S-1/A 1 d747286ds1a.htm S-1/A S-1/A
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As filed with the Securities and Exchange Commission on July 10, 2014

Registration No. 333-196375

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Amendment No. 2

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

Spark Energy, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   4931   46-5453215

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

2105 CityWest Blvd., Suite 100

Houston, Texas 77042

(713) 600-2600

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Gil Melman

Vice President, General Counsel and Corporate Secretary

2105 CityWest Blvd., Suite 100

Houston, Texas 77042

713-600-2600

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Alan Beck

Sarah K. Morgan

Vinson & Elkins L.L.P

1001 Fannin St., Suite 2500

Houston, Texas 77002-6760

(713) 758-2222

 

David C. Buck

Stephanie C. Beauvais

Andrews Kurth LLP

600 Travis Street, Suite 4200

Houston, Texas 77002

(713) 220-4200

 

 

Approximate date of commencement of proposed sale of the securities to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box:  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

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

 

Large accelerated filer  ¨   Accelerated filer  ¨   Non-accelerated filer  x   Smaller reporting company   ¨
    (Do not check if a smaller reporting company)  

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Amount

to be

Registered(1)

 

Proposed

Maximum

Offering Price

Per Share(2)

 

Proposed

Maximum

Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee(3)

Class A common stock

  3,450,000    $21.00    $72,450,000    $9,332 

 

 

 

(1) Estimated pursuant to Rule 457(a) under the Securities Act of 1933, as amended. Includes Class A common stock issuable upon exercise of the underwriters’ option to purchase additional Class A common stock.

 

(2) Estimated solely for the purpose of calculating the registration fee.

 

(3) The registration fee was previously paid in connection with the initial filing of the Registration Statement on May 29, 2014.

 

 

 

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell securities, and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED JULY 10, 2014

PRELIMINARY PROSPECTUS

3,000,000 Shares

 

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SPARK ENERGY, INC.

CLASS A COMMON STOCK

This is the initial public offering of our Class A common stock, par value $0.01 per share. We are selling 3,000,000 shares of Class A common stock in this offering.

Prior to this offering, there has been no public market for our Class A common stock. The initial public offering price of the Class A common stock is expected to be between $19.00 and $21.00 per share. We have applied to list our Class A common stock on the NASDAQ Global Select Market under the symbol “SPKE.”

We have granted the underwriters an option to purchase from us up to 450,000 additional shares of Class A common stock.

We are an “emerging growth company” as that term is used in the Jumpstart Our Business Startups Act of 2012, and as such, we have elected to take advantage of certain reduced public company reporting requirements for this prospectus and future filings. See “Risk Factors” and “Prospectus Summary—Emerging Growth Company Status.”

The initial public offering price of our Class A common stock may not be indicative of the market price of our Class A common stock after this offering. In addition, an active, liquid and orderly trading market for our Class A common stock may not develop or be maintained, and our stock price may be volatile. See “Risk Factors.”

Investing in our Class A common stock involves risks. See “Risk Factors” on page 25.

 

 

      Per Class A Share      Total  

Price to Public

   $                                $                

Underwriting Discounts and Commissions(1)

   $         $     

Proceeds to Spark Energy, Inc.(2)

   $         $     

 

(1) Includes a structuring fee equal to 0.50% of the gross proceeds of this offering payable to Robert W. Baird & Co. Incorporated and Stifel, Nicolaus & Company, Incorporated. Please read “Underwriting.”

 

(2) None of the net proceeds from this offering will be retained by Spark Energy, Inc. Please see “Use of Proceeds.”

Delivery of the shares of Class A common stock will be made on or about                 , 2014.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

Baird     Stifel
Janney Montgomery Scott     Wunderlich Securities
BB&T Capital Markets    

J.J.B. Hilliard, W.L. Lyons, LLC

Drexel Hamilton  

Halliday Financial

  U.S. Capital Advisors
SOCIETE GENERALE   Natixis   RB International Markets

                , 2014.


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TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     25   

USE OF PROCEEDS

     49   

CASH DIVIDEND POLICY

     50   

CAPITALIZATION

     66   

DILUTION

     67   

SELECTED HISTORICAL AND UNAUDITED PRO FORMA COMBINED FINANCIAL AND OPERATING DATA

     69   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     71   

BUSINESS

     97   

INDUSTRY

     111   

MANAGEMENT

     118   

EXECUTIVE COMPENSATION

     122   

CORPORATE REORGANIZATION

     127   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     132   

PRINCIPAL STOCKHOLDERS

     141   

DESCRIPTION OF CAPITAL STOCK

     143   

SHARES ELIGIBLE FOR FUTURE SALE

     148   

MATERIAL U.S. FEDERAL INCOME AND ESTATE TAX CONSEQUENCES TO NON-U.S. HOLDERS

     150   

UNDERWRITING

     154   

LEGAL MATTERS

     161   

EXPERTS

     161   

WHERE YOU CAN FIND MORE INFORMATION

     161   

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

     161   

INDEX TO FINANCIAL STATEMENTS

     F-1   

GLOSSARY

     A-1   

 

 

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by us or on our behalf or to the information which we have referred you. Neither we nor the underwriters have authorized anyone to provide you with information different from that contained in this prospectus and any free writing prospectus. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We are not, and the underwriters


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are not, making an offer to sell shares of Class A common stock in any jurisdiction where the offer or sale is not permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of any sale of the Class A common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

This prospectus contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. See “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”

Through and including            (the 25th day after the date of this prospectus), all dealers effecting transactions in our shares, whether or not participating in this offering, may be required to deliver a prospectus. This requirement is in addition to the dealers’ obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

Industry and Market Data

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, government publications and other published independent sources. Some data is also based on our good faith estimates. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the section entitled “Risk Factors.” These and other factors could cause results to differ materially from those expressed in these publications.

Trademarks and Trade Names

We own or have rights to various trademarks, service marks and trade names that we use in connection with the operation of our business. This prospectus may also contain trademarks, service marks and trade names of third parties, which are the property of their respective owners. Our use or display of third parties’ trademarks, service marks, trade names or products in this prospectus is not intended to, and does not imply a relationship with, or endorsement or sponsorship by us. Solely for convenience, the trademarks, service marks and trade names referred to in this prospectus may appear without the ®, TM or SM symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensor to these trademarks, service marks and trade names.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus carefully before making an investment decision, including the information under the headings “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical and pro forma combined financial statements and the related notes thereto appearing elsewhere in this prospectus. The information presented in this prospectus assumes (i) an initial public offering price of $20.00 per share of Class A common stock (the midpoint of the price range set forth on the cover of this prospectus) and (ii) unless otherwise indicated, that the underwriters do not exercise their option to purchase additional shares of Class A common stock.

In this prospectus, unless the context otherwise requires, the terms “Spark Energy,” “the Company,” “we,” “us” and “our” refer collectively to (i) the combined business and assets of the retail natural gas business and asset optimization activities of Spark Energy Gas, LLC (“SEG”) and the retail electricity business of Spark Energy, LLC (“SE”) before the completion of our corporate reorganization in connection with this offering and (ii) Spark Energy, Inc. and its subsidiaries as of the completion of our corporate reorganization and thereafter. See “Corporate Reorganization.” References to “Spark Energy Ventures” refer to Spark Energy Ventures, LLC, which owned SEG and SE prior to the transactions we implemented as part of our corporate reorganization. References to NuDevco refer collectively to NuDevco Retail Holdings, LLC (“NuDevco Retail Holdings”) and its wholly owned subsidiary, NuDevco Retail, LLC (“NuDevco Retail”), the interim owners of SE and SEG during the corporate reorganization and the owners of the Class B common stock and the related Spark HoldCo units following this offering. References to “Spark HoldCo” refer to Spark HoldCo, LLC, our subsidiary and the direct parent of SEG and SE at the completion of the corporate reorganization. Spark Energy Ventures, NuDevco, SEG and SE have historically been under common control. We have provided a glossary of certain retail energy industry terms used in this prospectus as Appendix A.

Business Overview

We are a growing independent retail energy services company founded in 1999 that provides residential and commercial customers in competitive markets across the United States with an alternative choice for their natural gas and electricity. We purchase our natural gas and electricity supply from a variety of wholesale providers and bill our customers monthly for the delivery of natural gas and electricity based on their consumption at either a fixed or variable price. Natural gas and electricity are then distributed to our customers by local regulated utility companies through their existing infrastructure.

As of May 31, 2014, we operated in 46 utility service territories across 16 states and had approximately 237,600 residential customers and 17,800 commercial customers, which translates to over 392,500 residential customer equivalents (“RCEs”). An RCE is an industry standard measure of natural gas or electricity usage with each RCE representing annual consumption of 100 MMbtu of natural gas or 10 MWh of electricity. We added over 44,800 customers, net of attrition, during the first five months of 2014. For the year ended December 31, 2013, approximately 60% of our retail revenues were derived from the sale of electricity, and the remainder were derived from the sale of natural gas.

We believe our business model is scalable, and our objective is to maximize profitability while proactively managing the risks inherent in our business. To achieve this objective, we actively manage our customer base to allocate retail energy sales between natural gas and electricity based on existing or developing market dynamics. In addition, the diversity in our customer base across geography, commodity and product offerings allows us to mitigate risk and react to changes in the retail energy environment so that we can quickly shift our focus and

 

 

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redirect our customer acquisition plan towards more profitable opportunities, resulting in enhanced cash-flow stability.

We believe that our management team has developed an effective proprietary customer acquisition and retention model. We identify and acquire customers on a cost-effective basis through a variety of sales channels, including door-to-door vendors, outbound telephone marketing vendors, our inbound customer care call center and online marketing. We also use email, direct mail, affinity programs, direct sales, brokers and consultants. Our marketing team continuously evaluates the effectiveness of each customer acquisition channel and makes adjustments in order to achieve our targeted growth and returns. We strive to attract new customers with competitive product offerings that are tailored to particular customer demographics. Once a customer is acquired, we apply a proprietary evaluation and segmentation process to optimize value both to us and the customer. We analyze historical usage, attrition rates and consumer behaviors to specifically tailor competitive products that aim to maximize the total expected return from energy sales to a specific customer, which we refer to as customer lifetime value.

We actively manage the commodity price risk inherent in our business. Our commodity risk management strategy is designed to hedge substantially all of our forecasted natural gas and electricity volumes on our fixed-price customer contracts as well as a portion of the near-term volumes on our variable-price customer contracts. Our in-house energy supply team, which is comprised of 18 experienced energy supply chain professionals, manages our commodity risk by monitoring market activity and engaging in commodities transactions that are designed to hedge, to the extent practicable, our commodity price exposure at any given time. The efficacy of our risk management program may be adversely impacted by unanticipated events and costs that we are not able to effectively hedge, including abnormal customer attrition and consumption, certain variable costs associated with electricity grid reliability, pricing differences in the local markets for local delivery of commodities, unanticipated events that impact supply and demand, such as extreme weather, and abrupt changes in the markets for, or availability or cost of, financial instruments that help to hedge commodity price. To mitigate these limitations, our in-house energy supply team uses historical attrition models to estimate customer attrition and proprietary weather services to estimate forecasted volumes. We seek to further mitigate the risk of extreme seasonal volume fluctuation by purchasing in advance additional supply for those periods with the highest potential for volatility.

Our in-house energy supply team also identifies wholesale natural gas arbitrage opportunities in conjunction with our retail procurement and hedging activities, which we refer to as asset optimization. These opportunities can include (i) optimizing the unused portion of storage and transportation assets allocated to us by the local regulated utility to support our retail load; (ii) capturing physical arbitrage opportunities using short or long-term transportation capacity; and (iii) maximizing our credit capacity by purchasing gas from affiliates and third parties and selling it at the same location to counterparties for whom we normally purchase retail supply. For additional detail regarding our asset optimization activities, please see “Business—Our Operations—Asset Optimization.”

We actively manage our customer credit risk through a variety of strategies. In many of the utility services territories where we conduct business, the local regulated utility offers services for billing the customer, collecting payment from the customer and remitting payment to us. This service results in substantially all of our credit risk being linked to the applicable utility and not to our end-use customer in these territories. For the year ended December 31, 2013, approximately 47% of our retail revenues were derived from territories in which substantially all of our credit risk was directly linked to local regulated utility companies, all of which had investment grade ratings as of such date. During the same period, we paid these local regulated utilities a weighted average discount of less than 1.0% of total revenues for customer credit risk. In markets where the local regulated utilities are not responsible for customer credit risk, we attempt to manage this risk through formal credit review, in the case of commercial customers, and credit screening, deposits and, in some markets, disconnection for non-payment, in the case of residential customers.

 

 

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We generated net income of $31.4 million and $26.1 million and Adjusted EBITDA of $33.5 million and $40.7 million for the years ended December 31, 2013 and 2012, respectively. For a definition of Adjusted EBITDA and a reconciliation to its most directly comparable financial measures calculated and presented in accordance with GAAP, please see “—Non-GAAP Financial Measures.” Please also see “Selected Historical and Unaudited Pro Forma Combined Financial and Operating Data.”

We intend to pay a cash dividend each quarter to holders of our Class A common stock to the extent we have cash available for distribution to do so. Our targeted quarterly dividend will be $0.3625 per share of Class A common stock, or $1.45 per share on an annualized basis, which amount may be raised or lowered in the future without advance notice. Please see “Cash Dividend Policy.”

Business Strategies

Our principal business objectives are to maintain stable cash flows and to grow our business by adding customers and optimizing our existing customer base. We expect to achieve these objectives by executing the following strategies:

 

  Continued focus on operational diversification, gross margin optimization and customer lifetime value. We plan to continue to focus our efforts on diversification of our customer base and optimization of gross margin and customer lifetime value in order to maintain stable cash flows. Maintaining diversity in our customer base across geography, commodity and product offerings allows us to mitigate risk, quickly react to changes in the retail energy environment and redirect our customer portfolio towards more profitable and customer value-enhancing opportunities.

 

  Pursue growth opportunities in our existing retail energy markets. We added over 44,800 customers, net of attrition, during the first five months of 2014. We plan to continue to grow our retail energy customer base within our existing markets using the full range of marketing resources available to us. We will continue to adjust our marketing model based on our estimations of cost, customer quality and market opportunities.

 

  Expansion into additional competitive markets that present attractive opportunities. Over the past three years, we have entered five new utility service territories and, as of May 31, 2014, we are active in 46 utility service territories across 16 states. To complement our growth in our existing markets, we will selectively expand into new competitive states and utility service territories that we believe present an attractive mix of supply, supportive regulatory environments, potential customers and attractive customer value propositions.

 

  Focus on creating innovative products. We will continue creating innovative and competitive product offerings that are responsive to changing market dynamics and customer demand. Our flexible business model enables us to respond quickly to changing market dynamics and customer needs, enhancing the profitability of our business. For example, we recently launched a successful, green, flat-rate natural gas product in certain of our markets that provides the customer with price security while preserving the environment as we retire carbon offsets on the customer’s behalf.

 

  Expanding our green energy business. We are actively developing and offering green products that allow our customers to choose environmentally conscious options rather than the traditional energy supply offered by their local utility. Green energy products are a growing market opportunity and typically provide increased unit margins as a result of less competition. We currently offer renewable electricity in all of our electricity markets and carbon neutral natural gas in several of our gas markets.

 

 

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  Pursue prudent risk management policies. We have implemented stringent corporate risk policies and procedures relating to the purchase and sale of natural gas and electricity, credit and collection functions and general risk management. Our management believes that our risk management policies enable us to operate with a low risk profile and achieve stable operating results.

 

  Pursue opportunistic strategic acquisitions. We intend to pursue growth through strategic acquisitions of other retail energy providers, their customer bases or other complementary businesses. Given the current fragmented landscape in the retail energy industry, we believe that significant opportunities for consolidation will arise, and we intend to review and opportunistically pursue acquisitions that present opportunities for long-term accretion to our business.

Competitive Strengths

We believe we can successfully execute our business strategies because of the following competitive strengths:

 

  Diversification across customer base, commodity and product offerings. Our diversified business model allows us to mitigate risk, quickly react to changes in the retail energy environment and redirect our customer portfolio towards more profitable opportunities in order to enhance cash flow stability and grow our business. Specifically, we believe that the diversity in our business provides the following benefits as they relate to geography and commodity and product offerings:

 

  Diverse geographic operations. Our geographic diversity in 46 utility service territories across 16 states as of May 31, 2014 reduces our dependence on any one particular market for growth or profitability. Also, we believe that the combination of this broad footprint and flexible business model enables us to quickly react to market opportunities in a particular area by accelerating customer acquisition efforts and leveraging existing market knowledge to quickly enter into new markets as opportunities arise. We believe that our geographic diversity also provides the following additional benefits:

 

  reduced risk of material impact from a regulatory change in a single jurisdiction;

 

  reduced risk of material impact from extreme regional weather patterns;

 

  reduced concentration of delivery risk associated with daily balancing gas markets;

 

  reduced concentration of supply price risk in any particular electricity market; and

 

  the ability to leverage natural gas storage and transportation assets in one market against supply requirements in another market.

 

  Diverse product and commodity offerings. By offering a range of products, we are able to attract customers across a breadth of segments. Our portfolio of product offerings includes a variety of commodities (natural gas and electricity), contract types (variable-price month-to-month or up to 36-month fixed-price) and product features (green energy, price certainty and cost savings). Our ability to provide customers with multiple options differentiates us from other independent retail energy services companies.

 

 

Our effective customer acquisition and retention model enables us to optimize customer lifetime value. We believe that our management team has developed an effective proprietary customer acquisition and retention model that allows us to cost-effectively identify and acquire customers through a variety of marketing and sales channels and quickly make necessary adjustments in order to optimize the value of those customers. We attract new customers with competitive product offerings that are tailored to particular customer demographics. Once we acquire a customer, we analyze historical usage, attrition

 

 

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  rates and consumer behaviors to specifically tailor competitive products intended to maximize overall customer lifetime value.

 

  Our in-house energy supply team enables us to optimize margin by lowering our energy supply costs. Our in-house energy supply team attempts to achieve lower energy supply costs through effective hedging strategies that leverage long-term relationships with numerous creditworthy suppliers. In addition, having an in-house team allows us to optimize our retail allocated storage and transportation assets in order to further reduce our cost of supply. Our in-house energy supply team also seeks to increase margin by identifying wholesale natural gas arbitrage opportunities in conjunction with our retail procurement and hedging activities.

 

  Adaptable and scalable business model. Our flexible business model enables us to adapt quickly to market changes and capitalize on opportunities. For instance, if a particular market imposes costly regulatory burdens that would affect our profitability, we can immediately begin shifting resources into other markets so that our customer acquisition expenditures are spent on higher margin opportunities. Our business model is also designed to integrate both organic growth and strategic acquisitions efficiently. We are currently implementing an outsourced, hosted billing and transaction platform that aims to address all of our back office functions consistently across all markets. We expect the implementation to be completed by the end of 2014. We believe these enhancements will improve the scalability of our back office processes and should also allow us to add new customers organically or through strategic acquisitions. It will also allow us to quickly integrate a wider variety of product offerings within our existing portfolio. Given our flexibility, we believe that we can move quickly and bring customers and products into our system more cost-effectively than our competitors.

 

  Conservative balance sheet. Following the consummation of this offering, we expect to have approximately $10.0 million of indebtedness outstanding under our new $70.0 million revolving credit facility, as well as approximately $15.0 million outstanding in letters of credit. We believe our liquidity will provide us with the financial flexibility to quickly and opportunistically take advantage of market entry and strategic acquisition opportunities.

 

  Experienced management team. Each member of our executive management team has over a decade of senior management experience in core aspects of the retail energy business, including energy risk management, retail energy marketing, public company management and mergers and acquisitions. Our Chief Executive Officer, Nathan Kroeker, has over 10 years of senior management experience in the retail energy industry, including four years with Spark Energy, and our Chief Operating Officer, Allison Wall, has 15 years of experience in operations, IT, customer care and marketing for several retail energy businesses. Our Chief Financial Officer, Georganne Hodges, has 11 years of experience in senior finance roles in the retail energy industry.

Retail Energy Market Overview

Until the 1980s, generation, distribution, sales, marketing and supply of natural gas and electricity in the United States was largely conducted by local, publicly-funded companies that had no competition in their respective markets. In the 1980s and 1990s, state legislatures began passing laws designed to create competitive retail sales and supply in the natural gas markets, and the competitive restructuring of electricity markets in the United States followed approximately a decade later. According to the Retail Energy Advisory Outlook Report produced by KEMA, Inc. (a subsidiary within the DNV GL Group, hereinafter “DNV GL”), excerpts from which are included below, electricity sales in competitive markets have increased from 259 TWh in 2003 to 757 TWh in 2013, representing an 11.3% compounded annual growth rate (“CAGR”) over the last decade.

 

 

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The graph below from DNV GL highlights the increase in electricity sales in competitive markets in the United States from 2003 through 2013.

U.S. Competitive Electricity Sales Market Size (2003-2013)

 

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Source: DNV GL Q4 2013 Retail Energy Outlook

As of December 31, 2013, 20 states and the District of Columbia allow some form of customer choice for electricity supply (according to DNV GL) and 21 states and the District of Columbia have passed legislation or adopted programs that allow customers to purchase natural gas from retail energy companies other than the local regulated utility (according to the U.S. Energy Information Administration, or EIA). In states and service territories where retail competition is allowed, customers may choose from licensed providers of the energy commodity. The competition among retail energy suppliers provides a variety of service plans that give residential and commercial consumers flexibility in their energy purchases. The availability and characteristics of product offerings by retail energy companies vary widely. For a map detailing the states in which Spark provides either or both of retail natural gas and electricity, please see the inside front cover page of this prospectus.

Energy retailers typically provide customers with a variety of fixed-price and variable-price service options for varying periods of time. In general, large commercial and industrial customers are serviced by more complex, structured energy supply contracts with terms of up to five years. By contrast, residential and small commercial customers are typically serviced by short-term, month-to-month variable-price contracts or fixed-term, fixed-price contracts with terms of up to three years. Some energy retailers focus on only one customer segment (e.g., residential), while others focus on the full spectrum of customers. Energy retailers can sell both natural gas and electricity to the same customers in states that allow retail competition in both markets and where they are licensed to sell both products.

Unlike local regulated utility companies whose rates are regulated and approved by the state public utility commissions, or PUCs, energy retailers’ rates for retail natural gas and electricity supply in restructured markets are determined by a variety of factors, including, but not limited to, wholesale commodity costs, transportation and storage costs, charges by the independent system operator (“ISO”), individual customer consumption profiles, competitive forces, applicable rules and regulations and the business objectives of market participants.

 

 

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Retail Energy Market Opportunities

Low Focus of Competitors on Natural Gas

We believe that the retail energy industry has historically concentrated its efforts on the electricity side of the business with relatively less capital investment and market research being devoted to the development of retail natural gas businesses. As of December 31, 2013, only 11.2% of the eligible residential natural gas customers (according to the EIA) in the states where we operate were served by an energy retailer other than the local regulated utility. We believe this presents market entry opportunities that we intend to capitalize on by focusing our marketing and sales channels efforts on increasing our natural gas customer base in markets where we believe such efforts will increase the profitability of our business.

Low Penetration

In most competitive energy markets, the majority of residential and commercial customers have not switched to a retail energy company and continue to be served by the local regulated utility. As of December 31, 2013, only 11.2% of the eligible residential natural gas customers (according to the EIA) and only 32.9% of the eligible residential electricity customers (according to DNV GL) in the states where we operate were served by an energy retailer other than the local regulated utility or its retail affiliate. Management believes these underserved residential markets provide an opportunity for further penetration over the foreseeable future as more customers become aware of their option to choose an energy retailer other than the local regulated utility.

Customer Growth

Notwithstanding the low current penetration rates of energy retailers compared to local regulated utilities, according to the EIA, over the last decade, residential natural gas accounts served by competitive energy retailers have grown from approximately 3.8 million to approximately 6.6 million (5.6% CAGR) and non-residential natural gas accounts have grown from approximately 433,944 to approximately 837,365 (4.8% CAGR). According to DNV GL, over the last decade, residential electricity accounts served by competitive electricity suppliers have grown from approximately 2.3 million to approximately 16.2 million (21.8% CAGR) and non-residential electricity accounts have grown from approximately 473,000 to approximately 2.8 million (19.6% CAGR).

According to DNV GL, licensing activity for mass market retail electric suppliers over the last year across all competitive energy markets continues to maintain a substantial pace. Customer growth and licensing activity is projected to continue experiencing growth, fueled by increased consumer awareness, changing utility prices and product innovation, as well as a favorable regulatory policy environment. As a result, management believes there is a significant opportunity for competitive retailers to gain market share by offering consumers innovative product options, excellent customer service and serving as a competitive choice for their energy supply.

 

 

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Electricity Accounts Switched by a Competitive Supplier

 

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* Current year is as of November 30, 2013, which is the most recent publicly available data.

 

   Source: DNV GL Q4 2013 Retail Energy Outlook

Fragmentation and Consolidation

We believe that favorable market conditions, including lower natural gas and electricity prices and low residential customer penetration, have led to an increase in the number of energy retailers in the United States. The vast majority of these new entrants are small regional energy retailers, which often experience rapid customer growth but have not historically had reliable access to capital or economies of scale to support this growth over the longer term or react to changing commodity price environments. According to DNV GL, 65 residential electricity retailers were active as of June 2013, approximately 77% (50) of which had fewer than 300,000 electricity customers, and approximately 55% (36) of which had fewer than 100,000 electricity customers.

According to DNV GL, market consolidation among the large number of competitive electricity retailers continues at a growing pace. Twenty-two acquisitions of electricity retailers, some of which also provide natural gas, and similar types of ownership transfers were completed from January 1, 2013 to September 30, 2013. Management believes that the current environment of small, private energy retailers presents significant acquisition opportunities to consolidate smaller retailers into our larger and more scalable platform and increase market share.

Corporate Reorganization

Spark Energy, Inc. was incorporated by Spark Energy Ventures as a Delaware corporation in April 2014. Spark HoldCo, LLC was formed by Spark Energy Ventures as a Delaware limited liability company in April 2014. Spark Energy Ventures formed NuDevco in May 2014 to hold its investment in Spark Energy, Inc. and Spark HoldCo. In connection with the completion of this offering and following the transactions related thereto that are described below, (i) Spark Energy, Inc. will be a holding company whose sole material asset will consist of a managing membership interest in Spark HoldCo and (ii) Spark HoldCo will own all of the outstanding membership interests in each of SEG and SE, the operating subsidiaries through which we operate. After the consummation of this offering and the transactions described in this prospectus, Spark Energy, Inc. will be the sole managing member of Spark HoldCo, will be responsible for all operational, management and administrative decisions relating to Spark HoldCo’s businesses and will consolidate the financial results of Spark HoldCo and its subsidiaries.

