Inspired Entertainment Inc (INSE) 2018 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Inspired Entertainment Fiscal 2018 Second Quarter Conference Call.

(Operator Instructions) Please also note, today's event is being recorded.

I'll begin today's conference by referring you to the company's safe harbor statement that appears in the second quarter 2018 earnings press release, which is available in the Investors section of the company's website at www.inseinc.com.

This safe harbor statement also applies to today's conference call as the company's management will be making certain statements that will be considered forward-looking under securities laws and rules of the SEC.

These statements are based on management's current expectations or beliefs and are subject to risks, uncertainties and changes in circumstances.

In addition, please note that the company will discuss both GAAP and non-GAAP financial measures.

A reconciliation is included in the earnings press release.

With that completed, I would now like to turn the conference call over to Lorne Weil, the company's Executive Chairman.

Mr. Weil, please go ahead.

Thank you, operator.

Good morning, everyone, and let me add my thanks to the operators for joining our second quarter conference call.

I'm joined here this morning by our Chief Operating Officer, Brooks Pierce; our Chief Strategy Officer, Dan Silvers; and our Chief Financial Officer, Stewart Baker.

Stewart and myself will present some prepared remarks, Stewart's being considerably longer than mine.

But Brooks and Dan will be available for Q&A, and I'm sure they'll be anxious to jump into the conversation.

So I'll begin with some brief comments, and then I'll turn things over to Stewart, who will discuss our financial and operating results in more detail, and then we should have plenty of time for Q&A.

Our results are showing significant growth year-over-year, with revenue in the quarter up 33.5% and adjusted EBITDA up over 43%.

So from these compared numbers, we can see that we're not only growing top and bottom line, but our margins have increased as well as we've begun to see the scale benefits inherent in businesses like ours, businesses driven by participation-based recurring revenue with significant operating leverage in the cost structure.

This is the sort of business that, in particular, Brooks Pierce and I have had between us 100 years of experience, about 90 of it mine and 10 of Brooks', and we're seeing exactly the same thing happening now in Inspired.

To put the momentum in a slightly different perspective, at the end of the second quarter of this year, we were at an annualized EBITDA run rate of about $50 million.

We were at a run rate of about $40 million at the end of the first quarter of this year and somewhat under $40 million in the second quarter of last year.

So on either year-to-year or sequential terms, the business is building very nicely.

Very importantly, I should emphasize that there had been no significant nonrecurring, onetime events during this time so that this momentum reflects positive trends in the underlying core business, again recurring revenue contracts in our core business unit of Server Based Gaming and Virtual Sports.

This growth, in turn, reflects our ongoing strategy of -- the success of our ongoing strategy of diversifying our revenue base, not only across product and service areas but across geographies as well.

I should tell you that virtually all our quarter-to-quarter growth and quarter-to-quarter annualized EBITDA came from outside the United Kingdom.

Our operations in Greece, in particular, continued to be a tremendous engine for growth.

But in terms of what we're talking about today, perhaps the most important development, I think, is that we have begun to see very important traction in North America, a market that to date accounts for very little of our current profitability.

There would be very few companies in the gaming technology space that would be as profitable and as rapidly growing as we are that would have done it completely outside the United States, unless it was a business that for regulatory reasons was precluded for being in the United States, but that is, of course, not the case with us.

So in that vein, we were very pleased to announce, just a couple of days ago, our selection as the exclusive provider of Virtual Sports to the Pennsylvania Lottery, where we hope to eventually deploy our products to the entire Pennsylvania Lottery network that currently numbers more than 9,000 locations.

We have had many years of experience with the Pennsylvania Lottery, and we know that it is among the most progressive, most accomplished lottery organizations in North America, if indeed not the entire world.

We expect to launch in Pennsylvania with Stock Car Racing and what we call our 1st Down Football, about which we are, to put it mildly, very excited.

We will continue to focus on growth in North America for both Virtual Sports and Server Based Gaming.

In both areas, as it happens, we see tremendous growth.

