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EX-32.2 - EXHIBIT 32.2 - BPZ RESOURCES, INC.ex32-2.htm
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EXCEL - IDEA: XBRL DOCUMENT - BPZ RESOURCES, INC.Financial_Report.xls

 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: March 31, 2015

 

or

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from         to

 

Commission File Number: 001-12697

 

BPZ RESOURCES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Texas

 

33-0502730

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

 

580 Westlake Park Blvd., Suite 525
Houston, Texas 77079
(Address of Principal Executive Office)

 

Registrant’s Telephone Number, Including Area Code: (281) 556-6200

 

N/A

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer ☐

 

Accelerated filer ☒

     

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

   

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

As of April 30, 2015, there were 118,663,139 shares of common stock, no par value, outstanding.

 



 

 

 

 
 

 

 

 

TABLE OF CONTENTS

 

PART I

       

Item 1.

Financial Statements

 

3

       
 

Consolidated Balance Sheets

 

3

       
 

Consolidated Statements of Operations

 

4

       
 

Consolidated Statements of Cash Flows

 

5

       
 

Notes to Consolidated Financial Statements

 

6

       

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

33

       

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

56

       

Item 4.

Controls and Procedures

 

57

       

PART II

       

Item 1.

Legal Proceedings

 

58

       

Item 1A.

Risk Factors

 

58

       

Item 6.

Exhibits

 

58

       

SIGNATURES

 

 
2

 

 

 

PART I

 

Item 1. Financial Statements

 

BPZ Resources, Inc. (Debtor in Possession) and Subsidiaries

Consolidated Balance Sheets 

(In thousands)

 

   

March 31,

   

December 31,

 
   

2015

   

2014

 
   

(Unaudited)

         

ASSETS

               
                 

Current assets:

               

Cash and cash equivalents

  $ 28,013     $ 62,149  

Accounts receivable

    3,636       1,922  

Income taxes receivable

    244       2,136  

Value-added tax receivable

    4,728       2,343  

Inventory

    11,784       11,878  

Prepaid and other current assets

    5,088       6,104  

Total current assets

    53,493       86,532  
                 

Property, equipment and construction in progress, net

    182,530       165,971  

Restricted cash

    2,209       2,209  

Other non-current assets

    2,207       2,150  

Investment in Ecuador property, net

    493       501  

Deferred tax asset

    34,555       33,997  

Total assets

  $ 275,487     $ 291,360  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               
                 

Current liabilities:

               

Accounts payable

  $ 5,164     $ 4,380  

Accrued liabilities

    7,444       6,524  

Other liabilities

    19,923       22,533  

Accrued interest payable

    -       4,883  

Current maturity of long-term debt

    -       214,312  

Total current liabilities

    32,531       252,632  

Liabilities subject to compromise

    223,316       -  

Asset retirement obligation

    5,434       5,330  

Total long-term liabilities

    5,434       5,330  
                 

Commitments and contingencies (Note 18 and 19)

               
                 

Stockholders’ equity:

               

Preferred stock, no par value, 25,000 authorized; none issued and outstanding

    -       -  

Common stock, no par value, 250,000 authorized; 118,663 and 118,657 shares issued and outstanding at March 31, 2015 and December 31, 2014, respectively

    573,465       572,890  

Accumulated deficit

    (559,259 )     (539,492 )

Total stockholders’ equity

    14,206       33,398  

Total liabilities and stockholders’ equity

  $ 275,487     $ 291,360  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
3

 

 

BPZ Resources, Inc. (Debtor in Possession) and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(In thousands, except per share data)

 

 

   

Three Months

Ended March 31,

 
   

2015

   

2014

 
                 

Net revenue:

               

Oil revenue, net

  $ 10,892     $ 20,904  

Other revenue

    427       72  
                 

Total net revenue

    11,319       20,976  
                 

Operating and administrative expenses:

               

Lease operating expense

    7,882       5,223  

General and administrative expense

    6,329       6,197  

Geological, geophysical and engineering expense

    782       821  

Depreciation, depletion and amortization expense

    4,458       6,612  
                 

Total operating and administrative expenses

    19,451       18,853  
                 

Operating income (loss)

    (8,132 )     2,123  
                 

Other income (expense):

               

Loss from investment in Ecuador property, net

    (8 )     (8 )

Interest expense, net (contractual interest $4,233)

    (5,974 )     (3,837 )

Other financing costs

    (4,636 )     -  

Gain on derivatives

    -       30  

Interest income

    20       5  

Other expense

    (547 )     67  
                 

Total other expense, net

    (11,145 )     (3,743 )
                 

Reorganization items, net

    (51 )     -  
                 

Loss before income taxes

    (19,328 )     (1,620 )
                 

Income tax expense

    439       1,950  
                 

Net loss

  $ (19,767 )   $ (3,570 )
                 

Basic net loss per share

  $ (0.17 )   $ (0.03 )

Diluted net loss per share

  $ (0.17 )   $ (0.03 )
                 

Basic weighted average common shares outstanding

    116,505       116,042  

Diluted weighted average common shares outstanding

    116,505       116,042  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
4

 

 

BPZ Resources, Inc. (Debtor in Possession) and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

   

For the Three Months Ended

March 31,

   

2015

   

2014

 
                 

Cash flows from operating activities:

               

Net loss

  $ (19,767 )   $ (3,570 )

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

               

Stock-based compensation

    573       834  

Depreciation, depletion and amortization

    4,458       6,612  

Amortization of investment in Ecuador property

    8       8  

Deferred income taxes

    123       1,344  

Amortization of discount and deferred financing fees

    1,741       2,218  

Gain on derivatives

    -       (30 )

Other non-cash items included in net loss

    10       (16 )

Changes in operating assets and liabilities:

               

Increase in accounts receivable

    (1,714 )     (10,334 )

(Increase) decrease in value-added tax receivable

    (2,441 )     1,559  

Decrease in inventory

    363       2,007  

Increase in other assets

    (928 )     (99 )

(Increase) decrease in income taxes receivable

    1,211       (76 )

Increase in accounts payable

    784       3,266  

Increase (decrease) in accrued liabilities

    5,245       (5,488 )

Increase (decrease) in other liabilities

    (2,611 )     38  

Net cash used in operating activities

    (12,945 )     (1,727 )
                 

Cash flows from investing activities:

               

Property and equipment additions

    (21,193 )     (9,166 )

Net cash used in investing activities

    (21,193 )     (9,166 )
                 

Cash flows from financing activities:

               

Proceeds from sale of common stock, net

    2       11  

Net cash provided by financing activities

    2       11  
                 

Net decrease in cash and cash equivalents

    (34,136 )     (10,882 )

Cash and cash equivalents at beginning of period

    62,149       57,395  

Cash and cash equivalents at end of period

  $ 28,013     $ 46,513  
                 

Supplemental cash flow information:

               

Cash paid for:

               

Interest

  $ -     $ 9,143  

Income tax

    105       700  

Non — cash items:

               

Depletion allocated to production inventory

    269       277  

Asset retirement obligation capitalized to property and equipment, net of revisions

    28       67  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
5

 

 

BPZ Resources, Inc. (Debtor in Possession) and Subsidiaries

Notes To Consolidated Financial Statements

(Unaudited)

 

Note 1 - Basis of Presentation and Significant Accounting Policies

 

Organization 

 

BPZ Resources, Inc., (together with its subsidiaries, collectively referred to as the “Company” or “BPZ” unless the context requires otherwise; references herein to “Debtor” refer only to BPZ Resources, Inc.) a Texas corporation, is based in Houston, Texas with offices in Lima, Peru, Zorritos, Peru, Quito, Ecuador and an office in Victoria, Texas. The Company is an independent oil and gas company focused on the exploration, development and production of oil and natural gas in Peru, and to a lesser extent, Ecuador. The Company also intends to utilize part of its planned future natural gas production as a supply source for the complementary development of a gas-fired power generation facility which may be wholly-owned or partially-owned by the Company, or may be wholly-owned by a third party.

 

The Company maintains a subsidiary, BPZ Exploración & Producción S.R.L. (“BPZ E&P”), registered in Peru through its wholly-owned subsidiary, BPZ Energy, LLC, a Texas limited liability company, and its subsidiary, BPZ Energy International Holdings, L.P., a British Virgin Islands limited partnership. Currently, the Company, through BPZ E&P, has license agreements for oil and gas exploration and production covering a total of approximately 2.2 million gross (1.9 million net) acres, in four blocks, in northwest Peru and off the northwest coast of Peru in the Gulf of Guayaquil. The Company’s license contracts cover ownership of the following properties: 51% working interest in Block Z-1 (0.6 million gross acres), 100% working interest in Block XIX (0.5 million gross acres), 100% working interest in Block XXII (0.9 million gross acres) and 100% working interest in Block XXIII (0.2 million gross acres). The Block Z-1 contract was signed in November 2001, the Block XIX contract was signed in December 2003 and the Blocks XXII and XXIII contracts were signed in November 2007. Generally, according to the Organic Hydrocarbon Law No. 26221 and the regulations thereunder (the “Organic Hydrocarbon Law” or “Hydrocarbon Law”) the seven-year term for the exploration phase can be extended in each contract by up to an additional three years to a maximum of ten years. However, this exploration extension is subject to government approval and specific provisions of each license contract can vary the exploration phase of the contract as established by the Hydrocarbon Law. The license contracts require the Company to conduct specified activities in the respective blocks during each exploration period in the exploration phase. If the exploration activities are successful, the Company may decide to enter the exploitation phase and the total contract term can extend up to 30 years for oil production and up to 40 years for gas production. In the event a block contains both oil and gas, as is the case in the Company’s Block Z-1 contract, the 40-year term may apply to oil production as well. The Company’s estimate of proved reserves has been prepared under the assumption that the Company’s license contract will allow production for the possible 40-year term for both oil and gas.

 

The Company owns a 10% non-operating net profits interest in an oil and gas producing property, Block 2, located in the southwest region of Ecuador (the “Santa Elena Property”). In May 2013, the license agreement and operating agreement covering the property were extended from May 2016 to December 2029.

 

The Company is in the process of developing its Peruvian oil and gas reserves.  The Company entered commercial production for Block Z-1 in November 2010 and produces and sells oil from the Corvina and Albacora fields under the Company’s current sales contracts with Petroleos del Peru - PETROPERU S.A. (“Petroperu”). The Company completed the installation and permitting of the CX-15 platform in the Corvina field in November 2012 to continue the development of the field. In July 2013, the Company spudded its first development well from the CX-15 platform and have completed drilling eight wells from the CX-15 platform. The Company also spudded a new development well from the A platform in the Albacora field in Block Z-1 in September 2013 and have completed drilling five wells thereafter from the A platform. Three onshore shallow exploration wells, ranging in depth from 3,500 to 3,800 feet, were drilled in Block XXIII during 2014. The Company is planning to pursue a long term testing program in these Block XXIII prospects, starting with Piedra Candela, and potentially sell the tested gas under a pilot program to the local communities.

 

On December 14, 2012, Perupetro S.A (“Perupetro”), a corporation owned by the Peruvian government empowered to become a party in the contracts for the exploration and/or exploitation of hydrocarbons in order to promote these activities in Peru, approved the terms of the amendment to the Block Z-1 License Contract to recognize the sale of a 49% participating interest (“closing”) in offshore Block Z-1 to Pacific Rubiales Energy Corp. (“Pacific Rubiales”). Under the terms of the agreements signed on April 27, 2012, the Company (together with its subsidiaries) formed an unincorporated joint venture with a Pacific Rubiales subsidiary, Pacific Stratus Energy S.A., to explore and develop the offshore Block Z-1 located in Peru. On December 30, 2012, the Peruvian Government signed the Supreme Decree for the execution of the amendment to the Block Z-1 License Contract.

 

 

 
6

 

 

Basis of Presentation and Principles of Consolidation

 

The accompanying consolidated financial statements of BPZ Resources, Inc. and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented on a basis consistent with the annual audited consolidated financial statements. All such adjustments are of a normal, recurring nature. All significant transactions between BPZ and its consolidated subsidiaries have been eliminated. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for the entire year. The balance sheet at December 31, 2014 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. These interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

The consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, the consolidated financial statements do not include any adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should the Debtor be unable to continue as a going concern.

 

As a result of the Chapter 11 proceedings, as described below, the satisfaction of the Company’s liabilities and funding of ongoing operations are subject to uncertainty and, accordingly, there is a substantial doubt of the Company’s ability to continue as a going concern.

 

The accompanying consolidated financial statements do not purport to reflect or provide for the consequences of the Chapter 11 Case, other than as set forth under “liabilities subject to compromise” on the accompanying consolidated balance sheet and “reorganization items, net” on the accompanying consolidated statement of operations (see Note 2-Liquidity and Capital Resources). In particular, the consolidated financial statements do not purport to show (1) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (2) as to prepetition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (3) as to shareowners’ equity accounts, the effect of any changes that may be made to the Debtor’s capitalization; or (4) as to operations, the effect of any changes that may be made to the Debtor’s business.

 

Use of Estimates

 

The preparation of the consolidated financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses in the consolidated financial statements, and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates.

 

Estimates of crude oil reserves are the most significant of the Company’s estimates. All of the reserves data in this Form 10-Q are estimates. Reservoir engineering is a subjective process of estimating underground accumulations of crude oil and natural gas. Numerous interpretations and assumptions are made in estimating quantities of proved crude oil and natural gas reserves. The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, reserves estimates may be different from the quantities of crude oil and natural gas that are ultimately recovered.

 

Other items subject to estimates and assumptions include the carrying amounts of property, plant and equipment, including impairments and asset retirement obligations, liabilities subject to compromise, and deferred income tax assets. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment. Current credit market conditions combined with volatile commodity prices have resulted in increased uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined accurately, actual results could differ significantly from management’s estimates.

 

 

 
7

 

 

Reclassification 

 

Certain reclassifications have been made to the 2014 consolidated financial statements to conform to the 2015 presentation. These reclassifications were not material to the accompanying consolidated financial statements.

 

Summary of Significant Accounting Policies

 

The Company provided a summary discussion of significant accounting policies, estimates and judgments in Note-1 and Note-3 to the Notes to Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2014. These interim financial statements should be read in conjunction with the consolidated audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

Recent Accounting Pronouncements  

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), which creates Topic 606, Revenue from Contracts with Customers, and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, ASU 2014-09 supersedes the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs— Contracts with Customers. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, ASU 2014-09 requires enhanced financial statement disclosures over revenue recognition as part of the new accounting guidance. ASU 2014-09 is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is currently evaluating the provisions of ASU 2014-09 and assessing the impact, if any, it may have on its financial position and results of operations. The FASB is currently proposing to delay the effective date by one year.

 

Note 2 — Liquidity and Capital Resources

 

The Company’s consolidated financial statements have been prepared assuming that it will continue as a going concern.  The conditions noted below raise substantial doubt about the Company’s ability to continue as a going concern.  The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

 

Voluntary Reorganization Under Chapter 11

 

Overview

 

The Company has not been profitable since it commenced operations and it requires substantial capital expenditures as the Company advances development projects at Block Z-1 and exploration projects in its other Blocks.  Currently, the Company requires substantial and significant additional financing to continue to fund its capital expenditure program, service its debt obligations, pay its suppliers and service providers and implement its business plan.  The Company’s major sources of funding to date have been debt and equity financing, asset sales and net margin from oil sales.  The severe downturn in the economic climate for the oil and gas industry, increased capital costs and debt service costs for the industry, combined with experiencing less-than-expected operating performance in Block Z-1, have placed an extreme strain on the Company’s cash flow from operations. This has resulted in the inability of the Company to meet its debt obligations, and has made it exceptionally difficult for the Company to obtain reasonable financing. As a result of these events, the Company had to explore restructuring alternatives, which culminated in BPZ Resources, Inc. filing for voluntary reorganization under Chapter 11 of the Bankruptcy Code during the first quarter of 2015, as discussed in further detail below. Because of the risks and uncertainties associated with the Chapter 11 case, the Company cannot predict or quantify the ultimate impact that events occurring during the Chapter 11 case will have on its business, financial condition and results of operations, and there is no certainty as to its ability to continue as a going concern.

 

The Company currently has the following convertible notes outstanding: (i) $59.9 million principal amount of Convertible Notes due 2015 (the “2015 Convertible Notes”), which bear interest semi-annually at a rate of 6.50% per year, and (ii) $168.7 million principal amount of Convertible Notes due 2017 (the “2017 Convertible Notes”), which bear interest semi-annually at a rate of 8.50% per year. The 2015 Convertible Notes matured with repayment of approximately $62 million in principal and interest due on March 1, 2015. The Company’s estimated capital and exploratory expenditures for 2015 call for it to spend approximately $49.0 million, excluding capitalized interest, for its three onshore Blocks in which the Company holds 100% working interests, and its share of the capital and exploratory expenditures for offshore Block Z-1 required under its Joint Venture Agreement with Pacific Rubiales. The carry amount Pacific Rubiales agreed to pay under the joint venture was completed in December 2014 and the Company is now responsible for funding its full share of capital expenditures and joint operating expenditures for Block Z-1.

 

 

 
8

 

 

The price of oil per barrel has dropped dramatically, particularly in the fourth quarter 2014 and continuing in the first quarter 2015, by more than half since its high in June 2014. In mid-October 2014, the Company withdrew its previously announced private placement offer of $150.0 million in senior secured notes due 2019 due to adverse market conditions.

 

On December 8, 2014, the Company received a notification from the New York Stock Exchange (“NYSE”) that the Company had fallen below the NYSE's continued listing standard relating to minimum share price, which requires a minimum average closing price of $1.00 per share over 30 consecutive trading days. The price has remained well below such threshold and the NYSE subsequently notified the Company on March 2, 2015 that it had determined to commence proceedings to delist our common stock.

 

As a result of the aforementioned events and circumstances, in December 2014 the Company engaged the services of Houlihan Lokey Capital Inc. and Stroock & Stroock & Lavan LLP (the “Advisors”) to assist it in analyzing various strategic alternatives and addressing the Company’s liquidity and capital structure, and formed a special committee of the Board of Directors to work with the Advisors. The Company engaged in discussions with representatives of its various debt holders regarding, among other items, the potential terms under which one or both bond issues could be restructured to provide a capital structure which would allow the Company to continue developing its oil and gas assets.  The Company has also pursued discussions with other potential investors regarding alternative financing solutions.  The Company decided that it was in the best long-term interest of all stakeholders, both credit and equity holders, to expeditiously address the Company's capital structure with the goal of reducing debt and the cost of capital to position the Company for the future, and on March 2, 2015 announced that it had decided not to pay approximately $62 million in principal and interest due on March 1, 2015 on its 2015 Convertible Notes and to use a 10-day grace period on principal due and a 30-day grace period on interest due to continue discussions with its debt holders.

 

The Company was unable to reach a mutually agreeable solution within the grace period for the principal amount due on the 2015 Convertible Notes and elected not to make the approximate $59.9 million in principal payment due at the end of the grace period for principal due. As a result, the Company is in default under the 2015 Convertible Notes, permitting the trustee for the 2015 Convertible Notes or the holders of at least 25% in aggregate principal amount of the outstanding 2015 Convertible Notes to declare the full amount of the principal and interest thereunder immediately due and payable.

 

On March 9, 2015 (the “Petition Date”), BPZ Resources, Inc. (the “Debtor”) filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”) to provide more time to find an appropriate solution to its financial situation and implement a plan of reorganization aimed at improving its capital structure (the "Chapter 11 case"). The Chapter 11 case is being administered by the Bankruptcy Court as Case No. 15-60016.

 

The filing of the Chapter 11 case constituted an event of default that triggered repayment obligations under the 2015 Convertible Notes and the 2017 Convertible Notes, permitting the trustee or the holders of at least 25% in aggregate principal amount of the outstanding 2017 Convertible Notes to also declare the full amount of the principal and interest thereunder immediately due and payable. The ability of the holders of the 2015 Convertible Notes and the 2017 Convertible Notes to seek remedies and enforce their rights under the indentures was automatically stayed as a result of the filing of the Chapter 11 case, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

 

Since the Petition Date, the Debtor has operated its business as a “debtor-in-possession” under the jurisdiction of the Bankruptcy Court and the applicable provisions of the Bankruptcy Code, which will allow the Debtor to continue operations during the reorganization proceedings.  The Debtor will remain in possession of its assets and properties, and its business and affairs will continue to be managed by its directors and officers, subject in each case to the supervision of the Bankruptcy Court. The Bankruptcy Court has also granted relief giving the Debtor the authority to take a broad range of actions, including, among others, authority to maintain bank accounts and the cash management system, pay certain employee obligations, post-petition utilities and other customary relief to continue Debtor’s operations.

 

None of the Debtor’s direct or indirect subsidiaries or affiliates has filed for reorganization under Chapter 11 and none is expected to file for reorganization or protection from creditors under any insolvency or similar law in the U.S. or elsewhere. The Debtor’s subsidiaries will continue to operate outside of any reorganization proceedings. The Company therefore does not expect the Debtor’s filing of Chapter 11 protection to impact its license agreements.

 

 

 
9

 

 

While operating as a debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Debtor may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or otherwise as permitted in the ordinary course of business. Moreover, the Debtor has not yet filed a plan of reorganization with the Bankruptcy Court. The Debtor currently retains the exclusive right to propose a plan of reorganization under section 1121(d) of the Bankruptcy Code. The ultimate plan of reorganzation, which would be subject to acceptance by the requisite majorities of empowered creditors under the Bankruptcy Code and Bankruptcy Court approval, will likely materially change the amounts and classifications in the Company's Consolidated Financial Statements. No assurance can be given as to the value, if any, that may be ascribed to the Debtor’s various prepetition liabilities and other securities. The Company cannot predict what the ultimate value of any of its securities may be and it remains too early to determine whether holders of any such securities will receive any distribution in the Debtor’s reorganization. In particular, in most cases under Chapter 11 of the Bankruptcy Code, holders of equity securities receive little or no recovery of value from their investment. Accordingly, the Debtor urges that caution be exercised with respect to existing and future investments in any of these securities or other Debtor claims. Our common stock currently only trades in the over-the-counter market on the OTC Pink Marketplace. From March 3, 2015 through March 11, 2015 the Company traded under the symbol “BPZR.” Currently, the Company is traded under the symbol “BPZRQ.”

