Inspired Entertainment, Inc. - FORM 10-Q

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - Inspired Entertainment, Inc.	s111885_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - Inspired Entertainment, Inc.	s111885_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Inspired Entertainment, Inc.	s111885_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Inspired Entertainment, Inc.	s111885_ex31-1.htm
EX-10.2 - EXHIBIT 10.2 - Inspired Entertainment, Inc.	s111885_ex10-2.htm
EX-10.1 - EXHIBIT 10.1 - Inspired Entertainment, Inc.	s111885_ex10-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number: 001-36689

INSPIRED ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

Delaware		47-1025534
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

250 West 57^th Street, Suite 2223
New York, NY		10107
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (646) 565-3861

(Former name or former address, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐		Accelerated filer ☐
Non-accelerated filer ☐		Smaller reporting company ☒
(Do not check if a smaller reporting company)		Emerging growth company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of August 13, 2018, there were 21,484,707 shares of the Company’s common stock issued and outstanding.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION	3

ITEM 1.	FINANCIAL STATEMENTS	3

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Operations and Comprehensive Loss	4

	Condensed Consolidated Statement of Stockholders’ Deficit	5

	Condensed Consolidated Statements of Cash Flows	6

	Notes to Condensed Consolidated Financial Statements	7

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	24

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	52

ITEM 4.	CONTROLS AND PROCEDURES	53

PART II.	OTHER INFORMATION	54

ITEM 1.	LEGAL PROCEEDINGS	54

ITEM 1A.	RISK FACTORS	54

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	73

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	73

ITEM 4.	MINE SAFETY DISCLOSURES	73

ITEM 5.	OTHER INFORMATION	73

ITEM 6.	EXHIBITS	74

SIGNATURES		75

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	June 30, 2018			September 30, 2017
	(Unaudited)
Assets
Current assets
Cash	$	10,176		$	20,028
Accounts receivable, net		17,756			20,469
Inventory, net		6,417			5,011
Prepaid expenses and other current assets		17,117			17,692
Total current assets		51,466			63,200

Property and equipment, net		46,445			43,485
Software development costs, net		45,690			46,433
Other acquired intangible assets subject to amortization, net		6,622			9,240
Goodwill		46,387			47,076
Other assets		10,028			9,589
Total assets	$	206,638		$	219,023

Liabilities and Stockholders’ Deficit
Current liabilities
Accounts payable	$	20,008		$	20,407
Accrued expenses		12,660			18,119
Earnout liability		8,961			—
Corporate tax and other current taxes payable		2,056			3,134
Deferred revenue, current		11,021			7,209
Other current liabilities		3,904			4,420
Current portion of long-term debt		—			7,369
Current portion of capital lease obligations		523			562
Total current liabilities		75,399			61,220

Long-term debt		127,923			115,396
Capital lease obligations, net of current portion		133			532
Deferred revenue, net of current portion		22,678			20,144
Earnout liability, net of current portion		—			16,728
Derivative liability		—			964
Other long-term liabilities		1,760			6,368
Total liabilities		211,627			221,352

Commitments and contingencies

Stockholders’ deficit
Preferred stock; $0.0001 par value; 1,000,000 shares authorized		—			—
Series A Junior Participating Preferred stock; $0.0001 par value; 1,000,000 shares authorized; 49,000 shares designated; no shares issued and outstanding at June 30, 2018 and September 30, 2017		—			—
Common stock; $0.0001 par value; 49,000,000 shares authorized; 20,860,591 shares and 20,402,602 shares issued and outstanding at June 30, 2018 and September 30, 2017, respectively		2			2
Additional paid in capital		326,967			323,429
Accumulated other comprehensive income		55,619			53,145
Accumulated deficit		(387,577	)		(378,905	)
Total stockholders’ deficit		(4,989	)		(2,329	)
Total liabilities and stockholders’ deficit	$	206,638		$	219,023

The accompanying notes are an integral part of these condensed consolidated financial statements.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except share and per share data)

(Unaudited)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2018			2017			2018			2017

Revenue:
Service	$	34,536		$	26,838		$	98,136		$	77,478
Hardware		2,390			5,473			7,630			9,930
Total revenue		36,926			32,311			105,766			87,408

Cost of sales, excluding depreciation and amortization:
Cost of service		(5,862	)		(4,166	)		(17,075	)		(11,146	)
Cost of hardware		(2,085	)		(4,908	)		(7,058	)		(8,520	)
Selling, general and administrative expenses		(15,245	)		(13,786	)		(47,241	)		(41,922	)
Stock-based compensation expense		(1,485	)		(1,377	)		(5,934	)		(2,703	)
Acquisition related transaction expenses		(14	)		(74	)		(816	)		(11,346	)
Depreciation and amortization		(10,616	)		(8,705	)		(31,296	)		(23,877	)
Net operating income (loss)		1,619			(705	)		(3,654	)		(12,106	)

Other income (expense)
Interest income		36			8			167			20
Interest expense		(5,185	)		(5,013	)		(15,253	)		(23,978	)
Change in fair value of earnout liability		(644	)		(2,384	)		7,767			(3,262	)
Change in fair value of derivative liability		—			(270	)		1,872			(349	)
Other finance income (costs)		194			(55	)		584			(162	)
Total other income (expense), net		(5,599	)		(7,714	)		(4,863	)		(27,731	)

Net loss before income taxes		(3,980	)		(8,419	)		(8,517	)		(39,837	)
Income tax benefit (expense)		(39	)		86			(155	)		3
Net loss		(4,019	)		(8,333	)		(8,672	)		(39,834	)

Other comprehensive income (loss):
Foreign currency translation (loss) gain		(188	)		(569	)		234			17,565
Actuarial gains (losses) on pension plan		2,984			(1,611	)		2,240			(4,734	)
Other comprehensive income/(loss)		2,796			(2,180	)		2,474			12,831

Comprehensive loss	$	(1,223	)	$	(10,513	)	$	(6,198	)	$	(27,003	)

Net loss per common share – basic and diluted	$	(0.19	)	$	(0.41	)	$	(0.42	)	$	(2.26	)

Weighted average number of shares outstanding during the period – basic and diluted		20,860,591			20,378,002			20,718,682			17,607,808

The accompanying notes are an integral part of these condensed consolidated financial statements.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

(in thousands, except share data)

(Unaudited)

	Common stock				Additional paid in			Accumulated other comprehensive		Accumulated			Total stockholders’
	Shares		Amount		capital			income		deficit			deficit

Balance at October 1, 2017		20,402,602	$	2	$	323,429		$	53,145	$	(378,905	)	$	(2,329	)
Foreign currency translation adjustments		—		—		—			234		—			234
Actuarial gains on pension plan		—		—		—			2,240		—			2,240
Shares issued on exercise of warrants		50		—		1			—		—			1
Shares issued upon net settlement of RSUs and RSAs		457,939		—		(1,043	)		—		—			(1,043	)
Stock-based compensation expense		—		—		3,214			—		—			3,214
Reclassification of RSUs from derivative liability due to stockholder approval of Second Long-Term Incentive Plan		—		—		2,848			—		—			2,848
Reclassification of RSUs to derivative liability due to modification		—		—		(1,482	)		—		—			(1,482	)
Net loss		—		—		—			—		(8,672	)		(8,672	)
Balance at June 30, 2018		20,860,591	$	2	$	326,967		$	55,619	$	(387,577	)	$	(4,989	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Nine Months Ended June 30,
	2018			2017

Cash flows from operating activities:
Net loss	$	(8,672	)	$	(39,834	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		31,296			23,877
Stock-based compensation expense		5,625			2,703
Change in fair value of derivative liability		(1,872	)		349
Change in fair value of earnout liability		(7,767	)		3,262
Non-cash interest expense relating to senior debt		5,824			—
Non-cash interest expense relating to PIK loan notes		—			9,762
Changes in assets and liabilities:
Accounts receivable		2,392			1,470
Inventory		(1,569	)		3,029
Prepaid expenses and other assets		1,061			(3,976	)
Corporate tax and other current taxes payable		(1,883	)		(926	)
Accounts payable		(4,126	)		4,790
Other current liabilities		(69	)		(11	)
Deferred revenues and customer prepayment		6,807			2,931
Accrued expenses		(5,274	)		(703	)
Other long-term liabilities		(4,004	)		(2,524	)
Net cash provided by operating activities		17,769			4,199

Cash flows from investing activities:
Purchases of property and equipment		(14,914	)		(12,761	)
Purchases of capital software		(13,228	)		(16,304	)
Net cash used in investing activities		(28,142	)		(29,065	)

Cash flows from financing activities:
Proceeds from issuance of revolver and long-term debt		9,290			5,732
Cash received in connection with Merger		—			36,664
Proceeds from sale of common stock		—			1,645
Repayments of long-term debt		(7,713	)		—
Repayments of finance leases		(438	)		(91	)
Net cash provided by financing activities		1,139			43,950

Effect of exchange rate changes on cash		(618	)		2,130
Net (decrease) increase in cash		(9,852	)		21,214
Cash, beginning of period		20,028			1,486
Cash, end of period	$	10,176		$	22,700

Supplemental cash flow disclosures
Cash paid during the period for interest	$	12,483		$	10,362
Cash paid during the period for income taxes	$	7		$	66

Supplemental disclosure of noncash investing and financing activities
Additional paid in capital from net settlement of RSUs	$	(1,043	)	$	—
Additional paid in capital reclassified to derivative liability	$	(1,482	)	$	—
Additional paid in capital reclassified from derivative liability	$	2,848		$	—
Derivative liability reclassified to accrued expenses	$	126		$	—
Fair value adjustment of PIK shareholder loans	$	—		$	174,990
Property acquired through capital lease	$	—		$	1,208

The accompanying notes are an integral part of these condensed consolidated financial statements.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

1.	Nature of Operations, Management’s Plans and Summary of Significant Accounting Policies

Company Description and Nature of Operations

Inspired Entertainment, Inc. (the “Company,” the “group,” “we,” “our,” and “us”) is a global business-to-business gaming technology company, supplying Virtual Sports, Mobile and Server Based Gaming (“SBG”) systems to regulated lottery, betting and gaming operators worldwide. We provide end-to-end digital gaming solutions on our proprietary and secure network, which accommodates a wide range of devices, including land-based gaming machine terminals, mobile devices such as smartphones and tablets and online computer and social applications.

The Company was formed in Delaware on May 30, 2014 under the name Hydra Industries Acquisition Corp. as a “blank check company” for the purpose of acquiring, through a merger, capital stock exchange, asset acquisition, stock purchase, reorganization, recapitalization or other similar business transaction, one or more operating businesses or assets. On December 23, 2016 (the “Closing Date”), the Company consummated a business combination by acquiring Inspired Gaming Group pursuant to a share sale agreement dated as of July 13, 2016 (the “Sale Agreement”), by and among the Company and those persons identified on Schedule 1 to the Sale Agreement, including DMWSL 633 Limited. Pursuant to the Sale Agreement, the Company acquired all of the outstanding equity and shareholder loan notes of Inspired Gaming Group. We refer to such acquisition and to the other transactions contemplated by the Sale Agreement, collectively, as the “Business Combination” or the “Merger.”

Management Liquidity Plans

As of June 30, 2018, the Company’s cash on hand was $10,176 and the Company had a working capital deficit of $7,667. As of June 30, 2018, $2,593 of our cash on hand had arisen in Greece and was being held in our Greek accounts. In the ordinary course of business, we seek, from time to time, to transfer funds earned in Greece to our accounts outside of Greece. However, Greece imposes capital controls that complicate, and can delay or prevent, the flow of capital out of that country. The Company recorded net losses of $8,672 and $39,834 for the nine months ended June 30, 2018 and 2017, respectively. The net losses arose principally due to interest on shareholder loan notes in the prior year, which are no longer a liability of the Company following the Merger, and non-cash items, including stock-based compensation. Historically, annually the Company has generally had positive cash flows from operating activities and has relied on a combination of cash flows provided by operations and the incurrence of debt and/or the refinancing of existing debt to fund its obligations. The working capital deficit of $7,667 includes non-cash settled items of $8,961 for the earnout liability and $11,021 of deferred income. Management currently believes that the Company’s cash balances on hand, cash flows expected to be generated from operations, ability to control and defer capital projects and amounts available from the Company’s external borrowings will be sufficient to fund the Company’s net cash requirements through August 2019.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 8 of Regulation S-X of the United States Securities and Exchange Commission (“SEC”). Certain information or footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted, pursuant to the rules and regulations of the SEC for interim financial reporting. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of financial position, results of operations, or cash flows. It is management’s opinion, however, that the accompanying unaudited interim condensed consolidated financial statements include all adjustments, consisting of a normal recurring nature, which are necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

The accompanying unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the periods ended September 30, 2017, September 24, 2016 and September 26, 2015. The financial information as of September 30, 2017 is derived from the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K filed with the SEC on December 4, 2017. The interim results for the three and nine months ended June 30, 2018 are not necessarily indicative of the results to be expected for the year ending September 30, 2018 or for any future interim periods.

The Company changed its reporting year end from a 52-week period ending on the last Saturday in September to a September 30 year end, commencing with the year ended September 30, 2017. Accordingly, the nine-month period ended June 30, 2017 includes the results of operations for the Company for the period from September 25, 2016 through June 30, 2017.

Principles of Consolidation

All monetary values set forth in these unaudited interim condensed consolidated financial statements are in US Dollars (“USD”) unless otherwise stated herein. The accompanying unaudited interim condensed consolidated financial statements include the results of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Foreign Currency Translation

For most of our operations, the British pound (GBP) is our functional currency. Our reporting currency is the U.S. Dollar. We also have operations where the local currency is the functional currency, including our operations in mainland Europe and South America. Assets and liabilities of foreign operations are translated at period-end rates of exchange, equity is translated at historical rates of exchange and results of operations are translated at the average rates of exchange for the period. Gains or losses resulting from translating the foreign currency financial statements are recorded as a separate component of accumulated other comprehensive loss in stockholders’ deficit. Gains or losses resulting from foreign currency transactions are included in selling, general and administrative expenses and interest income (expense) in the condensed consolidated statements of operations and comprehensive loss.

Use of Estimates

The preparation of unaudited interim condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates these estimates, including those related to the revenue recognition for contracts involving software and non-software elements, allowance for doubtful accounts, inventory reserve for net realizable value, goodwill and intangible assets, useful lives of long-lived assets, stock-based compensation, valuation allowances on deferred taxes, earnout liability, commitments and contingencies and litigation, among others. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. We regularly evaluate these significant factors and make adjustments when facts and circumstances dictate. Actual results may differ from these estimates.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 (ASC 606), “Revenue from Contracts with Customers,” which was subsequently modified in August 2015 by ASU No. 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date” (“ASU 2014-09”). As a result, ASU No. 2014-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2018. The core principle of ASU No. 2014-09 is that companies should recognize revenue when the transfer of promised goods or services to customers occurs in an amount that reflects what the company expects to receive. It requires additional disclosures to describe the nature, amount, timing and uncertainty of revenue and cash flows from contracts with customers. The Company will adopt the standard on October 1, 2019, which may result in a cumulative-effect adjustment for deferred revenue to the opening balance sheet for 2017 and the restatement of the financial statements for all prior periods presented. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements. In 2016 and 2017, the FASB issued additional ASUs that clarify the implementation guidance on principal versus agent considerations (ASU 2016-08), on identifying performance obligations and licensing (ASU 2016-10), and on narrow-scope improvements and practical expedients (ASU 2016-12), as well as on the revenue recognition criteria and other technical corrections (ASU 2016-20, ASU 2017-13 and ASU 2017-14).

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

2.	Accounts Receivable

Accounts receivable consist of the following:

	June 30, 2018			September 30, 2017
Trade receivables	$	22,519		$	25,527
Less: long-term receivable recorded in other assets		(2,588	)		(3,235	)
Other receivables		114			135
Allowance for doubtful accounts		(2,289	)		(1,958	)
Total accounts receivable, net	$	17,756		$	20,469

3.	Inventory

Inventory consists of the following:

	June 30, 2018		September 30, 2017
Component parts	$	4,155	$	4,100
Finished goods		2,262		911
Total inventories	$	6,417	$	5,011

Component parts include parts for gaming terminals. Included in component parts are reserves for excess and slow-moving inventory of $460 and $419 as of June 30, 2018 and September 30, 2017, respectively. Our finished goods inventory primarily consists of gaming terminals which are ready for sale.

4.	Prepaid Expenses and Other Assets

Prepaid expenses and other assets consist of the following:

	June 30, 2018		September 30, 2017
Prepaid expenses and other assets	$	5,484	$	8,150
Unbilled accounts receivable		11,633		9,542
Total prepaid expenses and other assets	$	17,117	$	17,692

5.	Property and Equipment, net

	June 30, 2018			September 30, 2017
Short-term leasehold property	$	365		$	371
Video lottery terminals		118,969			105,525
Computer equipment		8,487			8,428
Plant and machinery		3,284			3,358
		131,105			117,682
Less: accumulated depreciation and amortization		(84,660	)		(74,197	)
	$	46,445		$	43,485

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

Depreciation and amortization expense amounted to $5,398 and $4,669 for the three months ended June 30, 2018 and 2017, respectively, and $15,456 and $13,827 for the nine months ended June 30, 2018 and 2017, respectively.

6.	Software Development Costs, net

Software development costs, net consisted of the following:

	June 30, 2018			September 30, 2017
Software development costs	$	101,572		$	89,468
Less: accumulated amortization		(55,882	)		(43,035	)
	$	45,690		$	46,433

During the three and nine months ended June 30, 2018, the Company capitalized $4,447 and $13,127 of software development costs, respectively. Amounts in the above table include $1,352 and $2,676 of internal use software at June 30, 2018 and September 30, 2017, respectively.

The total amount of software costs amortized was $4,366 and $3,232 for the three months ended June 30, 2018 and 2017, respectively, and $12,927 and $7,425 for the nine months ended June 30, 2018 and 2017, respectively. Software costs written down to net realizable value amounted to $0 and $342 for the three and nine months ended June 30, 2018, respectively, and $0 and $263 for the three and nine months ended June 30, 2017, respectively. The weighted average amortization period was 3.2 years for the three and nine months ended June 30, 2018.

