Inspired Entertainment Inc (INSE) 2018 Q3 法說會逐字稿

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

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

I'll begin today's conference call by referring you to the company's safe harbor statement that appears in the third quarter fiscal year 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 over to Lorne Weil, the company's Executive Chairman.

Mr. Weil, please go ahead.

Thank you, operator.

Good morning, everyone, and thank you for joining our Fiscal Third Quarter 2018 Earnings Call.

As it happens, we're in the United Kingdom this morning, where I'm joined by President and CEO Brooks Pierce; CFO Stewart Baker; and our Chief Strategic Officer, Dan Silvers.

I'll first make some comments.

I apologize that they may be a little less brief than on previous calls.

We have a lot of things to talk about before turning things over to Stewart to discuss our financial results and the refi that we've announced this morning in more detail.

After that, we should have plenty of time for Q&A.

We were pleased with our results for the third quarter.

Revenue was up 14% year-over-year to $36.9 million.

And our adjusted EBITDA was $15.5 million, up 61% over the $9.7 million recorded in last year's Q3.

Sequentially, as importantly, adjusted EBITDA was 25% above this year's second quarter adjusted EBITDA of $12.4 million.

And that in turn sequentially was 25% ahead of the $9.8 million that we reported in the first quarter.

Because we still do not have clarity on the timing of the implementation of the outcome of the triennial review, there is really nothing we can add today to what we had said in our last conference call on this particular subject, but I should mention that, in the last 12 months, our quarterly adjusted EBITDA annualized has grown from a little under $40 million in the third quarter a year ago to a little over $60 million at present.

Importantly, none of this increase has come from the U.K. FOBT segment of our business.

And the increase itself of about $20 million is about double the amount that we had previously discussed as the potential negative impact of the triennial review.

Trailing 12-month adjusted EBITDA through June 2018 was $51.7 million, up from $45.8 million in the second quarter and $42.1 million in the first quarter.

Trailing 12-month adjusted EBITDA margin was 36.7% of revenue, which is the highest it's been since the acquisition of Inspired about 18 months ago.

At least as important as the financial performance in the quarter were the collection of very important strategic milestones.

Not necessarily in order of importance, these include the following: number one, the refinancing of our debt, extending our maturity by 5 years.

And after accounting for our swap from dollars into a combination of pounds and euros, where at least right now most of our revenue and profit comes from, moving from an [Aries] loan having had a 17% annual coupon to a loan with our new lender at approximately 10.9%, equating to about 610 basis points of savings before any accounting for fees; secondly, the signing of new contracts in Greece that increases our base of gaming machines and provides an additional channel of Virtual Sports, reflecting the continued superior performance of our products and game content and indeed the strength of the overall marketplace in that country; next, a contract extension with Paddy Power, one of our most important U.K. customers; and lastly but by absolutely no means lastly, the launch of Virtual Sports in Pennsylvania.

As it happens, it launched at 5:49 a.m.

Eastern time this morning, when the first ticket was sold in Pennsylvania.

And there were very quickly winners in both the football game and the car racing game.

Interestingly, as I think most of you know, pretty much all of the growth that we have generated since the acquisition of Inspired a little over 1.5 years ago has come from outside North America despite the fact that North America, as most of us know is the largest and most profitable gaming market in the world; and one to which myself and more importantly our recently recruited President and COO, Brooks Pierce, who by the way I can tell you was doing a terrific job, have devoted virtually our entire careers.

Brooks, again as many of you will know, was most recently Managing Director of Aristocrat Americas during a period of extraordinary growth in that business; and prior to that, Chief Revenue Officer of the gaming group of Scientific Games.

So while we continue to focus on maintaining and indeed accelerating our growth outside North America, we are now very clearly and deliberately targeting North America in both our Virtual Sports and Server Based Gaming lines of business.