 

General Information

 

Notices to Creditors; Effect of Automatic Stay. The Debtor has notified all known current or potential creditors that the Chapter 11 Case was filed. Subject to certain exceptions under the Bankruptcy Code, the filing of the Debtor’s Chapter 11 Case automatically enjoined, or stayed, the continuation of most judicial or administrative proceedings or filing of other actions against the Debtor or its property to recover on, collect or secure a claim arising prior to the Petition Date. Thus, for example, most creditor actions to obtain possession of property from the Debtor, or to create, perfect or enforce any lien against the property of the Debtor, or to collect on monies owed or otherwise exercise rights or remedies with respect to a prepetition claim, are enjoined unless and until the Bankruptcy Court lifts the automatic stay as to any such claim. Vendors are being paid for goods furnished and services provided after the Petition Date in the ordinary course of business.

 

Appointment of Creditors’ Committee

 

On April 14, 2015, the U.S. Trustee appointed a statutory official committee of unsecured creditors (the Creditors’ Committee) for the Chapter 11 Case.

 

Executory Contracts

 

Under Section 365 and other relevant sections of the Bankruptcy Code, the Debtor may assume, assume and assign, or reject certain executory contracts, subject to the approval of the Bankruptcy Court, and certain other conditions. 

 

In general, rejection of an executory contract is treated as a pre-petition breach of the executory contract in question and, subject to certain exceptions, relieves the Debtor from performing its future obligations under such executory contract but entitles the contract counterparty or lessor to a pre-petition general unsecured claim for damages caused by such deemed breach. Counterparties to such rejected contracts have the right to file claims against the Debtor's estate for such damages. Generally, the assumption of an executory contract requires the Debtor to cure existing defaults under such executory contract.

 

Any description of an executory contract elsewhere in this report or reflected in the Notes to the Consolidated Financial Statements, including where applicable the Debtor's express termination rights or a quantification of its obligations, must be read in conjunction with, and is qualified by, any rights the Debtor or counterparties have under Section 365 of the Bankruptcy Code.

 

The Debtor expects that liabilities subject to compromise and resolution in the Chapter 11 Case will arise in the future as a result of damage claims created by the Debtor's rejection of various executory contracts. Due to the uncertain nature of many of the potential rejection claims, the magnitude of such claims is not reasonably estimable at this time. Such claims may be material. See “Liabilities Subject to Compromise” in this Note 2.

 

Magnitude of Potential Claims

 

On April 22, 2014, the Debtor filed with the Bankruptcy Court schedules and statements of financial affairs setting forth, among other things, the assets and liabilities of the Debtor, subject to the assumptions filed in connection therewith. All of the schedules are subject to further amendment or modification.

 

Rule 3003(c)(3) of the Federal Rules of Bankruptcy Procedure requires the Bankruptcy Court to fix the time within which proofs of claim must be filed in a Chapter 11 case pursuant to Section 501 of the Bankruptcy Code. This Rule also provides that any creditor who asserts a claim against the Debtor that arose prior to the Petition Date and whose claim (i) is not listed on the Debtor’s schedules or (ii) is listed on the schedules as disputed, contingent, or unliquidated, must file a proof of claim. The Bankruptcy Court has not yet established a date and time by which such proofs of claim must be filed.

 

 

 
10

 

 

Differences between amounts scheduled by the Debtor and claims by creditors will be investigated and resolved in connection with the claims resolution process. In light of the expected number of creditors, the claims resolution process may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims is not presently known, nor can the ultimate recovery with respect to allowed claims be presently ascertained. 

 

Plan of Reorganization.

 

The Debtor has not yet filed a plan of reorganization with the Bankruptcy Court. The Debtor has the exclusive right to file a plan of reorganization through and including July 7, 2015, and to solicit votes on such a plan if filed by such date through and including September 4, 2015, subject to the ability of parties in interest to file motions seeking to terminate the Company's exclusive periods, as well as the Debtor 's right to seek further extensions of such periods. The Debtor has a right to seek further extensions of such exclusive periods, subject to the statutory limit of 18 months from the Petition Date in the case of filing a plan and 20 months in the case of soliciting and obtaining acceptances of such a plan. The implementation of a plan of reorganization is subject to confirmation of the plan by the Bankruptcy Court in accordance with the provisions of the Bankruptcy Code, and the occurrence of the effective date under the plan. At this time, there is no certainty as to when or if a plan will be filed, the provisions of a plan (including provisions with respect to the treatment of prepetition claims and equity interests), or whether a plan will be confirmed and become effective.

 

Under certain circumstances set forth in Section 1129(b) of the Bankruptcy Code, the Bankruptcy Court may confirm a plan even if such plan has not been accepted by all impaired classes of claims and equity interests - a process known as “cram down”. A class of claims or equity interests that does not receive or retain any property under the plan on account of such claims or interests is deemed to have voted to reject the plan. The precise requirements and evidentiary showing for confirming a plan notwithstanding its rejection by one or more impaired classes of claims or equity interests depends upon a number of factors, including the status and seniority of the claims or equity interests in the rejecting class (i.e., secured claims or unsecured claims, subordinated or senior claims, preferred or common stock). Generally, with respect to common stock interests, a plan may be “crammed down” even if the shareholders receive no recovery if the proponent of the plan demonstrates that: (i) no class junior to the common stock is receiving or retaining property under the plan; and (ii) no class of claims or interests senior to the common stock is being paid more than in full.

 

The availability and utilization of net operating losses post-emergence is uncertain at this time and will be highly influenced by the composition of restructuring plan alternatives that may be considered and ultimately pursued.

 

Debtor Condensed Financial Statements

 

The following condensed financial statements of the Debtor are shown below. The Debtor’s condensed financial statements include amounts due from related non-Debtors.

 

Condensed Balance Sheet

       
   

March 31,

 
   

2015

 

 

 

(In thousands)

 
ASSETS        

Current assets:

  $ 11,146  

Investment in and long-term receivables from subsidiaries (1)

    226,998  

Total assets

  $ 238,144  

LIABILITIES AND STOCKHOLDERS’ EQUITY

       

Current liabilities:

       

Accounts payable

  $ 7  

Accrued liabilities

    615  

Total current liabilities

    622  

Liabilities subject to compromise (2)

    223,316  

Total stockholders’ equity

    14,206  

Total liabilities and stockholders’ equity

  $ 238,144  

 

 

(1)

It is expected that upon consummation of the Chapter 11 Case, all intercompany receivables and payables will be offset and settled through equity contributions.  No allowances for intercompany receivables from the Debtor has been recorded in the consolidated financial statements.

 

(2)

See below for information on Liabilities subject to compromise.

 

 

 
11

 

 

Condensed Statement of Operations

       
   

Three Months

Ended March 31,

 
   

2015

 
   

(In thousands)

 

Intercompany revenue

  $ 2,712  

Operating and administrative expenses:

       

General and administrative expense

    2,648  

Geological, geophysical and engineering expense

    507  

Total operating and administrative expenses

    3,155  
         

Operating loss

    (443 )

Other income (expense):

       

Interest expense, net

    (5,974 )

Other financing costs

    (3,886 )

Equity in net loss of subsidiaries

    (9,022 )

Interest income

    2  

Other expense

    (9 )

Total other expense, net

    (18,889 )

Reorganization items, net (3)

    (51 )

Loss before income taxes

    (19,383 )

Income tax expense

    384  

Net loss

  $ (19,767 )

 

 

 

 

(3)

See below for information on Reorganization items, net.

 

Condensed Statement of Cash Flows

       
   

For the Three Months Ended

 
   

March 31,

 
   

2015

 
   

(In thousands)

 
Net cash provided by (used in)        

Net cash provided by (used in) operating activities

  $ (3,999 )

Net cash provided by (used in) investing activities

    (21,376 )

Net cash provided by (used in) financing activities

    2  

Net increase (decrease) in cash and cash equivalents

    (25,373 )
         

Cash and cash equivalents at beginning of period

    36,370  
         

Cash and cash equivalents at end of period

  $ 10,997  

 

 

 
12

 

 

 

 

Liabilities Subject to Compromise

 

The following table summarizes the components of liabilities subject to compromise included on the consolidated balance sheet as of March 31, 2015:

 

   

March 31,

2015

 
   

(in thousands)

 

Debt, net

  $ 214,109  

Accrued liabilities

    90  

Accrued interest payable

    9,117  

Liabilities subject to compromise

  $ 223,316  

 

 

Debt, including undersecured debt, classified as subject to compromise as of March 31, 2015 consisted of:

 

   

March 31,

2015

 
   

(in thousands)

 

Convertible Notes due 2017

  $ 154,219  

Convertible Notes due 2015

    59,890  

Debt, net

  $ 214,109  

 

 

Debt is reported net of unamortized discount and the remaining debt issue costs.

 

Liabilities subject to compromise refers to prepetition obligations which may be impacted by the Chapter 11 reorganization process. These amounts represent the Debtor’s current estimate of known or potential prepetition obligations to be resolved in connection with the Chapter 11 Case.

 

All of the Company’s unsecured debt has been classified as liabilities subject to compromise. 

 

Differences between liabilities the Debtor has estimated and the claims filed, or to be filed, will be investigated and resolved in connection with the claims resolution process. The Company will continue to evaluate these liabilities throughout the Chapter 11 proceedings and adjust amounts as necessary. Such adjustments may be material. In light of the expected number of creditors, the claims resolution process may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims is not presently known.

 

 

Reorganization Items, net

 

Reorganization items include expenses (including professional fees), realized gains and losses and provisions for losses that are realized or incurred as a direct result of the Chapter 11 proceedings.

 

The following table summarizes the components included in reorganization items, net on the consolidated statements of operations for the three months ended March 31, 2015:

 

 

   

March 31,

 
   

2015

 
   

(in thousands)

 

Professional fees

  $ (51 )

Reorganization items, net

  $ (51 )

 

 

 

 
13

 

 

 

Note 3 — Divestiture

 

On April 27, 2012, the Company and Pacific Rubiales (together with its subsidiaries) executed a SPA under which the Company formed an unincorporated joint venture with Pacific Rubiales to explore and develop the offshore Block Z-1 located in Peru. Pursuant to the SPA, Pacific Rubiales agreed to pay $150.0 million for a 49% participating interest, including reserves, in Block Z-1 and agreed to fund $185.0 million of the Company’s share of capital and exploratory expenditures in Block Z-1 from the effective date of the SPA, January 1, 2012. In order to finalize the joint venture, Peruvian governmental approvals were needed to allow Pacific Rubiales to become a party to the Block Z-1 License Contract. Until the required approvals were obtained, Pacific Rubiales provided a $65.0 million down payment on the purchase price and other funds which the Company initially accounted for as loans to continue to fund the Company’s Block Z-1 capital and exploratory activities. These amounts were reflected as long-term debt prior to closing the transaction. On December 30, 2012, the Peruvian Government signed the Supreme Decree for the execution of the amendment to the Block Z-1 License Contract.

 

The development of Block Z-1 is subject to the terms and conditions of a Joint Operating Agreement with Pacific Rubiales that governs the legal, technical and operating rights and obligations of the parties with respect to the operation of Block Z-1. Under the agreement, the Company is the operator and responsible for the administrative, regulatory, government and community related duties, and Pacific Rubiales manages the technical and operating duties in Block Z-1. The Joint Operating Agreement will continue for the term of the License Contract and thereafter until all decommissioning obligations under the License Contract have been satisfied.

 

The carry amount Pacific Rubiales agreed to pay under the joint venture was completed in December 2014 and the Company is now responsible for funding our full share of capital expenditures and joint operating expenditures for Block Z-1.

 

At March 31, 2015 and December 31, 2014, the Company reflected $19.9 million and $22.5 million, respectively, as other current liabilities for exploratory expenditures related to Block Z-1 under funding by Pacific Rubiales of the exploratory expenditures in Block Z-1 incurred in 2012.

 

Note 4 — Receivables, Accounts Payable and Accrued Liabilities

 

Accounts Receivable

 

Below is a summary of accounts receivable as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Commodity sales

  $ 2,887     $ 1,473  

Other

    749       449  

Accounts receivable

  $ 3,636     $ 1,922  

 

 

At March 31, 2015 and December 31, 2014, accounts receivable other consisted of $0.3 million and $0.3 million due to the Company from the Company’s joint venture partner for services and materials provided directly to the joint venture partner.

 

Income Taxes Receivable

 

The Company’s March 31, 2015 and December 31, 2014, income tax receivable amounts were $0.2 million and $2.1 million, respectively.

 

Value-Added Tax Receivable

 

Value-added tax (referred to as “IGV” in Peru) is generally imposed on goods and services at a rate of 18%.

 

The Company is recovering its IGV receivable with IGV payables associated with oil sales under the normal IGV recovery process.

 

 
14 

 

 

Activity related to the Company’s value-added tax receivable for the three months ended March 31, 2015 and the year ended December 31, 2014 is as follows:

 

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Value-added tax receivable as of the beginning of the period

  $ 4,493     $ 12,262  

IGV accrued related to expenditures during period

    4,965       13,943  

IGV reduced related to sale of oil during period

    (2,523 )     (21,712 )

Value-added tax receivable as of the end of the period

  $ 6,935     $ 4,493  
                 

Current portion of value-added tax receivable as of the end of the period

  $ 4,728     $ 2,343  
                 

Long-term portion of value-added tax receivable as of the end of the period

  $ 2,207     $ 2,150  

 

See Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets” for further information on the long-term portion of the value-added tax receivable.

 

Accounts Payable and Accrued Liabilities

 

Below is a summary of accounts payable as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Accounts payable - joint venture

  $ 4,679     $ 2,947  

Other accounts payable

    485       1,433  

Accounts payable

  $ 5,164     $ 4,380  

 

 

The March 31, 2015 and December 31, 2014 accrued liabilities amounts were $7.4 million and $6.5 million, respectively.

 

Note 5 — Inventory

 

Inventories consist of crude oil, tubular goods, accessories and spare parts for production equipment, stated at the lower of average cost or market.

 

The Company maintains crude oil inventories in storage vessels until the inventory quantities are at a sufficient level to make a delivery to the refinery in Talara.  Crude oil inventory is stated at the lower of average cost or market value. Cost is determined on a weighted average basis based on production costs.

 

Below is a summary of inventory as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Tubular goods, accessories and spare parts

  $ 9,800     $ 9,854  

Crude oil

    1,984       2,024  

Inventory

  $ 11,784     $ 11,878  

 

   

March 31,

2015

   

December 31,

2014

 

Crude oil (barrels)

    36,011       42,087  

Crude oil (cost per barrel)

  $ 55.10     $ 48.09  

 

 

 

 
15

 

 

Note 6 — Prepaid and Other Current Assets and Other Non-Current Assets

 

Below is a summary of prepaid and other current assets as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Prepaid expenses and other

  $ 4,626     $ 3,184  

Prepaid insurance

    462       976  

Debt issue costs, net

    -       1,944  

Prepaid and other current assets

  $ 5,088     $ 6,104  

 

 

Prepaid expenses and other are related to prepayments for drilling services, equipment rental and material procurement, debt issue costs, net, certain tax receivables and deposits that are rent deposits in connection with the Company’s offices in Houston and Peru. Prepaid insurance consists of premiums related to the Company’s operations as well as general liability and directors’ and officers’ insurance policies.

 

Below is a summary of other non-current assets as of March 31, 2015 and December 31, 2014:

 

   

March 31,

   

December 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Debt issue costs, net

  $ -     $ -  

Value-added tax receivable

    2,207       2,150  

Other non-current assets

  $ 2,207     $ 2,150  

 

 

Debt issue costs, net, consist of direct transaction costs incurred by the Company in connection with its debt raising efforts, less the amortization of the debt issuance costs to date.

 

As a result of the Company being in default under the 2015 Convertible Notes and the 2017 Convertible Notes and the Debtor’s voluntarily filing for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 2015, the Company’s debt issue costs has been netted in Liabilities subject to compromise at March 31, 2015. Based on the outcome of the Bankruptcy Court proceedings, the debt issue costs may have no future benefit to the Company and may be written off. The Company’s debt issue costs were classified as a current asset at December 31, 2014.

 

The debt issue costs, net associated with the 2015 Convertible Notes and the 2017 Convertible Notes were zero and $1.7 million at March 31, 2015, respectively, and these amounts were classified as Liabilities subject to compromise. The debt issue costs, net associated with the 2015 Convertible Notes and the 2017 Convertible Notes were $0.1 million and $1.8 million at December 31, 2014, respectively, and these amounts were classified as prepaid and other current assets.

 

The following table shows the amount of debt issue costs amortized into interest expense for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Amortization of debt issue costs

  $ 266     $ 374  
    $ 266     $ 374  

 

 

For further information regarding the Company’s debt, see Note-11, “Debt Obligations.”

 

At March 31, 2015 and December 31, 2014, the Company classified $2.2 million and $2.2 million, respectively, of its value-added tax receivable balance as a long-term asset as it believed it would take longer than one year to receive the benefit of this portion of the value-added tax receivable. For further information, see Note-4, “Receivables, Accounts Payable and Accrued Liabilities.”

 

 

 
16

 

 

Note 7 — Property, Equipment and Construction in Progress

 

Below is a summary of property, equipment and construction in progress as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Construction in progress:

               

Power plant and related equipment

  $ 32,801     $ 32,801  

Platforms and wells

    45,786       30,363  

Pipelines and processing facilities

    880       892  

Other

    2,328       216  

Producing properties (successful efforts method of accounting)

    150,749       147,071  

Producing equipment

    40,316       40,315  

Barge and related equipment

    34,289       34,289  

Office equipment, leasehold improvements and vehicles

    9,139       9,131  

Accumulated depletion, depreciation and amortization

    (133,758 )     (129,107 )

Property, equipment and construction in progress, net

  $ 182,530     $ 165,971  

 

 

The Company follows the “successful efforts” method of accounting for its costs of acquisition, exploration and development of oil and gas properties. Under this method, oil and gas lease acquisition costs and intangible drilling costs associated with exploration efforts that result in the discovery of proved reserves and costs associated with development drilling, whether or not successful, are capitalized when incurred. Capitalized costs of producing crude oil and natural gas properties, along with support equipment and facilities, are amortized to expense by the unit-of-production method based on proved developed crude oil reserves on a field-by-field basis. Certain costs of exploratory wells are capitalized pending determinations that proved reserves have been found. Exploratory well costs continue to be capitalized if the well has found a sufficient quantity of reserves to justify its completion as a producing well and the Company is making sufficient progress assessing the reserves and the economic and operating viability of the project. If the determination is dependent upon the results of planned additional wells and required capital expenditures to produce the reserves found, the drilling costs will be capitalized as long as sufficient reserves have been found to justify completion of the exploratory well and the additional wells are underway or planned. All costs related to unsuccessful exploratory wells are expensed when such wells are determined to be non-productive.

 

Suspended Exploratory Well Costs

 

Exploratory well costs capitalized greater than one year after completion of drilling were $6.6 million as of March 31, 2015, and December 31, 2014. The exploratory well costs relate to the CX11-16X gas well that was drilled in 2007, which tested sufficient quantities of gas and is currently shut-in until such time as a market is established for selling the gas. The Company plans to use the gas from the CX11-16X well for its gas-to-power project. See Note-18, “Commitments and Contingencies” for further information on the gas-to-power project.

 

Capital Expenditures

 

During the three months ended March 31, 2015, the Company incurred capital expenditures of approximately $21.2 million associated with its development initiatives for the exploration and production of oil and natural gas reserves in Peru.

 

The capital expenditures added were approximately $6.8 million related to the CX-15 development drilling program, approximately $6.5 million related to the development drilling program in Albacora, approximately $2.2 million related to the Delfin platform, approximately $1.6 million related to the Albacora gas compressor, approximately $1.1 million related to the Piedra Redonda platform, approximately $0.4 million related to the CX-15 platform and other capital expenditures of $2.6 million. There was no interest capitalized for the three months ended March 31, 2015.

 

In the first quarter of 2015 the Company agreed with its Block Z-1 partner and Perupetro to delay the installation of the Delfin platform, the Piedra Redonda platform and drilling of the Delfin well. The Company will be storing the platforms in the Gulf Island yards in Houma, Louisiana for a period of approximately twelve to eighteen months.

 

Asset Impairments

 

There were no asset impairment for the three months ended March 31, 2015 and March 31, 2014.

 

 
17

 

 

The following table shows the amount of interest expense capitalized to construction in progress for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense capitalized

  $ -     $ 2,870  

 

 

Note 8 — Asset Retirement Obligation

 

An obligation was recorded for the future plug and abandonment of the oil wells in the Corvina and Albacora fields in Block Z-1, the Pampa la Gallina well in Block XIX, the Caracol 1X well, the Cardo 2X well and the Piedra Candela 3X well in Block XXIII in accordance with the provisions of ASC Topic 410, “Asset Retirement and Environmental Obligations.” ASC 410-20 requires that an asset retirement obligation (“ARO”) associated with the retirement of a tangible, long-lived asset be recognized as a liability in the period in which it is incurred and becomes determinable. Under this method, when liabilities for dismantlement and abandonment costs, excluding salvage values, are initially recorded, the carrying amount of the related oil and natural gas properties is increased. The fair value of the ARO asset and liability is measured using expected future cash outflows discounted at the Company’s credit-adjusted risk-free interest rate. Accretion of the liability is recognized each period using the interest method of allocation, and the capitalized cost is depleted using the units of production method. Should either the estimated life or the estimated abandonment costs of a property change materially upon the Company’s periodic review, a new calculation is performed using the same methodology of taking the abandonment cost and inflating it forward to its abandonment date and then discounting it back to the present using the Company’s credit-adjusted-risk-free rate. The carrying value of the ARO is adjusted to the newly calculated value, with a corresponding offsetting adjustment to the asset retirement cost. Any negative adjustment in excess of asset retirement cost is reclassified to depreciation, depletion, and amortization expense.

 

Activity related to the Company’s ARO for the three months ended March 31, 2015 and the year ended December 31, 2014 is as follows:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

ARO as of the beginning of the period

  $ 5,330     $ 1,564  

Liabilities incurred during period

    214       2,800  

Accretion expense

    77       133  

Revisions in estimates during period

    (187 )     833  

ARO as of the end of the period

  $ 5,434     $ 5,330  

 

 

The 2014 revisions in estimates are due to the change in estimates of future costs and the shift in timing of cash flows associated with expected payment of the ARO liability.  As a revision to estimated costs in 2014, the present value of the liabilities was adjusted and, as a result, the Company adjusted both the liability and capitalized asset. Any negative adjustment in excess of asset retirement cost is reclassified to depreciation, depletion, and amortization expense.

