Inspired Entertainment, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual future results could differ materially from the historical results discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” included elsewhere in this report. Forward-Looking Statements We make forward-looking statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. For definitions of the term Forward-Looking Statements, see the definitions provided in the Cautionary Note Regarding Forward-Looking Statements at the start of this Annual Report on Form 10-K for the year ended December 31, 2021. COVID-19 Operating Restrictions During 2021 Governments in all of the major jurisdictions in which our land-based customers operate have now allowed the reopening of land-based venues, in certain circumstances subject to restrictions. United Kingdom Between April 12, 2021 and May 16, 2021, licensed betting offices in England and Wales were permitted to reopen with certain restrictions, including a limitation on operating only two of four gaming machines per venue, limited dwell time of 15 minutes, a maximum of two visits per day per patron and an 8:00pm curfew - these restrictions were removed on May 17, 2021. Gaming machines in pubs, holiday parks, motorway services, Scottish betting offices and adult gaming centers across the United Kingdom were permitted to reopen on May 17, 2021, with social distancing restrictions in place. On July 19, 2021, all social distancing restrictions were removed in England. On August 9, 2021, all remaining restrictions in the remainder of the United Kingdom were removed. In November 2021, the United Kingdom put in place further measures (that remained in place for the balance of 2021), but none of these measures resulted in the closure of any premises in which our land-based customers operate. Other Jurisdictions On August 20, 2021, Italy put in place restrictions such that only fully vaccinated people could enter our customers’ venues. On September 13, 2021, Greece put similar restrictions in place. These restrictions continue to be in force in both Italy and Greece. 36 It remains uncertain as to whether and when further restrictions or closures could be implemented in each jurisdiction and how long they may last to the extent they were implemented. We continue to protect our existing available liquidity by pro-actively managing capital expenditures and working capital as well as identifying both immediate and longer-term opportunities for cost savings. Revenue We generate revenue in four principal ways: i) on a participation basis, ii) on a fixed rental fee basis, iii) through product sales and iv) through software license fees. Participation revenue generally includes a right to receive a share of our customers’ gaming revenue, typically as a share of net win but sometimes as a share of the handle or “coin in” which represents the total amount wagered. Geographic Range Geographically, a majority of our revenue is derived from, and majority of our non-current assets are attributable to our UK operations. The remainder of our revenue is derived from, and non-current assets attributable to, Greece and the rest of the world (including North America). For the twelve months ended December 31, 2021, we derived approximately 71% of our revenue from the UK, 9% from Greece and the remaining 20% across the rest of the world. During the twelve months ended December 31, 2020, we derived approximately 76%, 9% and 15% of our revenue from those regions, respectively. As of December 31, 2021, our non-current assets (excluding goodwill) were attributable as follows: 73% to the UK, 9% to Greece and 18% across the rest of the world. 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 geographic region in which the largest portion of our business is operated is the UK 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 twelve months ended December 31, 2021, we derived approximately 29% of our revenue from sales to customers outside the UK, compared to 24% during the twelve months ended December 31, 2020. 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 functional currency at constant rate, is calculated as the difference in our functional currency, multiplied by the prior-period average GBP:USD rate. 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” below. 37 Results of Operations Our results are affected by changes in foreign currency exchange rates, primarily between our functional currency (GBP) and our reporting currency (USD). During the twelve-month periods ended December 31, 2021 and December 31, 2020, the average GBP:USD rates were 1.37 and 1.29, respectively. The following discussion and analysis of our results of operations has been organized in the following manner: ● a discussion and analysis of the Company’s results of operations for the twelve-month period ended December 31, 2021, compared to the same period in 2020; ● a discussion and analysis of the results of operations for each of the Company’s segments (Gaming, Virtual Sports, Interactive and Leisure) for the twelve-month period ended December 31, 2021, compared to the same period in 2020, including KPI analysis. In the discussion and analysis below, certain data may vary from the amounts presented in our consolidated financial statements due to rounding. Year-on-year comparisons may not be meaningful due to COVID-19 impacts in both the current and prior periods, as noted above. For all reported variances, refer to the overall company and segment tables shown below. All variances discussed in the overall company and segment results are on a functional currency (at constant rate) basis, which excludes the impact of any changes in foreign currency exchange rates. Overall Company Results Twelve Months ended December 31, 2021, compared to Twelve Months ended December 31, 2020 For the Twelve-Month Variance (In millions) Period ended 2021 vs 2020 December 31, 2021 December 31, 2020 Variance Attributable to Currency Movement Variance on a Functional currency basis Total Functional Currency Variance % Total Reported Variance % Revenue: Service $ 183.3 $ 178.7 $ 10.5 $ (5.9 ) (3.3 )% 2.6 % Product 25.6 21.1 1.5 3.0 14.4 % 21.5 % Total revenue 208.9 199.8 12.0 (2.9 ) (1.4 )% 4.6 % Cost of Sales, excluding depreciation and amortization: Cost of Service (34.3 ) (30.1 ) (2.1 ) (2.1 ) 6.8 % 13.7 % Cost of Product (16.4 ) (14.4 ) (0.9 ) (1.1 ) 7.9 % 14.2 % Selling, general and administrative expenses (97.2 ) (84.8 ) (5.9 ) (6.5 ) 7.7 % 14.7 % Stock-based compensation (13.0 ) (4.8 ) (0.8 ) (7.4 ) 155.7 % 171.7 % Acquisition and integration related transaction expenses (1.6 ) (7.0 ) (0.2 ) 5.7 (79.2 )% (77.4 )% Depreciation and amortization (47.0 ) (52.3 ) (3.3 ) 8.6 (16.3 )% (10.1 )% Net operating Income (Loss) (0.6 ) 6.4 (1.2 ) (5.7 ) (103.5 )% (109.3 )% Other income (expense) Interest expense, net (44.3 ) (30.0 ) (3.2 ) (11.2 ) 37.0 % 47.9 % Change in fair value of warrant liability 0.9 (3.2 ) 0.2 3.9 (150.4 )% (127.6 )% Other finance income (expense) 5.7 (4.7 ) 0.1 10.4 (208.4 )% (221.2 )% Loss from equity method investee - (0.5 ) (0.0 ) 0.5 (100.0 )% (100.0 )% Total other income (expense), net (37.7 ) (38.4 ) (2.9 ) 3.6 (9.5 )% (1.9 )% Net Income (loss) from continuing operations before income taxes (38.3 ) (32.1 ) (4.1 ) (2.1 ) 6.5 % 19.4 % Income tax expense 1.6 (0.4 ) 0.1 1.9 (518.4 )% (554.0 )% Net Income (Loss) $ (36.7 ) $ (32.4 ) $ (4.0 ) $ (0.3 ) 0.8 % 13.2 % Exchange Rate - $ to £ 1.37 1.29 See “Segments Results” below for a more detailed explanation of the significant changes in our components of revenue within the individual segment results of operations. Revenue Consolidated Reported Revenue by Segment For the twelve months ended December 31, 2021, revenue on a functional currency (at constant rate) basis decreased by $2.9 million, or 1.4%. Gaming revenue decreased by $33.4 million, due to $38.6 million of VAT-related revenue during 2020, excluding this, Gaming revenue would have grown by $5.2m. Virtual Sports, Interactive and Leisure grew by $1.3 million, $8.1 million, and $21.0 million, respectively. 38 Cost of Sales, excluding depreciation and amortization Cost of Sales, excluding depreciation and amortization, for the twelve months ended December 31, 2021 increased by $3.2 million, or 7.2%. Of this increase, $2.1 million was attributable to cost of Service and $1.1 million was attributable to cost of Product. Selling, general and administrative expenses Selling, general and administrative (“SG&A”) expenses for the twelve months ended December 31, 2021 increased by $6.5 million, or 7.7%. The increase was driven primarily by the return of furloughed staff for the majority of the period of $5.9 million, lower labor capitalization of $1.4 million, and $1.2 million of additional cost following a settlement with the Italian Tax Authorities in respect of an audit of the Italian Branch of Inspired Gaming (International) Limited for the period 2015-2017 in respect of the historic VAT treatment of supplies. This was partly offset by lower facility and marketing costs of $2.2 million. Stock-based compensation During the twelve months ended December 31, 2021, the Company recorded an expense of $13.0 million with respect to outstanding awards. The expense included $5.3 million related to awards made under the 2018 Plan, $6.6 million (including $1.4 million of upfront recognition) respectively related to awards made under the 2021 Plan and $1.1 million related to the vesting of awards from the 2018 Plan. The charge for stock-based compensation for the twelve months ended December 31, 2020, was $4.8 million. The expense included $4.5 million related to awards made under the 2018 Plan, $0.2 million, related to costs from awards made under a 2016 long term incentive plan and $0.1 million related to the vesting of awards in December 2020. Acquisition and integration related transaction expenses Acquisition and integration related transaction expenses decreased by $5.7 million, to $1.6 million. All expenses were integration costs in relation to the NTG acquisition. Depreciation and amortization Depreciation and amortization decreased for the twelve-month period by $8.6 million, driven primarily by a decrease in Gaming due to certain assets being fully depreciated. Net operating income/(loss) During the twelve-month period, net operating loss was $0.6 million, a decrease of $5.7 million. This was attributable primarily to the decrease in Gaming revenue driven by the recognition of VAT-related income in 2020. This was partially offset by increases in revenue in each of our Interactive, Virtuals and Leisure segments, as well as the decrease in acquisition and integration related transaction expenses, facility and marketing costs and depreciation and amortization. Interest expense, net Interest expense, net increased by $11.2 million in the twelve-month period ended December 31, 2021. This increase was due primarily to a $14.4 million write-off of previously capitalized debt fees following the refinancing in May 2021. Interest on term indebtedness increased by $1.8 million, but this was offset by currency movement of $3.2 million, reduction of revolver interest charges of $0.8 million and lower amortization of capitalized debt fees of $0.9 million following the refinancing. Change in fair value of warrant liability Change in fair value of warrant liability for the twelve-months ended December 31, 2021, resulted in a $0.9 million gain. The gain related to changes in liability accounting pursuant to the statement made by the Office of Chief Accountant of the SEC, released on April 12, 2021, informing market participants that warrants issued by special purpose acquisition companies may require classification as a liability of the entity measured at fair value, with changes in fair value each period reported in earnings. The credit reflects the decrease in the value of the warrants, driven by a decrease in the Company’s share price and a decrease in the time to warrant expiry, respectively. The warrants expired on December 23, 2021. Other finance income Other finance income for the twelve-months ended December 31, 2021, was $5.7 