** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

** **

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**FORM 10-K**

| (Mark  One)                                      |       |                                                                                          |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                             |       |                                                                                          |
| **ý**                                       |       | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|                                             |       |                                                                                          |
| **For the fiscal year ended: December 31, 2004** |
| **or**                                           |
|                                             |       |                                                                                          |
| **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: 0-16179**

 

**GexaCorp.**

(Exactname of registrant as specified in its charter)

 

| **Texas**                                                       | **76-0670175**                     |
|-----------------------------------------------------------------|------------------------------------|
| (State  or other jurisdiction of incorporation or organization) | (IRS Employer  Identification No.) |

 

| **20 Greenway Plaza, Suite 600, Houston, TX** | **77046**   |
|-----------------------------------------------|-------------|
| (Address  of principal executive offices)     | (Zip  Code) |

 

**(713) - 470 - 0400**

(Registrant’s telephone number, including area code) 

** **

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Securities registered pursuant to Section 12(b) of theAct: ** None**

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

**Common Stock, par value $0.01**(Title of class)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.                Yes ý     Noo

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of thischapter) is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).                Yeso     No ý

 

Aggregate market valueof the voting stock of Gexa Corp. held by non-affiliates as of June 30,2004  (based on the closing market priceon June 30, 2004) was $9,688,122.

 

The number of sharesoutstanding of Gexa Corp. common stock, $0.01 par value, at March 23, 2005 was10,063,160.

 

DOCUMENTS INCORPORATED BY REFERENCE: Portion of  the registrant’s annual proxy statement, tobe filed within 120 days after December 31, 2004, are incorporated by referenceinto Part III of the Form 10-K.

 

 

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**TABLE OF CONTENTS**

 
|     | **Part  I**                                                                                                          |   |
|----------|----------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.  | Business.                                                                                                            |   |
| Item 2.  | Properties.                                                                                                          |   |
| Item 3.  | Legal  Proceedings.                                                                                                  |   |
| Item 4.  | Submission of  Matters to a Vote of Security Holders.                                                                |   |
|     |                                                                                                                 |   |
|     | **Part  II**                                                                                                         |   |
| Item 5.  | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities. |   |
| Item 6.  | Selected  Financial Data.                                                                                            |   |
| Item 7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operation.                          |   |
| Item 7A. | Quantitative  and Qualitative Disclosures About Market Risk.                                                         |   |
| Item 8.  | Financial Statements  and Supplementary Data.                                                                        |   |
| Item 9.  | Changes in and  Disagreements With Accountants on Accounting and Financial Disclosure.                               |   |
| Item 9A. | Controls and  Procedures.                                                                                            |   |
|     |                                                                                                                 |   |
|     | **Part  III**                                                                                                        |   |
| Item 10. | Directors  and Executive Officers of the Registrant                                                                  |   |
| Item 11. | Executive  Compensation                                                                                              |   |
| Item 12. | Security  Ownership of Certain Beneficial Owners and Related Stockholder Matters                                     |   |
| Item 13. | Certain  Relationships and Related Transactions                                                                      |   |
| Item 14. | Principal  Accounting Fees and Services                                                                              |   |
|     |                                                                                                                 |   |
|     | **Part  IV**                                                                                                         |   |
| Item 15. | Exhibits,  Financial Statement Schedules.                                                                            |   |

 

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**Forward Looking Statements**

 

                Thisannual report on Form 10-K includes “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934, as amended(“Exchange Act”). All statements other than statements of historical fact areforward-looking statements. Forward-looking statements are subjectto certain risks, trends and uncertainties that could cause actual results todiffer materially from those projected. Among those risks, trends anduncertainties are our estimate of the sufficiency of existing capital sources,our ability to raise additional capital to fund cash requirements for futureoperations, our assumptions regarding the competitive restructuring andderegulation of the electricity market, competition from utility companies, ourdependence on the services of certain key personnel and our ability to manageour growth successfully. Although we believe that in making such forward-lookingstatements our expectations are based upon reasonable assumptions, suchstatements may be influenced by factors that could cause actual outcomes andresults to be materially different from those projected. We cannot assure youthat the assumptions upon which these statements are based will prove to havebeen correct.

 

                Whenused in this Form 10-K, the words “expect,” “anticipate,” “intend,” “plan,” “believe,”“seek,” “estimate”, “predicts”, “projects”, “targets”, “will likely result”, “may”,“could” and similar expressions are intended to identify forward-lookingstatements, although not all forward-looking statements contain theseidentifying words. Because these forward-looking statements involve risksand uncertainties, actual results could differ materially from those expressedor implied by these forward-looking statements for a number of importantreasons, including those discussed under “Risk Factors” and elsewhere in thisprospectus.

 

                Youshould read these statements carefully because they discuss our expectationsabout our future performance, contain projections of our future operatingresults or our future financial condition, or state other “forward-looking”information. The occurrence of any of the events described in “Risk Factors”and elsewhere in this Form 10-K could substantially harm our business, resultsof operations and financial condition.

 

                    Wecannot guarantee any future results, levels of activity, performance orachievements. Except as required by law, we undertake no obligation to updateany of the forward-looking statements in this Form 10-K after the date ofthis Form 10-K.

 

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**PART I**

ITEM1. BUSINESS

**THE BUSINESS**

**Overview and Company History**

                Gexa Corp.(d/b/a Gexa Energy), located in Houston, Texas, is a retail electric provider(a “REP”). As of December 31, 2004, we provide electric power to ourresidential and commercial customers in the deregulated Texas electricitymarket. We also are currently licensed to supply retail electricity power tothe Massachusetts electricity market and have submitted applications to becomean electricity provider in New York and Maine.

 

                InAugust 2001, the Public Utility Commission of the State of Texas (“PUCT”)approved our license to become a REP in Texas. As a REP, we sell electricenergy and provide the related billing, customer service, collections andremittance services to residential and commercial customers. We offer ourcustomers the attractive value proposition of lower electricity rates, flexiblepayment and pricing choices, simple offers with understandable terms andresponsive customer service. In general, the Texas regulatory structure permitsindependent REPs (companies unaffiliated with an incumbent utility in aparticular geographic area), such as Gexa, to procure and sell electricity atunregulated prices and pay the local transmission and distribution utilities aregulated tariff rate for delivering electricity to the customers. We arecurrently one of the largest independent REPs, not affiliated with a utility,operating in Texas that focuses on customers whose peak demand is under onemegawatt (defined by the Texas Public Utility Commission as “price-to-beat”commercial customers), as measured by total megawatt hours sold and by customercount. We have grown to over 104,000 total meters as of December 31, 2004.

 

                Todate, we have focused our sales efforts on the under one megawatt commercialand the residential multi-family housing (apartment community) segments.We have also begun to deploy several low cost marketing strategies to furtherpenetrate the single-family residential market. Employing severalfirst-to-market, co-marketing partnerships with leading brands (e.g.,Continental Airlines OnePass®, American Airlines AAdvantage® frequent flyerprograms), we expect to leverage the brand equity of these partners to provideaccess to new single-family residential customers without incurring largemarketing expenditures. The majority of our customers are located in theHouston and Dallas markets, although a growing number are located in a varietyof other metropolitan and rural areas in south and west Texas, such as CorpusChristi and Lubbock.

 

                Weprimarily offer one-year and two-year term contracts to our commercialcustomers and month-to-month terms to our residential customers. In the underone megawatt commercial segment, our position as an independent REP allows usto acquire customers primarily by switching the customers away from REPs thatare affiliated with an incumbent utility. In the residential market, we havesigned marketing agreements with major property management firms to serve theirresidential and on-site commercial accounts.

 

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                Withrespect to energy supply, we utilize an agreement with TXU Portfolio ManagementCompany LP (“TXU PM”), an unregulated entity of TXU Energy that buys and sellswholesale power, for the procurement of wholesale energy. We serve as our ownqualified scheduling entity for open market purchases and sales of electricity.We forecast our energy demand and conduct procurement activities through anexperienced team of in-house professionals. The forecast for electricity loadrequirements is based on our aggregate customer base currently served and anticipatedweather conditions, as well as forecasted customer acquisition and attrition.We continuously monitor and update our supply positions based on our retaildemand forecasts and market conditions. Our policy is to maintain a balancedsupply/demand book to limit commodity risk exposure. We do not currently usederivative instruments and we do not plan to engage in uncovered or speculativetrading of derivative instruments in the future, although we may usederivatives for hedging purposes in the future.

 

                Ourbusiness strategy can be summarized as follows:

 

•                             establishmarketing relationships with multi-family property managers and owners tomarket our services on-site to residents while also providing power to thecommercial meters on-site;

 

•                             use our insidedirect sales team, as well as a network of independent sales agents, to marketour service to commercial customers;

 

•                             utilize strongbranded partners (e.g., Continental Airlines, American Airlines) to provideaccess to a potential expanded customer base, particularly single-familyresidential customers, by providing a strong affinity-based electricityoffering with other tangible benefits;

 

•                             operate andfurther develop a cost-effective and efficient billing and customer serviceinfrastructure, utilizing a combination of internal resources and outsourcedpartners;

 

•                             leverage ourcredit support and energy supply agreement with TXU to provide a cost-effectivesupply of electricity to meet our customers’ needs; and

 

•                             evaluateopportunities to expand our business in the Texas marketplace and otherderegulated markets on an opportunistic basis.

 

                Weintend to evaluate opportunities to expand our areas of operations in Texas ascertain market regions in Texas elect to option-in to deregulation. In addition,there are a number of small REPs within the Texas market, and we intend tomonitor the activities of these REPs and to pursue and evaluate opportunitiesto acquire such REPs to the extent it would provide value to us.

 

                We will also continue to evaluate expansionopportunities in other deregulated electricity markets that offer growthpotential in our core under one megawatt commercial, multi-family andsingle-family residential customers. Beyond Texas, 17 other states andthe

 

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District of Columbia arecurrently open to competition in the U.S. with the majority of these in theMid-Atlantic and Northeast regions.  Thepace of deregulation in these states varies based on historical moves tocompetition and responses to market events. While many states continue theirsupport for retail competition and industry restructuring, other states thatwere considering deregulation have slowed their plans or postponedconsideration.  In addition, other statesare reconsidering deregulation.  Werecently filed applications to become a retail electric provider in thederegulated electricity markets of New York and Maine and began servicing certainof our existing customers in Massachusetts in March 2005.

 

                AtDecember 31, 2004, we had 122 full-time employees and 14 part time employeesand independent contractors. Our principal executive offices are located at 20Greenway Plaza, Suite 600, Houston, Texas 77046, and the telephone number is(713) 470-0400.

 

**Texas Market**

 

                Inthis section, we use the term “competitive REPs” to refer to independent REPsand affiliated REPs, only to the extent operating outside of their incumbentmarket, and the term “incumbent REPs” to refer to affiliate REPs only to theextent operating within their incumbent markets. The term “large commercial”refers to the market segment of non-residential customers whose peak demandover the preceding 12-month period was less than one megawatt but greater than50 kilowatts. The term “small commercial” refers to the market segment ofnon-residential customers whose peak demand over the preceding 12-month periodwas less than 50 kilowatts.

 

                TheTexas deregulated marketplace for under one megawatt customers includesapproximately 3,625 large commercial customers, 949,253 small commercialcustomers and 5.1 million residential customers, which we estimaterepresent collectively over a $10 billion per annum overall market.Approximately 62%, 27% and 21% of the large commercial, small commercial andresidential customers, respectively, in Texas had chosen to be served by acompetitive REP as of February 28, 2005, with the remainder being served by theincumbent REP.

 

                Furthermore,customers choosing to be served by a competitive REP as of February 28, 2005,accounted for 67%, 69% and 26% of peak megawatt demand, measured by usage at February28, 2005, in the large commercial, small commercial and residential markets,respectively.

 

**Regulatory Environment**

 

                Deregulationof the wholesale electricity market in Texas began in 1995 with Senate Bill373. This enabled independent power generators to establish operations in Texasalongside those of the regulated utilities and gain access to the transmissioncapabilities of the grid. This foundation, coupled with the passing of SenateBill 7 in 1999, has enabled an integrated marketplace linking generators,energy delivery companies, retail electric providers, and an independent gridoperator, the Electric Reliability Council of Texas (“ERCOT”), to offer choiceto end-use electricity customers. There are currently five

 

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major markets open to competition as defined by ERCOTbased on service areas in Texas covered by formerly integrated utilities.

 

                EffectiveJanuary 1, 2002, retail customers of independent operating utilities inthe ERCOT region of Texas were allowed to choose a REP. A REP serves end-usecustomers by purchasing its electricity from competing power producers in thewholesale market, receiving delivery services from the regulated transmissionand distribution service providers (formerly the integrated utilities) andperforming basic customer service functions including billing, collections andhandling customer service requests.

 

                Aspart of Texas Senate Bill 7, the formerly integrated utilities were essentiallysplit apart into three businesses: 1) unregulated wholesale businesses forpower generation, 2) regulated transmission and distribution serviceproviders (“TDSPs”) and 3) unregulated REPs. The REPs that were formed bythe previously integrated utilities are referred to as “affiliated REPs” and as“incumbent REPs” when operating in their incumbent market. The incumbent REPsare subject to restrictions on their ability to compete on price in their ownmarkets (the areas previously served by the integrated utility) to fostercompetition through price discounts from competitors. The two largestaffiliated REPs in Texas are TXU Energy and Reliant Energy, who are incumbentREPs in the Dallas/Ft. Worth and Houston areas, respectively. The otheraffiliated REPs include First Choice (an affiliate of Texas New Mexico Power),American Electric Power/Central Power and Light, and American ElectricPower/West Texas Utilities.

 

                EffectiveJanuary 1, 2002, all customers previously with the integrated utility,whose electricity demand was under one megawatt (commercial and residential),were transferred to the incumbent REPs to be served on a month-to-month rate,known as the “price-to-beat” until such time that these customers choose to beserved by an independent REP. The “price-to-beat” rate, set by the PUCT, was toserve as the benchmark, allowing independent REPs, such as Gexa, theflexibility to set their own prices to customers in each market.

 

                The “price-to-beat”rule requires the incumbent REPs to charge only one rate in their respectiveincumbent markets until certain conditions are met. For under one megawattcommercial consumers, incumbent REPs are required to charge the “price-to-beat”until either 40% of the load in the incumbent market is no longer served by theincumbent REP or until January 1, 2005. All of the incumbent REPs met the40% threshold by the end of 2003, and therefore have the opportunity, but notthe obligation, to charge a rate that is lower than the “price-to-beat” for theunder one megawatt commercial market.

 

                Forresidential customers, prior to January 1, 2005 incumbent REPs could onlycharge the “price-to-beat”. Beginning January 1, 2005, the incumbent REPsmay offer a rate that is lower than the “price-to-beat”.

 

                Forboth under one megawatt commercial consumers and residential customers,incumbent REPs are restricted from charging a rate that is higher than the “price-to-beat”in their incumbent market until after January 1, 2007, without the approvalof the PUCT.

 

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                Threecritical elements required to have a successful retail electricity market arepresent in Texas. First, the wholesale energy market is competitive, therebyenabling retailers to purchase supply at competitive prices. Second, a commonframework for operating throughout Texas has been established to enableretailers to effectuate switching, billing, service orders and other necessarytransactions with ERCOT (as a clearinghouse) and with the TDSPs. Third, aregulatory framework has been established that encourages competition byenabling the incumbent REP to adjust the “price-to-beat” based on the movementin natural gas or purchased power prices. This unique “price-to-beat” mechanismensures that the retail margins in the market can be preserved if commoditycosts increase.

 

                In2004, the PUCT enacted legislation permitting REPs who are not affiliated withthe incumbent utility in a particular market to directly disconnect services ofcustomers who fail to pay their bills in a timely manner, with certainexceptions including extreme weather conditions and whether the customer’smeter is used to power life support systems. We anticipate that the ability todisconnect delinquent customers will have a positive impact on the receivablescollection process for all market participants.

 

                Whenwe enter deregulated markets outside of Texas, we will be required to operatewithin the specific regulatory environments of such states and regions. Therules in the other markets do vary from Texas, with some aspects being morefavorable and some less favorable than Texas. For example, we currently bearthe full risk of bad debt in our Texas markets, including transmission anddistribution charges. In most other states, the TDSP collects directly from thecustomer and bears all of the credit risk, although the per kilowatt-hourmargins for REPs are typically lower in these states. We will evaluate theregulatory environment of each market in addition to the other operational,financial and customer considerations before determining whether to pursue anew market opportunity.

 

**Operations**

 

                Theprimary responsibilities of a REP in Texas include customer account initiationand termination, energy supply management and scheduling, billing/remittanceprocessing, and customer service. ERCOT oversees all aspects of the Texas powergrid**,** and all retail electricproviders must be certified by ERCOT to operate in the Texas markets. ERCOT wasfounded in 1970 to oversee the Texas power grid and under deregulation ERCOTserves as the Independent System Operator (“ERCOT ISO”) of the power grid inTexas and enables REPs, generators, TDSPs, and ultimately customers, to operatein a deregulated marketplace in Texas. ERCOT is continuously performing fivemajor processes to support the retail provider:

 

•                  registration

 

•                  marketoperations

 

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•                  power operations

 

•                  loadprofiling, date acquisition and aggregation

 

•                  settlements, billing and financial transfer

 

                Inits simplest form, ERCOT is responsible for coordinating and monitoring allcommunications by and between the power generator, the retail electric providerand the TDSP. ERCOT oversees all aspects of these communications includingcustomer sign up, meter reading and billing between the end user, powergenerator and REP.

 

                Withrespect to account initiation and termination, we utilize several inboundmethods to sign up new customers: telephone, fax, internet, and mail. Theseorders in turn are processed internally and sent through a service provider,Energy Services Group (“ESG”)**,** toERCOT, then to the TDSPs, and then back to us through ESG.  Customers terminate their service in the sameway.

 

                Weutilize ESG, a leading innovator in the automation of back-office businessprocesses for the emerging deregulated energy industry, to process our markettransactions for both account initiation/termination and meter reads. ESG, whois a certified processor of retail energy information for ERCOT, provides uswith the software and programs to exchange data with ERCOT. This allows ourbilling system, the Gexa Energy Management System (“GEMS”) to receive andprocess all information necessary to bill our customers. ESG also provides ustesting and system upgrade services to ensure all of our systems are compliantwith current regulations and ERCOT protocols which are ever evolving.

 

                GEMSnot only bills all of our customers, but also provides critical accounting andreporting data used to track billings, accounts receivable, adjustments toreceivables, customer deposits, and reports for managerial decision making. Wecontinue to develop and improve the GEMS system to meet our specific needs forfuture billing enhancements and to comply with changing ERCOT protocols andPUCT regulations.

 

                Ourcustomer service function is maintained internally, with customer servicerepresentatives able to provide service via the telephone, fax and email andusing GEMS as the core customer information system. Most inquiries are forcustomers making payments over the phone, account initiation/termination, andunderstanding of the billing and usage data.

 

                During2004, we added approximately 20 customer service representatives to handle anincrease in meters from approximately 62,000 meters as of December 31, 2003 toapproximately 104,000 meters as of December 31, 2004.  As a result of the increase in customerservice staff, the number of meters serviced per customer representativedecreased from 4,000 meters as of December 31, 2003 to 3,000 meters as ofDecember 31, 2004, which has improved our telephone response times.

 

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**Marketingand Sales**

We have focused our marketing and sales effort oncommercial accounts under one megawatt (small commercial) and the residentialmulti-family housing (apartment community) segments. During 2004, we havefurther penetrated the single-family residential segment. Employing severalfirst-to-market, and co-marketing arrangements with leading brands (e.g.,Continental Airlines OnePass®, American Airlines AAdvantage® frequent flyerprograms), we expect to leverage the brand equity of these programs to provideaccess to new single-family residential customers without incurring large marketingexpenditures.

 

Ourcustomer base grew in2004 at an average of 4 to 5 percent monthly during 2004.  Our customer base is diversewith no single customer representing more than 3% of total revenue in 2004. AtDecember 31, 2004, the majority of our customers are in the Houston and Dallasmarkets, with a growing presence in several other metropolitan and rural areasin south and west Texas including the cities of Corpus Christi and Lubbock.

Weprimarily offer one-year and two-year term contracts to our small commercialcustomers and month-to-month terms to our residential customers. The smallcommercial contracts have cancellation penalties that range from one to fourmonths’ energy usage depending on the term. Residential agreements are on a month-to-monthbasis, which offers us pricing flexibility, but allows the customers to leaveus at any time for a nominal fee.

Inthe small commercial market, our position as an independent REP allows us toacquire customers primarily by switching the customers away from affiliated REPs.  In the residential market, we have signedmarketing agreements with major property management firms to serve theirresidential and on-site commercial accounts. By effectively positioning ourselves as a low-cost provider and with theendorsement of the on-site property management companies, our strategy is tocontinue to cost effectively acquire new customers. We utilize a combination ofinternal sales representatives and independent sales representatives to acquirenew customers.  Our internal salesrepresentatives receive a one-time commission when a customer is acquired,regardless of whether the customer is commercial or residential. Ourindependent sales representatives earn a one-time commission for residentialcustomers and they earn an ongoing commission for small commercial customersduring the duration that we serve the customer.

During 2004, the Companycontinues to benefit from the joint marketing agreement with ContinentalAirlines, Inc (“Continental”). Through the agreement, Continental and we marketour electricity services to all Continental OnePass® members and Continentalemployees, enabling them to earn OnePass® miles for every dollar spent on electricity.  Commissions to Continentalfrom the program are based on monthly invoices received from Continental, andpayable in a combination of cash and shares of our common stock. In conjunctionwith the Continental joint marketing agreement, we offered two other limitedtime programs during 2004. During the second quarter of 2004, if a customersigned up for the OnePass® program during the months of June and July

 

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andused a Chase credit card, they received 1,000 bonus miles. During the thirdquarter of 2004, if a customer signed up for the OnePass® program during the monthsof July, August, or September, and they used an American Express card, theyreceived 1,000 bonus miles. Although these were limited time programs, wecontinue to maintain active relationships with both Chase and American Express.

During the second quarter of2004, we entered into a marketing agreement with American Airlines, Inc. (“AmericanAirlines”) to participate in the AAdvantage® program. American Airlines’customers also receive AAdvantage® miles for every dollar spent on electricity.Payment to American Airlines occurs when we purchase miles. All miles withinthe AAdvantage® program are prepaid. This program is similar to the Continentalprogram except that miles are prepaid and payment to American Airlines is onlyin cash.

 

**Other Markets**

 

Although our main serviceregions are all within the Texas market, we recently obtained a license toprovide retail electricity in the Massachusetts market and anticipate offeringservice in New York in May, 2005, subject to receiving our license in NewYork.  We also have submitted anapplication to provide retail electricity in Maine. Beyond these four markets,there are currently 14 additional states offering deregulated electricityservices open to competition in the U.S, with the majority of these in theMid-Atlantic and Northeast regions.  Thepace of deregulation in these states varies based on historical moves tocompetition and responses to market events. While many states continue theirsupport for retail competition and industry restructuring, other states thatwere considering deregulation have slowed their plans or postponedconsideration.  In addition, other statesare reconsidering deregulation.

 

As we enter these newregions and other regions in the future, we will be required to operate withinthe specific regulatory environments of such states and regions.  The rules in these other markets do vary fromTexas, with some aspects being more favorable and some less favorable. InTexas, the REP bears the full risk of bad debt, including the transmission anddistribution charges, whereas in most other states, the TDSP collects from thecustomer and is exposed to the bad debt risk, as the REP is paid by the TDSP.However, in such lower risk markets we will likely experience lower margins. Wewill continue to evaluate the regulatory environment as well as otheroperational, financial and customer considerations before making a decision topursue a new market opportunity.

 

**Electricity Supply**

 

With respect to energy supplyin Texas, we utilize an agreement with TXU PM for the procurement of wholesaleenergy.  We serve as our own qualifiedscheduling entity for open market purchases and sales of electricity.  We forecast our energy demand and conductprocurement activities through an experienced team of in-houseprofessionals.  The forecast forelectricity load requirements is based on our

 

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aggregate customer base currently served and anticipatedweather conditions, as well as forecasted customer acquisition andattrition.  We continuously monitor andupdate our supply positions based on our retail demand forecasts and marketconditions. Our objective is to maintain a balanced supply/demand book to limitcommodity risk exposure. We do not currently use derivative instruments and wedo not plan to engage in uncovered or speculative trading of derivativeinstruments in the future, although we may use derivatives for hedging purposesin the future.

 

Ouragreement with TXU PM provides both a source of electricity supply and vendorfinancing. Since our term commercial customer contracts generally havedurations of one and two years, we endeavor to match term supply purchases toterm customers obligations. We purchase electricity from TXU PM and from thirdparties based on our forecast of customer demand and monthly purchase limitsimposed by TXU PM. Additionally, TXU PM reserves the right to review the credit-worthinessof all customers with peak demand of at least one megawatt. We pay a monthlycredit fee to TXU PM based on our monthly electricity purchases from TXU PM, aswell as small, fixed monthly administrative fees. TXU PM also provides creditguarantees to us to enable us to purchase electricity from third parties, in returnfor a monthly fee. The agreement has an initial term of five years, expiring inApril 2008, and renews thereafter on a year-to-year basis unless eitherparty gives notice of termination.****

 

Purchasing this electricityexposes the wholesale electricity provider to credit risk that may exist due toany payment risk. Accordingly, TXU PM has three sources of security from us tosupport this agreement. First, TXU PM has a first lien on all of our assets,including our accounts receivable. Second, our customer receipts are managedthrough a lockbox arrangement with TXU PM under which certain costs of goodsold items and the monthly TXU PM invoice are paid during each month with usreceiving any remaining funds used for our operating expenses. TXU PM must approveall disbursements from our lockbox. Third, we are required to post aletter of credit, cash collateralized, in amounts determined by TXU PM pursuantour agreement.

 

We are currently in theprocess of negotiating agreements for electricity supply in markets outside ofTexas.

 

**Competition**

 

Our competitors in the Texasmarket broadly fall into two categories. The first category consists of theaffiliated REPs who inherited the “price-to-beat” customers (residential andsmall commercial) at the time the market opened to competition. As noted in “RegulatoryEnvironment” above, the ability for the affiliated REPs to compete on price intheir incumbent markets is dictated by specific rules. However, in all cases,the affiliated REPs enjoy the highest levels of brand recognition andfamiliarity, requiring competitive REPs, such as our company, to convincecustomers to switch their service away from the affiliated REPs. The affiliatedREPs in Texas include: TXU Energy, Reliant Energy, First Choice Power, WTURetail Energy, and CPL Retail Energy. The latter two affiliated REPs are ownedby Direct Energy, a unit of Centrica PLC. Outside of their incumbent markets,these affiliated REPs compete on the same regulatory environment as does Gexa.

 

The second category of competitorsconsists of REPs that are not affiliated with any TDSPs. These include, but arenot limited to, Green Mountain Energy, Cirro Energy,

 

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Strategic Energy, Constellation Energy andUtility Choice. Some of the REPs choose to compete only in small commercial,while others compete in both residential and small commercial. The sizes ofthese REPs vary as do their approach to the market.

 

While Texas has continued tosee some new entrants during the past year, most of the focus in both the smallcommercial and the residential segments is on enticing customers to leave theaffiliated REP’s service, and not on frequent switching between competitiveretailers.

 

**Subsequent Events**

** **

On March 28, 2005, the Company,and FPL Group, Inc., a Florida corporation (“FPL Group”), announced theexecution of an Agreement and Plan of Merger, dated as of March 28, 2005 (the“Merger Agreement”), by and among FRM Holdings, LLC, a Delaware limitedliability company (“FRM Holdings”), WPRM Acquisition Subsidiary, Inc., a Texascorporation and a wholly owned subsidiary of Holdings (“Merger Sub”), FPL Groupand the Company, pursuant to which, subject to the satisfaction or waiver ofthe conditions therein, Merger Sub will merge with and into the Company (the“Merger”).  As a result of the Merger,the Company will become an indirect wholly owned subsidiary of FPL Group.  The Merger is intended to qualify as atax-free reorganization under Section 368(a) of the Internal Revenue Code of1986, as amended.  Further informationregarding the Merger is set forth in Note 19 to the Company’s 2004 financialstatements included herein under Item 8. “Financial Statements and Supplementary Data”.

 

We have also recentlyundertaken certain changes in our disclosure controls and procedures inconnection with a material weakness letter we received from our independentauditors, Hein & Associates, LLP on March 25, 2005.  Further information regarding these changesis set forth herein in Item 9A. “Controls and Procedures—Changes to DisclosureControls and Procedures.”

 

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**RISK FACTORS**

 

***EARLY STAGEOPERATING COMPANY***

 

                Weare an early stage operating company created for the purpose of providingelectricity in deregulated electricity markets. We experienced significantgrowth in 2004, and future success is, to some degree, dependent upon ourability to continue to expand our operations through implementation of ourbusiness plan and model while devoting adequate resources to maintaining ourexisting customer base. We are subject to all of the risks inherent inattempting to expand a relatively new business venture. These risks include,but are not limited to, the possible inability to implement our business planand the inability to fund the working capital requirements of our businessplan. There can be no assurance that we will remain profitable, or that we willprovide any return on invested capital.

