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EX-32.1 - EXHIBIT 32.1 - Spark Energy, Inc.certceoandcfoexh32-q32016.htm
EX-31.2 - EXHIBIT 31.2 - Spark Energy, Inc.certcfoexh312-q32016.htm
EX-31.1 - EXHIBIT 31.1 - Spark Energy, Inc.certceoexh311-q32016.htm
EX-10.3 - EXHIBIT 10.3 - Spark Energy, Inc.a4600466v1_usx-longterminc.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 September 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 6,496,559 shares of Class A common stock and 10,224,742 shares of Class B common stock outstanding as of November 8, 2016.



 
PART I. FINANCIAL INFORMATION
 
 
ITEM 1. FINANCIAL STATEMENTS
 
 
 
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2016 AND DECEMBER 31, 2015 (unaudited)
 
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015 AND THE NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015 (unaudited)
 
 
 
 
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016 (unaudited)
 
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 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. INDEX TO EXHIBITS
 
APPENDIX A
 
SIGNATURES
 
EXHIBIT INDEX
 


1


PART 1. — FINANCIAL INFORMATION

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

 

Current assets:

 

Cash and cash equivalents
$
16,907


$
4,474

Accounts receivable, net of allowance for doubtful accounts of $1.9 million as of September 30, 2016 and December 31, 2015, respectively
79,744


59,936

Accounts receivable—affiliates
2,836


1,840

Inventory
3,725


3,665

Fair value of derivative assets
1,536


605

Customer acquisition costs, net
15,565


13,389

Customer relationships, net
19,042


6,627

Prepaid assets (1)
1,515


700

Deposits
8,158


7,421

Other current assets
10,717


4,023

Total current assets
159,745

 
102,680

Property and equipment, net
4,866


4,476

Fair value of derivative assets
318

 

Customer acquisition costs, net
4,531


3,808

Customer relationships, net
24,478


6,802

Non-current deferred tax assets
56,101


23,380

Goodwill
79,556


18,379

Other assets
8,136


2,709

Total assets
$
337,731

 
$
162,234

Liabilities and Stockholders' Equity

 

Current liabilities:

 

Accounts payable
$
34,964

 
$
29,732

Accounts payable—affiliates
2,598

 
1,962

Accrued liabilities
31,744

 
12,245

Fair value of derivative liabilities
13,762

 
10,620

Current portion of Senior Credit Facility
49,269


27,806

Contingent consideration for acquisitions - current
11,325


500

Current portion of note payable
13,445



Other current liabilities
3,662


1,323

Total current liabilities
160,769

 
84,188

Long-term liabilities:


 


Fair value of derivative liabilities
1,467

 
618

Long-term payable pursuant to tax receivable agreement—affiliates
50,625


20,713

Long-term portion of Senior Credit Facility


14,592

Non-current deferred tax liability


853

Convertible subordinated notes to affiliate
6,542


6,339

Contingent consideration for acquisitions
7,611



Other long-term liabilities


1,612

Total liabilities
227,014

 
128,915

Commitments and contingencies (Note 11)





Stockholders' equity:





       Common Stock:





Class A common stock, par value $0.01 per share, 120,000,000 shares authorized, 6,496,559 issued and outstanding at September 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, 10,224,742 issued and outstanding at September 30, 2016 and 10,750,000 issued and outstanding at December 31, 2015
103


108

        Preferred Stock:





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



        Additional paid-in capital
23,476


12,565

Accumulated other comprehensive loss
(33
)
 

        Retained deficit
(681
)

(1,366
)
       Total stockholders' equity
22,930


11,338

Non-controlling interest in Spark HoldCo, LLC
87,787


21,981

       Total equity
110,717


33,319

Total liabilities and stockholders' equity
$
337,731


$
162,234

(1)
Prepaid assets includes prepaid assets—affiliates of less than $1 and $210 as of September 30, 2016 and December 31, 2015, respectively. See Note 12 "Transaction with Affiliates" for further discussion.

2


(2)
See Note 4 "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.

3


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

Three Months Ended September 30,
Nine Months Ended September 30,

2016 (1)
 
2015 (2)
2016 (1)

2015 (2)
Revenues:
 
 
 



Retail revenues
$
157,986

 
$
91,812

$
378,063


$
261,996

Net asset optimization (expenses) revenues (3)
108

 
(545
)
(42
)

1,317

Total Revenues
158,094

 
91,267

378,021


263,313

Operating Expenses:

 
 



Retail cost of revenues (4)
122,830

 
60,967

248,593


176,000

General and administrative (5)
18,009

 
15,493

55,188


43,909

Depreciation and amortization
8,295

 
7,557

23,337


17,873

Total Operating Expenses
149,134

 
84,017

327,118


237,782

Operating income
8,960

 
7,250

50,903


25,531

Other (expense)/income:

 
 



Interest expense
(1,270
)
 
(800
)
(2,855
)

(1,415
)
Interest and other income
240

 
5

340


326

Total other expenses
(1,030
)
 
(795
)
(2,515
)

(1,089
)
Income before income tax expense
7,930

 
6,455

48,388


24,442

Income tax expense
1,129

 
580

6,852


1,599

Net income
$
6,801

 
$
5,875

$
41,536


$
22,843

Less: Net income attributable to non-controlling interests
6,618

 
4,561

34,839


18,959

Net income attributable to Spark Energy, Inc. stockholders
$
183

 
$
1,314

$
6,697


$
3,884

Other comprehensive loss, net of tax:
 
 
 
 
 
 
Currency translation loss
$
(12
)
 
$

$
(73
)
 
$

Other comprehensive loss
(12
)


(73
)


Comprehensive income
$
6,789

 
$
5,875

$
41,463

 
$
22,843

Less: Comprehensive income attributable to non-controlling interests
6,611


4,561

34,799


18,959

Comprehensive income attributable to Spark Energy, Inc. stockholders
$
178


$
1,314

$
6,664


$
3,884

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



       Basic
$
0.03


$
0.42

$
1.23


$
1.27

       Diluted
$
(0.04
)