million. This compares to a $4.7 million expense in the twelve-months ended December 31, 2020, giving a year-on-year movement of $10.4 million. Of this increase, $10.3 million related to the retranslation of the principal balance of our senior debt facilities in place at that time. 39 Income tax expense Our effective tax rate for the twelve months ended December 31, 2021, was (4.2%), compared to 1.1% for the twelve months ended December 31, 2020. Net Income/ (loss) During the twelve-month period, we had a net loss of $36.7 million, a decrease of $0.3 million, primarily due to the decrease in net operating income ($5.7 million) and the increase in interest expense net ($11.2 million), partially offset by the decreases in other finance expense of $10.4 million, change in fair value of warrant liability of $3.9 million and income tax expense of $1.9 million. Segment Results ( for the twelve months ended December 31, 2021, compared to the twelve months ended December 31, 2020) Gaming We generate revenue from our Gaming segment through the sales and rentals of our gaming machines. We receive rental fees for machines, typically in conjunction with long-term contracts, on both a participation and fixed fee basis. 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 gaming terminals placed in our customers’ facilities. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract. Revenue growth for our Gaming business is principally driven by changes in (i) the number of operator customers we have, (ii) the number of Gaming machines in operation, (iii) the net win performance of the machines and (iv) the net win percentage that we receive pursuant to our contracts with our customers. Gaming, Key Performance Indicators For the Twelve-Month Period ended Variance Dec 31, Dec 31, 2021 vs 2020 Gaming 2021 2020 % End of period installed base (# of terminals) 31,891 31,515 376 1.2 % Total Gaming - Average installed base (# of terminals) 31,894 32,069 (174 ) (0.5 )% Participation - Average installed base (# of terminals) 29,189 30,165 (976 ) (3.2 )% Fixed Rental - Average installed base (# of terminals) 2,705 1,903 802 42.1 % Service Only - Average installed base (# of terminals) 21,563 21,015 548 2.6 % Customer Gross Win per unit per day (1) (2) £ 50.7 £ 46.7 £ 4.0 8.5 % Customer Net Win per unit per day (1) (2) £ 37.7 £ 34.6 £ 3.2 9.1 % Inspired Blended Participation Rate 6.4 % 6.5 % (0.1 )% (2.1 )% Inspired Fixed Rental Revenue per Gaming Machine per week £ 26.3 £ 26.3 £ 0.0 0.0 % Inspired Service Rental Revenue per Gaming Machine per week £ 3.4 £ 3.3 £ 0.1 4.4 % Gaming Long term license amortization (£’m) £ 5.0 £ 5.1 £ (0.1 ) (1.9 )% Number of Machine sales 3,372 2,832 540 19.1 % Average selling price per terminal £ 4,436 £ 4,337 £ 100 2.3 % (1) Includes all SBG terminals in which the company takes a participation revenue share across all territories (2) Includes all days of the year, including the days during which the Gaming terminals were not operating due to COVID-19 closures. In the table above: “End of Period Installed Base” is equal to the number of deployed Gaming terminals at the end of each period that have been placed on a participation or fixed rental basis. Gaming participation revenue, which comprises the majority of Gaming Service revenue, is directly related to the participation terminal installed base. This is the medium by which our customers generate revenue and distribute a revenue share to the Company. To the extent all other KPIs and certain other factors remain constant, the larger the installed base, the higher the Company’s revenue would be for a given period. Management gives careful consideration to this KPI in terms of driving growth across the segment. This does not include Service Only terminals. Revenue is derived from the performance of the installed base as described by the Gross and Net Win KPIs. 40 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. We believe 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. “Total Gaming - Average Installed Base” is the average number of deployed Gaming terminals during the period split by Participation terminals and Fixed Rental terminals. Therefore, it is more closely aligned to revenue in the period. We believe this measure is particularly useful for assessing existing customers or markets to provide comparisons of historical size and performance. This does not include Service Only terminals. “Participation - Average Installed Base” is the average number of deployed Gaming terminals that generated revenue on a participation basis. “Fixed Rental - Average Installed Base” is the average number of deployed Gaming terminals that generated revenue on a fixed rental basis. “Service Only - Average Installed Base” is the average number of terminals that generated revenue on a Service only basis. “Customer Gross Win per unit per day” is a KPI used by our management to (i) assess impact on the Company’s revenue, (ii) determine changes in the performance 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 Gaming 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. Gaming revenue 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 management believes 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 participation terminals where revenue is earned on a participation basis, weighted by Customer Net Win per unit per day. “Inspired Fixed Rental Revenue per Gaming Machine per week” is the Company’s average fixed rental amount across all fixed rental terminals where revenue is generated on a fixed fee basis, per unit per week. “Inspired Service Rental Revenue per Gaming Machine per week” is the Company’s average service rental amount across all service only rental terminals where revenue is generated on a service only fixed fee basis, per unit per week. “Gaming Long term license amortization” is the upfront license fee per terminal which is typically spread over the life of the terminal. Our overall Gaming revenue from terminals placed on a participation basis can therefore be calculated as the product of the Participation - Average Installed Base, the Customer Net Win per unit per day, the number of days in the period, and the Inspired Blended Participation Rate, which is equal to “Participation Revenue”. “Number of Machine sales” is the number of terminals sold during the period. “Average selling price per terminal” is the total revenue in GBP of the Gaming terminals sold divided by the “number of Machine sales”. 