Inspired Entertainment Inc (INSE) 2018 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Inspired Entertainment Fourth Quarter and Fiscal Year-End 2018 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 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, sir.

Thank you, operator.

Good morning, everyone, and thanks for joining our year-end conference call.

As I think you know, we had planned to have the call last Wednesday, but then the markets were closed because of President Bush's funeral, so we decided to change the date.

Joining me today in the U.K. are Stewart Baker, our CFO; and Brooks Pierce, President and COO; and here with me in New York is Dan Silvers, our Chief Strategy Officer.

As described in the press release, we were quite pleased with our results for fiscal 2018.

Revenue and adjusted EBITDA were $141 million and $54 million, up 15% and 33%, respectively, for fiscal 2017.

Perhaps most importantly, adjusted EBITDA margin expanded by 475 basis points, driven by a number of significant operating and strategic factors that we could talk more about in the Q&A, if anyone is interested.

Adjusted EBITDA of $54 million was within our guidance range, but as we anticipated in our third quarter conference call, towards the lower end, largely related to the somewhat slower-than-expected launch of some new revenue sources.

As of now, many of these largely in the Virtual Sports and Interactive markets are solidly on stream.

In a moment, I'll discuss the interactive opportunity, in particular, in a little more detail.

Fourth quarter adjusted EBITDA of $16 million was 17% of last year, a 37% ahead when the effects of significant hardware sales to Colombia are excluded, illustrating both the momentum and profitability inherent in our recurring revenue model.

Looking at quarter-to-quarter progress, and this is very important for a number of reasons, our annualized adjusted EBITDA was approximately $40 million in the first quarter of fiscal 2018, $50 million in the second, $60 million in the third and $65 million in the fourth.

Reflecting on the ever-present issue of the U.K. Triennial Review, I think it's important to mention that little, if any, of the quarter-to-quarter growth in adjusted EBITDA that we experienced in fiscal 2018 was attributable to the U.K. FOBT segment of our business, although there were, of course, ups and downs from one customer to another.

As I imagine most of you're aware, it was recently announced that the implementation of the GBP 2 maximum stake occasioned by the Triennial Review was accelerated from October 2019 to April 2019.

In the intermediate term, this change should have no effect on our previously provided commentary, which estimated an annual steady-state adjusted EBITDA impact of $10 million to $11 million, in effect setting us back about 6 months in the growth -- for the quarter growth trajectory that I just summarized.

This being a case where we had no alternative, but to take a step back before we could take 2 steps forward.

In our press release this morning, we mentioned that we are, at this time, not comfortable providing guidance for calendar 2019.

As previously noted, we will be changing from our September 30 fiscal year to a calendar year beginning January 2019.

As explained in the release, the 6 months change in the Triennial implementation impacts the timing of the number of moving pieces in the equation, and frankly, it will make it a little harder for us to get ahead of it.

I think you can appreciate that we wanted to be certain to assess all of this as fully as possible.

One area where the acceleration will matter in the short run is in our ability to mitigate the impact of the U.K. change through new content development.

Superior performance that we recorded across the number of products in our fiscal 2018 was largely driven by the development and introduction of innovative content, and we are hopeful that this can have a meaningful post-Triennial impact in the U.K., but obviously, the timing is now less favorable.

More generally, while fundamental hardware system and software technologies continue to be important elements of our portfolio, our overall growth is becoming increasingly driven by content.

As a B2B company, nowhere is this more apparent and more relevant than in the opportunity that we have in the interactive space, which we're addressing through a vehicle known as RGS, or Remote Game Server.

For those not familiar with this concept, think of it as a jukebox that's loaded with all of our VLT and Virtual Sports content and soon electronic instant ticket lottery content that is then made available to mobile operators through what we call direct system integration.

Any of you who follow Scientific Games may know that its RGS activity, where it monetizes in the interactive space, the content otherwise developed for its retail equipment markets is among the fastest-growing, most profitable and perhaps the least appreciated of its businesses.

We have in the past been a little slow in pursuing this as a way to monetize our own growing and in many cases, unique content resources, but we are now highly focused on this.

We have been strengthening our organization accordingly, and we are seeing meaningful results.

Finally, I should touch on the other growth factor we are putting significant additional emphasis, and that is the untapped potential for all our business lines in the North American markets.

Again, as mentioned in the press release, the response to our VLT, Virtual Sports and Interactive product at the recent G2E in Las Vegas was tremendous.

We're following a number of excellent customer leads in both the gaming and lottery markets, are in the process of customizing certain products for the North American market.

With the Supreme Court ruling favoring sports betting in the United States, we would expect to see significant U.S. activity on the part of many of our online and mobile customers, who currently operate outside United States.

