Note 2 - Summary of Significant Accounting Policies

Nature of Operations and Principles of Consolidation

The Company is engaged in the business of crude oil marketing, tank truck transportation of liquid chemicals and oil and gas exploration and production. Its primary area of operation is within a 1,000 mile radius of Houston, Texas. The accompanying unaudited condensed consolidated financial statements include the accounts of Adams Resources & Energy, Inc., a Delaware corporation, and its wholly owned subsidiaries (the ‟Company”) after elimination of all intercompany accounts and transactions.

Cash and Cash Equivalents

Cash and cash equivalents include any Treasury bill, commercial paper, money market fund or federal funds with maturity of 90 days or less. Depending on cash availability and market conditions, investments in corporate and municipal bonds, which are classified as investments in marketable securities, may also be made from time to time. Cash and cash equivalents are maintained with major financial institutions and such deposits may exceed the amount of federally backed insurance provided. While the Company regularly monitors the financial stability of such institutions, cash and cash equivalents ultimately remain at risk subject to the financial viability of such institutions.

Inventory

Inventory consists of crude oil held in storage tanks and at third-party pipelines as part of the Company’s crude oil marketing operations. Crude oil inventory is carried at the lower of average cost or market.

Prepayments

The components of prepayments are as follows (in thousands):

	September 30,		December 31,
	2016		2015

Cash collateral deposits for commodity purchases	$	-	$	167
Insurance premiums		3,323		1,609
Rents, license and other		836		813

	$	4,159	$	2,589

Property and Equipment

Expenditures for major renewals and betterments are capitalized, and expenditures for maintenance and repairs are expensed as incurred. Interest costs incurred in connection with major capital expenditures are capitalized and amortized over the lives of the related assets. When properties are retired or sold, the related cost and accumulated depreciation, depletion and amortization is removed from the accounts and any gain or loss is reflected in earnings.

Oil and gas exploration and development expenditures are accounted for in accordance with the successful efforts method of accounting. Direct costs of acquiring developed or undeveloped leasehold acreage, including lease bonus, brokerage and other fees, are capitalized. Exploratory drilling costs are initially capitalized until the properties are evaluated and determined to be either productive or nonproductive. Such evaluations are made on a quarterly basis. If an exploratory well is determined to be nonproductive, the costs of drilling the well are charged to expense. Costs incurred to drill and complete development wells, including dry holes, are capitalized. As of September 30, 2016, the Company had no unevaluated or suspended exploratory drilling costs.

Depreciation, depletion and amortization of the cost of proved oil and gas properties is calculated using the unit-of-production method. The reserve base or denominator used to calculate depreciation, depletion and amortization for leasehold acquisition costs and the cost to acquire proved properties is the sum of proved developed reserves and proved undeveloped reserves. For lease and well equipment, development costs and successful exploration drilling costs, the reserve base includes only proved developed reserves. The numerator for such calculations is actual production volumes for the period. All other property and equipment is depreciated using the straight-line method over the estimated average useful lives of three to twenty years.

The Company reviews its long-lived assets for impairment whenever there is evidence that the carrying value of such assets may not be recoverable. Any impairment recognized is permanent and may not be restored. Producing oil and gas properties are reviewed on a field-by-field basis. Fields with carrying values in excess of their estimated undiscounted future net cash flows are deemed impaired. For properties requiring impairment, the fair value is estimated based on an internal discounted cash flow model. Cash flows are developed based on estimated future production and prices are then discounted using a market based rate of return consistent with that used by the Company in evaluating cash flows for other assets of a similar nature. At times during 2016, the commodity price for crude oil has been in decline which, if it continues, may require the recording of future impairments in the carrying value of oil and gas properties.