And at some point in the program, if anyone is interested in pursuing these in any greater depth, I'm sure Brooks Pierce, who has spent his entire career in this market and in these areas, will be happy to elaborate further.

And with that, I will turn it over to Stewart Baker, who will put some interesting meat on the bones.

Thank you, Lorne, and good morning all.

So as Lorne said, this is a successful quarter for Inspired, in which we continued to demonstrate meaningful growth in a number of key metrics.

So overall, revenue increased over 33% compared to the same quarter last year, with growth in Server Based Gaming division recorded 2% and Virtual Sports 14%.

Adjusted EBITDA grew more than 43%, all with strong underlying performance, albeit with a bit of an FX tailwind.

In Server Based Gaming, we ended the quarter at over 31,500 terminals, which was up nearly 4,500 from March 31 last year and up approximately 1,600 from the end of December.

This was driven by continued rollout into Greece as well as the completion of the majority of the increased deployment into the Betfred estates in U.K.

In Greece, we continued to perform very strongly versus the competition and have announced new volume gains during the period.

As seen in the earnings release, and I won't be telling all these here, we've signed a number of other deals since the start of the calendar year, including in Italy where we've extended the contract of our largest customer, Sisal, until 2022 and entered into a new content deal with Novomatic, where we will initially deploy 2 games onto terminals in their Italian retail estate.

In Virtual Sports, our headline numbers were impacted by 2 items in the prior year comparative.

Excluding these, we grew 24% year-over-year and by 13% on a sequential basis versus the first quarter.

In Virtual Sports, since the start of the calendar year, we are live with a number of new customers, both with virtual sports and mobile slots.

In the U.K. retail estate, we've added additional channels across a number of customers.

In mobile, we now have 22 RGS integrations, importantly, including [apps served] in Italy.

In New Jersey, MGM became our 6th New Jersey operator to go to live.

And as Lorne said, we believe most importantly, of all the recent developments, we've recently signed and announced the content deal with Pennsylvania Lottery, which we're incredibly excited about.

As part of this, we'll deploy with car racing and 1st Down Football to their entire lottery network of over 9,000 retailers.

Further down the profit and loss on a constant currency basis, SG&A costs declined year-on-year.

We saw the benefit of the headcount reduction exercises that was made over the past 12 months.

And overall, net loss reduced extremely significantly to just $0.5 million from the $9.5 million versus the same quarter last year.

From a cash flow perspective, for the 6 months, net cash provided by operating activities increased to $6.6 million from a net cash outflow of $12.3 million in the prior year.

Net cash used in investing activities decreased meaningfully, from over $20 million last year to $14 million this year, with reductions in both equipment purchases and software capitalization.

So with that, I'll hand back to Lorne for any additional comments before Q&A.

Thank you, Stewart.

A nice summary.

I have no further prepared comments.

So operator, if you would like to open the line up to questions, please do so.

(Operator Instructions) And our first question today comes from Chad Beynon from Macquarie.

Nice quarter here, both sequentially and year-over-year, as you highlighted, and it definitely puts you guys back on track for the guidance.

So just wanted to start with that.

You reiterated the guidance for the year.

Annualizing, Lorne, you said right now you're at $50 million.

The guide is a little bit above that.

So that would assume some sequential growth.

Should we assume that the growth is going to come from SBG, some of the highlights that you mentioned with the Greece rollout in the Betfred contract?

Or is the Virtual Sports segment starting to kind of spring up, as we saw in the quarter, from a revenue standpoint?

Just a little bit more color in terms of how we should think about getting to the guidance and then maybe how we should think about the bottom end versus the top end, and I'll start with that.

Sure.

Let me ask Stewart, who's a little closer to the underlying numbers to begin to respond to that question, and then maybe I'll chime in after, Chad.

Chad, thanks for the question.

So I think the positive answer is it's going to come from all areas of the business.

So as you say now, in terms of annualizing the quarter, it would take you to around $50 million.

Obviously, Q1 was a little bit lower.

So if you add on quarters -- even if you were to add on quarters 3 and 4 from a level to what we've just seen, it would take you to shy of $50 million.

So the incremental amount there comes from, as I say, across all areas.

