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EX-32 - EXHIBIT 32 CERTIFICATION BY CEO AND CFO - Spark Energy, Inc.certceoandcfoexh32-q22016.htm
EX-31.2 - EXHIBIT 31.2 CERTIFICATION BY CFO - Spark Energy, Inc.certcfoexh312-q22016.htm
EX-31.1 - EXHIBIT 31.1 - Spark Energy, Inc.certceoexh311-q22016.htm
EX-10.4 - EXHIBIT 10.4 AMENDMENT NO 3 TO AMENDED AND RESTATED CREDIT FACILITY - Spark Energy, Inc.exh104-amendmentno3totheam.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended June 30, 2016
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from          to          
 
Commission File Number: 001-36559
Spark Energy, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
 
 
Delaware
 
 
 
46-5453215
(State or other jurisdiction of
incorporation or organization)
 
 
 
(I.R.S. Employer
Identification No.)
12140 Wickchester Ln, Suite 100
Houston, Texas 77079

(Address of principal executive offices)
 
(713) 600-2600
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x    No o
 

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

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

Non-accelerated filer o (Do not check if a smaller reporting company)          Smaller reporting company x
    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No x

There were 6,493,152 shares of Class A common stock and 8,224,742 shares of Class B common stock outstanding as of August 9, 2016.



 
PART I. FINANCIAL INFORMATION
 
 
ITEM 1. FINANCIAL STATEMENTS
 
 
 
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2016 AND DECEMBER 31, 2015 (unaudited)
 
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED JUNE 30, 2016 AND 2015 AND THE SIX MONTHS ENDED JUNE 30, 2016 AND 2015 (unaudited)
 
 
 
 
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2016 (unaudited)

 
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2016 AND 2015 (unaudited)
 
 
 
 
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
 
 
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
ITEM 4. CONTROLS AND PROCEDURES
 
PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
ITEM 1A. RISK FACTORS
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
ITEM 4. MINE SAFETY DISCLOSURES
 
ITEM 5. OTHER INFORMATION
 
ITEM 6. EXHIBITS
 
APPENDIX A
 
SIGNATURES
 
EXHIBIT INDEX
 


1


PART 1. — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
SPARK ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2016 AND DECEMBER 31, 2015
(in thousands)
(unaudited)
 
June 30, 2016
 
December 31, 2015
Assets

 

Current assets:

 

Cash and cash equivalents
$
7,262


$
4,474

Accounts receivable, net of allowance for doubtful accounts of $2.0 million and $1.9 million as of June 30, 2016 and December 31, 2015
42,677


59,936

Accounts receivable—affiliates
1,009


1,840

Inventory
1,827


3,665

Fair value of derivative assets
2,705


605

Customer acquisition costs, net
11,857


13,389

Customer relationships, net
4,964


6,627

Prepaid assets (1)
1,699


700

Deposits
3,565


7,421

Other current assets
4,763


4,023

Total current assets
82,328

 
102,680

Property and equipment, net
5,035


4,476

Fair value of derivative assets
439

 

Customer acquisition costs, net
2,436


3,808

Customer relationships, net
4,418


6,802

Non-current deferred tax assets
52,460


23,380

Goodwill
18,379


18,379

Other assets
2,567


2,709

Total assets
$
168,062

 
$
162,234

Liabilities and Stockholders' Equity

 

Current liabilities:

 

Accounts payable
$
22,257

 
$
29,732

Accounts payable—affiliates
1,990

 
1,962

Accrued liabilities
14,368

 
12,245

Fair value of derivative liabilities
1,929

 
10,620

Current portion of Senior Credit Facility
5,306


27,806

Current payable pursuant to tax receivable agreement—affiliates
1,407

 

Other current liabilities
2,308


1,823

Total current liabilities
49,565

 
84,188

Long-term liabilities:


 


Fair value of derivative liabilities
458

 
618

Long-term payable pursuant to tax receivable agreement—affiliates
46,768


20,713

Long-term portion of Senior Credit Facility
11,939


14,592

Non-current deferred tax liability


853

Convertible subordinated notes to affiliate
6,502


6,339

Other long-term liabilities


1,612

Total liabilities
115,232

 
128,915

Commitments and contingencies (Note 10)





Stockholders' equity:





       Common Stock:





Class A common stock, par value $0.01 per share, 120,000,000 shares authorized, 6,470,128 issued and outstanding at June 30, 2016 and 3,118,623 issued and outstanding at December 31, 2015
65


31

Class B common stock, par value $0.01 per share, 60,000,000 shares authorized, 7,525,000 issued and outstanding at June 30, 2016 and 10,750,000 issued and outstanding at December 31, 2015
76


108

        Preferred Stock:





Preferred stock, par value $0.01 per share, 20,000,000 shares authorized, zero issued and outstanding at June 30, 2016 and December 31, 2015



        Additional paid-in capital
21,997


12,565

Accumulated other comprehensive loss
(28
)
 

        Retained earnings (deficit)
1,491


(1,366
)
       Total stockholders' equity
23,601


11,338

Non-controlling interest in Spark HoldCo, LLC
29,229


21,981

       Total equity
52,830


33,319

Total liabilities and stockholders' equity
$
168,062


$
162,234

(1)
Prepaid assets includes prepaid assets—affiliates of $100 and $210 as of June 30, 2016 and December 31, 2015, respectively. See Note 11 "Transaction with Affiliates" for further discussion.
(2)
See Note 3 "Equity" for disclosure of our variable interest entity in Spark HoldCo, LLC.
The accompanying notes are an integral part of the condensed consolidated financial statements.

2


SPARK ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2016 AND 2015
(in thousands, except per share data)
(unaudited)

Three Months Ended June 30,
Six Months Ended June 30,

2016
 
2015 (1)
2016

2015 (1)
Revenues:
 
 
 



Retail revenues
$
76,863

 
$
70,310

$
186,882


$
170,184

Net asset optimization (expenses) revenues (2)
(676
)
 
(67
)
(150
)

1,862

Total Revenues
76,187

 
70,243

186,732


172,046

Operating Expenses:

 
 



Retail cost of revenues (3)
37,845

 
45,948

106,644


115,033

General and administrative (4)
16,199

 
13,712

33,580


28,416

Depreciation and amortization
6,244

 
6,038

13,033


10,316

Total Operating Expenses
60,288

 
65,698

153,257


153,765

Operating income
15,899

 
4,545

33,475


18,281

Other (expense)/income:

 
 



Interest expense
(619
)
 
(234
)
(1,373
)

(615
)
Interest and other income
194

 
186

99


321

Total other expenses
(425
)
 
(48
)
(1,274
)

(294
)
Income before income tax expense
15,474

 
4,497

32,201


17,987

Income tax expense
4,736

 
458

5,723


1,019

Net income
$
10,738

 
$
4,039

$
26,478


$
16,968

Less: Net income attributable to non-controlling interests
8,397

 
3,878

19,964


14,398

Net income attributable to Spark Energy, Inc. stockholders
$
2,341

 
$
161

$
6,514


$
2,570

Other comprehensive loss, net of tax:
 
 
 
 
 
 
Currency translation loss
$
(61
)
 
$

$
(61
)
 
$

Other comprehensive loss
(61
)


(61
)


Comprehensive income
$
10,677

 
$
4,039

$
26,417

 
$
16,968

Less: Comprehensive income attributable to non-controlling interests
8,364


3,878

19,931


14,398

Comprehensive income attributable to Spark Energy, Inc. stockholders
$
2,313


$
161

$
6,486


$
2,570


 
 
 
 
 
 
Net income attributable to Spark Energy, Inc. per share of Class A common stock
 
 
 



       Basic
$
0.39


$
0.05

$
1.33


$
0.85

       Diluted
$
0.30


$
0.05

$
1.25


$
0.80










Weighted average shares of Class A common stock outstanding








       Basic
6,043


3,062

4,899


3,031

       Diluted
6,639


3,062

14,485


13,781

(1)
Financial information has been recast to include results attributable to the acquisition of Oasis Power Holdings LLC from an affiliate on May 12, 2015. See Note 2 "Basis of Presentation" for further discussion.
(2)
Net asset optimization (expenses) revenues includes asset optimization revenues—affiliates of $41 and $176 for the three months ended June 30, 2016 and 2015, respectively, and asset optimization revenues—affiliates cost of revenues of $376 and $3,114 for the three months ended June 30, 2016 and 2015, respectively and asset optimization revenues—affiliates of $154 and $665 for the six months ended June 30, 2016 and 2015, respectively, and asset optimization revenue—affiliates cost of revenues of $1,633 and $6,207 for the six months ended June 30, 2016 and 2015, respectively.
(3)
Retail cost of revenues includes retail cost of revenues—affiliates of less than $100 for each of the three and six months ended June 30, 2016 and 2015, respectively.
(4)
General and administrative includes general and administrative expense—affiliates of $4.0 million and $0 for the three months ended June 30, 2016, and 2015, respectively, and $8.4 million and $0 for the six months ended June 30, 2016 and 2015, respectively.

