Inspired Entertainment Inc (INSE) 2019 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Inspired Entertainment Fourth Quarter and Fiscal Year-End 2019 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 fourth quarter and fiscal year-end 2019 earnings press release, which is available at 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 like to now 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 thanks for joining our call this morning.

We're living in interesting times, to say the least.

And needless to say, it's never fun coping and competing for attention with a potential pandemic.

But it's particularly not fun for us when, unfortunately, but for obviously critically valid reasons, it eclipses a quarter like the one we just had, that our team has been working on really nonstop for the last 2 years.

As many of you know, I've been in this industry and doing what I do for maybe 45 years.

I think I was about 12 when I went to work for a company called General Instrument in the '70s, where, by the way, coincidentally -- actually, not coincidentally, I worked very closely hand-in-hand with the father of our President and CEO, Brooks Pierce.

And I never ever have seen anything like what our team has been able to do, in a way, forced to do, in the last couple of years.

So if I may, let me beg your indulgence for a few minutes and review a little of this recent history, since reviewing history is what companies seem to do in year-end conference calls anyway.

In February 2018, so almost exactly 2 years ago, we began talking seriously with Novomatic about buying their U.K. technology business, a business larger but somewhat less profitable than ourselves.

We signed a definitive agreement in June 2019 after a very comprehensive due diligence process, and we then closed in October 2019, following a lengthy and also complicated regulatory review.

In the 6 months since we've integrated the 2 companies, we've made significant progress in centralizing manufacturing, rationalized content development, streamlined the field service organizations and begun to really exploit additional significant revenue and cost synergies.

As if we weren't busy enough, in the middle of this process, of course, the U.K. regulatory authorities had to announce in May 2018 the reduction in the maximum FOBT stake to GBP 2, which struck the industry more or less like a lightning bolt.

It was originally intended to take effect in October 2019.

And then, as most of you know, at the 11th hour, it was accelerated to April 2019.

So in parallel with the Novomatic acquisition and integration process, we undertook to completely restructure our own U.K. operations to mitigate the Triennial impact, the results of which, I hope, are apparent today and, indeed, actually, the results both of the mitigation of the Triennial and the impact, at least the beginnings of the impact, of the Novomatic acquisition.

When we did the original Hydra-Inspired acquisition back in December 2016, those of you who were around then, know that we inherited a debt facility with Ares that initially we had no alternative but to extend.

In August of 2018, we refinanced the Ares facility with HG Vora.

And then when we completed the Novomatic acquisition, we completely refinanced all of our debt, both our original -- the Inspired acquisition debt and the Novomatic acquisition debt, again, this time with the help of Nomura, and we significantly lowered our cost of capital.

In April 2018, Brooks Pierce joined us as President and COO after several months as a consultant.

Brooks, as some of you know, had been Chief Revenue Officer of Scientific Games and, subsequently, President of Aristocrat in North America.

In fall of 2018, so not long after joining, Brooks' team began working on the development of the Valor cabinet to spearhead our entry into the North American market.

And in November 2019, we took our first orders.

Without question, a time-to-market record in terms of design and development, production, very importantly, regulatory approval and marketing.

Similarly, in May 2019, Steven Beason, who had also been a consultant to us for several months and previously CTO of both GTECH, now IGT, and Scientific Games joined us as CTO, and almost immediately launched our development facility in India, focused initially on supporting and driving our online and interactive businesses, which, in 2020, and we'll get into this a little more later, we expect will account for nearly 1/3 of our adjusted EBITDA and provide us with a critically valuable cushion as we watch the evolution of the coronavirus.

So those are some of the things we managed to do in the last couple of years, I think, actually remarkably for a company of our size and relatively limited resources.

And that brings us to the main reason we're here, which is to talk about the fourth quarter of 2019.

As we described in the press release, revenue was $66.4 million for the fourth quarter, an increase of 150% sequentially from $26.6 million in the third quarter and 116% year-over-year compared to December 2018 quarter.

Adjusted EBITDA for the quarter was $17.7 million, an increase of 103% sequentially from $8.7 million in the third quarter and 69% year after year -- year-over-year.

As noted in the press release, the overall adjusted EBITDA margin in the fourth quarter was 27% compared to 34% in the December quarter last year.