$
0.31

$
1.05


$
1.09










Weighted average shares of Class A common stock outstanding








       Basic
6,491


3,097

5,434


3,053

       Diluted
7,055


14,232

6,050


13,948

(1)
Financial information has been recast to include results attributable to the acquisition of Major Energy Companies by an affiliate on April 15, 2016. See Notes 2 and 3 "Basis of Presentation" and "Acquisitions," respectively, for further discussion.
(2)
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 Notes 2 "Basis of Presentation" for further discussion.    
(3)
Net asset optimization (expenses) revenues includes asset optimization revenues—affiliates of $0 and $263 for the three months ended September 30, 2016 and 2015, respectively, and asset optimization revenues—affiliates cost of revenues of $0 and $3,382 for the three months ended September 30, 2016 and 2015, respectively and asset optimization revenues—affiliates of $154 and $928 for the nine months ended September 30, 2016 and 2015, respectively, and asset optimization revenue—affiliates cost of revenues of $1,633 and $9,589 for the nine months ended September 30, 2016 and 2015, respectively.
(4)
Retail cost of revenues includes retail cost of revenues—affiliates of $0 for the three months ended September 30, 2016 and 2015, respectively, and less than $100 for the nine months ended September 30, 2016 and 2015 respectively.
(5)
General and administrative includes general and administrative expense—affiliates of $3,078 and $0 for the three months ended September 30, 2016, and 2015, respectively, and $11,521 and $100 for the nine months ended September 30, 2016 and 2015, respectively.
The accompanying notes are an integral part of the condensed consolidated financial statements.

4


SPARK ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 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






1,737


1,737


1,737

Restricted stock unit vesting
153



2



1,060


1,062


1,062

Excess tax benefit related to restricted stock vesting






186


186


186

Consolidated net income (1)







6,697

6,697

34,839

41,536

Foreign currency translation adjustment for equity method investee





(33
)


(33
)
(40
)
(73
)
Beneficial conversion feature






243


243


243

Distributions paid to non-controlling unit holders









(26,284
)
(26,284
)
Contribution of the Major Energy Companies in excess of cash









6,040

6,040

Dividends paid to Class A common stockholders







(6,012
)
(6,012
)

(6,012
)
Proceeds from disgorgement of stockholder short-swing profits






941


941


941

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
)

Issuance of Class B Common Stock

2,700


$

$
27

$

$

$

$
27

$
53,967

$
53,994

Balance at September 30, 2016
6,497

10,225


$
65

$
103

$
(33
)
$
23,476

$
(681
)
$
22,930

$
87,787

$
110,717

(1)
Financial information has been recast to include results attributable to the acquisition of the Major Energy Companies from an affiliate on August 23, 2016. See Notes 2 and 3 "Basis of Presentation" and "Acquisitions," respectively, for further discussion.

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


5


SPARK ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015
(in thousands)
(unaudited) 
  
Nine Months Ended September 30,
  
2016 (1)
 
2015 (2)
Cash flows from operating activities:

 

Net income
$
41,536

 
$
22,843

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

 

Depreciation and amortization expense
32,743

 
17,873

Deferred income taxes
1,408

 
872

Stock based compensation
4,027

 
1,992

Amortization of deferred financing costs
465

 
295

Change in fair value of CenStar Earnout
843

 

Bad debt expense
842

 
6,082

Loss on derivatives, net
(2,887
)
 
6,118

Current period cash settlements on derivatives, net
(18,693
)
 
(15,120
)
Other
314

 
21

Changes in assets and liabilities:

 

Decrease in restricted cash

 
707

Decrease in accounts receivable
21,147

 
18,566

(Increase) decrease in accounts receivable—affiliates
(997
)
 
(216
)
Decrease in inventory
568

 
2,978

Increase in customer acquisition costs
(10,234
)
 
(17,725
)
(Increase) decrease in prepaid and other current assets
(923
)
 
11,110

Increase in intangible assets—customer relationships

 
(2,776
)
Decrease (increase) in other assets
733

 
(256
)
Decrease in accounts payable and accrued liabilities
(6,490
)
 
(14,610
)
Increase in accounts payable—affiliates
636

 
849

Decrease in other current liabilities
(1,783
)
 
(1,534
)
(Decrease) increase in other non-current liabilities
(1,612
)
 
1,606

Net cash provided by operating activities
61,643

 
39,675

Cash flows from investing activities:

 

Purchases of property and equipment
(1,763
)
 
(1,255
)
Acquisition of CenStar and Oasis net assets

 
(41,234
)
Acquisition of Major Energy Companies and Provider Companies net assets
(30,507
)
 

Payment of CenStar Earnout
(1,343
)
 

Investment in eREX Spark Marketing Joint Venture
(562
)
 
(330
)
Net cash used in investing activities
(34,175
)
 
(42,819
)
Cash flows from financing activities:

 

Borrowings on the Senior Credit Facility
47,923

 
52,225

Payments on the Senior Credit Facility
(44,601
)
 
(38,000
)
Contributions from NuDevco

 
129

        Proceeds from issuance of Class B common stock
13,995

 

Proceeds from disgorgement of stockholders short-swing profits
941

 

        Issuance of convertible subordinated notes to affiliate

 
7,075

Restricted stock vesting
(1,183
)
 
(265
)
Excess tax benefit related to restricted stock vesting
185

 

Payment of dividends to Class A common stockholders
(6,012
)
 
(3,333
)
        Payment of distributions to non-controlling unitholders
(26,283
)
 
(11,691
)
Net cash (used in) provided by financing activities
(15,035
)
 
6,140

Increase in cash and cash equivalents
12,433

 
2,996

Cash and cash equivalents—beginning of period
4,474

 
4,359

Cash and cash equivalents—end of period
$
16,907

 
$
7,355

Supplemental Disclosure of Cash Flow Information:

 

Non-cash items:
 
 
 
        Issuance of Class B common stock to affiliates for Major Energy Companies acquisition
$
40,000

 
$

Contingent consideration - earnout obligations incurred in connection with the Provider      Companies and Major Energy Companies acquisitions
$
18,936