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

3


SPARK ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2016
(in thousands)
(unaudited)

Issued Shares of Class A Common Stock
Issued Shares of Class B Common Stock
Issued Shares of Preferred Stock
Class A Common Stock
Class B Common Stock
Accumulated Other Comprehensive Income (Loss)
Additional Paid-in Capital
Retained Earnings (Deficit)
Total Stockholders' Equity
Non-controlling Interest
Total Equity
Balance at December 31, 2015
3,119

10,750


$
31

$
108

$

$
12,565

$
(1,366
)
$
11,338

$
21,981

$
33,319

Stock based compensation






690


690


690

Restricted stock unit vesting
126



2



1,214


1,216


1,216

Excess tax benefit related to restricted stock vesting






141


141


141

Consolidated net income







6,514

6,514

19,964

26,478

Foreign currency translation adjustment for equity method investee





(28
)


(28
)
(33
)
(61
)
Beneficial conversion feature






63


63


63

Distributions paid to non-controlling unit holders









(9,967
)
(9,967
)
Dividends paid to Class A common stockholders







(3,657
)
(3,657
)

(3,657
)
Proceeds from disgorgement of stockholder short-swing profits






580


580


580

Tax impact from tax receivable agreement upon exchange of units of Spark HoldCo, LLC to shares of Class A Common Stock






4,028


4,028


4,028

Exchange of shares of Class B common stock to shares of Class A common stock
3,225

(3,225
)

32

(32
)

2,716


2,716

(2,716
)

Balance at June 30, 2016
6,470

7,525


$
65

$
76

$
(28
)
$
21,997

$
1,491

$
23,601

$
29,229

$
52,830

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


4


SPARK ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2016 AND 2015
(in thousands)
(unaudited) 
  
Six Months Ended June 30,
  
2016

2015 (1)
Cash flows from operating activities:



Net income
$
26,478


$
16,968

Adjustments to reconcile net income to net cash flows provided by operating activities:



Depreciation and amortization expense
13,033


10,316

Deferred income taxes
1,556


277

Stock based compensation
2,441


1,159

Amortization of deferred financing costs
235


101

Change in fair value of CenStar Earnout
1,000

 

Bad debt expense
462


4,179

Loss on derivatives, net
4,339


6,179

Current period cash settlements on derivatives, net
(15,828
)

(9,076
)
Accretion of discount to convertible subordinated notes to affiliate
71



Interest paid in kind - subordinated convertible notes
155

 

Income on equity method investment in eREX Spark Marketing Joint Venture
(104
)
 

Changes in assets and liabilities:



Decrease in restricted cash


707

Decrease in accounts receivable
16,797


19,608

Decrease in accounts receivable—affiliates
830


698

Decrease in inventory
1,837


5,087

Increase in customer acquisition costs
(5,104
)

(11,900
)
Decrease in prepaid and other current assets
1,881


5,610

Increase in intangible assets—customer relationships


(2,720
)
Decrease in other assets
535


457

Decrease in accounts payable and accrued liabilities
(5,002
)

(12,087
)
Increase (decrease) in accounts payable—affiliates
28


(228
)
Decrease in other current liabilities
(414
)

(1,195
)
(Decrease) increase in other non-current liabilities
(1,612
)

1,553

Net cash provided by operating activities
43,614


35,693

Cash flows from investing activities:



Purchases of property and equipment
(1,449
)

(892
)
Investment in eREX Spark Marketing Joint Venture
(413
)


Net cash used in investing activities
(1,862
)

(892
)
Cash flows from financing activities:



Borrowings on the Senior Credit Facility


6,000

Payments on the Senior Credit Facility
(25,152
)

(30,000
)
Contributions from NuDevco


129

Proceeds from disgorgement of stockholders short-swing profits
580

 

Restricted stock vesting
(909
)

(270
)
Excess tax benefit related to restricted stock vesting
141



Payment of dividends to Class A common stockholders
(3,657
)

(2,210
)
        Payment of distributions to non-controlling unitholders
(9,967
)

(7,794
)
Net cash used in financing activities
(38,964
)

(34,145
)
Increase in cash and cash equivalents
2,788


656

Cash and cash equivalents—beginning of period
4,474


4,359

Cash and cash equivalents—end of period
$
7,262


$
5,015

Supplemental Disclosure of Cash Flow Information:



Non-cash items:
 
 
 
       Liability due to tax receivable agreement
$
(27,462
)
 
$

       Tax benefit from tax receivable agreement
$
31,490

 
$

Construction in process accrual
$
22

 
$
179

Cash paid during the period for:
 
 
 
Interest
$
944


$
598

Taxes
$
1,892


$
150

(1)
Financial information has been recast to include results attributable to the acquisition of Oasis Power Holdings LLC from an affiliate on May 12, 2015. See Note 2 "Basis of Presentation" for further discussion.
The accompanying notes are an integral part of the condensed consolidated financial statements.

5


SPARK ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Formation and Organization
Organization

Spark Energy, Inc. ("Spark Energy," the "Company," "we" or "us") is an independent retail energy services company that provides residential and commercial customers in competitive markets across the United States with an alternative choice for natural gas and electricity. The Company is a holding company whose sole material asset consists of units in Spark HoldCo, LLC (“Spark HoldCo”). Spark HoldCo owns all of the outstanding membership interests or shares in each of Spark Energy, LLC (“SE”), Spark Energy Gas, LLC (“SEG”), Oasis Power Holdings, LLC ("Oasis") and CenStar Energy Corp. ("CenStar"), the operating subsidiaries through which the Company operates. The Company is the sole managing member of Spark HoldCo, is responsible for all operational, management and administrative decisions relating to Spark HoldCo’s business and consolidates the financial results of Spark HoldCo and its subsidiaries.
SE is a licensed retail electric provider in multiple states. SE provides retail electricity services to end-use retail customers, ranging from residential and small commercial customers to large commercial and industrial users. SE was formed on February 5, 2002 under the Texas Revised Limited Partnership Act (as recodified by the TBOC) and was converted to a Texas limited liability company on May 21, 2014.

SEG is a retail natural gas provider and asset optimization business competitively serving residential, commercial and industrial customers in multiple states. SEG was formed on January 17, 2001 under the Texas Revised Limited Partnership Act (as recodified by the TBOC) and was converted to a Texas limited liability company on May 21, 2014.

Oasis, through its operating subsidiary, Oasis Power LLC, is a retail energy provider formed on August 28, 2009 as a limited liability company under the TBOC. We acquired Oasis on July 31, 2015 from an affiliate.

CenStar is a retail energy provider incorporated on July 18, 2008 under the New York Business Corporation Law. We acquired CenStar on July 8, 2015.

We are a Delaware corporation formed on April 22, 2014 for the purpose facilitating an initial public offering ("IPO") of our Class A common stock, par value $0.01 per share ("Class A common stock"), and to become the sole managing member of, and to hold an ownership interest in, Spark HoldCo. In connection with our IPO, NuDevco Retail Holdings LLC ("NuDevco Retail Holdings") formed NuDevco Retail, LLC (“NuDevco Retail”), a single member limited liability company, on May 29, 2014, to hold the remaining Spark HoldCo units and shares of our Class B common stock, par value $0.01 per share ("Class B common stock"). In January 2016, Retailco, LLC ("Retailco") succeeded to the interest of NuDevco Retail Holdings of its Class B common stock and an equal number of Spark HoldCo units it held pursuant to a series of transfers. See Note 3 “Equity” for further discussion.
W. Keith Maxwell, III is the owner of a majority in voting power of our common stock through his ownership of NuDevco Retail and Retailco. Retailco is a wholly owned subsidiary of TxEx Energy Investments, LLC ("TxEx"), which is wholly owned by Mr. Maxwell. NuDevco Retail is a wholly owned subsidiary of NuDevco Retail Holdings, which is a wholly owned subsidiary of Electric HoldCo, LLC, which is also a wholly owned subsidiary of TxEx.

Emerging Growth Company Status

As a company with less than $1.0 billion in revenues during its last fiscal year, the Company qualifies as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other regulatory requirements.

6



The Company will remain an “emerging growth company” until as late as the last day of the Company's 2019 fiscal year, or until the earliest of (i) the last day of the fiscal year in which the Company has $1.0 billion or more in annual revenues; (ii) the date on which the Company becomes a “large accelerated filer” (the fiscal year-end on which the total market value of the Company’s common equity securities held by non-affiliates is $700 million or more as of June 30); (iii) the date on which the Company issues more than $1.0 billion of non-convertible debt over a three-year period.
As a result of the Company's election to avail itself of certain provisions of the JOBS Act, the information that the Company provides may be different than what you may receive from other public companies in which you hold an equity interest.
Exchange and Registration Rights

The Spark HoldCo Limited Liability Company Agreement provides that anytime the Company issues a new share of Class A or Class B common stock (except for issuances of Class A common stock upon an exchange of Class B common stock), Spark HoldCo will concurrently issue a limited liability company unit either to the holder of the Class B common stock or to the Company in the case of the issuance of shares of Class A common stock. As a result, the number of Spark HoldCo units held by the Company always equals the number of shares of Class A common stock outstanding.

Each share of Class B common stock, all of which are held by NuDevco Retail and Retailco, has no economic rights but entitles the holder to one vote on all matters to be voted on by stockholders generally. Holders of Class A common stock and Class B common stock 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 by our certificate of incorporation.
NuDevco Retail and Retailco have the right to exchange (the “Exchange Right”) all or a portion of their 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. In addition, NuDevco Retail and Retailco have the right, under certain circumstances, to cause the Company to register the offer and resale of NuDevco Retail's and Retailco's shares of Class A common stock obtained pursuant to the Exchange Right.
2. Basis of Presentation
The accompanying interim unaudited condensed consolidated financial statements (“interim statements”) of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC"), and include all wholly owned subsidiaries. This information should be read in conjunction with our consolidated financial statements and notes contained in our annual report on Form 10-K for the year ended December 31, 2015. The Company's unaudited condensed consolidated financial statements are presented on a consolidated basis and include all wholly-owned and controlled subsidiaries. We account for investments over which we have significant influence but not a controlling financial interest using the equity method of accounting.
The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the interim financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Effects on the business, financial condition and results of operations resulting from revisions to estimates are recognized when the facts that give rise to the revision become known. The information furnished herein reflects all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the condensed consolidated financial statements. Operating results

7


for the three and six months ended June 30, 2016 are not necessarily indicative of the results which may be expected for the full year or for any interim period. 