On a quarterly basis, management evaluates the carrying value of non-producing oil and gas leasehold properties and may deem them impaired based on remaining lease term, area drilling activity and the Company’s plans for the property. This fair value measure depends highly on management’s assessment of the likelihood of continued exploration efforts in a given area. Therefore, such data inputs are categorized as ‟unobservable” or ‟Level 3” inputs. (See ‟Fair Value Measurements” below). Importantly, this fair value measure only applies to the write-down of capitalized costs and will never result in an increase to reported earnings.

Impairment provisions are included in oil and gas segment operating losses and were as follows (in thousands):

	Nine Months Ended				Three Months Ended
	September 30,				September 30,
	2016		2015		2016		2015
Producing property impairments	$	1	$	207	$	-	$	-
Non-producing property impairments		86		984		-		568
Total	$	87	$	1,191		-	$	568

Capitalized costs for non-producing oil and gas leasehold interests currently represent approximately three percent of total oil and gas property costs and are categorized as follows (in thousands):

	September 30,		December 31,
	2016		2015
Napoleonville, Louisiana acreage	$	-	$	49
Wyoming and other acreage		200		182
Total Non-producing Leasehold Costs	$	200	$	231

Since the Company is generally not the operator of its oil and gas property interests, it does not maintain the underlying detail acreage data and the Company is dependent on the operator when determining which specific acreage will ultimately be drilled. However, the capitalized cost detail on a property-by-property basis is reviewed by management, and deemed impaired if development is not anticipated prior to lease expiration. Onshore leasehold periods are normally three years and may contain renewal options.

Investments

Investments reflect the Company’s interest in operating entities where the Company holds a non-controlling interest. Investments where the Company’s interest is between twenty percent and fifty percent of the ownership are accounted for under the “Equity Method”. Under the equity method, the initial investment is capitalized and adjusted periodically for the Company’s pro-rata share of earnings and losses. Any dividends received will reduce the equity investment balance. Investments where the Company’s interest is less than twenty percent are accounted for on the “Cost Method”. Under the cost method, the initial investment is capitalized, but no adjustments are made to capitalized costs for the underlying earnings of the investments. For cost method investments, dividends are recorded as income upon receipt.

On January 14, 2016 the Company’s wholly owned subsidiary Adams Resources Medical Management, Inc. (“ARMM”) acquired a 30% member interest in Bencap LLC (“Bencap”) for a $2,200,000 cash payment. Bencap provides medical insurance brokerage and medical claims auditing services to employers utilizing ERISA governed employee benefit plans. The Company accounts for this investment under the equity method of accounting. Bencap may require additional funding as it completes development of its operations. To fund such needs, on or after December 5, 2016 but before October 31, 2018, Bencap may request to borrow from ARMM an amount no greater than $1,500,000 and on or after September 1, 2017, but before August 31, 2019, Bencap may request to borrow an amount no greater than $2,000,000. ARMM is under no obligation to make such loans. However, in the event ARMM elects not to make such loans, ARMM’s interest in Bencap is forfeited. Bencap is subject to certain restrictions on its ability to make cash distributions during any period when such loans remain outstanding.

Bencap’s predecessor entities began operating in their current form in January 2014. Presently, Bencap’s primary focus is developing a general market for its medical claims auditing services. Unlike the traditional approach to employee medical insurance, Bencap’s methodology audits and pays claims based on a multiplier which takes into consideration a premium over Medicare rates and/or a premium over the “Cost-to-Charge Ratio” which facility providers must file with the Federal government. The Company has utilized this methodology over the past three years to process and pay medical claims for its employees, including all management personnel.

In April 2016 the Company, through its ARMM subsidiary, acquired an approximate 15% equity interest (less than 3% voting interest) in VestaCare, Inc., a California corporation (“VestaCare”), for a $2,500,000 cash payment. VestaCare provides an array of software as a service (“SaaS”) electronic payment technologies to medical providers, payers and patients including VestaCare’s most recent product offering, VestaPay™. VestaPay™ allows medical care providers to structure fully automated and dynamically updating electronic payment plans for their patients. As deductibles and copays have risen in recent years, medical care providers are experiencing a significant shift in revenues from the insurance company to the individual patient. The increasing level of patient obligations has led to significantly increased bad debt write-offs for providers. The VestaCare product earns a contingent collection fee and handling fees as account collections improve.