The estimated software amortization expense for the years ending September 30 are as follows:

Year ending September 30,
2018 (three months)	$	4,346
2019		16,014
2020		13,213
2021		8,304
2022		2,742
2023		1,071
Total	$	45,690

7.	Intangible Assets and Goodwill

The following tables present certain information regarding our intangible assets. Amortizable intangible assets are being amortized on a straight-line basis over their estimated useful lives of ten years with no estimated residual values, which materially approximates the expected pattern of use.

	June 30, 2018			September 30, 2017
Trademarks	$	17,854		$	18,119
Customer relationships		15,258			15,485
		33,112			33,604
Less: accumulated amortization		(26,490	)		(24,364	)
	$	6,622		$	9,240

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

Aggregate intangible asset amortization expense amounted to $853 and $804 for the three months ended June 30, 2018 and 2017, respectively, and $2,572 and $2,362 for the nine months ended June 30, 2018 and 2017, respectively.

The estimated intangible asset amortization expense for the years ending September 30 are as follows:

Year ending September 30,
2018 (three months)	$	828
2019		3,311
2020		2,483
Total	$	6,622

Goodwill

The difference in the carrying amount of goodwill at June 30, 2018 and September 30, 2017 (amounting to $689), as reported in the accompanying unaudited interim condensed consolidated balance sheets, is attributable to foreign currency translation adjustments.

8.	Accrued Expenses

Accrued expenses consist of the following:

	June 30, 2018		September 30, 2017
Direct costs of sales	$	4,007	$	6,038
Accrued corporate cost expenses		2,997		2,257
Interest payable - cash		808		4,116
Interest payable – payment in kind		642		664
Asset retirement obligations		43		40
Other creditors		4,163		5,004
	$	12,660	$	18,119

9.	Other Liabilities

Other liabilities consist of the following:

	June 30, 2018		September 30, 2017
Customer prepayments and deposits	$	3,904	$	4,346
Foreign exchange contract liabilities		—		74
Total other liabilities, current		3,904		4,420
Other payables, net of current portion		899		2,079
Asset retirement obligations		861		866
Pension liability		—		3,423
Total other liabilities, long-term		1,760		6,368
	$	5,664	$	10,788

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

10.

Long Term and Other Debt

Outstanding Debt and Capital Leases

The following reflects outstanding debt and capital leases as of the dates indicated below:

	June 30, 2018			September 30, 2017
Senior bank debt	$	127,923		$	122,765
Capital leases and hire purchase contract		656			1,094
Total long-term debt outstanding		128,579			123,859
Less: current portion of long-term debt		(16,789	)		(7,931	)
Long-term debt, excluding current portion	$	111,790		$	115,928

The Company is in compliance with all relevant financial covenants and the long term debt portion is correctly classified as such in line with the underlying agreements.

Long term debt for the years ending September 30 matures as follows:

Fiscal period:	Senior bank debt		Capital leases and hire purchase contract		Total
2018 (three months)	$	—		132		132
2019		—		454		454
2020		—		70		70
2021		16,266		—		16,266
2022		—		—		—
2023		111,657		—		111,657
Total	$	127,923	$	656		128,579

11.

Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset and liability in an orderly transaction between market participants at the measurement date. We estimate the fair value of our assets and liabilities utilizing an established three-level hierarchy. The hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as follows:

Level 1:

Quoted prices in active markets for identical assets or liabilities.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

	Level 2:	Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs also include non-binding market consensus prices that can be corroborated with observable market data, as well as quoted prices that were adjusted for security-specific restrictions.

	Level 3:	Unobservable inputs that are supported by little or no market activity that are significant to the fair value of the asset or liability. Level 3 inputs also include non-binding market consensus prices or non-binding broker quotes that are unable to be corroborated with observable market data.

The fair value of our financial assets and liabilities is determined by reference to market data and other valuation techniques as appropriate. We believe the fair value of our financial instruments, which are principally cash, accounts receivable, prepaid expenses and other current assets, accounts payable and other long term liabilities, approximates their recorded values.

For each period, derivative financial instrument assets and liabilities measured at fair value on a recurring basis are included in the financial statements as per the table below.

		June 30,		September 30,
	Level	2018		2017
Earnout liability (see Note 12)	3	$	8,961	$	16,728
Derivative liability (see Note 13)	2	$	—	$	964
Long term receivable (included in other assets)	2	$	2,588		3,235
Foreign exchange contract liability (included in other current liabilities)	2	$	—	$	74

Level 3 liabilities are valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the derivative liabilities. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s principal financial officer, who reports to the principal executive officer, determines its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s principal financial officer and approved by the principal executive officer.

Level 3 financial liabilities consist of the earnout liability for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate (see Note 12).

At June 30, 2018 and September 30, 2017, there were no transfers in or out of Level 3 from other levels in the fair value hierarchy.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

12.

Earnout Liability

An earnout payment of up to 2,500,000 shares of the Company’s common stock, subject to certain customary anti-dilution adjustments (the “Earnout Consideration”) shall be paid to the previous owners of Inspired Gaming Group (the “Selling Group”) and will be determined based on the financial performance of the Company’s businesses in six specific countries, China, Colombia, Greece, Norway, Spain and Ukraine (collectively, the “Earnout Jurisdictions”), as measured by earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the twelve months ending September 30, 2018 (the “Earnout Period”). If such EBITDA is equal to or greater than £15,000 ($19,805), the Selling Group will receive an aggregate of 2,500,000 shares of common stock. If such EBITDA is less than £15,000 ($19,805), the Selling Group will receive the number of shares equal to the product of (x) 2,500,000 and (y) a fraction, the numerator of which is such EBITDA and the denominator of which is £15,000 ($19,805).

In accordance with ASC 815, “Derivatives and Hedging” (“ASC 815”), the earnout shares are not considered indexed to the Company’s own stock and therefore are accounted for as a liability with fair value changes being recorded in the condensed consolidated statements of operations and comprehensive loss. The fair value of the Earnout Consideration is calculated using a Monte Carlo simulation to estimate the variance and relative risk of achieving future EBITDA during the Earnout Period in the Earnout Jurisdictions. This model is a discrete-time model that allows for sources of uncertainty, simulates the movements of the underlying metric and calculates the resulting derivative value for each trial. Such simulations are performed for a number of trials and the average value across all trials is determined in order to arrive at the concluded value of such derivative. The Earnout Consideration was valued at $8,961 and $16,728 at June 30, 2018 and September 30, 2017, respectively.

The key assumptions in applying the Monte Carlo simulation include the Company’s stock price, the Earnout Period EBITDA in the Earnout Jurisdictions for the period ending September 30, 2018, a risk-adjusted discount rate of 13.7% as of June 30, a standard deviation of 44.7% as of June 30, 2018 (based on the expected standard deviation of the Earnout Period EBITDA), a normal distribution of Earnout Period EBITDA and a Monte Carlo simulation run 100,000 times.

Significant increases or decreases to any of these inputs in isolation would result in a significantly higher or lower liability, with a higher liability capped by the contractual maximum Earnout Consideration obligation (a maximum of 2,500,000 shares). Ultimately, the liability will be equivalent to the amount paid in shares, and the difference between the fair value estimate and amount paid will be recorded in earnings.

The following table provides a reconciliation of the beginning and ending balances for the earnout liability measured using significant unobservable inputs (Level 3):

Balance – September 30, 2017	$	16,728
Change in fair value of earnout liability		(7,767	)
Balance – June 30, 2018	$	8,961

13.

Derivative Liability

The Company’s Second Long-Term Incentive Plan (the “Second Incentive Plan”) was adopted by the Company’s Board of Directors in December 2016 subject to approval by the Company’s stockholders, which was obtained in March 2018. Awards granted under the Second Incentive Plan prior to approval by stockholders were classified as a derivative liability due to the Company’s obligation to settle such awards in cash in the event stockholders did not approve the plan. Such obligation was eliminated upon stockholder approval being obtained, which resulted in the liability being reclassified to additional paid in capital at the fair value amount of $2,848.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

14.

Stock-Based Compensation

The Company’s stock-based compensation plans authorize awards of restricted stock units, stock options and other equity awards. As of June 30, 2018, there were 2,383,280 shares subject to outstanding awards and 1,133,207 shares remaining available for future awards.

On January 2, 2018, the Company granted 27,000 RSUs under its 2016 Long-Term Incentive Plan (the “First Incentive Plan”) to members of the Company’s Board of Directors. One-quarter of the RSUs vested on the date of grant, with the remaining RSUs vesting quarterly on April 1, 2018, July 1, 2018 and October 1, 2018. The weighted average fair value of the awards on the date of grant was $9.70 per share. The grant date fair value of the awards is being recognized as compensation expense over the vesting period. The aggregate grant date fair value of the RSUs amounted to $262, of which the Company recorded $71 and $154 as compensation expense during the three and nine months ended June 30, 2018, respectively.

On May 1, 2018, the Company granted 100,000 RSUs under the Second Incentive Plan to a member of the Company’s executive team, which will vest on May 1, 2020. The weighted average fair value of the award on the date of grant was $4.95 per share. The grant date fair value of the award is being recognized as compensation expense over the vesting period. The aggregate grant date fair value of the RSUs amounted to $495, of which the Company recorded $41 as compensation expense during the three and nine months ended June 30, 2018.

Stock-based compensation is recognized as an expense on a straight-line basis over the requisite service period, which is generally the vesting period. The modification of certain awards held by two executive officers of the Company in December 2017 resulted in $2,105 of incremental compensation cost being recognized as of the modification date.

The Company recognized stock-based compensation expense as follows:

	Three Months Ended June 30,				Nine Months Ended June 30,
	2018		2017		2018		2017

Restricted Stock and Restricted Stock Units	$	1,485	$	1,377	$	3,519	$	2,703
Modification of awards		—		—		2,105		—
Payroll taxes on vesting of Restricted Stock Units		—		—		310		—
	$	1,485	$	1,377	$	5,934	$	2,703

15.

Accumulated Other Comprehensive Loss (Income)

The accumulated balances for each classification of comprehensive loss (income) are presented below:

	Foreign Currency Translation Adjustments			Unrecognized pension benefit costs			Accumulated Other Comprehensive Loss (Income)
Balance at September 30, 2017	$	(78,668	)	$	25,523		$	(53,145	)
Change during the period		(234	)		(2,240	)		(2,474	)
Balance at June 30, 2018	$	(78,902	)	$	23,283		$	(55,619	)

16.

Net Loss per Share

Basic loss per share (“EPS”) is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period, excluding the effects of any potentially dilutive securities. Diluted EPS gives effect to all dilutive potential of shares of common stock outstanding during the period, including stock options, restricted stock and warrants, using the treasury stock method, and convertible debt or convertible preferred stock, using the if-converted method. Diluted EPS excludes all dilutive potential of shares of common stock if their effect is anti-dilutive.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

The computation of diluted EPS excludes the common stock equivalents of the following potentially dilutive securities because their inclusion would be anti-dilutive:

	Three and Nine Months Ended June 30,
	2018		2017
Earnout Shares		2,500,000		2,500,000
Restricted Stock Units		1,759,164		756,331
Unvested Restricted Stock		624,116		2,012,445
Stock Warrants		9,539,615		9,539,615
		14,422,895		14,808,391

17.

Income Taxes

On December 22, 2017 several significant changes to the U.S. tax code were signed into law under the Tax Cuts and Jobs Act (the “Act”). Included amongst such changes is a reduction of the US corporate tax rate from 35% to 21%. Most of the effective dates of provisions in the Act are based on tax years beginning after December 31, 2017. Accordingly, many of the related provisions should not impact the Company until the fiscal year beginning October 1, 2018. Nonetheless, the Company continues to evaluate the impact of the Act on the tax provision.

Income taxes are accounted for under the asset and liability method. Our provision for income taxes is principally based on current period income (loss), changes in deferred tax assets and liabilities and changes in estimates with regard to uncertain tax positions. We estimate current tax expense and assess temporary differences resulting from differing treatments of items for tax and accounting purposes using enacted tax rates in effect for each taxing jurisdiction in which we operate for the period in which those temporary differences are expected to be recovered or settled. These differences result in deferred tax assets and liabilities. Our total deferred tax assets are principally comprised of depreciation and net operating loss carry forwards.

The effective income tax rate for the three months ended June 30, 2018 and 2017 was (1.0%) and 1.0%, respectively, resulting in a ($39) and $86 income tax (expense)/benefit, respectively. The effective income tax rate for the nine months ended June 30, 2018 and 2017 was (1.8%) and 0.0%, respectively, resulting in a ($155) and $3 income tax (expense)/benefit, respectively. The income tax expense for the three and nine months ended June 30, 2018 differs from the amount that would be expected after applying the statutory U.S. federal income tax rate primarily due to the impact of the U.S. statutory tax rate change on deferred tax assets and liabilities, changes in the valuation allowance for deferred taxes and the net losses generated by the Company’s non-US foreign subsidiaries. The income tax expense for the three and nine months ended June 30, 2017 differs from the amount that would be expected after applying the statutory U.S. federal income tax rate primarily due to the changes in the valuation allowance for deferred taxes and the net losses generated by the Company’s non-US foreign subsidiaries.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considered the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on the consideration of these items, management determined that it is more likely than not that the Company will not realize the deferred income tax asset balances and therefore, recorded a full valuation allowance of $51,575 as of June 30, 2018.

The utilization of the Company’s pre-Merger net operating losses are subject to a limitation due to the “change of ownership provisions” under Section 382 of the Internal Revenue Code and similar state provisions.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

18.

Related Parties

We occupy office space leased by a company affiliated with our Executive Chairman. We acquired inventory and paid maintenance expenses for the office.

Three Months Ended
June 30,

Nine Months Ended

June 30,

2018

2017

2018

2017

Hydra Management LLC

Selling, general and administrative expenses

(17

)

(54

)

(117

)

(108

)

We incurred certain offering expenses in connection with an underwritten public offering of shares principally held by our largest stockholder, Landgame S.à.r.l, which closed in January 2018 as to which our expenses were reimbursed by the selling stockholders. For the three and nine months ended June 30, 2018, the aggregate amount invoiced for reimbursement was $20 and $670, respectively.

We paid consulting fees to an entity owned by Jim O’Halleran, who was a director of Inspired prior to the Business Combination. For the three and nine months ended June 30, 2017, the fees totaled $11 and $304, respectively. The agreement terminated in November 2017.

An affiliate of Landgame S.à.r.l has had an ownership interest in one of our customers. For the three and nine months ended June 30, 2017, we received contract revenues totaling $404 and $1,201, respectively. We also had an accounts receivable balance with respect to such customer in the amount of $633 as of September 30, 2017, which was no longer outstanding as of June 30, 2018.

19.

Commitments and Contingencies

Legal Matters

From time to time, the Company may become involved in lawsuits and legal matters arising in the ordinary course of business. While the Company believes that, currently, it has no such matters that are material, there can be no assurance that existing or new matters arising in the ordinary course of business will not have a material adverse effect on the Company’s business, financial condition or results of operations.

20.

Pension Plan

We operate a scheme which is comprised of a separately managed defined benefit section and a defined contribution section. The defined benefit section is closed to future accruals for services rendered to the Company. We estimate that $3,318 will be contributed to the pension plan during the year ending September 30, 2018.

The total amount of employer contributions paid during the nine months ended June 30, 2018 amounted to $2,559. We expect to contribute $759 during the remaining part of the fiscal period.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

For the nine months ended June 30, 2018 and 2017, the components of total periodic benefit costs were as follows:

	Nine Months Ended
	June 30,
	2018			2017
Components of net periodic (benefit)/cost:
Service cost	$	—		$	—
Interest cost		2,217			2,463
Expected return on plan assets		(2,800	)		(2,301	)
Net periodic (benefit)/cost	$	(583	)	$	162

21.

Segment Reporting and Geographic Information

The Company operates its business along two operating segments, which are segregated on the basis of revenue stream: Server Based Gaming and Virtual Sports. The Company believes this method of segment reporting reflects both the way its business segments are managed and the way the performance of each segment is evaluated.

The following tables present revenue, cost of sales, excluding depreciation and amortization, selling, general and administrative expenses, depreciation and amortization, stock-based compensation expense and acquisition related transaction expenses, operating profit/(loss), total assets and total capital expenditures for the three and nine months ended June 30, 2018, respectively, by business segment. Certain unallocated corporate function costs have not been allocated to the Company’s reportable operating segments because these costs are not allocable and to do so would not be practical. Corporate function costs consist primarily of selling, general and administrative expenses, depreciation and amortization, capital expenditures, cash, prepaid expenses and property and equipment and software development costs relating to corporate/shared functions.