41 Gaming, Recurring Revenue Set forth below is a breakdown of our Gaming recurring revenue. Gaming recurring revenue principally consists of Gaming participation revenue and fixed rental revenue. For the Twelve-Month Period ended Variance December 31, December 31, 2021 vs 2020 (In £ millions) 2021 2020 % Gaming Recurring Revenue Total Gaming Revenue £ 59.4 £ 85.1 £ (25.8 ) (30.3 )% Gaming Participation Revenue £ 27.7 £ 25.1 £ 2.6 10.2 % Gaming Other Fixed Fee Recurring Revenue £ 6.9 £ 7.5 £ (0.6 ) (8.3 )% Gaming Long-term license amortization £ 5.2 £ 5.1 £ 0.0 0.7 % Total Gaming Recurring Revenue * £ 39.8 £ 37.8 £ 2.0 5.2 % Gaming Recurring Revenue as a % of Total Gaming Revenue † 67.0 % 44.4 % 22.6 % Total Gaming excluding VAT related-revenue £ 57.1 £ 53.1 Gaming Recurring Revenue as a % of Total Gaming Revenue (excluding VAT related-revenue) 69.7 % 71.2 % * Does not reflect VAT-related revenue. † Total Gaming Revenue for the twelve-month period ended December 31, 2021, includes the £2.3 million for VAT-related revenue, which is not reflected in Gaming Recurring Revenue for that period. Excluding VAT-related revenue, Gaming Recurring Revenue was 70.9% of Total Gaming Revenue for such period. In the table above: “Gaming Participation Revenue” includes our share of revenue generated from (i) our Gaming terminals placed in gaming and lottery venues; and (ii) licensing of our game content and intellectual property to third parties. “Gaming Other Fixed Fee Recurring Revenue” includes service revenue in which the Company earns a periodic fixed fee on a contracted basis. “Gaming Long term license amortization” – see the definition provided above “Total Gaming Recurring Revenue” is equal to Gaming Participation Revenue plus Gaming Other Fixed Fee Recurring Revenue. Gaming, Service Revenue by Region Set forth below is a breakdown of our Gaming service revenue by geographic region. Gaming Service revenue consists principally of Gaming participation revenue, Gaming other fixed fee revenue, Gaming long-term license amortization and Gaming other non-recurring revenue. See “Gaming Segment Revenue” below for a discussion of gaming service revenue between the periods under review. 42 For the Twelve-Month Period ended Variance (In millions) December 31, 2021 December 31, 2020 2021 vs 2020 Total Functional Currency % Service Revenue: UK LBO $ 30.3 $ 26.7 $ 3.7 13.7 % 5.7 % UK VAT - Related Income 3.1 42.2 $ (39.1 ) (92.6 )% (92.8 )% UK Other 7.9 6.4 1.5 24.2 % 17.9 % Italy 2.2 2.1 0.1 3.9 % (2.0 )% Greece 14.9 14.3 0.6 4.0 % (2.5 )% Rest of the World 0.4 0.6 (0.2 ) (32.6 )% (36.0 )% Total Service revenue $ 58.8 $ 92.2 $ (33.4 ) (36.2 )% (39.6 )% Exchange Rate - $ to £ 1.37 1.30 Note: Exchange rate in the table is calculated by dividing the USD total service revenue by the GBP total service revenue, therefore this could be slightly different from the average rate during the period depending on timing of transactions. Gaming, key events Total Gaming Customer Gross Win per unit per day (in our functional currency, GBP) for the period increased by £3.94, or 8.4%. The increase was due primarily to strong UK performance in the three-month period ending June 30, 2021, following the reopening of land-based venues (as more fully described in “ COVID-19 Operating Restrictions During 2021 ” above). Revenues from Greece also grew, primarily driven by our release of new content in the market. During the period, our land-based customers’ venues in the UK LBO estate exhibited strong year-over-year growth which accounted for the majority of the overall Gross Win per unit per day increase. When venues were operational, revenue performance generally returned to prior year levels in the Greek and Italian markets. During the twelve-month period, land-based venues of our customers across the business were in operation for approximately 65 percent of the time in each of 2020 and 2021. The overall participation rate for our installed base decreased from 6.5 percent in 2020 to 6.4 percent in 2021. This was due primarily to the COVID-19 restrictions in place in UK venues in 2020 compared to those in place during 2021, as UK share terms typically are lower than the total blended Gaming average. During the period ended December 31, 2020, Inspired received VAT-related revenue of $42.2 million from two major UK customers. During the period ended December 31, 2021, Inspired received VAT-related revenue of $2.9 million from one major UK customer. Receipts in each of 2020 and 2021 were recorded as revenue in our results. During 2021, we sold 424 VLTs to a major UK customer resulting in revenue of $2.5 million. We also upgraded our UK Gaming estate with the installation of 418 “Flex” and 573 “Prismatic” terminals through a combination of outright sales and lease agreements. 