 
$

Assumption of legal liability in connection with the Major Energy Companies acquisition
$
5,000

 
$

Contribution of the Major Energy Companies in excess of cash
$
6,040

 
$

        Installment consideration incurred in connection with the Provider Companies acquisition
$
3,023

 
$

        Property and equipment purchase accrual
$
64

 
$
11

        Liability due to tax receivable agreement
$
(29,912
)
 
$

        Tax benefit from tax receivable agreement
$
33,124

 
$

Cash paid during the period for:
 
 
 
Interest
$
1,450

 
$
1,061

Taxes
$
3,783

 
$
157


6


(1)
Financial information has been recast to include results attributable to the acquisition of the Major Energy Companies from an affiliate on August 23, 2016. See Notes 2 and 3 "Basis of Presentation" and "Acquisitions," respectively, for further discussion.
(2)
Financial information has been recast to include results attributable to the acquisition of Oasis Power Holdings LLC by an affiliate on May 12, 2015. See Notes 2 "Basis of Presentation" for further discussion.

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

7


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

Spark Energy, Inc. ("Spark Energy," "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"), CenStar Energy Corp. ("CenStar"), Electricity Maine, LLC, Electricity N.H., LLC and Provider Power Mass, LLC (collectively, the "Provider Companies"); and Major Energy Services, LLC, Major Energy Electric Services, LLC, and Respond Power, LLC (collectively, the "Major Energy Companies"), 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.

The Provider Companies operate as retail energy providers. Electricity Maine, LLC, Electricity N.H., LLC, and Provider Power Mass, LLC were formed on June 17, 2010, January 20, 2012 and August 22, 2012, respectively, as limited liability companies under the Maine Limited Liability Company Act. We acquired the Provider Companies on August 1, 2016.

The Major Energy Companies operate as retail energy providers. Major Energy Services, LLC, Major Energy Electric Services, LLC and Respond Power, LLC were formed on October 11, 2005, September 12, 2007 and July 11, 2008, respectively, as limited liability companies under the New York Limited Liability Company Law. We completed the purchase of all the outstanding membership interests of the Major Energy Companies on August 23, 2016 from an affiliate, as described in Note 2.

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

8


("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 4 “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.

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. Retail Acquisition Co., LLC ("RAC") is entitled to similar registration rights under the CenStar Note and Oasis Note. Refer to Note 7 "Debt" for further discussion.
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

9


(“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 that are, in the opinion of management, necessary for a fair presentation of the condensed consolidated financial statements. Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that 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 12 “Transactions with Affiliates.”

Presentation of the Acquisition of Oasis Power Holdings, LLC

On May 12, 2015, RAC, an affiliate of the Company, 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 reflect operations of Oasis from May 12, 2015 to July 31, 2015. The unaudited condensed consolidated financial statements for this recast period had 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.

Presentation of the Acquisition of Major Energy Companies


10


On April 15, 2016, National Gas & Electric, LLC (“NG&E”), an affiliate of the Company, completed the acquisition of 100% of the membership interests of Major Energy Companies. On May 3, 2016, Spark HoldCo and Retailco entered into a Membership Interest Purchase Agreement (the "Major Purchase Agreement") with NG&E for the purchase of all of the membership interests of the Major Energy Companies. Spark HoldCo and Retailco completed the acquisition of the Major Energy Companies from NG&E on August 23, 2016. Because the acquisition of the Major Energy Companies was a transfer of equity interests of entities under common control, the Company's historical financial statements have been recast in this Form 10-Q to include the results attributable to Major Energy Companies from April 15, 2016. The unaudited condensed consolidated financial statements for this recast period have been prepared from Major Energy Companies' historical cost-basis and may not necessarily be indicative of the actual results of operations that would have occurred had the Company owned the Major Energy Companies 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 14 “Subsequent Events” for further discussion.

Reclassification
Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported earnings.

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 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.


11


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 are 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 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 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.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-15 provides guidance on the presentation and classification of eight specific cash flow issues in the statement of cash flows. Those issues are cash payment for debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instrument or other debt instrument with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; cash proceeds from the settlement of insurance claims, cash received from settlement of corporate-owned life insurance policies; distribution received from equity method investees; beneficial interest in securitization transactions; and classification of cash receipts and payments that have aspects of more than one class of cash flows. The guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. This ASU should be

12


applied using a retrospective transition method for each period presented. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). ASU 2016-16 requires immediate recognition of the current and deferred income tax consequences of intercompany asset transfers other than inventory. Current U.S. GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2017, with early adoption permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. This ASU should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.


3. Acquisitions


Acquisition of the Provider Companies

On August 1, 2016, the Company and Spark HoldCo completed the purchase of all of the outstanding membership interests of the Provider Companies. The Provider Companies serve electrical customers in Maine, New Hampshire and Massachusetts. The purchase price for the Provider Companies was approximately $34.1 million, which included $1.3 million in working capital, subject to adjustments, and up to $9.0 million in earnout payments, valued at $4.8 million as of the purchase date, to be paid by June 30, 2017, subject to the achievement of certain performance targets (the "Provider Earnout"). See Note 8 "Fair Value Measurements" for further discussion on the Provider Earnout. The purchase price was funded by the issuance of 699,742 shares of Class B common stock (and a corresponding number of Spark HoldCo units) sold to Retailco, valued at $14.0 million based on a value of $20 per share; borrowings under the Senior Credit Facility of $10.6 million; and $3.8 million in net installment consideration to be paid in ten monthly payments that commenced in August 2016. The first payment of $0.4 million was made with the initial consideration paid. See Note 7 "Debt" for further discussion of the Senior Credit Facility.
     
