Inspired Entertainment, Inc. Q4 FY2021 Earnings Call

Good morning, everyone, and welcome to the Inspired Entertainment Fourth Quarter and Full Year 2021 Conference Call. All participants will be in a listen-only mode. 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 fourth quarter and full year 2021 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 the securities laws and rules of the SEC. These statements are based on management's current expectations or beliefs and are subject to risks, uncertainties, and changes in circumstances. In addition, please note that the company will discuss both GAAP and non-GAAP financial measures. A reconciliation is included in the earnings press release. With that completed, I would now like to turn the conference call over to Lorne Weil, the company's Executive Chairman. Mr. Weil, please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining our fourth quarter and year-end conference call. I'm here today with Brooks Pierce and Dan Silvers. Our CFO, Stewart Baker, is recovering at home from an illness, and we expect Stewart to be back at work in a week or two. Stewart, if you're listening, we look forward to seeing you back in the office shortly. You need to rest up because there is a lot of work to do. We feel as though we ended the year firing on all cylinders, the integration of the Novomatic business interrupted the last couple of years by the fits and starts of COVID is entirely complete. The businesses are beautifully integrated from both an operating and revenue point of view, and each of the components is performing as well as we could have hoped. At this point, we're particularly pleased with the performance of the pub business, where we are steadily gaining both margin and market share and expect more growth and margin improvement to come as we complete the analog to digital conversion. We have had conviction going back at least 10 years to our Scientific Games days that there was a great opportunity for our style of digital server-based gaming in the pub sector. But ten years ago, unfortunately, we were, for better or worse, ahead of our time. But now the time has definitely come, and this business is really coming into its own. I might also mention that at the same time, some of the acquired Novomatic titles are among our best performing online games, so we're seeing real omnichannel revenue synergies here also. What we think of as our digital businesses, iGaming and Virtual Sports ended the year far ahead of last year in both revenue and profitability with margin improvement illustrating the way these businesses scale. As we mentioned in our last conference call, these businesses together are approaching 50% of our overall EBITDA, and we expect we will move well beyond that as we exit 2022. A couple of days ago, we launched iGaming in Connecticut with DraftKings and we just released our iGaming license in Ontario, my home province. By the way, earlier this week, we had plans to launch in Ontario in April. And at the same time, we can see Pennsylvania clearly on the horizon. Along with a number of new jurisdictions in virtual sports, we see this whole digital area as a tremendous driver of revenue growth, margin expansion, and asset utilization. For years, we were trained in the paradigm of revenue growth, margin improvement, asset utilization; you could pick any two, but we seem to be in a new paradigm now where if you understand what you're doing, you actually get to have all three. In a moment, Brooks will go into these areas in more detail because there are a number of important developments taking place in terms of products, markets, geographies, and so forth. Financially, of course, we could not have ended the year any stronger. Every measure of revenue and profitability was at a record level as was our liquidity position. We ended the year with about $48 million in cash and $75 million in liquidity, including our undrawn revolver. And our net debt to EBITDA was down below 3 on a stabilized basis. All of this taken together gives us confidence that our platform is ready to move very aggressively to the next level. Bear in mind also that the cash and liquidity balances are after the completion of the Sportech Lottery acquisition of about $12 million. So that, excluding this, our cash and revolver were together close to $100 million, a rather remarkable achievement considering where we were in the depths of COVID. The Sportech Lottery acquisition itself fits a critical piece into our strategic mosaic. As we have explained previously, we paid about $12 million for a three-year run rate EBITDA of about $4 million. So in effect, the purchase price was equal to the profit remaining in the existing contract. At the same time, we are fortunate to have been able to extend the contract with LEIDSA, the customer for an additional 10 years effectively generating therefore at least $40 million of recurring revenue. This was certainly a neat piece of financial engineering, but it's not the real reason we did this, although by itself, it's obviously made a compelling case. When we're finished with the development and launch of the iGaming platform in the Dominican Republic, we expect to see significant immediate upside there, given the very high incremental margin on revenue. We expect that the Dominican Republic will give us an operation with a strong retail foundation where we can refine and showcase our iLottery content, which will be greatly beneficial worldwide. We see significant opportunities to use the Dominican Republic as a platform to grow our business throughout the Caribbean and Latin America. Markets, again, from our past that we know extremely well. And lastly, and maybe most importantly, I believe we will end up with a state-of-the-art, probably beyond the state-of-the-art cloud-based lottery system capable of supporting both iLottery and land-based lottery systems anywhere in the world. I should also mention that we have assembled a really world-class team of lottery system developers under the leadership of our global Chief Technology Officer, Steve Beason, who some of you may remember was for many years prior to joining us, the CTO of Scientific Games. And here, I'm referring to the lottery company not the light and wonder company and before that GTECH, now IGT. Lastly, I should just mention that as a first-time accelerated filer this year and adding to that the increased reporting requirements that we now have as we moved this year from SOX 404A to SOX 404B, we will be intending to file our 10K by March 31, within the automatic extension period. And with that, I will hand it over to Brooks.

