Inspired Entertainment Inc

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

Company Description and Nature of Operations

We are a global gaming technology company, supplying content, platform, gaming terminals and other products and services to online and land-based regulated lottery, betting and gaming operators worldwide through a broad range of distribution channels, predominantly on a business-to-business basis. We provide end-to-end digital gaming solutions (i) on our own proprietary and secure network, which accommodates a wide range of devices, including land-based gaming machine terminals, mobile devices and online computer applications and (ii) through third party networks. Our content and other products can be found through the consumer-facing portals of our interactive customers and, through our land-based customers, in licensed betting offices, adult gaming centers, pubs, bingo halls, airports, motorway service areas and leisure parks.

Management Liquidity Plans

As of September 30, 2023, the Company’s cash on hand was $26.4 million, and the Company had working capital in addition to cash of $29.1 million. The Company recorded net income of $7.6 million and $17.1 million for the nine months ended September 30, 2023 and 2022, respectively. Net income includes non-cash stock-based compensation of $9.3 million and $7.9 million for the nine months ended September 30, 2023 and 2022, respectively. Working capital of $55.5 million includes $8.7 million of deferred income.

Historically, 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. Cash flows provided by operations amounted to $35.3 million and $31.8 million for the nine months ended September 30, 2023 and 2022, respectively.

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 November 2024.

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.

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 years ended December 31, 2022 and 2021. The financial information as of December 31, 2022 is derived from the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K/A filed with the SEC on February 27, 2024. The interim results for the nine months ended September 30, 2023 are not necessarily indicative of the results to be expected for the year ending December 31, 2023 or for any future interim periods.

Newly Adopted Accounting Standards

On January 1, 2023, the Company adopted Topic 326 Financial Instruments – Credit Losses (“ASC 326”). ASC 326 affects loans, debt securities, trade receivables, and any other financial assets that have the contractual right to receive cash. It requires an entity to recognize expected credit losses rather than incurred losses for financial assets and requires a modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption.

The adoption of ASC 326 did not have a material impact. Disclosures with respect to allowances for credit losses are given in footnote 4 to these financial statements.

2. Restatement of Previously Issued Financial Statements

Restatement Background

On November 2, 2023, the Company in concurrence with the Company’s audit committee, concluded that our 2023 and 2022 consolidated financial statements and our unaudited consolidated financial statements as of and for each of the first two quarterly periods in 2023 and all quarterly periods in 2022, included in our Quarterly Reports on Form 10-Q for the respective periods, (collectively the “Prior Period Financial Statements”) should no longer be relied upon due to misstatements that are described below, and that we would restate such financial statements to make the necessary accounting corrections. Details of the restated consolidated financial statements for the three and nine months ended September 30, 2022 are provided below (“Restatement Items”). Details of the restated consolidated financial statements as of December 31, 2022 are provided in the amendment to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2022, filed with the SEC as of the date of this report.

The Restatements Items reflect adjustments to correct errors in certain financial statement areas including capitalized software and costs to fulfill a contract, revenue and costs to obtain a contract, inventory, goodwill and intangibles, leasing, pension, and other reclassifications and immaterial errors identified. The nature and impact of these adjustments are described below and also detailed in the tables below.

The Company issued a revision for capitalized software and related amortization expense in the quarterly report on Form 10-Q filed on August 11, 2023 for the period ended June 30, 2023 (the “Revision”). This revision related to certain completed software development projects that were, but should not have been, delayed in the shift from work in progress to completed projects. Consequently, the commencement of amortization for certain projects was delayed and the reported amortization was lower than the actual amortization. The Revision covers the period ended September 30, 2023 and the year ended December 31, 2022 and is distinct from the capitalized software restatements below. The tables below have been updated to separate the impact of the Restatement Items from the Revision.

Restatement Items

Capitalized software and Costs to fulfill a contract – The Company historically assessed and applied incorrectly the accounting frameworks for developing external use software under ASC 985-20,Costs of Software to Be Sold, Leased or Marketed, and internal-use software under ASC 350-40,Intangibles – Goodwill and Other – Internal-Use Softwareand ASC 340-40,Other Assets and Deferred Costs – Contracts with Customers. In addition, the Company determined routine software updates and certain minor software enhancements were inappropriately capitalized and capitalized labor rates inappropriately included, certain indirect costs including overhead and non-development activities. Consequently, certain amortizationwas inappropriate. The corrections resulted in an increase to Selling, general and administrative expenses of $0.9 million and $2.7 million as well as a decrease in Depreciation and amortization of $0.7 million, and $1.7 million for the three and nine months ended September 30, 2022, respectively. Refer to reference “a” below.

