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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1
FORM 10/A
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(b) OR 12(g) OF
THE SECURITIES EXCHANGE ACT OF 1934
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RIDGEWOOD ENERGY Q FUND, LLC
(Exact Name of Registrant as Specified in its Charter)
Delaware 84-1689138
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(State of other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1314 King Street, Wilmington, Delaware 19801
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (302) 888-7444
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Securities to be registered pursuant to Section 12(b) of the Act: None
Securities to be registered pursuant to Section 12(g) of the Act:
Title of each class:
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Shares of Membership Interest
Explanatory Paragraph
This Amendment No. 1 on Form 10/A (the "Form 10") to the Ridgewood Energy Q
Fund, LLC (the "Fund") Form 10 originally filed with the Securities and Exchange
Commission (the "SEC") on April 21, 2006 is being filed in response to an SEC
Comment Letter dated May 19, 2006 (the "Comment Letter") and therefore includes
revisions and disclosures in response to the Comment Letter.
In addition, as reported under Item 4.02 of the Form 8-K filed by the Fund on
October 24, 2006, on October 20, 2006, Ridgewood Energy Corporation (the
"Manager") of the Fund concluded that the Fund's financial statements as of and
for the period from August 16, 2005 (Inception) to December 31, 2005 (the "2005
Financial Statements") as included in the Fund's Form 10 filed with the SEC on
April 21, 2006 should no longer be relied upon and should be restated to correct
for errors detected by management of the Fund. See Note 11 to the Audited
Financial Statements for a discussion of the restatement.
This Form 10/A amends and restates in its entirety the original filing. All
discussions, disclosures and financial information have been updated to include
the Fund's most recent quarter ended June 30, 2006.
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TABLE OF CONTENTS
Page
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Item 1. Business 4
Item 1A. Risk Factors 18
Item 2. Financial Information 27
Item 3. Properties 34
Item 4. Security Ownership of Certain Beneficial Owners and Management 34
Item 5. Directors and Executive Officers 35
Item 6. Executive Compensation 36
Item 7. Certain Relationships and Related Transactions 36
Item 8. Legal Proceedings 37
Item 9. Market Price of and Dividends on the Registrant's
Common Equity and Related Stockholder Matters 37
Item 10. Recent Sales of Unregistered Securities 37
Item 11. Description of Registrant's Securities to be Registered 38
Item 12. Indemnification of Directors and Officers 43
Item 13. Financial Statements and Supplementary Data 43
Item 14. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 43
Item 15. Financial Statements and Exhibits 44
3
ITEM 1. BUSINESS
GENERAL
Ridgewood Energy Q Fund, LLC (the "Fund") is a Delaware limited liability
company and was formed on August 16, 2005 to acquire interests primarily in oil
and natural gas projects located in the U.S. waters of the Gulf of Mexico.
Ridgewood Energy Corporation ("Ridgewood Energy" or the "Manager"), a Delaware
corporation, is the Manager. As the Manager, Ridgewood Energy has direct and
exclusive control over the management and control of Fund operations. The Fund
is engaged in the acquisition, development and production of oil and natural gas
projects in the Gulf of Mexico. To date, the Fund has focused primarily on
acquiring oil and natural gas projects in the shallow waters of the Gulf of
Mexico in locations with access to existing gathering and processing
infrastructure or where such infrastructure can be constructed economically and
efficiently.
The Fund initiated its private placement offering on September 6, 2005,
selling whole and fractional shares of membership interests primarily at
$150,000 per share. There is no public market for these shares and one is not
likely to develop. In addition, the shares are subject to severe restrictions on
transfer and resale and cannot be transferred or resold except in accordance
with the Fund's LLC operating agreement and applicable federal and state
securities laws. The offering was terminated on December 30, 2005. The Fund
raised approximately $123.0 million. After payment of approximately $19.7
million in offering fees, commissions and investment fees, the Fund had
approximately $103.3 million for investments and operating expenses. As of
November 9, 2006, the Fund had 1,308 shareholders.
THE MANAGER
Ridgewood Energy was founded in 1982 by Robert E. Swanson. As the Manager,
Ridgewood Energy has direct and exclusive control over the management of the
Fund's operations. With respect to project investment, Ridgewood Energy locates
potential projects, conducts appropriate due diligence and negotiates and
completes the transactions in which the investments are made. This includes not
only review of existing title documents, reserve information, and other
technical specifications regarding a project, but also the review and
preparation of participation agreements and other agreements relating to an
investment.
In addition, Ridgewood Energy performs (or arranges for the performance of)
the management and administrative services required for Fund operations. Among
other services, Ridgewood Energy administers the accounts and handles relations
with the shareholders, including tax and other financial information. In
addition, Ridgewood Energy provides the Fund with office space, equipment and
facilities and other services necessary for its operation. Finally, Ridgewood
Energy manages and conducts the Fund's relations with custodians, depositories,
accountants, attorneys, brokers-dealers, corporate fiduciaries, insurers, banks
and others, as required.
The Fund is required to pay all other expenses it incurs, including
expenses of preparing and printing periodic reports for shareholders and the
Securities and Exchange Commission ("SEC"), postage for mailings, commission
fees, interest, taxes, outside legal, accounting and consulting fees, litigation
expenses and other expenses, if any, properly payable by us. The Fund is
required to reimburse the Manager for all such Fund expenses paid by them.
4
As compensation for their management services, the Manager is entitled to
(i) an annual Management Fee, payable monthly, equal to 2.5% of the total
Capital Contributions made by our shareholders and (ii) a 15% interest in the
cash distributions made to our shareholders. The Manager received from the Fund
for its management services a total of approximately $1.5 million, $0.6 million
and $2.1 million for the six months ended June 30, 2006, the period ending
December 31, 2005, and the period August 16, 2005 (Inception) through June 30,
2006, respectively. There have been no cash distributions to shareholders paid
through June 30, 2006.
PROJECTS
The Fund's primary investment objective is to generate cash flow for
distribution to shareholders from the exploration and possible development of
oil and natural gas prospects in the offshore waters of Texas, Louisiana and
Alabama in the Gulf of Mexico ("GOM") on the Outer Continental Shelf ("OCS").
All of the Fund's projects are located in these offshore waters and the Manager
anticipates future projects, if any, will likewise be located in the same waters
of the Gulf of Mexico.
The Fund owns a 35% working interest (as defined in Item 1. under "Working
Interests in Oil and Natural Gas Leases") ownership in Main Pass 221 and a 45%
working interest ownership in Main Pass 30. Both projects are operated by
Chevron Corporation ("Chevron"). These projects are described more fully below
and in the table included in Item 3. "Properties".
MAIN PASS 221
The Fund acquired a 35% working interest from the Operator, Chevron. In
consideration for our 35% working interest the Fund paid a promote of $2.8
million. This project was to consist of three large potential natural gas
reservoirs stacked one on top of another between 19,700 feet and 22,000 feet.
The well began drilling on November 3, 2005 and reached its total depth on
January 24, 2006, 91 days after arriving on location. The well was perforated on
April 9, 2006 and flowed at non-commercial rates. On April 10, 2006 the decision
was made to plug and abandon the well. Dry-hole costs including plug and
abandonment expenses incurred by the Fund for the six months ended June 30,
2006, for the period ending December 31, 2005 and for the period August 16, 2005
(Inception) through June 30, 2006 were approximately $11.3 million, $7.8
million, and $19.1 million, respectively.
MAIN PASS 30
The Fund acquired a 45% working interest from the Operator, Chevron. In
consideration for our 45% working interest the Fund agreed to pay 90% of the
drilling costs on the first well and 75% of the drilling costs for additional
development wells. All completion costs and operating expenses will be charged
at the working interest percentage of 45%. This project has a five well
potential between 12,000 and 12,500 feet. For the six months ended June 30,
2006, for the period ending December 31, 2005 and for the period August 16, 2005
(Inception) through June 30, 2006, the Fund incurred project costs of $7.1
million, $10.8 million, and $17.9 million, respectively, toward a total budget
of approximately $77.8 million.
5
The first well in the Main Pass 30 project was put in production in June
2006 and is utilizing an existing Chevron production platform and pipeline. In
return for the use of this infrastructure, the Fund will pay 15 cents per one
thousand cubic feet ("MCF") as a processing fee for production.
The current production platform equipment has the capacity to process
natural gas from the first two wells. After the second well comes on production
it will be necessary to install additional equipment to the platform that has an
estimated cost, to the Fund, of approximately $0.5 million. After the third well
is drilled, a pipeline upgrade will be necessary. The cost to the Fund for the
pipeline upgrade is estimated to be approximately $3.2 million. All of these
facility upgrades are included in the total budget noted above.
BUSINESS STRATEGY
The Fund's primary investment objective is to generate cash flow from
the acquisition, exploration, production and sale of crude oil and natural gas
from oil and natural gas properties. The Fund has invested and participates in
exploration and production projects located in the waters of the Gulf of Mexico
offshore Texas, Louisiana and Alabama on the OCS. These activities are governed
by the Outer Continental Shelf Lands Act ("OCSLA") enacted in 1953 and
administered by the Mineral Management Services ("MMS"). The Fund generally
looks to invest in projects that have been proposed by larger independent oil
and natural gas companies seeking to minimize their risks by selling a portion
of their interest in a project. These investments may require the Fund to pay a
larger portion of the costs than its ownership interest would otherwise require.
This is called a promote and is relatively typical in the oil and natural gas
exploration industry. In addition, notwithstanding the sale of an interest to
the Fund, the seller may retain a right for some period of time to payments from
the sales of oil and natural gas production from a well or project. This is
called an overriding interest which is also relatively common in this industry.
Notwithstanding any such promote or overriding interest, the Fund has tried to
invest in projects that it believes contain sufficient commercial quantities of
oil or natural gas and which are near (i) existing oil or natural gas gathering
and processing infrastructure and (ii) developed markets where we can sell our
oil or natural gas.
The Fund tries to focus on projects that have significant reserve potential
and which are projected to have the shortest time period from our investment to
first production. However, the Fund does not operate these projects, and the
manner in which and schedule pursuant to which its projects are developed and
completed is determined exclusively by the operator and is beyond the Fund's
ability to significantly influence. Moreover, when performing due diligence with
respect to a project, we must rely on the independent reservoir engineers who
are hired and paid, in most cases, by the operator. We do engage certain
consultants for ourselves to examine and review such reserve estimates and
seismic information on our behalf.
PLAN OF OPERATION FOR REMAINDER OF FISCAL YEAR 2006
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The Fund does not act as an operator of any project or lease block in which
it has invested. During the remainder of 2006, the Fund intends to monitor the
drilling and, if applicable, the completion activities of the operators
including, without limitation, review of expenditures and proposed budgets,
participation in progress meetings, and general oversight of activities at the
project.
6
ACQUISITION CRITERIA
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The Manager has control over the selection of projects, the percentage
investment and ownership interest acquired. In evaluating various potential
investments, the Manager conducts due diligence of each such project against a
list of factors that it believes will result in the selection of those projects
that have the highest probability of success. These factors, in no particular
order, include, but are not limited to, the following:
o targeting projects that have or are expected to have operators
with significant resources and experience in oil and natural gas
exploration;
o targeting projects that have or are expected to have partners
that also have significant resources and experience in oil and
natural gas exploration;
o technical quality of the project including its geology, seismic
profile, locational trends, and whether the project has potential
for multiple prospects.
o oil or natural gas reserve potential;
o whether and the extent to which the operator participates as a
working interest owner in the project;
o economic factors, such as potential revenues from the project,
the rate of return, and estimated time to first production;
o risk factors; the location of the project, whether it is a deep
or shallow well, the partners and their experience, the size of
the investment to the Fund, and investment diversification;
o existence of drilling rigs, platforms and other infrastructure,
at or nearby the project;
o proposed drilling schedule;
o terms of the proposed transaction, including contractual
restrictions and obligations and lease term; and
o overall cost of the project.
WORKING INTEREST IN OIL AND NATURAL GAS LEASES
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Existing projects and future projects, if any, are expected to be located
in the waters of the Gulf of Mexico offshore from Louisiana, Texas and Alabama
on the OCS. The OCSLA, which was enacted in 1953, governs certain activities
with respect to working interests and the exploration of oil and natural gas in
the OCS.
Under OCSLA, as amended, the United States federal government has
jurisdiction over oil and natural gas exploration and development on the OCS. As
a result, the United States Secretary of the Interior is empowered to sell
exploration, development and production leases of a defined submerged area of
the OCS, or a block, through a competitive bidding process. Such activity is
conducted by the MMS, an agency of the United States Department of Interior. As
part of the leasing activity and as required by the OCSLA, the leases auctioned
include specified lease terms such as the length of the lease, the amount of
royalty to be paid, lease cancellation and suspension, and, to a degree, the
planned activities of exploration and production to be conducted by the lessee.
In addition, the OCSLA grants the Secretary of the Interior continuing oversight
and approval authority over exploration plans throughout the term of the lease.
The winning bidder(s) at the lease sale, or the lessee(s), are given a
lease by the MMS that grants such lessee(s) the exclusive right to conduct oil
and natural gas exploration and production activities within a specific lease
block, or working interest. Leases in the OCS are generally issued for a primary
7
lease term of 5, 8 or 10 years depending on the water depth of the lease block.
The 5-year lease term is for blocks in water depths generally less than 400
meters, 8 years for depths between 400 meters to 800 meters and 10 years for
depths in excess of 800 meters. During this primary lease term, except in
limited circumstances, lessees are not subject to any particular requirements to
conduct exploratory or development activities. However, once a lessee drills a
well and begins production, the lease term is extended for the duration of
commercial production.
The lessee of a particular block, for the term of the lease, has the right
to drill and develop exploratory wells and conduct other activities throughout
the block. If the initial well on the block is successful, a lessee (or
third-party operator for a project) may conduct additional geological studies
and may determine to drill additional or development wells. If a development
well is to be drilled in the block, each lessee owning working interests in the
block must be offered the opportunity to participate in, and cover the costs of,
the development well up to that particular lessee's working interest ownership
percentage.
Generally, working interests in an offshore gas lease under the OCSLA pay a
16.67% royalty to the MMS. Therefore, the net revenue interest of the holders of
100% of the working interest in the projects in which the Fund will invest is
approximately 83.33% of the total revenue of the project, and, is further
reduced by any other royalty burdens that apply to a lease block. However, as
described below, the MMS has adopted royalty relief for existing OCS leases for
those who drill deep oil and natural gas projects.
MINERAL MANAGEMENT SERVICES DEEP NATURAL GAS ROYALTY INCENTIVE
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On January 26, 2004, the MMS promulgated a rule providing incentives for
companies to increase deep oil and natural gas production in the Gulf of Mexico
(the "Royalty Relief Rule"). Under the Royalty Relief Rule, lessees will be
eligible for royalty relief on their existing leases if they drill and perforate
wells for new and deeper reserves at depths greater than 15,000 feet subsea. In
addition, an even larger royalty relief would be available for wells drilled and
perforated deeper than 18,000 feet subsea. It should be noted that the Royalty
Relief Rule does not extend to deep waters of the Gulf of Mexico off the
continental shelf nor does it apply if the price of natural gas exceeds $9.60
Million British Thermal Units ("mmbtu"). The Royalty Relief Rule is limited to
leases in a water depth less than 656 feet, or 200 meters. With respect to the
Fund's other projects that are currently drilling, the Fund will determine once
completed if the project will be able to claim relief under the Royalty Relief
Rule.
OIL AND NATURAL GAS AGREEMENTS
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As of the date of this filing, the Fund does not have oil or natural gas
sales agreements with any particular customer or entity. We have entered into a
short-term month to month agreement with Energy Upgrade, Inc. who is currently
marketing and selling our proportionate share of natural gas to the public
market. We are receiving market prices for such natural gas. The Manager
believes however, that it is likely that oil and natural gas from the Fund's
other projects will also have access to pipeline transportation and can be
marketed in a similar fashion. All of the Fund's current projects are near
existing transportation infrastructure and pipelines. As mentioned above in
Acquisition Criteria, as part of the Manager's review of a potential project,
8
access to existing transportation infrastructure is an extremely important
factor as the existence of such infrastructure enables production from a
successful well to get to market quickly.
OPERATOR
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The projects in which the Fund has invested are operated and controlled by
unaffiliated third-party entities acting as operators. The operator is
responsible for drilling, administration and production activities for leases
jointly owned by working interest owners and acts on behalf of all working
interest owners under the terms of the applicable offshore operating agreements.
In certain circumstances, operators will enter into agreements with independent
third-party subcontractors and suppliers to provide the various services
required for operating leases. Currently, the Fund's projects are operated by
Chevron.
Because the Fund does not operate any of the projects in which it has
acquired an interest, shareholders must not only bear the risk that the Manager
will be able to select suitable projects, but also that, once selected, such
projects will be managed prudently, efficiently and fairly by the operators.
Copies of the Fund's offshore operating agreements are attached hereto as
exhibits.