The acquisition of the Provider Companies has been accounted for under the acquisition method in accordance with ASC 805, Business Combinations (“ASC 805”). The allocation of purchase consideration was based upon the estimated fair value of the tangible and identifiable intangible assets acquired and liabilities assumed in the acquisition. The allocation was made to major categories of assets and liabilities based on management’s best estimates, supported by independent third-party analyses. The excess of the purchase price over the estimated fair value of tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. The allocation of the purchase consideration is as follows (in thousands):

Cash

$
51

Net working capital, net of cash acquired

1,229

Intangible assets - customer relationships and non-compete agreements

24,417

Intangible assets - trademark

529

Goodwill

26,040

Fair value of derivative liabilities

(18,163
)
Total

$
34,103



13



The fair values of intangible assets were measured primarily based on significant inputs that are not observable in the market and thus represent a Level 3 measurement as defined by ASC 820, "Fair Value Measurement" ("ASC 820"). The fair value of derivative liabilities were measured by 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 and represent a Level 2 measurement as defined by ASC 820. Refer to Note 8 "Fair Value Measurements" for further discussion on the fair values hierarchy. Significant inputs for Level 3 measurements were as follows:

Customer relationships. The customer relationships, reflective of the Provider Companies' customer base, were valued using an excess earnings method under the income approach. Using this method, the Company estimated the future cash flows resulting from the existing customer relationships, considering attrition as well as charges for contributory assets, such as net working capital, intangible assets, and assembled workforce. These future cash flows were then discounted using an appropriate risk-adjusted rate of return to arrive at the present value of the expected future cash flows. These customer relationships were bifurcated between unhedged and hedged and will be amortized to depreciation and amortization based on the expected future net cash flows by year and expensed to Retail cost of revenues based on the expected term of the underlying fixed price contract acquired in each reporting period, respectively.

Trademark. The fair value of the Provider Companies' trademark is reflective of the value associated with the recognition and reputation of the Provider Companies to its target markets. The fair value of the trademark was estimated using the income approach. Under this approach, the Company estimated the expected trademark royalty revenue by analyzing market royalty rates of comparative trademark agreements and applying an expected royalty rate to estimate royalty revenue. Such estimated royalty revenue was then added to the forecast of the Provider Companies' revenue, which was then discounted using an appropriate risk adjusted rate of return. The trademark is being amortized over the estimated five-year life of the asset on a straight-line basis.

Non-compete agreements. The non-compete agreements provide the Company with a certain level of assurance that the Provider Companies' expected earnings stream will not be disrupted by competition from Provider Companies' previous members. The fair value of the non-compete agreements was determined using the differential valuation approach. Under this approach, the Company estimated the present value of expected future cash flows under two scenarios; one scenario assumes the non-compete agreements are in place and the other scenario assumes the absence of non-compete agreements. The resulting difference between the two scenarios is the implied value of the non-compete agreements, which was further adjusted by an estimated probability factor representing the likelihood that previous members of the Provider Companies would be successful competitors.

Goodwill. The excess of the purchase consideration over the estimated fair value of the amounts initially assigned to the identifiable assets acquired and liabilities assumed was recorded as goodwill. Goodwill arose on the acquisition of the Provider Companies primarily due the value of its assembled workforce, along with access to new utility service territories. Goodwill recorded in connection with the acquisition of the Provider Companies is deductible for income tax purposes because the Provider Companies was an acquisition of all of the assets of the Provider Companies. The valuation and purchase price allocation of the Provider Companies was based on a preliminary fair value analysis. The Company anticipates adjustments to the working capital amounts that are expected to be finalized prior to the measurement period's expiration.

The Company’s condensed consolidated statements of operations for the three and nine months ended September 30, 2016, respectively, included $19.6 million of revenue and $6.9 million of losses from operations related to the operations of the Provider Companies. We have not included pro forma information for the Provider Companies acquisition because it did not have a material impact on our financial position or results of operations.


14


Acquisition of the Major Energy Companies

On August 23, 2016, the Company and Spark HoldCo completed the transfer of all of the outstanding membership interests of the Major Energy Companies, which are retail energy companies operating in Connecticut, Illinois, Maryland (including the District of Columbia), Massachusetts, New Jersey, New York, Ohio, and Pennsylvania across 43 utilities, from NG&E in exchange for consideration of $63.2 million, which included $4.3 million in working capital, subject to adjustments; an assumed litigation reserve of $5.0 million, and up to $35.0 million in installment and earnout payments, valued at $13.1 million as of the purchase date, to be paid to the previous members of the Major Energy Companies, in annual installments on March 31, 2017, 2018 and 2019, subject to the achievement of certain performance targets (the “Major Earnout”). In addition, the Company is obligated to issue up to 200,000 shares of Class B common stock (and a corresponding number of Spark HoldCo units) to NG&E, subject to the achievement of certain performance targets, valued at $0.8 million (40,718 shares valued at $20 per share) as of the purchase date (the "Stock Earnout"). See Note 8 “Fair Value Measurements” for further discussion on the Major Earnout and Stock Earnout. The purchase price was funded by the issuance of 2,000,000 shares of Class B common stock (and a corresponding number of Spark HoldCo units) valued at $40.0 million based on a value of $20 per share, to NG&E. NG&E is owned by W. Keith Maxwell, III, our Chairman of the Board, founder and majority shareholder.
The acquisition of the Major Energy Companies by the Company and Spark HoldCo from NG&E was a transfer of equity interests of entities under common control on August 23, 2016. Accordingly, the assets acquired and liabilities assumed were based on their historical values as of August 23, 2016. NG&E acquired the Major Energy Companies on April 15, 2016 and the fair value of the net assets acquired were as follows (in thousands):

Cash
 
$
17,368

Property and equipment
 
14

Intangible assets - customer relationships & non-compete agreements
 
24,271

Other assets - trademarks
 
4,973

Non-current deferred tax assets
 
1,042

Goodwill
 
35,137

Net working capital, net of cash acquired
 
(6,345
)
Fair value of derivative liabilities
 
(7,260
)
Total
 
$
69,200



The initial working capital estimate paid to the Major Energy Companies by NG&E was $10.3 million. The Company subsequently paid $4.3 million in working capital to NG&E. Approximately $6.0 million was recorded as an equity transaction and treated as a contribution.
Goodwill was transferred based on the acquisition of the Major Energy Companies by NG&E on April 15, 2016 and was primarily due to the Major Energy Companies brand strength, established vendor relationships and access to new utility service territories. Goodwill recorded in connection with the transfer of the Major Energy Companies is deductible for income tax purposes.
The Major Energy Companies contributed revenues of $47.6 million and earnings of $5.2 million to the Company for the three month period ending September 30, 2016; and contributed revenues of $80.8 million and earnings of $5.6 million to the Company for the nine month period ending September 30, 2016.
The following unaudited pro forma revenue and earnings summary presents consolidated information of the Company as if the acquisition had occurred on January 1, 2015 (in thousands):

