Inspired Entertainment, Inc. — Q3 2019 Form 10-Q
Business context and reporting period
Inspired is a global business-to-business gaming technology company operating in Server Based Gaming (SBG) and Virtual Sports, including Interactive. This report covers the three and nine months ended September 30, 2019, compared with the same 2018 periods. The company changed its fiscal year to a calendar year beginning in 2019.
Key financial metrics
Unless otherwise stated, amounts are U.S. dollars in millions. Figures are unaudited.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $26.6 | $35.6 | $87.0 | $110.0 |
| Operating loss | $(5.7) | $(3.7) | $(10.9) | $(2.9) |
| Net loss | $(8.5) | $(11.9) | $(24.2) | $(16.4) |
| Basic and diluted loss per share | $(0.38) | $(0.57) | $(1.11) | $(0.79) |
| Operating cash flow | Not separately stated | Not separately stated | $22.4 | $34.4 |
| Capital expenditures* | Not separately stated | Not separately stated | $14.0 | $33.9 |
| Company-defined Adjusted EBITDA | $8.7 | $16.3 | $31.3 | $44.3 |
*Segment capital expenditures reported in the filing. Investing cash outflow was $16.5 million for the nine months, versus $36.1 million in 2018.
- Q3 service revenue fell to $23.8 million from $32.8 million; hardware revenue was $2.8 million in both periods. Nine-month service revenue was $80.2 million versus $100.6 million, and hardware revenue was $6.8 million versus $9.4 million.
- Q3 SBG revenue was $18.3 million and segment operating loss was $1.0 million; Virtual Sports revenue was $8.3 million and segment operating income was $4.2 million. For the nine months, SBG revenue was $59.5 million with operating income of $0.4 million; Virtual Sports revenue was $27.5 million with operating income of $13.6 million.
- At September 30, cash was $29.6 million, current assets $58.0 million, current liabilities $51.2 million, and reported working capital $6.8 million. Management notes that working capital includes $9.3 million of deferred income.
- Debt principal at September 30 was $149.0 million, including $140.0 million of senior debt and $9.0 million drawn on the revolver; carrying value of total debt and leases was $141.9 million. The company reported $119.5 million of debt net of cash in its liquidity discussion.
- Total assets were $175.4 million and stockholders’ deficit was $31.8 million at September 30, 2019. No gross margin percentage is clearly provided.
Material changes versus prior comparable periods
- Revenue declined 25.3% in Q3 and 20.9% over nine months. Management attributes the principal SBG pressure to the UK’s April 2019 reduction in maximum permitted bets on B2 gaming machines, which reduced UK LBO customer gross win per unit per day. Management estimated the nine-month operating-loss impact of the change at $6.8 million.
- Nine-month revenue also reflected lower SBG software-license sales in Greece and higher Italian gaming taxes. Adverse currency movements reduced reported revenue by $1.5 million in Q3 and $5.3 million over nine months.
- Q3 net loss improved by $3.4 million year over year, while nine-month net loss worsened by $7.8 million. The Q3 comparison benefited from the absence of the prior-year $7.7 million impairment and a more favorable derivative fair-value movement; the nine-month comparison included a $2.3 million earnout fair-value charge versus a $4.0 million gain in 2018.
- Adjusted EBITDA declined to $8.7 million in Q3 from $16.3 million and to $31.3 million for the nine months from $44.3 million. This company-defined non-GAAP measure excludes multiple expenses and should be considered alongside GAAP results.
- Operating cash flow fell by $12.0 million year over year to $22.4 million for the nine months, despite lower investing outflows. Cash rose from $16.0 million at the start of 2019 to $29.6 million at September 30.
Outlook, financing, risks and unusual items
- Management believed cash on hand, operating cash generation, control over capital projects and external borrowing capacity would fund net cash requirements through November 2020. It identified a need for working capital and noted that $2.4 million of cash was held in Greek accounts; Greece’s capital controls had been lifted effective September 1, 2019.
- On October 1, 2019, the company completed the acquisition of Novomatic UK’s Gaming Technology Group and refinanced existing debt. The new facilities included £140 million and €90 million five-year term loans and a £20 million revolving facility, with term loans due October 1, 2024. The acquisition was funded in cash. The filing’s acquisition consideration is not consistent: the notes state approximately €104.6 million ($114.0 million), while MD&A states €104.6 million ($120.0 million).
- The new facilities include quarterly leverage testing beginning June 30, 2020 and annual capital-expenditure testing beginning December 31, 2019. The filing describes a maximum leverage ratio of 4.1x, stepping down to 3.0x on and after June 30, 2021. It also describes annual excess-cash-flow calculations that could require early repayment.
- Q3 included $3.3 million of acquisition and integration expenses. Nine-month acquisition and integration expenses were $4.9 million; the company also reported $3.1 million of restructuring costs in its Adjusted EBITDA reconciliation. Management expected approximately $7.9 million of total office-consolidation costs, including $2.5 million of capital investment and $5.4 million of one-time exit and related costs, with most expected by the end of Q1 2020.
- Key risks include regulation and gaming-tax changes, dependence on major customer contracts, customer concentration, acquisition integration and goodwill impairment, foreign-exchange and floating-rate exposure, and refinancing/covenant constraints. Three customers generated 20%, 16% and 10% of nine-month revenue; the top ten generated approximately 75%.
- The company reported compliance with applicable covenants at September 30, no material legal proceedings currently known to management, no off-balance-sheet arrangements, and effective disclosure controls.
Most important facts for investors to verify
- Reconcile the acquisition’s stated dollar consideration ($114.0 million in the notes versus $120.0 million in MD&A) and confirm the final Innov8 ownership and purchase-accounting allocation.
- Assess the continuing revenue and cash-flow impact of the UK B2 betting-limit change, including whether customer win trends and terminal activity stabilize.
- Review the post-acquisition debt balance, interest expense, covenant headroom and refinancing fees, including the approximately $7.2 million of remaining old debt fees to be expensed and expected new financing fees.
- Test management’s liquidity-through-November-2020 assessment against acquisition integration costs, capital needs, operating cash generation and the new facility terms.
- Evaluate the quality and comparability of Adjusted EBITDA and other non-GAAP measures, given exclusions for stock compensation, restructuring, acquisition costs and other items.