Inspired Entertainment, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. The company changed its fiscal year-end from September 30 to December 31; this is its first fiscal quarter of 2019. Financial amounts below are in U.S. dollars unless noted.
Business context
Inspired is a global business-to-business gaming technology company serving regulated operators through Server Based Gaming (SBG) and Virtual Sports, including Interactive. It generates revenue primarily from recurring participation and service arrangements, alongside hardware sales and software licenses.
Financial performance and liquidity
- Revenue: $33.7 million, down 10.1% from $37.5 million. Service revenue was $30.8 million; hardware revenue was $2.9 million. Management attributed $2.5 million of the reported decline to adverse currency movements; revenue fell 3.5% at constant functional currency.
- Segment trends: SBG revenue was $23.7 million, down 8.5% at constant currency, while Virtual Sports revenue was $10.0 million, up 11.0% at constant currency. SBG operating income rose to $3.0 million from $1.8 million; Virtual Sports operating income rose to $4.9 million from $3.1 million. Corporate functions reported an $8.6 million operating loss.
- Profit and margins: Operating loss improved to $0.7 million from $0.9 million. Net loss widened to $5.0 million from $0.5 million, or $0.24 per diluted share versus $0.02. Cost of service and hardware totaled $7.0 million, implying gross profit of approximately $26.7 million and a gross margin of approximately 79.2%, compared with approximately 73.1% a year earlier.
- Adjusted EBITDA: $13.7 million versus $12.4 million. This is a non-GAAP measure; the company’s adjustments include stock compensation, restructuring and transaction costs, among other items.
- Cash flow: Operating cash flow was $8.3 million, compared with $6.7 million. Investing cash outflow was $5.2 million, primarily capital expenditure and software development; financing cash outflow was $0.2 million. Cash increased $3.0 million during the quarter to $19.0 million.
- Liquidity: Cash was $19.0 million and undrawn revolver availability was approximately $9.5 million. Reported working capital was $14.3 million, including $10.1 million of current deferred revenue. The company held $1.9 million of cash in Greece, where capital controls can delay or restrict transfers.
- Debt: Senior debt principal was $140.0 million, with a carrying value of $131.9 million after deferred financing charges. The five-year notes mature in August 2023 and carry cash interest of 9% plus three-month LIBOR; the reported rate at quarter-end was 11.60%, reduced to 10.87% under cross-currency swaps. The company reported covenant compliance and no revolver borrowings.
Material changes versus the prior-year quarter
- Revenue declined mainly because of lower SBG hardware sales, lower SBG service revenue and currency translation. Virtual Sports growth partly offset the decline, including new customer launches and $0.8 million of one-off income from previously unreported historic recurring revenue.
- SBG’s installed base increased 11.6% to 35,286 terminals, but customer gross win per unit per day fell 8.5% and net win per unit per day fell 10.5%. SBG recurring revenue increased to 78.2% of segment revenue from 70.7%.
- Virtual Sports recurring revenue increased 16.7%; recurring revenue represented 92.0% of segment revenue versus 87.5%. Average live customers rose to 99 from 90.
- Net loss was affected by a $2.3 million earnout fair-value charge, compared with a $3.8 million gain in the prior-year quarter. The earnout was settled in March through issuance of 1,323,558 common shares; no earnout liability remained at quarter-end.
- Interest expense declined to $4.5 million from $5.2 million, partly because the August 2018 refinancing ended prior payment-in-kind interest. The new debt, however, carries a higher cash-interest burden than the prior facility.
Outlook, risks and unusual items
- Management said cash, expected operating cash flow, control over capital projects and external borrowing availability should fund net cash requirements through May 2020. This is management’s assessment, not a guarantee.
- The company expected approximately $7.8 million of UK office consolidation costs and investment, comprising about $2.3 million of capital investment and $5.5 million of one-time exit and related costs; most were expected in 2019.
- The UK reduced maximum permitted bets on B2 gaming machines effective April 1, 2019, a stated risk to the business. Other key risks include gaming regulation and licensing, customer retention, foreign exchange and interest rates, and geographic concentration.
- Customer concentration is significant: the top ten customers generated approximately 75% of quarterly revenue; three customers accounted for 23%, 14% and 11%. Italian gaming tax increases also weighed on SBG net win.
- Greek capital controls may hinder cash transfers. The company also disclosed potential additional U.S. tax from GILTI beginning in 2021. It had a full valuation allowance of $57.2 million against deferred tax assets.
- The company adopted ASC 606 on January 1, 2019 using the modified retrospective method; it reported no cumulative opening-equity adjustment. Management stated disclosure controls were effective and reported no material ordinary-course legal matters or covenant breaches.
Important facts for investors to verify
- Whether SBG revenue and customer win metrics stabilize, particularly after the UK betting-limit change and Italian tax increase.
- Whether Virtual Sports growth and recurring revenue continue, and how much of the quarter’s growth depended on one-off historic income.
- Cash generation, revolver availability, covenant headroom and the effect of floating-rate debt and currency hedges on interest costs.
- Actual restructuring expenditures versus the approximately $7.8 million estimate, and whether the actions deliver expected savings.
- Customer concentration, contract renewals, Greek cash-transfer constraints, and potential U.S. tax exposure from 2021.