Segment Information

Three Months Ended June 30, 2018

	Server Based Gaming			Virtual Sports			Corporate Functions			Total
Revenue:
Service	$	24,549		$	9,987		$	—		$	34,536
Hardware		2,390			—			—			2,390
Total revenue		26,939			9,987			—			36,926
Cost of sales, excluding depreciation and amortization:
Cost of service		(4,582	)		(1,280	)		—			(5,862	)
Cost of hardware		(2,085	)		—			—			(2,085	)
Selling, general and administrative expenses		(3,802	)		(1,784	)		(9,659	)		(15,245	)
Stock-based compensation expense		(65	)		(72	)		(1,348	)		(1,485	)
Acquisition related transaction expenses		—			—			(14	)		(14	)
Depreciation and amortization		(8,829	)		(1,456	)		(331	)		(10,616	)
Segment operating income (loss)		7,576			5,395			(11,352	)		1,619

Net operating gain										$	1,619

Total assets at June 30, 2018	$	117,022		$	72,163		$	17,453		$	206,638

Total goodwill at June 30, 2018	$	—		$	46,387		$	—		$	46,387
Total capital expenditures for the three months ended June 30, 2018	$	11,909		$	2,175		$	—		$	14,084

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

Three Months Ended June 30, 2017

	Server Based Gaming			Virtual Sports			Corporate Functions			Total
Revenue:
Service	$	17,834		$	9,004		$	—		$	26,838
Hardware		5,473			—			—			5,473
Total revenue		23,307			9,004			—			32,311
Cost of sales, excluding depreciation and amortization:
Cost of service		(3,119	)		(1,047	)		—			(4,166	)
Cost of hardware		(4,908	)		—			—			(4,908	)
Selling, general and administrative expenses		(3,912	)		(1,222	)		(8,652	)		(13,786	)
Stock-based compensation expense		(65	)		(79	)		(1,233	)		(1,377	)
Acquisition related transaction expenses		—			—			(74	)		(74	)
Depreciation and amortization		(6,622	)		(1,570	)		(513	)		(8,705	)
Segment operating income (loss)		4,681			5,086			(10,472	)		(705	)

Net operating loss										$	(705	)

Total assets at September 30, 2017	$	113,692		$	75,975		$	29,356		$	219,023

Total goodwill at September 30, 2017	$	—		$	47,076		$	—		$	47,076
Total capital expenditures for the three months ended June 30, 2017	$	7,558		$	2,016		$	415		$	9,989

Nine Months Ended June 30, 2018

	Server Based Gaming			Virtual Sports			Corporate Functions			Total
Revenue:
Service	$	69,931		$	28,205		$	—		$	98,136
Hardware		7,630			—			—			7,630
Total revenue		77,561			28,205			—			105,766
Cost of sales, excluding depreciation and amortization:
Cost of service		(13,333	)		(3,742	)		—			(17,075	)
Cost of hardware		(7,058	)		—			—			(7,058	)
Selling, general and administrative expenses		(11,789	)		(5,668	)		(29,784	)		(47,241	)
Stock-based compensation expense		(202	)		(238	)		(5,494	)		(5,934	)
Acquisition related transaction expenses		—			—			(816	)		(816	)
Depreciation and amortization		(25,165	)		(5,104	)		(1,027	)		(31,296	)
Segment operating income (loss)		20,014			13,453			(37,121	)		(3,654	)

Net operating loss										$	(3,654	)

Total capital expenditures for the nine months ended June 30, 2018	$	27,715		$	4,946		$	202		$	32,863

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

Nine Months Ended June 30, 2017

	Server Based Gaming			Virtual Sports			Corporate Functions			Total
Revenue:
Service	$	52,988		$	24,490		$	—		$	77,478
Hardware		9,930			—			—			9,930
Total revenue		62,918			24,490			—			87,408
Cost of sales, excluding depreciation and amortization:
Cost of service		(8,610	)		(2,536	)		—			(11,146	)
Cost of hardware		(8,520	)		—			—			(8,520	)
Selling, general and administrative expenses		(11,562	)		(4,472	)		(25,888	)		(41,922	)
Stock-based compensation expense		(129	)		(157	)		(2,417	)		(2,703	)
Acquisition related transaction expenses		—			—			(11,346	)		(11,346	)
Depreciation and amortization		(18,215	)		(4,193	)		(1,469	)		(23,877	)
Segment operating income (loss)		15,882			13,132			(41,120	)		(12,106	)

Net operating loss										$	(12,106	)

Total capital expenditures for the nine months ended June 30, 2017	$	19,479		$	5,258		$	2,159		$	26,896

Geographic Information

Geographic information for revenue is set forth below:

	Three Months Ended June 30,				Nine Months Ended June 30,
	2018		2017		2018		2017
Total revenue
UK	$	22,603	$	21,190	$	67,740	$	60,259
Italy		4,255		3,996		13,260		12,446
Greece		7,595		4,475		17,429		5,765
Rest of world		2,473		2,650		7,337		8,938
Total	$	36,926	$	32,311	$	105,766	$	87,408

Geographic information of our non-current assets excluding goodwill is set forth below:

	June 30, 2018		September 30, 2017
Total non-current assets excluding goodwill
UK	$	61,321	$	68,069
Italy		3,666		5,761
Greece		33,899		20,728
Rest of world		9,899		14,189
Total	$	108,785	$	108,747

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)

(Unaudited)

Software development costs are included as attributable to the market in which they are utilized.

22.

Customer Concentration

During the three months ended June 30, 2018, three customers represented at least 10% of revenues, accounting for 23%, 21% and 11% of the Company’s revenues. During the three months ended June 30, 2017, two customers represented at least 10% of revenues, accounting for 25% and 10% of the Company’s revenues. All these customers were served by both the Server Based Gaming and Virtual Sports segments.

During the nine months ended June 30, 2018, three customers represented at least 10% of revenues, accounting for 24%, 17% and 14% of the Company’s revenues. During the nine months ended June 30, 2017, two customers represented at least 10% of revenues, accounting for 27% and 11% of the Company’s revenues. All these customers were served by both the Server Based Gaming and Virtual Sports segments.

At June 30, 2018, two customers represented at least 10% of accounts receivable, accounting for 31% and 14% of the Company’s accounts receivable. At September 30, 2017, two customers accounted for 26% and 13% of the Company’s accounts receivable.

23.

Subsequent Events

The Company evaluates subsequent events and transactions that occur after the balance sheet date up to the date that the financial statements were issued. Other than as described below, the Company did not identify subsequent events that would have required adjustment or disclosure in the consolidated financial statements.

Refinancing of External Borrowings

After the quarter end, the Company and certain of its subsidiaries entered into a series of transactions that effected the refinancing of the group’s external borrowings, replacing the group’s senior term and revolving facilities, originally entered into in 2014, with senior notes of $140.0 million and a revolving credit facility of £7.5 million (equivalent to approximately $9.9 million). As described in further detail below, the senior notes have a 5-year duration and carry a cash interest rate of 9% plus 3-month LIBOR, and the revolving credit facility has a 3-year duration and carries a cash interest rate on any utilization at 4% plus 3-month LIBOR, with any unutilized amount carrying a 1.4% cash interest cost. In connection with the refinancing, the Company also entered into a three-year, fixed-rate, cross-currency swap, as described in further detail below.

Note Purchase Transaction

On August 13, 2018, Gaming Acquisitions Limited (“Gaming Acquisitions”), an indirect wholly owned subsidiary of the Company, certain subsidiaries of the Company (collectively, the “Subsidiary Guarantors” and together with Gaming Acquisitions and the Company, the “Credit Parties”) and the Company entered into a Note Purchase Agreement and Guaranty (the “Note Purchase Agreement”) to provide for the issuance and sale of promissory notes in the aggregate principal amount of $140,000,000, maturing in five years (the “Notes”), to the purchasers party thereto from time to time, including HG Vora Special Opportunities Master Fund, Ltd. (“HGV Fund”), with Cortland Capital Market Services LLC acting as note and collateral agent for the Purchasers (in such capacity, “Agent”).

The proceeds of the sale of the Notes will be used to, among other things, repay £98.5 million of obligations outstanding under the Company’s Senior Term and Revolving Facility Agreement dated March 18, 2014 (as amended and restated July 13, 2016), among certain subsidiaries of the Company, Ares Management Limited and Lloyds Bank PLC (the “Existing Credit Facility”). The Existing Credit Facility has been replaced in part by the Revolving Credit Facility described below.

The obligations under the Note Purchase Agreement are unconditionally guaranteed on a joint and several basis by each of the Company and the Subsidiary Guarantors party thereto and are secured on a first-priority basis (subject to certain exceptions) by a lien granted to the Agent for the benefit of the secured parties under the Note Purchase Agreement on substantially all of the assets of each Credit Party, including all of the capital stock held by such Credit Party. An intercreditor agreement will set forth the rights and obligations of the parties to the Note Purchase Agreement, the Revolving Credit Facility and the Nomura Swap described below, in and to the proceeds of the collateral securing the obligations under the Note Purchase Agreement, the Revolving Credit Facility and the Nomura Swap.

The Notes will be issued at 98% of the par value thereof. Interest on the Notes shall accrue on a daily basis and will bear an interest rate equal to, at the Credit Parties’ option, a base rate or LIBOR rate, plus an applicable margin, which for a base rate borrowing is 8% per annum and for a LIBOR borrowing is 9% per annum. The base rate is calculated based on the greatest of the prime rate, federal funds effective rate and LIBOR rate in effect on the date of calculation. Interest on the Notes is payable in cash (subject to extension in the case of the first interest payment due thereunder as provided in the Note Purchase Agreement) and at the maturity of the Notes in the case of any unpaid interest then outstanding.

Subject to certain conditions, voluntary prepayments are permitted under the Note Purchase Agreement.

Subject to certain exceptions, Gaming Acquisitions is required to make mandatory prepayments of the Notes in respect of amounts received on account of asset sales, insurance or condemnation proceeds and issuances of debt as well as amounts constituting excess cash flows. In the case of proceeds from asset sales and insurance or condemnation payments, so long as no event of default has occurred and to the extent such proceeds do not exceed $1,000,000, Gaming Acquisitions may invest such proceeds—directly or through one of its subsidiaries—in assets of the general type useful in the business of the Company and its subsidiaries. In the case of amounts constituting excess cash flow, Gaming Acquisitions is required to prepay an amount equal to 50% thereof, except that 25% thereof shall be required if the total leverage ratio is between 2.50:1.00 and 2.00:1.00 (in each case, minus voluntary repayments made during the applicable fiscal year), and no such prepayment shall be required if the total leverage ratio is 2.00:1.00 or less.

In the event the Notes are redeemed, repaid or prepaid (including as voluntary or mandatory prepayments described above), such repayments or prepayments shall be made together with a payment premium equal to 3.00% of the amount repaid or prepaid, except that such premium will not be payable in the case of mandatory prepayments made on account of insurance or condemnation proceeds or excess cash flows (and either no prepayment penalty or a reduced prepayment premium shall be payable in the case of prepayments made with the proceeds of certain VAT amounts). In the case of repayments of all or any portion of the Notes on or after the maturity date, such repayment will be made together with an exit premium equal to 3.00% of the amount so repaid.

The Note Purchase Agreement contains customary representations and warranties and affirmative covenants applicable to Gaming Acquisitions, the Company and the subsidiaries of the Company and also contains certain restrictive covenants, including, among others, limitations on: the incurrence of additional debt; provided, however, that Gaming Acquisitions is permitted to incur indebtedness under the Revolving Credit Facility (in an aggregate principal amount not to exceed £7,500,000), liens on property (except those securing the Revolving Credit Facility or certain hedging indebtedness), acquisitions and investments, loans and guarantees, mergers, consolidations, liquidations and dissolutions, asset sales, dividends and other payments in respect of the Company’s capital stock, prepayments of certain debt, transactions with affiliates and modifications of the Credit Parties’ organizational documents and certain debt agreements. The Note Purchase Agreement requires quarterly compliance with maximum leverage and fixed charge coverage ratios as well as a minimum liquidity covenant. The agreement also includes customary event of default provisions.

On or before the date of the first interest payment due and payable by Gaming Acquisitions in respect of the Notes, the Notes shall be listed on the International Stock Exchange of the Channel Islands and shall remain listed until the repayment of the Notes in full in accordance with the terms of the Note Purchase Agreement.

HGV Fund currently holds 100% of the Notes. As disclosed in stock ownership filings with the Securities and Exchange Commission pursuant to Section 16 under the Securities Act of 1934, HGV Fund owns approximately 17.5% of the Company’s outstanding common stock as well as warrants to purchase shares of the Company’s common stock. HGV Fund is also a stockholder and investor in Leisure Acquisition Corp., a special purpose acquisition company affiliated with two members of the Company’s management.

Revolving Credit Facility

Concurrently with the issuance of the Notes and repayment of the Existing Credit Facility, Gaming Acquisitions, the Company and the Subsidiary Guarantors entered into a Revolving Credit Facility Agreement (the “Revolving Credit Facility Agreement”) to provide for a £7,500,000 revolving facility from Lloyds Bank PLC (the “Revolving Facility Lender”) to be used for general corporate, working capital and capital expenditure purposes of the Company and its subsidiaries (the “Revolving Credit Facility”), with the Agent acting as security agent for the Revolving Facility Lender (in such capacity, the “RCF Security Agent”).

The obligations under the Revolving Credit Facility are guaranteed on a joint and several basis by each of Gaming Acquisitions, the Company and certain Subsidiary Guarantors party thereto and are secured on a first-priority basis (subject to certain exceptions) by a lien granted to the RCF Security Agent for the benefit of the Revolving Facility Lender on substantially all of the assets of each Credit Party, including all of the capital stock held by such Credit Party. Certain Subsidiary Guarantors will accede to the Revolving Credit Facility Agreement within 30 days of closing.

The Revolving Credit Facility requires cash interest payments on outstanding borrowings equal to a margin of 4.00% per annum, plus LIBOR, on the last day of each applicable interest period. In addition, a commitment fee is payable every three months with respect to unutilized lending commitments thereunder at a rate of 35% of the margin applicable to such unutilized commitments per annum. The Revolving Credit Facility is scheduled to mature on August 13, 2021. Subject to certain conditions, voluntary prepayments are permitted under the Revolving Credit Facility and mandatory prepayments are required in the event of a change of control and/or the sale of all or substantially all assets of the Credit Parties.

The Revolving Credit Facility contains customary representations and warranties and affirmative covenants applicable to Gaming Acquisitions, the Company and the Company’s subsidiaries and also contains certain restrictive covenants, including, among others, limitations on: the incurrence of additional debt, liens on property, acquisitions and investments, loans and guarantees, mergers, consolidations, liquidations and dissolutions, asset sales, dividends and other payments in respect of the Company’s capital stock, prepayments of certain debt, transactions with affiliates and modifications of the Credit Parties’ organizational documents and certain debt agreements. The Revolving Credit Facility requires quarterly compliance with maximum leverage and interest coverage ratios as well as a minimum liquidity covenant. The agreement also contains customary event of default provisions.

Hedging Transaction

In connection with the Note Purchase Agreement Gaming Acquisitions entered into a three (3) year, fixed-rate, cross-currency swap which swaps the principal and interest payments that will be payable in US Dollars (USD) under the Note Purchase Agreement to Euros (EUR), in part, and Pounds Sterling (GBP), in part. The swap is provided by Nomura (the “Nomura Swap”). Specifically, with respect to the principal payments under the Note Purchase Agreement, Gaming Acquisitions will swap 1/3rd of such principal payments from USD to EUR and 2/3rds of such principal payments from USD to GBP. Additionally, with respect to the interest payments under the Note Purchase Agreement, Gaming Acquisitions will swap 1/3rd of such interest payments from USD to GBP and 2/3rds of such interest payments from USD to EUR. The Nomura Swap provides for a foreign exchange rate of $1.13935 USD per €1 EUR and $1.27565 USD per £1 GPB.

The obligations under the Nomura Swap are unconditionally guaranteed on a joint and several basis by each of Gaming Acquisitions, the Company and Subsidiary Guarantors and are secured on a first-priority basis (subject to certain exceptions) by a lien granted to the Agent for the benefit of Nomura on substantially all of the assets of each Credit Party, including all of the capital stock held by such Credit Party.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes thereto contained elsewhere in this document.

Forward-Looking Statements

We make forward-looking statements in this Quarterly Report on Form 10-Q. These forward-looking statements relate to expectations for future financial performance, business strategies or expectations for our business, and the timing and ability for us to complete future acquisitions. Specifically, forward-looking statements may include statements relating to:

	●	the future financial performance of the Company;

	●	the market for the Company’s products and services;

	●	expansion plans and opportunities, including future acquisitions or additional business combinations; and

	●	other statements preceded by, followed by or that include words such as “anticipate”, “believe”, “can”, “continue”, “could”, “estimate”, “expect”, “forecast”, “intend”, “may”, “might”, “plan”, “possible”, “potential”, “predict”, “project”, “scheduled”, “seek”, “should”, “target”, “would” or similar expressions, among others.

These forward-looking statements are based on information available as of the date hereof, and current expectations, forecasts and assumptions that involve a number of judgments, risks and uncertainties. Accordingly, forward-looking statements should not be relied upon as representing our views as of any subsequent date, and we do not undertake any obligation to update forward-looking statements to reflect events or circumstances after the date they were made, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. As a result of a number of known and unknown risks and uncertainties, our actual results or performance may be materially different from those expressed or implied by these forward-looking statements. Some factors that could cause our actual results or performance to differ include:

●

our ability to compete effectively in our industries;

●

the effect of evolving technology on our business;

●

our ability to renew long-term contracts and retain customers, and secure new contracts and customers;

●

our ability to maintain relationships with suppliers;

●

our ability to protect our intellectual property;

●

government regulation of our industries;

●

the determination by the UK Government, announced in May 2018, to substantially reduce maximum permitted bets on B2 gaming machines in the UK;

●

our ability to successfully grow by acquisition as well as organically;

●

our ability to attract and retain key members of our management team;

●

our need for working capital;

●

our ability to secure capital for growth and expansion;

●

changing consumer, technology and other trends in our industries;

●

our ability to successfully operate across multiple jurisdictions and markets around the world;

●

changes in local, regional and global economic and political conditions; and

●

other factors.

Overview

Inspired Entertainment, Inc. (the “Company,” the “Group,” “we,” “our,” and “us”) is a global business-to-business gaming technology company, supplying Virtual Sports, Mobile and Server Based Gaming (“SBG”) systems to regulated lottery, betting and gaming operators worldwide. We provide end-to-end digital gaming solutions on our proprietary and secure network, which accommodates a wide range of devices, including land-based gaming machine terminals, mobile devices such as smartphones and tablets and online computer applications.

Our key strategic priorities are to:

	●	Extend our strong positions in each of Virtual Sports and SBG by developing new omni-channel products;

	●	Continue to invest in games and technology in order to grow our existing customers’ revenues;

	●	Add new customers by expanding into underpenetrated markets and newly-regulated jurisdictions; and

	●	Pursue targeted mergers and acquisitions to expand our product portfolio and distribution footprint.

On December 23, 2016, the business combination that created the current Inspired Entertainment, Inc. was consummated (the “Business Combination” or the “Merger”). In connection with the Merger, the Company changed its name from Hydra Industries Acquisition Corp. to Inspired Entertainment, Inc., and changed its fiscal-year end to September 30.

Business Segments

We report our operations in two business segments, Virtual Sports and SBG, representing our different products and services. We evaluate our business performance, resource allocation and capital spending on an operating segment level, where possible. We use our operating results and identified assets of each of our operating segments in order to make prospective operating decisions. Although our revenues and cost of sales (excluding depreciation and amortization) are reported exclusively by segment, we do include unallocated items in our consolidated financial statements for certain expenses including depreciation and amortization as well as selling, general and administrative expenses. Unallocated balance sheet line items include items that are a shared resource and therefore not allocated between operating segments.

Our Virtual Sports business segment designs, develops, markets and distributes ultra-high-definition games that create an always-on sports wagering experience. Our Virtual Sports customers include virtual sports retail and digital operators, including regulated betting operators, lotteries, casinos, online operators and other gaming and lottery operators in the UK, continental Europe, Asia, Africa and North America.

