Inspired Entertainment, Inc. — Form 10-Q summary
Reporting period: Quarter and nine months ended June 30, 2017; amounts below are in U.S. dollars unless noted. The company supplies server-based gaming (SBG) and virtual sports systems to regulated operators. The December 2016 merger is accounted for as a reverse merger; prior-period comparisons and balance-sheet debt are affected by the transaction. Financial statement amounts are unaudited.
Financial performance and liquidity
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Revenue, 2017 | $32.3 million | $87.4 million |
| Revenue, 2016 | $29.4 million | $90.7 million |
| Operating income (loss), 2017 | $(0.7) million | $(12.1) million |
| Net loss, 2017 | $(8.3) million | $(39.8) million |
| Net loss, 2016 | $(13.6) million | $(44.0) million |
| Basic and diluted loss per share, 2017 | $(0.41) | $(2.26) |
| Operating cash flow, 2017 | Not provided for the quarter | $4.2 million |
| Investing cash flow, 2017 | Not provided for the quarter | $(29.1) million |
Quarterly reported revenue rose 9.9%, while nine-month revenue declined 3.6%. Management reported constant-currency revenue growth of 23.2% for the quarter and 13.5% for nine months; adverse currency translation materially reduced reported results. Revenue less cost of sales, before depreciation and amortization, was approximately 71.9% of revenue for the quarter and 77.5% for nine months. Hardware sales, including nil-margin sales, affect these comparisons. Reported operating margins were approximately negative 2.2% for the quarter and negative 13.8% for nine months.
Quarterly net loss improved from $13.6 million to $8.3 million, mainly reflecting lower interest expense, partly offset by operating loss and fair-value charges. Nine-month net loss narrowed by $4.2 million. Adjusted EBITDA, a non-GAAP measure, was $9.7 million for the quarter versus $10.8 million and $26.8 million for nine months versus $32.0 million. The company cautions that its non-GAAP measures may not be comparable with other companies’ measures.
Cash was $22.7 million at June 30, up from $1.5 million at September 24, 2016. Working capital was negative $1.4 million. Nine-month operating cash flow fell to $4.2 million from $10.9 million; capital expenditure and capital software purchases totaled $29.1 million, leaving operating cash flow less those outlays at approximately negative $24.9 million. Financing provided $44.0 million, and cash increased $21.2 million overall.
Total debt and capital leases were $126.9 million at June 30, including $125.7 million of senior bank debt and $1.2 million of leases. The large fall from $412.8 million at September 2016 primarily reflects merger-related elimination and subsequent cancellation of PIK shareholder notes, not solely cash repayment. The company reported compliance with debt covenants. Management said cash, expected operating cash flows, ability to defer capital projects, and available credit should fund net cash needs through August 2018.
Material changes and business developments
- Quarterly SBG revenue increased 13.4% to $23.3 million, driven chiefly by hardware sales; service revenue fell 10.2% as reported, largely because of currency effects and temporary revised terms on certain UK contracts. SBG operating profit was $4.7 million versus $5.1 million.
- Virtual Sports quarterly revenue was $9.0 million, nearly flat as reported but up 13.9% at constant currency; segment operating profit rose to $5.1 million from $3.8 million. Live customers at period end increased to 82 from 71.
- SBG average installed base increased 4.5% year over year to 27,569 terminals in the quarter. The Greece rollout had 1,050 terminals installed by June 30, against a contracted 3,960-terminal deployment expected by early 2018. Management said performance in the Greek estate was strong.
- Hardware revenue rose to $5.5 million in the quarter from $0.7 million. The company described some terminal sales as nil-margin sales intended to secure recurring revenue; adjusted revenue excluding such sales was $29.4 million, essentially unchanged from $29.4 million in the prior-year quarter.
- Stock-based compensation of $1.4 million and merger-related transaction expenses of $11.3 million were recorded for the nine months. The quarter included a $2.4 million earnout fair-value expense; the earnout liability was $13.2 million at June 30. A separate derivative liability related to management bonuses was $1.4 million.
Outlook, risks, contingencies, and controls
- The filing provides no formal revenue or earnings guidance. Management’s liquidity expectation extends through August 2018 and depends in part on operating cash generation, credit availability, and control or deferral of capital spending.
- Key exposures include foreign exchange (especially GBP/USD), floating-rate debt, regulation and gaming taxes, competition, dependence on long-term customer contracts and a small number of large customers, and the capital needed to win and service terminal contracts. Two customers represented 27% and 11% of nine-month revenue.
- The company estimated that a 10% weakening of GBP against the U.S. dollar would reduce trading operating results by approximately $3.9 million. It estimated a $1.8 million additional interest charge for a 5% increase in floating rates; a 1% increase would have no impact at then-current LIBOR levels.
- NASDAQ delisted the company’s warrants in April 2017. Continued NASDAQ listing of the common stock was conditional on meeting shareholder-holder requirements by September 17, 2017 and satisfying interim milestones; the company said it was working toward compliance.
- Disclosure controls and procedures were deemed ineffective as of June 30, 2017. The filing identifies material weaknesses relating to U.S. GAAP expertise and describes remediation, including external accounting support and training.
- The company settled a UK Performing Rights Society claim for £250,000 (about $321,000). A former executive filed a New York lawsuit seeking unspecified damages said to be at least $1 million; the company said it intended to contest the case and believed any damages would not be material. The company also recorded a full $46.8 million valuation allowance against deferred tax assets.
Important facts for investors to verify
- Reconcile merger-related financing cash flows: the cash flow statement reports $36.7 million received in connection with the merger, while MD&A describes a $16.7 million merger cash injection and $21.6 million private placement proceeds; the amounts and classifications do not clearly reconcile in the filing text.
- Track operating cash generation against capital spending, cash availability, revolver utilization, and the company’s stated liquidity horizon through August 2018.
- Verify common-stock NASDAQ listing compliance and the status of the delisted warrants, which traded over the counter.
- Assess progress on the Greek SBG rollout, the economics of hardware sales and UK contract extensions, customer concentration, and the effect of currency movements on reported growth.
- Monitor remediation of the disclosed control weaknesses, the earnout liability and potential share issuance of up to 2.5 million shares, and the outcome of the former executive’s lawsuit.