**Revenue and Costs to obtain a contract –*The Company identified several corrections related to ASC 606,Revenue from Contracts with Customers.*The Company identified certain performance obligations were delivered and therefore should have been recognized at a specific point in time (rather than over time). Additionally, weidentified that (i) for certain Interactive Aggregator contracts, revenue should have been reported on a net, rather than gross, basis and (ii) certain parts the Company acquired and sold to its contract manufacturer should have not been reported as revenue. These two items have no impact to profit. The Company also identified an immaterial contract that should have been recognized as a sales type lease rather than an operating lease. Items reported on a gross, rather than net basis are corrected with no impact to profit. Lastly, the Company had historically expensed certain commissions in the period incurred instead of capitalizing and amortizing them under the accounting framework for costs to obtain contracts with customers pursuant to ASC 606,Revenue from Contracts with Customers, and ASC 340-40,Other Assets and Deferred Costs – Contracts with Customers. The corrections also resulted in a decrease in Revenue - service of $0.6 million and $2.3 million for the three and nine months ended September 30, 2022, respectively and a $0.1 million decrease and $0.5 million increase in Revenue – product sales for the three and nine months ended September 30, 2022, respectively, a decrease in Cost of sales – service of $1.7 million and $5.0 million for the three and nine months ended September 30, 2022, respectively, and as a $0.5 million increase in Cost of sales – product sales for the nine months ended September 30, 2022. The corrections also resulted in an increase in Depreciation and amortization increased by $1.2 million and $3.2 million for the three and nine months ended September 30, 2022, respectively as well as a $0.1 increase in Interest expense, net for the three months ended September 30, 2022. Refer to reference “b” below. Note 7, “Contract Liabilities and Other Disclosures” and Note 19, “Segment Reporting and Geographic Information” have also been corrected.

Inventory–The Company identified an error in the amount capitalizedfor field inventory, repair and consumable items. Refer to reference “c” below. Note 5, “Inventory” has also been corrected.

Goodwill and intangibles –Through review of the appropriate reporting units and asset groups to assess impairments atunder ASC 350,Intangibles – Goodwill and Other and ASC 360,Property, Plant and Equipment, the Company identified a triggering event in the first quarter of 2020, related to the beginning of the COVID-19 pandemic, for which impairment assessment was required for (i)Server Based Gaming (“SBG”)and Acquired Business reporting units and (ii) all landbased asset groups. Based on the assessment, we determined that an impairment of goodwill and long-lived assets occurred in the first quarter of 2020. Additionally, we determined that a significant number of synergies existed from the acquisition in the fourth quarter of 2019 and therefore a portion of the acquisition goodwill should have been reallocated to other reporting units upon acquisition. The corrections resulted in a decrease of Depreciation and amortization of $0.1 million for both the three and nine months ended September 30, 2022. Refer to reference “d” below.

Leasing– The Company had not historically included in-substance fixed payments related to certain leases according to the accounting framework in ASC 842,Leases. Refer to reference “f” below. Note 16, “Leases” has also been corrected.

Basic****and dilutednet income (loss) per share – An error to shares outstanding primarily relates to the Company not including deferred settlement equity awards that had vested in the number of outstanding shares used in the calculation of basic and diluted weighted average number of shares outstanding pursuant to ASC 260,Earnings Per Share. Refer to reference “h” below. Note 12, “Net earnings (loss) per share” has also been corrected.

Pension– The Company had corrections to pension that primarily related to no longer updating the plan liability/ asset quarterly to comply with US GAAP. In addition, the Company corrected the benefit obligation and fair value of plan assets for the buy-in contract. The Company corrected the measurement of the plan assets and the estimated fair value of the buy in contract. Note 18, “Pension Plan” has also been corrected. Refer to reference “g” below.

Other errors identified – Through the restatement process, the Company has reclassified certain costs for salaries of service employees and recorded an adjustment related to foreign currency impacts on an intangible. In addition to thereclassification and intangible adjustment, the Company has corrected other adjustments thatare quantitatively immaterial, individually and in aggregate, because we are correcting for these material errors, we have decided to correct these other adjustments. Refer to reference “f” below.