The Company’s investments are considered long-lived assets and will be reviewed for impairment whenever there is evidence that the carrying value of such assets may not be recoverable. These fair value measures depend highly on management’s assessment of the financial status of the underlying operation. Such data inputs are “unobservable” or “Level 3” inputs. The Company’s Bencap and VestaCare investments are in the early stage of product implementation. The Company monitors revenue and product acceptance trends in order to assess the current fair value of the investment. If the fair value of these investments is determined to be below their carrying value and that loss in fair value is deemed other than temporary, an investment loss will be recognized. During the third quarter of 2016, the Company completed a review of its equity method investment in Bencap and determined there was an other than temporary impairment. Underlying this decision are the terms of the investment agreement where Bencap has the option to request borrowings up to $1,500,000 on or after December 5, 2016 but before October 31, 2018. Given Bencap’s lower than projected revenue growth and operating losses, the Company is unlikely to loan any requested funds causing forfeiture of the investment, leading to the decision to fully impair the investment. The Company recognized a net loss of $1,430,000 from its investment in Bencap as of September 30, 2016. This loss included a pre-tax impairment charge of $1,732,000 and pre-tax losses from the equity method investment of $468,000.

Cash Deposits and Other Assets

The Company has established certain deposits to support participation in its liability insurance program and remittance of state crude oil severance taxes and other state collateral deposits. Insurance collateral deposits are invested at the discretion of the Company’s insurance carrier and such investments primarily consist of intermediate term federal government bonds and bonds backed by federal agencies. This fair value measure relies on inputs from quoted prices for similar assets and is thus categorized as a ‟Level 2” valuation in the fair value hierarchy. Components of cash deposits and other assets are as follows (in thousands):

	September 30,		December 31,
	2016		2015
Insurance collateral deposits	$	5,585	$	6,531
State collateral deposits		131		140
Materials and supplies		281		292
	$	5,997	$	6,963

Revenue Recognition

Certain commodity purchase and sale contracts utilized by the Company’s marketing business qualify as derivative instruments with certain specifically identified contracts also designated as trading activity. From the time of contract origination, such trading activity contracts are marked-to-market and recorded on a net revenue basis in the accompanying financial statements.

Most crude oil purchase contracts and sale contracts qualify and are designated as non-trading activities and the Company considers such contracts as normal purchases and sales activity. For normal purchases and sales, the Company’s customers are invoiced monthly based upon contractually agreed upon terms with revenue recognized in the month in which the physical product is delivered to the customer. Such sales are recorded gross in the financial statements because the Company takes title, has risk of loss for the products, is the primary obligor for the purchase, establishes the sale price independently with a third party and maintains credit risk associated with the sale of the product.

Certain crude oil contracts may be with a single counterparty to provide for similar quantities of crude oil to be bought and sold at different locations. These contracts are entered into for a variety of reasons, including effecting the transportation of the commodity, to minimize credit exposure, and/or to meet the competitive demands of the customer. Such buy/sell arrangements are reflected on a net revenue basis in the accompanying unaudited condensed consolidated financial statements. Reporting such crude oil contracts on a gross revenue basis would increase the Company’s reported revenues as follows (in thousands):

	Nine Months Ended				Three Months Ended
	September 30,				September 30,
	2016		2015		2016		2015

Revenue gross-up	$	245,245	$	388,936	$	70,236	$	122,273

Transportation segment customers are invoiced, and the related revenue is recognized, as the service is provided. Oil and gas revenue from the Company’s interests in producing wells is recognized as title and physical possession of the oil and gas passes to the purchaser.

Sales of Long-lived assets

Gains and losses from the sale or disposal of long-lived assets that do not meet the criteria for presentation as a discontinued operation are presented in the accompanying financial statements as a component of operating earnings.

