Inspired Entertainment Inc (INSE) 2020 Q1 法說會逐字稿

Good morning, everyone, and welcome to Inspired Entertainment First Quarter 2020 Conference Call. (Operator Instructions) After today's presentation, there'll be an opportunity to ask questions. Please note that this 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 first quarter 2020 earnings press release, which is also 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 the rules of the SEC. These statements are based on management's current expectations or beliefs and are subject to risks, uncertainty 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, everybody, and thank you for joining our first quarter conference call. With me virtually are Brooks Pierce; Stewart Baker; and Dan Silvers. I'll begin my remarks by briefly discussing the first quarter in the context of the plan that we had been implementing with COVID-19 hit. Then I'll discuss the positive revenue and cost trends that we've been seeing over the last 8 weeks or so, and the impact they have had on our liquidity and our outlook going forward. And finally, I'll talk a little bit about how we see our retail business coming back. At that point, I'll turn it over to Brooks to discuss some of these revenue and cost developments in more detail. In the departure from our usual conference call format, Stewart will not do a detailed review of the financials. All of the necessary detailed is in the press release and 10-K, and Stewart is, of course, available this morning to answer questions.

When we last spoke in early March during our fourth quarter earnings call, we were tracking ahead of our internal budget for the first quarter of 2020, and nicely on plan relative to 2020 full year consensus estimates of EBITDA, which would have been in the mid-$70 million. Because of the significant seasonality in the acquired Novomatic business, EBITDA, what would have been the seasonally weakest first quarter, would then have jumped sharply to EBITDA well into the 20s in the second and third quarter, and then leveling out the fourth. But of course, the entire scenario changed dramatically during March, when literally 100% of our retail business in all geographies was shut down.

As expected and previously discussed, first quarter EBITDA was impacted by a number of concurrent factors. The residual impact of the triennial review, which did not go into effect until April 2019, but fortunately, as of the end of March, has now finally been lapped deliberately increased spending levels during the first quarter in anticipation of very significant revenue increases that had been expected. And the second, the seasonality of acquired holiday park business, where the fixed cost structure erased significant EBITDA contributed by other parts of the acquired Novomatic business. And finally, the nonrecurrence of certain onetime revenue items in the fourth quarter of last year. But of course, what was not expected, and which completed, in effect, the perfect storm, was the impact of COVID-19, which eliminated a huge portion of retail revenue in betting shops, pubs, arcades, et cetera, before any attendant costs could be reduced.

In mid-March, as this was unfolding, it would have been difficult, if not impossible, to believe that we would have ended April with positive EBITDA for the month as well as positive cash flow. Week by week as we move through mid-March to the end of April, and now into mid-May, we've been able to steadily and dramatically lower our operating costs, aided significantly by the U.K. furlough reimbursement plan, which very critically was just extended from June through the end of October. At the same time, as almost a mirror image of our decline in costs, our online revenue began accelerating week by week, so that by the end of April, our EBITDA ended positive for the month and continues on a week-to-week growth trajectory. As a consequence of these 2 positive trends, we ended the month of April with slightly more than $49 million in cash, considerably more than we might have expected a couple of months ago.

Given our current liquidity, along with where EBITDA and cash flow are, we believe we're nicely positioned to wait for the retail world to reopen. Our retail networks in the U.K., Europe and the U.S. consists primarily a physically small, geographically widely dispersed, predominantly local facilities that will have a relatively short response time to turn back on, and highly likely to quickly recover their player base.

Reinforcing this view, I think it's important to mention in conclusion that just last week, I think it started last Monday, more than 3,500 OPAP shops in Greece were reopened for lottery in both live and Virtual Sports betting, though not as yet for VLTs. And in just the very first week, and notwithstanding the enforcement of significant customer limits and social distancing to deal with the COVID issue, the daily level of our Virtual Sports business for the entire week returned to about 80% to 85% of where it had been before COVID-19. So I think the fact that we were able to achieve this, I see -- I think it clearly supports both the thesis on the resilience of the wide-area locals market in general. And of course, it further accelerates our month-to-month EBITDA and cash flow, so that going forward, we'll hopefully continue to see the benefit of Greece as well and of course, we're looking forward to the restarting of VLTs not just in Greece, but in our other geographies as well.

And so with that, I'll hand the program over to Brooks.

Okay. Thanks, Lorne. I'll keep my comments brief as well to allow more time for Q&A at the end of the call. As Lorne mentioned, our Virtual Sports and Interactive businesses were growing prior to COVID-19, the shelter-in-place restrictions have really accelerated that growth. We're seeing significant growth in our current virtuals and Interactive customers organically with their existing customers, adding additional customers in the quarter in both segments, and importantly, a number of contract executions this quarter that we'll be launching soon and an incredibly robust pipeline of opportunities across both segments.