Income tax– The Company updated the income tax effects for the Restatement Items. Note 14, “Income Taxes” has also been updated.

Summary impact of Restatement Items to Prior Period Financial Statements

The following tables present the effect of the Restatement Items on the Company’s consolidated statement of operations for the periods indicated (in millions, except share and per share amounts):

The following tables present the effect of the Restatement Items on the Company’s consolidated statements of stockholders’ equity (deficit) for the periods indicated (in millions, except per share amounts):

The following tables present the effect of the Restatement Items on the Company’s consolidated statements of cashflows for the periods indicated (in millions):

3. Acquisitions and Disposals

In January 2022, the Company sold its Italian VLT business, including all terminal and other assets, staff costs and facilities and contracts, to a non-connected party for total proceeds of €1.1 million ($1.3 million), recognizing a profit on disposal of €0.8 million ($0.9 million). The Company continues to serve these Italian markets in the form of the provision of platform and games.

4. Allowance for Credit Losses

Changes in the allowance for doubtful accounts are as follows:

5. Inventory

Inventory consists of the following:

Component parts include parts for gaming terminals. Our finished goods inventory primarily consists of gaming terminals which are ready for sale.

6. Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following:

7. Contract Liabilities and Other Disclosures

The following table summarizes contract related balances:

Revenue recognized that was included in the deferred income balance at the beginning of the periods amounted to $3.9 million and $5.8 million, as restated, for the nine months ended September 30, 2023 and 2022, respectively.

For the periods ended September 30, 2023 and 2022 respectively, there was no significant amounts of revenue recognized as a result of changes in contract transaction price related to performance obligations that were satisfied in the respective prior periods.

Transaction Price Allocated to Remaining Performance Obligations

At September 30, 2023, the transaction price allocated to unsatisfied performance obligations for contracts expected to be greater than one year, or performance obligations for which we do not have a right to consideration from the customer in the amount that corresponds to the value to the customer for our performance completed to date, variable consideration which is not accounted for in accordance with the sales-based or usage-based royalties guidance, or contracts which are not wholly unperformed, is approximately $81.3 million. Of this amount, we expect to recognize as revenue approximately 9% through December 31, 2023, approximately 58% through December 31, 2025, approximately 28% through December 31, 2027, and the remaining balance through December 31, 2029.

8. Long term Debt

Senior Secured Notes

As of September 30, 2023, the aggregate principal amount of the Company’s Senior Secured Notes issued under an indenture (the “Indenture”) outstanding was $282.7 million.

The Indenture contains covenants and certain reporting requirements including the requirement to provide the Lender, within 60 days after the close of the quarter, unaudited quarterly financial statements with footnote disclosures. The Company was unable to comply with this requirement due to the requirement to restate previously reported financial statements as reported in a Current Report on Form 8-K filed with the SEC on November 8, 2023. The debt agreement allows the Company a 30-day grace period to provide such financial information once they receive any notice of non-compliance. No such notice has been received. Concurrent with the filing of this 10Q with the SEC, the reporting requirement has been met.

9. Stock-Based Compensation

A summary of the Company’s Restricted Stock Unit (“RSU”) activity during the nine months ended September 30, 2023 is as follows:

The Company issued a total of 431,001 shares during the nine months ended September 30, 2023 which included an aggregate of 332,227 shares issued in connection with the net settlement of RSUs that vested during the prior year (on December 30, 2022).

10. Repurchase of Common Stock

On May 10, 2022, the Board of Directors authorized the Company to use up to $25.0 million to repurchase Inspired common shares (such amount being exclusive of any fees, commissions or other expenses), subject to repurchases being effected on or before May 10, 2025 (the “Share Repurchase Program”). Management has discretion as to whether to repurchase shares of the Company.

During the nine months ended September 30, 2023, the Company repurchased 125,778 shares under the Share Repurchase Program for gross proceeds of approximately $1.6 million, which were canceled and retired during the nine months ended September 30, 2023. As of September 30, 2023, approximately $13.0 million remained available for future repurchases under the Share Repurchase Program.

Please refer to Part II, Item 2 of this report for further details regarding shares repurchased during the three months ended September 30, 2023.