 

 

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Prior to the completion of this offering, the following have occurred or will occur:

 

  SEG and SE were converted from limited partnerships into limited liability companies;

 

  SEG, SE and an affiliate will enter into an interborrower agreement, pursuant to which such affiliate will agree to be solely responsible for $31.0 million of outstanding indebtedness under our current credit facility, under which SEG, SE and the affiliate are co-borrowers, and SEG and SE will agree to be solely responsible for the remaining $10.0 million of indebtedness outstanding under our current credit facility;

 

  NuDevco Retail Holdings will contribute all of its interests in SEG and SE to Spark HoldCo in exchange for all of the outstanding units of Spark HoldCo and will transfer 1% of those Spark HoldCo units to NuDevco Retail;

 

  NuDevco Retail Holdings will transfer Spark HoldCo units having a value of $50,000 to Spark Energy, Inc. in exchange for a promissory note from Spark Energy, Inc. in the principal amount of $50,000 (the “NuDevco Note”), and the limited liability company agreement of Spark HoldCo will be amended and restated to admit Spark Energy, Inc. as its sole managing member; and

 

  Spark Energy, Inc. will issue 10,750,000 shares of Class B common stock to Spark HoldCo, 10,612,500 of which Spark HoldCo will distribute to NuDevco Retail Holdings, and 137,500 of which Spark HoldCo will distribute to NuDevco Retail.

Immediately prior to the consummation of the offering and following the transactions described above, (i) NuDevco will own 13,747,500 Spark HoldCo units and all of the outstanding shares of Class B common stock of Spark Energy, Inc., (ii) Spark Energy, Inc. will own the managing member interest in Spark HoldCo and 2,500 Spark HoldCo units, and (iii) Spark HoldCo will wholly own SEG and SE. Spark Energy, Inc. will offer 3,000,000 newly-issued shares of Class A common stock hereby to the public (or 3,450,000 shares if the underwriters exercise their option to purchase additional shares in full) and will use the net proceeds from this offering to purchase 2,997,500 Spark HoldCo units (or 3,447,500 Spark HoldCo units if the underwriters exercise their option to purchase additional shares in full) from NuDevco Retail Holdings and to repay the NuDevco Note. In connection with any exercise of the underwriters’ option to purchase additional shares of Class A common stock and our use of the proceeds from the exercise of that option to purchase additional Spark HoldCo units from NuDevco Retail Holdings, a corresponding number of shares of Class B common stock owned by NuDevco Retail Holdings will be cancelled. After giving effect to these transactions and this offering, Spark Energy, Inc. will own an approximate 21.82% interest in Spark HoldCo (or 25.09% if the underwriters’ option to purchase additional shares is exercised in full), NuDevco Retail Holdings will own an approximate 77.18% interest in Spark HoldCo and 10,612,500 shares of Class B common stock (or a 73.19% interest in Spark HoldCo and 10,162,500 shares of Class B common stock if the underwriters’ option to purchase additional shares is exercised in full) and NuDevco Retail will own a 1% interest in Spark HoldCo and 137,500 shares of Class B common stock. See “Use of Proceeds” and “Principal Stockholders.” Following the offering, Spark Energy Ventures will distribute its 100% interest in NuDevco Retail Holdings to NuDevco Partners Holdings, LLC. The distribution will result in NuDevco Retail Holdings being a direct wholly owned subsidiary of NuDevco Partners Holdings, LLC. Spark Energy Ventures will remain a wholly owned subsidiary of NuDevco Partners Holdings and, following the distribution, will not beneficially own any Class B common stock.

In connection with the closing of the offering, we expect to enter into a new $70.0 million senior secured revolving credit facility, which we refer to as our new revolving credit facility. We will borrow approximately $10.0 million under our new revolving credit facility at the closing of this offering to repay in full the portion of outstanding indebtedness under our current credit facility that SEG and SE have agreed to be responsible for pursuant to an interborrower agreement between SEG, SE and an affiliate. The remainder of indebtedness outstanding under our current credit

 

 

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facility will be paid down by our affiliate with its own funds in connection with the closing of this offering pursuant to the terms of the interborrower agreement. Following this repayment, our current credit facility will be terminated. For more information regarding our new revolving credit facility, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Historical Cash Flows—Credit Facility.”

Each share of Class B common stock, all of which will initially be held by NuDevco, has no economic rights but entitles its holder to one vote on all matters to be voted on by shareholders generally. Holders of Class A common stock and Class B common stock will vote together as a single class on all matters presented to our shareholders for their vote or approval, except as otherwise required by applicable law or by our certificate of incorporation. Please see “Description of Capital Stock.” We do not intend to list Class B common stock on any stock exchange.

NuDevco will have the right to exchange (the “Exchange Right”) all or a portion of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for Class A common stock (or cash at Spark Energy, Inc.’s or Spark HoldCo’s election (the “Cash Option”)) at an exchange ratio of one share of Class A common stock for each Spark HoldCo unit (and corresponding share of Class B common stock) exchanged, as described under “Certain Relationships and Related Party Transactions—Spark HoldCo LLC Agreement.” In addition, NuDevco will have the right, under certain circumstances, to cause us to register the offer and resale of its shares of Class A common stock as described under “Certain Relationships and Related Party Transactions—Registration Rights Agreement.”

We will enter into a Tax Receivable Agreement with Spark HoldCo, NuDevco Retail Holdings and NuDevco Retail. This agreement will generally provide for the payment by Spark Energy, Inc. to NuDevco of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that Spark Energy, Inc. actually realizes (or is deemed to realize in certain circumstances) in periods after this offering as a result of (i) any tax basis increases resulting from the purchase by Spark Energy, Inc. of Spark HoldCo units from NuDevco Retail Holdings prior to or in connection with this offering, (ii) any tax basis increases resulting from the exchange of Spark HoldCo units for shares of Class A common stock pursuant to the Exchange Right (or resulting from an exchange of Spark HoldCo units for cash pursuant to the Cash Option) and (iii) any imputed interest deemed to be paid by us as a result of, and additional tax basis arising from, any payments we make under the Tax Receivable Agreement. Spark Energy, Inc. will retain the benefit of the remaining 15% of these tax savings. See “Certain Relationships and Related Party Transactions—Tax Receivable Agreement.”

In certain circumstances, Spark Energy, Inc. will defer or partially defer any payment due (a “TRA Payment”) to the holders of rights under the Tax Receivable Agreement, which will initially be NuDevco Retail Holdings and NuDevco Retail. As described elsewhere in this prospectus, no TRA Payment will be made during 2014, and any future TRA Payments due with respect to a given taxable year are expected to be paid in December of the subsequent calendar year.

During the five-year period commencing October 1, 2014, Spark Energy, Inc. will defer all or a portion of any TRA Payment owed pursuant to the Tax Receivable Agreement to the extent that Spark HoldCo does not generate sufficient Cash Available for Distribution (as defined below) during the four-quarter period ending September 30th of the applicable year in which the TRA Payment is to be made in an amount that equals or exceeds 130% (the “TRA Coverage Ratio”) of the Total Distributions (as defined below) paid in such four-quarter period by Spark HoldCo. For purposes of computing the TRA Coverage Ratio:

 

  “Cash Available for Distribution” is generally defined as the Adjusted EBITDA of Spark HoldCo for the applicable period, less (i) cash interest paid by Spark HoldCo, (ii) capital expenditures of Spark HoldCo (exclusive of customer acquisition costs) and (iii) any taxes payable by Spark HoldCo; and

 

 

 

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  “Total Distributions” are defined as the aggregate distributions necessary to cause Spark Energy, Inc. to receive distributions of cash equal to (i) the targeted quarterly distribution we intend to pay to holders of our Class A common stock payable during the applicable four-quarter period, plus (ii) the estimated taxes payable by us during such four-quarter period, plus (iii) the expected TRA Payment payable during the calendar year for which the TRA Coverage Ratio is being tested.

In the event that the TRA Coverage Ratio is not satisfied in any calendar year, Spark Energy, Inc. will defer all or a portion of the TRA Payment to NuDevco under the Tax Receivable Agreement to the extent necessary to permit Spark HoldCo to satisfy the TRA Coverage Ratio (and Spark HoldCo is not required to make and will not make the pro rata distributions to its members with respect to the deferred portion of the TRA Payment). If the TRA Coverage Ratio is satisfied in any calendar year, Spark Energy, Inc. will pay NuDevco the full amount of the TRA Payment.

Following the five-year deferral period, Spark Energy Inc. will be obligated to pay any outstanding deferred TRA Payments (x) to the extent such deferred TRA Payments do not exceed (i) the lesser of Spark Energy Inc.’s proportionate share of aggregate Cash Available for Distribution of Spark HoldCo during the five-year deferral period or the cash distributions actually received by Spark Energy Inc. during the five-year deferral period, reduced by (ii) the sum of (a) the aggregate target quarterly dividends (which, for the purposes of the Tax Receivable Agreement, will be $0.3625 per share per quarter) during the five-year deferral period, (b) Spark Energy Inc.’s estimated taxes during the five-year deferral period, and (c) all prior TRA Payments and (y) if with respect to the quarterly period during which the deferred TRA Payment is otherwise paid or payable, Spark HoldCo has or reasonably determines it will have amounts necessary to cause Spark Energy, Inc. to receive distributions of cash equal to the target quarterly distribution payable during that quarterly period. Any portion of the deferred TRA Payments not payable due to these limitations will no longer be payable.

 

 

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Organizational Structure

The following diagram indicates our simplified ownership structure immediately following this offering and the transactions related thereto (assuming that the underwriters’ option to purchase additional shares is not exercised):

 

LOGO

 

 

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Our Principal Shareholder

Upon completion of this offering, NuDevco will initially own 10,750,000 Spark HoldCo units and 10,750,000 shares of Class B common stock, representing approximately 78.18% of the voting power of Spark Energy, Inc. NuDevco will be wholly owned by NuDevco Partners Holdings, LLC, which is in turn wholly owned by NuDevco Partners, LLC, which is in turned wholly owned by W. Keith Maxwell III, the founder of our Company. For more information on our reorganization and the ownership of our common stock by our principal shareholders, see “Corporate Reorganization.”

Risk Factors

Investing in our Class A common stock involves risks. You should read carefully the section of this prospectus entitled “Risk Factors” for an explanation of these risks, along with the other information in this prospectus, before investing in our Class A common stock. For example, the following considerations may cause a material adverse effect to the price of the Class A common stock, our financial condition, liquidity, cash flows, prospects and our ability to pay dividends to the holders of our Class A common stock:

Risks Related to Our Business

 

  We are subject to commodity price risk.

 

  Our financial results may be adversely impacted by weather conditions.

 

  Our risk management policies and hedging procedures may not mitigate risk as planned, and we may fail to fully or effectively hedge our commodity supply and price risk exposure against changes in consumption volumes or market rates.

 

  We depend on consistent state and federal regulation to permit us to operate in restructured, competitive segments of the natural gas and electricity industries. If competitive restructuring of the natural gas and electricity utility industries is altered, reversed, discontinued or delayed, our business prospects and financial results could be materially adversely affected.

 

  The retail energy business is subject to a high level of federal, state and local regulation.

 

  Our business is dependent on retaining licenses in the markets in which we operate.

 

  Our financial results will fluctuate on a seasonal and quarterly basis.

 

  Pursuant to our cash dividend policy, we intend to distribute all or substantially all of our cash available for distribution through regular quarterly dividends, and our ability to grow and make acquisitions with cash on hand could be limited.

 

  We may have difficulty retaining our existing customers or obtaining a sufficient number of new customers.

 

  We may experience strong competition from local regulated utilities and other competitors.

Risks Related to the Offering and our Class A Common Stock

 

  We expect to have shortfalls of cash available for distribution from operating cash flows in certain quarters during the four quarters following the closing of this offering, and we may not be able to continue paying our targeted quarterly dividend to the holders of our Class A common stock in the future.

 

  The assumptions underlying the forecast presented elsewhere in this prospectus are inherently uncertain and subject to significant business, economic, financial, regulatory and competitive risks that could cause our actual cash available for dividends to differ materially from our forecast.

 

 

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  We are a holding company. Our sole material asset after completion of this offering will be our equity interest in Spark HoldCo and we are accordingly dependent upon distributions from Spark HoldCo to pay dividends, pay taxes, make payments under the Tax Receivable Agreement and cover our corporate and other overhead expenses.

 

  We will be a “controlled company” under NASDAQ Global Select Market rules, and as such we are entitled to an exemption from certain corporate governance standards of the NASDAQ Global Select Market, and you may not have the same protections afforded to shareholders of companies that are subject to all of the NASDAQ Global Select Market corporate governance requirements.

 

  We will be required to make payments under the Tax Receivable Agreement for certain tax benefits we may claim, and the amounts of such payments could be significant.

 

  In certain cases, payments under the Tax Receivable Agreement may be accelerated and/or significantly exceed the actual benefits, if any, we realize in respect of the tax attributes subject to the Tax Receivable Agreement.

For a discussion of other considerations that could negatively affect us, see “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”

Emerging Growth Company Status

We are an “emerging growth company” within the meaning of the federal securities laws. For as long as we are an emerging growth company, we will not be required to comply with certain requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, (i) not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, (ii) the reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and (iii) the exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the “Securities Act,” for complying with new or revised accounting standards, but we have irrevocably opted out of the extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.

We intend to take advantage of these exemptions until we are no longer an emerging growth company. We will cease to be an “emerging growth company” upon the earliest of: (i) the last day of the fiscal year in which we have $1.0 billion or more in annual revenues; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which the total market value of our common equity securities held by non-affiliates is $700 million or more as of June 30); (iii) the date on which we issue more than $1.0 billion of non-convertible debt over a three-year period; or (iv) the last day of the fiscal year following the fifth anniversary of our initial public offering.

For a description of the qualifications and other requirements applicable to emerging growth companies and certain elections that we have made due to our status as an emerging growth company, see “Risk Factors—Risks Related to the Offering and our Class A Common Stock—For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.”

 

 

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Our Offices

Our principal executive offices are located at 2105 CityWest Blvd., Suite 100, Houston, Texas, 77042 and our telephone number at that address is (713) 600-2600. Our website address is www.sparkenergy.com. Information contained on our website does not constitute part of this prospectus.

 

 

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THE OFFERING

 

Shares of Class A common stock offered by us

3,000,000 shares of our Class A common stock.

 

Shares of Class A common stock outstanding after this offering

3,000,000 shares of our Class A common stock (or 3,450,000 shares of Class A common stock if the underwriters exercise in full their option to purchase additional shares of Class A common stock), without giving effect to the grant of restricted stock units that we expect to issue in connection with this offering. See “Executive Compensation—Compensation Following this Offering.”

 

Shares of Class B common stock outstanding after this offering

10,750,000 shares of our Class B common stock (or 10,300,000 shares of Class B common stock if the underwriters exercise in full their option to purchase additional shares of Class A common stock), which represents one share of Class B common stock for each Spark HoldCo unit held by NuDevco immediately after this offering. Shares of Class B common stock have voting rights, but no right to receive distributions. Each share of Class B common stock, when combined with a Spark HoldCo unit held by NuDevco, may be exchanged for a share of Class A common stock, in which case the share of Class B common stock would be cancelled. NuDevco will beneficially own all of our outstanding Class B common stock upon completion of this offering.

 

Option to purchase additional shares of our Class A common stock

We have granted the underwriters an option to purchase up to an additional 450,000 shares of our Class A common stock from us, at the initial public offering price, less the underwriting discounts and commissions, within 30 days from the date of this prospectus. We will use the proceeds from any exercise of such option to acquire from NuDevco Retail Holdings an additional number Spark HoldCo units equal to the number of additional shares of our Class A common stock purchased by the underwriters, and a corresponding number of shares Class B common stock owned by NuDevco Retail Holdings will be cancelled. Accordingly, we will not retain the proceeds from any exercise by the underwriters of their option to purchase additional shares.

 

Use of proceeds

Assuming no exercise of the underwriters’ option to purchase additional shares of Class A common stock, our net proceeds from this offering will be approximately $52.3 million after deducting underwriting discounts and commissions, structuring fees and estimated offering expenses. If the underwriters exercise in full their

 

 

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option to purchase additional shares of Class A common stock, we estimate that the net proceeds will be approximately $60.7 million, after deducting underwriting discounts and commissions, structuring fees and estimated offering expenses.

 

  We intend to use the net proceeds of this offering of approximately $52.3 million (or approximately $60.7 million if the underwriters exercise in full their option to purchase additional shares of Class A common stock) to acquire Spark HoldCo units representing approximately 21.82% (or approximately 25.09% if the underwriters exercise in full their option to purchase additional shares of Class A common stock) of the outstanding Spark HoldCo units after this offering, from NuDevco Retail Holdings and to repay the NuDevco Note. We intend to use the net proceeds resulting from any exercise of the underwriters’ option to purchase additional shares of Class A common stock to acquire an additional number of Spark HoldCo units from NuDevco Retail Holdings equal to the number of additional shares of our Class A common stock purchased by the underwriters. In connection with such acquisition, a corresponding number of shares of Class B common stock owned by NuDevco Retail Holdings will be cancelled. We will not retain any of the net proceeds from this offering or any exercise of the underwriters’ option to purchase additional shares of Class A common stock. Please see “Use of Proceeds.”

 

Cash dividends

Upon completion of this offering, we intend to pay a regular quarterly dividend to holders of our Class A common stock to the extent we have cash available for distributions to do so. Our targeted quarterly dividend will be $0.3625 per share of Class A common stock ($1.45 per share on an annualized basis), which amount may be raised or lowered in the future without advance notice. Our ability to pay any regular quarterly dividend is subject to various restrictions and other factors described in more detail under the caption “Cash Dividend Policy.”

 

  We expect to pay a quarterly dividend on or about the 75th day following the expiration of each fiscal quarter to holders of our Class A common stock of record on or about the 60th day following the last day of such fiscal quarter. With respect to our first dividend payable on or about December 15, 2014, we intend to pay a pro-rated dividend (calculated from the closing date of this offering through and including September 30, 2014) of $         per share of Class A common stock, which represents the pro-rata portion of the targeted quarterly dividend over that period.

 

 

We believe, based on our financial forecast and related assumptions included in “Cash Dividend Policy—Estimated Cash Available for Distribution for the Twelve Months Ending June 30, 2015,” that we will generate sufficient annual cash available for distribution to support our

 

 

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targeted quarterly dividend of $0.3625 per share of Class A common stock ($1.45 per share on an annualized basis). However, we do not have a legal obligation to declare or pay dividends at such targeted quarterly dividend level or at all. See “Cash Dividend Policy.”

 

Voting rights

Each share of our Class A common stock will entitle its holder to one vote on all matters to be voted on by stockholders generally.

 

  Each share of our Class B common stock will entitle its holder to one vote on all matters to be voted on by stockholders generally. Through its ownership of our Class B common stock, NuDevco will hold shares of our common stock having 78.18% (or 74.91% if the underwriters exercise in full their option to purchase additional shares of Class A common stock) of the combined voting power of all of our common stock outstanding. As a result, for the foreseeable future following this offering, NuDevco will be able to exercise control over matters requiring the approval of our stockholders, including the election of our directors and the approval of significant corporate transactions. Please see “Certain Relationships and Related Party Transactions.”

 

  Holders of our Class A common stock and Class B common stock will vote together as a single class on all matters presented to stockholders for their vote or approval, except for matters affecting one class disproportionately or as otherwise required by law. See “Description of Capital Stock.”

 

Economic interest

Immediately following this offering, the purchasers in this offering will own in the aggregate a 21.82% economic interest in our business through our ownership of Spark HoldCo units and NuDevco will own in aggregate a 78.18% economic interest in our business through its ownership of Spark HoldCo units (or a 25.09% economic interest and a 74.91% economic interest, respectively, if the underwriters exercise in full their option to purchase additional shares of our Class A common stock).

 

Exchange and registration rights

Under the Spark HoldCo limited liability company agreement, NuDevco may exchange its Spark HoldCo units (together with a corresponding number of shares of our Class B common stock) for shares of our Class A common stock (on a one-for-one basis, subject to conversion ratio adjustments for stock splits, stock dividends and reclassifications and other similar transactions) or, at Spark Energy or Spark HoldCo’s election, an equivalent amount of cash. When NuDevco exchanges a Spark HoldCo unit for a share of our Class A common stock, we will automatically redeem and cancel a corresponding share of our Class B common stock. See “Certain Relationships and Related Party Transactions—Spark HoldCo LLC Agreement.”

 

 

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  Pursuant to a registration rights agreement that we will enter into with NuDevco Retail Holdings and NuDevco Retail, we will agree to file a registration statement for the sale of the shares of our Class A common stock that are issuable pursuant to its Exchange Right upon request and cause that registration statement to be declared effective by the U.S. Securities and Exchange Commission (“SEC”) as soon as practicable thereafter. See “Certain Relationships and Related Party Transactions—Registration Rights Agreement” for a description of the timing and manner limitations on resales of these shares of our Class A common stock.

 

Material federal income tax consequences to non-U.S. holders.

For a discussion of the material federal income tax consequences that may be relevant to prospective investors who are non-U.S. holders, please see “Material U.S. Federal Income and Estate Tax Consequences to Non-U.S. Holders.”

 

Exchange listing

We have applied to list our Class A common stock on the NASDAQ Global Select Market under the symbol “SPKE”.

 

 

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SUMMARY HISTORICAL AND UNAUDITED

PRO FORMA COMBINED FINANCIAL AND OPERATING DATA

Spark Energy, Inc. was formed in April 2014 and does not have any historical financial operating results. Accordingly, the accompanying combined financial statements have been prepared from the combined business and assets of the retail natural gas business and asset optimization activities of SEG and the retail electricity business of SE.

The following table shows the summary historical combined financial data as of and for the years ended December 31, 2012 and 2013 and the three months ended March 31, 2013 and 2014. The summary historical combined financial data as of December 31, 2012 and 2013 and for the years ended December 31, 2012 and 2013 has been derived from the audited combined financial statements and the related notes thereto included elsewhere in this prospectus. The summary historical combined financial data as of March 31, 2014 and for the three months ended March 31, 2013 and 2014 has been derived from the unaudited condensed combined financial statements and the related notes included elsewhere in this prospectus.

The summary unaudited pro forma combined financial data presented below has been derived by the application of pro forma adjustments to the historical combined financial statements included elsewhere in this prospectus. The summary unaudited pro forma combined financial data presented below give effect to (i) our reorganization in connection with this offering as described in “Corporate Reorganization,” (ii) this offering and the use of the estimated net proceeds from this offering as described in “Use of Proceeds” and (iii) other related transactions to be effected at the closing of this offering, as if such transactions had taken place on January 1, 2013, in the case of the unaudited pro forma combined statement of operations for each of the year ended December 31, 2013 and the three months ended March 31, 2014, and as of December 31, 2013 and March 31, 2014, in the case of the unaudited pro forma combined balance sheet as of December 31, 2013 and March 31, 2014, respectively.

You should read these tables in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a discussion of factors materially affecting the comparability of the information presented, “Corporate Reorganization,” “Selected Historical and Unaudited Pro Forma Combined Financial and Operating Data” and the historical and pro forma combined financial statements and notes thereto included elsewhere in this prospectus. The summary unaudited pro forma combined financial data is presented for informational purposes only. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable.

 

 

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The summary unaudited pro forma combined financial data does not purport to represent what our results of operations or financial position would have been if we had operated as a public company during the period presented and may not be indicative of our future performance.

 

     Historical     Pro Forma  
    Year Ended
December 31,
    Three Months
Ended March 31,
    Year Ended
December 31,
    Three Months
Ended March 31,
 
     2012     2013     2013    

2014

    2013     2014  
                     

(restated)

             
                (unaudited)     (unaudited)  

Statement of Income Data (in thousands):

           

Revenues:

           

Retail revenues (including retail revenues—affiliates of $1,382 and $4,022 for the years ended December 31, 2012 and 2013, respectively, and $199 and $1,489 for the three months ended March 31, 2013 and 2014, respectively)

  $ 380,198      $ 316,776      $ 100,453      $ 104,352      $ 316,776      $ 104,352   

Net asset optimization revenues (including asset optimization revenues-affiliates of $8,334 and $14,940 for the years ended December 31, 2012 and 2013, and $1,500 and $2,500 for the three months ended March 31, 2013 and 2014, respectively, and asset optimization revenues affiliate cost of revenues of $568 and $15,928 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million and $7,900 for the three months ended March 31, 2013 and 2014, respectively)

    (1,136     314        (1,157     1,624        314        1,624   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    379,062        317,090        99,296        105,976        317,090        105,976   

Operating expenses:

           

Retail cost of revenues (including retail cost of revenues-affiliates of $254 and $55 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million for the three months ended March 31, 2013 and 2014, respectively)

    279,506        233,026        69,993       
88,121
  
    233,026        88,121   

General and administrative

    47,321        35,020        9,275        8,113        35,020        8,113   

Depreciation and amortization

    22,795        16,215        5,030        2,959        16,215        2,959   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    349,622        284,261        84,298        99,193        284,261        99,193   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    29,440        32,829        14,998        6,783        32,829        6,783   

Other (expense)/income:

           

Interest expense

    (3,363     (1,714     (384     (313     (1,183     (296

Interest income and other income

    62        353        11        70        353        70   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expenses)/income

    (3,301     (1,361     (373     (243     (830     (226
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

    26,139        31,468        14,625        6,540        31,999        6,557   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

    46        56        14        32        2,630        543   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 26,093      $ 31,412      $ 14,611      $ 6,508      $ 29,369      $ 6,014   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to non-controlling interest

            25,017        5,126   
         

 

 

   

 

 

 

Net income attributable to stockholders

          $ 4,352      $ 888   
         

 

 

   

 

 

 

Pro forma net income per common share

           

Basic

          $ 1.45      $ .30   

Diluted

          $ 1.45      $ .30   

Weighted average proforma common shares outstanding

           

Basic

            3,000,000        3,000,000   

Diluted

            13,750,000        13,750,000   

Balance Sheet Data (in thousands, at period end):

           

Current assets

  $ 104,246      $ 101,291        $ 119,720        $ 119,044   

Total liabilities

    67,976        73,160          99,768          97,741   

Total liabilities and members’ equity

    129,278        109,073          127,833          153,181   

Cash Flow Data (in thousands):

           

Cash flows from operating activities

  $ 44,076      $ 44,480      $ 17,868      $ 6,209       

Cash flows used in investing activities

    (1,643     (1,481     (93     (787    

Cash flows used in financing activities

    (39,904     (42,369     (22,239     (7,856    

Other Financial Data (in thousands)(1):

           

Adjusted EBITDA(1)

  $ 40,659      $ 33,533      $ 19,048      $ 9,322      $ 33,533      $ 9,322   

Retail gross margin(1)

    93,219        81,668        31,740        17,684        81,668        17,684   

Other Operating Data:

           

Customers

    237,436        210,556        215,715        240,993        210,556        240,993   

Natural gas volumes (MMBtu)

    17,527,252        16,598,751        6,994,627        6,593,580        16,598,751        6,593,580   

Electricity volumes (MWh)

    2,698,084        1,829,657        478,426        384,275        1,829,657        384,275   

 

 

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(1) Adjusted EBITDA and retail gross margin are non-GAAP financial measures. For a definition and a reconciliation of each of Adjusted EBITDA and retail gross margin to their most directly comparable financial measures calculated and presented in accordance with GAAP, please see “—Non-GAAP Financial Measures” below.