The adjusted EBITDA margin of the legacy Inspired business actually increased to 36% this year from 34% a year ago, indicating, among other things, that we've done a pretty good job of mitigating the impact of the Triennial, which went into effect in April 2019, as I mentioned before.

By comparison, the margin on the acquired business was about 17%, which averaged the combined margin down to 27%.

The positive news is that we see very significant runway for margin improvement as the acquired business continues the shift from analog to digital, which drives both revenue and reduced costs and as we realize very significant anticipated synergies.

Revenue for the full year 2019 was $153.4 million, an increase of 9% year-over-year.

And adjusted EBITDA for the full year was $49 million, a decrease of 10% compared to the 12 months ended December 31, 2018.

2019 revenue included a full year of the legacy Inspired business plus one seasonally below-average quarter for the Novomatic acquisition.

Our adjusted EBITDA for 2019 absorbed the impact of 3 full quarters of the Triennial impact.

2018 had not yet experienced any, so once again demonstrating our successful efforts to mitigate the Triennial by year-end.

We are very pleased with our results in the fourth quarter, the strongest quarter by far in the company's history.

And it was the strongest quarter, notwithstanding that we are not quite finished with our plans to mitigate the Triennial.

The fourth quarter is a seasonally below-average quarter for the acquired business, and we're only partway through implementing our synergy plans.

So this would suggest at this point that we have successfully created a platform that should support significant sustained growth in the future, driven, in turn, by 4 fundamental vectors: one, continued mitigation of the effects of the Triennial through operational restructuring and cost reduction efforts; two, generation of new business in our VLT, Virtual Sports and Interactive businesses to recapture the adjusted EBITDA loss to the Triennial and then some; three, integration and profitability improvement in the newly acquired businesses through both growth and digital conversion in the U.K. leisure segment; and then finally, maximization of revenue and cost synergies between the complementary businesses.

All of these are things that Brooks will talk more about in a moment.

After which, Stewart will cover the financials.

For some time, we've been forecasting that the fully mitigated adjusted EBITDA impact of the Triennial would be $10 million to $11 million a year.

In the fourth quarter, which was the third quarter following the implementation of the Triennial, we estimate that our adjusted EBITDA was negatively impacted by $1.8 million or about $7.2 million on an annualized basis, which would suggest that we're actually well ahead of the $10 million or $11 million estimate.

But I should mention that in the fourth quarter, we generated some nonrecurring revenue from the sale of machines that were removed from the field following customer shop closures.

And at some point, shop closures will stop, and there will no longer be any machines to remove -- to sell, obviously.

We continue to see a steady improvement in the sequential year-over-year trend in gross win per unit per day, which was down about 44% immediately following the April implementation, which, needless to say, was not fun.

It was then 37.5% on average in the third quarter and about 21% in the fourth quarter of last year and the first quarter of this year.

Along the way, we've seen the closure of approximately 850 shops, supporting our previously outlined thesis that a substantial portion of the revenue loss due to shop closures would be recovered throughout our remaining estate and that the shops closed would, on average, be at the lower end of the cash box distribution.

And so all of these factors have combined to give us, I think, the excellent results that we saw in the fourth quarter.

Given the positive sequential revenue trends we're seeing and the continued progress on cost-focused operational initiatives, we continue to feel that the impact will be, at most, $10 million to $11 million a year on a steady-state basis.

We said earlier on that we expected that by the end of this year, our overall adjusted EBITDA run rate would be back to where it was going into the Triennial.

In other words, that by the end of the year, our other business initiatives, such as the launch of our gaming machine business in North America, growth in Virtual Sports and additional Interactive customers will together be generating at least $2.5 million of incremental adjusted EBITDA per quarter, if not more, enough to offset the impact of the Triennial and take us back to a level of EBITDA that prevailed before the Triennial went into effect, and we were around $12.5 million, $13.5 million, so $50 million to $52 million or $53 million a year.

As we saw in the press release, the adjusted EBITDA from the legacy Inspired business in the fourth quarter was $12.2 million, so we're pretty much in that range, up from $10.5 million in the year prior.

