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EX-10.1 - AMENDMENT TO OPERATING AGREEMENT - BLUE DOLPHIN ENERGY CObdco_ex101.htm
EX-32.1 - CERTIFICATION - BLUE DOLPHIN ENERGY CObdco_ex321.htm
EX-31.2 - CERTIFICATION - BLUE DOLPHIN ENERGY CObdco_ex312.htm
EX-31.1 - CERTIFICATION - BLUE DOLPHIN ENERGY CObdco_ex311.htm
EX-32.2 - CERTIFICATION - BLUE DOLPHIN ENERGY CObdco_ex322.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)

þ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended:  June 30, 2015
 
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from _____________ to_____________
 
Commission File Number: 0-15905
 
BLUE DOLPHIN ENERGY COMPANY
(Exact name of registrant as specified in its charter)
 
Delaware
 
73-1268729
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
801 Travis Street, Suite 2100, Houston, Texas 77002
(Address of principal executive offices)
 
(713) 568-4725
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) 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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer 
o
Accelerated filer
o
       
Non-accelerated filer  
o
Smaller reporting company
þ
(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 o No þ
 
Number of shares of common stock, par value $0.01 per share outstanding as of August 14, 2015:  10,453,802
 


 
 
 
 
 
BLUE DOLPHIN ENERGY COMPANY & SUBSIDIARIES
FORM 10-Q REPORT INDEX
 
PART I   FINANCIAL INFORMATION
3
     
ITEM 1.
FINANCIAL STATEMENTS
3
     
 
Consolidated Balance Sheets (Unaudited)
3
     
 
Consolidated Statements of Income (Unaudited)
4
     
 
Consolidated Statements of Cash Flows (Unaudited)
5
     
 
Notes to Consolidated Financial Statements (Unaudited)
6
     
ITEM 2. 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
29
     
ITEM 3. 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
45
     
ITEM 4.
CONTROLS AND PROCEDURES
45
     
PART II  OTHER INFORMATION
46
     
ITEM 1. 
LEGAL PROCEEDINGS
46
     
ITEM 1A. 
RISK FACTORS
46
     
ITEM 2. 
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
46
     
ITEM 3. 
DEFAULTS UPON SENIOR SECURITIES
47
     
ITEM 4. 
MINE SAFETY DISCLOSURES
47
     
ITEM 5. 
OTHER INFORMATION
47
     
ITEM 6. 
EXHIBITS
47
     
SIGNATURES
48
 
 
 
 

 
 
PART I   FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
   
Blue Dolphin Energy Company & Subsidiaries

Consolidated Balance Sheets (Unaudited)

   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
 ASSETS
           
 CURRENT ASSETS
           
 Cash and cash equivalents
  $ 2,508,514     $ 1,293,233  
 Restricted cash
    4,296,327       1,008,514  
 Accounts receivable
    7,145,207       8,340,303  
 Prepaid expenses and other current assets
    422,443       771,458  
 Deposits
    120,176       68,498  
 Inventory
    3,844,533       3,200,651  
 Deferred tax assets, current portion, net
    2,962,488       -  
 Total current assets
    21,299,688       14,682,657  
                 
 Total property and equipment, net
    42,828,401       37,371,075  
 Restricted cash, noncurrent
    13,500,000       -  
 Surety bonds
    1,642,000       1,642,000  
 Debt issue costs, net
    1,313,244       479,737  
 Trade name
    303,346       303,346  
 Deferred tax assets, net
    905,067       5,928,342  
                 
 TOTAL ASSETS
  $ 81,791,746     $ 60,407,157  
                 
 LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
 CURRENT LIABILITIES
               
 Accounts payable
  $ 13,325,103     $ 12,370,179  
 Accounts payable, related party
    -       1,174,168  
 Notes payable
    3,000,000       -  
 Asset retirement obligations, current portion
    86,341       85,846  
 Accrued expenses and other current liabilities
    1,638,730       2,783,704  
 Interest payable, current portion
    62,303       56,039  
 Long-term debt, current portion
    1,618,828       1,245,476  
 Deferred tax liabilities, net
    -       168,236  
 Total current liabilities
    19,731,305       17,883,648  
                 
 Long-term liabilities:
               
 Asset retirement obligations, net of current portion
    1,886,413       1,780,924  
 Deferred revenues and expenses
    605,085       691,525  
 Long-term debt, net of current portion
    26,364,293       10,808,803  
 Long-term interest payable, net of current portion
    1,377,940       1,274,789  
 Total long-term liabilities
    30,233,731       14,556,041  
                 
 TOTAL LIABILITIES
    49,965,036       32,439,689  
                 
 Commitments and contingencies (Note 22)
               
                 
 STOCKHOLDERS' EQUITY
               
 Common stock ($0.01 par value, 20,000,000 shares authorized;10,603,802 and
               
 10,599,444 shares issued at June 30, 2015 and December 31, 2014, respectively)
    106,038       105,995  
 Additional paid-in capital
    36,738,737       36,718,781  
 Accumulated deficit
    (4,218,065 )     (8,057,308 )
 Treasury stock, 150,000 shares at cost
    (800,000 )     (800,000 )
 Total stockholders' equity
    31,826,710       27,967,468  
                 
 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 81,791,746     $ 60,407,157  
                 
                 

See accompanying notes to consolidated financial statements.  
 
 
3

 
 
Blue Dolphin Energy Company & Subsidiaries

Consolidated Statements of Income (Unaudited)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
                         
   
2015
   
2014
   
2015
   
2014
 
                         
REVENUE FROM OPERATIONS
                       
Refined petroleum product sales
  $ 58,839,160     $ 102,716,073     $ 119,906,222     $ 223,092,224  
Tank rental revenue
    286,892       282,516       573,784       565,032  
Pipeline operations
    35,562       67,862       73,957       121,893  
Total revenue from operations
    59,161,614       103,066,451       120,553,963       223,779,149  
                                 
COST OF OPERATIONS
                               
Cost of refined products sold
    53,801,698       96,622,257       103,189,147       207,037,864  
Refinery operating expenses
    2,586,151       2,641,205       5,467,122       5,596,224  
Joint Marketing Agreement profit share
    938,661       1,240,104       3,377,298       1,240,104  
Pipeline operating expenses
    60,887       61,713       107,483       89,442  
Lease operating expenses
    14,098       6,820       21,414       13,996  
General and administrative expenses
    400,018       427,060       745,902       796,544  
Depletion, depreciation and amortization
    402,937       391,167       802,168       781,772  
Accretion expense
    52,720       53,731       105,935       104,533  
                                 
Total cost of operations
    58,257,170       101,444,057       113,816,469       215,660,479  
                                 
Income from operations
    904,444       1,622,394       6,737,494       8,118,670  
                                 
OTHER INCOME (EXPENSE)
                               
Easement, interest and other income
    66,460       97,712       132,467       251,932  
Interest expense
    (732,296 )     (207,379 )     (940,371 )     (461,179 )
Total other expense
    (665,836 )     (109,667 )     (807,904 )     (209,247 )
                                 
Income before income taxes
    238,608       1,512,727       5,929,590       7,909,423  
                                 
Income tax expense
    (100,729 )     (74,170 )     (2,090,347 )     (276,593 )
                                 
Net income
  $ 137,879     $ 1,438,557     $ 3,839,243     $ 7,632,830  
                                 
                                 
Income per common share:
                               
Basic
  $ 0.01     $ 0.14     $ 0.37     $ 0.73  
Diluted
  $ 0.01     $ 0.14     $ 0.37     $ 0.73  
                                 
Weighted average number of common shares outstanding:
 
Basic
    10,450,210       10,441,695       10,449,829       10,436,363  
Diluted
    10,450,210       10,441,695       10,449,829       10,436,363  
 
See accompanying notes to consolidated financial statements.
 