 

Note 9 — Investment in Ecuador Property

 

The Company has a 10% non-operating net profits interest in the Santa Elena Property an oil and gas property in Ecuador. The Company accounts for this investment under the cost method and records its share of cash received as other income. Since the Company’s investment represents ownership of an oil and gas property, which is a depleting asset, the Company is amortizing the cost of the investment on a straight-line basis over the remaining term of the agreement, which expires in December 2029.

  

 

 
18

 

 

Below is a summary reflecting the Company’s income (loss) from the investment in the Ecuador property for the three months ended March 31, 2015 and 2014, respectively, and the investment in the Ecuador property at March 31, 2015 and December 31, 2014, respectively.

 

   

Three Months Ended

March 31,

 
   

2015

   

2014

 
                 

Distributions received from investment in Ecuador property

  $ -     $ -  

Amortization of investment in Ecuador property

    (8 )     (8 )

Loss from investment in Ecuador property, net

  $ (8 )   $ (8 )

 

   

March 31,

   

December 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Investment in Ecuador property, net

  $ 493     $ 501  

 

 

In 2013, in order to extend the term of the contract from 2016 to 2029, the Consortium, which includes the Company and three other partners, agreed to additional work commitments to increase production in the Santa Elena field. The Company’s total share of this commitment over the remaining life of the contract is $4.9 million (the Company’s 10% non-operating net profits interest) which amount is due throughout the period of 2015 through 2028. This commitment is expected to be funded by cash on hand, cash generated from new production, or loans of the Consortium. If the Consortium does not have sufficient cash on hand, the Company may elect to make a cash contribution to the Consortium for its 10% share of the commitment. If the Company elects not to make its 10% share contribution of the commitment, it would lose its rights in the Consortium and the contract for the Santa Elena field.

 

In the fourth quarter of 2014, the Consortium incurred a loan for the additional work commitments to increase production in the Santa Elena field. The Consortium loan is to be paid with cash generated from the production of the Santa Elena Field. The Company’s total share of this loan would be $0.9 million (our 10% non-operating net profits interest) which amounts are due quarterly through the fourth quarter of 2017. If the Consortium does not have sufficient cash on hand, the Company would make a cash contribution to the Consortium for its 10% share of this loan.

 

Note 10 — Restricted Cash and Performance Bonds

 

Below is a summary of restricted cash as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Performance bonds totaling $5.7 million for properties in Peru

  $ 1,559     $ 1,559  

Performance obligations and commitments for the gas-to-power site

    650       650  

Unsecured performance bond totaling $0.1 million for office lease agreement

    -       -  

Restricted cash

  $ 2,209     $ 2,209  
                 

Current portion of restricted cash as of the end of the period

  $ -     $ -  
                 

Long-term portion of restricted cash as of the end of the period

  $ 2,209     $ 2,209  

 

 

All of the performance and insurance bonds are issued by Peruvian banks and their terms are governed by the corresponding license contracts, customs laws, legal requirements or rental practices.

 

 

 
19

 

 

 

 

Note 11 — Debt Obligations

 

At March 31, 2015 and December 31, 2014, debt consisted of the following:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 
                 

Convertible Notes, 8.5%, due October 2017, net of discount of zero at March 31, 2015 and ($13.9) million at December 31, 2014

  $ -     $ 154,839  

Convertible Notes, 6.5%, due March 2015, net of discount of zero at March 31, 2015 and ($0.4) million at December 31, 2014

    -       59,473  
      -       214,312  

Less: Current maturity of long-term debt

    -       214,312  

Long-term debt, net

  $ -     $ -  

 

 

As a result of the Company’s decision to not pay the principal and interest on the 2015 Convertible Notes when due on March 1, 2015 and after its exercise of a grace period until March 10, 2015, a cross default provision contained in the 2017 Convertible Notes was triggered. In addition, the Debtor voluntarily filed for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 2015, which was also an event of default under both the 2015 Convertible Notes and the 2017 Convertible Notes. Therefore all of the Company’s debt and related interest is considered due and callable once the default provisions were triggered and, all debt has been classified as Liabilities subject to compromise at March 31, 2015 and current liabilities at December 31, 2014.

 

Convertible Notes due 2017

 

During the third quarter of 2013, the Company closed on an offering for an aggregate principal amount of $143.8 million of convertible notes due 2017, which includes the exercise of the underwriter’s option to purchase an additional $18.8 million of the 2017 Convertible Notes in addition to the original offering of $125.0 million. The 2017 Convertible Notes are the Company’s general senior unsecured obligations and rank equally in right of payment with all of the Company’s other existing and future senior unsecured indebtedness and rank senior in the right of payment to all of its existing and future subordinated debt.  The 2017 Convertible Notes are subordinate to any secured indebtedness the Company may have to the extent of the value of the assets collateralizing such indebtedness.  The 2017 Convertible Notes are not guaranteed by the Company’s subsidiaries. In April 2014, $26.0 million of the aggregate principal amount of the 2015 Convertible Notes were exchanged for an additional $25.0 million aggregate principal amount of 2017 Convertible Notes in a private transaction. As a result, the Company had $168.7 million principal amount of 2017 Convertible Notes outstanding at March 31, 2015.

 

The interest rate on the 2017 Convertible Notes is 8.50% per year with interest payments due on April 1st and October 1st of each year.  The 2017 Convertible Notes mature with repayment of the $168.7 million principal amount (assuming no conversion) on October 1, 2017 (the “2017 Maturity Date”).

 

The conversion rate is 249.5866 shares per $1,000 principal amount (equal to an initial conversion price of approximately $4.0066 per share of common stock). Upon conversion, if conversion is elected by the noteholders, the Company must deliver, at its option, either (1) a number of shares of its common stock determined as set forth in the Indenture dated September 24, 2013 (the “2013 Indenture”), (2) cash, or (3) a combination of cash and shares of its common stock.

 

Holders may convert their 2017 Convertible Notes at their option at any time prior to the close of business on the second business day immediately preceding the 2017 Maturity Date under any of the following circumstances:

 

(1) during any fiscal quarter (and only during such fiscal quarter) commencing after October 1, 2013, if the last reported sale price of the Company’s common stock is greater than or equal to 130% of the conversion price of the 2017 Convertible Notes for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter;

 

(2) prior to July 1, 2017, during the five business-day period after any ten consecutive trading-day period in which the trading price of $1,000 principal amount of the 2017 Convertible Notes for each trading day in the measurement period was less than 97% of the product of the last reported sale price of the Company’s common stock and the conversion rate on such trading day; or

 

 
20

 

 

 

(3) upon the occurrence of one of a specified number of corporate transactions.

 

Holders may also convert the 2017 Convertible Notes at their option at any time beginning on July 1, 2017, and ending at the close of business on the second business day immediately preceding the 2017 Maturity Date or may hold the 2017 Convertible Notes to maturity and be paid their outstanding principal in cash.

 

The Company may not redeem the 2017 Convertible Notes prior to the 2017 Maturity Date.

 

The 2013 Indenture for the 2017 Convertible Notes contains customary terms and covenants and events of default, the occurrence and continuation of which could result in the acceleration of amounts due under the 2017 Convertible Notes including (i) an event of default if the Company defaults in the payment when due, after the expiration of any applicable grace period, of indebtedness for money borrowed (including the 2015 Convertible Notes) in the aggregate principal amount then outstanding of $25 million or more, permitting the trustee or the holder of at least 25% in the aggregate principal amount of the outstanding 2017 Convertible Notes to declare the full amount of the principal and interest due thereunder immediately due and payable, and (ii) an event of default if the Company commences a voluntary case under any bankruptcy law, insolvency law or other similar law, whereby the full amount of the principal and interest due thereunder automatically and immediately becomes due and payable. See “—Convertible Notes due 2015” below.

 

Net proceeds from the sale of the 2017 Convertible Notes, after deducting the discounts and commissions and any offering expenses payable by the Company, were approximately $124.5 million.  The 2017 Convertible Notes were issued with a 10% discount or $14.4 million. The underwriter received commissions of approximately $4.3 million in connection with the sale and the Company incurred $0.6 million of direct expenses in connection with the offering.  The Company used the net proceeds for general corporate purposes, including funding its exploration and production efforts, other projects and to reduce or refinance its outstanding debt.

 

The Company accounts for the 2017 Convertible Notes in accordance with ASC Topic 470, “Debt”, as it pertains to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). Under the accounting guidance, convertible debt instruments that may be settled entirely or partially in cash upon conversion are required to be separated into liability and equity components, with the liability component amount determined in a manner that reflects the issuer’s non-convertible debt borrowing rate. The value assigned to the liability component is determined by measuring the fair value of a similar liability that does not have an equity conversion feature. The value assigned to the equity component is determined by deducting the fair value of the liability component from the initial proceeds. The excess of the principal amount of the liability component over its carrying amount (the non-cash discount) is amortized to interest cost using the effective interest method over the term of the 2017 Convertible Notes. In addition, transaction costs incurred that directly relate to the issuance of convertible debt instruments must be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as debt issuance costs and equity issuance costs, respectively.

 

The Company estimated its non-convertible borrowing rate at the date of issuance of the 2017 Convertible Notes to be 12.9%. The 12.9% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as the Company and was obtained through a quote from the underwriter. Using the income method and discounting the principal and interest payments of the 2017 Convertible Notes using the 12.9% non-convertible borrowing rate, the Company estimated the fair value of the $143.8 million 2017 Convertible Notes to be approximately $124.5 million, with the discount being approximately $19.3 million. The discount of $19.3 million includes the 10% discount of $14.4 million and the value of the equity component of $4.9 million. The discount is being amortized as non-cash interest expense over the life of the 2017 Convertible Notes using the effective interest method. In addition, the Company allocated approximately $2.3 million of the $4.9 million of fees and commissions as debt issue costs that are being amortized as non-cash interest expense over the life of the notes using the effective interest method. Approximately $0.1 million of fees and commissions were treated as transaction costs associated with the equity component and the remaining $2.5 million was expensed to other expense under the caption, “Other income (expense)” in the third quarter of 2013.

 

As a result of the exchange during the second quarter of 2014, the Company estimated its non-convertible borrowing rate at the date of issuance of the $25.0 million 2017 Convertible Notes to be 7.89%. The 7.89% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as the Company and was obtained through a quote from a financial advisor. Using the income method and discounting the principal and interest payments of the 2017 Convertible Notes with the 7.89% non-convertible borrowing rate, the Company estimated the fair value of the $25.0 million 2017 Convertible Notes to be approximately $25.4 million, with the premium being approximately $0.4 million. The value of the equity component was estimated at $0.5 million. The premium is being amortized as non-cash interest expense over the life of the 2017 Convertible Notes using the effective interest method. In addition, approximately $0.3 million of fees were considered debt issue costs that are being amortized as a non-cash interest expense over the life of the notes using the effective interest method. The Company recognized a loss on this transaction of approximately $0.9 million and this loss was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the second quarter of 2014. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

 

 
21

 

 

As a result of the Company’s decision to not pay the principal and interest on the 2015 Convertible Notes when due on March 1, 2015 and after exercise of a grace period until March 10, 2015, a cross default provision contained in the 2017 Convertible Notes was triggered. In addition, the Debtor voluntarily filed for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 2015, which was an event of default under both the 2015 Convertible Notes and the 2017 Convertible Notes. Therefore all of the Company’s debt and related interest is considered due and callable once the default provisions were triggered and all debt has been classified as Liabilities subject to compromise at March 31, 2015.

 

The Company evaluated the 2013 Indenture for the 2017 Convertible Notes for potential embedded derivatives, noting that the conversion feature and make-whole provisions did not meet the embedded derivative criteria as set forth in ASC Topic 815, “Derivatives and Hedging”. Therefore, no additional amounts have been recorded for those items.

 

As of March 31, 2015, the net amount of $154.2 million includes the $168.7 million of principal reduced by $12.8 million of the remaining unamortized discount and $1.7 million of the remaining debt issue costs. The remaining unamortized discount of $12.8 million and the remaining debt issue costs of $1.7 million may be written off as a result of the Chapter 11 Case. However, if the structure of the debt remains unchanged after the post Chapter 11 proceedings, the unamortized discount and debt issue costs will be amortized into interest expense, using the effective interest method, over the remaining life of the 2017 Convertible Notes, which mature in October 2017.  The Company is currently in default on its 2015 Convertible Notes. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in Note 2 to our Consolidated Financial Statements under the caption “—Voluntary Reorganization Under Chapter 11”. At March 31, 2015, using the conversion rate of 249.5866 shares per $1,000 principal amount of the 2017 Convertible Notes, if the $168.7 million of principal were converted into shares of common stock, the notes would convert into approximately 42.1 million shares of common stock.  As of March 31, 2014, there is no excess if-converted value to the holders of the 2017 Convertible Notes as the price of the Company’s common stock at March 31, 2015, $0.03 per share, is less than the conversion price.

 

The annual effective interest rate on the 2017 Convertible Notes, including the amortization of debt issue costs, is approximately 12.5%.

 

The following table shows the amount of interest expense related to the 2017 Convertible Notes, disregarding capitalized interest considerations, for the three months ended March 31, 2015 and 2014, respectively:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense related to the contractual interest coupon

  $ 3,585     $ 3,055  

Amortization of debt discount expense

    1,058       959  

Amortization of debt issue costs

    160       135  

Interest expense related to the 2017 Convertible Notes

  $ 4,803     $ 4,149  

 

 

Convertible Notes due 2015

 

During the first quarter of 2010, the Company closed on a private offering for an aggregate principal amount of $170.9 million of convertible notes due 2015. The 2015 Convertible Notes are the Company’s general senior unsecured obligations and rank equally in right of payment with all of the Company’s other existing and future senior unsecured indebtedness.  The 2015 Convertible Notes are subordinate to all of the Company’s secured indebtedness to the extent of the value of the assets collateralizing such indebtedness.  The 2015 Convertible Notes are not guaranteed by the Company’s subsidiaries. In September 2013, the Company repurchased $85.0 million of the aggregate principal amount of the $170.9 million of the 2015 Convertible Notes, leaving a principal balance of $85.9 million. In April 2014, $26.0 million of the aggregate principal amount of the 2015 Convertible Notes were exchanged for an additional $25.0 million aggregate principal amount of 2017 Convertible Notes in a private transaction. As a result, the Company had $59.9 million principal amount of 2015 Convertible Notes outstanding at March 31, 2015.

 

The interest rate on the 2015 Convertible Notes is 6.50% per year with interest payments due on March 1st and September 1st of each year.  The 2015 Convertible Notes mature with repayment of the $59.9 million principal amount (assuming no conversion) on March 1, 2015 (the “2015 Maturity Date”).

 

 

 
22

 

 

The Company elected not to pay the approximately $62 million in principal and interest due on March 1, 2015 on the 2015 Convertible Notes in order to use a 10-day grace period on principal due and a 30-day grace period on interest due to continue discussions with its debt holders regarding potential terms under which either one or both of the 2015 Convertible Notes and 2017 Convertible Notes could be restructured to provide a capital structure which would allow the Company to continue developing our oil and gas assets, and discussions with potential investors regarding alternative financing solutions. The Company was unable to reach an appropriate solution during the grace period and is in default on payment of the principal amount due under its 2015 Convertible Notes due on March 10, 2015 following its exercise of a 10-day grace period, which also triggered an event of default under its 2017 Convertible Notes, allowing the trustee or the holders of at least 25% in aggregate principal amount under each set of notes to declare the full amounts of principal and interest due. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in this Item under the caption “—Voluntary Reorganization Under Chapter 11.” The filing of the Chapter 11 Case also constituted an event of default that triggered repayment obligations under the 2015 Convertible Notes and the 2017 Convertible Notes. The ability of the holders of the 2015 Convertible Notes and the 2017 Convertible Notes to seek remedies and enforce their rights under the indentures was automatically stayed as a result of the filing of the Chapter 11 Case, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

 

The initial conversion rate of 148.3856 shares per $1,000 principal amount (equal to an initial conversion price of approximately $6.74 per share of common stock) was adjusted on February 3, 2011 in accordance with the terms of the Indenture agreement dated February 8, 2010 (the “2010 Indenture”).

 

As a result, the conversion rate and conversion price changed to 169.0082 shares per $1,000 principal amount and $5.9169 per share of common stock, respectively. Upon conversion, if conversion is elected by the noteholders, the Company must deliver, at its option, either (1) a number of shares of its common stock determined as set forth in the 2010 Indenture, (2) cash, or (3) a combination of cash and shares of its common stock.

 

Holders were permitted to convert their 2015 Convertible Notes at their option at any time prior to the close of business on the second business day immediately preceding the 2015 Maturity Date under any of the following circumstances:

 

(1) during any fiscal quarter (and only during such fiscal quarter) commencing after March 31, 2010, if the last reported sale price of the Company’s common stock is greater than or equal to 130% of the conversion price of the 2015 Convertible Notes for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter;

 

(2) prior to January 1, 2015, during the five business-day period after any ten consecutive trading-day period in which the trading price of $1,000 principal amount of the 2015 Convertible Notes for each trading day in the measurement period was less than 97% of the product of the last reported sale price of the Company’s common stock and the conversion rate on such trading day;

 

(3) if the 2015 Convertible Notes have been called for redemption; or

 

(4) upon the occurrence of one of a specified number of corporate transactions.

 

Holders were also permitted to convert the 2015 Convertible Notes at their option at any time beginning on February 1, 2015, and ending at the close of business on the second business day immediately preceding the 2015 Maturity Date or may hold the 2015 Convertible Notes to maturity and be paid their outstanding principal in cash.

 

As of February 3, 2013, the Company was permitted to redeem for cash all or a portion of the 2015 Convertible Notes at a redemption price of 100% of the principal amount of the notes to be redeemed plus any accrued and unpaid interest to, but not including, the redemption date, plus a “make-whole” payment if: (1) for at least 20 trading days in any consecutive 30 trading days ending within 5 trading days immediately before the date the Company mails the redemption notice, the “last reported sale price” of its common stock exceeded 175% of the conversion price in effect on that trading day, and (2) there is no continuing default with respect to the notes that has not been cured or waived on or before the redemption date.

 

No holders converted their 2015 Convertible Notes and the Company did not redeem any 2015 Convertible Notes prior to the 2015 Maturity Date.

 

The 2010 Indenture for the 2015 Convertible Notes contains customary terms and covenants and events of default, the occurrence and continuation of which could result in the acceleration of amounts due under the 2015 Convertible Notes.

 

Net proceeds from the sale of the $170.9 million of 2015 Convertible Notes, after deducting the discounts and commissions and any offering expenses payable by the Company, were approximately $164.9 million.  The initial purchaser received commissions of approximately $5.5 million in connection with the sale and the Company incurred approximately $0.6 million of direct expenses in connection with the offering.  The Company used the net proceeds for general corporate purposes, including capital expenditures and working capital, reduction or refinancing of debt, and other corporate obligations.

 

 

 
23

 

 

The Company accounts for the 2015 Convertible Notes in accordance with ASC Topic 470, “Debt,” as it pertains to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). Under the accounting guidance, convertible debt instruments that may be settled entirely or partially in cash upon conversion are required to be separated into liability and equity components, with the liability component amount determined in a manner that reflects the issuer’s non-convertible debt borrowing rate. The value assigned to the liability component is determined by measuring the fair value of a similar liability that does not have an equity conversion feature. The value assigned to the equity component is determined by deducting the fair value of the liability component from the initial proceeds. The excess of the principal amount of the liability component over its carrying amount (the non-cash discount) is amortized to interest cost using the effective interest method over the term of the 2015 Convertible Notes. In addition, transaction costs incurred that directly relate to the issuance of convertible debt instruments must be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as debt issuance costs and equity issuance costs, respectively.

 

The Company estimated its non-convertible borrowing rate at the date of issuance of the 2015 Convertible Notes to be 12%. The 12% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as the Company and was obtained through a quote from the initial purchaser. Using the income method and discounting the principal and interest payments of the 2015 Convertible Notes using the 12% non-convertible borrowing rate, the Company estimated the fair value of the $170.9 million 2015 Convertible Notes to be approximately $136.3 million with the discount being approximately $34.6 million. The discount is being amortized as non-cash interest expense over the life of the notes using the effective interest method. In addition, the Company allocated approximately $4.8 million of the $6.1 million of fees and commissions as debt issue costs that are being amortized as non-cash interest expense over the life of the 2015 Convertible Notes using the effective interest method. The remaining $1.3 million of fees and commissions were treated as transaction costs associated with the equity component. The net amount of the equity component was $33.3 million, which included the initial discount of $34.6 million reduced by $1.3 million of direct transaction costs.

 

In September 2013, the Company repurchased $85.0 million of aggregate principal amount of the 2015 Convertible Notes. As a result of the $85.0 million repurchase during the third quarter of 2013, approximately $12.2 million of the repayment was considered a retirement of debt and the remaining $72.8 million of the repayment were considered an exchange of debt. The $85.0 million of 2015 Convertible Notes were repurchased with an approximate discount of 10%. The Company recognized a gain on the retirement of the debt of approximately $0.2 million and this gain was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the third quarter of 2013. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

As a result of the exchange during the second quarter of 2014, the $26.0 million of aggregate principal amount of 2015 Convertible Notes exchanged was considered a retirement of debt and deemed a substantial modification of debt. The $26.0 million of 2015 Convertible Notes were exchanged with an approximate discount of 4%. The Company recognized a loss on the retirement of the debt of approximately $0.3 million and this loss was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the second quarter of 2014. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

The Company evaluated the 2010 Indenture for the 2015 Convertible Notes for potential embedded derivatives, noting that the conversion feature and make-whole provisions did not meet the embedded derivative criteria as set forth in ASC Topic 815, “Derivatives and Hedging.” Therefore, no additional amounts have been recorded for those items.

 

As of March 31, 2015, the net amount of $59.9 million of 2015 Convertible Notes outstanding includes the $59.9 million of principal reduced by zero of the remaining unamortized discount. The Company is currently in default on its 2015 Convertible Notes. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in Note 2 to our Consolidated Financial Statements under the caption “—Voluntary Reorganization Under Chapter 11”. At March 31, 2015, using the conversion rate of 169.0082 shares per $1,000 principal amount of the 2015 Convertible Notes, if the $59.9 million of principal were converted into shares of common stock, the notes would convert into approximately 10.1 million shares of common stock.  As of March 31, 2015, there is no excess if-converted value to the holders of the 2015 Convertible Notes as the price of the Company’s common stock at March 31, 2015, $0.03 per share, is less than the conversion price.

