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Operator
Thank you. Thank you. Thank you. Thank you. Thank you.
spk00
Good morning, everyone, and welcome to the Inspired Entertainment third quarter 2020 conference call. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. I'll begin today's conference call by referring you to the company's Safe Harbor statement that appears in the third quarter 2020 earnings press release, which is also available in the investor section of the company's website at www.safeharbor.com. This Safe Harbor statement also applies to today's conference call, as the company's management will make certain statements that will be considered forward-looking under security 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 gaps 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 Lauren Wheel, the company's executive chairman. Mr. Wheel, please go ahead.
Lauren Wheel
Thank you, operator. Good morning, everyone, and thank you for joining our third quarter conference call. I'm here as usual with Brooks Pierce, Stuart Baker, and Dan Silvers. I'll begin with an overview of the significant momentum that we saw building across the business throughout the third quarter and then discuss the recent resurgence of COVID-driven measures taking place in parts of Europe. Brooks will then talk about the individual business lines in more detail and we should have plenty of time for Q&A. We were very pleased with our performance in the third quarter. During our first quarter call, when we were in the middle of the pandemic wave, we set up a thesis that our business would come back very quickly post-lockdown for three fundamental reasons. Number one, our business predominantly comprises wide area networks, so small, locals-oriented venues in comparison to single, large destination resorts. Number two, 90% of our business is driven by contracted multi-year recurring revenue so there's no issue of recreating backlog and finally there are no time lags in starting back up due to supply chain issues since all of our equipment in bedding shops pups truck stops etc is ready to turn back on at a moment's notice and things played out pretty much as we had expected even though the business was still ramping upwards as we moved through the third quarter. Our core business EBITDA for the third quarter was very close to the high watermark we had reached in the fourth quarter of 2019 before the onset of COVID. Momentum in our retail-related business built steadily through the quarter, while at the same time the growth we had been experiencing in our online business showed little sign of slowing down. despite the reopening of both retail and live sports. So we were confidently planning that EBITDA in the fourth quarter of this year would overtake the 2019 high watermark and be in the range of $20 million or perhaps more, and then grow from there in 2021 to produce annual EBITDA in excess of $80 million, which we felt would begin to reflect the fundamental earnings power of the combined, inspired, and former nomadic businesses, and we still very much feel that this is the inherent earnings power. That scenario was playing out quite nicely through the first week of November when, as is now pretty well known, the UK went once again into lockdown for what was announced to be a month, joining Italy, which had gone into a one-month lockdown a couple of weeks earlier. In response to these developments, we return to the playbook that we had developed pretty much on the fly back in March and April. So we have at this point furloughed about two-thirds of our employees, while the remaining one-third are experiencing reduced hours or salary reductions. At the same time, though, continuing to heavily support development in our online business, a strategy that paid great dividends during the last shutdown. Very importantly, the UK has extended the very generous furlough reimbursement scheme through March 2021, and this is helping us greatly. Fortunately, we're in dramatically better shape to weather the current storm, regardless of its duration. We hope it will only be a month as announced, but we don't necessarily need to plan on that. Having been through the cost mitigation drill once before, actually twice if we count the actions taken following the triennial review, we have been able to take action more quickly and more aggressively than we had before, and we're doing this against the cost structure that is already considerably lower than it had been. As we've discussed previously, our online business grew very substantially during the spring lockdown. And at this time, it continues to grow, but from a far higher starting point, obviously. Well, part of the online growth during the pandemic resulted predictably from the retail closure. Much of it was driven by our continued spending on both content and technology development. They, in turn, have allowed us to meaningfully expand our customer base, and at the same time drive significant growth in existing customers. And lastly, our liquidity situation is light years beyond where it was last spring, reflecting both the recent strong operating performance of the business and the VAT refunds that were referenced in today's press release. Before I conclude, let me take a moment and elaborate on the VAT and liquidity situations. As indicated in the press release, we received $9.3 million net of taxes in VAT refund money during the third quarter. And on this past Tuesday, we received an additional $32.5 million again net of any applicable taxes. At this point, we anticipate receiving an additional and final $4.1 million in the coming weeks, which would bring the total VAT receipts, again net of taxes, to $46 million. Our cash balance on Monday was about $32 million, which included the impact of the first roughly $9 million, so that at this point there's an additional $37 million to consider the difference between the $46 million and $9 million, and that would bring our total projected cash balance to just under $70 million. Our net debt in that case, being somewhat conservative, will stand at about $250 million. Achieving our target run rate EBITDA of at least $80 million, which, as I said a moment ago, we're quite confident we will reach once the current lockdown ends, would have the effect of reducing our leverage to about 3.1, which is getting very close to the target of 3 we had established when we made the Novomatic acquisition, and I think put us in a very strong position in the league table of balance sheets of companies in our industry. Exactly when the current lockdown will end, is, of course, impossible to predict. But we're confident that when it does, our retail business will recover quickly for the reasons established earlier. Our online business carrying very strong margins and margins which are getting stronger as the business grows, which Brooks will explain in a moment in a little more detail, will continue to accelerate. And we will quickly establish, I apologize for sounding like a broken record, an annualized EBITDA run rate upwards of $80 million. And on that note, I'll turn the program over to Brooks who will discuss many of these issues and developments in greater detail. Brooks.