 
4

 
 
Blue Dolphin Energy Company & Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

   
Six Months Ended June 30,
 
             
   
2015
   
2014
 
OPERATING ACTIVITIES
           
Net income
  $ 3,839,243     $ 7,632,830  
Adjustments to reconcile net income to net cash
               
provided by (used in) operating activities:
               
Depletion, depreciation and amortization
    802,168       781,772  
Unrealized gain (loss) on derivatives
    467,000       (44,400 )
Deferred taxes
    1,892,551       -  
Amortization of debt issue costs
    500,566       16,900  
Accretion expense
    105,935       104,533  
Common stock issued for services
    19,999       75,001  
Changes in operating assets and liabilities
               
Restricted cash
    (3,287,813 )     (677,109 )
Accounts receivable
    1,195,096       5,350,253  
Prepaid expenses and other current assets
    349,015       33,704  
Deposits and other assets
    (1,385,751 )     (492,053 )
Inventory
    (643,882 )     (2,815,138 )
Accounts payable, accrued expenses and other liabilities
    (634,025 )     (3,224,935 )
Accounts payable, related party
    (1,174,168 )     (1,395,621 )
Net cash provided by operating activities
    2,045,934       5,345,737  
                 
INVESTING ACTIVITIES
               
Capital expenditures
    (6,259,494 )     (329,871 )
Change in restricted cash, noncurrent
    (13,500,000 )     -  
Net cash used in investing activities
    (19,759,494 )     (329,871 )
                 
FINANCING ACTIVITIES
               
Proceeds from issuance of debt
    25,000,000       -  
Payments on long-term debt
    (9,071,159 )     (5,946,901 )
Proceeds from notes payable
    3,000,000       2,000,000  
Payments on notes payable
    -       (62,483 )
Net cash provided by (used in) financing activities
    18,928,841       (4,009,384 )
Net increase in cash and cash equivalents
    1,215,281       1,006,482  
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    1,293,233       434,717  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 2,508,514     $ 1,441,199  
      -       -  
Supplemental Information:
               
Non-cash operating activities
               
Surety bond funded by seller of pipeline interest
  $ -     $ 850,000  
Non-cash investing and financing activities:
               
New asset retirement obligations
  $ -     $ 300,980  
Interest paid
  $ 353,833     $ 1,048,553  
Income taxes paid
  $ 95,000     $ -  

See accompanying notes to consolidated financial statements.
 
 
 
5

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
   
(1)
Organization

Nature of Operations

Blue Dolphin Energy Company (http://www.blue-dolphin-energy.com, referred to herein, with its predecessors and subsidiaries, as “Blue Dolphin,” “we,” “us” and “our”) is primarily an independent refiner and marketer of petroleum products.  Our primary asset is a 15,000 bpd crude oil and condensate processing facility that is located in Nixon, Texas (the “Nixon Facility”).  As part of our refinery business segment, we conduct petroleum storage and terminaling operations under third-party lease agreements at the Nixon Facility.  We also own and operate pipeline assets and have leasehold interests in oil and gas properties. See “Note (4) Business Segment Information” of this report for further discussion of our business segments.

Structure and Management

We were formed as a Delaware corporation in 1986.  We are currently controlled by Lazarus Energy Holdings, LLC (“LEH”), which owns approximately 81% of our common stock, par value $0.01 per share (the “Common Stock). LEH manages and operates all of our properties pursuant to an Operating Agreement (the “Operating Agreement”).  Jonathan P. Carroll is Chairman of the Board of Directors (the “Board”), Chief Executive Officer and President of Blue Dolphin, as well as a majority owner of LEH.   See “Note (10) Accounts Payable, Related Party,” “Note (22) Commitments and Contingencies – Guaranty Fee Agreements” and “Note (23) Subsequent Events” of this report for additional disclosures related to the Operating Agreement, Jonathan P. Carroll, and LEH.

Our operations are conducted through the following operating subsidiaries:

Lazarus Energy, LLC, a Delaware limited liability company (“LE”);
Lazarus Refining & Marketing, LLC, a Delaware limited liability company (“LRM”);
Blue Dolphin Pipe Line Company, a Delaware corporation;
Blue Dolphin Petroleum Company, a Delaware corporation; and
Blue Dolphin Services Co., a Texas corporation.

See "Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Owned and Leased Assets” of this report for additional information regarding our operating subsidiaries.

(2)
Basis of Presentation

We have prepared our unaudited consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”), as codified by the Financial Accounting Standards Board (the “FASB”) in its Accounting Standards Codification (“ASC”), and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Our consolidated financial statements include Blue Dolphin and its subsidiaries. Significant intercompany transactions have been eliminated in the consolidation. In the opinion of management, such consolidated financial statements reflect all adjustments necessary to present fair consolidated statements of income, financial position and cash flows. We believe that the disclosures are adequate and the presented information is not misleading.  This report has been prepared in accordance with the SEC’s Form 10-Q instructions and therefore, certain information and footnote disclosures normally included in our annual audited financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the SEC’s rules and regulations.

 (3)
Significant Accounting Policies

The summary of significant accounting policies of Blue Dolphin is presented to assist in understanding our consolidated financial statements. Our consolidated financial statements and accompanying notes are representations of management who is responsible for its integrity and objectivity. These accounting policies conform to GAAP and have been consistently applied in the preparation of our consolidated financial statements.

Use of Estimates

We have made a number of estimates and assumptions related to the reporting of our consolidated assets and liabilities and to the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. While we believe our current estimates are reasonable and appropriate, actual results could differ from those estimated.

 
6

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
 
Cash and Cash Equivalents

Cash and cash equivalents represent liquid investments with an original maturity of three months or less. Cash balances are maintained in depository and overnight investment accounts with financial institutions that, at times, may exceed insured deposit limits. We monitor the financial condition of the financial institutions and have experienced no losses associated with these accounts.  Cash and cash equivalents amounted to $2,508,514 and $1,293,233 at June 30, 2015 and December 31, 2014, respectively.

Restricted Cash

Restricted cash totaled $4,296,327 and $1,008,514 at June 30, 2015 and December 31, 2014, respectively. Restricted cash, noncurrent totaled $13,500,000 and $0 at June 30, 2015 and December 31, 2014, respectively. Restricted cash primarily represents: (i) a construction contingency account under which Sovereign Bank, a Texas state bank (“Sovereign”) will fund contingencies, a payment reserve account held by Sovereign as security for payments under a loan agreement, and (iii) a certificate of deposit held by Sovereign as security under a loan agreement.  Restricted cash, noncurrent, represents a disbursement account under which Sovereign will make payments for construction related expenses to build new petroleum storage tanks.  See “Note (11) Notes Payable” and “Note (14) Long-Term Debt” of this report for additional disclosures related to loan agreements with Sovereign.

Accounts Receivable, Allowance for Doubtful Accounts and Concentration of Credit Risk

Accounts receivable are customer obligations due under normal trade terms. The allowance for doubtful accounts represents our estimate of the amount of probable credit losses existing in our accounts receivable. We have a limited number of customers with individually large amounts due on any given date. Any unanticipated change in any one of these customers’ credit worthiness or other matters affecting the collectability of amounts due from such customers could have a material adverse effect on our results of operations in the period in which such changes or events occur. We regularly review all of our aged accounts receivable for collectability and establish an allowance for individual customer balances as necessary.

Concentration of Risk

Bank Accounts

Financial instruments that potentially subject us to concentrations of risk consist primarily of cash, trade receivables and payables. We maintain our cash balances at financial institutions located in Houston, Texas. In the United States, the Federal Deposit Insurance Corporation (the “FDIC”) insures certain financial products up to a maximum of $250,000 per depositor.  We had cash balances in excess of the FDIC insurance limit per depositor in the amount of $19,203,627 and $1,113,977 at June 30, 2015 and December 31, 2014, respectively.