 

                Wealso operate in a new and very competitive industry that is emerging from therecent deregulation of the retail electricity market in Texas. The retailelectric industry is in the early stages of development as a competitiveindustry and we expect there will be a great deal of change. Our successdepends on our ability to adapt to changes in the industry, including changesto market dynamics and regulatory structures in Texas and in other marketswhich we may decide to enter in the future. It also depends on the continuingexistence and development of market conditions, including regulatory matters,which enable independent retail electric providers to compete effectivelyagainst incumbent utilities and are favorable to our business model. Adverse changesin the industry, including its regulatory structure, could have a materialadverse effect on our prospects, operating results and financial condition.

 

                Whileour gross profits increased in 2004, we have also experienced a decrease in ourgross profit percentage as a result of several factors including an increase inthe number of commercial accounts we service. Due to competitive market forces,prices for commercial contracts typically yield lower margins per kWh thanprices for residential contracts. We believe that as we grow a higherpercentage of our revenues will be generated from commercial accounts and,therefore, expect that our gross margin percentage may continue to decline.Other factors may have an effect on our gross margin percentage and aredescribed herein under the “Gross Profits” section of “Management’s Discussionand Analysis of Financial Condition and Result of Operations—Results ofOperations.”

 

***INABILITY TOMANAGE OUR GROWTH***

 

                Ourcustomer base and operations have grown at a rapid rate in 2004. The furtherdevelopment of our operations will depend upon, among other things, our abilityto expand our customer base in Texas and to enter new markets in a timelymanner and at reasonable costs. In addition, our employee base has increasedsince inception and we anticipate that our employee base will continue to growin order for us to accommodate our increased customer base. We may experiencedifficulty managing the growth of a portfolio of customers that is diverse bothwith respect to the types of services they will require, the

 

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market rules in their jurisdiction and the infrastructuredelivering our products to those customers. Expanding our operations may alsorequire continued development of our operating and financial controls and mayplace additional stress on our management and operational resources. If we areunable to manage our growth and development successfully, our operating resultsand financial condition could be materially adversely affected.

 

***STRONGCOMPETITION FROM INCUMBENT UTILITIES AND OTHER COMPETITORS***

 

                Themarket in which we compete is highly competitive, and we may not be able tocompete effectively, especially against established industry competitors withsignificantly greater financial resources. We will face competition from manycompetitors with significantly greater financial resources, well-establishedbrand names and large, existing installed customer bases. We expect the levelof competition to intensify in the future. We expect significant competitionfrom incumbent, traditional, and new electricity providers, many of whom haveaccess to more significant capital resources.

 

                Inmost markets, our principal competitor may be the local incumbent utility companyor its affiliated incumbent REPs.  Thisis the case in Texas where we currently operate. The incumbent utilities havethe advantage of long-standing relationships with their customers, and they mayhave longer operating histories, greater financial and other resources andgreater name recognition in their markets than we do. In addition, incumbentREPs have been subject to regulatory oversight, in some cases for close to acentury, and thus have a significant amount of experience regarding the regulators’policy preferences as well as a critical economic interest in the outcome ofproceedings concerning their revenues and terms and conditions of service.Incumbent REPs may seek to decrease their tariffed retail rates to limit or topreclude the opportunities for competitive energy suppliers, and otherwise seekto establish rates, terms and conditions to the disadvantage of competitiveREPs. Some of our competitors, including incumbent REPs, have formed alliancesand joint ventures in order to compete in the restructured retail electricityand natural gas industry. Many customers of these incumbent REPs may decide tostay with their long-time energy provider if they have been satisfied with itsservice in the past. Therefore, it may be difficult for us to compete againstincumbent REPs and their affiliates for customers who are satisfied with theirhistorical utility provider.

 

                Inaddition to competition from the incumbent and affiliated REPs, we facecompetition from a number of independent REPs. In Texas, these competitorsinclude, but are not limited to, the following companies: Cirro Energy, TexasCommercial Energy, Liberty Power, Green Mountain and Direct Energy (anaffiliate of American Electric Power). We also may face competition from largecorporations in businesses with similar billing and customer servicecapabilities, such as telecommunication service providers, and nationallybranded providers of consumer products and services that have a significantbase of existing customers. Many of these competitors or potential competitorsare larger than us and have access to more significant capital resources.

 

***WE MAY HAVEDIFFICULTY RETAINING OUR EXISTING CUSTOMERS AND OBTAINING A SUFFICIENT NUMBEROF NEW CUSTOMERS***

 

                Weanticipate that we will incur significant costs as we enter new markets outsideof Texas and pursue customers by utilizing a variety of marketing methods. Inorder for us to recover these expenses, we must attract and retain a largenumber of customers to our service. We cannot assure that our future efforts tosecure additional customers will provide the operating base needed to expandinto additional markets. Many customers may be reluctant to switch to a newcompany for the supply of a commodity as critical to their well being as electricpower. A major focus of our ongoing marketing effort is to demonstrate topotential customers that we will be a reliable provider with sufficientresources to meet our commitments. If our marketing strategy does not continueto be successful, our business, results of operations, and financial conditionwill be materially adversely affected.

 

                Wehave been successful in gaining a significant number of customers in themarkets where we operate. There exists, however, significant ongoingcompetition for these customers and we cannot assure that we will be able toretain such customers. In addition, as part of our business, we willperiodically discontinue service to particular customers who represent a badcredit risk or where continued service to such customer is not economicallyadvantageous to us.  We believe ourgrowth will continue in the Texas market, but not as rapidly as during 2004.

 

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***CERTAINCOMPETITIVE RESTRICTIONS FOR THE RESIDENTIAL SEGMENT APPLICABLE TO INCUMBENTREPS EXPIRED ON JANUARY 1, 2005***

 

                InTexas, the “price-to-beat” rule requires the incumbent REPs to charge only oneprice until certain conditions are met. For under one megawatt commercialconsumers, incumbent REPs can only charge the “price-to-beat” until either 40%of the load in the incumbent market is no longer served by incumbent REP oruntil January 1, 2005. All of the incumbent REPs met the 40% threshold bylate 2003, and therefore may charge a rate that is lower than the “price-to-beat”for the under one megawatt commercial market.

 

                Forresidential consumers, prior to January 1, 2005 incumbent REPs could onlycharge the “price-to-beat.” Beginning January 1, 2005, the incumbent REPsmay offer a rate that is lower than the price-to-beat.

 

                Ourability to obtain new customers or even retain existing customers may beadversely affected by the termination of these restrictions.

 

                Further,for both under one megawatt commercial consumers and residential consumers,incumbent REPs are restricted from charging a rate that is higher than the “price-to-beat”in their incumbent market until after January 1, 2007, without theapproval of the PUCT.

 

***WEATHER ANDOTHER RELATED COMMODITY RISKS MAY AFFECT OUR ABILITY TO MANAGE AND MAINTAIN ABALANCED SUPPLY/DEMAND BOOK***

 

                Commitmentsfor future purchase of electricity supply (forward power contracts) are basednot only on our expected customer base at a given point in time, but alsoweather forecasts for the geographical areas in which we operate. We maintain along position in our forward power contracts (contracted electricity supplypurchases are slightly greater than forecasted demand by our customers) tominimize the need to purchase power on the balancing markets at varying marketprices. However, fluctuations in actual weather conditions can have an impacton the actual power needs of customers on a given day. Extreme weatherconditions may force us to purchase electricity supply on the balancing marketson days when weather is unexpectedly severe, and the pricing for balancingmarket energy can be significantly higher on such days than the cost ofelectricity in our forward contracts. Unusually mild weather conditions couldleave us with excess power which may be sold in the balancing markets at a lossif the balancing market price is lower than the Company’s forward contractprices.

 

                Commoditypricing is an inherent component of our financial results. The prevailingmarket prices for electricity and fuel in the market may fluctuatesubstantially over relatively short periods of time, potentially adverselyimpacting our results of operations, financial condition and cash flows.Changes in market prices for electricity and fuel may result from any of thefollowing:

 

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•                             weather conditions;

•                             seasonality;

•                             demand for energy commodities and general economic conditions;

•                             forced or unscheduled plant outages;

•                             disruption of electricity or gas transmission or transportationinfrastructure or other constraints or inefficiencies;

•                             addition of generating capacity;

•                             availability of competitively priced alternative energy sources;

•                             availability and levels of storage and inventory for fuel stocks;

•                             natural gas, crude oil and refined products, and coal production levels;

•                             the creditworthiness or bankruptcy or other financial distress of marketparticipants;

•                             changes in market liquidity;

•                             natural disasters, wars, embargoes, acts of terrorism and othercatastrophic events; and

•                             federal, state and foreign governmental regulation and legislation.

***WE HAVE ALEVERAGED CAPITAL STRUCTURE AND THE TERMS OF OUR DEBT MAY SEVERELY LIMIT OURABILITY TO PLAN FOR OR RESPOND TO CHANGES IN OUR BUSINESS***

 

                Wehave a leveraged capital structure due to the facility with Highbridge/ZwirnSpecial Opportunities Fund, L.P. (“Highbridge”) and our creditarrangements with TXU PM, which limits our financial flexibility. For adescription of these obligations, see “Management Discussion andAnalysis—Liquidity and Capital Resources” herein. Our level of indebtedness hasseveral important effects on our future operations including:

 

•                             a substantialportion of our cash flow from operations will need to be dedicated to paymentof interest on our indebtedness;

 

•                             covenants contained in our debt obligations require us tomeet certain financial tests, and other restrictions limit our ability toborrow additional funds or dispose of assets and may affect our flexibility inplanning for,

 

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and reacting to, changes in our business,including possible acquisition activities; and

 

•                             our ability to obtain financing in the future for working capital, capitalexpenditures, acquisitions, general corporate purposes and other purposes maybe impaired.

                Ourability to meet our debt service obligations and to reduce our totalindebtedness will be dependent upon future performance, which will be subjectto general economic conditions and financial, business and other factorsaffecting our operations, many of which are beyond our control. In addition,our ability to comply with the covenants in our debt agreements, as theycurrently exist or as they may be modified, may be affected by many eventsbeyond our control and our future operating results may not allow us to complywith those financial covenants. Our failure to comply with the covenants couldresult in a default, which could cause our indebtedness to become immediatelydue and payable. If we are unable to repay those amounts, Highbridge, subjectto the senior security interests of TXU PM, may proceed against the collateral.If those holders accelerate the payment of our subordinated debt, it isunlikely that we could pay that indebtedness immediately and continue tooperate our business.

 

***DELAY INDEREGULATION IN OTHER STATES OR CHANGE IN COMPETITIVE MARKET RULES***

 

                To date, only alimited number of markets have opened to retail energy competition. In many ofthese markets, the market rules adopted have not resulted in energy serviceproviders being able to compete successfully with the incumbent utilities, andcustomer-switching rates have been low. Only recently have a number ofmarkets opened to competition under rules, some of which we believe may offerattractive competitive opportunities. Texas, our primary marketplace sinceinception, is among them. Our business model may depend on other favorablemarkets opening under viable competitive rules in a timely manner. In anyparticular market, there are a number of rules that will ultimately determinethe attractiveness of that market. Markets that we enter may have bothfavorable and unfavorable rules. While many markets outside of Texas continuetheir support for retail competition and industry restructuring, others thatwere considering deregulation have slowed their plans or postponedconsideration.  In addition, some statesare reconsidering deregulation. If the trend towards competitive restructuringof retail energy markets does not continue or is delayed or reversed, ourbusiness prospects and financial condition could be materially adverselyimpaired.

                Retailenergy market restructuring has been, and will continue to be, a complicatedregulatory process, with competing interests advanced not only by relevantstate and federal utility regulators, but also by state legislators, federallegislators, incumbent utilities, consumer advocacy groups, and potentialmarket participants. As a result, the extent to which there are legitimatecompetitive opportunities for alternative energy suppliers in a given jurisdictionmay vary widely, and we cannot assure you that regulatory structures will offerus competitive opportunities to sell energy to consumers on a 

 

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profitable basis. The regulatory process could be negativelyimpacted by a number of factors, including interruptions of service,significant or rapid price increases, and other factors, which may beattributed by opponents of competition in these markets to restructuring and tothe lack of regulatory control. The legislative and regulatory processes insome states take prolonged periods. In a number of jurisdictions, it may bemany years from the date legislation is enacted until restructuring iscompleted.

 

                Inaddition, although most retail energy market restructuring has been conductedat the state and local levels, bills have been proposed in Congress in the pastthat would preempt state law concerning the restructuring of the retail energymarkets. Although none of these initiatives has been successful, we cannotassure you that federal legislation will not be passed in the future that couldmaterially adversely affect our business.

 

***EXTENSIVEGOVERNMENTAL REGULATION MAY INCREASE OUR COSTS AND SLOW OUR GROWTH***

 

                Significantregulations imposed at the international, federal, state and local levelsgovern the provision of utility services and affect our business and ourexisting and potential competitors. Delays in receiving required regulatoryapprovals, the enactment of new and adverse legislation, regulations orregulatory requirements or the application of existing laws and regulations tocertain services may have a material adverse effect on our business, financialcondition, results of operations and cash flow. In addition, futurelegislative, judicial and regulatory agency actions could alter competitiveconditions in the markets in which we intend to operate, in ways notnecessarily to our advantage.

 

                ERCOThas and may continue to modify the market structure and other market mechanismsin an attempt to improve market efficiency. Moreover, existing regulations maybe revised or reinterpreted and new laws and regulations may be adopted orbecome applicable to our commercial activities. These actions could have amaterial adverse effect on our results of operations, financial conditions andcash flows.

 

***WE BEAR THECREDIT RISK AND BILLING RESPONSIBILITY FOR OUR CUSTOMERS***

 

                InTexas, the primary market in which we currently operate, we are responsible forthe billing and collection functions for our customers. As we seek to expandour operations into additional markets, the billing and collection functionsmay also be our responsibility. In many of these markets, we may be limited inour ability to terminate service to customers who are delinquent in payment.Even if we terminate service to customers who fail to pay their electricitybill in a timely manner, we may remain liable to our suppliers of electricityfor the cost of those commodities and to the local utilities for servicesrelated to the transmission and distribution of electricity and natural gas tothose customers. The failure of our customers to pay their bills in a timelymanner or our failure to maintain adequate billing and collection programscould materially adversely affect our business.

 

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                TheCompany has placed several initiatives in place to help manage the credit riskof our customers, including the following:

 

•                             increasing the number and amount of security depositsrequired;

 

•                             aggressive inside collection efforts;

 

•                             providing more convenient payment methods;

 

•                             engaging outside collection agencies; and

 

•                             charging late fees on past due balances.

 

                In2004, the PUCT enacted legislation which permits independent REPs to order thedisconnection of electricity services of customers who fail to pay their billsin a timely manner, with certain exceptions including extreme weatherconditions and whether the customer’s meter is used to power life supportsystems. We anticipate that the ability to disconnect delinquent customers willhave a positive impact on the receivables collection process for all marketparticipants. These actions, along with the reduction in problems related toreceiving timely customer meter reads, contributed to a reduction in our baddebt expense as a percentage of sales from 3.4% as of December 31, 2003 to 2.6%as of December 31, 2004.

 

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***DEPENDENCE ONPROVIDERS OF ELECTRICITY FOR RESALE AND RELIANCE ON TXU FOR FINANCIAL SUPPORT***

 

                Wemust rely on a limited number of suppliers of wholesale electricity in order tomeet our customer’s needs. The unavailability of electricity from one or moreof our suppliers at times of high demand could have an adverse impact on ourfinancial condition if we are forced to purchase substantial electricity supplyin the open market to meet customer demand at a time when energy prices arevolatile. Our primary supplier of electricity in Texas is TXU PM. We haveentered into a five-year wholesale credit agreement with TXU PM which allows usto purchase electricity in Texas with the credit backing of TXU PM. In exchangefor the credit support, we granted TXU PM a first lien on our receivables,assets and contracts.

 

                TheTXU PM agreement also has a monthly limit for megawatt hours, which wasincreased in 2004 to enable us to continue to grow and handle the higherseasonal summer volumes. Given our recent growth experience, we anticipate thatwe may reach such monthly limit in future periods of high demand and maypotentially need to increase such monthly limit through further negotiationswith TXU PM or through other suppliers. There is no guaranty that TXU PM willbe willing to increase this limit or that we could find alternate suppliers toprovide such electrical demand on terms acceptable to us.

 

                Asof December 31, 2004, we had deposited approximately $5.8 million with JPMorgan Chase Bank to obtain letters of credit allowing us to purchase power onforward contracts from TXU PM, buy and sell power in the daily balancingmarkets and pay TDSP invoices for metering charges passed through to customerson thirty-five day terms. We believe that we have sufficient liquidity tosupport the letters of credit that may be required. However, we cannot assure thatwe will have sufficient liquidity in the future to support customer growth andanticipated increases in power purchases. As we grow, our letter of creditrequirement may become larger and other terms may change and adversely affectus.

 

***OUR SUCCESS INTEXAS MAY NOT TRANSLATE TO OTHER DEREGULATED MARKETS***

 

                Whilewe are actively reviewing various opportunities in markets outside Texas, therecan be no assurance that we will be able to replicate our model outside of theTexas market. We also are currently licensed to supply retailelectricity power to the Massachusetts electricity market and have submittedapplications to become an electricity provider in New York and Maine.  Otherstates that are currently in various phases of deregulation of their retailelectricity market include: Arizona, Connecticut, Delaware, District ofColumbia, Illinois, Maryland, Michigan, Nevada, New Hampshire, New Jersey,Ohio, Oregon, Pennsylvania, Rhode Island and Virginia. The regulations relatingto the markets in these states vary from the regulations in Texas. In anyparticular market, there are a number of rules that will ultimately determinethe attractiveness of that market. Markets that we seek to enter may have bothfavorable and unfavorable rules. In addition, the relative size,

 

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demographics and energy consumption patterns of aparticular market may not allow us to use the same or similar growth strategiesas we have used in Texas. In addition, we must be able to procure necessarysupply and credit agreements through energy wholesalers in any markets that weseek to enter. There can be no assurance that we will be able to secure suchagreements on terms that allow us to effectively serve these other markets.

 

***RELIANCE ONINFORMATION TECHNOLOGY SYSTEMS***

 

                Ourbusiness is dependent on information sharing among market participants(including ERCOT, the TDSPs, and third-party service providers). Thisinformation includes customer enrollment information, ERCOT transactions, meterreadings, invoices for wire line charges, etc. Therefore, our success as anindependent REP is impacted by our ability to handle this information and weare dependant on third parties to provide timely and accurate information tous. We rely on a combination of internal systems including telephone, internet,load forecasting, as well as systems operated by third parties. Failure toreceive timely and accurate information could have an adverse impact on ourbusiness.

 

                Wehave implemented both processes and infrastructure to provide for redundancy ofcore data due to business interruption associated with our billing platform;however, that is only one component of our business model. In addition, oursystems and those we rely upon from third parties need continued developmentand investment to ensure reliability and scalability as our business grows at arapid rate.

 

                Despitethe implementation of security measures, our networks may be vulnerable tounauthorized access, computer viruses and other disruptive problems. A partywho is able to circumvent security measures could misappropriate proprietaryinformation or cause interruptions in our Internet operations. We may berequired to expend significant capital or other resources to protect againstthe threat of security breaches or to alleviate problems caused by suchbreaches. Although we intend to continue to implement industry-standardsecurity measures, there can be no assurance that measures implemented by uswill not be circumvented in the future.

 

***RELIANCE ONTDSPS AFFILIATED WITH OUR COMPETITORS TO PERFORM SOME FUNCTIONS FOR OURCUSTOMERS***

 

                Underthe regulatory structures adopted in most jurisdictions, we will be required toenter into agreements with local incumbent utilities for use of the local distributionsystems, and for the creation and operation of functional interfaces necessaryfor us to serve our customers. While we currently enjoy acceptable agreementsin Texas, any delay in future negotiations for access to new markets or ourinability to enter into reasonable agreements to operate in new markets coulddelay or negatively impact our ability to serve customers in thosejurisdictions, which could have a material negative impact on our business,results of operations, and financial condition.

 

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                Weare dependent on TDSPs for maintenance of the infrastructure through which wedeliver electricity to our retail customers. Any infrastructure failure thatinterrupts or impairs delivery of electricity to our customers could negativelyimpact the satisfaction of our customers with our service and could have amaterial adverse effect on our results of operations, financial condition andcash flow. Additionally, we are dependant on TDSPs for performing serviceinitiations and changes, and for reading our customers’ energy meters. We arerequired to rely on the TDSPs, or, in some cases, ERCOT, to provide us with ourcustomers’ information regarding energy usage, and we may be limited in ourability to confirm the accuracy of the information. The provision of inaccurateinformation or delayed provision of such information by the TDSPs or ERCOTcould have a material adverse effect on our business, results of operations,financial condition and cash flow. In addition, any operational problems withour new systems and processes could similarly have a material adverse effect onour business, results of operations, financial condition and cash flow.

 

***PAYMENTDEFAULTS BY OTHER REPS TO ERCOT***

 

                Inthe event of a default by a REP of its payment obligations to ERCOT, theportion of that obligation that is unrecoverable by ERCOT from the defaultingREP is assumed by the remaining market participants in proportion to eachparticipant’s load ratio share. As a REP and market participant in ERCOT, wewould pay a portion of the amount owed to ERCOT should such a default occur,and ERCOT is not successful in recovering such amounts. Any such default of aREP in its obligations to ERCOT could have a material adverse effect on ourbusiness, results of operations, financial conditions and cash flows.

 

***ERCOT HASEXPERIENCED PROBLEMS WITH ITS INFORMATION SYSTEMS***

 

                ERCOTis the independent system operator responsible for maintaining reliableoperations of the bulk electric power supply system in the ERCOT Region and foracting as a central agent for the registration of customers with their chosenretail electric supplier. Its responsibilities include ensuring thatinformation relating to a customer’s choice of REP, including data needed foron-going servicing of customer accounts, is conveyed in a timely manner to theappropriate parties. Problems in the flow of information between ERCOT, the TDSPsand the REPs have resulted in delays and other problems in enrolling andbilling customers. While the flow of information has improved materially overthe course of the last two years of full market choice operations, remainingsystem and process problems are still being addressed. When customer enrollmenttransactions are not successfully processed by all involved parties, ownershiprecords in the various systems supporting the market are not synchronizedproperly and subsequent transactions for billing and settlement are adverselyaffected. The impact can include us not being the electric provider-of-recordfor intended or agreed upon time periods, delays in receiving customerconsumption data that is necessary for billing and settlement either throughERCOT or directly with TDSPs, as well as the incorrect application of rates orprices and imbalances in our electricity supply forecast and actual sales.

 

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***IF WE AREUNABLE TO MAINTAIN EFFECTIVE INTERNAL CONTROLS AND PROCEDURES, THERE COULD BE AMATERIAL ADVERSE EFFECT ON OUR OPERATIONS OR FINANCIAL RESULTS***

 

                During both the audit of our fiscal year end 2004 and2003, our independent auditors, Hein & Associates LLP (“Hein”), issuedmaterial weakness letters noting significant deficiencies in our internalcontrols.  The letters related todifferent matters.

 

OnMarch 25, 2005, Hein issued a material weakness letter related to the audit ofour fiscal year end 2004 identifying a deficiency in our internalcontrols.  The deficiency identified byHein was that we did not adequately provide information to Hein regarding acontrol deficiency over input of rates into our billing system and a resultingreserve accrual.  In addition, Heinindicated that the Company failed to fully investigate and quantify the extentof the error caused by such control deficiency. The deficiency arose in connection with our determination of the size ofour reserve for customer credits to be issued relating to errors in inputtingrates on our billing system.

Inresponse to the initial inquiries of Hein related to this matter, the AuditCommittee of our Board of Directors, with the assistance of external counsel,conducted a review of this matter through discussions with the outside auditor,review of the applicable documents and interviews and discussions with ourmanagement.  On March 25, 2005, the AuditCommittee recommended an action plan related to this material weakness, whichwas implemented immediately, which included the following action items:

 

•                        In 2004, wecreated a Disclosure and Materiality Committee that includes our CEO, CFO, COOand those staff people responsible for SEC reporting and monitoring of new oramended regulations, including the employee responsible for investorrelations.  The committee shall beresponsible for the determination that disclosure of all material informationhas been made in each applicable proposed public filing or furnishing ofinformation by us pursuant to the Securities Act and the Exchange Act and thatall disclosures are made on a timely basis. Our outside accountants and counsel will be invited to participate inany meeting of this committee and the timing of those meetings will be set toensure their attendance.

•                        Any reservessuggested by our management for inclusion in our financial statements must bedisclosed to and approved by the Audit Committee and

 

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disclosed to our outside auditors, in eachcase with sufficient detail to enable an understanding of the reasons for thereserve.  Upon establishment of any suchreserve, our management shall, in subsequent financial periods, perform theapplicable investigation to confirm the need and size of such reserve, asapplicable, and report those findings to the Audit Committee and outsideauditors on a timely basis.

The audit committee’s report further concluded that the controldeficiency related to input of rates into our billing system was corrected bythe Company as of the third quarter of 2004, and probably did not result in amaterial error to the Company’s financial statements.

                Inaddition, during the audit of our fiscal year 2003, Hein issued a materialweakness letter relating to our internal controls and procedures.  The material weakness identified by Hein wasdiscovered in connection with a review by Hein of the our proposed changes to ourrevenue calculation method.  Managementbegan the process of reviewing our revenue calculation method inNovember 2003.  The identifieddeficiencies were the following:

 

•      inadequateU.S. GAAP, financial reporting and public company expertise and experiencewithin our accounting department; and

 

•      inadequatequality control over the financial reporting process, including inadequatereview of facts, circumstances and events impacting estimates and judgmentsrequiring accounting recognition or disclosure.

 

                Heinalso indicated at that time that our new method for calculating our revenuesrequired additional review and testing. Previously, we estimated revenues basedon billings (the “billing” method), but the availability of accurate and timelyelectricity supply delivery data for the entire 2003 fiscal year allowed us toestimate revenues based on measuring electricity as delivered to our customers(the “flow” method).  In the fourthquarter of 2003 and first quarter of 2004, we conducted additional testing andreview of the controls and the source data being used to calculate revenues aswell as the flow method of

 

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revenue calculation. Based on that review, we adopted the flow method for determining itsrevenues in fiscal year 2003 and thereafter.

 

                Inresponse to this prior material weakness letter, the Audit Committee of ourBoard of Directors, with the assistance of independent counsel, began aninvestigation of the issues raised by our auditors, including our revenuecalculation methods, which process was completed in the second quarter of 2004. The Audit Committee recommended, and theBoard of Directors reviewed and adopted, an action plan during the secondquarter of 2004.  The action plan wasfully implemented as of September 30, 2004, through the following actions:

 

•                        the institution of new document controlprocedures, including an updated disaster and recovery plan;

 

•                        David K. Holeman’s election as VicePresident and Chief Financial Officer on June 2, 2004;

 

•                        the hiring of a Controller and a Managerof Financial Reporting, each with experience in SEC reporting and accounting,and a Human Resources Manager;

 

•                        the creation of interim policies andprocedures for the issuance of press releases and the preparation of SECreports;

 

•                        the establishment of an internalDisclosure Review Committee to review and coordinate SEC reports and preparedan interim policy regarding the notification of senior management and the Boardof material developments;

 

•                        the completionof a training program for all relevant personnel regarding SEC reporting, Sarbanes-Oxley Act compliance, andrelated issues; and

 

•                        the selection of a provider for Sarbanes-OxleyAct Section 404 related services and to assist us in a review andassessment of our accounting policies and procedures.

 

                Wewill continue to evaluate the effectiveness of internal controls and procedureson an ongoing basis. It should be noted that in designing and evaluating thedisclosure controls and procedures, management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired controlled objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost benefit relationship of possible controls and procedures. Based on theevaluation described above and the implementation of the action plans describedabove, our CEO and CFO have concluded that our disclosure controls andprocedures are effective at reaching that level of reasonable assurance.

 

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                Ourmanagement does not expect that our disclosure controls and procedures, or itsinternal control over financial reporting, will prevent all error and allfraud. A control system, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystem are met.  Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs.  Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the Company have beendetected.  These inherent limitationsinclude the realities that judgments in decision-making can be faulty,and that breakdowns can occur because of simple error or mistake. Additionally,controls can be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the control.  The design of any system of controls also isbased in part upon certain assumptions about the likelihood of future events,and there can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions.  Over time, controls may become inadequatebecause of changes in conditions, or the degree of compliance with the policiesor procedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

                OurBoard of Directors, in coordination with our Audit Committee, will continuallyassess the sufficiency of these initiatives and make adjustments as necessary.  If we are unable at any time to continue tomaintain an effective system of internal controls and procedures, there couldbe a material adverse effect on our operations or financial results.

