Inspired Entertainment, Inc. — FY2017 Form 10-K
Business context and reporting period. Inspired supplies digital gaming technology, Virtual Sports and server-based gaming (SBG) products to regulated operators. The fiscal year ended September 30, 2017; it covered 371 days, versus 364 days in the prior comparable year ended September 24, 2016. The company completed its business combination on December 23, 2016, accounted for as a reverse merger. Unless stated otherwise, amounts below are U.S. dollars.
Financial performance and position
| Metric | FY2017 | Prior comparable year |
|---|---|---|
| Revenue | $122.5 million | $119.8 million |
| Operating income (loss) | $(11.9) million | $(1.3) million |
| Net income (loss) | $(49.1) million | $(59.9) million |
| Basic and diluted loss per share | $(2.68) | $(5.11) |
| Adjusted EBITDA (non-GAAP) | $40.7 million | $41.6 million |
| Net cash from operating activities | $18.3 million | $18.6 million |
| Net cash used in investing activities | $(35.4) million | $(31.9) million |
| Cash at year end | $20.0 million | $1.5 million |
- Reported revenue rose 2.3%; management reported 16.2% growth at constant currency, as adverse currency movements reduced the reported increase by $16.6 million. Service revenue was $107.5 million and hardware revenue $15.0 million.
- Gross profit before depreciation and amortization was approximately $95.9 million, or 78.2% of revenue, based on reported revenue and cost of sales. Operating loss widened to $11.9 million; net loss narrowed, mainly because interest expense fell to $29.4 million from $58.3 million.
- Segment operating profit: SBG $24.4 million, approximately flat as reported and up 12.5% at constant currency; Virtual Sports $17.3 million, up 11.1% reported and 26.7% at constant currency.
- Cash from operations was more than offset by investing outflows, principally $15.1 million of property and equipment purchases and $20.3 million of capitalized software purchases. Operating cash flow less investing cash flow was approximately negative $17.1 million.
- At September 30, 2017, current assets were $63.2 million and current liabilities $61.2 million; reported working capital was $2.0 million. Total assets were $219.0 million and total liabilities $221.4 million, leaving a $2.3 million stockholders’ deficit.
- Reported senior bank debt was $122.8 million, including the term facility and accrued PIK interest; the revolving facility had $7.4 million drawn. The former $298.2 million PIK shareholder notes were eliminated/cancelled in connection with the merger. Senior facility maturity is scheduled for September 2019; the company reported no covenant breaches. Cash interest on term borrowings was 10.0% at year end.
Material changes versus the prior comparable period
- SBG constant-currency revenue increased 16.9%, supported by hardware sales in Greece, the UK and Colombia, Greek service rollout and a software license sale. The average installed base rose 5.1% to 27,666 terminals.
- Virtual Sports constant-currency revenue increased 14.2%, aided by new customers and expanded mobile remote gaming server deployments; live customers grew from 77 to 85.
- Reported operating results were affected by $11.4 million of acquisition-related transaction expenses and $4.2 million of stock-based compensation, neither recorded in the prior year. A $7.1 million fair-value expense on the merger earnout also arose in FY2017.
- Hardware cost increased substantially, including $5.3 million of nil-margin sales; management’s non-GAAP adjusted revenue, excluding those sales, was $117.2 million versus $119.7 million.
- Debt restructuring in the merger reduced external PIK-note interest, contributing to lower interest expense and a smaller net loss. FY2017 also included $36.7 million of cash received in connection with the merger and $1.6 million from common-stock sales.
- The reporting year-end changed to September 30, and foreign exchange materially affects comparisons. Prior-period amounts are not fully comparable in length or currency basis.
Outlook, risks and unusual items
- Management said cash, expected operating cash flow, control over capital projects and available credit facilities should fund net cash requirements through fiscal 2018; the financial-statement notes describe liquidity sufficiency through December 2018. No specific revenue or earnings guidance is provided.
- UK regulatory consultation proposed reducing the maximum B2/FOBT stake from £100 to one of £50, £30, £20 or £2. Management warned that a reduction, particularly to £30 or £2, could materially harm SBG revenue, earnings and cash flow; effects were not expected to be material before FY2019.
- Italian rules require substantial technical upgrades to VLT platforms, machines and games by April 1, 2019. Management expected material expenditure but had not decided whether to make the investment or modify its Italian business.
- Customer concentration is significant: the top ten generated 70% of FY2017 revenue; two customers contributed approximately 26% and 10%. Two customers represented 26% and 13% of year-end receivables. The UK generated about 65% of revenue.
- Other principal risks include gaming regulation and licensing, contract renewals, competition, customer and supplier concentration, foreign exchange, interest costs, capital needs, technology and cybersecurity, and Brexit-related uncertainty. The Greek rollout and future terminal deployment also require capital and successful execution.
- The company settled a Performing Rights Society claim for an uninsured cost of £250,000. A former executive’s lawsuit seeks at least $1 million in unspecified damages; the company is contesting it and believes any damages would not be material. Management reported internal controls over financial reporting effective at year-end and said previously identified U.S. GAAP knowledge weaknesses had been remediated.
FY2017 fourth-quarter snapshot
For the quarter ended September 30, 2017, revenue was $35.1 million, operating income was $0.2 million and net loss was $9.3 million (loss per share of $0.46). Quarterly figures are unaudited.
Investor verification points
- Verify the trajectory and cash returns of Greek SBG deployment, including the stated target of at least 5,300 terminals by early 2018.
- Assess exposure to UK B2 stake changes and the expected impact of each possible regulatory outcome.
- Determine the cost, funding plan and strategic decision for the Italian VLT upgrade deadline.
- Reconcile reported revenue growth with constant-currency growth, nil-margin hardware sales and the company’s Adjusted EBITDA definition.
- Review debt amortization, PIK accruals, 2019 maturities, covenant headroom and the assumptions underlying management’s liquidity outlook.
- Monitor major customer contract renewals, receivable concentration and collection trends.
- Check the earnout liability valuation and potential share issuance of up to 2.5 million shares, alongside other equity awards and dilution.