Non-GAAP Financial Measures

Adjusted EBITDA. We define “Adjusted EBITDA” as EBITDA less (i) customer acquisition costs incurred in the current period, (ii) net gain (loss) on derivative instruments, and (iii) net current period cash settlements on derivative instruments, plus (iv) non-cash compensation expense and (v) other non-cash operating items. EBITDA is defined as net income before provision for income taxes, interest expense and depreciation and amortization. We deduct all current period customer acquisition costs in the Adjusted EBITDA calculation because such costs reflect a cash outlay in the year in which they are incurred, even though we capitalize such costs and amortize them over 24 months in accordance with our accounting policies. The deduction of current period customer acquisition costs is consistent with how we manage our business, but the comparability of Adjusted EBITDA between periods may be affected by varying levels of customer acquisition costs. We deduct our net gains (losses) on derivative instruments, excluding current period cash settlements, from the Adjusted EBITDA calculation in order to remove the non-cash impact of net gains and losses on derivative instruments. Although we have not historically incurred non-cash compensation expense, we expect that we will incur non-cash compensation expense following the completion of this offering as a result of equity awards that may be issued under our long-term incentive plan.

We believe that the presentation of Adjusted EBITDA provides information useful to investors in assessing our liquidity and financial condition and results of operations and that Adjusted EBITDA is also useful to investors as a financial indicator of a company’s ability to incur and service debt, pay dividends and fund capital expenditures. Adjusted EBITDA is a supplemental financial measure that management and external users of our combined financial statements, such as industry analysts, investors, commercial banks and rating agencies, use to assess the following, among other measures:

 

  our operating performance as compared to other publicly traded companies in the retail energy industry, without regard to financing methods, capital structure or historical cost basis;

 

  the ability of our assets to generate earnings sufficient to support our proposed cash dividends; and

 

  our ability to fund capital expenditures (including customer acquisition costs) and incur and service debt.

The GAAP measures most directly comparable to Adjusted EBITDA are net income and net cash provided by operating activities. Our non-GAAP financial measure of Adjusted EBITDA should not be considered as an alternative to net income or net cash provided by operating activities. Adjusted EBITDA is not a presentation made in accordance with GAAP and has important limitations as an analytical tool. You should not consider Adjusted EBITDA in isolation or as a substitute for analysis of our results as reported under GAAP. Because Adjusted EBITDA excludes some, but not all, items that affect net income and net cash provided by operating activities, and is defined differently by different companies in our industry, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.

Management compensates for the limitations of Adjusted EBITDA as an analytical tool by reviewing the comparable GAAP measures, understanding the differences between the measures and incorporating these data points into management’s decision-making process.

 

 

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The following table presents a reconciliation of Adjusted EBITDA to net income (loss) and net cash provided by operating activities for each of the periods indicated:

 

     Historical   Pro Forma
    Year Ended
December 31,
  Three Months
Ended March 31,
  Year Ended
December 31,
  Three Months
Ended March 31,
     2012   2013   2013   2014   2013   2014
               

(restated)

       
            (unaudited)   (unaudited)

Reconciliation of Adjusted EBITDA to Net Income:

                       

Net income

    $ 26,093       $ 31,412       $ 14,611       $ 6,508       $ 29,369       $ 6,014  

Depreciation and amortization

      22,795         16,215         5,030         2,959         16,215         2,959  

Interest expense

      3,363         1,714         384         313         1,183         296  

Income tax expense

      46         56         14         32         2,630         543  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

EBITDA

      52,297         49,397         20,039         9,812         49,397         9,812  

Less:

                       

Net gains (losses) on derivative instruments

      (21,485 )       6,567         2,242         5,460         6,567         5,460  

Net cash settlements on derivative instruments

      26,801         1,040         (1,471 )       (10,197 )       1,040         (10,197 )

Customer acquisition costs

      6,322         8,257         220         5,227         8,257         5,227  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Adjusted EBITDA

    $ 40,659       $ 33,533       $ 19,048       $ 9,322       $ 33,533       $ 9,322  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Reconciliation of Adjusted EBITDA to Net Cash Provided by Operating Activities:

                       

Net cash provided by operating activities

    $ 44,076       $ 44,480       $ 17,868       $ 6,209          

Amortization and write off of deferred financing costs

      (919 )       (678 )       (120 )       (113 )        

Allowance for doubtful accounts and bad debt expense

      (1,835 )       (3,101 )       (513 )       (565 )        

Interest expense

      3,363         1,714         384         313          

Income tax expense

      46         56         14         32          

Changes in operating working capital:

                       

Accounts receivable, prepaids, current assets

      (12,737 )       (17,792 )       (6,491 )       27,108          

Inventory

      (3,442 )       599         (3,411 )       (4,322 )        

Accounts payable and accrued liabilities

      12,689         7,880         11,011         (18,335 )        

Other

      (582 )       375         306         (1,005 )        
   

 

 

     

 

 

     

 

 

     

 

 

         

Adjusted EBITDA

    $ 40,659       $ 33,533       $ 19,048       $ 9,322          
   

 

 

     

 

 

     

 

 

     

 

 

         

Cash Flow Data:

                       

Cash flows from operating activities

    $ 44,076       $ 44,480       $ 17,868       $ 6,209          

Cash flows used in investing activities

      (1,643 )       (1,481 )       (93 )       (787 )        

Cash flows used in financing activities

      (39,904 )       (42,369 )       (22,239 )       (7,856 )                    

Retail Gross Margin. We define retail gross margin as operating income plus (i) depreciation and amortization expenses and (ii) general and administrative expenses, less (i) net asset optimization revenues, (ii) net gains (losses) on derivative instruments, and (iii) net current period cash settlements on derivative instruments. Retail gross margin is included as a supplemental disclosure because it is a primary performance measure used by our management to determine the performance of our retail natural gas and electricity business by removing the impacts of our asset optimization activities and net non-cash income (loss) impact of our economic hedging activities. As an indicator of our retail energy business’ operating performance, retail gross margin should not be considered an alternative to, or more meaningful than, operating income, as determined in accordance with GAAP.

 

 

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The following table presents a reconciliation of retail gross margin to operating income, its most directly comparable financial measure calculated and presented in accordance with GAAP, for each of the periods indicated:

 

     Historical     Pro Forma  
    Year Ended
December 31,
    Three Months
Ended March 31,
    Year Ended
December 31,
    Three Months
Ended March 31,
 
     2012     2013     2013     2014     2013     2014  
                     

(restated)

             
                (unaudited)     (unaudited)  

Reconciliation of Retail Gross Margin to Operating Income:

           

Operating income

  $ 29,440      $ 32,829      $ 14,998      $ 6,783      $ 32,829      $ 6,783   

Depreciation and amortization

    22,795        16,215        5,030        2,959        16,215        2,959   

General and administrative

    47,321        35,020        9,275        8,113        35,020        8,113   

Less:

           

Net asset optimization revenues

    (1,136     314        (1,157     1,624        314        1,624   

Net gains (losses) on retail derivative instruments

    (19,016     1,429        660        11,448        1,429        11,448   

Net cash settlements on retail derivative instruments

    26,489        653        (1,940     (12,901     653        (12,901
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Retail Gross Margin

  $ 93,219      $ 81,668      $ 31,740      $ 17,684      $ 81,668      $ 17,684   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                                                 

 

 

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RISK FACTORS

Investing in our Class A common stock involves risks. You should carefully consider the information in this prospectus, including the matters addressed under “Cautionary Note Regarding Forward-Looking Statements,” and the following risks before making an investment decision. The trading price of our Class A common stock could decline and our ability to pay dividends on our Class A common stock could be adversely impacted due to any of these risks, and you may lose all or part of your investment.

Risks Related to Our Business

We are subject to commodity price risk.

Our financial results are largely dependent on the prices at which we can acquire the commodities we resell. The prevailing market prices for natural gas and electricity have historically, and may continue to, fluctuate substantially over relatively short periods of time, potentially adversely impacting our results of operations, financial condition, cash flows and our ability to pay dividends to the holders of our Class A common stock. Changes in market prices for natural gas and electricity may result from many factors that are outside of our control, including the following:

 

  weather conditions;

 

  seasonality;

 

  demand for energy commodities and general economic conditions;

 

  disruption of natural gas or electricity transmission or transportation infrastructure or other constraints or inefficiencies;

 

  reduction or unavailability of generating capacity, including temporary outages, mothballing, or retirements;

 

  the level of prices and availability of natural gas and competing energy sources, including the impact of changes in environmental regulations impacting suppliers;

 

  the creditworthiness or bankruptcy or other financial distress of market participants;

 

  changes in market liquidity;

 

  natural disasters, wars, embargoes, acts of terrorism and other catastrophic events;

 

  federal, state, foreign and other governmental regulation and legislation; and

 

  demand side management, conservation, alternative or renewable energy sources.

Additionally, significant changes in the pricing methods in the wholesale markets in which we operate could affect our commodity prices. Regulatory policies concerning how markets are structured, how compensation is provided for service, and the kinds of different services that can or must be offered, may change and could have significant impacts on our costs of doing business. For example, the Electric Reliability Council of Texas (“ERCOT”) has recently considered supplementing the existing energy and ancillary service markets with a mandate to purchase installed capacity, which could have the effect of increasing our supply costs. Similarly, ERCOT recently adopted a new reserve imbalance market that will increase prices in certain circumstances. Changes to the prices we pay to acquire commodities and that we are not able to pass along to our customers could materially adversely affect our operations, which could negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our financial results may be adversely impacted by weather conditions.

Weather conditions directly influence the demand for and availability of natural gas and electricity and affect the prices of energy commodities. Generally, on most utility systems, demand for natural gas peaks in the winter and demand for electricity peaks in the summer. Typically, when winters are warmer or summers are cooler, demand

 

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for energy is lower than expected, resulting in less natural gas and electricity consumption than forecasted. When demand is below anticipated levels due to weather patterns, we may be forced to sell excess supply at prices below our acquisition cost, which could result in reduced margins or even losses.

Conversely, when winters are colder or summers are warmer, consumption may outpace the volumes of natural gas and electricity against which we have hedged, and we may be unable to meet increased demand with storage or swing supply. In these circumstances, we may experience reduced margins or even losses if we are required to purchase additional supply at higher prices. Our failure to accurately anticipate demand due to fluctuations in weather or to effectively manage our supply in response to a fluctuating commodity price environment could negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our risk management policies and hedging procedures may not mitigate risk as planned, and we may fail to fully or effectively hedge our commodity supply and price risk exposure against changes in consumption volumes or market rates.

To provide energy to our customers, we purchase the relevant commodity in the wholesale energy markets, which are often highly volatile. Our commodity risk management strategy is designed to hedge substantially all of our forecasted volumes on our fixed-price customer contracts, as well as a portion of the near-term volumes on our variable-price customer contracts. We use both physical and financial products to hedge our fixed-price exposure. The efficacy of our risk management program may be adversely impacted by unanticipated events and costs that we are not able to effectively hedge, including abnormal customer attrition and consumption, certain variable costs associated with electricity grid reliability, pricing differences in the local markets for local delivery of commodities, unanticipated events that impact supply and demand, such as extreme weather, and abrupt changes in the markets for, or availability or cost of, financial instruments that help to hedge commodity price.

We are exposed to basis risk in our operations when the commodities we hedge are sold at different delivery points from the exposure we are seeking to hedge. For example, if we hedge our natural gas commodity price with Chicago basis but physical supply must be delivered to the individual delivery points of specific utility systems around the Chicago metropolitan area, we are exposed to basis risk between the Chicago basis and the individual utility system delivery points. These differences can be significant from time to time, particularly during extreme, unforecasted cold weather conditions. Similarly, in certain of our electricity markets, customers pay the load zone price for electricity, so if we purchase supply to be delivered at a hub, we may have basis risk between the hub and the load zone electricity prices due to local congestion that is not reflected in the hub price. We attempt to hedge basis risk where possible, but hedging instruments are sometimes not economically feasible or available in the smaller quantities that we require.

In addition, we incur costs monthly for ancillary charges such as reserves and capacity in the electricity sector by the ISOs. For instance, the ISOs will charge all retail electricity providers for monthly reserves that the ISO determines are necessary to protect the integrity of the grid. We attempt to estimate such amounts but they are difficult to estimate because they are charged in arrears by the ISOs and are subject to fluctuations based on weather and other market conditions. We may be unable to fully pass the higher cost of ancillary reserves and reliability services through to our customers, and increases in the cost of these ancillary reserves and reliability services could negatively impact our results of operations.

Additionally, assumptions that we use in establishing our hedges may reduce the effectiveness of our hedging instruments. Considerations that may affect our hedging policies include, but are not limited to, human error, assumptions about customer attrition, the relationship of prices at different trading or delivery points, assumptions about future weather, and our load forecasting models.

 

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Many of the natural gas utilities we serve allocate a share of transportation and storage capacity to us as a part of their competitive market operations. We are required to fill our allocated storage capacity with natural gas, which creates commodity supply and price risk. Sometimes we cannot hedge the volumes associated with these assets because they are too small compared to the much larger bulk transaction volumes required for trades in the wholesale market or it is not economically feasible to do so. In some regulatory programs or under some contracts, this capacity may be subject to recall by the utilities, which could have the effect of us being required to access the spot market to cover such recall.

In general, if we are unable to effectively manage our risk management policies and hedging procedures, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

We depend on consistent regulation within a particular utility territory (or state), as well as at the federal level, to permit us to operate in restructured, competitive segments of the natural gas and electricity industries. If competitive restructuring of the natural gas and electricity utility industries is altered, reversed, discontinued or delayed, our business prospects and financial results could be materially adversely affected.

We operate in the highly regulated natural gas and electricity retail sales industry. Regulations may be revised or reinterpreted or new laws and regulations may be adopted or become applicable to us or our operations. Such changes may have a detrimental impact on our business.

In certain restructured energy markets, state legislatures, governmental agencies and/or other interested parties have made proposals to fully or partially re-regulate these markets, which would interfere with our ability to do business. If competitive restructuring of natural gas or electricity markets is altered, reversed, discontinued or delayed, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

The retail energy business is subject to a high level of federal, state and local regulation.

State, federal and local rules and regulations affecting the retail energy business are subject to change, which may adversely impact our business model. Our costs of doing business may fluctuate based on these regulatory changes. For example, many electricity markets have rate caps, and changes to these rate caps by regulators can impact future price exposure. Similarly, regulatory changes can result in new fees or charges that may not have been anticipated when existing retail contracts were drafted, which can create financial exposure. For example, mandates to purchase a certain quantity or type of electricity capacity can create unanticipated costs. Our ability to manage cost increases that result from regulatory changes will depend, in part, on how the “change in law provisions” of our contracts are interpreted and enforced, among other factors.

Operators of systems providing for the delivery of natural gas and electricity maintain detailed tariffs that are kept on file with regulators. These tariffs and market rules applicable to operators are often very long and complex, and often are subject to service provider proposals to change them. We may not be able to prevent adoption of adverse tariff changes. Users of energy delivery systems also have rules and obligations applicable to them that are established by regulators. For instance, transactions involving a shipper’s release of interstate pipeline capacity are subject to regulation at the federal level. Our failure to abide by tariffs, market rules or other delivery system rules may result in fines, penalties and damages.

We are also subject to regulatory scrutiny in all of our markets that can give rise to compliance fees, licensing fees, or enforcement penalties. Regulations vary widely in the markets in which we operate, and these regulations change from time to time. Failure to follow prescribed regulatory guidelines could result in customer complaints and regulatory sanctions.

 

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In addition, regulators are continuously examining certain aspects of our industry. For example, a number of public utility commissions in the northeast are investigating the impact of the harsh weather conditions during the 2013-2014 winter season on consumers in their territories due to the number of consumer complaints attributable to high bills for the winter season and are urging FERC to investigate circumstances during that period in wholesale energy markets. To the extent any of these commissions takes regulatory action to address these complaints, such as imposing limits on products, services, rates or other business limitations, our business prospects in the region could be materially adversely affected.

In addition, door-to-door marketing and outbound telemarketing are a significant part of our marketing efforts. Each of these channels is continually under scrutiny by state and federal regulators and legislators. Additional regulation or restriction of these marketing practices could negatively impact our customer acquisition plan, and therefore our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our business is dependent on retaining licenses in the markets in which we operate.

We generally must apply to the relevant state utility commission to become a retail marketer of natural gas and/or electricity in the markets that we serve. Approval by the state regulatory body is subject to our understanding of and compliance with various federal, state and local regulations that govern the activities of retail marketers. If we fail to comply with any of these regulations, we could suffer certain consequences, which may include:

 

  higher customer complaints and increased unanticipated attrition;

 

  damage to our reputation with customers and regulators; and

 

  increased regulatory scrutiny and sanctions, including fines and termination of our license.

In addition, FERC regulates the sale of wholesale electricity by requiring us and other companies who sell into the wholesale market to obtain market-based rate authority. If that authority were revoked, our financial results and our ability to pay dividends to the holders of our Class A common stock could be materially adversely affected.

Our business model is dependent on continuing to be licensed in existing markets. If we have a license revoked or are not granted renewal of a license, or if our license is adversely conditioned or modified (e.g., by increased bond posting obligations), our financial results could be materially negatively impacted, which could materially negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our financial results will fluctuate on a seasonal and quarterly basis.

Our overall operating results fluctuate substantially on a seasonal basis depending on: (1) the geographic mix of our customer base; (2) the concentration of our product mix; (3) the impact of weather conditions on commodity pricing and demand, (4) variability in market prices for natural gas and electricity, and (5) changes in the cost of delivery of such commodities through energy delivery networks. These factors can have material short-term impacts on monthly and quarterly operating results, which may be misleading when considered outside of the context of our annual operating cycle. In addition, our accounts payable and accounts receivable are impacted by seasonality due to the timing differences between when we pay our suppliers for accounts payable versus when we collect from our customers on accounts receivable. We typically pay our suppliers for purchases on a monthly basis. However, it takes approximately two months from the time we deliver the electricity or natural gas to our customers before we collect from our customers on accounts receivable attributable to those supplies. This timing difference could affect our cash flows, especially during peak cycles in the winter and summer months. Furthermore, as a result of the seasonality of our business, we may reserve a portion of our excess cash available for distribution in the first and fourth quarters in order to fund our second and third quarter distributions. Because of

 

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the seasonal nature of our business and operating results, it may be difficult for investors to accurately and adequately value our business based on our interim result, which could materially negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Pursuant to our cash dividend policy, we intend to distribute substantially all of our cash available for distribution through regular quarterly dividends, and our ability to grow and make acquisitions with cash on hand could be limited.

Pursuant to our cash dividend policy, we intend to distribute substantially all of our cash available for distribution through regular quarterly dividends to holders of our Class A common stock, as discussed in more detail in “Cash Dividend Policy.” As such, our growth may not be as fast as that of businesses that reinvest their available cash to expand ongoing operations. To the extent we issue additional equity securities in connection with any acquisitions or growth capital expenditures, the payment of dividends on these additional equity securities may increase the risk that we will be unable to maintain our per share dividend rate. We may also rely upon external financing sources, including the issuance of debt and equity securities and borrowings under our new revolving credit facility to fund our acquisitions and growth capital expenditures. The incurrence of bank borrowings or other debt to finance our growth strategy will result in increased interest expense and the imposition of additional or more restrictive covenants, which, in turn, may impact our ability to pay dividends to holders of our Class A common stock. We may decide not to pursue otherwise attractive acquisitions if the projected short-term cash flow from the acquisition or investment is not adequate to service the capital raised to fund the acquisition or investment, after giving effect to our available cash reserves. See “Cash Dividend Policy—General—Our Ability to Fund Our Quarterly Dividend and Reinvest Excess Cash Available for Distribution in Our Growth.”

We may have difficulty retaining our existing customers or obtaining a sufficient number of new customers.

As of May 31, 2014, approximately 59% of our natural gas customers had fixed-price contracts, and the remaining 41% of our natural gas customers had variable-price contracts. As of May 31, 2014, approximately 46% of our electricity customers had fixed-price contracts, and the remaining 54% of our electricity customers had variable-price contracts. A significant decrease in the retail price of natural gas or electricity may cause our customers to switch retail energy service providers during their contract terms to obtain more favorable prices. Although we generally have a right to collect a termination fee from each customer on a fixed-price contract who terminates their contract following such an event, we may not be able to collect the termination fees in full or at all. Our variable-price contracts typically may be terminated by our customers at any time without penalty.

Furthermore, significant ongoing competition exists for customers in the markets where we operate, and we cannot guarantee that we will be able to retain our existing customers or obtain a sufficient number of new customers. We anticipate that we will incur significant costs as we enter new markets and pursue customers by utilizing a variety of marketing methods. In order for us to recover these expenses, we must attract and retain these customers on economic terms and for extended periods. We cannot be certain that our future efforts to retain our customers or secure additional customers will generate sufficient gross margins for us to expand into additional markets or that we will be able to prevent customer attrition and attract new customers in existing markets. If our marketing strategy is not successful, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

We may experience strong competition from local regulated utilities and other competitors.

The markets in which we compete are highly competitive, and we may not be able to compete effectively, especially against established industry competitors and new entrants with greater financial resources. We expect

 

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significant competition from local regulated utilities or their retail affiliates and traditional and new retail energy providers with greater financial resources, well established brand names and/or large, existing installed customer bases. In most markets, our principal competitor may be the local regulated utility company or its affiliated retail arm. The local regulated utilities have the advantage of longstanding relationships with their customers, and they may have longer operating histories, better access to data, greater financial and other resources and greater name recognition in their markets than we do. Convincing customers to switch to a new company for the supply of a critical commodity such as natural gas or electricity is a challenge.

In certain markets, local regulated utilities may seek to decrease their tariffed retail rates to limit or to preclude opportunities for retail energy providers to acquire market share, and otherwise seek to establish rates, terms and conditions to the disadvantage of retail energy providers such that these retail energy providers cannot remain competitive in that market. Also, in states where the utility service rate is set through the procurement of energy over a period of months or years, the utility service rate will lag behind market conditions. If energy prices rise significantly above the utility service rate over a prolonged period of time, we may be forced to reduce our operating margins in order to price more competitively with the utility service rate and may experience increased customer attrition, as some customers may switch to the service offer from the utility.

In addition to competition from the local regulated utilities, we face competition from a number of other retail energy providers. We also may face competition from large corporations with similar billing and customer service capabilities, such as telecommunication service providers and nationally branded providers of consumer products and services that have a significant base of existing customers. Many of these competitors or potential competitors are larger than us and have access to more significant capital resources. For example, a larger competitor may be able to incur more costs to acquire customers if its cost of capital is lower than ours. Similarly, marketers with a larger presence in the relevant market or that have interruptible load as part of their customer base may benefit from synergies or scale economies that smaller marketers, or marketers serving only firm customers, cannot obtain. In addition, product offerings that provide a consumer with an alternative source of energy, such as a solar panel, may become more common and indirectly compete with us. If our marketing strategy is not successful, it may affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

The accounting method we use for our hedging activities results in volatility in our quarterly and annual financial results.

We enter into a variety of financial derivative and physical contracts to manage commodity price risk, and we use mark-to-market accounting to account for this hedging activity. Under the mark-to-market accounting method, changes in the fair value of our hedging instruments that are not qualifying or not designated as hedges under accounting rules are recognized immediately in earnings. As a result of this accounting treatment, changes in the forward prices of natural gas and electricity cause volatility in our quarterly and annual earnings, which we are unable to fully anticipate.

In addition to the volatility described above, we could incur volatility from quarter to quarter associated with gains and losses on settled hedges relating to natural gas held in inventory if we choose to hedge the summer-winter spread on our retail allocated storage capacity. We typically purchase natural gas inventory and store it from April to October for withdrawal from November through March. Since a portion of the inventory is used to satisfy delivery obligations to our fixed-price customers over the winter months, we hedge the associated price risk using derivative contracts. Any gains or losses associated with settled derivative contracts are reflected in the statement of operations as a component of cost of goods sold.

 

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Increased collateral requirements in connection with our supply activities may restrict our liquidity which could limit our ability to grow our business or pay dividends.

Our contractual agreements with certain local regulated utilities and our supplier counterparties require us to maintain restricted cash balances or letters of credit as collateral for credit risk or the performance risk associated with the future delivery of natural gas or electricity. These collateral requirements may increase as we grow our customer base. Collateral requirements will increase based on the volume or cost of the commodity we purchase in any given month and the amount of capacity or service contracted for with the local regulated utility. Significant changes in market prices also can result in fluctuations in the collateral that local regulated utilities or suppliers require. The effectiveness of our operations and future growth, and our ability to pay dividends to the holders of our Class A common stock depend in part on the amount of cash and letters of credit available to enter into or maintain these contracts. The cost of these arrangements may be affected by changes in credit markets, such as interest rate spreads in the cost of financing between different levels of credit ratings. These liquidity requirements may be greater than we anticipate or are able to meet and therefore could limit our ability to grow our business or pay dividends to the holders of shares of our Class A common stock.

Our supply contracts expose us to counterparty credit risk.

We do not independently produce natural gas and electricity and depend upon third parties for our supply. If the counterparties to our supply contracts are unable to perform their obligations, we may suffer losses, including as a result of being unable to secure replacement supplies of natural gas or electricity on a timely and cost-effective basis or at all. If we cannot identify alternative supplies of natural gas or electricity, or secure natural gas or electricity in a timely fashion, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

We are subject to direct credit risk for certain customers who may fail to pay their bills as they become due.

We bear direct credit risk related to our customers located in markets that have not implemented POR programs as well as indirect credit risk in those POR markets that pass collection efforts along to us after a specified non-payment period. For the year ended December 31, 2013, customers in non-POR markets represented approximately 53% of our retail revenues. We generally have the ability to terminate contracts with customers in the event of non-payment, but in most states in which we operate we cannot disconnect their natural gas or electricity gas service. In POR markets where the local regulated utility has the ability to return non-paying customers to us after specified periods, we may realize a loss for one to two billing periods until we can terminate these customers’ contracts. We may also realize a loss on fixed-price customers in this scenario due to the fact that we will have already fully hedged the customer’s expected commodity usage for the life of the contract. Even if we terminate service to customers who fail to pay their bill, we remain liable to our suppliers of natural gas and electricity for the cost of those commodities. Furthermore, in the Texas market, we are responsible for billing the distribution charges for the local regulated utility and are at risk for these charges, in addition to the cost of the commodity, in the event customers fail to pay their bills. Changing economic factors, such as rising unemployment rates and energy prices also result in a higher risk of customers being unable to pay their bills when due.

The failure of our customers to pay their bills or our failure to maintain adequate billing and collection procedures could adversely affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

We are subject to credit, operational and financial risks related to certain local regulated utilities that provide billing services and guarantee the customer receivables for their markets.

In POR markets, we rely on the local regulated utility to purchase our customer accounts receivable and to perform timely and accurate billing. POR markets represented approximately 47% of our retail revenues for the

 

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year ended December 31, 2013. As our business grows, the portion of customers we serve in POR markets could increase. The bankruptcy of a local regulated utility could result in a default in such local regulated utility’s payment obligations to us, or efforts to reject contracts for service that they have with us if they believe there is a high value alternative opportunity.