On the Virtual Sports side, as I mentioned a moment ago, we reached a critical milestone with the launch this morning of Virtual Sports, being sold in 9,000 retailers across the state of Pennsylvania; right now approximately 1,500 of these we would consider specialty Virtual Sports retailers with full video monitors.

And we hope that this will fairly rapidly increase to 3,000 such specialty retailers.

Integrating our virtual sports product so that it plays seamlessly on a traditional North American lottery system platform, in the case of Pennsylvania the Scientific Games platform, was a fairly technically demanding process, but with this behind us, future implementations will be much easier.

We continue to believe that the North American lottery market is a natural fit with Virtual Sports, and I'm very excited with the potential.

In parallel with the above mentioned integration effort, we've developed and delivered a virtual sports product that's been customized for the Pennsylvania marketplace.

And our team has been educating Pennsylvania retailers and consumers about the product and how it plays.

For those who are interested, I would refer you to the Inspired Entertainment YouTube page, where you can see the Pennsylvania how-to-play videos as well as demos of the Pennsylvania American football and stock car racing product.

Parenthetically, I apologize for our use of the term American football.

I realize it sounds a little affected, but the largest contributor to our worldwide virtual sports play right now is on soccer in countries where, of course, they call it football.

So we're trying to avoid confusion.

For example, in a North American sports league called Major League Soccer the reigning champion happens to be my hometown team, Toronto, known as the Toronto Football Club.

Fortunately, to my knowledge, they don't have stock car racing in Europe.

In any case, we're hopeful that the outcome we experienced in Pennsylvania can unfold similarly to what we've seen in Greece, Italy, the U.K. and elsewhere, including importantly online.

The introduction of new products that can exploit both new demographics and new distribution channels has been a primary growth driver of the North American lottery industry pretty much since its inception some 4 years ago.

Interestingly, many of our virtual sports partners in Europe have their corporate roots in the lottery world, Lottomatica, OPAP and Sisal as examples.

And typically they offer side-by-side both virtual and traditional live sports betting, where the synergy between the two has become pretty clearly demonstrated.

So in the fullness of time, we would expect to benefit from the recent change in U.S. sports betting regulations.

At the same time, we are aggressively laying the groundwork for building a Server Based Gaming business in North America, intending to target a small handful of customers with appropriately modified systems and games.

As we have discussed often both during our time at Scientific Games and since our involvement with Inspired, again going back about 1.5 years, the advantages offered by Server Based Gaming are most clearly pronounced in distributed or wide-area gaming environments, where the ability to monitor and control thousands of individual locations at once and regularly develop and deliver new content to them is critical.

As mentioned previously, we were recently rewarded for our outstanding performance in Greece by a contract extension; and an increase in the number of gaming devices, which will then total in excess of 8,000.

I might mention that in Greece our products incorporate the G2S protocol, the recent adoption of which by Illinois in its wide-area network perhaps signals an important and potentially beneficial emerging trend.

Lastly, a word on guidance.

As mentioned earlier, our 12-month adjusted EBITDA through the end of the third quarter was just under $52 million, against the guidance range for the year of between $54 million and $58 million.

We expect that we will end the year within the guidance range, but due to delays during the year and the launch of certain new projects, Pennsylvania as an important example, where we will get, I guess, about 6 weeks in this fiscal year, and we've been hoping for at least double that together with recent currency movements, which Stewart in a moment can explain in somewhat more detail, that -- we expect we will be at the lower end of the guidance range.

And with that, I'll turn the program over to Stewart Baker, who will provide the overview of both our financials and discuss in detail the recent refi.

Stewart?

Thank you, Lorne.

So good morning, all.

Or good afternoon, depending on exactly where you're dialing in from.

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

So overall revenue increased roughly 14% compared to the same quarter last year, with growth in the Server Based Gaming division at about 15.5% and Virtual Sports at about 11%.

It's worth noting that the same quarter last year had a high level of what we call no-margin hardware sales, so when you look at the adjusted revenue metric, which strips these out, this was up 24%.