43 Inspired furthered its relationship with a major customer in the Dutch market with the sale and delivery of an additional 415 terminals during 2021. Inspired also secured a three-year contract extension with a major UK LBO customer for the service of self-service betting terminals (SSBTs), which are placed on a rental basis. Inspired recognized hardware sales for an additional 150 SSBTs during the period, generating revenue of $0.6 million. Inspired recognized a 944 VLT hardware sale to a major Italian customer in 2021, generating revenue of $1.1 million. This completed a 1,624 VLT hardware sale. As part of this transaction, Inspired expects to transition to a content supplier only model during 2022 resulting in meaningful operating expense savings. In conjunction with this transition, Inspired transferred a portion of its operation, including customer contracts and “in country” staff to a major Italian customer at the end of 2021. Inspired expects to continue to provide platform and content services to the customer. In the North America market, Inspired sold an aggregate of 274 Valor™ terminals to a number of customers in Illinois which increased cumulative North American unit sales to 703 since the December 2019 launch. Land-based venues in Illinois experienced Covid-related shutdowns during January 2021, which negatively impacted sales throughout the year. As of February 2021, each of the eleven regions in Illinois were no longer subject to COVID-related shutdowns. During the period, Inspired made its first sales to Western Canada Lottery Corporation (WCLC), our second jurisdiction in North America. Inspired recorded the sale of 100 Valor™ terminals to WCLC during March 2021, generating revenue of $1.5 million. On December 31, 2021 Inspired completed the acquisition of a lottery business based in the Dominican Republic. The business operates more than 2,500 terminals in various locations. In conjunction with this acquisition, Inspired secured a ten year extension to the agreement to supply the lottery terminals which now runs until March 9, 2035. Gaming, Results of Operations For the Twelve-Month Variance (In millions) Period ended 2021 vs 2020 December 31, 2021 December 31, 2020 Variance Attributable to Currency Movement Variance on a Functional currency basis Total Functional Currency Variance % Total Reported Variance % Revenue: Service $ 58.8 $ 92.2 $ 3.0 $ (36.5 ) (39.6 )% (36.2 )% Product 22.6 18.3 $ 1.3 3.0 16.5 % 23.8 % Total revenue 81.4 110.5 4.4 (33.4 ) (30.3 )% (26.3 )% Cost of Sales, excluding depreciation and amortization: Cost of Service (12.8 ) (15.7 ) $ (0.8 ) 3.8 (23.8 )% (18.9 )% Cost of Product (14.4 ) (12.4 ) $ (0.8 ) (1.2 ) 9.9 % 16.6 % Total cost of sales (27.2 ) (28.1 ) (1.6 ) 2.5 (9.0 )% (3.3 )% Selling, general and administrative expenses (28.1 ) (24.5 ) $ (1.7 ) (1.8 ) 7.4 % 14.5 % Stock-based compensation (1.8 ) (0.8 ) $ (0.1 ) (1.0 ) 127.1 % 140.0 % Depreciation and amortization (22.5 ) (27.6 ) $ (1.6 ) 6.6 (23.7 )% (18.3 )% Net operating Income (Loss) $ 1.8 $ 29.5 $ (0.6 ) $ (27.1 ) (93.7 )% (93.8 )% Exchange Rate - $ to £ 1.37 1.30 44 Note: Exchange rate in the table is calculated by dividing the USD total revenue by the GBP total revenue, therefore this could be slightly different from the average rate during the period depending on timing of transactions. All variances discussed in the Gaming results below are on a functional currency (at constant rate) basis, which excludes the impact of any changes in foreign currency exchange rates. Gaming Revenue During the twelve-month period, Gaming revenue was impacted by COVID-19 closures and restrictions which were imposed upon certain of our customers, with land-based venues across the business being operational for approximately 65% of the time for each of the current and prior year periods. Our UK LBO customers operated at an average of 69% of the time across 2020 and 68% of the time in 2021 with our customers in other UK business lines operating at an average of 62% of the time across both periods. Our Italian and Greek operated at an average of 54% of the time and 57% of the time in 2021 and 2020, respectively. During the twelve-month period, Gaming revenue decreased by $33.4 million, or 30.3%. This was driven primarily by a $38.6 million decrease in VAT-related revenue compared to the prior period. Excluding the VAT-related revenue, Gaming revenue during the twelve-month period increased by $5.2 million. During the twelve-month period, Gaming Service revenue (excluding VAT-related revenue) increased by $2.1 million. This was driven by an increase in the UK market (including LBOs and UK other) of $2.7 million primarily driven by the timing of COVID-19 closures, with closures and restrictions coming during the first and fourth quarter of the year in 2021 versus the second and fourth quarter in 2020. This was partially offset by declines in Greece of $0.4 million and Rest of World of $0.2 million. Product revenue increased in the twelve-month period by $3.0 million. This increase was primarily driven by Product sales of $1.9 million of Valor terminal sales in North America, $1.0 million in the UK markets, $0.7 million sales to Italy, partially offset by lower spare sales in Belgium of $0.4 million. Gaming Operating Income Operating Income decreased during the twelve-month period by $27.1 million. The decrease in Operating Income in the twelve-month period was primarily due to the decrease of $37.5 million in VAT-related income compared to the prior period and an increase of $1.8 million in SG&A as staff returned from furlough or to full salary for a higher proportion of 2021. This was partially offset by the decrease in Cost of Sales of $2.5 million and a $6.6 million decrease in depreciation and amortization driven by a decrease in depreciation in the UK LBO and Greece markets. Excluding the VAT-related Income, Operating Income would have increased by $10.4 million in the period. Virtual Sports We generate revenue from our Virtual Sports segment through the licensing of our products. We receive fees in exchange for the licensing of our products, typically on a long-term contract basis, on a participation basis. 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 other promotional costs and any relevant regulatory levies) from Virtual Sports content placed on our customers’ websites or in our customers’ facilities. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract. 45 Revenue growth for our Virtual Sports segment is principally driven by the number of customers we have, the net win performance of the games and the net win percentage that we receive pursuant to our contracts with our customers. Virtual Sports, Key Performance Indicators For the Twelve-Month Period ended Variance Dec 31, Dec 31, 2021 vs 2020 Virtuals 2021 2020 % No. of Live Customers at the end of the period 61 55 6 10.9 % Average No. of Live Customers 60 58 1 2.6 % Total Revenue (£’m) £ 26.2 £ 25.2 £ 1.0 3.9 % Total Revenue £’m - Retail £ 7.2 £ 9.5 £ (2.3 ) (23.9 )% Total Revenue £’m - Online Virtuals £ 19.0 £ 15.7 £ 3.3 20.7 % 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 (£m)” represents total revenue for the Virtual Sports segment, including recurring and upfront service revenue. Total revenue is also divided between “Total Revenue (£m) – Retail,” which consists of revenue earned through players wagering at Virtual Sports venues, “Total Revenue (£m) – Online Virtuals,” which consists of revenue earned through players wagering on Virtual Sports online. Virtual Sports, Recurring Revenue Set forth below is a breakdown of our Virtual Sports recurring revenue, which consists of Retail Virtuals and Online Virtuals recurring revenue as well as long-term license amortization. See “Virtual Sports Segment Revenue” below for a discussion of Virtual Sports Service revenue between the periods under review. For the Twelve-Month Period ended Variance December 31, December 31, 2021 vs 2020 (In £ millions) 2021 2020 % Virtual Sports Recurring Revenue Total Virtual Sports Revenue £ 26.2 £ 25.2 £ 1.0 3.9 % Recurring Revenue - Retail Virtuals £ 6.8 £ 8.4 £ (1.6 ) (18.7 )% Recurring Revenue - Online Virtuals £ 18.1 £ 13.8 £ 4.4 31.3 % Total Virtual Sports Long-term license amortization £ 0.8 £ 1.5 £ (0.7 ) (48.1 )% Total Virtual Sports Recurring Revenue £ 25.7 £ 23.7 £ 2.2 8.5 % Virtual Sports Recurring Revenue as a Percentage of Total Virtual Sports Revenue 98.1 % 93.9 % 4.2 % 46 “Recurring Revenue” includes our share of revenue generated from (i) our Virtual Sports products placed with operators; (ii) licensing our game content and intellectual property to third parties; and (iii) our games on third-party online gaming platforms that are interoperable with our game servers. “Virtual Sports Long term license amortization” is the upfront license fee which is typically spread over the life of the contract. Virtual Sports, key events During the twelve months ended December 31, 2021, we launched our Virtual Sports suite of products with BetMGM in New Jersey and OPAP and Novibet in Greece via our new proprietary Virtuals Plug & Play (VPP) platform. In Greece, US Basketball was deployed into the OPAP retail estate of approximately 3,500 venues. In Poland, we launched soccer and a mixed sports channel on 250 self serving betting terminals (SSBTs) with Fortuna, which complements our over the counter offer that was previously available. We also launched our Virtual Sports products on their Croatian retail estate consisting of approximately 200 venues and expect this to extend to a further 1,200 SSBTs during 2022. In Ireland, we deployed our new Horses and Greyhounds products in the approximately 750 venue Paddy Power UK and Irish retail estates. In Italy, multiple Italian clients, including Snaitech, launched with our new products Penalty Shootout, Matchday Ultra and Marbles. They also made various upgrades to existing products. We also deployed a suite of new content with Eurobet, part of Entain, across its retail and online channels which include approximately 790 retail venues. A new 5-year contract for a global distribution of Virtual Sports was signed with Entain covering both retail and online channels across multiple jurisdictions. Our largest online customer, Bet365, launched four channels of our brand-new V-Play Soccer 3 product and we renewed our contract with Bet365 to include the provision of additional products including Baseball, U.S Horses and Women’s Soccer. We signed new contracts with Mozzarbet (Serbia), Betplay (Colombia), Novibet (Greece), Betshop (Greece), iBet and Fonbet to deliver Virtuals via our new VPP (Virtual Plug and Play) platform, and with Scientific Games for distribution of Virtual Sports via its Open Arena platform. We also signed a new four-year contract with the Major League Baseball Players Alumni Association (MLBPAA) to allow Inspired to produce a suite of betting and gaming products utilizing the brand and image of MLBPAA members. During the last twelve-month period, Inspired’s Virtual products were shortlisted for the following awards: ● Global Gaming Awards London 2021, in the Retail Supplier of the Year category ● Virtual Sports Supplier and Virtual Sports Innovation at the 2021 SBC Awards ● EGR B2B 2021 in the Lottery Supplier category ● Virtual Sports Supplier and Casino Content Supplier at the 2022 EGR Nordics Awards. Virtual Sports, Results of Operations For the Twelve-Month Variance (In millions) Period ended 2021 vs 2020 December 31, 2021 December 31, 2020 Variance Attributable to Currency Movement Variance on a Functional currency basis Total Functional Currency Variance % Total Reported Variance % Service Revenue $ 36.0 $ 32.4 $ 2.4 $ 1.3 3.9 % 11.2 % Cost of Service (1.9 ) (2.9 ) (0.1 ) 1.1 (39.2 )% (34.8 )% Selling, general and administrative expenses (7.1 ) (4.4 ) (0.4 ) (2.3 ) 53.8 % 63.3 % Stock-based compensation (0.8 ) (0.4 ) (0.1 ) (0.3 ) 72.6 % 84.7 % Depreciation and amortization (3.4 ) (3.7 ) (0.2 ) 0.5 (14.7 )% (8.1 )% Net operating Income (Loss) $ 22.8 $ 21.0 $ 1.5 $ 0.3 1.5 % 8.6 % Exchange Rate - $ to £ 1.37 1.28 Note: Exchange rate in the table is calculated by dividing the USD service revenue by the GBP service revenue, therefore this could be slightly different from the average rate during the period depending on timing of transactions. All variances discussed in the Virtual Sports results below are on a functional currency (at constant rate) basis, which excludes the impact of any changes in foreign currency exchange rates. Virtual Sports revenue During the twelve-month period, revenue increased by $1.3 million, or 3.9%. This increase was driven by a $4.2 million increase in Online Virtuals, primarily driven by the growth of one of our major online customers, which was partially offset by a decline in recurring Retail Virtuals of $2.0 million - driven by the implementation of COVID restrictions in the Italian and Greek markets, allowing only fully vaccinated people to enter our venues, slower UK recovery after venues reopened, regulatory changes in China and