Significant Customers

Customers of our refined petroleum products include distributors, wholesalers, and refineries primarily in the lower portion of the Texas Triangle (the Houston - San Antonio - Dallas/Fort Worth area).  We have bulk term contracts, including month-to-month, six months, and up to five year terms in place with most of our customers.  Certain of our contracts require us to sell fixed quantities and/or minimum quantities of intermediate and finished petroleum products and many of these arrangements are subject to periodic renegotiation, which could result in us receiving higher or lower relative prices for our refined petroleum products.  See “Note (16) Concentration of Risk” of this report for additional disclosures related to significant customers.

Inventory

The nature of our business requires us to maintain inventory, which primarily consists of refined petroleum products and chemicals.  Inventory reflected for crude oil and condensate is nominal and represents line fill.  Our overall inventory is valued at lower of cost or market with costs being determined by the average cost method.  If the market value of our refined petroleum product inventories declines to an amount less than our average cost, we record a write-down of inventory and an associated impairment expense.  See “Note (7) Inventory” of this report for additional disclosures related to our inventory.
 
 
7

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Derivatives

We are exposed to commodity prices and other market risks including gains and losses on certain financial assets as a result of our inventory risk management policy.  Under our inventory risk management policy, Genesis Energy, LLC (“Genesis”) may, but is not required to, use commodity futures contracts to mitigate the change in value for certain of our refined petroleum product inventories subject to market price fluctuations. The physical inventory volumes are not exchanged and these contracts are net settled with cash.

Although these commodity futures contracts are not subject to hedge accounting treatment under FASB ASC guidance, we record the fair value of these Genesis hedges in our consolidated balance sheet each financial reporting period because of contractual arrangements with Genesis under which we are effectively exposed to the potential gains or losses. We recognize all commodity hedge positions as either current assets or current liabilities in our consolidated balance sheets and those instruments are measured at fair value. Changes in the fair value from financial reporting period to financial reporting period are recognized in our consolidated statements of income.  Net gains or losses associated with these transactions are recognized within cost of refined products sold in our consolidated statements of income using mark-to-market accounting.

See “Note (20) Fair Value Measurement” and “Note (21) Refined Petroleum Products Inventory Risk Management” of this report for additional disclosures related to derivatives.

Property and Equipment

Refinery and Facilities

Additions to refinery and facilities are capitalized. Expenditures for repairs and maintenance are expensed as incurred and are included as operating expenses under the Operating Agreement.  Management expects to continue making improvements to the Nixon Facility based on technological advances.

Refinery and facilities are carried at cost. Adjustment of the asset and the related accumulated depreciation accounts are made for refinery and facilities’ retirements and disposals, with the resulting gain or loss included in the consolidated statements of income.  For financial reporting purposes, depreciation of refinery and facilities is computed using the straight-line method using an estimated useful life of 25 years beginning when the refinery and facilities are placed in service.  We did not record any impairment of our refinery and facilities for the three and six months ended June 30, 2015 and 2014.

Oil and Gas Properties

We account for our oil and gas properties using the full-cost method of accounting, whereby all costs associated with acquisition, exploration and development of oil and gas properties, including directly related internal costs, are capitalized on a cost center basis.  Amortization of such costs and estimated future development costs are determined using the unit-of-production method.  Our oil and gas properties had no production during the three and six  months ended June 30, 2015 and 2014.  All leases associated with our oil and gas properties have expired.

Pipelines and Facilities

We record pipelines and facilities at the lower of cost or net realizable value.  Depreciation is computed using the straight-line method over estimated useful lives ranging from 10 to 22 years. In accordance with FASB ASC guidance on accounting for the impairment or disposal of long-lived assets, assets are grouped and evaluated for impairment based on the ability to identify separate cash flows generated therefrom.

Construction in Progress

Construction in progress expenditures, which relate to refurbishment activities at the Nixon Facility, are capitalized as incurred. Depreciation begins once the asset is placed in service.

See “Note (8) Property, Plant and Equipment, Net” of this report for additional disclosures related to our refinery and facilities, oil and gas properties, pipelines and facilities, and construction in progress.
 
 
8

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Intangibles – Other

We have an acquisition-related intangible asset consisting of the Blue Dolphin trade name in the amount of $303,346. We have determined our trade name to have an indefinite useful life. We account for other intangible assets under FASB ASC guidance related to intangibles, goodwill and other. Under the guidance, we test intangible assets with indefinite lives annually for impairment. Management performed its regular annual impairment testing of trade name in the fourth quarter of 2014. Upon completion of that testing, we determined that no impairment was necessary as of December 31, 2014.

Debt Issue Costs

We have debt issue costs related to certain refinery and facilities debt. Debt issue costs are capitalized and amortized over the term of the related debt using the straight-line method, which approximates the effective interest method. When a loan is paid in full, any unamortized financing costs are removed from the related asset accounts and expensed as interest expense.  See “Note (9) Debt Issue Costs” of this report for additional disclosures related to debt issue costs.

Revenue Recognition

Refined Petroleum Products Revenue

We sell various refined petroleum products including jet fuel, naphtha, distillates and atmospheric gas oil (“AGO”). Revenue from refined petroleum products sales is recognized when title passes. Title passage occurs when refined petroleum products are sold or delivered in accordance with the terms of the respective sales agreements. Revenue is recognized when sales prices are fixed or determinable and collectability is reasonably assured.

Customers assume the risk of loss when title is transferred. Transportation, shipping, and handling costs incurred are included in cost of refined products sold. Excise and other taxes that are collected from customers and remitted to governmental authorities are not included in revenue.

Tank Rental Revenue

Tank rental fees are invoiced monthly in accordance with the terms of the related lease agreement and recognized in revenue as earned.

Easement Revenue

Land easement revenue is recognized monthly as earned and is included in other income.

Pipeline Transportation Revenue

Revenue from our pipeline operations is derived from fee-based contracts and is typically based on transportation fees per unit of volume transported multiplied by the volume delivered. Revenue is recognized when volumes have been physically delivered for the customer through the pipeline.

Deferred Revenue

On February 5, 2014, we entered into an Asset Sale Agreement (the “Purchase Agreement”) with WBI Energy Midstream, LLC, a Colorado limited liability company (“WBI”), whereby we reacquired WBI’s 1/6th interest in the Blue Dolphin Pipeline System, the Galveston Area Block 350 Pipeline, and the Omega Pipeline (the “Pipeline Assets”) effective October 31, 2013.  Pursuant to the Purchase Agreement, WBI paid us $100,000 in cash, and a surety company $850,000 in cash as collateral for supplemental pipeline bonds for our benefit in exchange for the payment and discharge of any and all payables, claims, and obligations related to the Pipeline Assets.  We recorded the amount received for our benefit for the supplemental pipeline bonds as deferred revenue.  The deferred revenue is being recognized on a straight-line basis through December 31, 2018, the expected retirement date of the assets that the supplemental pipeline bonds secure.
 
 
9

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Income Taxes

We account for income taxes under FASB ASC guidance related to income taxes, which requires recognition of income taxes based on amounts payable with respect to the current year and the effects of deferred taxes for the expected future tax consequences of events that have been included in our financial statements or tax returns.  Under this method, deferred tax assets and liabilities are determined based on the differences between the financial accounting and tax basis of assets and liabilities, as well as for operating losses and tax credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse.  

As of each reporting date, management considers new evidence, both positive and negative, to determine the realizability of deferred tax assets.  Management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized, which is dependent upon the generation of future taxable income prior to the expiration of any net operating loss (“NOL”) carryforwards.  When management determines that it is more likely than not that a tax benefit will not be realized, a valuation allowance is recorded to reduce deferred tax assets.

The guidance also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, as well as guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.

See “Note (18) Income Taxes” of this report for further information related to income taxes.

Impairment or Disposal of Long-Lived Assets

In accordance with FASB ASC guidance on accounting for the impairment or disposal of long-lived assets, we initiate a review of our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparing its carrying amount to the expected future undiscounted cash flows expected to result from the use and eventual disposition of that asset, excluding future interest costs that would be recognized as an expense when incurred. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Significant management judgment is required in the forecasting of future operating results that are used in the preparation of projected cash flows and, should different conditions prevail or judgments be made, material impairment charges could be necessary.