11. Accumulated Other Comprehensive Loss (Income)

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

In connection with the issuance of Senior Secured Notes and the entry into an RCF Agreement, on May 19, 2021, the Company terminated all of its interest rate swaps. Accordingly, hedge accounting is no longer applicable. The amounts previously recorded in Accumulated Other Comprehensive Income are amortized into Interest expense over the terms of the hedged forecasted interest payments. Losses reclassified from Accumulated Other Comprehensive Income into Interest expense in the Consolidated Statements of Operations and Income for the nine months ended September 30, 2023 and September 30, 2022 amounted to $0.3 million and $0.5 million, respectively.

12. Net Income (Loss) per Share

Basic income (loss) per share (“EPS”) is computed by dividing net income (loss) attributable 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 shares of common stock outstanding during the period, including RSUs, using the treasury stock method, unless the inclusion would be anti-dilutive.

The computation of diluted EPS excludes the common stock equivalents of the following potentially dilutive securities because they were either contingently issuable shares or because their inclusion would be anti-dilutive:

The following tables reconcile the numerators and denominators of the basic and diluted EPS computations:

The calculation of Basic EPS includes the effects of 1,790,728 and 1,607,638 shares for the three and nine months ended September 30 2023 and 2022, respectively, with respect to RSU awards that have vested but have not yet been issued.

13. Other Finance Income (Expense)

Other finance income (expense) consisted of the following for the three and nine months ended September 30, 2023 and 2022:

14. Income Taxes

The effective income tax rate for the three months ended September 30, 2023 and 2022 was 37.6% and 1.5%, as restated, respectively, resulting in a $2.0 million and $0.1 million income tax expense, respectively. The effective income tax rate for the nine months ended September 30, 2023 and 2022 was 27.6% and 2.7%, as restated, respectively, resulting in a $2.8 million and $0.4 million income tax expense, respectively. The Company’s effective income tax rate has fluctuated primarily as a result of the income mix between jurisdictions and increase in impact of the Global Intangible Low-Taxed Income (GILTI) due to foreign profits.

The income tax expense for the three and nine months ended September 30, 2023 and 2022 differs from the amount that would be expected after applying the statutory U.S. federal income tax rate primarily due to changes in tax attributes in jurisdictions where realization of benefits is not expected to occur.

The Company recorded a valuation allowance against all of our deferred tax assets as of both September 30, 2023 and 2022. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve.

15. Related Parties

Macquarie Corporate Holdings Pty Limited (UK Branch) (“Macquarie UK”) (an arranger and lending party under our RCF Agreement) is an affiliate of MIHI LLC, which owned approximately 11.5% of our common stock as of September 30, 2023. Macquarie UK did not hold any of the Company’s aggregate senior debt at September 30, 2023 or December 31, 2022 and the Company’s RCF was undrawn as of each of those periods. Macquarie UK’s portion of the RCF loan commitment is $2.8 million which represents 11% of the aggregate RCF commitment. Interest expense incurred and payable to Macquarie UK relating to RCF non-utilization fees for the three months ended September 30, 2023 and 2022 amounted to $0.0 million and $0.0 million, respectively, and for the nine months ended September 30, 2023 and 2022 amounted to $0.0 million and $0.0 million, respectively. MIHI LLC is also a party to a stockholders agreement with the Company and other stockholders, dated December 23, 2016, pursuant to which, subject to certain conditions, MIHI LLC, jointly with Hydra Industries Sponsor LLC, are permitted to designate two directors to be nominated for election as directors of the Company at any annual or special meeting of stockholders at which directors are to be elected, until such time as MIHI LLC and Hydra Industries Sponsor LLC in the aggregate hold less than 5% of the outstanding shares of the Company.

On December 31, 2021, the Company entered into a consultancy agreement with Richard Weil, the brother of A. Lorne Weil, our Executive Chairman, under which he received a success fee in the amount of $130,000 for services he provided in connection with our acquisition of Sportech Lotteries, LLC. The success fee was paid during the nine months ended September 30, 2022. Under the agreement, as extended in November 2022 and again in July 2023, he will provide consulting services to the Company relating to the lottery in the Dominican Republic through to December 31, 2023, for which he was compensated at a rate of $10,000 per month in consulting fees through to June 30, 2023, and will be compensated at a rate of $12,500 per month for the remainder of the term of the agreement. The aggregate amount incurred by the Company in consulting fees for the three months ended September 30, 2023 and 2022 was $37,500 and $30,000, respectively and for the nine months ended September 30, 2023 and 2022 was $97,500 and $90,000, respectively.

