Good morning, ladies and gentlemen. Welcome to the Spark Energy Incorporated Second Quarter 2018 Earnings Conference Call. My name is Juby [ph] and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

[Operator Instructions] As a reminder, this conference is being recorded for replay purposes and this call will be posted on Spark Energy Inc.'s website. I would now like to turn the conference over to Mr. Christian Hettick with Spark Energy Inc. Please go ahead..

Thank you, Juby [ph]. Good morning and welcome to Spark Energy Inc.'s second quarter 2018 earnings call. This morning's call is being broadcast live over the phone and via webcast, which can be located under Events and Presentations in the Investor Relations section of our website at sparkenergy.com.

With us today from our management is our President and CEO, Nathan Kroeker; and our Vice President and CFO, Robert Lane. Please note that today's discussion may contain forward-looking statements, which are based on assumptions that we believe to be reasonable as of this date.

Management may make forward-looking statements concerning future expectations, projections of our operations, economic performance and financial condition. These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, we give no assurance that such expectations will be realized. We urge everyone to review the Safe Harbor statement provided in yesterday's earnings release as well as the risk factors contained in our SEC filings.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. During this morning's call, we will refer to both GAAP and non-GAAP financial measures of the company's operating and financial results.

For information regarding our non-GAAP financial measures and reconciliation to the most directly comparable GAAP measures, please refer to yesterday's earnings release.

We also invite you to check our website regularly because we use it to disclose material information and to comply with our obligations under Regulation FD, that web address is ir.sparkenergy.com. With that, I'll turn the call over to Nathan Kroeker, our President and Chief Executive Officer..

Thank you, Christian. I want to welcome our shareholders and analysts to today's earnings call. After I provide a summary of our results for the second quarter, I will turn the call over to our CFO Robert Lane, who will provide more details on the financials.

We recorded $16.1 million in adjusted EBITDA and $43.4 million in retail gross margin in the quarter, a decrease of 20% and an increase of 1%, respectively compared to our record second quarter last year.

Rob will provide a more detailed walkthrough of our results and impacts of operations compared to the prior year, but our second quarter results were negatively impacted by a number of factors, a continuation of the impact of the full year hedges we put on in January and we discussed on our last earnings call, the increased cost of buying additional physical power as a form of insurance and our costs this summer, and an increase in ISO New England Capacity costs for the current capacity period.

Each of these factors contributed to higher per unit electricity costs, which was a primary negative driver of our results. Countering all of this were a number of positive factors; our electricity and natural gas volumes both increased year-over-year and our natural gas margins also improved.

On a normalized basis, our G&A costs per RCE were down 19% year-over-year, and we continue to drive additional cost savings across our platform. In addition, we averaged 3.7% in monthly attrition in the second quarter, which is our best attrition rate in any quarter over the last 4 years.

We remain focused on executing our ongoing integration initiatives of prior acquisitions, which will help us drive down costs and increase adjusted EBITDA. As we’ve discussed previously, we’re focused on simplifying our structure, streamlining our operations, de-risking the business and curtailing collateral requirements.

These initiatives include consolidating brands and billing systems, closing satellite offices and automating a number of manual processes, each of which we expect to result in additional cost savings and significantly reduce our G&A expenses.

In addition, we have turned from adding larger C&I customers through a renewed focus on adding residential and small commercial customers, which have higher unit margins.

As we detailed in yesterday evening's earnings release, we made considerable progress on our synergy and brand consolidation efforts during the second quarter, and we achieved our initial target of annualized G&A cost savings of $15 million through process integration and headcount reductions, including the closure of five satellite offices.

We successfully switched a total of 110,000 customers to more cost effective billing platforms during the second quarter, and we’ve notified an additional 62,000 customers of planned platform switches in the current quarter. As highlighted above, this led to a near 20% decrease year-over-year in our G&A costs per RCE on a normalized basis.

We expect to drive an additional $5 million in annualized cost savings through a series of discrete projects during the remainder of this year, putting as well ahead of our initial plan of driving $20 million in annual cost savings by the end of 2019.