And the adjusted EBITDA margin increased to 36% from 34%, which illustrates the 2 fundamental things we've been talking about: the mitigation of the Triennial itself because the legacy business was able to outperform the year before despite absorbing the impact of the Triennial and the organic growth initiatives that we've been talking about over and over.

The fact that the adjusted EBITDA of our legacy Inspired business grew 16.5% largely from non-U.

K. LBO growth, specifically the launch of the VLT business in the U.S. and continued growth in virtuals and Interactive now clearly shows that we're in a very strong upward trajectory.

Finally, on October 1, we completed the acquisition of Novomatic's U.K. Gaming Technology Group, which I just discussed before, and which, at least for the time being, we will refer to separately as the "acquired businesses" in order to allow us to demonstrate and focus on the synergies coming from the merger and the important and obvious opportunities for margin improvement.

Once this process has run its course, the acquired businesses will be, for reporting purposes, fully integrated in what will then be 3 business segments, a gaming segment, a virtuals Interactive segment and a leisure segment.

These acquired businesses are experiencing positive trends, both in terms of stand-alone revenue and profitability and the integration synergy work we continue to do.

Indeed, the underlying trends have been stronger than we had originally anticipated.

Our thesis that the profitability of the pub segment would improve in line with the conversion to digital is being borne out by both improving cash box for gaming device and reduced costs.

In a moment, Brooks will discuss how it is, this apparent paradox that increasing revenue actually goes hand-in-hand with lower cost as these machines in this field convert from analog to digital.

Very importantly, trends in the U.K. pub segment itself are improving as the number of pubs increased in 2019 for the first time in a decade.

There are quite a few other positives we're seeing in the acquired businesses that Brooks will discuss in more detail.

On the basis of the foregoing, we expect that the 2020 adjusted EBITDA coming from the acquired business will grow nicely over what it was in 2019.

And at the same time, we now think that the total annualized synergies will be closer to $15 million by the end of 2020, greater than our prior projection of $12 million to $13 million.

As many of you know, we are not, in general, widely enthusiastic about guidance.

But because there's so much going on in both the legacy Inspired and the acquired businesses, I do think we need to offer some direction in how to think about our business in the near term.

A consensus of research analysts that follow us seems to be around $73 million of adjusted EBITDA for 2020.

And I think we're pretty comfortable with that or at least we certainly were prior to the rising of the coronavirus situation.

We feel that the fourth quarter performance this year is quite consistent with that range, though as we look ahead over the arc of the next year, we should expect that there will be variation from quarter-to-quarter.

We expect a decline sequentially in the first quarter, both because of the timing of onetime sales and because the first quarter seasonally is the weakest of the 4 quarters of the acquired businesses that this will be followed by very strong, significantly above-average second and third quarters and then a somewhat moderate seasonally in between-driven fourth quarter.

All that being said, this does not take into effect the potential impact of the coronavirus.

So far, we haven't seen any impact in our U.K. or Greek businesses.

We have seen Italy close all the betting shops and live sports events.

They have not closed the shops known as corners, basically small convenience or these agents, tobacco shops, et cetera.

And these are very important for our Virtual Sports business.

Italy altogether, retail virtuals and online makes up less than 5% of our total company revenue, and quarter-to-date, the impact has been de minimis.

We have been told to expect the betting shops in Italy to open back up on April 2. And in theory, we could, in the meantime, see an uptick in our online business from the quarantine.

It's a fluid situation, and we're monitoring it very closely in all the geographies in which we operate.

I think it's reasonable to assume that if there is a prolonged and material impact from coronavirus, there's going to be an impact on our growth.

But we've got a very profitable business model, where, as I mentioned earlier on, 1/3 of our adjusted EBITDA comes from our online businesses, which should not only not be subject to the coronavirus but conceivably could increase as the opportunities for retail play are diminished.

We have made very detailed, very comprehensive internal contingency plans based on what we're seeing today, and we will continue to monitor this.

And with that, I'll now hand it over to Brooks.

Okay.

Thank you, Lorne.

I'm happy to add a little bit of color to some of the points that you touched on, in particular, the benefits and integration plans for the acquired businesses as well as the business developments that you spoke of and the legacy Inspired business.