Stuart Baker
Okay. Thank you, Lauren. And I'll give some details Lauren discussed on each of the business units and their results for the quarter, as well as some relevant numbers to give some more context to the progress we believe we're making across the business. So breaking it down into the lines of business, excuse me, first our server-based gaming business, which encompasses our recurring revenue business in the UK, Greece, and Italy, as well as our for sale business in North America, showed both resiliency and the ability to recover quickly from the COVID lockdown in the spring. Put some numbers to this, our UK business was at roughly 95% of pre-COVID levels, even with the impact of 116 betting shops being closed in the quarter. And our Greece business, where we have over 8,000 machines installed, returned to its pre-COVID levels on a machine income basis. In our for sale segment, we sold an additional 54 units in Illinois despite the fact that Illinois was shut down for a significant portion of the third quarter and also announced the sale of 100 units to the Western Canada Lottery Corporation, our second customer in North America. Our performance in Illinois continued to be strong with our machines largely performing as either the first or second based on that terminal income in most venues where they are installed. We are gratified to get a significant order and then a subsequent follow-on order from the second largest operator in the state based in large part on our performance and believe that there is significant opportunity for us to grow our share in Illinois as well as going forward, starting to expand into some of the other distributed gaming markets throughout North America. Moving on to our virtual sports business, our virtual sports business, which includes our legacy interactive slots, continues to show growth with Q3 revenue increasing by 11% over Q2 after showing Q2 revenue increasing approximately 9% compared to Q1. This steady growth is a result of a combination of factors but is primarily related to virtual sports filling the gap of the reduction in live sporting events, growth in the number of customers we supply, and organic growth of existing customers as well as the addition of some significant bespoke events, such as the Kentucky Derby Triple Crown Showdown, the Virtual Grand National, and the just recently completed Lexus Melbourne Cup Race of Dreams. Finally, we're happy to announce that we have signed our second U.S. lottery, the District of Columbia lottery, to launch our V-Play 2.0 horse racing product, which has already shown itself to be successful with the Pennsylvania lottery. We believe that the lottery We also announced some recent key business developments that we expect to augment this growth with the launch of additional channels like our virtual basketball with OPAP in Greece, the expansion of our relationship with GVC now to include additional brands of theirs such as BWIN and SportingBet, and the early results from a contract we launched at the very end of September with our VPP products, our virtual plug-and-play product, in Turkey with CESAL and MISLI, which we, based on the numbers we're seeing thus far, should be a major contributor to our business going forward. Getting into the retail side of the business, the retail business came back gradually during the quarter and ultimately almost returning to its pre-COVID levels by the end of the quarter. The online component of virtuals, as you can imagine, declined from its high watermark in quarter two when there was no live sports and retail was shut down. But for just illustration, our Q3 online virtual sports was still 45% higher than Q3 of 2019. So let me move on to the interactive slots side of our business. The interactive slots business showed tremendous growth in the quarter, but really also it has throughout the year. This is due to a number of factors, including the quality and volume of new game content we've developed and deployed. the utilization of key game assets acquired through the NTG acquisition, such as Real King Megaways, which was our best-performing game in the quarter, the expansion of our geographies, including notably North America and Greece. We added 29 new customers and five major integrations throughout this year, and also the addition of our online business in Belgium that came as part of the NTG acquisitions. So to put that into a numbers perspective, our interactive slots business was up 78.5% overall year to date, with the legacy interactive business up 132% year to date. Just to really comment on what Lauren was saying about the acceleration in third quarter, our interactive slots business was up 103%, and the legacy part of the interactive business was up 197%. And we talked about this before, but this part of the business scales beautifully. And so as revenues grow at these rates, the profitability grows even faster. In terms of potential for this business, we think it's huge. With a number of jurisdictions being added in North America, Michigan probably notably for many on the call, as well as Germany and Holland and Europe in 2021. So over the next 12 months, we're targeting to increase our non-UK revenues in this segment to be roughly 40%. Moving on to the last part of our business, the acquired business, the leisure business. This is the one that was probably the most impacted by the COVID situation. It's a big part of this business, as you would know, is both seasonal and operates primarily in quarters two and