As I mentioned earlier, we’re also focusing on organic growth using sales channels recently integrated through the Verde acquisition as well as new retail sales channels that we believe will help us increase our mass market concentration and improve margins as we pivot away from the larger low margin C&I customers.

We’re investing in this growth now, and we expect these new channels to ramp up over the course of the next two to three quarters.

This expected growth combined with our strategies to improve customer mix while concentrating on mass market RCE growth and the impact of synergy projects and cost reduction initiatives will result in stronger long-term margin and adjusted EBITDA performance.

While our total RCE count may decrease as we elect not to renew some of our larger C&I customers, we believe that the increase in unit margins will more than offset any loss in value. On the M&A front, we continue to focus on building our book organically, but we look for small tuck-in acquisitions as well as other strategic acquisitions.

Following our strategic review, our executives team and Board of Directors believe the best way to deliver long term value to our shareholders is to continue streamlining our operations and building our mass market customer book. We continue to work with Morgan Stanley to review opportunities to maximize value to our shareholders.

Before I turn the call over to Rob, I want to give you an update on our business in Japan. We have a profitable business over there with 107,000 customers currently on flow that have been acquired through a diverse set of sales channels. We continue to see development of the wholesale markets and corresponding new product alternatives over there.

The business continues to outperform our business case, and we expect to begin taking distributions early next year. And that concludes my prepared remarks.

Rob?.

Thank you, Nathan. Good morning. In the quarter, we achieved $16.1 million in adjusted EBITDA, a decrease of 20% compared to last year's second quarter of $20 million. Total gross margin for the quarter was $43.4 million compared with $43.1 million last year, an increase of 1%. There are a few items to be mindful of in this comparison to last year.

Our volumes are higher in both our natural gas and electricity segments due to the contribution from customers we purchased in our recent acquisitions as well as some of the commercial growth we experienced over the course of last year.

However, electricity unit margins are compressed compared with last year, both due to the commercial segment increasing as a portion of our overall book as well as some market movements and hedging strategies during the quarter that Nathan addressed earlier in his comments.

In our Retail Electricity Segment, gross margin for the quarter was approximately $32.6 million, a decrease of approximately $2.2 million or 6% as a result of the impact of full year hedges we put on earlier in the year, buying more physical power in ERCOT as summer insurance and increased capacity cost in New England.

In our Retail Natural Gas segment, gross margin was approximately $10.8 million, an increase of $2.5 million or 30% over the second quarter last year. This increase was a result of increased volumes and increased unit margins.

For G&A, expenses increased $8.4 million from last year to $27.8 million, primarily due to variable costs associated with our increased RCE account as a result of our recent acquisition, higher broker commissions from our C&I book and certain customer acquisition cost to our new opt-in channel that we cannot capitalize.

In addition, lastly, we decreased the fair value of earn-out liabilities, which lowered G&A expenses and which did not recur this year. As Nathan mentioned, we've made a number of moves during the first six months in the year that we expect to bring our G&A numbers down overtime. On a normalized basis, our G&A cost per RCE are down 17% year-over-year.

We ended the second quarter with 1.47 million RCEs, down slightly from the first quarter, but up 27% compared to the prior quarter as a result of commercial growth and acquisitions.

Interest expense for the quarter decreased from $2.5 million to $2.3 million, primarily because of a decrease in non-cash accretion of our earn-out liabilities from sellers note. Income tax expense for the quarter increased to $3.3 million as compared to $400,000 for the second quarter of 2017, primarily due to an increase in pretax income.

Our net income for the quarter was $23.9 million or $0.41 per fully diluted share compared to the net income of $4.7 million or $0.01 per fully diluted share for the second quarter of 2017 honest per adjusted basis.

The increase in net income is primarily driven by non-cash mark-to-market accounting associated with the hedges we put in place to lock in margins on our retail contracts. We had a mark-to-market gain this quarter of $25.4 million compared to a mark-to-market loss of $6.2 million a year ago.

On June 14, we paid the quarterly cash dividend on our Class A common stock, and on July 16, we paid the quarterly dividend on our Series A preferred stock. On July 19, we announced our third quarter dividend of $0.18125 per share on our common stock to be paid on September 13 and $0.54688 per share preferred stock to be paid on October 15.