Transactions with Affiliates
The Company also enters into transactions with and pays certain costs on behalf of affiliates that are commonly controlled by W. Keith Maxwell III, and these affiliates enter into transactions with and pay certain costs on our behalf, in order to reduce risk, reduce administrative expense, create economies of scale, create strategic alliances and supply goods and services among these related parties.
These transactions include, but are not limited to, employee benefits provided through the Company’s benefit plans, insurance plans, leased office space, administrative salaries for management due diligence work, recurring management consulting, and accounting, tax, legal, or technology services based on services provided, departmental usage, or headcount, which are considered reasonable by management. As such, the accompanying condensed consolidated financial statements include costs that have been incurred by the Company and then directly billed or allocated to affiliates, and costs that have been incurred by our affiliates and then directly billed or allocated to us, and are recorded net in general and administrative expense on the condensed consolidated statements of operations with a corresponding accounts receivable—affiliates or accounts payable—affiliates, respectively, recorded in the condensed consolidated balance sheets. Additionally, the Company enters into transactions with certain affiliates for sales or purchases of natural gas and electricity, which are recorded in retail revenues, retail cost of revenues and net asset optimization revenues in the condensed consolidated statements of operations with a corresponding accounts receivable—affiliate or accounts payable—affiliate in the condensed consolidated balance sheets. The allocations and related estimates and assumptions are described more fully in Note 11 “Transactions with Affiliates.”

Presentation of the Acquisition of Oasis Power Holdings, LLC

On May 12, 2015, Retailco Acquisition Co, LLC ("RAC"), an affiliate of NuDevco Retail Holdings, completed the acquisition of 100% of the membership interests of Oasis. Also, on May 12, 2015, Spark HoldCo entered into a Membership Interest Purchase Agreement (the "Oasis Purchase Agreement") with RAC for the purchase of all the membership interests of Oasis. Spark HoldCo completed the acquisition of Oasis from RAC on July 31, 2015. Because the acquisition of Oasis was a transfer of equity interests of entities under common control, the Company's historical financial statements for the three and six months ended June 30, 2015 previously filed with the SEC have been recast in this Form 10-Q to include the results attributable to Oasis from May 12, 2015. The unaudited condensed consolidated financial statements for this recast period have been prepared from RAC's historical cost-basis and may not necessarily be indicative of the actual results of operations that would have occurred had the Company owned Oasis during the recast period.

Subsequent Events

Subsequent events have been evaluated through the date these financial statements are issued. Any material subsequent events that occurred prior to such date have been properly recognized or disclosed in the condensed consolidated financial statements. See Note 13 “Subsequent Events” for further discussion.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB") issued Accounting Standards Update (“ASU”) No. 2014-09 ("ASU 2014-09"), Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date to periods beginning after December 15, 2017. Early adoption is permitted only as of annual

8


reporting periods beginning after December 15, 2016. The Company is selecting a transition method and determining the effect of the standard on its ongoing financial reporting.

The FASB issued additional amendments to ASU 2014-09, as amended by ASU 2015-14:
March 2016 - ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) ("ASU 2016-08"). ASU 2016-08 clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to customers.
April 2016 - ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing ("ASU 2016-10"). ASU 2016-10 covers two specific topics: performance obligations and licensing. This amendment includes guidance on immaterial promised goods or services, shipping or handling activities, separately identifiable performance obligations, functional or symbolic intellectual property licenses, sales-based and usage-based royalties, license restrictions (time, use, geographical) and licensing renewals.
May 2016 - ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients ("ASU 2016-12"). ASU 2016-12 clarifies certain core recognition principles including collectability, sales tax presentation, noncash consideration, contract modifications and completed contracts at transition and disclosures no longer required if the full retrospective transition method is adopted.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 amends existing guidance to require subsequent measurement of inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Earlier application is permitted as of the beginning of an interim or annual reporting period. The Company does not expect the adoption of ASU 2015-11 will have a material effect on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 amends existing accounting standards for lease accounting by requiring entities to include substantially all leases on the balance sheet by requiring the recognition of right-of-use assets and lease liabilities for all leases. Entities may elect to not recognize leases with a maximum possible term of less than 12 months. For lessees, a lease is classified as finance or operating and the asset and liability are initially measured at the present value of the lease payments. For lessors, accounting for leases is largely unchanged from previous guidance. ASU 2016-02 also requires qualitative disclosures along with certain specific quantitative disclosures for both lessees and lessors. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, with early adoption permitted, and is effective for interim periods in the year of adoption. The ASU should be applied using a modified retrospective approach, which requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718) ("ASU 2016-09"). ASU 2016-09 includes provisions intended to simplify various aspects of accounting for shared-based payments, including income tax consequences, classification of awards as either equity or liability and classification on the statement of cash flows. Under current U.S. GAAP, excess tax benefits are currently recorded in equity and as presented as a financing activity on the statement of cash flows. Upon adoption, excess tax benefits for share-based payments will be recorded as a reduction of income taxes and reflected in operating cash flows. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 requires entities to use a current

9


expected credit loss ("CECL") model, which is a new impairment model based on expected losses rather than incurred losses. The model requires financial assets measured at amortized cost be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected credit losses during the period. The measurement of expected losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.
3. Equity

Non-controlling Interest

The Company holds an economic interest and is the sole managing member in Spark HoldCo, with NuDevco Retail and Retailco holding the remaining economic interest in Spark HoldCo. As a result, the Company has consolidated the financial position and results of operations of Spark HoldCo and reflected the economic interest retained by NuDevco Retail and Retailco as a non-controlling interest.

From January 1, 2015 through June 30, 2016, the Company and NuDevco Retail and Retailco owned the following economic interests in Spark HoldCo:

 
The Company
NuDevco Retail and Retailco (1)
From January 1, 2015 to May 3, 2015
21.82
%
78.18
%
From May 4, 2015 to December 30, 2015
22.37
%
77.63
%
From December 31, 2015 to February 2, 2016
22.49
%
77.51
%
From February 3, 2016 to March 31, 2016
29.70
%
70.30
%
From April 1, 2016 to May 3, 2016
42.14
%
57.86
%
From May 4, 2016 to May 17, 2016
42.46
%
57.54
%
From May 18, 2016 to May 24, 2016
42.64
%
57.36
%
From May 25, 2016 to June 7, 2016
42.66
%
57.34
%
From June 8, 2016 to June 30, 2016
46.23
%
53.77
%
(1)
In January 2016, Retailco succeeded to the interest of NuDevco Retail Holdings of its Class B common stock and an equal number of Spark HoldCo units it held pursuant to a series of transfers.

The Company's economic interests in Spark HoldCo increased on May 4, 2015, December 31, 2015, May 4, 2016, May 18, 2016 and May 25, 2016 due to the vesting of restricted stock units.

On May 4, 2015, 118,629 restricted stock units vested, with 97,193 shares of common stock distributed to the holders of these units and with 21,436 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units. On December 31, 2015, 29,500 restricted stock units vested, with 21,430 shares of common stock distributed to the holders of these units and with 8,070 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units.

On May 4, 2016, 101,210 restricted stock units vested, with 77,814 shares of common stock distributed to the holders of these units and with 23,396 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units. On May 18, 2016, 53,853 restricted stock units vested, with 43,683 shares of common stock distributed to the holders of these units and with 10,170 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units. On May 25, 2016, 5,000 restricted stock units vested, with 5,000 shares of common stock distributed to the holders of these units.

10



On February 3, 2016, April 1, 2016 and June 8, 2016, Retailco exchanged 1,000,000, 1,725,000 and 500,000, respectively, of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock 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. Refer to Note 9 "Taxes" and Note 13 "Subsequent Events" for further discussion.

The following table summarizes the portions of net income and income tax expense (benefit) attributable to non-controlling interest (in thousands):

Three Months Ended June 30,

Six Months Ended June 30,

2016

2015

2016

2015
 


 



 
Net income allocated to non-controlling interest
$
8,521


$
3,500


$
20,529


$
14,046

Income tax expense (benefit) allocated to non-controlling interest
124


(378
)

565


(352
)
Net income attributable to non-controlling interest
$
8,397


$
3,878


$
19,964


$
14,398


Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income attributable to stockholders (the numerator) by the weighted-average number of Class A common shares outstanding for the period (the denominator). Class B common shares are not included in the calculation of basic earnings per share because they are not participating securities and have no economic interest in the Company. Diluted earnings per share is similarly calculated except that the denominator is increased (1) using the treasury stock method to determine the potential dilutive effect of the Company's outstanding unvested restricted stock units, (2) using the if-converted method to determine the potential dilutive effect of the Company's Class B common stock and (3) using the if-converted method to determine the potential dilutive effect of the outstanding convertible subordinated notes into the Company's Class B common stock.