 

The annual effective interest rate on the 2015 Convertible Notes, including the amortization of debt issue costs, was approximately 12.0%.

 

 

 
24

 

 

The following table shows the amount of interest expense related to the 2015 Convertible Notes, disregarding capitalized interest considerations, for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense related to the contractual interest coupon

  $ 648     $ 1,396  

Amortization of debt discount expense

    417       885  

Amortization of debt issue costs

    106       239  

Interest expense related to the 2015 Convertible Notes

  $ 1,171     $ 2,520  

 

 

Interest Expense

 

The following table is a summary of interest expense for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense

  $ 5,974     $ 6,707  

Capitalized interest expense

    -       (2,870 )

Interest expense, net

  $ 5,974     $ 3,837  

 

 

Other Financing Costs

 

The following table is a summary of other financing costs, which includes fees associated with potential debt restructuring, in the Consolidated Statements of Operations for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Other financing costs

  $ 4,636     $ -  

 

 
25 

 

 

Note 12 — Derivative Financial Instruments

 

Objective and Strategies for Using Derivative Instruments:

 

In connection with the $75.0 million secured debt facility through July 2014, the Company and Credit Suisse agreed that a portion of the arranger fee would be based on the performance for oil prices and be payable at each of the principal repayment dates.  The fee is calculated by multiplying the principal payment amount by the change in oil prices from the loan origination date and the oil price at each principal repayment date. Additionally, the fee is capped at 12% of the $75.0 million secured debt facility. The Performance Based Arranger Fee is being accounted for as an embedded financing derivative under ASC Topic 815, “Derivatives and Hedging” and, accordingly, is being recorded at fair value with any changes in value reflected as a gain or loss on derivatives in the accompanying Consolidated Statements of Operations. The following table sets forth a reconciliation of the changes in fair value of the Company’s derivative financial instruments for the three months ended March 31, 2015 and the year ended December 31, 2014:

 

Derivative Financial Instruments Not Designated as Hedging Instruments

 

             
   

2015

   

2014

 
   

(in thousands)

 

Beginning fair value of derivatives

  $ -     $ 30  

(Gain) loss on derivatives

    -       (2 )

Cash settlements paid

    -       (28 )

Ending fair value of derivatives

  $ -     $ -  

 

 

See Note-14, “Fair Value Measurements and Disclosures” for a discussion of methods and assumptions used to estimate the fair values of the Company’s derivative instruments.

 

Note 13 — Stockholders’ Equity

 

The Company has 25,000,000 shares of preferred stock, no par value, and 250,000,000 shares of common stock, no par value, authorized for issuance.

 

Potentially Dilutive Securities

 

Basic earnings (loss) per share of common stock is computed using the weighted average number of shares of common stock outstanding during each period. The diluted earnings (loss) per share of common stock may include the effect of the Company’s shares issuable under convertible debt agreements, outstanding stock options, shares of restricted stock or performance stock units, except in periods in which there is a net loss. The following table summarizes the calculation of basic and diluted earnings (loss) per share:

 

 

   

Three Months Ended

March 31,

 
   

2015

   

2014

 
   

(in thousands, except per

share data)

 
                 

Net loss

  $ (19,767 )   $ (3,570 )
                 

Shares:

               

Basic weighted average common shares outstanding

    116,505       116,042  
                 

Incremental shares from assumed conversion of dilutive share based awards

    -       -  
                 

Diluted weighted average common shares outstanding

    116,505       116,042  

Excluded share based awards (1) (2)

    7,574       9,122  

Excluded 2017 convertible debt shares (1)

    42,108       35,878  

Excluded 2015 convertible debt shares (1)

    10,122       14,516  
                 

Basic net loss per share

  $ (0.17 )   $ (0.03 )

Diluted net loss per share

  $ (0.17 )   $ (0.03 )
                 

 

(1) Inclusion of the shares for these awards would have had an antidilutive effect.

               

(2) Inclusion of the performance share units for these awards would have had an antidilutive effect. The actual number of performance share units earned may range from 0% to 200%.

               

 

 
26 

 

 

The following table summarizes stock-based compensation costs recognized under ASC Topic 718, “Stock Compensation,” for the three months ended March 31, 2015 and 2014, respectively, which are included in “General and administrative expense” on the Consolidated Statements of Operations:

 

   

Three Months Ended

March 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Employee stock-based compensation costs

  $ 468     $ 639  

Director stock-based compensation costs

    105       193  

Employee stock purchase plan costs

    -       2  

Total stock-based compensation costs

  $ 573     $ 834  

 

Stock Option, Restricted Stock and Performance Share Plans

 

The Company has in effect the 2007 Long-Term Incentive Compensation Plan, as amended in 2010 and 2014 to increase the number of shares available (the “2007 LTIP”), and the 2007 Directors’ Compensation Incentive Plan (the “Directors’ Plan”). The 2007 LTIP and Directors’ Plan provide for awards of options, stock appreciation rights, restricted stock, restricted stock units, performance awards, other stock-based awards and cash-based awards to any of the Company’s officers, employees, consultants and the employees of certain of the Company’s affiliates, as well as non-employee directors. The number of shares authorized under the amended 2007 LTIP and Directors’ Plan is 12.0 million and 4.0 million, respectively, which includes an additional 4.0 million shares related to the 2007 LTIP and 1.5 million shares related to the Directors’ Plan approved by the Company’s shareholders on June 20, 2014. As of March 31, 2015, approximately 4.5 million shares remain available for future grants under the 2007 LTIP and 1.8 million shares remain available for future grants under the Directors’ Plan.

 

Restricted Stock Awards and Performance Stock Units

 

Restricted Stock

 

Restricted stock is subject to certain restrictions on ownership and transferability when granted. The fair value of restricted stock awards is based on the market price of the Common Stock on the date of grant. Compensation cost for such awards is recognized ratably over the vesting or service period, net of forfeitures; however, compensation cost related to performance shares will not be recorded or will be reversed if the Company does not believe it is probable that such performance criteria will be met or if the service provider (employee or otherwise) fails to meet such criteria. There has been no restricted stock awarded in 2015.

 

Performance Stock Units

 

Compensation expense associated with these Relative Performance Stock Units is based on the grant date fair value of a single Relative Performance Stock Unit as determined using a Monte Carlo simulation model.  As the Company intends to settle these Relative Performance Stock Units with shares of the Company’s common stock at the end of the performance period, the Relative Performance Stock Unit awards are accounted for as equity awards and the expense is calculated on the grant date and amortized over the life of the Relative Performance Stock Unit awards. There have been no Relative Performance Stock Unit awards granted in 2015.

 

Compensation expense associated with these Absolute Performance Stock Units is based on the grant date fair value of a single Absolute Performance Stock Unit as determined using a Monte Carlo simulation model.  As the Company intends to settle these Absolute Performance Stock Units with shares of the Company’s common stock at the end of the performance period, the Absolute Performance Stock Unit awards are accounted for as equity awards and the expense is calculated on the grant date and amortized over the life of the Absolute Performance Stock Unit awards. There have been no Absolute Performance Stock Unit awards granted in 2015.

 

Stock Options

 

Incentive and non-qualified stock options issued to directors, officers, employees and consultants are typically granted at the fair market value on the date of grant. The Company’s stock options generally vest in equal annual installments over a two to three year period and expire ten years from the date of grant. There have been no stock options awarded in 2015.

 

 

 
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Employee Stock Purchase Plan

 

The employee stock purchase plan, which was approved by the shareholders on June 24, 2011, provides eligible employees the opportunity to acquire shares of BPZ Resources, Inc. common stock at a discount through payroll deductions. Employees are allowed to purchase up to 2,500 shares in any one offering period (not longer than twenty-seven months), within IRS limitations and plan rules. The offering period means each period of time which common stock is offered to participants. Unless otherwise determined by the Compensation Committee, a new offering period shall commence on the first day of each calendar quarter. Generally, the purchase price for stock acquired under the plan is the lower of 85% (subject to Compensation Committee adjustment) of the fair market value of the common stock on the grant date or the fair market value of the common stock on the investment date. Under this plan, 2,000,000 common shares were reserved for issuance and purchase by eligible employees. Activity under this plan began in the first quarter of 2012. At March 31, 2015, 1,906,124 shares were available for issuance. On April 1, 2015, 54 shares were issued to employees at a price of $0.03 per share.    

 

Note 14 Fair Value Measurements and Disclosures

 

The Company records certain of its assets and liabilities on the balance sheet at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). A three-level valuation hierarchy has been established to allow readers to understand the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

 

Level 1 —

Fair value measurements which use quoted market prices (unadjusted) in active markets for identical assets or liabilities.

     

Level 2 —

Fair value measurements which use inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly.

     

Level 3 —

Fair value measurements which use unobservable inputs.

 

The following describes the valuation methodologies the Company uses for its fair value measurements.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

Cash and Cash Equivalents

 

Cash and cash equivalents include all cash balances and any highly liquid investments with an original maturity of 90 days or less. The carrying amount approximates fair value because of the short maturity of these instruments.

 

Restricted Cash

 

Restricted cash includes all cash balances which are associated with the Company’s long-term assets, short-term debt and long-term debt. The carrying amount approximates fair value because the nature of the restricted cash balance is the same as cash. The fair value of restricted cash is measured using Level 1 inputs within the three-level valuation hierarchy.

 

Derivative Financial Instruments   

 

The Company’s derivative financial instruments consist of variable financing arranger fee payments that are dependent on the change in oil prices from the loan origination date of the Company’s $75.0 million secured debt facility (through July 2014) and the oil price on each repayment date. The Company estimated the fair value of these payments based on published forward commodity price curves at each financial reporting date. The discount rate used to discount the associated cash flows is based on the Company’s credit-adjusted risk-free rate. Accordingly, these derivatives are considered to be a Level 2 measurement on the fair value hierarchy. For further information regarding the Company’s derivatives, see Note-12, “Derivative Financial Instruments.” At March 31, 2015 and December 31, 2014 there were no variable financing arranger fees payments outstanding.

 

Non-Financial Assets and Liabilities

 

The Company discloses or recognizes its non-financial assets and liabilities, such as impairments of long-lived assets, at fair value on a non-recurring basis. As none of the Company’s non-financial assets and liabilities were impaired for the three months ended March 31, 2015 and March 31, 2014, and no other fair value measurements were required to be recognized on a non-recurring basis, additional disclosures were not provided.

 

 

 
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Additional Fair Value Disclosures

 

Debt with Fixed Interest Rates

 

The fair value information regarding the Company’s fixed rate debt at March 31, 2015 and December 31, 2014 is as follows:

 

   

Subject to Compromise

   

Not Subject to Compromise

 
   

March 31,

2015

   

December 31,

2014

 
                                 
   

Carrying Amount

   

Fair Value

   

Carrying Amount

   

Fair Value

 
   

(in thousands)

   

(in thousands)

 

Convertible Notes, 8.5%, due October 2017, net of debt issue costs of ($1.7) million and net of discount of ($12.8) million at March 31, 2015 and net of discount of ($13.9) million at December 31, 2014 (1)

  $ 154,219     $ 25,307     $ 154,839     $ 57,361  

Convertible Notes, 6.5%, due March 2015, net of debt issue costs of  zero and net of discount of zero at March 31, 2015 and net of discount of ($0.4) million at December 31, 2014 (2)

    59,890       9,133       59,473       20,662  

 


 

(1)       The Company estimated the fair value of the 2017 Convertible Notes to be approximately $25.3 million and $57.4 million at March 31, 2015 and December 31, 2014, respectively, based on observed market prices for the same or similar types of debt issues. The fair value of the 2017 Convertible Notes is considered to be a Level 1 measurement on the fair value hierarchy.

 

(2)       The Company estimated the fair value of the 2015 Convertible Notes to be approximately $9.1 million and $20.7 million at March 31, 2015 and December 31, 2014, respectively, based on observed market prices for the same or similar types of debt issues. The fair value of the 2015 Convertible Notes is considered to be a Level 1 measurement on the fair value hierarchy.

 

Note 15 Revenue

 

The oil produced is delivered by vessel to the refinery owned by the Peruvian national oil company, Petroperu, in Talara, located approximately 70 miles south of the platforms.  Produced oil is kept in production inventory until inventory quantities are at a sufficient level to make a delivery to the refinery in Talara.  Although all of the Company’s oil sales are to Petroperu, it believes the loss of Petroperu as its sole customer would not materially impact the Company’s business because it could readily find other purchasers for its oil production both in Peru and throughout the world.

 

The Company’s revenues are reported net of royalties owed to the government of Peru. Royalties are assessed by Perupetro, as stipulated in the Block Z-1 License Contract, based on production.

 

The following table shows the amount of royalty costs related to gross revenues for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Royalty costs

  $ 611     $ 1,171  
    $ 611     $ 1,171  

 

 

 

 
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Note 16 — Income Tax

 

The following is a summary of income (loss) before income taxes and income tax expense (benefit) for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 
Income (loss) before income taxes:                

United States

  $ (11,186 )   $ (5,061 )

Foreign

    (8,142 )     3,441  
    $ (19,328 )   $ (1,620 )
                 
                 

Income tax expense (benefit):

               

United States

  $ -     $ -  

Foreign

    439       1,950  
    $ 439     $ 1,950  

 

 

The Company has recognized a gross deferred tax asset related to net operating loss carryforwards attributable to the United States, before application of the valuation allowances. The Company has a valuation allowance for the full amount of the domestic net deferred tax asset, as it believes, based on the weight of available evidence, that it is more likely than not that the deferred tax asset will not be realized prior to the expiration of net operating loss carryforwards in various amounts through 2034. Furthermore, because the Company has no operations within the U.S. taxing jurisdiction, it is likely that sufficient generation of revenue to offset the Company’s deferred tax asset is remote.

 

The difference from the 22% statutory rate provided for under the Block Z-1 License Contract is due to other Peruvian operations that have a different statutory tax rate than the 22%, valuation adjustments on certain foreign entities and deferred tax balances where the Company believes it is not more likely than not it will receive the benefit of those deferred taxes, the effect of permanent differences and certain expenses which are not deductible in Peru.

 

The March 31, 2015 and December 31, 2014 balance of unrecognized tax benefits includes $0.7 million that, if recognized, would impact the Company's effective income tax rate. Over the next 12 months, the Company does not anticipate any reduction in the balance. The Company had accrued interest and penalties related to unrecognized tax benefits of $47,000 and $46,000 as of March 31, 2015 and December 31, 2014, respectively. Estimated interest and penalties related to potential underpayment on unrecognized tax benefits, if any, are classified as a component of income tax expense in the Consolidated Statement of Operations.

 

Note 17 — Business Segment Information

 

The Company determines and discloses its segments in accordance with ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), which uses a “management” approach for determining segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. ASC Topic 280 also requires disclosures about products or services, geographic areas, and major customers. The Company’s management reporting structure provided for only one segment for the three months ended March 31, 2015 and 2014, respectively. Accordingly, no separate segment information is presented. In addition, the Company operates only in Peru and has only one customer for its oil production, Petroperu. The majority of the Company’s long-lived assets are located in Peru. Management does not consider its investment in Ecuador as a separate business segment.

 

Note 18 — Commitments and Contingencies

 

Profit Sharing

 

The Constitution of Peru and Legislative Decree Nos. 677 and 892 give employees working in private companies engaged in activities generating income as defined by the Income Tax Law, the right to share in the company’s profits.  According to Article 3 of the United Nations International Standard Industrial Classification, BPZ E&P’s tax category is classified under the “mining companies” section, which sets the profit sharing rate at 8%. However, in Peru, the Hydrocarbon Law states, and the Supreme Court ruled, that hydrocarbons are not related to mining activities. Hydrocarbons are included under “Companies Performing Other Activities,” thus Oil and Gas Companies pay profit sharing at a rate of 5%. The 5% of income is determined by calculating a percentage of the Company’s Peruvian subsidiaries’ annual total revenues subject to income tax less the expenses required to produce revenue or maintain the source of revenues. The benefit granted by the law to employees is calculated on the basis of “income subject to taxation” per the Peruvian tax code, and not based on income (loss) before income taxes as reported under GAAP. For the three months ended March 31, 2015 and 2014, respectively, profit sharing expense was not material to the Company as the Company’s Peruvian subsidiaries did not have a material amount of “income subject to taxation” per the Peruvian tax code as a result of declaring commercial production in the Corvina field, which allowed certain exploration and development costs to be deductible in 2015 and 2014 that were not deductible in previous years.  The Company is subject to profit sharing expense in any year its Peruvian subsidiaries are profitable according to the Peruvian tax laws.

 

 

 
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Gas-to-Power Project Financing

 

The gas-to-power project entails the planned installation of approximately 10 miles of gas pipeline from the CX-11 platform to shore, the construction of gas processing facilities and the building of an approximately 135 megawatt (“MW”) simple-cycle electric generating plant.  The power plant site is located adjacent to an existing substation and power transmission lines. The existing substation and transmission lines are owned and operated by third parties.

 

The Company currently estimates the gas-to-power project will cost approximately $153.5 million, excluding capitalized interest, working capital and 18% value-added tax which will be recovered via future revenue billings. The $153.5 million includes $133.5 million for the estimated cost of the power plant and $20.0 million for the natural gas pipeline. While the Company has held initial discussions with several potential joint venture partners for the gas-to-power project in an attempt to secure additional financing and other resources for the project, the Company has not entered into any definitive agreements with a potential partner. In the event the Company is able to identify and reach an agreement with a potential joint venture partner, it may only retain a minority position in the project, or the power generation facility may be wholly owned by a third party. However, the Company, along with its Block Z-1 partner, Pacific Rubiales, expects to retain the responsibility for the construction of the pipeline as well as retain ownership of the pipeline. The Company has obtained certain permits and is in the process of obtaining additional permits to proceed with the project.

 

Santa Elena Field

 

In 2013, in order to extend the term of the contract from 2016 to 2029, the Consortium, which includes the Company and three other partners, agreed to additional work commitments to increase production in the Santa Elena field. The Company’s total share of this commitment over the remaining life of the contract is $4.9 million (the Company’s 10% non-operating net profits interest) which amount is due for the remainder of 2014 to 2028. This commitment is expected to be funded by cash on hand, cash generated from new production, or loans of the Consortium. If the Consortium does not have sufficient cash on hand, the Company may elect to make a cash contribution to the Consortium for its 10% share of the commitment. If the Company elects not to make its 10% share contribution of the commitment, it would lose its rights in the Consortium and the contract for the Santa Elena field.

 

In the fourth quarter of 2014, the Consortium incurred a loan for the additional work commitments to increase production in the Santa Elena field. The Consortium loan is to be paid with cash generated from the production of the Santa Elena Field. The Company’s total share of this loan would be $0.9 million (our 10% non-operating net profits interest) which amounts are due quarterly through the fourth quarter of 2017. If the Consortium does not have sufficient cash on hand, the Company would make a cash contribution to the Consortium for its 10% share of this loan.

 

Note 19 — Legal Proceedings

 

Legal Proceedings Related to the Chapter 11 Case

 

On March 9, 2015, BPZ Resources, Inc. filed a voluntary petition in the United States Bankruptcy Court for the Southern District of Texas Victoria Division (the “Bankruptcy Court”) seeking relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code (the “Bankruptcy Code”). The Chapter 11 case is being administered under the caption In re BPZ Resources, Inc., Case No. 15-60016 (the “Chapter 11 Case”). The Company will continue to operate its business as “debtor-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As a result of the filing, attempts to collect, secure, or enforce remedies with respect to pre-petition claims against the Company are subject to the automatic stay provisions of section 362 of the Bankruptcy Code.  None of the Company’s direct or indirect subsidiaries has filed for reorganization under Chapter 11 and none are expected to file for reorganization or protection from creditors under any insolvency or similar law in the U.S. or elsewhere. The Chapter 11 Case is discussed in greater detail in Note-2 “Liquidity and Capital Resources” to our Consolidated Financial Statements.

 

Other Legal Proceedings

 

From time to time the Company may become a party to various legal proceedings arising in the ordinary course of business. While the outcome of lawsuits cannot be predicted with certainty, the Company is not currently a party to any proceeding that it believes could have a potentially material adverse effect on its financial condition, results of operations or cash flows.

 

 

 
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Additionally, the Company is subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. To the extent laws are enacted or other governmental action is taken that restricts drilling or imposes environmental protection requirements that result in increased costs to the oil and natural gas industry in general, the business and prospects of the Company could be adversely affected.

 

Note 20Subsequent Event

 

In April 2015, at offshore Block Z-1, the Corvina CX15-9D well was tested and the well failed to produce oil, therefore the geologic model for the Corvina field is being reevaluated to better understand the impact of the well test results on this area of the field.  However, approximately 35 feet of gas pay was found in the upper Zorritos non-associated gas reservoir in the CX15-9D well, which is where the CX11-16X, CX11-14D and CX11-21XD wells at the CX-11 previously tested rates of gas between 20 and 40 million cubic feet per day in the non-associated gas reservoir.  Activity on the CX15-9D well has been suspended and the well is being considered for completion as a gas producer in the future. 

 

In April 2015, at offshore Block Z-1, the Albacora A-22D well tested water with no oil shows from the three targeted zones which are productive in the main part of the field.  These results establish the southeastern extent of the field.  A reinterpretation of all Albacora well and seismic data is underway to further update the field's geologic model.

 

On May 1, 2015, BPZ Resources, Inc. was notified by the New York Stock Exchange (“NYSE”) of its intention to remove the entire class of common stock of BPZ Resources, Inc. from listing and registration on the NYSE at the opening of business on May 11, 2015. Our common stock currently only trades in the over-the-counter market on the OTC Pink Marketplace.

 

 

 

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

 

You should read the following discussion and analysis together with our consolidated financial statements and notes thereto and the discussion contained in Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 7A., “Quantitative and Qualitative Disclosures About Market Risk,” and Item 1A., “Risk Factors,” included in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Unless the context requires otherwise, references herein to “BPZ”“we”, “us”, “our” and the “Company” refer to BPZ Resources, Inc., and its consolidated subsidiaries. References herein to “Debtor” refer only to BPZ Resources, Inc.

 

 The following information contains forward-looking statements that involve risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, our actual results may differ from those expressed or implied by the forward-looking statements. See “Disclosure Regarding Forward-Looking Statements” below. Also, see “Cautionary Statement Regarding Certain Information Releases” below for material related to the release of certain information.