Okay. Thanks, Lorne. And I share your views that we're seeing excellent performance across all the segments of our business and have an outsized number of opportunities we're working on that we are confident will continue our momentum in 2022. As we've learned from the experience with COVID and now with the war in Ukraine, general macroeconomic issues, supply chain challenges, etc., there are a number of things beyond our immediate control. I do take comfort, however, in the amazing resiliency and tenacity of this management team to take on any challenge they confront head-on and find ways to continue to build this company to realize its potential, and we want to express our respect, admiration, and appreciation for the work that they've done over the last couple of years. So as we've done in the past few calls, I'd like to go into a little more detail on each of the areas of the business and report on our progress and what we're working on in each but aligned with our core strategy of growing our digital businesses and its increasing EBITDA contribution by leveraging not only our existing content portfolio but as well as our content creation. I'll also update on our progress in North America, specifically, that's a geography for which we see tremendous potential to grow our footprint substantially. Moving into the business segment. So the Interactive business had a strong fourth quarter with 36% year-over-year revenue growth as well as revenue growth throughout all of 2021 of over 72%, even with the land-based businesses coming back during the second half of the year. North America, in particular, showed strong growth throughout the year. As Lorne mentioned, we've just gone live in Connecticut with DraftKings and we'll be going live in Ontario, hopefully, in the second quarter after now receiving our license. We already have agreements in place with most of our customers, and we think Ontario is going to be a very strong market. We hope to be live in Pennsylvania in Q2 as well subject to licensing approval. And as I've mentioned in the past, we're currently serving roughly 70% of the markets in New Jersey and Michigan and would hope to add both FanDuel and Penn National by the second half of the year, which should get us close to 90% of each market. So you can see that by the second half of the year, we're expecting several key market drivers to accelerate our growth trajectory in this segment. We continue to produce 3 to 4 new games monthly, and that combined with the quality of our games coming out of our studios is driving share gains as part of our organic growth. Needless to say, we're very bullish on the prospects for this part of our business. Now moving on to Virtual Sports. Our Virtual Sports business continues to perform exceptionally well, and we're excited about the footprint we're building with the online aspect of this business as our Virtual Plug & Play, VPP. Product went live in additional markets like Belgium with Napoleon and Greece with both OPAP and Novae, and early results are very encouraging. Q4 revenue growth of 26% illustrates the potential we see for this business with online continuing to grow and land-based now back at pre-COVID levels across our geographies. North America, we now have a launch date of April 4 for our second US lottery customer, the DC Lottery, and we'll be introducing a new football product with the Pennsylvania lottery in the second half of this year. We remain very bullish on the lottery sector as a great market for Virtual Sports in North America, as we have seen in some of our big lottery customers around the world, including OPAP in Greece and Sisal in Italy and Turkey. On the product side, we have a number of enhancements coming out in 2022, including our first women's soccer game in time for the women's Euros tournament this summer, and we are signing customers currently for our newly licensed Major League baseball players, Alumni Association Home Run Shoot Out, which I have to tell you, looks amazing in development. Moving over to the Leisure segment. Our Leisure business grew well with revenue up 183% compared to the prior year Q4 due to a number of factors, including reduced COVID restrictions, extended season for holiday parks, increased traffic to our MSA locations. And as Lorne mentioned, the continued growth in our pub sector, as well as reaching now 78% of the estate being digital, with the majority of the rest of the estate converting in the rest of the first half of this year. The Prismatic cabinet continues to be the leader in Cat C gaming and pubs, and we're excited to be introducing our Vantage cabinet later this year, not only to our pub customers but also our LBO and AGC customers as well. As we've said a number of times, we designed our games to work across our product portfolio, including online, leisure, and our gaming segments, and we are seeing the benefit of this omnichannel strategy with players' recognition of our brands and the ability to play our games in whichever venue or mode they choose for themselves. As Lorne mentioned in his remarks, we firmly believe that the pub sector will recover well from the COVID restrictions and increased footfall should drive machine play with our content and cabinet performance being major drivers for success in this segment. Last, the Gaming segment continues to perform well with land-based back to pre-COVID levels across our major geographies of the UK and Greece. In Greece, we've seen our lead and performance expand over Q4 and believe the addition of some of our new key titles of our own, along with the first game from Aristocrat being introduced to the market, will strengthen our offering in this key market. We completed the transition to a content and platform provider in the Italian market with our deal with Crystal Tech finalized, and we're seeing the benefits to our P&L taking hold. We continue to expand our footprint in Illinois and have introduced some new content and a roadmap for additional content going into the market in Q1 2022 that should continue to improve our performance in that highly competitive market. And we've submitted a number of proposals to several key North American VLT markets in Q1 and expect to report on those in future earnings calls. Last but certainly not least, we're delighted to now have 2 months under our belt with our Leza lottery customer in the Dominican Republic and early results are very positive. We expect to expand their offering to make it available online in the first half of 2022, which could expand the sales opportunity significantly in that market. Lorne and I both worked with Leza for many years in our prior lives, and they run a world-class lottery, and we look forward to building a lottery platform for them that's state-of-the-art and will be an opportunity for growth for us in markets outside of the Dominican Republic and will include the ability to be a platform provider for iLottery as well. So needless to say, we have a lot going on at the moment as we continue to build this business. And clearly, our financial position gives us increased flexibility as we expand organically as well as review the many opportunities going on out in the market today. So thanks, and I'll hand it back to Lorne for his closing remarks before we take Q&A.