So to summarize, we're very pleased with our performance in fiscal 2018, and we're extremely sanguine about continued growth prospects throughout the world notwithstanding the anticipated impact of the U.K. Triennial Review.

And on that note, I'll pass this over to Stewart Baker, our CFO.

Thank you, Lorne.

Good morning all.

As Lorne said, this is a successful year for Inspired, in which we continued to build our business and showed revenue momentum and improved operating leverage.

Overall, revenue for the fiscal year increased 15%, with growth in the Server Based Gaming division about 16% and Virtual Sports approximately 13%, and adjusted EBITDA grew 33% to $54 million.

In constant currency terms, this is up 114% from full year [2017].

Whilst there was a small FX tailwind in the year, all these metrics showed strong underlying performance.

Reported revenue for the fourth quarter was up only slightly due to the large hardware sale in the prior year that Lorne mentioned as well as no hardware sales.

Excluding these, revenue for the quarter grew about 14%, which is in line with our growth rate throughout the year and showed strength in the underlying business.

Adjusted EBITDA growth is 17% in the fourth quarter, that was also impacted by the hardware sales in last year's fourth quarter.

And adjusting for these, adjusted EBITDA grew roughly 37%, which better illustrates the improved leverage in the cost structure.

In Server Based Gaming, we ended the quarter at 33,200 terminals, which was up nearly 4,500 from September last year, and this was driven by the continued rollout to Greece as well as units into Betfred in the U.K. In Greece, we continued to perform very strongly versus the competition, having installed 5,500 VLTs as of September of the 8,360 contracted.

As OPAP announced on their earnings, they have a plan to have 19,000 VLTs in Greece by the end of December and currently have around 17,500 in operation, which makes us the largest supplier of VLT terminals in Greece.

Our machines in Italy also continued to outperform during the quarter.

For the full fiscal year, customer gross win per unit per day was up 14% in local currency.

In Virtual Sports, as mentioned, the headline revenue number was up 13% in the year or 8% in constant currency.

However, stripping out the benefit in the prior year number, previously unreported numbers to us and the timing movement in the contract extension as well as a reduction in historic license fee unwinds that we discussed before, underlying revenue increased nearly 21% due to increases in Greece, U.K., Finland and Poland as well as the new customer revenue in the Interactive division.

Since the start of the calendar year, we are live with a number of new customers, both for Virtual Sports and Interactive.

In Greece, we went live with an additional Virtual Sports channel after the quarter-end that was very well received and that will be highlighted on the OPAP's earnings call.

We've also announced the worldwide exclusive contract with Bet Stars, which we're also very excited about.

And in Interactive, we now have 27 RGS integrations, which is up from 10 last year.

To look further down in the income statement, stock-based compensation expense increased primarily as a result of having 12 months trading as a public company versus 9 in the prior year, and depreciation and amortization increased 24% or 19% on a like-for-like basis, reflecting the charge for increased product investment in prior years.

In addition, we incurred an impairment expense during the quarter of $7.7 million.

This is related to assets of which the carrying value can no longer be substantiated given the change in management and the strategic focus on North America compared to other areas.

It's important to stress, this is a noncash adjustment and related primarily to impairment of intangible assets.

Despite these increases, as a result of the adjusted EBITDA year-on-year increase, our net operating results improved for the full year.

And from a cash flow perspective, we are seeing the benefits of growth in CapEx-light areas and reductions in capital spend, both tangible and intangible in areas that Lorne referred to, primarily in scheduled Virtual Sports and Interactive.

We're also seeing SBG capital hardware being deployed on the U.K. and the Italian estates for longer periods than historically was the case.

So for the 3 months, if we define free cash flow as the net cash provided by operating activities less net cash used in investing activity, free cash flow for the quarter was positive $1.7 million.

From a cash flow perspective for the 12 months, net cash provided by operating activity increased to $34 million from $18 million in the prior year, and net cash used in investing activity increased from $35 million last year to $43 million this year, mainly due to additional CapEx to fund the VLT terminals in Greece.

So despite the fact that we paid out $6.2 million more of cash in interest this year, due mainly to the way the timing of payments worked out given the refinancing and that also, we expensed $4 million on restructuring costs in the period, free cash flow improved $8.4 million year-on-year and we closed the year at $22.5 million in cash.

As a management team, we focus heavily on cash flow and believe we'll have full year of positive free cash flows in the short to medium term.

And now onto the balance sheet.

As we mentioned during the last earnings call, we successfully completed an approximately $150 million refinancing, which strengthens our balance sheet, lowers our cost of capital, increases the cash on the balance sheet and gives us much more flexibility to grow our business as well as dealing with the challenges that come with the change in the U.K. strategic landscape.