It comes from the rollout in Greece, where we're seeing increased volume all the time.

Also, you've seen that we've announced that we're up to just under 7,500 contracted but only just over 4,000 live.

So that's ramping up through the quarter.

In Virtual Sports, we see new customers going live all the time in online and retail and with mobile slots all building upon that base.

And also importantly, we announced our new ETG products at ICE, and we expect to realize sales during that period during the second half of the year.

And all other points in time where we expect SG&A to remaining relatively flat, so realizing those scale benefits that Lorne reflected earlier.

So to summarize, I'll say, yes, across all the areas of the business.

Okay, great.

Then I wanted to move to the Pennsylvania announcement because I think it's important.

And as you noted, it's -- they are one of the more progressive and successful lottery states and markets in the U.S. and the country.

Could you provide a little bit more details around potential timing, how the deal would work, CapEx that would be affiliated with this?

And then now that you have one here, I'm guessing your plan is to kind of use this as kind of a sales pitch to other markets.

So just a little bit more color around the Pennsylvania deal and how we should think about this wide spreading in future quarters and years?

Yes, sure.

Brooks Pierce, who I mentioned a moment ago and who everyone knows from seeing our most recent press release, is now the Chief Operating Officer of the company, has actually been working for us as a consultant for many, many months, focused predominantly in building or laying the groundwork for the growth of our business in North America and most recently has been very close to the situation in Pennsylvania.

So I'll ask Brooks to respond in terms of the timing, in terms of the CapEx and anything else he'd like to add that he thinks is important.

Sure.

Thanks, Lorne.

In terms of the timing, we're looking at the end of June for launch.

This was in part with the launch that Pennsylvania Lottery did with both Keno and virtual sports.

They started Keno as of May 1. We had an integration we had to do and complete with Scientific Games, but we'll actually roll it out, and it will go towards the end of June.

In terms of the retailer configuration, we've talked about 9,000, which is the total retailer base in Pennsylvania, but it's continually growing.

And I think most importantly is going into some new venues, bars and taverns, where we'll have monitors.

And by the time we launch, we'll have, in 2,000 locations, growing hopefully over the next few months to roughly 3,000 locations.

So you'll be able to buy a Virtual Sports product in your regular retailer or at a bar and tavern.

And the way it's set up is essentially, as Lorne mentioned, we'll have 2 sports going continuously.

So an event roughly every 2 minutes staggered between the car racing and the football product.

So in terms of support, as Lorne mentioned, the Pennsylvania Lottery is very progressive.

They've got a marketing campaign that they're doing online.

If you went into a bar and tavern in Pennsylvania right now, you'd see a preamble showing the product and the coming soon.

So they really put some emphasis behind the launch of the product, and we're obviously very excited about it.

And then to the last part, we do think this is really a template and a potential road map...

CapEx.

I'll talk to that -- for other lotteries, and we're in discussions with some, but we think that hopefully with the successful Pennsylvania, it will be a way for lotteries to increase their revenues for good causes, and we certainly will be supportive of that.

In terms of the CapEx, frankly, it's really great for us because, quite frankly, we provide the software, and then the lottery system, retail in this case, and Pennsylvania Scientific Games provides the hardware.

So from a margin standpoint, it's obviously a very high-margin business.

It's really just providing software, and the hardware comes out of someone else's pocket.

The another thing I would add to that, Chad, it's actually not in response to a question that you asked, but I think it's really important.

In all the years, I actually prefer not to think about how many years that I have been involved with the lottery business in the United States, the really big issue has been the demographics of the player base.

And over the course of the last several years, the player base has been slowly getting older and there has not been anything in the traditional North American lottery business that has enabled to be attractive to a younger demographic to continue to drive growth in the business.

In those lotteries outside the United States, where Virtual Sports has been incorporated because our biggest customers and our most successful customers outside the United States are all for the most part lotteries, except for the bookmakers in the U.K. So in Greece, OPAP is the national lottery operator.

In Italy, our main customers are Lottomatica, Sisal and so forth, who are all lottery operators.