15


 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
2015
 
2016
2015
 
 
 
 
 
 
 
Revenue
 
$158,094
$136,590
 
$434,997
$411,357
 
 
 
 
 
 
 
Earnings
 
$2,878
$2,567
 
$17,071
$6,503


The pro forma results are not necessarily indicative of our consolidated results of operations in future periods or the results that actually would have been realized had the companies operated on a combined basis during the periods presented. The revenue and earnings for the three months ended September 30, 2016 reflects actual results of operations since the financial results were fully combined during that period. The pro forma results include adjustments primarily related to amortization of acquired intangibles, and certain accounting policy alignments as well as direct and incremental acquisition related costs reflected in the historical financial statements. The preliminary purchase price allocation was used to prepare the pro forma adjustments. The final allocation could differ materially from the preliminary allocation used in the pro forma adjustments.


4. 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 September 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
%
From July 1, 2016 to July 14, 2016
46.23
%
53.77
%
From July 15, 2016 to July 31, 2016
46.32
%
53.68
%
From August 1, 2016 to August 17, 2016
44.12
%
55.88
%
From August 18, 2016 to August 22, 2016
44.13
%
55.87
%
From August 23, 2016 to September 22, 2016
38.85
%
61.15
%
From September 23, 2016 to September 30, 2016
38.85
%
61.15
%
(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.

16


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

Three Months Ended September 30,

Nine Months Ended September 30,

2016

2015

2016

2015
 


 



 
Net income allocated to non-controlling interest
$
6,569


$
5,011


$
35,356


$
19,058

Income tax expense (benefit) allocated to non-controlling interest
(49
)

450


517


99

Net income attributable to non-controlling interest
$
6,618


$
4,561


$
34,839


$
18,959


Issuance of Class A Common Stock Upon Vesting of Restricted Stock Units

The Company's economic interests in Spark HoldCo increased on May 4, 2015, December 31, 2015, May 4, 2016, May 18, 2016, May 25, 2016, July 15, 2016, August 18, 2016 and September 23, 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.

On July 15, 2016, 32,704 restricted stock units vested, with 23,030 shares of common stock distributed to the holders of these units and 9,674 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units.

On August 18, 2016, 4,166 restricted stock units vested, with 3,019 shares of common stock distributed to the holders of these units and 1,147 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units. On September 23, 2016, 580 restricted stock units vested, with 383 shares of common stock distributed to the holders of these units and 197 shares of common stock withheld by the Company to cover taxes owed on the vesting of such units.

Issuance of Class B Common Stock

On August 1, 2016, the Company issued 699,742 shares of Class B common stock to Retailco in connection with the acquisition of the Provider Companies. On August 23, 2016, the Company issued 2,000,000 shares of Class B common stock to Retailco in connection with the acquisition of Major Energy Companies.

Conversion of Class B Common Stock to Class A Common Stock

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

17


HoldCo unit (and corresponding share of Class B common stock) exchanged. Refer to Note 10 "Taxes" for further discussion.

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 nine months ended September 30, 2016 and 2015 (in thousands, except per share data):

Three Months Ended September 30,
Nine Months Ended September 30,

2016
2015
2016
2015
Net income attributable to stockholders of Class A common stock
$
183

$
1,314

$
6,697

$
3,884

Basic weighted average Class A common shares outstanding
6,491

3,097

5,434

3,053

Basic EPS attributable to stockholders
$
0.03

$
0.42

$
1.23

$
1.27






Net income attributable to stockholders of Class A common stock
$
183

$
1,314

$
6,697

$
3,884

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

3,605


11,734

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
(467
)
(520
)
(358
)
(436
)
Diluted net income (loss) attributable to stockholders of Class A common stock
(284
)
4,399

6,339

15,182

Basic weighted average Class A common shares outstanding
6,491

3,097

5,434

3,053

Effect of dilutive Class B common stock

10,750


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
505

351

505

118

Effect of dilutive restricted stock units
59

34

111

27

Diluted weighted average shares outstanding
7,055

14,232

6,050

13,948






Diluted EPS attributable to stockholders
$
(0.04
)
$
0.31

$
1.05

$
1.09


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 and nine months ended September 30, 2016 as the effect of the conversion was antidilutive.


18


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.

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 September 30, 2016 (in thousands):


September 30, 2016
Assets

Current assets:

Cash and cash equivalents
$
16,850

Accounts receivable
79,744

Other current assets
63,094

Total current assets
159,688

Non-current assets:

Goodwill
79,556

Other assets
42,485

Total non-current assets
122,041

Total Assets
$
281,729



Liabilities

Current liabilities:

Accounts payable and accrued liabilities
$
78,511

Intercompany payable with Spark Energy, Inc.
5,555

Current portion of Senior Credit Facility
49,269

Contingent consideration
11,464

Other current liabilities
20,021

Total current liabilities
164,820

Long-term liabilities:

Convertible subordinated notes to affiliates
6,542

Contingent consideration
7,472

Other long-term liabilities
1,467

Total long-term liabilities
15,481

Total Liabilities
$
180,301



19



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

Estimated 
useful
lives
 
September 30, 2016
 
December 31, 2015
 
(years)
 
(In thousands)
Information technology
2 – 5
 
$
29,228

 
$
27,392

Leasehold improvements
2 – 5
 
4,568

 
4,568

Furniture and fixtures
2 – 5
 
1,012

 
1,007

Total

 
34,808

 
32,967

Accumulated depreciation

 
(29,942
)
 