As we’ve stated in the past, we expect to continue to pay these quarterly dividends on a go forward basis. That’s all I have. Back to you, Nathan..

Thanks Rob. Well, this year will be down as compared to last from an adjusted EBITDA standpoint, the outlook for our business remains strong, and we’re confident that we’re implementing the appropriate strategies to maximize shareholder value.

We make meaningful progress during the second quarter that will help us achieve stronger margins and adjusted EBITDA performance longer term, efforts to consolidate office space and lower overhead costs have already begun to positively impact performance in the current quarter and our other ongoing initiatives to maximize the synergy potential of our acquisitions will continue materializing in our financial performance throughout the next year.

These actions combined with the strategies we’re implementing to migrate our customers to higher margin mass market customers, will contribute to stronger improvements in profitability next year as we grow our acquired and new organic sales channels.

We have an excellent team in place and we’re confident that the consolidated platform that we’re establishing will emerge as a clear leader within the industry. With that, I would now like to open up the line for questions from our analysts.

Operator?.

[Operator Instructions] Our first question is from Sophie Karp from Guggenheim Securities. Your line is now open..

Maybe -- could you help us understand a little bit of what’s happening in the hedge book -- in your hedges book at this point? Because I think you've said that you put on a lot of hedges in January, but also had to buy power in ERCOT during the summer. So can you give us some color about how that worked out together? Thank you..

Sure. Thanks, Sophie. So two very discrete issues that you just highlighted. Let’s recap what we talked about last quarter in terms of the January hedges. In January, we had a significant amount of financial hedges in the book that had significant collateral costs associated with them. And we did two things in January.

We unwind some of those financial hedges and replaced them with physical hedges in order to reduce the collateral requirements. And in some cases, in many cases, those physical hedges were put back on at a higher cost or a premium for being physical.

The second component of it, in order to avoid paying the extremely high day-ahead prices for the incremental load associated with the colder weather, we deferred some of that short-term paying, by buying longer-term hedges for the balance of the quarter and the balance of the year.

And because of the whole market was elevated at that time, we ended up buying hedges through calendar '18 that were added elevated levels. So those hedges are still in the book and are still actualizing today and will continue to actualize through the balance of the year. The majority of that was in the first quarter and then the second quarter.

So every quarter that impact becomes less and less, but it is there through calendar '18. The second part of your question was around ERCOT. And as you saw with the extreme change in the weather up in New England last winter, we were short in a high priced environment. That’s the exact scenario that we are trying to avoid in ERCOT this summer.

Reserves margins are tighter than they’ve been the last several years, as you know, price caps in ERCOT are high, and we want to avoid any of the extreme events that could result in that scenario.

So as a way to mitigate that, we've been biased long in other comp this summer recognizing that in all likelihood we're going to sell that excess length backend loss, but it protects us for many extreme price rollouts that may happen should replant outages or any other unexpected events in the market.

So it is an incremental cost to the business, but it's really the way we look at it. It's an insurance cost to avoid any of the extreme price spikes that are potentially out there..

So you actually did not have to buy any power in the market in ERCOT at these prices?.

Every day, we're buying a few hours just to shape it to our exact book, but we're generally a seller in the real time market, not a buyer in the real time market..

Got it. Thank you..

And we're also a seller in most hours in the day-ahead market. If we are buying in the day-ahead market, we're just buying on the super peaks just to account for whatever the weather forecast changes in the last couple of days. But we're biased long right now in ERCOT, I would say..

Great. Thanks a lot for this color..

Alright. Thank you..

Thank you. [Operator Instructions] Our next question is from Mike Gyure from Janney. Your line is now open..

Yes, good morning guys. Can you talk a little bit about your customer acquisition cost spending sort of this quarter? And I guess sort of maybe your outlook for the rest of the year and maybe how we should think about that trend going forward? It seems like you're spending a little bit less than I've expected.

So can you just kind of talk about that a little bit?.

Sure, Mike. Happy to do that. Over the course of the last, I would say, 1.5 to 2 years, we had slowed down organic sales efforts because we were putting a lot of focus on M&A. There were a lot of M&A opportunities out in the market at what we believe to be very attractive multiples.