Virtual Sports has not only been tremendously successful but, perhaps most importantly, has shown that it has a much younger -- much, much younger average demographic than lottery players in general.

So this is a new product that is -- not only adds to the portfolio of options that the lotteries and estates can offer, but one that we happened to at least -- Inspired happened to believe quite strongly based upon the experiments we've had in other geographies that it will finally be the product that is able to attract the younger demographic into playing lottery games.

Okay.

Last one from me.

It's been about just a week since the press release came out with the management changes.

I mean, I know you gave the introduction.

And Brooks, good to hear from you.

Can you just elaborate a little bit more in terms of how Inspired management will be running the company?

Obviously, the changes; Lorne, your involvement; and just anything else that's kind of helpful for investors to understand the updated vision for the company in 2018 and beyond?

Yes, sure.

Thank you.

I think it's pretty much as was described in the press release.

Brooks and I will be working together in a very similar manner to the modality that we worked in for years, with myself effectively being the CEO, my title is actually Executive Chairman, but fulfilling the -- that executive role and all of the day-to-day business, technology, product development, sales, marketing, field operations things that Brooks has demonstrated over and over at both Scientific Games more recently at Aristocrat that he is very, very effective and as long as he continues to take direction from me, I'm sure that working together and supported in those roles by Stewart Baker, who really despite his youth is one of the very best CFOs I've ever worked with, and Dan, who you know is brilliant in the whole area of strategy, M&A and so forth.

So I think we have -- I was going to say particularly for a company our size, but honestly for a company of any size as good a senior management organization as we could reasonably hope to have.

And at the next layer of management, the -- there is a terrific organization of people that Luke, during his period, did a great job of recruiting and organizing.

So I think we're in terrific shape right now in terms of taking this company forward.

Our next question comes from Alex Silverman from Special Situations Fund.

Chad asked most of my questions around Pennsylvania.

So the June launch, I assume, will be staged.

What's the timing for a full rollout?

Yes.

It will be towards the end of June, maybe even the last week of June.

And the retail base of those locations with monitors is growing literally every day.

Good news for us as we think actually by the time we launch at the end of June, it will be almost fully 100% deployed with monitors.

But again, as we talked about before, you'll be able to buy a Virtual Sports wager regardless of whether there's a monitor in the venue or not.

So we'll essentially the -- when we flip the switch at the end of June, you'll be able to buy from any retailer in Pennsylvania.

Okay.

Is there a natural path to mobile in Pennsylvania as well?

Yes.

We certainly think so.

In terms of not only being able to see the product on your mobile device, which would be the next phase in an ideal world, and, again, this may take some time, but the idea would be to be able to wager, again, if legal with regulatory approvals and whatnot.

That would be an ideal scenario where you could go into a retail location that didn't have monitors, but you could actually see the event on your phone and ultimately be able to make a wager over your phone.

That would be ideal.

Okay.

And along those lines, can you give us any update on Michigan?

It just so happens that we have a team that's in Michigan today, and we're still working towards the launch.

I don't think we're prepared to say at this point when that will be, but it's, I would say, imminent.

Okay.

And then last question.

Contract renewal timing and other issues hurt virtual by $1.6 million in terms of revs.

Can you explain that a little further, give us a little more information there?

Sure.

So -- and there's 2 different contracts to talk about there.

One is, as we mentioned in the earnings release and the Q when that started -- giving a little bit more color on that, is in relation to in the prior year when a customer reported to us that they had underdeclared royalties, so we have the catch-up from there.

And then the second one, I'm not going to go into the commercial specifics relating to that customer, but slight restructuring of a contract which gives similar levels of revenue through the course of the year, but the way it was structured previously made it effectively a bit spiky in the quarter that's just gone.

So you shouldn't read that in terms of there's declining terms year-on-year or lost contracts or the like.

It's more just the nature of looking at the comparatives to a short-term period.

And the second, the latter contract, is there an expectation that in this June quarter there should be some sort of catch-up?

There will.

It's one which now gives a flatter profile over the period.

So they will -- it should be a case that -- yes, there's a little bit of a incremental discord there in Q3 over Q3 last year.