INSURANCE
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The Manager has obtained hazard, property, general liability and other
insurance in commercially reasonable amounts to cover the projects, as well as
general liability and similar coverage for its business operations. However,
there is no assurance that such insurance will be adequate to protect the Fund
from material losses related to the projects. In addition, the Manager's past
practice has been to obtain insurance as a package that is intended to cover
most, if not all, of the funds under its management. These projects are owned by
affiliates of the Fund. While the Manager believes it has obtained adequate
insurance in accordance with customary industry practices, the possibility
exists, depending on the extent of the incident, insurance coverage may not be
sufficient to cover all losses. In addition, depending on the extent, nature and
payment of any claims to the Fund's affiliates, yearly insurance limits may
become exhausted and be insufficient to cover a claim made by the Fund in that
year.
SALVAGE FUND
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As to projects in which we own a working interest, we deposit in a separate
interest-bearing account, or a salvage fund, which is in the nature of a sinking
fund, money to help provide for our proportionate share of the cost of
anticipated salvage value of dismantling production platforms and facilities,
plugging and abandoning the projects, and removing the platforms, facilities and
projects in respect of each of such projects after their useful life, in
accordance with applicable federal and state laws and regulations. There is no
assurance that the salvage fund will have sufficient assets to meet these
requirements and any unfunded expenses, and the Fund may be liable for such
expenses. In 2006, the Fund has deposited approximately $1 million from capital
contributions into a salvage fund which we estimate to be sufficient to meet our
potential requirements. If management later determines the deposit and earned
interest is not enough to cover the Fund's proportionate share of expense, the
Fund will deposit payments from operating income to make up any differences. Any
9
portion of a salvage fund that remains after the Fund pays its share of the
actual salvage cost will be distributed to the shareholders. There are no legal
restrictions on the withdrawal of the salvage fund.
SEASONALITY
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Generally, the Fund's business operations are not subject to seasonal
fluctuations in the demand for oil and natural gas that would result in more of
the Fund's oil and natural gas being sold, or likely to be sold, during one or
more particular months or seasons. Once a project is drilled and reserves of oil
and natural gas are determined to exist, the operator of the project extracts
such reserves throughout the year. Oil and natural gas, once extracted, can be
sold at any time during the year.
However, the Fund's drilling, production and transportation operations are
subject to seasonal risks, such as hurricanes, that may affect our ability to
bring such oil or natural gas to the market and, consequently, affect the price
for such oil and natural gas. The National Hurricane Center defines hurricane
season in the Atlantic Region, Caribbean, and Gulf of Mexico to be from June 1
through November 30. During hurricane season, the number and intensity of and
resulting damage from hurricanes in the Gulf of Mexico region could affect the
gathering and processing infrastructure, drilling platforms or the availability
or price of repair or replacement equipment. As a result, these factors may
affect the supply and, consequently, the price of oil and natural gas resulting
in an increase in price if supplies are reduced. However, even if commodity
prices increase because of weather related shortages, the Fund may not be in a
position to take immediate advantage of any such price increase if, as a result
of such weather related incident, damage occurred to its projects, the gathering
infrastructure or in the transportation network.
The Manager has had past experiences which indicate the typical
interruption in operations resulting from a hurricane that does not result in
significant damage may be approximately three to seven days. The Manager has
experienced the range of possible interruptions in operations due to hurricanes
from as little as no damage and insignificant or no interruptions to significant
damage and extended interruptions. However, it is of course impossible to
predict whether and to what extent hurricanes and damage may occur and to what
projects.
CUSTOMERS
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All of the oil and natural gas production from our producing property, Main
Pass 30, is sold by Energy Upgrade, Inc. on our behalf. As a result, the Fund
did not contract to sell oil and natural gas to third parties. Therefore, we had
no customers or any one customer upon which we depend for more than ten percent
(10%) of our revenues.
COMPETITION
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Strong competition exists in the acquisition of oil and natural gas leases
and in all sectors of the oil and natural gas exploration and production
industry. Although the Fund does not compete for the acquisition of working
interests from the MMS, it does compete with other companies for the acquisition
of percentage ownership interests in oil and natural gas working interests in
the secondary market.
In many instances, the Fund competes for projects with large independent
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oil and natural gas producers who generally have significantly greater access to
capital resources, have a larger staff, and more experience in oil and natural
gas exploration and production than the Fund. As a result, these larger
companies are in a position that they could outbid the Fund for a project.
However, because these companies are so large and have such significant
resources, they tend to focus more on projects that are larger, have greater
reserve potential, but cost significantly more to explore and develop. These
larger projects increasingly tend to be projects in the deepwater areas of the
Gulf of Mexico and the North Sea off the coast of Great Britain. However, the
focus of these companies on larger projects does not necessarily mean that they
will not investigate and/or acquire smaller projects in shallow waters for which
we compete. Many of these larger companies have participated in the auctions for
lease blocks directly from the U.S. Government. In such cases, these companies
obtain from the U.S. Government 100% of the leasehold of a particular lease
block in the Gulf of Mexico. In order to obtain even more resources to invest in
other larger and more expensive projects, they diversify current holdings,
including projects they own in the shallow waters of the Gulf of Mexico, by
selling off percentage interests in these lease blocks. As a result, very good
projects in the shallow waters of the Gulf of Mexico become available. The Fund,
therefore, has opportunities to acquire interests in these smaller, yet
economically attractive projects.
EMPLOYEES
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The Fund has no employees as the Manager operates and manages the Fund.
REGULATIONS
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Oil and natural gas exploration, development and production activities are
subject to extensive federal and state laws and regulations. Regulations
governing exploration and development activities require, among other things,
our operators to obtain permits to drill projects and to meet bonding, insurance
and environmental requirements in order to drill, own or operate projects. In
addition, the location of projects, the method of drilling and casing projects,
the restoration of properties upon which projects are drilled and the plugging
and abandoning of projects are also subject to regulations.
OUTER CONTINENTAL SHELF LANDS ACT
The Fund's projects are located in the offshore waters of the Gulf of
Mexico on the OCS. The Fund's operations and activities, therefore, are governed
by, among other things, or the OCSLA, which was enacted in 1953.
Under OCSLA, as amended, the United States federal government has
jurisdiction over oil and natural gas development on the OCS. As a result, the
United States Secretary of the Interior is empowered to sell exploration,
development and production leases of a defined submerged area of the OCS, or a
block, through a competitive bidding process. Such activity is conducted by the
MMS, an agency of the United States Department of Interior. The MMS administers
federal offshore leases pursuant to regulations promulgated under the OCSLA.
Lessees must obtain MMS approval for exploration, development and production
plans prior to the commencement of offshore operations. In addition, approvals
and permits are required from other agencies such as the U.S. Coast Guard, the
Army Corps of Engineers and the Environmental Protection Agency. Offshore
operations are subject to numerous regulatory requirements, including stringent
11
engineering and construction specifications related to offshore production
facilities and pipelines and safety-related regulations concerning the design
and operating procedures of these facilities and pipelines. MMS regulations also
restrict the flaring or venting of production and proposed regulations would
prohibit the flaring of liquid hydrocarbons and oil without prior authorization.
The MMS has also imposed regulations governing the plugging and abandonment
of wells located offshore and the installation and removal of all production
facilities. Under certain circumstances, the MMS may require operations on
federal leases to be suspended or terminated. Any such suspension or termination
could adversely affect our operations and interests.
The MMS conducts auctions for lease blocks of submerged areas offshore. As
part of the leasing activity and as required by the OCSLA, the leases auctioned
include specified lease terms such as the length of the lease, the amount of
royalty to be paid, lease cancellation and suspension, and, to a degree, the
planned activities of exploration and production to be conducted by the lessee.
In addition, the OCSLA grants the Secretary of the Interior continuing oversight
and approval authority over exploration plans throughout the term of the lease.
SALES AND TRANSPORTATION OF NATURAL GAS/OIL
The Fund expects to sell our proportionate share of oil and natural gas to
the market and to receive market prices from such sales. These sales are not
currently subject to regulation by any federal or state agency. However, in
order for the Fund to make such sales it is dependent upon unaffiliated pipeline
companies whose rates, terms and conditions of transport are subject to
regulation by the Federal Energy Regulatory Commission ("FERC"). The rates,
terms and conditions are regulated by FERC pursuant to a variety of statutes
including the OSCLA, the Natural Gas Policy Act and the Energy Policy Act of
1992. Generally, depending on certain factors, pipelines can charge rates that
are either market-based or cost-of-service. In some circumstances, rates can be
agreed upon pursuant to settlement. Thus, the rates that pipelines charge us,
although regulated, are beyond our control. Nevertheless, such rates would apply
uniformly to all transporters on that pipeline and, as a result, the impact to
the Fund of any changes in such rates, terms or conditions would not impact its
operations differently in any material way than the impact upon other oil or
natural gas producers and marketers.
ENVIRONMENTAL REGULATION
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The Fund's operations are subject to pervasive environmental laws and
regulations governing the discharge of materials into the air and water and the
protection of aquatic species and habitats. However, although it shares the
liability along with its other working interest owners for any environmental
damage, most of the activities to which these environmental laws and regulations
apply are conducted by the operator on our behalf. Nevertheless, environmental
laws and regulations to which its operations are subject may require the Fund,
or the operator, to acquire permits to commence drilling operations, restrict or
prohibit the release of certain materials or substances into the environment,
impose the installation of certain environmental control devices, require
certain remedial measures to prevent pollution and other discharges such as the
plugging of abandoned projects and, finally, impose in some instances severe
penalties, fines and liabilities for the environmental damage that is caused by
our projects.
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Some of the environmental laws that apply to oil and natural gas
exploration and production are:
The Oil Pollution Act. The Oil Pollution Act ("OPA") amends Section 311 of
the Federal Water Pollution Act (the "Clean Water Act") and was enacted in
response to the numerous tanker spills, including the Exxon Valdez that occurred
in the 1980s. Among other things, the OPA clarifies the federal response
authority to and increases penalties for spills. The OPA establishes a new
liability regime for oil pollution incidents in the aquatic environment.
Essentially, the OPA provides that a responsible party for a vessel or facility
from which oil is discharged or which poses a substantial threat of a discharge
could be liable for certain specified damages resulting from a discharge of oil,
including clean-up and remediation, loss of subsistence use of natural
resources, real or personal property damages, as well as certain public and
private damages. A responsible party includes a lessee of an offshore facility.
The OPA also requires a responsible party to submit proof of its financial
responsibility to cover environmental cleanup and restoration costs that could
be incurred in connection with an oil spill. Under the OPA, parties responsible
for offshore facilities must provide financial assurance of at least $35 million
to address oil spills and associated damages. In certain limited circumstances,
that amount may be increased to $150 million. As indicated earlier, the Fund has
not been required to make any such showing to the MMS as the operator is
responsible for such compliance. However, notwithstanding the operator's
responsibility for compliance, in the event of an oil spill, the Fund, along
with the operator and other working interest owners, could be liable under the
OPA for the resulting environmental damage.
Federal Water Pollution Act/Clean Water Act. Generally, the Federal Water
Pollution Act/Clean Water Act imposes liability for the unauthorized discharge
of petroleum products into the surface and coastal U.S. waters except in strict
conformance with discharge permits issued by the federal (or state if
applicable) agency. Regulations governing water discharges also impose other
requirements, such as the obligation to prepare spill response plans. Again, the
Fund's operators are responsible for compliance with the Clean Water Act
although it may be liable for any failure of the operator to do so.
Federal Clean Air Act. The Federal Clean Air Act restricts the emission of
certain air pollutants. Prior to constructing new facilities, permits may be
required before work can commence and existing facilities may be required to
incur additional capital costs to add equipment to ensure and maintain
compliance. As a result, the Fund's operations may be required to incur
additional costs to comply with the Clean Air Act.
Other Environmental Laws. In addition to the above, the Fund's operations
may be subject to the Resource Conservation and Recovery Act, which regulates
the generation, transportation, treatment, storage, disposal and cleanup of
certain hazardous wastes, as well as the Comprehensive Environmental Response,
Compensation and Liability Act which imposes joint and several liability without
regard to fault or legality of conduct on classes of persons who are considered
responsible for the release of a hazardous substance into the environment.
The above represents a brief outline of the major environmental laws that
may apply to the Fund's operations. The Fund believes that its operators are in
compliance with each of these environmental laws and the regulations promulgated
there under.
13
POTENTIAL TAX BENEFITS
- ----------------------
The following discussion is a summary of the primary tax benefits of
ownership of a membership interest in the Fund and does not include all possible
tax benefits or other tax implications of such ownership.
DEDUCTION OF INTANGIBLE DRILLING AND DEVELOPMENT COSTS
Section 263(c) of the Internal Revenue Service (the "IRS") Tax Code (the
"Code") authorizes an election by the Fund to deduct as expenses intangible
drilling and development costs incurred in connection with oil and natural gas
properties at the time such costs are incurred in accordance with the Fund's
method of accounting, provided that the costs are not more than would be
incurred in an arm's length transaction with an unrelated drilling contractor.
Such costs include, for example, amounts paid for labor, fuel, wages, repairs,
supplies and hauling necessary to the drilling of the project and preparation of
the project for production. Generally, this election applies to items that in
themselves do not have salvage value. Alternatively, each Shareholder may elect
to capitalize their share of the intangible drilling and development costs and
amortize them ratably over a 60-month period.
The Fund may enter into Carried Interest arrangements whereby the Fund
would purchase interests in certain leases and agree to pay a disproportionate
part of the costs of drilling the first project thereon. In such situations, the
party who is paying more than their share of costs of drilling may not deduct
all such costs as intangible drilling and development costs unless their
percentage of ownership of the lease is not reduced before they have recovered
from the first production of the project an amount equal to the cost they
incurred in drilling, completing, equipping and operating the project. The Fund
may not have this right in certain of the transactions of this type in which it
may engage. If circumstances permit, however, the Fund will adopt the position
that all of the intangible drilling and development costs incurred are
deductible (even though such costs may be disproportionate to its ownership of
the lease) on the basis that such arrangements constitute partnerships for
federal income tax purposes and that the excess intangible drilling and
development costs are specifically allocable to the Fund. There can be no
assurance that this position would prevail against challenge by the IRS.
In the case of a shareholder who constitutes an integrated oil company, 30%
of the amount otherwise allowable as a deduction for intangible drilling costs
under Section 263(c) must be capitalized and deducted ratably over a 60-month
period beginning with the month the costs are paid or incurred. This provision
does not apply to nonproductive projects. For this purpose, an integrated oil
company is generally defined as an individual or entity with retail sales of oil
and natural gas aggregating more than $5 million and refining more than 50,000
barrels per day for the taxable year.
To the extent that drilling and development services were performed for the
Fund in 2005, amounts incurred pursuant to bona fide arm's-length drilling
contracts and constituting intangible drilling and development costs were
deductible by the Fund in 2005. To the extent that such services are performed
in 2006, however, the Fund will only be allowed to deduct for the year 2006
amounts that are:
14
o incurred pursuant to bona fide arm's-length drilling contracts
which provide for absolute noncontingent liability for payment,
and
o attributable to wells spud within 90 days after December 31,
2005.
Sections 461(h)(1) and 461(i)(2) provide, in relevant part:
...in determining whether an amount has been incurred with respect to
any item during any taxable year, the all events tests shall not be
treated as met any earlier than when economic performance with respect
to such item occurs.
* * *
...economic performance with respect to the act of drilling an oil or
natural gas well shall be treated as having occurred within a taxable
year if drilling of the well commences before the close of the 90th day
after the close of a taxable year.
The clear implication of these provisions is that an amount incurred during
a taxable year for drilling or completion services which could otherwise be
accrued for tax purposes will not be disqualified as a deduction merely because
the services are performed during the subsequent taxable year (provided that the
services commence within the first 90 days of such subsequent year).
Consequently, intangible drilling and development costs meeting the above
criteria were deducted by the Fund in 2005 even though a portion of such costs
are attributable to services performed during 2006.
Each shareholder, however, may deduct their share of amounts paid in 2005
for services performed in 2006 only to the extent of their cash basis in the
Fund as of the end of 2005. For this purpose, a taxpayer's cash basis in a tax
shelter which is taxable as a partnership (such as the Fund) is the taxpayer's
basis in the Fund determined without regard to any amount borrowed by the
taxpayer with respect to the Fund which (a) is arranged by the Fund or by any
person who participated in the organization, sale or management of the Fund (or
any person related to such person within the meaning of Section 461(b)(3)(c)),
or (b) is secured by any asset of the Fund. Inasmuch as cash basis excludes
borrowing arranged by an extremely broad group of persons who could be related
to a person who participated in the organization, sale or management of the
Fund, it is not possible to express an opinion as to whether each Shareholder
will be allowed to deduct their allocable share of any prepaid drilling expenses
to the extent that they exceed their actual cash investment in the Fund.
DEPLETION DEDUCTIONS
Subject to the limitations discussed hereafter, the shareholders will be
entitled to deduct, as allowances for depletion under Section 611 of the Code,
their share of percentage or cost depletion, whichever is greater, for each oil
and natural gas producing project owned by the Fund.
Cost depletion is computed by dividing the basis of the project by the
estimated recoverable reserves to obtain a unit cost, then multiplying the unit
15
cost by the number of units sold in the current year. Cost depletion cannot
exceed the adjusted basis of the project to which it relates. Thus, cost
depletion deductions are limited to the capitalized cost of the project, while
percentage depletion may be taken as long as the project is producing income.