Asset Retirement Obligations

FASB ASC guidance related to asset retirement obligations (“AROs”) requires that a liability for the discounted fair value of an ARO be recorded in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted towards its future value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized.

Management has concluded that there is no legal or contractual obligation to dismantle or remove the refinery and facilities. Further, management believes that these assets have indeterminate lives under FASB ASC guidance for estimating AROs because dates or ranges of dates upon which we would retire these assets cannot reasonably be estimated at this time. When a date or range of dates can reasonably be estimated for the retirement of these assets, we will estimate the cost of performing the retirement activities and record a liability for the fair value of that cost using present value techniques.

We recorded an ARO liability related to future asset retirement costs associated with dismantling, relocating, or disposing of our offshore platform, pipeline systems, and related onshore facilities, as well as for plugging and abandoning wells and restoring land and sea beds. We developed these cost estimates for each of our assets based upon regulatory requirements, structural makeup, water depth, reservoir characteristics, reservoir depth, equipment demand, current retirement procedures, and construction and engineering consultations.  Because these costs typically extend many years into the future, estimating future costs are difficult and require management to make judgments that are subject to future revisions based upon numerous factors, including changing technology, political, and regulatory environments. We review our assumptions and estimates of future abandonment costs on an annual basis.

See “Note (13) Asset Retirement Obligations” of this report for additional information related to our AROs.
 
 
10

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Computation of Earnings Per Share

We apply the provisions of FASB ASC guidance for computing earnings per share (“EPS”). The guidance requires the presentation of basic EPS, which excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding for the period. The guidance requires dual presentation of basic EPS and diluted EPS on the face of our consolidated statements of income and requires a reconciliation of the numerators and denominators of basic EPS and diluted EPS. Diluted EPS is computed by dividing net income available to common stockholders by the diluted weighted average number of common shares outstanding, which includes the potential dilution that could occur if securities or other contracts to issue shares of common stock were converted to common stock that then shared in the earnings of the entity.

The number of shares related to options, warrants, restricted stock, and similar instruments included in diluted EPS is based on the “Treasury Stock Method” prescribed in FASB ASC guidance for computation of EPS. This method assumes theoretical repurchase of shares using proceeds of the respective stock option or warrant exercised, and, for restricted stock, the amount of compensation cost attributed to future services that has not yet been recognized and the amount of any current and deferred tax benefit that would be credited to additional paid-in-capital upon the vesting of the restricted stock, at a price equal to the issuer’s average stock price during the related earnings period. Accordingly, the number of shares includable in the calculation of EPS in respect of the stock options, warrants, restricted stock, and similar instruments is dependent on this average stock price and will increase as the average stock price increases.  See “Note (19) Earnings Per Share” for additional information related to EPS.

Stock-Based Compensation

In accordance with FASB ASC guidance for stock-based compensation, share-based payments to personnel, including grants of restricted stock units, are measured at fair value as of the date of grant and are expensed in our consolidated statements of income over the service period (generally the vesting period).

Treasury Stock

We account for treasury stock under the cost method.  When treasury stock is re-issued, the net change in share price subsequent to acquisition of the treasury stock is recognized as a component of additional paid-in-capital in our consolidated balance sheets.  See “Note (15) Treasury Stock” for additional disclosures related to treasury stock.

Reclassification

We have reclassified certain insignificant prior period amounts related to our tank rental revenue to conform to our 2015 presentation.

New Pronouncements Issued but Not Yet Effective

In July 2015, FASB Issued Accounting Standards Update (“ASU”) 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”).  Current guidance requires an entity to measure inventory at the lower of cost or market.  Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin.  Under ASU 2015-11, an entity should measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  Amendments under ASU 2015-11 more closely align the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards.  For public business entities, ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years.  ASU 2015-11 should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. We do not anticipate adoption of this guidance to have a material effect on our consolidated financial statements.

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”).  ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.  This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized.  The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services.
 
 
11

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

On July 9, 2015, FASB approved a delay in the effective date of ASU 2014-09.  The effective date for public business entities is annual reporting periods beginning after December 15, 2017.  Public business entities would apply the new revenue standard to interim reporting periods after December 15, 2017.  As such, for a public business entity with a calendar year-end, ASU 2014-09 would be effective on January 1, 2018, for both its interim and annual reporting periods.  This represents a one-year deferral from the original effective date.  The new effective date guidance allows early adoption for all entities as of the original effective date (December 15, 2016).  We do not anticipate adoption of this guidance to have a material effect on our consolidated financial position, results of operations, cash flows or related disclosures.

In April 2015, FASB issued ASU 2015-03, Interest – Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). ASU 2015-03 requires debt issue costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issue costs are not affected by ASU 2015-03. The amendments in this ASU are effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2015.  Early adoption is permitted. We do not anticipate adoption of this guidance to have a material effect on our consolidated financial statements.

(4)
Business Segment Information

We have two reportable business segments: (i) “Refinery Operations” and (ii) “Pipeline Transportation.”  Business activities related to our “Refinery Operations” business segment are conducted at the Nixon Facility.  Business activities related to our “Pipeline Transportation” business segment are primarily conducted in the Gulf of Mexico through our Pipeline Assets and leasehold interests in oil and gas properties.

Business segment information for the three months ended June 30, 2015 and 2014 (and at June 30, 2015 and 2014), was as follows:
 
   
Three Months Ended June 30, 2015
   
Three Months Ended June 30, 2014
 
   
Segment
               
Segment
             
   
Refinery
   
Pipeline
   
Corporate &
         
Refinery
   
Pipeline
   
Corporate &
       
   
Operations
   
Transportation
   
Other
   
Total
   
Operations
   
Transportation
   
Other
   
Total
 
Revenue from operations
  $ 59,126,052     $ 35,562     $ -     $ 59,161,614     $ 102,998,589     $ 67,862     $ -     $ 103,066,451  
Less: cost of operations(1)
    (56,504,401 )     (127,704 )     (283,467 )     (56,915,572 )     (99,326,771 )     (122,263 )     (363,751 )     (99,812,785 )
Other non-interest income(2)
    -       62,500       -       62,500       -       83,333       -       83,333  
Adjusted EBITDA
    2,621,651       (29,642 )     (283,467 )     2,308,542       3,671,818       28,932       (363,751 )     3,336,999  
Less:  JMA Profit Share(3)
    (938,661 )     -       -       (938,661 )     (1,240,104 )     -       -       (1,240,104 )
EBITDA
  $ 1,682,990     $ (29,642 )   $ (283,467 )           $ 2,431,714     $ 28,932     $ (363,751 )        
                                                                 
Depletion, depreciation and amortization
                            (402,937 )                             (391,167 )
Interest expense, net
                            (728,336 )                             (193,001 )
                                                                 
Income before income taxes
                          $ 238,608                             $ 1,512,727  
                                                                 
Capital expenditures
  $ 4,967,579     $ -     $ -     $ 4,967,579     $ 270,693     $ -     $ -     $ 270,693  
                                                                 
Identifiable assets(4)
  $ 74,957,208     $ 2,788,381     $ 4,046,157     $ 81,791,746     $ 53,458,327     $ 3,132,068     $ 528,110     $ 57,118,505  
                                                                 
                                                                 
(1) 
Operation cost within the “Refinery Operations” and “Pipeline Transportation” segments includes related general, administrative, and accretion expenses.  Operation cost within “Corporate and Other” includes general and administrative expenses associated with corporate maintenance costs, such as accounting fees, director fees, and legal expense.
(2)
Other non-interest income primarily represents easement income from FLNG Land II, Inc. See “Note (22) Commitments and Contingencies – FLNG Master Easement Agreement” of this report for further discussion related to easement income.
(3) 
The Joint Marketing Agreement profit share (the “JMA Profit Share”) represents the GEL Profit Share plus the Performance Fee for the period pursuant to the Joint Marketing Agreement.  See “Note (22) Commitments and Contingencies – Genesis Agreements” and “Part 1, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Relationship with Genesis” of this report for further discussion related to the Joint Marketing Agreement.
(4)
Identifiable assets contain related legal obligations of each business segment including cash, accounts receivable, and recorded net assets.