And then as Lorne mentioned, adjusted EBITDA grew 61%.

These metrics were helped by small FX wind -- sorry, tailwind [for the benefit we produced] in the prior quarter.

And importantly, all metrics demonstrate strong underlying performance.

So in Server Based Gaming we ended the quarter at over 32,500 terminals, which was up over 4,500 from June last year and up approximately 2,500 from the end of December.

This was driven by the continued rollout into Greece, which Lorne referenced; as well as units into Betfred in the U.K. And then the participation revenue from Greece was also supplemented in the quarter by nonparticipation service revenue.

In Greece we continued to perform very strongly versus the competition and, as Lorne mentioned, have announced a contract extension and a commitment for more machines.

And as seen in the earnings release, so I won't detail all of those here, we've signed a number of deals since the start of the third quarter, including a contract extension with Paddy Power; as well as Sisal, our large customer in Italy.

Over in Virtual Sports our headline revenue numbers were up nearly 11%.

However, our ongoing revenue was up over 20% due to increases in Greece, U.K., Finland and Poland.

And it's worth noting that there's a drag on the overall revenue metric which comes from a reduction in long-term license sales, which (inaudible) the life of the initial contract.

And these give a headwind of about $0.6 million.

So since the start of the calendar year, we're live with a number of new customers in both Virtual Sports and mobile slots.

In Greece we've extended our Virtual Sports contract and added an additional channel.

And in mobile we now have over 25 integrations, which is up significantly from 9 last year.

But as Lorne also said, we believe the most important development in Virtual Sports is the go-live in Pennsylvania Lottery today, which we're -- I was incredibly excited about.

And further down the income statement.

Net operating result improved from a net loss to a profit due to the increased revenue and a decreased cost of sales.

SG&A increased year-over-year, but once the items outside the normal course of business are taken into account, namely the restructuring costs, these reduced 1% in U.S. dollar or 7% in constant currency.

So we have a strong focus on costs.

From a cash flow perspective, for the 9 months, net cash provided by operating activity increased to $17.8 million and up from $4.2 million in the prior year.

And net cash used in investing activities decreased slightly from $29 million last year to $28 million this year.

And that's, as we closed the quarter, at just over $10 million in cash.

So carrying on with the balance sheet and thinking about the recent refinance which we mentioned in the earnings release.

We successfully completed a refinancing of approximately $150 million facility, which includes a $140 million loan which brought us at LIBOR plus 900.

And then we also have a GBP 7.5 million revolving credit facility.

The majority of these proceeds are being used to pay off the existing debt and revolver and any accrued and unpaid interest and related premiums and fees and costs.

If we think about this and potentially oversimplify we're taking the loan out in U.S. dollars, but as our earnings at the moment are predominantly in pounds and euros, we're locking into a cross-currency swap, which will have the effect of swapping the floating interest rate to a fixed interest rate and also fixing the exchange rates into pounds and euros during the 3-year term of the swap.

So to think about it the all-in implied rate for the term of the swap, excluding fees and repayments for the 3-year period, is 10.9%.

This will effectively strengthen our balance sheet by adding approximately $9 million of cash as well as leave an unfunded revolver position of GBP 7.5 million.

It will lower our cost of capital significantly and provide the flexibility to grow our business, which we've been after.

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

Thank you, Stewart.

I think that was a great description of the operational aspects in the quarter as well as the details surrounding and benefits of the refi that we're obviously all quite happy about.

Other than that, I really don't have any additional comments, so operator, at this time, we're happy to open the program up to Q&A.

(Operator Instructions) Our first question comes from Jordan Bender of Macquarie.

It's Chad Beynon from Macquarie.

Congrats on the refi.

Just wanted to start with the Virtual Sports launch in Pennsylvania.