The depletion allowance for oil and natural gas production will be computed
separately by each shareholder and not by the Fund. The Fund will allocate to
each shareholder their proportionate share of production and the adjusted basis
of each Fund project. Each shareholder must keep records of their share of the
adjusted basis and any depletion taken on the project and use their adjusted
basis in the computation of gain or loss on the disposition of the project by
the Fund.
Percentage depletion with respect to production of oil and natural gas is
available only to those qualifying for the independent producer's exemption, and
is limited to an average of 1,000 barrels per day of domestic oil production or
6,000,000 cubic feet per day of domestic natural gas production. The applicable
rate of percentage depletion on production under the independent producer
exemption is 15% of gross income from oil and natural gas sales. The depletion
deduction under the independent producer exemption may not exceed 65% of the
taxpayer's taxable income for the year, computed without regard to certain
deductions. Any percentage depletion not allowed as a deduction due to the 65%
of adjusted taxable income limitation may be carried over to subsequent years
subject to the same annual limitation. For a shareholder that is a trust, the
65% limitation shall be computed without deduction for distributions to
beneficiaries during the taxable year.
The determination of whether a shareholder will qualify for the independent
producer exemption will be made at the shareholder level. A shareholder who
qualifies for the exemption, but whose average daily production exceeds the
maximum number of barrels on which percentage depletion can be computed for that
year, will have to allocate their exemption proportionately among all of the
properties in which they have an interest, including those owned by the Fund. In
the event percentage depletion is not available, the shareholder would be
entitled to utilize cost depletion as discussed above.
The independent producer exemption is not available to a taxpayer who
refines more than 50,000 barrels of oil on any one day in a taxable year or who
directly or through a related person sells oil or natural gas or any product
derived therefrom (i) through a retail outlet operated by them or a related
person or (ii) to any person who occupies a retail outlet which is owned and
controlled by the taxpayer or a related person. In general, a related person is
defined by Section 613A of the Code as a corporation, partnership, estate, or
trust in which the taxpayer has a 5% or greater interest. For the purpose of
applying this provision: (i) bulk sales of oil or oil and natural gas to
commercial or industrial users are excluded from the definition of retail sales;
(ii) if the taxpayer or a related person does not export any domestic oil or
natural gas production during the taxable year or the immediately preceding
year, retail sales outside the U.S. are not deemed to be disqualifying sales;
and (iii) if the taxpayer's combined receipts from disqualifying sales do not
exceed $5,000,000 for the taxable year of all retail outlets taken into account
for the purpose of applying this restriction, such taxpayer will not be deemed a
retailer.
DEPRECIATION
Costs of equipment, such as casing, tubing, tanks, pumping units,
pipelines, production platforms and other types of tangible property and
equipment generally cannot be deducted currently, but may be eligible for
accelerated cost recovery. All or part of the depreciation claimed may be
16
subsequently recaptured upon disposition of the property by the Fund or of a
share by any shareholder.
In addition, the Code provides for certain uniform capitalization rules
which could result in the capitalization rather than deduction of Fund
management fee and administration costs.
REPORTS TO SHAREHOLDERS
- -----------------------
The Fund does not anticipate providing annual reports to shareholders but
will make available upon request and free of charge copies of the Fund's
periodic reports to the SEC on Form 10-K and on Form 10-Q.
AVAILABLE INFORMATION
- ---------------------
The Fund will be registered under Section 12(g) of the Securities Exchange
Act (the "Act") and must comply with, among other things, the periodic reporting
requirements of Section 13(a) of the Act. As a result, the Fund will prepare and
file annual reports with the SEC on Form 10-K, quarterly reports on Form 10-Q
and, from time to time, current reports on Form 8-K. Moreover, the Manager
maintains a website at http://www.ridgewoodenergy.com that contains important
information about the Manager, including biographies of key management
personnel, as well as information about the oil and natural gas investments made
by the Fund and the other investment programs managed by the Manager. Such
information includes, without limitation, a map of the Gulf of Mexico that
provides the location of every well and project managed by the Manager along
with information as to whether the project is exploratory, in completion or
producing. This information is publicly available (i.e., not password protected)
and is updated regularly.
WHERE YOU CAN GET MORE INFORMATION
- ----------------------------------
The Fund will be filing annual, quarterly and current reports and certain
other information with the SEC. Persons may read and copy any documents the Fund
files at the SEC public reference room at 100 F Street, NE, Washington D.C.
20549. You may obtain information on the operation at the public reference room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC at http://www.sec.gov. A
copy of any such filings will be provided free of charge to any shareholder upon
written request to the Fund at its business address 947 Linwood Avenue,
Ridgewood, New Jersey 07450, ATTN: General Counsel.
17
ITEM 1A. RISK FACTORS
- ---------------------
The following risk factors should be considered carefully in addition to
the other information contained in this registration statement. This Form 10/A
contains forward-looking statements that involve risks and uncertainties. The
Fund's actual results could differ materially from those contained in the
forward-looking statements. Factors that may cause these differences include
those discussed below as well as those discussed elsewhere in this registration
statement.
THE FUND'S EXPLORATION AND PRODUCTION ACTIVITIES ARE SUBJECT TO RISKS THAT
--------------------------------------------------------------------------
IT CANNOT CONTROL AND IT MAY HAVE INSUFFICIENT INSURANCE TO COVER THESE RISKS.
- ------------------------------------------------------------------------------
TO THE EXTENT THE FUND IS NOT COVERED BY INSURANCE, IT COULD INCUR LOSSES AND
- -----------------------------------------------------------------------------
LIABILITIES WHICH COULD REDUCE REVENUES, INCREASE COSTS OR ELIMINATE DOLLARS
- ----------------------------------------------------------------------------
AVAILABLE FOR FUTURE EXPLORATION AND DEVELOPMENT PROJECTS.
- ----------------------------------------------------------
Costs of drilling, completing and operating projects are often uncertain
and drilling operations may be curtailed, delayed or canceled as a result of a
variety of factors including:
o Fires, explosions, blowouts and cratering
o Equipment failures, casing collapse, pipe and cement failures
o Marine risks such as capsizing or collisions
o Adverse weather conditions, including hurricanes
o Shortages or delays in the delivery of equipment
o Acts of terrorism
o Environmental hazards
o Pipeline ruptures and discharge of toxic gases
Many of the above-mentioned risks could result in damage to life and/or
property or cause sustained interruption of production.
Insurance to cover certain of these risks may be prohibitively expensive or
unavailable, particularly with respect to acts of terrorism. Additionally,
insurance coverage may not be sufficient to cover certain catastrophic events.
The Fund could be liable for costs in excess of its insurance coverage.
In addition, it is significantly less costly for insurance to be acquired
and maintained by the Manager as a package that covers all of the oil and
natural gas projects under its management. The majority of these projects are
owned by other entities that are likewise managed by Ridgewood Energy. As a
result, given insurance limits, if significant damage occurs to other projects
owned by other investment vehicles managed by the Manager in any given year, the
18
amount of insurance available to cover any damage to the Fund's projects could
be significantly reduced.
THE FUND'S INVESTMENT ACTIVITIES MAY RESULT IN UNSUCCESSFUL PROJECTS.
---------------------------------------------------------------------
There is always significant risk that a project will not have commercially
productive oil or natural gas reservoirs. In other words, the well may be a
dry-hole. The successful acquisition of producing properties requires assessment
of reserves, seismic and other engineering information, future commodity prices,
operating costs and potential environmental liabilities. The Fund's assessment
of these factors may not be successful.
THE FUND HAS ALREADY EXPERIENCED A DRY-HOLE AND FURTHER DRY-HOLES
-----------------------------------------------------------------
WILL ADVERSELY IMPACT THE FUND'S PROFITABILITY AND RETURNS.
- -----------------------------------------------------------
The Fund has already had one dry hole, Main Pass 221. Cumulative
dry-hole costs to the Fund for the six months ended June 30, 2006, the period
ending December 31, 2005 and the period August 16, 2005 (Inception) through June
30, 2006 totaled approximately $11.3 million, $7.8 million and $19.1 million,
respectively. With respect to this dry-hole, the Fund does not anticipate
incurring any significant future costs as the well has been plugged and
abandoned. However, given that the Fund's capital is limited to the amount it
raised (less various fees) in the offering of its shares, the aforementioned
dry-hole, and every other dry-hole that the Fund may experience, has the effect
of reducing the limited capital available for investment. In addition, because
dry-holes reduce the capital available for additional investment, a significant
number of dry-holes will reduce the returns of the Fund because the remaining
capital, even if invested in successful wells, may not generate enough cash for
investors to see significant or positive returns on their investments.
THE FUND'S RESERVE ESTIMATES ARE INHERENTLY UNCERTAIN AND MAY BE
----------------------------------------------------------------
INACCURATE AND IF SO, MAY ADVERSELY AFFECT THE FUND'S REVENUE AND PROFITABILITY.
- --------------------------------------------------------------------------------
There are many uncertainties inherent in estimating quantities of proved
reserves and in projecting future rates of production and timing of development
expenditures, including many factors beyond our control. Estimates of reserves
by necessity are projections based on engineering and geological data, including
but not limited to volumetrics, reservoir size, reservoir characteristics, the
projection of future rates of production and the timing of future expenditures.
The accuracy of any reserve estimate is a function of the amount and quality of
available data and of engineering and geological interpretation and judgment. As
a result, estimates of different engineers normally vary and may not be
accurate. Development of our reserves may not occur as scheduled and the actual
results may not be as estimated.
In addition, results of drilling, testing and production subsequent to the
date of an estimate may justify revision of such reserve and cost estimate
upward or downward. Accordingly, reserve estimates are often different,
sometimes materially, from the quantities ultimately recovered. The Manager
reviews the reserve estimates provided by the operators of the projects in which
we participate and may retain independent reserve engineers to review such
reserve estimates and/or conduct an independent review, as appropriate. Future
performance that deviates significantly from reserve estimates could have a
material effect (positive or negative) on our operations, business and
prospects, as well as on the amounts of such reserves.
Moreover, the Fund's estimated or proved oil and natural gas reserves and
the estimated future net revenues from such reserves will be based upon various
assumptions, including available geological, geophysical, engineering and
production data. The process also requires certain economic assumptions such as
oil and natural gas prices, drilling and operating expenses, capital
expenditures, and availability of funds. As a result, the Fund is required to
19
make assumptions and judgments, all of which can be wrong or inaccurate. Thus,
these estimates are inherently imprecise and the quality and reliability of this
information can vary, perhaps significantly, from actual results.
THE PRICES THAT THE FUND MAY RECEIVE FOR ITS OIL OR NATURAL GAS ARE
-------------------------------------------------------------------
HIGHLY VOLATILE AND UNPREDICTABLE AND MAY NOT BE SUFFICENT TO GENERATE ENOUGH
- -----------------------------------------------------------------------------
CASH FLOW TO MAKE DISTRIBUTIONS TO INVESTORS.
- ---------------------------------------------
The Fund's revenue, profitability and cash flow are highly dependent on the
prices of oil and natural gas. Historically, the markets for crude oil and
natural gas have been extremely volatile, and they are likely to continue to be
volatile in the future. This volatility is caused by numerous factors and market
conditions. Therefore, it is impossible to predict the future price of crude oil
and natural gas with any certainty. Low commodity prices could have an adverse
affect on our future profitability and, in such an event we may be required by
accounting rules to write down the carrying value of our projects.
The Fund has not engaged in any price risk management programs or hedges to
date and does not anticipate engaging in those types of transactions in the
future.
THE UNAVAILABILITY AND COST OF NEEDED EQUIPMENT MAY ADVERSELY AFFECT
--------------------------------------------------------------------
THE FUND'S PROFITABILITY AND OPERATIONS.
- ----------------------------------------
As a result of the increase in oil and natural gas prices, drilling
activity in the Gulf of Mexico has increased significantly. Drilling rigs and
other equipment have become harder to obtain and more costly to acquire,
especially if weather occurrences, such as hurricanes, occur with frequency in
the Gulf of Mexico. These circumstances could have a negative impact on the
Fund's operations.
THE FUND HAS A LIMITED AMOUNT OF CAPITAL AVAILABLE TO INVEST AND
----------------------------------------------------------------
THEREFORE HAS LIMITED ABILITY TO INVEST IN MANY MORE PROJECTS. FURTHER, EACH
- ----------------------------------------------------------------------------
UNSUCCESSFUL PROJECT ERODES THE FUND'S LIMITED CAPITAL.
- -------------------------------------------------------
The capital raised by the Fund in its private placement is more than likely
all the capital it will be able to obtain for investments in projects. Given its
structure, obtaining traditional financing from public markets is unlikely and
it is not practical to assume the Fund can raise additional funds through a
supplemental offering or through debt financing. As a result, it has little, if
any, ability to grow its business beyond its current projects or through
investing its available cash in new projects. In any event, the number of
projects in which the Fund can invest will naturally be limited and each
unsuccessful project the Fund experiences, if any, will not only reduce its
ability to generate revenue, but also exhaust its limited supply of capital.
THE FUND MAY INCUR COSTS TO COMPLY WITH THE MANY ENVIRONMENTAL AND
------------------------------------------------------------------
OTHER GOVERNMENTAL REGULATIONS THAT APPLY TO ITS OPERATIONS, WHICH MAY ADVERSELY
- --------------------------------------------------------------------------------
IMPACT ITS ABILITY TO GENERATE CASH FLOW FOR DISTRIBUTIONS.
- -----------------------------------------------------------
20
The oil and natural gas industry, in general, and offshore activities, in
particular, are subject to numerous governmental laws and regulations which may
affect the ongoing and future operational decisions and financial results of the
Fund. United States legislation affecting the oil and natural gas industry is
under constant review for amendment and expansion. Also, numerous departments
and agencies, both federal and state, are authorized by statute to issue and
have issued rules and regulations which, among other things, require permits for
the drilling of projects, impose construction, abandonment and remediation
requirements, prevent the waste of natural gas and liquid hydrocarbons through
restrictions on flaring, require drilling bonds and regulate environmental and
safety matters. Additionally, governmental regulations may also impact the
demand for oil and natural gas, which could adversely affect the price at which
oil and natural gas is sold. The regulatory burden on the oil and natural gas
industry increases its cost of doing business and, subsequently, affects its
profitability. Finally, as additional legislation or amendments may be enacted
in the future, the Fund is unable to predict the ultimate cost of compliance.
THE FUND RELIES ON THIRD PARTIES TO OPERATE, MANAGE AND MAINTAIN ITS
--------------------------------------------------------------------
PROJECTS OVER WHICH IT HAS LIMITED CONTROL. THEREFORE, DECISIONS MAY BE MADE
- ----------------------------------------------------------------------------
BY THESE THIRD PARTIES THAT ADVERSELY AFFECT THE FUND OR ITS OPERATIONS.
- ------------------------------------------------------------------------
Neither the Fund nor the Manager currently own or have any plans to acquire
drilling or production equipment nor does the Fund or Manager maintain a staff
of technical employees required for on-site drilling operations. Therefore, the
Fund must rely on unrelated third party operators to oversee and/or perform all
drilling, completion and ongoing maintenance and production activities for the
projects in which it participates. For example, lack of operating control could
lead to higher operating costs, drilling delays, increased rig costs or labor
issues. As such, the Fund has little or no control over the day-to-day
operations of these projects. However, the Fund has acquired and will continue
to seek projects, to the extent of its available capital, in which the operators
have significant resources, are experienced in offshore operations and have a
long term presence and track record of success in the Gulf of Mexico.
THE FUND OWNS PROJECTS JOINTLY WITH OTHER COMPANIES OVER WHOM IT HAS NO
-----------------------------------------------------------------------
CONTROL AND WHO MAY INFLUENCE THE MANNER IN WHICH THE PROJECT IS OPERATED.
- --------------------------------------------------------------------------
The Fund participates in projects as a working interest owner along with
other unrelated third party entities, including the operator. While the Manager
may monitor and participate in decisions affecting exploration and development
of the leases or projects in which the Fund participates, other decisions with
respect to lease exploration and development activities may be controlled by the
other participants and could be unfavorable to the Fund. Finally, the Fund could
be held liable for the joint activity obligations or tortuous actions of the
operator or other working interest owners. If our co-participants fail to pay
their portion of the drilling and completion or ongoing maintenance costs, the
project may lack sufficient funds to perform such work. As a result, the Fund,
as well as the remaining working interest owners, may be required to pay such
additional sums in order to complete drilling or development of the project.
THE FUND FACES COMPETITION FROM LARGER ENTITIES WITH GREATER CAPITAL
--------------------------------------------------------------------
RESOURCES WHICH COULD LIMIT THE NUMBER AND AVAILABILITY OF ECONOMICALLY
- -----------------------------------------------------------------------
ATTRACTIVE PROJECTS.
- --------------------
21
As an independent oil and natural gas producer, the Fund faces competition
in all aspects of its business. Many of its competitors are large,
well-established companies that have significantly larger staffs and have
greater capital resources. These companies may be able to pay more for a project
or sustain losses for a longer period of time than the Fund.
THE FUND MAINTAINS A SALVAGE FUND WHICH MAY BE INSUFFICIENT TO COVER
--------------------------------------------------------------------
SUCH SALVAGE COSTS, IN WHICH EVENT THE FUND COULD BE LIABLE FOR ANY EXCESS.
- ---------------------------------------------------------------------------
The Fund has created a salvage fund to cover certain anticipated salvage
costs associated with our projects. The salvage fund may not have sufficient
assets to meet salvage costs and thus the Fund may be liable for its
proportionate share of the unfunded expenses if in excess of the salvage fund.