Concentration of Credit Risk

The Company’s largest customers consist of large multinational integrated oil companies and independent refiners of crude oil. In addition, the Company transacts business with independent oil producers, major chemical concerns, crude oil trading companies and a variety of commercial energy users. Within this group of customers the Company generally derives approximately 50 percent of its revenues from three to five large crude oil refining concerns. While the Company has ongoing established relationships with certain domestic refiners of crude oil, alternative markets are readily available since the Company supplies less than one percent of U.S. domestic refiner demand. As a fungible commodity delivered to major Gulf Coast supply points, the Company’s crude oil sales can be readily delivered to alternative end markets. Management believes that a loss of any customers where the Company currently derives more than 10 percent of its revenues would not have a material adverse effect on the Company’s operations.

Accounts receivable associated with crude oil activities comprise approximately 90 percent of the Company’s total receivables and industry practice requires payment for such sales to occur within 20 days of the end of the month following a transaction. The Company’s customer makeup, credit policies and the relatively short duration of receivables mitigate the uncertainty typically associated with receivables management.

Letter of Credit Facility

The Company maintains a Credit and Security Agreement with Wells Fargo Bank to provide up to a $60 million stand-by letter of credit facility used to support crude oil purchases within the marketing segment. This facility is collateralized by the eligible accounts receivable within the segment and outstanding amounts were as follows (in thousands):

	Nine Months Ended
	September 30,
	2016		2015

Stand-by letters of credit	$	-	$	1,000

The issued stand-by letters of credit are cancelled as the underlying purchase obligations are satisfied by cash payment when due. The letter of credit facility places certain restrictions on the Company’s Gulfmark Energy, Inc. subsidiary. Such restrictions include the maintenance of a combined 1.1 to 1.0 current ratio and the maintenance of positive net earnings excluding inventory valuation changes, as defined, among other restrictions. The Company is currently in compliance with all such financial covenants.

Statement of Cash Flows

There were no significant non-cash financing activities in any of the periods reported. Statements of cash flow disclosure items include the following (in thousands):

	Nine Months Ended
	September 30,
	2016		2015

Interest paid	$	-	$	5

Federal and state tax paid		2,582		4,038

Capitalized amounts included in property and equipment that were not included in amounts reported for cash additions in the Statements of Cash Flows for the applicable report dates were as follows (in thousands):

	As of September 30,
	2016		2015

Property and equipment additions	$	382	$	3

Earnings Per Share

Earnings per share are based on the weighted average number of shares of common stock and potentially dilutive common stock shares outstanding during the period presented herein. The weighted average number of shares outstanding was 4,217,596 for 2016 and 2015. There were no potentially dilutive securities during those periods.

Share-Based Payments

During the periods presented herein, the Company had neither stock-based employee compensation plans nor any other share-based payment arrangements.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Examples of significant estimates used in the accompanying consolidated financial statements include oil and gas reserve volumes forming the foundation for calculating depreciation, depletion and amortization and for estimating cash flows when assessing impairment triggers and when estimating values associated with oil and gas properties. Other examples include revenue accruals, the provision for bad debts, insurance related accruals, income tax permanent and timing differences, contingencies and valuation of fair value contracts.

Income Taxes

Income taxes are accounted for using the asset and liability method. Under this approach, deferred tax assets and liabilities are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax basis.

Use of Derivative Instruments

The Company’s marketing segment is involved in the purchase and sale of crude oil. The Company seeks to profit by procuring the commodity as it is produced and then delivering the material to the end users or the intermediate use marketplace. As typical for the industry, such transactions are made pursuant to the terms of forward month commodity purchase and/or sale contracts. Some of these contracts meet the definition of a derivative instrument, and therefore, the Company accounts for such contracts at fair value, unless the normal purchase and sale exception is applicable. Such underlying contracts are standard for the industry and are the governing document for the Company’s crude oil wholesale distribution businesses. None of the Company’s derivative instruments have been designated as hedging instruments. The accounting methodology utilized by the Company for its commodity contracts is further discussed below under the caption ‟Fair Value Measurements”.