Our SBG business segment designs, develops, markets and distributes a broad portfolio of games through our digital network architecture. Our SBG customers include UK licensed betting offices (“LBOs”), casinos, gaming hall operators, bingo operators and regulated operators of lotteries, as well as government-affiliated operators.

Geographic Range

Geographically, more than half of our revenues are derived from, and more than half of our non-current assets are attributed to, our UK operations, with the remainder of our revenues derived from, and non-current assets attributed to, Italy, Greece and the rest of the world.

For the three months ended June 30, 2018, we earned approximately 61.2% of our revenue in the UK, 20.6% in Greece, 11.5% in Italy and the remaining 6.7% across the rest of the world. During the three months ended June 30, 2017, the percentages were 65.6%, 13.8%, 12.4% and 8.2%, respectively. For the nine months ended June 30, 2018, we earned approximately 64.0% of our revenue in the UK, 16.5% in Greece, 12.5% in Italy and the remaining 6.9% across the rest of the world. During the nine months ended June 30, 2017, the percentages were 68.9%, 6.6%, 14.2% and 10.3%, respectively.

Foreign Exchange

Our results are affected by changes in foreign currency exchange rates as a result of the translation of foreign functional currencies into our reporting currency and the re-measurement of foreign currency transactions and balances. The impact of foreign currency exchange rate fluctuations represents the difference between current rates and prior-period rates applied to current activity. The largest geographic region in which we operate is the United Kingdom, and the British pound (“GBP”) is considered to be our functional currency. Our reporting currency is the U.S. dollar (“USD”). Our results are translated from our functional currency of GBP into the reporting currency of USD using average rates for profit and loss transactions and applicable spot rates for period-end balances. The effect of translating our functional currency into our reporting currency, as well as translating the results of foreign subsidiaries that have a different functional currency into our functional currency, is reported separately in Accumulated Other Comprehensive Income.

During the three months ended June 30, 2018, we derived approximately 38.8% of our revenue from sales to customers outside of the UK, compared to 34.4% during the three months ended June 30, 2017. During the nine months ended June 30, 2018, we derived approximately 36.0% of our revenue from sales to customers outside of the UK compared to 31.1% during the nine months ended June 30, 2017.

In the section “Results of Operations” below, currency impacts shown have been calculated as the current-period average GBP: USD rate less the equivalent average rate in the prior period, multiplied by the current period amount in our functional currency (GBP). The remaining difference, referred to as constant currency, is calculated as the difference in our functional currency, multiplied by the prior-period average GBP: USD rate, as a proxy for constant currency movement. This is not a U.S. GAAP measure, but is one which management believes gives a clearer indication of results. In the tables below, variances in particular line items from period to period exclude currency translation movements, and currency translation impacts are shown independently.

Non-GAAP Financial Measures

We use certain financial measures that are not compliant with U.S. GAAP (“non-GAAP financial measures”), including EBITDA and Adjusted EBITDA, to analyze our operating performance. In this discussion and analysis, we present certain non-GAAP financial measures, define and explain these measures and provide reconciliations to the most comparable U.S. GAAP measures. See “Non-GAAP Financial Measures” later in this Item 2.

Refinancing of External Borrowings

After the quarter end, we refinanced our external borrowings. For further information, see “—Refinancing of External Borrowings”, below.

Results of Operations

The discussion and analysis of our results of operations have been organized in the following manner:

	●	a discussion and analysis of the Company’s results of operations for the three-month period ended June 30, 2018, compared to the same period in 2017;

	●	a discussion and analysis of the results of operations of our SBG and Virtual Sports business segments for the three-month period ended June 30, 2018, compared to the same period in 2017, including Key Performance Indicator (“KPI”) analysis;

	●	a discussion and analysis of the Company’s results of operations for the nine-month period ended June 30, 2018, compared to the same period in 2017; and

	●	a discussion and analysis of the results of operations of our SBG and Virtual Sports business segments for the nine-month period ended June 30, 2018, compared to the same period in 2017, including KPI analysis.

The three-month financial periods presented consist of a 91-day period for 2018 and 2017. The balance sheet date of each fiscal period is June 30. Each of the foregoing periods is herein referred to as a “three-month period.”

The nine-month financial periods presented consist of a 273-day period for 2018 and a 279-day period for 2017. The balance sheet date of each fiscal period is June 30. Each of the foregoing periods is herein referred to as a “nine-month period.”

Our results are affected by changes in foreign currency exchange rates, primarily between our functional currency (GBP) and our reporting currency (USD). In the three-month periods ended June 30, 2018 and 2017, the average USD: GBP rate was 1.36 and 1.28, respectively. In the nine-month periods ended June 30, 2018 and 2017, the average USD: GBP rate was 1.37 and 1.26, respectively.

In the tables below, the “Days Movement” column represents values relating to the additional six days in the 2017 “nine-month period” as compared to the 2018 “nine-month period”. The “Days Movement” column allows for the comparisons shown in the additional “Like-for-Like Variance” columns. Such columns are not presented for the three months periods, as such periods in both years were 91 days. For line items in respect of which daily information was available for the additional days in 2017, specific adjustments were made. For line items in respect of which no such information was available, a straight-line method was used to provide pro-rated values. For certain line items, such as Stock-based compensation and Change in fair value of earnout liability, there were no values relating to the additional days in 2017.

In the discussion and analysis below, certain data may vary from the amounts presented in our consolidated financial statements due to rounding.

Results of Operations –

Three Months ended June 30, 2018 compared to Three Months ended June 30, 2017

	For the Three-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Variance					Variance
(In thousands)	2018			2017			2018 vs 2017					Constant Currency					Currency Movement

Revenue:
Service	$	34,536		$	26,838		$	7,698		28.7	%	$	5,758		21.5	%	$	1,941
Hardware		2,390			5,473			(3,083	)	(56.3	%)		(3,217	)	(58.8	%)		134
Total revenue		36,926			32,311			4,615		14.3	%		2,540		7.9	%		2,075
Cost of sales, excluding depreciation and amortization:
Cost of service		(5,862	)		(4,166	)		(1,696	)	40.7	%		(1,363	)	32.7	%		(333	)
Cost of hardware		(2,085	)		(4,908	)		2,823		(57.5	)%		2,939		(59.9	)%		(117	)
Selling, general and administrative expenses		(15,245	)		(13,786	)		(1,459	)	10.6	%		(588	)	4.3	%		(871	)
Stock-based compensation		(1,485	)		(1,377	)		(108	)	7.8	%		(22	)	1.6	%		(86	)
Acquisition related transaction expenses		(14	)		(74	)		60		(81.1	)%		61		(82.8	)%		(1	)
Depreciation and amortization		(10,616	)		(8,705	)		(1,911	)	22.0	%		(1,300	)	14.9	%		(611	)
Net operating Income (Loss)		1,619			(705	)		2,324		329.6	%		2,268		321.6	%		56
Other income (expense)
Interest income		36			8			28		346.6	%		26		321.1	%		2
Interest expense		(5,185	)		(5,013	)		(172	)	3.4	%		125		(2.5	)%		(297	)
Change in fair value of earnout liability		(644	)		(2,384	)		1,740		(73.0	)%		1,751		(73.4	)%		(11	)
Change in fair value of derivative liability		0			(270	)		270		(100.0	)%		270		(100.0	)%		0
Other finance income (costs)		194			(55	)		248		(453.1	)%		237		(432.8	)%		11
Total other income (expense), net		(5,599	)		(7,714	)		2,114		27.4	%		2,409		31.2	%		(294	)
Net loss from continuing operations before income taxes		(3,980	)		(8,419	)		4,438		(52.7	)%		4,676		(55.5	)%		(238	)
Income tax expense		(39	)		86			(125	)	(145.6	)%		(123	)	(143.1	)%		(2	)

Net loss	$	(4,019	)	$	(8,333	)	$	4,314		51.8	%	$	4,554		54.6	%	$	(240	)

Exchange Rate - $ to £		1.36			1.28

Revenue

Total revenue for the quarter ended June 30, 2018 increased by $4.6 million, or 14.3%, from the quarter ended June 30, 2017, to $36.9 million, on a reported basis. Favorable currency movements accounted for $2.1 million of the increase, with constant currency revenue increasing by $2.5 million, or 7.9%.

SBG revenue, which is included in total revenue above, increased by $2.1 million on a constant currency basis, or 9.2%, comprised of growth in service revenue of $5.4 million, partly offset by lower hardware sales of $3.2 million.

SBG service revenue increased by $5.4 million on a constant currency basis, or 30.0%, as a result of the continued rollout of terminals in Greece driving a $1.9 million increase and software license sales of $3.4 million into the Greek market.

Hardware revenue decrease was driven by lower hardware sales in the Greek and the Electronic Table Gaming (“ETG”) markets of $2.8 million and $0.3 million, respectively. The hardware sales in Greece were nil margin sales.

Virtual Sports revenue increased by $0.4 million on a constant currency basis, or 4.5%, driven by new customer revenue from our mobile remote game server (“Mobile RGS”) product and continued growth in Greece, Finland and Poland. Growth was negatively affected by $0.6 million due to a reduction in revenue from long-term Virtual Sports licenses that have now come to an end. Underlying Virtual Sports revenue increased by $1.0 million, or 12.8%. Of which $0.6 million came from Virtual Sports land-based and online customers and $0.4 million from Mobile RGS.

Cost of sales, excluding depreciation and amortization

Cost of sales, excluding depreciation and amortization, which includes machine cost of sales, consumables, content royalties and connectivity costs, decreased from the period ended June 30, 2017 by $1.1 million, or 12.4%, on a reported basis, to $7.9 million. Of this decrease, $0.5 million arose from adverse currency movements. On a constant currency basis, cost of sales decreased by $1.6 million, or 17.4%.

Cost of service increased by $1.4 million, or 32.7%, on a constant currency basis due to an increase in Greece SBG service costs of $1.1 million, driven by the continued terminal rollout, and $0.1 million from additional costs to service UK SBG terminals. $0.2 million of the increase was due to the additional cost of supporting new recurring contracts for Virtual Sports.

Cost of hardware decreased by $2.9 million, or 59.9%, on a constant currency basis due to lower nil margin hardware sales in Greece. Hardware sales are made at nil margin in certain circumstances to secure long-term revenue share contracts.

Selling, general and administrative expenses

Selling, general, and administrative (“SG&A”) expenses include staff compensation costs (including outsourced costs), travel, professional services fees and technology expenses (including hosting fees, data centers and similar charges).

SG&A expenses increased by $1.5 million, or 10.6%, on a reported basis, to $15.2 million. Of this increase, $0.9 million arose from adverse currency movements. On a constant currency basis, SG&A expenses increased by $0.6 million, or 4.3%. $1.5 million of this adverse variance was due to restructuring costs relating to the senior management changes announced in May (which amount has been excluded from our Adjusted EBITDA calculations set forth elsewhere in this Item 2). This was partly offset by $0.9 million of staff-related cost savings.

Stock-based compensation

We have two stock-based compensation plans pursuant to which we issue awards of restricted stock units, stock options and other equity awards: the 2016 Long-Term Incentive Plan, which was approved by stockholders in December 2016 (the “First Incentive Plan”), and the Second Long-Term Incentive Plan, which was approved by stockholders in March 2018 (the “Second Incentive Plan”).

The aggregate number of shares authorized for issuance under these plans is 4,078,818 and, as of June 30, 2018, there were 2,383,280 shares subject to outstanding awards and 1,133,207 shares remaining available for future awards. A total of 562,331 shares have been settled (either issued in settlement of vested awards or surrendered to pay for taxes due on settlement of vested awards). Awards are fair-valued at the time of issuance, with the value being spread over the vesting period. During the 2018 period, the Company recorded an expense of $1.5 million in respect of outstanding awards, which was $0.1 million higher than the prior year charge for stock-based compensation due to additional awards being made.

Depreciation and amortization

Depreciation and amortization increased by $1.9 million, or 22.0%, to $10.6 million, on a reported basis. Of this increase, $0.6 million arose from adverse currency movements.

On a constant currency basis, depreciation and amortization increased by $1.3 million, or 14.9%. This increase was driven by additional amortization in connection with new platforms and games going live on SBG ($0.6 million) and an increase of $0.4 million due to machine and machine related depreciation, comprised of a $0.5 million increase from the continued roll out of machines in Greece, partly offset by a $0.1 million decrease from the sale of machines in Colombia.

Net operating income (loss)

On a reported basis, net operating profit (loss) improved from a loss of $0.7 million in the 2017 period to a profit of $1.6 million in the 2018 period, of which $0.1 million arose from favorable currency movements. On a constant currency basis, net operating income (loss) improved by $2.3 million, due to an increase in revenue and a decrease in cost of sales. This was partly offset by an increase in depreciation and amortization and SG&A.

Interest expense

Interest expense increased by $0.1 million, or 2.9%, in the quarter ended June 30, 2018, to $5.1 million, on a reported basis. This variance arose from adverse currency movements of $0.3 million. On a constant currency basis, interest expense decreased by $0.2 million from the quarter ended June 30, 2017. There were higher cash and PIK charges on the existing senior debt due to continued compounding of the PIK interest charge of $0.4 million which was largely offset due to no amortization of debt fees in the current year ($0.3 million in the corresponding quarter of the prior year). These fees had been fully amortized by the end of September 2017.

Change in fair value of earnout liability

Change in fair value of earnout liability relates to the potential earnout payment that may be made to the former owners of DMWSL 633 Limited, the amount of which is dependent upon the financial performance of Inspired’s businesses in six specific countries (China, Colombia, Greece, Norway, Spain and Ukraine) (collectively, the “Earnout Jurisdictions”), as measured by earnings before interest, taxes, depreciation and amortization for the twelve months ending September 30, 2018 (the “Earnout Period”). As a result of changes in expectations relating to the Earnout Jurisdictions, and share-price movements ($6.25 at June 30, 2018 and $5.50 at March 31, 2018), the charge that accrued in the current quarter resulting from a change in fair value of earnout liability was $0.6 million. In the corresponding quarter in the prior year, the corresponding figure was a charge of $2.4 million.

Change in fair value of derivative liability

Change in fair value of derivative liability decreased by $0.3 million to $0 on a reported basis as a result of the approval of the Second Incentive Plan in March 2018, which resulted in awards granted thereunder being charged as stock-based compensation rather than as a derivative liability.

Net loss

On a reported basis, net loss improved from a loss of $8.3 million to a loss of $4.0 million. This was affected by a $0.2 million adverse currency movement. On a constant currency basis, net loss improved by $4.6 million due to an increase in revenue, a decrease in cost of sales and the change in fair value liabilities, partly offset by an increase in depreciation and amortization and SG&A.

Results of Operations –

Three Months ended June 30, 2018 compared to Three Months ended June 30, 2017 –

Server Based Gaming Segment

We generate revenue from our SBG business segment through product sales (both hardware and software) and long-term participation agreements, which include access to our SBG platform and the selection of game titles, usually over a term of between three and five years but longer in certain territories. Our participation contracts are typically structured to pay us a percentage of net win (defined as net revenue to our operator customers, after deducting player winnings, free bets or plays and any relevant regulatory levies) from SBG terminals placed in our customers’ facilities, which include retail outlets, casinos and other gaming operations, or from SBG gaming software used by customers’ players through mobile or online devices. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract.

Revenue growth for our SBG business is principally driven by the number of operator customers we have, the number of SBG machines in operation, the net win performance of the machines and the net win percentage that we receive pursuant to our contracts with our customers.

SBG segment, Key Performance Indicators

	For the Three-Month Period ended						Variance
	Unaudited June 30,			Unaudited June 30,			2018 vs 2017
SBG	2018			2017						%

End of period installed base (# of terminals)		32,579			28,011			4,568			16.3	%
Average installed base (# of terminals)		32,107			27,569			4,538			16.5	%
Customer Gross Win per unit per day ⁽¹⁾	£	112.07		£	118.13		£	(6.05	)		(5.1	)%
Customer Net Win per unit per day ⁽¹⁾	£	79.97		£	85.13		£	(5.15	)		(6.1	)%
Inspired Blended Participation Rate		6.0	%		6.0	%		(0.0	)%

⁽¹⁾Includes all SBG terminals in which the company takes a participation revenue share across all territories.

In the table above:

“End of Period Installed Base” is equal to the number of deployed SBG terminals at the end of each period that have been placed on a participation basis. SBG participation revenue, which comprises the majority of SBG service revenue, is directly related to the terminal installed base. This is the medium by which customers generate revenue and distribute a revenue share to the Company. To the extent all other KPIs remain constant, the larger the installed base, the higher the Company’s revenue will be for that period. Management gives careful consideration to this KPI in terms of driving growth across the segment.

Revenues are derived from the performance of the installed base as described by the Gross and Net Win KPIs.

If the End of Period Installed Base is materially different from the Average Installed Base (described below), we believe this gives an indication as to potential future performance. The End of Period Installed Base is particularly useful for assessing new customers or markets, to indicate the progress being made with respect to entering new territories or jurisdictions.

“Average Installed Base” is the average number of deployed SBG terminals during the period. Therefore, it is more closely aligned to revenue in the period. This measure is particularly useful for assessing existing customers or markets to provide comparisons of historical size and performance.

Customer Gross Win (defined as stake less amounts returned to player in prize, less free bets or plays, before gaming tax deductions) per unit per day is a KPI used by our internal decision makers to (i) assess impact on the Company’s revenue, (ii) determine changes in the strength of the overall market and (iii) evaluate the impacts of regulatory change and our new content releases on our customers. Customer Gross Win per unit per day is the average per unit cash generated across all SBG terminals in which the Company takes a participation revenue share across all territories in the period, defined as the difference between the amounts staked less winnings to players divided by the Average Installed Base in the period, then divided by the number of days in the period.

SBG revenue share income accrued in the period is derived from Customer Gross Win accrued in the period after deducting gaming taxes (defined as a regulatory levy paid by the Customer to government bodies) and applying the Company’s contractual revenue share percentage.

Our internal decision makers believe Customer Gross Win measures are meaningful because they represent a view of customer operating performance that is unaffected by our revenue share percentage and allow management to (1) readily view operating trends, (2) perform analytical comparisons and benchmarking between customers and (3) identify strategies to improve operating performance in the different markets in which we operate.

“Customer Net Win per unit per day” is Customer Gross Win per unit per day after giving effect to the deduction of gaming taxes.