In POR markets where local regulated utilities purchase our receivables and in certain other markets, local regulated utilities are responsible for billing services. Local regulated utilities that provide billing services rely on us for accurate and timely communication of contract rates and other information necessary for accurate billing to customers. The number of territories within which we provide natural gas and electricity supply poses a constant challenge that demands considerable management, personnel and information system resources. Each territory requires unique and often varied electronic data interface systems. Rules that govern the exchange of data may be changed by the local regulated utilities. In certain instances, we must rely on manual processes and procedures to communicate data to local regulated utilities for inclusion in customer bills. In addition, some utilities may experience difficulty in providing accurate, timely data when changing metering equipment (e.g., from manually-read to telemetry). Failure to provide accurate data to local regulated utilities on a timely basis could result in underpayment or nonpayment by our customers, and therefore adversely affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our indebtedness could adversely affect our ability to raise additional capital to fund our operations or pay dividends. It could also expose us to the risk of increased interest rates and limit our ability to react to changes in the economy or our industry as well as impact our cash available for distribution.

In connection with the closing of the offering, we expect to enter into a new $70.0 million senior secured revolving credit facility, which we refer to as our new revolving credit facility. We expect to have approximately $10.0 million of indebtedness outstanding under our new revolving credit facility and approximately $15.0 million in issued letters of credit following this offering. Any debt we incur under our new revolving credit facility or otherwise could have important negative consequences on our financial condition, including:

 

  increasing our vulnerability to general economic and industry conditions;

 

  requiring cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to pay dividends to holders of our Class A common stock or to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

  limiting our ability to fund operations or future acquisitions;

 

  restricting our ability to make certain distributions with respect to our capital stock and the ability of our subsidiaries to make certain distributions to us, in light of restricted payment and other financial covenants, including requirements to maintain certain financial ratios, in our credit facilities and other financing agreements;

 

  exposing us to the risk of increased interest rates because borrowings under our new revolving credit facility will be at variable rates of interest; and

 

  limiting our ability to obtain additional financing for working capital including collateral postings, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes.

Our new revolving credit facility will contain financial and other restrictive covenants that may limit our ability to return capital to stockholders or otherwise engage in activities that may be in our long-term best interests. Our inability to satisfy certain financial covenants could prevent us from paying cash dividends, and our failure to comply with those and other covenants could result in an event of default which, if not cured or waived, may entitle the lenders to demand repayment or enforce their security interests, which could negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

 

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We depend on the accuracy of data in our billing systems. Inaccurate data could have a negative impact on our results of operations, financial condition, cash flows and reputation with customers and/or regulators.

We depend on the accuracy and timeliness of customer billing, collections and consumption information in our information systems. We rely on many internal and external sources for this information, including:

 

  our internal marketing, pricing and customer operations functions; and

 

  various local regulated utilities and independent system operators (“ISOs”) for volume or meter read information, certain billing rates and billing types (e.g., budget billing) and other fees and expenses.

Inaccurate or untimely information, which may be outside of our direct control, could result in:

 

  inaccurate and/or untimely bills sent to customers;

 

  inaccurate accounting and reporting of customer revenues, gross margin and accounts receivable activity;

 

  inaccurate measurement of usage rates, throughput and imbalances;

 

  customer complaints; and

 

  increased regulatory scrutiny.

We may become liable for incorrectly calculating taxes, and certain of our charges may become uncollectable due to billing errors. Although customers are responsible for the payment of taxes related to the sales of natural gas and electricity, we estimate the amount of taxes they owe and invoice our customers through our billing process. We subsequently remit those taxes to the relevant taxing authorities. If we were to later determine that the amount we billed them for taxes was insufficient, we would not be able to recover the difference from them and would ultimately be responsible for those costs. Additionally, some of the markets in which we operate require us to bill customers within a specific period of time. If we do not bill our customer within that period of time, the customer may not be obligated to pay us.

Regulations in the restructured markets in which we operate require that meter reading be performed by the local regulated utility; and we are required to rely on the local regulated utility to provide us with our customers’ information regarding energy usage. Our inability to obtain this usage information or confirm information received from the utilities could negatively impact our billing systems and reputation with customers and, therefore, our financial results and our ability to pay dividends to the holders of our Class A common stock.

Information management systems could prove unreliable.

We operate in a high volume business with an extensive array of data interchanges and market requirements. We are highly dependent on our information management systems to track, monitor and correct or otherwise verify a high volume of data to ensure the reported financial results and our forecasting efforts are accurate. Our information management systems are designed to help us forecast new customer enrollments and their energy requirements, which helps ensure that we are able to supply new customers estimated average energy requirements without exposing us to excessive commodity price risk.

We may be subject to disruptions in our information flow arising out of events beyond our control, such as natural disasters, epidemics, failures in hardware or software, power fluctuations, telecommunications and other similar disruptions. In addition, our information management systems may be vulnerable to computer viruses, incursions by intruders or hackers and cyber terrorists and other similar disruptions. The failure of our information management systems to perform as anticipated for any reason or any significant breach of security could disrupt our business and result in numerous adverse consequences, including reduced effectiveness and efficiency of our

 

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operations, inappropriate disclosure of confidential information and increased overhead costs, all of which could impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

We depend on local transportation and transmission facilities of third parties to supply our customers. Our financial results may be adversely impacted if transportation and transmission availability is limited or unreliable.

We depend on transportation and transmission facilities owned and operated by local regulated utilities and other energy companies to deliver the natural gas and electricity we sell to customers. Under the regulatory structures adopted in most jurisdictions, we are required to enter into agreements with regulated local regulated utilities for use of the local distribution systems and to establish functional data interfaces necessary to serve our customers. Any delay in the negotiation of such agreements or inability to enter into reasonable agreements could delay or negatively impact our ability to serve customers in those jurisdictions. Additionally, failure to coordinate upstream and downstream receipts and deliveries on an energy transportation network can result in significant penalties. Any of these factors could have an adverse impact on our financial results and our ability to pay dividends to the holders of our Class A common stock.

We also depend on local regulated utilities for maintenance of the infrastructure through which we deliver natural gas and electricity to our customers. We are unable to control the level of service the utilities provide to our customers, including the timeliness and effectiveness of upkeep and repairs to infrastructure. Any infrastructure failure that interrupts or impairs delivery of electricity or natural gas to our customers could cause customer dissatisfaction, which could adversely affect our business. If transportation or transmission/distribution is disrupted, or if transportation or transmission/distribution capacity is inadequate, our ability to sell and deliver products may be hindered. Such disruptions could also hinder our providing electricity or natural gas to our customers and adversely impact our risk management policies, hedge contracts, our financial results and our ability to pay dividends to the holders of our Class A common stock.

In addition, the power generation and transmission/distribution infrastructure in the United States is very complex. Maintaining reliability of the infrastructure requires appropriate oversight by regulatory agencies, careful planning and design, trained and skilled operators, sophisticated information technology and communication systems, ongoing monitoring and, where necessary, improvements to various components of the infrastructure, including with regard to security. Major electric power blackouts are possible, which could disrupt electrical service for extended periods of time to large geographic regions of the United States. If such a major blackout were to occur, we may be unable to deliver electricity to our customers in the affected region, which would have an adverse impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

The adoption of derivatives legislation by Congress will continue to have an adverse impact on our ability to hedge risks associated with our business.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), enacted on July 21, 2010, established federal oversight and regulation of the over-the-counter derivatives market and entities, such as us, that participate in that market. Although we qualify for the end-user exception to the mandatory clearing requirements for swaps to hedge our commercial risks, the application of the mandatory clearing and trade execution requirements to other market participants, such as swap dealers, has changed the cost and availability of the swaps that we use for hedging. In addition, the Act requires that regulators establish margin rules for uncleared swaps. CFTC Rules that require end users to post initial or variation margin impact liquidity and reduce cash available to us.

The full impact of the Act and related regulatory requirements upon our business will not be known until the regulations are implemented and the market for derivatives contracts has adjusted. The Act and any new

 

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regulations could significantly increase the cost of derivative transactions, materially alter the terms of derivative contracts, reduce the availability of derivatives to protect against risks that we encounter, reduce our ability to monetize or restructure our existing derivative contracts or increase our exposure to less creditworthy counterparties. If we reduce our use of derivatives as a result of the Act and related regulations, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Any of these consequences could have a material adverse effect our financial results and our ability to pay dividends to the holders of our Class A common stock.

We may not be able to manage our growth successfully, which could strain our liquidity and other resources and lead to poor customer satisfaction with our services.

The growth of our operations will depend upon our ability to expand our customer base in our existing markets and to enter new markets in a timely manner at reasonable costs. As we expand our operations, we may encounter difficulties implementing new product offerings or integrating new customers and employees as well as any legacy systems of acquired entities.

We may experience difficulty managing the growth of a portfolio of customers that is diverse with respect to the types of service offerings, applicable market rules and the infrastructure for product delivery. We also may experience difficulty integrating an acquired company’s personnel and operations, or key personnel of the acquired company may decide not to work for us. Furthermore, if we acquire the residential or commercial businesses of an incumbent local regulated utility or other energy provider in a particular market, the customers of that business may not be under any obligation to use our services. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our cash flows.

Expanding our operations could result in increased liquidity needs to support working capital for the purchase of natural gas and electricity supply to meet our customers’ needs, for the credit requirements of forward physical supply and for generally higher operating expenses. Expanding our operations also may require continued development of our operating and financial controls and may place additional stress on our management and operational resources. If we are unable to manage our growth and development successfully, this could affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our success depends on key members of our management, the loss of whom could disrupt our business operations.

We depend on the continued employment and performance of key management personnel. A number of our senior executives have substantial experience in consumer and energy markets that have undergone regulatory restructuring and have extensive risk management and hedging expertise. We believe their experience is important to our continued success. We do not maintain key life insurance policies for our executive officers. If our key executives do not continue in their present roles and are not adequately replaced, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

We rely on a capable, well-trained workforce to operate effectively. Retention of employees with strong industry or operational knowledge is essential to our ongoing success.

Many of the employee positions within our customer operations, energy supply, information systems, pricing, marketing, risk management and finance functions require extensive industry, operational, regulatory or financial experience or skills that may not be easily replaced if an employee were to leave employment with us. While some normal employee turnover is expected, high turnover could strain our ability to manage our ongoing operations as well as inhibit organic and acquisition growth.

 

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We rely on a third party vendor for our customer billing and transactions platform which exposes us to third party performance risk.

We have outsourced our back office customer billing and transactions functions to a third party, and we rely heavily on the continued performance of that vendor under the outsourcing agreement. Failure of our vendor to operate in accordance with the terms of the outsourcing agreement or the vendor’s bankruptcy or other event that prevents it from performing under our outsourcing agreement could have a material adverse effect on our financial results and our ability to pay dividends to the holders of our Class A common stock.

The failures or questionable activities of various local regulated utilities and other retail marketers within the markets that we serve adversely impact us.

A general positive perception on the part of customers and regulators of utilities and retail energy providers in general, and of us in particular, is essential for our continued growth and success. Questionable pricing, billing, collections, marketing or customer service practices on the part of any utility or retail marketer, or unsuccessful implementation of competitive energy programs can damage the reputation of all market participants, which could result in lower customer renewals and impact our ability to sign-on new customers. Any utility or retail marketer that defaults on its obligations to its customers, suppliers, lenders, hedge counterparties, or employees can have similar impacts on the retail energy industry as a whole and on our operations in particular. Any of these factors could affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

A large portion of our current customers are concentrated in a limited number of states, making us vulnerable to customer concentration risks.

As of May 31, 2014, approximately 86% of our customers were located in five states. Specifically, 29%, 28%, 13%, 11% and 5% of our customers were located in Illinois, California, Texas, New York and Pennsylvania, respectively. If we are unable to increase our market share across other competitive markets or enter into new competitive markets effectively, we may be subject to continued or greater customer concentration risk. In addition, if any of the states that contain a large percentage of our customers were to reverse regulatory restructuring or change the regulatory environment in a manner that causes us to be unable to economically operate in that state, our financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

Increases in state renewable portfolio standards or an increase in the cost of renewable energy credit and carbon offsets may adversely impact the price, availability and marketability of our products.

Pursuant to state renewable portfolio standards, we must purchase a specified amount of renewable energy credits, or RECs, based on the amount of electricity we sell in a state in a year. In addition, we have contracts with certain customers which require us to purchase RECs or carbon offsets. If a state increases its renewable portfolio standards, the demand for RECs within that state will increase and therefore the market price for RECs could increase. We attempt to forecast the price for the required RECs and carbon offsets at the end of each month and incorporate this forecast into our customer pricing models, but the price paid for RECs and carbon offsets may be higher than forecasted. We may be unable to fully pass the higher cost of RECs through to our customers, and increases in the price of RECs may decrease our results of operations and affect our ability to compete with other energy retailers that have not contracted with customers to purchase RECs or carbon offsets. Further, a price increase for RECs or carbon offsets may require us to decrease the renewable portion of our energy products, which may result in a loss of customers. A further reduction in benefits received by local regulated utilities from production tax credits in respect of renewable energy may adversely impact the availability to us, and marketability

 

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by us, of renewable energy under our brands. Accordingly, such decrease may result in reduced revenue and may negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

The suppliers from which we purchase our natural gas and electricity are subject to environmental laws and regulations that impose extensive and increasingly stringent requirements on their operations.

The assets of the suppliers from which we purchase natural gas and electricity are subject to numerous and significant federal, state and local laws, including statutes, regulations, guidelines, policies, directives and other requirements governing or relating to, among other things: protection of wildlife, including threatened and endangered species; air emissions; discharges into water; water use; the storage, handling, use, transportation and distribution of dangerous goods and hazardous, residual and other regulated materials, such as chemicals; the prevention of releases of hazardous materials into the environment; the prevention, presence and remediation of hazardous materials in soil and groundwater, both on and offsite; land use and zoning matters; and workers’ health and safety matters. Environmental laws and regulations have generally become more stringent over time. Significant costs may be incurred for capital expenditures under environmental programs to keep the assets compliant with such environmental laws and regulations, which could have a material adverse impact on the businesses of our producers, which may increase the prices they charge us for natural gas and electricity and have a material adverse effect on our financial results and our ability to pay dividends to the holders of our Class A common stock.

Technological improvements and changing consumer preferences could reduce demand and alter consumption patterns.

Technological improvements in energy efficiency could potentially reduce the overall demand for natural gas and electricity. Additionally, increased competitiveness of alternative energy sources or consumer preferences that alter fuel choices could potentially reduce the demand for natural gas and electricity. A prolonged decrease in demand for natural gas and electricity in the retail energy markets would adversely affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

We employ independent contractors to broker sales for which they receive residual commissions. The residual commissions paid to independent contractors could adversely affect our operating margins and financial performance, particularly if our costs rise and we do not adjust our pricing strategy.

Some of our independent contractors earn ongoing residual commissions. Residual commissions are calculated based on a fixed percentage of revenues attributable to a customer’s energy consumption, without regard to our wholesale supply costs. Should our supply costs rise, our operating margins, financial results and our ability to pay dividends to the holders of our Class A common stock could be adversely affected.

Our access to marketing channels may be contingent upon the viability of our telemarketing and door-to-door agreements with our vendors.

Our vendors are essential to our telemarketing and door-to-door sales activities. Our ability to increase revenues in the future will depend significantly on our access to high quality vendors. If we are unable to attract new vendors and retain existing vendors to achieve our marketing targets, our growth may be materially reduced. There can be no assurance that competitive conditions will allow these vendors and their independent contractors to continue to successfully sign up new customers. Further, if our products are not attractive to, or do not generate sufficient revenue for, our vendors, we may lose our existing relationships, which would have a material adverse effect on our business, revenues, results of operations and financial condition, as well as our ability to pay dividends to the holders of our Class A common stock. In addition, the decline in landlines reduces the number of potential

 

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customers that may be reached by our telemarketing efforts and as a result our telemarketing sales channel may become less viable, which may materially impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our vendors may expose us to risks.

We are subject to reputational risks that may arise from the actions of our vendors and their independent contractors that are wholly or partially beyond our control, such as violations of our marketing policies and procedures as well as any failure to comply with applicable laws and regulations. If our vendors engage in marketing practices that are not in compliance with local laws and regulations, we may be in breach of applicable laws and regulations which may result in regulatory proceeding, disadvantageous conditioning of our energy retailer license, or the revocation of our energy retailer license, which would materially impact our financial results and our ability to pay dividends to the holders of our Class A common stock. In addition, the independent contractors of our vendors may consider us to be their employer and seek compensation.

Risks Related to the Offering and our Class A Common Stock

We expect to have shortfalls of cash available for distribution from operating cash flows in certain quarters during the four quarters following the closing of the offering, and we may not be able to continue paying our targeted quarterly dividend to the holders of our Class A common stock in the future.

The amount of our cash available for distribution principally depends upon the amount of cash we generate from our operations, which will fluctuate from quarter to quarter based on, among other things:

 

  changes in commodity prices, which may be driven by a variety of factors, including, but not limited to, weather conditions, seasonality and demand for energy commodities and general economic conditions;

 

  the level and timing of customer acquisition costs we incur;

 

  the level of our operating and general and administrative expenses;

 

  seasonal variations in revenues generated by our business;

 

  our debt service requirements and other liabilities;

 

  fluctuations in our working capital needs;

 

  our ability to borrow funds and access capital markets;

 

  restrictions contained in our debt agreements (including our new revolving credit facility);

 

  abrupt changes in regulatory policies; and

 

  other business risks affecting our cash flows.

As a result of these and other factors, we cannot guarantee that we will have sufficient cash generated from operations to pay a specific level of cash dividends to holders of our Class A common stock.

Consistent with our forecast, due to the seasonality of our retail natural gas business, we expect to generate the substantial majority of our cash available for distribution in the first and fourth quarters of each year. In addition, we anticipate continuing to incur increased customer acquisition costs over the first nine months of 2014, which is consistent with our growth strategy. As a result of seasonality and our increased customer acquisition costs, we may not have sufficient cash available for distribution from the third quarter of 2014 to cover the pro-rated quarterly dividend for that period (calculated from the closing date of this offering through and including September 30, 2014). For a summary of historical unaudited pro forma cash available for distribution and estimated cash available for distribution, including pro forma historical and anticipated shortfalls, please read “Cash Dividend Policy” under “—Unaudited Pro Forma Cash Available for Distribution for the Year Ended December 31, 2013,” “—Estimated Cash Available for Distribution for the Twelve Months Ending June 30, 2015” and “—General Considerations and Risks—Cash Available for Distribution for the Third Quarter of 2014.”

 

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Furthermore, holders of our Class A common stock should be aware that the amount of cash available for distribution depends primarily on our cash flow, and is not solely a function of profitability, which is affected by non-cash items. We may incur other expenses or liabilities during a period that could significantly reduce or eliminate our cash available for distribution and, in turn, impair our ability to pay dividends to holders of our Class A common stock during the period. Because we are a holding company, our ability to pay dividends on our Class A common stock is limited by restrictions on the ability of our subsidiaries to pay dividends or make other distributions to us. We will be entitled to pay cash dividends to the holders of the Class A common stock and Spark HoldCo will be entitled to make cash distributions to NuDevco and us so long as: (a) no default exists or would result from such a payment; (b) Spark HoldCo, SE and SEG are in pro forma compliance with all financial covenants before and after giving effect to such payment and (c) the outstanding amount of all loans and letters of credit does not exceed borrowing base limits. Finally, dividends to holders of our Class A common stock will be paid at the discretion of our board of directors. Our board of directors may decrease the level of or entirely discontinue payment of dividends. For a description of additional restrictions and factors that may affect our ability to pay cash dividends, please see “Cash Dividend Policy.”

The assumptions underlying the forecast presented elsewhere in this prospectus are inherently uncertain and subject to significant business, economic, financial, regulatory and competitive risks that could cause our actual cash available for dividends to differ materially from our forecast.

The forecast presented elsewhere in this prospectus is based on our current business operations and was prepared using assumptions that our management believes are reasonable. See “Cash Dividend Policy—Significant Forecast Assumptions.” These include assumptions regarding our customer acquisition strategy, the seasonality of our business, the effectiveness of our hedging program, our natural gas and electricity revenues, our operating costs and expenses, interest expense, our asset optimization activities, income tax expense and regulatory, industry and economic factors. The forecast assumes that no unexpected risks will materialize during the forecast period. Any one or more of these assumptions may prove to be incorrect, in which case our actual results of operations will be different from, and possibly materially worse than, those contemplated by the forecast. There can be no assurance that the assumptions underlying the forecast presented elsewhere in this prospectus will prove to be accurate. Actual results for the forecast period will likely vary from the forecasted results and those variations may be material. We make no representation that actual results achieved in the forecast period will be the same, in whole or in part, as those forecasted herein or that we will be able to pay dividends on our targeted levels or at all.

We are a holding company. Our sole material asset after completion of this offering will be our equity interest in Spark HoldCo and we are accordingly dependent upon distributions from Spark HoldCo to pay dividends, pay taxes, make payments under the Tax Receivable Agreement and cover our corporate and other overhead expenses under the Spark HoldCo LLC Agreement.

We are a holding company and will have no material assets other than our equity interest in Spark HoldCo. Please see “Corporate Reorganization.” We have no independent means of generating revenue. The Spark HoldCo LLC Agreement provides, to the extent Spark HoldCo has available cash and is not prevented by restrictions in any of its credit agreements, for distributions pro rata to its unitholders, including us, such that we receive an amount of cash sufficient to pay the estimated taxes payable by us, the targeted quarterly dividend we intend to pay holders of our Class A common stock, and payments under the Tax Receivable Agreement we will enter into with Spark HoldCo, NuDevco Retail Holdings and NuDevco Retail. In addition, Spark HoldCo will pay for our corporate and other overhead expenses pursuant to the Spark HoldCo LLC Agreement. To the extent that we need funds and Spark HoldCo or its subsidiaries are restricted from making such distributions under applicable law or regulation or under the terms of their financing arrangements, or are otherwise unable to provide such funds, it could materially adversely affect our financial results and our ability to pay dividends to the holders of our Class A common stock.

 

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Market interest rates may have an effect on the value of our Class A common stock.

One of the factors that will influence the price of shares of our Class A common stock will be the effective dividend yield of such shares (i.e., the yield as a percentage of the then market price of our shares) relative to market interest rates. An increase in market interest rates, which are currently at low levels relative to historical rates, may lead prospective purchasers of shares of our Class A common stock to expect a higher dividend yield, and our inability to increase our dividend as a result of an increase in borrowing costs, insufficient cash available for distribution or otherwise, could result in selling pressure on, and a decrease in the market price of, our Class A common stock as investors seek alternative investments with higher yield.

The initial public offering price of our Class A common stock may not be indicative of the market price of our Class A common stock after this offering. In addition, an active, liquid and orderly trading market for our Class A common stock may not develop or be maintained, and our stock price may be volatile.

Prior to this offering, our Class A common stock was not traded in any market. An active, liquid and orderly trading market for our Class A common stock may not develop or be maintained after this offering. Active, liquid and orderly trading markets usually result in less price volatility and more efficiency in carrying out investors’ purchase and sale orders. The market price of our Class A common stock could vary significantly as a result of a number of factors, some of which are beyond our control. In the event of a drop in the market price of our Class A common stock, you could lose a substantial part or all of your investment in our Class A common stock. The initial public offering price will be negotiated between us and the representatives of the underwriters, based on numerous factors which we discuss in “Underwriting,” and may not be indicative of the market price of our Class A common stock after this offering. Consequently, you may not be able to sell shares of our Class A common stock at prices equal to or greater than the price paid by you in this offering.

The following factors could affect our stock price:

 

  our operating and financial performance and changes in our per share distribution levels;

 

  our retail gross margin and our asset optimization activities;

 

  quarterly variations in the rate of growth of our financial indicators, such as net income per share, net income and revenues;

 

  the public reaction to our press releases, our other public announcements and our filings with the SEC;

 

  strategic actions by our competitors;

 

  changes in revenue or earnings estimates, or changes in recommendations or withdrawal of research coverage, by equity research analysts;

 

  speculation in the press or investment community;

 

  the failure of research analysts to cover our Class A common stock;

 

  sales of our Class A common stock by us, our stockholders, or the perception that such sales may occur;

 

  changes in accounting principles, policies, guidance, interpretations or standards;

 

  additions or departures of key management personnel;

 

  actions by our stockholders;

 

  general market conditions, including fluctuations in commodity prices;

 

  domestic and international economic, legal and regulatory factors unrelated to our performance; and

 

  the realization of any risks described in this prospectus, including under this “Risk Factors” section.

The stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our Class A common stock. Securities class action litigation has often been instituted against companies following

 

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periods of volatility in the overall market and in the market price of a company’s securities. Such litigation, if instituted against us, could result in very substantial costs, divert our management’s attention and resources and negatively impact our financial results and our ability to pay dividends to the holders of our Class A common stock.

Our principal shareholder will collectively hold a substantial majority of the voting power of our common stock.

Holders of Class A common stock and Class B common stock will vote together as a single class on all matters presented to our stockholders for their vote or approval, except as otherwise required by applicable law or our certificate of incorporation and bylaws. Upon completion of this offering (assuming no exercise of the underwriters’ option to purchase additional shares), NuDevco will own all of our Class B common stock (representing 78.18% of our combined voting power).

NuDevco is entitled to act separately in its own interest with respect to its investment in us. NuDevco will have the ability to elect all of the members of our board of directors, and thereby to control our management and affairs. In addition, NuDevco will be able to determine the outcome of all matters requiring shareholder approval, including mergers and other material transactions, and will be able to cause or prevent a change in the composition of our board of directors or a change in control of our company that could deprive our stockholders of an opportunity to receive a premium for their Class A common stock as part of a sale of our company. The existence of a significant shareholder may also have the effect of deterring hostile takeovers, delaying or preventing changes in control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in the best interests of our company.

So long as NuDevco continues to control a significant amount of our common stock, it will continue to be able to strongly influence all matters requiring shareholder approval, regardless of whether other stockholders believe that a potential transaction is in their own best interests. In any of these matters, the interests of NuDevco may differ or conflict with the interests of our other stockholders. Moreover, this concentration of stock ownership may also adversely affect the trading price of our Class A common stock to the extent investors perceive a disadvantage in owning stock of a company with a controlling shareholder.

We will be a “controlled company” under NASDAQ Global Select Market rules, and as such we are entitled to an exemption from certain corporate governance standards of the NASDAQ Global Select Market, and you may not have the same protections afforded to shareholders of companies that are subject to all of the NASDAQ Global Select Market corporate governance requirements.

We will qualify as a “controlled company” within the meaning of Nasdaq Global Select Market corporate governance standards because NuDevco will control more than 50% of our voting power following this offering. Under NASDAQ Global Select Market rules, a company of which more than 50% of the voting power is held by an individual, a group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including (i) the requirement that a majority of the board of directors consist of independent directors, (ii) the requirement to have a nominating/corporate governance committee composed entirely of independent directors and a written charter addressing the committee’s purpose and responsibilities, (iii) the requirement to have a compensation committee composed entirely of independent directors and a written charter addressing the committee’s purpose and responsibilities and (iv) the requirement of an annual performance evaluation of the nominating/corporate governance and compensation committees.