And obviously you mentioned that [this took into effect] your reduction or your target on the guidance range, but can you help us think about maybe the POS opportunity by the end of the year?

Obviously this is very early and you probably can't talk about any results, but are there near-term goals in terms of how many locations you want to have these products rolled out to by the end of the year?

And then secondarily, have you had any further conversations with states in the U.S.?

Or do you think they're kind of waiting to see how successful the launch is in Pennsylvania?

Well, we'll have -- I'll ask Brooks to answer that question, Chad.

Yes.

In terms of -- so the distribution of retailers in Pennsylvania is, as Lorne mentioned, 1,500, as he called them, specialty retailers, are really bars and taverns where they have monitors.

They'll have 2 monitors for -- one for Xpress Sports or Xpress football, and the other one for car racing.

But they'll also have a third monitor for Keno.

And Keno was launched on May 1, and they've built a business up on that basis.

And so we're -- quite frankly, this is new ground in North America, so the metrics we look at is really kind of population.

We take a look at what the Keno sales are in comparable markets and what they're doing in Pennsylvania and try and get a rough estimate of what we think sales are.

But as I said, this is a brand-new product in the North American market, so we're obviously tracking it very closely.

Goals of adding...

Yes.

So in terms of the number of retailers, that's really in control of the Pennsylvania Lottery.

Obviously we're both hopeful, the lottery and ourselves, that sales will be very good and that they will want to add more and more locations.

The original target was to have 3,000 locations.

So as we said, we're at 1,500, so we're halfway there.

And hopefully, this will drive retail recruitment going forward.

And then, I guess, moving around the globe, to Italy.

I guess politically and from a regulatory standpoint there has been a lot of noise in the past couple months.

Can you just kind of flesh out in terms of what the final decision was with respect to SBGs in that market?

Not looking for any quantification of what the impact is, but just can you help us think about kind of where we are from a regulatory standpoint in the taxation and when that goes into effect in the out-years?

(inaudible) Brooks.

Yes.

So we are -- we don't believe that the tax impact is going to be significant for us.

And I assume the second part of your question is in term of -- in terms of the ban on advertising for gaming, which clearly we would have preferred not to have happened.

And it will take some time.

I will tell you that our Italy business from a Server Based Gaming side is actually doing very, very well showing kind of north of 20% growth out of that market.

So we're hopeful that both the tax, which is fairly modest; and the advertising ban won't have a real negative impact, but time will tell.

Great.

And then my last question is just with respect to a little bit more emphasis on the North American opportunities from an SBG side.

Obviously, Brooks and Lorne, you're very familiar with the markets and kind of the landscape and the opportunities.

Is this something that could be as early as 2019?

Or is this more of 2020 and beyond in terms of potential contribution in goals in terms of growing the North American SBG business?

And that's all for me.

Sure.

So I would say that, for the fiscal '19, there will be probably a very minor impact.

We're -- we spend a lot of time in the North American market, as you probably know.

I know that market well, but we've had teams over, meeting with customers, taking a look at locations both in Canada as well as in the United States.

We have a very good idea of what product we need to succeed in that market, but it's probably not reasonable to think we'll have much contribution in '19, more of a '20 impact.

(Operator Instructions) Our next question comes from Stavros Jones of Harwood Capital.

Just one question from me.

What is the impact of Betfred's win on the VAT against HMRC?

And in your view, what would be the overall impacts to your [4] clients once they get the VAT back?

Yes, I'll take that.

It's Stewart here.

So obviously we're aware of the Betfred news.

And we actually supported them, as part of that, with evidence and witnesses.

And I mean I don't have the calculations to look at what I think the overall impact is from a full industry-wide view, but I guess, if I take your question as could it impact Inspired -- I'm guessing that's the real point of your question, but I think -- and Betfred got through the first two.

There's more to get through.

We'll see if HMRC appeals that and how that goes.

We'll see how the various claims go.