 
12

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
Business segment information for the six months ended June 30, 2015 and 2014 (and at June 30, 2015 and 2014), was as follows:
 
   
Six Months Ended June 30, 2015
   
Six Months Ended June 30, 2014
 
   
Segment
               
Segment
             
   
Refinery
   
Pipeline
   
Corporate &
         
Refinery
   
Pipeline
   
Corporate &
       
   
Operations
   
Transportation
   
Other
   
Total
   
Operations
   
Transportation
   
Other
   
Total
 
Revenue from operations
  $ 120,480,006     $ 73,957     $ -     120,553,963     $ 223,657,256     $ 121,893     $ -     $ 223,779,149  
Less: cost of operations(1)
    (108,763,871 )     (181,616 )     (691,515 )     (109,637,002 )     (212,695,349 )     (244,773 )     (698,480 )     (213,638,602 )
Other non-interest income(2)
    -       125,000       -       125,000       -       208,333       -       208,333  
Adjusted EBITDA
    11,716,135       17,341       (691,515 )     11,041,961       10,961,907       85,453       (698,480 )     10,348,880  
Less:  JMA Profit Share(3)
    (3,377,298 )     -       -       (3,377,298 )     (1,240,104 )     -       -       (1,240,104 )
EBITDA
  $ 8,338,837     $ 17,341     $ (691,515 )           $ 9,721,803     $ 85,453     $ (698,480 )        
                                                                 
Depletion, depreciation and amortization
                            (802,168 )                             (781,772 )
Interest expense, net
                            (932,905 )                             (417,581 )
                                                                 
Income before income taxes
                          $ 5,929,590                             $ 7,909,423  
                                                                 
Capital expenditures
  $ 6,259,494     $ -     $ -     $ 6,259,494     $ 329,871     $ -     $ -     $ 329,871  
                                                                 
Identifiable assets(4)
  $ 74,957,208     $ 2,788,381     $ 4,046,157     $ 81,791,746     $ 53,458,327     $ 3,132,068     $ 528,110     $ 57,118,505  
                                                                 
                                                                 
(1) 
Operation cost within the “Refinery Operations” and “Pipeline Transportation” segments includes related general, administrative, and accretion expenses.  Operation cost within “Corporate and Other” includes general and administrative expenses associated with corporate maintenance costs, such as accounting fees, director fees, and legal expense.
(2)
Other non-interest income primarily represents easement income from FLNG Land II, Inc. See “Note (22) Commitments and Contingencies – FLNG Master Easement Agreement” of this report for further discussion related to easement income.
(3) 
The Joint Marketing Agreement profit share (the “JMA Profit Share”) represents the GEL Profit Share plus the Performance Fee for the period pursuant to the Joint Marketing Agreement.  See “Note (22) Commitments and Contingencies – Genesis Agreements” and “Part 1, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Relationship with Genesis” of this report for further discussion related to the Joint Marketing Agreement.
(4)
Identifiable assets contain related legal obligations of each business segment including cash, accounts receivable, and recorded net assets.

   
(5)
Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Prepaid insurance
  $ 217,969     $ 156,558  
Prepaid related party operating expenses
    168,074       -  
Unrealized hedging gains
    28,900       495,900  
Prepaid listing fees
    7,500       15,000  
Prepaid professional fees
    -       104,000  
                 
    $ 422,443     $ 771,458  
                 
 
 
13

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

(6)
Deposits

Deposits consisted of the following:
  
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Equipment deposits
  $ 100,463     $ 48,785  
Utility deposits
    10,250       10,250  
Rent deposits
    9,463       9,463  
                 
    $ 120,176     $ 68,498  
                 
 
(7)
Inventory

Inventory consisted of the following:

   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Jet fuel
  $ 1,890,450     $ 2,631,546  
Naphtha
    1,088,526       194,688  
AGO
    482,839       224,007  
HOBM
    176,738       124,176  
Chemicals
    156,685       -  
Propane
    23,708       -  
Crude
    19,041       19,041  
LPG mix
    6,546       7,193  
                 
    $ 3,844,533     $ 3,200,651  

 
(8)
Property, Plant and Equipment, Net

Property, plant and equipment, net, consisted of the following:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Refinery and facilities
  $ 37,371,819     $ 36,462,451  
Pipelines and facilities
    2,127,207       2,127,207  
Onshore separation and handling facilities
    325,435       325,435  
Land
    602,938       602,938  
Other property and equipment
    630,534       597,064  
      41,057,933       40,115,095  
                 
Less:  Accumulated depletion, depreciation, and amortization
    (5,388,743 )     (4,586,575 )
      35,669,190       35,528,520  
                 
Construction in progress
    7,159,211       1,842,555  
                 
    $ 42,828,401     $ 37,371,075  
                 
 
 
14

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

(9)
Debt Issue Costs

Debt issue costs, net of accumulated amortization, totaled $1,313,244 and $479,737 at June 30, 2015 and December 31, 2014, respectively.  Debt issue costs at June 30, 2015 related to loan agreements with Sovereign.  Debt issue costs at December 31, 2014 related to a loan agreement with American First National Bank.

Accumulated amortization totaled $5,695 and $211,244 at June 30, 2015 and December 31, 2014, respectively.  Amortization expense, which is included in interest expense, was $492,116 for the three months ended June 30, 2015, including $456,287 related to refinancing debt owed to American First National Bank. Amortization expense was $8,450 for the three months ended June 30, 2014. Amortization expense was $500,566 and $16,900 for the six months ended June 30, 2015 and 2014, respectively.

See “Note (14) Long-Term Debt” of this report for additional disclosures related to the loan agreements with Sovereign and American First National Bank.

(10)
Accounts Payable, Related Party

LEH manages and operates all of our properties pursuant to the Operating Agreement.  For services rendered, LEH receives reimbursements and fees as follows:

ReimbursementsFor management and operation of all properties excluding the Nixon Facility, LEH is reimbursed at cost for all reasonable expenses incurred while performing the services.  Reimbursements are reflected within either prepaid expenses or accounts payable, related party in our consolidated balance sheets.  Amounts reimbursed to LEH are reflected in the appropriate asset or expense accounts in our consolidated statements of income.
   
FeesFor management and operation of the Nixon Facility, LEH receives fees: (i) in the form of weekly payments from GEL TEX Marketing, LLC (“GEL”) not to exceed $750,000 per month, (ii) $0.25 for each barrel processed at the Nixon Facility up to a maximum quantity of 10,000 barrels per day determined on a monthly basis, and (iii) $2.50 for each barrel processed at the Nixon Facility in excess of 10,000 barrels per day determined on a monthly basis.  In the normal course of business, we make estimates and assumptions related to amounts expensed for fees since actual amounts can vary depending upon production volumes. We then use the cumulative catch-up method to account for revisions in estimates, which may result in prepaid expenses or accounts payable, related party on our consolidated balance sheets.  Amounts expensed as fees are reflected as refinery operating expenses in our consolidated statements of income.
   
At June 30, 2015, we were in a prepaid position with respect to fees and reimbursements under the Operating Agreement.  Prepaid related party operating expenses totaled $168,074 and $0 at June 30, 2015 and December 31, 2014, respectively. Accounts payable, related party totaled $0 and $1,174,168 at June 30, 2015 and December 31, 2014, respectively.

For the three months ended June 30, 2015 and 2014, refinery operating expenses totaled $2,586,151 (approximately $2.83 per barrel of throughput) and $2,641,205 (approximately $2.73 per barrel of throughput), respectively.  For the six months ended June 30, 2015 and 2014, refinery operating expenses totaled $5,467,122 (approximately $2.76 per barrel of throughput) and $5,596,224 (approximately $2.72 per barrel of throughput), respectively.