And we were spending a lot of our focus and our dollars, frankly on pursuing growth through that avenue. In the current environment, we're seeing less M&A opportunities out there, certainly less at attractive multiples. So we're refocusing on mass market growth, really focusing on two things.

How do we get additional value out of the M&A deals we've done over the last two years. And that's a lot of what we've talked about what driving $20 million worth of cost out of the business, but then how do we ramp up those organic sales channels.

Now we've got a significant focus right now both on the lead-gen channel as well as the retail sales channel, but of which we acquired through two of our acquisitions and trying to increase dollars through those channels. Also looking at our door-to-door and our telemarketing channels, again and ramping those back up.

It takes a while to ramp those channels up in a quality form. So I would say you are going to see us increase our CAC spending over the next two to three quarters. And then the other thing just to highlight Rob's fascinating note here, the way the accounting works for the opt-in sales channel that all flows through G&A.

So there is actually some customer acquisition costs that are buried within the G&A line, now that we're ramping up that lead gen channel..

Great. And maybe you can touch on, I think, you just highlighted sort of the M&A activity. Why do you think sort of that to the market is -- I would say softening as far as M&A deals.

Is it just the sellers are asking too high prices or I guess what's going on there in your head?.

So this is just one man's opinion, but we're not seeing a lot of deals come to market. And I think part of the reason for that is the trailing 12-month numbers are all impacted by the extreme weather event we saw last winter.

The forward 12 months either have increased capacity costs or the archive volatility and nobody wants to price off of those numbers. So -- yes, I just don’t think the M&A market is not as many sellers out there for those reasons.

I do think, we will see some small books and we are seeing some small books come to market as owners get squeezed on collateral requirements or growth capital coming out of last winter. But those tend to be smaller tuck-in deals from what we see. And we’re looking at them, but I’m not going to overpay for them.

We’re going to be very diligent in our evaluations..

And then maybe one more.

Are you seen anything, I guess, new or different change your thought process on what’s going on in New York? And I guess what are you hearing there from that perspective?.

New York? No, I mean, the New York Commission is really requiring the entire ESCO community to complete the administrative process, which has been ongoing for a while and we’ll continue to play out, before they are willing to enter into any settlement negotiations with us. So that’s what we’re doing.

I mean we’re with all the other market participants going through that administrative process. I expect at some point in the future we will get into settlement discussions with them as we’ve been saying for probably two years now..

Thank you. Our next question is from Carter Driscoll from B. Riley FBR. Your line is now open..

So just kind of following up on, maybe different tag on Sophie’s question, so obviously we had just extreme weather in ERCOT, and I mean not just higher peak prices that have shot up, not just spike.

Are you -- do you feel you’re properly hedge for some other exogenous potential weather events? We’ll see we had a milder summer last year that that was fairly unpredictable, obviously, can predictable Hurricane Harvey.

How are you thinking about potential exogenous events in the latter part of this year, obviously, summer winds up and then heading into the winter season. Just trying to get a sense of your thought process, given the volatility you’ve already experienced to date..

So my thought process is to protect ourselves from the catastrophic events.

So if I’m weighing between the risks of a mild or -- yes, mild August in ERCOT versus a plant outage on a hot day in ERCOT, I always want to be protected for the plant outage on the hot days because I can calculate the downside risk if it comes in mild, right, because the risk of the price spike is so much more significant than the risk of me selling back power at zero dollars.

So we’re positioned long in ERCOT for the month of August and the month of September just to protect against any of those sort of extreme unexpected weather events.

If it comes in mild and we continue to see rain in ERCOT for the next 6 weeks, yes, I’m going to be long and I’m going to be selling power backed, and I’m going to be crystallizing some losses, but those are much less significant that if I’m caught short in a price rollout.

And that’s generally how we think about ERCOT in the summertime, and that’s generally how we think about the Northeast in January-February. Not to keep rehashing what we went through last winter, because I think, we’re all tired of talking about it.

But we had such an extreme weather event that showed up in late December, I was sort of flat to slightly short anticipating very mild weather. I hadn't yet put all that length on which we had the length in February; we didn't have it in December last year. So we're not always going to get it exactly right.