16. Leases

Certain of our arrangements include leases for equipment installed at customer locations. As the lessor, we combine lease and non-lease components for all classes of underlying assets in arrangements that involve operating leases. The single combined component is accounted for under ASC 606,Revenue from Contracts with Customers based on the consideration that the non-lease components are the predominant items in the arrangements. If a component cannot be combined, the consideration is allocated between the lease component and the non-lease component based on relative standalone selling price. The lease component is accounted for under ASC 842,Leasesand the non-lease component is accounted for under ASC 606.

Lease income from operating leases and from sales type leases is not material for any of the periods presented.

17. Commitments and Contingencies

Employment Agreements

We are party to employment agreements with our executive officers and other employees of the Company and our subsidiaries which contain, among other terms, provisions relating to severance and notice requirements.

Arrangements with Daniel B. Silvers, former Executive Vice President and Chief Strategy Officer

Effective January 10, 2023, Mr. Silvers stepped down from his position as Executive Vice President and Chief Strategy Officer of the Company. Pursuant to Mr. Silvers’ employment agreement dated December 14, 2016, as amended, Mr. Silvers was entitled to receive a base salary at a rate of $385,000 per year, a target annual bonus of not less than 100% of his base salary and a maximum annual bonus of 200% of his base salary. He was also entitled to reimbursement for private medical insurance and to certain severance benefits.

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.

18. Pension Plan

We operate a defined contribution plan in the US, and both defined benefit and defined contribution pension schemes in the UK. The defined contribution scheme assets are held separately from those of the Company in independently administered funds.

Defined Benefit Pension Scheme

The defined benefit scheme has been closed to new entrants since April 1, 1999 and closed to future accruals for services rendered to the Company for the entire financial statement periods presented.

The latest actuarial valuation of the scheme (as at March 31, 2021), which was finalized in June 2022, determined that the statutory funding objective was not met, i.e., there were insufficient assets to cover the scheme’s technical provisions and there was a funding shortfall.

In June 2022, a recovery plan was put in place to eliminate the funding shortfall. The plan expects the shortfall to be eliminated by October 31, 2026. Deficit reduction contributions of $1.1 million and expense contributions of $0.3 million will be payable during the year ending December 31, 2023.

The total amount of employer contributions paid during the nine months ended September 30, 2023 amounted to $1.1 million.

The following table presents the components of our net periodic pension cost (benefit):

The following table sets forth the estimate of the combined funded status of the pension plans and their reconciliation to the related amounts recognized in our consolidated financial statements at the respective measurement dates:

19. Segment Reporting and Geographic Information

The Company operates its business along four operating segments, which are segregated on the basis of revenue stream: Gaming, Virtual Sports, Interactive and Leisure. 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) and total capital expenditures for the periods ended September 30, 2023 and September 30, 2022, 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, right of use assets, cash, prepaid expenses and property and equipment and software development costs relating to corporate/shared functions.

Segment Information

Three Months Ended September 30, 2023

Three Months Ended September 30, 2022, as restated

Nine Months Ended September 30, 2023

Nine Months Ended September 30, 2022, as restated

Geographic Information

Geographic information for revenue is set forth below:

UK revenue includes revenue from customers headquartered in the UK, but whose revenue is generated globally.

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

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

20. Customer Concentration, as restated

During the three months ended September 30, 2023, one customer represented at least 10% of the Company’s revenues, accounting for 23% of the Company’s revenues. This customer was served by the Gaming, Virtual Sports and Interactive segments.

During the three months ended September 30, 2022, one customer represented at least 10% of the Company’s revenues, accounting for 14% of the Company’s revenues. This customer was served by the Virtual Sports and Interactive segments.

During the nine months ended September 30, 2023, two customers represented at least 10% of the Company’s revenues, accounting for 13% and 12% of the Company’s revenues, respectively. The customers were served by the Gaming, Virtual Sports and Interactive segments, and the Virtual Sports and Interactive segments, respectively.

During the nine months ended September 30, 2022, one customer represented at least 10% of the Company’s revenues, accounting for 13% of the Company’s revenues. This customer was served by the Virtual Sports and Interactive segments.

At September 30, 2023, no customers represented at least 10% of the Company’s accounts receivable. At December 31, 2022, there was one customer that represented at least 10% of the Company’s accounts receivable, accounting for 24% of the Company’s accounts receivable.

21. 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. Based upon this review, except for the effects of the restatement as discussed in Note 2 to the consolidated financial statements, the Company did not identify subsequent events that would have required adjustment or disclosure in the consolidated financial statements.