The Operating Agreement expires upon the earliest to occur of: (a) the date of the termination of the Joint Marketing Agreement pursuant to its terms, (b) August 12, 2018, or (c) upon written notice of either party to the Operating Agreement of a material breach of the Operating Agreement by the other party.

See “Note (23) Subsequent Events” of this report for additional disclosures related to the Operating Agreement.
 
 
15

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
 
(11)
Notes Payable

Notes payable consisted of the following:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Bridge Loan Due 2015
  $ 3,000,000     $ -  
                 
    $ 3,000,000     $ -  
                 
 
Bridge Loan Due 2015

We entered into a Loan and Security Agreement with Sovereign as lender on June 22, 2015, for a short term note in the principal amount of $3.0 million (the “Bridge Loan Due 2015”).  The Bridge Loan Due 2015 matures in December 2015 and accrues interest at the greater of the Wall Street Journal Prime Rate plus 2.75% or 6.00%.  The Bridge Loan Due 2015 requires a monthly payment of interest with full payment of the outstanding principal due at maturity.  The principal balance outstanding on the Bridge Loan Due 2015 was $3,000,000 and $0 at June 30, 2015 and December 31, 2014, respectively.  Interest was accrued on the Bridge Loan Due 2015 in the amount of $15,000 and $0 at June 30, 2015 and December 31, 2014, respectively.

Proceeds of the Bridge Loan Due 2015 were used to purchase idle refinery equipment for the Nixon Facility. The Bridge Loan Due 2015 is secured by: (i) a first lien on the equipment being purchased, (ii) a $1.5 million certificate of deposit at Sovereign, (iii) assignment of an easement agreement on land in Freeport, Texas (iv) a second lien on all LRM assets (excluding accounts receivable and inventory), and (v) a second lien and deed of trust on the Nixon Facility.  The Bridge Loan Due 2015 contains representations and warranties, affirmative, restrictive, and financial covenants, as well as events of default which are customary for credit facilities of this type.  Repayment of funds borrowed and interest accrued under the Bridge Loan Due 2015 is guaranteed by Blue Dolphin, LE, and Jonathan P. Carroll.  See “Note (22) Commitments and Contingencies – Guaranty Fee Agreements” of this report for additional disclosures related to the Bridge Loan Due 2015 and Jonathan P. Carroll.

(12)
Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following: 
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Excise and income taxes payable
  $ 978,926     $ 1,228,411  
Transportation and inspection
    195,000       190,000  
Unearned revenue
    157,861       252,500  
Other payable
    152,981       149,962  
Board of director fees payable
    61,429       345,000  
Property taxes
    60,502       -  
Insurance
    32,031       96,092  
Genesis JMA Profit Share payable
    -       521,739  
                 
    $ 1,638,730     $ 2,783,704  
 
 
16

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
 
(13)
Asset Retirement Obligations

Refinery and Facilities

Management has concluded that there is no legal or contractual obligation to dismantle or remove the refinery and facilities. Management believes that the refinery and facilities have indeterminate lives under FASB ASC guidance for estimating AROs because dates or ranges of dates upon which we would retire these assets cannot reasonably be estimated at this time. When a date or range of dates can reasonably be estimated for the retirement of these assets, we will estimate the cost of performing the retirement activities and record a liability for the fair value of that cost using present value techniques.

Pipelines and Facilities and Oil and Gas Properties

We have AROs associated with the dismantlement and abandonment in place of our pipelines and facilities, as well as the plugging and abandonment of our oil and gas properties.  We recorded a discounted liability for the fair value of an ARO with a corresponding increase to the carrying value of the related long-lived asset at the time the asset was installed or placed in service. We amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the asset.

For the three and six months ended June 30, 2015 and 2014, we did not incur any abandonment expense related to our oil and gas properties. Plugging and abandonment costs for oil and gas properties and pipelines are recorded as information becomes available from operators to substantiate actual and/or probable costs.
 
AROs on a roll-forward basis were as follows:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Asset retirement obligations, at the beginning of the period
  $ 1,866,770     $ 1,597,661  
New asset retirement obligations and adjustments
    49       300,980  
Liabilities settled
    -       (243,866 )
Accretion expense
    105,935       211,995  
      1,972,754       1,866,770  
Less:  current portion of asset retirement obligations
    (86,341 )     (85,846 )
                 
Long-term asset retirement obligations, at the end of the period
  $ 1,886,413     $ 1,780,924  
 
The WBI transaction resulted in a $300,980 increase in our AROs related to the Pipeline Assets, which represents the fair value of the liability, and increased accretion expense throughout the remaining useful life of certain of the Pipeline Assets.  For additional information related to the WBI Transaction, see “Note (3) Significant Accounting Policies – Revenue Recognition – Deferred Revenue” and “Note (22) Commitments and Contingencies – Supplemental Pipeline Bonds” of this report.

 
17

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

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Long-Term Debt

Long-term debt consisted of the following:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Term Loan Due 2034
  $ 25,000,000     $ -  
Notre Dame Debt
    1,300,000       1,300,000  
Term Loan Due 2017
    1,294,955       1,638,898  
Capital Leases
    388,166       466,401  
Refinery Note
    -       8,648,980  
      27,983,121       12,054,279  
Less:  current portion of long-term debt
    (1,618,828 )     (1,245,476 )
                 
    $ 26,364,293     $ 10,808,803  
                 
 
Term Loan Due 2034

We entered into a Loan and Security Agreement with Sovereign on June 22, 2015, as administrative agent and lender pursuant to a term loan in the principal amount of $25.0 million (the “Term Loan Due 2034”).  The Term Loan Due 2034 matures in June 2034, has a monthly payment of $185,289 plus interest, and accrues interest at a rate based on the Wall Street Journal Prime Rate plus 2.75%.  Pursuant to a construction rider in the Term Loan Due 2034, proceeds available for use have been placed in a disbursement account whereby Sovereign will make payments for construction related expenses. Amounts held in the disbursement account are reflected as restricted cash, noncurrent in our consolidated balance sheets.  The principal balance outstanding on the Term Loan Due 2034 was $25,000,000 and $0 at June 30, 2015 and December 31, 2014, respectively.  Interest was accrued on the Term Loan Due 2034 in the amount of $37,500 and $0 at June 30, 2015 and December 31, 2014, respectively.

Proceeds of the Term Loan Due 2034 were used to refinance approximately $8.5 million of debt owed to American First National Bank under the Refinery Note.  Remaining proceeds will primarily be used to construct new petroleum storage tanks. The Term Loan Due 2034 is secured by: (i) a first lien on all Nixon Facility business assets (excluding accounts receivable and inventory), (ii) assignment of all Nixon Facility contracts, permits, and licenses, (iii) absolute assignment of Nixon Facility rents and leases, including tank rental income, (iv) a $1.0 million payment reserve account held by Sovereign, and (v) a pledge of $5.0 million of a life insurance policy on Jonathan P. Carroll.  The Term Loan Due 2034 contains representations and warranties, affirmative, restrictive, and financial covenants, as well as events of default which are customary for credit facilities of this type.  Repayment of funds borrowed and interest accrued under the Term Loan Due 2034 is guaranteed by Blue Dolphin, LRM, Jonathan P. Carroll, and LEH.  See “Note (10) Accounts Payable, Related Party” and Note (22) Commitments and Contingencies – Guaranty Fee Agreements” of this report for additional disclosures related to the Term Loan Due 2034, Jonathan P. Carroll, and LEH.

Notre Dame Debt

We entered into a loan with Notre Dame Investors, Inc. as evidenced by a Promissory Note in the original principal amount of $8.0 million, which is currently held by John Kissick (the “Notre Dame Debt”). The Notre Dame Debt matures in July 2016, and accrues interest at a rate of 16.00%.  The principal balance outstanding on the Notre Dame Debt was $1,300,000 at June 30, 2015 and December 31, 2014.  Interest was accrued on the Notre Dame Debt in the amount of $1,377,940 and $1,274,789 at June 30, 2015 and December 31, 2014, respectively.
 