So in terms of the acquired businesses, the conversion of analog to digital in the pub market is going faster than originally projected, primarily due to the success we're seeing in performance in that segment and the demand from our pub customers.

So from the beginning to the end of the quarter, just 90 days, digital machines as a percent of our total Cat C machines in the pubs increased from 61% to 66%.

We've talked about this before, but the conversion of analog to digital has the ability to improve revenue and increase our margins for several reasons that I'll outline: number one, we don't have to physically move machines every 12 weeks like you do in the analog model; second, the ability to download games and update them remotely; third, the refreshing of game content more frequently, higher daily cash box driving higher rental rates and our plans in the future to be able to implement cashless in the pub market which will significantly increase our margins.

In the leisure segment, which includes both holiday parks, motorway services and AGCs, adult gaming centers, the results for the quarter were better than we were originally anticipating, even in a seasonally low quarter.

We're anticipating an even better season this year, but that really starts to manifest itself in the second quarter, as Lorne outlined.

As for the synergies, our teams have been working very hard on the integration plans, and we see a number of opportunities in both cost savings and revenue growth.

During the quarter, the annualized cost synergies from the acquired businesses were tracking at a $3.5 million run rate, mainly driven by savings in technology, followed by service operations and gaming sales, and that doesn't include the revenue synergy opportunities.

And let me touch on that for a second.

So Novomatic is a leading arcade operator in the U.K., but they also have the B2B business that we acquired.

And what is often the case when you're both in the B2B and B2C in the same market, you actually penalize your B2B business because, in certain instances, your customers are also your competitors.

This could have been part of Novomatic's rationale in divesting the business, but what we're now beginning to see is that we're able to generate business from B2C customers that used to be competitors of Novomatic.

We're also starting to see the benefits of having 3 design studios, the Astra, Bell-Fruit and our existing Inspired design studio.

We strongly believe that the combination of these 3 groups position us well as we execute on our omnichannel strategy across multiple geographies.

Bell-Fruit and Astra, for example, are producing content for the U.K. pubs market that's growing that business significantly and is producing industry-leading results.

This content, combined with the leading Prismatic cabinet, is the key to success in that segment of the business.

And as we've discussed on previous calls, we'll also be leveraging this new content, plus the 6 key Novomatic titles that we acquired in the transaction within our U.K. LBO business to both drive increased cash box as well as reduce our reliance on third-party content to increase both our margins and our revenue.

The combination and addition of all this content creation will drive not only our server-based gaming business but will also serve as catalysts for our interactive remote gaming server business as we develop content for the multiple markets we serve.

We're seeing significant growth in that space and expect that to continue as we expand further into existing markets like North America, Sweden and Italy and then move into new markets for Inspired like Spain.

Needless to say, we are very pleased with this acquisition, which is starting to come through in the results.

Clearly, we're getting more financial synergies than expected, we have more capacity in terms of our design studios, we're in segments that are growing, we have positive momentum in the conversion from analog to digital, and then we're seeing improving results in the other channels which we expect to continue.

So let's move on to the legacy Inspired business.

As Lorne talked about, the impact of the Triennial is continuing to mitigate every quarter, and that trend is continuing into the first quarter.

We saw meaningful growth in our virtual segment in the U.K. retail sector, which is helping to offset the lower handle from the Triennial.

We're also seeing significant growth in Interactive from both Europe and North America, so quarter-to-date, we have 6 Interactive clients live in North America: Mohegan Sun, Resorts, Caesars and Gold Nugget in Jersey; and in Canada, both BCLC, British Columbia Lottery Corporation, and Loto-Quebec.

And the results we're seeing across the whole North American estate are, frankly, quite encouraging.

We talked about this before, but in the North America virtuals business, we rolled out our new Derby Cash game in Pennsylvania in November and supported by extensive marketing from the Pennsylvania Lottery.

And what we've seen is a significant ramp-up in the sales almost immediately, growing week-by-week on a very consistent basis.

It's not yet where we want it to be, and we certainly like to add another channel into the Pennsylvania Lottery, but as I said, we are seeing it grow every week, and that's supporting our thesis on this market.

Let's talk a little bit about the North American VLT market.

In Illinois, our bespoke content specifically designed for that market has been performing exceedingly well.

