ma’anit-Joseph License in June 2007.

C.

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 achieve profitable operations. The uncertainty of these conditions raises substantial doubt about the Company's ability to continue as a going concern. The unaudited interim financial statements do not include any adjustments that might result from the outcome of this uncertainty.

15

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

C.

Basis of Presentation (cont’d)

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, 2007. The results of operations for the period ended March 31, 2008 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

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 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 an unproved property and a major development project 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 as a reserve base has not yet been established. An impairment requiring a charge to expense may be indicated through evaluation of drilling results, relinquishing drilling rights or other information.

 

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Note 2 - Summary of Significant Accounting Policies (cont’d)

A.

Oil and Gas Properties and Impairment (cont’d)

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. Considering the desire to optimize drilling operations on the Company’s planned Ma’anit-Rehoboth #2, the Company decided to cease operations on the Ma’anit #1 well and, as required by the Israeli Petroleum Law, formally relinquish the Ma’anit-Joseph License. It is the current intent of the Company to use the Ma’anit #1 wellbore, down to approximately 3,200 meters, as the upper part of the wellbore for the planned Ma’anit-Rehoboth #2 well. Plans are that this well will be directionally drilled from that point to penetrate the middle and the lower Triassic, which is still considered highly prospective by the Company. In addition, the Company intends to drill down to the Permian section of the upper Paleozoic formation.

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 unsuccessful Ma’anit #1 well and formal relinquishment of the Ma’anit-Joseph License, the Company recorded an impairment of $9,494 thousand to its unproved oil and gas properties.

The Company’s ability to maintain present operations is dependent on two petroleum exploration licenses: (a) The Joseph License, in respect of which the planning of and preparations for the drilling of a well are under way (See Note 1A); and (b) the Asher-Menashe License, in respect of which a geophysical program commenced in December 2007. (See Note 5I)

The Company has no economically recoverable reserves and no amortization base. Excluding the $9,494 thousand impairment recorded after the formal surrender of the Ma’anit-Joseph License, the Company’s unproved oil and gas properties consist of capitalized exploration costs of $3,156 thousand at March 31, 2008

 

17

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Note 2 - Summary of Significant Accounting Policies (cont’d)

A.

Oil and Gas Properties and Impairment (cont’d)

Comprised as follows:

		March 31 2008			December 31 2007
		US$ thousands			US$ thousands
Excluded from amortization base:
Drilling operations, completion costs and other related costs			2,063			2,035
Capitalized salary costs			252			145
Legal costs and license fees			612			220
Other costs			229			190
		$	3,156		$	2,590

Impairment of unproved oil and gas properties comprised as follows:

		Period Ended March 31 2008			Year Ended December 31 2007			Period from April 6, 2000 (inception) to March 31, 2008
		US$ thousands			US$ thousands			US$ thousands
Drilling operations, completion costs and other related costs			-			7,959			7,959
Capitalized salary costs			-			683			683
Legal costs and license fees			-			509			509
Other costs			-			343			343
			-			9,494			9,494

B.

Recently Issued Accounting Pronouncements

1. SFAS 141R - Business Combinations (SFAS 141R)

In December 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 141R, Business Combinations (“SFAS 141R”). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value”. SFAS 141R is effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS 141R will be applied to business combinations occurring after the effective date.

The Company does not expect the adoption of SFAS 141R to have a material impact on its balance sheet or statement of operations.

 

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Note 2 - Summary of Significant Accounting Policies (cont’d)

B.

Recently Issued Accounting Pronouncements (cont’d)

2. SFAS 160 – Noncontrolling Interest in Consolidated Financial Statements (SFAS 160)

In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment to ARB No. 51 (“SFAS 160”). SFAS 160 requires noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. SFAS 160 is effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS 160 will be applied prospectively to all non-controlling interests, including any that arose before the effective date.

The Company does not expect the adoption of SFAS 160 to have a material impact on its balance sheet or statement of operations.

3. SFAS 161 – Disclosures about Derivative Instruments and Hedging Activities (SFAS 161)

In March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand the effects of the derivative instruments on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning on or after November 15, 2008, with early adoption encouraged.

The Company does not expect the adoption of SFAS 161 to have a material impact on its balance sheet or statement of operations.

C.

Recently adopted accounting pronouncements

1. SFAS 157 – Fair Value Measurements (SFAS 157)

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. The Statement does not require any new fair value measures. SFAS 157 is effective for fair value measures already required or permitted by other standards for fiscal years beginning after November 15, 2007. The Company is required to adopt SFAS 157 beginning on January 1, 2008. SFAS 157 is required to be applied prospectively, except for certain financial instruments. Any transition adjustment will be recognized as an adjustment to opening retained earnings in the year of adoption. In February 2008, the FASB issued SFAS No. 157-2, which grants a one-year deferral of SFAS 157’s fair-value measurement requirements for nonfinancial assets and liabilities, except for

 

Note 2 - Summary of Significant Accounting Policies (cont’d)

C.