The Virtual Grand National and the Kentucky Derby Triple Crown showdown showcase our product to new audiences with viewership in the U.K. of almost 5 million people, and in the U.S. of almost 2 million people. We're enthusiastic about the announcement of our deal with the Oregon Lottery and SBTech. We've been steadfast in our belief that the lottery channel will be a significant driver of growth for us with the wide distribution and vast number of retailers in their networks. This channel, along with the expansion of sports betting across North America, in both retail and online, are key to our long-term strategy. Combination of all of this, and importantly, the lack of live sports has been a tremendous lift to our virtuals business, and experience around the world, shows us that these products are sticky players and will be a core offering to our customers on a worldwide basis.

Moving to the interactive slot side. Our slot portfolio showed all the same characteristics, as we mentioned, about the virtuals business, with substantial growth in play from existing customers, a number of new customers added, and importantly, record numbers out of our North American business in New Jersey and with Loto-Quebec and BCLC in Canada. We'll be adding customers in New Jersey as we currently only provide to 4 of the top 10 customers that have announced agreements, as you'll have seen for both virtuals and slot content with DraftKings, FanDuel and the GVC licenses in New Jersey. And these will be going live here in the second quarter.

We've also noticed that additional states like Michigan that will be coming online and are hopeful that more states will be added. We're also thrilled to see how our omnichannel strategy is working as many of our core retail titles like Centurion and Super Hot Fruits are also the leading titles online. We're expecting growth out of some key international markets like Greece and Spain as they launch this year, and our success in Greece retail already should service well as the products go online with customers like OPAP.

Finally, we're very excited from a product standpoint with 2 Megaways titles, we're launching this summer with the Centurion Megaways game as well as the title we acquired as part of the NTG acquisition, a Reel King Megaways games. So these are very exciting for our customers.

Moving on to the VLT side of the business. We discussed last quarter about our early success in Illinois with the launch of our Valor cabinet into the market starting in the fourth quarter in 2019 and what we saw in sales in the first 2 months of 2020. We had sold 161 terminals over the first 2 months, and we're expecting a robust third month to end the quarter, which obviously was stopped with the shutting down of gaming in Illinois. We believe that there will be strong demand for our products when Illinois opens back up, as our games are consistently a leading performer in the venues we serve, and we also believe that distributed gaming in Illinois and other markets we are targeting will be much easier to manage, as Lorne had mentioned before, with social distancing practices. We also believe that the social distancing requirements will be easier to manage in our venues throughout the world, just as Lorne mentioned before about Greece, but also in the U.K. and Italy.

Let me move to the cost side of the business and talk a little bit about some of the cost initiatives we've undertaken subsequent to the closure of our retail business, and I wanted to add some color to that. So along with all the measures previously mentioned, we've been able to execute on the synergy plans as part of the NTG acquisition that we've spoken of in the past in this time frame, and are confident of our updated synergy projections of $15 million. We'll be in a stronger financial position when our retail businesses open back up, and we will have rightsized the organization to service our customers when their business is open. We couldn't have achieved this without the extraordinary efforts of our employees working under extremely difficult circumstances for reduced pay, but they've really stepped up, and we're looking forward to bringing back our employees that are on furlough as soon as the retail businesses return.

These have been difficult times for all, but we feel very good about the growth we are seeing in our online businesses. The early results we've seen in Greece from our first retail market is coming back, the difficult measures we've taken to align our cost structure with the new realities going forward, and our strong belief that we're in the market segments that have the chance to recover the fastest and will be the easiest for our customers to manage in this new operating world.

So with that, that's my remarks. I'll turn it back over to Lorne.

Thanks, Brooks. Okay, operator, I think at this time, we can open the program up to Q&A, please.

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

Nice to hear you guys are doing well. I wanted to start with just kind of the business model and the margin ramp recovery. I believe the majority of your revenues are recurring, so as the locations open back up, I'm assuming your margins can ramp quite quickly, obviously, dependent on the amount of revenues going into the machines. But could you just kind of help us think with maybe a fixed versus variable in your cost structure? And as the business kind of gets back to close to a normal state, what the margin profile could look like across the company?

I'll take a shot at the -- at least a high level on that. And then Brooks or Stewart can certainly add more detail. But I think the -- I think there's no question -- I think there's 3 things -- yes, 3 things going on. As our retail business comes back, the margins on the legacy business overall should come back at least to the levels where they were before COVID. So EBITDA margins, and I think we're comfortably, on average, in the 30s. It's obviously an average of a few different businesses having different margin characteristics. The online business, the margin is obviously higher. But assuming it comes back at roughly the same mix, we would expect to see margins comfortably in the 30s for us.