In light of our status as a controlled company, our board of directors has determined to take partial advantage of the controlled company exemption. Our board of directors has determined not to have a nominating and corporate governance committee and that our compensation committee will not consist entirely of independent directors. As

 

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a result, non-independent directors may among other things, appoint future members of our board of directors, resolve corporate governance issues, establish salaries, incentives and other forms of compensation for officers and other employees and administer our incentive compensation and benefit plans.

Accordingly, in the future, you may not have the same protections afforded to shareholders of companies that are subject to all of NASDAQ Global Select Market corporate governance requirements. For a description of our expected corporate governance practices, please see “Management—Controlled Company.”

We have engaged in transactions with our affiliates and expect to do so in the future. The terms of such transactions and the resolution of any conflicts that may arise may not always be in our or our stockholders’ best interests.

We have engaged in transactions and expect to continue to engage in transactions with affiliated companies, as described under the caption “Certain Relationships and Related Party Transactions.” We will continue to enter into back-to-back transactions for the sale of natural gas from an affiliate. We will also continue to pay certain expenses on behalf of several of our affiliates for which we will seek reimbursement. We will also continue to share our corporate headquarters with certain affiliates. We cannot assure that our affiliates will reimburse us for the costs we have incurred on their behalf or perform their obligations under any of these contracts.

Our amended and restated certificate of incorporation and amended and restated bylaws, as well as Delaware law, contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of our Class A common stock.

Our amended and restated certificate of incorporation authorizes our board of directors to issue preferred stock without shareholder approval. If our board of directors elects to issue preferred stock, it could be more difficult for a third party to acquire us.

In addition, some provisions of our amended and restated certificate of incorporation and amended and restated bylaws could make it more difficult for a third party to acquire control of us, even if the change of control would be beneficial to our stockholders. Among other things, our amended and restated certificate of incorporation and amended and restated bylaws will:

 

  provide for our board of directors to be divided into three classes of directors, with each class as nearly equal in number as possible, serving staggered three year terms. Our staggered board may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of us, because it generally makes it more difficult for shareholders to replace a majority of the directors;

 

  provide that the authorized number of directors may be changed only by resolution of the board of directors;

 

  provide that all vacancies in our board, including newly created directorships, may, except as otherwise required by law or, if applicable, the rights of holders of a series of preferred stock, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;

 

  provide our board of directors the ability to authorize undesignated preferred stock. This ability makes it possible for our board of directors to issue, without shareholder approval, preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of us. These and other provisions may have the effect of deferring hostile takeovers or delaying changes in control or management of our company;

 

 

provide that at any time after the first date upon which W. Keith Maxwell II no longer beneficially owns more than fifty percent of the outstanding Class A common stock and Class B common stock, any action required or permitted to be taken by the shareholders must be effected at a duly called annual or special

 

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  meeting of shareholders and may not be effected by any consent in writing in lieu of a meeting of such shareholders, subject to the rights of the holders of any series of preferred stock with respect to such series (prior to such time, such actions may be taken without a meeting by written consent of holders of the outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting);

 

  provide that at any time after the first date upon which W. Keith Maxwell II no longer beneficially owns more than fifty percent of the outstanding Class A common stock and Class B common stock, special meetings of our shareholders may only be called by the board of directors, the chief executive officer or the chairman of the board (prior to such time, special meetings may also be called by our Secretary at the request of holders of record of fifty percent of the outstanding Class A common stock and Class B common stock);

 

  provide that our amended and restated certificate of incorporation and amended and restated bylaws may be amended by the affirmative vote of the holders of at least two-thirds of our outstanding stock entitled to vote thereon;

 

  provide that our amended and restated bylaws can be amended by the board of directors; and

 

  establish advance notice procedures with regard to shareholder proposals relating to the nomination of candidates for election as directors or new business to be brought before meetings of our shareholders. These procedures provide that notice of shareholder proposals must be timely given in writing to our corporate secretary prior to the meeting at which the action is to be taken. These requirements may preclude shareholders from bringing matters before the shareholders at an annual or special meeting.

In addition, in our amended and restated certificate of incorporation, we have elected not to be subject to the provisions of Section 203 of the Delaware General Corporation Law (the “DGCL”) regulating corporate takeovers until the date on which W. Keith Maxwell III no longer beneficially owns in the aggregate more than fifteen percent of the outstanding Class A common stock and Class B common stock. On and after such date, we will be subject to the provisions of Section 203 of the DGCL.

In addition, certain change of control events have the effect of accelerating the payment due under our Tax Receivable Agreement, which could be substantial and accordingly serve as a disincentive to a potential acquirer of our company. Please see “Certain Relationships and Related Party Transactions—Tax Receivable Agreement.”

Our amended and restated certificate of incorporation will designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents.

Our amended and restated certificate of incorporation will provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees or agents to us or our stockholders, (iii) any action asserting a claim against us or any director or officer or other employee of ours arising pursuant to any provision of the DGCL, our amended and restated certificate of incorporation or our bylaws, or (iv) any action asserting a claim against us or any director or officer or other employee of ours that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our amended and restated certificate of incorporation described in the

 

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preceding sentence. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our amended and restated certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations.

Future sales of our Class A common stock in the public market could reduce our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us.

Subject to certain limitations and exceptions, NuDevco may exchange its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock (on a one-for-one basis, subject to conversion rate adjustments for stock splits, stock dividends and reclassification and other similar transactions) and then sell those shares of Class A common stock. Additionally, we may issue additional shares of Class A common stock or convertible securities in subsequent public offerings. After the completion of this offering, we will have 3,000,000 outstanding shares of Class A common stock, and 10,750,000 outstanding shares of Class B common stock. Following the completion of this offering, NuDevco will own 10,750,000 shares of Class B common stock, representing approximately 78.18% (or 10,300,000 shares of Class B common stock, representing approximately 74.91% if the underwriters’ option to purchase additional shares is of our total outstanding common stock exercised in full). All such shares are restricted from immediate resale under the federal securities laws and are subject to the lock-up agreements between such parties and the underwriters described in “Underwriting,” but may be sold into the market in the future. We expect that NuDevco Retail Holdings and NuDevco Retail will each be party to a registration rights agreement with us that will require us to effect the registration of their shares in certain circumstances no earlier than the expiration of the lock-up period contained in the underwriting agreement entered into in connection with this offering. Employees will be subject to certain restrictions on the sale of their shares for 180 days after the date of this prospectus; however, after such period, and subject to compliance with the Securities Act or exemptions therefrom, these employees may sell such shares into the public market. See “Shares Eligible for Future Sale” and “Certain Relationships and Related Party Transactions—Registration Rights Agreement.”

In connection with this offering, we intend to file a registration statement with the SEC on Form S-8 providing for the registration of 1,375,000 shares of our Class A common stock issued or reserved for issuance under our equity incentive plan. Subject to the satisfaction of vesting conditions and the expiration of lock-up agreements, shares registered under the registration statement on Form S-8 will be available for resale immediately in the public market without restriction.

We cannot predict the size of future issuances of our Class A common stock or securities convertible into Class A common stock or the effect, if any, that future issuances or sales of shares of our Class A common stock will have on the market price of our Class A common stock. Sales of substantial amounts of our Class A common stock (including shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices of our Class A common stock. Our amended and restated certificate of incorporation allows us to issue up to an additional 186,250,000 shares of equity securities, including securities ranking senior to our Class A common stock.

 

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The underwriters of this offering may waive or release parties to the lock-up agreements entered into in connection with this offering, which could adversely affect the price of our Class A common stock.

Our directors and executive officers have entered into lock-up agreements with respect to their Class A common stock, pursuant to which they are subject to certain resale restrictions for a period of 180 days following the effective date of the registration statement of which this prospectus forms a part. Please see “Underwriting.” Robert W. Baird & Co. Incorporated at any time and without notice, may release all or any portion of the Class A common stock subject to the foregoing lock-up agreements. If the restrictions under the lock-up agreements are waived, then Class A common stock will be available for sale into the public markets, which could cause the market price of our Class A common stock to decline and impair our ability to raise capital.

We will be required to make payments under the Tax Receivable Agreement for certain tax benefits we may claim, and the amounts of such payments could be significant.

We will enter into a Tax Receivable Agreement with Spark HoldCo, NuDevco Retail Holdings and NuDevco Retail. This agreement will generally provide for the payment by us to NuDevco of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that we actually realize (or are deemed to realize in certain circumstances) in periods after this offering as a result of (i) any tax basis increase resulting from the purchase by Spark Energy, Inc. of Spark HoldCo units from NuDevco Retail Holdings prior to or in connection with this offering, (ii) any tax basis increases resulting from the exchange of Spark HoldCo units for shares of Class A common stock pursuant to the Exchange Right (or resulting from an exchange of Spark HoldCo units for cash pursuant to the Cash Option) and (iii) imputed interest deemed to be paid by us as a result of, and additional tax basis arising from, any payments we make under the Tax Receivable Agreement. In addition, payments we make under the Tax Receivable Agreement will be increased by any interest accrued from the due date (without extensions) of the corresponding tax return.

Spark Energy, Inc. may be required to defer or partially defer any payment due to holders of rights under the Tax Receivable Agreement in certain circumstances during the five-year period commencing on October 1, 2014. Following the expiration of the five-year deferral period, Spark Energy, Inc. will be obligated to pay any outstanding deferred TRA Payments. While this payment obligation is subject to certain limitations described elsewhere in this prospectus, the obligation may nevertheless be significant and could adversely affect our liquidity and ability to pay dividends to the holders of our Class A common stock. See “Certain Relationships and Related Party Transactions—Tax Receivable Agreement.”

The payment obligations under the Tax Receivable Agreement are our obligations and not obligations of Spark HoldCo. For purposes of the Tax Receivable Agreement, cash savings in tax generally are calculated by comparing our actual tax liability to the amount we would have been required to pay had we not been able to utilize any of the tax benefits subject to the Tax Receivable Agreement. The term of the Tax Receivable Agreement will commence upon the completion of this offering and will continue until all such tax benefits have been utilized or expired, unless we exercise our right to terminate the Tax Receivable Agreement by making the termination payment specified in the agreement.

The actual increase in tax basis, as well as the amount and timing of any payments under the Tax Receivable Agreement, will vary depending upon a number of factors, including the timing of the exchanges of Spark HoldCo units, the price of Class A common stock at the time of each exchange, the extent to which such exchanges are taxable, the amount and timing of the taxable income we generate in the future and the tax rate then applicable, and the portion of our payments under the Tax Receivable Agreement constituting imputed interest or depletable, depreciable or amortizable basis. We expect that the payments that we will be required to make under the Tax Receivable Agreement could be substantial.

 

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The payments under the Tax Receivable Agreement will not be conditioned upon a holder of rights under the Tax Receivable Agreement having a continued ownership interest in either Spark HoldCo or us. See “Certain Relationships and Related Party Transactions—Tax Receivable Agreement.”

In certain cases, payments under the Tax Receivable Agreement may be accelerated and/or significantly exceed the actual benefits, if any, we realize in respect of the tax attributes subject to the Tax Receivable Agreement.

If we elect to terminate the Tax Receivable Agreement early or it is terminated early due to certain mergers or other changes of control, we would be required to make an immediate payment equal to the present value of the anticipated future tax benefits subject to the Tax Receivable Agreement, which calculation of anticipated future tax benefits will be based upon certain assumptions and deemed events set forth in the Tax Receivable Agreement, including the assumption that we have sufficient taxable income to fully utilize such benefits and that any Spark HoldCo units that NuDevco or its permitted transferees own on the termination date are deemed to be exchanged on the termination date. Any early termination payment may be made significantly in advance of the actual realization, if any, of such future benefits.

In these situations, our obligations under the Tax Receivable Agreement could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control due to the additional transaction cost a potential acquirer may attribute to satisfying such obligations. For example, if the Tax Receivable Agreement were terminated immediately after this offering, the estimated termination payment would be approximately $73.8 million (calculated using a discount rate equal to the LIBOR, plus 200 basis points). The foregoing number is merely an estimate and the actual payment could differ materially. There can be no assurance that we will be able to finance our obligations under the Tax Receivable Agreement.

Payments under the Tax Receivable Agreement will be based on the tax reporting positions that we will determine. The holders of rights under the Tax Receivable Agreement will not reimburse us for any payments previously made under the Tax Receivable Agreement if such basis increases or other benefits are subsequently disallowed, except that excess payments made to any such holder will be netted against payments otherwise to be made, if any, to such holder after our determination of such excess. As a result, in such circumstances, we could make payments that are greater than our actual cash tax savings, if any, and may not be able to recoup those payments, which could adversely affect our liquidity.

We may issue preferred stock whose terms could adversely affect the voting power or value of our Class A common stock.

Our certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations, preferences, limitations and relative rights, including preferences over our Class A common stock respecting dividends and distributions, as our board of directors may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our Class A common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of the Class A common stock.

 

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We will incur increased costs as a result of being a public company.

As a publicly traded company with listed equity securities, we will need to comply with new laws, regulations and requirements, including corporate governance provisions of the Sarbanes-Oxley Act of 2002, and rules and regulations of the SEC and the NASDAQ. Additional or new regulatory requirements may be adopted in the future. The requirements of existing and potential future rules and regulations will increase our legal, accounting and financial compliance costs, make some activities more difficult, time-consuming or costly and may also place undue strain on our personnel, systems and resources, which could adversely affect our business, financial condition and ability to pay dividends to the holders of our Class A common stock.

For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.

In April 2012, President Obama signed into law the JOBS Act. We are classified as an “emerging growth company” under the JOBS Act. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to, among other things, (i) provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act, (ii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, (iii) provide certain disclosure regarding executive compensation required of larger public companies or (iv) hold nonbinding advisory votes on executive compensation. We will remain an emerging growth company for up to five years, although we will lose that status sooner if we have more than $1.0 billion of revenues in a fiscal year, have more than $700 million in market value of our Class A common stock held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period.

To the extent that we rely on any of the exemptions available to emerging growth companies, you will receive less information about our executive compensation and internal control over financial reporting than issuers that are not emerging growth companies. If some investors find our common stock to be less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

As a result of becoming a public company, we will be obligated to design and operate proper and effective internal control over financial reporting and to report our financial results in a timely fashion. If our internal control over financial reporting is determined to be ineffective or we fail to meet financial reporting deadlines, investor confidence in our company, and our Class A common stock price, may be adversely affected.

We are not currently required to comply with the SEC’s rules that implement Section 404 of the Sarbanes-Oxley Act, and are therefore not yet required to make a formal assessment of the effectiveness of our internal control over financial reporting for that purpose. Upon becoming a public company, we will however be required to comply with certain of these rules, which will require management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of our internal control over financial reporting commencing with our second annual report. This assessment will need to include the disclosure of any material weakness in internal control over financial reporting identified by our management and our independent registered public accounting firm. A “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

 

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Also, as a private company, we have not previously been required to prepare quarterly financial statements, nor have we been required to generate financial statements in the time frames mandated for public companies by the Commission’s reporting requirements. We are currently evaluating our internal control over financial reporting for purposes of complying with our obligations as a public company.

Our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting until the end of the fiscal year after we are no longer an “emerging growth company” under the JOBS Act, which may be for up to five fiscal years after the completion of this offering.

Upon our further review and analysis of information related to our unaudited condensed interim combined financial statements as of and for the three months ended March 31, 2014, included in our previous Form S-1 as filed with the Securities and Exchange Commission, we identified errors in our retail revenues and retail cost of revenues due to inaccurate data and assumptions used in estimating the recorded amounts of retail sales, retail costs of revenues and related imbalances for the three months ended March 31, 2014. Our unaudited condensed interim combined financial statements as of and for the three-months ended March 31, 2014, included herein have been restated to correct the related errors. We also determined there is a material weakness in our internal control over financial reporting as of March 31, 2014 due to the lack of internal controls designed to ensure that estimated retail revenues, cost of revenues and related imbalances are based on complete and accurate data and assumptions on a timely basis. See Note 1 to our unaudited condensed interim combined financial statements beginning on page F-41.

We are implementing further controls to more precisely estimate and validate our recorded estimated retail revenues, retail cost of revenues and related imbalances in accordance with U.S. GAAP and on a timeline that ensures we can prepare our financial statements on a timely basis in compliance with reporting timelines under the Exchange Act, however, there is no guarantee that these controls will be effective. We also believe that we will need to expand our accounting resources, including the size and expertise of our internal accounting team, to effectively execute a quarterly close process on an appropriate time frame for a public company. In the event that our internal control over financial reporting is perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and the trading price of our Class A common stock could decline.

Our amended and restated certificate of incorporation limits the fiduciary duties of one of our directors and certain of our affiliates and restricts the remedies available to our stockholders for actions taken by Mr. Maxwell or certain of our affiliates that might otherwise constitute breaches of fiduciary duty.

Our amended and restated certificate of incorporation contains provisions that we renounce any interest in existing and future investments in other entities by, or the business opportunities of, NuDevco Partners, LLC, NuDevco Partners Holdings, LLC and W. Keith Maxwell III, or any of their officers, directors, agents, shareholders, members, affiliates and subsidiaries (other than a director or officer of the Company who is presented an opportunity solely in his capacity as a director or officer). Because of this provision, these persons and entities have no obligation to offer us those investments or opportunities that are offered to them in any capacity other than solely as an officer or director of the Company. If one of these persons or entities pursues a business opportunity instead of presenting the opportunity to the Company, we will not have any recourse against such person or entity for a breach of fiduciary duty.

 

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USE OF PROCEEDS

We expect the net proceeds from this offering to be approximately $52.3 million, assuming an initial public offering price of $20.00 per share of Class A common stock (the midpoint of the price range set forth on the cover page of this prospectus) and after deducting estimated underwriting discounts and commissions, structuring fees and estimated offering expenses of approximately $7.7 million, in the aggregate.

We intend to use net proceeds of this offering to acquire Spark HoldCo units representing approximately 21.82% of the outstanding Spark HoldCo units after this offering from NuDevco Retail Holdings and to repay the NuDevco Note. Accordingly, we will not retain any of the net proceeds from this offering. The NuDevco Note has an initial principal amount of $50,000, bears interest at a rate of 3.0% per annum, and was issued by us as consideration for NuDevco Retail Holdings’ transfer to us of 2,500 Spark HoldCo units as described in “Prospectus Summary—Corporate Reorganization.”

We have granted the underwriters a 30-day option to purchase up to an aggregate of 450,000 additional shares of our Class A common stock. If the underwriters exercise in full their option to purchase additional shares of Class A common stock from us, we estimate that the net proceeds will be approximately $60.7 million, after deducting underwriting discounts and commissions, structuring fees and estimated offering expenses.

If the underwriters exercise their option to purchase additional shares of Class A common stock, we intend to use the net proceeds from any exercise of such option to acquire an additional number Spark HoldCo units from NuDevco Retail Holdings equal to the number of additional shares of our Class A common stock purchased by the underwriters. In connection with such acquisition, a corresponding number of shares of Class B common stock owned by NuDevco Retail Holdings will be cancelled. We will not retain any of the net proceeds from the exercise by the underwriters of their option.

 

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CASH DIVIDEND POLICY

General

We intend to pay a regular quarterly dividend to holders of our Class A common stock to the extent we have cash available for distribution to do so. Our targeted quarterly dividend will be $0.3625 per share of Class A common stock ($1.45 per share on an annualized basis), which amount may be increased or decreased in the future without advance notice. Our ability to pay the regular quarterly dividend is subject to various restrictions and other factors as described below.

We expect to pay a quarterly dividend on or about the 75th day following the expiration of each fiscal quarter to holders of our Class A common stock of record on or about the 60th day following the last day of such fiscal quarter. With respect to our first dividend payable on or about December 15, 2014, we intend to pay a pro-rated dividend (calculated from the closing date of this offering through and including September 30, 2014) of $         per share of Class A common stock.

Rationale for Our Dividend

We have established our targeted quarterly dividend level after considering the amount of cash we expect to receive from Spark HoldCo as a result of our membership interest in Spark HoldCo after this offering. Our only cash-generating asset is our membership interest in Spark HoldCo. In accordance with its operating agreement and in our capacity as the sole managing member, we intend to cause Spark HoldCo to make regular quarterly cash distributions to its members, including us, in an amount sufficient to enable us to pay our taxes, make payments under the Tax Receivable Agreement and to pay a regular quarterly dividend, to the extent Spark HoldCo has sufficient cash available for distribution (described below) less reserves for the prudent conduct of its business. We intend to use the amount distributed to us, after allotments by our board of directors for the payment of taxes and for payments under the Tax Receivable Agreement, to pay a regular quarterly dividend to holders of our Class A common stock. We may choose to cause Spark HoldCo to retain cash available for distribution in excess of the amount distributed to the members of Spark HoldCo to fund additional growth in our business. Our cash dividend policy reflects a basic judgment that holders of our Class A common stock will be better served by us distributing all of the cash distributions we receive from Spark HoldCo each quarter in the form of a quarterly dividend rather than retaining it.

The amount of cash that Spark HoldCo generates from its operations is likely to fluctuate from quarter to quarter, in some cases significantly, as a result of the seasonality of consumption patterns, the impact of supply cost volatility on our unit margins, the effectiveness of our hedging program and our ability to enroll new customers and manage customer attrition along with our asset optimization activities. Accordingly, during quarters in which Spark HoldCo generates cash available for distribution to us in excess of the amount necessary for us to pay our taxes and targeted quarterly dividend, we may cause it to reserve a portion of the excess to fund its cash distributions in future quarters. In quarters in which Spark HoldCo does not generate cash available for distribution to us in an amount sufficient to fund our taxes, make payments under the Tax Receivable Agreement and to pay a quarterly cash dividend, if our board of directors so determines, we may use sources of cash not included in our calculation of cash available for distribution, such as net cash provided by financing activities, all or any portion of cash on hand or, if applicable, borrowings under Spark HoldCo’s new revolving credit facility, to cause it to make distributions to us in an amount sufficient to pay our taxes, make payments under the Tax Receivable Agreement and to pay dividends to holders of our Class A common stock. Although these other sources of cash may be substantial and available to fund a dividend payment in a particular period, we exclude these items from our calculation of cash available for distribution because we consider them non-recurring or otherwise not representative of the operating cash flows we typically expect to generate on an annualized basis.

 

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Estimate of Future Cash Available for Distribution

We primarily considered forecasted cash available for distribution in assessing the amount of cash that we expect to be available for the purposes of our regular quarterly dividend. Accordingly, we believe that an understanding of cash available for distribution is useful to investors in evaluating our ability to pay dividends pursuant to our stated cash dividend policy. In general, we expect that our “cash available for distribution” each quarter will equal Spark HoldCo’s Adjusted EBITDA for the period, less:

 

  cash interest paid;

 

  non-customer acquisition capital expenditures;

 

  taxes paid at Spark HoldCo;

 

  NuDevco’s pro rata portion of cash available for distribution as a non-controlling interest owner;

 

  payments under the Tax Receivable Agreement; and

 

  income tax payments at Spark Energy, Inc.

Limitations on Cash Dividends and Our Ability to Change Our Cash Dividend Policy

There is no guarantee that we will pay quarterly cash dividends to holders of our Class A common stock. We do not have a legal obligation to pay a quarterly dividend of $0.3625 per share of Class A common stock, at any other amount or at all. Our cash dividend policy may be changed at any time and is subject to certain restrictions and uncertainties, including the following:

 

  We may lack sufficient cash to pay dividends to holders of our Class A common stock due to cash flow shortfalls at Spark HoldCo attributable to a number of operational, commercial or other factors, as well as increases in operating and/or general and administrative expenses, principal and interest payments on outstanding debt, income tax expenses, working capital requirements or anticipated cash needs.

 

  As the sole managing member of Spark HoldCo, we and, accordingly, our board of directors will have the authority to establish, or cause Spark HoldCo to establish, cash reserves for the prudent conduct of our business and for future cash dividends to holders of our Class A common stock, and the establishment of or increase in those reserves could result in a reduction in cash dividends from levels we currently anticipate pursuant to our targeted cash dividend policy. These reserves may account for the fact that our cash flows may vary quarterly or from year to year based on, among other things, the seasonality of consumption patterns, the impact of supply cost volatility on unit margin, the effectiveness of our hedging program, our ability to sign-up new customers and manage customer attrition along with our asset optimization activities.

 

  The amount of our quarterly cash available for distribution could be impacted by restrictions on cash distributions contained in Spark HoldCo’s new revolving credit facility. We will be entitled to pay cash dividends to the holders of the Class A common stock and Spark HoldCo will be entitled to make cash distributions to NuDevco and us so long as: (a) no default exists or would result from such a payment under our credit facility; (b) Spark HoldCo, SE and SEG are in pro forma compliance with all financial covenants before and after giving effect to such payment and (c) the outstanding amount of all loans and letters of credit does not exceed borrowing base limits. Should Spark HoldCo be unable to satisfy these covenants or is otherwise in default under such facility, we may be unable to receive sufficient cash distributions from Spark HoldCo to pay our targeted quarterly cash dividends notwithstanding our targeted cash dividend policy. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Historical Cash Flows—Credit Facility.”

 

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  The amount of expenses that Spark HoldCo pays on our behalf under the Spark HoldCo LLC Agreement could impact cash available for distribution.

 

  The amount of tax savings that we recognize under the Tax Receivable Agreement that must be paid to NuDevco could impact cash available for distribution.

 

  Section 170 of the DGCL allows our board of directors to declare and pay dividends on the shares of our Class A common stock either:

 

  out of our surplus, as defined in and computed in accordance with the DGCL; or

 

  in case there shall be no such surplus, out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

Our Ability to Fund Our Quarterly Dividend and Reinvest Excess Cash Available for Distribution in Our Growth

We intend to grow our business primarily by pursuing organic growth opportunities in our existing retail energy markets and through expansion into additional competitive markets that show opportunities, which, we believe, will facilitate the growth of Spark HoldCo’s business. We do not currently intend to increase our dividend per share over time, but to reinvest any cash available for distribution in excess of amounts required to pay our regular quarterly dividend in the growth of our business.

We currently expect our annual cash flow from operations to be sufficient to pay our quarterly dividend at the targeted rate, as well as fund additional growth in our businesses over time. However, the determination of the amount of cash dividends to be paid to holders of our Class A common stock will be made by our board of directors and will depend upon our financial condition, results of operations, cash flow, long-term prospects and any other matters that our board of directors deem relevant.

We may also rely on external financing sources, including commercial bank borrowings and issuances of debt and equity securities, to fund future growth capital expenditures to the extent we do not have sufficient excess cash flow from operations after paying our quarterly dividend. If external financing is not available to us on acceptable terms, our board of directors may decide to finance acquisitions with cash from operations, which would reduce or even eliminate our cash available for distribution and, in turn, impair our ability to pay dividends to holders of our Class A common stock. To the extent we issue additional shares of capital stock to fund growth capital expenditures, the payment of dividends on those additional shares may increase the risk that we will be unable to maintain our per share dividend level. There are no limitations in our bylaws, and there will not be any limitations under Spark HoldCo’s new revolving credit facility, on our ability to issue additional shares of authorized capital stock, including preferred stock that would have priority over our Class A common stock with respect to the payment of dividends. Additionally, the incurrence of additional commercial bank borrowings or other debt to finance our growth would result in increased interest expense, which may impact our cash available for distribution and, in turn, our ability to pay dividends to holders of our Class A common stock.