three and relies on both travel and football. September was the best month for the holiday park. part of the business, but the business was then forced to largely close down in October, even though there were substantial bookings planned. In the pub side of the business, the pub's machine business was impacted in several different dimensions, with social distancing requirements being instituted that reduced the number of machines that could be played, the curfew that cut back operating hours in pubs, and now the lockdown. Just on an encouraging note, our digital machines performed at 95% of their pre COVID levels, but with fewer machines turned on. Um, the majority getting onto the cost side for a second, the majority of the cost synergies that we were expecting to achieve and have talked about, uh, in previous calls from the NTG acquisition have now been implemented. And we believe the business is positioned to recover once the lockdown conditions are lifted and hopefully won't repeat in the seasonal part of this business in 2021. As Lorne mentioned, we're in the midst of a temporary lockdown across our retail business and have already implemented the necessary steps we needed to take to reduce our overall cost structure leveraging the furlough program in the UK. We're confident that we'll recover quickly once lockdowns are lifted as we did the last time and that we'll continue to invest in our online businesses that are showing tremendous growth with attractive margins in the interim and and that will help to mitigate this temporary shutdown, and most importantly, position us for the future with strengthened online businesses. And with that, I'll pass it back to Lorne for her final remarks.
Lauren Wheel
Thanks, Brooks. Unfortunately, I don't have any final remarks prepared other than to say I hope everyone understands how well the business has been doing and how strong the future is. And at this point, operator, if you could open the program up to Q&A, I would appreciate it. Thank you.
spk00
We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble the roster. The first question comes from David Bain of Roth Capital. Please go ahead.
David Bain
Great. Thank you. First, congratulations on the execution post-COVID-1. And, of course, fighting for that VAT rebate, that's fantastic. I guess my first question would be just any specifics I know you're not going to get into as it relates to M&A activity with, you know, retail partners. But if you have any kind of big-picture thoughts, you know, I know a lot of your contracts will probably run with the change of control, but can you speak to any, you know, different comp structures in the market, maybe some CapEx opportunities from, you know, a new – a new partner that may really intend to focus on the business. Anything big picture-wise would be helpful.
Lauren Wheel
David, maybe you could be a little more explicit in your question.
David Bain
I'm speaking to William Hill in particular.
Lauren Wheel
Oh, I see. I get it. Well, actually, you know, I think Brooks is probably, now that I understand the thrust of the question, Brooks, do you feel comfortable? I mean, we have to be obviously a little bit careful because William Hill is a very, very good customer and I wouldn't want to try and conjecture anything about what might happen as a result of the, you know, the impending deal with, uh, Caesars, but you know, Brooks, if you want to try and say something.
Stuart Baker
Well, I think probably the only thing I would say is, is, and David, as you would know this, it looks like it's going to be kind of bifurcated that it'll be, um, the retail and all my business in the UK looks like it might go somewhere else, but the Caesars acquisition that, that Lauren mentioned, All I can really say is that they're already an existing customer of ours, William Hill in Nevada, the CEO of that part of the business. Joe Asher is a guy that Borna and I have both known for 25 years. He certainly understands what we're about and understands the value of virtual sports, and I would expect and would certainly hope that as the ability to provide virtual sports expands in North America, that I would see William Hill slash Caesars as a key customer of ours. I don't know if that answers your question, but that's kind of how I see it.
David Bain
Got it. Okay. Perfect. You know, I guess a follow-up, if I could ask about North America, you know, Brooks, you spoke to the, you know, the, potential for new route markets that you may enter or route markets that you may enter. Um, have you been building distributor relationships in any of the upcoming potential markets that have been spoken about recently? Like, you know, places that would have a hundred percent white space, like, like Pennsylvania.
Stuart Baker
Um, is that a, yeah, I think, well, we're certainly, we're certainly monitoring it closely and, um, It appears as though many of the people that are the operators in Illinois would certainly be interested in Pennsylvania if that were to happen. I would say probably the next market, we just received our licensure in West Virginia. And that's a market we know well. And that's going to be a replacement market. And I would see that as a market in 21 that we would be targeting. as well as most of the Canadian provinces, as well as Oregon. So we think there's a fair bit of runway for us in those markets, notwithstanding any potential new markets that may pass legislatively, like expansion in Pennsylvania or Missouri or any other market.