THE FUND'S PROJECTS AND OPERATIONS ARE LOCATED EXCLUSIVELY IN THE GULF
----------------------------------------------------------------------
OF MEXICO AND ARE SUBJECT TO INTERRUPTIONS AND DAMAGE FROM HURRICANES WHICH
- ---------------------------------------------------------------------------
COULD ADVERSELY AFFECT THE FUND'S CASH FLOW DUE TO SUCH EXCLUSIVITY.
- --------------------------------------------------------------------
The Fund has invested in projects exclusively within the Gulf of Mexico and
any future investments by the Fund in projects will likewise be located in the
Gulf of Mexico. As a result of such exclusivity in location, the Fund is
particularly susceptible to hurricane risks in that the impact to the Fund's
operations of a severe storm or storms could be more pronounced and severe
(depending on the storm, its path, and resulting damage) because the Fund does
not have projects in other areas of the globe to offset such damage. If, for
example, the Fund had projects in areas not affected by hurricanes those
projects could still operate and generate cash flow during the interruptions in
operations in the Gulf of Mexico. As it is, a hurricane, or series of hurricanes
in a season, has the potential of interrupting all of the Fund's operations, at
least for some period of time, if all of the Fund's projects were affected. In
such event, the Fund would not have sufficient cash flow to make distributions
to investors and, additionally and as disclosed earlier, insurance may not be
sufficient to cover all of the damages caused by the hurricanes.
RISKS RELATED TO THE NATURE OF OUR SHARES.
- ------------------------------------------
THE FUND'S SHARES HAVE SEVERE RESTRICTIONS ON TRANSFERABILITY AND
-----------------------------------------------------------------
LIQUIDITY AND SHAREHOLDERS ARE REQUIRED TO HOLD THE SHARES FOR A LONG PERIOD OF
- -------------------------------------------------------------------------------
TIME.
- -----
The Fund's shares are illiquid investments. There is currently no market
for these shares. Because there will be a limited number of persons who purchase
shares and because there are significant restrictions on the transferability of
such shares under the limited liability company agreement ("LLC agreement") and
under applicable federal and state securities laws, it is expected that no
public market will develop. Moreover, neither the Fund nor the Manager will
provide any market for the shares. Shareholders are generally prohibited from
selling or transferring their shares except in the circumstances permitted under
the LLC agreement and applicable law, and all such sales or transfers require
22
the Fund's consent, which it may withhold at its sole discretion. Accordingly,
shareholders have no assurance that an investment can be transferred and must be
prepared to bear the economic risk of the investment indefinitely.
SHAREHOLDERS ARE NOT PERMITTED TO PARTICIPATE IN THE FUND'S MANAGEMENT
----------------------------------------------------------------------
OR OPERATIONS AND MUST RELY EXCLUSIVELY ON THE MANAGER.
- -------------------------------------------------------
Shareholders have no right, power or authority to participate in the Fund's
management or decision making or in the management of the Fund's projects. The
Manager has the exclusive right to manage, control and operate the Fund's
affairs and business and to make all decisions relating to its operation.
THE FUND'S ASSETS ARE ILLIQUID AND THEREFORE CASH FLOW FOR
----------------------------------------------------------
DISRIBUTIONS, IF ANY, MUST COME FROM OPERATIONS AND NOT FROM DISPOSITIONS OF
- ----------------------------------------------------------------------------
ASSETS.
- -------
The Fund's interest in projects are illiquid. It does not anticipate
selling any interests in the projects, or any part thereof. Even if it elected
to sell, it is likely that there will be little or no market for these assets.
However, if the Fund were to attempt to sell any such interest, a successful
sale would depend upon, among other things, the operating history and prospects
for the project or interest being sold, proven oil and natural gas reserves, the
number of potential purchasers and the economics of any bids made by them and
the current economics of the oil and natural gas market. In addition, any such
sale may result in adverse tax consequences to the shareholders. The Manager has
full discretion to determine whether any project, or any partial interest,
should be sold. Shareholders have no ability to override the decision of the
Manager. Consequently, shareholders will depend on the Manager for the decision
to sell all or a portion of a project, or retain it, for the benefit of the
shareholders.
THE FUND INDEMNIFIES ITS OFFICERS, AS WELL AS THE MANAGER AND ITS
-----------------------------------------------------------------
EMPLOYEES, FOR CERTAIN ACTIONS TAKEN ON ITS BEHALF AND THEREFORE FUND ASSETS MAY
- --------------------------------------------------------------------------------
BE USED TO REIMBURSE SUCH OFFICERS.
- -----------------------------------
The LLC agreement provides that the Fund's officers and agents, the
Manager, the affiliates of the Manager and their respective directors, officers
and agents when acting on behalf of the Manager or its affiliates on the Fund's
behalf, will be indemnified and held harmless by the shareholders from any and
all claims rising out of the Fund's management, except for claims arising out of
bad faith, gross negligence or willful misconduct or a breach of the LLC
agreement. Therefore, the Fund may have difficulty sustaining an action against
the Manager, or its affiliates and their officers based on breach of fiduciary
responsibility or other obligations to the shareholders.
THE MANAGER WILL RECEIVE A MANAGEMENT FEE REGARDLESS OF THE FUND'S
------------------------------------------------------------------
PROFITABILITY AND, ADDITIONALLY, CASH DISTRIBUTIONS.
- ----------------------------------------------------
The Manager is entitled to receive an annual management fee from the Fund
regardless of whether the Fund is profitable in that year. The annual fee,
payable monthly, is equal to 2.5% of total capital contributed by shareholders.
23
In addition to its annual management fee, the Manager, as compensation for
its management services, will receive 15% of our cash distributions to
shareholders although the Manager has not contributed any cash to the Fund.
Accordingly, shareholders contribute all of the cash utilized for the Fund's
investments and activities. If the Fund's projects are unsuccessful, the
shareholders lose 100% of their investment while the Manager, not having
contributed any capital, will lose nothing.
Inherent in these fee arrangements is the possibility of conflicts between
the Fund's interests and the best interests of the Manager. The Manager may have
incentive to act in its best interests rather than in The Fund's best interest
by taking actions designed to increase its fees but with significant risk to the
Fund. Any such conflict of interests will be addressed by the Manager as
described subsequently. See, Conflicts of Interest.
None of the compensation to be received by the Manager has been derived as
a result of arm's length negotiations.
UNDER DELAWARE LAW SHAREHOLDERS HAVE LIMITED ACCESS TO INFORMATION AND
----------------------------------------------------------------------
THEREFORE THE FUND AND MANAGER CAN RESTRICT CERTAIN INFORMATION, INCLUDING
- --------------------------------------------------------------------------
SHAREHOLDER INFORMATION, MAKING COMMUNICATIONS WITH OTHER SHAREHOLDERS
- ----------------------------------------------------------------------
DIFFICULT. AS A RESULT, THE INFORMATION YOU RECIEVE ABOUT THE FUND AND ITS
- --------------------------------------------------------------------------
ACTIVITIES WILL BE LIMITED TO WHAT THE MANAGER CHOOSES TO PROVIDE.
- ------------------------------------------------------------------
Delaware law permits Delaware limited liability companies to restrict
access to certain information provided that such restricted access is set forth
in the LLC agreement. The Fund's LLC agreement contains provisions that limit
shareholder access to certain sensitive or confidential information such as
trade secrets, agreements or confidential or proprietary information. Moreover,
shareholder access to information regarding other shareholders is likewise
limited and the Fund may refuse to give shareholder information, such as name
and address of other shareholders, which could make it difficult for a
shareholder to contact other shareholders. Nevertheless, shareholders do have
access to tax, other financial information or any other reasonable information
regarding Fund operations.
CASH DISTRIBUTIONS ARE NOT GUARANTEED AND MAY BE LESS THAN ANTICIPATED
----------------------------------------------------------------------
OR ESTIMATED.
- -------------
Distributions depend primarily on available cash from oil and natural gas
operations. At times, distributions may be delayed to repay the principal and
interest on Fund borrowings, if any, or to fund other costs, although the Fund
does not anticipate such borrowings. The Fund's taxable income will be taxable
to the shareholders in the year earned, even if cash is not distributed.
BECAUSE THE MANAGER MANAGES MANY OTHER OIL AND NATURAL GAS FUNDS IT MAY
-----------------------------------------------------------------------
HAVE CONFLICTS OF INTEREST IN ITS MANAGEMENT OF OUR OPERATIONS .
- ----------------------------------------------------------------
24
Shareholders will not be involved in the management of the Fund's
operations. Accordingly, they must rely on the Manager's judgment in such
matters. Inherent with the exercise of its judgment, the Manager will be faced
with conflicts of interest. While neither the Fund nor the Manager have specific
procedures in place in the event of any such conflicting responsibilities, the
Manager recognizes that it has fiduciary duties to the Fund in connection with
its position and responsibilities as Manager and it intends to abide by such
fiduciary responsibilities in performing its duties. Therefore, the Manager and
its affiliates will attempt, in good faith, to resolve all conflicts of interest
in a fair and equitable manner with respect to all parties affected by any such
conflicts of interest. The Manager is not liable to the Fund for how conflicts
of interest are resolved unless it has acted in bad faith, or engaged in gross
negligence or willful misconduct.
TAX RISKS ASSOCIATED WITH AN INVESTMENT IN SHARES.
- --------------------------------------------------
Tax Risks Associated with the Structure of the Fund.
The Fund is organized as a Delaware limited liability company and the
Manager intends to qualify the Fund as a partnership for federal tax purposes.
The principal tax risks to shareholders are that:
o The Fund may recognize income taxable to the shareholders but may
not distribute enough cash to cover the income taxes on the
Fund's taxable income.
o The allocation of Fund items of income, gain, loss, and deduction
may not be recognized for federal income tax purposes.
o All or a portion of the Fund's expenses could be considered
either investment expenses (which would be deductible by a
shareholder only to the extent the aggregate of such expenses
exceeded 2% of such shareholder's adjusted gross income) or as
nondeductible items that must be capitalized.
o All or a substantial portion of the Fund's income could be deemed
to constitute unrelated business taxable income, such that
tax-exempt shareholders could be subject to tax on their
respective portions of such income.
o If any Fund income is deemed to be unrelated business taxable
income, a shareholder that is a Charitable Remainder Trust could
have all of its income from any source deemed to be taxable.
o All or a portion of the losses, if any, allocated to the
shareholders will be passive losses and thus deductible by the
shareholder only to the extent of passive income.
o The shareholders could have capital losses in excess of the
amount that is allowable as a deduction in a particular year.
Although the Fund has obtained an opinion of counsel regarding the matters
described in the preceding paragraph, it will not obtain a ruling from the IRS
as to any aspect of the Fund's tax status. The tax consequences of investing in
the Fund could be altered at any time by legislative, judicial, or
administrative action.
If the IRS audits the Fund, it could require investors to amend or adjust
their tax returns or result in an audit of their tax.
25
The IRS may audit the Fund's tax returns. Any audit issues will be resolved
at the Fund level by the Manager. If adjustments are made by the IRS,
corresponding adjustments will be required to be made to the federal income tax
returns of the shareholders, which may require payment of additional taxes,
interest, and penalties. An audit of the Fund's tax return may result in the
examination and audit of a shareholder's return that otherwise might not have
occurred, and such audit may result in adjustments to items in the shareholder's
return that are unrelated to the Fund operations. Each shareholder bears the
expenses associated with an audit of that shareholder's return.
In the event that an audit of the Fund by the IRS results in adjustments to
the tax liability of a shareholder, such shareholder will be subject to interest
on the underpayment and may be subject to substantial penalties. In addition, a
number of substantial penalties could potentially be asserted by the IRS on any
such deficiencies.
The tax treatment of the Fund can not be guaranteed for the life of the
Fund. Changes in law or regulations may adversely affect any such tax treatment.
Deductions, credits or other tax consequences may not be available to
shareholders. Legislative or administrative changes or court decisions could be
forthcoming which would significantly change the statements herein. In some
instances, these changes could have substantial effect on the tax aspects of the
Fund. Any future legislative changes may or may not be retroactive with respect
to transactions prior to the effective date of such changes. Bills have been
introduced in Congress in the past and may be introduced in the future which, if
enacted, would adversely affect some of the tax consequences of the Fund.
26
ITEM 2. FINANCIAL INFORMATION
A. SELECTED FINANCIAL DATA.
The following table summarizes certain selected financial data for the six
months ended June 30, 2006, the period ended December 31, 2005 and the period
August 16, 2005 (Inception) through June 30, 2006. The year ended December 31,
2005 and as of December 31, 2005 information included below is derived from the
audited financial statements included herein. The six months ended June 30,
2006, for the period August 16, 2005 (Inception) through June 30, 2006, and as
of June 30, 2006 information included below is derived from the unaudited
financial statements included herein and is prepared on a basis consistent with
the audited financial statements. Although the date of formation of the Fund is
August 16, 2005, the Fund did not begin operations until September 6, 2005 when
it began its private offering of shares. There were no business activities prior
to September 6, 2005. The information summarized below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and the Fund's audited Financial Statements and related
Notes.
For the period For the period
Six months August 16, 2005 August 16, 2005
ended (Inception) through (Inception) through
June 30, 2006 December 31, 2005 June 30, 2006
------------- ----------------- -------------
(Restated) *
Statement of Operations Data:
Revenues $ 936,268 $ - $ 936,268
Loss from operations (12,411,849) (14,080,523) (26,492,372)
Net loss (10,740,472) (13,625,910) (24,366,382)
Net loss per share $ (12,644) $ (16,189) $ (28,833)
Number of shares outstanding 830.5577 830.557 830.5577
Balance Sheet Data: June 30, 2006 December 31, 2005
------------- -----------------
Restated *
Cash and cash equivalents $38,677,290 $86,240,180
Short-term investment in
marketable securities 35,718,046 -
Salvage fund 1,017,013 -
Oil and gas properties, net 17,845,708 11,787,240
Total assets 94,199,595 98,271,257
Total current liabilities 9,522,099 5,894,225
Total long-term liabilities 76,764 -
Total members' capital 84,600,732 92,377,032
Total liabilities and members' capital 94,199,595 98,271,257
* See note 11 to audited financial statements for further details of
restatement.
27
B. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Overview of Our Business
The Fund is an independent oil and natural gas producer. Our primary
investment objective is to generate cash flow for distribution to our
shareholders through participation in oil and natural gas exploration and
development projects in the Gulf of Mexico. The Fund began its operations by
offering Shares in a private offering on September 6, 2005. As a result of such
offering, it raised approximately $123.0 million through the sale of 830.5577
shares of LLC membership interests. After the payment of approximately $19.7
million in offering fees, commissions and investment fees to Ridgewood Energy
Corporation, affiliates, and broker-dealers, the Fund retained approximately
$103.3 million available for investment. Investment fees represent a one time
fee of 4.5% of initial capital contributions. The fee is payable for the service
of investigating and evaluating investment opportunities and affecting
transactions when the capital contributions are made. Since inception in August
2005, the Fund has acquired an interest in two offshore projects in the Main
Pass area of the Gulf of Mexico. Chevron is the partner and operator of both
projects. The Main Pass 221 well was determined to be a dry-hole in April 2006
and the costs related to this property were expensed in the accompanying
statements of operations. The Main Pass 30 project has the potential for five
wells. The first well began producing in June 2006.
The Manager performs certain duties on the Fund's behalf including the
evaluation of potential projects for investment and ongoing administrative and
advisory services associated with these projects. The Fund does not currently,
nor is there any plan, to operate any project in which the Fund participates.
The Manager enters into operating agreements with third-party operators for the
management of all exploration, development and producing operations, as
appropriate. As compensation for the above duties, the Manager is paid a one
time investment fee (4.5%) for the evaluation of projects on the Fund's behalf
and an annual management fee (2.5%), payable monthly, for ongoing administrative
and advisory duties as well as reimbursement of expenses. The Manager also
participates in distributions as additional compensation for its administrative
and management services. See also Item 1. "Business".
The following review of operations for the six months ended June 30,
2006, the period ended December 31, 2005 and the period August 16, 2005
(Inception) through June 30, 2006 should be read in conjunction with our
financial statements and the notes thereto beginning on page F-1. Management's
discussion and analysis has been revised for the effects of the restatement as
discussed in Note 11 to the audited financial statements.
Results of Operations
For the six months ended June 30, 2006, the period ended December 31, 2005
and the period August 16, 2005 (Inception) through June 30, 2006 the loss from
operations totaled approximately $12.4 million, $14.1 million, and $26.5
million, respectively. Losses for the period ended December 31, 2005, were
primarily due to investment and management fees. The decrease in losses for the
six months ended June 30, 2006, were primarily a result of the Main Pass 30 well
beginning production in June 2006.
Operating Revenues. During 2005, the Fund did not record any operating
revenues and, as a result, was considered an exploratory stage enterprise.
28
Effective June 2006, the Fund achieved first revenue and is no longer in the
exploratory stage. As the Fund has a producing well effective May 2006, the Fund
has incurred revenues in 2006 from the sale of oil and natural gas. For the six
months ended June 30, 2006, the period ended December 31, 2005, and the period
August 16, 2005 (Inception) through June 30, 2006, operating revenues totaled
approximately $0.9 million, nil, and $0.9 million, respectively as a result of
the success of the Main Pass 30 well.