 

***WE MAY HAVE ACONTINGENT LIABILITY ARISING OUT OF THE ISSUANCE OF SHARES TO THE STOCKHOLDERSOF GEXA GOLD***

 

                Gexawas formed as a Texas corporation in 2001 to conduct all of the Company’sbusiness, and is the successor to Gexa Gold Corp., a Nevada corporation (“GexaGold”). Gexa and Gexa Gold executed an agreement in January 2001 wherebyGexa Gold would be reincorporated as a Texas corporation by merging with Gexa.However, no shareholder meeting was held and no documentation relating to thecontemplated reincorporation merger of Gexa and Gexa Gold was filed with theSecretary of State of Nevada or of Texas or the Securities and ExchangeCommission (“SEC”). Gexa Gold also forfeited its charter in 1998 for failure topay its annual taxes and file its annual report in Nevada. However, Gexa hasoperated as if the reincorporation merger occurred, issued 377,957 shares ofGexa common stock to the stockholders of Gexa Gold, and has assumed effectiveas of January 31, 2001, the assets and liabilities of Gexa Gold and GexaGold’s obligation to file reports with the SEC. Gexa also filed a number ofreports with the SEC in order to make Gexa Gold current in its SEC Reportingobligations. Gexa Gold had not filed the required SEC reports for nine yearsprior to Gexa’s succession to Gexa Gold in 2001.

 

                UnderNevada law, the directors of Gexa Gold hold all of the property and assets ofGexa Gold in trust after its charter was forfeited and are able to act withrespect to that property and assets in the same manner as is applicable toinsolvent corporations under the Nevada Revised Statutes. In October 2003,after discovering that no merger documents had

 

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been filed, the former directors of Gexa Gold enteredinto a new agreement to transfer to Gexa all of Gexa Gold’s assets andliabilities as if the merger of Gexa and Gexa Gold had occurred as the partiesintended. By this remedial action, the parties have effectuated their intentionto merge Gexa Gold with Gexa in January 2001.

 

                The377,957 shares of common stock issued to the stockholders of Gexa Gold in 2001were issued without being registered under the Securities Act of 1933, butexemptions from such registration requirements may be available. Gexa may havea contingent liability to the stockholders of Gexa Gold arising out of apossible violation of Section 5 of the Securities Act of 1933 inconnection with the issuance of these unregistered shares if such exemptionsare not available. As Gexa Gold common stock has no value and was not traded atthe time of the issuance of the Gexa stock in 2001, Gexa does not believe theGexa Gold stockholders have any measurable or recoverable damages relating tothese possible claims. The statute of limitations may also limit the ability ofsome stockholders to bring any such claims. Additionally, the SEC could bringcivil penalties against Gexa for Gexa Gold’s failure to file required reportsand the failure to comply with SEC Rules relating to the merger of Gexa andGexa Gold, which actions could include monetary penalties and otheradministrative remedies. If any such claims are asserted, we intend to contestthe matter vigorously.

 

***DEPENDENCE ONKEY PERSONNEL***

 

                Weare substantially dependent upon the continued services of our presentmanagement, including Neil M. Leibman, our Chairman and CEO. To the extent thatMr. Leibman’s services become unavailable, we will be required to retainother qualified personnel. We are currently conducting a search for a newPresident and COO to replace James A. Burke, who resigned effectiveOctober 1, 2004. There can be no assurance that we will be able to recruitand hire a COO or other qualified persons under acceptable terms.

 

***WE ARESUBSTANTIALLY CONTROLLED BY OUR CHAIRMAN AND CHIEF EXECUTIVE OFFICER***

 

                OurChairman and Chief Executive Officer, Neil M. Leibman, beneficially owns orcontrols shares of our common stock and other convertible securitiesrepresenting approximately 36.3% of the issued and outstanding shares of ourcommon stock. As a result, Mr. Leibman has the ability to exercisesubstantial control over our affairs and corporate actions requiringshareholder approval, including electing directors, a merger, or selling all orsubstantially all of our assets. Control by Mr. Leibman could delay, deteror prevent a change in control and could adversely affect the price thatinvestors might be willing to pay in the future for our securities.

 

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***STATE BLUE SKYREGISTRATION; POTENTIAL LIMITATIONS ON RESALE OF THE SECURITIES***

 

                Becauseour common stock has not been registered for resale under the Act or the “bluesky” laws of any state, the holders of such shares and persons who desire topurchase them in any trading market that might develop in the future, should beaware that there may be significant state blue-sky law restrictions upon theability of investors to resell our securities. Accordingly, investors shouldconsider the secondary market for our securities to be a limited one.

 

                Weintend to seek coverage and publication of information regarding the Company inan accepted publication manual which permits a manual exemption. The manualexemption permits a security to be distributed in a particular state withoutbeing registered if the issuer of that security has a listing for that securityin a securities manual recognized by the state. However, it is not enough forthe security to be listed in a recognized manual. The listing entry mustcontain (1) the names of issuers, officers, and directors, (2) anissuer’s balance sheet and (3) a profit and loss statement for either thefiscal year preceding the balance sheet or for the most recent fiscal year ofoperations. Furthermore, the manual exemption is a non-issuer exemptionrestricted to secondary trading transactions, making it unavailable for issuersselling newly issued securities.

 

                Mostof the accepted manuals are those published in Standard and Poor’s, Moody’sInvestor Service, Fitch’s Investment Service, and Best’s Insurance Reports, andmany states expressly recognize these manuals. A smaller number of statesdeclare that they “recognize securities manuals” but do not specify therecognized manuals. The following states do not have any provisions andtherefore do not expressly recognize the manual exemption: Alabama, California,Georgia, Illinois, Kentucky, Louisiana, Montana, South Dakota, Tennessee,Vermont and Wisconsin.

 

***POTENTIALREQUIREMENT TO COMPLY WITH PENNY STOCK RULES***

 

                Oursecurities are considered “penny stocks” as defined in the Exchange Act and therules thereunder, to the extent the price of shares of our common stock is lessthan $5.00. Unless our common stock is otherwise excluded from the definitionof “penny stock,” the penny stock rules apply with respect to that particularsecurity. The penny stock rules require a broker-dealer prior to atransaction in penny stock not otherwise exempt from the rules, to deliver astandardized risk disclosure document prepared by the SEC that providesinformation about penny stocks and the nature and level of risks in the pennystock market. The broker-dealer also must provide the customer withcurrent bid and offer quotations for the penny stock, the compensation of thebroker-dealer and its sales person in the transaction, and monthlyaccount statements showing the market value of each penny stock held in thecustomer’s account. In addition, the penny stock rules require that the broker-dealer,not otherwise exempt from such rules, must make a special written determinationthat the penny stock is suitable for the purchaser and receive the purchaser’swritten agreement to the transaction. These disclosure rules have the effect ofreducing the

 

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level of trading activity in the secondary market for astock that becomes subject to the penny stock rules. So long as our commonstock is subject to the penny stock rules, it may become more difficult to sellsuch securities. Such requirements, if applicable, would result in a reductionin the level of trading activity for our common stock and would make it moredifficult for investors to sell shares of our common stock.

 

***LITIGATIONRISKS***

 

                Wecurrently are involved in various litigation matters which are described hereinin the section entitled “Legal Proceedings”. Any such claim or any futureclaims, regardless of merit:

 

•                        is timeconsuming and costly to defend and may harm our reputation;

 

•                        divertsmanagement’s attention and resources; and

 

•                        if resolvedadversely against us, could require the payment of monetary damages.

 

                Anyof these consequences could impair our financial condition and adversely affectour ability to conduct our business.

 

***POTENTIALNEGATIVE EFFECT ON OUR STOCK PRICE RELATED TO SHARES ELIGIBLE FOR FUTURE SALE***

 

                The issuance of asignificant number of shares of common stock upon the exercise of stock optionsand warrants, or the availability for sale or sale of a substantial number ofthe shares of common stock eligible for future sale under effectiveregistration statements, Rule 144 or otherwise, could adversely affect themarket price of the common stock.  Wehave reserved approximately 3.6 million shares of common stock for issuanceunder outstanding options and warrants, of which 2.4 million are registered forresale on currently effective registration statements. Further, we are aware that (1) affiliates of Corsair Capital Management,LLC currently hold 1,176,008 shares of our common stock and currentlyexercisable options to purchase an additional 105,000 shares of our commonstock and (2) affiliates of Perry Corp. currently hold 950,000 shares of ourcommon stock, all of which shares have been registered for resale under theSecurities Act and are available for sales in the market withoutrestriction.  In addition, an additional3,812,432 shares beneficially held by Neil M. Leibman, our Chairman and ChiefExecutive Officer, will become eligible for resale under Rule 144, subjectto limitations on Mr. Leibman as an “affiliate” of the Company, upon theexpiration of his lock-up agreement with Oppenheimer & Co. Inc.,which expires on the later of 180 days after closing of the Oppenheimerfinancing (November 23, 2004) or 90 days after the effectiveness of ourregistration on Form S-1 (No. 333-121548) (which went effective on March 7,2005).

 

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**AVAILABLE INFORMATION**

                We will makeavailable our annual report on Form 10-K, our quarterly reports on Form 10-Q,our current reports on Form 8-K, and amendments to those reports, filed orfurnished pursuant to Section 13(a) or 15(d) of the Securities ExchangeAct of 1934, free of charge through our Internet website at www.gexaenergy.comas soon as reasonably practicable after we electronically file such materialwith, or furnish it to, the Securities and Exchange Commission.

 

                Theinformation contained on our website is not incorporated by reference into thisForm 10-K and should not be considered to be a part of this Form 10-K.

 

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ITEM 2. PROPERTIES

                Our offices are presently located at 20 GreenwayPlaza, Suite 600, Houston, Texas  77002.The office facility consists of approximately 27,000 square feet of officespace under lease through January 2011. We remain liable for monthly rent obligations under the lease for ourold office space at 24 Greenway Plaza, but, during the third quarter of 2004, weentered into a sublease agreement for the old office space whereby the subleasetenant, Consultants Choice Inc., pays approximately 40% of our monthly rentalobligation.

ITEM3. LEGAL PROCEEDINGS

                During 2003, we were sued in the matter of KyleHolland vs. Gexa Corp. et al. in the United States District Court, WesternDistrict of Texas. Mr. Holland alleged damages in connection with hisacquisition of our common stock.  Thecomplaint seeks unspecified damages.  OnMarch 15, 2005, this case was dismissed without prejudice for failure to statea claim.  While this lawsuit could berefiled at a later date, we believe the lawsuit has no merit and willvigorously defend any such refiled action.

                On July 15, 2004, a class action lawsuitFrederick T. Pappey, et al. vs. Gexa Corp., Neil Leibman, Marcie Zlotnik andSarah Veach, Civil Action No. H-04-2869, was filed in the United StatesDistrict Court for the Southern District of Texas, Houston District. Thecomplaint alleges, among other things, that our publicly filed reports andpublic statements contained false and misleading information, which resulted indamages to the plaintiff and members of the proposed class when they purchasedour securities. Specifically, the complaint alleges that we overstated revenueduring the second and third quarters of 2003 by $2.07 million and$2.05 million, respectively, by utilizing an improper accounting methodfor calculating sales of electric power. The complaint alleges that our conductand the conduct of the other defendants violated Sections 10(b) and 10b-5 andthat the individual defendants violated Section 20(a) of the SecuritiesExchange Act of 1934. The complaint seeks unspecified damages. OnDecember 20, 2004, the lawsuit was dismissed without prejudice. While thislawsuit could be refiled at a later date, we believe the lawsuit has no meritand will vigorously defend any such refiled action.

                OnNovember 30, 2004, we entered into a settlement with Capello Capital Corp.(“Capello”) relating to the matter of Capello Capital Corp. vs. Gexa Corp,originally filed in the Los Angeles Superior Court-West District. Capello’scomplaint had alleged a breach of contract regarding investment banker feesbeing claimed by Capello in connection with the credit facility withHighbridge/Zwirn Special Opportunities Fund, L.P. In exchange for Capello’sagreement to dismiss the lawsuit and release its claims against us, we agreedto: (i) pay Capello $275,000, (ii) issue to Capello warrants datedNovember 1, 2004, to purchase 400,000 shares of our common stock at anexercise price of $4.50 per share and (iii) issue to Capello an interestfree unsecured promissory note in the principal amount of $500,000. We accrued$1.2 million in the third quarter of 2004 in investment banking charges toother assets as deferred financing cost to be amortized over the life of theHighbridge facility.

 

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                On December 2, 2004, we weresued in the matter of Essential Utilities Corporation v. Gexa Energy Corp., CauseNo. 04-12056, in the 191st District Court of Dallas County, Texas.  The petition alleges breach of contract,quantum meruit, conversion and unjust enrichment in connection with the allegednonpayment of consultation fees.  Theamount of the claim is unknown.  Thiscase is in the preliminary stages and we intend to contest this suitvigorously.

                On January 31, 2005, a lawsuit styled Griffin/JubanCapital Management, L.L.C. d/b/a GC Realty Services v. Gexa Corporation wasfiled in the 11th Judicial District Court of Harris County, Texas.  This lawsuit claims that we agreed to provideContinental Airlines frequent flyer miles to the plaintiff in turn for doingbusiness with us.  The plaintiff has suedus for breach of contract, fraud and negligent misrepresentation.  The amount of damages sought in the lawsuitis unknown.  This case is in thepreliminary stages and we intend to contest this suit vigorously.

                On or about February 11, 2005, we were made aware ofa potential lawsuit that may be filed by Prenova, Inc. and 24 Hour Fitness USA,Inc. against us and XERS, Inc. d/b/a XCEL Energy, Inc.  The proposed complaint claims that we failedto timely provide electrical service to 24 Hour Fitness and, as a result, theyincurred substantial damages in the form of significantly higher rates forseveral months in 2004.  The plaintiffsclaim damages in the amount of $150,000.00 plus interest and attorneys’fees.  If filed, we intend to contestthis suit vigorously.

                We are also involved in various receivable collectionsmatters as a plaintiff. We believe that thereare no pending matters that will have a significantimpact on our financial position or results of operations.

ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

                None.

 

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**PART II**

 

ITEM 5. MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES.

 

**Market Information**

                OnAugust 2, 2004, our common stock began trading on the Nasdaq SmallCap Marketunder the stock symbol GEXA. Prior to August 2, 2004, our common stock wastraded on the OTC:BB market under the symbol GEXC.OB. We believe that ourlisting on the Nasdaq SmallCap Market has provided us additional visibility andaccess to incremental investors and enhanced the liquidity of our common stock.

                The followinginformation presented in the table below shows the high and low bid prices forthe year ended December 31, 2003 and the high and low bid prices (prior toAugust 2, 2004) or sales prices (beginning August 2, 2004) for the year endedDecember 31, 2004 for our common stock as reported:
| ** **                  | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------|------------|----------|------------|---------|------------|
| **Fiscal Year 2003**        |       |     |       |    |       |
|                        |       |     |       |    |       |
| Quarter Ended March 31,     |       | $        | 1.90       |    | $          | 0.75 |   |
|                        |       |     |       |    |       |
| Quarter Ended June 30,      |       | $        | 1.90       |    | $          | 1.10 |   |
|                        |       |     |       |    |       |
| Quarter Ended September 30, |       | $        | 2.60       |    | $          | 1.45 |   |
|                        |       |     |       |    |       |
| Quarter Ended December 31,  |       | $        | 9.00       |    | $          | 2.10 |   |
|                        |       |     |       |    |       |
| **Fiscal Year 2004**        |       |     |       |    |       |
|                        |       |     |       |    |       |
| Quarter Ended March 31,     |       | $        | 8.50       |    | $          | 3.30 |   |
|                        |       |     |       |    |       |
| Quarter Ended June 30,      |       | $        | 6.60       |    | $          | 3.15 |   |
|                        |       |     |       |    |       |
| Quarter Ended September 30, |       | $        | 6.60       |    | $          | 4.30 |   |
|                        |       |     |       |    |       |
| Quarter Ended December 31,  |       | $        | 5.24       |    | $          | 4.05 |   |

**Holders of Common Stock**

                Asof March 23, 2005, we had approximately 2,400 holders of record of our commonstock.

 

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**Dividends**

                We have not paid any dividends on our common stock, and do not intend to pay dividends in the foreseeable future. We intendto retain earnings to finance the development and expansion of our business.Payment of dividends in the future will depend, among other things, on ourability to generate earnings, on our need for capital and on our overallfinancial condition. The potential for future dividend payments may also belimited by the terms of our credit agreements.

**Equity Compensation Plan Information**

                The information required by this item will be included in a definitive proxystatement, pursuant to Regulation 14A, to be filed not later than 120 daysafter December 31, 2004.  Suchinformation is incorporated herein by reference.

 

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ITEM 6. SELECTED FINANCIAL DATA

                The selected financial data inthe following table sets forth (a) consolidated balance sheet data as ofDecember 31, 2002, 2003 and 2004, and statement of operations data for thefiscal years ended December 31, 2002, 2003 and 2004 derived from ourconsolidated financial statements audited by Hein & Associates LLP,independent registered public accounting firm and (b) consolidated balancesheet data as of December 31, 2000 and 2001, and statement of operations datafor the fiscal years ended December 31, 2000 and 2001 derived from ourconsolidated financial statements audited by Grassano Accounting, P.A. Theinformation below should be read in conjunction with “Item 8. FinancialStatements and Supplementary Data” included elsewhere in this filing.
| **(in thousands except for per share data)**       | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2003** | ** ** | **Fiscal 2002** | ** ** | **Fiscal 2001** | ** ** | **Fiscal 2000** | ** ** |
|----------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| **Statement of Operations Data:**                  |       |            |       |            |       |            |       |            |       |            |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Sales                                              |       | $               | 273,894    |            | $          | 115,143         |       | $               | 19,039     |            | $          | — |   | $ | — |   |
| Cost of goods sold                                 |       | 238,206         |       | 99,697          |       | 14,589          |       | —          |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Gross profit                                       |       | 35,688          |       | 15,446          |       | 4,450           |       | —          |       | —          |       |
| Selling, general and administrative expenses       |       | 24,144          |       | 12,662          |       | 3,492           |       | 210             |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Income from operations                             |       | 11,544          |       | 2,784           |       | 958             |       | (210            | )          | —          |       |
| Interest income (expense), net                     |       | (2,078          | )          | (428            | )          | 13              |       | (1              | )          | —          |       |
| Gain on extinguishment of debt                     |       | 688             |       | —          |       | —          |       | —          |       | —          |       |
| Other financing income (expense)                   |       | 2,062           |       | (3,630          | )          | —          |       | —          |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Income (loss) before provision                     |       | 12,216          |       | (1,274          | )          | 971             |       | (211            | )          | —          |       |
| Provision for income taxes                         |       | 4,034           |       | 922             |       | 331             |       | —          |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Net income (loss)                                  |       | 8,182           |       | (2,196          | )          | 640             |       | (211            | )          | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Preferred stock dividend                           |       | —          |       | (167            | )          | (50             | )          | —          |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Net income (loss) available to common shareholders |       | $               | 8,182      |            | $          | (2,363          | )          | $               | 590        |            | $          | (211 | ) | $ | — |   |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Earnings (loss) per common share                   |       |            |       |            |       |            |       |            |       |            |       |
| Basic                                              |       | $               | 0.95       |            | $          | (0.31           | )          | $               | 0.08       |            | $          | (0.05 | ) | $ | — |   |
| Diluted                                            |       | 0.83            |       | (0.31           | )          | 0.07            |       | (0.05           | )          | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| Weighted-average shares outstanding:               |       |            |       |            |       |            |       |            |       |            |       |
| Basic                                              |       | 8,606           |       | 7,647           |       | 7,328           |       | 4,209           |       | —          |       |
| Diluted                                            |       | 9,835           |       | 7,647           |       | 8,402           |       | 4,209           |       | —          |       |
|                                               |       |            |       |            |       |            |       |            |       |            |       |
| **Consolidated Balance Sheet Data:**               |       |            |       |            |       |            |       |            |       |            |       |
| Working capital                                    |       | $               | 12,348     |            | $          | 7,763           |       | $               | 2,930      |            | $          | 364 |   | $ | — |   |
| Total assets                                       |       | 56,255          |       | 38,202          |       | 10,988          |       | 1,081           |       | —          |       |
| Shareholders’ equity                          |       | 16,410          |       | 2,129           |       | 3,347           |       | 759             |       | —          |       |

 

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**Recent Sales of UnregisteredSecurities**

                During the three months ended December 31, 2004, theCompany issued 18,050  shares of commonstock for services provided. The services were provided by Continental Airlinesfor the One Pass ® partner program where theCompany provides mileage to customers in exchange for payment by the Company toContinental of cash and Company common stock.

ITEM 7. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

**Overview**

                Gexa Corp(d/b/a Gexa Energy), located in Houston, Texas, is a retail electric provider(“REP”). As of December 31, 2004 we currently provide electric power to ourresidential and commercial customers in the deregulated Texas electricitymarket. In addition to the states in which we currently operate, we are alsolicensed to supply retail electricity power by applicable state agencies inMassachusetts and have submitted an application to be a retail provider ofelectricity in New York and Maine.

 

                InAugust 2001, the PUCT approved our license to become a REP in Texas. As aREP, we sell electric energy and provide the related billing, customer service,collection and remittance services to residential and under one megawattcommercial customers. We offer our customers the attractive value propositionof lower electricity rates, flexible payment and pricing choices, simple offerswith understandable terms and responsive customer service. In general, theTexas regulatory structure permits independent REPs (companies unaffiliatedwith an incumbent utility in a particular geographic area), such as Gexa, toprocure and sell electricity at unregulated prices and pay the local TDSPs a regulated tariff rate fordelivering electricity to the customers. We are currently one of the largestindependent REPs, not affiliated with a utility, operating in Texas thatfocuses on customers whose peak demand is under one megawatt (defined by theTexas Public Utility Commission as “price-to-beat” commercial customers), asmeasured by total megawatt hours sold and by meter count. We have grown to over104,000 total meters as of December 2004, continuing our pattern of basecustomer growth of 4-5% per month during 2004.

 

                Todate, we have focused our sales efforts on the under one megawatt commercialand the residential multi-family housing (apartment community) segments.We have also begun to deploy several low cost marketing strategies to furtherpenetrate the single-family residential market. Employing severalfirst-to-market, co-marketing partnerships with leading brands (e.g., ContinentalAirlines OnePass®, American Airlines AAdvantage® frequent flyer programs), weexpect to leverage the brand equity of these partners to provide access to newsingle-family residential customers without incurring large marketingexpenditures. As of December 31, 2004, the majority of our customers werelocated in the Houston and Dallas markets, although a growing number

 

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are located in a variety of othermetropolitan and rural areas in south and west Texas, such as Corpus Christiand Lubbock.

 

                Withrespect to energy supply, we utilize an agreement with TXU PM, for theprocurement of wholesale energy. We serve as our own “qualified schedulingentity” for open market purchases and sales of electricity. We forecast ourenergy demand and conduct procurement activities through an experienced team ofin-house professionals. The forecast for electricity load requirements is basedon our aggregate customer base currently served and anticipated weather conditions,as well as forecasted customer acquisition and attrition. We continuouslymonitor and update our supply positions based on our retail demand forecastsand market conditions. Our objective is to maintain a balanced supply/demand positionto limit commodity risk exposure. We do not currently use derivativeinstruments and we do not plan to engage in speculative trading of derivativeinstruments in the future, although we may use derivatives for hedging purposesin the future.

 

## **Business Strategy**

 

                Our businessstrategy can be summarized as follows:

 

•                                          establishmarketing relationships with multi-family property managers and owners tomarket our services on-site to residents while also providing power to thecommercial meters on-site;

 

•                                          use our insidedirect sales team, as well as a network of independent sales agents, to marketour service to commercial customers;

 

•                                          utilize strongbranded partners (e.g., Continental Airlines, American Airlines) to provideaccess to a potential expanded customer base, particularly single-familyresidential customers, by providing a strong affinity-based electricityoffering with other tangible benefits;

 

•                                          operate andfurther develop a cost-effective and efficient billing and customer serviceinfrastructure, utilizing a combination of internal resources and outsourcedpartners;

 

•                                          leverage ourcredit support and energy supply agreement with TXU to provide a cost-effectivesupply of electricity to meet our customers’ needs; and

 

•                                          evaluateopportunities to expand our business in the Texas marketplace and otherderegulated markets on an opportunistic basis.

 

                We intend toevaluate opportunities to expand our areas of operations in Texas as certainmarket regions in Texas elect to option-in to deregulation. In addition, thereare a

 

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number of small REPs within the Texas market,and we intend to monitor the activities of these REPs and to pursue andevaluate opportunities to acquire such REPs to the extent it would provide valueto us.

 

                Althoughour current service regions are all within the Texas market, we will alsocontinue to evaluate expansion opportunities in other deregulated electricitymarkets that offer growth potential in our core under one megawatt commercial,multi-family and single-family residential segments. Beyond Texas,17 other states and the District of Columbia are currently open to competitionin the U.S. with the majority of these in the Mid-Atlantic and Northeastregions. As of December 31, 2004, we are licensed to supply retail electricitypower by applicable state agencies in New York and Massachusetts and havesubmitted an application to be a retail provider of electricity in Maine.

 

                AtDecember 31, 2004, we had 122 full-time employees and 14 part time employeesand independent contractors. Our principal executive offices are located at 20Greenway Plaza, Suite 600, Houston, Texas 77046, and the telephone number is(713) 470-0400.

 

**Subsequent Events**

 

                OnMarch 28, 2005, the Company, and FPL Group, Inc., a Florida corporation (“FPLGroup”), announced the execution of an Agreement and Plan of Merger, dated asof March 28, 2005 (the “Merger Agreement”), by and among FRM Holdings, LLC, aDelaware limited liability company (“FRM Holdings”), WPRM Acquisition Subsidiary,Inc., a Texas corporation and a wholly owned subsidiary of Holdings (“MergerSub”), FPL Group and the Company, pursuant to which, subject to thesatisfaction or waiver of the conditions therein, Merger Sub will merge withand into the Company (the “Merger”).  Asa result of the Merger, the Company will become an indirect wholly ownedsubsidiary of FPL Group.  The Merger isintended to qualify as a tax-free reorganization under Section 368(a) of theInternal Revenue Code of 1986, as amended. Further information regarding the Merger is set forth in Note 19 to theCompany’s 2004 financial statements included herein under Item 8.  “Financial Statements and SupplementaryData”.

 

We have also recently undertaken certain changes inour disclosure controls and procedures in connection with a material weaknessletter we received from our independent auditors, Hein & Associates, LLP onMarch 25, 2005. Further information regarding these changes is set forth hereinin Item 9A. “Controls and Procedures—Changes to Disclosure Controls andProcedures.”

 

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**Results of Operations**
| ** **                                     | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2003** | ** ** | **Fiscal 2002** | ** ** |
|------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Sales                                          |       | $               | 273,894    |            | $          | 115,143         |       | $ | 19,039 |   |
| Cost of goods sold                             |       | 238,206         |       | 99,697          |       | 14,589          |       |
|                                           |       |            |       |            |       |            |       |
| Gross profit                                   |       | 35,688          |       | 15,446          |       | 4,450           |       |
|                                           |       |            |       |            |       |            |       |
| Selling, general & administrative expenses |       | 24,144          |       | 12,662          |       | 3,492           |       |
|                                           |       |            |       |            |       |            |       |
| Income from operations                         |       | $               | 11,544     |            | $          | 2,784           |       | $ | 958 |   |

Revenues

Operatingrevenue for the year ended December 31, 2004 was $273.9 million compared withoperating revenue of $115.1 million for the year ended December 31, 2003, anincrease of 138%. Revenues for 2004 rose as the result of increased consumerconfidence in the deregulated markets, increases in prices charged to customersas result of increased electricity cost, and the continued successful executionof our marketing strategy as outlined above. The majority of our revenues comefrom the flow of electricity to customers. However, we also generate revenues from“pass through of TDSP charges”, a standard base charge to each customer,contract cancellation fees, disconnection fees, and late fees.

 

Inaddition, during 2004 our marketing department contracted with multi-familycommunities to secure their corporately paid meters, and also to gain access tocurrent and future residents through direct marketing at the leasing offices.These sales provided us with a large number of customers at low costs ofacquisition. As of December 31, 2004, we have marketing agreements with over600 apartment communities as compared with approximately 500 at December 31,2003.

 

During 2004, we focused ongrowing our internal sales force and developing stronger business relationshipswith our large “name brand” accounts. We rely on internal innovation along withstrategic alliances and acquisitions to provide innovative products to enhanceour competitive position. We have plans to expand our internal sales forceduring 2005, primarily to focus on our value added service offerings. Thisexpansion will enable us to penetrate new markets and to cost effectivelyexpand our presence throughout Texas.

 

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Costof Goods Sold

 

Cost of goods sold, which is recognized concurrently withrelated energy sales, primarily includes the aggregated cost of purchasedelectric power and fees incurred from TDSP’s. Our cost of goods sold increasedto $238.2 million for the year ended December 31, 2004, an increase of $138.5million, or 139%, from $99.7 million for the year ended December 31, 2003. Thesignificant increase in cost of goods sold is primarily a result of thefollowing:

 

•                                          increase in cost per retail “kWh” delivered, which occurred primarily as aresult of increase natural gas costs which are a significant factor influencingelectricity costs; and

 

•                                          increase in our customer base.