Unaudited Pro Forma Cash Available for Distribution for the Year Ended December 31, 2013

If we had completed the transactions contemplated in this prospectus on January 1, 2013, our unaudited pro forma cash available for distribution for the year ended December 31, 2013 would have been approximately $3.5 million. These amounts would not have been sufficient to pay the full quarterly cash dividend on all of our Class A common stock to be outstanding immediately after consummation of this offering based on our targeted quarterly dividend rate of $0.3625 per share of our Class A common stock per quarter ($1.45 on an annualized basis).

 

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Our calculation of unaudited pro forma cash available for distribution includes incremental external general and administrative expenses that we expect to incur as a result of being a publicly traded company, including costs associated with SEC reporting requirements, tax return preparation, independent auditor fees, investor relations activities, Sarbanes-Oxley compliance, registrar and transfer agent fees, director and officer liability insurance expense and additional director compensation. We estimate that these incremental general and administrative expenses initially will be approximately $3.0 million per year and will be allocated to Spark HoldCo pursuant to the Spark HoldCo LLC Agreement. Such expenses are not reflected in our unaudited combined pro forma financial statements.

Our unaudited pro forma combined financial statements, from which our unaudited pro forma cash available for distribution was derived, do not purport to present our results of operations had the transactions contemplated in this prospectus actually been completed as of the dates indicated. Furthermore, cash available for distribution is a cash accounting concept, while our historical combined financial statements and our pro forma combined financial statements were prepared on an accrual basis. We derived the amounts of unaudited pro forma cash available for distribution stated above in the manner shown in the table below. As a result, the amount of unaudited pro forma cash available for distribution should only be viewed as a general indication of the amount of cash available for distribution that we might have generated had we been formed and completed the transactions contemplated in this prospectus in earlier periods.

Our unaudited pro forma combined financial statements were derived from our audited and unaudited combined historical financial statements included elsewhere in this prospectus and our accounting records, which are also unaudited. Our unaudited pro forma combined financial statements and the table below should be read together with “Prospectus Summary—Summary Historical and Unaudited Pro Forma Combined Financial and Operating Data,” “Selected Historical and Unaudited Pro Forma Combined Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited and unaudited historical combined financial statements of SE and SEG included elsewhere in this prospectus.

 

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The following table illustrates our unaudited pro forma cash available for distribution for the year ended December 31, 2013. The footnotes to the table below provide additional information about the pro forma adjustments and should be read along with the table.

Spark Energy, Inc.

Unaudited Pro Forma Cash Available for Distribution

 

     

Year Ended

December 31, 2013

 
    

(in thousands except

per share data)

 

Revenues

  

Retail electricity revenues

   $ 191,872   

Retail natural gas revenues

     124,904   

Net asset optimization revenues (including asset optimization revenues-affiliates of $14,940 and asset optimization revenues-affiliate cost of revenues of $15,928)

     314   
  

 

 

 

Total revenues

     317,090   

Operating Expenses

  

Retail cost of electricity revenues

     149,885   

Retail cost of natural gas revenues

     83,141   
  

 

 

 

Total retail cost of revenues

     233,026   

Depreciation and amortization

     16,215   

General and administrative(1)

     37,359   
  

 

 

 

Total operating costs and expenses

     286,600   
  

 

 

 

Operating income

     30,490   

Interest expense(2)

     1,183   

Interest and other income

     353   

Income tax expense

     56   
  

 

 

 

Net Income of Spark HoldCo, LLC

     29,604   

 

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Year Ended

December 31, 2013

 
    

(in thousands except

per share data)

 

Add:

  

Depreciation and amortization

   $ 16,215   

Interest expense(2)

     1,183   

Income tax expense

     56   
  

 

 

 

EBITDA of Spark HoldCo, LLC

     47,058   

Less:

  

Net gains (losses) on derivative instruments

     6,567   

Net cash settlements on derivative instruments

     1,040   

Customer acquisition costs paid in the period

     8,257   

Plus:

  

Non-cash compensation expense(3)

     2,339   
  

 

 

 

Adjusted EBITDA of Spark HoldCo, LLC

     33,533   

Less:

  

Cash interest paid(4)

     933   

Capital expenditures

     1,481   

Income taxes paid

     56   

Incremental general and administrative expense(5)

     3,000   
  

 

 

 

Pro forma Cash Available for Distribution to Spark HoldCo, LLC Unitholders

     28,063   

Less:

  

Distributions to NuDevco Retail Holdings, LLC

     22,364   

Distributions to NuDevco Retail, LLC

     226   
  

 

 

 

Pro Forma Cash Available for Distribution to Spark Energy, Inc.

     5,473   

Less:

  

Tax receivable agreement payment

     0   

Income tax payable by Spark Energy, Inc.

     1,954   
  

 

 

 

Pro Forma Cash Available for Distribution to Holders of Class A Common Stock

   $ 3,519   

Aggregate annual dividends to holders of our Class A common stock (based on targeted quarterly dividend rate of $0.3625 per share of our Class A common stock)

   $ 4,350   

Excess (Shortfall)

     (831)   

 

(1) General and administrative expense includes approximately $2.3 million in non-cash compensation expense pursuant to issuances of equity awards under our long-term incentive plan.

 

(2) Our interest expense is based on the following assumptions: (i) average borrowings under our new working capital facility of $10 million with an interest rate of approximately 4.1%; (ii) average issued letters of credit of $15 million at a rate of approximately 2.0%; (iii) commitment fees payable to the lenders under our new credit facility of approximately 0.5% on $45 million and (iv) two-year amortization of debt issuance costs of $500,000. Our estimates of the interest rates used in these assumptions are based upon the term sheet for our new credit facility.

 

(3) Although we have not historically incurred non-cash compensation expense, we expect that we will incur non-cash compensation expense following the completion of this offering as a result of equity awards that may be issued under our long-term incentive plan. Therefore, we have included the non-cash compensation expense we expect to incur as a result of equity awards we anticipate issuing in connection with this offering as an addition in our calculation of Adjusted EBITDA.

 

(4) Cash interest paid equals interest expense as noted in note (2) less non cash amortization of debt issuance costs of $250,000.

 

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(5) Reflects the incurrence of estimated incremental cash expenses associated with being a publicly traded company of approximately $3.0 million, including costs associated with SEC reporting requirements, tax return preparation, independent auditor fees, investor relations activities, Sarbanes-Oxley compliance, registrar and transfer agent fees, director and officer liability insurance expense and additional director compensation. These costs will be allocated to Spark HoldCo pursuant to the Spark HoldCo LLC Agreement. Our pro forma general and administrative expense does not reflect this incremental expense.

Estimated Cash Available for Distribution for the Twelve Months Ending June 30, 2015

We forecast that our cash available for distribution during the twelve months ending June 30, 2015, which we refer to as the “forecast period,” will be approximately $13.0 million. This amount would be sufficient to pay our targeted regular quarterly dividend of $0.3625 per share ($1.45 on an annualized basis) on all of our Class A common stock for the twelve months ending June 30, 2015.

We are providing this financial forecast to supplement our historical combined financial statements in support of our belief that Spark HoldCo will have sufficient cash available for distribution to make distributions to us in amounts sufficient to allow us to pay a regular quarterly dividend on all of our outstanding shares of Class A common stock immediately after consummation of this offering for each quarter during the twelve months ending June 30, 2015, at our targeted quarterly dividend rate of $0.3625 per share (or $1.45 per share on an annualized basis). Please see “—Significant Forecast Assumptions” for further information as to the assumptions we have made for the financial forecast. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” for information regarding the accounting policies we have followed for the forecast.

Our forecast is a forward-looking statement and reflects our judgment as of the date of this prospectus of the conditions we expect to exist and the course of action we expect to take during the twelve months ending June 30, 2015. It should be read together with our historical combined financial statements and the accompanying notes thereto included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We believe that we have a reasonable basis for these assumptions and that our actual results of operations will approximate those reflected in our forecast, but we can give no assurance that our forecasted results will be achieved. The assumptions and estimates underlying the forecast, as described below under “—Significant Forecast Assumptions,” are inherently uncertain and, although we consider them reasonable as of the date of this prospectus, they are subject to a wide variety of significant business, economic, and competitive risks and uncertainties that could cause actual results to differ materially from forecasted results, including, among others, the risks and uncertainties described in “Risk Factors.” Any of the risks discussed in this prospectus, to the extent they occur, could cause actual results of operations to vary significantly from those that would enable Spark HoldCo to generate sufficient cash available for distribution to make distributions to us in amounts sufficient to allow us to pay the aggregate annualized quarterly dividend on all of our outstanding shares of Class A common stock for the twelve months ending June 30, 2015, calculated at the quarterly dividend rate of $0.3625 per share per quarter (or $1.45 per share on an annualized basis). Accordingly, there can be no assurance that the forecast will be indicative of our future performance or that actual results will not differ materially from those presented in the forecast. If our forecasted results are not achieved, we may not be able to pay a quarterly dividend to holders of our Class A common stock at our regular quarterly dividend level or at all. Inclusion of the forecast in this prospectus should not be regarded as a representation by us, the underwriters or any other person that the results contained in the forecast will be achieved.

The statement that we believe that we will have sufficient cash available for distribution to allow us to pay distributions at the level stated above for the twelve months ending June 30, 2015, should not be regarded as a representation by us, the underwriters or any other person that we will pay such dividends. Therefore, you are cautioned not to place undue reliance on this information.

 

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We do not, as a matter of course, make public forecasts as to future sales, earnings, or other results. We have prepared the following forecast to illustrate to investors our estimated cash available for distribution during the forecast period. The accompanying forecast was not prepared with a view toward complying with the guidelines established by the American Institute of Certified Public Accountants with respect to prospective financial information, but, in our view, was prepared on a reasonable basis, reflects the best currently available estimates and judgments, and presents, to the best of management’s knowledge and belief, the expected course of action and our expected future financial performance. However, this information is not necessarily indicative of future results.

Neither our independent auditors, nor any other independent accountants, have compiled, examined, or performed any procedures with respect to the forecast contained herein, nor have they expressed any opinion or any other form of assurance on such information or its achievability, and assume no responsibility for, and disclaim any association with, the forecast.

We do not undertake to release publicly after this offering any revisions or updates to the financial forecast or the assumptions on which our forecasted results of operations are based.

 

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The following table illustrates our estimated cash available for distribution for the twelve months ending June 30, 2015.

Spark Energy, Inc.

Estimated Cash Available for Distribution

 

     Quarter Ending    

Twelve Months
Ending

June 30, 2015

 
(in thousands except per share data)  

September 30,

2014

    December 31,
2014
       March 31,   
2015
   

   June 30,   

2015

   

Revenues

         

Retail electricity revenues

  $ 49,983      $ 39,651      $ 43,665      $ 41,592      $ 174,891   

Retail natural gas revenues

    13,294        48,067        67,126        23,001        151,488   

Net asset optimization revenues

                                  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

      63,277          87,718        110,791          64,593        326,379   

Operating Expenses

         

Retail cost of electricity revenues

    38,982        30,924        34,054        32,437        136,397   

Retail cost of natural gas revenues

    8,774        31,724        44,303        15,181        99,982   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total retail cost of revenues

    47,756        62,648        78,357        47,618        236,379   

Depreciation and amortization

    3,175        3,751        4,321        4,675        15,922   

General and administrative(1)

    9,585        9,585        9,585        9,584        38,339   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

    60,516        75,984        92,263        61,877        290,640   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    2,761        11,734        18,528        2,716        35,739   

Interest expense(2)

    296        296        296        295        1,183   

Interest and other income

                                  

Income tax expense

    26        43        55        29        153   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income of Spark HoldCo, LLC

    2,439        11,395        18,177        2,392        34,403   

Add:

         

Depreciation and amortization

    3,175        3,751        4,321        4,675        15,922   

Interest expense(2)

    296        296        296        295        1,183   

Income tax expense

    26        43        55        29        153   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA of Spark HoldCo, LLC

    5,936        15,485        22,849        7,391        51,661   

Less:

         

Net gains (losses) on derivative instruments

                                  

Net cash settlements on derivative instruments

                                  

Customer acquisition costs paid in the period

    4,836        4,836        3,255        3,255        16,182   

Plus:

         

Non-cash compensation expense(3)

    585        585        585        584        2,339   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

ADJUSTED EBITDA of Spark HoldCo, LLC

    1,685        11,234        20,179        4,720        37,818   

Less:

         

Cash interest paid(4)

    233        233        233        234        933   

Non-customer acquisition capital expenditures

    125        125        125        125        500   

Income taxes paid

  $ 26      $ 43      $ 55      $ 29      $ 153   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated Cash Available for Distribution to Spark HoldCo, LLC Unitholders

  $ 1,301      $ 10,833      $ 19,766      $ 4,332      $ 36,232   

Less:

         

Distributions to NuDevco Retail Holdings, LLC

    3,081        5,848        8,442        3,965        21,336   

Distributions to NuDevco Retail, LLC

    31        59        85        40        215   

Estimated Cash Available for Distribution to Spark Energy, Inc.

    (1,811     4,926        11,239        327        14,681   

Less:

         

Tax receivable agreement payment

                                  

Income tax payable by Spark Energy, Inc.

    (219     561        1,292        30        1,664   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated Cash Available for Distribution to Holders of Class A Common Stock(5)

  $ (1,592   $ 4,365      $ 9,947      $ 297      $ 13,017   

Aggregate annual dividends to holders of our Class A common stock (based on targeted quarterly dividend rate of $0.3625 per share of our Class A common stock)

  $ 1,088      $ 1,088      $ 1,088      $ 1,088      $ 4,352   

Excess (Shortfall)

    (2,680     3,277        8,859        (791     8,665   

 

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(1) Includes the incurrence of estimated incremental cash expenses associated with being a publicly traded company of approximately $3.0 million, including costs associated with SEC reporting requirements, tax return preparation, independent auditor fees, investor relations activities, Sarbanes-Oxley compliance, registrar and transfer agent fees, director and officer liability insurance expense and additional director compensation. These costs will be allocated to Spark HoldCo pursuant to the Spark HoldCo LLC Agreement. General and administrative expense also includes approximately $2.3 million in non-cash compensation expense pursuant to issuances of equity awards under our long-term incentive plan.

 

(2) Our forecasted interest expense is based on the following assumptions: (i) anticipated average borrowings under our new working capital facility of $10 million with an interest rate of approximately 4.1%; (ii) anticipated average issued letters of credit of $15 million at a rate of approximately 2.0%; (iii) commitment fees payable to the lenders under our new credit facility of approximately 0.5% on $45 million and (iv) two-year amortization of debt issuance costs of $500,000. Our estimates of the interest rates used in these assumptions are based upon the term sheet for our new credit facility.

 

(3) Although we have not historically incurred non-cash compensation expense, we expect that we will incur non-cash compensation expense following the completion of this offering as a result of equity awards that may be issued under our long-term incentive plan. Therefore, we have included the non-cash compensation expense we expect to incur as a result of equity awards we anticipate issuing in connection with this offering as an addition in our calculation of Adjusted EBITDA.

 

(4) Cash interest paid equals interest expense as noted in note (2) less non cash amortization of debt issuance costs of $250,000.

 

(5) Excludes any payments with respect to restricted stock units and related dividend equivalents that we plan to issue in connection with the offering pursuant to our long-term incentive plan, both of which are expected to be settled in shares of our common stock rather than cash.

Significant Forecast Assumptions

In this section, we present in detail the basis for our belief that we will be able to fully fund our targeted quarterly dividend of $0.3625 per share ($1.45 on an annualized basis) on all of our Class A common stock for the forecast period with the significant assumptions upon which this forecast is based.

The forecast has been prepared by and is the responsibility of our management. Our forecast reflects our judgment as of the date of this prospectus of conditions we expect to exist and the course of action we expect to take during the forecast period. While the assumptions disclosed in this prospectus are not all-inclusive, the assumptions listed below are those that we believe are material to our forecasted results of operations and any assumptions not discussed below were deemed to not be material. We believe we have a reasonably objective basis for these assumptions. We believe our actual results of operations will approximate those reflected in our forecast, but we can give no assurance that our forecasted results will be achieved. There likely will be differences between our forecast and actual results, and those differences could be material. If our forecast is not achieved, we may not be able to pay our regular targeted quarterly dividend of $0.3625 per share of Class A common stock or any other amount.

General Considerations and Risks

Customer Growth

We have estimated that we will increase our customer count on a gross basis by an average of 15,500 customers per month during the forecast period. This rate is based upon historic customer growth rates during periods of increased customer acquisition spending. For example, through the first five months of 2014, we have added

 

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approximately 19,700 customers per month of which approximately 12,800 were natural gas customers and 6,900 were electricity customers. This substantial increase in natural gas customers relative to electricity customers is based on our recent growth in the California gas market in the first five months of 2014. We expect this enhanced focus on natural gas customers to continue through the second quarter of 2014. At the end of the second quarter we expect our natural gas and electricity customers to be reasonably equivalent, and we have assumed approximately half of the growth in the forecast period will be attributable to new natural gas customers and half of such growth will be attributable to new electricity customers.

Customer Acquisition Strategy

Our results of operations are significantly influenced by our customer acquisition spending, although the impact of increasing or reducing our customer counts on our results of operations may not occur until several months after the shift in strategy. While the time required to recoup the costs we expend to acquire new customers varies based upon contract terms and prevailing market conditions, we typically recover our customer acquisition costs within twelve months. In addition, we generally begin to recognize margin improvements from new customer acquisitions six to twelve months after the customer acquisition cost has been incurred. Similarly, the negative impact on our results of operations of a shift in strategy to decrease customer acquisitions will occur over time as natural customer attrition occurs.

In 2011, we invested approximately $24 million in growing and maintaining our customer base. The expansion was successful in expanding our customer base by approximately 63% or 123,000 customers, net of attrition, in 2011. In 2012, our owner made the determination to invest excess cash flows from our operations in other affiliated businesses. As a result, we significantly reduced our customer acquisition costs, including completely discontinuing some marketing channels, and focused our efforts on integrating and optimizing our existing expanded customer base. In addition, we took steps to decrease our general and administrative expenses through implementation of system improvements and reduced head count to create a more efficient and scalable platform. In the year ended December 31, 2012, our increased volumes resulting from the realization of prior efforts to expand our customer base, combined with reduced customer acquisition and general and administrative costs resulted in significantly increased Adjusted EBITDA as compared to prior periods.

In 2013, we continued to evaluate our customer base through segmentation and optimization strategies, which resulted in reduced customer count as certain underperforming segments experienced higher attrition levels. This segmentation and corresponding customer attrition, coupled with a decreased focus on lower margin commercial customers in 2013, resulted in lower overall sales volumes and Adjusted EBITDA in our retail segments in 2013, but enhanced gross margin per unit sold.

Recognizing the growth opportunities in the retail energy space, beginning in the second quarter of 2013, we increased our customer acquisition spending and reactivated certain marketing channels. By the end of 2013, we had grown the customer base by 8.3% from the low point in August of 2013. This growth trajectory has increased through the first five months of 2014, resulting in an increase of approximately 31.4% in our customer base as of May 31, 2014 from August of 2013. Consistent with our historical experience, we anticipate seeing the results of this expansion reflected in gross margins six to twelve months from the acquisition date of each customer.

Additionally, system and process improvements in 2012 and 2013 have resulted in a flexible and efficient platform that we believe will be able to accommodate significant growth with limited additional fixed general and administrative expense.

In addition, in early 2013, as a result of our increased focus on margin optimization, we shifted the concentration of our marketing efforts from commercial customers to residential customers, which we believe should result in

 

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higher long-term returns. This strategic shift has also resulted in a number of changes in our operating and financial results, which are continuing to be realized and are reflected in our forecast, including:

 

  lower volumes and revenues per customer as residential customers generally consume less natural gas and electricity as compared to commercial customers;

 

  higher overall customer count as a result of enhanced focus and spending on residential customer acquisition; and

 

  increases in our gross margin reflecting higher unit margins associated with residential customers as compared to commercial customers, which generally purchase larger volumes of natural gas and electricity on a lower margin basis.

Seasonality of our Business

Our overall operating results fluctuate substantially on a seasonal basis depending on: (a) the geographic mix of our customer base; (b) the relative concentration of our commodity mix; (c) weather conditions, which directly influence the demand for natural gas and electricity and affect the prices of energy commodities; and (d) variability in market prices for natural gas and electricity. These factors can have material short-term impacts on monthly and quarterly operating results, which may be misleading when considered outside of the context of our annual operating cycle.

We experience a lag between paying our accounts payable and collecting on our accounts receivable. This timing difference could affect our cash flows, especially during peak cycles in the winter and summer months.

In addition, natural gas accounted for approximately 40% of our retail revenues for the year ended December 31, 2013, which exposes us to a high degree of seasonality in our cash flows and income earned throughout the year as a result of the varying levels of customer demand. We utilize borrowing capacity to fund working capital, which includes inventory purchases from April through October of each year. We sell our natural gas inventory during the months of November through March of each year.

Primarily as a result of these seasonal impacts, we receive the substantial majority of our cash flow from operations during the first and fourth quarter of the year. For example, we generated approximately 39% and 28% of our annual Retail Gross Margin in the first and fourth quarter of the year ended December 31, 2013, respectively. We expect that the significant seasonality impacts to our cash flows and income will continue in future periods. As a result, we may reserve a portion of our excess cash available for distribution in the first and fourth quarters in order to fund our second and third quarter dividends.

Cash Available for Distribution for the Third Quarter of 2014

Consistent with our forecast, due to the seasonality of our retail natural gas business, we expect to generate the substantial majority of our cash available for distribution in the first and fourth quarters of the year. In addition, we anticipate continuing to incur increased customer acquisition costs over the first nine months of 2014, which is consistent with our growth strategy. As a result of seasonality and our increased customer acquisition costs, we may not have sufficient cash available for distribution from the third quarter of 2014 to cover the pro-rated quarterly dividend for that period (calculated from the closing date of this offering through and including September 30, 2014). We believe this risk is mitigated by (i) our ability to borrow under our working capital facility to pay dividends and (ii) the occurrence of the first dividend payment date 75 days after the end of the third quarter as, due to the seasonality of our operations, we anticipate generating substantial cash receipts during the fourth quarter sufficient to cover any shortfall in cash available for distribution as well as our quarterly dividend payment for the fourth quarter.

 

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Effectiveness of our Hedging Program

We have assumed for purposes of our forecast that we have effectively hedged substantially all of our forecasted load, in accordance with our risk policy. While we attempt to hedge substantially all of our forecasted load, the efficacy of our risk management program may be adversely impacted by unanticipated events and costs that we are not able to effectively hedge, including abnormal customer attrition and consumption, certain variable costs associated with electricity grid reliability, pricing differences in the local markets for local delivery of commodities, unanticipated events that impact supply and demand, such as extreme weather, and abrupt changes in the markets for, or availability or cost of, financial instruments that help to hedge commodity price. Failures in our hedging strategy could adversely affect our cash flow and our ability to pay dividends.

Revenues

We forecast that our total revenues for the twelve months ending June 30, 2015 will be approximately $326.4 million, as compared to $317.1 million for the year ended December 31, 2013 on a pro forma combined basis. We estimate that we will have an average of approximately 308,000 customers during the forecast period, as compared to an average of 206,194 customers during the year ended December 31, 2013 and an average of 239,239 customers for the five months ended May 31, 2014. This increase in our customer base is expected to result from the continued implementation of our strategic shift toward residential customers and increased customer acquisition spending, as described above. Except as described below under “—Asset Optimization Activities,” we have assumed no incremental activity or impact on our results of operation for the forecast period from our asset optimization activities.

Retail Electricity Revenues

We forecast that our retail electricity revenues for the forecast period will be approximately $174.9 million, as compared to $191.9 million for the year ended December 31, 2013 on a pro forma combined basis. Our retail electricity revenues forecast assumes:

 

  that our average number of retail electricity customers during the forecast period will be approximately 154,000, as compared to an average of 124,029 customers during the year ended December 31, 2013 and an average of 128,936 customers for the five months ended May 31, 2014. This anticipated increase in retail electricity customers is expected to result from our increased customer acquisition spending described below.

 

  that the average usage for a retail electricity customer during the forecast period will be 11.0 MWh, as compared to 14.7 MWh for the year ended December 31, 2013. This anticipated decrease in average usage is based on our strategic shift to residential customers who have a lower expected average consumption than commercial customers.

 

  that we will deliver approximately 1,673,600 MWh during the forecast period, as compared to the 1,829,657 MWh that we delivered for the year ended December 31, 2013. The anticipated decrease in the delivered MWh is based on our strategic shift described above and lower expected consumption of residential customers as compared to commercial customers.

Retail Natural Gas Revenues

We forecast that our retail natural gas revenues for the forecast period will be approximately $151.5 million, as compared to $125.2 million for the year ended December 31, 2013 on a pro forma combined basis. Our retail natural gas revenues forecast assumes:

 

 

that our average number of retail natural gas customers during the forecast period will be approximately 154,000, as compared to an average of 82,164 customers during the year ended December 31, 2013

 

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  and an average of 110,303 customers for the five months ended May 31, 2014. This anticipated increase in retail natural gas customers is expected to result from our increased customer acquisition spending described below.

 

  that the average usage for a retail natural gas customer during the forecast period will be 130 MMBtu, as compared to 187.5 MMBtu for the year ended December 31, 2013. This anticipated decrease in average usage is based on our strategic shift to residential customers who have a lower expected average consumption than commercial customers.

 

  that we will deliver approximately 20,198,300 MMBtu during the forecast period, as compared to 16,598,751 MMBtu we delivered for the year ended December 31, 2013. The anticipated increase in the delivered MMBtu is due to our expected increase in customer count which is partially mitigated by our expected decrease in average customer consumption.

Asset Optimization Activities

We have assumed that our asset optimization activities will generate a sufficient amount of revenues to cover the cost of the demand charges associated with our two existing non-retail transportation contracts. We estimate that the cost associated with these demand charges for the forecast period will be approximately $2.6 million. As we are unable to predict when other asset optimization opportunities may occur, we have not assumed any other incremental revenues or costs associated with our asset optimization activities. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting Our Results of Operations.”

We expect to continue to purchase natural gas from one of our affiliates at the same price that SEG receives via the spot and term contracts it enters into with wholesale market participants. We have not forecasted any revenues associated with these activities as they have no impact on our net optimization revenues due to the back-to-back nature of the contractual arrangements.

Operating Costs and Expenses

Our costs and operating expenses primarily include the cost of revenues from natural gas and electricity revenues, general and administrative expenses, and depreciation and amortization expenses. We forecast our costs and operating expenses will be approximately $288.3 million for the forecast period, as compared to $284.3 million for the year ended December 31, 2013 on a pro forma combined basis. Our forecasted estimates are based on historical costs and operating expenses and incorporate the following assumptions:

Retail Cost of Electricity Revenues

We estimate that our retail cost of electricity revenues for the forecast period will be approximately $136.4 million, as compared to $149.9 million for the year ended December 31, 2013 on a pro forma combined basis. Our forecast is based on historical costs and operating expenses per MWh delivered and our estimated delivery of approximately 1,673,600 MWh during the forecast period. The decrease in the retail cost of electricity revenues is expected to result from lower volumes of MWh delivered during the forecast period as compared to the year ended December 31, 2013.