Recently adopted accounting pronouncements (cont’d)

1. SFAS 157 – Fair Value Measurements (SFAS 157) (cont’d)

items that are measured or disclosed at fair value in the financial statements on a recurring basis.

The adoption of SFAS 157 did not have a material effect on the Company’s balance sheet or results of operations.

2. SFAS 159 – Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159)

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits all entities the option to measure most financial instruments and certain other items at fair value at specified election dates and to report related unrealized gains and losses in earnings. The fair value option will generally be applied on an instrument-by-instrument basis and is generally an irrevocable election. SFAS 159 is effective for fiscal years beginning after November 15, 2007.

The adoption of SFAS 159 did not have a material effect on the Company’s balance sheet of results of operations.

D.

Certain prior year’s amounts have been reclassified to conform to the current year presentation.

Note 3 - Stockholders’ Equity

A.

Private Placement Offerings

During 2000, John Brown purchased 2,400,000 shares at the then current par value ($0.001 per share) on his behalf and on behalf of 25 other founding shareholders. Between January 1, 2001 and December 31, 2004, the Company raised $3,125 thousand in private placements from the sale (adjusted for the reincorporation merger on July 9, 2003) of 1,830,298 shares of common stock and: (i) warrants with an original expiration date of December 31, 2004 to purchase 275,833 shares of common stock at $1.00 per share; (ii) warrants with an original expiration date of December 31, 2004 to purchase 411,770 shares of common stock at $1.50 per share; and (iii) warrants with an original expiration date of December 31, 2006 to purchase 181,500 shares of common stock at $5.00 per share. The December 31, 2004 warrant expiration date was extended to January 31, 2005 by which date the warrants were exercised.

 

20

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Note 3 - Stockholders’ Equity (cont’d)

A.

Private Placement Offerings (cont’d)

Between January 1, 2005 and March 31, 2005, the Company raised $2,140 thousand through the sale of 535,000 shares of common stock and warrants to purchase 214,000 shares of the Company’s common stock in a private placement offering. The warrants designated as “E warrants” were exercisable at $5.00 per share through December 31, 2006. Between April 22 and June 10, 2005, the Company raised $1,380 thousand through the sale of 276,000 shares of common stock and 55,200 E Warrants. Between June 20, 2005 and October 24, 2005, the Company raised $3,230 thousand through the sale of 646,000 shares of common stock.

During December 2005, the Company raised $440 thousand from the sale of 80,000 shares of common stock and warrants to purchase 12,500 shares of common stock at $5.50 per share at any time from July 1, 2007 through December 31, 2008, such warrants being designated as “G” warrants.

During 2006, the Company (i) raised $489 thousand from the sale of 89,000 shares of common stock and 7,125 G warrants; (ii) issued 62,493 shares of common stock for $291 thousand in consideration of services; (iii) issued 175,357 shares of common stock for $877 thousand upon the exercise of E warrants; (iv) issued 35,000 shares of common stock for $105 thousand upon the exercise of $3.00 warrants; and (v) issued 42,957 shares of common stock for $172 thousand upon the exercise of “D” warrants (See Note 3D).

B.

Initial Public Offering

On December 29, 2006, the Company completed its first closing of the Public Offering in which it accepted subscriptions in the amount of $3,059 thousand in consideration of the planned issuance of 436,907 shares of common stock. Between January 1, and May 25, 2007, the Company completed additional closings in which it accepted additional subscriptions for 1,369,428 shares of its common stock in the amount of $9,587 thousand, bringing the total amount raised in the Public Offering through May 25, 2007 to $12,645 thousand. The offering terminated on May 25, 2007 (See Note 5G).

 

C.

2005 Stock Option Plan

During 2005, a stock option plan (the “Plan”) was adopted by the Company, pursuant to which 1,000,000 shares of common stock are reserved for issuance to officers, directors, employees and consultants. The Plan is administered by the Board of Directors or one or more committees appointed by the board (the “Administrator”).

The Plan contemplates the issuance of stock options by the Company both as a private company and as a publicly traded company and is available to residents of the United States, the State of Israel and other jurisdictions as determined by the Administrator. Awards of stock options under the Plan are made pursuant to an agreement between the Company and each grantee. The agreement will, among other provisions, specify the number of shares subject to the option, intended tax qualifications, the exercise price, any vesting provisions and the term of the stock option grant, all of which are determined on behalf of the Company by the Administrator. The Plan will remain in effect for a term of ten years unless terminated or extended according to its provisions.

 

21

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Note 3 - Stockholders’ Equity (cont’d)

C.