 

Gross Profits

 
| ** **          | ** ** | **Year Ended**        | ** ** |
|---------------------|------------|-----------------------|------------|
| ** **          | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|                |       |                  |       |   |   |
| Sales               |       | $                     | 273,894    |   | $ | 115,143 |   |
| Cost of goods  sold |       | 238,206               |       | 99,697 |   |
|                |       |                  |       |   |   |
| Gross profit        |       | 35,688                |       | 15,446 |   |
|                |       |                  |       |   |   |
| Gross Profit %      |       | 13.0                  | %          | 13.4 | % |
|                     |            |                       |            |  |  |  |  |

 

Gross profit wasapproximately $35.7 million or 13.0% of sales for the year ended December 31,2004, compared with approximately $15.4 million or 13.4% of sales for the yearended December 31, 2003.

 

Our gross profitincreased over the prior year by $20.2 million. While larger sales volumes increased our gross profit over the prioryear, our gross profit percentage for the year decreased.  The major factors that may impact grossprofit percentage include:

 

•                                          Customer mix: Due to competitive market forces,pricing for commercial contracts typically yield lower margins per kwh thanpricing for residential contracts. Despite typically lower margins forcommercial accounts, we believe the administrative costs (as a percentage ofsales) for commercial accounts are significantly lower than for single andmulti-family customers, and commercial accounts provide attractive profitopportunities. In general, when commercial accounts increase as a percentage ofour portfolio, our overall gross profit per kwh will decrease.

 

•                                          Cost of electricity supply purchases: The price ofnatural gas is the primary driver of our electricity supply cost.  We attempt to mitigate our exposure to pricevolatility by matching, as accurately as possible, power purchases to expecteddemand.  For term customers, we generallypurchase electricity supply to match the length of the customer’scontract.  Single and multi-familycustomers are on the equivalent of month-to-month contracts, for which wepurchase electricity on month-ahead and day-ahead contracts.  In an environment of rapidly rising naturalgas prices, we are unlikely to raise our month-to-month customers’ prices asquickly as our cost increases.  Thisfactor was the main driver for the decrease in our gross profit percentage forthe year ended December 31, 2004.

 

•                                          Competitive pricing: As a REP operating in thederegulated retail electricity market in Texas, part of our strategy is tooffer electricity rates at a discount to the affiliated REPs “price-to-beat”rates. While this strategy has led to significant growth in our customer base,it can cause our margins to decrease during periods of rising supply costs if“price-to-beat” rates are not increased. During the third quarter of 2004, the “price-to-beat” rates did notincrease with the supply costs for every market we serve, limiting our abilityto raise rates in those markets.

 

•                                          Weather Impact: We purchase supply based on ourcustomers’ forecasted use, historical use throughout the term of theircontracts and normalized temperatures. During 2004, we experienced mildersummer weather which resulted in instances of us having to sell excesspurchased electricity into the balancing market at prices lower then we paid.

 

Generaland Administrative Expenses

 

Selling,general and administrative expenses as of December 31, 2004 were $24.1 millioncompared with selling, general and administrative expenses of $12.7 million asof December 31, 2003, an increase of 91%.

 
| **(In thousands)** | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------|------------|------------|-----------------------|------------|-----------------------|------------|
| Billing fees       |       | $          | 1,891                 |       | $                     | 1,432      |   |
| Sales commissions  |       | 4,573      |                  | 1,925      |                  |
| Bad debt           |       | 7,052      |                  | 3,912      |                  |
| Salaries and other |       | 10,628     |                  | 5,393      |                  |
|               |       |       |                  |       |                  |
| Total              |       | $          | 24,144                |       | $                     | 12,662     |   |

 

                Billing fees are primarilycosts paid to third party EDI providers to handle transactions between us,ERCOT and the TDSPs in order to produce customer bills. Billing fees increasedto $1.9 million for the year ended December 31, 2004, an increase of $459,000,or 32% from $1.4 million for the year ended December 31, 2003. Billing feeshave increased at a slower rate than customer growth due to economies of scaleand reduction of rates charged by third party EDI providers.

 

                Sales commissions are fees paid to employees andexternal contractors for new customer acquisition. Sales commissions increasedto $4.6 million for the year ended December 31, 2004, an increase of $2.6million, or 138%, from $1.9 million for the year ended December 31, 2003. Salescommissions are primarily paid in three ways:

 

•                                          one-time payment upon collection of the first month’s bill from thecustomer;

 

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•                                          residual ongoing payments as a percentage of the customers’ bill or anamount per “kWh” delivered to the customer;

•                                          payments to Continental and American Airlines based on miles earned by thecustomer

 

                The increase in sales commissions for 2004 isprimarily the result of customer growth, an increase in new commercial customerswhich have a higher acquisition cost, and additional commissions incurred in2004 related to the Continental and American Airlines partner programs.

 

                Bad debt expense increasedto $7.1 million for the year ended December 31, 2004, an increase of $3.1million, or 81%, from $3.9 million for the year ended December 31, 2003. Baddebt expense as a percentage of total revenue decreased to 2.6% for the yearended December 31, 2004, from 3.4% for the year ended December 31, 2003. Baddebt expense has improved as a result of the implementation of late fees,improved collection procedures, improved credit check processes and theaddition of disconnect rights which were granted by the PUCT during 2004.

 

                Salaries and other increased to $10.6 million for theyear ended December 31, 2004, an increase of $5.2 million, or 97% from $5.4million for the year ended December 31, 2003. The primary increases in salariesand other are as follows:

 

•                                          salaries of $2.2 million;

•                                          bank fees of $0.8 million;

•                                          professional fees of $0.9 million;

•                                          telephone, rent and other office expenses of $0.6 million

                Salaries expense has increased significantly during2004 as a result of normal staff additions to accommodate growth and, asnecessary, to improve our system of internal controls as discussed in *Item 9A. Controls and Procedures*. The positions added duringthe year ended December 31, 2004 include Chief Financial Officer, CorporateController, Manager of Financial Reporting, Manager of Human Resources,Director of Operations, Manager of Transaction Processing, several customerservice representatives, and a significant number of information technologyresources related to our relocating the GEMS billing system from Atlanta,Georgia to Houston, Texas. Although salaries expense has significantlyincreased during 2004, we anticipate that the overall rate of increase will belower than the overall sales growth rate.

 

                Bank fees primarily related to fees paid for customerlockbox processing and credit card processing fees. Credit card processing feesincreased specifically due to the fact that during 2004, we began offeringcustomers the alternative of paying their bill with a credit card on arecurring basis.  These costs increasedin line with our customer growth. Professional fees increased primarily as aresult of legal and accounting fees

 

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related to thestrengthening of our internal controls. Telephone, rent and other officeexpenses primarily increased as a result of the relocation of our corporateoffices in 2004 and an upgrade of the customer service phone system.

 

Otherfinancing income (net of expense)

 

                On July 16, 2003,warrants to acquire 550,000 shares of common stock were granted to The CatalystFund Ltd. and certain other affiliates in consideration of a term loan. Thesewarrants contained a put feature allowing the holders to exercise the warrantsat a $1.00 per share exercise price, and then force us to repurchase them atmarket value upon the occurrence of certain events. In accordance with SFAS No.150, the warrants were initially recorded as a discount to debt based on the closingprice of our common stock on the date of issuance ($1.90) minus the exerciseprice, multiplied by the number of warrants, or approximately $0.5 million. Ateach balance sheet date, any change in the closing price of our common stockmust be used to calculate and record financing expense or income amount toreflect the difference on that date between the market price of our stock andthe exercise price of the warrants.

 

                On July 8, 2004, 458,333 ofthese warrants were repurchased and the remaining 91,667 warrants were amendedto delete the put option. At July 8, 2004, our stock closed at $4.75 per share.The decrease in the market price from the valuation at December 31, 2003 basedon the closing price of $8.50 per share, on December 31, 2003, required us torecord a decrease in the value of the puttable warrant obligation of $2.1million for the year ended December 31, 2004 as other financing income inaccordance with SFAS No. 150.  An additional $0.7 million in gain onextinguishment of debt was recorded during 2004. We also recorded $0.6 millionof write-off of deferred financing cost and $0.3 million of transaction fees tointerest expense during fiscal 2004, as a result of the extinguishment of thedebt.  As a result of the repurchase and amendment of warrants the ongoingincome (expense) effect arising from the put option, as described above, willno longer be applicable.

 

**2003**

**Year Ended December 31, 2003 Compared to YearEnded December 31, 2002**

Revenues

Operatingrevenue increased $96.1 million, or 505%, to $115.1 in 2003, as compared to2002. Revenue for 2003 rose as the result of increased consumer confidence inthe deregulated markets and the continued successful execution of our marketingstrategy outlined above. Other revenues in fiscal year 2003 includedapproximately $670,000 related to fees from early cancellation of contracts andlate fees in accordance with our agreements with commercial customers. Aportion of these fees was offset by refunds due to customers on sales taxes based on an opinion letter issued bythe Texas State Comptroller’s office declaring that certain meters billed tocommercial entities for

 

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multi-family dwellingsshould be taxed as residential meters instead of commercial meters.

 

Inaddition, in 2003 our marketing department contracted with multi-familycommunities to secure their corporately paid meters, and also to gain access tocurrent and future residents through direct marketing at the leasing offices.These sales provided us with a large number of customers at low costs ofacquisition. As of December 31, 2003, we have marketing agreements with over500 apartment communities as compared with approximately 350 at December 31,2002.

 

In 2003,our in house sales department focused their efforts on expanding our base ofsmall commercial clients providing us a wide range of customers from smallbusinesses to medium-sized office towers. Additionally, an inbound salesdepartment was established to sign up customers who contacted us to requesttheir service be switched. During 2003, we also effectively utilized a largenetwork of independent sales agents who provided us with an opportunity toreach customers without incurring large fixed costs.  These independent sales agents have broughtus a very broad and diverse group of customers in all our existing marketsranging from multi-family residents to commercial contracts.

Cost of Goods Sold

Costs ofgoods sold increased $85.1 million, or 583%, to $99.7 million in fiscal year2003, as compared to fiscal year 2002. Costs of goods sold are composed largelyof electricity supply purchases and the energy delivery charges we pay to theTDSPs. Two factors in 2003 have driven the increase of costs of goods sold at arate greater than operating revenues for the year. First, as we acquired morecommercial accounts as a percentage of our overall portfolio, our margins on aweighted average basis compressed.  Thistrend is more pronounced as the customer accounts approach one megawatt insize.  These commercial accounts, whilestill attractive from a profit perspective, do have lower per kWh margins thanresidential accounts. Second, during the three months ended March 31, 2003,there was an unexpected volatile price swing in the natural gas market which isthe primary determinant of electricity prices. This unexpected price increaseoccurred over a three day period at the end of February 2003. As a result, openmarket electricity prices increased substantially along with average committedelectricity volumes related to our daily customer usage. The result of thisunexpected price volatility was a reported net loss for the three months endedMarch 31, 2003, and a negative impact of approximately $700,000 on the costs ofgoods sold for 2003.

Generaland Administrative Expenses

 

Generaland administrative expenses increased $9.2 million, or 263%, to $12.7 millionin fiscal year 2003, as compared to fiscal year 2002. Since we grewsignificantly in 2002 and 2003, there were economies of scale achieved as wegrew and also further improved our business processes and information systems.The most significant components of general and administrative costs in 2003were bad debt expense, salaries

 

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expense, sales commissionsand billing fees. In 2003, bad debt expense was largely attributable toresidential services, and was addressed with the assessment of late fee chargesin accordance with the terms of customer contracts, collections procedures, andimproved credit check processes in the latter part of 2003 leading into 2004.Additionally, in 2004 the PUCT began allowing competitive retailers, includingGexa, to disconnect the services of customers who fail to pay their bills in atimely manner. Together, these factors are expected to greatly improvedelinquent receivables collection for all competitive REPs, for whom bad debtexposure has been an important concern.

 

Salaries for 2003 included severance expenses relatedto the resignation of the former President, Marcie C. Zlotnik, from heroperational and board positions within the Company. In the fourth quarter of2003, three months severance pay totaling $50,250 was accrued as a severanceexpense, as was a $718,075 non cash severance expense reflecting a fairvaluation of options (using the Black-Scholes model) that were amended andreinstated on the conclusion of Ms. Zlotnik’s employment. Salary expenseincreased in 2004 not only as a result of normal staff additions to accommodategrowth, but also the hiring of new employees in executive and middle managementroles, specifically in the accounting function as necessary to improve ouraccounting systems and controls as discussed below in “Item 9A.- Controls andProcedures.”

 

Otherfinancing expense

 

On July 16, 2003, 550,000 warrants were granted tothe Catalyst Fund Ltd. in consideration of a term loan. These warrantscontained a put feature allowing the holder to exercise the warrants at a $1.00per share exercise price, and then force us to repurchase them at market value upon theoccurrence of certain events. In accordancewith SFAS No. 150, the warrants were initially recorded as a discount to debtbased on the close price of the Company’s common stock on the date of issuance($1.90) minus the exercise price, multiplied by the number of warrants, or$495,000. At each balance sheet date, any change in the close price of thecommon stock must be used to calculate and record an interest expense or incomeamount to reflect the difference on that date between the market price of ourstock and the exercise price of the warrants.

At December 31, 2003, our stock closed at $8.50 pershare. This increase in the market price over the initial valuation of $495,000required us to record an increase in the value of the puttable warrantobligation of $3,630,000 for the year ended December 31, 2003 as otherfinancing expense in accordance with SFAS No. 150.

**Liquidity and Capital Resources**

 

In this section, we discussthe principal sources of capital required for us to operate our business.  We also identify known trends, demands,commitments, events or uncertainties which may affect our current and futureliquidity or capital resources.  Ourprincipal sources of liquidity and capital resources are cash from operations,private equity placements, revolving credit lines, and payment terms fromsuppliers and term loan debt.

 

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Working capital (current assets less current liabilities) increased to$12.3 million at December 31, 2004 from $7.8 million at December 31, 2003. Theprimary components of the increase are:

•                                          increase incurrent assets of $14.9 million. This increase is primarily a result of anincrease in customer accounts receivable, net of the allowance for bad debt, of$13.3 million. This increase is due primarily to customer growth; there hasbeen an increase to 104,000 meters as of December 31, 2004 compared with 62,000meters as of December 31, 2003.

•                                          increase incurrent liabilities of $10.3 million. The primary increases are as follows:

•                                          accrued TDSPcharges increased by $3.6 million due to customer growth.

•                                          customerdeposits increased by $2.7 million due to customer growth.

•                                          taxes Payable,including federal income tax, state franchise tax and sales tax, increased by$3.9 million due to increased profitability.

Our use of capital is primarily driven by working capital needed tooperate as a REP. We experience a time delay between purchasing electricity toflow to customers and receiving payments from our customers. This workingcapital cycle is impacted by seasonality and customer count growth rates.  In 2004, our average days sales outstandingwas approximately 46 days when considering both the billed and unbilled receivablesconcurrently.

Seasonality impacts our working capital needs, as the hotter summermonths (driven by air conditioning) increase our electricity needs during thesecond and third quarters, and commensurately reduces those needs in the firstand fourth quarters. With respect to customer growth rates, our constantaddition of customers drives an increasing need for working capital funding forelectricity purchases. Over time, should our growth rate level off, we wouldanticipate funding working capital from cash reserves on hand. However, givenour growth rates, we have continued needs for additional sources of workingcapital financing to purchase electricity and expand our operations. Inaddition to working capital, we spend capital for investments in operationalinfrastructure to serve our customers; however this amount is relatively minorcompared to the working capital required for electricity purchases.

Our largest cost inconducting business is the purchase of electricity. Our agreement with TXU PMprovides both a source of electricity supply and vendor financing. Pursuant to our agreement with TXU PM, payments to TXU PM for monthlyelectricity purchases are made on the last business day of the month followingdelivery.

 

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Since our term commercial customer contractsgenerally have durations of one and two year terms, we endeavor to match termsupply purchases to term customers obligations. We purchase electricity fromTXU PM and from third parties based on our forecast of customer demand andmonthly purchase limits imposed by TXU PM. Additionally, TXU PM reserves theright to review the credit-worthiness of all customers with peak demand of atleast one megawatt. We pay a monthly credit fee to TXU PM based on our monthlyelectricity purchases from TXU PM, as well as small, fixed monthlyadministrative fees. TXU PM also provides credit guarantees to us to enable usto purchase electricity from third parties, in return for a monthly fee. Theagreement has an initial term of five years, expiring in April 2008, and renewsthereafter on a year-to-year basis unless either party gives notice oftermination.

Purchasing this electricity exposes the wholesale electricity providerto credit risk that may exist due to any payment risk. Accordingly, TXU PM hasthree sources of security from us to support this agreement. First, TXU PM hasa first lien on all of our assets. Second, our customer receipts are managedthrough a lockbox arrangement controlled by TXU PM. Under the lockboxarrangement, certain cost of goods sold items and TXU PM’s monthly wholesaleelectricity invoice are paid during each month with us receiving any remainingfunds to be used for operating expenses. TXU PM must approve all disbursementsfrom our lockbox. Third, we are required to post a cash collateralized letterof credit in an amount determined by TXU PM pursuant to the agreement betweenus and TXU PM.

The TXU PM agreement alsohas a monthly limit for megawatt hours, which has been flexible to enable us tocontinue to grow and handle the higher seasonal summer volumes.  Thecurrent monthly limit for megawatt hours is 400,000 per month. Due to ourcontinued growth, we anticipate that we will reach that cap as we approach thesummer months of 2005, and will need to increase it to continue ourgrowth.  There is no guarantee that TXU PM will increase this limit but wewere in this same position as we approached the summer months in 2004 and TXUgranted us the increase after discussion between TXU personnel and ourmanagement. As of December 31, 2004 we had $3.3 million posted as a fullycash-collateralized letter of credit to TXU PM. Under the current TXU PM agreement, we anticipate needing to post a cashcollateralized letter of credit of approximately $8 million for power purchasesthis summer. We may require additional financing to collateralize and postthis letter of credit. These funds add to the working capital requirements ofour business and pose liquidity limitations to our growth.  Without havingan investment grade credit rating, we anticipate that we will continue toeither increase our limits with TXU PM or use availability under our creditagreement with Highbridge/Zwirn Opportunities Fund, L.P.

It is our policy to match, as accurately as possible, power purchasesto expected customer demand.  For powerpurchases, we use a combination of long term contracts, short term contracts,month-ahead purchases, and day-ahead purchases to match up with forecasteddemand of our commercial customers on long term sales contracts, commercialcustomers on month-to-month contracts, and residential customers (which are allon month-to month contracts). Our sales force determines their pricing quotesto potential customers on our minimum margin targets, ensuring better integrity of ourcash

 

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flow from continuedoperations. As of December 31, 2004, we have committed to future power purchasecontracts with TXU PM totaling $86.7 million in 2005 and $17.8 million in 2006.

All ourfuture obligations as of December 31, 2004 for the next five years aresummarized as follows:
| **(In thousands)**           | ** ** | ** ** | **Payments due by period** | ** ** |
|------------------------------|------------|------------|----------------------------|------------|
| **Contractual  Obligations** | ** ** | ** ** | **Total**                  | ** ** | **Less  than 1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More  than 5 years** |   |
| Forward power  contracts     | ** ** | $          | 104,486                    |       | $ | 86,698 |   | $ | 17,788 |   | $ | — |   | $ | — |   |
| Long-term debt               |       | —     |                       | —     |   | — |   | — |   | — |   |
| Rent                         |       | 2,330      |                       | 383        |   | 766 |   | 766 |   | 415 |   |
|                         |       |       |                       |       |   |   |   |   |   |   |   |
| Total                        | ** ** | $          | 106,816                    |       | $ | 87,081 |   | $ | 18,554 |   | $ | 766 |   | $ | 415 |   |

 

                Demand forelectrical power is continually influenced, by both seasonal and abnormalweather patterns. To the extent that one or more of our markets experiences aperiod of unexpected weather, we may be required to either attempt to procureadditional electricity to service our customers or to sell surplus electricityin the open market.

 

                We believe our growth will continue in the Texasmarket for 2005 but not as rapidly as during 2004. We also plan to continue toevaluate opportunities to enter additional markets. We have begun servingcommercial customers in Massachusetts and plan to offer service in New Yorkeffective May, 2005, subject to regulatory approval. We have also submitted anapplication to become a REP in Maine as of the date of this report. As we continue to assess new deregulated markets in other states, our growthwithin the Texas market takes precedence.

                Thecapital demands of our rapid growth and/or severe seasonality will likelyimpact our cash flow and require us to use availability under our creditarrangements periodically during 2005. We may also continue to raise additional funds from the sale of equityor debt securities or other borrowings.

                Asof December 31, 2004, we had deposited approximately $5.8 million with JPMorgan Chase Bank to obtain letters of credit allowing us to purchase power onforward contracts from TXU PM, buy and sell power in the daily balancingmarkets and pay TDSP invoices for metering charges passed through to customerson thirty-five day terms. We believe that we have sufficient liquidity(described below) to support the letters of credit that may be required.

                Wehave several sources of liquidity to provide the increased level of workingcapital to support our growth in customer load and purchases of power and otherservices to support that customer growth:

•                                          Cash fromOperations: During the twelve months ended December 31, 2004, we generatedapproximately $2.8 million in cash from operations as

 

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comparedwith $8.3 million during the twelve months ended December 31, 2003. The primaryuse of cash during the twelve months ended December 31, 2004 was accountsreceivable of $13.3. Additionally, the December 2003 TXU invoice forelectricity purchases in the amount of $7.8 million was paid in January 2004.However, the December 2004 TXU invoice for electricity purchases was paid inDecember 2004. Therefore, 13 months of electricity was paid for with 2004 cashflows.

•                                          Highbridge/ZwirnSpecial Opportunities Fund, L.P. Credit Facility: On July 8, 2004, we enteredinto the facility with Highbridge/Zwirn Special Opportunities Fund, L.P. TheFacility, which matures on July 8, 2007, may be used to provide working capitalfor our normal routine operations and for providing a cash reserve tocollateralize letters of credit that we are required to post.  The Facility is secured by a lien onsubstantially all of our assets, subject to the liens already held on suchassets by TXU and/or JP Morgan Chase. For the twelve months ended December 31,2004, we were in compliance with all financial covenants under the creditagreement. *See Footnote 8 to our Financial Statements for theyear ended December 31, 2004 herein for a detailed description of the covenantsand restrictions under the facility.* As of December 31, 2004, we hadno amounts outstanding under the facility. We were able to fulfill our letterof credit requirements with TXU by using our cash from operations.

•                                          Equity:  During the twelve months ended December 31,2004, we raised approximately $0.7 million via private placement of 168,754shares of our common stock of $4.00 per share and approximately $0.2 millionthrough the exercise of warrants to acquire approximately 200,000 shares ofcommon stock by one of our directors. 100,000 shares were exercised at $1.25per share and the remaining 100,000 were exercised at $1.00 per share. We alsocompleted a private placement equity offering on November 23, 2004 withOppenheimer & Co. Inc. This private placement raised approximately $4.2million. These funds were used to support our continued operational expansions.

                We believe that cash flow plusthe advances from the Facility will provide the required liquidity to addressour current growth rate in the Texas market and allow us the flexibility tomove into additional markets if we decide to expand our business additionally.

 

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**Critical Accounting Policies**

Followingare critical accounting policies adopted by the Company for use in thepreparation of key material financial data.

**Normal Purchases and Sales Accounting**

**               **In fiscal 2004, we used a combination of long term contracts, short termcontracts, month-ahead purchases, and day-ahead purchases to match up withforecasted demand of our commercial customers on long term sales contracts,commercial customer on month-to-month contracts, and residential customers(which are all on month-to-month contracts). We apply the normal purchase, normal sale accounting treatment to ourforward purchase supply contracts and our customer sales contracts.Accordingly, we record revenue generated from our sales contracts as energy isdelivered.

**Revenue and CostRecognition**

We recordelectricity sales under the accrual method and these revenues are recognizedupon delivery of electricity to the customer’s meter. Electric services areaccrued based upon estimated deliveries to customers as tracked and recorded byERCOT multiplied by our average billing rate per kilowatt hour (“kWh”) ineffect at the time.

 

In November 2003, we changedour revenue estimation technique to one referred to as the “flow”technique.  In the latter half of 2003,we determined that the market was operating at a point of efficiency such thatit would be appropriate for us to begin accruing revenue based on ERCOTsettlements of power deliveries, and given the limitations of the billingstechnique, we chose to change to the flow technique.  In addition, by the end of the fiscal year2003, we had sufficient initial settlement and resettlement data from ERCOT toarrive at a reasonable estimate for 2003 revenues assuming that the flow methodhad been in place since January 1, 2003.

 

The flow technique ofrevenue calculation relies upon ERCOT settlement statements to determine theestimated revenue for a given month. Supply delivered to our customers for themonth, measured on a daily basis, provides the basis for revenues. ERCOTprovides net electricity delivered data in three time frames. Initial dailysettlements become available approximately 17 days after the day being settled.Approximately 45 days after the day being settled, a ‘resettlement’ is providedto adjust the initial settlement to the actual supply delivered based onsubsequent comparison of prior forecasts to actual meter reads processed. Afinal resettlement is provided approximately 180 days after power is delivered,marking the last routine****settlementadjustment to the power deliveries for that day.

 

Because flow data forresettlements and final resettlements are not available in sufficient time tobe booked to the appropriate period, the effect of such resettlements arebooked in the month in which the cost of goods sold (“COGS”) effect of thoseresettlements is realized. This allows for a proper matching of revenues withCOGS.

 

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Sales represent the total proceeds from energy sales,including pass through charges from the TDSPs billed to the customer at cost.COGS includes electric power purchased, and pass through charges from the TDSPsin the areas serviced by us. TDSP charges are costs for metering services andmaintenance of the electric grid. TDSP charges are established by regulation bythe PUCT.

 

The energy portion of ourcost of goods sold is comprised of two components: bilateral wholesale costsand balancing/ancillary costs.  These twocost components are incurred and recognized in different manners.

 

Bilateral wholesale costsare incurred through contractual arrangements with wholesale power suppliersfor firm delivery of power at a fixed volume and fixed price.  We are invoiced for these wholesale volumesat the end of each calendar month for the volumes purchased for delivery duringthe month, with payment due 30 days after the end of the month.

 

Balancing/ancillary costsare based on the customer load and are determined by ERCOT through a multiplestep settlement process. Balancing costs/revenues are related to thedifferential between supply provided by us through its bilateral wholesalesupply and the supply required to serve our customer load. We endeavor tominimize the amount of balancing/ancillary costs through our load forecastingand forward purchasing programs.

 

**UnbilledRevenue and Accounts Receivable**

At the endof each calendar month, revenue is accrued to unbilled receivables based on theestimated amount of power delivered to customers using the flow technique.  Unbilled revenue also includes accruals forestimated TDSP charges and monthly service charges applicable to the estimatedelectricity usage for the period.

All charges that werephysically billed to customers in the calendar month are recorded from theunbilled account to the customer receivables account.  Accountsreceivables are customer obligations billed at the conclusion of a month’selectricity usage and due within 16 to 30 days of the date of the invoice. Balancespast due are subject to a late fee that is assessed on that billing.

 

The large number ofcustomers and significant volume of transactions create a challenge to managereceivables as well as to estimate the account balances that ultimately willnot be paid by the customers (“bad debt write-offs”).  We use a variety of tools to estimate andprovide an accurate and adequate allowance for doubtful accounts reserve; the allowance for doubtful accounts is expensed eachmonth as a percentage of revenue based on the historical bad debt write-offtrends that will result from that month’s gross revenues. As of December 31,2004, 2003 and 2002, the Company’s bad debt expense was approximately $7.1million, or 2.6% of sales, $3.9 million, or 3.4% of sales and $679,000, or 3.6%of sales respectively.

 

51

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We follow a consistentprocess to determine which accounts should be written off and compare the totalactual write-offs to the estimated percentage of total revenue accrued andexpensed each month.  Past due accounts are regularly reviewed based onaging for possible removal from service, in-house or external collectionsefforts, or write-off.  For residentialcustomers and commercial customers with balances less than $700.00, with someminor exceptions, the total balance for all accounts with any portion of theirbalance over 60 days past due is considered to be uncollectible and is writtenoff, net of security deposits held for these accounts.  Delinquent commercial accounts with balancesgreater than $700.00 are reviewed individually by in-house collections, andpayment arrangements, removal from service and possible write-off of all or aportion of the receivable is determined on a case-by-case basis.