Operating and Other Expenses
Dry-hole costs. Dry-hole costs are those costs incurred to drill and
develop a well that is ultimately found to be incapable of producing either oil
or natural gas in sufficient quantities to justify completion of the well. In
2006, one of the projects which began drilling in 2005 was determined to be a
dry-hole. The following table summarizes dry-hole costs inclusive of plug and
abandonment costs for the six months ended June 30, 2006, the period ended
December 31, 2005 and the period August 16, 2005 (Inception) through June 30,
2006.
For the period For the period
Six months August 16, 2005 August 16, 2005
ended (Inception) through (Inception) through
June 30, 2006 December 31, 2005 June 30, 2006
------------- ----------------- -------------
Dry-hole costs:
Main Pass 221 $11,284,103 $ 7,806,792 $19,090,895
=========== =========== ===========
Depletion and Amortization. Depletion and amortization of the cost of
proved oil and natural gas properties are calculated using the units of
production method. Proved developed reserves are used as the base for depleting
the cost of successful exploratory drilling and development costs. The sum of
proved developed and proved undeveloped reserves is used as the base for
depleting (or amortizing) leasehold acquisition costs, the costs to acquire
proved properties and platform and pipeline costs. As of June 30, 2006
(unaudited) and the period ended December 31, 2005 the Fund had recorded
depletion and amortization of approximately $144 thousand and nil, respectively
as a result of the Main Pass 30 project having been determined to have proved
reserves as of April 2006.
Investment Fee. The Manager is paid a one time investment fee of 4.5% of
initial capital contributions. The fee is payable for the service of
investigating and evaluating investment opportunities and affecting transactions
when the capital contributions are made. Investment fees incurred and paid
during the period ended December 31, 2005 were approximately $5.6 million. There
were no investment fees paid in 2006.
Management Fee. The Manager receives an annual management fee, payable
monthly, of 2.5% of total capital contributions. Management fees are charged to
cover expenses associated with overhead incurred by the Manager for its on-going
management, administrative and advisory services. Such overhead expenses include
but are not limited to rent, payroll and benefits for employees of the Manager,
and other administrative costs. Management fees incurred and paid for the six
months ended June 30, 2006, the period ended December 31, 2005 and the period
August 16, 2005 (Inception) through June 30, 2006 totaled approximately $1.5
million, $0.6 million and $2.1 million, respectively.
29
General and Administrative Expenses. Accounting, legal, fiduciary fees and
insurance expenses represent costs specifically identifiable or allocable to the
Fund. Accounting and legal fees represent annual audit and tax preparation fees,
quarterly reviews and filing fees of the Fund. Fiduciary fees represent bank
fees associated with the management of the Fund's short-term investment
portfolio in US Treasury Notes and have increased in 2006 due to greater
investment activity. Insurance expense represents premiums related to well
control insurance and directors and officers liability policy, and are allocated
by the Manager to the Fund based on capital raised by the Fund to total capital
raised by all oil and natural gas funds managed by the Manager. Insurance
expense increased in 2006 due to well control insurance, which only began once
the project began drilling in November 2005. Since there was very little
drilling in 2005 versus 2006, well control insurance expense was higher in 2006.
The following table summarizes general and administrative expenses for the
six months ended June 30, 2006, the period ended December 31, 2005 and the
period August 16, 2005 (Inception) through June 30, 2006.
For the period For the period
Six months August 16, 2005 August 16, 2005
ended (Inception) through (Inception) through
June 30, 2006 December 31, 2005 June 30, 2006
------------- ----------------- -------------
General and administrative expenses:
Accounting and legal fees $ 91,729 $ 75,000 $166,729
Fiduciary fees 42,120 - 42,120
Insurance 246,772 26,351 273,123
Other general and administrative expenses 434 6,259 6,693
-------- -------- --------
$381,055 $107,610 $488,665
======== ======== ========
Other Income
Other income is comprised solely of interest income and represents interest
earned on money market accounts and short-term US Treasury Notes. Interest
income for the six months ended June 30, 2006, the period ended December 31,
2005 and the period August 16, 2005 (Inception) through June 30, 2006, totaled
approximately $1.7 million, $0.4 million and $2.1 million, respectively. In 2006
the average monthly interest income increased as a result of higher interest
rates in 2006 as compared to 2005.
Capital Resources and Liquidity
The following table summarizes sources and uses of cash for the period
August 16, 2005 (Inception) through June 30, 2006 and is not prepared in
accordance with generally accepted accounting principles. This table is utilized
internally by management to track resources and ensure the Fund does not
over-allocate its funds. Management believes it provides readers a more thorough
understanding of cash available for future investments.
30
For the period
August 16, 2005
(Inception) through
June 30, 2006
-------------
Sources and uses of cash
Initial private placement $ 123,036,639
Fees (1) (19,632,733)
-------------
Net proceeds 103,403,906
Oil and gas revenues 936,268
Interest income 2,125,990
-------------
Total available for investment 106,466,164
Exploration and development expenditures (27,725,076)
Management fees (2,141,816)
Expenses (G&A, etc) (488,665)
Net receivable (717,679)
Salvage fund (997,592)
-------------
Cash proceeds 74,395,336
Reconciliation to GAAP
Cash and cash equivalents $ 38,677,290
Short-term investments in marketable securities $ 35,718,046
-------------
Cash proceeds $ 74,395,336
Funds for future project development (2)
2006 (9,278,819)
2007 (60,270,000)
---- -------------
Available uninvested capital - end of period $ 4,846,517
=============
(1) Includes syndication fees of approximately $14.1 million and a one
time investment fee of approximately $5.6 million both of which are
paid to the manager.
(2) The funds for future project development represent cash the Fund
expects to use in future periods.
The primary sources of cash during the period August 16, 2005 (Inception)
through June 30, 2006 included the initial net cash contribution of
approximately $123.0 million obtained from our private offering. Interest earned
on money market accounts and short-term US Treasury Notes of approximately $2.1
million includes an accrual of approximately $0.7 million thus actual cash
received was approximately $1.4 million. Interest income for the six months
ended June 30, 2006 includes interest from short-term US Treasury Notes.
Cash outflows for the period August 16, 2005 (Inception) through June 30,
2006 included approximately $15.9 million used for exploration and development
expenditures. Of this amount approximately $15.4 million and $0.5 million
represents exploration and development activiites related to Main Pass 221 and
Main Pass 30, respectively. For the period ended December 31, 2005, investing
cash outflows for capital expenditures were approximately $7.8 million. In
addition to the capital expenditures, as of December 31, 2005 the Fund advanced
an approximate $11.8 million to operators for working interests and expenditures
to be utilized for 2006 exploration and development activities primarily related
to the Main Pass 30 project.
During 2006 the Fund invested $75.2 million in three separate Treasury
Notes scheduled to mature in June, July and September 2006. Approximately $40.2
million of the investment is in three-month Treasury Notes which are included in
cash and cash equivalents.
For the six months ended June 30, 2006, exploration and development
expenditures were approximately $8.1 million primarily representing dry-hole
costs related to Main Pass 221.
Additional cash outflows of approximately $19.7 million were incurred for
the period August 16, 2005 (Inception) through June 30, 2006. This amount is
comprised of approximately $14.1 million relating to syndication costs and
approximately $5.6 million relating to the one time investment fee paid to the
Manager.
31
We expect to meet our cash commitments for the next twelve months from our
cash and investments on hand.
Exploration and Development
The following table represents oil and gas exploration and development
costs included on the balance sheet and those amounts written-off to dry-hole
costs included in the statement of operations as of and for the period ended
December 31, 2005, along with budgeted amounts for future periods:
Actual Budget Budget
2005 2006 (1) 2007 (1)
---- -------- --------
Expenditure Category
Capital
Exploration
Property acquisition costs $ 5,392,665 $ 3,144,510 -
Exploratory drilling costs 5,392,665 - -
----------- ----------- -----------
Total exploration 10,785,330 3,144,510 -
Development
Developmental drilling & facilities costs - 3,921,665 60,270,000
----------- ----------- -----------
Total development - 3,921,665 60,270,000
Total exploration & development costs 10,785,330 7,066,175 60,270,000
Dry-hole costs 7,806,792 11,284,102 -
Total exploration, development
and dry-hole costs $18,592,122 $18,350,277 $60,270,000
=========== =========== ===========
(1) Budget amounts assume well projects are commercially successful. If any
of the budgeted exploratory projects are unsuccessful, budgeted
development capital will be reallocated to one or more new unspecified
projects. Budget 2006 includes actual expenditures incurred through
June 30, 2006 of $18.5.
In spite of the number and intensity of storms and resulting damage in the
Gulf of Mexico in 2005, the Fund has been fortunate that neither one of its
wells, Main Pass 30 or Main Pass 221 was drilling at the time of the Hurricanes.
Off-Balance Sheet Arrangements
The Fund had no off-balance sheet arrangements as of June 30, 2006 and
December 31, 2005 and does not anticipate the use of such arrangements in the
future.
Contractual Obligations
The Fund enters into operating agreements with operators. On behalf of the
Fund, an Operator enters into various contractual commitments pertaining to
exploration, development and production activities. The Fund does not discuss
or negotiate any such contracts. No contractual obligations exist at June 30,
2006 and December 31, 2005.
C. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Fund does not have or use, any derivative instruments nor does it have
any plans to enter into such derivative arrangements. The Fund will generally
invest cash in high-quality credit instruments consisting primarily of money
market funds, bankers acceptance notes and government agency securities with
maturities of six months or less. The Fund does not expect any material loss
32
from cash equivalents and therefore believes its potential interest rate
exposure is not material. The Fund has no plan to conduct any international
activities and therefore believes it is not subject to foreign currency risk.
The principal market risks to which the Fund is exposed that may adversely
impact the Fund's results of operations and financial position are changes in
oil and natural gas prices.
Low commodity prices could have an adverse affect on our future
profitability and, in such an event we may be required by accounting rules to
write down the carrying value of our projects. Revenue to the Fund will be
sensitive to changes in price to be received for oil and natural gas production.
Prevailing market prices fluctuate in response to many factors that are outside
of the Fund's control such as the supply and demand for oil and natural gas.
Availability of alternative fuels as well as seasonal risks such as hurricanes
can also impact the supply and demand.
High oil and natural gas prices have resulted in a strong demand for and a
tight supply of drilling rigs necessary to drill new projects. The increased
cost in daily rig rates could have a negative impact on the return to
shareholders in the Fund. The shortage of drilling rigs could delay the
application of capital to such projects and thus delay revenue from operations.
Projects drilled may not have commercially productive oil and natural gas
reservoirs. In such an event, the Funds' revenue, future results of operations
and financial condition would be adversely impacted.
33
ITEM 3. PROPERTIES
The following table is a summary of our investments detailing the drilling
risk and the actual dollars spent in millions on each project. The total spent
on producing projects demonstrates the completion and facilities costs in
addition to the drilling risk money. The total spent on dry-holes represents the
total amount spent on each project and subsequently written off.
Offshore
Location Target Drilling Risk Total
Working in Gulf of Depth ($ in millions) Spent 6/30/06
Lease Block Interest Operator Mexico (feet) (b) ($ in millions)
----------- -------- -------- ------ ------ --- ---------------
Successful
Main Pass 30 45% Chevron Alabama 12,500 $10.8 $18.0
Dry-Holes (a)
Main Pass 221 35% Chevron Alabama 22,000 $19.1 $19.1
(a) Dry-hole costs represent wells that have been drilled but do not have
commercially productive oil and/or gas reservoirs.
(b) Drilling risk represents the estimated dry-hole costs, leasehold costs or
sunk costs including promote for project participation per AFE's adjusted
for current operating conditions (i.e. projected cost overruns, increased
drilling rates, etc).
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information with respect to beneficial
ownership of the shares as of June 30, 2006 and December 31, 2005 (no person
owns more than 5% of the shares) by:
o each executive officer (there are no directors); and
o all of the executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the SEC
and includes voting or investment power with respect to the securities. Except
as indicated by footnote, and subject to applicable community property laws, the
persons named in the table below have sole voting and investment power with
respect to all shares shown as beneficially owned by them. Percentage of
beneficial ownership is based on 830.5577 shares outstanding at June 30, 2006
and December 31, 2005. Other than the above, no officer and director owns any of
the Fund's shares.
Number
Name of beneficial owner of shares Percent
- ------------------------ --------- -------
Robert E. Swanson (1), President and Chief
Executive Officer....................... 2.6667 *
Executive officers as a group (1)......... 2.6667 *
* Represents less than one percent.
(1) Includes shares owned by the spouse of Mr. Swanson or one of his Trust's.
34
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS
The Fund has engaged Ridgewood Energy as Manager. Ridgewood Energy was
founded in 1982 and, as Manager, has very broad authority, including the
election of executive officers.
Executive officers of Ridgewood Energy and the Fund and their ages at
December 31, 2005 are as follows:
Name, Age and Position with Registrant Officer Since*
Robert E. Swanson, 58
President and Chief Executive Officer 1982
W. Greg Tabor, 45
Executive Vice President and
Director of Business Development 2004
Robert L. Gold, 46
Executive Vice President 1987
Kathleen P. McSherry, 40
Senior Vice President and 2000
Chief Financial Officer
Daniel V. Gulino, 45
Senior Vice President and General Counsel 2003
Mary Lou Olin, 51
Vice President and Secretary 1982
* Each officer has served as an executive officer of the Fund since its
inception.
Set forth below is the name of, and certain biographical information
regarding the executive officers of Ridgewood Energy and the Fund:
Robert E. Swanson has served as the President, Chief Executive Officer, sole
director, and sole stockholder of Ridgewood Energy since its inception. Mr.
Swanson is also the controlling member of Ridgewood Power and Ridgewood Capital,
affiliates of Ridgewood Energy. Mr. Swanson has been President and registered
principal of Ridgewood Securities and has served as the Chairman of the Board
of Ridgewood Capital since its organization in 1998. Mr. Swanson is a member
of the New York State and New Jersey State Bars, the Association of the Bar of
the City of New York and the New York State Bar Association. He is a graduate
of Amherst College and Fordham University Law School.
Greg Tabor has served as the Executive Vice President and Director of Business
Development for Ridgewood Energy since January 2004. Mr. Tabor was senior
business development manager for El Paso Production Company from December 2001
to December 2003. From April 2000 to December 2001, Mr. Tabor was Vice
President, Business Development for Madison Energy Advisors. Mr. Tabor is a
graduate of the University of Houston.
35
Robert L. Gold has served as the Executive Vice President of Ridgewood Energy
since 1987. Mr. Gold is also Executive Vice President of Ridgewood Power. Mr
Gold has also served as the President and Chief Executive Officer of Ridgewood
Capital since its inception in 1998. Mr. Gold is a member of the New York State
Bar. He is a graduate of Colgate University and New York University School of
Law.
Kathleen P. McSherry has served as the Senior Vice President and Chief Financial
Officer of Ridgewood Energy since 2000. Ms. McSherry has been employed by
Ridgewood Energy since 1987, first as the Assistant Controller and then as the
Controller before being promoted to Chief Financial Officer in 2000. Ms.
McSherry also serves as Vice President of Systems and Administration of
Ridgewood Power. Ms. McSherry holds a Bachelor of Science degree in Accounting.
Daniel V. Gulino has served as Senior Vice President and General Counsel of
Ridgewood Energy since August 2003. Mr. Gulino also serves as Senior Vice
President and General Counsel of Ridgewood Power Management, Ridgewood Power,
and Ridgewood Capital and has done so since 2000. Mr. Gulino is a member of the
New Jersey State and Pennsylvania State Bars. He is a graduate of Fairleigh
Dickinson University and Rutgers School of Law.
Mary Lou Olin has served as the Vice President and Secretary of Ridgewood Energy
since its inception. Ms. Olin has been a Vice President of Ridgewood Power
Management and Ridgewood Capital Management, LLC since their inception. Ms. Olin
has a Bachelor of Arts degree from Queens College.
ITEM 6. EXECUTIVE COMPENSATION
None of the executive officers receive compensation from the Fund. The
Manager, or its affiliates, compensates the officers without additional payments
by the Fund. See Item 7. "Certain Relationships and Related Transactions" for
more information regarding Manager compensation and payments to affiliated
entities.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with the sale of shares in 2005, Ridgewood Securities
Corporation, an affiliate of the Manager, earned a placement fee and for
commissions totaling approximately $1.4 million included in syndication costs.
The Manager earned an investment fee for the services of investigating and
evaluating projects for future investment totaling approximately $5.6 million.
The Manager was paid approximately $4.3 million to cover legal and
syndication fees for the organization, distribution and offering expenses.
The Manager receives an annual management fee, payable monthly, equal to
2.5% of total capital contributions, for general and administrative and
management services supplied to us. Additionally, when distributions are made,
the Manager is entitled to a portion of funds distributed to shareholders. For
the six months ended June 30, 2006, the period ended December 31, 2005 and the
period August 16, 2005 (Inception) through June 30, 2006 the Manager was paid
fees which totaled approximately $1.5 million, $0.6 million and $2.1 million,
respectively. There have been no distributions for the period August 16, 2005
(Inception) through June 30, 2006.