(28,491
)
Property and equipment—net

 
$
4,866

 
$
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 September 30, 2016 and December 31, 2015, information technology includes $0.8 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 $0.3 million for the three months ended September 30, 2016 and 2015, respectively, and $1.4 million and $1.2 million for the nine months ended September 30, 2016 and 2015, respectively.
6. Goodwill, Customer Relationships and Trademarks
Goodwill, customer relationships and trademarks consist of the following amounts (in thousands):
 
September 30, 2016
December 31, 2015
Goodwill
$
79,556

$
18,379

Customer relationships - Acquired (1)


Cost
$
63,571

$
14,883

Accumulated amortization
(22,022
)
(4,503
)
Customer relationships - Acquired, net
$
41,549

$
10,380

Customer relationships - Other (2)


Cost
$
4,320

$
4,320

Accumulated amortization
(2,349
)
(1,271
)
Customer relationships - Other, net
$
1,971

$
3,049

Trademarks (3)


Cost
$
6,770

$
1,268

Accumulated amortization
(311
)
(74
)
Trademarks, net
$
6,459

$
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, Oasis, the Major Energy Companies and the Provider Companies. These trademarks are recorded as other assets in the condensed consolidated balance sheets.


20


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

Additions
61,177

48,688


5,502

Amortization expense

(17,519
)
(1,078
)
(237
)
Balance at September 30, 2016
$
79,556

$
41,549

$
1,971

$
6,459


Approximately $9.4 million of the $17.5 million customer relationships amortization expense for the nine months ending September 30, 2016 is included in cost of revenues.

Estimated future amortization expense for customer relationships and trademarks at September 30, 2016 is as follows (in thousands):
Year ending December 31,

2016
$
10,117

2017
12,913

2018
10,337

2019
5,892

2020
2,895

> 5 years
7,825

Total
$
49,979

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

September 30, 2016

December 31, 2015
Current portion of Senior Credit Facility—Working Capital Line (1) (2)
$
26,000


$
22,500

Current portion of Senior Credit Facility—Acquisition Line (1) (2)
23,269


5,306

Current portion of Note Payable—Pacific Summit Energy
13,445

 

Total current debt
62,714


27,806

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


14,592

Convertible subordinated notes to affiliate (3)
6,542


6,339

Total long-term debt
6,542


20,931

Total debt
$
69,256


$
48,737

(1)
As of September 30, 2016 and December 31, 2015, the Company had $33.0 million and $21.5 million in letters of credit issued, respectively.
(2)
As of September 30, 2016 and December 31, 2015, the weighted average interest rate on the current portion of our Senior Credit Facility was 4.38% and 3.90%, respectively.
(3)
During the three and nine months ended September 30, 2016, respectively, we paid in-kind $0.2 million and $0.4 million of interest, which was added to the outstanding balance of the convertible subordinated notes. Unamortized discount of $0.9 million and $0.7 million at September 30, 2016 and December 31, 2015, respectively, is related to beneficial conversion features of the convertible subordinated notes. On October 5, 2016, RAC issued to the Company an irrevocable commitment to convert the CenStar Note and the Oasis Note into shares of Class B common stock on January 8, 2017 and January 31, 2017, respectively. See Note 14 "Subsequent Events."


21


Deferred financing costs were $0.6 million and $0.7 million as of September 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 September 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 September 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 September 30,

Nine Months Ended September 30,

2016

2015

2016

2015
Interest incurred on Senior Credit Facility
$
712


$
351


$
1,435


$
670

Commitment fees
30


44


113


141

Letters of credit fees
165


124


457


223

Amortization of deferred financing costs 
231


195


465


295

Interest incurred on convertible subordinated notes to affiliate (1)
132


86


385


86

Interest Expense
$
1,270


$
800


$
2,855


$
1,415


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 nine months ended September 30, 2016
Senior Credit Facility

The Company, as guarantor, and Spark HoldCo (the “Borrower,” and together with SE, SEG, CenStar, CenStar Operating Company, LLC, Oasis, Oasis Power, LLC, Electricity Maine, LLC, Electricity N.H., LLC, and Provider Power Mass, 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 up to $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. On September 30, 2016, the Company and the Co-Borrowers elected to reduce the capacity of the Working Capital Line from $82.5 million to $60.0 million. 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 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.

On August 1, 2016, the Company and the Co-Borrowers entered into Amendment No. 4 to the Senior Credit Facility to, among other things, amend the provisions under the Acquisition Line to allow for the Provider Companies acquisition. Amendment No. 4 also raises the minimum availability under the Working Capital Line to $40.0 million. In addition, Amendment No. 4 designates Major Energy Companies as "unrestricted subsidiaries" upon the closing of such acquisition on August 23, 2016. Refer to Note 3 "Acquisitions" for further discussion.

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

22


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 $40.0 million to $82.5 million. On September 30, 2016, the Company and the Co-Borrowers elected to reduce the capacity of the Working Capital Line from $82.5 million to $60.0 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, 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 cash 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 up to a maximum of 1.25). 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.

23



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.

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.

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 RAC for $2.1 million on July 8, 2015. The CenStar Note matures on July 8, 2020, and bears interest at an annual rate of 5%, payable semiannually. The Company has the right to pay interest in kind at its option. The CenStar Note is convertible into shares of the Company’s Class B common stock, par value $0.01 per share (and a related unit of Spark HoldCo) at a conversion price of $16.57 per share. RAC may not exercise conversion rights for the first eighteen months after the CenStar Note is issued. The CenStar Note is subject to automatic conversion upon a sale of the Company. The CenStar Note is subordinated in certain respects to the Senior Credit Facility pursuant to a subordination agreement. The Company may pay interest and prepay principal so long as the Company is in compliance with its covenants; is not in default under the Senior Credit Facility and has minimum availability of $5.0 million under its borrowing base under the Senior Credit Facility. Shares of Class A common stock resulting from the conversion of the shares of Class B common stock issued as a result of the conversion right under the CenStar Note will be entitled to registration rights identical to the registration rights currently held by NuDevco Retail and Retailco on shares of Class A common stock it receives upon conversion of

24


its existing shares of Class B common stock. On October 5, 2016, RAC issued to the Company an irrevocable commitment to convert the CenStar Note into 134,731 shares of Class B common stock (and related Spark HoldCo units) on January 8, 2017. Please see Note 14 "Subsequent Events."