Belgium which resulted in no revenue for 2021 and a decline of $0.9 million from historical license fee amortization related to contracts which expired. Virtual Sports operating income Operating Income increased by $0.3 million during the twelve-month period. The increase in the period was primarily due to the increase in revenue of $1.3 million, the decrease in Cost of Sales of $1.1 million and the decrease in Depreciation and Amortization of $0.5 million. This was partly offset by the increase in SG&A expenses of $2.3 million, driven by the $1.2 million expense from the settlement with the Italian Tax Authorities, an increase in staff costs as staff returned from furlough and to full pay and an increase in technology costs driven by the growth of Online Virtuals. Interactive We generate revenue from our Interactive segment through the licensing of our products. Typically, we receive fees in exchange for the licensing of our products, typically on a long-term contract basis, on a participation basis. 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 other promotional costs and any relevant regulatory levies) from Interactive content placed on our customers’ websites. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract. 47 Revenue growth for our Interactive segment is principally driven by the number of customers we have, the number of live games, the net win performance of the games and the net win percentage that we receive pursuant to our contracts with our customers. Interactive, Key Performance Indicators For the Twelve-Month Period ended Variance Dec 31, Dec 31, 2021 vs 2020 Interactive 2021 2020 % No. of Live Customers at the end of the period 109 92 17 18.5 % Average No. of Live Customers 100 80 20 25.4 % No. of Live Games at the end of the period 232 208 24 11.5 % Average No. of Live Games 216 196 20 10.0 % Total Revenue (£’m) £ 16.6 £ 10.3 £ 6.3 60.6 % 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 Interactive revenue at the end of the period and the average number of customers from which there is Interactive revenue during the period, respectively. “No. of Live Games at the end of the period” and “Average No. of Live Games” represents the number of games from which there is Interactive revenue at the end of the period and the average number of games from which there is Interactive revenue during the period, respectively. “Total Revenue (£m)” represents total revenue for the Interactive segment, including recurring and upfront service revenue. Interactive, Recurring Revenue Set forth below is a breakdown of our Interactive recurring revenue which consists principally of Interactive participation revenue. See “Interactive Segment Revenue” below for a discussion of Interactive service revenue between the periods under review. For the Twelve-Month Period ended Variance December 31, December 31, 2021 vs 2020 (In £ millions) 2021 2020 % Interactive Recurring Revenue Total Interactive Revenue £ 16.6 £ 10.3 £ 6.3 60.6 % Total Recurring Revenue - Interactive £ 16.6 £ 10.2 £ 6.4 62.3 % Interactive Recurring Revenue as a Percentage of Total Interactive Revenue 100.0 % 98.9 % 1.1 % Interactive, key events We undertook 44 new brand launches during 2021, including with BetMGM in New Jersey and Michigan, Golden Nugget in Michigan, Gamesys, DraftKings in Michigan, Rush Street Interactive in New Jersey and four brands under The Stars Group. We also launched with Luckia, 888 and Leo Vegas as our first operators in Spain. 48 During the twelve-month period, we were shortlisted for 15 iGaming awards including: - ● SBC Awards for “Casino / Slots Developer of the Year” ● Gaming Intelligence Awards, “Best iGaming Supplier” and “Best Game of the Year” ● Global Gaming Awards for “Digital Industry Supplier of the Year” ● EGR Operator Awards for “Game of the Year” ● EKG Slot Awards for Top Performing Online Slot ● International Gaming Awards for “Best Game of the Year” and “Best Slot Provider of the Year” ● Global Gaming Awards Las Vegas, for “Digital Industry Supplier of the Year” ● Sigma Europe Gaming Awards for “Online Casino Supplier of the Year” and “Online Slot Games” ● EGR North America Awards for “Casino Content Supplier” ● EGR Nordic Awards for “Casino Content Supplier” ● CasinoBeats Game Developer Awards for “Game Retro Style” ● |Women in Gaming Awards for “Leader of the Year” and “Innovator” ● iGB Most Influential Women in 2021, which Claire Osborne, our VP of Interactive, won We deployed 34 new games in 2021 across the estate including three seasonal titles, four operator-branded games and our own new branded games, including “Space Invaders” and “Big Fishing Fortune”. Interactive, Results of Operations For the Twelve-Month Variance (In millions) Period ended 2021 vs 2020 December 31, 2021 December 31, 2020 Variance Attributable to Currency Movement Variance on a Functional currency basis Total Functional Currency Variance % Total Reported Variance % Service Revenue $ 22.8 $ 13.3 $ 1.5 $ 8.1 60.6 % 71.6 % Cost of Service (3.7 ) (1.9 ) (0.2 ) (1.6 ) 87.4 % 99.4 % Selling, general and administrative expenses (6.1 ) (3.9 ) (0.4 ) (1.8 ) 47.0 % 55.8 % Stock-based compensation (0.6 ) (0.3 ) (0.0 ) (0.3 ) 113.5 % 128.2 % Depreciation and amortization (3.2 ) (2.3 ) (0.2 ) (0.6 ) 27.3 % 36.7 % Net operating Income (Loss) $ 9.2 $ 4.9 $ 0.6 $ 3.7 74.2 % 87.1 % Exchange Rate - $ to £ 1.37 1.29 Note: Exchange rate in the table is calculated by dividing the USD service revenue by the GBP service revenue, therefore this could be slightly different from the average rate during the period depending on timing of transactions. 