But that's the thinking and how we look at those types of risks to managing those types of risks. Going forward for next winter, at this point for next winner, we're doing everything just based on normal weather. And it won't be until we get closer that will decide how much additional length.

I mean we'll look at sales growth, we'll look at attrition numbers, and we'll continue to refine our hedge position as we get ready to go into next winter. But as of right now, everything is just set up for normal..

So let me ask, maybe a slightly different way.

Have you explored the potential comprehensive -- almost an insurance policy or reinsurance policy for hedges, I mean, some of your competitors have talked about for seeing a blanket type of policy on an annual basis to protect against this, obviously, I don’t necessarily speak to the find trend in terms of the pricing or the cost to do so.

But is that something that you're considering? Or do you think that could be effective rather than kind of doing on -- almost on a daily basis?.

I've heard my competitors referred to this as well. We've looked at it, I would tell you probably every six months or so, we have this conversation with a couple of potential providers. And to date, I have -- in the last 3 to 5 years ago I think it was cost effective.

In the last 3 to 5 years, I have not found a product that, I think, effectively mitigate that risk in a cost efficient manner. So the products are there, but they're really expensive or the cheaper products don't properly mitigate the risk. I've not seen one that I think is a good cost effective way to mitigate the risks we're talking about.

But I will absolutely continue to look at them..

Just getting back to ERCOT perspective gives us really unprecedented heat spikes. I mean do you feel now they were in August that positions you put on you are able to survive the extremes in July.

Is that for that reasonable?.

Yes. Nothing -- we saw some very high trends in the day-ahead market in July, but nothing blew out in the real time market. And so for me what happened in July -- what happened in June and what happened in July is I was buying a couple of megawatt hours in the day-ahead market just to match my exact load.

I was selling the ramp hours into the day-ahead market all of that was kind of a wash and nothing blew up in a big way. So the additional length that I put on kind of materialized in a small loss and that was the cost of the insurance, but it worked..

Okay. Maybe shifting ….

I mean, just to preempt -- the July is -- that's kind of how July behaves as well..

Okay. Maybe shifting gears, so you've been engaged with Morgan Stanley for a while and it sounded though maybe some of the options that they were presenting to you, didn't feel, probably reflected fair value.

And it sounds the decisions they made by management and the Board that you want to continue to run the business and probably not going to pursue some of the alternatives they talk about maybe even a company sale.

Is that the right read on what you put in the queue?.

Yes, I mean, I'm just going to reiterate what we've already said which is we continue to -- we have not terminated anything with Morgan Stanley, we continue to have them engaged.

We continue to look at opportunities, but at the present time, both the management team and the Board believe the best way to deliver long-term value is just to continue to focus on driving costs out of the business and returning to growth on our mass market customer book..

So, I mean, if I look at the opportunities that you’ve talked about traditionally for M&A and why they’re not necessarily working today, you can -- get one of those alternatives with Morgan Stanley was beside yourselves, it might apply to your own book, right? You’re not necessarily being valued for -- you had some exogenous weather events and that probably doesn’t be reflected long-term value of the business?.

I mean that's all I’m looking at it..

Okay. Let’s see, I just had a couple of others if I may. So obviously you've talked about New York. Can you talk about eyes on bringing a little bit? Maybe doesn’t get quite same level of discussion sometimes as ERCOT and, obviously New York, but there’s some changes to that marketplace.

Is that all either change the way you think about your presence in that territory or growth opportunities there or even potentially maybe opening up some smaller books, maybe that might be more prevalent in ERCOT given that heat spikes? Is it a similar type of opportunity with the new capacity requirements in ISO New England?.

Yes, so six months ago what we saw was a change to their collateral requirements, which we talked about on the last call. The most recent thing that we saw was this methodology change in the capacity costs and that methodology change or changes resulted in a significant increase in the capacity multipliers specifically.

And the way that market works, you know what the clearing price is, you know what the cap tags are, but you kind of don’t know what the multiplier is until the start of the capacity period. So that was what we saw here in June and early July. That went into effect June 1st for the current capacity period.

It’s an industry wide issue, it affects everybody. But what I will tell you is its more obvious in the thinner margin C&I contracts. And the reason why we always price in some risks around those capacity multipliers is just because we can’t know them too far in advance.