The overall margin -- the second fact -- the overall margin of the acquired businesses, as we pointed out a few times, was considerably lower than ours at the time of the acquisition. But the digitization is moving fairly quickly. We have, I think, a terrific plan for taking much of the business cashless, which will have a tremendous impact on margins. And so I don't know on a stand-alone basis if we could expect the acquired business overall EBITDA margins without taking account of synergies to get up into the 30s where ours are. But certainly, let's say, 10 points higher than they were at the time we acquired the business, and then there are the synergies, as Brooks pointed out. Once everything settles down, and ironically, the COVID experience has actually accelerated the implementation of the synergies. That will add another $15 million on top of everything else. So that's probably another 6 or 7 points of margin. So if you combine those 3 pieces, our -- the legacy margin is pretty much going back to where they were, an increase in the Novomatic margins for both the digitization and going cashless, and then finally, the realization of the synergies. So I think I feel pretty good that whenever our revenues get back to where they were prior to COVID that the overall margin of the company should be considerably higher.

Okay. That makes sense. And on the analog to digital transformation on the acquired businesses, given what's going on right now and the cash situation or your view of just kind of preserving cash, should that take a little bit longer than, I guess, what you had talked about before? I know you already had a pretty high percentage on the digitization, but could you walk through the timeline there?

Well, the payback on the investment in the digital machines is so quick that even in the -- in an environment where, obviously, we're being as stingy as we possibly can with CapEx, I think the one thing we probably won't necessarily slow down is that because it takes maybe not even a year to get our investment back. And so it would be maybe being, penny-wise -- foolish not to stay with that investment.

Yes. And Lorne, let me just add one more point to that, and Chad, the other part about the digitization is the business model in the pubs market is on a rental rate. So even though it may take some time for pub traffic to come back and cash boxes to come back the way it's structured is, we get paid a daily rental fee. So to Lorne's point, the payback is, a, very quick; and b, there's not a risk that the play won't come back at the pace that we'd like it to come back.

Okay. That sounds great. And then the last one, just moving to the United States, on Illinois. You talked about your successes in that -- which started in the fourth quarter, continued in the first quarter. Brooks, I think you said essentially every Illinois operator has trialed your machines there and followed through with orders. So can you give us maybe an updated kind of total addressable market? Maybe what medium-term expectations could be once this -- once the market recovers? We all understand that in the next couple of quarters, operators are going to be constrained here. But given the success that you've had, do you kind of have an updated view on what the total addressable market could be in Illinois or just updated expectations in North America?

Yes. So in Illinois, obviously, it will depend on when it comes back, it will also depend on when people go to the sixth machine. We think they will. And obviously, with the larger stakes and prizes, we think the Illinois market will come back fairly, fairly quickly. And we would expect, just based on our performance, right now, as you know, Chad, it's basically been 2 vendors in the market. Novomatic has had a little bit of success, but frankly, we would expect to be a core offering based on the results that we've seen in all of the locations. It appears to us that it's going to be requirement from a customer-demand standpoint for people to have our machines. So we feel that that's a market that will support us. And then in terms of the other markets, I think we've talked about this before. Certainly, we're targeting the G2S markets like Oregon and the Canadian provinces. And again, pre-COVID, we were seeing some real positive feedback from those customers and felt like we would be making some announcements this year about that. We'll have to see how that plays out. But we're no less bullish on those markets. And I think as we've talked about before, we think that distributed gaming has a much better chance of expanding than building large casinos.

Our next question is from David Bain from Roth Capital.

Great. I was hoping we could start with Interactive, actually, and congratulations on the expansion there. Could you walk us through maybe a bifurcation of online revenue versus the rest of the business? I mean in essence, when you say Interactive has increased 30% and 100% over March and February, can you give us an actual baseline revenue number for either January or February?

So Stewart, do you want to take that one?

Yes. Dave, it's Stu here. The way I think about it is in terms of where we were beforehand, we would have expected overall Interactive revenues to be just under 10% of the overall group. So that's a combination of online virtuals and online slots. So hopefully, that gives you the size of where we were before and where we're trading at now.

Got it. Okay. And then can you give us a snapshot of maybe the economics for virtuals, with -- like the FanDuels or DraftKings, those types of channels in terms of like a percentage of revenue or basically any way you would look at capitalizing this for us to sort of model growth across the channels? And as you add additional, I assume this is a pretty high-margin business. Can you speak to margins at all?