 

                Wehave initiated a variety of actions targeted to reduce the amount of bad debtthat we incur. The principal actions are as follows:

 

•                                          improvedpolicies requiring credit reviews, deposits, and late fees, and

 

•                                          implementingmore aggressive collection efforts including customer disconnections

 

AccountsReceivable contains billed receivables, unbilled receivables and theallowance for doubtful accounts as follows:

 
| **(In thousands)**              | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------|------------|------------|-----------------------|------------|-----------------------|------------|
| Billed receivables              |       | $          | 20,759                |       | $                     | 13,126     |   |
| Unbilled receivables            |       | 17,160     |                  | 10,313     |                  |
| Allowance for doubtful accounts |       | (2,433     | )                     | (1,300     | )                     |
|                            |       |       |                  |       |                  |
| Accounts receivable, net        |       | $          | 35,486                |       | $                     | 22,139     |   |

 

52

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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

                In fiscal 2004, we used a combination of longterm contracts, short term contracts, month-ahead purchases, and day-aheadpurchases to match up with forecasted demand of our commercial customers onlong term sales contracts, commercial customer on month-to-month contracts, andresidential customers (which are all on month-to-month contracts).  Weapply the normal purchase, normal sale accounting treatment to our forwardpurchase supply contracts. Accordingly, we record revenue generated from oursales contracts as energy is delivered to our retail customers, and directenergy costs are recorded when the energy under our long-term forward physicaldelivery contracts is delivered. During fiscal 2004, we did not use financialhedging, or derivative instruments to hedge our commodity risk and we do notplan to engage in uncovered or speculative trading of derivative instrustmentsin the future, although we may use derivatives for hedging purposesin the future. Additionally, we do not purchase power until we have locked inour respective customers for whom power will be supplied and purchased.

 

53

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ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

**INDEX TO FINANCIAL STATEMENTS**

 
| ** **                                                                                    | **Page** |
|-----------------------------------------------------------------------------------------------|----------|
| Report  of Independent Registered Public Accounting Firm                                      | 55       |
| Balance  Sheets as of December 31, 2004 and 2003                                              | 56       |
| Statements of Operations for  the Years Ended December 31, 2004, 2003 and 2002                | 57       |
| Statements of  Shareholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002 | 58       |
| Statements of Cash Flows for  the Years Ended December 31, 2004, 2003 and 2002                | 59       |
| Notes to  Financial Statements                                                                | 62       |

 

54

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

 

To the Board of Directors and Shareholders of GexaCorp., Houston, Texas:

 

We have audited the accompanying balance sheets ofGexa Corp. as of December 31, 2004 and 2003, and the related statements ofoperations, shareholders’ equity and cash flows for each of the three years inthe period ended December 31, 2004. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company has determined that it is not required to have, norwere we engaged to perform, an audit of its internal control over financialreporting. Our audit included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of GexaCorp. at December 31, 2004 and 2003, and the results of its operations and itscash flows for each of the three years in the period ended December 31, 2004 inconformity with U.S. generally accepted accounting principles.

 

 
| /s/ Hein  & Associates LLP |
|--------------------------------|
|                           |
| March 25, 2005                 |
| Houston, Texas                 |

 

55

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**GexaCorp.**

**BALANCE SHEETS**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                                                                   | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Assets                                                                                                                                                                                                                       |       |                  |       |                  |       |
| Current Assets:                                                                                                                                                                                                              |       |                  |       |                  |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                    |       | $                     | 8,862      |                  | $          | 10,829 |   |
| Cash - restricted                                                                                                                                                                                                            |       | 6,685                 |       | 3,613                 |       |
| Accounts receivable, net of allowance for doubtful accounts                                                                                                                                                                  |       | 35,486                |       | 22,139                |       |
| Deferred tax asset                                                                                                                                                                                                           |       | 841                   |       | 458                   |       |
| Other current assets                                                                                                                                                                                                         |       | 319                   |       | 270                   |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Total Current Assets                                                                                                                                                                                                         |       | 52,193                |       | 37,309                |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Property and equipment, net                                                                                                                                                                                                  |       | 1,195                 |       | 374                   |       |
| Deferred tax asset                                                                                                                                                                                                           |       | 45                    |       | 292                   |       |
| Other assets                                                                                                                                                                                                                 |       | 2,822                 |       | 227                   |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Total Assets                                                                                                                                                                                                                 |       | $                     | 56,255     |                  | $          | 38,202 |   |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Liabilities and Shareholders’ Equity                                                                                                                                                                                    |       |                  |       |                  |       |
| Current Liabilities:                                                                                                                                                                                                         |       |                  |       |                  |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Current portion of long-term debt                                                                                                                                                                                            |       | $                     | —     |                  | $          | 608 |   |
| Accrued electricity costs                                                                                                                                                                                                    |       | 15,463                |       | 16,555                |       |
| Accrued transimission and distribution costs                                                                                                                                                                                 |       | 8,879                 |       | 5,273                 |       |
| Accounts payable and other accrued expenses                                                                                                                                                                                  |       | 2,524                 |       | 811                   |       |
| Sales tax payable                                                                                                                                                                                                            |       | 2,877                 |       | 1,446                 |       |
| Income tax payable                                                                                                                                                                                                           |       | 3,983                 |       | 1,477                 |       |
| Customer deposits                                                                                                                                                                                                            |       | 6,119                 |       | 3,376                 |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Total Current Liabilities                                                                                                                                                                                                    |       | 39,845                |       | 29,546                |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Long-term debt                                                                                                                                                                                                               |       | —                |       | 2,382                 |       |
| Puttable warrant obligation (See Note 10)                                                                                                                                                                                    |       | —                |       | 4,125                 |       |
| Accrued interest payable - officer                                                                                                                                                                                           |       | —                |       | 20                    |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Total Liabilities                                                                                                                                                                                                            |       | 39,845                |       | 36,073                |       |
| Commitments and contingencies (See Notes 9, 10 and 17)                                                                                                                                                                       |       |                  |       |                  |       |
| Shareholders’ Equity:                                                                                                                                                                                                   |       |                  |       |                  |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Common stock, $0.01 par  value; 75,000,000 shares authorized; 9,757,222 shares issued and 9,743,375  shares outstanding at December 31, 2004; 8,261,128 shares issued and  8,247,281 shares outstanding at December 31, 2003 |       | 98                    |       | 83                    |       |
| Additional paid-in capital                                                                                                                                                                                                   |       | 13,727                |       | 7,348                 |       |
| Unearned stock-based compensation                                                                                                                                                                                            |       | (295                  | )          | —                |       |
| Treasury stock, at cost; 13,847 shares                                                                                                                                                                                       |       | (15                   | )          | (15                   | )          |
| Retained earnings (accumulated deficit)                                                                                                                                                                                      |       | 2,895                 |       | (5,287                | )          |
| Total Shareholders’ Equity                                                                                                                                                                                              |       | 16,410                |       | 2,129                 |       |
|                                                                                                                                                                                                                         |       |                  |       |                  |       |
| Total Liabilities and Shareholders’ Equity                                                                                                                                                                              |       | $                     | 56,255     |                  | $          | 38,202 |   |

 

*Seeaccompanying notes to financial statements*

 

56

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**GEXACORP.**

**STATEMENTSOF OPERATIONS**

**(Inthousands, except per share data)**

 
| ** **                                         | ** ** | **For the years ended,** | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|
| ** **                                         | ** ** | **December 31, 2004**    | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|                                               |       |                     |       |   |   |   |   |   |   |   |
| Sales                                              |       | $                        | 273,894    |   | $ | 115,143 |   | $ | 19,039 |   |
| Cost of goods sold                                 |       | 238,206                  |       | 99,697 |   | 14,589 |   |
|                                               |       |                     |       |   |   |   |   |
| Gross profit                                       |       | 35,688                   |       | 15,446 |   | 4,450 |   |
|                                               |       |                     |       |   |   |   |   |
| Selling, general and administrative expenses       |       | 24,144                   |       | 12,662 |   | 3,492 |   |
|                                               |       |                     |       |   |   |   |   |
| Income from operations                             |       | 11,544                   |       | 2,784 |   | 958 |   |
|                                               |       |                     |       |   |   |   |   |
| Interest income                                    |       | 45                       |       | 21 |   | 23 |   |
| Interest expense                                   |       | (2,123                   | )          | (449 | ) | (10 | ) |
| Gain on extinguishment of debt                     |       | 688                      |       | — |   | — |   |
| Other financing income (expense)                   |       | 2,062                    |       | (3,630 | ) | — |   |
|                                               |       |                     |       |   |   |   |   |
| Income (loss) before income taxes                  |       | 12,216                   |       | (1,274 | ) | 971 |   |
|                                               |       |                     |       |   |   |   |   |
| Income tax expense                                 |       | 4,034                    |       | 922 |   | 331 |   |
|                                               |       |                     |       |   |   |   |   |
| Net income (loss)                                  |       | 8,182                    |       | (2,196 | ) | 640 |   |
|                                               |       |                     |       |   |   |   |   |
| Preferred stock dividend                           |       | —                   |       | (167 | ) | (50 | ) |
|                                               |       |                     |       |   |   |   |   |
| Net income (loss) available to common shareholders |       | $                        | 8,182      |   | $ | (2,363 | ) | $ | 590 |   |
|                                               |       |                     |       |   |   |   |   |
| Weighted average shares outstanding:               |       |                     |       |   |   |   |   |
| Basic                                              |       | 8,606                    |       | 7,647 |   | 7,328 |   |
| Diluted                                            |       | 9,835                    |       | 7,647 |   | 7,989 |   |
|                                               |       |                     |       |   |   |   |   |
| Earnings per share:                                |       |                     |       |   |   |   |   |
| Basic                                              |       | $                        | 0.95       |   | $ | (0.31 | ) | $ | 0.08 |   |
| Diluted                                            |       | $                        | 0.83       |   | $ | (0.31 | ) | $ | 0.07 |   |

 

*Seeaccompanying notes to  financialstatements*

 

57

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**GEXA CORP.**

**STATEMENTS OF SHAREHOLDERS’ EQUITY**

**YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**

**(In thousands)**

 
| ** **                                          | ** ** | ** **           | ** ** | ** **        | ** ** | ** **  | ** ** | ** **   | ** ** | **Additional**   | ** ** | ** **      | ** ** | **Stock**      | ** ** | **Unearned**     | ** ** | **Retained**  | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|----------------------|------------|-------------------|------------|-------------|------------|--------------|------------|------------------|------------|-----------------|------------|----------------|------------|------------------|------------|---------------|------------|------------|------------|
| ** **                                          | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Treasury** | ** ** | **Subscription** | ** ** | **Stock-based** | ** ** | **Earnings**   | ** ** | ** **       | ** ** |
| ** **                                          | ** ** | **Shares**           | ** ** | **Amount**        | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **Capital**      | ** ** | **Stock**       | ** ** | **Receivable** | ** ** | **Compensation** | ** ** | **(Defecit)** | ** ** | **Total**  | ** ** |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Balance,  Dec 31, 2001                         |       | —               |       | $                 | —     |        | 6,485      |         | $          | 65               |       | $               | 4,058      |           | $          | —           |       | $             | —     |       | $          | — |   | $ | (3,514 | ) | $ | 609 |   |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Issued common  stock for services                   |       | —               |       | —            |       | 401         |       | 4            |       | 297              |       | —          |       | —         |       | —           |       | —        |       | 301        |       |
| Sale of preferred  stock                            |       | 508                  |       | 25                |       | —      |       | —       |       | 900              |       | —          |       | —         |       | —           |       | —        |       | 925        |       |
| Sale of common  stock                               |       | —               |       | —            |       | 685         |       | 7            |       | 789              |       | —          |       | —         |       | —           |       | —        |       | 796        |       |
| Company purchased  treasury stock                   |       | —               |       | —            |       | —      |       | —       |       | —           |       | (60             | )          | —         |       | —           |       | —        |       | (60        | )          |
| Sale of treasury  stock                             |       | —               |       | —            |       | —      |       | —       |       | —           |       | 50              |       | —         |       | —           |       | —        |       | 50         |       |
| Warrants issued  in financing agreement             |       | —               |       | —            |       | —      |       | —       |       | 300              |       | —          |       | —         |       | —           |       | —        |       | 300        |       |
| Warrants  cancelled from financing agreement        |       | —               |       | —            |       | —      |       | —       |       | (200             | )          | —          |       | —         |       | —           |       | —        |       | (200       | )          |
| Common stock  dividend to preferred shareholders    |       | —               |       | —            |       | 34          |       | —       |       | 50               |       | —          |       | —         |       | —           |       | (50           | )          | —     |       |
| Stock  subscription receivable                      |       | —               |       | —            |       | —      |       | —       |       | —           |       | —          |       | (14            | )          | —           |       | —        |       | (14        | )          |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Net Income                                          |       | —               |       | —            |       | —      |       | —       |       | —           |       | —          |       | —         |       | —           |       | 640           |       | 640        |       |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Balances,  December 31, 2002                   |       | 508                  |       |              | 25         |        | 7,605      |         |       | 76               |       |            | 6,194      |           |       | (10              | )          |          | (14        | )          |       | — |   |   | (2,924 | ) |   | 3,347 |   |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Issued common  stock for services                   |       | —               |       | —            |       | 33          |       | —       |       | 65               |       | —          |       | —         |       | —           |       | —        |       | 65         |       |
| Sales of common  stock                              |       | —               |       | —            |       | 3           |       | —       |       | 11               |       | —          |       | —         |       | —           |       | —        |       | 11         |       |
| Issued warrants  for Loan Agreement                 |       | —               |       | —            |       | —      |       | —       |       | 123              |       | —          |       | —         |       | —           |       | —        |       | 123        |       |
| Purchased common  stock from former employee        |       | —               |       | —            |       | —      |       | —       |       | —           |       | (3              | )          | —         |       | —           |       | —        |       | (3         | )          |
| Exercise of stock  warrants                         |       | —               |       | —            |       | 29          |       | —       |       | 51               |       | —          |       | —         |       | —           |       | —        |       | 51         |       |
| Stock  subscription receivable                      |       | —               |       | —            |       | —      |       | —       |       | —           |       | (15             | )          | 14             |       | —           |       | —        |       | (1         | )          |
| Issued treasury  stock for services                 |       | —               |       | —            |       | —      |       | —       |       | —           |       | 13              |       | —         |       | —           |       | —        |       | 13         |       |
| Issuance of  options to former employee             |       | —               |       | —            |       | —      |       | —       |       | 718              |       | —          |       | —         |       | —           |       | —        |       | 718        |       |
| Preferred stock  conversion to common stock         |       | (508                 | )          | (25               | )          | 588         |       | 7            |       | 19               |       | —          |       | —         |       | —           |       | —        |       | —     |       |
| Common stock  dividend to preferred shareholders    |       | —               |       | —            |       | 20          |       | —       |       | 167              |       | —          |       | —         |       | —           |       | (167          | )          | —     |       |
| Common shares  extinguished                         |       | —               |       | —            |       | (16         | )          | —       |       | —           |       | —          |       | —         |       | —           |       | —        |       | —     |       |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Net loss                                            |       | —               |       | —            |       | —      |       | —       |       | —           |       | —          |       | —         |       | —           |       | (2,196        | )          | (2,196     | )          |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Balances, December 31,  2003                   |       | —               |       |              | —     |        | 8,262      |         |       | 83               |       |            | 7,348      |           |       | (15              | )          |          | —     |       |       | — |   |   | (5,287 | ) |   | 2,128 |   |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Issued common  stock and warrants for services      |       | —               |       | —            |       | 120         |       | 1            |       | 1,451            |       | —          |       | —         |       | (295             | )          | —        |       | 1,157      |       |
| Stock and warrant  offerings, net of issuance costs |       | —               |       | —            |       | 1,176       |       | 12           |       | 4,871            |       | —          |       | —         |       | —           |       | —        |       | 4,883      |       |
| Exercise of  warrants                               |       | —               |       | —            |       | 199         |       | 2            |       | 222              |       | —          |       | —         |       | —           |       | —        |       | 224        |       |
| Fees capitalized  in Equity                         |       | —               |       | —            |       | —      |       | —       |       | (165             | )          | —          |       | —         |       | —           |       | —        |       | (165       | )          |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Net Income                                          |       | —               |       | —            |       | —      |       | —       |       | —           |       | —          |       | —         |       | —           |       | 8,182         |       | 8,182      |       |
|                                                |       |                 |       |              |       |        |       |         |       |             |       |            |       |           |       |             |       |          |       |       |       |
| Balances,  December 31, 2004                   |       | —               |       | $                 | —     |        | 9,757      |         | $          | 98               |       | $               | 13,727     |           | $          | (15              | )          | $             | —     |       | $          | (295 | ) | $ | 2,895 |   | $ | 16,410 |   |

* *

*See accompanying notes to financialstatements*

 

58

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**GexaCorp.**

**STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **For the years ended,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                | ** ** | **December 31, 2004**    | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash flows from operating activities:                                                     |       |                     |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                        | 8,182      |   | $ | (2,196 | ) | $ | 640 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                     |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 329                      |       | 145 |   | 33 |   |
| Amortization of financing costs                                                           |       | 489                      |       | 75 |   | 100 |   |
| Accretion of debt discount                                                                |       | (153                     | )          | 61 |   | — |   |
| Stock compensation to officers, directors and consultants for  services                   |       | 179                      |       | 78 |   | 301 |   |
| Stock compensation to former officer                                                      |       | —                   |       | 718 |   |   |   |
| Gain on extinguishment of debt                                                            |       | (688                     | )          | — |   | — |   |
| Change in puttable warrant obligation                                                     |       | (2,062                   | )          | 3,630 |   | — |   |
| Deferred income tax benefit                                                               |       | (136                     | )          | (554 | ) | (37 | ) |
|                                                                                      |       |                     |       |   |   |   |   |
| Changes in operating assets and liabilities:                                              |       |                     |       |   |   |   |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Accounts receivable                                                                       |       | (13,347                  | )          | (16,328 | ) | (6,881 | ) |
| Other current assets                                                                      |       | 54                       |       | (196 | ) | (73 | ) |
| Other long-term assets                                                                    |       | (113                     | )          | (149 | ) | (53 | ) |
| Accrued electricity costs                                                                 |       | (1,092                   | )          | 13,620 |   | 2,935 |   |
| Accrued TDSP costs                                                                        |       | 3,606                    |       | 3,624 |   | 1,649 |   |
| Accounts payable and other accrued expenses                                               |       | 938                      |       | 692 |   | (99 | ) |
| Sales tax payable                                                                         |       | 1,431                    |       | 1,172 |   | 1,344 |   |
| Income tax payable                                                                        |       | 2,506                    |       | 1,108 |   | 369 |   |
| Customer deposits                                                                         |       | 2,743                    |       | 2,790 |   | 586 |   |
| Accrued interest payable                                                                  |       | (20                      | )          | 8 |   | 8 |   |
| Net cash provided by operating activities                                                 |       | 2,846                    |       | 8,297 |   | 822 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash flows from investing activities:                                                     |       |                     |       |   |   |   |   |
| Restricted cash                                                                           |       | (3,072                   | )          | (2,651 | ) | (962 | ) |
| Purchases of equipment                                                                    |       | (1,656                   | )          | (232 | ) | (233 | ) |
| Net cash used in investing activities                                                     |       | (4,728                   | )          | (2,883 | ) | (1,195 | ) |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash flows from financing activities:                                                     |       |                     |       |   |   |   |   |
| Borrowings on credit facility                                                             |       | —                   |       | — |   | 500 |   |
| Repayments on credit facility and puttable warrant obligation                             |       | (5,029                   | )          | (500 | ) | — |   |
| Borrowings on revolving credit line                                                       |       | 6,057                    |       | — |   | 28 |   |
| Repayments on revolving credit line                                                       |       | (6,057                   | )          | (28 | ) | — |   |
| Borrowings on term loan                                                                   |       | —                   |       | 3,650 |   | — |   |
| Repayments on term loan                                                                   |       | —                   |       | (202 | ) | — |   |
| Proceeds on sales of preferred stock                                                      |       | —                   |       | — |   | 925 |   |
| Proceeds from the sales of common stock                                                   |       | 5,109                    |       | 61 |   | 796 |   |
| Purchase of treasury stock                                                                |       | —                   |       | (3 | ) | (60 | ) |
| Retirement of treasury stock                                                              |       | —                   |       | — |   | 50 |   |
| Stock subscriptions receivable                                                            |       | —                   |       | — |   | (14 | ) |
| Payments for stock offering expenses                                                      |       | (165                     | )          | — |   | — |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Net cash provided by (used in) financing activities                                       |       | (85                      | )          | 2,978 |   | 2,225 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Net change in cash and cash equivalents                                                   |       | (1,967                   | )          | 8,392 |   | 1,852 |   |
| Cash and cash equivalents at beginning of period                                          |       | 10,829                   |       | 2,437 |   | 585 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash and cash equivalents at end of period                                                |       | $                        | 8,862      |   | $ | 10,829 |   | $ | 2,437 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash paid for interest                                                                    |       | $                        | 280        |   | $ | 231 |   | $ | 1 |   |
|                                                                                      |       |                     |       |   |   |   |   |
| Cash paid for income taxes                                                                |       | $                        | 1,649      |   | $ | 435 |   | $ | — |   |

 

*See accompanying notes to financialstatements*

 

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Supplementary disclosure of non-cash transactions

During thetwelve months ended December 31, 2004, certain broker commissions were paidwith 7,400 shares of common stock valued at market price on date of issue,averaging $7.17 per share.

During thetwelve months ended December 31, 2004, employees of the Company were granted6,750 shares of common stock, that were valued at an average market price of$5.33 per share, in lieu of compensation.

During thetwelve months ended December 31, 2004, the Company issued 21,356 shares ofcommon stock for services provided. The services were provided by ContinentalAirlines for the One Pass ® partner program where the Company provides mileageto customers in exchange for payment by the Company to Continental of cash andCompany common stock. The common stock was issued in separate issues asfollows: 3,306 shares issued at a market price of $4.40, 5,232 shares issued ata market price of $4.75, 5,006 shares issued at a market price of $5.00, and7,812 shares issued at a market price of $4.99.

During thetwelve months ended December 31, 2004, the Company issued 275,000 warrants topurchase common stock. These warrants have a five year term and were issued inconjunction with obtaining a revolving credit facility with Highbridge/ZwirnOpportunities Fund, L.P. as follows: 150,000 warrants were issued to HBZ andthe remaining 125,000 were issued to a broker who assisted in facilitating thecredit facility. The warrants were valued using the Black Scholes valuationmethod. For information on the Company’s assumptions for Black Scholes,reference *Note 8. Long Term Debt, for details on thevaluation of these warrants.*

During thetwelve months ended December 31, 2004, the Company issued 85,000 shares ofrestricted stock to employees. This stock was issued to officers of theCompany. 25,000 shares vest by May 26, 2005, with the remaining 60,000 vestingby October 28, 2005. Based on an issuance price of $4.41 per share on date ofissue, the total value of this award is $374,850. The total amount expensedduring fiscal 2004 is $79,996 with the remaining $294,854 deferred andrecognized over the vesting period of the options.

During the twelve months ended December 31, 2003, theCompany issued warrants for the right to purchase up to 631,000 shares of theCompany’s common stock at an exercise price of $1.00 per share in connectionwith a term loan issued on July 16, 2003. Warrants to purchase 550,000 sharesof common stock included a put option that requires these warrants to receiveliability treatment under SFAS No. 150. These warrants had an initial value of$495,000 which was reflected as a discount to the long-term debt. See Note 10for a discussion of the valuation of the warrants with put options under SFASNo. 150. The remaining warrants to acquire 81,000 shares of common stock wereissued under a portion of the term loan that represented a modification to theCompany’s existing loan agreement with another third party bringing that loanunder the term loan agreement with the party 

 

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receivingthe warrants to acquire 550,000 shares of common stock. These warrants werefair-valued at $122,733 using the Black-Sholes model and are reflected as adiscount to the long-term debt.

On December31, 2003 19,634 shares of common stock valued at $166,889 were issued topreferred shareholders as a preferred stock dividend. On December 31, 2003 all508,214 shares of preferred stock in the amount of $924,400 were converted tocommon stock in accordance with the mandatory conversion provision at December31, 2003 attached to the preferred shares. The preferred shares were convertedto 588,484 shares of common stock.

During theyear ended December 31, 2003, sales tax refunds of approximately $1.1 millionwere made to customers based on an opinion letter issued by the Texas StateComptroller’s office declaring that certain meters billed to commercialentities for multi-family dwellings should be taxed as residential metersinstead of commercial meters. Such treatment exempts said meters from state,county and certain special district taxes. These refunds were offset againstcustomer billings, offset against losses related to bad debt losses forcustomers no longer with the Company where a bad debt loss was incurred, orrefunded via check.

During thetwelve months ended December 31, 2002, the Company issued stock warrants to alender as part of the Company’s financing agreement. Thewarrants for 300,000 shares were valued at $300,000 and were amortized at$8,333 per month to match the three year term of the financing agreement. AtDecember 31, 2002, the financing agreement was terminated and the warrants werecancelled; the unamortized portion of the value at the time of thecancellation, $200,000, was offset against additional paid in capital.

During the twelve months ended December 31, 2002, theCompany issued 33,549 shares of common stock, valued at $50,323, as dividendpayments to holders of the Company’s preferred stock.

 

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**Gexa Corp.**Notes to Financial Statements

**1.****Organization**

Gexa Corp.(“the Company”) was incorporated in Texas on February 13, 2001. On August 2,2001, the Company received its license from the Public Utility Commission ofTexas to serve as a retail provider of electricity to residential andcommercial customers in deregulated markets within the state of Texas. OnJanuary 1, 2002, Gexa began to provide retail electric services in the State ofTexas.

**2. Basis ofPresentation and Significant Accounting Policies**

The accompanying financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of America.

**Reclassifications**

The Company has reclassified certain prior fiscal year amounts in theaccompanying financial statements in order to be consistent with the currentfiscal year presentation. During fiscal 2004, the Company reclassified certaincosts associated with sales commissions, marketing programs and transactionprocessing fees from cost of goods sold to selling, general and administrativeexpenses in our statements of operations. The reclassified amounts decreasedcost of goods sold and increased selling, general and administrative expensesby $6.5 million, $3.4 million and $0.7 million in fiscal 2004, 2003 and 2002,respectively. Such reclassifications had no effect on net income or loss.

**Use of estimates**

The preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the financial statementsand revenues and expenses during the reporting period.  Actual results could differ from thoseestimates. The significant estimates for the Company include:

•                                          estimation of volumes delivered to customers, including the effects ofresettlements from ERCOT;

•                                          estimation of rates for determination of revenues;

•                                          bad debt expense; and

•                                          estimation of the fair value of stock options and warrantsissued.

 

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**NormalPurchases and Sales Accounting**

In fiscal 2004, the Companyused a combination of long term contracts, short term contracts, month-aheadpurchases, and day-ahead purchases to match up with forecasted demand of ourcommercial customers on long term sales contracts, commercial customer onmonth-to-month contracts, and residential customers (which are all onmonth-to-month contracts).  The Companyapplied the normal purchase, normal sales accounting treatment to its forwardpurchase supply contracts and its customer sales contracts. Accordingly, theCompany recorded revenue generated from its sales contracts as energy wasdelivered to its retail customers, and direct energy costs are recorded whenthe energy under its long-term forward physical delivery contracts wasdelivered.

**Revenue and CostRecognition**

The Company recordselectricity sales under the accrual method and these revenues are recognizedupon delivery of electricity to the customer’s meter. Electric services notbilled by month-end are accrued based upon estimated deliveries to customers astracked and recorded by ERCOT multiplied by the Company’s average billing rateper kilowatt hour (“kWh”) in effect at the time.

In November 2003, theCompany changed its revenue estimation technique to one referred to as the “flow”technique.  In the latter half of 2003,the Company determined that the market was operating at a point of efficiencysuch that it would be appropriate for the Company to begin accruing revenuebased on ERCOT settlements of power deliveries, and given the limitations ofthe billings technique, the Company chose to change to the flow technique.  In addition, by the end of the fiscal year2003, the Company had sufficient initial settlement and resettlement data fromERCOT to arrive at a reasonable estimate for 2003 revenues assuming that theflow method had been in place since January 1, 2003.

The flow technique ofrevenue calculation relies upon ERCOT settlement statements to determine theestimated revenue for a given month. Supply delivered to our customers for themonth, measured on a daily basis, provides the basis for revenues. ERCOTprovides net electricity delivered data in three time frames. Initial dailysettlements become available approximately 17 days after the day being settled.Approximately 45 days after the day being settled, a ‘resettlement’ is providedto adjust the initial settlement to the actual supply delivered based onsubsequent comparison of prior forecasts to actual meter reads processed. Afinal resettlement is provided approximately 180 days after power is delivered,marking the last routine settlement adjustment to the power deliveries for thatday.

Because flow data for resettlements and final resettlements are notavailable in sufficient time to be booked to the appropriate period, the effectof such resettlements are booked in the month in which the cost of goods sold (“COGS”)effect of those resettlements is realized. This allows for a proper matching ofrevenues with COGS.

 

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Sales represent the totalproceeds from energy sales, including pass through charges from theTransmission and Distribution Providers (“TDSPs”) billed to the customer atcost. COGS includes electric power purchased, and pass through charges from theTDSPs in the areas serviced by the Company. TDSP charges are costs for meteringservices and maintenance of the electric grid. TDSP charges are established byregulation by the Public Utility Commission of Texas (“PUCT”).

The energy portion of theCompany’s COGS is comprised of two components: bilateral wholesale costs andbalancing/ancillary costs.  These twocost components are incurred and recognized in different manners.

Bilateral wholesale costsare incurred through contractual arrangements with wholesale power suppliersfor firm delivery of power at a fixed volume and fixed price.  The Company is invoiced for these wholesalevolumes at the end of each calendar month for the volumes purchased fordelivery during the month, with payment due 30 days after the end of the month.