The following table presents the computation of earnings per share for the three and six months ended June 30, 2016 and 2015 (in thousands, except per share data):

11



Three Months Ended June 30,
Six Months Ended June 30,

2016
2015
2016
2015
Net income attributable to stockholders of Class A common stock
$
2,341

$
161

$
6,514

$
2,570

Basic weighted average Class A common shares outstanding
6,043

3,062

4,899

3,031

Basic EPS attributable to stockholders
$
0.39

$
0.05

$
1.33

$
0.85






Net income attributable to stockholders of Class A common stock
$
2,341

$
161

$
6,514

$
2,570

Effect of conversion of Class B common stock to shares of Class A common stock, net of tax effect


11,837

8,496

Effect of conversion of convertible subordinated notes into shares of Class B common stock and shares of Class B common stock into shares of Class A common stock, net of tax effect
(332
)

(312
)

Diluted net income attributable to stockholders of Class A common stock
2,009

161

18,039

11,066

Basic weighted average Class A common shares outstanding
6,043

3,062

4,899

3,031

Effect of dilutive Class B common stock


9,006

10,750

Effect of dilutive convertible subordinated notes into shares of Class B common stock and shares of Class B common stock into shares of Class A common stock
493


493


Effect of dilutive restricted stock units
103


87


Diluted weighted average shares outstanding
6,639

3,062

14,485

13,781






Diluted EPS attributable to stockholders
$
0.30

$
0.05

$
1.25

$
0.80


The conversion of shares of Class B common stock to shares of Class A common stock was not recognized in dilutive earnings per share for the three months ended June 30, 2016 and 2015 as the effect of the conversion was antidilutive. The Company's unvested restricted stock units were not recognized in dilutive earnings per share for the three and six months ended June 30, 2015 as the effect of the conversion was antidilutive. The Company's convertible subordinated notes were not outstanding during the three and six months ended June 30, 2015.

Variable Interest Entity

On January 1, 2016, we adopted ASU No. 2015-02, Consolidation (Topic 810) (“ASU 2015-02”). ASU 2015-02 changed the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. Upon adoption, we continued to consolidate Spark HoldCo, but considered Spark HoldCo to be a variable interest entity requiring additional disclosures in the footnotes of our condensed consolidated financial statements.

Spark HoldCo is a variable interest entity due to its lack of rights to participate in significant financial and operating decisions and inability to dissolve or otherwise remove its management. Spark HoldCo owns all of the outstanding membership interests in each of the operating subsidiaries through which the Company operates. The Company is the sole managing member of Spark HoldCo, manages Spark HoldCo's operating subsidiaries through this managing membership interest, and is considered the primary beneficiary of Spark HoldCo.

The assets of Spark HoldCo cannot be used to settle the obligations of the Company except through distributions to the Company, and the liabilities of Spark HoldCo cannot be settled by the Company except through contributions to Spark HoldCo.


12


The following table includes the carrying amounts and classification of the assets and liabilities of Spark HoldCo that are included in the Company's condensed consolidated balance sheet as of June 30, 2016 (in thousands):


June 30, 2016
Assets

Current assets:

Cash and cash equivalents
$
7,252

Accounts receivable
42,677

Intercompany receivable with Spark Energy, Inc.
36,774

Other current assets
32,389

Total current assets
119,092

Non-current assets:

Goodwill
18,379

Other assets
14,885

Total non-current assets
33,264

Total Assets
$
152,356



Liabilities

Current liabilities:

Accounts payable
$
22,257

Current portion of Senior Credit Facility
5,306

Other current liabilities
18,235

Total current liabilities
45,798

Long-term liabilities:

Long-term portion of Senior Credit Facility
11,939

Convertible subordinated notes to affiliates
6,502

Other long-term liabilities
458

Total long-term liabilities
18,899

Total Liabilities
$
64,697



4. Property and Equipment
Property and equipment consist of the following amounts:

Estimated 
useful
lives

June 30, 2016

December 31, 2015
 
(years)
 
(In thousands)
Information technology
2 – 5

$
28,858


$
27,392

Leasehold improvements
2 – 5

4,568


4,568

Furniture and fixtures
2 – 5

1,012


1,007

Total


34,438


32,967

Accumulated depreciation


(29,403
)

(28,491
)
Property and equipment—net


$
5,035


$
4,476

Information technology assets include software and consultant time used in the application, development and implementation of various systems including customer billing and resource management systems. As of June 30,

13


2016 and December 31, 2015, information technology includes $0.9 million and $0.5 million, respectively, of costs associated with assets not yet placed into service.
Depreciation expense recorded in the condensed consolidated statements of operations was $0.5 million and $0.4 million for the three months ended June 30, 2016 and 2015, respectively, and $0.9 million and $0.8 million for the six months ended June 30, 2016 and 2015, respectively.
5. Goodwill, Customer Relationships and Trademarks
Goodwill, customer relationships and trademarks consist of the following amounts (in thousands):
 
June 30, 2016
December 31, 2015
Goodwill
$
18,379

$
18,379

Customer relationships - Acquired (1)


Cost
$
14,883

$
14,883

Accumulated amortization
(7,832
)
(4,503
)
Customer relationships - Acquired, net
$
7,051

$
10,380

Customer relationships - Other (2)


Cost
$
4,320

$
4,320

Accumulated amortization
(1,989
)
(1,271
)
Customer relationships - Other, net
$
2,331

$
3,049

Trademarks (3)


Cost
$
1,268

$
1,268

Accumulated amortization
(137
)
(74
)
Trademarks, net
$
1,131

$
1,194


(1) Customer relationships - Acquired represents those customer acquisitions accounted for under the acquisition method in accordance with ASC 805.
(2) Customer relationships - Other represent portfolios of customer contracts not accounted for in accordance with ASC 805 as these acquisitions were not in conjunction with the acquisition of businesses.
(3) Trademarks reflect values associated with the recognition and positive reputation of acquired businesses accounted for as part of the acquisition method in accordance with ASC 805 through the acquisition of CenStar and Oasis. These trademarks are recorded as other assets in the condensed consolidated balance sheets.

Changes in goodwill, customer relationships and trademarks consisted of the following (in thousands):


Goodwill
Customer Relationships - Acquired
Customer Relationships - Others
Trademarks
Balance at December 31, 2015
$
18,379

$
10,380

$
3,049

$
1,194

Amortization expense

(3,329
)
(718
)
(63
)
Balance at June 30, 2016
$
18,379

$
7,051

$
2,331

$
1,131


Estimated future amortization expense for customer relationships and trademarks at June 30, 2016 is as follows (in thousands):

14


Year ending December 31,

2016
$
2,644

2017
4,116

2018
2,204

2019
861

2020
127

> 5 years
561

Total
$
10,513

6. Debt
Debt consists of the following amounts (in thousands):

June 30, 2016

December 31, 2015
Current portion of Senior Credit Facility—Working Capital Line (1) (2)
$


$
22,500

Current portion of Senior Credit Facility—Acquisition Line (1) (2)
5,306


5,306

Total current debt
5,306


27,806

Long-term portion of Senior Credit Facility—Acquisition Line (1)
11,939


14,592

Convertible subordinated notes to affiliate (3)
6,502


6,339

Total long-term debt
18,441


20,931

Total debt
$
23,747


$
48,737

(1)
As of June 30, 2016 and December 31, 2015, the Company had $17.2 million and $21.5 million in letters of credit issued, respectively.
(2)
As of June 30, 2016 and December 31, 2015, the weighted average interest rate on the current portion of our Senior Credit Facility was 4.21% and 3.90%, respectively.
(3)
During the six months ended June 30, 2016, we paid in-kind $0.2 million of interest, which was added to the outstanding balance of the convertible subordinated notes. No in-kind interest was paid for the three months ended June 30, 2016, as payments in-kind may be elected only on January 1 and July 1 under the terms and conditions of the convertible subordinated notes. Unamortized discount of $0.7 million and $0.7 million at June 30, 2016 and December 31, 2015, respectively, is related to beneficial conversion features of the convertible subordinated notes.

Deferred financing costs were $0.6 million and $0.7 million as of June 30, 2016 and December 31, 2015, respectively, representing capitalized financing costs in connection with the amendment and restatement of our Senior Credit Facility on July 8, 2015. Of these amounts, $0.6 million and $0.5 million is recorded in other current assets in the condensed consolidated balance sheets as of each of June 30, 2016 and December 31, 2015, and zero and $0.2 million is recorded in other assets in the condensed consolidated balance sheets as of June 30, 2016 and December 31, 2015, respectively, based on the terms of the Senior Credit Facility.
Interest expense consists of the following components for the periods indicated (in thousands):

Three Months Ended June 30,

Six Months Ended June 30,

2016

2015

2016

2015
Interest incurred on Senior Credit Facility
$
192


$
90


$
510


$
319

Commitment fees
53


19


83


96

Letters of credit fees
131


75


292


99

Amortization of deferred financing costs 
117


50


235


101

Interest incurred on convertible subordinated notes to affiliate (1)
126




253



Interest Expense
$
619


$
234


$
1,373


$
615


(1)
Includes amortization of the discount on the convertible subordinated notes to affiliates of less than $0.1 million and $0.1 million, respectively for the three and six months ended June 30, 2016

15


Senior Credit Facility

The Company, as guarantor, and Spark HoldCo (the “Borrower,” and together with SE, SEG, CenStar, CenStar Operating Company, LLC, Oasis and Oasis Power, LLC, each a subsidiary of Spark HoldCo, the “Co-Borrowers”) are party to a senior secured revolving credit facility (“Senior Credit Facility”), which includes a senior secured revolving working capital facility of $82.5 million ("Working Capital Line") and a secured revolving line of credit of $25.0 million ("Acquisition Line") to be used specifically for the financing of up to 75% of the cost of acquisitions with the remainder to be financed by the Company either through cash on hand or the issuance of subordinated debt or equity. The Senior Credit Facility will mature on July 8, 2017 and may be extended for one additional year with lender consent. Borrowings under the Acquisition Line will be repaid 25% per year with the remainder due at maturity.