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. The Oasis Note matures on July 31, 2020, and bears interest at an annual rate of 5%, payable semiannually. The Company has the right to pay-in-kind any interest at its option. The Oasis Note is convertible into shares of the Company's Class B common stock, par value $0.01 per share (and a related unit of Spark HoldCo) at a conversion price of $14.00 per share. RAC may not exercise conversion rights for the first eighteen months after the Oasis Note is issued. The Oasis Note is subject to automatic conversion upon a sale of the Company. The Oasis Note is subordinated in certain respects to the Senior Credit Facility pursuant to a subordination agreement. The Company may pay interest and prepay principal so long as the Company is in compliance with its covenants; is not in default under the Senior Credit Facility and has minimum availability of $5.0 million under its borrowing base under the Senior Credit Facility. Shares of Class A common stock resulting from the conversion of the shares of Class B common stock issued as a result of the conversion right under the Oasis Note will be entitled to registration rights identical to the registration rights currently held by NuDevco Retail and Retailco on shares of Class A common stock it receives upon conversion of its existing shares of Class B common stock. On October 5, 2016, RAC issued to the Company an irrevocable commitment to convert the Oasis Note into 383,090 shares of Class B common stock (and related Spark HoldCo units) on January 31, 2017. Please see Note 14 "Subsequent Events."

The conversion rate of $14.00 per share for the Oasis Note was fixed as of the date of the execution of the Oasis acquisition agreement on May 12, 2015. Due to a rise in the price of our common stock from May 12, 2015 to the closing of Oasis acquisition on July 31, 2015, the conversion rate of $14.00 per share was below the market price per share of Class A common stock of $16.21 on the issuance date of the Oasis Note on July 31, 2015. As a result, the Company assessed the Oasis Note for a beneficial conversion feature. Due to this conversion feature being "in-the-money" upon issuance, we recognized a beneficial conversion feature based on its intrinsic value of $0.8 million as a discount to the Oasis Note and as additional paid-in capital. This discount will be amortized as interest expense under the effective interest method over the life of the Oasis Note.

Pacific Summit Energy LLC
The Major Energy Companies acquired by the Company are party to three trade credit arrangements with Pacific Summit Energy LLC (“Pacific Summit”), which consist of purchase agreements, operating agreements relating to purchasing terms, security agreements, lockbox agreements and guarantees, providing for the exclusive supply of gas and electricity on credit by Pacific Summit to the Major Energy Companies for resale to end users.
Under these arrangements, when the costs that Pacific Summit has paid to procure and deliver the gas and electricity exceed the payments that the Major Energy Companies have made attributable to the gas and electricity purchased, the Major Energy Companies incur interest on the difference. The operating agreements also allow Pacific Summit to provide credit support. Each form of borrowing incurs interest at the floating 90-day LIBOR rate plus 300 basis points (except for certain credit support guaranties that do not bear interest). In connection with these arrangements, the Major Companies have granted first liens to Pacific Summit on a substantial portion of the Major Companies’ assets, including present and future accounts receivable, inventory, liquid assets, and control agreements relating to bank accounts. As of September 30, 2016, the Company had aggregate outstanding amounts payable under these arrangements of approximately $13.4 million, bearing an interest rate of approximately 3.9%. The Company was also the beneficiary under various credit support guarantees issued by Pacific Summit under these arrangements as of such date. On September 27, 2016, we notified Pacific Summit of our election to trigger the expiration of these arrangements as of March 31, 2017, at the end of the primary term. 
8. Fair Value Measurement

25


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. The Level 3 category includes estimated earnout obligations related to the Company's acquisitions.
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): 

Level 1

Level 2

Level 3

Total
September 30, 2016
 

 

 

 
Non-trading commodity derivative assets
$


$
915


$


$
915

Trading commodity derivative assets


939




939

Total commodity derivative assets
$


$
1,854


$


$
1,854

Non-trading commodity derivative liabilities
$
(448
)

$
(14,448
)

$


$
(14,896
)
Trading commodity derivative liabilities
(58
)

(275
)



(333
)
Total commodity derivative liabilities
$
(506
)

$
(14,723
)

$


$
(15,229
)
Contingent payment arrangement
$

 
$

 
$
(18,935
)
 
$
(18,935
)

26



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 nine months ended September 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 that is calculated based on the Company’s or the counterparty’s historical credit risks. As of September 30, 2016 and December 31, 2015, the credit risk valuation adjustment was not material.
The contingent payment arrangements referred to above reflect estimated earnout obligations incurred in relation to the Company's acquisitions. As of September 30, 2016, the estimated earnout obligations were $18.9 million, which was comprised of the Provider Earnout, the Major Earnout and the Stock Earnout in the amount of $4.8 million, $13.3 million, and $0.8 million, respectively. As of December 31, 2015, the estimated earnout obligations were attributed to the CenStar acquisition (the "CenStar Earnout") in the amount of $0.5 million, which was settled by September 30, 2016. As of September 30, 2016, the estimated earnouts reside on our condensed consolidated balance sheets in current liabilities - contingent consideration and long-term liabilities - contingent consideration in the amount of $11.3 million and $7.6 million, respectively; and as of December 31, 2015, in current liabilities - contingent consideration in the amount of $0.5 million.
The CenStar Earnout was 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 was based on management's estimates of the liability, we classified the CenStar Earnout as a Level 3 measurement. During the first quarter of 2016, our estimate of the CenStar Earnout was increased to $1.5 million which was based on the results of operations during such period. In August 2016, we entered into a settlement and release agreement with the seller of CenStar in which the Company paid $1.3 million to such seller and released an additional $0.6 million from escrow in full satisfaction of the earnout obligation under the CenStar stock purchase agreement. During the three and nine months ended September 30, 2016, the residual earnout amount of $0.2 million was written off via a reduction to general and administrative expense in our condensed consolidated statements of operations.