Thanks, Brooks. I don't actually have anything to add. I think you did a great job of summing up where we are. So operator, if you're standing by, we can open the program up to Q&A, please.

We will now begin the question-and-answer session. The first question comes from David Bain with B. Riley. Please go ahead.

Great. Thank you and congrats on another strong quarter and our best to Stewart. First, just because it's very topical, just given the geopolitical macroenvironment, any change that you're seeing in player habits, particularly in retail or potential CapEx, or buying activity from route operators, whatnot in North America or any of the other business initiatives that you have?

No. Amazingly, thus far. And as you know, Dave, we track this kind of daily. We're not seeing anything in the European markets, which you would probably expect if there is any impact we'd see it there. Certainly, I don't see it in the Illinois route market as well. I know that just reported their results, which were terrific. So the Illinois market continues to be robust. And as I mentioned in my remarks, we've got some proposals out, and we hope to be reporting on that later in the year. So no, so far, so good.

Okay. Great. And then if we could circle back on the strategic opportunity of Sportech with the Cloudtech, it just seems like that may be transformative for your iLottery initiative. And if I'm gathering it correctly, Sportech is going to allow you to be both a platform provider and you're already a content provider and you will be for iLottery. So can you describe like the take rate differential perhaps in the strategy to be more active as a platform and content provider perhaps outside the US versus more content-related in the US, and if there's any update with US iLottery, that would be great, too.

Hi, David, it's Lorne. No, overall I definitely understand the question. But anyway, just to clarify, the contract that we bought is a contract that is currently held by UK companies, Sportech, the customer is the operator of the National Dominican Republic lottery, called LEIDSA, L-E-I-D-S-A. It's an acronym that I have no idea what it stands for. I'm pretty sure the L stands for lottery, but after that, I can't tell you.

Electronic.

