Spark Energy, Inc.
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good day ladies and gentlemen, and welcome to the Spark Energy, Inc.'s Third Quarter 2014 Earnings Conference Call. My name is Ashley and I will be your operator for today. (Operator Instructions) As a reminder this conference call is being recorded for replay purposes and this call is being posted on Spark Energy, Inc.'s website. I would now like to turn the conference over to Mr. Andy Davis, Head of Investor Relations for Spark Energy, Inc. Please go ahead, sir.

[Andy Davis:]

Thank you. Good morning and welcome to Spark Energy, Inc.'s third quarter 2014 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 www.sparkenergy.com. With us today from management is our president and CEO, Nathan Kroeker; and our CFO, Georganne Hodges. Please note that today's discussion may contains 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. With that, I will turn the call over to Nathan Kroeker, our President and CEO.

[Nathan Kroeker:]

Thank you Andy. I would like to welcome our shareholders and analysts to Spark Energy's third quarter of 2014 conference call. I will make some opening remarks about our operating results and opportunities ahead and then our Chief Financial Officer, Georganne Hodges, will provide some detail on the financial results. We will conclude with questions from our analysts. During the third quarter, we continued to see strong customer count growth, with an 18% increase in overall customer count, ending the third quarter with approximately 305,000 customers. Consistent with the first half of the year, 73% of all new sales were on green energy products as we continue to focus on this aspect of our business. The third quarter was a transitional quarter for us, having closed on our IPO on August the 1st, and then shifting our focus from the accelerated growth we targeted as a private company to the longer-term sustainable growth consistent with our focus on distributable cash flow. We significantly reduced our customer acquisition spending in the latter part of the quarter to reflect this shift in focus. In addition, we continued to progress our CIS outsourcing project during the quarter with nearly 70% of our customers now billing through the new platform. Unfortunately, we had several challenges in the third quarter. Our recent growth in the Southern California gas market has fallen short of our adjusted EBITDA expectation as we are seeing lower average consumption, higher customer attrition, and corresponding higher bad debt than we had expected. While we are seeing positive returns in this market, we are disappointed because they are below our expectations. As a result, we have renegotiated the commission structure with our primary vendors in order to reduce our customer acquisition costs. We have significantly slowed our customer additions in this market and we are pursuing more aggressive collection strategies to lower our bad debt expense. We are also working on alternative sales channels and product structures and we are confident that these changes will improve the customer economics in this region. Following the challenges in the Southern California gas market, we are shifting more of our sales efforts to the northeast electricity business where we have seen recent opportunities to offer a competitive savings message given current utility and competitive pricing. We are already seeing success in this strategy as we have added nearly three times the number of new residential electric customers in New England as we did in the second quarter. In addition we are refocusing our efforts on the small commercial segment and see the potential for longer-term contracts and acceptable unit margins in this space. Again, we are seeing success in this strategy as our contracted small commercial margin increased 18% quarter-over-quarter. We are still seeing the lagging effect of last winter's polar vortex in terms of increased attrition of a high margin, commercial customers in the northeast region. Both the developments in the Southern California gas market and the higher attrition in the northeast have had a negative impact on third quarter adjusted EBITDA. These factors will continue to negatively impact results in the next several quarters as we refocus our efforts on other growth areas. We are pleased to announce that we have signed an asset purchase agreement with Discount Power to buy 14,000 customer contracts in Connecticut. We have also signed a smaller deal with Town Square Energy to acquire an additional 4,100 customers in Connecticut. And we expect both of these transactions to close in the fourth quarter. We spend approximately $150 per customer in aggregate in these transactions and both of them are accretive to earnings and EBITDA. Additionally we are very pleased to announce that we have recently signed a joined marketing agreement with SunPower to co-market solar panel installations to our new customers in the east and southwest regions. This is a continuation of our green strategy and we may expand this into other markets going forward as well. While our third quarter results reflect a seasonality inherent in our business, we will be paying our third quarter dividend as planned. Our board declared the dividend at it's meeting on Tuesday and it will be paid on December the 15th. And we expect to continue paying this dividend and to achieve at least a 1.0 times annual coverage ratio on our dividends and tax payments for the foreseeable future. As we proceed into the fourth quarter, we plan on continuing to improve the economics our Southern California gas business. We are also very exited about integrating the discount power in Town Square Energy customers into the portfolio, and we are seeing lots of opportunities in the M&A sector just as we predicted back at the time of our IPO. We are actively evaluating additional M&A transactions both in the form of tuck-in opportunities as well as larger scale energy services businesses to grow our adjusted EBITDA. Thanks for your attention, and with that I will now turn the call over to Georganne Hodges, our Chief Financial Officer, for her financial review. Georganne!