But I'll say that impact is spread over the course of the year.

(Operator Instructions) And our next question comes from [Gene Riley], private investor.

Leverage ratio on your senior debt, it's pretty low, about 3. The interest rate is a lot higher than I would expect.

What's going on there?

I'll ask Dan Silvers to try and respond to that.

Yes.

Look, I think, this is something that we've -- you don't talk about in the context of various strategic initiatives that we've looked at.

I think it's -- the current coupon of the debt is very much top of mind to us.

And I think we are exploring a number of possibilities in the immediate term to rationalize that disconnect between the credit ratios and the cost of the funding.

And our next question comes from Matthew Campbell from Laridae Capital.

It seems like the Greece rollout has been better than expected.

Who you're competing with there?

And how should we think about those results?

And do you see continued growth there?

Well, the -- we have 2 businesses in the Greek rollout, one being Virtual Sports, where we really don't have any competition, and the rollout in the shops has been great.

The interesting thing is -- and this is a digression, but it's an important digression.

The playbook -- you should pardon the expression that Pennsylvania seems to be laying the groundwork for in terms of very punchy, cute TV ads and all kinds of interesting point-of-sale promotion and so forth is very similar to the kinds of things that OPAP, who is the operator in Greece, did with tremendous success.

And so this gives us a lot of -- certainly, a lot of confidence that we should see and hopefully we'll see a similar kind of result in Pennsylvania.

But in terms of competition, it's really just ourselves.

And I would say that most of the credit for the tremendous success in Virtual Sports has had in Greece would go to OPAP, who have done a marvelous job of selling and marketing and merchandising the product in the OPAP shops.

As far as Server Based Gaming goes, our primary competitors are IGT and Scientific Games.

We have been fortunate recently to be outperforming them in terms of the average daily cash box or machine win that our games have been able to achieve in Greece.

And because we've had the best-performing games and the best-performing average daily cash box per machine, then, therefore, our number of machines in the market are accelerating for reasons that anybody operating would do.

Again, I think we all feel that OPAP deserves a tremendous amount of the credit for how successful the whole program is done in Greece.

I think it has surpassed everyone's expectations in terms of how well it's done.

And in terms of ourselves versus our competition, again, it's been the machine performance that in turn is primarily a function of the content and the games that are on our machines compared to the content of the competition.

And our challenge is to continue to try to stay ahead of the curve by regularly introducing new games that continue to keep us ahead and continue to capture the imagination of the players.

I think we did a terrific job of really trying to understand the particular mindset of the Greek players and to design games that were most responsive to that mindset.

And this is what we're going to continue to do.

I don't know, Stewart, if you have anything to add to that?

No.

[I think that's a] comprehensive answer to the question.

I think we're very pleased with performance in Greece.

As Lorne said, we're working alongside a customer who we respect and work very well -- very well with.

In terms of expectations, there's a question there of have we surpassed expectations.

I think we've surpassed external expectations.

Internally, we were confident in what we were delivering.

It was a project which for reasons which have been gone over many time dragged down in the implementation phase for reasons outside of our control.

So great ones, but it's finally gone well.

It's gone to plan.

As Lorne said, I think we're bearing this -- we're seeing the fruits of the research beforehand and the great games that we developed as a result of that.

And ladies and gentlemen, at this time I'm showing no additional questions, I'd like to turn the conference call back over to management for any closing remarks.

Thank you, operator.

Thank you all for joining us.

I hope we've conveyed to you both through the press release earlier this morning and our comments in the course of the conference call that we just had that our confidence and our enthusiasm for the business is, I think, as high as it probably realistically could be.

The business is hitting on all cylinders.

We've got a ton of growth prospects.

I'm very, very bullish on the opportunities we have now in North America.

And we're very much looking forward to speaking to all of you in another 90 days.

In the meantime, enjoy the gorgeous weather that we're having, at least, in New York.

And we will talk to you soon.

Ladies and gentlemen, with that, we'll conclude today's presentation.

We do thank you for attending.

You may now disconnect your lines.