2005 Stock Option Plan (cont’d)

On July 5, 2006, award agreements under the 2005 Stock Option Plan were entered into as follows: (a) with two directors each for the purchase of 25,000 shares of common stock at an exercise price of $5.00 per share (50,000 shares in the aggregate) through December 31, 2008 at a value of $59 thousand in the aggregate (the rights to these options vested on the date the award agreement was signed, and the options became exercisable commencing on July 1, 2007); (b) with one employee (who resigned effective June 1, 2007) for the purchase of 80,000 shares of common stock at an exercise price of $5.00 per share through December 31, 2010 (of these, options to purchase 26,667 shares of common stock vested on January 1, 2007 at a value of $65 thousand charged to the Company according to the vesting period, with an adjustment recorded at the termination date of June 1, 2007; the remaining non-vested options to purchase 53,333 shares of common stock were cancelled upon the resignation of the officer in accordance with the terms of the award agreement; the vested options were not able to be exercised prior to July 1, 2007); and (c) with one employee for the purchase of 40,000 shares of common stock at an exercise price of $5.00 per share through December 31, 2010 (these options will vest in four equal tranches of four vesting periods of 10,000 shares each, on the date the award agreement was signed, and on October 1, 2006, on October 1, 2007 and October 1, 2008 at a value of $97 thousand that will be charged according to the vesting periods, and the options exercisable commencing July 1, 2007). Although award agreements with respect to these options were signed in July 2006: (a) their issuance was authorized and their terms, including their exercise price, were fixed by resolution of the board of directors taken on October 27, 2005; (b) the commencement of the service period for the options preceded the grant date and (c) the value of the options were initially accounted for during December 2005. Compensation expense was recorded commencing December 2005 based on the fair value of the options at that time.

On July 1, 2007, an award agreement under the 2005 Stock Option Plan was entered into with one employee for the purchase of 50,000 shares of common stock at an exercise price of $5.60 per share through December 31, 2012 (these options will vest in three tranches – 20,000 on June 30, 2008; 15,000 on June 30, 2009 and 15,000 on June 30, 2010, at a value of $126 thousand that will be charged according to the vesting periods).

On December 4, 2007, award agreements under the 2005 Stock Option Plan were entered into as follows: (a) with 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 at a value of $257 thousand (these options vest in four equal tranches of four vesting periods of 10,000 shares each, on January 29, 2008, April 28, 2008, July 27, 2008 and October 25, 2008); (b) with 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 at a value of $257 thousand (the rights to these options vested on the date of the award); and (c) with one employee for the purchase of 3,882 shares of common stock at an exercise price of $0.01 per share through December 3, 2017 at a value of $25 thousand (the rights to these options vested on the date of the award).

 

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Note 3 - Stockholders’ Equity (cont’d)

D.

Fair Value of Warrants and Options

The Company has reserved 411,795 shares of common stock as of March 31, 2008 for the exercise of warrants and options to employees and non-employees. These warrants and options have been excluded from earnings per share calculations because they are anti-dilutive at March 31, 2008 and 2007 and the period from April 6, 2000 (inception) to March 31, 2008. 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:

Exercise

Number of

Expiration

Warrants or

Price

shares

date

Options

To non-employees

5.00

10,000

December 31, 2008

Warrants

8.75

46,621

September 26, 2009

Warrants

To employees and directors

5.00

85,000

December 31, 2008

Warrants

5.00

50,000

December 31, 2008

Options

5.00

66,667

December 31, 2010

Options

5.60

50,000

December 31, 2012

Options

0.01

83,882

December 3, 2017

Options

To investors

5.50

19,625

December 31, 2008

Warrants

4.50*

411,795

 

* 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, 2006 to:
Employees, officers and directors			1,750,936			1.73
Underwriters (in connection with IPO)			11,590			8.75
Private placement investors and others			1,105,492			2.84
Expired/canceled			(587,726	)		2.68
Exercised			(1,984,077	)		1.59
Outstanding, December 31, 2006			296,215			5.18
Granted to:
Employees, officers and directors as part compensation			133,882			2.10
Underwriters (in connection with IPO)			35,031			8.75
Private placement investors and others			-			-
Expired/Canceled			(53,333	)		5.00
Exercised			-			-
Outstanding, December 31, 2007			411,795			4.50
Outstanding, March 31, 2008			411,795			4.50
Exercisable, March 31, 2008			321,795			4.74

 

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Note 3 - Stockholders’ Equity (cont’d)

F.

Warrant Descriptions

Through the balance sheet date the Company issued nine 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

 

Other than price and date details, all of the warrants were issued on the same conditions, except that the F, FF and G Warrants were not exercisable before July 1, 2007, 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 Public Offering (See Note 3C).

G.

Gift Shares

As part of the Public Offering, 150,000 shares of common stock held by four executive officers were registered and given by the officers to individuals and entities. 21,000 of the gift shares were given to directors, employees and service providers. The related cost of $147 thousand was charged to the statement of operations and credited as additional paid in capital during 2006.

Note 4 - Related Party Transactions

The Company had $1,219 thousand of deferred officers compensation at March 31, 2008 which represents payables to officers and directors of the Company. Such officers have committed to defer payments of these sums until at least July 1, 2008, subject to partial earlier payment in certain circumstances.

A.

Cimarron Resources, Inc.