The Notre Dame Debt is secured by a Deed of Trust, Security Agreement and Financing Statements (the “Subordinated Deed of Trust”), which encumbers the Nixon Facility and general assets of LE.  There are no financial maintenance covenants associated with the Notre Dame Debt. Pursuant to a Subordination Agreement dated June 22, 2015, the holder of the Notre Dame Debt agreed to subordinate its interest and liens on the Nixon Facility and general assets of LE first in favor of Sovereign as holder of the Term Loan Due 2034 and second in favor of GEL.  See “Note (22) Commitments and Contingencies” of this report for additional disclosures related to the Genesis Agreements.
 
 
18

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Term Loan Due 2017

We entered into a Loan and Security Agreement with Sovereign on May 2, 2014, for a term loan facility in the principal amount of $2.0 million (the “Term Loan Due 2017”).  The Term Loan Due 2017 was amended on March 25, 2015, pursuant to a Loan Modification Agreement (the “Loan Modification Agreement”).  Under the Loan Modification Agreement, the interest rate was modified to be the greater of the U.S. Prime Rate plus 2.75% or 6.00% and the due date was extended to March 2017.  Pursuant to the Loan Modification Agreement, the monthly payment due under the Term Loan Due 2017 is $61,665 plus interest.  The principal balance outstanding on the Term Loan Due 2017 was $1,294,955 and $1,638,898 at June 30, 2015 and December 31, 2014, respectively.  Interest was accrued on the Term Loan Due 2017 in the amount of $6,475 and $8,470 at June 30, 2015 and December 31, 2014, respectively.

The proceeds of the Term Loan Due 2017 are being used primarily to finance costs associated with refurbishment of the Nixon Facility’s naphtha stabilizer and depropanizer units.  The Term Loan Due 2017 is: (i) subject to a financial maintenance covenant pertaining to debt service coverage ratio, (ii) secured by the assignment of certain leases of LRM and assets of LEH, and (iii) guaranteed by Jonathan P. Carroll.  See “Note (10) Accounts Payable, Related Party” and “Note (22) Commitments and Contingencies – Guaranty Fee Agreements” of this report for additional disclosures related to the Term Loan Due 2017, Jonathan P. Carroll, and LEH.

Capital Leases

We entered into a 36 month “build-to-suit” capital lease on August 7, 2014, for the purchase of new boiler equipment for the Nixon Facility.  The equipment was delivered in December 2014 and the cost was added to construction in progress.  Once placed in service, the equipment will be reclassified to refinery and facilities and depreciation will begin.  The capital lease requires a quarterly payment in the amount of $42,996.  Capital lease obligations totaled $388,166 and $466,401 at June 30, 2015 and December 31, 2014, respectively.  Interest was accrued on capital leases in the amount of $3,328 and $0 at June 30, 2015 and December 31, 2014, respectively.

The following is a summary of equipment held under long-term capital leases:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Boiler equipment
  $ 538,598     $ 538,598  
Less:  accumulated depreciation
    -       -  
                 
    $ 538,598     $ 538,598  
 
Refinery Note

We entered into a Loan Agreement with First International Bank on September 29, 2008, in the principal amount of $10.0 million (the “Refinery Note”).  The Refinery Note was subsequently acquired by American First National Bank.  The Refinery Note matured in October 2028 and accrued interest at a rate based on the U.S. Prime Rate plus 2.25%.   The principal balance outstanding on the Refinery Note was $0 and $8,648,980 at June 30, 2015 and December 31, 2014, respectively.  Interest was accrued on the Refinery Note in the amount of $0 and $47,569 at June 30, 2015 and December 31, 2014, respectively.   All amounts due and outstanding under the Refinery Note were repaid in June 2015.

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Treasury Stock

At June 30, 2015 and December 31, 2014, we had 150,000 shares of treasury stock.

 
 
19

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
 
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Concentration of Risk

Key Supplier

Under the Crude Oil and Supply Throughput Services Agreement dated August 12, 2011 (the “Crude Supply Agreement”), GEL is our exclusive supplier of crude oil and condensate.  We have the ability to purchase crude oil and condensate from other suppliers with the prior consent of GEL.  The initial term was to expire on August 12, 2014.  However, on October 30, 2013, we entered into a Letter Agreement Regarding Certain Advances and Related Agreements with GEL and Milam Services, Inc. (“Milam”)(the “October 2013 Letter Agreement”), effective October 24, 2013.  In accordance with the terms of the October 2013 Letter Agreement, we agreed not to terminate the Crude Supply Agreement and GEL agreed to automatically renew the Crude Supply Agreement at the end of the initial term for successive one year periods until August 12, 2019, unless sooner terminated by GEL with 180 days prior written notice.

Significant Customers

For the three months ended June 30, 2015, we had 5 customers that accounted for approximately 82% of our refined petroleum products sales.  These 5 customers represented approximately $5.2 million in accounts receivable at June 30, 2015.  For the three months ended June 30, 2014, we had 4 customers that accounted for approximately 85% of our refined petroleum products sales.  These 4 customers represented approximately $5.9 million in accounts receivable at June 30, 2014.

For the six months ended June 30, 2015, we had 3 customers that accounted for approximately 58% of our refined petroleum products sales.  These 3 customers represented approximately $3.2 million in accounts receivable at June 30, 2015.  For the six months ended June 30, 2014, we had 4 customers that accounted for approximately 86% of our refined petroleum products sales.  These 4 customers represented approximately $5.9 million in accounts receivable at June 30, 2014.

Refined Petroleum Product Sales

All of our refined petroleum products are currently sold in the United States. The following table summarizes total refined petroleum product sales by distillation (from light to heavy):
 
                                                 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2015
   
2014
   
2015
   
2014
 
                                                 
LPG mix
  $ 234,184       0.4 %   $ 367,497       0.4 %   $ 291,492       0.2 %   $ 524,022       0.2 %
Naphtha
    13,413,484       22.7 %     25,094,263       24.4 %     26,829,683       22.4 %     53,865,261       24.2 %
Jet fuel
    17,411,470       29.6 %     19,602,651       19.1 %     33,930,973       28.3 %     39,637,642       17.8 %
NRLM
    -       0.0 %     23,962,082       23.3 %     -       0.0 %     62,729,475       28.1 %
HOBM
    13,622,360       23.2 %     7,227,076       7.0 %     31,031,439       25.9 %     7,227,076       3.2 %
AGO
    14,157,662       24.1 %     26,462,504       25.8 %     27,822,635       23.2 %     59,108,748       26.5 %
                                                                 
    $ 58,839,160       100.0 %   $ 102,716,073       100.0 %   $ 119,906,222       100.0 %   $ 223,092,224       100.0 %
 
On May 31, 2014, we ceased production of NRLM, a transportation-related diesel fuel product.  On June 1, 2014, we began producing heavy oil-based mud blendstock (“HOBM”), a non-transportation lubricant blend product.  The shift in product slate from NRLM to HOBM was the result of the Environmental Protection Agency’s (the “EPA’s”) phased-in requirements for small refineries to reduce the sulfur content in transportation-related diesel fuel, such as NRLM, to a maximum of 15 ppm sulfur by June 1, 2014.  “Topping units,” like the Nixon Facility, typically lack a desulfurization process unit to lower sulfur content levels within the range required by the EPA’s recently implemented fuel quality standards, and integration of such a unit generally requires additional permitting and significant capital upgrades.  We can produce and sell a low sulfur diesel as a feedstock to other refineries and blenders in the United States and as a finished petroleum product to other countries.

 
20

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

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Leases

Our company headquarters is located in downtown Houston, Texas.  We lease 13,878 square feet of office space, 7,389 square feet of which is used and paid for by LEH. The office lease has a 10 year term expiring in 2017, includes free rent periods and escalating rent payment provisions, and requires payment of a portion of related actual operating expenses.  Rent expense is recognized on a straight-line basis.   For the three months ended June 30, 2015 and 2014, rent expense totaled $57,060 and $25,829, respectively. For the six months ended June 30, 2015 and 2014, rent expense totaled $82,889 and $51,658, respectively.