The Provider Earnout is based on achievement by the Provider Companies of a certain customer count criteria over the nine month period following the closing of the Provider Companies acquisition. The sellers of the Provider Companies are entitled to a maximum of $9.0 million and a minimum of $5.0 million in earnout payments based on the level of customer count attained, as defined by the Provider Companies membership interest purchase agreement. In determining the fair value of the Provider Earnout, the Company forecasted an expected customer count and certain other related criteria and calculated the probability of such forecast being attained. As this calculation is based on management's estimates of the liability, we classified the Provider Earnout as a Level 3 measurement.

27


The Major Earnout is based on the achievement by the Major Energy Companies of certain performance targets over the 33 month period following NG&E's closing of the Major Energy Companies acquisition (i.e., April 15, 2016). The previous members of Major Energy Companies are entitled to a maximum of $20.0 million in earnout payments based on the level of performance targets attained, as defined by the Major Purchase Agreement. The Stock Earnout obligation is contingent upon the Major Energy Companies achieving the Major Earnout's performance target ceiling, thereby earning the maximum Major Earnout payments. If the Major Energy Companies earn such maximum Major Earnout payments, NG&E would be entitled to a maximum of 200,000 shares of Class B common stock (and a corresponding number of Spark HoldCo units). In determining the fair value of the Major Earnout and the Stock Earnout, the Company forecasted certain expected performance targets and calculated the probability of such forecast being attained. As this calculation is based on management's estimates of the liability, we classified the Major Earnout as a Level 3 measurement.
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.
9. 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 September 30, 2016 and December 31, 2015, the Company had $1.2 million 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

28


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

September 30, 2016

December 31, 2015
Natural Gas
MMBtu

6,760


7,543

Natural Gas Basis
MMBtu



455

Electricity
MWh

3,278


1,187

Trading
Commodity
Notional

September 30, 2016

December 31, 2015
Natural Gas
MMBtu

(2,366
)

8

Natural Gas Basis
MMBtu

242


(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 September 30,
  
2016
 
2015
(Loss) gain on non-trading derivatives, net
$
(1,183
)
 
$
132

Gain (loss) on trading derivatives, net
574

 
(71
)
(Loss) gain on derivatives, net
(609
)
 
61

Current period settlements on non-trading derivatives (1) (2)
(8,889
)
 
4,035

Current period settlements on trading derivatives
20

 
128

Total current period settlements on derivatives
$
(8,869
)
 
$
4,163

(1)
Excludes settlements of $0.5 million and $2.0 million, respectively, for the three months ended September 30, 2016 and 2015 related to non-trading derivative liabilities assumed in the acquisitions of CenStar and Oasis.
(2)
Excludes settlements of $11.2 million for the three months ended September 30, 2016 related to non-trading derivative liabilities assumed in the acquisitions of the Provider Companies and Major Energy Companies.



Nine Months Ended September 30,
  
2016

2015
Gain (loss) on non-trading derivatives, net
$
2,519


$
(5,876
)
Gain (loss) on trading derivatives, net
368


(242
)
Loss on derivatives, net
2,887


(6,118
)
Current period settlements on non-trading derivatives (1) (2)
3,341


12,643

Current period settlements on trading derivatives
86


244

Total current period settlements on derivatives
$
3,427


$
12,887

(1)
Excludes settlements of $0.6 million and $2.2 million, respectively, for the nine months ended September 30, 2016 and 2015 related to non-trading derivative liabilities assumed in the acquisitions of CenStar and Oasis.
(2)
Excludes settlements of $14.7 million for the nine months ended September 30, 2016 related to non-trading derivative liabilities assumed in the acquisitions of the Provider Companies and Major Energy Companies.
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.

29


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):
  
September 30, 2016
Description
Gross Assets

Gross
Amounts
Offset

Net Assets

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
1,909


$
(1,312
)

$
597


$


$
597

Trading commodity derivatives
952


(13
)

939




939

Total Current Derivative Assets
2,861


(1,325
)

1,536




1,536

Non-trading commodity derivatives
411


(93
)

318




318

Total Non-current Derivative Assets
411


(93
)

318




318

Total Derivative Assets
$
3,272


$
(1,418
)

$
1,854


$


$
1,854


September 30, 2016
Description
Gross 
Liabilities

Gross
Amounts
Offset

Net
Liabilities

Cash
Collateral
Offset

Net Amount
Presented
Non-trading commodity derivatives
$
(24,955
)

$
10,326


$
(14,629
)

$
1,200


$
(13,429
)
Trading commodity derivatives
(356
)

23


(333
)



(333
)
Total Current Derivative Liabilities
(25,311
)

10,349


(14,962
)

1,200


(13,762
)
Non-trading commodity derivatives
(4,532
)

3,065


(1,467
)



(1,467
)
Total Non-current Derivative Liabilities
(4,532
)

3,065


(1,467
)



(1,467
)
Total Derivative Liabilities
$
(29,843
)

$
13,414


$
(16,429
)

$
1,200


$
(15,229
)
  
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
)



30


10. Taxes

Income Taxes

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 nine months ended September 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 September 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 September 30, 2016.


31


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 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 September 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 September 30, 2016, the Company had a total liability of $50.6 million for the effect of the Tax Receivable Agreement liability classified as a long-term liability. The Company had a long-term deferred tax asset of approximately $20.0 million related to the Tax Receivable Agreement liability. See Note 12 “Transactions with Affiliates” for further discussion.

The effective U.S. federal and state income tax rate for the nine months ended September 30, 2016 and 2015 is 14.2% and 6.5%, respectively, with respect to pre-tax income attributable to the Company's stockholders. The higher effective tax rate for the nine months ended September 30, 2016 is primarily attributable to the CenStar acquisition, discrete items and a decrease in the non-controlling interest. The discrete items were related to federal tax rate increase that is driven by the additional taxable income from the two acquistions, Provider Companies and Major Energy Companies. 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 nine months ended September 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.