On June 1, 2016, the Company and the Co-Borrowers entered into Amendment No. 3 to the Senior Credit Facility to, among other things, increase the Working Capital Line (defined below) from $60.0 million to $82.5 million in accordance with the Co-Borrowers' right to increase under the existing terms of the Senior Credit Facility. Amendment No. 3 also provides for the addition of new lenders and re-allocates working capital and revolving commitments among existing and new lenders. Amendment No. 3 also provides for additional representations of the Co-Borrowers and additional protections of the lenders of the Senior Credit Facility.

At our election, the interest rate under the Working Capital Line is generally determined by reference to:
the Eurodollar rate plus an applicable margin of up to 3.00% per annum (based upon the prevailing utilization); or
the alternate base rate plus an applicable margin of up to 2.00% per annum (based upon the prevailing utilization). The alternate base rate is equal to the highest of (i) Société Générale’s prime rate, (ii) the federal funds rate plus 0.50% per annum, or (iii) the reference Eurodollar rate plus 1.00%; or
the rate quoted by Société Générale as its cost of funds for the requested credit plus up to 2.50% per annum (based upon the prevailing utilization).

The interest rate is generally reduced by 25 basis points if utilization under the Working Capital Line is below fifty percent.

Borrowings under the Acquisition Line are generally determined by reference to:
the Eurodollar rate plus an applicable margin of up to 3.75% per annum (based upon the prevailing utilization); or
the alternate base rate plus an applicable margin of up to 2.75% per annum (based upon the prevailing utilization). The alternate base rate is equal to the highest of (i) Société Générale's prime rate, (ii) the federal funds rate plus 0.50% per annum, or (iii) the reference Eurodollar rate plus 1.00%.

The Co-Borrowers pay an annual commitment fee of 0.375% or 0.5% on the unused portion of the Working Capital Line depending upon the unused capacity and 0.5% on the unused portion of the Acquisition Line. The lending syndicate under the Senior Credit Facility is entitled to several additional fees including an upfront fee, annual agency fee, and fronting fees based on a percentage of the face amount of letters of credit payable to any syndicate member that issues a letter a credit.

The Company has the ability to elect the availability under the Working Capital Line between $30.0 million to $82.5 million. Availability under the working capital line will be subject to borrowing base limitations. The borrowing base is calculated primarily based on 80% to 90% of the value of eligible accounts receivable and unbilled product sales (depending on the credit quality of the counterparties) and inventory and other working capital assets. The Co-Borrowers must generally seek approval of the agent or the lenders for permitted acquisitions to be financed under the Acquisition Line.

The Senior Credit Facility is secured by pledges of the equity of the portion of Spark HoldCo owned by the Company and of the equity of Spark HoldCo’s subsidiaries and the Co-Borrowers’ present and future subsidiaries,

16


all of the Co-Borrowers’ and their subsidiaries’ present and future property and assets, including accounts receivable, inventory and liquid investments, and control agreements relating to bank accounts. The Senior Credit Facility also contains covenants that, among other things, require the maintenance of specified ratios or conditions as follows:

Minimum Net Working Capital. The Co-Borrowers must maintain minimum consolidated net working capital through December 30, 2016 equal to the greater of $5.0 million or 10%, and from December 31, 2016 and thereafter equal to the greater of $5.0 million or 15% of the elected availability under the Working Capital Line.

Minimum Adjusted Tangible Net Worth. Spark Energy, Inc. must maintain a minimum consolidated adjusted tangible net worth at all times equal to the net proceeds from equity issuances occurring after the date of the Senior Credit Facility plus the greater of (i) 20% of aggregate commitments under the Working Capital Line plus 33% of borrowings under the Acquisition Line and (ii) $18.0 million.

Minimum Fixed Charge Coverage Ratio. Spark Energy, Inc. must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00 (with quarterly increases to the numerator of increments of 0.05 beginning in the third quarter of 2016). The Fixed Charge Coverage Ratio is defined as the ratio of (a) Adjusted EBITDA to (b) the sum of consolidated interest expense (other than interest paid-in-kind in respect of any Subordinated Debt), letter of credit fees, commitment fees, acquisition earn-out payments, distributions and scheduled amortization payments.

Maximum Total Leverage Ratio. Spark Energy, Inc. must maintain a ratio of total indebtedness (excluding the Working Capital Facility and qualifying subordinated debt) to Adjusted EBITDA of a maximum of 2.50 to 1.00.

The Senior Credit Facility contains various negative covenants that limit the Company’s ability to, among other things, do any of the following:

incur certain additional indebtedness;
grant certain liens;
engage in certain asset dispositions;
merge or consolidate;
make certain payments, distributions, investments, acquisitions or loans; or
enter into transactions with affiliates.

Spark Energy, Inc. is 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 Retail and Retailco (or their successors in interest) so long as: (a) no default exists or would result from such a payment; (b) the Co-Borrowers 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 the borrowing base limits. Spark HoldCo’s inability to satisfy certain financial covenants or the existence of an event of default, if not cured or waived, under the Senior Credit Facility could prevent the Company from paying dividends to holders of the Class A common stock.

The Senior Credit Facility contains certain customary representations and warranties and events of default. Events of default include, among other things, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults and cross-acceleration to certain indebtedness, change in control in which affiliates of W. Keith Maxwell III own less than 40% of the outstanding voting interests in the Company, certain events of bankruptcy, certain events under ERISA, material judgments in excess of $5.0 million, certain events with respect to material contracts, actual or asserted failure of any guaranty or security document supporting the Senior Credit Facility to be in full force and effect and changes of control. If such an event of default occurs, the lenders under the Senior Credit Facility would be entitled to take various actions, including the acceleration of amounts due under the facility and all actions permitted to be taken by a secured creditor.

17



In addition, the Senior Credit Facility contains affirmative covenants that are customary for credit facilities of this type. The covenants include delivery of financial statements (including any filings made with the SEC, maintenance of property and insurance, payment of taxes and obligations, material compliance with laws, inspection of property, books and records and audits, use of proceeds, payments to bank blocked accounts, notice of defaults and certain other customary matters.
7. Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. Fair values are based on assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and the risks inherent in valuation techniques and the inputs to valuations. This includes not only the credit standing of counterparties involved and the impact of credit enhancements but also the impact of the Company’s own nonperformance risk on its liabilities.
The Company applies fair value measurements to its commodity derivative instruments and a contingent payment arrangement based on the following fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:

Level 1—Quoted prices in active markets for identical assets and liabilities. Instruments categorized in Level 1 primarily consist of financial instruments such as exchange-traded derivative instruments.
Level 2—Inputs other than quoted prices recorded in Level 1 that are either directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived from observable market data by correlation or other means. Instruments categorized in Level 2 primarily include non-exchange traded derivatives such as over-the-counter commodity forwards and swaps and options.
Level 3—Unobservable inputs for the asset or liability, including situations where there is little, if any, observable market activity for the asset or liability. A contingent payment arrangement related to the CenStar acquisition is categorized as Level 3.
As the fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3), the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. In these cases, the lowest level input that is significant to a fair value measurement in its entirety determines the applicable level in the fair value hierarchy.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents assets and liabilities measured and recorded at fair value in the Company’s condensed consolidated balance sheets on a recurring basis by and their level within the fair value hierarchy as of (in thousands): 


18



Level 1

Level 2

Level 3

Total
June 30, 2016
 

 

 

 
Non-trading commodity derivative assets
$
243


$
2,890


$


$
3,133

Trading commodity derivative assets


11




11

Total commodity derivative assets
$
243


$
2,901


$


$
3,144

Non-trading commodity derivative liabilities
$


$
(2,387
)

$


$
(2,387
)
Trading commodity derivative liabilities







Total commodity derivative liabilities
$


$
(2,387
)

$


$
(2,387
)
Contingent payment arrangement
$

 
$

 
$
(1,500
)
 
$
(1,500
)


Level 1

Level 2

Level 3

Total
December 31, 2015







Non-trading commodity derivative assets
$


$
200


$


$
200

Trading commodity derivative assets


405




405

Total commodity derivative assets
$


$
605


$


$
605

Non-trading commodity derivative liabilities
$
(3,324
)

$
(7,661
)

$


$
(10,985
)
Trading commodity derivative liabilities


(253
)



(253
)
Total commodity derivative liabilities
$
(3,324
)

$
(7,914
)

$


$
(11,238
)
Contingent payment arrangement
$

 
$

 
$
(500
)
 
$
(500
)
The Company had no transfers of assets or liabilities between any of the above levels during the six months ended June 30, 2016 and the year ended December 31, 2015.
The Company’s derivative contracts include exchange-traded contracts fair valued utilizing readily available quoted market prices and non-exchange-traded contracts fair valued using market price quotations available through brokers or over-the-counter and on-line exchanges. In addition, in determining the fair value of the Company’s derivative contracts, the Company applies a credit risk valuation adjustment to reflect credit risk which is calculated based on the Company’s or the counterparty’s historical credit risks. As of June 30, 2016 and December 31, 2015, the credit risk valuation adjustment was not material.
The contingent payment arrangement referred to above reflects the CenStar Earnout incurred in connection with the acquisition of CenStar and is recorded in other current liabilities in the condensed consolidated balance sheet. The CenStar Earnout is based on a financial measurement attributable to the operations of CenStar for the year following the closing of the acquisition. In determining the fair value of the CenStar Earnout, the Company forecasted a one year performance measurement, as defined by the CenStar stock purchase agreement. As this calculation is based on management's estimates of the liability, we classified the CenStar Earnout as a Level 3 measurement as of June 30, 2016. We anticipate payment of the CenStar Earnout within one year from the close of the performance measurement period, which ended in July 2016. The $1.0 million increase in our estimate of the CenStar Earnout for the six months ended June 30, 2016 was determined based on results of operations and was recorded as general and administrative expense in our condensed consolidated statements of operations.
Other Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, accounts receivable—affiliates, accounts payable, accounts payable—affiliates, and accrued liabilities recorded in the condensed consolidated balance sheets approximate fair value due to the short-term nature of these items. The carrying amount of the Senior Credit Facility recorded in the condensed consolidated balance sheets approximates fair value because of the variable rate nature of the Company’s line of credit. The fair value of our convertible subordinated notes to affiliates is not determinable for accounting purposes due to the affiliate nature and terms of the associated debt instrument with the affiliate. The fair value of the payable pursuant to tax receivable agreement—affiliate is not determinable for accounting purposes due to the affiliate nature and terms of the associated agreement with the affiliate.