In a few short months, we've had trials with nearly every operator, and all completed trials have resulted in follow-on orders.

As mentioned in the release, in the fourth quarter, we sold 116 terminals, and period to date, in the first quarter, we sold 144.

So we've seen nothing that would tell us this momentum is going to change in Illinois because our performance has been outstanding.

The 6 machines are still being added to the market.

And increased stakes and prizes are creating drive and demand for the customers to replace machines.

We're very comfortable with the volume of North American VLTs assumed in Lorne's comments about 2020.

And we are excited to be able to report soon on progress in a second market.

It's nice to have a quarter to talk about all the positive trends with everything else going on in the world, and we're very happy to see that throughout our business, with the Triennial pretty much in our rearview mirror, the future looks very good for us.

So I echo Lorne's comments regarding seasonality of the business and the timing of the business developments, but it's rewarding to see the strategy that we outlined over the last couple of years is actually delivering the results that we anticipated.

So now let me pass it over to Stewart to discuss the financials.

Thank you, Brooks.

Good morning, all.

So let me spend a few minutes talking through the high-level numbers.

I'm trying to add a bit of color and trying to help you make sense of what was a busy but, we believe, ultimately, successful quarter.

Clearly, the results of the acquisition on the first day of the period do play a large part on variances to the same quarter in 2018.

And as I go through, I'll try to make it clear if I'm talking about the total results or organic only, i.e.

considering just the legacy business.

It's also worth noting for the first time in a long time, the quarter had very similar U.S. dollar-to-GB pound rates to the prior year quarter.

So at least there's minimal FX differences, which certainly makes it easier to understand those trends.

So overall, as we see, revenue grew 116% to $66.4 million over the same quarter in the prior year.

And clearly, a large part of this was due to the acquisition.

But even excluding this, revenue grew 9% or 13%, including sales to the acquired business, and we saw growth across both the SBG and the Virtual Sports segments.

So despite the Triennial and SBG, revenue grew 11%.

I think it's worth emphasizing 3 key objectives that we hit in the quarter.

Firstly, as mentioned by both Brooks and Lorne, we sold our first terminals into the U.S. market.

Secondly, OPAP rolled out all of the nearly 9,000 contracted terminals in the Greek market by the end of December.

And thirdly, as we said, we improved the Triennial position in the U.K. market.

It was also a very strong quarter for hardware sales with self-serve betting terminal sales increasing nearly $2 million year-on-year and electronic table games increasing $1.3 million over the prior year quarter.

And the Virtual Sports segment, which incorporates Interactive, grew 17% to just under $10 million due to 3 main reasons.

Firstly, U.K. and Ireland retail grew $0.6 million primarily due to a number of new channels across most operators.

Secondly, we saw growth in online virtuals of $0.4 million, particularly in our U.K.-based customers as well as Interactive slots of $0.3 million, the latter increasing by more than 50% year-on-year due to both new customers and some new high-performing content.

And we also had a strong quarter in virtuals for project work.

So in terms of the acquired businesses, they also performed well during the quarter, albeit it's in one of the quieter 2 quarters of the year, given that the number of leisure parks are closed for the majority of the period.

So for obvious reasons, we don't show the prior period numbers.

However, based on representation of previous ownership, we believe this quarter would have shown an increase in revenue of about 9% and adjusted EBITDA of about 22%.

A part of this came from an increase in leisure park revenue of 15%, but the majority came from increased pub digital revenue.

So just quoting a few statistics.

So the number of digital Cat C machines in the U.K. pub market was up 44% on the prior year to approximately 5,400.

The revenue per terminal per week had increased 11% in this time frame.

And there, as mentioned before, as a percentage of the total Cat C estate, digital machines has increased from under 50% to nearly 2/3.

So on a total group level, adjusted EBITDA grew 69% to $17.7 million, including an impact of $5.5 million from the acquired businesses.

This means that the legacy business grew 17%.

So in relation to the base of this as well as the revenue increases described, we also continue to benefit from cost reduction measures, including those linked to the Triennial.

And above the line, SG&A costs reduced 6%.

Below EBITDA in the income statement, net loss increased from $4.7 million last year to $12.8 million this year.