36
Profits and losses are allocated in accordance with the LLC operating
agreement. In general, profits and losses in any year are allocated 85% to
shareholders and 15% to the Manager. The primary exception to this treatment is
that all items of expense, loss, deduction and credit attributable to the
expenditure of shareholders' capital contributions are allocated 99% to
shareholders and 1% to the Manager.
ITEM 8. LEGAL PROCEEDINGS
None.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
There is currently no established public trading market for the shares of
membership interest of the Fund. The Fund is not currently offering or proposing
to offer any shares for sale to the public. There are no outstanding options or
warrants to purchase, or securities convertible into shares and the Fund does
not have any equity-based compensation plans. The shares are restricted as to
resale. Shareholders wishing to transfer shares should also consider the
applicability of state securities laws. The shares have not been registered
under the Securities Act, or under any other similar law of any state (except
for certain registrations that do not permit free resale) in reliance upon what
the Fund believes to be exemptions from the registration requirements contained
therein. Because the shares have not been registered, they are restricted
securities as defined in Rule 144 under the 1933 Act.
As of the date of this filing, there were approximately 1,308 holders of
Fund shares.
To date, the Fund has not declared or paid cash dividends to the Fund
shareholders. Ridgewood Energy Corporation, the Manager, may distribute
dividends from available cash from operations as defined in the Fund LLC
operating agreement.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
During the period from September 6, 2005 until December 31, 2005, the Fund
issued an aggregate of 830.5577 shares for gross proceeds of approximately
$123.0 million. All sales of unregistered securities relied on Section 4(2) of
the Securities Act and Rule 506 of Regulation D promulgated thereunder. All of
the sales were made without the use of an underwriter. All purchasers of shares
represented and warranted to the Fund that they were accredited investors as
defined in Rule 501(a) under the Securities Act and that the shares were being
purchased for investment and not for resale.
From the amount raised, approximately $14.1 million was disbursed for
commissions and legal syndication fees. Additionally, approximately $5.6 million
was paid as an investment fee to Ridgewood Energy Corporation, the Manager, for
the investigation and evaluation of investment property prospects. Remaining
funds are expected to be used for exploration and development activities of oil
and gas properties as well as the operation of the Fund.
37
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED
The shares to be registered hereunder are shares of membership interest in
the Fund, which is a limited liability company. The following is a summary of
certain provisions of the LLC operating agreement.
CONTROL OF LLC OPERATIONS
The powers vested in the Manager under the LLC operating agreement are
broad. The Manager has full, exclusive and complete discretion in the management
and control of the affairs of the Fund and shareholders have no power to take
part in the management of, or to bind, the Fund.
The Fund's officers are appointed by the Manager and may be removed by it
at any time. Additionally, the Manager may authorize any sale, lease, pledge or
other transfer of substantially all of a Fund's assets without a vote of the
shareholders.
AMENDMENTS AND VOTING RIGHTS
The Manager may amend the LLC operating agreement without notice to or
approval of the holders of shares for the following purposes:
o to cure ambiguities or errors;
o to equitably resolve issues arising under the LLC operating
agreement so long as similarly situated shareholders are not
treated materially differently;
o to comply with law; to make other changes that will not
materially and adversely affect any shareholder's interest;
o to maintain the federal income tax status of the Fund or any
shareholder, as long as no shareholder's liability is materially
increased; or
o to make modifications to the computation of items affecting the
shareholders' capital accounts to comply with the Code or to
reflect the creation of an additional class or series of shares
and the terms thereof.
Other amendments to the LLC operating agreement may be proposed either by
the Manager or by Fund shareholders. A vote on the proposal may be made by
either by calling a meeting of the shareholders or by soliciting written
consents. Proposed amendments require the approval of shareholders who hold of
record at least a majority of the total shares on the record date for the
action, given at a meeting of shareholders or by written consents. Any amendment
requiring shareholder action (other than an amendment to allow the Fund to be
taxed other than as a partnership) may not increase any shareholder's liability,
change the capital contributions required of him or her or his or her rights in
interest in the Fund's profits, losses, deductions, credits, revenues or
distributions in more than a de minimis matter, or change his or her rights on
dissolution or any voting rights without the shareholder's consent. Any
amendment that changes the Manager's management rights requires its consent.
Generally, shareholders have no right to vote on matters not involving an
amendment to the LLC operating agreement or the removal of the Manager. However,
if any other matter does require a vote of shareholders, it must be approved by
shareholders who own of record at least a majority of the total shares, or if a
different vote is required by law, each shareholder will have voting rights
38
equal to his or her total shares for purposes of determining the number of votes
cast or not cast.
For all purposes, a majority of the shares is a majority of the issued and
outstanding shares, including those owned, if any, by the Manager or its
affiliates. A majority of the shares voted is insufficient if it is less than a
majority of the outstanding shares.
The consent of all holders of shares is required for dissolving or
terminating the Fund, other than as provided by the LLC operating agreement; or
adding a new Manager except as described below.
PARTICIPATION IN COSTS AND REVENUES
Available cash determines what amounts in cash the Fund will be able to
distribute in cash to shareholders. There are two types of available cash:
o available cash from dispositions is total cash received by the Fund
from the proceeds of the sale or other disposition of the Fund's
Property (including items such as insurance proceeds, refinancing
proceeds, condemnation proceeds and other amounts received out of the
ordinary course of business), but excluding dispositions of temporary
investments of the Fund; and
o available cash from operations is all other available cash.
Available Cash from Dispositions and Available Cash from Operations are
defined in the LLC operating agreement and are not defined by and are not the
same as similar concepts under generally accepted accounting principles.
There is no fixed requirement to distribute available cash. Instead,
available cash will be distributed to shareholders to the extent, and at such
times, as the Fund believes is advisable. Once the amount and timing of a
distribution is determined, it shall be made to shareholders as described below.
DISTRIBUTIONS FROM OPERATIONS
At various times during a calendar year, the Fund will determine whether
there is enough available cash from operations for a distribution to
shareholders. The amount of available cash from operations determined to be
available, if any, will be distributed to the shareholders. At all times, the
Manager will be entitled to 15% and shareholders will be entitled to 85% of the
available cash from operations distributed.
DISTRIBUTIONS OF AVAILABLE CASH FROM DISPOSITIONS
Available cash from dispositions that the Fund decides to distribute will
be paid as follows:
o before shareholders have received total distributions (including
distributions from available cash from operations and available cash
from dispositions) equal to their capital contributions, 99% of
available cash from dispositions will be distributed to shareholders
and 1% to the Manager; and
39
o after shareholders have received total distributions (including
available cash from operations and available cash from dispositions)
equal to their capital contributions, 85% of available cash from
dispositions will be distributed to shareholders and 15% to the
Manager.
GENERAL DISTRIBUTION PROVISIONS
Distributions to shareholders under the foregoing provisions will be
apportioned among them in proportion to their ownership of shareholder shares.
The Manager has the sole discretion to determine the amount and frequency of any
distributions. However, distributions may not be made selectively to one
shareholder or group of shareholders, but must be made ratably to all
shareholders entitled to that type of distribution at that time. The Manager in
its discretion nevertheless may credit select persons with a portion of its
compensation from the Fund or distributions otherwise payable to the Manager.
RETURN OF CAPITAL CONTRIBUTIONS
If the Fund for any reason at any time does not find it necessary or
appropriate to retain or expend all capital contributions, it may, in its sole
discretion, return any or all of such excess capital contributions ratably to
shareholders. A return of capital contributions is not treated as a
distribution. The Fund and the Manager will not be required to return any fees
deducted from the original capital contribution or any costs and expenses
incurred and paid by the Fund. The shareholders will be notified of the source
of the payment. Any such return of capital will decrease the shareholders'
capital contributions.
VOLUNTARY ADDITIONAL CAPITAL CONTRIBUTIONS AND SUPPLEMENTAL OFFERING
OF SHARES
The LLC operating agreement does not provide for any mandatory assessments
of capital from shareholders. This means that the Fund cannot require any
shareholder to contribute more money after such shareholder completes his
subscription and pays his initial capital contributions.
If voluntary additional capital contributions are requested by the Fund to
fund additional project activities, the Manager will do so through a
supplemental offering of shares in the Fund. The LLC operating agreement
provides the Manager with discretion in determining the nature, scope, amount
and terms of such supplemental offering.
A shareholder who elects to not participate in any supplemental offering of
shares and does not provide additional capital contributions for such additional
project activities will have no interest in such additional project activities,
but will retain his interest in the projects in which the Fund has already
invested. The failure of a shareholder to participate in a supplemental offering
may have a dilutive effect on such shareholder's investment.
REMOVAL OF MANAGER
Shareholders may propose the removal of the Manager, either by calling a
40
meeting or soliciting consents in accordance with the terms of the LLC operating
agreement. Removal of the Manager requires the affirmative vote of shareholders
who are holders of record of at least a majority of the total shareholder
shares. Removal of a Manager causes us to terminate the Fund's operations and
dissolve the Fund unless a majority of the shareholder shares elects to continue
operations. The shareholders may replace the removed Manager or fill a vacancy
by vote of shareholders who hold of record a majority of the total shareholder
shares.
If the Manager is removed, resigns (other than voluntarily without cause)
or is unable to serve, it may elect to exchange its management rights and rights
to distributions, if any, for a series of cash payments from the Fund in amounts
equal to the amounts of distributions to which the Manager would otherwise have
been entitled under the LLC operating agreement in respect of investments made
by the Fund prior to the date of any such removal, resignation or other
incapacity. The removed Manager would continue to receive its pro rata share of
all allocations to shareholders as provided in the LLC operating agreement which
are attributable to any shareholder shares owned by it.
Alternatively, the removed Manager may elect to engage a qualified
independent appraiser and cause the Fund to engage another qualified independent
appraiser (at the Fund's expense in each case) to value the Fund property as of
the date of such removal, resignation or other incapacity as if the property had
been sold at its fair market value so as to include all unrealized gains and
losses. If the two appraisers cannot agree on a value, they would appoint a
third independent appraiser (whose cost would be borne by the Fund) whose
determination, made on the same basis, would be final and binding.
Based on the appraisal, the Fund would make allocations to the removed
Manager's capital account of profits, losses and other items resulting from the
appraisal as of the date of such removal, resignation or other incapacity as if
the Fund's fiscal year had ended, solely for the purpose of determining the
Manager's capital account. If the removed Manager has a positive capital account
after such allocation, the Fund would deliver a promissory note of the Fund to
the Manager, the principal amount of which would be equal to the Manager's
capital account and which would bear interest at a rate per annum equal to the
prime rate in effect at Chase Manhattan Bank, N.A. on the date of removal,
resignation or other incapacity, with interest payable annually and unpaid
principal payable only from 25% of any available cash before any distributions
thereof are made to the shareholders under the LLC operating agreement.
If the capital account of the removed Manager has a negative balance after
such allocation, it would be obligated to contribute to the capital of the Fund
in its sole discretion either cash in an amount equal to the negative balance in
its capital account or a promissory note to the Fund in such principal amount
maturing five years after the date of such removal, resignation or other
incapacity, bearing interest at the rate specified above. If the removed Manager
chose to elect the appraisal alternative, its entire interest in the Fund would
be terminated other than the right to receive the promissory note and payments
thereunder as provided above.
DISSOLUTION OF FUND
The Fund will dissolve and terminate its operations on the earliest to
occur of (a) December 31, 2040, (b) the sale of substantially all of the Fund's
Property, (c) the removal, dissolution, resignation, insolvency, bankruptcy,
death or other legal incapacity or disqualification of the Manager, (d) the vote
41
of either all shareholders or of the Manager and shareholders who own at least a
majority of the shareholder shares of record or (e) any other event requiring
dissolution by law. The Fund will wind up its business after dissolution unless
(i) the Manager and shareholders who own at least a majority of the shareholder
shares of record or (ii) if there is no Manager, shareholders who own at least a
majority of the shareholder shares of record, elect to continue the Fund. The
Manager (or in the absence thereof, a liquidating trustee chosen by the
shareholders) will liquidate the Fund's assets if it is not continued.
TRANSFERABILITY OF INTERESTS
No shareholder may assign or transfer all or any part of his or her
interest in the Fund and no transferee will be deemed a substituted shareholder
or be entitled to exercise or receive any of the rights, powers or benefits of a
shareholder other than the right to receive distributions attributable to the
transferred interest unless (i) such transferee has been approved and accepted
by the Fund, in its sole and absolute discretion, as a substituted shareholder,
and (ii) certain other requirements set forth in the Fund's LLC operating
agreement (including receipt of an opinion of counsel that the transfer does not
have adverse effects under the securities laws and the Investment Company Act of
1940) have been satisfied.
The Manager may not resign except for cause (which cause does not include
the fact or determination that continued service would be unprofitable to it)
and may not transfer its interest in the Fund except to pledge it as security
for a loan to the Manager if the pledge does not reduce cash flow distributable
to other shareholders.
LIABILITY
Assuming compliance with the LLC operating agreement and applicable
formative and qualifying requirements in Delaware and any other jurisdiction in
which the Fund conducts its business, a shareholder will not be personally
liable under Delaware law for any obligations of the Fund, except to the extent
of any unpaid capital contributions, except for the amount of any wrongful
distributions that render the Fund insolvent and except for indemnification
liabilities arising from any misrepresentation made by him or her to the Fund
when purchasing shares.
42
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Delaware Limited Liability Company Act permits a Delaware limited
liability company to indemnify and hold harmless any member or manager or other
person from and against any and all claims and demands whatsoever.
The Fund's LLC operating agreement provides that each managing person
(which includes the Manager and the Fund's officers, agents, consultants and
affiliates and their directors, trustees, officers, agents and affiliates when
acting on behalf of the Fund) will be indemnified and held harmless to the full
extent of the Fund's assets (and to the maximum extent permitted by applicable
law) from any loss or damage incurred by the managing person, including any
amounts paid in settlement of any claims incurred in connection with the Fund or
in connection with claims by the Fund, in the right of the Fund or by or in
right of any shareholder, due to any act or omission performed or omitted by the
managing person, if the managing person, in good faith, determined that such
course of conduct was in the Fund's best interest and the course of conduct did
not constitute bad faith, gross negligence or willful misconduct by such
managing person.
The Fund's LLC operating agreement provides that the Fund will not
indemnify any managing person for liability imposed or expenses incurred in
connection with any claim arising out of an alleged violation of any federal or
state securities laws, unless the claim is successfully adjudicated on the
merits in favor of the managing person, dismissed with prejudice on the merits,
or subject to a court approved settlement.
The Manager has full and complete discretion to authorize indemnification
of any managing person consistent with the requirements of the LLC operating
agreement at any time, regardless of whether a claim is pending or threatened
and regardless of any conflict of interest between the Manager and the Fund that
may arise in regard to the decision to indemnify a managing person.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 15. "Financial Statements and Exhibits".
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As reported on a Form 8-K filed with the United States Securities and
Exchange Commission ("SEC") on July 27, 2006, the Manager of the Fund dismissed
Perelson Weiner, LLP as the Fund's independent registered public accountants
effective June 8, 2006.
As reported on a Form 8-K filed with the SEC on July 13, 2006, the Manager
of the Fund appointed Deloitte & Touche LLP ("D&T") as the Fund's independent
registered public accountants effective July 12, 2006.
43
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(a) Index to Financial Statements:
Report of Independent Registered Public Accounting Firm F-1
Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005 (restated) F-2
Statements of Operations, for the six months ended June 30, 2006 (unaudited), for the
period of August 16, 2005 (Inception) to December 31, 2005 (restated), and for the
period from August 16, 2005 (Inception) to June 30, 2006 (unaudited) F-3
Statements of Changes in Members' Capital, for the six months ended June 30, 2006
(unaudited), for the period of August 16, 2005 (Inception) to December 31, 2005
(restated), and for the period from August 16, 2005 (Inception) to June 30, 2006
(unaudited) F-4
Statements of Cash Flows, for the six months ended June 30, 2006 (unaudited), for the
period of August 16, 2005 (Inception) to December 31, 2005 (restated), and for the
period from August 16, 2005 (Inception) to June 30, 2006 (unaudited) F-5
Notes to Audited Financial Statements F6-16
(b) Exhibits:
EXHIBIT
NUMBER TITLE OF EXHIBIT
- ------ ----------------
3.1 Articles of Formation of Ridgewood Energy Q Fund, LLC dated August 16,
2005 and filed with the Secretary of State of the State of Delaware on
August 16, 2005. (1)
3.2 Limited Liability Company Agreement between Ridgewood Energy
Corporation and Investors of Ridgewood Energy Q Fund, LLC dated
September 6, 2005 Private Offering Memorandum, dated September 6,
2005. (1)
3.3 Private Offering Memorandum, dated September 6, 2005. (1)
10.1 Exploration Participation Agreement between Chevron U.S.A., Inc. and
Ridgewood Energy Corporation as Manager for Main Pass 30. (1)
10.2 Offshore Operating Agreement between Chevron U.S.A., Inc. and
Ridgewood Energy Q Fund, LLC dated Novemebr 30, 2006 covering Main
Pass Block 30. (1)
10.3 Exploration Participation Agreement between Chevron U.S.A., Inc. and
Ridgewood Energy Corporation as Manager for Main Pass 221. (1)
10.4 Offshore Operating Agreement between Chevron U.S.A., Inc., Newfield
Exploration Company and Ridgewood Energy Corporation, Manager
Ridgewood Energy Q Fund, LLC effective October 1, 2005 covering Main
Pass Block 221; Main Pass Block 222. (1)
(1) Previously filed as an exhibit by the same number of the Fund's Form 10
filed on April 21, 2006.
