Inspired Entertainment, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended March 31, 2017; amounts are in U.S. dollars unless stated otherwise. The filing is a 10-Q, and the company had recently completed its merger and changed its fiscal year-end. Prior-period comparisons therefore merit attention to period length and transaction effects.
Business context and reporting period
Inspired supplies virtual sports and server-based gaming systems, software and terminals to regulated gaming, betting and lottery operators. It reports Server Based Gaming (SBG) and Virtual Sports segments. The merger with Inspired closed on December 23, 2016 and is accounted for as a reverse merger, with Inspired treated as the accounting acquirer. Consequently, 2017 results include the combined public company only after closing, while historical results principally reflect Inspired.
Financial performance
| Metric | Three months ended March 31 | Six months ended March 31 |
|---|---|---|
| Revenue, 2017 | $28.1 million | $55.1 million |
| Revenue, 2016 | $30.4 million | $61.3 million |
| Operating income (loss), 2017 | $(2.1) million | $(11.4) million |
| Net loss, 2017 | $(9.1) million | $(31.5) million |
| Adjusted EBITDA, non-GAAP, 2017 | $8.6 million | $17.1 million |
| Operating cash flow, 2017 | Not separately stated | $(12.3) million |
| Investing cash flow, 2017 | Not separately stated | $(20.3) million |
Quarterly revenue declined 7.8% as reported, although management said it grew 9.1% at constant currency. Six-month reported revenue declined 10.1%, while constant-currency revenue increased 8.5%. Foreign exchange was a significant headwind. Service revenue fell as reported, while hardware revenue more than doubled in both comparison periods, partly reflecting SBG terminal sales.
Quarterly net loss improved from $13.5 million to $9.1 million, primarily as interest expense fell after the merger eliminated external PIK shareholder-loan interest. The six-month net loss increased from $30.4 million to $31.5 million, substantially affected by $11.3 million in merger transaction expenses. Adjusted EBITDA is a company-defined non-GAAP measure and is not a substitute for GAAP results or cash flow.
For the quarter, SBG revenue was $19.6 million and segment operating profit was $4.7 million; Virtual Sports revenue was $8.5 million and segment operating profit was $4.7 million. SBG terminal installed base rose 3.8% year over year to 27,151 at period end. Virtual Sports live customers increased from 67 to 78.
Liquidity, debt and balance sheet
At March 31, 2017, cash was $13.3 million, working capital was positive $4.4 million, and total assets were $201.5 million. Six-month operating cash use of $12.3 million and investing cash use of $20.3 million were funded principally by financing cash flow of $42.9 million, including merger-related proceeds. Cash increased by $11.9 million from September 24, 2016.
Balance-sheet long-term debt was $103.3 million, with a current portion of $13.7 million; the debt note reports $117.6 million of senior-bank-debt principal and $117.9 million of total debt and capital leases on a book-value basis. The former $298.2 million PIK shareholder loan balance was eliminated in consolidation in connection with the merger. The company reported compliance with its debt covenants and no covenant breaches.
Management said cash, expected operating cash flows, ability to control or defer capital projects and available credit facilities should fund net cash requirements through May 2018. That assessment depends on operating performance, liquidity and access to borrowing.
Material changes, outlook and risks
- Merger and financing: The merger materially changed capital structure, share count and reported interest expense. Merger-related transaction costs were $11.3 million for the six months. Management expected most transaction costs to have been incurred, apart from potential earnout payments.
- Operating developments: The company began deploying SBG terminals in Greece, with 340 installed by March 31 and an expected deployment of at least 3,960 terminals by the first quarter of 2018. It also described Virtual Sports launches and customer agreements in Greece, Poland and Italy. These are plans and developments, not guaranteed results.
- Earnout and compensation liabilities: The merger earnout liability was $10.5 million at March 31, with fair-value changes recognized in earnings. A separate $1.1 million derivative liability relates to management bonuses that may be settled in cash or stock; the associated incentive plan still required stockholder approval.
- Currency and customer concentration: The pound is the principal functional currency while the company reports in U.S. dollars. Management identified foreign exchange and floating interest rates as market risks. Two customers accounted for 29% and 12% of six-month revenue; one customer represented 30% of accounts receivable at period end.
- Legal contingency: An ongoing Performing Rights Society copyright claim sought approximately £7 million. The company said it would defend the claim and had recorded a $0.3 million provision it considered adequate for its estimated net exposure; the outcome was uncertain.
- Listing status: Nasdaq granted the common stock continued listing subject to interim milestones and evidence of compliance with the 300-round-lot-holder requirement by September 17, 2017. The warrants were delisted on April 28, 2017 and moved to OTC markets.
- Controls: Management concluded disclosure controls and procedures were not effective as of March 31, 2017, citing a material weakness in U.S. GAAP expertise within the finance team. Remediation included external accounting support and staff training; effectiveness remained to be demonstrated.
- Other risks: The filing highlights gaming regulation and taxation, contract renewals, competition, capital requirements, technology and cybersecurity, foreign exchange, and possible effects of Brexit. No formal earnings guidance was provided.
Investor verification priorities
- Reconcile merger-related financing proceeds, the elimination of PIK loans and the resulting senior-debt balance; confirm future debt service and covenant headroom.
- Track operating cash flow, working-capital movements, capital expenditures and the assumptions supporting liquidity through May 2018.
- Assess constant-currency growth against reported revenue trends, customer concentration, contract extensions and the profitability of hardware sales.
- Monitor progress on the Greek deployment and other announced market launches, including actual installations, revenue contribution and required capital spending.
- Follow the earnout measurement, management bonus plan approval, Performing Rights Society claim and Nasdaq common-stock listing milestones.
- Look for evidence that the disclosed finance-control remediation has addressed the material weakness and improved reporting controls.