19


8. Accounting for Derivative Instruments
The Company is exposed to the impact of market fluctuations in the price of electricity and natural gas and basis costs, storage and ancillary capacity charges from independent system operators. The Company uses derivative instruments to manage exposure to these risks.
The Company holds certain derivative instruments that are not held for trading purposes and are not designated as hedges for accounting purposes. These derivative instruments represent economic hedges that mitigate the Company’s exposure to fluctuations in commodity prices. For these derivative instruments, changes in the fair value are recognized currently in earnings in retail revenues or retail cost of revenues.
As part of the Company’s strategy to optimize its assets and manage related risks, it also manages a portfolio of commodity derivative instruments held for trading purposes. The Company’s commodity trading activities are subject to limits within the Company’s Risk Management Policy. For these derivative instruments, changes in the fair value are recognized currently in earnings in net asset optimization revenues.
Derivative assets and liabilities are presented net in the Company’s condensed consolidated balance sheets when the derivative instruments are executed with the same counterparty under a master netting arrangement. The Company’s derivative contracts include transactions that are executed both on an exchange and centrally cleared as well as over-the-counter, bilateral contracts that are transacted directly with a third party. To the extent the Company has paid or received collateral related to the derivative assets or liabilities, such amounts would be presented net against the related derivative asset or liability’s fair value. As of June 30, 2016 and December 31, 2015, the Company had zero and $0.1 million in collateral outstanding, respectively. The specific types of derivative instruments the Company may execute to manage the commodity price risk include the following:

Forward contracts, which commit the Company to purchase or sell energy commodities in the future;
Futures contracts, which are exchange-traded standardized commitments to purchase or sell a commodity or financial instrument;
Swap agreements, which require payments to or from counterparties based upon the differential between two prices for a predetermined notional quantity; and
Option contracts, which convey to the option holder the right but not the obligation to purchase or sell a commodity.
The Company has entered into other energy-related contracts that do not meet the definition of a derivative instrument or qualify for the normal purchase or normal sale exception and are therefore not accounted for at fair value including the following:

Forward electricity and natural gas purchase contracts for retail customer load, and
Natural gas transportation contracts and storage agreements. 

Volumetric Underlying Derivative Transactions
The following table summarizes the net notional volume buy/(sell) of the Company’s open derivative financial instruments accounted for at fair value, broken out by commodity, as of (in thousands):
Non-trading 
Commodity
Notional

June 30, 2016

December 31, 2015
Natural Gas
MMBtu

1,792


7,543

Natural Gas Basis
MMBtu



455

Electricity
MWh

1,304


1,187


20


Trading
Commodity
Notional

June 30, 2016

December 31, 2015
Natural Gas
MMBtu

(354
)

8

Natural Gas Basis
MMBtu



(455
)

Gains (Losses) on Derivative Instruments
Gains (losses) on derivative instruments, net and current period settlements on derivative instruments were as follows for the periods indicated (in thousands):


Three Months Ended June 30,
  
2016

2015
Gain (loss) on non-trading derivatives, net
$
5,487


$
(4,808
)
Loss on trading derivatives, net
(77
)

(66
)
Gain (loss) on derivatives, net
5,410


(4,874
)
Current period settlements on non-trading derivatives (1)
4,394


4,493

Current period settlements on trading derivatives
71


40

Total current period settlements on derivatives
$
4,465


$
4,533

(1)
Excludes settlements of $0.9 million and $0.2 million, respectively, for the three months ended June 30, 2016 and 2015 related to non-trading derivative liabilities assumed in the acquisitions of CenStar and Oasis.

Six Months Ended June 30,
  
2016

2015
Loss on non-trading derivatives, net
$
(4,133
)

$
(6,008
)
Loss on trading derivatives, net
(206
)

(171
)
Loss on derivatives, net
(4,339
)

(6,179
)
Current period settlements on non-trading derivatives (1)
15,672


8,608

Current period settlements on trading derivatives
65


116

Total current period settlements on derivatives
$
15,737


$
8,724

(1)
Excludes settlements of $0.1 million and $0.2 million, respectively, for the six months ended June 30, 2016 and 2015 related to non-trading derivative liabilities assumed in the acquisitions of CenStar and Oasis.
Gains (losses) on trading derivative instruments are recorded in net asset optimization revenues and gains (losses) on non-trading derivative instruments are recorded in retail revenues or retail cost of revenues on the condensed consolidated statements of operations.
Fair Value of Derivative Instruments
The following tables summarize the fair value and offsetting amounts of the Company’s derivative instruments by counterparty and collateral received or paid as of (in thousands):

21


  
June 30, 2016
Description
Gross Assets

Gross
Amounts
Offset

Net Assets

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
5,681


$
(2,987
)

$
2,694


$


$
2,694

Trading commodity derivatives
23


(12
)

11




11

Total Current Derivative Assets
5,704


(2,999
)

2,705




2,705

Non-trading commodity derivatives
705


(266
)

439




439

Total Non-current Derivative Assets
705


(266
)

439




439

Total Derivative Assets
$
6,409


$
(3,265
)

$
3,144


$


$
3,144


June 30, 2016
Description
Gross 
Liabilities

Gross
Amounts
Offset

Net
Liabilities

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
(3,489
)

$
1,560


$
(1,929
)

$


$
(1,929
)
Trading commodity derivatives









Total Current Derivative Liabilities
(3,489
)

1,560


(1,929
)



(1,929
)
Non-trading commodity derivatives
(683
)

225


(458
)



(458
)
Total Non-current Derivative Liabilities
(683
)

225


(458
)



(458
)
Total Derivative Liabilities
$
(4,172
)

$
1,785


$
(2,387
)

$


$
(2,387
)
  
December 31, 2015
Description
Gross Assets

Gross
Amounts
Offset

Net Assets

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
589


$
(389
)

$
200


$


$
200

Trading commodity derivatives
411


(6
)

405




405

Total Current Derivative Assets
1,000


(395
)

605




605

Non-trading commodity derivatives









Total Non-current Derivative Assets









Total Derivative Assets
$
1,000


$
(395
)

$
605


$


$
605


December 31, 2015
Description
Gross 
Liabilities

Gross
Amounts
Offset

Net
Liabilities

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
(13,618
)

$
3,151


$
(10,467
)

$
100


$
(10,367
)
Trading commodity derivatives
(320
)

67


(253
)



(253
)
Total Current Derivative Liabilities
(13,938
)

3,218


(10,720
)

100


(10,620
)
Non-trading commodity derivatives
(950
)

332


(618
)



(618
)
Total Non-current Derivative Liabilities
(950
)

332


(618
)



(618
)
Total Derivative Liabilities
$
(14,888
)

$
3,550


$
(11,338
)

$
100


$
(11,238
)


9. Taxes

Income Taxes


22


The Company and CenStar are each subject to U.S. federal income tax as a corporation. Spark HoldCo and its subsidiaries, with the exception of CenStar, are treated as flow-through entities for U.S. federal income tax purposes, and, as such, are generally not subject to U.S. federal income tax at the entity level. Rather, the tax liability with respect to their taxable income is passed through to their members or partners. Accordingly, the Company is subject to U.S. federal income taxation on its allocable share of Spark HoldCo’s net U.S. taxable income.

The Company accounts for income taxes using the assets and liabilities method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and those assets and liabilities tax bases. The Company applies existing tax law and the tax rate that the Company expects to apply to taxable income in the years in which those differences are expected to be recovered or settled in calculating the deferred tax assets and liabilities. Effects of changes in tax rates on deferred tax assets and liabilities are recognized in income in the period of the tax rate enactment.

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes ("ASU 2015-17") that is intended to simplify the presentation of deferred taxes by requiring that all deferred taxes be classified as noncurrent and presented as a single noncurrent amount for each tax-payment component of an entity. The ASU 2015-17 is effective for fiscal years beginning after December 15, 2016; however, the Company elected early adoption on January 1, 2016, on a retrospective basis. The adoption of ASU 2015-17 resulted in the reclassification of previously-classified net current deferred taxes of approximately $0.9 million from other current liabilities, resulting in a $23.4 million noncurrent deferred tax asset and a $0.9 million noncurrent deferred tax liability on the Company’s condensed consolidated balance sheet at December 31, 2015. There was no impact to our condensed consolidated statements of operations for the three and six months ended June 30, 2016 or 2015.