And on a mass market contract, you’ve got more room in that margin through absorb that. On a thinner margin C&I contract, you just don’t have as much room in there to absorb that.

So I think the takeaway for me from what we’ve learned in New England is highs right into the broader strategy, which is I'm very interested in that market from a residential small commercial standpoint. But with this latest increase in capacity costs, I mean, it’s difficult for me to make any money there on the C&I side.

So we’re going to not renew a lot of those contracts and refocus on the mass market piece of the business whether that being New England or any of the other ISOs in which we operate..

So, yes, because if I remember correctly, you were talked about maybe a bit of a shift towards the small commercial segment, and you’re saying that it’s beyond just some of the changes to ISO New England that have caused you to refocus away from commercial and back to mass market.

Is that fair?.

It’s the, I mean, one of the big drivers is the changes in New England. New England is where we saw a lot of the C&I growth, particularly the large C&I growth, over the course of the last 18 months. So then you could have change like this that it impacts us. So we’re shifting back to resi and small comp.

But I don’t -- I've never had a big of a shift towards large comp in any of the other parts of the business as I did in New England. So when we shift back to where we were a couple years ago, you’re going to see the biggest change in New England..

And I mean that's -- I mean, between the -- I mean at a high level between the weather volatility and the changes in ISO New England. It sounds that though you're trying to optimize the business shift back your strategy.

But if I take a little time to reengage in mass market which seems to be the emphasis why you don't feel you can outgrow last year's EBITDA.

Is that a fair explanation?.

Yes, one of the things that I want to not sure -- I'm trying to be careful in answering your question accurately. One thing that we've talked about a lot, particularly in our investor meetings is diversification being a key component of risk management.

And right now, I've got a disproportionate share of my business in electricity, C&I and New England. And so I'm taking deliberate steps to get back to a more balanced book whether its gas and power, mass and C&I geography, and I think overtime that's going to result in more predictable stable earnings and growth.

So that's kind of a broad high level how I think about it. And when we post our new Investor deck later today, you'll see us talk about that a little bit in there. I mean that's a deliberate shift on those three different metrics..

So that index, your hedging policy shifts, right? So you're trying to mitigate the volatility is nothing else and become more predictable in the business.

Is that reasonable?.

Yes, exactly right. And I will tell you if you look ahead '19 and '20, our view is that this business returns back to the unit margin levels and the attrition levels and the OpEx levels that we've seen historically.

We will walk you through the specifics, but when you're building your long term models, I mean, we should be in the high-20s for power unit margins over the next couple of years, which could be in the high-3s for gas unit margins in the next couple of years.

And then our G&A expenses, we should be down less than 50% G&A to gross margin overtime as well, given all the costs we're driving out of the business this year..

And then just last one from me. So how do you think about capital allocation right now given some near term headwinds as you reposition for diversification, balancing the dividend policy you're currently have, maybe small book opportunities opportunistically.

What are the priorities, and what do you think is feasible and the cushion you'd like to have for the base business as you reposition it?.

We don't anticipate any change to the dividend policy. We'll start payer. And then the second one, in terms of capital allocation, we're committed to -- we'll have to spend a little bit of money not a lot in order to drive some of these additional $5 million of cost savings that we're chasing.

There are some process automation projects we're working on that require a little capital investment. So there will be a few dollars go on stuff like that, but the line share of our capital now is going to be mass market, organic growth and -- if the opportunities are out there, some tuck-in acquisitions..

And how effective will the Verde's channels be in terms of that mass market? And you're expecting a disproportionate resumption of that growth in your historical channel -- if historical segment from Verde? Or is it just a contributing factor to that?.

It's a contributing factor. You're going to see us operate on three or four different sales channels and we’re trying to ramp all of them at the same time. The one thing about the channels through, whether it’s the channels we acquire through major or Verde or anybody else, I want to roll those out broadly across the whole business.

And so that require some systematic changes and we’re currently working on that. So we can roll those out in other markets or on other billing platforms..

Appreciate taking all my questions, guys. Thank you..

Thank you. Anybody else back in? Operator Thank you. We have no further questions at this time..