44
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant has duly caused this registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: November 13, 2006 RIDGEWOOD ENERGY Q FUND, LLC
By: /s/ ROBERT E. SWANSON
Name: Robert E. Swanson
Title: President and Chief Executive Officer
45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Manager of Ridgewood Energy Q Fund, LLC:
We have audited the accompanying balance sheet of Ridgewood Energy Q Fund, LLC
(an exploratory stage enterprise) (the "Fund") as of December 31, 2005 and the
related statements of operations, changes in members' capital, and cash flows
for the period ended December 31, 2005. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Fund is not required to have,
nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Fund's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Ridgewood Energy Q Fund, LLC at December 31,
2005, and the results of its operations and its cash flows for the period ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 11, the accompanying 2005 financial statements have been
restated.
/s/ Deloitte & Touche LLP
November 9, 2006
Parsippany, New Jersey
F-1
RIDGEWOOD ENERGY Q FUND, LLC
(An exploratory stage enterprise)
BALANCE SHEETS
June 30, 2006 December 31, 2005
------------- -----------------
(Restated -
(Unaudited) See Note 11)
ASSETS
Current assets:
Cash and cash equivalents $ 38,677,290 $ 86,240,180
Short-term investment in marketable securities 35,718,046 -
Production receivable 936,268 -
Interest receivable - 206,946
Prepaid expenses 5,270 36,891
------------- -------------
Total current assets 75,336,874 86,484,017
------------- -------------
Salvage fund 1,017,013 -
------------- -------------
Oil and gas properties
Advances to operators for working interests and expenditures - 11,787,240
Proved properties 17,989,438 -
Less: accumulated depletion and amortization -
proved properties (143,730) -
------------- -------------
Total oil and gas properties, net 17,845,708 11,787,240
------------- -------------
Total assets $ 94,199,595 $ 98,271,257
============= =============
LIABILITIES AND MEMBERS' CAPITAL
Current liabilities:
Due to operators $ 9,278,819 -
Accrued expenses payable 243,260 2,720,993
Due to affiliates (Note 7) 20 3,173,232
------------- -------------
Total current liabilities 9,522,099 5,894,225
------------- -------------
Non-current liabilities:
Asset retirement obligations 76,764 -
------------- -------------
Total non-current liabilities 76,764 -
------------- -------------
Total Liabilities 9,598,863 5,894,225
------------- -------------
Commitments and contingencies (Note 9)
Members' capital:
Manager:
Deficit accumulated during the exploratory stage (419,325) (180,100)
------------- -------------
Manager's total (419,325) (180,100)
------------- -------------
Shareholders:
Capital contributions (1,335 shares authorized;
830.5577 issued and outstanding) 123,036,639 123,036,639
Subscription receivable - (2,964,172)
Syndication costs (14,069,525) (14,069,525)
Deficit accumulated during the exploratory stage (23,947,057) (13,445,810)
------------- -------------
Shareholders' total 85,020,057 92,557,132
------------- -------------
Total members' capital 84,600,732 92,377,032
------------- -------------
Total liabilities and members' capital $ 94,199,595 $ 98,271,257
============= =============
The accompanying notes are an integral part of these financial statements.
F-2
RIDGEWOOD ENERGY Q FUND, LLC
(An exploratory stage enterprise)
STATEMENTS OF OPERATIONS
For the period For the period
August 16, 2005 August 16, 2005
Six months (Inception) (Inception)
ended through through
June 30, 2006 December 31, 2005 June 30, 2006
------------- ----------------- -------------
(Restated -
(Unaudited) See Note 11) (Unaudited)
Revenue
Oil and gas revenues $ 936,268 $ - $ 936,268
------------ ------------ ------------
Expenses
Investment fees to affiliate (Note 7) - 5,563,208 5,563,208
Dry-hole costs 11,284,103 7,806,792 19,090,895
Depletion and amortization 143,730 - 143,730
Accretion expense 326 - 326
Management fees to affiliate (Note 7) 1,538,903 602,913 2,141,816
Other general and administrative expenses 381,055 107,610 488,665
------------ ------------ ------------
Total expenses 13,348,117 14,080,523 27,428,640
------------ ------------ ------------
Loss from operations (12,411,849) (14,080,523) (26,492,372)
Other income
Interest income 1,671,377 454,613 2,125,990
------------ ------------ ------------
Total other income 1,671,377 454,613 2,125,990
Net loss $(10,740,472) $(13,625,910) $(24,366,382)
============ ============ ============
Manager - Net loss $ (239,225) $ (180,100) $ (419,325)
Shareholders - Net loss $(10,501,247) $(13,445,810) $(23,947,057)
Net loss per share $ (12,644) $ (16,189) $ (28,833)
The accompanying notes are an integral part of these financial statements.
F-3
RIDGEWOOD ENERGY Q FUND, LLC
(An exploratory stage enterprise)
STATEMENTS OF CHANGES IN MEMBERS' CAPITAL
For the six months ended June 30, 2006
(Unaudited)
# of Shares Manager Shareholders Total
----------- ------- ------------ -----
Balances, January 1, 2006 830.5577 $ (180,100) $ 92,557,132 $ 92,377,032
Collection of subscription receivable - 2,964,172 2,964,172
Net loss incurred in the exploratory stage (239,225) (10,501,247) (10,740,472)
-------- ------------ ------------ ------------
Balances, June 30, 2006 830.5577 $ (419,325) $ 85,020,057 $ 84,600,732
======== ============ ============ ============
For the period August 16, 2005 (Inception)
through December 31, 2005
-----------------------------------------------------------------
(Restated - See Note 11)
# of Shares Manager Shareholders Total
----------- ------- ------------ -----
Balances, August 16, 2005 (Inception) - $ - $ - $ -
Shareholders' capital contributions 830.5577 - 123,036,639 123,036,639
Syndication costs (included offering fee of
$4,342,921 paid to the Manager and
selling commissions and placement fees of
$193,400 and $1,204,187, respectively, paid
to Ridgewood Securities Corp. - Note 7) - (14,069,525) (14,069,525)
Subscription receivable - (2,964,172) (2,964,172)
Net loss incurred in the exploratory stage (180,100) (13,445,810) (13,625,910)
-------- ------------ ------------ ------------
Balances, December 31, 2005 830.5577 $ (180,100) $ 92,557,132 $ 92,377,032
======== ============ ============ =============
For the period August 16, 2005 (Inception)
through June 30, 2006
-----------------------------------------------------------------
(Unaudited)
# of Shares Manager Shareholders Total
----------- ------- ------------ -----
Balances, August 16, 2005 (Inception) - $ - $ - $ -
Shareholders' capital contributions 830.5577 - 123,036,639 123,036,639
Syndication costs (included offering fee of
$4,342,921 paid to the Manager and
selling commissions and placement fees of
$193,400 and $1,204,187, respectively, paid
to Ridgewood Securities Corp. - Note 7) - (14,069,525) (14,069,525)
Net loss incurred in the exploratory stage (419,325) (23,947,057) (24,366,382)
-------- ---------- ------------ ------------
Balances, June 30, 2006 830.5577 $ (419,325) $ 85,020,057 $ 84,600,73
======== ========== ============ ===========
The accompanying notes are an integral part of these financial statements.
F-4
RIDGEWOOD ENERGY Q FUND, LLC
(An exploratory stage enterprise)
STATEMENTS OF CASH FLOWS
For the period For the period
August 16, 2005 August 16, 2005
For the six (Inception) (Inception)
months ended through through
June 30, 2006 December 31, 2005 June 30, 2006
------------- ----------------- -------------
(Restated -
(Unaudited) See Note 11) (Unaudited)
Cash flows from operating activities
Net loss $ (10,740,472) $ (13,625,910) $ (24,366,382)
Adjustments to reconcile net loss to net cash
used in operating activities
Dry-hole costs 11,284,103 7,806,792 19,090,895
Depletion and amortization 143,730 - 143,730
Accretion expense 326 - 326
Interest earned on marketable securities (718,642) - (718,642)
Interest earned on salvage fund (19,421) - (19,421)
Changes in assets and liabilitie
Increase in production receivable (936,268) - (936,268)
Decrease (increase) in interest receivable 206,946 (206,946) -
Decrease (increase) in prepaid expenses 31,621 (36,891) (5,270)
Increase in accrued expenses payable 31,978 211,282 243,260
(Decrease) increase in due to affiliates (1,569,737) 1,569,757 20
------------- ------------- -------------
Net cash used in operating activities (2,285,836) (4,281,916) (6,567,752)
------------- ------------- -------------
Cash flows from investing activities
Payments to operators for working interests
and expenditures - (11,787,240) (11,787,240)
Capital expenditures for oil and gas properties (8,131,044) (7,806,792) (15,937,836)
Funding of salvage fund (997,592) - (997,592)
Investment in marketable securities (34,999,404) - (34,999,404)
------------- ------------- -------------
Net cash used in investing activities 44,128,040) (19,594,032) (63,722,072)
------------- ------------- -------------
Cash flows from financing activities
Contributions from shareholders - 123,036,639 123,036,639
Subscriptions receivable 2,964,172 (2,964,172) -
Syndication costs paid (4,113,186) (9,956,339) (14,069,525)
------------- ------------- -------------
Net cash (used in) provided by financing activities (1,149,014) 110,116,128 108,967,114
------------- ------------- -------------
Net (decrease) increase in cash
and cash equivalents (47,562,890) 86,240,180 38,677,290
Cash and cash equivalents, beginning of period 86,240,180 - -
------------- ------------- -------------
Cash and cash equivalents, end of period $ 38,677,290 $ 86,240,180 $ 38,677,290
============= ============= =============
Supplemental schedule of non-cash investing activities
Advances used for capital expenditures in oil
and gas properties reclassified to unproved properties $ 11,787,240 $ - $ 11,787,240
============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-5
RIDGEWOOD ENERGY Q FUND, LLC
(An exploratory stage enterprise)
NOTES TO AUDITED FINANCIAL STATEMENTS
1. Organization and Purpose
The Ridgewood Energy Q Fund, LLC ("Fund"), a Delaware limited liability company,
was formed on August 16, 2005 and operates pursuant to a limited liability
company agreement ("Agreement") dated as of September 6, 2005 by and among
Ridgewood Energy Corporation ("Manager"), and the shareholders of the Fund.
Although the date of formation is August 16, 2005, the Fund did not begin
operations until September 6, 2005 when it began its private offering of shares.
There were no business activities prior to September 6, 2005.
The Fund was organized to acquire, drill, construct and develop oil and natural
gas properties located in the United States offshore waters of Texas, Louisiana
and Alabama in the Gulf of Mexico. The Fund has devoted most of its efforts to
raising capital and oil and natural gas exploration activities. The Fund began
earning revenue in June 2006 from these operations and prior to that point in
time was considered to be in the exploratory stage.
The Manager performs (or arranges for the performance of) the management and
administrative services required for Fund operations. Such services include,
without limitation, the administration of shareholder accounts, shareholder
relations and the preparation, review and dissemination of tax and other
financial information. In addition, the Manager provides office space, equipment
and facilities and other services necessary for Fund operations. The Manager
also engages and manages the contractual relations with outside custodians,
depositories, accountants, attorneys, broker-dealers, corporate fiduciaries,
insurers, banks and others as required (Notes 2, 6 and 7).
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, the Manager reviews its
estimates, including those related to amounts advanced to and billed by
operators, determination of proved reserves, impairment allowances and
environmental liabilities. Actual results may differ from those estimates.
Advances to Operators for Working Interests and Expenditures
Each participation agreement that the Fund executes for an exploratory project
requires the Fund to make a payment to the working interest owner for the Fund's
ownership rights and working interest in the project. The Fund accounts for such
payments as advances to operators for working interests and expenditures. As
drilling costs are incurred, the payments are capitalized as unproved
properties.
F-6
Oil and natural gas properties
Investments in oil and natural gas properties are operated by unaffiliated
entities ("Operators") who are responsible for drilling, administering and
producing activities pursuant to the terms of the applicable Operating
Agreements with working interest owners. The Fund's portion of exploration,
drilling, operating and capital equipment expenditures relating to the wells are
advanced and billed by Operators through authorization for expenditures.
The successful efforts method of accounting for oil and natural gas producing
activities is followed. Acquisition costs are capitalized when incurred. Other
oil and natural gas exploration costs, excluding the costs of drilling
exploratory wells, are charged to expense as incurred. The costs of drilling
exploratory wells are capitalized pending the determination of whether the wells
have discovered proved commercial reserves. If proved commercial reserves have
not been found, exploratory drilling costs are expensed to dry-hole expense.
Costs to develop proved reserves, including the costs of all development wells
and related facilities and equipment used in the production of crude oil and
natural gas, are capitalized. Expenditures for ongoing repairs and maintenance
of producing properties are expensed as incurred.
Upon the sale or retirement of a proved property (i.e. a producing well), the
cost and related accumulated depletion and amortization will be eliminated from
the property accounts, and the resultant gain or loss is recognized. On the sale
or retirement of an unproved property, gain or loss on the sale is recognized,
taking into consideration the amount of any recorded impairment if the property
had been assessed for impairment. It is not the Manager's intention to sell any
of the Fund's property interests.
Capitalized acquisition costs of producing oil and natural gas properties after
recognizing estimated salvage values are depleted by the unit-of-production
method.
Revenue Recognition
Oil and natural gas sales are recognized when delivery is made by the Operator
to the purchaser and title is transferred (i.e., production has been delivered
to a pipeline or transport vehicle). The Fund earned revenue for the six months
ended June 30, 2006 (unaudited), approximating $0.9 million. No revenue was
earned in 2005.
The volume of oil and natural gas sold on the Fund's behalf may differ from the
volume of oil and natural gas the Fund is entitled to. The Fund will account for
such oil and natural gas production imbalances by the entitlements method. Under
the entitlements method, the Fund will recognize a receivable from other working
interest owners for volumes oversold by other working interest owners, and a
payable to other working interest owners for volumes oversold by the Fund. For
the period August 16, 2005 (Inception) through June 30, 2006 (unaudited), there
were no material oil or natural gas balancing arrangements between the Fund and
other working interest owners.
Interest Income
Interest income is recognized when earned.
F-7
Syndication Costs
Direct Costs associated with offering the Fund's shares including professional
fees, selling expenses and administrative costs payable to the Manager, an
affiliate of the Manager and outside brokers are reflected as a reduction of
shareholders' capital.
Asset Retirement Obligations
For oil and natural gas properties, there are obligations to perform removal and
remediation activities when the properties are retired. The Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No.
143"), effective for years beginning after December 15, 2002. SFAS No. 143
requires the Fund to record a separate liability for the discounted present
value of the Fund's asset retirement obligations, with an offsetting increase to
the related oil and natural gas properties on the balance sheet. When a project
reaches drilling depth and is determined to be either proved or dry, an asset
retirement obligation is incurred. Plug and abandonment costs associated with
unsuccessful projects are expensed as incurred as dry-hole costs.
June 30, 2006 December 31, 2005
------------- -----------------
(Unaudited)
Balance - Beginning of period $ - $ -
Liabilities incurred 191,050 -
Liabilities settled (114,612) -
Accretion expense 326 -
------------- ------------
Balance - End of period $ 76,764 $ -
============= ============
In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting
for Conditional Asset Retirement PHIC OMITTED][GRAPHIC OMITTED] Obligations"
("FIN 47"). This interpretation clarifies that the term "conditional asset
retirement obligation" as used in SFAS No. 143 refers to a legal obligation to
perform an asset retirement activity in which the timing and/or method of
settlement are conditional on a future event that may or may not be within the
control of the entity incurring the obligation. The obligation to perform the
asset retirement activity is unconditional even though uncertainty exists about
the timing and/or method of settlement. Thus, the timing and/or method of
settlement may be conditional on a future event. Accordingly, an entity is
required to recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability can be reasonably
estimated. Uncertainty about the timing and/or method of settlement of a
conditional asset retirement obligation should be factored into the measurement
of the liability, rather than the timing of recognition of the liability, when
sufficient information exists. FIN 47 was effective for calendar year-end
entities no later than December 31, 2005. The application of FIN 47 did not have
an impact on the Fund's financial position or results of operations.
Impairment of Long-Lived Assets
In accordance with the provisions of SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets" ("SFAS No. 144"), long-lived assets, such as
oil and natural gas properties, are evaluated when events or changes in
circumstances indicate the carrying value of such assets may not be recoverable.
The determination of whether impairment has occurred is made by comparing the
carrying values of long-lived assets to the estimated future undiscounted cash
F-8
flows attributable to the asset. The impairment loss recognized is the excess of
the carrying value over the future discounted cash flows attributable to the
asset or the estimated fair value of the asset. As of June 30, 2006 (unaudited)
and December 31, 2005, no impairments were recorded.
Depletion and Amortization
Depletion and amortization of the cost of proved oil and natural gas properties
are calculated using the units of production method. Proved developed reserves
are used as the base for depleting the cost of successful exploratory drilling
and development costs. The sum of proved developed and proved undeveloped
reserves is used as the base for depleting (or amortizing) leasehold acquisition
costs, the costs to acquire proved properties and platform and pipeline costs.