I also want to remind everyone that our next quarter, the quarter that we currently in, will be a transitional quarter as we compare to calendar fiscal year.

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

Thank you, Stewart.

Operator, I don't have any additional comments.

So we can go ahead with Q&A, please.

(Operator Instructions) And your first question will be from Chad Beynon of Macquarie.

Wanted to start with a high-level one on -- in North America on SBG.

You kind of noted that this is increasingly becoming a bigger area of focus and some of the content performance outside of North America has drawn some attention from some operators here.

So a couple part question on this.

One is the goal on SBG in North America is still kind of 2020 and beyond?

Secondarily, where are you from a licensing standpoint?

And then lastly, just any other feedback from G2E just on the content and kind of how this would translate in North America.

Sure.

I think, Brooks, you're on the call in London, right?

Correct.

Yes.

So Chad, I'll let Brooks Pierce respond to that because he has been very, very close to this effort, and as you know, brings to this effort a huge amount of experience from his time in both Aristocrat and Scientific Games.

So Brooks, why don't you take a shot at that, please?

Sure, Chad (sic) [Lorne].

Yes, so we're -- we had a great G2E show, and I think, as you know because you came to the booth, you saw what we're doing.

We'll be doing some bespoke development on the content side for the North American market and we have had teams over in North America really studying that, which is kind of the road map we use for Greece and why we're, by a substantial margin, the highest-performing games in Greece.

So we'll have new a cabinet for North America, which we hope to be showing at ICE, and we would look to be able to go into market probably the middle to the latter part of 2019.

But yes, 2020 is where we'll expect to see some pretty meaningful growth at in the North American market.

In terms of the licensing question you asked, we've had a number of the regulators coming through here, interviewing us, as you would imagine.

We're active in not only the U.S. market, but obviously, the Canadian provinces because of their use of G2S, which is what we have in the market in Greece.

So I'm quite happy with how we're developing and using what we've done both in the Greece market as well as in Italy, where we're substantially overperforming relative to the competition.

So we feel very good about our ability to be able to translate what we've done in those markets and with the experience and with the time we spent in North America, bringing a product that, quite frankly, in the space that we're going after, which you would know is primarily the route and VLT based hasn't seen a whole lot of innovation.

So we're -- we feel pretty good about the North American market.

Okay, great.

It's a great rundown.

And then switching to Italy, you noted that your performance from revenue per day or win per day was up 14%.

Are you seeing a benefit from maybe some of the reductions in the AWPs that happened earlier in the year and players are kind of just gravitating towards the better machines or the machines that they like best?

Or is there anything else that we should think about from a dynamic standpoint going on?

And then as we look into next year, could we still expect some nice growth in this content -- or in this arena outside of, obviously, the tax impact that most people are well aware of?

Yes.

I think, as you -- again, as you would know, it seems like every time you take a step forward in Italy, there is a tax that comes in that takes some of that benefit away.

But we're certainly seeing kind of every month continued nice success in Italy, and I think part of it is really the market has centralized down to a few suppliers, which we're one.

And we also have some titles in Italy that are doing extremely well, Centurion, which is actually a brand that goes across kind of all of our markets.

So I think it's a combination of really all of those factors, and there is nothing that we're seeing in the future that would say that the growth would slow down in Italy.

All right.

And then lastly just on, I guess, build versus buy and how you think about the company over the next couple of years now that you know, I guess, all of the factors that can play into your business model and you can come up with internal projections on the growth.

How are you thinking about potential tuck-on acquisitions versus just doing everything in-house going forward?

Lorne, do you want to take that one?

Or you -- I'm happy to talk about the build stuff, but Lorne is probably best suited to talk about the buy stuff.

Yes.

We -- the idea of kind of having a balanced growth plan between organic development of the sort that we've seen over the course of the last year because, again, all of that quarter-to-quarter growth actually go back to the time when we first bought Inspired and merged it with our public vehicle.

I think the EBITDA then was in the 30s.

So in effect, we've gone in less than 2 years from EBITDA in the 30s to, on a run-rate basis, right now over $60 million.

And all of that has been organic.

And hopefully with the number of the things that we've talked about, not to steal Brooks' thunder but -- and, again, notwithstanding the hiccup that will come from the Triennial, we're very sanguine about the continued organic growth of the company.

But at the same time, we're very focused on looking at appropriate, as you might call them, tuck-in, or I sometimes call them buttressing acquisitions, that might get us both in terms of increased scope and increased scale where we want to go even faster than we're experiencing organically.