Notes payable to related parties as at December 31, 2006, included $32 thousand under a loan facility with Cimarron Resources, Inc. (Cimarron), a company owned by the former Chief Executive Officer of the Company, Cimarron obtained the monies to lend to the Company through a loan facility with Bank One. The note accrued interest at Bank One’s Prime Rate (8.25% at December 31, 2006) plus 2.5%. During the month of January 2007, the loan was repaid in full.

 

26

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Zion Oil & Gas Inc

(A Development Stage Company)

Notes to the Unaudited Interim Financial Statements as of March 31, 2008 

---

 

Note 4 - Related Party Transactions (cont’d)

B.

Rappaport loan

Notes payable to related parties as at December 31, 2006, included $75,000 under a line of credit loan agreement with a shareholder of the Company. Through July 31, 2006, outstanding balances accrued interest at 10% per annum. At the direction of the shareholder, a commitment fee of $10 thousand in the aggregate was paid to two children of the shareholder in the form of 12,000 shares of common stock (in the aggregate) and warrants to purchase 5,000 shares (in the aggregate) of the Company’s common stock. On July 31, 2006, the Rappaport loan was further extended to a date 15 days following the initial closing of a public offering. In connection with this extension the shareholder and the Company agreed to increase the interest rate on the facility to 12% per annum. During the month of January 2007 the loan was repaid in full.

C.

Robert E. Render

Mr. Render provided consulting services to the Company totaling $20 thousand during the eight months ended August 31, 2006. Mr. Render has not provided any consulting services to the Company since September 1, 2006.

D.

Richard J. Rinberg

In October 2005 Mr. Rinberg was elected President of the Company and effective November 1, 2005, entered into a two year Retention and Management Agreement with the Company (the “Retention Agreement”). Pursuant to the Retention Agreement, Mr. Rinberg was awarded 200,000 shares of common stock of the Company valued at $500,000 as compensation for his services during the two year period beginning November 1, 2005, subject to restrictions and vesting requirements. The company received a valuation from an independent appraisal firm supporting this valuation. The Rinberg shares were subject to repurchase by the Company at $0.01 per share if Mr. Rinberg had left his position with the Company prior to October 31, 2007. In May 2006, the Company issued the referenced 200,000 shares of common stock to a trust company for the benefit of Mr. Rinberg.

In March 2007, upon the resignation of the previous Chief Executive Officer (“CEO”) of the Company, Mr. Rinberg was appointed to the position of CEO under his existing Retention Agreement. Effective November 1, 2007, the Company entered into an employment agreement with Mr. Rinberg, effective through December 31, 2008.

E.

Other issuances

In respect of issuances to John Brown (related party) see Note 3A.

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Note 5 - 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.

Should it be determined that a liability exists with respect to any environmental clean up or restoration, the liability to cure such a violation could fall upon the Company. No claim has 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 costs can be reasonably estimated.

B.

Royalty Commitments

The Company is obligated, according to the Israeli Petroleum Law, 5712-1952 (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 March 31, 2008 or December 31, 2007, the Company did not have any outstanding obligation in respect to royalty payments, since it is at the “exploration stage” and, to this date, no proved reserves have been found.

C.

Long-term Incentive Plan

The Company has initiated 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 shall be assigned to key employees. At March 31, 2008 or December 31, 2007, the Company did not have any outstanding obligation in respect of the long-term incentive plan, since it is at the “exploration stage” and, to this date, no proved reserves have been found.

D.

Charitable Foundations

The Company has initiated the establishment of two charitable foundations, one in Israel and one in the United States or another appropriate jurisdiction, for the purpose of supporting charitable projects and other charities in Israel, the United States and internationally. A 3% overriding royalty or equivalent interest in any Israeli oil and gas interests as may now be held or, in the future be acquired, by the Company shall be assigned to each charitable organization (6% overriding interest in the aggregate). At March 31, 2008 or December 31, 2007, 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.

 

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Note 5 - Commitments and Contingencies (cont’d)

G.

Underwriting Agreement (cont’d)

In addition, pursuant to the Underwriting Agreement, the Underwriter was to receive warrants (“H” warrants) to purchase a number of shares of the Company’s common stock in an amount equal to 3% of the number of shares of common stock sold in the Public Offering by it and other placement agents appointed by it pursuant to the Underwriting Agreement at a price of $8.75 per share (or 125% of the offering price). The H warrants are exercisable beginning six months after the final closing of the Public Offering and expire on September 26, 2009. Pursuant to this undertaking, the Company issued 46,621 H Warrants (See Note 3F) to purchase shares at a price of $8.75 of the Company’s common stock.