But the majority of this was caused by one-off costs in relation to the refinancing, as prepaid costs relating to the old debt of $7.3 million were written off.

And we also served a noncapitalizable cost of the new debt of just under $2 million.

So the total interest expense in the quarter of $15 million, only $5.4 million related to ongoing coupon costs.

So turning attention to cash and cash flows.

We ended the last quarter with just under $30 million on the balance sheet and ended this quarter with a little over $29 million.

So a little difference on the face of it, but there's quite a bit going on beneath there.

So we acquired $8.4 million of cash, including floats, with the businesses.

There's movement from new debt and the acquisitions, acquisition costs and integration fees resulted in outflow of about $3 million.

We've reduced the level of revolver draw in the quarter of $6.5 million.

And then from a trading point of view, there was cash utilization of just under $3 million.

But we had a large quarter of capital expenditure of $11 million, including both Greece VLT rollout in the legacy business and, as we talked about, digital pub rollout in the acquired businesses.

So as a reminder, post the refinance, we have GBP 140 million of borrowings at LIBOR plus 7.25% and EUR 90 million at LIBOR plus 6.75% with a 0 floor.

Post the quarter end, we entered into an interest rate hedge covering approximately 2/3 of the variable element and now pay a blended coupon rate of about 7.7%.

On top of the term loan, we have a GBP 20 million revolving credit facility, of which GBP 2 million or $2.6 million was drawn at the quarter end.

So turning briefly to the quarter we're in now, so the first quarter of 2020, I think it's worth flagging a couple of points, and these observations do exclude any impact of coronavirus, which, as we said, has been minimal to date.

So in terms of the first quarter, we see that the acquired business has its lowest quarter of the year, primarily due to leisure parks being closed for the majority of the time.

And as such, I would expect less than 10% of the acquired business's adjusted EBITDA of 2020 to be achieved in quarter 1. But at the same time, we have a large proportion of the acquired business capital spend takes place in this quarter before the parks open for the year.

In Italy, even including any coronavirus impact in server-based gaming, we have seen some reductions in gross win due to another round of increased taxes.

And there have also been some reductions, as you know, I'm sure you've read about elsewhere due to the new card reader.

And finally, in Greece, whilst 2020 will be a year of estate optimization, which I do think will be beneficial to us in the medium to longer term, in the short term, we have seen our estate size on an average basis reduced by a few hundred as machines are taken out of one location and put into another.

So finally, just quickly on synergies.

We've heard that we're increasing our steady-state run rate to $15 million of savings by the year-end.

These savings are coming across most areas of the business.

And by the quarter, we were at about $3.5 million, with approximately $0.8 million of benefit in quarter.

I think it's worth denoting that we have a very clear line of sight to get to the $15 million that we talked about.

And by the end of the first quarter or soon after, we hope to have -- be more than double the run rate position that we saw at the end of 2019.

So hopefully, that adds some context for the numbers.

So with that, I'll hand back to Lorne.

Thanks, Stewart.

Operator, I guess, if you can, let's now open the program to Q&A.

(Operator Instructions) Our first question comes from Chad Beynon from Macquarie.

Really thorough prepared remarks, so I think you probably hit on most of my questions already.

But Brooks, maybe if we can start with U.S. Obviously, very strong unit sales in the fourth quarter and the first quarter, nice to see that, that's continued.

Can you just help us understand how long it's taking for trials to be converted to sales?

How pricing has been in that market?

And then just from a title perspective, if all of these are on the Valor cabinet with the multiple titles?

Sure.

Well, I'll answer the last question first.

Yes, all of the titles, all of it is on Valor.

In terms of the trials, it really runs the gamut.

We've had some people that have literally taken the machines for a week and paid.

And we've had some that go out kind of the full 30 to 45 days.

But as I think we said in the release, all of the trials have converted.

And nicely, we've been rewarded with a number of customers making their second and even some third orders.

So the Illinois results are certainly very positive for us.

It validates the strategy.

I think one of the interesting things, Chad, is of our 10 games on the cabinet, there's a very equal distribution of all the gameplay, which is pretty unique.

Most suppliers would have one or 2 titles that generate the large volume.

So I think it validates our strategy of having gone into the market and developed bespoke content for the market.