The estimated fair value of forward month commodity contracts (derivatives) is reflected in the accompanying Unaudited Condensed Consolidated Balance Sheet as of September 30, 2016 as follows (in thousands):

	Balance Sheet Location and Amount
	Current		Other		Current		Other
	Assets		Assets		Liabilities		Liabilities
Asset Derivatives
- Fair Value Forward Hydrocarbon Commodity
Contracts at Gross Valuation	$	153	$	-	$	-	$	-
Liability Derivatives
- Fair Value Forward Hydrocarbon Commodity
Contracts at Gross Valuation		-		-		43		-
Less Counterparty Offsets		-		-		-		-

As Reported Fair Value Contracts	$	153	$	-	$	43	$	-

As of September 30, 2016, three commodity purchase and sale contracts comprise the Company’s derivative valuations. These contracts encompass approximately 65 barrels per day of diesel fuel during October 2016 through March 2017, 142,000 barrels of crude oil for the month of November 2016 and 3,000 barrels of crude oil during October 2016 through December 2016.

Forward month commodity contracts (derivatives) are reflected in the accompanying Unaudited Condensed Consolidated Balance Sheet as of December 31, 2015 as follows (in thousands):

	Balance Sheet Location and Amount
	Current		Other		Current		Other
	Assets		Assets		Liabilities		Liabilities
Asset Derivatives
- Fair Value Forward Hydrocarbon Commodity
Contracts at Gross Valuation	$	-	$	-	$	-	$	-
Liability Derivatives
- Fair Value Forward Hydrocarbon Commodity
Contracts at Gross Valuation		-		-		195		-
Less Counterparty Offsets		-		-		-		-

As Reported Fair Value Contracts	$	-	$	-	$	195	$	-

As of December 31, 2015, one commodity purchase and sale contract comprised the Company’s derivative valuations. The purchase and sale contract encompasses approximately 65 barrels per day of diesel fuel in each of January, February and March 2016.

The Company only enters into commodity contracts with creditworthy counterparties or obtains collateral support for such activities. As of September 30, 2016 and December 31, 2015, the Company was not holding nor has it posted any collateral to support its forward month fair value derivative activity. The Company is not subject to any credit-risk related trigger events. The Company has no other financial investment arrangements that would serve to offset its derivative contracts.

Forward month commodity contracts (derivatives) are reflected in the accompanying Unaudited Condensed Consolidated Statement of Operations for the nine months and three months ended September 30, 2016 and 2015 as follows (in thousands):

	Earnings		Earnings
	Nine Months Ended		Three Months Ended
	September 30,		September 30,
	2016	2015	2016	2015

Revenues – Marketing	$ 305	$ (158)	$ 181	$ (208)

Fair Value Measurements

The carrying amount reported in the consolidated balance sheet for cash and cash equivalents, accounts receivable and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments. Marketable securities are recorded at fair value based on market quotations from actively traded liquid markets.

Fair value contracts consist of derivative financial instruments and are recorded as either an asset or liability measured at its fair value. Changes in fair value are recognized immediately in earnings unless the derivatives qualify for, and the Company elects, cash flow hedge accounting. The Company had no contracts designated for hedge accounting during any current reporting periods.

Fair value estimates are based on assumptions that market participants would use when pricing an asset or liability and the Company uses a fair value hierarchy of three levels that prioritizes the information used to develop those assumptions. Currently, for all items presented herein, the Company utilizes a market approach to valuing its contracts. On a contract by contract, forward month by forward month basis, the Company obtains observable market data for valuing its contracts. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The fair value hierarchy is summarized as follows:

Level 1 – quoted prices in active markets for identical assets or liabilities that may be accessed at the measurement date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. For Level 1 valuation of marketable securities, the Company utilizes market quotations provided by its primary financial institution and for the valuation of derivative financial instruments the Company utilizes the New York Mercantile Exchange (‟NYMEX”) for such valuations.