“Inspired Blended Participation Rate” is the Company’s average revenue share percentage across all terminals where revenue is earned on a participation basis, weighted by Customer Net Win per unit per day.

Our overall SBG revenue from terminals placed on a participation basis can therefore be described as the product of the Average Installed Base, the Customer Net Win per unit per day, the number of days in the period, and the Inspired Blended Participation Rate, to give “participation revenue”.

SBG segment, key events that affected results for the Three Months ended June 30, 2018

Our SBG rollout into the Greek market continued, with approximately 4,800 terminals installed as of June 30, 2018. During the period a further 965 terminals were contracted, which form part of our phase two rollout plan to be delivered across calendar year 2018. The performance of our Greek terminals continues to be strong compared to other suppliers during the period.

In the Italian market, a contract extension was agreed for a further four years with our largest customer. The contract included continuing hardware, platform and games supply. The contract also included an increased revenue share due to the Company. Customer Gross Win per unit per day (in EUR) in the Italian market increased by 21.9%, due to new content releases and improved account management.

During the period, another of our major UK LBO customers contracted with us for a further two and a half years. The contract extension includes the redeployment of 120 “Eclipse” terminals during July and October 2018. This extended supplier agreement also comes with no further capital expenditure.

Overall, the size of our Average Installed Base increased 16.5%, to 32,107, due to our continued terminal rollout in Greece and growth from new contracts in the UK LBO estate. Customer Gross Win per unit per day (in our functional currency, GBP) decreased by 5.1% across the entire estate, driven by the impact of our SBG installations in Greece, as our Greek machines return a lower daily Customer Gross Win compared to our UK machines, partly offset by the increase in the Italian market Customer Gross Win per unit per day. Our blended participation rate remained at 6.0%.

SBG segment, Three Months ended June 30, 2018 compared to Three Months ended June 30, 2017

Server Based Gaming	For the Three-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Variance					Variance
(In thousands)	2018			2017			2018 vs 2017					Constant Currency					Currency Movement

Revenue:
Service	$	24,549		$	17,834		$	6,715		37.7	%	$	5,351		30.0	%	$	1,364
Hardware		2,390			5,473			(3,083	)	(56.3	)%		(3,217	)	(58.8	)%		134
Total revenue		26,939			23,307			3,632		15.6	%		2,134		9.2	%		1,498

Cost of sales, excluding depreciation and amortization:
Cost of service		(4,582	)		(3,119	)		(1,463	)	46.9	%		(1,202	)	38.5	%		(261	)
Cost of hardware		(2,085	)		(4,908	)		2,823		(57.5	)%		2,939		(59.9	)%		(117	)
Total cost of sales		(6,667	)		(8,027	)		1,360		(16.9	)%		1,737		21.6	%		(378	)

Selling, general and administrative expenses		(3,802	)		(3,912	)		110		(2.8	)%		329		(8.4	)%		(219	)

Stock-based compensation		(65	)		(65	)		-		0.0	%		4		(5.8	)%		(4	)

Depreciation and amortization		(8,829	)		(6,622	)		(2,207	)	33.3	%		(1,698	)	25.6	%		(509	)

Net operating profit	$	7,576		$	4,681		$	2,895		61.8	%	$	2,507		53.5	%	$	388

Exchange Rate - $ to £		1.36			1.28

SBG segment revenue. In the period ended June 30, 2018, SBG revenue increased $3.6 million, to $26.9 million, on a reported basis. Of this increase, $1.5 million arose from favorable currency movements. On a constant currency basis, SBG revenue increased by $2.1 million, or 9.2%.

SBG service revenue increased by $6.7 million, or 37.7%, on a reported basis. Of this increase, $1.4 million arose from favorable currency movements. On a constant currency basis, SBG service revenue increased by $5.4 million, or 30.0%, to $24.5 million, primarily due to the continued rollout of terminals into Greece. This rollout drove additional participation revenue of $1.8 million and other recurring revenue of $0.2 million. In addition, during the quarter we completed a software license sale into the Greek market, generating revenue of $3.4 million. SBG service revenue increased on a constant currency basis in the Greek and Italian markets by $5.3 million and $0.2 million, respectively, due to the continued rollout in Greece and growth in Italy. This was partly offset by a decrease in service revenue in other jurisdictions by $0.2 million, due to the revised terms in Colombia following the sale of machines in 2017.

UK LBO Customer Gross Win per unit per day declined by 0.6%. These decreases were offset by an increase in average live terminals of 988, resulting in UK LBO service revenue in line with the prior period.

SBG hardware revenue decreased by $3.1 million to $2.4 million, on a reported basis, including favorable currency movements of $0.1 million. On a constant currency basis, SBG hardware revenue decreased by $3.2 million, principally due to lower hardware sales in the Greek (nil margin), ETG and Colombian markets of $2.8 million, $0.3 million and $0.1 million, respectively.

SBG segment operating profit. In the 2018 period, SBG operating profit increased by $2.9 million to $7.6 million, on a reported basis, $0.4 million of which arose from favorable currency movements. On a constant currency basis, SBG operating profit increased by $2.5 million.

SBG cost of sales (excluding depreciation and amortization) decreased by $1.4 million to $6.7 million, on a reported basis, $0.4 million of which arose from adverse currency movements. On a constant currency basis, cost of sales decreased by $1.7 million. This was principally due to a decrease in hardware costs of $2.9 million due to lower hardware sales in the Greek, ETG and Colombian markets. This was partly offset by an increase in service costs of $1.2 million due to Greek SBG service costs of $1.1 million and additional UK machine consumable costs of $0.1 million.

SBG SG&A expenses decreased by $0.1 million to $3.8 million, on a reported basis. $0.2 million arose from adverse currency movements, which resulted in a constant currency decrease of $0.3 million.

SBG depreciation and amortization increased by $2.2 million to $8.8 million on a reported basis. Of this amount, $0.5 million arose from adverse currency movements. On a constant currency basis, the increase was $1.7 million, driven by a $0.6 million increase in intangible amortization due to new projects going live in the UK and new international markets. There was also an increase in machine and machine related depreciation of $0.4 million driven by the continued terminal rollout in the Greek market.

SBG segment, Service Revenue by Region

Set forth below is a breakdown of our SBG service revenue by geographic region. SBG service revenue consists principally of SBG participation revenue.

Server Based Gaming Service Revenue by Region	For the Three-Month Period ended
	Unaudited June 30,		Unaudited June 30,		Variance					Variance
(In thousands)	2018		2017		2018 vs 2017					Constant Currency					Currency Movement

Service Revenue:
UK LBO	$	14,635	$	13,712	$	924		6.7	%	$	68		0.5	%	$	855
UK Other		1,373		1,374		(1	)	(0.1	)%		(81	)	(5.9	)%		80
Italy		2,252		1,869		383		20.5	%		252		13.5	%		130
Greece		6,021		439		5,581		1,270.0	%		5,299		1,205.6	%		283
Rest of the World		267		439		(172	)	(39.1	)%		(186	)	(42.4	)%		15

Total service revenue	$	24,549	$	17,834	$	6,715		37.7	%	$	5,351		30.0	%	$	1,364

Exchange Rate - $ to £		1.36		1.28

Results of Operations –

Three Months ended June 30, 2018 compared to Three Months ended June 30, 2017 –

Virtual Sports Segment

Our Virtual Sports products create a form of simulated sports betting in both a streaming and on-demand environment, overcoming the relative infrequency of live sporting events on which players can wager. We generate revenue from our Virtual Sports segment by licensing to our operator customers the software related to our Virtual Sports products, which consists of a complex graphics and networking software package that provides fixed-odds wagering on an ultra-high definition computer rendering of a virtual sporting event, such as soccer or boxing. Our customers pay us for the use of this software through either a fixed license fee per period, or on a participation basis based on the volume of customer net win. We also generate revenue by providing upfront services to our customers. Revenue growth for our Virtual Sports segment is driven by the number of customers, the number of player end-points and the customer net win attributable to our products.

Our customers for Virtual Sports include regulated betting operators, lotteries, casinos, online operators and other gaming and lottery operators in the UK, continental Europe, Asia, Africa and North America. Virtual Sports can be adapted to function in a sports betting, lottery, or gaming environment and is therefore available to a wide range of customers in both public and private implementations.

Virtual Sports segment, Key Performance Indicators

	For the Three-Month Period ended				Variance
	Unaudited June 30,		Unaudited June 30,		2018 vs 2017
Virtuals	2018		2017					%

No. of Live Customers at the end of the period		95		82		13			15.9	%
Average No. of Live Customers		93		83		10			11.6	%
Total Revenue (£'000)	£	7,339	£	7,022	£	317			4.5	%
Total Revenue £'000 - Retail	£	4,596	£	4,555	£	41			0.9	%
Total Revenue £'000 - Interactive	£	2,743	£	2,467	£	276			11.2	%
Average Revenue Per Customer per day (£)	£	870	£	930	£	(59	)		(6.4	)%

In the table above:

“No. of Live Customers at the end of the period” and “Average No. of Live Customers” represent the number of customers from which there is Virtual Sports revenue at the end of the period and the average number of customers from which there is Virtual Sports revenue during the period, respectively.

“Total Revenue (£000)” represents total revenue for the Virtual Sports segment, including recurring and upfront service revenue. Total revenue is also divided between “Total Revenue (£000) – Retail,” which consists of revenue earned through players wagering at Virtual Sports venues, and “Total Revenue (£000) – Interactive,” which consists of revenue earned through players wagering online, including through our Mobile RGS product.

“Average Revenue per Customer per day” represents total revenue for the Virtual Sports segment in the period, divided by the Average No. of Live Customers, divided by the number of days in the period.

Virtual Sports segment, key events that affected results for the Three Months ended June 30, 2018

As of June, 2018, OPAP offered and took bets on our Virtual Sports product in over 3,400 retail venues following the launch in April 2017.

In the UK, our Virtual Sports products continued to drive incremental growth with Betfred with the network solution deployed in over 1,600 retail venues.

Our Virtual Sports products in Poland deployed in over 400 retail venues with Fortuna have driven growth in the quarter.

During the period, our Virtual Sports revenue grew in Finland from to the annualization of Veikkaus, Finland’s national lottery.

In April 2018, we launched our Virgo™ RGS and premium omni-channel casino content in Italy with SNAI, and will soon launch with Sisal, Eurobet and Betsson’s StarCasino.

During the period, we celebrated the success of our Virtual Grand National 2018, which saw the predicted winner, Tiger Roll, finish in first place in the live event at Aintree Racecourse. The Grand National is an annual steeplechase horse race that attracts both serious and casual sports fans, and is seen by over 500 million television viewers.

We won the tender to provide our Virtual Sports products to one of the two Moroccan state lotteries deploying in 200 retail venues.

By the end of the period, our Mobile RGS business was live with twenty-five customers, having launched sixteen new customers since June 30, 2017, including Bet Victor, Aspire Global, White Hat Gaming, Casino Land, Casino777 and Netbet.

The Average Number of Live Customers increased by ten, from 83 to 93, including new Mobile RGS customers.

Virtual Sports segment, Three Months ended June 30, 2018 compared to Three Months ended June 30, 2017

Virtual Sports	For the Three-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Variance					Variance
(In thousands)	2018			2017			2018 vs 2017					Constant Currency					Currency Movement

Service Revenue	$	9,987		$	9,004		$	983		10.9	%	$	406		4.5	%	$	577

Cost of Service		(1,280	)		(1,047	)		(233	)	22.2	%		(161	)	15.3	%		(72	)

Selling, general and administrative expenses		(1,784	)		(1,222	)		(562	)	46.0	%		(459	)	37.6	%		(103	)

Stock-based compensation		(72	)		(79	)		7		(8.9	)%		11		(14.1	)%		(4	)

Depreciation and amortization		(1,456	)		(1,570	)		114		(7.3	)%		198		(12.6	)%		(84	)

Net operating profit	$	5,395		$	5,086		$	309		6.1	%	$	(4	)	(0.1	)%	$	313

Exchange Rate - $ to £		1.36			1.28

Virtual Sports segment revenue. During the period, revenue increased $1.0 million or 10.9% to $10.0 million on a reported basis. Of this increase, $0.6 million arose from favorable currency movements. On a constant currency basis, Virtual Sports revenue increased by $0.4 million, or 4.5%.

Growth was negatively affected by $0.6 million due to a reduction in revenue from long-term Virtual Sports licenses that have now come to an end. Excluding this reduction, underlying Virtual Sports revenue increased by $1.0 million, or 12.8%, of which $0.6 million came from Virtual Sports land-based and online customers, driven by increases in Greece, the UK, Finland and Poland of $0.2 million, $0.2 million, $0.2 million and $0.1 million, respectively. The remaining $0.4 million was driven by Mobile RGS, due to further penetration into that market, where the number of our customers increased from nine to twenty-five.

Virtual Sports segment operating profit. During the period, Virtual Sports operating profit increased by $0.3 million, on a reported basis, $0.3 million of which is from favorable currency movements. On a constant currency basis, net operating profit was in line with the prior period.

Virtual Sports cost of service increased by $0.2 million to $1.3 million, on a reported basis. Of this increase, $0.1 million arose from adverse currency movements. On a constant currency basis, cost of service increased by $0.2 million, due to additional costs of supplying new recurring contracts.

Virtual Sports SG&A expenses increased by $0.6 million, on a reported basis. Of this increase, $0.1 million arose from adverse currency movement, resulting in a constant currency increase of $0.5 million. This was due to an increase in staff related costs and technology costs due to increasing Virtual Sports deployments.

Virtual Sports depreciation and amortization decreased by $0.1 million to $1.5 million, on a reported basis. This decrease was offset by a $0.1 million adverse currency movement, resulting in a constant currency decrease of $0.2 million.

Results of Operations –

Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017

	For the Nine-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Variance					Variance
(In thousands)	2018			2017			2018 vs 2017					Currency Movement			Days Movement			Like-for-Like Variance

Revenue:
Service	$	98,136		$	77,478		$	20,658		26.7	%	$	7,999		($	1,562	)	$	14,220		18.7	%
Hardware		7,630			9,930			(2,300	)	(23.2	)%		671			-			(2,971	)	(29.9	)%
Total revenue		105,766			87,408			18,358		21.0	%		8,670			(1,562	)		11,249		13.1	%
Cost of sales, excluding depreciation and amortization:
Cost of service		(17,075	)		(11,146	)		(5,929	)	53.2	%		(1,405	)		256			(4,780	)	43.9	%
Cost of hardware		(7,058	)		(8,520	)		1,462		(17.2	)%		(630	)		-			2,092		(24.6	)%
Selling, general and administrative expenses		(47,241	)		(41,922	)		(5,319	)	12.7	%		(3,830	)		841			(2,329	)	5.7	%
Stock-based compensation		(5,934	)		(2,703	)		(3,231	)	119.5	%		(457	)		-			(2,774	)	102.6	%
Acquisition related transaction expenses		(816	)		(11,346	)		10,530		(92.8	)%		(65	)		-			10,596		(93.4	)%
Depreciation and amortization		(31,296	)		(23,877	)		(7,419	)	31.1	%		(2,578	)		498			(5,340	)	22.8	%
Net operating Loss		(3,654	)		(12,106	)		8,452		(69.8	)%		(295	)		33			8,714		(72.2	)%
Other income (expense)
Interest income		167			20			147		732.6	%		15			(1	)		133		686.6	%
Interest expense		(15,253	)		(23,978	)		8,725		(36.4	)%		(1,250	)		883			9,092		(39.4	)%
Change in fair value of earnout liability		7,767			(3,262	)		11,029		(338.1	)%		679			-			10,351		(317.3	)%
Change in fair value of derivative liability		1,872			(349	)		2,221		(636.1	)%		179			-			2,041		(584.8	)%
Other finance income (costs)		584			(162	)		745		(460.8	)%		48			3			694		(438.2	)%
Total other income (expense), net		(4,863	)		(27,731	)		22,868		(82.5	)%		(329	)		886			22,311		(83.1	)%
Net loss from continuing operations before income taxes		(8,517	)		(39,837	)		31,320		(78.6	)%		(624	)		918			31,025		(79.7	)%
Income tax expense		(155	)		3			(158	)	(5717.1	)%		(13	)		(0	)		(144	)	(5234.4	)%

Net loss	$	(8,672	)	$	(39,834	)	$	31,162		(78.2	)%	$	(637	)	$	918		$	30,881		(79.4	)%

Exchange Rate - $ to £		1.37			1.26

Revenue

Total revenue for the nine-month period ended June 30, 2018 increased by $18.4 million, or 21.0%, to $105.8 million, on a reported basis. Favorable currency movements accounted for $8.7 million of the increase, which was partly offset by a $1.6 million decrease due to there being fewer days in the 2018 period than in the 2017 period. On a constant currency basis, revenue increased by $11.2 million, or 13.1%.

SBG revenue, which is included in total revenue, above, increased by $9.4 million on a constant currency basis, or 15.3%, comprised of growth in service revenue of $12.4 million offset by a reduction in hardware sales of $3.0 million.

The increase in SBG service revenue of $12.4 million on a constant currency basis, or 23.9%, is primarily as a result of the continued rollout of terminals in Greece driving $6.7 million of incremental revenue and software license sales of $5.6 million into the Greek market.

The decrease in hardware revenue was driven by a decrease in the Greek, ETG and Colombian markets of $3.9 million, $0.9 million and $0.7 million, respectively. This was partly offset by SBG terminal sales in the UK market of $2.7 million.

Virtual Sports revenue increased by $1.8 million on a constant currency basis, or 7.5%, driven by new customer revenue in Mobile RGS and new Virtual Sports customers in Greece, Ireland, Finland and Poland, as well as an increase in revenue from existing customers, due in part to additional channels offered. Growth was negatively affected by $1.5 million due to a reduction in revenue from long-term Virtual Sports licenses that have now come to an end, $0.7 million due to a timing difference in the 2018 contract renewal of a major customer and $0.5 million due to the recognition of revenues previously unreported to us in 2017. Excluding these items, underlying Virtual Sports revenue increased by $4.5 million on a constant currency basis, or 24.3%, of which $3.5 million came from Virtual Sports land-based and online customers and $1.0 million from Mobile RGS.