[Georganne Hodges:]

Thanks Nathan. For the three months ended September 30, 2014, adjusted EBITDA was negative $4.4 million versus negative 1.5 million in the third quarter of 2013. This 2.9 million decrease is predominantly attributable to increased customer acquisition spending and increased general and administrative costs offset by a significant increase in retail gross margin. Our retail gross margin increased 70% year-over-year to 14.6 million on lower overall customer volume but expanded unit margins across our portfolio. The Southern California gas market campaign to acquire low volume but high margin customers is a contributor to this increase as well as continued focus on segmentation and margin expansion in our existing books. Customer acquisition spending increased by 287% to $8.7 million for the quarter. We had 91,000 new customers come on flow and grew the overall count by 18% during the quarter. This $8.7 million spend will generate approximately $30 million in Customer Lifetime Margin over the next five years. General and administrative expenses for the quarter are up by $3 million over the prior year. 1.4 million is attributable to increased bad debt expense with approximately 55% of that increase coming from Southern California customers. Our G&A has also increased due to cost associated with a larger customer base as well as higher cost associated with being a public company. GAAP net income for the quarter totaled $400,000 compared to negative 1.6 million in the third quarter of 2013. As of September 30th, we had $20.5 million drawn on our $70 million senior credit facility. Additional we had 11.6 million in letters of credit outstanding leaving $37.9 million available on our facility. That concludes my prepared remarks. I will now turn the call back over to Nathan for some brief closing remarks, and then we will take questions from our analysts. Nathan!

[Nathan Kroeker:]

Thanks Georganne. In closing, I would like to reiterate our strong customer count growth of 18% in the quarter. We've increased our customer additions in both New England residential and the small commercial space. And in addition, we executed on two M&A transactions, both of which will be accretive to our earnings, and we announced our quarterly dividend which will be paid on December the 15th. We will now open the line for questions from our analysts. Operator!

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Selman Akyol of Stifel. Your line is open.

[Selman Akyol:]

Great, thank you. Good morning.

[Georganne Hodges:]

Good morning.

[Nathan Kroeker:]

Good morning.

[Selman Akyol:]

Can you talk or give a little more color, what do you think changed in the southwest region, California? I guess what assumptions were incorrect going into that market? Just talk a little bit about that?

[Nathan Kroeker:]

Yeah, happy to do that. I mean that's a relatively new market for us and we had expectations around average consumption per customer, attrition rates and bad debt. What we saw in going into that market is the consumption was a little bit lower than we had anticipated and the attrition was higher and then correspondingly bad debt was higher than we had anticipated. A lot of that is driven by the fact that it is a relatively new market and there seems to be a lack of consumer awareness and consumer understanding. So we have focused a lot of our efforts on consumer education in order to improve that over the longer term.

[Selman Akyol:]

Okay. And then as it relates to the two M&A transactions that you did subsequent to the quarter, you talk about integration -- integrating the two. And what costs are you anticipating for bringing those two acquisitions into the fold?

[Nathan Kroeker:]

Yes, it's very minimal and it's within our existing G&A because we are literally doing market switches to migrate those customers on to our existing platform and our existing processes.

[Selman Akyol:]

Okay. And then just along that, in terms of the 2.4 million or the 2.7 million that you spent for that, I assume that also goes against the revolver as well subsequent to the quarter?

[Nathan Kroeker:]

Yes.

[Selman Akyol:]

Okay. And then I guess in terms of just the fourth quarter, and I know we are early into it, but I mean we've seen some weather patterns, early snows in places and I'm just wondering how that's affecting you guys so far?

[Nathan Kroeker:]

Yes, I mean we are one month into the fourth quarter and I will say it's really too early to tell or comment in any detail on that.

[Selman Akyol:]

Okay. Well, thank you very much.

[Nathan Kroeker:]

Thank you.

[Operator:]

Thank you. (Operator Instructions) Our next question comes from Dave Parker of Robert Baird. Your line is open.

[Dave Parker:]

Good morning everyone. Questions on the recent acquisition. The acquisition price a little higher than what your -- I guess your past experience has been. Maybe you can talk a little bit about those dynamics? And as you are looking at accelerating customer acquisition opportunities, maybe what's driving that first off and then maybe what the cost of acquisition may be? And then generally overall what you are looking at as far as the revenue and therefore profit opportunity with these acquisition opportunities? Thank you.

[Nathan Kroeker:]

Sure, Dave. As we stated earlier, we paid approximately $150 per customer combined across the two deals and in an M&A transaction, we have the ability to review the customer's historical usage as well as other customer data before we buy those customers. Unlike a normal organic customer add where we don't get access to that historical usage until after that customer comes on flow with us. In this case the quality of these customers supports the higher purchase price, and we are really looking at it just like we would in organic campaign in that we are looking for targeted returns on that investment.

[Dave Parker:]

Got you. All right, perfect.

[Nathan Kroeker:]

And we are -- obviously, I mean, we do believe they are accretive to EBITDA. So they were good deals for us.

[Dave Parker:]

All right, got you. And then beyond the fact it sounds as if -- understanding the history, it sounds as if you get kind of better dynamics on churn and profit opportunities. So is that what we should look for, Nathan, as far as the opportunities to grow here? Has that been a little bit of a tweak in the growth strategy here near-term?

[Nathan Kroeker:]

Yes, although I will tell you that this represents about 18,000 customers overall. So I am not sure that it's big enough to move the needle on our overall churn results. But obviously yes, we do anticipate these to be good quality customers and a good compliment to the portfolio.

[Dave Parker:]

All right, perfect. Thank you very much.

[Operator:]

Thank you. And we have no further questions at this time Mr. Kroeker.

[Nathan Kroeker:]

Okay. Well I just want to say thanks to everybody for joining the call today. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today’s program. You may all disconnect. Everyone have a great day.