Retail Cost of Natural Gas Revenues

We estimate that our retail cost of natural gas revenues for the forecast period will be approximately $100.0 million, as compared to $83.1 million for the year ended December 31, 2013 on a pro forma combined

 

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basis. Our forecast is based on historical costs and operating expenses per MMBtu delivered and our estimated delivery of approximately 20,198,300 MMBtu during the forecast period. The increase in the retail cost of natural gas revenues is expected to result from higher volumes of MMBtu delivered during the forecast period as compared to the year ended December 31, 2013.

General and Administrative

We estimate that our general and administrative expenses will be approximately $38.3 million for the forecast period, as compared to $37.4 million for the year ended December 31, 2013 on a pro forma combined basis. Our forecast reflects approximately $3.0 million of incremental general and administrative expenses that we expect to incur as a result of being a publicly traded company, including costs associated with SEC reporting requirements, tax return preparation, independent auditor fees, investor relations activities, Sarbanes-Oxley compliance, registrar and transfer agent fees, director and officer liability insurance expense and additional director compensation. Our forecast also reflects approximately $2.3 million in share-based compensation expense related to restricted stock units that we expect to issue in connection with the offering. These costs will be allocated to Spark HoldCo pursuant to the Spark HoldCo LLC Agreement. These increased expenses are offset by reduced fees paid to brokers on commercial accounts, which we expect to decrease during the forecast period, and reduced fees to IT contractors due to the completion of the implementation of an outsourced, hosted billing and transactions platform.

Depreciation and Amortization

We estimate that our depreciation and amortization expense will be approximately $15.9 million for the forecast period, as compared to $16.2 million for the year ended December 31, 2013 on a pro forma combined basis. Forecasted depreciation and amortization expense reflects management’s estimates, which are based on consistent average depreciable asset lives and depreciation methodologies. Additionally, our forecasted depreciation and amortization expense includes the amortization of our forecasted customer acquisition costs described below. We amortize our customer acquisition costs over two years.

Customer Acquisition Costs

We estimate that customer acquisition costs paid will be approximately $16.2 million for the forecast period as compared to $8.3 million for the year ended December 31, 2013 on a pro forma combined basis. The increase in customer acquisition costs is expected to result from our increased focus on adding residential customers during the forecast period. A portion of these costs will be incurred in order to offset our customer attrition for the forecast period. We have assumed average customer attrition for the twelve months ended June 30, 2015 of 3.9% per month, which is consistent with the average customer attrition for the year ended December 31, 2013 and historical norms. We have assumed an acquisition cost per customer that is consistent with our costs to acquire customers in 2013.

Interest Expense

We estimate that interest expense will be approximately $1.2 million for the forecast period as compared to $1.2 million for the year ended December 31, 2013 on a pro forma combined basis. Our interest expense is based on the following assumptions: (i) anticipated average borrowings under our new working capital facility of $10 million with an interest rate of approximately 4.1%; (ii) anticipated average issued letters of credit of $15 million at a rate of approximately 2.0%; (iii) commitment fees payable to the lender under our new credit facility of approximately 0.5% on $45 million and (iv) two-year amortization of debt issuance costs of $500,000.

 

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Income Tax Expense Payable by Spark Energy, Inc. and Tax Receivable Agreement Payment

We estimate that income tax expense will be approximately $3.0 million for the forecast period as compared to $2.6 million for the year ended December 31, 2013 on a pro forma basis. Our income tax expense is based on a federal income tax rate of 34%, a blended state income tax rate of 3.5% and taxable income of $7.9 million. Cash paid for taxes will differ from our financial statement provision for income taxes primarily due to the fact that Spark Energy, Inc. is entitled to tax depreciation and amortization deductions attributable to amounts paid for the interests in Spark HoldCo and due to other temporary and permanent differences between the financial and taxable income of Spark HoldCo. Comparable depreciation and amortization deductions with respect to amounts paid for the interests in Spark HoldCo are not reported in the financial statements because Spark Energy, Inc.’s acquisition of interests in Spark HoldCo is treated as a transaction between parties under common control for financial accounting purposes.

We do not expect any payments to be made under the Tax Receivable Agreement during the forecast period. Although we expect there to be a tax basis increase from the purchase by us of Spark HoldCo units from NuDevco Retail Holdings in connection with this offering, we do not expect any payment to become due as a result of this tax basis increase until December 2015. We estimate that this payment, which is based upon the net cash savings we expect to generate from the closing of this offering through December 31, 2014, will be approximately $560,000.

Regulatory, Industry and Economic Factors

Our forecast for the twelve months ending June 30, 2015 is based on the following significant assumptions related to regulatory, industry, economic and other factors:

 

  There will not be any new federal, state or local regulatory developments regarding the portions of the natural gas or electricity industries in which we operate, or a new interpretation of existing regulations, that will be materially adverse to our business.

 

  There will not be any major adverse change in our business, in the portions of the natural gas and electricity industries that we serve, or in general economic conditions in the geographic areas that we serve.

 

  There will not be any material non-performance or credit issues in relation to our suppliers, customers or other counterparties that are inconsistent with historical norms.

 

  There will not be any material accidents, weather-related incidents, unscheduled downtime or similar unanticipated events with respect to our facilities or those of third parties on which we depend.

 

  There will not be any material weather event or adverse market change that would result in significant long-term changes to ancillary service charges, real time prices, basis or other costs of energy supply that could not be passed through to our customers.

 

  Although we may opportunistically pursue acquisitions in the future, no acquisitions have been assumed for purposes of this forecast.

 

  That market, insurance and overall economic conditions will not change substantially.

 

  No material changes in commodity pricing.

Actual results could vary significantly from the foregoing assumptions. Please see “Risk Factors—Risks Related to Our Business.” The assumptions underlying the forecast of cash available for distribution that we include in “Cash Dividend Policy” are inherently uncertain and subject to significant business, economic, financial, regulatory, and competitive risks and uncertainties that could cause our actual cash available for distribution to differ materially from our forecast.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2014:

 

  on a historical basis; and

 

  on a pro forma, as adjusted basis to give effect to (i) the transactions described under “Corporate Reorganization,” (ii) the sale of shares of our Class A common stock in this offering at an assumed initial offering price of $20.00 per share (which is the midpoint of the range set forth on the cover of this prospectus) and (iii) the application of the net proceeds from this offering in the manner as set forth under “Use of Proceeds.”

You should read the following table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our combined financial statements and related notes appearing elsewhere in this prospectus.

 

      March 31, 2014
     

Historical

  

Pro Forma,

as

adjusted

     (restated)     
     (in thousands, except share
and per share data)

Cash and cash equivalents

     $ 4,755        $ 4,205  
    

 

 

      

 

 

 

Long-term debt (including current portion):

         

Spark HoldCo New Revolving Credit Facility(1)

     $        $ 10,000  

Note Payable

       34,000           
    

 

 

      

 

 

 

Total long-term debt

       34,000          10,000  
    

 

 

      

 

 

 

Member’s/Stockholders’ Equity:

         

Member’s equity

     $ 28,065        $  

Class A common stock, par value $0.01 per share; no shares authorized or issued and outstanding (actual); 120,000,000 shares authorized (pro forma, as adjusted); 3,000,000 shares issued and outstanding (pro forma, as adjusted)

                30  

Class B common stock, par value $0.01 per share; no shares authorized or issued and outstanding (actual); 60,000,000 shares authorized (pro forma, as adjusted); 10,750,000 shares issued and outstanding (pro forma, as adjusted)

                108  

Preferred stock, par value $0.01 per share; no shares authorized or issued and outstanding (actual); 20,000,000 shares authorized (pro forma, as adjusted); no shares issued and outstanding (pro forma, as adjusted)

                 

Additional paid-in capital

                14,936  
    

 

 

      

 

 

 

Total member’s/stockholders’ equity

       28,065          15,074  
    

 

 

      

 

 

 

Noncontrolling interest

                40,366  
    

 

 

      

 

 

 

Total member’s/stockholders’ equity attributable to the Company

       28,065          55,440  
    

 

 

      

 

 

 

Total capitalization

     $ 62,065        $ 65,440  
    

 

 

      

 

 

 
                       

 

(1) Excludes approximately $15 million in letters of credit that we expect to be outstanding upon completion of this offering.

The information presented above assumes no exercise of the option to purchase additional shares by the underwriters, and is based on the number of shares of our Class A common stock outstanding as of the closing of the offering. The table does not reflect other shares of Class A common stock reserved for issuance under our long-term incentive plan, which we plan to adopt in connection with this offering, or restricted stock units that we expect to issue in connection with this offering. See “Executive Compensation—Compensation Following this Offering.”

 

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DILUTION

Purchasers of the Class A common stock in this offering will experience immediate and substantial dilution in the net tangible book value per share of the Class A common stock for accounting purposes. Dilution is the amount by which the offering price paid by the purchasers of Class A common stock sold in this offering will exceed the net tangible book value per share of Class A common stock, after giving pro forma effect to the transactions described under “Corporate Reorganization.” Because our existing owners do not own any Class A common stock or other economic interest in us, we have presented dilution in pro forma net tangible book value per share of Class A common stock to investors in this offering assuming that our existing investors exchanged their Spark Holdco Units for newly-issued shares of Class A common stock on a one-for-one basis in order to more meaningfully present the dilutive impact on the investors in this offering.

On a pro forma basis as of March 31, 2014, our net tangible book value would have been approximately $44.5 million, or $3.24 per share of Class A common stock. Because we will not retain any of the net proceeds from this offering, our pro forma net tangible book value will remain unchanged when adjusted for the sale by us of Class A common stock in this offering at an assumed initial public offering price of $20.00 per share of Class A common stock (the mid-point of the price range set forth on the cover of this prospectus). The following table illustrates the per share dilution to new investors purchasing shares in this offering (assuming that 100% of the Spark HoldCo units held by NuDevco have been exchanged for shares of Class A common stock):

 

Assumed initial public offering price per share(1)

     $ 20.00  

Pro forma net tangible book value per share of Class A common stock before and after the offering

       3.24  

Dilution in pro forma net tangible book value per share to new investors in this offering(2)

     $ 16.76  

 

(1) The mid-point of the price range set forth on the cover of this prospectus.

 

(2) Because the net proceeds received by us pursuant to any exercise by the underwriters of their option to purchase additional shares of Class A common stock will be used to purchase Spark HoldCo Units from NuDevco Retail Holdings, there will be no change to the dilution in net tangible book value per share of Class A common stock to purchasers in the offering due to any such exercise of the option.

The following table summarizes, on an adjusted, pro forma basis as of March 31, 2014, the total number of shares of Class A common stock owned by existing shareholders (assuming that 100% of our Class B common stock has been exchanged for Class A common stock on a one-for-one basis) and to be owned by new investors, the total consideration paid, and the average price per share paid by our existing shareholders and to be paid by new investors in this offering at $20.00, the midpoint of the range of the initial public offering prices set forth on the cover page of this prospectus, calculated before deduction of estimated underwriting discounts and commissions.

 

      Shares of Class A
Common Stock
  Total Consideration   Average Price
Per Share
      Number    Percent   Amount
(in thousands)
   Percent  

Existing shareholders(1)

       10,750,000          78.18 %     $ 34,794.8          36.7 %     $ 3.24  

New investors in this offering

       3,000,000          21.82         60,000          63.3       $ 20.00  
    

 

 

      

 

 

     

 

 

      

 

 

     

Total

       13,750,000          100 %     $ 94,794.8          100 %     $ 6.89  
    

 

 

      

 

 

     

 

 

      

 

 

     

 

 

 
                                                      

 

(1) The net assets contributed by NuDevco will be recorded at historical cost. The net tangible book value of the consideration to be provided by NuDevco as of March 31, 2014 was approximately $34.8 million. Excludes 386,150 restricted stock units to be issued in connection with the closing of this offering under our long-term incentive plan.

 

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The data in the table excludes 1,375,000 additional shares of Class A common stock initially reserved for issuance under our long-term incentive plan, based on an assumed public offering price of $20.00 per share (which is the midpoint of the price range set forth on the cover page of this prospectus), and restricted stock units that we expect to issue in connection with this offering. See “Executive Compensation—Compensation Following this Offering.”

If the underwriters’ option to purchase additional shares is exercised in full, the number of shares held by new investors will be increased to 3,450,000, or approximately 25.09% of the total number of shares of Class A common stock.

 

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SELECTED HISTORICAL AND UNAUDITED PRO FORMA COMBINED FINANCIAL AND OPERATING DATA

Spark Energy, Inc. was formed in April 2014 and does not have any historical financial operating results. Accordingly, the accompanying combined financial statements have been prepared from the combined business and assets of the retail natural gas business and asset optimization activities of SEG and the retail electricity business of SE.

The following table shows the selected historical combined financial data as of and for the years ended December 31, 2012 and 2013 and the three months ended March 31, 2013 and 2014. The selected historical combined financial as of December 31, 2012 and 2013 and for the years ended December 31, 2012 and 2013 has been derived from the audited combined financial statements and the related notes thereto included elsewhere in this prospectus. The selected historical combined financial data as of March 31, 2014 and for the three months ended March 31, 2013 and 2014 has been derived from the unaudited condensed combined financial statements and the related notes included elsewhere in this prospectus.

The selected unaudited pro forma combined financial data presented below has been derived by the application of pro forma adjustments to the historical combined financial statements included elsewhere in this prospectus. The selected unaudited pro forma combined financial data presented below give effect to (i) our reorganization in connection with this offering as described in “Corporate Reorganization,” (ii) this offering and the use of the estimated net proceeds from this offering as described in “Use of Proceeds” and (iii) other related transactions to be effected at the closing of this offering, as if such transactions had taken place on January 1, 2013, in the case of the unaudited pro forma combined statement of operations for each of the year ended December 31, 2013 and the three months ended March 31, 2014, and as of December 31, 2013 and March 31, 2014, in the case of the unaudited pro forma combined balance sheet as of December 31, 2013 and March 31, 2014, respectively.

You should read these tables in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a discussion of factors materially affecting the comparability of the information presented, “Organizational Structure” and the historical and pro forma combined financial statements and notes thereto included elsewhere in this prospectus. The selected unaudited pro forma combined financial data is presented for informational purposes only. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable. The selected unaudited pro forma combined financial data does not purport to represent what our results of operations or financial position would have been if we had operated as a public company during the period presented and may not be indicative of our future performance.

 

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     Historical     Pro Forma  
    Year Ended December 31,     Three Months
Ended March 31,
    Year Ended
December 31,
    Three Months
Ended
March 31,
 
     2012     2013     2013    

2014

    2013     2014  
                      (restated)              
                (unaudited)     (unaudited)  

Statement of Income Data (in thousands):

           

Revenues:

           

Retail revenues (including retail revenues—affiliates of $1,382 and $4,022 for the years ended December 31, 2012 and 2013, respectively, and $199 and $1,489 for the three months ended March 31, 2013 and 2014, respectively)

  $ 380,198      $ 316,776      $ 100,453      $ 104,352      $ 316,776      $ 104,352   

Net asset optimization revenues (including asset optimization revenues-affiliates of $8,334 and $14,940 for the years ended December 31, 2012 and 2013, and $1,500 and $2,500 for the three months ended March 31, 2013 and 2014, respectively, and asset optimization revenues affiliate cost of revenues of $568 and $15,928 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million and $7,900 for the three months ended March 31, 2013 and 2014, respectively)

    (1,136     314        (1,157     1,624        314        1,624   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    379,062        317,090        99,296        105,976        317,090        105,976   

Operating expenses:

           

Retail cost of revenues (including retail cost of revenues-affiliates of $254 and $55 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million for the three months ended March 31, 2013 and 2014, respectively)

    279,506        233,026        69,993        88,121        233,026        88,121   

General and administrative

    47,321        35,020        9,275        8,113        35,020        8,113   

Depreciation and amortization

    22,795        16,215        5,030        2,959        16,215        2,959   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    349,622        284,261        84,298        99,193        284,261        99,193   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    29,440        32,829        14,998        6,783        32,829        6,783   

Other (expense)/income:

           

Interest expense

    (3,363     (1,714     (384     (313     (1,183     (296

Interest income and other income

    62        353        11        70        353        70   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expenses)/income

    (3,301     (1,361     (373     (243     (830     (226
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

    26,139        31,468        14,625        6,540        31,999        6,557   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

    46        56        14        32        2,630        543   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 26,093      $ 31,412      $ 14,611      $ 6,508      $ 29,369      $ 6,014   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to non- controlling interest

            25,017        5,126   
         

 

 

   

 

 

 

Net income attributable to stockholders

          $ 4,352      $ 888   
         

 

 

   

 

 

 

Pro forma net income per common share

           

Basic

          $ 1.45      $ .30   

Diluted

          $ 1.45      $ .30   

Weighted average proforma common shares outstanding

           

Basic

            3,000,000        3,000,000   

Diluted

            13,750,000        13,750,000   

Balance Sheet Data (in thousands, at period end):

           

Current assets

  $ 104,246      $ 101,291        $ 119,720        $ 119,044   

Total liabilities

    67,976        73,160          99,768          97,741   

Total liabilities and members’ equity

    129,278        109,073          127,833          153,181   

Cash Flow Data (in thousands):

           

Cash flows from operating activities

  $ 44,076      $ 44,480      $ 17,868      $ 6,209       

Cash flows used in investing activities

    (1,643     (1,481     (93     (787    

Cash flows used in financing activities

    (39,904     (42,369     (22,239     (7,856    

Other Financial Data (in thousands)(1):

           

Adjusted EBITDA(1)

  $ 40,659      $ 33,533      $ 19,048      $ 9,322      $ 33,533      $ 9,322   

Retail gross margin(1)

    93,219        81,668        31,740        17,684        81,668        17,684   

Other Operating Data:

           

Customers

    237,436        210,556        215,715        240,993        210,556        240,993   

Natural gas volumes (MMBtu)

    17,527,252        16,598,751        6,994,627        6,593,580        16,598,751        6,593,580   

Electricity volumes (MWh)

    2,698,084        1,829,657        478,426        384,275        1,829,657        384,275   

 

(1) Adjusted EBITDA and retail gross margin are non-GAAP financial measures. For a definition and a reconciliation of each of Adjusted EBITDA and retail gross margin to their most directly comparable financial measures calculated and presented in accordance with GAAP, please see “Prospectus Summary—Non-GAAP Financial Measures.”

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the “Selected Historical and Unaudited Pro Forma Combined Financial and Operating Data” and the accompanying combined financial statements and related notes included elsewhere in this prospectus. The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, market prices for retail natural gas and electricity, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in this prospectus, particularly in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements,” all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.

Overview

We are a growing independent retail energy services company founded in 1999 that provides residential and commercial customers in competitive markets across the United States with an alternative choice for their natural gas and electricity. We purchase our natural gas and electricity supply from a variety of wholesale providers and bill our customers monthly for the delivery of natural gas and electricity based on their consumption at either a fixed or variable-price. Natural gas and electricity are then distributed to our customers by local regulated utility companies through their existing infrastructure.

As of May 31, 2014, we operated in 46 utility service territories across 16 states and had approximately 237,600 residential customers and 17,800 commercial customers, which translates to over 392,500 residential customer equivalents (“RCEs”). An RCE is an industry standard measure of natural gas or electricity usage with each RCE representing annual consumption of 100 MMbtu of natural gas or 10 MWh of electricity.

We operate these businesses in two operating segments:

 

  Retail Natural Gas Segment. We purchase natural gas supply through physical and financial transactions with market counterparts and supply natural gas to residential and commercial consumers pursuant to fixed-price, variable-price and flat-rate contracts. For the year ended December 31, 2013, approximately 40% of our retail revenues were derived from the sale of natural gas. We also identify wholesale natural gas arbitrage opportunities in conjunction with our retail procurement and hedging activities, which we refer to as asset optimization. These opportunities can include (i) optimizing the unused portion of storage and transportation assets that are allocated to us by the local regulated utility to support our retail load; (ii) capturing physical arbitrage opportunities using short or long-term transportation capacity; and (iii) maximizing our credit capacity by purchasing gas from affiliates and third parties and selling it at the same location to counterparties for whom we normally purchase retail supply.

 

  Retail Electricity Segment. We purchase electricity supply through physical and financial transactions with market counterparts and ISOs and supply electricity to residential and commercial consumers pursuant to fixed-price and variable-price contracts. For the year ended December 31, 2013, approximately 60% of our retail revenues were derived from the sale of electricity.

Spark Energy, Inc.

Spark Energy, Inc. was formed in April 2014 and does not have any historical financial operating results. The following discussion analyzes our historical combined financial condition and results of operations, which is the combined businesses and assets of the retail natural gas business and asset optimization activities of SEG and

 

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the retail electricity business of SE. SE and SEG are the operating subsidiaries through which we have historically operated our retail energy business and are currently commonly controlled by NuDevco Partners, LLC. All of the ownership interests in each of SE and SEG will be contributed to Spark HoldCo prior to the completion of this offering.

Spark Energy, Inc. will be a holding company whose sole material assets will consist of a managing membership interest in Spark HoldCo and approximately 3,000,000 of the outstanding Spark HoldCo units with the remaining Spark HoldCo units being held by NuDevco. Spark Energy, Inc. will be the managing member of Spark HoldCo, will be responsible for all operational, management and administrative decisions relating to Spark HoldCo’s business and will consolidate the financial results of Spark HoldCo and its subsidiaries.

Factors Affecting Our Results of Operations

Our Ability to Grow Our Business. Customer growth is a key driver of our operations. We attempt to grow our customer base by offering customers competitive pricing, price certainty or green product offerings. In addition, we intend to offer bundled products in the third quarter of 2014. We manage growth on a market-by-market basis by developing price curves in each of the markets we serve and comparing the market prices to the price the local regulated utility is offering. We then determine if there is an opportunity in a particular market based on our ability to create a competitive product on economic terms that satisfies our profitability objectives. We develop marketing campaigns using a combination of sales channels, with an emphasis on door-to-door marketing and outbound telemarketing given their flexibility and historical effectiveness. We identify and acquire customers through a variety of additional sales channels, including our inbound customer care call center, online marketing, email, direct mail, affinity programs, direct sales, brokers and consultants. Our marketing team continuously evaluates the effectiveness of each customer acquisition channel and makes adjustments in order to achieve desired growth and profitability targets.

A key component in our ability to grow our business is management of customer acquisition costs, which we capitalize and amortize over a 24-month period. We attempt to maintain a disciplined approach to recovery of our customer acquisition costs within defined periods. We factor in the recovery of customer acquisition costs in determining which markets we enter and the pricing of our products in those markets. While the time required to achieve payback relative to the costs we expend to acquire new customers varies based upon contract terms and prevailing market conditions, we generally realize the economic benefits of new customer acquisition in less than one year. Accordingly, our results of operations are significantly influenced by our customer acquisition spending. For example, increased customer acquisition spending in 2011 was a factor that led to increased profitability in 2012. However, our 2013 results were negatively impacted by our strategic initiative in 2012 to reduce customer acquisition spending and to optimize our customer base, following a determination by our owner to invest excess cash flows from our retail operations in other affiliated businesses. Similarly, since the third quarter of 2013, we have spent significant amounts on customer acquisition costs and we expect to realize the benefit of this spending beginning in 2014.

Our Ability to Manage Customer Attrition. Average customer attrition for the year ended December 31, 2013 and the five months ended May 31, 2014 was approximately 3.6% and 4.3%, respectively. This attrition was primarily due to: (i) customer initiated switches; (ii) residential moves and (iii) customer payment defaults. We evaluate our customers and offer products and pricing to manage our attrition rates and maximize customer lifetime value.

Market Regulation and Oversight. We operate in the highly regulated natural gas and electricity retail sales industry. Regulations may be revised or reinterpreted or new laws and regulations may be adopted or become applicable to us or our operations. Such changes may have a detrimental impact on our business either by making it more costly to operate in that state or by forcing us to shift our focus to other states.

 

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Weather Conditions. Weather conditions directly influence the demand for natural gas and electricity and affect the prices of energy commodities. Our hedging strategy is based on forecasted customer energy usage, which can vary substantially as a result of weather patterns deviating from historical norms. We are particularly sensitive to this variability because of our current substantial concentration and focus on growth in the residential customer segment in which energy usage is highly sensitive to weather conditions that impact heating and cooling demand. The extreme weather patterns during the 2013 and 2014 winter season caused commodity demand and prices to rise significantly beyond industry forecasts. As a result, the retail energy industry generally charged higher prices to its variable-price customers and was subject to decreased margins on fixed-price contracts due to unanticipated increases in volumetric demand that had to be purchased in the spot market at high prices.

Commodity Price Risk and Effectiveness of our Risk Management Program. We hedge and procure our energy requirements from various wholesale energy markets, including both physical and financial markets, through short-term and long-term contracts. Our financial results are largely dependent on the difference between prices at which we purchase and resell natural gas and electricity. We actively manage our commodity price risk. Our commodity risk management strategy is designed to hedge substantially all of our forecasted natural gas and electricity volumes on our fixed-price customer contracts as well as a portion of the near-term volumes on our variable-price customer contracts. We are required to deliver our wholesale energy at various utility load zones for electricity and various city gates for natural gas. We manage our exposure to short-term and long-term movements in wholesale energy prices by hedging using a variety of derivative instruments. Our hedging strategy is based on a number of variables and estimates, including weather patterns, changes in commodity prices, assumptions regarding attrition and changes in weather-related volumetric demand. If the actual attrition or demand from our customers differs significantly from our projections, we may be exposed to overhedged or unhedged volumes. If the market price of natural gas or electricity increases or decreases from the original hedge price, we may realize a corresponding loss or gain.

We are exposed to basis risk in our operations when the commodities we hedge are sold at different delivery points from the exposure we are seeking to hedge. For example, if we hedge our natural gas commodity price with Chicago basis but physical supply must be delivered to the individual delivery points of specific utility systems around the Chicago metropolitan area, we are exposed to basis risk between the Chicago basis and the individual utility system delivery points. These differences can be significant from time to time, particularly during extreme, unforecasted cold weather conditions. Similarly, in certain of our electricity markets, customers pay the load zone price for electricity, so if we purchase supply to be delivered at a hub, we may have basis risk between the hub and the load zone electricity prices due to local congestion that is not reflected in the hub price. We attempt to hedge basis risk where possible, but hedging instruments are sometimes not economically feasible or available in the smaller quantities that we require.

Because natural gas accounted for approximately 40% of our retail revenues for the year ended December 31, 2013 and is a key component of the wholesale price of electricity, our operating results are heavily impacted by price movements in natural gas. Price volatility in the natural gas market generally exceeds volatility in most energy and other commodity markets. Changes in market prices for natural gas and electricity may result from many factors that are outside of our control. Please see “Risk Factors—Risks Related to Our Business—We are subject to commodity price risk.”

We incur monthly ancillary service charges and capacity costs in the electricity sector. For instance, the ISOs charge all retail electricity providers for monthly reserves that the ISO determines are necessary to protect the integrity of the grid. We attempt to estimate such amounts but they are difficult to estimate because they are charged in arrears by the ISOs and are subject to fluctuations based on weather and other market conditions. Many of the utilities we serve also allocate natural gas transportation and storage assets to us as a part of their

 

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competitive choice program. We are required to fill our allocated storage capacity with natural gas, which creates commodity supply and price risk. Sometimes we cannot hedge the volumes associated with these assets because they are too small compared to the much larger bulk transaction volumes required for trades in the wholesale market or because it is not economically feasible to do so.