Cost of sales, excluding depreciation and amortization

Cost of sales, excluding depreciation and amortization, increased year-over-year by $4.5 million, or 22.7%, on a reported basis, to $24.1 million. Of this increase, $2.0 million arose from adverse currency movements, offset by a reduction of $0.3 million due to there being fewer days in the 2018 period. On a constant currency basis, cost of sales increased by $2.7 million, or 13.9%.

Cost of service increased by $4.8 million, or 43.9%, on a constant currency basis, due to an increase in Greece SBG service costs of $2.5 million, $1.0 million from additional machine consumable costs to service UK SBG terminals and $1.0 million due to additional costs supporting new recurring contracts for Virtual Sports.

Cost of hardware decreased by $2.1 million, or 24.6%, on a constant currency basis, due to lower nil margin hardware sales in Greece and lower hardware sales in the ETG and Colombian markets. This was partly offset by higher nil margin sales of the “Flex 4k” product terminal and other hardware sales in the UK market.

Selling, general and administrative expenses

SG&A expenses increased year-over-year by $5.3 million, or 12.7%, on a reported basis, to $47.2 million. Of this increase, $3.8 million arose from adverse currency movements, offset by a reduction of $0.8 million due to there being fewer days in the current year period. On a constant currency basis, SG&A expenses increased by $2.3 million, or 5.7%. This increase was driven by incremental group restructuring costs of $2.0 million and additional public company costs of $0.7 million due to the prior period containing only six months of post-Business Combination transaction expenses. This was offset by staff related cost savings of $0.4 million.

Stock-based compensation

During the 2018 nine-month period, the Company recorded an expense of $5.9 million in respect of outstanding awards. This included a $2.1 million charge relating to the cancellation of awards under the First Incentive Plan covering 1,076,272 shares, the granting of awards under the Second Incentive Plan (which at that time was not yet stockholder-approved) covering an equal number of shares, and the differences in accounting treatment applied to both plan awards prior to the stockholder approval of the Second Incentive Plan. In the corresponding nine-month period in 2017, there was a $2.7 million charge for stock-based compensation.

Acquisition related transaction expenses

Acquisition related transaction expenses decreased by $10.5 million in the nine-month period ended June 30, 2018 to $0.8 million, on a reported basis. All of the 2018 period expenses were related to work in respect of potential acquisitions. All of the prior period expenses were related to the Business Combination.

Depreciation and amortization

Depreciation and amortization increased by $7.4 million, or 31.1%, in the nine-month period ended June 30, 2018, to $31.3 million, on a reported basis. Of this increase, $2.6 million arose from adverse currency movements, partly offset by $0.5 million due to there being fewer days in the 2018 period.

On a constant currency basis, depreciation and amortization increased by $5.3 million, or 22.8%. This increase was driven by a $4.6 million increase due to additional amortization in connection with new platforms and games going live across SBG ($3.6 million) and Virtual Sports ($0.6 million) and a $0.6 million increase due to additional machine and machine related depreciation.

Net operating loss

On a reported basis, net operating loss improved from a loss of $12.1 million in the nine-month period ended June 30, 2017 to a loss of $3.7 million in the nine-month period ended June 30, 2018. This improvement was partly offset by a $0.3 million adverse currency movement. On a constant currency basis, net operating loss decreased by $8.7 million, mainly due to an increase in revenue and a reduction in transaction expenses, partly offset by higher cost of sales, depreciation and amortization and stock-based compensation.

Interest expense

Interest expense decreased by $8.9 million, or 37.0%, in the nine-month period ended June 30, 2018, to $15.1 million, on a reported basis. Of this variance, $1.2 million arose from adverse currency movements. On a constant currency basis, interest expense decreased by $9.2 million. This decrease was principally due to a $9.5 million reduction in PIK loan note interest and a $0.9 million reduction in debt fee amortization. All PIK loan notes were external to the group prior to the Business Combination, at which point they became internal before subsequently being waived on May 31, 2017. This reduction was partly offset by a $0.5 million increase in PIK interest charged on our senior debt, as a result of the quarterly compounding of the debt increasing the effective daily charge.

Change in fair value of earnout liability

As a result of changes in expectations relating to of the Earnout Jurisdictions, and share-price movements ($6.25 at June 30, 2018 and $5.50 at March 31, 2018), the credit that accrued in the 2018 nine-month period resulting from a change in fair value of earnout liability was $7.8 million. In the prior nine-month period, the corresponding figure was a $3.3 million charge.

Change in fair value of derivative liability

Change in fair value of derivative liability decreased by $2.2 million, to a $1.9 million credit on a reported basis, between 2017 and 2018. This was predominantly due to the reduction in share price and the conversion of the awards in March 2018 to Stock based compensation.

Net loss

On a reported basis, net loss improved from a loss of $39.8 million in the nine-month period ended June 30, 2017 to a loss of $8.7 million in the nine-month period ended June 30, 2018. Of this variance, $0.6 million arose from adverse currency movements. This resulted in a constant currency improvement of $30.9 million, mainly due to a reduction in transaction expenses, a reduction in interest expense, an increase in revenue and the change in fair value of liabilities. This was partly offset by higher cost of sales, depreciation and amortization and stock-based compensation.

Results of Operations –

Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017 –

Server Based Gaming Segment

SBG segment, Key Performance Indicators

	For the Nine-Month Period ended						Variance
	June 30,			June 30,			2018 vs 2017
SBG	2018			2017						%

End of period installed base (# of terminals)		32,579			28,011			4,568			16.3	%
Average installed base (# of terminals)		30,606			27,264			3,342			12.3	%
Customer Gross Win per unit per day ⁽¹⁾	£	114.19		£	118.04		£	(3.85	)		(3.3	)%
Customer Net Win per unit per day ⁽¹⁾	£	81.52		£	85.12		£	(3.60	)		(4.2	)%
Inspired Blended Participation Rate		6.1	%		6.0	%		0.1	%

⁽¹⁾Includes all SBG terminals in which the company takes a participation revenue share across all territories.

For definitions of the terms used in the table above, see the definitions provided under the corresponding “SBG segment, Key Performance Indicators” table for the three-month periods ended June 30, 2017 and 2018, set forth earlier in this Management’s Discussion and Analysis section.

SBG segment, key events that affected results for the Nine Months ended June 30, 2018

Our SBG rollout into the Greek market continued during the period, with approximately 4,800 terminals installed as of June 30, 2018. During the period a further 3,000 terminals were awarded, which form part of our phase two rollout plan to be delivered across 2018 and also carry a software license sale award. The performance of our Greek terminals continues to be strong compared to other suppliers during the period.

During the period, we launched our new SBG cabinet, the “Flex 4K” product with trials with two of our major UK LBO customers, and we sold 600 Flex terminals to our second largest UK LBO customer, all of which were installed before the end of the period. We deployed a further 600 of our “Eclipse” terminals with the same UK customer, resulting in a total machine growth of 23% with this customer.

Two of our major UK LBO customers agreed contract extensions which included additional deployment of terminals, further increasing our UK LBO estate.

In the Italian market, a contract extension was agreed for a further four years with our largest customer. The contract included a continuation of hardware, platform and games supply, but in addition to this we will provide up to 2,024 SBG VLT terminals with both remote and field services. The contract also included an increased revenue share due to the Company. Customer Gross Win per unit per day (in EUR) in the Italian market increased by 11.7% due to new content releases.

Overall, the size of our Average Installed Base increased 12.3%, to 30,606, due to our continued terminal rollout in Greece and growth from new contract awards in the UK LBO estate. Customer Gross Win per unit per day (in our functional currency, GBP) decreased by 3.3% across the entire estate, driven by the impact of our SBG installations in Greece, as our Greek machines return a lower daily Customer Gross Win compared to our UK machines. Our blended participation rate increased 0.1% to 6.1% due to an increased proportion of Greece installed base.

SBG segment, Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017

Server Based Gaming	For the Nine-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Variance						Variance
(In thousands)	2018			2017			2018 vs 2017						Currency Movement			Days Movement			Like-for-Like Variance
	$ '000			$ '000			$ '000			%

Revenue:
Service	$	69,931		$	52,988		$	16,943			32.0	%	$	5,675		$	(1,138	)	$	12,406		23.9	%
Hardware		7,630			9,930			(2,300	)		(23.2	)%		671			-			(2,971	)	(29.9	)%
Total revenue		77,561			62,918			14,643			23.3	%		6,346			(1,138	)		9,435		15.3	%

Cost of sales, excluding depreciation and amortization:
Cost of service		(13,333	)		(8,610	)		(4,723	)		54.9	%		(1,095	)		195			(3,823	)	45.4	%
Cost of hardware		(7,058	)		(8,520	)		1,462			(17.2	)%		(630	)		-			2,092		(24.6	)%
Total cost of sales		(20,391	)		(17,130	)		(3,261	)		19.0	%		(1,725	)		195			(1,731	)	10.2	%

Selling, general and administrative expenses		(11,789	)		(11,562	)		(227	)		2.0	%		(964	)		234			503		(4.4	)%

Stock-based compensation		(202	)		(129	)		(73	)		56.6	%		(17	)		-			(56	)	43.8	%

Depreciation and amortization		(25,165	)		(18,215	)		(6,950	)		38.2	%		(2,058	)		346			(5,238	)	29.3	%

Net operating profit	$	20,014		$	15,882		$	4,132			26.0	%	$	1,582		$	(362	)	$	2,912		18.8	%

Exchange Rate - $ to £		1.37			1.26

SBG segment revenue. In the nine-month period ended June 30, 2018, SBG revenue increased $14.6 million, to $77.6 million, on a reported basis. Of this increase, $6.3 million arose from favorable currency movements, partly offset by $1.1 million due to fewer days in the 2018 period. On a constant currency basis, SBG revenue increased by $9.4 million, or 15.3%.

SBG service revenue increased by $16.9 million, or 32.0%, on a reported basis. Of this increase, $5.7 million arose from favorable currency movements, partly offset by $1.1 million due to there being fewer days in the 2018 period. On a constant currency basis, SBG service revenue increased by $12.4 million, or 23.9%, to $69.9 million, primarily due to the continued rollout of terminals into Greece. This rollout drove additional participation revenue of $5.2 million and other recurring revenue of $1.6 million. In addition, during the 2018 period we completed a software license sale into the Greek market, generating revenue of $5.6 million.

SBG service revenue increased on a constant currency basis in the Greek, UK Other, Italian and UK LBO markets by $12.3 million, $0.3 million, $0.3 million and $0.2 million, respectively, due to the continued rollout in Greece and growth in the UK and Italy markets. This was partly offset by a decrease in service revenue in other jurisdictions by $0.7 million due to the revised terms in Colombia following the sale of machines in 2017.

UK LBO Customer Gross Win per unit per day grew by 1.8%. These gains were offset by revised terms agreed in a SBG contract extension and a SBG contract renewal with two major customers in our UK LBO market, respectively. The contract extension and renewal allowed us to continue to generate revenue without the obligation to make further capital investment.

SBG hardware revenue decreased by $2.3 million to $7.6 million, on a reported basis, including favorable currency movements of $0.7 million. On a constant currency basis, SBG hardware revenue decreased by $3.0 million, principally due to higher terminal sales in 2017 in the Greek, ETG and Colombian markets, totaling $3.9 million, $0.9 million and $0.7 million, respectively. This is partly offset by higher sales in 2018 in the UK market of $2.6 million

SBG segment operating profit. In the nine-month period ended June 30, 2018, SBG operating profit increased by $4.1 million to $20.0 million, on a reported basis. Of this variance, $1.6 million arose from favorable currency movements, offset by a decrease of $0.4 million due to there being fewer days in the period. On a constant currency basis, SBG operating profit increased by $2.9 million, or 18.8%.

SBG cost of sales (excluding depreciation and amortization) increased by $3.3 million to $20.4 million, on a reported basis. Of this variance, $1.7 million arose from adverse currency movements, partly offset by $0.2 million due to there being fewer days in the period. On a constant currency basis, cost of sales increased by $1.7 million. This was principally due to an increase in service costs of $3.8 million (due to Greek SBG service costs of $2.5 million), and additional machine consumable costs of $1.0 million offset by lower hardware costs of $2.1 million due to lower hardware sales in the Greek market.

SBG SG&A expenses increased by $0.2 million to $11.8 million, on a reported basis. Of this variance, $1.0 million arose from adverse currency movements, partly offset by $0.2 million due to there being fewer days in the period. This resulted in a constant currency decrease of $0.5 million.

SBG depreciation and amortization increased by $7.0 million to $25.2 million on a reported basis. Of this amount, $2.1 million arose from adverse currency movement, partially offset by $0.3 million due to there being fewer days in the period. On a constant currency basis, the increase was $5.2 million, driven by a $3.6 million increase in intangible amortization due to new projects going live in the Greek and UK markets plus an increase in machine and machine related depreciation of $0.6 million, driven by the continued terminal rollout in the Greek and UK markets. This was partially offset by savings from fully depreciated terminals in the Italian market and the sale of assets in the Colombian market.

SBG segment, Revenue by Region

Set forth below is a breakdown of our SBG service revenue by geographic region. SBG service revenue consists principally of SBG participation revenue.

Server Based Gaming Service Revenue by Region	For the Nine-Month Period ended
	Unaudited June 30,		Unaudited June 30,		Variance					Variance
(In thousands)	2018		2017		2018 vs 2017					Currency Movement		Days Movement			Like-for-Like Variance

Service Revenue:
UK LBO	$	43,683	$	40,824	$	2,859		7.0	%	$	3,582	$	(886	)	$	163		0.4	%
UK Other		4,755		4,135		620		15.0	%		392		(97	)		326		8.1	%
Italy		6,797		6,044		753		12.5	%		563		(122	)		312		5.3	%
Greece		13,860		531		13,330		2,511.3	%		1,069		-			12,260		2,309.8	%
Rest of the World		837		1,454		(618	)	(42.5	)%		69		(33	)		(653	)	(46.0	)%

Total service revenue	$	69,931	$	52,988	$	16,944		32.0	%	$	5,675	$	(1,138	)	$	12,407		23.9	%

Exchange Rate - $ to £		1.37		1.26

Results of Operations –

Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017 –

Virtual Sports Segment

Virtual Sports segment, Key Performance Indicators

	For the Nine-Month Period ended				Variance
	June 30,		June 30,		2018 vs 2017
Virtual Sports	2018		2017					%

No. of Live Customers at the end of the period		95		82		13			15.9	%
Average No. of Live Customers		89		79		10			12.8	%
Total Revenue (£'000)	£	20,608	£	19,488	£	1,120			5.7	%
Total Revenue £'000 - Retail	£	12,683	£	12,221	£	462			3.8	%
Total Revenue £'000 - Interactive	£	7,926	£	7,267	£	659			9.1	%
Average Revenue Per Customer per day (£)	£	847	£	884	£	(37	)		(4.2	)%

For definitions of the terms used in the table above, see the definitions provided under the corresponding “Virtual Sports segment, Key Performance Indicators” table for the three-month periods ended June 30, 2017 and 2018, set forth earlier in this Management’s Discussion and Analysis section.

Virtual Sports segment, key events that affected results for the Nine Months ended June 30, 2018

As of June 30, 2018, OPAP offered our Virtual Sports product in over 3,400 retail venues following the launch in April 2017.

In the UK our Virtual Sports products continued to drive incremental growth with Betfred with the network solution deployed in over 1,600 retail venues.

During the nine-month period, our Virtual Sports revenue grew in Poland through the retail venues and online channels of Fortuna (now deployed in over 400 retail venues), Central Europe’s largest betting operator. Under an agreement that extends to 2019, Fortuna customers in Poland are able to play Virtual Football (soccer), Virtual Horses, Virtual Greyhounds, Virtual Speedway and Virtual Motor Racing. We also launched Virtual Sports in Finland through the retail venues and online channels of Veikkaus, Finland’s national lottery.

In April 2018 we launched our Virgo™ RGS and premium omni-channel casino content in Italy with SNAI, and soon to launch with Sisal, Eurobet and Betsson’s StarCasino.

Inspired won the tender to provide our Virtual Sports products to one of the two Moroccan state lotteries deploying in 200 retail venues.

During the period we celebrated the success of our Virtual Grand National 2018, which saw the predicted winner, Tiger Roll, finish in first place in the live event at Aintree Racecourse. The Grand National is an annual steeplechase horse race that attracts both serious and casual sports fans, and is seen by over 500 million television viewers.

By the end of the nine-month period, our Mobile RGS business was live with twenty-five customers having launched sixteen new customers since June 30, 2017, including Bet Victor, Aspire Global, White Hat Gaming, Casino Land, Casino777 and Netbet.

The Average Number of Live Customers increased by ten, from 79 to 89, including new Mobile RGS customers.

Virtual Sports segment, Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017

Virtual Sports	For the Nine-Month Period ended
	Unaudited			Unaudited			Variance					Variance
(In thousands)	June 30, 2018			June 30, 2017			2018 vs 2017					Currency Movement			Days Movement			Like-for-Like Variance

Service Revenue	$	28,205		$	24,490		$	3,715		15.2	%	$	2,325		$	(424	)	$	1,815		7.5	%

Cost of Service		(3,742	)		(2,536	)		(1,206	)	47.6	%		(307	)		60			(959	)	38.7	%

Selling, general and administrative expenses		(5,668	)		(4,472	)		(1,196	)	26.7	%		(464	)		110			(842	)	19.3	%

Stock-based compensation		(238	)		(157	)		(81	)	51.6	%		(19	)		-			(62	)	39.2	%

Depreciation and amortization		(5,104	)		(4,193	)		(911	)	21.7	%		(417	)		65			(559	)	13.5	%

Net operating profit	$	13,453		$	13,132		$	321		2.4	%	$	1,117		$	(188	)	$	(607	)	(4.7	)%

Exchange Rate - $ to £		1.37			1.26

Virtual Sports segment revenue. In the period ended June 30, 2018, Virtual Sports revenue increased $3.7 million on a reported basis. Of this increase, $2.3 million arose from favorable currency movements, partly offset by $0.4 million due to there being fewer days in the period. On a constant currency basis, Virtual Sports revenue increased by $1.8 million, or 7.5%, to $28.2 million.

Growth was negatively affected by $1.5 million due to a reduction in revenue from long-term Virtual Sports licenses that have now come to an end, $0.7 million due to a timing difference in the 2018 contract renewal of a major customer and $0.5 million due to the recognition of revenues previously unreported to us in 2017. Excluding these items, underlying Virtual Sports revenue increased by $4.5 million on a constant currency basis, or 24.3%. Of this $3.5 million was driven by Virtual Sports land-based and online, driven by new customer revenue in Finland of $0.3 million as well as continued growth in Greece, UK, Ireland and Poland of $2.0 million $0.6 million, $0.4 million and $0.3 million, respectively. The remaining $1.0 million increase arose from further Mobile RGS penetration into the mobile market, where the number of our customers increased from nine to twenty-five.