 

Introduction

 

We are an independent oil and gas company focused on the exploration, development and production of oil and natural gas in Peru and Ecuador. We also intend to utilize part of our planned future natural gas production as a supply source for the development of a gas-fired power generation facility in Peru, which may be wholly– owned or partially-owned, or may be wholly-owned by a third party. We have the license agreements for oil and gas exploration and production covering approximately 2.2 million gross (1.9 million net) acres in four blocks in northwest Peru and off the northwest coast of Peru in the Gulf of Guayaquil. We also own a 10% non-operating net profits interest in an oil and gas producing property, Block 2, located in the southwest region of Ecuador.

 

Voluntary Reorganization Under Chapter 11 

 

Overview

 

We have not been profitable since we commenced operations and we require substantial capital expenditures as we advance development projects at Block Z-1 and exploration projects in our other Blocks.  Currently, we require substantial and significant additional financing to continue to fund our capital expenditure program, service our debt obligations, pay our suppliers and service providers and implement our business plan.  Our major sources of funding to date have been debt and equity financing, asset sales and net margin from oil sales.  The severe downturn in the economic climate for the oil and gas industry, increased capital costs and debt service costs for the industry, combined with experiencing less-than-expected operating performance in Block Z-1, have placed an extreme strain on our cash flow from operations. This has resulted in our inability to meet our debt obligations, and has made it exceptionally difficult for us to obtain reasonable financing. As a result of these events, we had to explore restructuring alternatives, which culminated in BPZ Resources, Inc. filing for voluntary reorganization under Chapter 11 of the Bankruptcy Code during the first quarter of 2015, as discussed in further detail below. Because of the risks and uncertainties associated with the Chapter 11 case, we cannot predict or quantify the ultimate impact that events occurring during the Chapter 11 case will have on our business, financial condition and results of operations, and there is no certainty as to our ability to continue as a going concern.

 

We currently have the following convertible notes outstanding: (i) $59.9 million principal amount of Convertible Notes due 2015 (the “2015 Convertible Notes”), which bear interest semi-annually at a rate of 6.50% per year, and (ii) $168.7 million principal amount of Convertible Notes due 2017 (the “2017 Convertible Notes”), which bear interest semi-annually at a rate of 8.50% per year. The 2015 Convertible Notes matured with repayment of approximately $62 million in principal and interest due on March 1, 2015. Our estimated capital and exploratory expenditures for 2015 call for us to spend approximately $49.0 million, excluding capitalized interest, for our three onshore Blocks in which we hold 100% working interests, and our share of the capital and exploratory expenditures for offshore Block Z-1 required under our Joint Venture Agreement with Pacific Rubiales. The carry amount Pacific Rubiales agreed to pay under the joint venture was completed in December 2014 and we are now responsible for funding our full share of capital expenditures and joint operating expenditures for Block Z-1.

 

The price of oil per barrel has dropped dramatically, particularly in the fourth quarter 2014 and continuing in the first quarter 2015, by more than half since its high in June 2014. In mid-October 2014, we withdrew our previously announced private placement offer of $150.0 million in senior secured notes due 2019 due to adverse market conditions.

 

On December 8, 2014, the Company received a notification from the New York Stock Exchange (“NYSE”) that the Company had fallen below the NYSE's continued listing standard relating to minimum share price, which requires a minimum average closing price of $1.00 per share over 30 consecutive trading days. The price has remained well below such threshold and the NYSE subsequently notified us on March 2, 2015 that it had determined to commence proceedings to delist our common stock.

 

As a result of the aforementioned events and circumstances, in December 2014 we engaged the services of Houlihan Lokey Capital Inc. and Stroock & Stroock & Lavan LLP (the “Advisors”) to assist us in analyzing various strategic alternatives and addressing our liquidity and capital structure, and formed a special committee of the Board of Directors to work with the Advisors. We engaged in discussions with representatives of our various debt holders regarding, among other items, the potential terms under which one or both bond issues could be restructured to provide a capital structure which would allow us to continue developing our oil and gas assets.  We have also pursued discussions with other potential investors regarding alternative financing solutions.  We decided that it was in the best long-term interest of all stakeholders, both credit and equity holders, to expeditiously address the Company's capital structure with the goal of reducing debt and the cost of capital to position the Company for the future, and on March 2, 2015 announced that we had decided not to pay approximately $62 million in principal and interest due on March 1, 2015 on our 2015 Convertible Notes and to use a 10-day grace period on principal due and a 30-day grace period on interest due to continue discussions with our debt holders.

 

 

 
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We were unable to reach a mutually agreeable solution within the grace period for the principal amount due on the 2015 Convertible Notes and elected not to make the approximate $59.9 million in principal payment due at the end of the grace period for principal due. As a result, we are in default under the 2015 Convertible Notes, permitting the trustee for the 2015 Convertible Notes or the holders of at least 25% in aggregate principal amount of the outstanding 2015 Convertible Notes to declare the full amount of the principal and interest thereunder immediately due and payable.

 

On March 9, 2015 (the “Petition Date”), BPZ Resources, Inc. (the “Debtor”) filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”) to provide more time to find an appropriate solution to its financial situation and implement a plan of reorganization aimed at improving its capital structure (the "Chapter 11 case"). The Chapter 11 case is being administered by the Bankruptcy Court as Case No. 15-60016.

 

The filing of the Chapter 11 case constituted an event of default that triggered repayment obligations under the 2015 Convertible Notes and the 2017 Convertible Notes, permitting the trustee or the holders of at least 25% in aggregate principal amount of the outstanding 2017 Convertible Notes to also declare the full amount of the principal and interest thereunder immediately due and payable. The ability of the holders of the 2015 Convertible Notes and the 2017 Convertible Notes to seek remedies and enforce their rights under the indentures was automatically stayed as a result of the filing of the Chapter 11 case, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

 

Since the Petition Date, the Debtor has operated its business as a “debtor-in-possession” under the jurisdiction of the Bankruptcy Court and the applicable provisions of the of the Bankruptcy Code, which will allow the Debtor to continue operations during the reorganization proceedings.  The Debtor will remain in possession of its assets and properties, and its business and affairs will continue to be managed by its directors and officers, subject in each case to the supervision of the Bankruptcy Court. The Bankruptcy Court has also granted the Debtor the authority to take a broad range of actions, including, among others, authority to maintain bank accounts and the cash management system, pay certain employee obligations, post-petition utilities and other customary relief to continue Debtor’s operations.

 

None of the Debtor’s direct or indirect subsidiaries or affiliates has filed for reorganization under Chapter 11 and none is expected to file for reorganization or protection from creditors under any insolvency or similar law in the U.S. or elsewhere. The Debtor’s subsidiaries will continue to operate outside of any reorganization proceedings. We therefore do not expect the Debtor’s filing for Chapter 11 protection to impact our license agreements.

 

While operating as a debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Debtor may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or otherwise as permitted in the ordinary course of business. Moreover, the Debtor has not yet filed a plan of reorganization with the Bankruptcy Court. The Debtor currently retains the exclusive right to propose a plan of reorganization under section 1121(d) of the Bankruptcy Code. The ultimate plan of reorganzation, which would be subject to acceptance by the requisite majorities of empowered creditors under the Bankruptcy Code and Bankruptcy Court approval, will likely materially change the amounts and classifications in the Company's Consolidated Financial Statements.

 

No assurance can be given as to the value, if any, that may be ascribed to the Debtor’s various prepetition liabilities and other securities. The Company cannot predict what the ultimate value of any of its securities may be and it remains too early to determine whether holders of any such securities will receive any distribution in the Debtor’s reorganization. In particular, in most cases under Chapter 11 of the Bankruptcy Code, holders of equity securities receive little or no recovery of value from their investment. Accordingly, the Debtor urges that caution be exercised with respect to existing and future investments in any of these securities or other Debtor claims. Our common stock currently only trades in the over-the-counter market on the OTC Pink Marketplace. From March 3, 2015 through March 11, 2015 the Company traded under the symbol “BPZR.” Currently, the Company is traded under the symbol “BPZRQ.”

 

 

 

 
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General Information

 

Notices to Creditors; Effect of Automatic Stay. The Debtor has notified all known current or potential creditors that the Chapter 11 Case was filed. Subject to certain exceptions under the Bankruptcy Code, the filing of the Debtor’s Chapter 11 Case automatically enjoined, or stayed, the continuation of most judicial or administrative proceedings or filing of other actions against the Debtor or its property to recover on, collect or secure a claim arising prior to the Petition Date. Thus, for example, most creditor actions to obtain possession of property from the Debtor, or to create, perfect or enforce any lien against the property of the Debtor, or to collect on monies owed or otherwise exercise rights or remedies with respect to a prepetition claim, are enjoined unless and until the Bankruptcy Court lifts the automatic stay as to any such claim. Vendors are being paid for goods furnished and services provided after the Petition Date in the ordinary course of business.

 

Appointment of Creditors’ Committee

 

On April 14, 2015, the U.S. Trustee appointed a statutory official committee of unsecured creditors (the Creditors’ Committee) for the Chapter 11 Case.

 

Executory Contracts

 

Under Section 365 and other relevant sections of the Bankruptcy Code, the Debtor may assume, assume and assign, or reject certain executory contracts, subject to the approval of the Bankruptcy Court, and certain other conditions.

 

In general, rejection of an executory contract is treated as a pre-petition breach of the executory contract in question and, subject to certain exceptions, relieves the Debtor from performing its future obligations under such executory contract but entitles the contract counterparty or lessor to a pre-petition general unsecured claim for damages caused by such deemed breach. Counterparties to such rejected contracts have the right to file claims against the Debtor's estate for such damages. Generally, the assumption of an executory contract requires the Debtor to cure existing defaults under such executory contract.

 

Any description of an executory contract elsewhere in this report or reflected in the Notes to the Consolidated Financial Statements, including where applicable the Debtor's express termination rights or a quantification of its obligations, must be read in conjunction with, and is qualified by, any rights the Debtor or counterparties have under Section 365 of the Bankruptcy Code.

 

The Debtor expects that liabilities subject to compromise and resolution in the Chapter 11 Case will arise in the future as a result of damage claims created by the Debtor's rejection of various executory contracts. Due to the uncertain nature of many of the potential rejection claims, the magnitude of such claims is not reasonably estimable at this time. Such claims may be material.

 

Magnitude of Potential Claims

 

On April 22, 2014, the Debtor filed with the Bankruptcy Court schedules and statements of financial affairs setting forth, among other things, the assets and liabilities of the Debtor, subject to the assumptions filed in connection therewith. All of the schedules are subject to further amendment or modification.

 

Rule 3003(c)(3) of the Federal Rules of Bankruptcy Procedure requires the Bankruptcy Court to fix the time within which proofs of claim must be filed in a Chapter 11 case pursuant to Section 501 of the Bankruptcy Code. This Rule also provides that any creditor who asserts a claim against the Debtor that arose prior to the Petition Date and whose claim (i) is not listed on the Debtor’s schedules or (ii) is listed on the schedules as disputed, contingent, or unliquidated, must file a proof of claim. The Bankruptcy Court has not yet established a date and time by which such proofs of claim must be filed.

 

Differences between amounts scheduled by the Debtor and claims by creditors will be investigated and resolved in connection with the claims resolution process. In light of the expected number of creditors, the claims resolution process may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims is not presently known, nor can the ultimate recovery with respect to allowed claims be presently ascertained. 

 

 
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Plan of Reorganization.

 

The Debtor has not yet filed a plan of reorganization with the Bankruptcy Court. We are currently working on a plan of reorganization to be implemented in our bankruptcy proceedings while simultaneously evaluating other potential strategic transactions. Although we continue to engage in discussions with our creditors in an effort to reach an agreement regarding the terms of a potential plan of reorganization that would allow us to restructure our debt obligations and emerge from the Chapter 11 proceedings, no such agreement has been reached, and there can be no assurance that such an agreement will be reached in the future.

 

The Debtor has the exclusive right to file a plan of reorganization through and including July 7, 2015, and to solicit votes on such a plan if filed by such date through and including September 4, 2015, subject to the ability of parties in interest to file motions seeking to terminate the Company's exclusive periods, as well as the Debtor 's right to seek further extensions of such periods. The Debtor has a right to seek further extensions of such exclusive periods, subject to the statutory limit of 18 months from the Petition Date in the case of filing a plan and 20 months in the case of soliciting and obtaining acceptances of such a plan. The implementation of a plan of reorganization is subject to confirmation of the plan by the Bankruptcy Court in accordance with the provisions of the Bankruptcy Code, and the occurrence of the effective date under the plan. At this time, there is no certainty as to when or if a plan will be filed, the provisions of a plan (including provisions with respect to the treatment of prepetition claims and equity interests), or whether a plan will be confirmed and become effective.

 

Under certain circumstances set forth in Section 1129(b) of the Bankruptcy Code, the Bankruptcy Court may confirm a plan even if such plan has not been accepted by all impaired classes of claims and equity interests - a process known as “cram down”. A class of claims or equity interests that does not receive or retain any property under the plan on account of such claims or interests is deemed to have voted to reject the plan. The precise requirements and evidentiary showing for confirming a plan notwithstanding its rejection by one or more impaired classes of claims or equity interests depends upon a number of factors, including the status and seniority of the claims or equity interests in the rejecting class (i.e., secured claims or unsecured claims, subordinated or senior claims, preferred or common stock). Generally, with respect to common stock interests, a plan may be “crammed down” even if the shareholders receive no recovery if the proponent of the plan demonstrates that: (i) no class junior to the common stock is receiving or retaining property under the plan; and (ii) no class of claims or interests senior to the common stock is being paid more than in full.

 

The availability and utilization of net operating losses post-emergence is uncertain at this time and will be highly influenced by the composition of restructuring plan alternatives that may be considered and ultimately pursued.

 

Further Information

 

For further information regarding the Chapter 11 Case, see Note 2 to the Consolidated Financial Statements. Additional information about the Company’s Chapter 11 proceedings are also available on www.kccllc.net/bpz.

 

Overview

 

BPZ Resources, Inc., a Texas corporation, is based in Houston, Texas with offices in Victoria, Texas, Lima and Zorritos, Peru and Quito, Ecuador. We are focused on the exploration, development and production of oil and natural gas in Peru and to a lesser extent Ecuador. We also intend to utilize part of our planned future natural gas production as a supply source for the development of a gas-fired power generation facility in Peru, which may be wholly-owned or partially-owned, or may be wholly-owned by a third party.

 

We maintain a subsidiary, BPZ Exploración & Producción S.R.L. (“BPZ E&P”),  registered in Peru through our wholly-owned subsidiary BPZ Energy International Holdings, L.P., a British Virgin Islands limited partnership, and its subsidiary BPZ Energy, LLC, a Texas limited liability company. Currently, we, through BPZ E&P, have license agreements for oil and gas exploration and production covering a total of approximately 2.2 million gross (1.9 million net) acres, in four blocks, in northwest Peru and off the northwest coast of Peru in the Gulf of Guayaquil. Our license contracts cover ownership of the following properties: 51% working interest in Block Z-1 (0.6 million gross acres), 100% working interest in Block XIX (0.5 million gross acres), 100% working interest in Block XXII (0.9 million gross acres) and 100% working interest in Block XXIII (0.2 million gross acres). The Block Z-1 contract was signed in November 2001, the Block XIX contract was signed in December 2003 and the Blocks XXII and XXIII contracts were signed in November 2007. Generally, according to the Organic Hydrocarbon Law No. 26221 and the regulations thereunder (the “Organic Hydrocarbon Law” or “Hydrocarbon Law”), the seven-year term for the exploration phase can be extended in each contract by an additional three years up to a maximum of ten years. However, this exploration extension is subject to government approval and specific provisions of each license contract can vary the exploration phase of the contract as established by the Hydrocarbon Law. The license contracts require us to conduct specified activities in the respective blocks during each exploration period in the exploration phase. If the exploration activities are successful, we may decide to enter the exploitation phase and our total contract term can extend up to 30 years for oil production and up to 40 years for gas production. In the event a block contains both oil and gas, as is the case in our Block Z-1, the 40-year term may apply to oil production as well. Our estimate of proved reserves has been prepared under the assumption that our license contract will allow production for the possible 40-year term for both oil and gas.

 

 
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We own a 10% non-operating net profits interest in an oil and gas producing property, Block 2, located in the southwest region of Ecuador (the “Santa Elena Property”). In May 2013, the license agreement and operating agreement covering the property were extended from May 2016 through December 2029.

 

We are in the process of developing our Peruvian oil and gas reserves.  We entered commercial production for Block Z-1 in November 2010 and produce and sell oil from the Corvina and Albacora fields under our current sales contracts with Petroleos del Peru - PETROPERU S.A. (“Petroperu”). We completed the installation and permitting of the CX-15 platform in the Corvina field in November 2012 to continue the development of the field. In July 2013, we spudded the first development well from the CX-15 platform and have completed eight wells from the CX-15 platform. We also spudded a new development well from the A platform in the Albacora field of Block Z-1 in September 2013 and have completed five wells thereafter from the A platform. From the time we began producing from the Corvina field in November 2007 and the Albacora field in December 2009, through March 31, 2015, the two fields have produced approximately 7.7 MMBbls (100% gross and net through December 14, 2012 and 51% net thereafter) of oil. Three onshore shallow exploration wells, ranging in depth from 3,500 to 3,800 feet, have been drilled at Block XXIII during 2014. We are planning to pursue a long term testing program in these Block XXIII prospects, starting with Piedra Candela, and potentially sell the tested gas under a pilot program to the local communities.

 

On December 14, 2012 Perupetro S.A. (“Perupetro”), a corporation owned by the Peruvian government empowered to become a party in the contracts for the exploration and/or exploitation of hydrocarbons in order to promote these activities in Peru, approved the terms of the amendment to the Block Z-1 License Contract to recognize the sale of a 49% participating interest (“closing”), in offshore Block Z-1 to Pacific Rubiales Energy Corp. (“Pacific Rubiales”). Under terms of the agreements signed on April 27, 2012, we (together with our subsidiaries) formed an unincorporated joint venture with a Pacific Rubiales subsidiary, Pacific Stratus Energy S.A., to explore and develop the offshore Block Z-1 located in Peru. On December 30, 2012, the Peruvian Government signed the Supreme Decree for the execution of the amendment to the Block Z-1 License Contract.

 

The development of Block Z-1 is subject to the terms and conditions of a Joint Operating Agreement with Pacific Rubiales that governs the legal, technical and operating rights and obligations of the parties with respect to the operation of Block Z-1. Under the agreement, we are the operator and responsible for the administrative, regulatory, government and community related duties, and Pacific Rubiales manages the technical and operating duties in Block Z-1. The Joint Operating Agreement will continue for the term of the Block Z-1 License Contract and thereafter until all decommissioning obligations under the License Contract have been satisfied.

 

At December 31, 2014, we had estimated net proved oil reserves of 13.6 MMBbls, of which 9.8 MMBbls were in the Corvina field and 3.8 MMBbls were from the Albacora field. Both fields are located in Block Z-1 offshore of northwest Peru. Of our total proved reserves, 4.2 MMBbls (30.9%) are classified as proved developed reserves consisting of proved developed producing and proved developed non-producing reserves from 22 gross (11.2 net) wells, and 9.4 MMBbls (69.1%) are classified as proved undeveloped reserves. The process of estimating oil and natural gas reserves is complex and requires many assumptions that may turn out to be inaccurate.

 

We have determined our reporting structure provides for only one operating segment as we only operate in Peru and currently have only one customer for our production.

 

 

 
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Our current activities and related planning are focused on the following objectives:

 

 

At Block Z-1 with our joint venture partner, Pacific Rubiales;

 

 

Optimizing oil production in the Corvina and Albacora fields in Block Z-1, through a low cost workover program and infrastructure improvements;

 

 

Analyzing the data from the 3-D seismic survey in Block Z-1 to guide further exploration and development activities within the Block;

 

 

Exploring the remainder of the Block, starting with the Delfin and Piedra Redonda prospects where we have received the permits to install platforms and begin exploratory drilling; and

     
 

Reviewing the offshore development drilling campaign from the Corvina CX-15 platform and Albacora platform in light of the current low oil price environment and drilling results;

 

 

Continuing acquisition, processing and interpretation of seismic data to better understand the characteristics and potential of our onshore properties;

 

 

Executing a testing program of our gas discovery in Block XXIII, and planning a drilling program if the testing program warrants;

 

 

Planning and permitting an onshore drilling campaign to explore and appraise Block XXII and meet our applicable license requirements;

 

 

Identifying potential partners for our other operations; and

 

 

Continuing business development efforts for our gas-to-power project to monetize our natural gas resources, which we have identified in the Corvina field but for which no market has yet been secured and related financing has yet to be obtained.

 

Our activities in Peru include analysis and evaluation of technical data on our properties, preparation of the development plans for the properties, meeting requirements under the license contracts, procuring equipment for an extended drilling campaign, obtaining all necessary environmental, technical and operating permits, optimizing current production and obtaining preliminary engineering and design of the power plant and gas processing facilities.

 

Our Business Plan 

 

Our business plan is to enhance value through application of our knowledge of our targeted areas in Peru and to leverage management’s experience with the local suppliers and regulatory authorities to effectively and efficiently (i) identify and quantify the potential value of our oil and gas holdings in Peru; (ii) develop and increase production and cash flows from our identified holdings; (iii) create an additional revenue stream through implementation of our gas marketing strategy and (iv) bring working interest partners into some or all of our Peruvian blocks to facilitate the exploration and development of these blocks.

 

Our focus is to reappraise and develop properties that we control under license agreements in northwest Peru that have been explored by other companies that have reservoirs that appear to contain commercially productive quantities of oil and gas, as well as other areas that have geological formations that we believe potentially contain commercial amounts of hydrocarbons.

 

Our management team has extensive engineering, geological, geophysical, technical and operational experience and valuable knowledge of oil and gas operations throughout Latin America and, in particular, Peru.

 

Two of the four blocks (Block Z-1 and Block XXIII) contain structures drilled by previous operators who encountered hydrocarbons. However, at the time the wells were drilled, the operators did not consider it economically feasible to produce those hydrocarbons.  Having tested oil in Block Z-1 in our first well in the Corvina field in 2007 and our first well in Albacora in December 2009, we are focusing on development of the proved oil reserves in those two fields. Before considering further drilling activity in Block XIX, we are planning to acquire additional seismic data. In Block XXII, the process for an environmental permit is underway and approval must be received before anticipated drilling can begin in 2016. Three onshore shallow exploration wells, ranging in depth from 3,500 to 3,800 feet, were drilled in Block XXIII during 2014. These wells targeted the Caracol, El Cardo, and Piedra Candela prospects, which are on a six-mile trend. All three wells tested dry gas from the Mancora formation.