In addition to our supply costs, we incur costs such as RECs, ancillary services charges, ISO fees and, in some markets, transmission costs, which we estimate and incorporate into the pricing of our offered contracts. To the extent our estimates are incorrect, we may incur costs that we are unable to pass along to our customers.

Seasonality. Our overall operating results fluctuate substantially on a seasonal basis depending on: (i) the geographic mix of our customer base; (ii) the relative concentration of our commodity mix; (iii) weather conditions, which directly influence the demand for natural gas and electricity and affect the prices of energy commodities; and (iv) variability in market prices for natural gas and electricity. These factors can have material short-term impacts on monthly and quarterly operating results, which may be misleading when considered outside of the context of our annual operating cycle.

Our accounts payable and accounts receivable are impacted by seasonality due to the timing differences between when we pay our suppliers for accounts payable versus when we collect from our customers on accounts receivable. We typically pay our suppliers for purchases on a monthly basis. However, it takes approximately two months from the time we deliver the natural gas or electricity to our customers to the time we collect from our customers on accounts receivable attributable to those supplies. This timing difference could affect our cash flows, especially during peak cycles in the winter and summer months.

Natural gas accounts for approximately 40% of our retail revenues, which exposes us to a high degree of seasonality in our cash flows and income earned throughout the year as a result of the high concentration of heating load in the winter months. We utilize a considerable amount of cash from operations and borrowing capacity to fund working capital, which includes inventory purchases from April through October each year. We sell our natural gas inventory during the months of November through March of each year. We expect that the significant seasonality impacts to our cash flows and income will continue in future periods. For example, we generated approximately 39% and 28% of our annual Retail Gross Margin in the first and fourth quarter of the year ended December 31, 2013. As a result, we intend to reserve a portion of our excess cash available for distribution in the first and fourth quarters in order to fund our second and third quarter dividends.

Electricity consumption is typically highest during the summer months due to cooling demand, however this increase in volumes does not typically impact our overall profitability as the cost of electricity typically also increases in the summer months.

Asset Optimization and Certain Long-term Contracts. We contract for term transportation capacity in connection with our asset optimization activities which obligates us to pay demand charges to the relevant counterparty. For 2014, we are obligated to pay demand charges for certain transportation assets of approximately $2.6 million. Although these demand payments will decrease over time, the related capacity agreements extend through 2028. Prior to 2013, we entered into several hedging transactions associated with this capacity. As a result of weather-related pipeline transportation constraints, our hedging strategy for the winter of 2012 through 2013 on one of those transactions involving interruptible transportation resulted in losses that were recognized in late 2012 and 2013. We have since revised our risk policies such that this business is limited to back-to-back purchase and sale transactions, or open positions subject to our aggregate net open position limits, which are not held for a period longer than two months. Further, all additional capacity procured outside of a utility allocation of retail assets must be approved by our risk committee, hedges on our firm transportation obligations are limited to two years or less and hedging of interruptible capacity is prohibited.

 

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Asset optimization opportunities primarily arise during the winter heating season when demand for natural gas is the highest. As such, we expect the majority of our asset optimization profits to be made in the winter. Given the opportunistic nature of these activities we will experience variability in our earnings from our asset optimization activities from year to year. As these activities are accounted for using mark-to-market accounting, the timing of our revenue recognition may differ from the actual cash settlement.

Retail Contract Types. We offer both fixed-price contracts and variable-price contracts, which we believe enables us to increase overall customer lifetime value. Fixed-price contracts provide consumers with price protection against increases in natural gas and electricity prices with terms of up to three years. Incorporated into the calculation of our fixed prices are also prevailing billing charges, switching fees, volumetric conversion rates and other charges. Though we are advised in advance of future changes in these items through tariff filings and notices by the local regulated utility, changes in these charges, fees, rates and other charges could occur before the termination date of our current fixed-price contracts. We cannot pass through those additional costs to customers on fixed-price contracts, which would negatively impact projected margins on those contracts. With respect to our variable-price contracts, we are generally able to pass through increased costs; however customers may terminate these contracts at any time if they are not satisfied with the current rate being charged. In addition, we may decide not to pass through the entire cost of significant commodity price increases in a given monthly period to avoid excessive customer complaints and attrition.

We had approximately 113,000 customers under fixed-price contracts and 128,000 customers under variable-price contracts as of March 31, 2014. As of March 31, 2014, approximately 111,000 were customers who purchase natural gas and approximately 130,000 were customers who purchase electricity.

Timing of Hedge Settlements. In addition to the volatility described above, we could incur volatility from quarter-to-quarter associated with gains and losses on settled hedges relating to natural gas held in inventory if we choose to hedge the summer-winter spread on our retail allocated storage capacity. Inventory is typically purchased and stored from April to October and withdrawn from storage from November through March. Since a portion of the inventory is used to satisfy delivery obligations to our fixed-price customers over the winter months, we hedge the associated price risk using a combination of NYMEX and basis derivative contracts. Any gains or losses associated with settled derivative contracts are reflected in the statement of operations for the period in which the contract settles as a component of cost of revenues.

Customer Credit Risk. In many of the utility services territories where we conduct business, POR programs have been established, whereby the local regulated utility offers services for billing the customer, collecting payment from the customer and remitting payment to us. This service results in substantially all of our credit risk being linked to the applicable utility and not to our end-use customer in these territories. For the year ended December 31, 2013, approximately 47% of our retail revenues were derived from territories in which substantially all of our credit risk was directly linked to local regulated utility companies, all of which had investment grade ratings as of such date. During the same period, we paid these local regulated utilities a weighted average discount of less than 1.0% of total revenues for customer credit risk. In certain of the POR markets in which we operate, the utilities limit their collections exposure by retaining the ability to transfer a delinquent account back to us for collection when collections are past due for a specified period. If our collection efforts are unsuccessful, we return the account to the local regulated utility for termination of service. Under these service programs, we are exposed to credit risk related to payment for services rendered during the time between when the customer is transferred to us by the local regulated utility and the time we return the customer to the utility for termination of service, which is generally one to two billing periods. We may also realize a loss on fixed-price customers in this scenario due to the fact that we will have already fully hedged the customer’s expected commodity usage for the life of the contract. We recorded accounts receivable from POR markets of $22.1 million and $25.1 million in accounts receivable on the combined balance sheets as of December 31, 2013 and 2012, respectively.

 

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In non-POR markets (and in POR markets where we may choose to direct bill our customers), we manage customer credit risk through formal credit review, in the case of commercial customers, and credit screening, deposits and disconnection for non-payment, in the case of residential customers. Our bad debt expense for each of the year ended December 31, 2013, the three months ended March 31, 2014 and the five months ended May 31, 2014 was less than 1.0% of retail revenues. Economic conditions may affect our and our customers’ ability to pay bills in a timely manner, which could increase customer delinquencies and may lead to an increase in bad debt expense.

How We Evaluate Our Operations

Adjusted EBITDA. We define “Adjusted EBITDA” as EBITDA less (i) customer acquisition costs incurred in the current period, (ii) net gain (loss) on derivative instruments, and (iii) net current period cash settlements on derivative instruments, plus (iv) non-cash compensation expense and (v) other non-cash operating items. EBITDA is defined as net income before provision for income taxes, interest expense and depreciation and amortization. We deduct all current period customer acquisition costs in the Adjusted EBITDA calculation because such costs reflect a cash outlay in the year in which they are incurred, even though we capitalize such costs and amortize them over 24 months in accordance with our accounting policies. The deduction of current period customer acquisition costs is consistent with how we manage our business, but the comparability of Adjusted EBITDA between periods may be affected by varying levels of customer acquisition costs. We deduct our net gains (losses) on derivative instruments, excluding current period cash settlements, from the Adjusted EBITDA calculation in order to remove the non-cash impact of net gains and losses on derivative instruments. Although we have not historically incurred non-cash compensation expense, we expect that we will incur non-cash compensation expense following the completion of this offering as a result of equity awards that may be issued under our long-term incentive plan.

We believe that the presentation of Adjusted EBITDA provides information useful to investors in assessing our liquidity and financial condition and results of operations and that Adjusted EBITDA is also useful to investors as a financial indicator of a company’s ability to incur and service debt, pay dividends and fund capital expenditures. Adjusted EBITDA is a supplemental financial measure that management and external users of our combined financial statements, such as industry analysts, investors, commercial banks and rating agencies, use to assess the following, among other measures:

 

  our operating performance as compared to other publicly traded companies in the retail energy industry, without regard to financing methods, capital structure or historical cost basis;

 

  the ability of our assets to generate earnings sufficient to support our proposed cash dividends; and

 

  our ability to fund capital expenditures (including customer acquisition costs) and incur and service debt.

For a more detailed description of Adjusted EBITDA, including a reconciliation to its most direct financial measures calculated in accordance with GAAP, please see “Prospectus Summary—Non-GAAP Financial Measures.”

Retail Gross Margin. We define retail gross margin as operating income plus (i) depreciation and amortization expenses and (ii) general and administrative expenses, less (i) net asset optimization revenues, (ii) net gains (losses) on derivative instruments, and (iii) net current period cash settlements on derivative instruments. Retail gross margin is included as a supplemental disclosure because it is a primary performance measure used by our management to determine the performance of our retail natural gas and electricity business by removing the impacts of our asset optimization activities and net non-cash income (loss) impact of our economic hedging activities. As an indicator of our retail energy business’ operating performance, retail gross margin should not be considered an alternative to, or more meaningful than, operating income, as determined in accordance with GAAP.

 

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General Trends and Outlook

Product Innovation

We expect to see continued innovation in products and a greater emphasis on bundled offers in the retail energy industry. We intend to begin offering bundled products in the third quarter of 2014. Many retail energy providers have begun offering bundled products and utilizing co-marketing relationships in order to provide customers with a variety of services at lower prices and with the convenience of a single billing system. For example, we recently entered into an agreement to offer customers the option to bundle their energy services with other products such as surge and line protection through our relationship with Cross Country Home Services. We also have a co-marketing relationship with DirecTV in which we co-market their services to our customers. At present, these products and services do not generate material earnings.

The industry is also seeing an increased interest in “distributed generation” alternatives, in which end users are able to rely on their own generation capabilities for all or a part of their electricity needs. Home solar programs are a primary driver of this trend. Energy efficiency products such as smart thermostats and remote thermostat programming that give the consumer the ability to change settings during non-peak usage periods are also being integrated into traditional retail energy offerings.

Environmental Awareness

We believe consumer demand for environmentally friendly alternatives has and will continue to shape the direction of the retail energy industry. For example, we offer renewable and carbon neutral (“green”) products in certain markets. Green energy products are a growing market opportunity and typically provide increased unit margins as a result of improved customer satisfaction and less competition. Renewable electricity products allow customers to choose electricity sourced from wind, solar, hydroelectric and biofuel sources, through the purchase of renewable energy credits (“RECs”). Carbon neutral products give customers the option to reduce or eliminate the carbon footprint associated with their energy usage through the purchase of carbon offset credits. These products typically provide for fixed or variable prices and generally follow the terms of our other products with the added benefit of carbon reduction and reduced environmental impact. We currently offer renewable electricity in all of our electricity markets and carbon neutral natural gas in several of our natural gas markets. We have also begun to partner with solar and other green energy providers in order to co-market our respective green energy services. We believe increasing consumer demand for green energy will continue, and we believe our flexible business model positions us well to meet these demands.

Changes in Regulations

We are subject to regulatory scrutiny in all of our markets. A number of public utility commissions in the northeast are investigating the impact of the harsh weather conditions during the 2013-2014 winter season on consumers in their territories due to the number of consumer complaints attributable to high bills for the winter season and are urging FERC to investigate circumstances during that period in wholesale energy markets. Several states are evaluating new disclosure standards for variable-price products. We anticipate that public utility commissions in these regions may in the future adopt new or revised regulations in response to these customers complaints that could have a negative impact on our business prospects in these regions.

Customer Growth

According to the EIA, over the last decade, residential natural gas accounts served by competitive energy retailers have grown from approximately 3.8 million to approximately 6.6 million (5.6% CAGR) and non-residential

 

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electricity accounts have grown from approximately 433,944 to approximately 837,365 (4.8% CAGR). According to DNV GL, over the last decade, residential electricity accounts served by competitive electricity suppliers have grown from approximately 2.3 million to approximately 16.2 million (21.8% CAGR) and non-residential electricity accounts have grown from approximately 473,000 to approximately 2.8 million (19.6% CAGR).

According to DNV GL, licensing activity for mass market retail electric suppliers over the last year across all competitive energy markets continues to maintain a substantial pace. Customer growth and licensing activity is projected to continue experiencing growth, fueled by increased consumer awareness, changing utility prices and product innovation, as well as a favorable regulatory policy environment. As a result, management believes there is a significant opportunity for competitive retailers to gain market share by offering consumers innovative product options, providing excellent customer service and serving as a competitive choice for their energy supply.

Fragmentation and Consolidation of Market

We believe that favorable market conditions, including lower natural gas and electricity prices and low residential customer penetration, have led to an increase in the number of energy retailers in the United States. The vast majority of these new entrants are small regional energy retailers, which often experience rapid customer growth but have not historically had reliable access to capital or economies of scale to support this growth over the longer term or react to changing commodity price environments. According to DNV GL, 65 residential electricity retailers were active as of June 2013, approximately 77% (50) of which had fewer than 300,000 electricity customers, and approximately 55% (36) of which had fewer than 100,000 customers.

According to DNV GL, market consolidation among the large number of competitive electricity retailers continues at a growing pace. Twenty-two acquisitions of electricity retailers, some of which also provide natural gas, and similar types of ownership transfers were completed from January 1, 2013 to September 30, 2013. Management believes that the current environment of small, private energy retailers presents significant acquisition opportunities to consolidate smaller retailers into our larger and more scalable platform and increase market share.

Natural Gas Market

Natural gas prices are driven by a number of variables including demand from the industrial, residential, and electric sectors, productivity across natural gas supply basins, costs of natural gas production, changes in pipeline infrastructure, and the financial and hedging profile of natural gas consumers and producers. In 2013, average natural gas prices at Henry Hub were 31% higher than 2012. Although supply continues to increase, reflecting increased production from mainly the shale basins, winter weather and delivery system constraints in January 2014 caused natural gas within several northeastern markets to trade in excess of $100/MMbtu for short periods of time. Prolonged or unanticipated increased natural gas prices can erode our retail gross margin on both our natural gas and electricity sales.

Factors Affecting Comparability of Historical Financial Results

Tax Receivable Agreement. The Tax Receivable Agreement will provide for the payment by Spark Energy, Inc. to NuDevco of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that Spark Energy, Inc. actually realizes (or is deemed to realize in certain circumstances) in periods after this offering as a result of (i) any tax basis increases resulting from the purchase by Spark Energy, Inc. of Spark HoldCo units from NuDevco Retail Holdings prior to or in connection with this offering, (ii) any tax basis increases resulting from the exchange of Spark HoldCo units for shares of Class A common stock pursuant to the Exchange Right (or resulting from an exchange of Spark HoldCo units for cash pursuant to the Cash Option) and (iii) any imputed interest deemed to be paid by us as a result of, and additional tax basis arising from, any payments we make

 

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under the Tax Receivable Agreement. In addition, payments we make under the Tax Receivable Agreement will be increased by any interest accrued from the due date (without extensions) of the corresponding tax return. We will record 85% of the estimated tax benefit as an increase to amounts payable under the Tax Receivable Agreement as a liability. See “Certain Relationships and Related Party Transactions—Tax Receivable Agreement.”

Executive Compensation Programs. As described in “Executive Compensation—Compensation Following this Offering,” in connection with this offering, we expect to grant restricted stock units to our non-employee directors, and certain of our officers, employees and employees of certain of our affiliates who perform services for us valued at an aggregate of approximately $7.7 million under our long-term incentive plan. It is expected that the initial restricted stock unit awards will generally vest ratably over three or four years commencing May 4, 2015 and will include tandem dividend equivalents that will vest upon the same schedule. Accordingly, assuming they all vest in accordance with their vesting schedule, this grant of restricted stock units will result in a charge to our income statement of $1.2 million in 2014, $2.2 million in 2015, $2.1 million in 2016, $1.6 million in 2017, and $0.6 million in 2018. Although we have not historically paid equity compensation, we expect that, going forward, equity will comprise a portion of our compensation program. We cannot, however, predict the amount of future equity awards or the effect of any potential equity awards on our overall compensation structure and, as a result, cannot accurately predict the effects of future equity compensation on our financial statements or future results of operations.

Asset Optimization Business. We contract for term transportation capacity in connection with our asset optimization activities which obligates us to pay demand charges to the relevant counterparty. For 2014, we are obligated to pay demand charges for certain transportation assets of approximately $2.6 million. Although these demand payments will decrease over time, the related capacity agreements extend through 2028. Prior to 2013, we entered into several hedging transactions associated with this capacity. As a result of weather-related pipeline transportation constraints, our hedging strategy for the winter of 2012 through 2013 on one of those transactions involving interruptible transportation resulted in losses that were recognized in late 2012 and 2013. We have since revised our risk policies such that this business is limited to back-to-back purchase and sale transactions, or open positions subject to our aggregate net open position limits, which are not held for a period longer than two months. Further, all additional capacity procured outside of a utility allocation of retail assets must be approved by our risk committee, hedges on our firm transportation obligations are limited to two years or less and hedging of interruptible capacity is prohibited.

Asset optimization opportunities primarily arise during the winter heating season when demand for natural gas is the highest. As such, we expect the majority of our asset optimization profits to made in the winter. Given the opportunistic nature of these activities we will experience variability in our earnings from our asset optimization activities from year to year. As these activities are accounted for using mark-to-market accounting, the timing of our revenue recognition may differ from the actual cash settlement.

Public Company Costs. We expect that we will incur incremental general and administrative (“G&A”) expenses as a result of this offering. Specifically, we will incur certain expenses related to being a publicly traded company, including costs associated with SEC reporting requirements, tax return preparation, independent auditor fees, investor relations activities, Sarbanes-Oxley compliance, registrar and transfer agent fees, director and officer liability insurance expense and additional director compensation. These costs will be allocated to Spark HoldCo pursuant to the Spark HoldCo LLC Agreement.

Financing. The total amounts outstanding under our prior credit facility as of December 31, 2013 and March 31, 2014, include amounts used to fund equity distributions to our common control owner to fund operations of an

 

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affiliated company. As such, historical borrowings under our prior credit facility may not provide an accurate indication of what we need to operate our natural gas and electricity business.

Historical Financial and Operating Data

The following table shows our summary combined historical financial data, for the fiscal years ended December 31, 2012 and 2013 and the three months ended March 31, 2013 and 2014. The following table should be read in conjunction with “Selected Historical and Unaudited Pro Forma Combined Financial and Operating Data.”

 

     Historical  
    Year Ended December 31,     Three Months Ended March 31,  
     2012     2013               2013               

          2014          

 
                      (restated)  
                (unaudited)  

Statement of Operations Data (in thousands):

       

Revenues:

       

Retail revenues (including retail revenues—affiliates of $1,382 and $4,022 for the years ended December 31, 2012 and 2013, respectively, and $199 and $1,489 for the three months ended March 31, 2013 and 2014, respectively)

  $ 380,198      $ 316,776      $ 100,453      $ 104,352   

Net asset optimization revenues (including asset optimization revenues-affiliates of $8,334 and $14,940 for the years ended December 31, 2012 and 2013, and $1,500 and $2,500 for the three months ended March 31, 2013 and 2014, respectively, and asset optimization revenues affiliate cost of revenues of $568 and $15,928 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million and $7,900 for the three months ended March 31, 2013 and 2014, respectively)

    (1,136     314        (1,157     1,624   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    379,062        317,090        99,296        105,976   

Operating expenses:

       

Retail cost of revenues (including retail cost of revenues-affiliates of $254 and $55 for the years ended December 31, 2012 and 2013, respectively, and less than $0.1 million for the three months ended March 31, 2013 and 2014, respectively)

    279,506        233,026        69,993        88,121   

General and administrative

    47,321        35,020        9,275        8,113   

Depreciation and amortization

    22,795        16,215        5,030        2,959   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    349,622        284,261        84,298        99,193   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    29,440        32,829        14,998        6,783   

Other (expense)/income:

       

Interest expense

    (3,363     (1,714     (384     (313

Interest income and other income

    62        353        11        70   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expense)/income

    (3,301     (1,361     (373     (243

Income before income tax expense

    26,139        31,468        14,625        6,540   

Income tax expense

    46        56        14        32   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 26,093      $ 31,412      $ 14,611      $ 6,508   
 

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Data:

       

Adjusted EBITDA(1)

  $ 40,659      $ 33,533      $ 19,048      $ 9,322   

Retail gross margin(1)

  $ 93,219      $ 81,668      $ 31,740      $ 17,684   

Other Operating Data:

       

Customer acquisition costs

  $ 6,322      $ 8,257      $ 220      $ 5,227   

Customers

    237,436        210,556        215,715        240,993   

Natural gas volumes (MMBtu)

    17,527,252        16,598,751        6,994,627        6,593,580   

Electricity volumes (MWh)

    2,698,084        1,829,657        478,426        384,275   

 

(1) Adjusted EBITDA and retail gross margin are non-GAAP financial measures. For a definition and a reconciliation of each of Adjusted EBITDA and retail gross margin to their most directly comparable financial measures calculated and presented in accordance with GAAP, please see “Prospectus Summary—Non-GAAP Financial Measures.”

 

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Combined Results of Operations

Our results of operations are significantly influenced by our customer acquisition spending, although the impact of increasing or reducing our customer counts on our results of operations may not occur until several months after the shift in strategy. While the time required to recoup the costs we expend to acquire new customers varies based upon contract terms and prevailing market conditions, we typically recover our customer acquisition costs within twelve months. In addition, we generally begin to recognize margin improvements from new customer acquisitions six to twelve months after the customer acquisition cost has been incurred. Similarly, the negative impact on our results of operations of a shift in strategy to decrease customer acquisitions will occur over time as natural customer attrition occurs.

In 2011, we invested approximately $24 million in growing and maintaining our customer base. The expansion was successful in expanding our customer base by approximately 63% or 123,000 customers, net of attrition, in 2011. In 2012, our owner made the determination to invest excess cash flows from our operations in other affiliated businesses. As a result, we significantly reduced our customer acquisition costs, including completely discontinuing some marketing channels, and focused our efforts on integrating and optimizing our existing expanded customer base. In addition, we took steps to decrease our general and administrative expenses through implementation of system improvements and reduced head count to create a more efficient scalable platform. In the year ended December 31, 2012, our increased volumes resulting from the realization of prior efforts to expand our customer base, combined with reduced customer acquisition and general and administrative costs resulted in significantly increased Adjusted EBITDA as compared to prior periods.

In 2013, we continued to evaluate our customer base through segmentation and optimization strategies, which resulted in reduced customer count as certain underperforming segments experienced higher attrition levels. This segmentation and corresponding customer attrition, coupled with a decreased focus on lower margin commercial customers in 2013, resulted in lower overall sales volumes and Adjusted EBITDA in our retail segments in 2013, but increased gross margin per unit sold.

Recognizing the growth opportunities in the retail energy space, beginning in the second quarter of 2013, we increased our customer acquisition spending and reactivated certain marketing channels. By the end of 2013, we had grown the customer base by 8% from the low point in August of 2013. This growth trajectory has increased through the first quarter of 2014 resulting in an increase of approximately 24% in our customer base as of March 31, 2014 from August of 2013. Consistent with our historical experience, we anticipate seeing the results of this expansion reflected in gross margins six to twelve months from the acquisition date of each customer.

Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012

Total Revenues. Total revenues for the year ended December 31, 2013 were approximately $317.1 million, a decrease of approximately $62.0 million, or 16%, from approximately $379.1 million for the year ended December 31, 2012. This decrease was primarily due to lower customer sales volumes, which resulted in a decrease in total revenues of $89.2 million. This decrease was offset by an increase of total revenues of $25.7 million due to increased customer pricing and a $1.5 million increase in net asset optimization revenues.

Net Asset Optimization Revenues. Net asset optimization revenues for the year ended December 31, 2013 were approximately $0.3 million, an increase of approximately $1.4 million, or 128%, from $(1.1) million in the same period in the prior year. We recognized losses in late 2012 and early 2013 on a hedge strategy involving interruptible transportation, partially offset by increased arbitrage opportunities in the fourth quarter of 2013 in the northeast United States.

 

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Retail Cost of Revenues. Total retail cost of revenues for the year ended December 31, 2013 was approximately $233.0 million, a decrease of approximately $46.5 million, or 17%, from approximately $279.5 million for the year ended December 31, 2012. This decrease was primarily due to lower customer sales volumes, which resulted in a decrease in total retail cost of revenues of $70.0 million. This decrease was offset by an increase of total retail cost of revenues of $18.1 million due to energy supply prices and a $5.4 million decrease in net gains on retail derivative instruments, net of cash settlements.

General and Administrative Expense. General and administrative expense for the year ended December 31, 2013 was approximately $35.0 million, a decrease of approximately $12.3 million or 26%, as compared to $47.3 million for the year ended December 31, 2012. Approximately $8.0 million of the decrease in our general and administrative expenses was due to a companywide initiative to reduce costs and realize operational efficiencies in conjunction with our shift in focus from increasing our customer base to optimizing our customer base. Additionally, approximately $2.7 million was attributable to a decrease in sales and marketing expenses.

Depreciation and Amortization Expense. Depreciation and amortization expense for the year ended December 31, 2013 was approximately $16.2 million, a decrease of approximately $6.6 million, or 29%, from approximately $22.8 million in the same period in the prior year. This decrease was primarily due to the amortization in 2011 of a portion of higher customer acquisition costs that were incurred in 2011.

Interest Expense. Interest expense for the year ended December 31, 2013 was approximately $1.7 million, a decrease of approximately $1.7 million, or 50%, from approximately $3.4 million in the same period in the prior year. This decrease was primarily due to reduced interest expense due to lower average borrowing amounts during the year as a result of reduced customer acquisition expenses in connection with the strategic initiative to optimize our customer base in 2012 discussed above.

Customer Acquisition Cost. Customer acquisition cost for the year ended December 31, 2013 was approximately $8.3 million, an increase of approximately $2.0 million, or 31%, from approximately $6.3 million in the prior year. This increase was primarily due to increasing our marketing efforts during the second half of 2013 to grow our customer base.

Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013

Total Revenues. Total revenues for the three months ended March 31, 2014 were approximately $106.0 million, an increase of approximately $6.7 million, or 7%, from approximately $99.3 million for the three months ended March 31, 2013. This increase was primarily due to increased customer pricing that we effected to capture a portion of increased supply costs from our customers, which resulted in an increase in total revenues of $16.3 million, as well as a $2.8 million increase in net asset optimization revenues. This increase was offset by a decrease of $12.4 million due to customer sales volumes which were lower, primarily due to the strategic shift of the concentration of our marketing efforts from commercial customers to residential customers.