And clearly Inspired's revenue share during the relevant period of 2005 to 2013 was based upon after-tax income levels.

And therefore, we would have had that deducted, but like I said, there's a long way to go in this.

We're not counting on any upside from that.

You'll see in our disclosures we put out tonight there's nothing in there.

And I think that just shows how, which is further down the road, that we expect this to have to play out before we say anything.

(Operator Instructions) Our next question comes from Mark Heiman of Saguaro Capital Advisors.

Congrats on getting the refi done.

Just a couple quick questions about it.

I noticed that the initial purchaser of these is an equity shareholder, who must know the company well, which is a nice vote of confidence.

And at the same time, I guess the rate was a little higher than I might have thought for a company that's not super highly levered.

Do you feel as though you might be able to eventually refinance that at a lower rate once the U.K. situation is finalized?

Because it -- as I mentioned, it was a bit of a higher rate than I might have thought considering the progress that you guys have made.

Yes.

So it's Stewart.

Again, I'll take that one.

So I mean I think that we were keen to refinance with a loan which gave us options for -- in part, for the exact reasons that you say.

So yes, clearly banks and the like are risk averse when it comes to thinking about situations like the B2 change in states in the U.K. So sure, that meant that this process was a bit tougher than it might have been, but like I say, we're keen when looking at the options that we have on the table in front of us.

The -- we had a -- then we picked the option which gave us the flexibility to take out that loan at an appropriate point when we can demonstrate how we get through the B2 state change levels.

Okay, got it, got it.

And I just actually flipped through the filing, but there is like a 2% or 3% premium if and when you do decide to refinance it.

Yes.

That's correct.

Got it, okay.

And just a more general question perhaps for Lorne.

Obviously the big domestic U.S. news in the industry has been sports betting.

Do you feel that, that may have slowed down people's interest or ability to process virtual sports projects, when obviously the big news right now is sports betting?

I -- no, I don't think that.

The -- I alluded to this in my prepared remarks, but if we look outside of the United States, most of the places, most of the markets where we're doing very well in Virtual Sports, the virtual sports is actually being sold alongside live sports, whether it's in brick-and-mortar venues, like you'd see with Lottomatica in Italy or Snai in Italy or OPAP in Greece, William Hill in the U.K., and -- or with any of a number of online sports betting operators, bet365 for example, who are selling both betting on live sports and virtuals.

The -- all of the observations that we've made and certainly the operators feel, that there's significant synergy between the two.

And generally what's happening is that the live betting tends to be relatively infrequent with fairly large-denomination bets.

And then while the live event is taking place, the virtual betting will be much more frequent with considerably lower-denomination bets.

And the two basically reinforce each other.

So if we assume, as we do, that that dynamic will eventually play out in the States, then at least on all the evidence we've seen, the two should be synergistic and helpful to each other rather than competitive or exclusionary.

And the other thing is it's going to take, unfortunately, a considerable period of time before all the individual jurisdictions in the United States put in place the regulations necessary to launch live sports.

And in the meantime, any state either under the auspices of its lottery, as Pennsylvania is doing, or some other way to launch virtual sports in anticipation of that.

So in general, I don't think the change of the past regulation has retarded the interest in virtual sports.

And certainly we're seeing, if anything, accelerating interest.

(Operator Instructions) This concludes our question-and-answer session.

I would like to turn the conference back over to Lorne Weil for any closing remarks.

Thank you, operator.

And thank all of you for joining the call this morning.

I think we, with this conference call, have reached maybe almost a tipping point with Inspired.

The confluence all at once of the refinancing of our debt, the launch in Pennsylvania of Virtual Sports and the continuing establishment of record earnings and margin levels in the business itself suggests that this is indeed a very important time in our evolution.

And we're quite enthusiastic about continuing this trend.

So we look forward to speaking to you all 3 months from now, and hopefully, in that period of time, we'll have a number of new things to talk about.

Thank you.

Thanks...

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.