Balancing/ancillary costsare based on the customer load and are determined by ERCOT through a multiplestep settlement process. Balancing costs/revenues are related to thedifferential between supply provided by the Company through its bilateralwholesale supply and the supply required to serve the Company’s customer load.The Company endeavors to minimize the amount of balancing/ancillary coststhrough its load forecasting and forward purchasing programs.

**Unbilled Revenue and Accounts Receivable**

At the end of each calendarmonth, revenue is accrued to unbilled receivables based on the estimated amountof power delivered to customers using the flow technique.  Unbilled revenue also includes accruals forestimated TDSP charges and monthly service charges applicable to the estimatedelectricity usage for the period.

All charges that werephysically billed to customers in the calendar month are recorded from theunbilled account to the customer receivables account.  Accounts receivables are customer obligationsbilled at the conclusion of a month’s electricity usage and due within 16 to 30days of the date of the invoice depending on customer payment terms. Balancespast due are subject to a late fee that is assessed on that billing.

The large number of customers and significant volume of transactionscreate a challenge to manage receivables as well as to estimate the accountbalances that ultimately will not be paid by the customers (“bad debtwrite-offs”).  The Company uses a varietyof tools to estimate and provide an accurate and adequate allowance fordoubtful accounts reserve; the allowance for doubtful accounts is expensed eachmonth as a percentage of revenue based on the historical bad debt write-offtrends that will result from that month’s gross revenues. For the years ended,December 31, 2004, 2003 and 2002, the Company’s bad debt expense wasapproximately $7.1 million, or 2.6% of sales, $3.9 million, or 3.4% of salesand $679,000, or 3.6% of sales respectively.

 

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The Company follows aconsistent process to determine which accounts should be written off andcompares the total actual write-offs to the estimated percentage of totalrevenue accrued and expensed each month. Past due accounts are regularlyreviewed based on aging for possible removal from service, in-house or externalcollections efforts, or write-off.  Forresidential customers and commercial customers with a balance under $700.00,with some minor exceptions, the total balance for all accounts with any portionof their balance over 60 days past due is considered to be uncollectible and iswritten off, net of security deposits held for these accounts.  Delinquent commercial accounts with balancesgreater than $700.00 are reviewed individually by in-house collections, andpayment arrangements, removal from service and possible write-off of all or aportion of the receivable is determined on a case-by-case basis.

The Company has initiated avariety of actions targeted to reduce the amount of bad debt incurred by theCompany. The principal actions are as follows:

•                                          improvedpolicies requiring credit reviews, deposits, and late fees, and

•                                          implementingmore aggressive collection efforts including customer disconnections

**Cash and CashEquivalents**

The Company considers allhighly liquid short-term investments purchased with a maturity of three monthsor less at the date of purchase to be cash equivalents.

**Restricted Cash**

The Company has restrictedcash related to customer deposits and certificates of deposit used to secureletters of credit for the purchase of electricity, the payment of TDSP passthrough charges, and operations. Customer deposit cash must be held by theCompany and may not be directly spent on any operational or other expense.Restricted cash securing letters of credit may not be used for any purpose bythe Company unless the underlying obligation being secured is relieved orsecured with other collateral.*See Note 7, RestrictedCash, Cash Equivalents, and Energy Deposits for more details.*

**Fair Value of Financial Instruments**

The Company’s financialinstruments consist primarily of cash and cash equivalents, accountsreceivable, and accounts payable. The carrying amounts of these financialinstruments are reflected in the accompanying balance sheets at amountsconsidered by management to approximate their fair values due to theirshort-term nature.

**Equipment**

Equipment is stated at cost. Maintenance, repairs and minor renewalsare expensed when incurred. The Company’s fixed assets are classified asfurniture, 

 

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computer hardware, computersoftware, telephones, and leasehold improvements. The Company considersleasehold improvements to be improvements that can not be removed withoutsubstantially damaging or requiring substantial repair to leased asset. TheCompany depreciates these items over the term of the lease or the service lifeof the improvement, whichever is shorter. All of these items, except for leasehold improvements,  are depreciated on a straight-line basis overa three year period. Depreciation expense for the years ended December 31,2004, 2003 and 2002 was $265,000, $145,000, and $33,000 respectively.

**Income Taxes**

The Company accounts forincome taxes pursuant to the asset and liability method which requires deferredincome tax assets and liabilities to be computed annually for temporarydifferences between the financial statement and tax bases of assets andliabilities that will result in taxable or deductible amounts in the futurebased on enacted tax laws and rates applicable to the periods in which thedifferences are expected to affect taxable income. Valuation allowances will beestablished when necessary to reduce deferred tax assets to the amount expectedto be realized.  No allowances have beenestablished through the end of fiscal 2004.

**DeferredFinancing Costs**

The Company defers costsincurred in connection with financings and amortizes the costs over the life ofthe related debt in accordance with the effective interest method.  During fiscal 2004, 2003 and 2002 we incurredfinancing costs of $2.3 million, $0.8 million and $0.0 million, respectively.The Company expensed $0.5 million, $0.1 million and $0.1 million in fees andother costs related to our financing in 2004, 2003 and 2002 respectively.  The Company had $1.9 million in deferredfinancing costs classified as “Other long-term assets” on December 31, 2004 and$0.1 million on December 31, 2003.

**Net Income (loss)per share**

The Company presents “basic”net income (loss) per share and “diluted” net income (loss) per share. Basicnet income (losses) per share is calculated by dividing net income (loss)available to common shareholders by the weighted average number of sharesoutstanding during each period. The calculation of diluted net income (loss)available to common shareholders per share is similar to that of basic earningsper share, except that the denominator is increased to include the number ofadditional common shares that would have been outstanding if all of thepotential common share equivalents were exercised. *See Note 13,Earnings Per Share for more details.*

**Comprehensiveincome**

Comprehensive income represents any non-owner changes in equity besidesincome (loss) and dividends. The Company’s comprehensive income (loss) for theyears 

 

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ended December 31, 2004, 2003and 2002 was equal to net income (loss) as reported herein.

**Stock-based compensation**

The Company accounts forstock based compensation to employees using the intrinsic value method. Proforma information regarding net income (loss) and net income (loss) per shareavailable to common shareholders is required by SFAS No. 148 and has beendetermined as if the Company had accounted for its stock options under the fairvalue method as provided therein.

For purposes of pro formadisclosures, the estimated fair value of the options is amortized to expenseover the options’ graded vesting period.

In December 2002, theFinancial Accounting Standards Board (“FASB”) amended the transition anddisclosure requirements of SFAS No. 123 through the issuance of SFAS No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure”. SFAS No. 148 amendsthe existing disclosures to make more frequent and prominent disclosure ofstock-based compensation expense beginning with financial statements for fiscalyears ending after December 15, 2002. The company has adopted the disclosureprovisions of SFAS No. 148.

If the Company had accounted for its stock-based employee and outsidedirector’s compensation under the minimum fair value recognition andmeasurement principles, the Company’s reported net income amounts would havebeen adjusted to the pro forma net income amounts presented below:

 

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| **(In thousads, except share data)**                                                                                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| **Pro Forma impact of fair value method (FAS 148)**                                                                               |       |                   |       |                   |       |                   |       |
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| Reported net income (loss) available to common shareholders                                                                       |       | $                      | 8,182      |                   | $          | (2,363                 | )          | $ | 590 |   |
| Less: Total stock-based compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (640                   | )          | (348                   | )          | (213                   | )          |
| Pro forma net income (loss) available to common shareholders                                                                      |       | $                      | 7,542      |                   | $          | (2,711                 | )          | $ | 377 |   |
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| **Earnings per common share**                                                                                                     |       |                   |       |                   |       |                   |       |
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| Basic - as reported                                                                                                               |       | $                      | 0.95       |                   | $          | (0.31                  | )          | $ | 0.08 |   |
| Diluted - as reported                                                                                                             |       | 0.83                   |       | (0.31                  | )          | 0.07                   |       |
| Basic - pro forma                                                                                                                 |       | 0.88                   |       | (0.35                  | )          | 0.05                   |       |
| Diluted - pro forma                                                                                                               |       | 0.77                   |       | (0.35                  | )          | 0.05                   |       |
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| **Weighted average Black-Scholes value assumptions**                                                                              |       |                   |       |                   |       |                   |       |
|                                                                                                                              |       |                   |       |                   |       |                   |       |
| Risk free interest rate                                                                                                           |       | 3                      | %          | 5                      | %          | 3                      | %          |
| Expected life                                                                                                                     |       | 3  yrs                 |       | 3  yrs                 |       | 3  yrs                 |       |
| Expected volatility                                                                                                               |       | 36  - 176              | %          | 193                    | %          | 124                    | %          |
| Expected dividend yield                                                                                                           |       | 0                      | %          | 0                      | %          | 0                      | %          |

 

** **

**RecentAccounting Standards**

In October 2004, the FASBconcluded that SFAS No. 123R, “Share-Based Payment”, which would require allcompanies to measure compensation cost for all share-based payments (includingemployee stock options) at fair value. SFAS No. 123R is effective for theCompany for interim or annual period beginning after June 15, 2005. The Companywill adopt SFAS No. 123R on July 1, 2005 and does not believe the adoption willhave a material impact on its financial statements.

**3.  Sales and Cost of Goods Sold**

Below are the major components of our sales and cost of goods sold forthe last three fiscal years.  Electricityincludes the power we deliver to customers, while TDSP charges (which arebilled to the customer at cost) include metering services and maintenance ofthe electrical grid.  Other revenue isprimarily comprised of monthly service charges and late fees. See the tablebelow for details of our revenue and cost of goods sold for the year endedDecember 31, 2004, 2003, and 2002:

 

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| **(In thousands)**       | ** ** | ** **                                 | **Major Components of Sales** | ** **            |
|--------------------------|------------|--------------------------------------------|-------------------------------|-----------------------|
| ** **               | ** ** | **December 31, 2004**                      | ** **                    | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|                     |       |                                       |                          |                  |   |   |   |
| Electricity              |       | $                                          | 203,918                       |                  | $ | 86,405 |   | $ | 13,684 |   |
| TDSP                     |       | 62,115                                     |                          | 25,973                |   | 5,013 |   |
| Other                    |       | 7,861                                      |                          | 2,765                 |   | 342 |   |
|                     |       |                                       |                          |                  |   |   |   |
| Total sales              |       | $                                          | 273,894                       |                  | $ | 115,143 |   | $ | 19,039 |   |
|                     |       |                                       |                          |                  |   |   |   |
| ** **               | ** ** | **Major Components of Cost of Goods Sold** | ** **                    |
| ** **               | ** ** | **December 31, 2004**                      | ** **                    | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|                     |       |                                       |                          |                  |   |   |   |
| Electricity              |       | $                                          | 176,091                       |                  | $ | 73,724 |   | $ | 9,576 |   |
| TDSP                     |       | 62,115                                     |                          | 25,973                |   | 5,013 |   |
|                     |       |                                       |                          |                  |   |   |   |
| Total cost of goods sold |       | $                                          | 238,206                       |                  | $ | 99,697 |   | $ | 14,589 |   |

 

**4. Accounts Receivable, net**

Accounts receivableconsisted of billed receivables, unbilled receivables and allowance fordoubtful accounts as follows: 
| **(In thousands)**              | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------|------------|------------|-----------------------|------------|-----------------------|------------|
|                            |       |       |                  |       |                  |
| Billed receivables              |       | $          | 20,759                |       | $                     | 13,126     |   |
| Unbilled receivables            |       | 17,160     |                  | 10,313     |                  |
| Allowance for doubtful accounts |       | (2,433     | )                     | (1,300     | )                     |
|                            |       |       |                  |       |                  |
| Accounts receivable, net        |       | $          | 35,486                |       | $                     | 22,139     |   |

Thefollowing table sets forth the activity in the Company’s allowance for doubtfulaccounts for the years ended:
| **(In thousands)**               | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|----------------------------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
|                             |       |       |                  |       |                  |       |                  |
| Balance, beginning of year       |       | $          | 1,300                 |       | $                     | 326        |                  | $          | — |   |
| Provisions charged to operations |       | 7,052      |                  | 3,900      |                  | 679        |                  |
| Write-offs (net of recoveries)   |       | (5,918     | )                     | (2,926     | )                     | (353       | )                     |
|                             |       |       |                  |       |                  |       |                  |
| Balance, end of year             |       | $          | 2,434                 |       | $                     | 1,300      |                  | $          | 326 |   |

 

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**5. Equipment**

Equipment,net by asset class consisted of the following:
| **(In thousands)**             | ** ** | ** ** | **Estimated Life** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------|------------|------------|--------------------|------------|-----------------------|------------|-----------------------|------------|
|                           |       |       |               |       |                  |       |                  |
| Computers and printers         |       | 3  years   |               | $          | 696                   |       | 134                   |       |
| Furniture and fixtures         |       | 3  years   |               | 159        |                  | 137        |                  |
| Telephone system               |       | 3  years   |               | 400        |                  | 114        |                  |
| Software and programs          |       | 3  years   |               | 277        |                  | 167        |                  |
| Leasehold improvements         |       | 3  years   |               | 107        |                  | —     |                  |
| Less: accumulated depreciation |       |       |               | (444       | )                     | (178       | )                     |
|                           |       |       |               |       |                  |       |                  |
| Equipment, net                 |       |       |               | $          | 1,195                 |       | $                     | 374        |   |
|                                |            |            |                    |            |                       |            |                       |            |  |  |

**6. OtherLong-Term Assets**

Otherlong-term assets consisted of the following:
| **(In thousands)**                | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------|------------|------------|-----------------------|------------|-----------------------|------------|
|                              |       |       |                  |       |                  |
| Capitalized software, net         |       | $          | 471                   |       | $                     | —     |   |
| Deposits                          |       | 345        |                  | 104        |                  |
| Capital lease                     |       | 97         |                  | —     |                  |
| Deferred financing costs          |       | 1,909      |                  | 123        |                  |
|                              |       |       |                  |       |                  |
| Total other long-term assets, net |       | $          | 2,822                 |       | $                     | 227        |   |

**7. RestrictedCash, Cash Equivalents and Energy Deposits**

The Company has cash, cashequivalents and deposits related to outstanding letters of credit or cashdeposited as collateral to secure performance under energy purchase contractsas follows:

 

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| **(In thousands)**                                                                                                                   | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
|                                                                                                                                 |       |                  |       |                  |       |
| Short-term investments pledged as collateral for letters of credit in  connection with agreements for the purchase of electric power |       | $                     | 5,767      |                  | $          | 2,509 |   |
|                                                                                                                                 |       |                  |       |                  |       |
| Cash and cash equivalents not pledged to letters of credit                                                                           |       | 918                   |       | 1,104                 |       |
|                                                                                                                                 |       |                  |       |                  |       |
| Total restricted cash and cash equivalents                                                                                           |       | 6,685                 |       | 3,613                 |       |
|                                                                                                                                 |       |                  |       |                  |       |
| Energy deposits pledged as collateral in connection with agreements  for the purchase of electric power                              |       | 304                   |       | 103                   |       |
|                                                                                                                                 |       |                  |       |                  |       |
| Total restricted cash, cash equivalents and energy deposits                                                                          |       | $                     | 6,989      |                  | $          | 3,716 |   |

At December 31, 2004, the Companyhad outstanding $5.8 million in letters of credit which were 100%collateralized with restricted cash. $1.2 million of these letters of creditsecure the Company’s credit to participate in the ERCOT balancing marketallowing the Company to buy and sell power on the balancing markets each day toensure electricity supplies match customer demand. A letter of credit with JPMorgan Chase Bank in the amount of approximately $0.7 million, secured by cash,is available for use by the Company. A letter of credit in the amount of $3.3million secures the Company’s credit to purchase power from TXU PortfolioManagement (“TXU PM”) and pay for the power in the month following purchase.The remaining letters of credit totaling approximately $0.6 million are withthe TDSPs in the regions in which the Company provides power to customers, andsecure the Company’s outstanding pass-through charge invoices charged tocustomers and later paid to the TDSPs for their meter reading services andother grid maintenance charges.

**8. Long-Term Debt**

During the twelve months ended December 31, 2004, the Company enteredinto the (“Facility”) with Highbridge/Zwirn Special Opportunities Fund, L.P.The Facility, which matures on July 8, 2007, may be used to provide workingcapital for the Company’s normal routine operations and for providing a cashreserve to collateralize letters of credit that the Company is required topost.  The Facility is collateralized bya lien on substantially all of the Company’s assets, subject to the liensalready held on such assets by TXU PM and/or JP MorganChase.

Advances under the Facilitybear interest at the rate of 14% per annum and the Company is permitted toprepay advances outstanding under the Facility at any time without penalty uponproper notice to the lenders thereunder. If at any time the Company hasunrestricted cash or cash equivalents in excess of $1.2 million, the Company isrequired to make a prepayment on the advances then outstanding under theFacility in an amount equal to the amount of such cash or cash equivalentsbeing held by the Company on the fifteenth and/or the last day of any monthduring the term of the Facility in excess 

 

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of $1.2 million, within one business day of such occurrence. In addition,the Company has agreed to pay to Highbridge/Zwirn Special Opportunities Fund,L.P., for the account of each lender under the Facility, an annual fee in theamount of $150,000 and a commitment fee, which accrues at 2% per annum on theaverage daily unused amount of the line during the term of the Facility.

The Facility contains the following covenants:

•                                          the Company maynot permit the leverage ratio (as defined in the Facility), as of the last dayof each fiscal quarter, to be greater than 1.5;

 

•                                          the Company maynot permit the fixed charge coverage ratio (as defined in the Facility) as ofthe last day of each fiscal quarter to be lower than 1.3 for each quarterfollowing September 30, 2004;

 

•                                          the Company maynot permit the interest coverage ratio (as defined in the Facility) as of thelast day of each fiscal quarter to be lower than (i) 6.0 for the quarter endedDecember 31, 2004 and (ii) 4.7 for each of the quarters thereafter;

 

•                                          the Company maynot permit trailing twelve months EBITDA (as defined in the Facility) as of thelast day of each fiscal quarter to be less than (i) $11.0 million for each ofthe quarters between October 1, 2004 and June 30, 2005 and (iii) $12.0 millionfor each of the quarters thereafter;

 

•                                          the Company maynot permit the current ratio (as defined in the Facility) as of the last day ofany fiscal quarter to be lower than 1.1;

 

•                                          the Company maynot permit the amount of general and administrative costs (as defined in theFacility), which does not include bad debt or sales expenses, for any fiscalquarter to be greater than 6% of the Company’s sales; and

 

•                                          the Company maynot make any capital expenditures in the aggregate in an amount greater thanthe capital budget approved by the administrative agent under the Facility.

The Facility also containsother restrictions with respect to: the incurrence of debt and liens; themaking of restricted payments, investments, loans and advances; entering intoleases or sale and leasebacks; the sale or discount of receivables; the mergerof the Company; the sale of its properties; entering into transactions withaffiliates or into material agreements; and entering into negative pledgeagreements, certain dividend restrictions and certain swap agreements. As ofDecember 31, 2004, the Company was in compliance with all debt covenants.

 

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In connection with the closing of the Facility, the Company issued toHighbridge/Zwirn Special Opportunities Fund, L.P. warrants to acquire 150,000shares of Company common stock for an exercise price of $4.00 per share.  The warrants are currently exercisable,expire on July 9, 2009 and contain anti-dilution protection for the holder ofthe warrants. Specifically, if the Company issues additional shares of commonstock or other securities that are convertible into shares of the Company’scommon stock, and the consideration for the shares are less than $4.00 pershare, the exercise price for the warrants immediately preceding such issuancewill be reduced according to the formula specified in the warrants. Thesewarrants were fair valued using the Black Scholes model to determine the callwarrant value of these warrants and were recorded as deferred financing costsand amortized over the life of the Facility. The assumptions used to valuethese warrants are presented below:
| **Input Variables**                   | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|------------|
|                                  |       |       |       |
| Stock price (at market)               |       | $          | 4.75       |       |
| Exercise price                        |       | 4.00       |       |
| Term (in yrs)                         |       | 3.0        |       |
| Volatility                            |       | 36         | %          |
| Annual rate of quarterly dividends    |       | 0          |       |
| Discount rate - bond equivalent yield |       | 3          | %          |
|                                       |            |            |            |            |  |

These warrants were valued at approximately$250,000.

The Company also granted the holder of the warrants certain demand andpiggyback registration rights pursuant to the terms of the warrants.  After July 8, 2005, the holder of thewarrants may, on one occasion, request that the Company register the sale ofall or part of the Company’s common stock underlying the warrants under theSecurities Act of 1933, as amended (the “Securities Act”).  With respect to the piggyback registrationrights, the Company must promptly notify the holder of the warrants of anyproposed filing of certain registration statements under the Securities Actrelating to underwritten offerings before such filing is to be made.  The Company must also cause the holder’ssecurities to be included in the registration statement unless the Company’sunderwritten offering becomes too large (as determined by the underwriter) toaccommodate the securities of the holder, in which case the accounts of allpersons with shares to be included in the offering may be reduced pro rata.

In connection with theclosing of the Credit Facility, the Company paid a broker $200,000 in cash andissued to the broker warrants to acquire 125,000 shares of Company common stockfor an exercise price of $4.00 per share as commission. The holder of thewarrants was also granted “piggyback” registration rights similar to the “piggyback”registration rights discussed in the prior paragraph. The broker fees have beenrecorded as deferred financing costs and will be amortized over the life of theFacility. These warrants were fair valued using the Black Scholes model. Theassumptions used to value these warrants are presented below:

 

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| **Input Variables**                   | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|------------|
|                                  |       |       |       |
| Stock price (at market)               |       | $          | 5.02       |       |
| Exercise price                        |       | 4.00       |       |
| Term (in yrs)                         |       | 3.0        |       |
| Volatility                            |       | 36         | %          |
| Annual rate of quarterly dividends    |       | 0          |       |
| Discount rate - bond equivalent yield |       | 3          | %          |
|                                       |            |            |            |            |  |

These warrants were valued at approximately$230,000.

In connection with the closing of the Facility and pursuant to aTermination Agreement, the Company repaid The Catalyst Fund, Ltd. (“Catalyst”)approximately $2.5 million, which represented all amounts outstanding under aLoan Agreement with Catalyst. The Company also repaid JTS Enterprisesapproximately $0.5 million and repaid Neil Leibman, the Company’s Chairman andCEO approximately $125,000 for outstanding loans. The Termination Agreementalso terminated the loan documents executed in connection with the Catalystloan, including a Security Agreement, Consulting Agreement and RegistrationRights Agreement.

In addition, the Company purchased from Catalyst for approximately $1.6million, warrants to acquire 458,333 shares of the Company’s common stock thatwere granted to Catalyst in connection with the Loan Agreement in order toeliminate the put option contained in such warrants in favor of the holder ofsuch warrants. The Company also amended 91,667 warrants to delete the putoption feature. *See footnote 10 — Put Warrant Obligation.*

Catalyst was granted a “look back” right with respect to the exerciseprice of the warrants to acquire 458,333 shares of the Company’s common stockas follows.  In the event the Companyconsummates within one year, the disposition, by way of a sale, businesscombination, merger or other transaction by a corporation or other businessentity, of all or part of the Company’s outstanding capital stock or all orsubstantially all of the Company’s assets (each such transaction being hereincalled a “Transaction”), and the price per share of the Company’s common stockactually received by the Company’s shareholders or the Company pursuant to theterms of the Transaction is greater than $4.00, then, upon the consummation ofthe Transaction, the Company is required to pay Catalyst an amount equal to theproduct of (a) 458,333 and (b) the difference between (i) the priceper share of the Company’s common stock actually received by the Company’sshareholders or the Company pursuant to the terms of the Transaction and (ii)$4.00.

As of December 31, 2004 theCompany had available a credit line of $15,000,000 with the Highbridge/ZwirnOpportunities Fund, L.P. with no outstanding borrowings against this line.

 

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Long-term debt as of December 31,2004 and 2003 consisted of the following:

 
| **(In thousands)**                                                                                                                                                                                                                                                                                                                                                               | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Term loan payable to the Catalyst Fund Ltd., less a discount of  $446,384, at 12.5% interest, collateralized by a second lien on all Company  assets, payable in quarterly principal installments of $166,667 from January 1,  2004 until April 1, 2008. As of December 31, 2004, this loan has  been repaid.                                                     |       | $                      | —     |                   | $          | 2,833 |   |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Term loan payable to JTS Enterprises Inc., less a discount of  $110,679, at 12.5% interest, collateralized by a lien on all Company assets  subordinate to the term loan with The Catalyst Fund Ltd., payable in  quarterly principal installments of $36,111 from January 1, 2004 until  April 1, 2008. As of December 31, 2004, this loan has been repaid. |       | —                 |       | 614                    |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Note payable to officer, unsecured, accruing interest at 6%,  principal and accrued interest payable in full on or before May 1, 2006.  As of December 31, 2004, this loan has been repaid.                                                                                                                                                                            |       | —                 |       | 100                    |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Total Debt                                                                                                                                                                                                                                                                                                                                                                       |       | —                 |       | 3,547                  |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Less: discount for warrants                                                                                                                                                                                                                                                                                                                                                      |       | —                 |       | (557)                  |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Debt, net of discount                                                                                                                                                                                                                                                                                                                                                            |       | —                 |       | 2,990                  |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Less: current portion                                                                                                                                                                                                                                                                                                                                                            |       | —                 |       | (608)                  |       |
|                                                                                                                                                                                                                                                                                                                                                                             |       |                   |       |                   |       |
| Long-term debt, net of discount and current portion                                                                                                                                                                                                                                                                                                                              |       | $                      | —     |                   | $          | 2,382 |   |

**9. Commitments and Contingencies**

PurchaseCommitments

The Company acquires theforecasted balance of its electricity load needs for resale through advancecontract purchases. As of December 31, 2004, the Company had purchasecommitments for the future delivery of electricity in the amount of $86.7million for 2005, and $17.8 for 2006. The Company has no commitments forpurchases of electricity beyond December 31, 2006.
| **(In thousands)**          | ** ** | **Payments due by period** | ** ** |
|-----------------------------|------------|----------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                  | ** ** | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5 years** | ** ** |
| Forward power contracts     |       | $                          | 104,486    |   | $ | 86,698 |   | $ | 17,788 |   | $ | — |   | $ | — |   |
| Long-term debt              |       | —                     |       | — |   | — |   | — |   | — |   |
| Rent                        |       | 2,330                      |       | 383 |   | 766 |   | 766 |   | 415 |   |
|                        |       |                       |       |   |   |   |   |   |   |   |   |
| Total                       |       | $                          | 106,816    |   | $ | 87,081 |   | $ | 18,554 |   | $ | 766 |   | $ | 415 |   |
|                        |       |                       |       |   |   |   |   |   |   |   |   |
|                             |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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OperatingLeases

At December 31, 2004, the Company’s lease commitments included a rentalcontract through April 2007 for its old corporate offices, and a rentalcontract through January 2011 on the Company’s new corporate offices. Leaseexpense for the Company was approximately $423,000, $186,000 and $72,000 for theyears ended 2004, 2003 and 2002 respectively.

Long-Term Sales Contracts

TheCompany serves three categories of customers: commercial customers on long-termcontracts, commercial customers on month to month contracts, and residentialcustomers on month-to-month contracts. The Company strives to add long-term purchase commitments to match itslong-term sales.

**10. Puttable Warrant Obligation**

SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity,* was issued in May 2003 and requiresissuers to classify as liabilities (or assets under certain circumstances) freestanding financial instruments which, at inception, require or may require anissuer to settle an obligation by transferring assets. SFAS No. 150 waseffective for financial instruments entered into or modified after May 31, 2003and was otherwise effective at the beginning of the first interim periodbeginning after June 15, 2003.

SFAS No. 150 requiredwarrants issued under a term loan agreement with The Catalyst Fund Ltd. (“Catalyst”)and certain other warrants held by affiliates to be classified as a liability.In January of 2005, the holders of the warrants could have exercised theirrights to force the Company to repurchase the 550,000 common shares at thecurrent market price on the common stock, less the warrant exercise price of$1.00. The put feature could have been accelerated by a change of control or acapital offering in excess of $10 million; therefore, the Company could havebeen forced to purchase up to 550,000 shares of its own common stock at themarket price (less the $1 warrant exercise price) on the day the put option isexercised.

On July 8, 2004, 458,333 of these warrants were repurchased and theremaining 91,667 warrants were amended to delete the put option. At July 8,2004, our stock closed at $4.75 per share. The decrease in the market pricefrom the valuation at December 31, 2003 based on the close price of $8.50 pershare, on December 31, 2003, required us to record a decrease in the value ofthe puttable warrant obligation of $2.1 million for the year ended December 31,2004 as other financing income in accordance with SFAS No. 150.  Anadditional $0.7 million in gain on extinguishment of debt was recorded during2004. We also recorded $0.6 million of write-off of deferred financing cost and$0.3 million of transaction fees to interest expense during fiscal 2004, as aresult of the extinguishment of the debt.  As a result of the repurchaseand amendment of warrants the 

 

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ongoing income (expense)effect arising from the put option, as described above, will no longer be applicable.