David Bain
Okay, great.
Lauren Wheel
David, let me just add to that. I think you know this, but just to remind you, the The markets that Brooks is talking about, particularly markets like West Virginia and the Canadian provinces, these are places where we've been doing business for 25 years and have very significant relationships that go back forever. So as we begin to turn our attention to them, we have let's say, a built-in marketing infrastructure that, you know, that we can rely on.
David Bain
Right on. And I promised last one. The only thing I wanted to ask lastly was with regard to, you know, net debt now much lower, you know, and again, great job with that rebate. EBITDA run rate looks like it was higher, and I'm sure it will be again. in one queue than what the street has had and what we had. Any kind of thoughts on accelerating an M&A strategy based on those components?
Lauren Wheel
Well, we can accelerate an M&A strategy only as fast as the opportunities you know, to do what we want to do strategically, you know, present themselves. I think, you know, we don't want to fall into the trap that many others who have gone before us have fallen into, that once our leverage, you know, declines to a manageable level, then we go on a shopping spree and we put it back, you know, to where it was before for no reason. you know, real strategic purpose. I mean, I think we've talked about the fact that our focus from an M&A point of view, you know, geographically is clearly in North America because it's by far the largest market in the world that we're not represented nearly proportionally as a company and not nearly represented in terms of, in particular, as I said a second ago, the history that Brooks and I have had for many years in the gaming industry. And I think from a product or a technology or a service point of view, I think we're pretty focused on the digital world as we see how our digital slots and online virtual sports has grown, it's clear that particularly the slots part is, you know, the potential there is almost limitless. So I think we know exactly, you know, we have a tremendous history in the lottery world and the... the online opportunities in lottery, I think, are also phenomenal. So I think we know pretty clearly what and where it is that, from an M&A point of view, we want to focus. And as the EBITDA comes up and the leverage comes down, obviously, we'll have... And ideally... You know, the trifecta, of course, is our debt comes down, our EBITDA goes up, and please God, at last, our share price, as the third part of the trifecta begins to reflect that, then we have the financial resources to execute an M&A strategy. But again, I think we're going to be very careful to be sure that whatever we do really does make strategic sense and we're not doing it just for the sake of doing something.
David Bain
Fantastic. Thank you.
spk00
The next question comes from Chad Beynon of Conquari. Please go ahead.
Chad Beynon
Good morning. This is for Chad. Thanks for taking my question. So, when thinking about the temporary cost savings with the permanent cost savings that you discussed on the call, Can you discuss the margin structure of the business at similar pro forma revenue levels that were prior to COVID?
Lauren Wheel
Stuart, since you're not going to have your own section to talk about today, why don't you respond to that question?
spk01
Absolutely. Thanks, John. So, yeah, in terms of thinking about the margin of the business, I think we put in the announcement that if you look at on a pro forma basis, year on year, we increased, I think it was from about 26.2% to up to 31.4% this year. So, you know, a sizable increase. And, okay, there were some temporary cost savings in there, but that was... more than offset by temporary income, what we hope to be temporary income reductions, particularly in the leisure part of the business. So of the SG&A savings, as we say, there's the Synergy savings in there is probably about $2.5 million, which forms a significant part of the $9 million SG&A production year on year, but of the remaining, you know, a sizable amount of that will become permanent savings. You know, and our challenge is obviously to, I think we talked about this a little bit on the last quarterly earnings call, our challenge is to make sure that we can stop as much of that cost coming back and keeping it as a permanent savings. So, yeah, in terms of just focusing back on the margins in terms of the the numbers we saw this year, this quarter into the 30s, I think that's a level that we're comfortable with in the future.
Lauren Wheel
Chad, what I would add to that, which I think is extremely important, just to reflect back on something that Brooks said a minute ago, at any point in time, the margins in the online business are considerably higher than the margins in the retail business, even though the margins in the retail business, you know, when we're at full strength, are very good. So as the mix of the business generally swings from retail to online, that alone, obviously, is going to bring the average margin up. But as that's happening, because the operating leverage is so tremendous in the online business and it scales so fast that as the online business is growing its its own margins are increasing and so there's an effective double whammy on the company overall because the mix is swinging more to online and the online margins themselves are growing so that helps you think about where the margins are headed i'm I offer that object nation.