In January 2008, in connection with the filing of the 2008 Registration Statement, the Company entered into an underwriting agreement with Network 1 Financial Securities, Inc. (the “January 2008 Underwriting Agreement”). The January 2008 Underwriting Agreement provided for a two year extension to the existing investment banking/consultant agreement for an additional fee of $60 thousand, payable upon the closing of the offering in a minimum aggregate amount of $5,000 thousand. Under the terms of the January 2008 Underwriting Agreement, the Company was required to, and did, remit an advance payment of $50 thousand against the non-accountable expense allowance to be paid to Network 1 Financial Securities (“Network 1”) in connection with services to be rendered in the course of the offering. In addition to a 6% underwriting commission and a 3% non-accountable expense allowance, under the January 2008 Underwriting Agreement, Network 1, was entitled to certain underwriters warrants. During March 2008, the Board made a decision to terminate the agreement with Network 1. In April 2008, the January 2008 Underwriting Agreement with Network 1 was terminated in accordance with its terms. On April 2, 2008, a new underwriting agreement, as subsequently amended, (the “April 2008 Underwriting Agreement”) was entered into with Brockington Securities, Inc. (“Brockington”). The April 2008 Underwriting Agreement, as amended, does not include provisions relating to an investment banking/consultant agreement nor does it contain underwriters warrants. Additionally, the April 2008 Underwriting Agreement, as amended, provides for a 5% underwriting commission and a 3% non-accountable expense allowance. Upon the decision to terminate the January 2008 Underwriting Agreement, the advance payment of $50 thousand was recorded as an expense by the Company.

H.

Lease Commitments

The Company leases approximately 3,600 square feet of office space in Dallas under a lease which expires on October 31, 2008. The monthly rent is $4 thousand for each of the twelve-month periods ending October 31, 2006, 2007 and 2008 respectively, less any sublease payments received. Until mid-July 2006 approximately 800 square feet (and access to the common areas) were subleased month-to-month for payments of $1 thousand per month.

The Company also leases office premises in the industrial area of Caesarea, Israel under a lease agreement through January 31, 2009, with two additional six-month options, at a monthly rental cost of $3 thousand throughout both the additional year and the two option periods. The monthly rent has been $3 thousand per month since the inception of the lease in July 2005.

 

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Note 5 - Commitments and Contingencies (cont’d)

H.

Lease Commitments (cont’d)

The future minimum lease payments are as follows:

		US$ thousands
April 1 – December 31 2008			55
2009			3
			58

 

I.

Contract with Geophysical Institute of Israel

In connection with planned seismic, magnetic and gravimetric surveys, on September 17, 2007, the Company entered into an agreement with the Geophysical Institute of Israel (“GII”) that provided for the Company to acquire the necessary data from GII. The agreement provided for a 40-kilometer program subject to increase or decrease (but not to less than 20 kilometers) by the Company. Under the agreement, the Company submitted a program originally designed for the acquisition of about 60 kilometers of data, later reduced to approximately 52 kilometers. The agreement provided for the survey to be performed by GII on a per kilometer basis at a rate of NIS 40 thousand (approximately $11 thousand at the representative rate of NIS 3.607 per US dollar published on February 5, 2008) per kilometer. In addition, the agreement provided for an NIS 80 thousand (approximately $22 thousand) mobilization and demobilization fee and for the Company to reimburse GII certain payments made to third parties, including permitting fees and damages other than those caused by fault of GII. Under the agreement, the Company paid NIS 160 thousand (approximately $44 thousand) on signing and made an additional payment of NIS 690 thousand (approximately $190 thousand) prior to the commencement of field acquisition work on December 24, 2007. The remaining amount of NIS 1,431 thousand (approximately $397 thousand at the representative rate of NIS 3.607 per US dollar published on February 5, 2008) was paid on February 5, 2008 following the completion of the survey on January 23, 2008. In the survey a total of 52.5 kilometers of new seismic data were acquired.

Note 6 - Subsequent Events

On April 22, 2008, the Company filed Amendment No. 1 to the 2008 Registration Statement. On May 2, 2008, the Company filed Amendment No. 2 to the 2008 Registration Statement. The Company’s 2008 Registration Statement was declared effective by the SEC on May 14, 2008 (See Note 1B).

 

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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-KSB FOR THE YEAR ENDED DECEMBER 31, 2007 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

Forward-Looking Statements

The preceding discussion should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this Form 10-Q. 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;
·	generation of additional properties, reserves;
·	new prospects and drilling locations;
·	future capital expenditures;
·	sufficiency of working capital;
·	plans regarding and ability to raise additional capital;
·	drilling plans;
·	availability and costs of drilling rigs;
·	timing or results of any wells;
·	interpretation and results of seismic surveys or seismic data;
·	permit, license and lease rights;
·	participation of operating partners;
·	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

 

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Overview

 