Yes, just to clarify the terminology, based on various contracts we observe, it's reasonable to estimate that our ability to provide an iLottery platform could potentially yield double the take rate compared to merely supplying content. If our initial market opportunity was at a certain level, with the platform it could increase to twice that amount. While it's important to manage expectations, the way we are designing this system will allow it to function not just efficiently, but excellently as a retail lottery system as well. I can't specify our marketing focus at this time, but it will likely be outside the United States initially. If incorporating the iLottery platform alongside our content does indeed double revenue potential, then having a system that can also handle retail could double it once more. While my experience in the lottery business spans around 30 or 40 years, we plan to take it step by step. Currently, our primary emphasis is on the growing iLottery content opportunity. As mentioned in our press release, our work in the Dominican Republic will play a significant role in this, allowing us to integrate all the lottery content we develop, assess its performance, and make necessary improvements. This encapsulates our approach to the entire lottery sector. Additionally, it's worth noting the remarkable synergy between gaming and lottery operations. It's possible to have different philosophical views on this matter. I have always believed that there is incredible potential for synergy between the gaming business we were starting to build when Brooks and I left SciGames and the lottery business. I think what SciGames has accomplished in breaking down their business structure is impressive. However, I am strongly convinced that the synergies for us are significant, especially in utilizing our extensive content library in iGaming and adapting that content for iLottery. That's our primary focus right now. Also, as Brooks mentioned, we are becoming increasingly excited about the prospects in the lottery sector for virtual sports and more. In the next month or two, we hope to announce some intriguing developments regarding virtual sports in the lottery space.

Very cool. Awesome. Thank you.

The next question comes from Barry Jonas with Truist Securities. Please go ahead.

Hey, guys. Good morning. I wanted to follow up on the lottery on LEIDSA. There's a few large players, as you know who dominate the traditional lottery space. Can you maybe just talk about what you see as your sweet spot for new contracts going forward and maybe help size the opportunity?

I'm sorry, Barry. It's one of those mornings. I would say that every lottery in the United States and indeed the world is our target market for the iLottery content. There is absolutely no question about that. We're seeing this unfold very rapidly. Much like the iGaming business in North America, it's really in its infancy. There are only a handful of states currently involved in iLottery, but I believe it will accelerate exponentially across the country just like iGaming has. For context, countries like the UK, which have been engaged in it for several years, show that iLottery can grow to represent 20% to 25% of lottery revenues without impacting the underlying lottery business. The global retail lottery market is around $300 billion, with nearly $100 billion of that in the United States. So this 20% to 25% represents the potential for iLottery and seems like a reasonable estimate. As I mentioned earlier in response to David's question, I would estimate that the revenue split between content and the core iLottery platform itself would be 50/50. Our focus in North America will primarily be on developing iLottery content. Initially, our efforts to build our iLottery platform, and ultimately the retail lottery platform, will likely concentrate outside the United States in markets where Brooks and I have extensive experience. I believe we have excellent opportunities to grow the business.

Yes. I mean, Barry, let me just add one more point. I think one of the advantages that we see as we're starting this development from kind of a clean sheet. So we think that there is some innovation and some benefits that we can bring to the whole segment. And I think as Lorne said, probably our focus outside of the iLottery stuff will be outside of North America first, but we expect to build a world-class lottery platform that can be both iLottery and retail, and it's a lot easier kind of starting from scratch than some of the stuff having to modify some of the existing systems as others would have to do. If that helps you.

That's great. And then just as a follow-up question. Any updates on the UK gaming regulatory review? I think our thoughts, or you're better positioned than others there. But just curious if you can share any updates as you're aware.

Yes. The only update I have is that the white paper everyone has been discussing for some time is now expected to be released in May. We have no reason to believe it will differ from what we have discussed in previous calls. It seems that the operators are becoming increasingly proactive about responsible gaming initiatives ahead of the white paper, likely trying to address any operational issues they may have before its release. So, like everyone else, we will wait to see what happens in May.

That's great. Appreciate it, and best wishes to Stewart. Thanks.

Thanks, Barry.

The next question comes from Ryan Sigdahl with Craig-Hallum. Please go ahead.

Good morning, guys. And Stewart, hope you're feeling better. Two questions for us. First, Interactive segment was down sequentially, good year-over-year growth and pretty steady trend. But anything to comment, I guess, directionally on what happened in Q4 relative to Q3 in the trend?

Yes. October and December were actually better. November was not, primarily due to a set of regulations from the UK regarding spending speed that we had to implement. We made that transition in November, which consumed a lot of our time and capacity, and we didn't have as many new games released as we typically do. So there was a slight dip in November, but what we're observing in the first quarter gives us confidence about the business's direction. It was just a minor setback in November.

Helpful. Then just on the new Vantage hub cabinet that you mentioned. Can you talk through kind of what the new features are? What's exciting about that one relative to the past ones you have out there today?