Brooks, do you want to try that?

I can take -- yes, I can take I think the first part of it. Yes. I'll take the first part of it. So David, how it works is we get paid a percentage of the NGR, and mostly that, just to give you a range, it's in kind of double digits. But just not way in double digits, but in double digits. So for us, kind of like it is with our existing virtuals customers, the whole idea is to be able to drive play with the customers. And I think most of our customers like DraftKings and FanDuel, who have a large base of customers, will be trying to kind of cross-pollinate the virtuals product with what they're seeing in live sports, and frankly, with slots. So it's just another part of their portfolio that they'll be able to try and get their customers engage. And obviously, we'll do everything we can to help them in that. But that's kind of the business model. I don't know, Stewart, if there's anything more? Or Lorne, anything more you want to add about that?

Well, I think in terms of David's question of thinking about how to model the opportunity overall going forward, I think the best guidance you could get, David, is to look at the experience in Europe, where the customers all have almost unlimited live sports, and they have -- some of them have 15 or 16 or more channels of our virtuals. And generally, the virtuals do surprisingly, it could be 10% or 15%. It varies a little bit between online and the retail market. But something in that range is not an unrealistic estimate of what the volume of virtuals betting handle can be. And so if you start with whatever your projections are for the base sports betting business and then take a percentage of that as virtuals, and then estimate what the GGR on that is for the operator, and that gives us, as Brooks said, in the low double-digit percent of that and multiplying those 3 things together would give you some target of what that business could mean to us. And of course, from a profitability point of view, essentially, the incremental profit on the incremental revenue is very, very, very high.

That was very helpful. I guess the last question, if I could, would be back to retail. It looks like William Hill and others, they look fairly healthy. And when you look across the portfolio of those you work with, just any kind of thoughts on the health of their businesses? And any sort of thoughts on the competitive landscape and how that may change if this accelerates closures by some competitors or anything as we come out the other side of COVID on the retail side from a share perspective?

What I was going to say -- yes, David, what I was going to say is, as you know, a large portion due to the impact of the triennial of the kind of taking the lower end of the shops and closing them has pretty much occurred. I think William Hill closed over 700 shops. My guess is that there'll probably be some slight additions to the shop closure numbers because of COVID-19. But again, I think it will be on the kind of the last link of the chain, so to speak. And as we've talked about before in a couple of other calls, what generally happens is a big chunk of that goes to other of our customers since we have William Hill, Paddy Power and Betfred. But now I think we're encouraged by what we're seeing with online and expect that there's going to be a stickiness component to the online revenue that may not have existed before. So we would hope to recapture what any additional store closures would be, or at least a big chunk of that, through either one of those channels.

Okay. Great. Congrats again on the expansion of online or Interactive.

Sure. Thanks, David.

(Operator Instructions) Our next question is from Ryan Sigdahl from Craig-Hallum and Capital Group.

So you guys talked a little bit about virtual sports in the U.S., but we've been hearing about a surge in betting on simulated Madden and e-sports in the U.S. while traditional sports are postponed and kind of the big growth opportunity there. How do you think about the opportunity for virtual sports in the U.S.? And maybe how it compares to e-sports and simulated sports such as Madden?

Well, I'll give you my thought, and then, again, I'll ask Brooks to chime in. So again, if we start with Europe, the experience there is that the play volume of virtuals, both online and in the retail world, tends to track the betting on live sports fairly, fairly closely. And there's a lot of overlap in the players. And there's sort of a rhythm to the way they play. Since sports betting was effectively legalized a couple of years ago when they got rid of PASPA, we have been very active, obviously, in talking with all of the players that we're planning to launch sports betting in the states in -- I think now that it's up to 16 or 17 states that have passed state laws. And the response that we had been getting was, yes, this looks like a really great product. We love to talk to you about maybe doing something. But we've just got so much on our plate. We're so busy with creating our infrastructure and dealing with the state government and recruiting players and doing all of that stuff that we really just can't worry about this right now. And so we kind of -- in a way, in a long-term sense, caught a break because, as Brooks was saying, whether it's the GVC brands or DraftKings or FanDuel in those certain states, lotteries and so forth. Now with there not being much to bet on because of live sports being shut down, have all accelerated their interest in talking to us about putting virtual sports on their platform.

So I think by the time the world recovers from COVID, both -- recovery in the sense of sports coming back and the sense of people having the opportunity to bet on them, I think -- I don't think, I know we will have very significantly expanded our U.S. customer base of virtual sports customers. And the experience in Europe would say that, when real sports come back, it is probably not going to cannibalize the business that we will have created in the meantime. And in fact, it might even help it, because it's going to bring players back that had been absent for a while. So I think the key thing here is that -- and again, the interest, we have. I don't know -- Brooks, I don't know how many potential new customers we have queued up to have an integration done, but it's very significant. Maybe you want to comment on that.