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Income Taxes

Income Tax Expense

Our income tax expense consisted of the following:
 
   
Three Months June 30,
   
Six Months June 30,
 
   
2015
   
2014
   
2015
   
2014
 
                         
Current:
                       
Federal
  $ (14,038 )   $ 30,812     $ 85,243     $ 151,364  
State
    29,701       43,358       112,554       125,229  
Deferred:
                               
Federal
    85,066       -       1,892,550       -  
State
    -       -       -       -  
                                 
    $ 100,729     $ 74,170     $ 2,090,347     $ 276,593  
                                 

The state of Texas has a Texas margins tax (“TMT”), which is a form of business tax imposed on gross margin to replace the state’s prior franchise tax structure. Although TMT is imposed on an entity’s gross margin rather than on its net income, certain aspects of TMT make it similar to an income tax.

Deferred Income Taxes

Under Section 382 of the Internal Revenue Code of 1986, as amended (“IRC Section 382”), a corporation that undergoes an “ownership change” is subject to limitations on its use of pre-change NOL carryforwards to offset future taxable income. Within the meaning of IRC Section 382, an “ownership change” occurs when the aggregate stock ownership of certain stockholders (generally 5% shareholders, applying certain look-through rules) increases by more than 50 percentage points over such stockholders' lowest percentage ownership during the testing period (generally three years). In general, the annual use limitation equals the aggregate value of common stock at the time of the ownership change multiplied by a specified tax-exempt interest rate.  We experienced ownership changes in 2005 in connection with a series of private placements, and in 2012 as a result of a reverse acquisition.  The 2012 ownership change will subject NOL carryforwards to an annual use limitation, which will significantly reduce our ability to use them to offset taxable income in periods following the 2012 ownership change.  The amount of NOLs subject to such limitations is approximately $18.7 million.  As a result of the limitation under IRC Section 382, the annual use limitation is $638,196 per year, the effect of which will result in approximately $6.7 million in NOL carryforwards expiring unused.

At June 30, 2015, approximately $4.0 million of net deferred tax asset remains available for future use, reflecting use of approximately $4.7 million of net operating loss carryforwards through the period.  At June 30, 2015, approximately $10.2 million of NOLs generated prior to the 2012 ownership change remain available for future use.  At June 30, 2015, approximately $8.1 million of NOLs generated subsequent to the 2012 ownership change remain available for future use and are not subject to an annual use limitation under IRC Section 382.
 
 
 
21

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes.  The following table shows significant components of our deferred tax assets and liabilities:
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
Deferred tax assets:
           
Net operating loss and capital loss carryforwards
  $ 8,482,012     $ 10,067,144  
Start-up costs (Nixon Facility)
    1,579,367       1,648,036  
Asset retirement obligations liability/deferred revenue
    876,465       869,821  
AMT credit and other
    170,572       85,467  
Total deferred tax assets
    11,108,416       12,670,468  
                 
Deferred tax liabilities:
               
Fair market value adjustments
    (46,116 )     (46,116 )
Unrealized hedges
    (9,826 )     (168,606 )
Basis differences in property and equipment
    (4,914,597 )     (4,425,318 )
Total deferred tax liabilities
    (4,970,539 )     (4,640,040 )
                 
Deferred tax assets, net
    6,137,877       8,030,428  
                 
Valuation allowance
    (2,270,322 )     (2,270,322 )
                 
    $ 3,867,555     $ 5,760,106  
                 
 
The following table shows our current and noncurrent deferred tax assets (liabilities):
 
   
June 30,
   
December 31,
 
   
2015
   
2014
 
             
             
Current deferred tax assets (liabilities)
  $ 2,962,488     $ (168,236 )
Noncurrent deferred tax assets, net
    3,175,389       8,198,664  
Deferred tax assets, net
    6,137,877       8,030,428  
                 
Valuation allowance
    (2,270,322 )     (2,270,322 )
    $ 3,867,555     $ 5,760,106  
                 
 
Valuation Allowance

As of each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets.  As of June 30, 2015 and December 31, 2014, management determined that sufficient positive evidence existed to conclude that it was more likely than not that net deferred tax assets of approximately $3.9 million and $5.8 million, respectively, were realizable, and as a result, reflected a valuation allowance accordingly.

Uncertain Tax Positions

We have adopted the provisions of the FASB ASC guidance on accounting for uncertainty in income taxes. The guidance clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The guidance also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The standard also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 
22

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued
 
 
As part of this guidance, we record income tax related interest and penalties, if applicable, as a component of the provision for income tax expense. However, there were no amounts recognized relating to interest and penalties in the consolidated statements of income for the three and six months ended June 30, 2015 and 2014. Furthermore, none of our federal and state income tax returns are currently under examination by the Internal Revenue Service (“IRS”) or state authorities. As of June 30, 2015, fiscal years 2011 and later remain subject to examination by the IRS and fiscal years 2009 and later remain subject to examination by the state of Texas. We believe there are no uncertain tax positions for both federal and state income taxes.

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Earnings Per Share

The following table provides reconciliation between basic and diluted income per share:
 
                         
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2015
   
2014
   
2015
   
2014
 
                         
Net income
  $ 137,879     $ 1,438,557     $ 3,839,243     $ 7,632,830  
                                 
Basic and diluted income per share
  $ 0.01     $ 0.14     $ 0.37     $ 0.73  
                                 
Basic and Diluted
                               
Weighted average number of shares of common stock
                               
outstanding and potential dilutive shares of common stock
    10,450,210       10,441,695       10,449,829       10,436,363  
                                 
 
 
 
 
Diluted EPS is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding.  Diluted EPS for the three and six months ended June 30, 2015 and 2014 was the same as basic EPS as there were no stock options or other dilutive instruments outstanding.

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Fair Value Measurement

We are subject to gains or losses on certain financial assets based on our various agreements and understandings with Genesis. Pursuant to these agreements and understandings, Genesis may execute the purchase and sale of certain financial instruments for the purpose of economically hedging certain commodity price risks associated with our refined petroleum products and, over time, this program may also include mitigating certain risks associated with the purchase of crude oil and condensate. These financial instruments are direct contractual obligations of Genesis and not us. However, under our agreement with Genesis, we financially benefit from any gains and financially bear any losses associated with the purchase and/or sale of such financial instruments by Genesis. Because such instruments represent embedded derivatives for the purpose of financial reporting, we account for such embedded derivatives in our financial records by utilizing the market approach when measuring fair value of our financial instruments (typically in current assets and/or liabilities, as discussed below). The market approach uses prices and other relevant information generated by such market transactions executed on our behalf involving identical or comparable assets or liabilities.

The fair value hierarchy consists of the following three levels:

Level 1
Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs, which are derived principally from or corroborated by observable market data.
Level 3
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable and cannot be corroborated by market data or other entity-specific inputs.

The carrying amounts of accounts receivable, accounts payable, and accrued liabilities approximated their fair values at June 30, 2015 and December 31, 2014 due to their short-term maturities. The fair value of our long-term debt and short-term notes payable at June 30, 2015 and December 31, 2014 was $30,983,121 and $12,054,279, respectively. The fair value of our debt was determined using a Level 3 hierarchy.
 
 
23

 
Blue Dolphin Energy Company & Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) - Continued

 
The following table represents our assets and liabilities measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014 and the basis for the measurement:
 
         
Fair Value Measurement at June 30, 2015 Using
 
Financial assets (liabilities):
 
Carrying Value at June 30, 2015
   
Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)
   
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
                         
Commodity contracts
  $ 28,900     $ 28,900     $ -     $ -  
                                 
 
         
Fair Value Measurement at December 31, 2014 Using
 
Financial assets (liabilities):
 
Carrying Value at December 31, 2014
   
Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)
   
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
                         
Commodity contracts
  $ 495,900     $ 495,900     $ -     $ -