General Contingency

The Company has establishedreserves that it believes to be adequate based on current evaluation and itsexperience in these types of claim situations. Nevertheless, an unexpectedoutcome in any such case could have a material adverse impact on the Company’sresults of operations in the period it occurs. Moreover, future adversedevelopments in such cases could require material changes in the recordedreserve amounts.

**11. Related PartyTransactions**

During the twelve months ended December 31, 2004, the Company completed aprivate placement with Perry Capital, Zimmer Lucas Partners, LLC, CorsairCapital Management and other accredited investors. This private placement alsoincluded the Company’s Chairman, CEO, and President, Neil M. Leibman, selling750,000 shares of Common Stock. Oppenheimer & Co. Inc. acted as theplacement agent for the transaction. *See Note 14, Shareholder’sEquity for more details on this private placement.*

During the twelve monthsended December 31, 2004, the Company repaid Neil Leibman, Chairman and CEO,approximately $125,000 for outstanding loans. Additionally, in connection withrepaying and terminating the Catalyst loan, a Consulting Agreement executed inconnection with the Catalyst loan was also terminated during this period. NeilLeibman, Chairman, President and CEO, and non-employee directors Bobby Orr, DonAron and Stuart Gaylor received the amounts due to them under the ConsultingAgreement, which were one-time cash payments equal to approximately $9,000,$9,000, $18,000, and $9,000 respectively.

**12. Adjustment of Prior Periods**

As described in Item 7,Management’s Discussion and Analysis, subsequent to December 31, 2003, theCompany determined that its revenues reported in reports on Form 10-QSB for thethree months and year to date ended June 30, 2003 and September 30, 2003 (whichwere based on the “billings” technique for estimating volumes delivered tocustomers) did not reflect the consideration of all information available atthe time to calculate a reasonable estimate of the Company’s revenues inaccordance with GAAP as discussed below.

Until November of 2002, the Company was not a Qualified SchedulingEntity (“QSE”), and therefore did not receive ERCOT supply and delivery volumeinformation with which to estimate electricity volumes delivered to itscustomers. The only data available to the Company to estimate deliveries tocustomers and therefore to estimate revenues were the billings sent tocustomers.  The use of actual billingswas the most appropriate and conservative technique for the following reasons:

 

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•                                          estimatingrevenue based on billings did not include in the revenue estimation lost orseverely late transactions (which were at high risk for bad debt classificationand in some instances were unbillable to customers due to their age),

•                                          the newness ofthe market created many technical difficulties with transactional flow and alsocreated concerns regarding accuracy and timeliness of information from ERCOT,and

•                                          since theCompany was not a QSE, the Company did not have access to daily ERCOTsettlement data (provided to all QSEs) until November 2002, and also did nothave access to final resettlement data from ERCOT showing final power deliveriesfor a given month until late 2003 (final resettlements are deliveredapproximately 6-7 months after the month end).

The billings technique wasdesigned to estimate revenue based on a 30-day period of billing that mostclosely approximated the flow month to which the revenue was being accrued. TheCompany assessed meter read cycles, billing dates and the time lag ofconverting meter reads to customer billings in attempting to determine thebilling dates appropriate for estimating monthly revenue. Typically, the 30-daybilling period included electricity deliveries that were made on days in thecurrent and subsequent months as meter readings typically cover a thirtyday-period, and occur throughout the month based on meter reading cyclesperformed by the transmission and distribution service provider.

**2003**

During 2003, the Company’smanagement used a variety of information to help ensure the accuracy of theestimated revenues, including daily estimates of power flow, knowledge ofweather patterns, knowledge of inaccuracies of billing information and/orsupply information, and expected power supply resettlements.

After the preparation of thethird quarter 2003 financial statements, the Company’s management began to morefully recognize the limitations of the billings technique, particularly asindicated by the volatility of the quarterly and monthly margin analysis.

In recognition of these limitations, in November 2003, the Companychanged its revenue estimation technique to the “flow” technique.  In the latter half of 2003, the Companydetermined that the market was operating at a point of efficiency that made itpossible for the Company to begin accruing revenue based on ERCOT settlementsof power deliveries, and given the limitations of the billings technique notedabove, the Company chose to change to the flow technique.  In addition, by the end of 2003, the Companyhad sufficient initial settlement and resettlement data from ERCOT to arrive ata reasonable estimate for 2003 revenues assuming that the flow method had beenin place since January 1, 2003.

 

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As described above, thebillings technique includes delivered volumes from future months in the monthfor which volumes are being estimated. In periods of relatively low growth, this characteristic should not havea material effect on the accuracy of the estimation.  However, in periods of strong customer growthand utilization, such as occurred during the second half of 2003, including thebillings from a future period may overestimate the revenue for the period beingreported.

Additionally, the Companyconducted an exhaustive review of the application of the billings technique forJanuary-October 2003, which revealed that during the second and third quarters,the estimated energy revenue appears to be overstated when compared to othermethods and information available.  Thisoverestimation appears to be the result of much higher power usage of customersin subsequent periods, which were included in the reported period.  This resulted in higher reported revenue forthe second and third quarters than what should have been accrued.

Pursuant to applicableaccounting guidance, reporting the correction of an error in previously issuedfinancial statements should be reported as a prior period adjustment.  The nature of the error in previously issuedfinancial statements and the effect of its correction on income beforeextraordinary item, net income, and the related per share amount should bedisclosed in the period in which the error was discovered and corrected.  Since the error was discovered and correctedduring the preparation of the 2003 10-KSB, the corrections for the second andthird quarter of 2003 are disclosed in the 2003 10-KSB.

These adjustments resultedin a redistribution of revenues across the second, third, and fourth quartersof 2003.  Cash flow for the second,third, and fourth quarters of 2003 was not affected by these changes.

Information regarding the adjustments is provided below as it relates tochanges in the Statement of Operations, specifically for adjusted sales, incomefrom operations, net income available to common shareholders and net income(loss) per share for the three months and year-to-date periods ending June 30,2003 and September 30, 2003.

 

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| **(In thousands, except per share amounts)**       | ** ** | ** **                   | ** ** | ** **       | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|------------------|------------|
| **Three months ended June 30, 2003**               | ** ** | **As Reported  Previously**  | ** ** | **As Adjusted**  | ** ** |
|                                               |       |                         |       |             |       |
| Sales                                              |       | $                            | 23,516     |             | $          | 21,448 |   |
|                                               |       |                         |       |             |       |
| Income (loss) from operations                      |       | 1,583                        |       | (31              | )          |
|                                               |       |                         |       |             |       |
| Net Income (loss) available to common shareholders |       | 937                          |       | (80              | )          |
|                                               |       |                         |       |             |       |
| Basic net income (loss) per share                  |       | 0.12                         |       | (0.01            | )          |
|                                               |       |                         |       |             |       |
| Diluted net income (loss) per share                |       | $                            | 0.11       |             | $          | (0.01 | ) |
|                                               |       |                         |       |             |       |
| **Six  months ended June 30, 2003**                | ** ** | **As  Reported  Previously** | ** ** | **As  Adjusted** |       |
|                                               |       |                         |       |             |       |
| Sales                                              |       | $                            | 36,436     |             | $          | 34,368 |   |
|                                               |       |                         |       |             |       |
| Income (loss) from operations                      |       | 1,197                        |       | (417             | )          |
|                                               |       |                         |       |             |       |
| Net Income (loss) available to common shareholders |       | 678                          |       | (340             | )          |
|                                               |       |                         |       |             |       |
| Basic net income (loss) per share                  |       | 0.09                         |       | (0.04            | )          |
|                                               |       |                         |       |             |       |
| Diluted net income (loss) per share                |       | $                            | 0.09       |             | $          | (0.04 | ) |
|                                               |       |                         |       |             |       |
| **Three  months ended September 30, 2003**         | ** ** | **As  Reported  Previously** | ** ** | **As  Adjusted** |       |
|                                               |       |                         |       |             |       |
| Sales                                              |       | $                            | 41,690     |             | $          | 39,644 |   |
|                                               |       |                         |       |             |       |
| Income from operations                             |       | 3,664                        |       | 2,046            |       |
|                                               |       |                         |       |             |       |
| Net Income available to common shareholders        |       | 2,027                        |       | 1,006            |       |
|                                               |       |                         |       |             |       |
| Basic net income per share                         |       | 0.27                         |       | 0.13             |       |
|                                               |       |                         |       |             |       |
| Diluted net income per share                       |       | $                            | 0.25       |             | $          | 0.13 |   |
|                                               |       |                         |       |             |       |
| **Nine  months ended September 30, 2003**          | ** ** | **As  Reported  Previously** | ** ** | **As  Adjusted** |       |
|                                               |       |                         |       |             |       |
| Sales                                              |       | $                            | 78,127     |             | $          | 74,012 |   |
|                                               |       |                         |       |             |       |
| Income from operations                             |       | 4,861                        |       | 1,629            |       |
|                                               |       |                         |       |             |       |
| Net Income available to common shareholders        |       | 2,769                        |       | 732              |       |
|                                               |       |                         |       |             |       |
| Basic net income per share                         |       | 0.36                         |       | 0.10             |       |
|                                               |       |                         |       |             |       |
| Diluted net income per share                       |       | $                            | 0.36       |             | $          | 0.10 |   |

 

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**13. Earnings Per Share**

 

                Basic earnings per share is computed based on weighted average sharesoutstanding and excludes dilutive securities. Diluted earnings per share arecomputed including the impacts of all potentially dilutive securities. Thefollowing table sets forth the computation of basic and diluted earnings pershare for the years ended December 31, 2004, 2003 and 2002:

 
| **(In thousands)**                                 | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
|                                               |       |                  |       |                  |       |                  |       |
| **Numerator:**                                     |       |                  |       |                  |       |                  |       |
| Net Income (loss)                                  |       | $                     | 8,182      |                  | $          | (2,196)               |       | $ | 640 |   |
| Preferred stock dividend                           |       | —                |       | (167)                 |       | (50)                  |       |
|                                               |       |                  |       |                  |       |                  |       |
| Net Income (loss) available to common stockholders |       | $                     | 8,182      |                  | $          | (2,363)               |       | $ | 590 |   |
|                                               |       |                  |       |                  |       |                  |       |
| **Denominator:**                                   |       |                  |       |                  |       |                  |       |
| Basic weighted average shares outstanding          |       | 8,606                 |       | 7,647                 |       | 7,328                 |       |
| Effect of dilutive securities:                     |       |                  |       |                  |       |                  |       |
| Stock options issued to employees and directors    |       | 1,054                 |       | —                |       | 187                   |       |
| Warrants issued for services                       |       | 175                   |       | —                |       | —                |       |
| Assumed conversion of convertible preferred stock  |       | —                |       | —                |       | 474                   |       |
|                                               |       |                  |       |                  |       |                  |       |
| Adjusted weighted average shares outstanding       |       | 9,835                 |       | 7,647                 |       | 7,989                 |       |
|                                               |       |                  |       |                  |       |                  |       |
| Basic earnings (loss) per share                    |       | $                     | 0.95       |                  | $          | (0.31)                |       | $ | 0.08 |   |
| Diluted earnings (loss) per share                  |       | 0.83                  |       | (0.31)                |       | 0.07                  |       |

 

**               **For the twelve months ended December 31, 2004,there were no common share equivalents that would have been anti-dilutiveand  therefore not used in thecomputation of diluted weighted average shares.

 

                For the twelve months endedDecember 31, 2003, there were 754,378 common share equivalents that would havebeen anti-dilutive and are therefore not used in the computation of dilutedweighted average shares.

 

                For the twelve months endedDecember 31, 2002, there were 685 common share equivalents that would have beenanti-dilutive and are therefore not used in the computation of diluted weightedaverage shares.

 

**14. Shareholder’s Equity**

 

**Stock Options & Stock Warrants**

 

                During the twelve months ended, 2004, theCompany, in connection with the closing of the Highbridge/Zwirn Credit Facility,issued warrants to purchase 125,000

 

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shares of Company commonstock as a commission to Prospect Street Ventures Ltd. for an exercise price of$4.00 per share. In addition, the Company, also in connection with the closingof the Highbridge/Zwirn Credit Facility, issued to Highbridge/Zwirn SpecialOpportunities Fund, L.P. warrants to purchase 150,000 shares of Company commonstock for an exercise price of $4.00.

                During the twelve months ended December 31,2004, the Company entered into a Severance Agreement with James Burke, theCompany’s former President and Chief Operating Officer. As part of his exitfrom the Company, if there is a “change of control” as defined in his severanceagreement on or before December 31, 2005, options for Mr. Burke to purchase anadditional 116,667 shares of common stock will vest.  If the change in control does not occur on orbefore December 31, 2005, the 116,667 option shares of the Company’s commonstock will not vest and will thus be cancelled.

                Duringthe twelve months ended December 31, 2004, the Board of Directors, subject toshareholder approval, adopted the 2004 Incentive Plan, which provides for theissuance of up to 1.5 million shares of common stock pursuant to incentiveawards under the plan.  During the twelve months ended December31, 2004, 930,000 options were issued to officers and employees and 100,000options were issued to non-employee directors under the 2004 Incentive Plan.These options were issued with exercise prices ranging from $4.50 to $5.51. Seethe stock option table below for detailed weighted average share information.

                During the twelve months endedDecember 31, 2004, the Company negotiated an agreement to settle a lawsuit withCapello Capital Corp. The settlement involves in part the issuance of 400,000warrants with an exercise price of $4.50 to Capello Capital Corp.

                Theassumptions used to value these warrants are presented below :
| **Input Variables**                   | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|------------|
|                                  |       |       |       |
| Stock price (at market)               |       | $          | 4.05       |       |
| Exercise price                        |       | 4.50       |       |
| Term (in yrs)                         |       | 3.0        |       |
| Volatility                            |       | 36         | %          |
| Annual rate of quarterly dividends    |       | 0          |       |
| Discount rate - bond equivalent yield |       | 3          | %          |
|                                       |            |            |            |            |  |

 

                These 400,000 warrants were valued at approximately$390,000.

                During the twelve months endedDecember 31, 2004, the Company completed a private placement with PerryCapital, Zimmer Lucas Partners, LLC, Corsair Capital Management and otheraccredited investors of 175,000 equity units at $43.00 per Unit for aggregategross proceeds of $7,525,000. Each unit sold in the Private Placement

 

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consisted of 10 shares ofthe Company’s common stock, $0.1 par value and three 5-year warrants topurchase 1 share of the Company’s common stock. In total, the Company sold1,000,000 shares of common stock and 525,000 warrants, and Neil M. Leibman, theCompany’s Chairman and CEO sold 750,000 shares of common stock. Oppenheimer& Co. Inc. acted as the placement agent for the transaction. These warrantswere issued to the accredited investors mentioned above and to Oppenheimer& Co. Inc. These warrants were fair valued using the Black Scholes model.The assumptions used to value these warrants, are presented below:

                The assumptions used to valuethese warrants are presented below:

 
| **Input Variables**                   | ** ** |   |   |   |
|---------------------------------------|------------|--------|--------|--------|
|                                  |       |   |   |
| Stock price (at market)               |       | $      | 4.25   |   |
| Exercise price                        |       | 5.59   |   |
| Term (in yrs)                         |       | 3      |   |
| Volatility                            |       | 36     | %      |
| Annual rate of quarterly dividends    |       | 0      |   |
| Discount rate - bond equivalent yield |       | 3      | %      |
|                                       |            |        |        |        |  |

 

                These 525,000 warrants were valued at approximately$400,000.

 

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                Stock optionactivity for the years ended December 31, 2002, 2003, and 2004 is set forthbelow:

 
| ** **                              | ** ** | ** **             | ** ** | ** **                        | ** ** | ** **         | ** ** | ** **                | ** ** | **Weighted Average Per Share** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------------------|------------|--------------------|------------|---------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **Number of  Options** | ** ** | **Option Price Range Per  Share** | ** ** | **Exercise Price** | ** ** | **Grant Date Fair Value** | ** ** |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Options oustanding at December 31, 2001 |       | 600,000                |       | $                                 | 1.50       |               | -          |                      | $          | 1.50                           |       | $ | 1.50 |   | $ | 1.38 |   |
| Granted                                 |       | 250,000                |       | 2.00                              |       | -                  |       | 2.00                      |       | 2.00                           |       | 1.70 |   |
| Exercised                               |       | —                 |       | —                            |       |               |       | —                    |       | —                         |       | — |   |
| Canceled                                |       | —                 |       | —                            |       |               |       | —                    |       | —                         |       | — |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Options oustanding at December 31, 2002 |       | 850,000                |       | 1.50                              |       | -                  |       | 2.00                      |       | 1.65                           |       | 1.47 |   |
| Granted                                 |       | 1,000,000              |       | 1.00                              |       | -                  |       | 2.25                      |       | 1.89                           |       | 1.80 |   |
| Exercised                               |       | —                 |       | —                            |       |               |       | —                    |       | —                         |       | — |   |
| Canceled                                |       | (300,000               | )          | 1.50                              |       | -                  |       | 1.50                      |       | 1.50                           |       | 1.38 |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Options oustanding at December 31, 2003 |       | 1,550,000              |       | 1.00                              |       |               |       | 2.25                      |       | 1.83                           |       | 1.70 |   |
| Granted                                 |       | 1,030,000              |       | 4.35                              |       | -                  |       | 5.51                      |       | 4.67                           |       | 1.39 |   |
| Exercised                               |       | —                 |       | —                            |       |               |       | —                    |       | —                         |       | — |   |
| Canceled                                |       | (100,000               | )          | 4.35                              |       | -                  |       | 4.35                      |       | 4.35                           |       | 1.39 |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Options oustanding at December 31, 2004 |       | 2,480,000              |       | 1.00                              |       | -                  |       | 5.51                      |       | 2.91                           |       | 1.59 |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Exercisable at December 31, 2002        |       | 600,000                |       |                              |       |               |       |                      |       |                           |       |   |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Exercisable at December 31, 2003        |       | 942,000                |       |                              |       |               |       |                      |       |                           |       |   |   |
|                                    |       |                   |       |                              |       |               |       |                      |       |                           |       |   |   |
| Exercisable at December 31, 2004        |       | 1,466,800              |       |                              |       |               |       |                      |       |                           |       |   |   |
|                                         |            |                        |            |                                   |            |                    |            |                           |            |                                |            |  |  |  |  |  |  |

 

                The weighted average characteristics of stock optionsoutstanding as of December 31, 2004 were as follows:
| **Range of Exercise Prices** | ** ** | **Number of Shares  Outstanding** | ** ** | **Average Remaining  Contractual Life  (Yrs.)** | ** ** | **Shares  Exercisable** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|------------------------------|------------|-----------------------------------|------------|-------------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|
|                         |       |                              |       |                                            |       |                    |       |                                 |       |
| $ 1.00 - $1.50          |       | 650,000                           |       | 1.4                                             |       | 650,000                 |       | $                                    | 1.50       |   |
| $ 2.00 - $2.25          |       | 900,000                           |       | 2.7                                             |       | 775,050                 |       | $                                    | 2.10       |   |
| $ 4.56 - $5.51          |       | 930,000                           |       | 10.0                                            |       | 41,750                  |       | $                                    | 4.70       |   |
|                         |       |                              |       |                                            |       |                    |       |                                 |       |
| $ 1.00 - $5.51          |       | 2,480,000                         |       | 5.09                                            |       | 1,466,800               |       | $                                    | 2.91       |   |

                The fair value of each option grant is estimated on the date of grant usingthe Black-Scholes option-pricing model with the following weighted averageassumptions used for options issued in 2002 and 2003: risk-free interest rateof 3.0% for 2003 and 3% for 2004; expected lives of three years, assumedvolatility of 124% for 2003 and 36-176% for 2004; and no expected dividends.

 

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                Stock warrant activity is set forth below:

 
| ** **                               | ** ** | ** **              | ** ** | ** **                         | ** ** | ** **          | ** ** | ** **                 | ** ** | **Weighted Average Per Share** | ** ** |
|------------------------------------------|------------|-------------------------|------------|------------------------------------|------------|---------------------|------------|----------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **Number of  Warrants** | ** ** | **Warrant Price Range Per  Share** | ** ** | **Exercise  Price** | ** ** | **Grant Date Fair  Value** | ** ** |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Warrants oustanding at December 31, 2001 |       | $                       | —     |                               | $          | —              |       |                       |       | $                              | —     |   | $ | — |   | $ | — |   |
| Granted                                  |       | 100,000                 |       | 1.25                               |       | -                   |       | 1.25                       |       | 1.25                           |       | 2.29 |   |
| Exercised                                |       | —                  |       | —                             |       |                |       | —                     |       | —                         |       | — |   |
| Canceled                                 |       | —                  |       | —                             |       |                |       | —                     |       | —                         |       | — |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Warrants oustanding at December 31, 2002 |       | 100,000                 |       | 1.25                               |       | -                   |       | 1.25                       |       | 1.25                           |       | 2.29 |   |
| Granted                                  |       | 931,000                 |       | 1.00                               |       | -                   |       | 1.00                       |       | 1.00                           |       | 1.60 |   |
| Exercised                                |       | —                  |       | —                             |       |                |       | —                     |       | —                         |       | — |   |
| Canceled                                 |       | (300,000                | )          | 1.00                               |       | -                   |       | 1.00                       |       | 1.00                           |       | 1.51 |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Warrants oustanding at December 31, 2003 |       | 731,000                 |       | 1.00                               |       | -                   |       | 1.25                       |       | 1.03                           |       | 1.73 |   |
| Granted                                  |       | 1,359,250               |       | 4.00                               |       | -                   |       | 6.02                       |       | 5.00                           |       | 1.01 |   |
| Exercised                                |       | (199,334                | )          | 1.00                               |       | -                   |       | 1.25                       |       | 1.13                           |       | 1.97 |   |
| Canceled                                 |       | —                  |       | —                             |       |                |       | —                     |       | —                         |       | — |   |
| Repurchased                              |       | (458,333                | )          | 1.00                               |       | -                   |       | 1.00                       |       | 1.00                           |       | 1.64 |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Warrants oustanding at December 31, 2004 |       | 1,432,583               |       | 1.00                               |       | -                   |       | 6.02                       |       | 4.79                           |       | 1.04 |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Exercisable at December 31, 2002         |       | 100,000                 |       |                               |       |                |       |                       |       |                           |       |   |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Exercisable at December 31, 2003         |       | 731,000                 |       |                               |       |                |       |                       |       |                           |       |   |   |
|                                     |       |                    |       |                               |       |                |       |                       |       |                           |       |   |   |
| Exercisable at December 31, 2004         |       | 1,432,583               |       |                               |       |                |       |                       |       |                           |       |   |   |
|                                          |            |                         |            |                                    |            |                     |            |                            |            |                                |            |  |  |  |  |  |  |  |

 

                The weighted average characteristics of stockwarrants outstanding as of December 31, 2004 were as follows:
| **Range of Exercise Prices** | ** ** | **Number of Shares  Outstanding** | ** ** | **Average Remaining   Contractual Life  (Yrs.)** | ** ** | **Shares  Exercisable** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|
|                         |       |                              |       |                                             |       |                    |       |                                 |       |
| $ 1.00 - $1.25          |       | 73,333                            |       | 0.6                                              |       | 73,333                  |       | $                                    | 1.00       |   |
| $ 4.00 - $6.02          |       | 1,359,250                         |       | 4.8                                              |       | 1,359,250               |       | $                                    | 5.00       |   |
|                         |       |                              |       |                                             |       |                    |       |                                 |       |
|                         |       | 1,432,583                         |       | 4.6                                              |       | 1,432,583               |       | $                                    | 4.80       |   |

 

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**15. Income Taxes**

Theprovision for income taxes consisted of the following for theyears presented below:
| **(In thousands)**       | ** ** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|--------------------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
|                     |       |       |                  |       |                  |       |                  |
| Current:                 |       |       |                  |       |                  |       |                  |
| Federal                  |       | $          | 3,649                 |       | $                     | 1,357      |                  | $          | 368 |   |
| State                    |       | 521        |                  | 119        |                  | —     |                  |
| Deferred benefit         |       | (136       | )                     | (554       | )                     | (37        | )                     |
|                     |       |       |                  |       |                  |       |                  |
| Total income tax expense |       | $          | 4,034                 |       | $                     | 922        |                  | $          | 331 |   |

 

Thedeferred tax asset at December 31, 2004 and 2003 respectively was comprised ofthe following:
| ** **                | ** ** | **2004**   | ** **  | **2003**   | ** **      |
|---------------------------|------------|------------|-------------|------------|-----------------|
| **(In thousands)**        | ** ** | ** ** | **Current** | ** ** | **Non Current** | ** ** | **Current** | ** ** | **Non Current** | ** ** |
|                      |       |       |        |       |            |   |   |   |   |
| Allowance for bad debts   |       | $          | 827         |       | $               | — |   | $ | 442 |   | $ | — |   |
| Unamortized billings      |       | 21         |        | 21         |            | 16 |   | — |   |
| Restricted stock grant    |       | (10        | )           | —     |            | — |   | — |   |
| Capitalized labor         |       | —     |        | (44        | )               | — |   | 48 |   |
| Capitalized software      |       | —     |        | (11        | )               | — |   | — |   |
| Former officers options   |       | —     |        | 244        |            | — |   | 244 |   |
| Related party interest    |       | 3          |        | —     |            | — |   | — |   |
| Investment in partnership |       | —     |        | 5          |            | — |   | — |   |
| Depreciation              |       | —     |        | (170       | )               | — |   | — |   |
|                      |       |       |        |       |            |   |   |   |   |
| Total deferred tax assets |       | $          | 841         |       | $               | 45 |   | $ | 458 |   | $ | 292 |   |
|                           |            |            |             |            |                 |  |  |  |  |  |  |  |  |  |

 

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The differences between income taxes computed for federaltaxes at 34% from the provision for income taxes for the years ended, December31, 2004, 2003, and 2002 are as follows:

 
| ** **                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                  |       |     |       |     |       |     |       |
| Earnings (loss) before income taxes                   |       | $        | 12,216     |     | $          | (1,274   | )          | $ | 971 |   |
|                                                  |       |     |       |     |       |     |       |
| Federal statutory rate                                |       | 34       | %          | 34       | %          | 34       | %          |
|                                                  |       |     |       |     |       |     |       |
| Income tax expense (benefit) at statutory rate        |       | $        | 4,153      |     | $          | (433     | )          | $ | 330 |   |
|                                                  |       |     |       |     |       |     |       |
| Net addition (reduction) in taxes resulting from:     |       |     |       |     |       |     |       |
|                                                  |       |     |       |     |       |     |       |
| State income taxes, net of federal income tax benefit |       | $        | 344        |     | $          | 78       |       | $ | — |   |
| Other financing expense (income)                      |       | (701     | )          | 1,342    |       | —   |       |
| Penalties and interest                                |       | 311      |       | —   |       | —   |       |
| Other, net                                            |       | (73      | )          | (65      | )          | 1        |       |
|                                                  |       |     |       |     |       |     |       |
| Total                                                 |       | $        | (119       | )        | $          | 1,355    |       | $ | 1 |   |
|                                                  |       |     |       |     |       |     |       |
| Income tax expense                                    |       | $        | 4,034      |     | $          | 922      |       | $ | 331 |   |

 

**16. Employee Benefits**

TheCompany offers a preferred provider health plan to all full-time employeesafter the first month of full time service. The Company pays for 75% of theemployee’s coverage, with the employee responsible for the remaining 25% plusany expenses for added family members. The Company also offers dental insuranceat employee expense and a defined contribution plan, both of which become availableafter one month of full time service. The defined contribution plan isavailable to all employees. At this time, the Company is not offering matchingcontributions pursuant to the defined contribution plan.

**17. LegalProceedings**

                During 2003, we were sued in the matter of KyleHolland vs. Gexa Corp. et al. in the United States District Court, WesternDistrict of Texas. Mr. Holland alleged damages in connection with hisacquisition of our common stock.  The complaintseeks unspecified damages.  On March 15,2005, this case was dismissed without prejudice for failure to state aclaim.  While this lawsuit could berefiled at a later date, we believe the lawsuit has no merit and willvigorously defend any such refiled action.

                OnJuly 15, 2004, a class action lawsuit Frederick T. Pappey, et al. vs. GexaCorp., Neil Leibman, Marcie Zlotnik and Sarah Veach, Civil ActionNo. H-04-2869, was filed in the United States District Court for theSouthern District of Texas, Houston District. The complaint alleges, amongother things, that our publicly filed reports and public statements containedfalse and misleading information, which resulted in damages to the plaintiffand members of the proposed class when they purchased our securities.Specifically, the complaint alleges that we overstated revenue during thesecond and third quarters of 2003 by $2.07 million and $2.05 million,respectively, by utilizing an improper accounting

 

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methodfor calculating sales of electric power. The complaint alleges that our conductand the conduct of the other defendants violated Sections 10(b) and 10b-5 andthat the individual defendants violated Section 20(a) of the SecuritiesExchange Act of 1934. The complaint seeks unspecified damages. OnDecember 20, 2004, the lawsuit was dismissed without prejudice. While thislawsuit could be refiled at a later date, we believe the lawsuit has no meritand will vigorously defend any such refiled action.