And obviously, from our customers' perspective, they'd love to see their players playing kind of all types of games.

Great.

And then in the U.K., just on the legacy business, so sub-$2 million impact in the fourth quarter, certainly better than anybody was expecting.

Could you update us on, I guess, non-customer closures, where that's been?

I recall last quarter, I feel like some of the other shops where you didn't have product remained open a little bit longer than yours.

And then also in the $10 million number, just so I'm clear on this, are the hardware sales netting against that?

Or is that like a separate item to think about?

Okay.

Well, I'll answer the part about the shop closures, and I'll let Stewart answer the second part of your question.

So in terms of, I think, GVC in their release came out and said that.

So from our customers' perspective, we're not seeing any more shop closures, pretty much William Hill and Paddy Power and Betfred have done all that they're going to do.

GVC had a number of closures in the quarter, and it's probably too early for us to see the impact.

But I think the thesis based on what we've seen with our own is that there will be redistribution from the GVC shops.

And because we have such a large proportion of non-GVC business, we fully expect to start seeing the benefit of that going forward, and we'll probably talk about that after the first quarter.

So Stewart, do you want to answer the second question?

Yes.

So good question, Chad.

So in terms of what we're seeing, the displaced terminals added probably about $0.5 million of EBITDA in the fourth quarter.

But more importantly, if you look at the correlation of that to the $10 million to $11 million, in the first year, 15 months or so, we'll get the benefit of that, which brings us within that range.

But then afterwards, whilst we don't have the benefit of being able to sell those, we will have the benefit of continually increasing gross win, and that's the trend that we're seeing.

So if you look at the first 12 months for kind of a long term at steady state, you still get back to roughly $10 million to $11 million kind of at the pessimistic end of our forecasts.

Okay, great.

Perfect.

And then last one, Stewart, just on the cash flow statement.

Now that the debt refinance and the merger cost and a lot of that is in the fourth quarter, how should we think about cash flow from operations as a percentage of EBITDA or another way to think about it for 2020?

Or could you just -- I think you mentioned this in the prepared remarks, but given the current debt situation, what's the annual expected interest expense?

Just trying to bridge all that together, given all the moving parts.

Sure.

So I mean, in terms of CapEx spend to flow into cash flow, you'll have seen in the release that we talk around 50% of EBITDA as a max for CapEx.

Then in terms of ongoing interest expense, on an annual basis will be around GBP 17 million, so about $24 million, $25 million.

I mean, we will, in the first quarter, maybe second quarter of the year, so we're going to have some costs of implementing the synergies.

So I think if you look at the industry norms, the cost of implementing synergies tend to be in the range of 60% to 80% of the annual impact of those.

So hopefully, those moving pieces together give you a sense of cash flow on an ongoing basis.

Our next question comes from David Bain of Roth Capital.

Great.

And yes, congrats on the fourth quarter results.

Encouraging, definitely, and the prepared remarks helped a lot with my questions.

But if I could, Stewart, I think you touched on this for sure.

But our understanding is that William Hill closed about 700 stores in September and is done while GVC is closing a few hundred more this quarter.

I mean, so is that to say that William Hill is just now focusing on kind of optimizing what they have?

And can you confirm that they're looking to increase the density of games in their shops?

So I mean, in terms of William Hill, you're right, 700 closed on the -- I think, the very last day of the third quarter.

And they've said publicly they wanted to do that in one big swoop rather than, I think, as they called it, rather than lots of salami slicing.

We have seen a few shop closures recently from GVC, which, as we mentioned before, certainly on the SBG side of things, only benefits us as some of that revenue finds its way back into William Hill, Betfred or Paddy Power stores.

In terms of density, the amount is capped at 4 terminals per shop kind of as it was before any Triennial impact.

Okay.

I felt that they were under that cap in general, but maybe I got that wrong.

Okay.

And then the lay of the land from a regulatory perspective in the U.K. in terms of forward sentiment for any further restrictions, credit cards, betting duties or otherwise?

Do you want to take that one, Brooks?

Yes, I'll take that.

I mean, it's always difficult to handicap these things.

We're not seeing anything more than what we've talked about or what's been announced publicly in regards to the credit card side of things, which won't -- we're -- we don't think will have a material impact on us.