In April 2006, the Main Pass 30 project was determined to have proved reserves.
As of June 30, 2006 (unaudited) and December 31, 2005 the Fund had recorded
depletion and amortization of approximately $144 thousand and nil, respectively.
Income Taxes
No provision is made for income taxes in the financial statements as the income
or losses are passed through and included in the tax returns of the individual
shareholders.
Cash and cash equivalents / Salvage Fund
All highly liquid investments with maturities when purchased of three months or
less are considered as cash and cash equivalents. At times, bank deposits may be
in excess of federal insured limits. As of June 30, 2006 (unaudited) and
December 31, 2005, respectively, bank balances exceeded federally insured limits
by approximately $18.2 million and $86.0 million, respectively, inclusive of the
salvage fund. The Fund maintains bank deposits with accredited financial
institutions to mitigate such risk. Cash and cash equivalents of approximately
$20.3 million and nil are investments in three month US Treasury Notes as of
June 30, 2006 (unaudited) and December 31, 2005, respectively.
Income and Expense Allocation
Profits and losses are to be allocated 85% to shareholders in proportion to
their relative capital contributions and 15% to the Manager, except for certain
expenses, such as dry-hole costs and fiduciary fees, and interest income, which
are allocated 99% to shareholders and 1% to the Manager.
3. Recent Accounting Standards
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
("SFAS No. 157") which applies under most other accounting pronouncements that
require or permit fair value measurements. SFAS No. 157 provides a common
definition of fair value as the price that would be received to sell an asset or
paid to transfer a liability in a transaction between market participants. The
new standard also provides guidance on the methods used to measure fair value
and requires expanded disclosures related to fair value measurements. SFAS No.
157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007. The Fund does not expect this guidance to have a
material impact on the financial statements.
F-9
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154"). SFAS No. 154 requires, unless impracticable, retrospective
application to prior periods' financial statements of changes in accounting
principle where transition is not specified by a new accounting pronouncement.
SFAS No. 154 also requires that retrospective application of a change in
accounting principle be limited to the direct effects of the change. Indirect
effects of a change in accounting principle should be recognized in the period
of the accounting change. SFAS No. 154 was effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The adoption of SFAS No. 154 had no impact on the financial statements.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities", ("FIN 46") which changes the criteria by which one company includes
another entity in its consolidated financial statements. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. The consolidation requirements of FIN 46 apply immediately to variable
interest entities created after December 31, 2003, and apply in the first fiscal
period ending after March 15, 2004, for variable interest entities created prior
to January 1, 2004. In December 2003, the FASB issued a revision of FIN 46 ("FIN
46R") to clarify some of the provisions and to exempt certain entities from its
requirements. The Fund has applied the provisions of FIN 46R effective December
21, 2004, with no impact on the financial statements.
FASB Staff Position ("FSP") 115-1 and 124-1, the Meaning of Other Than Temporary
Impairment and its Application to Certain Investments ("FSP 115-1 and 124-1").
This FSP addresses the determination as to when an investment is considered
impaired, whether that impairment is other than temporary and the measurement of
the impairment loss. It also requires certain disclosures about unrealized
losses that have not been recognized as other than temporary impairments. This
guidance applies to equity securities that have a readily determinable fair
value and all debt securities. It does not apply to investments accounted for
under the equity method. An investment is impaired if its fair value is less
than its cost, as assessed at the individual security level. When an investment
is impaired, the investor is required to evaluate whether the impairment is
other than temporary. If other than temporary, the unrealized loss must be
recognized. For all investments in an unrealized loss position for which other
than temporary impairments have not been recognized, the investor should
disclose by category of investment the amount of unrealized losses and the fair
value of investments with unrealized losses and related narrative disclosures.
FSP 115-1 and 124-1 was effective for reporting periods beginning after December
15, 2005. The adoption of FSP 115-1 and 124-1 had no impact on the financial
statements.
4. Unproved Properties - Capitalized Exploratory Well Costs
In April 2005, FASB issued FSP 19-1, "Accounting for Suspended Well Costs",
("FSP 19-1"). This FSP was issued to address whether there were circumstances
that would permit the continued capitalization of exploratory well costs beyond
one year, other than when further exploratory drilling is planned and major
capital expenditures would be required to develop the project. FSP 19-1 requires
the continued capitalization of suspended well costs if the well has found a
sufficient quantity of reserves to justify its completion as a producing well
and the entity is making sufficient progress assessing these reserves and the
economic and operating viability of the project. All relevant facts and
circumstances should be evaluated in determining whether an entity is making
sufficient progress assessing the reserves and FSP 19-1 provides several
F-10
indicators in this evaluation. FSP 19-1 prohibits continued capitalization of
suspended well costs on the chance that market conditions will change or
technology will be developed to make the project economic.
The Fund adopted FSP 19-1 during the third quarter of 2005. Leasehold
acquisition and exploratory drilling costs are capitalized pending determination
of whether the well has found proved reserves. Unproved properties are assessed
on a quarterly basis by evaluating and monitoring if sufficient progress is made
on assessing the reserves. Capitalization costs are expensed as dry-hole costs
in the event that reserves are not found or are not in sufficient quantities to
complete the well and develop the field. Dry-hole costs were $11.3 million, $7.8
million and $19.1 million for the six months ended June 30, 2006 (unaudited),
the period ended December 31, 2005 and for the period August 16, 2005
(Inception) through June 30, 2006 (unaudited), respectively.
As of June 30, 2006 (unaudited) and December 31, 2005, the Fund had no unproved
property costs greater than one year.
5. Short-term Investments in Marketable Securities inclusive of Salvage Fund
Short-term investments are comprised of US Treasury Notes with maturities
greater than six months and are considered held-to-maturity investments.
Held-to-maturity securities are those investments that the Fund has the ability
and intent to hold until maturity. Held-to maturity investments are recorded at
cost plus accrued income, adjusted for the amortization of premiums and
discounts, which approximate market value. Interest income is accrued as earned.
US Treasury Notes mature in July 2006.
6. Distributions
Distributions to shareholders are allocated in proportion to the number of
shares held.
The Manager will determine whether Available Cash from Operations, as defined in
the Fund's Operating Agreement, is to be distributed. Such distribution will be
allocated 85% to the shareholders and 15% to the Manager, as defined in the
Fund's Operating Agreement.
Available Cash from Dispositions, as defined in the Fund's Operating Agreement,
will be paid 99% to shareholders and 1% to the Manager until the shareholders
have received total distributions equal to their capital contributions. After
shareholders have received distributions equal to their capital contributions,
85% of Available Cash from Dispositions will be distributed to shareholders and
15% to the Manager.
There have been no distributions made by the Fund.
7. Related Parties
Ridgewood Energy Corporation, the Manager, was paid a one time investment fee of
4.5% of initial capital contributions. Fees are payable for services of
investigating and evaluating investment opportunities and effecting transactions
when the capital contribution is made. For the period ended December 31, 2005
investment fees were approximately $5.6 million. Of this amount approximately
nil and $1.6 million was included in due to affiliates as of June 30, 2006
(unaudited), and December 31, 2005, respectively. In 2006, there were no
investment fees.
F-11
A management agreement provides that the Manager render management,
administrative and advisory services. For such services, the Manager receives an
annual management fee, payable monthly, of 2.5% of total capital contributions.
Management fees of approximately $1.5 million, $0.6 million and $2.1 million
were incurred and paid for the six months ended June 30, 2006 (unaudited), the
period ended December 31, 2005 and for the period August 16, 2005 (Inception)
through June 30, 2006 (unaudited), respectively.
The Manager was paid an offering fee which approximated 3.5% of capital
contributions to cover expenses incurred in the offer and sale of shares of the
Fund. Such offering fee was included in syndication costs (Note 2) of $14.1
million. For the period ended December 31, 2005, offering fees were
approximately $4.3 million. Of this amount approximately nil and $1.2 million
was included in due to affiliates as of June 30, 2006 (unaudited) and December
31, 2005, respectively.
From time to time, short-term payables and receivables, which do not bear
interest, arise from transactions with affiliates in the ordinary course of
business. As of June 30, 2006 (unaudited) and December 31, 2005, the Manager
owed the Fund approximately nil and $1 thousand for the overpayment of fees
respectively, which is included in due to affiliates.
In 2005, Ridgewood Securities Corporation, a registered broker-dealer affiliated
with the Manager, was paid selling commissions and placement fees of
approximately $0.2 million and $1.2 million, respectively, for shares sold of
the Fund which are reflected in syndication costs (Note 2). As of June 30, 2006
(unaudited) and December 31, 2005, approximately nil and $0.4 million was
included in due to affiliates.
None of the compensation to be received by the Manager has been derived as a
result of arm's length negotiations.
The Fund has working interest ownership in certain projects to acquire and
develop oil and natural gas projects with other entities that are likewise
managed by the Manager.
8. Fair Value of Financial Instruments
As of June 30, 2006 (unaudited) and the period ended December 31, 2005, the
carrying value of cash and cash equivalents, short-term investments in
marketable securities, and salvage fund, approximate fair value. Cash and cash
equivalents principally consist of money market funds and short-term investments
in US Treasury Notes.
9. Commitments and Contingencies
Environmental Considerations
The exploration for and development of oil and natural gas involves the
extraction, production and transportation of materials which, under certain
conditions, can be hazardous or cause environmental pollution problems. The
Manager and the Operators are continually taking action they believe appropriate
to satisfy applicable federal, state and local environmental regulations and do
not currently anticipate that compliance with federal, state and local
environmental regulations will have a material adverse effect upon capital
expenditures, results of operations or the competitive position of the Fund in
the oil and natural gas industry. However, due to the significant public and
governmental interest in environmental matters related to those activities, the
Manager cannot predict the effects of possible future legislation, rule changes,
or
F-12
governmental or private claims. As of June 30, 2006 (unaudited) and December 31,
2005, there were no known environmental issues that required the Fund to record
a liability.
Salvage Fund
Pursuant to the Fund's Operating Agreement, the Fund deposits in a separate
interest-bearing account, or a salvage fund, money to provide for dismantling
production platforms and facilities, plugging and abandoning the wells and
removing the platforms, facilities and wells after their useful lives, in
accordance with applicable federal and state laws and regulations.
Interest earned on the account will become part of the salvage fund; there are
no legal restrictions on the withdrawal from the salvage fund.
Insurance Coverage
The Fund is subject to all risks inherent in the exploration for and development
of oil and natural gas. Insurance coverage as is customary for entities engaged
in similar operations is maintained, but losses may occur from uninsurable risks
or amounts in excess of existing insurance coverage. The occurrence of an event
which is not insured or not fully insured could have an adverse impact upon
earnings and financial position.
10. Information About Oil and Natural Gas Producing Activities
In accordance with Statement of Financial Accounting Standards No. 69,
"Disclosures About Oil and Gas Producing Activities," this section provides
supplemental information on oil and natural gas exploration and producing
activities of the Fund. Tables I through III provide historical cost information
pertaining to capitalized costs, costs incurred in exploration, property
acquisitions and development, and results of operations. As of December 31,
2005, the Fund did not have any proved reserves to warrant additional
disclosures.
The Fund is engaged solely in oil and natural gas activities, all of which are
located in the United States offshore waters of Texas, Louisiana Alabama in the
Gulf of Mexico.
Table I - Capitalized Costs Related to Oil and Natural Gas Exploration and
Producing Activities
December 31, 2005
-----------------
Property acquisition costs $ 11,787,240
Exploratory drilling costs -
------------
Unproved oil and natural gas properties $ 11,787,240
============
Table II - Costs Incurred in Exploration, Property Acquisitions and Development
For the period
August 16, 2005
(Inception)
through
December 31, 2005
-----------------
Property acquisition costs $ 11,787,240
Exploratory drilling costs 7,806,792
------------
Total Incurred in Exploration, Property Acquisitions $ 19,594,032
and Development ============
Table III - Results of Operations for Oil and Natural Gas Producing Activities
For the year
ended
December 31, 2005
-----------------
Revenue $ -
------------
Dry-hole costs $ 7,806,792
Total Expenses $ 7,806,792
------------
Results of Operations for Oil and Natural Gas
Producing Activities $ (7,806,792)
============
F-13
11. Restatement of Previously Issued Financial Statements
Subsequent to the issuance of the Fund's financial statements as of and for the
period ended December 31, 2005, management identified accounting errors.
Accordingly, the Fund has restated the 2005 financial statements in this Form
10/A (Amendment No. 1).
The financial statements as of December 31, 2005 and for the period ended
December 31, 2005 have been restated to reflect the following adjustments:
o Advances to operators for working interests and expenditures which
were erroneously written off as dry hole costs have been corrected,
resulting in a $1.0 million increase in advances to operators for
working interests and expenditures and a corresponding decrease in dry
hole costs.
o Advances to operators for working interests and expenditures, which
were erroneously recorded as unproved properties, were corrected,
resulting in a $10.8 million increase in advances to operators for
working interests and expenditures and a corresponding decrease in
unproved properties.
o Subscriptions receivable of $75 thousand were determined to not be
collectable, resulting in a decrease to capital contributions and
subscription receivable. The decrease in capital contributions also
caused a decrease of $9 thousand and $3 thousand in syndication costs
and investment fees, respectively and a corresponding decrease of $6
thousand and $7 thousand in accrued expenses payable and due to
affiliates, respectively. This also caused a decrease in outstanding
shares from 831.0577 to 830.5577.
The above corrections resulted in a $1.0 million decrease in net loss, which
resulted in a $0.9 million decrease in shareholders' deficit accumulated during
the exploratory stage and a $0.1 million decrease in manager's deficit
F-14
accumulated during the exploratory stage (the effects of such restatements are
also included in the statement of changes in members' capital for the period
ended December 31, 2005).
The following tables summarize the effects of the restatement on the Fund's 2005
balance sheet and statement of operations:
Balance Sheet Effects:
December 31, 2005
As Previously December 31, 2005
Reported Adjustments As Restated
----------------------------------------------------------
Assets:
Unproved properties 10,785,330 (10,785,330) -
Advances to operators for working interests
and expenditures - 11,787,240 11,787,240
Total oil and gas properties 10,785,330 1,001,910 11,787,240
Total assets $ 97,269,347 $ 1,001,910 $ 98,271,257
Accrued expenses payable 2,726,994 (6,001) 2,720,993
Due to affiliates 3,179,982 (6,750) 3,173,232
Total current liabilities 5,906,976 (12,751) 5,894,225
Total Liabilities 5,906,976 (12,751) 5,894,225
Manager:
Deficit accumulated during the
exploratory stage (245,785) 65,685 (180,100)
Manager's total (245,785) 65,685 (180,100)
Shareholders:
Capital contributions (1,335 shares authorized;
830.5577 issued and outstanding) 123,111,639 (75,000) 123,036,639
Subscriptions receivable (3,039,172) 75,000 (2,964,172)
Syndication costs (14,078,901) 9,376 (14,069,525)
Deficit accumulated during the
exploratory stage (14,385,410) 939,600 (13,445,810)
Shareholders' total 91,608,156 948,976 92,557,132
Total members' capital 91,362,371 1,014,661 92,377,032
Total Liabilities and members' capital 97,269,347 1,001,910 98,271,257
F-15
Statement of Operations Effects:
For the Period Ended
December 31, 2005 For the Period Ended
As Previously December 31, 2005
Reported Adjustments As Restated
----------------------------------------------------------
Investment fees to affiliate $ 5,566,583 $ (3,375) $ 5,563,208
Dry-hole costs 8,808,702 (1,001,910) 7,806,792
Total expenses 15,085,808 (1,005,285) 14,080,523
Loss from operations (15,085,808) 1,005,285 (14,080,523)
Total Other Income 454,613 - 454,613
Net loss $(14,631,195) $ 1,005,285 $(13,625,910)
Manager - Net loss $ (245,785) $ 65,685 $ (180,100)
Shareholders - Net loss $(14,385,410) $ 939,600 $(13,445,810)
Net loss per share $ (17,310) $ 1,121 $ (16,189)
The restatements noted above had the following effects on the statement of cash
flows for the period ended December 2005:
Statement of Cash Flow Effects:
For the Period Ended
December 31, 2005 For the Period Ended
As Previously December 31, 2005
Reported Adjustments As Restated
-------- ----------- -----------
Cash flows from operating activities
Net loss $(14,631,195) $ 1,005,285 $ (13,625,910)
Adjustments to reconcile net loss to net cash
used in operating activities
Dry-hole costs 8,808,702 (1,001,910) 7,806,792
Increase in due to affiliates 1,573,132 (3,375) 1,569,757
Net cash used in operating activities (4,281,916) - (4,281,916)
Cash flows from investing activities
Payments to operators for working interests
and expenditures - (11,787,240) (11,787,240)
Capital expenditures for oil and gas properties (19,594,032) 11,787,240 (7,806,792)
Net cash used in investing activities (19,594,032) - (19,594,032)
Cash flows from financing activities
Contributions from shareholders 123,111,639 (75,000) 123,036,639
Subscriptions receivable (3,039,172) 75,000 (2,964,172)
Net cash provided by financing activities 110,116,128 - 110,116,128
F-16