                On November 30, 2004, we entered into asettlement with Capello Capital Corp. (“Capello”) relating to the matter ofCapello Capital Corp. vs. Gexa Corp, originally filed in the Los AngelesSuperior Court-West District. Capello’s complaint had alleged a breach ofcontract regarding investment banker fees being claimed by Capello inconnection with the credit facility with Highbridge/Zwirn Special OpportunitiesFund, L.P. In exchange for Capello’s agreement to dismiss the lawsuit andrelease its claims against us, we agreed to: (i) pay Capello $275,000,(ii) issue to Capello warrants dated November 1, 2004, to purchase400,000 shares of our common stock at an exercise price of $4.50 per share and(iii) issue to Capello an interest free unsecured promissory note in theprincipal amount of $500,000. We accrued $1.2 million in the third quarterof 2004 in investment banking charges to other assets as deferred financingcost to be amortized over the life of the Highbridge facility.

                On December 2, 2004, we were sued in the matter ofEssential Utilities Corporation v. Gexa Energy Corp., Cause No. 04-12056, inthe 191st District Court of Dallas County, Texas.  The petition alleges breach of contract,quantum meruit, conversion and unjust enrichment in connection with the allegednonpayment of consultation fees.  Theamount of the claim is unknown.  Thiscase is in the preliminary stages and we intend to contest this suitvigorously.

                On January 31, 2005, a lawsuit styled Griffin/JubanCapital Management, L.L.C. d/b/a GC Realty Services v. Gexa Corporation wasfiled in the 11th Judicial District Court of Harris County, Texas.  This lawsuit claims that we agreed to provideContinental Airlines frequent flyer miles to the plaintiff in turn for doingbusiness with us.  The plaintiff has suedus for breach of contract, fraud and negligent misrepresentation.  The amount of damages sought in the lawsuitis unknown.  This case is in thepreliminary stages and we intend to contest this suit vigorously.

                On or about February 11, 2005, we were made aware ofa potential lawsuit that may be filed by Prenova, Inc. and 24 Hour Fitness USA,Inc. against us and XERS, Inc. d/b/a XCEL Energy, Inc.  The proposed complaint claims that we failedto timely provide electrical service to 24 Hour Fitness and, as a result, theyincurred substantial damages in the form of significantly higher rates forseveral months in 2004.  The plaintiffsclaim damages in the amount of $150,000.00 plus interest and attorneys’fees.  If filed, we intend to contestthis suit vigorously.

                Weare also involved in various receivable collections matters as a plaintiff. Webelieve that there are no pendingmatters that will have asignificant impact on our financial position or results of operations.

 

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**18. Concentration of Credit Risk**

For thefiscal years ended December 31, 2004 and 2003, the Company has a creditsupport agreement with TXU that allows the Company to purchase power from TXUor other third party suppliers.

As ofDecember 31, 2004, the Company has secured numerous large commercial customers**:**however none is of sufficient size to have a significant negative impact on ourcash flow or ability to continue operations in the event of default, refusal topay, or undue delay in payment. For the years endedDecember 31, 2004 and2003, no single customer accounted for more than 3%of revenues. All of the Company’s customers were located in Texas for the yearsended December 31, 2004, 2003, and 2002.

**19.Subsequent Events (unaudited)**

**Merger**

On March 28, 2005 theCompany and FPL Group, Inc., a Florida corporation (“FPL Group”), announced theexecution of an Agreement and Plan of Merger, dated as of March 28, 2005 (the“Merger Agreement”), by and among FRM Holdings, LLC, a Delaware limitedliability company (“FRM Holdings”), WPRM Acquisition Subsidiary, Inc., a Texascorporation and a wholly owned subsidiary of Holdings (“Merger Sub”), FPL Groupand the Company, pursuant to which, subject to the satisfaction or waiver ofthe conditions therein, Merger Sub will merge with and into the Company (the“Merger”).  As a result of the Merger,the Company will become an indirect wholly owned subsidiary of FPL Group.  The Merger is intended to qualify as atax-free reorganization under Section 368(a) of the Internal Revenue Code of1986, as amended.

Atthe effective time of the Merger (the “Effective Time”), each share of Companycommon stock issued and outstanding immediately prior to the Effective Time(other than treasury shares) will be cancelled and automatically convert intothe right to receive $6.88, payable in shares of validly issued, fully paid andnon-assessable shares of FPL Group common stock, based on an exchange ratioequal to the quotient (rounded to four decimal points) obtained by dividing$6.88 by the average of the daily closing sale prices of FPL Group common stockfor the 10 consecutive trading days ending on the third business day (includingsuch third business day) immediately prior to the closing date.  In addition, at the Effective Time, each optionand warrant to purchase shares of Company common stock outstanding immediatelyprior to the Effective Time will be assumed by FPL Group and converted into theright to purchase shares of FPL Group common stock with correspondingadjustments to the exercise price based upon the foregoing exchange ratio, butotherwise will remain unchanged except that vesting of the options will beaccelerated at the Effective Time.

Simultaneouslywith the execution of the Merger Agreement, certain directors and officers ofthe Company holding approximately 36% of the outstanding Company common stock,including its Chairman and CEO, entered into a Voting Agreement with FPL Group,pursuant to which, they agreed to vote their shares of Company common stock infavor of the Merger, the Merger Agreement and the transactions contemplatedthereby.  In the event that suchdirectors and officers fail to so vote, the Voting Agreement provides for thegrant proxies to FPL Group to vote and otherwise act with respect to suchshares of Company common stock at any meeting of shareholders or consent inlieu of any such meeting or otherwise, on the Merger, the Merger Agreement andthe transactions contemplated thereby.

TheCompany has made customary representations and warranties and covenants in theMerger Agreement, including among others (i) to conduct its businesses in theordinary course between the execution of the Merger Agreement and theconsummation of the Merger, (ii) to cause a meeting of the Company’sshareholders to be held to consider the adoption of the Merger Agreement, (iii)subject to certain exceptions, for the Company’s board of directors torecommend that the Company’s shareholders adopt and approve the MergerAgreement, and (iv) subject to certain exceptions, not to (A) solicit proposalsrelating to alternative business combination transactions or (B) enter intodiscussions concerning or provide information in connection with alternativebusiness combination transactions.

Consummationof the Merger is subject to customary conditions, including, among others, (i)approval of the Company’s shareholders, (ii) expiration or termination of theapplicable Hart-Scott-Rodino Act waiting period, (iii) approval by theCommission of Texas (the “PUCT”) of an amendment application regarding thechange of ownership of the Company with respect to its retail electric providerlicense and, if required by the PUCT, of an application for recertification,(iv) absence of any order or injunction prohibiting the consummation of theMerger, (v) the Company having $13.5 million of Working Capital (as defined inthe Merger Agreement) as of month end not ending more than 60 days prior toclosing, (vi) subject to certain exceptions, the accuracy of representationsand warranties with respect to the Company’s or FPL Group’s business, asapplicable, and (vii) receipt of customary tax opinions.  The Merger Agreement contains certaintermination rights and provides that, upon the termination of the MergerAgreement under specified circumstances, the Company will be required to payFPL Group a termination fee of $3.25 million.

 

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Theforegoing description of the Merger Agreement does not purport to be completeand is qualified in its entirety by reference to the full text of the MergerAgreement, included as Exhibit 2.2 in this 10-K and incorporated herein byreference.

TheCompany also amended the Amended and Restated Employment Agreement, dated as ofOctober 28, 2004, between the Company and Neil M. Leibman, the Company’sChairman and CEO (the “Employment Agreement”), to exclude the consummation ofthe Merger and the other transactions contemplated by the Merger Agreement fromcertain payments he would otherwise be entitled to receive in the event of achange in control transaction.  Theforegoing description of the amendment to the Employment Agreement does notpurport to be complete and is qualified in its entirety by reference to thefull text of the amendment to the Employment Agreement, included as Exhibit10.20 to this 10-K and incorporated herein by reference.

Atthe Effective Time, Mr. Leibman will be employed by the Company as itsPresident, and will be compensated pursuant to a new Employment Agreement withthe Company, and the Employment Agreement, as amended by the amendment to theEmployment Agreement, will automatically be terminated.

**Controlsand Procedures**

Wehave also recently undertaken certain changes in our disclosure controls andprocedures in connection with a material weakness letter we received from ourindependent auditors, Hein & Associates, LLP on March 25, 2005.  Further information regarding these changesis set forth herein in Item 9A. “Controls and Procedures — Changes toDisclosure Controls and Procedures.”

**20.Consolidated Quarterly Data (Unaudited)**
| ** **                                           | ** ** | **Fiscal 2004**  | ** ** |
|------------------------------------------------------|------------|------------------|------------|
| ** **                                           | ** ** | **First**        | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total** | ** ** |
| **(In thousands, except per share data)**            | ** ** | **Quarter**      | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Year** | ** ** |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Sales                                                |       | $                | 50,513     |   | $ | 62,025 |   | $ | 86,781 |   | $ | 74,575 |   | $ | 273,894 |   |
| Gross profit                                         |       | 7,365            |       | 8,073 |   | 10,196 |   | 10,054 |   | 35,688 |   |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings from operations                         |       | 2,664            |       | 2,409 |   | 2,794 |   | 3,677 |   | 11,544 |   |
| Net earnings                                         |       | $                | 3,492      |   | $ | 1,659 |   | $ | 1,057 |   | $ | 1,974 |   | $ | 8,182 |   |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings per share:                              |       |             |       |   |   |   |   |   |   |   |   |
| Basic                                                |       | $                | 0.42       |   | $ | 0.20 |   | $ | 0.12 |   | $ | 0.22 |   | $ | 0.95 |   |
| Diluted                                              |       | $                | 0.37       |   | $ | 0.17 |   | $ | 0.11 |   | $ | 0.19 |   | $ | 0.83 |   |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| ** **                                           | ** ** | **Fiscal  2003** | ** ** |
| ** **                                           | ** ** | **First**        | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total** |   |
| **(In  thousands, except per share data)**           | ** ** | **Quarter**      | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Year** |   |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Sales                                                |       | $                | 12,920     |   | $ | 21,448 |   | $ | 39,644 |   | $ | 41,131 |   | $ | 115,143 |   |
| Gross profit                                         |       | 1,272            |       | 2,584 |   | 5,706 |   | 5,884 |   | 15,446 |   |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings (loss) from operations                  |       | (386             | )          | (31 | ) | 2,046 |   | 1,155 |   | 2,784 |   |
| Net earnings (loss) available to common shareholders |       | $                | (301       | ) | $ | (80 | ) | $ | 1,007 |   | $ | (2,989 | ) | $ | (2,363 | ) |
|                                                 |       |             |       |   |   |   |   |   |   |   |   |
| Basic                                                |       | $                | (.04       | ) | $ | (.01 | ) | $ | 0.13 |   | $ | (0.39 | ) | $ | (0.31 | ) |
| Diluted                                              |       | $                | (.04       | ) | $ | (.01 | ) | $ | 0.13 |   | $ | (0.39 | ) | $ | (0.31 | ) |

 

90

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** **

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

 

Tothe Board of Directors and Shareholders

GexaCorp.

Houston,Texas

 

Wehave audited in accordance with auditing standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements of Gexa Corp. included in this Form 10-K and have issued our reportthereon dated March 25, 2005. Our audits were made for the purpose of formingan opinion on the basic financial statements taken as a whole. The financial statementschedule listed below (Schedule II — Valuation and Qualifying Accounts) is theresponsibility of the Company’s management and is presented for the purpose ofcomplying with the Securities and Exchange Commission’s rules and is not partof the basic financial statements. The financial statement schedule has beensubjected to the auditing procedures applied in the audits of the basicfinancial statements and, in our opinion, is fairly stated in all material respectswith the financial data required to be set forth therein in relation to thebasic financial statements taken as a whole.

 
| /s/ HEIN & ASSOCIATES LLP |
|-------------------------------|
| HEIN & ASSOCIATES LLP     |
|                          |
| Houston, Texas                |
| March 25, 2005                |

** **

**GexaCorp.**

**ScheduleII - Reserves**

**For theThree Years Ended December 31, 2004**

**(In Thousands)**

 
| **Description**                       | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Income** | ** ** | **Deductions  from  Reserves** | ** ** | **Balance at  End of Period** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------|------------|--------------------------------|------------|-------------------------------|------------|
|                                  |       |                                 |       |                   |       |                           |       |                          |       |
| For The Year Ended December 31, 2004: |       |                                 |       |                   |       |                           |       |                          |       |
| Accumulated provisions:               |       |                                 |       |                   |       |                           |       |                          |       |
| Allowance for doubtful accounts       |       | $                                    | 1,300      |                   | $          | 7,052                          |       | $                             | (5,919     | ) | $ | 2,433 |   |
| Reserves for severance                |       | 50                                   |       | 54                     |       | (104                           | )          | —                        |       |
| For The Year Ended December 31, 2003: |       |                                 |       |                   |       |                           |       |                          |       |
| Accumulated provisions:               |       |                                 |       |                   |       |                           |       |                          |       |
| Allowance for doubtful accounts       |       | 326                                  |       | 3,900                  |       | (2,926                         | )          | 1,300                         |       |
| Reserves for severance                |       | —                               |       | 50                     |       | —                         |       | 50                            |       |
| For The Year Ended December 31, 2002: |       |                                 |       |                   |       |                           |       |                          |       |
| Accumulated provisions:               |       |                                 |       |                   |       |                           |       |                          |       |
| Allowance for doubtful accounts       |       | —                               |       | 679                    |       | (353                           | )          | 326                           |       |
| Reserves for severance                |       | —                               |       | —                 |       | —                         |       | —                        |       |
|                                       |            |                                      |            |                        |            |                                |            |                               |            |  |  |  |  |

 

91

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ITEM 9. CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.  CONTROLS AND PROCEDURES

As of the end of theperiod covered by this report, we carried out an evaluation, under the supervisionand the participation of our management, including our Chief Executive Officerand our Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures pursuant to Rule 13a-15 ofthe Securities and Exchange Act of 1934, as amended (the "ExchangeAct"). Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that our disclosure controls and procedures werenot effective, for the reasons discussed below, in timely accumulations andcommunicating to our management of the information required to be disclosed byus in the reports that we file or submit under the Exchange Act.

During both the audit of our fiscal year end 2004 and2003, our independent auditors, Hein & Associates LLP (“Hein”), issuedmaterial weakness letters noting significant deficiencies in our internalcontrols.  The letters related todifferent matters.

On March 25, 2005,Hein issued a material weakness letter related to the audit of our fiscal yearend 2004 identifying a deficiency in our internal controls.  The deficiency identified by Hein was that wedid not adequately provide information to Hein regarding a control deficiencyover input of rates into our billing system and a resulting reserveaccrual.  In addition, Hein indicatedthat the Company failed to fully investigate and quantify the extent of theerror caused by such control deficiency. The deficiency arose in connection with our determination of the size ofour reserve for customer credits to be issued relating to errors in inputtingrates on our billing system.

 

92

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In response to the initial inquiries of Hein relatedto this matter, the Audit Committee of our Board of Directors, with theassistance of external counsel, conducted a review of this matter throughdiscussions with the outside auditor, review of the applicable documents andinterviews and discussions with our management. On March 25, 2005, the Audit Committee recommended an action planrelated to this material weakness, which was implemented immediately, whichincluded the following action items:

•                                          In 2004, wecreated a Disclosure and Materiality Committee that includes our CEO, CFO, COOand those staff people responsible for SEC reporting and monitoring of new oramended regulations, including the employee responsible for investorrelations.  The committee shall beresponsible for the determination that disclosure of all material informationhas been made in each applicable proposed public filing or furnishing ofinformation by us pursuant to the Securities Act and the Exchange Act and thatall disclosures are made on a timely basis. Our outside accountants and counsel will be invited to participate inany meeting of this committee and the timing of those meetings will be set toensure their attendance.

•                                          Any reservessuggested by our management for inclusion in our financial statements must bedisclosed to and approved by the Audit Committee and disclosed to our outsideauditors, in each case with sufficient detail to enable an understanding of thereasons for the reserve.  Uponestablishment of any such reserve, our management shall, in subsequentfinancial periods, perform the applicable investigation to confirm the need andsize of such reserve, as applicable, and report those findings to the AuditCommittee and outside auditors on a timely basis.

The audit committee’s reportfurther concluded that the control deficiency related to input of rates intoour billing system was corrected by the Company as of the third quarter of 2004and, as of December 31, 2004, probably did not result in a material error tothe Company’s financial statements.

 

93

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In addition, during the audit of our fiscal year 2003,Hein issued a material weakness letter relating to our internal controls andprocedures.  The material weaknessidentified by Hein was discovered in connection with a review by Hein of the ourproposed changes to our revenue calculation method.  Management began the process of reviewing ourrevenue calculation method in November 2003.  The identified deficiencies were thefollowing:

•                                          inadequate U.S.GAAP, financial reporting and public company expertise and experience within ouraccounting department; and

•                                          inadequatequality control over the financial reporting process, including inadequatereview of facts, circumstances and events impacting estimates and judgmentsrequiring accounting recognition or disclosure.

Hein also indicated at that time that our new methodfor calculating our revenues required additional review and testing.  Previously, we estimated revenues based onbillings (the “billing” method), but the availability of accurate and timelyelectricity supply delivery data for the entire 2003 fiscal year allowed us toestimate revenues based on measuring electricity as delivered to our customers(the “flow” method).  In the fourthquarter of 2003 and first quarter of 2004, we conducted additional testing andreview of the controls and the source data being used to calculate revenues aswell as the flow method of revenue calculation. Based on that review, we adopted the flow method for determining itsrevenues in fiscal year 2003 and thereafter.

In response to this prior material weakness letter,the Audit Committee of our Board of Directors, with the assistance ofindependent counsel, began an investigation of the issues raised by ourauditors, including our revenue calculation methods, which process wascompleted in the second quarter of 2004.  The Audit Committee recommended, and the Boardof Directors reviewed and adopted, an action plan during the second quarter of2004.  The action plan was fullyimplemented as of September 30, 2004, through the following actions:
| • |   | the institution of new  document control procedures, including an updated disaster and recovery plan;                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                    |
| • |   | David K. Holeman’s election  as Vice President and Chief Financial Officer on June 2, 2004;                                                   |
|   |   |                                                                                                                                                    |
| • |   | the hiring of a Controller and a Manager of  Financial Reporting, each with experience in SEC reporting and accounting,  and a Human Resources Manager; |
|   |   |                                                                                                                                                    |
| • |   | the creation of interim policies and procedures  for the issuance of press releases and the preparation of SEC reports;                                 |

 

94

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•                                          the establishmentof an internal Disclosure Review Committee to review and coordinate SEC reportsand prepared an interim policy regarding the notification of senior managementand the Board of material developments;

•                                          the completionof a training program for all relevant personnel regarding SEC reporting,Sarbanes-Oxley Act compliance, and related issues; and

•                                          the selectionof a provider for Sarbanes-Oxley Act Section 404 related servicesand to assist us in a review and assessment of our accounting policies andprocedures.

We will continue to evaluate the effectiveness ofinternal controls and procedures on an ongoing basis. It should be noted thatin designing and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrolled objectives, and management necessarily was required to apply itsjudgment in evaluating the cost benefit relationship of possible controls andprocedures.

Based on theevaluation described above and the implementation of the action plans describedabove, our CEO and CFO have concluded, as of March 25, 2005, that ourdisclosure controls and procedures are effective at reaching that level ofreasonable assurance.

 

95

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**PART III**

ITEM 10. DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

Theinformation required by this item will be included in a definitive proxystatement, pursuant to Regulation 14A, to be filed not later than 120 daysafter December 31, 2004. Such information is incorporated herein by reference.

ITEM 11. EXECUTIVECOMPENSATION

Theinformation required by this item will be included in a definitive proxystatement, pursuant to Regulation 14A, to be filed not later than 120 daysafter December 31, 2004. Such information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS, MANAGEMENT AND RELATED SHAREHOLDER MATTERS

Theinformation required by this item will be included in a definitive proxystatement, pursuant to Regulation 14A, to be filed not later than 120 daysafter December 31, 2004. Such information is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS

Theinformation required by this item will be included in a definitive proxystatement, pursuant to Regulation 14A, to be filed not later than 120 daysafter December 31, 2004. Such information is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information requiredby this item will be included in a definitive proxy statement, pursuant toRegulation 14A, to be filed not later than 120 days after December 31, 2004.Such information is incorporated herein by reference.

 

96

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**PART IV**

ITEM 15.  EXHIBITS

97

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                     | ** ** | **Filed  Herewith or Incorporated By Reference from:** |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 2.1             |       | Amended and Restated Agreement dated as of October  21, 2003, among the Company, Gexa Gold Corp., Robert D. McDougal, Justin  Rice, Gary Rice, and Neil M. Leibman                                                                                  |       | Exhibit 2.1 to Form 8-K/A, filed on December 9, 2003   |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| *2.2            |       | Agreement and Plan of Merger dated as of March 28,  2005, among FRM Holdings, LLC, WPRM Acquisition Subsidiary, Inc. FPL Group,  Inc. and Gexa Corp.                                                                                                |       | Exhibit 2.1 to Form 8-K, filed on March 28, 2005       |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 2.3             |       | Voting Agreement                                                                                                                                                                                                                                    |       | Exhibit 2.2 to Form 8-K filed on March 28, 2005        |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 3.1             |       | Articles of Incorporation of the Company.                                                                                                                                                                                                           |       | Exhibit 3.1 to Form 8-K/A, filed on June 21, 2001      |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 3.2             |       | Bylaws of the Company.                                                                                                                                                                                                                              |       | Exhibit 3.2 to Form 8-K/A, filed on June 21, 2001      |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.1            |       | Credit Agreement dated July 8, 2004 among Gexa  Corp., Highbridge/Zwirn Special Opportunities Fund, L.P., and the Lenders  Party Hereto                                                                                                             |       | Exhibit 10.1 to Form 8-K, filed on July 19, 2004       |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.2            |       | Warrant Agreement by and between Gexa Corp. and  Highbridge/Zwirn Special Opportunities Fund, L.P., dated as of July 8, 2004                                                                                                                        |       | Exhibit 4.1 to Form 8-K, filed on July 19, 2004        |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.3            |       | Form of Warrant for the Purchase of Shares of Common  Stock of Gexa Corp. in favor of Neil M. Leibman, Robert C. Orr, Don Aron and  Gaylor Investment Trust Partnership                                                                             |       | Exhibit 4.2 to Form 8-K, filed on July 19, 2004        |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.4            |       | Termination Agreement dated July 7, 2004 by and  among Gexa Corp., The Catalyst Fund, Ltd., Southwest/Catalyst Capital, Ltd.,  Catalyst/Hall Growth Capital, LP, Neil M. Leibman, Robert C. Orr, Don Aron,  and Gaylor Investment Trust Partnership |       | Exhibit 10.2 to Form 8-K, filed on July 19, 2004       |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.5            |       | Lease Agreement dated April 12, 2004, between  Entergy Enterprises, Inc. and the Company                                                                                                                                                            |       | Exhibit 10.7 to Form 10-KSB, filed on May 18, 2004     |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.6            |       | Sublease by and between Entergy Enterprises, Inc.  and Gexa Corp.                                                                                                                                                                                   |       | Exhibit 10.1 to Form 10-Q, filed on August 11, 2004    |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| **10.7          |       | Energy Marketing Support Agreement dated April 8, 2003  between the Company and TXU Portfolio Management LP, as amended                                                                                                                             |       | Exhibit 10.8 to Form 10-KSB, filed on May 18, 2004     |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.8            |       | Amended and Restated Employment Agreement dated  effective as of October 28, 2004, between Neil M. Leibman and the Company                                                                                                                          |       | Exhibit 10.2 to Form 8-K, filed on November 3, 2004    |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.9            |       | Employment Agreement by and between David K. Holeman  and the Company, dated effective as of May 26, 2004                                                                                                                                           |       | Exhibit 10.2 to Form 10-Q, filed on August 11, 2004    |
|            |       |                                                                                                                                                                                                                                                |       |                                                   |
| 10.10           |       | First Amendment to Employment Agreement by and  between David K. Holeman and the Company, dated effective as of October 28,  2004                                                                                                                   |       | Exhibit 10.3 to Form 8-K, filed on November 3, 2004    |

 

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|   |   |                                                                                                                                                                             |   |                                                                          |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------|
| 10.11  |   | Employment Agreement by and between Rod Danielson  and the Company, dated effective as of October 28, 2004                                                                       |   | Exhibit 10.4 to Form 8-K, filed on November 3, 2004                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.12  |   | Employment Agreement by and between David Atiqi and  the Company, dated effective as of October 28, 2004                                                                         |   | Exhibit 10.5 to Form 8-K, filed on November 3, 2004                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.13  |   | Termination Agreement by and between James Burke and  the Company, dated October 1, 2004                                                                                         |   | Exhibit 10.1 to Form 8-K, filed on November 3, 2004                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.14  |   | Amended and Restated 2004 Incentive Plan, dated  effective as of May 27, 2004                                                                                                    |   | Exhibit 10.7 to Form 8-K, filed on November 3, 2004                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.15  |   | Gexa Corp. 2002 Non Employee Director Stock Option  Plan                                                                                                                         |   | Exhibit 4.1 to Form S-8, Registration No. 333  116722, filed on June 22, 2004 |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.16  |   | Form of Securities Purchase Agreement dated as of  November 23, 2004 by and among Gexa Corp., the Selling Shareholder and the  Investor in connection with the Private Placement |   | Exhibit 10.1 to Form 8-K, filed on November 24, 2004                          |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.17  |   | Warrant Agreement by and between Gexa Corp. and  Cappello Capital Corp., dated as of November 1, 2004                                                                            |   | Exhibit 4.1 to Form 8-K, filed on December 6, 2004                            |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.18  |   | Promissory Note between Gexa Corp. and Cappello  Capital Corp. dated November 29, 2004                                                                                           |   | Exhibit 10.1 to Form 8-K, filed on December 6, 2004                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.19  |   | Form of Indemnification Agreement between the  Company and each of its directors and certain officers                                                                            |   | Exhibit 10.1 to Form 8-K, filed on January 31, 2005                           |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 10.20  |   | Amendment to Amended and Restated Employment  Agreement dated as of March 28, 2005, between Gexa Corp. and Neil M. Leibman                                                       |   | Exhibit 10.1 to Form 8-K, filed on March 28, 2005                             |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 21.1   |   | Subsidiaries of Registrant                                                                                                                                                       |   | Filed herewith                                                                |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 23.1   |   | Consent of Hein & Associates LLP                                                                                                                                             |   | Filed herewith                                                                |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                |   | Filed herewith                                                                |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                |   | Filed herewith                                                                |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                              |   | Filed herewith                                                                |
|   |   |                                                                                                                                                                             |   |                                                                          |
| 32.2   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                              |   | Filed herewith                                                                |

 
| *  | Schedules and similar attachments to the Agreement and Plan of Merger  have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The  Registrant will furnish supplementally a copy of any omitted schedule or  similar attachment to the Securities and Exchange Commission upon request. |
|----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** | The Company has omitted certain portions of this  agreement in reliance on Rule 24b-2 under the Securities Exchange Act of  1934, as amended.                                                                                                                                                    |

 

 

99

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**SIGNATURES**

 

                Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, onMarch 31, 2005.

 
|   | GEXA  CORP. |
|--------|-------------|
|   |        |   |
|   | By:         | *  /s/*Neil M. Leibman |
|   |        |   Neil  M. Leibman |
|   |        |   Chairman  of the Board and    Chief Executive Officer |

 

Pursuant to the requirements of the Securities Exchange Actof 1934, this report has been signed below by the following persons on behalfof the registrant and in the capacities and on the dates indicated.

 

| **Signatures**          | ** ** | **Title**                             | ** ** | **Date**        |
|-------------------------|------------|---------------------------------------|------------|-----------------|
|                    |       |                                  |       |            |
| /s/ Neil M. Leibman     |       | Chairman and Chief  Executive Officer |       | March  31, 2005 |
| Neil  M. Leibman        |       | (principal executive  officer)        |       |            |
|                    |       |                                  |       |            |
| /s/ David K. Holeman    |       | Chief Financial Officer               |       | March  31, 2005 |
| David  K. Holeman       |       | (principal accounting  officer)       |       |            |
|                    |       |                                  |       |            |
| /s/ Stuart C. Gaylor    |       | Director                              |       | March  31, 2005 |
| Stuart  C. Gaylor       |       |                                  |       |            |
|                    |       |                                  |       |            |
| /s/ Don S. Aron         |       | Director                              |       | March  31, 2005 |
| Don  S. Aron            |       |                                  |       |            |
|                    |       |                                  |       |            |
|                    |       | Director                              |       | March  31, 2005 |
| Dan  C. Fogarty         |       |                                  |       |            |
|                    |       |                                  |       |            |
| /s/ Robert C. Orr, Jr.  |       | Director                              |       | March  31, 2005 |
| Robert  C. Orr, Jr.     |       |                                  |       |            |
|                    |       |                                  |       |            |
| /s/ Tom D. O’Leary |       | Director                              |       | March  31, 2005 |
| Tom  D. O’Leary    |       |                                  |       |            |
|                    |       |                                  |       |            |

 

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