I guess, perversely, maybe one of the benefits of this crazy corona thing is that maybe the government will not be as focused on the betting laws as they are with everything else.

But quite frankly, we're not hearing or seeing anything that would change our view on the U.K. market from a regulatory standpoint.

Okay.

And then just lastly, Illinois ramping faster than we had.

Can you speak to any sort of data points on play level post the increased stakes and max price in January that's leading to some of the accelerated game changes there?

And I know you spoke to outperformance versus competitors.

Outperformance, apples-to-apples, meaning it looks like you guys have changed that max play a little bit before some of your competitors.

And then finally, just if you can give us any sort of framework as to that second jurisdiction that you've kind of hinted to.

Any framework as to size, type of route market, what may or may not be similar than Illinois?

Okay.

Well, so in terms of the increased stake and prices, yes, that clearly has helped.

Our technology enabled us to make the change almost immediately, where some of our competitors have been taking some time doing it.

And they're doing it one game at a time where we immediately switched all our games, all 10 games to that.

So that certainly has helped us.

In terms of -- you know the way it's reported in Illinois, you have to actually get the data from the route operator.

So we're getting piecemeal of some of that, but one customer that we have that has shared data almost right from the get-go validates where we see where we're essentially #1 by a large margin in cash in and also significantly ahead of all other competitors in net win.

So clearly, the reordering from a number of customers who've taken our product, hopefully even without the supporting data behind it, would validate that, that's what we're seeing.

In terms of the next market that we can talk about, we certainly have a number of markets that we are targeting, that would be the route market, all of which are -- this is public information, the Oregons, the Canadian provinces, et cetera, et cetera.

Certainly, the results in Illinois helped validate for -- because for many people, even though we've been very successful in the SBG business overseas, we hadn't done it yet in North America, so this will validate that.

So we would expect to be able to have an announcement in the next quarter or 2 on our second market, but we will certainly be targeting every one of the route markets.

Our next question comes from Mike Malouf of Craig-Hallum.

Well done on the quarter, very impressive.

If I could just focus a little bit on the acquisition.

It sounds like you're doing just a great job on getting the digital transition, going from basically 61% to 66%.

And I'm just trying to get a sense of where do you think that will go over the next -- basically over 2020.

How fast can you get to 100%, if that's where you're targeting?

And that when you look at 2021, where do you expect, just given the move to digitalization, what will be the impact on the margins?

Well, let me -- the first part, I don't think we'll talk about 2021.

And we -- I would suggest that for the rest of the year, we would look to get to closer to 75% digital.

And everything that we talked about in the remarks in terms of the margins, and part -- most of that is, frankly, controlled by us.

So it's a matter of being prudent in our capital expansion.

And as you can imagine, as you get further and further down the chain of pubs, there are some pubs that, frankly, just won't support the digital because they won't be able to pay the rental rates that we ask.

So we won't get to 100%, but I would say 75% is a good target for us this year.

Okay, great.

And then with regards to virtuals, specifically in Pennsylvania, what -- obviously, Derby Cash is out.

It seems to be doing really well.

Is there any other new virtuals that you have planned, specifically, and maybe a relaunch of football?

Yes.

We made a presentation to the Pennsylvania Lottery with the license that we acquired that we mentioned before, the NFL Alumni.

They were super excited about the game, and we would expect that would be the next game to launch in Pennsylvania.

We're just working out the details.

It really takes 3. It takes ourselves, Scientific Games as the system supplier and the Lottery themselves.

So I would anticipate -- although they liked the basketball game as well.

But I would anticipate that the second channel will be either the NFL Alumni game or the basketball game.

This concludes our question-and-answer session.

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

Okay.

Thank you, operator.

I don't really have anything to add to what we've discussed so far in the program.

We appreciate all of you calling in.

We're obviously excited about where we've finally got to in this quarter.

We're also cautious about thinking about the immediate future because of this unknown impact of the coronavirus.

But hopefully, by the time we talk to you one quarter from now, this situation will be resolved, and we can get back to worrying about the real issues involved in the business.

So thanks for joining, and we'll talk to you in a few weeks.

Thanks.

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