Virtual Sports segment operating profit. In the period ended June 30, 2018, Virtual Sports operating profit increased by $0.3 million on a reported basis to $13.5 million. Of this increase, $1.1 million arose from favorable currency movements, partly offset by $0.2 million due to there being fewer days in the period. On a constant currency basis, this represented a decrease of $0.6 million.

Virtual Sports cost of service increased by $1.2 million to $3.7 million, on a reported basis. Of this increase, $0.3 million arose from adverse currency movements, offset by $0.1 million due to there being fewer days in the period. On a constant currency basis, cost of service increased by $1.0 million, due to additional third-party costs payable on new recurring contracts.

Virtual Sports SG&A expenses increased by $1.2 million, on a reported basis. Of this increase, $0.5 million arose from adverse currency movements, offset by $0.1 million due to there being fewer days in the period. This resulted in a constant currency increase of $0.8 million.

Virtual Sports depreciation and amortization increased by $0.9 million to $5.1 million, on a reported basis. Of this increase, $0.4 million arose from adverse currency movement, offset by $0.1 million due to there being fewer days in the period. This resulted in a constant currency increase of $0.6 million, due to additional depreciation of platforms and games going live.

Non-GAAP Financial Measures

We use certain non-GAAP financial measures, including EBITDA and Adjusted EBITDA, to analyze our operating performance. We use these financial measures to manage our business on a day-to-day basis. We believe that these measures are also commonly used in our industry to measure performance. For these reasons, we believe that these non-GAAP financial measures provide expanded insight into our business, in addition to standard U.S. GAAP financial measures. There are no specific rules or regulations for defining and using non-GAAP financial measures, and as a result the measures we use may not be comparable to measures used by other companies, even if they have similar labels. The presentation of non-GAAP financial information should not be considered in isolation from, or as a substitute for, or superior to, financial information prepared and presented in accordance with U.S. GAAP. You should consider our non-GAAP financial measures in conjunction with our U.S. GAAP financial measures.

We define our non-GAAP financial measures as follows:

EBITDA is defined as net loss excluding depreciation and amortization, interest expense, interest income and income tax expense.

Adjusted EBITDA is defined as net loss excluding depreciation and amortization, interest expense, interest income and income tax expense, and other additional exclusions and adjustments. Such additional excluded amounts include stock-based compensation U.S. GAAP charges where the associated liability is expected to be settled in stock, and changes in the value of earnout liabilities and income and expenditure in relation to legacy portions of the business (being those portions where trading no longer occurs) including closed defined benefit pension schemes. Additional adjustments are made for items considered outside the normal course of business, including (1) restructuring costs, which include charges attributable to employee severance, management changes, restructuring and integration (2) merger and acquisition costs and (3) gains or losses not in the ordinary course of business.

We believe Adjusted EBITDA, when considered along with other performance measures, is a particularly useful performance measure, because it focuses on certain operating drivers of the business, including sales growth, operating costs, selling and administrative expense and other operating income and expense. We believe Adjusted EBITDA can provide a more complete understanding of our operating results and the trends to which we are subject, and an enhanced overall understanding of our financial performance and prospects for the future. Adjusted EBITDA is not intended to be a measure of liquidity or cash flows from operations or a measure comparable to net income or loss, because it does not take into account certain aspects of our operating performance (for example, it excludes non-recurring gains and losses which are not deemed to be a normal part of underlying business activities). Our use of Adjusted EBITDA may not be comparable to the use by other companies of similarly termed measures. Management compensates for these limitations by using Adjusted EBITDA as only one of several measures for evaluating our operating performance. In addition, capital expenditures, which affect depreciation and amortization, interest expense, and income tax benefit (expense), are evaluated separately by management.

Adjusted Revenue (Revenue Excluding Nil Margin Hardware Sales) is defined as revenue excluding hardware sales that are sold at nil margin with the intention of securing longer term recurring revenue streams.

Incremental Costs since Closing of the Business Combination is defined as the incremental costs incurred as a result of becoming a public company, shown to allow comparability to the prior periods when we were not a public company. These costs include costs associated with the public company’s Board of Directors and its committees and advisors, the remuneration of those who became employed or received increases as a result of the Business Combination, SEC counsel costs and costs associated with PCAOB audit compliance.

Constant Currency. Currency impacts shown have been calculated as the current-period average GBP: USD rate less the equivalent average rate in the prior period, multiplied by the current period amount in our functional currency (GBP). The remaining difference, referred to as constant currency, is calculated as the difference in our functional currency, multiplied by the prior-period average GBP: USD rate, as a proxy for constant currency movement.

Currency Movement represents the difference between the results in our reporting currency (USD) and the results on a Constant Currency basis.

Days Movement represents values relating to the additional six days in the 2017 half year as compared to the 2018 half year using specific information where available and otherwise applying a straight-line method that reflects pro-rated values.

Like-for-Like Variance represents the difference between the results in our reporting currency calculated under GAAP and the results after adjusting for Currency Movement and Days Movement impacts.

Reconciliations from net loss, as shown in our Consolidated Statements of Operations and Comprehensive Loss, to Adjusted EBITDA are shown below.

Reconciliation to Adjusted EBITDA

	For the Three-Month Period ended
	Unaudited June 30,			Unaudited June 30,
(In thousands)	2018			2017

Net loss	$	(4,019	)	$	(8,333	)

Items Relating to Legacy Activities:
Pension charges		135			177
Costs relating to former operations		3			-

Items outside the normal course of business:
Costs of group restructure		1,655			29
Transaction fees		14			73

Stock-based compensation expense		1,485			1,377

Depreciation and amortization		10,616			8,705
Total other expense, net		5,599			7,714
Income tax		39			(86	)
Adjusted EBITDA	$	15,526		$	9,656

Adjusted EBITDA	£	11,411		£	7,531

Exchange Rate - $ to £		1.36			1.28

Notes to table:

(1) “Pension charges” are profit and loss charges included within selling, general and admin expenses, relating to a defined benefit scheme which was closed to new entrants in 1999 and to future accrual in 2010. As well as the amortization of net loss, the figure also includes charges relating to the Pension Protection Fund (which were historically borne by the pension scheme) and a small amount of associated professional services expenses. These costs are included within Central Functions.

(2) “Costs relating to former operations” refers to gains and losses from our Mexican SBG division, which ceased trading prior to the years shown in the consolidated financial statements included in this report. This affects Server Based Gaming results.

(3) “Costs of group restructure” include redundancy costs, Payments In Lieu of Notice Costs and any associated employer taxes. To qualify as being an adjusting item, costs must be part of a large restructuring project, which will net save future costs.

(4) Transaction fees, Stock-based compensation expense, Depreciation and amortization, Total other expense, net and Income tax are as described above in the Results of Operations line item discussions.

	For the Nine-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Adjusted June 30,
(In thousands)	2018			2017			2017

Net loss	$	(8,672	)	$	(39,834	)	$	(38,916	)

Items Relating to Legacy Activities:
Pension charges		414			522			511
(Credit)/Costs relating to former operations		8			(70	)		(62	)
Litigation settlement		260			-			-

Items outside the normal course of business:
Costs of group restructure		2,691			497			497
Transaction fees		816			11,346			11,346

Stock-based compensation expense		5,934			2,703			2,703

Depreciation and amortization		31,296			23,877			23,379
Total other expense, net		4,863			27,731			26,931
Income tax		155			(3	)		(3	)
Adjusted EBITDA	$	37,765		$	26,769		$	26,387

Adjusted EBITDA	£	27,612		£	21,316		£	21,011


Exchange Rate - $ to £		1.37			1.26			1.26

Notes to table:

(1) The adjusted column restates the prior year figures based on a 273-day period rather than the actual 279-day period so as to show a constant currency comparison.

(2) “Litigation settlement” refers to settlement of an employment related litigation with the former general counsel of Hydra Industries Acquisition Corp.

(3) For definitions of the terms used in the table, see notes 1-4 to the prior table showing the reconciliation of Adjusted EBITDA for the three-month periods ended June 30, 2017 and 2018.

Reconciliation to Adjusted Revenue

We believe that accounting for nil margin hardware sales in conformance with U.S. GAAP can result in a distorted presentation of our revenue and growth. Therefore, we use Revenue Excluding Nil Margin Sales, or Adjusted Revenue, to internally analyze our operating performance. A reconciliation from revenue, as shown in our Consolidated Statements of Operations and Comprehensive Loss included elsewhere in this report, to Adjusted Revenue is shown below.

	For the Three-Month Period ended
	Unaudited June 30,			Unaudited June 30,
(In thousands)	2018			2017

Net revenues	$	36,926		$	32,311
Less Nil Margin Sales		(412	)		(2,934	)
Adjusted Revenue	$	36,514		$	29,377

Adjusted Revenue	£	26,835		£	22,911

Exchange Rate - $ to £	$	1.36		$	1.28

	For the Nine-Month Period ended
	Unaudited June 30,			Unaudited June 30,			Adjusted June 30,
(In thousands)	2018			2017			2017

Net revenues	$	105,766		$	87,408		$	85,845
Less Nil Margin Sales		(4,021	)		(4,319	)		(4,319	)
Adjusted Revenue	$	101,745		$	83,089		$	81,526

Adjusted Revenue	£	74,392		£	66,163		£	64,918

Exchange Rate - $ to £		1.37			1.26			1.26

Liquidity and Capital Resources

Nine Months ended June 30, 2018 compared to Nine Months ended June 30, 2017

	Period Ended						Variance
(in thousands)	June 30,			June 30,
	2018			2017			2018 to 2017
Net loss	$	(8,672	)	$	(39,834	)	$	31,162
Non-cash interest expense		5,824			9,762			(3,938	)
Change in fair value of derivative and earnout liabilities and stock based compensation expense		(4,014	)		6,314			(10,328	)
Other net cash provided by operating activities		24,631			27,957			(3,326	)
Net cash provided by operating activities		17,769			4,199			13,570

Net cash used in investing activities		(28,142	)		(29,065	)		923
Net cash provided by financing activities		1,139			43,950			(42,811	)
Effect of exchange rates on cash		(618	)		2,130			(2,748	)
Net (decrease)/increase in cash and cash equivalents	$	(9,852	)	$	21,214		$	(31,066	)

Net cash provided by operating activities. In the 2018 nine-month period, net cash inflow generated by operating activities was $17.8 million, compared to a $4.2 million inflow in the prior nine-month period, representing an $13.6 million improvement in cash generation.

Non-cash interest expense decreased by $3.9 million, to $5.8 million, as a consequence of the Business Combination in the prior nine-month period. As part of that transaction, outstanding PIK loan notes became internal and were subsequently waived on May 31, 2017. The related non-cash interest expense ceased to be an external charge to the Company from the date of the Business Combination.

Change in fair value of derivative and earnout liabilities and stock based compensation expense decreased by $10.3 million from an inflow of $6.3 million to an outflow of $4.0 million. Movements in the market value of the stock price resulted in a $13.2 million higher outflow in the 2018 nine-month period which was partly offset by a $2.9 million movement in stock based compensation expense.

Other net cash provided by operating activities decreased by $3.3 million, to $24.6 million. This decrease is largely explained by the relative movements in the level of capital creditors (included within supplier payables) of $7.1 million and movements in inventory holding levels $4.7 million, both as a result of timing of relative levels of activity in machine build. These were offset by a higher current year depreciation charge $7.4 million.

Net cash used in investing activities. In the 2018 nine-month period, net cash used in investing activities decreased by approximately $0.9 million, to $28.1 million. The decrease was attributable to $3.1 million lower spending on capital software compared to the prior nine-month period due to the relative project and staff resource mix. This was partly offset by higher levels of spend relating to plant, property and equipment due to the continued rollout of machines into Greece.

Net cash provided by financing activities. In the 2018 nine-month period, net cash from financing activities decreased by $42.8 million, to a $1.1 million inflow. This was due to the prior period benefitting from a cash injection of $16.7 million received following the Business Combination, and $21.6 million of proceeds received from a private placement of common stock. In addition, during the 2018 nine-month period, we paid $7.7 million to reduce the outstanding balance under our then-existing senior debt facility. This was partly offset by a $3.6 million increase in proceeds from greater utilization of our then-existing revolver facility in the 2018 nine-month period.

Funding Needs and Sources

To fund our obligations, we have historically relied on a combination of cash flows provided by operations and the incurrence of additional debt or the refinancing of existing debt. As of June 30, 2018, we had liquidity of $10.2 million in cash and cash equivalents. This compares to $22.7 million at the end of the prior nine-month period. We had a working capital outflow of $6.7 million in the 2018 nine-month period, compared to a $4.1 million inflow in the prior nine-month period. The level of our working capital surplus or deficit varies with the level of machine production we are undertaking and our capitalization. In periods where significant levels of machines are being produced, the levels of inventory and creditors are higher than average and there is a natural timing difference between converting the stock into sellable or capitalized plant and settling payments to suppliers. These factors, along with movements in trading activity levels, can result in significant working capital volatility. In periods of low activity, our working capital volatility is reduced. Working capital is reviewed and managed with the aim of ensuring that current liabilities are covered by the level of cash held and the expected level of short-term receipts.

Significant portions of our cash flows from operations arise in Greece, from our operations in that country. As of June 30, 2018, $2.6 million of our $10.2 million of cash and cash equivalents had arisen in Greece and was being held there in our Greek accounts. In the ordinary course of business, we seek from time to time to transfer funds earned in Greece to accounts of ours outside Greece. However, Greece imposes capital controls that complicate, and can delay or prevent, the flow of capital out of that country. Historically, we have always been able to complete such transfers. Nevertheless, if approvals of our transfers of funds out of Greece are ever materially delayed or prevented, our cash planning and our ability to deploy cash across our operations could be adversely affected. See “Risk Factors – The capital controls imposed by Greece as a consequence of its financial crisis can cause problems for the transfer of our earnings out of Greece.”

Management currently believes that the Company’s cash balances on hand, cash flows expected to be generated from operations, ability to control and defer capital projects and amounts available from the Company’s external borrowings will be sufficient to fund the Company’s net cash requirements through August 2019. If the Company were to undertake any acquisitions, it might be required to finance them, in whole or in part, by issuing additional equity or debt securities or increasing its borrowing levels.

After the quarter end, we refinanced our external borrowings. Unless otherwise indicated, the discussion below, from “—Long Term and Other Debt” through “—Contractual Obligations”, addresses our financial position, including our then-existing external borrowings, as of June 30, 2018, prior to the refinancing. For information regarding our refinanced external borrowings, see “—Refinancing of External Borrowings”, below.

Long Term and Other Debt

(In thousands)	June 30, 2018						June 30, 2017
Cash held	£	7,707		$	10,176		£	17,468		$	22,700
Revolver drawn		(12,320	)		(16,266	)		(12,320	)	$	(16,010	)
Original principal senior debt		(72,500	)		(95,722	)		(72,500	)	$	(94,214	)
Compounded PIK interest		(12,070	)		(15,936	)		(12,130	)	$	(15,763	)
PIK interest accrued		(487	)		(643	)		(487	)	$	(633	)
Cash interest accrued		(612	)		(808	)		(885	)	$	(1,150	)
Finance lease creditors		(497	)		(656	)		(942	)	$	(1,224	)
Total	£	(90,779	)	$	(119,856	)	£	(81,796	)	$	(106,294	)

As of June 30, 2018, our long-term debt consisted of senior bank debt and a revolving credit facility.

As of June 30, 2018, the Company had bank facilities of £90.0 million (equivalent to approximately $118.8 million), consisting of a senior term loan facility of £72.5 million (equivalent to approximately $95.7 million) and a revolving credit facility of £17.5 million (equivalent to approximately $23.1 million). As of June 30, 2018 and June 30, 2017, the Company had aggregate borrowings under the term loan facility of £72.5 million (equivalent to $95.7 million) and £72.5 million (equivalent to $94.2 million), respectively. As of June 30, 2018, the term loan facility imposed a cash interest rate on outstanding borrowings equal to the base rate margin of 7.00% per annum, plus the higher of 3.00% and LIBOR, and the current rate at which cash interest accrued was 10.00% per annum. The Company had interest accruals of £0.6 million (equivalent to $0.8 million) and £0.9 million (equivalent to $1.2 million) at June 30, 2018 and June 30, 2017, respectively. In addition, as of June 30, 2018, the term loan facility imposed PIK interest at a rate of 7.00% per annum on the outstanding borrowings, which amount is added to the total principal outstanding. The Company had PIK interest accruals of £0.5 million (equivalent to $0.6 million) and £0.5 million (equivalent to $0.6 million) at June 30, 2018 and June 30, 2017, respectively. The term loan facility was scheduled to mature on September 30, 2019.

As of June 30, 2018 and June 30, 2017, the Company had aggregate borrowings under the revolving credit facility of £12.3 million (equivalent to $16.3 million) and £12.3 million (equivalent to $16.0 million), respectively. As of June 30, 2018, the revolving credit facility imposed a cash interest rate on outstanding borrowings equal to the base rate margin of 5.00% per annum, plus LIBOR, and the current rate at which cash interest accrued was 5.50% per annum. In addition, a commitment fee was payable with respect to unutilized borrowing capacity at a rate of 2.00% per annum. The revolving credit facility was scheduled to mature on August 17, 2019. In addition to the revolving credit facility borrowings described above, further amounts under the facility have been used for the Company’s VAT Duty Deferment guarantee and the Company’s credit card program. The amounts so used as of June 30, 2018 and June 30, 2017 were $0.2 million and $0.2 million, respectively.

Debt issuance fees were capitalized at the time the debt was issued. As at June 30, 2018 and June 30, 2017, the amount of debt issuance fees capitalized was $0 and $0.3 million, respectively.

Debt Covenants

Under our debt facilities in place as of June 30, 2018, we were subject to covenant testing at quarterly intervals. The covenant testing was set at the level of DMWSL 631 Limited, an intermediate holding company above all trading companies, and consisted of tests on Leverage (Net Debt/EBITDA), Interest Cover (EBITDA/Interest Costs) and Super Senior Leverage (Net Debt + Revolver/EBITDA). These were measured under UK generally accepted accounting principles. In addition to the quarterly tests, there was an annual requirement that no more than £3 million be spent on non-machine capital additions, excluding labor capitalization.