Zion Oil & Gas, Inc. has been engaged in oil and natural gas exploration on approximately 219,000 acres, and currently holds 162,000 acres, onshore in the State of Israel between Netanya in the south and Haifa in the north. The areas have been subject to a series of exploration permits and licenses that have been granted to and held by us pursuant to the Israeli Petroleum Law. We currently hold two exploration licenses. One license, named the “Asher-Menashe License”, covers an area of approximately 78,824 acres which is 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 has a three-year term that commenced on June 10, 2007 and runs through June 9, 2010, which term may be extended for additional periods up to a maximum of 7 years. The second license, named the “Joseph License”, covers approximately 83,272 acres located on the Israeli coastal plain south of the Asher-Menashe License between Caesarea in the north and Netanya in the south; the Joseph License also has a three-year term that commenced on October 11, 2007 and runs through October 10, 2010, which term may be extended for up to a maximum of 7 years. Under the terms of both licenses, we are under an obligation to commence the drilling a well to a depth of at least 4,000 meters (approximately 13,200 feet) in the case of the Asher-Menashe License and 4,500 meters (approximately 14,850 feet) in the case of the Joseph License by July 2009, as such date may be extended with respect to either or both licenses by the Petroleum Commissioner. In the event of a discovery, we will be entitled to convert the relevant portions of our licenses to 30-year production leases, extendable to up to 50 years.

 

In 2005, in accordance with terms of the Ma’anit-Joseph License, the predecessor of our Joseph License, we 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 us from isolating highly conductive water bearing zones from the tighter hydrocarbon bearing formations, the shows were never successfully tested and the well was abandoned in June 2007, following unsuccessful remedial workover operations conducted between April and June 2007.

 

Currently, we are developing one prospect and four leads in its license areas. The prospect and one lead are located in the Joseph License area and three of the leads are located in the Asher-Menashe License area. We are utilizing an Israeli country-wide seismic database so as to better understand and interpret the geology of our license areas. The database consists of 219 seismic sections totaling 3,100 kilometers of coverage and also includes the stratigraphic sections from all the wells drilled in Israel.

 

During the eight years between our formation and March 31, 2008, we have received net proceeds from the issuance of our equity securities of $23,775 thousand and have invested in unproved oil and gas properties $12,800 thousand in order to satisfy our work commitments under the terms of our permits and licenses received from the State of Israel, of which $9,494 thousand was written off during 2007. As of March 31, 2008, our officers and key employees have deferred a substantial portion of their salaries and other compensation due through July 2008. From time to time, they have all exchanged portions of the deferred compensation for our equity securities, which (with four exceptions relating to employee stock options) were priced at the same price as concurrent sales of our equity securities. (Deferred compensation has been paid to our officers upon their retirement or resignation.)

 

Planned Drilling Activities/Business Plan

 

Our current plans are to re-enter the Ma'anit #1 well (Ma’anit-Rehoboth #2) and then ‘sidetrack’ and drill directionally to a distance approximately 2,500 feet northeast of the present location to at least a total vertical depth of 15,400 feet to the Triassic formation in fulfillment of the terms of the Joseph License. We would ultimately like to deepen the well to a projected true vertical depth of 18,040 feet in the Permian section of the Paleozoic Age. The purpose of the well is 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 bottom hole location for the second well on the Ma’anit structure has been chosen in an attempt to maximize the chance of being in localized fracturing in both the Triassic and the Permian sections.

 

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Preparations for drilling the Ma’anit-Rehoboth #2 well are continuing. All long lead-time items have arrived and the equipment on hand to be used for future wells reflects a cost of approximately $1,500 thousand (all of which sum is reflected in the figure shown for Unproved Oil and Gas Properties on the Balance Sheet for March 31, 2008). The estimated dry hole cost of the planned Ma’anit-Rehoboth #2 well if drilled to the Triassic is $4,500 thousand, and $6,600 thousand if drilled to the Permian. The completed hole costs of the well if drilled to the Triassic is currently estimated as $5,300 thousand, and $7,400 thousand if drilled to the Permian. These amounts include $900 thousand that has been already expended.

The timing of the commencement of drilling the well is uncertain. Because there is currently no drilling rig in Israel capable of drilling to either the Triassic or the Permian, we are in negotiation with an international contractor for the purpose of bringing into Israel a rig capable of drilling to the target depths. There can be no assurance that we will be able to reach an agreement on acceptable terms with such contractor.

 

To enable us to drill the Ma’anit-Rehoboth #2 to the Permian, the Asher-Menashe test well required to be drilled under the terms of the Asher-Menashe License and possibly commit to drill at least one additional well in a multi-well drilling program being developed both in context of our plans to explore our Asher-Menashe and Joseph Licenses, we will need to raise additional funds through equity offerings or loans during 2008 and/or sell a portion of our rights in all or part of our licenses.