The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets. In making this determination, the Company considers all available positive and negative evidence and makes certain assumptions. The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends, and its outlook for future years. The Company believes it is more likely than not that the deferred tax assets will be utilized.

On February 3, 2016, Retailco exchanged 1,000,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $8.0 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $10.3 million pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $3.9 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our condensed consolidated balance sheet at June 30, 2016.

On April 1, 2016, Retailco exchanged 1,725,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $7.6 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $10.3 million pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $3.9 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our condensed consolidated balance sheet at June 30, 2016.

On June 8, 2016, Retailco exchanged 500,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $5.3 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $6.9 million

23


pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $2.6 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our condensed consolidated balance sheet at June 30, 2016.

As of June 30, 2016, the Company had a net deferred tax asset of approximately $15.6 million related to the step up in tax basis resulting from the purchase by the Company of Spark HoldCo units from NuDevco Retail and NuDevco Retail Holdings (predecessor to Retailco) on the IPO date. In addition, as of June 30, 2016, the Company had a total liability of $20.7 million for the effect of the Tax Receivable Agreement liability, with approximately $19.3 million classified as a long-term liability and $1.4 million classified as a current liability related to the IPO. The Company had a long-term deferred tax asset of approximately $7.9 million related to the Tax Receivable Agreement liability related to the IPO. See Note 11 “Transactions with Affiliates” for further discussion.

The effective U.S. federal and state income tax rate for the six months ended June 30, 2016 and 2015 is 17.8% and 5.7%, respectively, with respect to pre-tax income attributable to the Company's stockholders. The higher effective tax rate for the six months ended June 30, 2016 is primarily attributable to the CenStar acquisition, discrete items and a decrease in the non-controlling interest. The CenStar acquisition resulted in an increase in the effective tax rate based on its taxable status as a corporation. The discrete items were related to revisions of prior period state income. The remaining increase is primarily attributable to units exchanged by Retailco which corresponds with an increase in taxable income allocable to the Company from Spark HoldCo that is subject to U.S. federal income taxation.

Total income tax expense for the six months ended June 30, 2016 differed from amounts computed by applying the U.S. federal statutory tax rates to pre-tax income primarily due to state taxes and the impact of permanent differences between book and taxable income, most notably the income attributable to non-controlling interest. The effective tax rate includes a rate benefit attributable to the fact that Spark HoldCo operates as a limited liability company treated as a partnership for federal and state income tax purposes and is not subject to federal and state income taxes. Accordingly, the portion of earnings attributable to non-controlling interest is subject to tax when reported as a component of the non-controlling interest’s taxable income. The February, April and June 2016 exchanges by Retailco decreased the effective tax rate benefit attributable to non-controlling interest.

10. Commitment and Contingencies
From time to time, the Company may be involved in legal, tax, regulatory and other proceedings in the ordinary course of business. Other than proceedings discussed below, management does not believe that we are a party to any litigation, claims or proceedings that will have a material impact on the Company’s condensed consolidated financial condition or results of operations. Liabilities for loss contingencies arising from claims, assessments, litigations or other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated.

Indirect Tax Audits

The Company is undergoing various types of indirect tax audits spanning from years 2006 to 2016 for which the Company may have additional liabilities arise. At the time of filing these condensed consolidated financial statements, these indirect tax audits are at an early stage and subject to substantial uncertainties concerning the outcome of audit findings and corresponding responses. We accrued an additional $1.6 million during the three and six months ended June 30, 2016, which increased accrued liabilities for these indirect tax audits to reflect our best estimate of the amounts we believe we will owe to $1.9 million at June 30, 2016. The outcome of these indirect tax audits may result in additional expense.

Legal Proceedings

The Company is the subject of the following lawsuits:


24


John Melville et al v. Spark Energy Inc. and Spark Energy Gas, LLC is a purported class action filed on December 17, 2015 in the United States District Court for the District of New Jersey alleging, among other things, that (i) sales representatives engaged as independent contractors for Spark Energy Gas, LLC engaged in deceptive acts in violation of the New Jersey Consumer Fraud Act and (ii) Spark Energy Gas, LLC  breached its contract with plaintiff, including a breach of the covenant of good faith and fair dealing. Plaintiff seeks unspecified compensatory and punitive damages for himself and the purported class, injunctive relief and/or declaratory relief, disgorgement of revenues and/or profits and attorneys’ fees. On March 14, 2016, Spark Energy Gas, LLC and Spark Energy, Inc. filed a Motion to Dismiss this case. On April 18, 2016, Plaintiff filed his Opposition to the Motion to Dismiss. On April 25, 2016, Spark Energy, Inc. and Spark Energy Gas, LLC filed a Reply in support of their Motion to Dismiss. The Motion to Dismiss was set on the Court's submission docket for May 2, 2016. The parties are currently waiting on the Court’s ruling. Discovery has not yet commenced in this matter. We cannot predict the outcome or consequences of this case.

Arturo Amaya et al v. Spark Energy Gas, LLC is a purported class action filed on May 22, 2015 in the United States District Court for the Northern District of California alleging, among other things, that certain door-to-door sales representatives engaged as independent contractors for Spark Energy Gas, LLC allegedly engaged in deceptive practices in violation of the California Civil Code, California Unfair Competition Law, California False Advertising Law and the California Consumer Legal Remedies Act while marketing Spark Energy Gas, LLC’s gas services to consumers in California. Plaintiffs are seeking unspecified compensatory and punitive damages for the purported class, injunctive relief and/or declaratory relief, disgorgement of revenues and/or profits and attorneys’ fees. On September 29, 2015, Spark Energy Gas, LLC filed a motion to dismiss the complaint in its entirety and a motion to compel arbitration in the case of one of the named plaintiffs. On April 11, 2016 the Court issued an Order denying without prejudice Spark Energy Gas, LLC’s Motion to Compel Arbitration and denying the Motion to Dismiss. The Court also reset the date to hear any Motion for Class Certification that plaintiffs may file in this matter to August 5, 2016.  On April 15, 2016, the parties attended a court-ordered mediation during which a confidential resolution of this matter was reached. Subsequently, a confidential settlement agreement and release of all claims was executed by the parties. On July 5, 2016, a Joint Stipulation of Dismissal with Prejudice was filed with the Court. On July 6, 2016, the Court issued an Order Dismissing the Entire Action. We expensed and paid $0.5 million related to this litigation during the six months ended June 30, 2016 in our condensed consolidated statement of operations.

11. Transactions with Affiliates
The Company enters into transactions with and pays certain costs on behalf of affiliates that are commonly controlled in order to reduce risk, reduce administrative expense, create economies of scale, create strategic alliances and supply goods and services to these related parties. The Company also sells and purchases natural gas and electricity with affiliates. The Company presents receivables and payables with the same affiliate on a net basis in the condensed consolidated balance sheets as all affiliate activity is with parties under common control.

Master Service Agreement with Retailco Services, LLC

We entered into a Master Service Agreement (the “Master Service Agreement”) effective January 1, 2016 with Retailco Services, LLC ("Retailco Services"), which is wholly owned by W. Keith Maxwell III. The Master Service Agreement is for a one-year term and renews automatically for successive one-year terms unless the Master Service Agreement is terminated by either party. Retailco Services provides us with operational support services such as: enrollment and renewal transaction services; customer billing and transaction services; electronic payment processing services; customer services and information technology infrastructure and application support services under the Master Service Agreement. See "Cost Allocations" for further discussion of the fees paid in connection with the Master Service Agreement during the three and six months ended June 30, 2016.
Accounts Receivable and PayableAffiliates

25


The Company recorded current accounts receivable—affiliates of $1.0 million and $1.8 million as of June 30, 2016 and December 31, 2015, respectively, and current accounts payable—affiliates of $2.0 million and $2.0 million as of June 30, 2016 and December 31, 2015, respectively, for certain direct billings and cost allocations for services the Company provided to affiliates, services our affiliates provided to us, and sales or purchases of natural gas and electricity with affiliates.
Prepaid AssetsAffiliates

The Company prepaid NuDevco Retail and Retailco for costs of certain employee benefits to be provided through the Company’s benefit plans and recorded current prepaid assets—affiliates of $0.1 million and $0.2 million as of June 30, 2016 and December 31, 2015, respectively.