Chad Beynon
Awesome. Thanks for the caller. I'm going to pass it on.
spk00
As a reminder, if you have a question, please press star 1. The next question comes from Ryan Sigdahl of Craig Helen Capital Group. Please go ahead.
Ryan Sigdahl
Great. Congrats on the results and getting the refund, guys.
Lauren Wheel
Thank you.
Ryan Sigdahl
First question is, back in April, May, kind of first go around when the world shut down, you talked about getting the cash burned down to about a half a million pounds per month. Is that still the expectation now if the world were, again, to completely shut down, not just a few countries kind of regionally, but kind of worldwide shut down? And then, I guess, secondly, has the growth in online, some of the cost containment that you guys have done, has that changed that expectation?
Lauren Wheel
Yeah, the coda to your question actually was going to be the main part of my answer. So the difference between now and then is that the online business, as Brooks explained, in both the virtual sports and the slots is at a much higher level now than it was before. say eight or nine months ago, and our cost structure is in better shape. What we don't know right now is what will happen to the online businesses in response to much of the retail business being closed, because whether they spike up, uh, as they did, uh, back in the spring or not, uh, has a significant impact on, on what the cash performance will be. So I think it, it right this minute, it's, it's hard to say, I think using where we were, uh, back in the spring as a starting point, I think makes all the sense in the world. And where it goes from there, I think we'll have a better picture, certainly over the course of the next few weeks. But I think there isn't any reason to think that we can't use the experience of the last shutdown as at least a point of departure and then look at it in the context of the impact of the online business and the fact that the cost structure is stronger now than it was then, yeah.
Ryan Sigdahl
And then just one follow-up to that. So it sounds like kind of the base business, you know, modestly better than when it was then, given all those, you know, accelerants in those pieces. Can you remind me what the debt service is and then kind of minimum maintenance capex, again, if you're not really making machines or putting anything into place?
Lauren Wheel
Yeah, well, the maintenance capex is, through any period of shutdown other than the development of games for our online business. So this would be our own programmers and game developers developing games because I think you know we introduce two or three new game titles a month in the online space. So that's capital investment that pays back almost instantaneously, and we won't cut back on that. But any kind of machine CapEx or stuff like that, I think for the duration of a shutdown, I think we can assume for all practical purposes that that's going to be zero. As far as debt service, you know, if we took the net debt and we assumed that we use a significant part of the $70 million in cash we're going to have to reduce the debt, then, you know, as a rough order of magnitude, the debt service would be around 8% of $250 million. So call that around a million and a half ish dollars a month. If we were going to be paying monthly, which we don't, we actually had a semi-annual interest payment that we made fairly recently, which if you're trying to reconcile the cash numbers that I was talking about before in my prepared remarks, that would be accounted for by the interest payment, which was the last semi-annual interest payment we made going forward. We'll be paying interest quarterly, but if we were to, let's say, amortize that into something monthly, if you used 250, you know, that would bring you to around a million and a half a month. But right this minute, we're still thinking through exactly what we're going to do.
Ryan Sigdahl
Great. It's helpful. Also answered one of my other questions on the difference between the cash you mentioned versus what was on your balance sheet. So appreciate that. One more for me just on virtuals and thinking more the, the retail side of that versus online. Now with kind of eight months removed from the start of COVID, sports, live sports have largely resumed. Have those conversations gone with retail? Are you seeing any acceleration? Or is it kind of back to business as it was before?
Lauren Wheel
I think Brooks is the right person to answer that.
Stuart Baker
Yeah, I think it has pretty much gone back to where it was before. We have a number of customers where we're adding additional channels. As I mentioned in my remarks about adding basketball to our customers in Greece, so having a third channel, we've done that with GPC as well. So I think what we're seeing in the retail side of the business when they're out of lockdown is because of the growth from the past is kind of being augmented or at least being pushed a little bit more by the operators themselves. So we see the retail business and virtuals being very strong.
Ryan Sigdahl
Great. That's it for me, guys. Thanks. Good luck.
Lauren Wheel
Thank you. Thanks.
spk00
As a reminder, if you have a question, please press star 1. Seeing that there are no further questions, I would like to turn the conference back over to Loren Wheel for closing remarks.
Lauren Wheel
Okay. Thank you, operator. Thank you, everyone, for joining the call this morning. I know there's a very busy earnings schedule, and so we really appreciate your finding time to join our call. The questions were great. We're, as you can tell, pretty bullion about the business right now. And we look forward to talking to you in another three months. Thanks. Bye.
spk00
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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