 

The surface rights to the drill site on which we plan to drill the Ma’anit Rehoboth #2 well are held under a long-term lease by Kibbutz Ma'anit. The rights are owned by the State of Israel and administered by the Israel Lands Authority. Permission necessary to re-enter and use the drill site to conduct petroleum operations has been granted to Zion by the Kibbutz in consideration for a monthly fee of $350. Permission of the Israel Lands Authority for the use of the surface rights is also required, which permission the Israel Lands Authority is required to grant under the Petroleum Law. On April 12, 2007, the Authority granted the required permission for a one year period (which period could be extended), subject to our paying an annual surface use fee and signing a land use agreement. The use fee through April 2008 was paid, but the agreement was not finalized pending receipt from the Israel Lands Authority of the land use agreement. Recently the Israel Lands Authority adopted new procedures for the grant of surface rights for oil exploration (including drilling) activities and adopted a form of land use agreement for such purpose, which procedures include requirements for special approval if the applicant is a non-Israeli entity. With the expiration on April 12, 2008 of our previously granted permission, we applied for an extension under the new procedures. The Israel Lands Authority is currently reviewing our file in light of the new procedures. We cannot give any assurance when or pursuant to what conditions we will obtain formal permission from the Israel Lands Authority for the use of the drill site.

 

On February 1, 2008, we filed a Form S-3 registration statement (the “Registration Statement”) with the SEC for an offering (the “Follow-On Offering”) of a minimum of 325,000 "Units", on a "best efforts, all or none" basis (the "Minimum Offering"), and an additional 2,175,000 Units on a "best efforts" basis, for a maximum of 2,500,000 Units (the "Maximum Offering"), at $10.00 per Unit for aggregate gross proceeds to us of $3,250 thousand and $25,000 thousand, respectively. On April 22, 2008, we filed Amendment No. 1 to the Registration Statement. Each Unit to be offered in the Follow-On Offering consists of (i) one share of common stock, par value $.01 per share and (ii) one warrant (the "Unit Warrant") to purchase one share of common stock at a per share exercise price equal to $7.00. On May 2, ,2008, we filed Amendment No. 2 to the Registration Statement. The Follow-On Offering is being made through Brockington Securities, Inc. and other licensed broker/dealers. The Registration Statement was declared effective by the SEC on May 14, 2008. There can be no assurance that we will be able to raise funds through this offering.

 

We intend to use most of the net proceeds of this offering for appraisal and exploratory drilling on our Israeli licenses. Our work program calls for the drilling of an appraisal and/or exploratory well (the Ma’anit-Rehoboth #2) on our Joseph License at an estimated "dry hole" cost of $4,500 thousand to a total measured depth of approximately 4,700 meters (15,400 feet) to the Triassic formation in fulfillment of the terms of the Joseph License, and an estimated $6,600 thousand to drill the Ma'anit-Rehoboth #2 to a total measured depth of approximately 5,550 meters (18,040 feet) to the Permian. Our work program also calls for the drilling of a well to a minimum depth of approximately 4,500 meters (14,800 feet) at an estimated cost of approximately $7,800 thousand on the Asher-Menashe License. Drilling a subsequent well on the Joseph License area to 5,500 meters (18,040 feet) would cost approximately $9,300 thousand. We intend to evaluate the new wells through a combination of electrical wireline tool investigations, recovery of samples from the target formations (coring) and testing. A "dry hole" is a well that for either geological or mechanical reasons is judged by us to be incapable of producing oil or gas in commercial quantities. If any well is not a "dry hole," a completion attempt would be made at an estimated completion cost of between $800 thousand and $1,500 thousand in order to set production casing, perforate, install the production tubing and wellhead and conduct extended tests of the well. We cannot assure you that any well will be completed or produce oil and/or gas in commercial quantities.

 

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If only the minimum of approximately $2,700 thousand net proceeds are raised from this offering, we intend to drill the Ma'anit-Rehoboth #2 to a total measured depth of approximately 4,700 meters (15,400 feet) to the Triassic formation and appraise the apparent findings of the Ma'anit #1 well in that formation. Drilling the Ma'anit-Rehoboth #2 to the Triassic formation will fulfill our obligations under the Joseph License. Amounts raised in the Follow-On Offering in excess of the Minimum Offering will be applied to deepen the Ma'anit-Rehoboth #2 well to its designed total depth of approximately 5,500 meters (18,040 feet) to the Permian formation and evaluate the well. If the maximum of approximately $ 22,635 thousand net proceeds are raised, we intend to drill the Ma'anit-Rehoboth #2 well to the Permian, drill a well on the Asher-Menashe License to a minimum depth of 4,500 meters (14,800 feet), and prepare to drill a third well to a depth of between 4,500 to 5,400 meters (14,800 to 17,700 feet) on one of our two licenses.

There can be no guarantees that we will be successful in the Follow-On Offering or otherwise in raising the capital necessary for us to complete our plan of operations and drill the Menashe-Rehoboth #2 well to either the Triassic or the Permian target or that capital will be available on terms acceptable to us.

We might also enter into negotiations to sell a portion of the Joseph Project (and our petroleum rights and prospect data) in order to spread our risk, conserve our capital and raise additional funds necessary to drill the planned Ma’anit-Rehoboth #2 well and/or the Asher-Menashe test well and additional wells on the Asher-Menashe and Joseph Licenses and to obtain co-venturers with technical and financial capability to supplement our efforts. There is no assurance that we will be able to attract any parties to join our drilling operations to enable the completion of our plan of operation. We cannot predict the terms and conditions upon which any joint venture agreement might be reached.

