Inspired Entertainment, Inc. quarterly report, Q3 FY2022

Business context and reporting period

Inspired Entertainment, Inc. is a global gaming technology company serving regulated lottery, betting and gaming operators through Gaming, Virtual Sports, Interactive and Leisure segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2022; comparisons are with the corresponding 2021 periods. The company cautions that prior-year land-based closures and restrictions related to COVID-19 make some comparisons less meaningful. Amounts below are in U.S. dollars unless noted.

Financial performance and position

• Revenue mix and trends: Q3 service revenue was $69.2 million and product sales $5.7 million. On management’s constant-currency basis, total revenue increased 13% in Q3 and 62% for the nine months; reported revenue decreased 3.4% in Q3 and increased 45.8% year to date. Sterling weakness reduced reported results.
• Profit and margins: Q3 net income fell year over year primarily because Q3 2021 included a $17.3 million gain from the change in fair value of warrant liabilities. Nine-month improvement reflects higher operating income and lower interest expense, partly offset by the absence of prior-year warrant gains and lower other finance income. Adjusted EBITDA, a non-GAAP measure, was $27.8 million in Q3 and $74.0 million for the nine months; the company cautions it is not comparable to GAAP net income or cash flow.
• Cash flow and investment: Nine-month operating cash flow was $39.9 million; investing cash outflow was $31.4 million, including $16.6 million for property and equipment and $14.2 million for capitalized software. Financing cash outflow was $10.4 million, including $10.0 million of share repurchases. Cash declined by $10.4 million to $37.4 million, including an $8.5 million adverse effect from exchange rates.
• Liquidity and debt: At September 30, cash was $37.4 million and $22.3 million of the revolving facility was undrawn. Current assets were $117.7 million and current liabilities $66.9 million, implying working capital of $50.8 million; management separately cites $13.4 million of working capital excluding cash. Long-term debt was $257.1 million on the balance sheet; the company reports original senior debt principal of $262.5 million. Debt is fixed-rate, and the company was in compliance with its revolving-credit covenant.
• Other financial items: Total assets were $286.6 million and stockholders’ deficit was $50.6 million. Nine-month capital expenditures totaled $31.2 million in the segment disclosure. The company repurchased approximately 1.03 million shares for gross payments of about $10.1 million during the nine months.

Material changes versus the prior comparable period

• Nine-month reported revenue rose 45.8%, led by reopening-related recovery in Gaming and Leisure and strong Online Virtual Sports growth. Virtual Sports revenue increased 63% in Q3 and 79% year to date on a constant-currency basis; Interactive grew more modestly.
• Q3 reported revenue declined despite constant-currency growth, principally reflecting foreign exchange and lower product sales. Gaming and Leisure Q3 operating income weakened year over year, while Virtual Sports operating income improved.
• SG&A increased 39% on a constant-currency basis for the nine months, primarily from staff returning from furlough or full pay and wage inflation. Higher cost of sales also reflected reopened operations and higher costs.
• Nine-month net interest expense fell to $18.7 million from $37.9 million, largely because 2021 included a $14.4 million write-off of fees related to prior debt and because of refinancing savings.
• In January 2022, the company sold its Italian VLT business for approximately $1.1 million and recognized a $0.9 million gain; it continues supplying platform and games in the market. The Sportech Lotteries acquisition added nearly 2,500 terminals and lottery revenue.

Outlook, commentary, risks and unusual items

• Management believes available cash, expected operating cash flows, the ability to control or defer capital projects, and external borrowings will fund net cash requirements through November 2023, absent an unanticipated COVID-19 impact. No specific revenue or earnings guidance is provided.
• Management is actively managing capital expenditure and working capital. Inventory rose to $25.2 million from $16.9 million at year-end, partly reflecting efforts to reduce the risk of machine-build delays from component shortages.
• Key risks include regulation, competition, technology change, contract renewals and customer retention, suppliers, cybersecurity, acquisitions, seasonality, working-capital needs, international operations, economic and political conditions, foreign exchange, and continuing uncertainty about COVID-19.
• The company disclosed that its disclosure controls and procedures were not effective at the reasonable-assurance level as of September 30, 2022 because of a previously reported material weakness. Remediation controls had not operated long enough to conclude the weakness was fully remediated; management nevertheless believes the interim financial statements fairly present the results.
• The UK defined-benefit pension scheme had a funding shortfall under its statutory valuation. A June 2022 recovery plan targets eliminating it by October 2026; 2022 contributions were expected to include $1.0 million of deficit-reduction and $0.5 million of expense contributions. The company reports no currently material legal matters and no off-balance-sheet arrangements.
• Other notable items include $6.2 million of Q3 actuarial losses on the pension plan in other comprehensive income, a $25 million share-repurchase authorization through May 2025, and a post-quarter UK employee share-saves plan. The company identifies significant foreign-exchange exposure; a hypothetical 10% weakening of sterling against the dollar would reduce trading results by approximately $1.5 million and produce an approximately $7.2 million unfavorable translation adjustment in other comprehensive loss.

Important facts for investors to verify

• Reconcile reported revenue and profitability with management’s constant-currency comparisons and assess the sustainability of recovery from the 2021 COVID-19 disruption.
• Review debt terms, scheduled principal repayment, fixed interest costs, revolver availability and covenant headroom; the filing lists $262.5 million of senior-debt principal due in the 3–5-year period.
• Assess cash conversion and the impact of capital spending, inventory buildup, working-capital movements and share repurchases on liquidity.
• Track remediation of the disclosed material weakness in disclosure controls and procedures.
• Evaluate the pension recovery plan, foreign-exchange sensitivity, customer concentration (one customer represented 14% of Q3 revenue), and execution of announced contracts and market launches.