All of our operations are included within the DMWSL 631 Limited group, except for certain overhead and director fees and expenses, non-recurring costs relating to the Business Combination and the movement in stock-based compensation expense and fair values on earnout and derivative liabilities. The costs of these items in the nine months ended June 30, 2018 were $4.8 million, $0.6 million and -$5.7 million, respectively, and in the nine months ended June 30, 2017 were $2.3 million, $4.6 million and $4.9 million, respectively.

There were no breaches of the debt covenants in the periods ended June 30, 2018 and June 30, 2017.

Liens and Encumbrances

As of June 30, 2018, our senior bank debt was secured by the imposition of a fixed and floating charge in favor of the lender over all the assets of the Company and certain of the Company’s subsidiaries.

Contractual Obligations

As of June 30, 2018, our contractual obligations, adjusted to reflect the refinancing of external borrowings effected on August 13, 2018, were as follows:

			Less than						More than
Contractual Obligations (in thousands)	Total		1 year		1-3 years		3-5 years		5 years
Operating activities
Interest on long term debt	$	78,577	$	13,634	$	31,525	$	31,525	$	1,892

Financing activities
Revolver repayment		16,266		0		0		16,266		0
Senior bank debt - principal repayment		95,722		0		0		0		95,722
Senior bank debt - compounded PIK debt interest		26,772		0		0		0		26,772
Finance lease payments		656		523		133		0		0
Interest on non-utilization fees		565		450		115		0		0
Total	$	218,558	$	14,608	$	31,773	$	47,791	$	124,386

Refinancing of External Borrowings

After the quarter end, on August 13, 2018, the Company and certain of its subsidiaries entered into a series of transactions that effected the refinancing of the group’s external borrowings, replacing the group’s senior term and revolving facilities, originally entered into in 2014, with senior notes of $140.0 million and a revolving credit facility of £7.5 million (equivalent to approximately $9.9 million). The senior notes have a 5-year duration and carry a cash interest rate of 9% plus 3-month LIBOR, and the revolving credit facility has a 3-year duration and carries a cash interest rate on any utilization at 4% plus 3-month LIBOR, with any unutilized amount carrying a 1.4% cash interest cost. In connection with the refinancing, the Company also entered into a three-year, fixed-rate, cross-currency swap. For further information regarding the new external borrowings and the swap, see Note 23 to the Interim Condensed Consolidated Financial Statements, “Subsequent Events”.

Off-Balance Sheet Arrangements

As of June 30, 2018, there were no off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

Critical Accounting Policies

The preparation of our unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to exercise its judgment. We exercise considerable judgment with respect to establishing sound accounting policies and in making estimates and assumptions that affect the reported amounts of our assets and liabilities, our recognition of revenues and expenses, and our disclosure of commitments and contingencies at the date of the consolidated financial statements. On an on-going basis, we evaluate our estimates and judgments. We base our estimates and judgments on a variety of factors, including our historical experience, knowledge of our business and industry and current and expected economic conditions, that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We periodically re-evaluate our estimates and assumptions with respect to these judgments and modify our approach when circumstances indicate that modifications are necessary. While we believe that the factors we evaluate provide us with a meaningful basis for establishing and applying sound accounting policies, we cannot guarantee that the results will always be accurate. Since the determination of these estimates requires the exercise of judgment, actual results could differ from such estimates.

Please refer to our Annual Report on Form 10-K filed with the SEC on December 4, 2017, for a further discussion of our critical accounting policies. During the nine months ended June 30, 2018, there were no material changes to these policies.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our principal market risks are our exposure to changes in interest rates and foreign currency exchange rates.

Interest Rate Risk

We have external borrowings that are subject to the risk of higher interest charges associated with increases in interest rates. As of June 30, 2018, we had £72.5 million ($95.7 million) of senior bank debt and £12.1 million ($15.9 million) of capitalized PIK debt interest that is subject to a floating interest rate charge that can vary with the LIBOR rate if this rate increases over a level of 3%. Due to the current rates of LIBOR, if floating interest rates increased by 1%, there would be no impact on the interest expense. If the floating interest rates increased by 5%, the additional interest charge would be approximately $2.1 million.

After the quarter end, we refinanced our external borrowings, and in connection therewith entered into a three-year, fixed-rate, cross-currency swap. For further information regarding the swap, see Note 23 to the Interim Condensed Consolidated Financial Statements, “Subsequent Events”.

Foreign Currency Exchange Rate Risk

Our operations are conducted in various countries around the world and we receive revenue and pay expenses from these operations in a number of different currencies. As such, our earnings are subject to movements in foreign currency exchange rates when transactions are denominated in (i) currencies other than GBP, which is our functional currency, or (ii) the functional currency of our subsidiaries, which is not necessarily GBP. Excluding intercompany balances, our Euro functional currency net assets total approximately $8.5 million and our US Dollar functional currency net liabilities total approximately $14.2 million. We use a sensitivity analysis model to measure the impact of a 10% adverse movement of foreign currency exchange rates against the US Dollar. A hypothetical 10% adverse change in the value of the Euro and the US Dollar relative to GBP as of June 30, 2018 would result in translation adjustments of approximately $1.0 million and $1.9 million, respectively, recorded in other comprehensive loss.

Included within our trading results are earnings outside of our functional currency. Retained earnings earned in Euros and in US Dollars in the nine months ended June 30, 2018 were €1.2 million and $0.1 million, respectively. A hypothetical 10% adverse change in the value of the Euro and the US Dollar relative to GBP as of June 30, 2018 would result in translation adjustments of approximately $0.1 million and $0.0 million, respectively, recorded in trading operations.

The majority of the group’s trading is in GBP, the functional currency, although the reporting currency of the group is the US Dollar. As such, changes in the GBP: USD exchange rate have an effect on the group’s results. A 10% weakening of GBP against the US Dollar would change the trading operational results by approximately $0.9 million and would result in translation adjustments of approximately $0.5 million, recorded in other comprehensive loss.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our Certifying Officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer (together, the “Certifying Officers”), we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on the foregoing, our Certifying Officers concluded that our disclosure controls and procedures were effective as of June 30, 2018, the end of the period covered by this Report.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we may become involved in lawsuits and legal proceedings arising in the ordinary course of business. While we believe that, currently, we have no such matters that are material, there can be no assurance that existing or new matters arising in the ordinary course of business will not have a material adverse effect on our business, financial condition or results of operations.

ITEM 1A. RISK FACTORS

Our business is subject to a high degree of risk. You should carefully read and assess our discussion of the risk factors facing our business, below. Any of these risks could materially and adversely affect our business, operating results, financial condition and prospects, and cause the value of our common stock to decline, which could cause investors in our common stock to lose all or part of their investments.

Risks Relating to Our Business and Industry

We operate in a highly competitive industry and our success depends upon our ability to effectively compete with numerous worldwide businesses.

We face competition from a number of businesses, including worldwide businesses, many of which have substantially greater financial resources and operating scale than we do. Such competition could adversely affect our ability to win new contracts and sales and renew existing contracts. We operate in a period of intense price-based competition in some key markets, which could affect the profitability of the contracts and sales we do win.

In certain markets, our businesses also face competition from suppliers, operators or licensees who offer products for internet gaming in illegal or unregulated markets, but are still able or permitted to supply products and compete with us in regulated markets. These competitors often have substantially greater financial resources and operating scale than we do.

If we cannot successfully compete in our industry and business segments, our business, results, financial condition and prospects could suffer.

We are heavily dependent on our ability to renew our long-term contracts with our customers and we could lose substantial revenue if we are unable to renew certain of these contracts.

Generally, our Virtual Sports contracts are for initial terms of three to five years, with renewals at the customer’s option. Generally, our SBG terminal contracts are for terms of four to six years (although in certain cases they are longer), but certain customers have options for early termination under certain circumstances, and we may face pressure to renew or upgrade terminals during the lives of these contracts, which could adversely affect revenues or our return on capital and leave us with surplus terminals. At any given time, we have multiple substantial customer contracts that have years to run and others that may be nearing expiration or renewal, which we may lose if we cannot compete effectively to retain their business.

There can be no assurance that our current contracts will be extended or that we will be awarded contract extensions or new contracts as a result of competitive bidding processes or otherwise. The termination, expiration or failure to renew one or more of our contracts could cause us to lose substantial revenue.

Changes in applicable gambling regulations or taxation regimes may affect the revenues or profits generated by the contracts we enter into with our customers. Many of the contracts have with our customers are on revenue-sharing terms, and therefore changes which adversely affect our customers may also adversely affect us. In addition, such changes may cause our customers to seek to renegotiate their contracts, may alter the terms on which such customers are prepared to renew their contracts and may affect their ability or willingness to renew their contracts.

We rely on a relatively small number of customers for a significant portion of our sales, and the loss of, or material reduction in, sales to any of our top customers could have an adverse effect on our business, results of operations, financial condition and prospects.

Certain key customers, including certain UK, Italian and Greek SBG terminal customers and certain Virtual Sports customers, make a significant contribution to our revenues and profitability. Our top ten customers generated 70% of total revenues in the three and nine months ended June 30, 2018. During the three months ended June 30, 2018, there were three customers that represented at least 10% of our revenues, accounting for 22%, 22% and 11% of the Company’s revenues, respectively. During the nine months ended June 30, 2018, there were three customers that represented at least 10% of our revenues, accounting for 24%, 17% and 14% of the Company’s revenues, respectively. We expect that these customers will continue to represent a significant portion of our sales in the future. However, the loss of any of our top customers, whether through contract expiry and non-renewal, breach of contract or other adverse factors could materially adversely affect our revenues or return on capital and leave us with surplus terminals. Moreover, if any of these customers experience reduced revenue, such reduction could adversely affect any revenue-sharing arrangements we have with those customers, reduce our own revenues and adversely affect our financial results.

We are dependent on our relationships with key suppliers to obtain equipment and other supplies for our business on acceptable terms.

We have achieved significant cost savings through our centralization of equipment and non-equipment purchases. However, as a result, we are exposed to the credit and other risks of a group of key suppliers. While we make every effort to evaluate our counterparties prior to entering into long-term and other significant procurement contracts, we cannot predict the impact on our suppliers of the current economic environment and other developments in their respective businesses. Insolvency, financial difficulties or other factors may result in our suppliers not being able to fulfill the terms of their agreements with us. Further, such factors may render suppliers unwilling to extend contracts that provide favorable terms to us, or may force them to seek to renegotiate existing contracts with us. In addition, our business has signed a number of significant contracts whose performance depends upon third party suppliers delivering equipment on schedule for us to meet its contract commitments. Failure of the suppliers to meet their delivery commitments could result in us being in breach of and subsequently losing those contracts. Although we believe we have alternative sources of supply for the equipment and other supplies used in our business, concentration in the number of our suppliers could lead to delays in the delivery of products or components, and possible resultant breaches of contracts that we have entered into with our customers, increases in the prices we must pay for products or components, problems with product quality and other concerns.

Our ability to bid on new contracts is dependent upon our ability to fund any required up-front capital expenditures through our cash from operations, the incurrence of indebtedness or the raising of additional equity capital.

Our SBG terminal contracts in the UK, Italy and Greece often require significant up-front capital expenditures for terminal assembly, software customization and implementation, systems and equipment installation and telecommunications configuration. Historically, we have funded these up-front costs through cash flows generated from operations and external borrowings. Our ability to continue to procure new contracts, including in new jurisdictions, will depend upon, among other things, our liquidity levels at the time or our ability to obtain additional debt or equity funding at commercially acceptable terms to finance the initial up-front costs. If we do not have adequate liquidity or are unable to obtain other funding for these up-front costs on favorable terms or at all, we may not be able to bid on certain contracts, which could restrict our ability to grow and have an adverse effect on our ability to retain existing contracts and therefore on future profitability.

Our business depends upon the protection of our intellectual property and proprietary information.

We believe that our success depends, in part, on protecting our intellectual property in the UK and in other countries. Our intellectual property includes certain trademarks relating to our systems, as well as certain patents and proprietary or confidential information that is not subject to patent or similar protection. Our intellectual property protects the integrity of our games, systems, products and services, which is a core value of the industries in which we operate. Protecting our intellectual property can be expensive and time-consuming, may not always be successful depending on local laws or other circumstances, and we also may choose not to pursue registrations in certain countries. Competitors may independently develop similar or superior products, software, systems or business models. In cases where our intellectual property is not protected by an enforceable patent, or other intellectual property protection, such independent development may result in a significant diminution in the value of its intellectual property.

There can be no assurance that we will be able to protect our intellectual property. We enter into confidentiality or license agreements with our employees, vendors, consultants and, to the extent legally permissible, our customers, and generally control access to, and the distribution of, our game designs, systems and other software documentation and other proprietary information, as well as the designs, systems and other software documentation and other information we license from others. Despite our effort to protect these proprietary rights, parties may try to copy our gaming products, business models or systems, use certain of our confidential information to develop competing products, or independently develop or otherwise obtain and use our gaming products or technology, any of which could have an adverse effect on our business. Policing unauthorized use of our technology is difficult and expensive, particularly because of the global nature of our operations. The laws of some countries may not adequately protect our intellectual property.

There can be no assurance that our business activities, games, products and systems will not infringe upon, misappropriate of otherwise violate the proprietary rights of others, or that other parties will not assert infringement or misappropriation claims against us. Any such claim and any resulting litigation, should it occur, could subject us to significant liability for costs and damages and could result in invalidation of our proprietary rights, distract management, and/or require us to enter into costly and burdensome royalty and licensing agreements. Such royalty and licensing agreements, if required, may not be available on terms acceptable to us, or may not be available at all. In the future, we may also need to file lawsuits to defend the validity of our intellectual property rights and trade secrets, or to determine the validity and scope of the proprietary rights of others. Such litigation, whether successful or unsuccessful, could result in substantial costs and diversion of resources.

We also rely on certain products and technologies that we license from third parties. Proprietary licenses typically limit our use of intellectual property to specific uses and for specific time periods. There can be no assurance that these third-party licenses, or the support for such licenses, will continue to be available to us on commercially reasonable terms. In the event that we cannot renew and/or expand existing licenses, we may be required to discontinue or limit our use of the products that include, incorporate, or rely on licensed intellectual property.

Our industry is subject to strict government regulations that could limit our existing operations and have a negative impact on our ability to grow.

In certain jurisdictions, forms of wagering, betting and lottery may be expressly authorized and governed by law and in other jurisdictions forms of wagering, betting and lottery may be expressly prohibited by law. If expressly authorized, such activities are typically subject to extensive and evolving governmental regulation. Gaming regulatory requirements vary from jurisdiction to jurisdiction. Therefore, we are subject to a wide range of complex gaming laws, rules and regulations in the jurisdictions in which we are licensed or may seek to be licensed. Most jurisdictions require that we are licensed or authorized, that our key personnel and certain of our security holders are found to be suitable or are licensed, and that our products are reviewed, tested and certified or approved before placement. If a license, approval, certification or finding of suitability is required by a regulatory or national authority and we fail to seek or do not receive the necessary approval, license, certification or finding of suitability, or if it is revoked, then we may be prohibited from distributing our products for use in the respective jurisdiction. Additionally, such prohibition could trigger reviews of our Company by regulatory bodies in other jurisdictions and adversely affect our ability to obtain or retain the required licenses and approvals in those jurisdictions.

The regulatory environment in any particular jurisdiction may change in the future, and any such change could have an adverse effect on our results of operations or business in general. Moreover, there can be no assurance that the operation of Server Based Gaming terminals, Video Lottery Terminals, Virtual Sports betting, lottery or other forms of wagering systems will be approved, certified or found suitable by additional jurisdictions or that those jurisdictions in which these activities are currently permitted will continue to permit such activities in their existing forms or at all. While we believe that we have the means to continue to develop procedures and policies designed to comply with and monitor the requirements of evolving laws, there can be no assurance that law enforcement agencies, governmental agencies or gaming regulatory authorities, whether in existing or new jurisdictions, will not seek to restrict our business or otherwise institute enforcement proceedings or other legal claims against the Company. Moreover, in addition to the risk of such enforcement actions or claims, we are also at risk from loss of business reputation in the event of any potential legal or regulatory investigation whether or not we are ultimately accused of or found to have committed any violations.

We supply our products to operators of gaming venues, platforms and websites who typically must themselves be licensed by gaming regulators. If any one of these operators fails to maintain its gaming licenses, or violates gaming laws or regulations, our business may suffer, due to our loss of a viable customer and, in instances where we have a revenue-sharing arrangement with the operator, due to our loss of our shares of the revenue generated by that operator’s business.

We supply certain of our products to operators who operate gaming websites. Some of those operators may take bets from customers in markets where no gaming laws or regulations exist and where the provision of online gaming is effectively unregulated. Although the Company seeks to ensure that its customers only take bets in markets where online gaming is legal, if any of those operators is subjected to investigatory or enforcement action for acting otherwise, this could result in the operator suffering interventions ranging from special conditions being applied to its licenses, license suspension or license loss, or the operator otherwise withdrawing from or curtailing its activities in its market. Any such developments could adversely affect such operator’s revenues and in turn adversely affect our earnings from such operator. The Company may itself be subject to investigatory or enforcement action (if and to the extent that local laws or the laws of other jurisdictions in which the Company operates impose liability on suppliers for the activities of the customers that they supply or for receiving funds that are deemed to be illegal because of such activities). We seek to protect ourselves against any such liability for the activities of the operators that we supply, including by contractually requiring those operators not to operate in certain territories and only supplying operators who we have reviewed to determine whether they uphold the requisite standards of regulatory and legal compliance. Nonetheless, there is a risk that we may fail to undertake sufficient due diligence, fail to receive accurate information on which to conduct due diligence, or become subject to investigatory or enforcement action should we or any of our customers be accused of breaching any regulations or laws. Any such action may adversely affect our standing with gaming regulators and our ability to obtain and retain required licenses and other approvals in other jurisdictions.

We may be required to obtain and maintain licenses and certifications from various state and local jurisdictions in order to operate certain aspects of our business and we and our key personnel and certain security holders may be subject to extensive background investigations and

Inspired Entertainment, Inc. - FORM 10-Q - August 14, 2018

Attached files