Yes. I won't comment on the specific numbers, but yes, there is -- the pipeline is huge. And I think Lorne's points are all spot on. I guess probably the only other thing I would add to that is the idea of, let's say, when the NBA comes back, I don't think that anybody is going to be watching 2 NBA players playing each other in NBA 2K, but I do think people will be betting on virtual sports as an event that's going off every 4 or 5 minutes, just like they would be betting live NBA basketball. So I mean, we feel very good about how our product actually sits alongside live sports. And to Lorne's point, that's kind of been proven over the years in Europe. And remember, most of our customers here had their start in Europe and know all about this. So I think they see the potential for this in the States as well.

Good. That's helpful. You guys talked kind of regionally, you talked a lot about Greece coming back online, Illinois and the other regions. But what are you specifically hearing from retail in the U.K.? And what's your expectation for the time line and pace of reopenings there?

Brooks, go ahead.

Yes. So the way -- and Stewart, since you're there in the U.K., you're probably as close to it as anybody. But I'll tell you, the way the U.K., at least as it stands right now is they're talking about coming back in phases. And it looks to us as though the lion's share of our business will be categorized in phase 3 of the retail relaunch, which would include everything from our motorway services to pubs to holiday parks and licensed betting shop offices. Although there's a lot of political stuff going on behind the scenes, it looks to us like the first week of July is when we expect the U.K. retail. We could consume some positive movement earlier because I know there's certainly -- the industries are lobbying, 50 opened earlier as nonessential retail. But I think, from a planning standpoint, we're assuming the first week of July. I don't know, Stewart, if you want to add anything more?

No, no. You've got the latest position, as you say, that we're working to. But I guess, like everywhere, it's subject to change.

Good. Last question for me. So assuming retail opens kind of on those time lines, along with the cost cuts you guys have done, do you think you can inflect the positive free cash flow exiting this calendar year?

I'm sorry, could you repeat the last part of the question? I just didn't hear it.

Yes. Just some -- any color or thoughts on free cash flow and kind of as you look at the back half of this year or exiting the year, with retail coming back online, the cost cuts you've made. Can we inflect back to positive free cash flow either in the back half or exiting the year, early 2021? I guess any thoughts or time line there?

Yes. Stewart, do you want to -- I mean I have an opinion, but we should have our CFO, who's closest to that, take a shot at that first?

No, no. I'll be happy, unless you want to give your opinion, Lorne, and then I'll follow-up.

No, because I don't want the people on the call to think I've been influencing your answer. So I'd rather have you take your best shot.

Sure. So Ryan, I guess a couple of things to think about there is, as you say, the revenue is going to come back online, and as we said, it's recurring. So we expect it to come back pretty quickly, and then we will only bring back costs where the revenue is high enough to cover it. So we shouldn't go into position where we turn on more costs than we're getting in revenue. And there'll be a small working capital outflow there to begin with June. The ramp-up, as our costs, i.e., namely, people need paying quicker than weeks sometimes get cash in, so that we need to invoice for it. But then kind of as you allude to as well, Ryan, we're not going to turn the CapEx on anywhere near the same extent as we had before. To use Lorne's word from before, we're going to carry on being stingy. Obviously, an element of our CapEx is labor capitalization. So as that comes on, we've got an element now still in the business, working on the interactive side. But when the retail side comes on, that will ramp up. But we should be -- you should assume that going forwards, that certainly in the short- to medium-term, that CapEx will be reducing. So yes, you should be expecting that the trend, therefore, moves into positive free cash flow.

At this time, we have no more questions. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Lorne Weil for any closing remarks.

Thank you, operator. I don't really have much to conclude with, except thank you all for calling in from wherever you're hopefully safely hunkered down. I think you can tell by the tenor of our call today that we're feeling pretty good about where we are considering the predicament that everybody in the world is in. The -- I think we played a hand as well as we possibly could have. Our businesses are doing, as we've said in the online world and now with Greece back, considerably better than we might have expected. And consequently, our liquidity is very strong. Our month-to-month performance is surprisingly good. And we're just going to have to wait this out until more of the markets like Greece come back, and in each of our markets, most of whom are remarkably similar in style to our customers in Greece. And therefore, as things respond as quickly as Greece has, then I think by the time we get to the end of this year, we should really be up lugging along pretty close to where we might have been, had it not for this whole unfortunate incident. So thanks again, and we'll talk to you in another quarter. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.