 

In the near term, management is focused on drilling operations at both the CX-15 platform in the Corvina field and at the A platform in the Albacora field, utilizing the results of the 1,600 square kilometers (“km”) of three dimensional (“3-D”) seismic survey in Block Z-1. We plan to pursue a long-term testing program in the Block XXIII prospects and are in preliminary discussions with a local compressed natural gas (CNG) distributor to purchase the gas produced as a result of the long-term testing program. Additional appraisal wells could be included in the long-term testing program if test results warrant.

 

In addition, our business plan includes a gas-to-power project as part of our overall gas marketing strategy, which entails the installation of a 10-mile gas pipeline from the CX-11 platform to shore, the construction of gas processing facilities and the building of an approximately 135 megawatt (“MW”) simple cycle electric generating plant. The proposed power plant site is located adjacent to an existing substation and power transmission lines. The power generation facility may be wholly or partially owned by us, or wholly owned by a third party. The gas-to-power project is planned to generate a revenue stream by creating a market for the non-associated gas in our Corvina field that is currently shut-in. This project has not yet been financed and we continue to consider the alternatives for the project. Meanwhile, we have obtained certain permits and are in the process of obtaining additional permits to proceed with the project.

 

 
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Oil Development 

 

General

 

We plan to conduct additional drilling activities based in part on an ongoing assessment of economic efficiencies, license contract requirements, likely success and logistical issues such as scheduling, required maintenance and replacement of equipment and consultation with our joint venture partner with respect to Block Z-1.  This assessment could result in increased emphasis and activities on a given prospect and conversely, could result in decreased emphasis on a given prospect for a period of time.  In particular, we will assess allocation of our current resources among the Corvina, Albacora, and other Block Z-1 prospects and certain onshore prospects as they develop, along with our gas-to-power project.

 

Further, our ability to produce reserves in the Corvina and Albacora fields depends on our ability to finance our continued operations and get our produced oil to market. Any failure in meeting these requirements could negatively affect our reserves and their value as reported under the Securities and Exchange Commission (“SEC”) rules. Therefore, in the evaluation of reserves, we attempt to account for all possible delays we can reasonably predict and their impact on the production forecast and remaining reserves to be produced.

 

Block Z-1

 

The Block Z-1 License Contract provides for an initial exploration phase of seven years, and exploration can continue in the exploitation phase for an additional six years (in three two-year periods). Each period has a commitment for exploration activities and requires a financial guarantee to secure the performance of the work commitment during such period. We are in the exploitation phase in Block Z-1 which requires one exploration well or 224 exploration work units in each of the three two-year periods. We received approval from Perupetro for the initial two-year period and have committed to drill an exploratory well. The initial two-year phase was originally set to expire in January 2015, but has been extended to July 2015 and additionally extended until the Delfin platform and rig is installed plus five months due to Force Majeure, which can be claimed by the license contractor in the case of delays or other causes beyond its control. At the end of the third two-year period, we will be required by the License Contract to surrender back to Perupetro all unexplored areas in Block Z-1.

 

Divestiture

 

On April 27, 2012, we and Pacific Rubiales (together with its subsidiaries) executed a Stock Purchase Agreement under which we formed an unincorporated joint venture with Pacific Rubiales to explore and develop the offshore Block Z-1 located in Peru. Pursuant to the SPA, Pacific Rubiales agreed to pay $150.0 million for a 49% participating interest, including reserves, in Block Z-1 and agreed to fund $185.0 million of our share of capital and exploratory expenditures in Block Z-1 from the effective date of the SPA, January 1, 2012. In order to finalize the joint venture, Peruvian governmental approvals were needed to allow Pacific Rubiales to become a party to the Block Z-1 License Contract. On December 30, 2012, the Peruvian Government signed the Supreme Decree for the execution of the amendment to the Block Z-1 License Contract.

 

The development of Block Z-1 is subject to the terms and conditions of a Joint Operating Agreement with Pacific Rubiales that governs the legal, technical and operating rights and obligations of the parties with respect to the operation of Block Z-1. Under the agreement, we are the operator and responsible for the administrative, regulatory, government and community related duties, and Pacific Rubiales manages the technical and operating duties in Block Z-1. The Joint Operating Agreement will continue for the term of the License Contract and thereafter until all decommissioning obligations under the License Contract have been satisfied.

 

The carry amount Pacific Rubiales agreed to pay under the joint venture was completed in December 2014 and we are now responsible for funding our full share of capital expenditures and joint operating expenditures for Block Z-1.

 

At March 31, 2015 and December 31, 2014, we reflected $19.9 million and $22.5 million, respectively, as other current liabilities for exploratory expenditures related to Block Z-1 under funding by Pacific Rubiales of the exploratory expenditures in Block Z-1 incurred in 2012.

 

 

 
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Corvina Field

 

We originally began producing oil from the CX-11 platform, located in the Corvina field within the offshore Block Z-1 in northwest Peru, under a well testing program that started on November 1, 2007.  The Corvina field was placed into commercial production on November 30, 2010.  On the CX-11 platform, we have completed a total of nine gross (4.6 net) oil wells, one of which is currently being used as gas injection and/or water injection well. Produced oil is kept in production inventory until such time as it is delivered to the refinery. The oil is delivered by vessel to storage tanks at the refinery in Talara owned by Petroperu, which is located 70 miles south of the platform. 

 

The CX-15 platform was anchored in the West Corvina field, one mile south of the existing CX-11 platform, in the second half of September 2012. On November 8, 2012, we received an environmental permit from the DGAAE allowing us to begin the drilling and subsequent operation of all production and injection facilities on the CX-15 platform at the Corvina field. We installed three pipelines between the two Corvina platforms and one pipeline from the CX-15 platform to discharge manifold for the floating storage and offloading vessel. We made modifications to the platform monitoring and control systems to facilitate operation of the CX-15 platform. Equipment is tracking platform response to weather and ocean conditions as well as draft. As a precaution, we installed an anchoring system to provide redundancy to the spud can, which anchors the platform.

 

In July 2013, we spudded the first development well, the CX15-1D, from the CX-15 platform. Production from the CX15-1D well began in October 2013. In September 2014, the CX15-1D well was shut in due to sand intrusion. In April 2015 work began on this well to restore production but due to the operational complications in the fishing job during the work over, the decision was taken to stop with the operations and complete the well as a gas well in shallower intervals. We spudded the second development well, the CX15-2D, in November 2013. The CX15-2D well was drilled near the existing CX11-18XD well to a measured depth of approximately 9,000 feet. We completed the CX15-2D well in January 2014. Production from the CX15-2D well began in February 2014. We spudded the CX15-3D development well in February 2014 and production began in April 2014. In July 2014, the CX-15-3D well was shut in due to high water production. The well was then evaluated to determine the appropriate work plan. The CX15-3D well returned to production in September 2014. We spudded the CX15-5D development well in April 2014 and production began in July 2014. The CX15-7D development well was spudded in July 2014 and production began in September 2014. The CX15-10D development well was spudded in September 2014 and production began in October 2014. The CX15-14D development well was spudded in October 2014 and production began in December 2014. The CX15-8D development well was spudded in December 2014 and production began in February 2015. The CX15-9D development well was spud in February 2015 and failed to produce oil but produced gas. The CX15-9D development is being considered for completion as a gas producer. For the remainder of 2015, the Company is reviewing a plan to focus on lower cost workovers at the Corvina field at Block Z-1 to optimize production.

 

Production at each of the Corvina oil wells has declined differently, partly due to the fact that these wells were completed in different zones and some of the wells encountered mechanical problems. The wells have all initially shown typical solution gas drive behavior which can lead to significant production declines during the first year before leveling off to sustainable rates. We believe these results are influenced by technical/mechanical problems encountered with our initial wells, including unintentional production from intervals in the gas cap; however, it is possible we will see similar production declines with new Corvina wells. We believe that our initiation of gas reinjection into the gas cap is helping to slow production decline rates. The work planned during the development drilling program, as well as the data we plan to collect during this program, should help us to better understand future performance expectations.

 

Further, our ability to produce indicated reserves in Corvina and in Albacora depends on our ability to finance our continued operations and get our produced oil to market. Any failure in meeting these requirements could negatively affect our indicated reserves and their value as reported in our public filings pursuant to SEC requirements. Therefore, in the evaluation of reserves, we attempt to account for all possible delays we can reasonably predict and their impact on the production forecast and remaining reserves to be produced.

 

Albacora Field

 

The Albacora field is located in the northern part of our offshore Block Z-1 in northwest Peru.  The current area of interest within the Albacora field is located in water depths of less than 100 feet. We currently have completed a total of ten gross (5.1 net) oil wells, two of which are currently being used as a gas injection or a water injection well. We had been producing oil from the Albacora field from December 2009 through late October 2012 under various extended well testing permits.

 

Installation of the gas and water reinjection equipment was completed on the Albacora A platform and the equipment was ready for reinjection start up early in the first quarter of 2012. We received the required environmental permit for gas injection on October 29, 2012. The Albacora field is no longer subject to an extended well testing program.

 

 

 
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We spudded a development well, the A-18D well, from the A platform in the Albacora field of Block Z-1 in September 2013. This well was completed in December 2013. The A-18D well, which began producing at the end of 2013, was shut-in in late March 2014 due to gas intrusion. The well was sidetracked to a depth of 12,800 feet. The A-18D side track well was completed in September 2014 and production began in September 2014. We also spudded a development well, the A-19D well, from the A platform in the Albacora field of Block Z-1 on January 1, 2014. The A-19D well began production on March 1, 2014. The A-21D development well was spud in early March 2014 and production began in May 2014. In July 2014, the A-21D well was shut in due to high water production. The well was then evaluated to determine the appropriate work plan. The A-21D well returned to production in September 2014. We spudded the A-26D development well in May 2014 and production began in July 2014. The A-27D development well was spudded in October 2014 and production began in January 2015. The A-22D development well was spudded in January 2015 and failed to produce oil. A workover has begun on the Albacora A-27D well to perforate additional untested zones. This is expected to optimize production in the well, and also provide additional data for further evaluation of the deeper Zorritos reservoirs.

 

Piedra Redonda Prospect

 

We have received the permit to install a platform and begin exploratory drilling in the Piedra Redonda prospect. The Piedra Redonda prospect is located south of the Corvina field. Construction of the platform began in the third quarter of 2014.

 

In the first quarter of 2015 we agreed with our Block Z-1 partner and Perupetro to delay the installation of the Piedra Redonda platform. We will be storing the platform in the Gulf Island yards in Houma, Louisiana for a period of approximately twelve to eighteen months.

 

Delfin Prospect

 

We have also received the permit to install a platform and begin exploratory drilling in the Delfin prospect. The Delfin prospect is located southwest of the Corvina field. Construction of the platform began in the third quarter of 2014.

 

In the first quarter of 2015 we agreed with our Block Z-1 partner and Perupetro to delay the installation of the Delfin platform and drilling of the Delfin well. We will be storing the platform in the Gulf Island yards in Houma, Louisiana for a period of approximately twelve to eighteen months.

 

 Block Z-1 Seismic

 

We completed the 3-D seismic survey in February 2013 and seismic data processing of the area in September 2013 to assess our prospects before conducting further drilling operations, as well as to comply with our exploration commitments under our Block Z-1 License Contract.

 

The technical team continues to interpret the Block Z-1 3-D seismic data.  

 

Block XIX 

 

We are in the fourth exploration phase in Block XIX which requires 117 exploration work units which will determine our exploration commitment for the period. The fourth exploration phase was set to expire in September 2015, but has been extended until the approval of our Risk Assessment and Contingency Plan plus ten months.

 

We have received approval from Perupetro to conduct a limited 3-D seismic survey as part of our minimum work commitment for the fourth exploration period to further evaluate future drilling locations. The environmental permit for the additional seismic work was received in August 2014 following the environmental assessment process. The Risk Assessment and Contingency Plan has been submitted to the OSINERGMIN for approval.

 

Block XXII

 

We are in the second exploration phase in Block XXII which requires the drilling of one exploration well. The second exploration well phase is set to expire after the approval of the drilling environmental impact assessment plus 28 months.

 

As a result of the 258 km of 2-D seismic survey completed in 2011, three prospects and one lead have been defined. Evaluation continues and we expect to develop a detailed assessment of each prospect in order to define their technical merit and risk to determine their exploration potential.

 

 

 
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We have notified Perupetro that the commitment for the second exploration period will be the drilling of one well. The timing of the actual drilling in Block XXII will depend on approval of the environmental assessment, which has been submitted to the DGAAE, and subsequent receipt of the necessary ancillary permits. Drilling in Block XXII is expected in 2016.

 

Block XXIII

 

We are in the second exploration phase in Block XXIII which requires 678 exploration work units which will determine the number of wells drilled. The second exploration phase is set to expire after the approval of a new drilling environmental impact assessment plus 24 months.

 

In 2011, we acquired approximately 370 square km of 3-D seismic data and 312 km of 2-D seismic data which included certain areas of interest within the Palo Santo region and four other prospects that are a part of the Mancora gas play. The processing of the 3-D and 2-D seismic data of Block XXIII has been completed and evaluated.

 

The environmental permits for the drilling of several prospects identified by the 2-D and 3-D seismic data acquired in 2011 on Block XXIII were approved in January 2013. We have received approval to move the previously agreed drilling locations to conform to the 3-D seismic results.

 

We spudded an exploration well, the Caracol 1X, on January 5, 2014. This was the first of three exploratory wells drilled in Block XXIII in 2014. The depth of the Caracol 1X well is approximately 3,500 feet. The Cardo 2X exploratory well was spud in late March 2014, and reached a total depth of 3,800 feet in April 2014. The Piedra Candela 3X exploratory well was spud in late April 2014 and reached a total depth of 3,515 feet in May 2014. The Caracol 1X exploratory well tested dry gas from the Mancora formation, light oil from the Heath formation and dry gas from the Zorritos formation. The Cardo 2X exploratory well and the Piedra Candela 3X exploratory well tested dry gas from the Mancora formation. We are planning to pursue a long-term testing program in these Block XXIII prospects.

 

Marine Operations 

 

In December 2013, we entered into a Management Services Agreement with a third party marine operator to manage our marine fleet. We transferred our BPZ Marine Peru S.R.L. employees to the new operator in the fourth quarter of 2013.

 

Gas-to-Power Project 

 

Our gas-to-power project entails the planned installation of an approximately 10-mile gas pipeline from the CX-11 platform to shore, the construction of gas processing facilities and a 135 MW net simple-cycle power generation facility.  The proposed power plant site is located adjacent to an existing substation near Zorritos and a 220 kilovolt transmission line. The existing substation and transmission lines are owned and operated by third parties.

 

In order to support our proposed electric generation project, we commissioned an independent power market analysis for the region. The Peruvian electricity market is deregulated and power is transported through an interconnected national grid managed by the Committee for Economic Dispatching of Electricity. Based on this study, we believe we will be able to sell, under contract, economic quantities of electricity from the initial 135 MW power plant. The market study also indicates that there may be future opportunities for us to generate and sell significantly greater volumes of power into the Peruvian and possibly Ecuadorian power markets.  Accordingly, the revenues from the natural gas delivered to the power plant will be derived from the sale of electricity.

 

We currently estimate the gas-to-power project will cost approximately $153.5 million, excluding capitalized interest, working capital and 18% value-added tax which will be recovered via future revenue billings.  The $153.5 million includes $133.5 million for the estimated cost of the power plant and $20.0 million for the natural gas pipeline. While we have held initial discussions with several potential joint venture partners for the gas-to-power project in an attempt to secure additional financing and other resources for the project, we have not entered into any definitive agreements with a potential partner.  In the event we are able to identify and reach an agreement with a potential joint venture partner, we may retain only a minority position in the project, or the power generation facility may be wholly-owned by a third party. However, we, along with our Block Z-1 partner, expect to retain the responsibility for the construction and ownership of the pipeline. We have obtained certain permits and are in the process of obtaining additional permits to proceed with the project.

 

 

 
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Results of Operations

 

The following table sets forth revenues and operating expenses for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
         
   

2015

   

2014

   

Increase/

(Decrease)

 
   

(in thousands except per bbl information)

         
Net sales volume:                        

Oil (MBbls)

    223       212       11  
                         

Net revenue:

                       

Oil revenue, net

  $ 10,892     $ 20,904     $ (10,012 )

Other revenue

    427       72       355  

Total net revenue

    11,319       20,976       (9,657 )
                         

Average sales price (approximately):

                       

Oil (per Bbl)

  $ 48.79     $ 98.78     $ (49.99 )
                         

Operating and administrative expenses:

                       

Lease operating expense

    7,882       5,223       2,659  

General and administrative expense

    6,329       6,197       132  

Geological, geophysical and engineering expense

    782       821       (39 )

Depreciation, depletion and amortization expense

    4,458       6,612       (2,154 )

Total operating and administrative expenses

  $ 19,451     $ 18,853     $ 598  
                         

Operating income (loss)

  $ (8,132 )   $ 2,123     $ (10,255 )

  

Net Oil Revenue

 

For the three months ended March 31, 2015, our net oil revenue decreased by $10.0 million to $10.9 million from $20.9 million for the same period in 2014. The decrease in net oil revenue is due to a decrease of $49.99 per barrel, or 50.6%, in the average per barrel sales price received from $98.78 per barrel in 2014 to $48.79 per barrel in 2015, partially offset by an increase in the amount of oil sold of 11 MBbls. Total sales for the three months ended March 31, 2015 were 223 MBbls compared to 212 MBbls for the same period in 2014.

 

The increase in amount of oil sold for the three months ended March 31, 2015 compared to the same period in 2014 is due to a lower oil inventory at March 31, 2015 compared to March 31, 2014, partially offset by lower production for the three months ended March 31, 2015 compared to the same period in 2014.

 

The price/volume analysis is as follows:

 

   

Three Months Ended

March 31,

 
   

(in thousands)

 

2014 Oil revenue, net

  $ 20,904  

Changes associated with sales volumes

    1,148  

Changes associated with prices

    (11,160 )

2015 Oil revenue, net

  $ 10,892  

 

For the three months ended March 31, 2015, the decrease in oil production is due to decreased production volumes Albacora field related to the A-18D and A-19D wells during the first quarter of 2015. At the Corvina field, the declines in production from the wells at the CX-11 platform were more than offset by the new production from the CX-15 platform’s CX15-3D, CX15-5D, CX15-7D, CX15-8D, CX15-10D and CX15-14D wells. Total oil production for the three months ended March 31, 2015 was 217 MBbls compared to 231 MBbls for the same period in 2014.

 

The revenues above are reported net of royalties owed to the government of Peru. Royalties are assessed by Perupetro as stipulated in the Block Z-1 License Contract based on production levels.

 

 

 
43

 

 

The following table shows the amount of royalty costs related to gross revenues for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Royalty costs

  $ 611     $ 1,171  
    $ 611     $ 1,171  

 

 

Other Revenue

 

For the three months ended March 31, 2015, other revenue increased by $355,000 to $427,000 compared to $72,000 for the same period in 2014.

 

Lease Operating Expense 

 

Lease operating expenses include costs incurred to operate and maintain wells and related equipment and facilities, as well as crude oil transportation and inventory changes. These costs include, among others, workover expenses, maintenance and repair expenses, operator fees, processing fees, insurance and transportation expenses.

 

For the three months ended March 31, 2015, lease operating expenses increased by $2.7 million to $7.9 million ($35.31 per Bbl) from $5.2 million ($24.68 per Bbl) for the same period in 2014. The increase is due to higher crude oil transportation and storage expense of $1.1 million due to higher crude oil sales and water production, higher costs of $0.7 million associated with the change in oil inventory in the three months ended March 31, 2015, compared to the change in oil inventory in the three months ended March 31, 2014 and higher other lease operating expenses of $0.9 million.

 

General and Administrative Expense

 

General and administrative expenses are overhead-related expenses, including employee compensation, legal, consulting and accounting fees, insurance, and investor relations expenses.

 

For the three months ended March 31, 2015, general and administrative expenses increased by $0.1 million to $6.3 million from $6.2 million for the same period in 2014.  Stock-based compensation expense, a subset of general and administrative expenses, was $0.6 million for the three months ended March 31, 2015 and $0.8 million for the same period in 2014. Other general and administrative expenses increased $0.3 million to $5.7 million from $5.4 million for the same period in 2014. The $0.3 million increase is due higher salary and related costs from severance benefits of $0.6 million, partially offset by lower other general and administrative expenses of $0.3 million.

 

Geological, Geophysical and Engineering Expense

 

Geological, geophysical and engineering expenses include laboratory, environmental and seismic acquisition related expenses.

 

For the three months ended March 31, 2015, geological, geophysical and engineering expenses was $0.8 million and $0.8 million for the same period in 2014.

 

Depreciation, Depletion and Amortization Expense

 

For the three months ended March 31, 2015, depreciation, depletion and amortization expense decreased $2.1 million to $4.5 million from $6.6 million for the same period in 2014.

 

For the three months ended March 31, 2015, depletion expense decreased $0.9 million to $3.5 million from $4.4 million during the same period in 2014. Depletion expense decreased due to capital costs in Block Z-1 reimbursed under the Carry Agreement with Pacific Rubiales and reserves added to the depletion base in 2014 and lower production in 2015 compared to 2014.

 

For the three months ended March 31, 2015, depreciation expense decreased $1.2 million to $1.0 million compared to $2.2 million for the same period in 2014. Depreciation expense decreased due to the Namoku and the Nu’uanu vessels being fully depreciated in 2014.

 

 

 
44

 

 

Other Income (Expense)

 

Other income (expense) includes non-operating income items. These items include interest expense and income, other financing costs (cost incurred related to the bankruptcy), loss on the extinguishment of debt, gains or losses on foreign currency transactions, income and amortization related to the investment in our Ecuador property as well as gains or losses on derivative financial instruments.

 

For the three months ended March 31, 2015, total other expense increased $7.4 million to $11.1 million compared to $3.7 million during the same period in 2014.

 

The change is due to the following:

 

Interest expense: For the three months ended March 31, 2015, we recognized approximately $6.0 million of net interest expense, which included $6.0 million of interest expense reduced by zero amount of capitalized interest expense. For the same period in 2014, we recognized $3.8 million in net interest expense, which included $6.7 million of interest expense reduced by $2.9 million of capitalized interest. The increase of $2.2 million in net interest expense is due to lower capitalized interest of $2.9 million due to no capitalized interest recorded in the first quarter of 2015, partially offset by lower interest expense of $0.7 million resulting from a lower average interest cost of debt outstanding between the periods and no interest expense recorded on the 2015 Convertible Notes in the month of March 2015.

