Business context and reporting period
Inspired Entertainment, Inc. supplies gaming technology and content to regulated operators through its Server Based Gaming (SBG) and Virtual Sports businesses. This Form 10-Q covers the three and six months ended June 30, 2019, compared with the same periods in 2018. The company changed its fiscal year-end to December 31 beginning in 2019.
Financial performance and position
| Metric (USD millions, except per-share data) | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | 26.7 | 36.9 | 60.4 | 74.4 |
| Operating income (loss) | (4.5) | 1.6 | (5.2) | 0.8 |
| Net income (loss) | (10.7) | (4.0) | (15.7) | (4.5) |
| Adjusted EBITDA, non-GAAP | 8.9 | 15.5 | 22.6 | 27.9 |
| Net loss per share, basic and diluted | (0.48) | (0.19) | (0.73) | (0.22) |
- Q2 revenue fell 27.6% reported (23.6% at constant currency); first-half revenue fell 18.8% reported (13.6% at constant currency). Service and hardware revenue both declined.
- Q2 gross profit before depreciation and amortization was $20.4 million (revenue less cost of sales of $6.3 million); the comparable 2018 amount was $28.9 million. Operating results moved from profit to loss in both comparisons.
- First-half operating cash flow was $19.7 million, versus $17.9 million; investing cash outflow was $9.8 million, versus $21.3 million; financing cash inflow was $9.0 million, versus $2.9 million. Cash increased by $17.7 million to $33.7 million.
- At June 30, cash was $33.7 million and working capital was $11.3 million. Current assets were $62.3 million and current liabilities $51.0 million. The company reported that working capital includes $10.2 million of non-cash-settled deferred income.
- Debt principal was $149.3 million, including $9.3 million drawn on the revolver; debt carrying value was $141.7 million before capital leases. Senior notes carry a stated rate of 9% plus three-month LIBOR; management reported an effective rate of 11.33%, reduced to 10.87% under cross-currency swaps. The $140 million term loan matures in August 2023. The company said it was compliant with financial covenants.
- Stockholders’ deficit was $22.6 million. The company had a $59.0 million full valuation allowance against deferred tax assets.
Material changes versus comparable periods
- The principal pressure was the UK reduction in maximum permitted B2 machine bets, effective April 1, 2019. Management attributed $5.5 million of Q2 SBG service-revenue decline to the UK LBO market impact; the reported decline in customer gross win per unit per day across the UK LBO estate was 41.1% for the quarter.
- SBG revenue at constant currency declined 31.6% in Q2 and 20.1% in the first half. Lower UK machine performance, reduced Greek software-license sales and lower hardware sales contributed. The SBG installed base nevertheless grew 7.7% year over year to 35,077 terminals at quarter-end.
- Virtual Sports revenue declined 1.9% at constant currency in Q2, including a major-customer contract timing shift and fully amortized legacy licenses; management said underlying revenue increased $0.5 million. For the first half, Virtual Sports revenue grew 4.4% at constant currency, with recurring revenue up 7.7% in GBP.
- SG&A declined 16.3% reported in Q2 and 10.9% in the first half, reflecting savings and favorable currency effects. Stock-based compensation and acquisition-related expenses increased. Adjusted EBITDA fell to $8.9 million in Q2 and $22.6 million for the first half.
- Interest expense declined year over year, partly because the August 2018 refinancing eliminated prior payment-in-kind interest; cash interest and debt-fee amortization increased. The first-half net loss also reflected fair-value movements in earnout and derivative liabilities. The earnout was settled in March 2019 with 1,323,558 shares.
Outlook, risks and unusual items
- Management believed cash, expected operating cash flows, capacity to defer capital projects and external borrowing availability would fund net cash requirements through August 2020. It cautioned that $2.9 million of cash was held in Greece, where capital controls can delay or prevent transfers.
- The company agreed to acquire Novomatic UK’s Gaming Technology Group for the euro equivalent of $120 million, subject to regulatory and other closing conditions. It anticipated a third-quarter 2019 close and planned to refinance existing debt with a £220 million loan and a £20 million revolver; financing commitments had been obtained. Completion, integration, financing and expected benefits remain uncertain.
- Management said the UK regulatory change’s net impact on first-half operating results was $4.0 million and expected its impact to lessen as further cost savings and benefits from store closures and returned machines were realized. No formal full-year revenue or earnings guidance is provided in the supplied filing text.
- UK office consolidation and related workforce actions were expected to cost approximately $7.7 million in total: $2.3 million of capital investment and $5.4 million of one-time costs, mostly during 2019.
- Key risks include customer concentration (top ten customers generated about 75% of revenue), gaming regulation and licensing, foreign exchange and floating-rate debt exposure, Greek cash-transfer controls, and acquisition completion and integration. A 1% rise in floating rates was estimated to add about $0.7 million of annual interest expense absent offsets. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Progress in SBG revenue and UK LBO machine performance following the April 2019 betting-limit change, including whether cost savings offset lost revenue.
- Novomatic acquisition closing conditions, regulatory approval, final purchase financing, debt terms and post-close leverage.
- Cash conversion and working-capital movements, including the availability and transferability of Greek-held cash and undrawn borrowing capacity.
- Debt servicing costs, covenant headroom and the exposure remaining after cross-currency and interest-rate hedges.
- Virtual Sports customer renewals, the timing of the major-customer contract, recurring-revenue trends and customer concentration.
- Actual restructuring costs versus the stated estimate, and the timing and extent of expected savings.