Level 2 – (a) quoted prices for similar assets or liabilities in active markets, (b) quoted prices for identical assets or liabilities but in markets that are not actively traded or in which little information is released to the public, (c) observable inputs other than quoted prices and (d) inputs derived from observable market data. Source data for Level 2 inputs include information provided by the NYMEX, published price data and indices, third party price survey data and broker provided forward price statistics.

Level 3 – unobservable market data inputs for assets or liabilities.

As of September 30, 2016, the Company’s fair value assets and liabilities are summarized and categorized as follows (in thousands):

	Market Data Inputs
	Gross Level 1		Gross Level 2			Gross Level 3		Counterparty
	Quoted Prices		Observable			Unobservable		Offsets		Total
Derivatives
- Current assets	$	-		153		$	-	$	-	$	153
- Current liabilities		-		(43	)		-		-		(43	)
Net Value	$	-	$	110		$	-	$	-	$	110

As of December 31, 2015, the Company’s fair value assets and liabilities are summarized and categorized as follows (in thousands):

	Market Data Inputs
	Gross Level 1		Gross Level 2			Gross Level 3		Counterparty
	Quoted Prices		Observable			Unobservable		Offsets		Total
Derivatives
- Current assets	$	-	$	-		$	-	$	-	$	-
- Current liabilities		-		(195	)		-		-		(195	)
Net Value	$	-	$	(195	)	$	-	$	-	$	(195	)

When determining fair value measurements, the Company makes credit valuation adjustments to reflect both its own nonperformance risk and its counterparty’s nonperformance risk. When adjusting the fair value of derivative contracts for the effect of nonperformance risk, the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, and guarantees are considered. Credit valuation adjustments utilize Level 3 inputs, such as credit scores to evaluate the likelihood of default by the Company or its counterparties. As of September 30, 2016 and December 31, 2015, credit valuation adjustments were not significant to the overall valuation of the Company’s fair value contracts. As a result, applicable fair value assets and liabilities are included in their entirety in the fair value hierarchy.

Recent Accounting Pronouncements

In May 2014, the FASB amended the existing accounting standards for revenue recognition. The amendments are based on the principle that revenue should be recognized 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. The new guidance is effective for annual periods ending after December 15, 2017. Early adoption is permitted. The amendments may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application. Management is currently evaluating the impact of these amendments on the Company’s consolidated financial statements as well as the transition alternatives.

In August 2014, the FASB issued guidance requiring management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. The standard also provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. The new guidance is effective for the annual period ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. Management does not expect the adoption of this guidance to have a material impact on the consolidated financial statements.

In March 2016, the FASB issued Accounting Standard Update No. 2016-02, Leases (Topic 842). The standard amends existing accounting standards to require the capitalization and recording on the balance sheet the assets and liabilities associated with lease terms of more than 12 months. The new standard is effective for fiscal years beginning after December 15, 2018. As of December 31, 2015, the Company had rental obligations under long-term non-cancellable operating leases and terminaling arrangements totaling $12,393,000 payable through 2019, with only nominal activity during 2016. Management is currently evaluating the impact of these amendments on the Company’s consolidated financial statements as well as the transition alternatives.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, “Statement of Cash Flows (Topic 230)” which is intended to clarify and align how certain cash receipts and cash payments are presented and classified in the statement of cash flows where there is currently diversity in practice. ASU 2016-15 specifically addresses eight classification issues within the statement of cash flows including proceeds from the settlement of insurance claims; distributions received from equity method investees; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for annual and interim periods in fiscal years beginning after December 15, 2017. Management is currently evaluating the impact of these amendments on the Company’s consolidated financial statements.

With the exception of the new standards for revenue recognition and leases, as discussed, management believes the impact of recently issued standards and updates, which are not yet effective, will not have a material impact on the Company’s consolidated financial position, results of operations or cash flows upon adoption.