 

Other financing costs: For the three months ended March 31, 2015, we recognized approximately $4.6 million of other financing costs, which includes fees associated with potential debt restructuring in the Consolidated Statements of Operations. For the same period in 2014, we recognized zero amount of other financing costs.

 

Gain on derivatives: The Performance Arranger Fees under our prior credit facilities expired in July 2014. For the three months ended March 31, 2015 there was no gain or loss. For the three months ended March 31, 2014, a gain associated with the embedded derivatives was $0.03 million.

 

Other income (expense): For the three months ended March 31, 2015, other income decreased $0.6 million to $0.5 million of loss compared to $0.06 million of income for the same period in 2014. For the three months ended March 31, 2015 and 2014, interest income was $0.02 million and $0.005 million, respectively. For the three months ended March 31, 2015 and 2014, foreign currency gains (losses), a component of other income, were ($0.5) million and ($0.1) million, respectively.

 

Reorganization Items, net

 

Reorganization items include expenses (including professional fees), realized gains and losses and provisions for losses that are realized or incurred as a direct result of the Chapter 11 proceedings.

 

The following table summarizes the components included in reorganization items, net on the consolidated statements of operations for the three months ended March 31, 2015:

 

 

   

Three Months Ended

March 31,

 
   

2015

 
   

(in thousands)

 

Professional fees

  $ (51 )

Other

    -  

Reorganization items, net

  $ (51 )

 

 
45

 

 

Income Taxes

 

The following is a summary of income (loss) before income taxes and income tax expense (benefit) for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 
Income (loss) before income taxes:                

United States

  $ (11,186 )   $ (5,061 )

Foreign

    (8,142 )     3,441  
    $ (19,328 )   $ (1,620 )
                 
                 

Income tax expense (benefit):

               

United States

  $ -     $ -  

Foreign

    439       1,950  
    $ 439     $ 1,950  

 

 

We have recognized a gross deferred tax asset related to net operating loss carryforwards attributable to the United States, before application of the valuation allowances. We have a valuation allowance for the full amount of the domestic net deferred tax asset, as we believe, based on the weight of available evidence, that it is more likely than not that the deferred tax asset will not be realized prior to the expiration of net operating loss carryforwards in various amounts through 2034. Furthermore, because we have no operations within the U.S. taxing jurisdiction, it is likely that sufficient generation of revenue to offset our deferred tax asset is remote.

 

The difference from the 22% statutory rate provided for under the Block Z-1 License Contract is due to other Peruvian operations that have a different statutory tax rate than the 22%, valuation adjustments on certain foreign entities and deferred tax balances where we believe it is not more likely than not we will receive the benefit of those deferred taxes, the effect of permanent differences and certain expenses which are not deductible in Peru.

 

The March 31, 2015 and December 31, 2014 balance of unrecognized tax benefits includes $0.7 million that, if recognized, would impact the Company's effective income tax rate. Over the next 12 months, we do not anticipate any reduction in the balance. We accrued interest and penalties related to unrecognized tax benefits of $47,000 and $46,000 as of March 31, 2015 and December 31, 2014, respectively. Estimated interest and penalties related to potential underpayment on unrecognized tax benefits, if any, are classified as a component of income tax expense in the Consolidated Statement of Operations.

 

Net Loss

 

For the three months ended March 31, 2015, our net loss increased $16.2 million to a net loss of $19.8 million or ($0.17) per basic and diluted share from a net loss of $3.6 million or ($0.03) per basic and diluted share for the same period in 2014.

  

Liquidity, Capital Resources and Capital Expenditures

 

At March 31, 2015, we had cash and cash equivalents of $28.0 million, an accounts receivable balance of $3.6 million and working capital of $21.0 million. At April 30, 2015, we had estimated cash and cash equivalents of $16.4 million.

 

At March 31, 2015, we had trade accounts payable and accrued liabilities of $12.6 million.

 

At March 31, 2015 we had liabilities subject to compromise of $223.3 million.

 

   

For the Three Months Ended

March 31,
 

Cash Flows

 

2015

   

2014

 
   

(in thousands)

 

Cash provided by (used in):

               

Operating activities

  $ (12,945 )   $ (1,727 )

Investing activities

    (21,193 )     (9,166 )

Financing activities

    2       11  

 

 
46

 

 

Operating Activities

 

Cash used in operating activities increased by $11.2 million to a use of cash of $12.9 million for the three months ended March 31, 2015 from a use of cash of $1.7 million for the same period in 2014. The change in cash flows before changes in operating assets and liabilities provided a use of cash of $20.2 million due to a higher net loss from lower revenues, higher other financing costs and higher lease operating expense. Changes in cash flow as a result of changes in operating assets and liabilities provided an increase in the source of cash of $9.0 million. The increase in the source of cash is due to the changes in liabilities (accrued liabilities of $10.7 million), partially offset by a change in other liabilities and accounts payable of $5.1 million providing an increase in the source of cash of $5.6 million. Also providing a source of cash were changes in assets (accounts receivable of $8.6 million and income taxes receivable of $1.3 million) of $9.9 million, partially offset by changes in assets (value-added tax receivables of $4.0 million, changes in inventory of $1.7 million and changes in other assets of $0.8 million) providing a use of cash of $6.5 million.

 

Investing Activities

 

Net cash used in investing activities increased by $12.0 million to $21.2 million for the three months ended March 31, 2015 from a use of cash of $9.2 million for the same period in 2014. The increase in cash used in investing activities is due to increased capital expenditures of $12.0 million in 2015 due to our development initiatives for the exploration and production of our oil and natural gas properties. The carry amount Pacific Rubiales agreed to pay under the joint venture agreement was completed in December 2014 and the we are now responsible for funding our full share of capital expenditures for Block Z-1 in addition to any other capital expenditures for our other activities.

 

2015 Capital Expenditures

 

During the three months ended March 31, 2015, we incurred capital expenditures of approximately $21.2 million associated with our development initiatives for the exploration and production of oil and natural gas reserves in Peru.

 

The capital expenditures added were approximately $6.8 million related to the CX-15 development drilling program, approximately $6.5 million related to the development drilling program in Albacora, approximately $2.2 million related to the Delfin platform, approximately $1.6 million related to the Albacora gas compressor, approximately $1.1 million related to the Piedra Redonda platform, approximately $0.4 million related to the CX-15 platform and other capital expenditures of $2.6 million.

 

Financing Activities

 

Cash provided by financing activities decreased by $9,000 to a source of cash of $2,000 for the three months ended March 31, 2015, compared to a use of cash of $11,000 for the same period in 2014.

 

Debt Obligations

 

At March 31, 2015 and December 31, 2014, debt consisted of the following:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 
                 

Convertible Notes, 8.5%, due October 2017, net of discount of zero at March 31, 2015 and ($13.9) million at December 31, 2014

  $ -     $ 154,839  

Convertible Notes, 6.5%, due March 2015, net of discount of zero at March 31, 2015 and ($0.4) million at December 31, 2014

    -       59,473  
      -       214,312  

Less: Current maturity of long-term debt

    -       214,312  

Long-term debt, net

  $ -     $ -  

 

As a result of our decision to not pay the principal and interest on the 2015 Convertible Notes when due on March 1, 2015 and after our exercise of a grace period until March 10, 2015, a cross default provision contained in the 2017 Convertible Notes was triggered. In addition, the Debtor voluntarily filed for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 2015, which was also an event of default under both the 2015 Convertible Notes and the 2017 Convertible Notes. Therefore all of our debt and related interest is considered due and callable once the default provisions were triggered and, all debt has been classified as Liabilities subject to compromise at March 31, 2015 and current liabilities at December 31, 2014.

 

 

 
47

 

 

Convertible Notes due 2017

 

During the third quarter of 2013, we closed on an offering for an aggregate principal amount of $143.8 million of convertible notes due 2017, which includes the exercise of the underwriter’s option to purchase an additional $18.8 million of the 2017 Convertible Notes in addition to the original offering of $125.0 million. The 2017 Convertible Notes are general senior unsecured obligations and rank equally in right of payment with all of our other existing and future senior unsecured indebtedness and rank senior in the right of payment to all of our existing and future subordinated debt.  The 2017 Convertible Notes are subordinate to any secured indebtedness we may have to the extent of the value of the assets collateralizing such indebtedness.  The 2017 Convertible Notes are not guaranteed by our subsidiaries. In April 2014, $26.0 million of the aggregate principal amount of the 2015 Convertible Notes were exchanged for an additional $25.0 million aggregate principal amount of 2017 Convertible Notes in a private transaction. As a result, we had $168.7 million principal amount of 2017 Convertible Notes outstanding at March 31, 2015.

 

The interest rate on the 2017 Convertible Notes is 8.50% per year with interest payments due on April 1st and October 1st of each year.  The 2017 Convertible Notes mature with repayment of the $168.7 million principal amount (assuming no conversion) on October 1, 2017 (the “2017 Maturity Date”).

 

The conversion rate is 249.5866 shares per $1,000 principal amount (equal to an initial conversion price of approximately $4.0066 per share of common stock). Upon conversion, if conversion is elected by the noteholders, we must deliver, at our option, either (1) a number of shares of our common stock determined as set forth in the Indenture dated September 24, 2013 (the “2013 Indenture”), (2) cash, or (3) a combination of cash and shares of our common stock.

 

Holders may convert their 2017 Convertible Notes at their option at any time prior to the close of business on the second business day immediately preceding the 2017 Maturity Date under any of the following circumstances:

 

(1) during any fiscal quarter (and only during such fiscal quarter) commencing after October 1, 2013, if the last reported sale price of our common stock is greater than or equal to 130% of the conversion price of the 2017 Convertible Notes for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter;

 

(2) prior to July 1, 2017, during the five business-day period after any ten consecutive trading-day period in which the trading price of $1,000 principal amount of the 2017 Convertible Notes for each trading day in the measurement period was less than 97% of the product of the last reported sale price of our common stock and the conversion rate on such trading day; or

 

(3) upon the occurrence of one of a specified number of corporate transactions.

 

Holders may also convert the 2017 Convertible Notes at their option at any time beginning on July 1, 2017, and ending at the close of business on the second business day immediately preceding the 2017 Maturity Date or may hold the 2017 Convertible Notes to maturity and be paid their outstanding principal in cash.

 

We may not redeem the 2017 Convertible Notes prior to the 2017 Maturity Date.

 

The 2013 Indenture for the 2017 Convertible Notes contains customary terms and covenants and events of default, the occurrence and continuation of which could result in the acceleration of amounts due under the 2017 Convertible Notes including (i) an event of default if the Company defaults in the payment when due, after the expiration of any applicable grace period, of indebtedness for money borrowed (including the 2015 Convertible Notes) in the aggregate principal amount then outstanding of $25 million or more, permitting the trustee or the holder of at least 25% in the aggregate principal amount of the outstanding 2017 Convertible Notes to declare the full amount of the principal and interest due thereunder immediately due and payable, and (ii) an event of default if the Company commences a voluntary case under any bankruptcy law, insolvency law or other similar law, whereby the full amount of the principal and interest due thereunder automatically and immediately becomes due and payable. See “—Convertible Notes due 2015” below.

 

Net proceeds from the sale of the 2017 Convertible Notes, after deducting the discounts and commissions and any offering expenses payable by us, were approximately $124.5 million.  The 2017 Convertible Notes were issued with a 10% discount or $14.4 million. The underwriter received commissions of approximately $4.3 million in connection with the sale and the Company incurred $0.6 million of direct expenses in connection with the offering.  We used the net proceeds for general corporate purposes, including funding our exploration and production efforts, other projects and to reduce or refinance our outstanding debt.

 

 

 
48

 

 

We account for the 2017 Convertible Notes in accordance with ASC Topic 470, “Debt”, as it pertains to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). Under the accounting guidance, convertible debt instruments that may be settled entirely or partially in cash upon conversion are required to be separated into liability and equity components, with the liability component amount determined in a manner that reflects the issuer’s non-convertible debt borrowing rate. The value assigned to the liability component is determined by measuring the fair value of a similar liability that does not have an equity conversion feature. The value assigned to the equity component is determined by deducting the fair value of the liability component from the initial proceeds. The excess of the principal amount of the liability component over its carrying amount (the non-cash discount) is amortized to interest cost using the effective interest method over the term of the 2017 Convertible Notes. In addition, transaction costs incurred that directly relate to the issuance of convertible debt instruments must be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as debt issuance costs and equity issuance costs, respectively.

 

We estimated our non-convertible borrowing rate at the date of issuance of the 2017 Convertible Notes to be 12.9%. The 12.9% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as us and was obtained through a quote from the underwriter. Using the income method and discounting the principal and interest payments of the 2017 Convertible Notes using the 12.9% non-convertible borrowing rate, we estimated the fair value of the $143.8 million 2017 Convertible Notes to be approximately $124.5 million, with the discount being approximately $19.3 million. The discount of $19.3 million includes the 10% discount of $14.4 million and the value of the equity component of $4.9 million. The discount is being amortized as non-cash interest expense over the life of the 2017 Convertible Notes using the effective interest method. In addition, we allocated approximately $2.3 million of the $4.9 million of fees and commissions as debt issue costs that are being amortized as non-cash interest expense over the life of the notes using the effective interest method. Approximately $0.1 million of fees and commissions were treated as transaction costs associated with the equity component and the remaining $2.5 million was expensed to other expense under the caption, “Other income (expense)” in the third quarter of 2013.

 

As a result of the exchange during the second quarter of 2014, we estimated our non-convertible borrowing rate at the date of issuance of the $25.0 million 2017 Convertible Notes to be 7.89%. The 7.89% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as us and was obtained through a quote from a financial advisor. Using the income method and discounting the principal and interest payments of the 2017 Convertible Notes with the 7.89% non-convertible borrowing rate, we estimated the fair value of the $25.0 million 2017 Convertible Notes to be approximately $25.4 million, with the premium being approximately $0.4 million. The value of the equity component was estimated at $0.5 million. The premium is being amortized as non-cash interest expense over the life of the 2017 Convertible Notes using the effective interest method. In addition, approximately $0.3 million of fees were considered debt issue costs that are being amortized as a non-cash interest expense over the life of the notes using the effective interest method. We recognized a loss on this transaction of approximately $0.9 million and this loss was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the second quarter of 2014. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

As a result of our decision to not pay the principal and interest on the 2015 Convertible Notes when due on March 1, 2015 and after exercise of a grace period until March 10, 2015, a cross default provision contained in the 2017 Convertible Notes was triggered. In addition, the Debtor voluntarily filed for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 2015, which was an event of default under both the 2015 Convertible Notes and the 2017 Convertible Notes. Therefore all of our debt and related interest is considered due and callable once the default provisions were triggered and all debt has been classified as Liabilities subject to compromise at March 31, 2015.

 

We evaluated the 2013 Indenture for the 2017 Convertible Notes for potential embedded derivatives, noting that the conversion feature and make-whole provisions did not meet the embedded derivative criteria as set forth in ASC Topic 815, “Derivatives and Hedging”. Therefore, no additional amounts have been recorded for those items.

 

As of March 31, 2015, the net amount of $154.2 million includes the $168.7 million of principal reduced by $12.8 million of the remaining unamortized discount and $1.7 million of the remaining debt issue costs. The remaining unamortized discount of $12.8 million and the remaining debt issue costs of $1.7 million may be written off as a result of the Chapter 11 Case. However, if the structure of the debt remains unchanged after the post Chapter 11 proceedings, the unamortized discount and debt issue costs will be amortized into interest expense, using the effective interest method, over the remaining life of the 2017 Convertible Notes, which mature in October 2017.  We are currently in default on our 2017 Convertible Notes. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in this Item 2 under the caption “—Voluntary Reorganization Under Chapter 11.” At March 31, 2015, using the conversion rate of 249.5866 shares per $1,000 principal amount of the 2017 Convertible Notes, if the $168.7 million of principal were converted into shares of common stock, the notes would convert into approximately 42.1 million shares of common stock.  As of March 31, 2014, there is no excess if-converted value to the holders of the 2017 Convertible Notes as the price of the Company’s common stock at March 31, 2015, $0.03 per share, is less than the conversion price.

 

 

 
49

 

 

The annual effective interest rate on the 2017 Convertible Notes, including the amortization of debt issue costs, is approximately 12.5%.

 

The following table shows the amount of interest expense related to the 2017 Convertible Notes, disregarding capitalized interest considerations, for the three months ended March 31, 2015 and 2014, respectively:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense related to the contractual interest coupon

  $ 3,585     $ 3,055  

Amortization of debt discount expense

    1,058       959  

Amortization of debt issue costs

    160       135  

Interest expense related to the 2017 Convertible Notes

  $ 4,803     $ 4,149  

 

 

Convertible Notes due 2015

 

During the first quarter of 2010, we closed on a private offering for an aggregate principal amount of $170.9 million of convertible notes due 2015. The 2015 Convertible Notes are our general senior unsecured obligations and rank equally in right of payment with all of our other existing and future senior unsecured indebtedness.  The 2015 Convertible Notes are subordinate to all of the Company’s secured indebtedness to the extent of the value of the assets collateralizing such indebtedness.  The 2015 Convertible Notes are not guaranteed by our subsidiaries. In September 2013, we repurchased $85.0 million of the aggregate principal amount of the $170.9 million of the 2015 Convertible Notes, leaving a principal balance of $85.9 million. In April 2014, $26.0 million of the aggregate principal amount of the 2015 Convertible Notes were exchanged for an additional $25.0 million aggregate principal amount of 2017 Convertible Notes in a private transaction. As a result, we had $59.9 million principal amount of 2015 Convertible Notes outstanding at March 31, 2015.

 

The interest rate on the 2015 Convertible Notes is 6.50% per year with interest payments due on March 1st and September 1st of each year.  The 2015 Convertible Notes mature with repayment of the $59.9 million principal amount (assuming no conversion) on March 1, 2015 (the “2015 Maturity Date”).

 

We elected not to pay the approximately $62 million in principal and interest due on March 1, 2015 on the 2015 Convertible Notes in order to use a 10-day grace period on principal due and a 30-day grace period on interest due to continue discussions with our debt holders regarding potential terms under which either one or both of the 2015 Convertible Notes and 2017 Convertible Notes could be restructured to provide a capital structure which would allow us to continue developing our oil and gas assets, and discussions with potential investors regarding alternative financing solutions. We were unable to reach an appropriate solution during the grace period and are in default on payment of the principal amount due under our 2015 Convertible Notes due on March 10, 2015 following our exercise of a 10-day grace period, which also triggered an event of default under our 2017 Convertible Notes, allowing the trustee or the holders of at least 25% in aggregate principal amount under each set of notes to declare the full amounts of principal and interest due. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in this Item under the caption “—Voluntary Reorganization Under Chapter 11.” The filing of the Chapter 11 Case also constituted an event of default that triggered repayment obligations under the 2015 Convertible Notes and the 2017 Convertible Notes. The ability of the holders of the 2015 Convertible Notes and the 2017 Convertible Notes to seek remedies and enforce their rights under the indentures was automatically stayed as a result of the filing of the Chapter 11 Case, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

 

The initial conversion rate of 148.3856 shares per $1,000 principal amount (equal to an initial conversion price of approximately $6.74 per share of common stock) was adjusted on February 3, 2011 in accordance with the terms of the Indenture agreement dated February 8, 2010 (the “2010 Indenture”).

 

As a result, the conversion rate and conversion price changed to 169.0082 shares per $1,000 principal amount and $5.9169 per share of common stock, respectively. Upon conversion, if conversion is elected by the noteholders, we must deliver, at our option, either (1) a number of shares of our common stock determined as set forth in the 2010 Indenture, (2) cash, or (3) a combination of cash and shares of our common stock.

 

 

 
50

 

 

Holders were permitted to convert their 2015 Convertible Notes at their option at any time prior to the close of business on the second business day immediately preceding the 2015 Maturity Date under any of the following circumstances:

 

(1) during any fiscal quarter (and only during such fiscal quarter) commencing after March 31, 2010, if the last reported sale price of our common stock is greater than or equal to 130% of the conversion price of the 2015 Convertible Notes for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter;

 

(2) prior to January 1, 2015, during the five business-day period after any ten consecutive trading-day period in which the trading price of $1,000 principal amount of the 2015 Convertible Notes for each trading day in the measurement period was less than 97% of the product of the last reported sale price of our common stock and the conversion rate on such trading day;

 

(3) if the 2015 Convertible Notes have been called for redemption; or

 

(4) upon the occurrence of one of a specified number of corporate transactions.

 

Holders were also permitted to convert the 2015 Convertible Notes at their option at any time beginning on February 1, 2015, and ending at the close of business on the second business day immediately preceding the 2015 Maturity Date or may hold the 2015 Convertible Notes to maturity and be paid their outstanding principal in cash.

 

As of February 3, 2013, we were permitted to redeem for cash all or a portion of the 2015 Convertible Notes at a redemption price of 100% of the principal amount of the notes to be redeemed plus any accrued and unpaid interest to, but not including, the redemption date, plus a “make-whole” payment if: (1) for at least 20 trading days in any consecutive 30 trading days ending within 5 trading days immediately before the date we mail the redemption notice, the “last reported sale price” of its common stock exceeded 175% of the conversion price in effect on that trading day, and (2) there is no continuing default with respect to the notes that has not been cured or waived on or before the redemption date.

 

No holders converted their 2015 Convertible Notes and the Company did not redeem any 2015 Convertible Notes prior to the 2015 Maturity Date.

 

The 2010 Indenture for the 2015 Convertible Notes contains customary terms and covenants and events of default, the occurrence and continuation of which could result in the acceleration of amounts due under the 2015 Convertible Notes.

 

Net proceeds from the sale of the $170.9 million of 2015 Convertible Notes, after deducting the discounts and commissions and any offering expenses payable by us, were approximately $164.9 million.  The initial purchaser received commissions of approximately $5.5 million in connection with the sale and the Company incurred approximately $0.6 million of direct expenses in connection with the offering.  We used the net proceeds for general corporate purposes, including capital expenditures and working capital, reduction or refinancing of debt, and other corporate obligations.