So obviously, we can't talk about any specific targets that we're looking at or even whether there are specific targets that we're looking at, but this absolutely is a critical part of our business plan, and hopefully, in the course of 2019, something meaningful in that regard will take place.

(Operator Instructions) And the next question will be from Mike Malouf of Craig-Hallum.

I wonder if you could focus in on what you touched on earlier on, Lorne, with regards to the 475 basis point increase in EBITDA, just a little bit more color on that mix shift.

And then as you look at over the next year, what does that mean to free cash flow for the firm?

Okay.

That's a good question, Chad (sic) [Michael].

Let me set the margin one off to the side for a minute and talk about this issue with mix and cash flow because obviously that's the cash flow, in particular, is the area that's important.

Ironically, the same trend that is helping us in mitigate the impact of the Triennial is actually very significantly helping our cash flow and will have actually, in my view, a profound impact on that looking ahead over the course of the next couple of years.

Because the most capital-intensive part of our business, and therefore, the part of the business that has the greatest impact on our free cash flow is, in fact, the U.K. FOBT business.

So if we wind the clock back a couple of years when the U.K. FOBT business was the overwhelming dominant part of the business, the cash flow characteristics were not great because of the peculiarities of the U.K. business model that I know you're familiar with.

Now we've seen all of this growth from $30-something million EBITDA to $55 million or $60 million of EBITDA, that is away from the FOBT business.

So just that trend alone is significant and the -- that trend is further reinforced by the fact that Brooks didn't mention this one, he was describing the what we think is a tremendous opportunity for our Server Based Gaming games in North America is that this will be almost entirely a sales model.

So unlike the U.K. where the cash conversion of EBITDA into cash is minimized because of need periodically to refresh the capital, the business model in North America will be a sales model and in effect, 100% of the EBITDA will convert to cash.

So that will be very, very important.

If we turn to -- look at other parts of the business, as -- again as the business swings, particularly to virtuals, the capital characteristics of the Virtual Sports business is interesting.

There is very significant capital upfront for developing these games, but then once the game is developed, the maintenance CapEx is almost trivial so that, that business scales really better than almost [every] business that I've never seen.

Right now, we have, I think, 14 sports or 15 sports that are complete.

We're in the process of completing our basketball game, which is -- looks like it's going to be a phenomenal game and is hugely anticipated in markets all over the world, not just in the States.

We should be introducing that in the late winter or early spring in 2019.

And at that point, we'll be mostly done.

I think maybe the only thing possibly left would be hockey.

So once all of the game library is created, then we can market these games all over the world with very little CapEx.

So again, the cash flow conversion is tremendous.

And then finally, as more and more of the business swings to mobile and online through the RGS dynamic that I explained in my comments, all of the content that is being launched on the RGS was developed for the sake of either the VLT business or the Virtual Sports business.

So in effect, that capital is free to the RGS business and all of that EBITDA converts almost 100% to cash.

So if we put those 3 things together, Mike, I think, and again, Stewart can talk more specifically about this since he is closer to the numbers, but as we move through 2019 and into 2020, given the confluence of these factors, I think we will see a dramatic change in the cash conversion profile of the business.

Great.

That's really helpful.

And then just a quick comment on the announcement of Bet Stars.

I'm wondering if you could provide sort of a little bit more color on there and the opportunity around that.

Brooks, do you want to talk about that?

Yes.

Nothing more than we can say about that it's an exclusive deal for virtuals and we'll ultimately go across their different brands.

And as we've seen with some of our other customers in that space, we have -- we think there is huge potential and Lorne did a nice job covering out both on the interactive side and the retail side, we're sharing the content development across those groups.

So as we gain traction across the business, particularly with brands, I'd mentioned before Centurion, but -- Super Hot Fruits, but also some of our Virtual Sports brand names, I think that's going to become a bigger and bigger part of the business and I think it will stay in very nicely with the Stars Group.

(Operator Instructions) And I'm showing no additional questions at this time.

I would conclude the question-and-answer session, and I'd like to turn the conference back over to Lorne Weil for any closing remarks.

Thank you, operator.

I don't really have much to say beyond what we've discussed.

I think that the business is running beautifully right now.

We're getting ready to deal with this Triennial, but at the same time, all the other growth factors of the business are performing very, very nicely.

And obviously, we appreciate your support, and look forward to talking to you at the end of our next quarter, which will be, I guess, as we call the stub period as we then beginning in January 2019 shift from a fiscal to a calendar year.

So thanks very much, and we'll see you in a quarter.

Thank you, sir.

Ladies and gentlemen, the conference has concluded.

Thank you for attending today's presentation.

And at this time, you may disconnect your lines.