Going Concern Basis

Our unaudited interim financial statements for the period ended March 31, 2008 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. Our ability to continue as a going concern is dependent upon our ability to obtain additional financing or equity capital and, ultimately, to achieving profitable operations. The uncertainty of these conditions raises 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.

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.

 

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Based upon the encouraging but inconclusive results of the drilling and testing of the Ma’anit #1, the Company’s oil and gas operations represent an investment in an unproved property including additional drilling 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 as a reserve base has not yet been established. An impairment requiring a charge to expense may be indicated through evaluation of drilling results, relinquishing drilling rights or other information.

We record an investment impairment charge when we believe an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investment that may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future.

In June 2007, following the analysis of the results of the testing of our Ma’anit #1 well workover, evaluation of the mechanical condition of the well and the desire to optimize drilling operations on our planned Ma’anit-Rehoboth #2 well, we decided to cease operations on the Ma’anit #1 well and, as required by the Israeli Petroleum Law, formally relinquish the Ma‘anit-Joseph License. It is our current intent to use the Ma’anit #1 wellbore, down to approximately 3,200 meters, as the upper part of the wellbore for the planned Ma’anit-Rehoboth #2 well. We plan to directionally drill this well from that point to penetrate the middle and the lower Triassic, which we still consider highly prospective by the Company. In addition, we intend to drill down to the Permian section of the upper Paleozoic formation.

Immediately after the relinquishment of the Ma’anit-Joseph License, we filed an application with the Petroleum Commissioner for a petroleum exploration license, the Joseph License, covering approximately 85,000 acres of the original Ma’anit-Joseph License including the Ma’anit structure on which the Ma’anit #1 well was drilled. This license was subsequently granted. As a result of the unsuccessful Ma’anit #1 well and formal relinquishment of the Ma’anit-Joseph License, we recorded an impairment of $9,494 thousand to its unproved oil and gas properties.

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that we were to determine that it would be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase net income in the period such determination was made.

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.

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

Our working capital (current assets minus current liabilities) was $1,898 thousand at March 31, 2008 and $3,399 thousand at December 31, 2007.

No cash was provided by financing activities during the three month period ended March 31, 2008. Net cash provided was $5,810 thousand for the three month period ended March 31, 2007, of which the substantial majority was from the sale of equity securities, net of equity sales costs. Net cash used in investing activities was $605 thousand for the three months ended March 31, 2008 and $342 thousand for the three month period ended March 31, 2007, which was used for exploration costs on the license and purchasing equipment to be used in our future wells.

 

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On March 31, 2008, we had cash and cash equivalents in the amount of $3,220 thousand. On May 14, 2008, we had cash and cash equivalents in the amount of $2,692 thousand.

 

As discussed above, on February 1, 2008 we filed a Registration Statement for a Follow-On Offering on a best efforts minimum-maximum basis, of a minimum of 325,000 Units at $10.00 per Unit for an aggregate gross proceeds to us of $3,250 thousand and a maximum of 2,500,000 Units for an aggregate gross proceeds to us of $25,000 thousand. The Registration Statement, which has been subsequently amended, has not yet been declared effective.

 

We believe that, in the event we are successful in closing the Minimum Offering, the proceeds of the Minimum Offering together with the funds currently available will be sufficient to enable us to meet our needs in carrying out our Plan of Operations described above through to December 31, 2008. In the event we do not succeed in closing the Minimum Offering, we will have to attract additional investments in our company or additional parties to join our drilling operations in order to carry out our Plan of Operations described above through December 31, 2008, and the deferring officers and employees must continue to defer the monies due them and continue to accept partial payment of their currently due salaries. There can be no guarantees that we will be successful in any of these efforts.

 

Results of Operations

 

COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2007

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

General and administrative expenses. General and administrative expenses were $1,070 thousand for the three month period ended March 31, 2008 compared to $698 thousand for the three month period ended March 31, 2007. Legal and Professional fees were $323 thousand for the three month period ended March 31, 2008 compared to $271 thousand for the three month period ended March 31, 2007. This increase is due to the expensing of the advance payment made to Network 1 upon the termination of our Underwriting Agreement with them. Salary expenses were $454 thousand for the three month period ended March 31, 2008 compared to $236 thousand for the three month period ended March 31, 2007. The higher salary expenses are related to higher salaries, most of which have been deferred by those officers and employees. Other general and administrative expenses were $293 thousand for the three month period ended March 31, 2008 compared to $191 thousand for the three month period ended March 31, 2007. This increase of $102 thousand is related to increased office activity related primarily to investor relations activities.

Interest income, net. Interest income was $31 thousand for both of the three month periods ended March 31, 2008 and 2007. Interest expense for these periods was negligible

Net Loss. Net loss was $1,039 thousand for the three month period ended March 31, 2008 compared to $667 thousand for the three month period ended March 31, 2007.

 

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