 

We account for the 2015 Convertible Notes in accordance with ASC Topic 470, “Debt,” as it pertains to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). Under the accounting guidance, convertible debt instruments that may be settled entirely or partially in cash upon conversion are required to be separated into liability and equity components, with the liability component amount determined in a manner that reflects the issuer’s non-convertible debt borrowing rate. The value assigned to the liability component is determined by measuring the fair value of a similar liability that does not have an equity conversion feature. The value assigned to the equity component is determined by deducting the fair value of the liability component from the initial proceeds. The excess of the principal amount of the liability component over its carrying amount (the non-cash discount) is amortized to interest cost using the effective interest method over the term of the 2015 Convertible Notes. In addition, transaction costs incurred that directly relate to the issuance of convertible debt instruments must be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as debt issuance costs and equity issuance costs, respectively.

 

We estimated our non-convertible borrowing rate at the date of issuance of the 2015 Convertible Notes to be 12%. The 12% non-convertible borrowing rate represented the borrowing rate of similar companies with the same credit quality as the Company and was obtained through a quote from the initial purchaser. Using the income method and discounting the principal and interest payments of the 2015 Convertible Notes using the 12% non-convertible borrowing rate, we estimated the fair value of the $170.9 million 2015 Convertible Notes to be approximately $136.3 million with the discount being approximately $34.6 million. The discount is being amortized as non-cash interest expense over the life of the notes using the effective interest method. In addition, we allocated approximately $4.8 million of the $6.1 million of fees and commissions as debt issue costs that are being amortized as non-cash interest expense over the life of the 2015 Convertible Notes using the effective interest method. The remaining $1.3 million of fees and commissions were treated as transaction costs associated with the equity component. The net amount of the equity component was $33.3 million, which included the initial discount of $34.6 million reduced by $1.3 million of direct transaction costs.

 

 

 
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In September 2013, we repurchased $85.0 million of aggregate principal amount of the 2015 Convertible Notes. As a result of the $85.0 million repurchase during the third quarter of 2013, approximately $12.2 million of the repayment was considered a retirement of debt and the remaining $72.8 million of the repayment were considered an exchange of debt. The $85.0 million of 2015 Convertible Notes were repurchased with an approximate discount of 10%. We recognized a gain on the retirement of the debt of approximately $0.2 million and this gain was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the third quarter of 2013. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

As a result of the exchange during the second quarter of 2014, the $26.0 million of aggregate principal amount of 2015 Convertible Notes exchanged was considered a retirement of debt and deemed a substantial modification of debt. The $26.0 million of 2015 Convertible Notes were exchanged with an approximate discount of 4%. We recognized a loss on the retirement of the debt of approximately $0.3 million and this loss was included in the “Loss on extinguishment of debt” in the consolidated statement of operations in the second quarter of 2014. For further information on debt issue costs see Note-6, “Prepaid and Other Current Assets and Other Non-Current Assets.”

 

We evaluated the 2010 Indenture for the 2015 Convertible Notes for potential embedded derivatives, noting that the conversion feature and make-whole provisions did not meet the embedded derivative criteria as set forth in ASC Topic 815, “Derivatives and Hedging.” Therefore, no additional amounts have been recorded for those items.

 

As of March 31, 2015, the net amount of $59.9 million of 2015 Convertible Notes outstanding includes the $59.9 million of principal reduced by zero of the remaining unamortized discount. We are currently in default on our 2015 Convertible Notes. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in this Item 2 under the caption “—Voluntary Reorganization Under Chapter 11.” At March 31, 2015, using the conversion rate of 169.0082 shares per $1,000 principal amount of the 2015 Convertible Notes, if the $59.9 million of principal were converted into shares of common stock, the notes would convert into approximately 10.1 million shares of common stock.  As of March 31, 2015, there is no excess if-converted value to the holders of the 2015 Convertible Notes as the price of our common stock at March 31, 2015, $0.03 per share, is less than the conversion price.

 

The annual effective interest rate on the 2015 Convertible Notes, including the amortization of debt issue costs, was approximately 12.0%.

 

The following table shows the amount of interest expense related to the 2015 Convertible Notes, disregarding capitalized interest considerations, for the three months ended March 31, 2015 and 2014:

 

   

Three Months Ended

March 31,
 
   

2015

   

2014

 
   

(in thousands)

 

Interest expense related to the contractual interest coupon

  $ 648     $ 1,396  

Amortization of debt discount expense

    417       885  

Amortization of debt issue costs

    106       239  

Interest expense related to the 2015 Convertible Notes

  $ 1,171     $ 2,520  

 

 
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Restricted Cash and Performance Bonds 

 

Below is a summary of restricted cash as of March 31, 2015 and December 31, 2014:

 

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Performance bonds totaling $5.7 million for properties in Peru

  $ 1,559     $ 1,559  

Performance obligations and commitments for the gas-to-power site

    650       650  

Unsecured performance bond totaling $0.1 million for office lease agreement

    -       -  

Restricted cash

  $ 2,209     $ 2,209  
                 

Current portion of restricted cash as of the end of the period

  $ -     $ -  
                 

Long-term portion of restricted cash as of the end of the period

  $ 2,209     $ 2,209  

 

 

All of the performance and insurance bonds are issued by Peruvian banks and their terms are governed by the corresponding license contracts, customs laws, legal requirements or rental practices. 

 

Liquidity Outlook 

 

The matters described herein, to the extent that they relate to future events or expectations, may be significantly affected by the Chapter 11 Case.  As a result of the risks and uncertainties associated with the Chapter 11 Case, the value of our liabilities and securities is highly speculative and trading in the Company’s securities during the pendency of the Chapter 11 Case will pose substantial risks.  We urge that extreme caution be exercised with respect to existing and future investments in any of the liabilities and/or securities of the Debtor.  See “—Voluntary Reorganization Under Chapter 11” under this Item 2 and Item 1A in our 2014 Form 10-K Risk Factors—Risks Related to Bankruptcy” regarding the impact of the Chapter 11 Case and the proceedings in Bankruptcy Court on the Debtor, the Debtor’s liquidity and its status as a going concern and its stakeholders.

 

We have not been profitable since we commenced operations and we require substantial capital expenditures as we advance development projects at Block Z-1 and exploration projects in our other Blocks.  Currently, we require substantial and significant additional financing to continue to fund our capital expenditure program, service our debt obligations, pay our suppliers and service providers and implement our business plan.  Our major sources of funding to date have been debt and equity financing, asset sales and net margin from oil sales.  The severe downturn in the economic climate for the oil and gas industry, increased capital costs and debt service costs for the industry, combined with experiencing less-than-expected operating performance in Block Z-1, have placed an extreme strain on our cash flow from operations. This has resulted in our inability to meet our debt obligations, and has made it exceptionally difficult for us to obtain reasonable financing. As a result of these events, we had to explore restructuring alternatives, which culminated in BPZ Resources, Inc. filing for voluntary reorganization under Chapter 11 of the Bankruptcy Code during the first quarter of 2015, as discussed in further detail below. Because of the risks and uncertainties associated with the Chapter 11 case, we cannot predict or quantify the ultimate impact that events occurring during the Chapter 11 case will have on our business, financial condition and results of operations, and there is no certainty as to our ability to continue as a going concern.

 

We are in default on payment of the principal amount due under our 2015 Convertible Notes due on March 10, 2015 following our exercise of a 10-day grace period, which also triggered an event of default under our 2017 Convertible Notes, allowing the trustee or the holders of at least 25% in aggregate principal amount of each to declare the full amounts of principal and interest due. On March 9, 2015, the Debtor filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy Code as described in Item 2 under the caption “—Voluntary Reorganization Under Chapter 11” and “Item 3. in our 2014 Form 10-K, Legal Proceedings—Legal Proceedings Related to the Chapter 11 Case.” The filing of the Chapter 11 Case constituted an event of default that triggered repayment obligations under the 2015 Convertible Notes and the 2017 Convertible Notes. The ability of the holders of the 2015 Convertible Notes and the 2017 Convertible Notes to seek remedies and enforce their rights under the indentures was automatically stayed as a result of the filing of the Chapter 11 Case, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

 

The Chapter 11 Case involves various restrictions on our activities, limitations on financing, the need to obtain Bankruptcy Court and Creditors’ Committee approval for various matters and uncertainty as to relationships with vendors, suppliers, customers and others with whom we may conduct or seek to conduct business. 

 

None of the Debtor’s direct or indirect subsidiaries or affiliates has filed for reorganization under Chapter 11 and none is expected to file for reorganization or protection from creditors under any insolvency or similar law in the U.S. or elsewhere. The Debtor’s operating subsidiaries are expected to continue to operate in the normal course of business. We therefore do not expect the Debtor’s filing for Chapter 11 protection to impact our license agreements, and the Debtor’s corporate guaranty to Perupetro that provides for joint and several liability to Perupetro with respect to the fulfillment of each minimum work program of the license agreements remains in place in addition to the subsidiary performance bonds that are unaffected.

 

 

 
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In addition, we expect the Debtor will need to obtain debtor-in-possession (“DIP”) financing during the pendency of the Chapter 11 Case. It is not certain that we can secure DIP Financing and, if we can, at what cost. Any such DIP Financing will be senior in priority to all of our other debt and equity.

 

Notwithstanding the direct positive impact of the Chapter 11 Case on our liquidity, including the stay of payments on debt subject to compromise and continuation of our ability to use cash for our operations under the supervision of the Bankruptcy Court and pursuant to certain court approved motions, we are currently uncertain as to the outcome of our petition for reorganization relief, so at this time, we cannot predict if and when we would emerge as a restructured company. Therefore, substantial doubt exists about our ability to continue as a going concern, and therefore, we may be unable to realize the full value of our assets and discharge our liabilities in the normal course of business. In addition, our auditors have expressed substantial doubt about our ability to continue as a going concern.

 

Regardless of the results of our reorganization efforts, our current and future liquidity is greatly dependent upon our operating results, which are driven by overall economic conditions, conditions in the oil and gas industry and oil and gas demand and prices, as well as other factors referenced herein and under “Item 1A. Risk Factors” of the 2014 Form 10-K. We expect to continue to have significant capital expenditure commitments and debt service obligations on a long-term basis.

 

Our reorganization may result in additional limitations on levels of debt and debt transactions. If we are successful in raising additional financing or issuing our securities in exchange for an extension of debt, securities comprising a significant percentage of our fully diluted equity capital may be issued in connection with the completion of such transactions, potentially resulting in very substantial dilution to our current equity holders. See “Item 1A. Risk Factors” in our 2014 Form 10-K for risks and uncertainties that could adversely affect our financial condition or short-term or long-term liquidity.

 

Depending upon the outcome of our restructuring, from time to time, we may consider the feasibility and timing of transactions that could raise capital for additional liquidity, debt reduction, debt extension, refinancing of existing indebtedness and for additional working capital and growth opportunities. There can be no assurance we will be successful in any of these efforts to consummate timely any such transactions or at all or to obtain any such financing on acceptable terms or at all, especially in consideration of the state of the current economic situation for oil and gas companies. If our plans or assumptions change or prove inaccurate, including those with respect to our debt levels, operations or cash flow from operating activities, if we experience unexpected costs or competitive pressures or if existing cash and any other borrowings prove to be insufficient to meet our obligations, we may need to obtain such financing and/or relief sooner than expected. In such circumstances, there can be no assurance we will be successful in these efforts to obtain new capital at acceptable terms or to exchange or to extend debt. Also there can be no assurance that changes in assumptions or conditions, including those referenced herein and under “Item 1A. Risk Factors” in our 2014 Form 10-K will not adversely affect our financial condition or short-term or long-term liquidity.     

 

Off-Balance Sheet Arrangements 

 

Off-balance sheet arrangements comprise those arrangements that may potentially impact our liquidity, capital resources and results of operations, even though such arrangements are not recorded as liabilities under U.S. generally accepted accounting principles. As part of our normal ongoing business operations and consistent with normal industry practice, we enter into agreements with other parties to pursue business opportunities, which share costs and apportion risks among the parties as governed by the agreements. Such customary agreements in the oil and gas industry include operating leases and commitments.

 

Critical Accounting Estimates 

 

In our annual report on Form 10-K for the year ended December 31, 2014, we identified our most critical accounting policies. In preparing the consolidated financial statements, we make assumptions, estimates and judgments that affect the amounts reported. We periodically evaluate our estimates and judgments that are the most critical in nature which are related to oil reserves, successful efforts method of accounting, revenue recognition, impairment of long-lived assets, future dismantlement, restoration, and abandonment costs, derivative instruments, liabilities subject to compromise, income taxes, as well as stock-based compensation. Our estimates are based on historical experience and on our future expectations that we believe are reasonable. Those estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses in the consolidated financial statements, and the disclosure of contingent assets and liabilities. Actual results are likely to differ from our current estimates and those differences may be material.

 

 

 

 
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Recent Accounting Pronouncements 

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), which creates Topic 606, Revenue from Contracts with Customers, and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, ASU 2014-09 supersedes the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs— Contracts with Customers. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, ASU 2014-09 requires enhanced financial statement disclosures over revenue recognition as part of the new accounting guidance. ASU 2014-09 is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The FASB is currently proposing to delay the effective date by one year. We are currently evaluating the provisions of ASU 2014-09 and assessing the impact, if any, it may have on our financial position and results of operations.

 

Disclosure Regarding Forward-Looking Statements 

 

We caution that this document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included in or incorporated by reference into this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts,” “plans” and similar expressions, or the negative thereof, are also intended to identify forward-looking statements. In particular, statements, expressed or implied, concerning future operating results, the ability to replace or increase reserves, or to increase production, or the ability to generate income or cash flows are by nature, forward-looking statements. These statements are based on certain assumptions and analyses made by the management of BPZ in light of its experience and its perception of historical trends, current conditions and expected future developments as well as other factors it believes are appropriate in the circumstances. However, forward-looking statements are not guarantees of performance and no assurance can be given that these expectations will be achieved.

 

Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include, but are not limited to, any of the following in the jurisdictions in which BPZ or its subsidiaries are doing business: the outcome and impact on our business of the proceedings of the Debtor under Chapter 11 of the Bankruptcy Code; the availability and access, in general, of funds to fund our operations and necessary capital expenditures, either through cash on hand, cash flows from operating activities, further borrowings and alternative financing sources and, in particular, our ability to fund debt obligations; the outcome of our discussions with certain note holders regarding restructuring our bonds; our ability to repay debt prior to or when it becomes due and/or successfully access the capital or credit markets to refinance that debt through new issuances, exchange offers or otherwise, including restructuring our balance sheet and leverage position, especially given recent volatility and disruption in the oil and gas industry; market conditions, uncertainties inherent in oil and gas production operations and estimating reserves, unexpected future capital expenditures, the timing and extent of changes in commodity prices for crude oil, natural gas and related products, currency exchange rates, interest rates, inflation, the availability of goods and services, drilling and other operational risks, receipt of all required permits, successful completion and installation of new drilling platforms, successful installation and operation of the turbines for the gas-to-power project, availability of capital resources, success of our operational risk management activities, governmental relations, legislative or regulatory changes, political developments, acts of war and terrorism. A more detailed discussion on risks relating to the oil and natural gas industry and to our Company is included in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

In light of these risks, uncertainties and assumptions, we caution the reader that these forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, which could cause actual events or results to differ materially from those expressed or implied by the statements. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements. We undertake no obligations to update or revise our forward-looking statements, whether as a result of new information, future events or otherwise.

 

Cautionary Statement Regarding Certain Information Releases  

 

We are aware that certain information concerning our operations and production is available from time to time from Perupetro and the Peruvian Ministry of Energy and Mines. This information is available from the websites of Perupetro and the Peruvian Ministry of Energy and Mines and may be available from other official sources of which we are unaware. This information is published by Perupetro and the Peruvian Ministry of Energy and Mines outside our control and may be published in a format different from the format we use to disclose such information, in compliance with SEC and other U.S. regulatory requirements.

 

Additionally, our joint venture partner in Block Z-1, Pacific Rubiales, is a Canadian public company that is not listed on a U.S. stock exchange, but is listed on the Toronto (TSX), Bolsa de Valores de Colombia (BVC) and BOVESPA stock exchanges. As such, Pacific Rubiales may be subject to different disclosure requirements than us. While Pacific Rubiales is subject to various confidentiality requirements regarding us, information concerning us, such as information concerning energy reserves, may be released by Pacific Rubiales outside of our control and may be released in a format different from the format we use to disclose such information, in compliance with SEC and other U.S. regulatory requirements.

 

 

 
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We provide any such information in the format required, and at the times required, by the SEC and as determined to be both material and relevant by our management. We urge interested investors and third parties to consider closely the disclosure in our SEC filings, available from us at 580 Westlake Park Blvd., Suite 525, Houston, Texas 77079; Telephone: (281) 556-6200; Internet: www.bpzenergy.com. These filings can also be obtained from the SEC via the internet at www.sec.gov.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk 

 

The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. The term “market risk” refers to the risk of loss arising from adverse changes in interest rates, oil and natural gas prices and foreign currency exchange rates. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonable possible losses. This forward-looking information provides indicators of how we view and manage our ongoing market risk exposures. All of our market risk sensitive instruments were entered into for purposes other than speculative trading.

 

Interest Rate Risk

 

As of March 31, 2015, we had debt classified as Liabilities subject to compromise of approximately $214.1 million.

 

The fair value of our 2017 Convertible Notes and 2015 Convertible Notes as compared to the carrying value at March 31, 2015 and December 31, 2014, is as follows:

 

   

Subject to Compromise

March 31,

2015

   

Not Subject to Compromise

December 31,

2014

 
                                 
   

Carrying Amount

   

Fair Value

   

Carrying Amount

   

Fair Value

 
   

(in thousands)

   

(in thousands)

 

Convertible Notes, 8.5%, due October 2017, net of debt issue costs of ($1.7) million and net of discount of ($12.8) million at March 31, 2015 and net of discount of ($13.9) million at December 31, 2014 (1)

  $ 154,219     $ 25,307     $ 154,839     $ 57,361  

Convertible Notes, 6.5%, due March 2015, net of debt issue costs of zero and net of discount of zero at March 31, 2015 and net of discount of ($0.4) million at December 31, 2014 (2)

    59,890       9,133       59,473       20,662  

 

 

(1)

We estimated the fair value of the 2017 Convertible Notes to be approximately $25.3 million and $57.4 million at March 31, 2015 and December 31, 2014, respectively, based on observed market prices for the same or similar type of debt issues.

 

 

(2)

We estimated the fair value of the 2015 Convertible Notes to be approximately $9.1 million and $20.7 million at March 31, 2015 and December 31, 2014, respectively, based on observed market prices for the same or similar type of debt issues.

 

Commodity Price Risk

 

With respect to our oil and gas business, any revenues, cash flow, profitability and future rate of growth we achieve will be greatly dependent upon prevailing prices for oil and gas.  Our ability to maintain or increase our borrowing capacity and to obtain additional capital on attractive terms is also expected to be dependent on oil and gas prices.  Historically, oil and gas prices and markets have been volatile and are likely to continue to be volatile in the future.  Prices for oil and gas are subject to potentially wide fluctuations in response to relatively minor changes in supply of and demand for oil and gas, market uncertainty, and a variety of additional factors that are beyond our control.

 

Lower oil and natural gas prices may not only decrease our revenues on a per unit basis, but may also reduce the amount of oil and natural gas we can produce economically, if any.  A substantial or extended decline in oil and natural gas prices may materially affect our future business, financial condition, results of operations, liquidity and borrowing capacity, and may require a reduction in the carrying value of our oil and gas properties.  While our revenues may increase if prevailing oil and gas prices increase significantly, exploration and production costs and acquisition costs for additional properties and reserves may also increase.

 

With respect to our planned electricity generation business, the price we can obtain from the sale of electricity through our proposed power plant may not rise at the same rate, or may not rise at all, to match a rise in the cost of production and transportation of our gas reserves which will be used to generate the electricity.  Prices for electricity in Peru have been volatile in the past and may be volatile in the future.  However, gas prices for gas sourced in Peru are regulated and therefore not volatile.

 

 

 
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Foreign Currency Exchange Rate Risk

 

The U.S. Dollar is the functional currency for our operations in both Peru and Ecuador.  Ecuador has adopted the U.S. Dollar as its official currency.  Peru, however, uses its local currency, the Nuevo Sol, in addition to the U.S. Dollar, and therefore, our financial results are subject to favorable or unfavorable fluctuations in the exchange rate and inflation in that country.  Transaction differences have been nominal to date but are expected to increase as our activities in Peru continue to escalate. 

 

For the three months ended March 31, 2015 and 2014, foreign currency gains (losses) were ($0.5) million and ($0.1) million, respectively.

 

Foreign currency gains (losses) are included in other income (expense) in the Consolidated Statements of Operations.

 

We currently have no foreign currency derivative instruments outstanding. However, we may enter into foreign currency derivative instruments (such as forward contracts, costless collars or swap agreements) in the future if we determine that it is necessary to invest in such instruments in order to mitigate our foreign currency exchange risk.

 

Item 4. Controls and Procedures 

 

(a) Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as defined in Rule 13a-15(e) of the Exchange Act were effective as of the end of the period covered by this report to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

(b) Changes in Internal Control over Financial Reporting

 

During the quarter ended March 31, 2015, there was no change in internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II

 

Item 1. Legal Proceedings 

 

See Note-19, “Legal Proceedings,” of the Notes to Unaudited Consolidated Financial Statements included in this Form 10-Q and Item 3. of Part I of our Annual Report on Form 10-K for the year ended December 31, 2014 for a discussion of legal proceedings, which are incorporated into this Part II, Item 1. “Legal Proceedings” by reference.

 

Item 1A. Risk Factors 

 

There are no material changes to our risk factors as previously described in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Item 6. Exhibits

   

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith)

   

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith)

   

32.1

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith)

   

32.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith)

   

101.INS XBRL Instance Document. (Filed herewith)

 

101.SCH XBRL Schema Document. (Filed herewith)

 

101.CAL XBRL Calculation Linkbase Document. (Filed herewith)

 

101.LAB XBRL Label Linkbase Document. (Filed herewith)

 

101.PRE XBRL Presentation Linkbase Document. (Filed herewith)

 

101.DEF XBRL Definition Linkbase Document. (Filed herewith)

 

 

 

 

 
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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

BPZ RESOURCES, INC.

     

Date: May 11, 2015

 

/s/  MANUEL PABLO ZÚÑIGA-PFLÜCKER

   

Manuel Pablo Zúñiga-Pflücker

   

President, Chief Executive Officer and Director

 

 

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