Convertible Subordinated Notes to Affiliate

In connection with the financing of the CenStar acquisition, the Company, together with Spark HoldCo, issued the CenStar Note to Retailco Acquisition Co, LLC ("RAC"), which is wholly owned by W. Keith Maxwell III, for $2.1 million on July 8, 2015. In connection with the financing of the Oasis acquisition, the Company, together with Spark HoldCo, issued the Oasis Note to RAC for $5.0 million on July 31, 2015. Refer to Note 6 "Debt" for further discussion.
Revenues and Cost of RevenuesAffiliates
The Company and an affiliate are party to an agreement whereby the Company purchases natural gas from an affiliate. Cost of revenues—affiliates, recorded in net asset optimization revenues in the condensed consolidated statements of operations for the three months ended June 30, 2016 and 2015 related to this agreement were $0.4 million and $3.1 million, respectively. Cost of revenues—affiliates, recorded in net asset optimization revenues in the condensed consolidated statements of operations for the six months ended June 30, 2016 and 2015 related to this agreement were $1.6 million and $6.2 million, respectively.
The Company also purchases natural gas at a nearby third-party plant inlet which is then sold to an affiliate. Revenues—affiliates, recorded in net asset optimization revenues in the condensed consolidated statements of operations for the three months ended June 30, 2016 and 2015 related to these sales were less than $0.1 million and $0.2 million, respectively. Revenues—affiliates, recorded in net asset optimization revenues in the condensed consolidated statements of operations for the six months ended June 30, 2016 and 2015 related to these sales were $0.2 million and $0.7 million, respectively.
Additionally, the Company entered into a natural gas transportation agreement with another affiliate at its pipeline, whereby the Company transports retail natural gas and pays the higher of (i) a minimum monthly payment or (ii) a transportation fee per MMBtu times actual volumes transported. The current transportation agreement renews annually on February 28 at a fixed rate per MMBtu without a minimum monthly payment. While this transportation agreement remains in effect, this entity was no longer an affiliate as Mr. Maxwell terminated his interest in the affiliate on May 16, 2016. Cost of revenues—affiliates, recorded in retail cost of revenues in the condensed consolidated statements of operations related to this activity, was less than $0.1 million for each of the periods from April 1, 2016 to May 16, 2016 and from January 1, 2016 to May 16, 2016.
Cost Allocations

The Company paid certain expenses on behalf of affiliates, which are reimbursed by the affiliates to the Company, and our affiliates paid certain expenses on our behalf, which are reimbursed by us. These transactions include costs that can be specifically identified and certain allocated overhead costs associated with general and administrative services, including executive management, due diligence work, recurring management consulting, facilities, banking arrangements, professional fees, insurance, information services, human resources and other support departments to or from the affiliates. Where costs incurred on behalf of the affiliate or us could not be determined

26


by specific identification for direct billing, the costs were primarily allocated to the affiliated entities or us based on percentage of departmental usage, wages or headcount.

The total net amount direct billed and allocated from affiliates was $4.6 million and $9.6 million, respectively, for the three and six months ended June 30, 2016. Of this total net amount, the Company recorded general and administrative expense of $3.8 million and $8.0 million for the three and six months ended June 30, 2016, respectively, in the condensed consolidated statement of operations in connection with fees paid under the Master Service Agreement with Retailco Services. Additionally under the Master Service Agreement, we capitalized $0.5 million and $1.1 million of property and equipment for the application, development and implementation of various systems during three and six months ended June 30, 2016. The remaining amount was direct billed and allocated from other affiliates and recorded as general and administrative expense in the condensed consolidated statement of operations.

The total net amount direct billed and allocated to affiliates was $0.7 million and $1.6 million, respectively, for the three and six months ended June 30, 2015, which was recorded as a reduction in general and administrative expense in the condensed consolidated statement of operations.

Distributions to and Contributions from Affiliates

During the six months ended June 30, 2016 and 2015, the Company made distributions to NuDevco Retail and Retailco of $6.4 million and $7.8 million in conjunction with the payment of its quarterly distributions attributable to its holding of Spark HoldCo units. During the six months ended June 30, 2016, the Company made distributions to NuDevco Retail and Retailco for gross-up distributions of $3.5 million in connection with distributions made between Spark HoldCo and Spark Energy, Inc. for payment of income taxes incurred by Spark Energy, Inc. Additionally, during the six months ended June 30, 2015, the Company received a contribution from NuDevco of $0.1 million as NuDevco forgave an account payable due to NuDevco that arose from the payment of withholding taxes related to the vesting of restricted stock units of certain employees of NuDevco who perform services for the Company.

Proceeds from Disgorgement of Stockholder Short-swing Profits

During the six months ended June 30, 2016, the Company received $0.6 million from Retailco for the disgorgement of stockholder short-swing profits under Section 16(b) under the Exchange Act. The amount was recorded as an increase to additional paid-in capital in our condensed consolidated balance sheet.

Tax Receivable Agreement

The Company is party to a Tax Receivable Agreement with Spark HoldCo, NuDevco Retail Holdings and NuDevco Retail. This agreement generally provides for the payment by the Company to Retailco, LLC (as successor to NuDevco Retail Holdings) and NuDevco Retail of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that the Company actually realizes (or is deemed to realize in certain circumstances) in future periods as a result of (i) any tax basis increases resulting from the purchase by the Company of Spark HoldCo units from NuDevco Retail Holdings, (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 the Company as a result of, and additional tax basis arising from, any payments the Company makes under the Tax Receivable Agreement. The Company retains the benefit of the remaining 15% of these tax savings. See Note 9 “Taxes” for further discussion.

In certain circumstances, the Company may defer or partially defer any payment due (a “TRA Payment”) to the holders of rights under the Tax Receivable Agreement, which are currently Retailco and NuDevco Retail.


27


During the five-year period ending September 30, 2019, the Company 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
“Total Distributions” are defined as the aggregate distributions necessary to cause the Company to receive distributions of cash equal to (i) the targeted quarterly distribution the Company intends to pay to holders of its Class A common stock payable during the applicable four-quarter period, plus (ii) the estimated taxes payable by the Company 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, the Company 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, the Company will pay NuDevco the full amount of the TRA Payment.

Following the five-year deferral period ending September 30, 2019, the Company will be obligated to pay any outstanding deferred TRA Payments to the extent such deferred TRA Payments do not exceed (i) the lesser of the Company'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 the Company 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) the Company'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 the Company 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.

We expect to meet the threshold coverage ratio required to fund the first payment to Retailco under the Tax Receivable Agreement during the four-quarter period ending September 30, 2016. As such, the initial payment of $1.4 million under the Tax Receivable Agreement due in late 2016 was recorded as a current liability in our condensed consolidated balance sheet at June 30, 2016.

12. Segment Reporting
The Company’s determination of reportable business segments considers the strategic operating units under which the Company makes financial decisions, allocates resources and assesses performance of its retail and asset optimization businesses.
The Company’s reportable business segments are retail natural gas and retail electricity. The retail natural gas segment consists of natural gas sales to, and natural gas transportation and distribution for, residential and commercial customers. Asset optimization activities, considered an integral part of securing the lowest price natural gas to serve retail gas load, are part of the retail natural gas segment. The Company recorded asset optimization revenues of $20.8 million and $23.0 million and asset optimization cost of revenues of $21.5 million and $23.1 million for the three months ended June 30, 2016 and 2015, respectively, which are presented on a net basis in asset optimization revenues. The Company recorded asset optimization revenues of $63.1 million and $93.0 million and asset optimization cost of revenues of $63.3 million and $91.1 million for the six months ended June 30, 2016 and

28


2015, respectively, which are presented on a net basis in asset optimization revenues. The retail electricity segment consists of electricity sales and transmission to residential and commercial customers. Corporate and other consists of expenses and assets of the retail natural gas and retail electricity segments that are managed at a consolidated level such as general and administrative expenses.
To assess the performance of the Company’s operating segments, the Chief Operating Decision Maker analyzes retail gross margin. The Company defines retail gross margin as operating income plus (i) depreciation and amortization expenses and (ii) general and administrative expenses, less (i) net asset optimization revenues (expenses), (ii) net gains (losses) on derivative instruments, and (iii) net current period cash settlements on derivative instruments. The Company deducts net gains (losses) on derivative instruments, excluding current period cash settlements, from the retail gross margin calculation in order to remove the non-cash impact of net gains and losses on derivative instruments.
Retail gross margin 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.
Below is a reconciliation of retail gross margin to income before income tax expense (in thousands):

  
Three Months Ended June 30,
Six Months Ended June 30,
  
2016

2015
2016

2015
Reconciliation of Retail Gross Margin to Income before taxes






Income before income tax expense
$
15,474


$
4,497

$
32,201


$
17,987

Interest and other income
(194
)

(186
)
(99
)

(321
)
Interest expense
619


234

1,373


615

Operating Income
15,899


4,545

33,475


18,281

Depreciation and amortization
6,244


6,038

13,033


10,316

General and administrative
16,199


13,712

33,580


28,416

Less:






Net asset optimization (expenses) revenues
(676
)

(67
)
(150
)

1,862

Net, Gain (losses) on non-trading derivative instruments
5,487


(4,808
)
(4,133
)

(6,008
)
Net, Cash settlements on non-trading derivative instruments
4,394


4,493

15,672


8,608

Retail Gross Margin
$
29,137


$
24,677

$
68,699


$
52,551


The Company uses retail gross margin and net asset optimization revenues as the measure of profit or loss for its business segments. This measure represents the lowest level of information that is provided to the chief operating decision maker for our reportable segments.

Financial data for business segments are as follows (in thousands): 
Three Months Ended June 30, 2016
Retail
Electricity

Retail
Natural Gas

Corporate
and Other

Eliminations

Spark Retail
Total Revenues
$
57,556

 
$
18,631

 
$

 
$

 
$
76,187

Retail cost of revenues
33,302

 
4,543

 

 

 
37,845

Less:
 
 
 
 
 
 
 
 
 
Net asset optimization expenses

 
(676
)
 

 

 
(676
)
Gains on non-trading derivatives
3,599

 
1,888

 

 

 
5,487

Current period settlements on non-trading derivatives
2,981

 
1,413

 

 

 
4,394

Retail Gross Margin
$
17,674

 
$
11,463

 
$

 
$

 
$
29,137

Total Assets at June 30, 2016
$
184,869

 
$
123,679

 
$
113,913

 
$
(254,399
)
 
$
168,062

Goodwill at June 30, 2016
$
16,476

 
$
1,903

 
$

 
$

 
$
18,379



Three Months Ended June 30, 2015
Retail
Electricity

Retail
Natural Gas

Corporate
and Other

Eliminations

Spark Retail
Total revenues
$
48,698


$
21,545


$


$