Yes, thank you for the question. We're really excited about this and have just begun showcasing it to customers. From a hardware standpoint, we have larger, brighter, and newer screens. What we're observing aligns with our omnichannel strategy, particularly in the UK, where the distinction between a pub experience, an adult gaming center, and a licensed betting office has become minimal. We're enhancing the menu experience so that customers can easily find the games they enjoy. If someone is used to playing in an adult gaming center and enters a pub, they will see familiar content, and the same goes for the licensed betting office. The feedback from customers at a major amusement show last week was incredibly positive. As Lorne mentioned, we may have been ahead of our time in the pub market, but it is now evolving towards server-based, digital content in an engaging format. With the increase in foot traffic returning post-COVID, we anticipate generating more revenue not only for ourselves but also for our pub customers. We are very enthusiastic about this product.

Great. Thanks, guys. Good luck.

Thank you.

The next question comes from Chad Beynon with Macquarie. Please go ahead.

Hey, good morning. This is Aaron on for Chad. Thanks for taking my questions. Just wanted to touch on the interactive segment again. And it looks like you've continued to have good momentum launching with new customers here. Can you just talk about what sort of investments are needed to support growth from here? And how we should think about margins in 2022?

Yes, I believe our investments are focused on continuing to enhance our content pipeline, as well as on areas where we currently have gaps. We're also prioritizing direct integrations with customers instead of relying on integrators. This shift is expected to boost our margins, as we won't need to pay a 20% fee to third parties for integrations. Therefore, as the business expands, you can anticipate improvements in margins due to both increased scale and direct integrations. Lorne mentioned this in his comments.

Great. Thank you.

I believe we will see a significant example of this, with Aaron speaking for Chad. We were informed yesterday that we have received our license to launch in Ontario in April, and we already have around a dozen operating customers in Ontario signed to contracts. All technical work is complete, and we're using the same library of games as in our other markets. Almost 90% of the revenue from Ontario is expected to contribute directly to our profitability. Each time we expand into a new jurisdiction, especially since we are generally working with the same customers and games, our additional investment is relatively minimal compared to the revenue and margins we generate. This reinforces my earlier point about being able to achieve strong revenue, margins, and capital simultaneously. In my nearly 50-year business career, I have never seen a scenario quite like this; it is indeed very unique.

That’s great. Thank you.

The next question comes from Edward Engel with ROTH Capital. Please go ahead.

Hi, thank you for taking my question. Just to follow up on the last one. At this point, do you feel like you're now live with all the major content aggregator platforms? And then I guess, as a follow-up, do you think that maybe even owning one of these platforms could accelerate both your distribution and then maybe even boost your margins on your own games?

Well, I'll answer the first one, and I'll let Lorne answer the second one. Yes, we are. We've integrated with pretty much everyone that we need to. So the perfect illustration of that is Ontario. So I think we expect to hit the ground running with kind of over 20 customers when they open on 4 without really much work at all. And I think that's a testimony to the idea of that we're integrated with everybody. But no, I actually think we, as a company, and I think our customers would prefer to have direct integrations with us. And I think that's a trend that you'll probably see, certainly with our bigger customers that will be going directly with them more often. But I'll let Lorne give his views on the aggregator business.

Yes, the question about entering the aggregator space is quite complex. Generally, I prefer not to put ourselves in a position where we compete with our customers. If we were to intentionally enter the aggregator business, we would be competing with the aggregators who are currently our customers, and I wouldn't be comfortable with that. However, in some ways, we are already moving towards that direction. For instance, in Greece, we plan to include Aristocrat games on our platform. We are increasingly seeing that many of our customers, even when we're the main platform provider or when it comes to the remote game server for our iGaming operations, are using games from other developers on our platform. We have always adopted a philosophy of maintaining as open a system as possible, allowing our customers to include their preferred games without feeling limited to just ours. While we are gradually entering the aggregator space at the request of our customers, I don't foresee us actively competing with companies like Scientific Games right now. I just don't believe that is a direction we will take.

Great. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Lorne Weil for any closing remarks.

Thank you, operator. Now again, I don't have much to add. I think actually the questions that we had this morning were as good a collection of questions as I can recall any conference call having had in the last few years at Inspired. So I appreciate everyone who asked the questions. And we continue to appreciate your support. And I'm trying to think of when we'll be reporting in the first quarter, but probably in mid-May. So we'll be talking to you in mid-May and look forward to doing that then. So thanks, again. Bye.

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