49 All variances discussed in the Interactive results below are on a functional currency (at constant rate) basis, which excludes the impact of any changes in foreign currency exchange rates. Interactive revenue During the twelve-month period, revenue increased by $8.1 million, primarily driven by recurring revenue growth due to the consistent launch of new content across the estate, growth in the customer base in new, emerging and core markets and increased promotional activity through exclusive deals with tier-one customers. Interactive operating income Operating Income increased in the twelve-month period by $3.7 million. The increase was primarily due to the increase in revenue (detailed above), partially offset by an increase in cost of sales ($1.6 million) driven by an increase in third party platform provider costs (in line with the revenue increase for the period) as well as an increase in SG&A expenses ($1.8 million) driven by the investment in the segment to help drive the increasing revenues. Leisure We typically generate revenue from our Leisure segment through the rental of our gaming and amusement machines. We receive rental fees for machines, typically on a long-term contract basis, on both a participation and fixed fee basis, with our newer digital pub machines typically contracted on a fixed fee basis. 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 gaming terminals placed in our customers’ facilities. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract. Revenue growth for our Leisure segment is principally driven by the number of customers we have, the number of gaming 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. Leisure, Key Performance Indicators For the Twelve-Month Period ended Variance Dec 31, Dec 31, 2021 vs 2020 Leisure 2021 2020 % End of period installed base Gaming machines (# of terminals) 11,418 11,667 (249 ) (2.1 )% Average installed base Gaming machines (# of terminals) 11,576 12,083 (507 ) (4.2 )% End of period installed base Other (# of terminals) 6,838 7,193 (355 ) (4.9 )% Average installed base Other (# of terminals) 7,080 7,925 (845 ) (10.7 )% Pub Digital Gaming Machines - Average installed base (# of terminals) 6,087 5,772 315 5.5 % Pub Analogue Gaming Machines - Average installed base (# of terminals) 2,092 2,570 (478 ) (18.6 )% MSA and Bingo Gaming Machines - Average installed base (# of terminals) (1) 3,204 3,461 (257 ) (7.4 )% Inspired Leisure Revenue per Gaming Machine per week £ 36.9 £ 29.2 £ 7.7 26.4 % Inspired Pub Digital Revenue per Gaming Machine per week £ 36.2 £ 32.8 £ 3.4 10.3 % Inspired Pub Analogue Revenue per Gaming Machine per week £ 22.5 £ 18.7 £ 3.8 20.1 % Inspired MSA and Bingo Revenue per Gaming Machine per week £ 50.3 £ 32.4 £ 17.9 55.4 % Inspired Other Revenue per Machine per week £ 11.0 £ 6.9 £ 4.1 59.0 % Total Leisure Parks Revenue (Gaming and Non Gaming) (£’m) £ 21.1 £ 9.1 £ 12.0 132 % (1) Motorway Service Area machines In the table above: “End of period installed base Gaming” and “Average installed base Gaming” represent the number of gaming machines installed (excluding Leisure park machines) that are Category B and Category C only, from which there is participation or rental revenue at the end of the period or as an average over the period. 50 “End of period installed base Other” and “Average installed base Other” represent the number of all other category machines installed (excluding Leisure park machines) from which there is participation or rental revenue at the end of the period or as an average over the period. “Revenue per machine unit per week” represents the average weekly participation or rental revenue recognized during the period. Leisure, Recurring Revenue Set forth below is a breakdown of our Leisure recurring revenue which consists principally of Leisure participation revenue and Leisure other fixed fee revenue. See “Leisure Segment Revenue” below for a discussion of leisure service revenue between the periods under review. For the Twelve-Month Period ended Variance December 31, December 31, 2021 vs 2020 (In £ millions) 2021 2020 % Leisure Recurring Revenue Total Leisure Revenue £ 50.0 £ 33.7 £ 16.3 48.3 % Total Leisure Recurring Revenue £ 47.9 £ 31.6 £ 16.3 51.6 % Leisure Recurring Revenue as a Percentage of Total Leisure Revenue 95.7 % 93.5 % 2.1 % Leisure, key events During the twelve-month period ending December 31, 2021, all major components of the Leisure segment (Pubs, Holiday Parks, Motorway Service Areas and Bingo Halls) remained closed due to the COVID-19 closures in the UK until May 17 th , 2021. Venues subsequently reopened with social distancing and other restrictions imposed due to COVID-19. All significant COVID-19 restrictions were removed on July 19, 2021. After the removal of restrictions, further measures continued to result in frequent amendments to overseas travel policies in the UK. The additional costs and COVID testing requirements added to the uncertainty of overseas travel, resulting in a strong end to the season for our Leisure Parks business. A significant number of locations remained open into November due to increased demand for out-of-season holiday breaks. The MSA sector also continued to trade strongly due to increased travel within the UK and increasing volume of road transport. 51 Leisure, Results of Operations For the Twelve-Month Variance (In millions) Period ended 2021 vs 2020 December 31, 2021 December 31, 2020 Variance Attributable to Currency Movement Variance on a Functional currency basis Total Functional Currency Variance % Total Reported Variance % Revenue: Service $ 65.7 $ 40.8 $ 3.8 $ 21.0 51.5 % 60.9 % Product 3.0 2.8 0.2 0.0 0.2 % 7.2 % Total revenue 68.7 43.6 4.0 21.0 48.3 % 57.5 % Cost of Sales, excluding depreciation and amortization: Cost of Service (15.9 ) (9.6 ) (1.0 ) (5.3 ) 55.7 % 65.7 % Cost of Product (2.0 ) (2.0 ) (0.1 ) 0.1 (4.1 )% (0.2 )% Total cost of sales (17.9 ) (11.6 ) (1.0 ) (5.2 ) 45.3 % 54.3 % Selling, general and administrative expenses (35.1 ) (30.8 ) (2.1 ) (2.3 ) 7.4 % 14.3 % Stock-based compensation (0.6 ) (0.1 ) (0.0 ) (0.4 ) 283 % 307 % Depreciation and amortization (16.1 ) (16.9 ) (1.1 ) 1.9 (11.1 )% (4.7 )% Net operating Income (Loss) (1.0 ) (15.8 ) $ (0.3 ) $ 15.0 (93.9 )% (93.4 )% Exchange Rate - $ to £ 1.37 1.29 Note: Exchange rate in the table is calculated by dividing the USD total revenue by the GBP total revenue, therefore this could be slightly different from the average rate during the period depending on timing of transactions. All variances discussed in the Leisure results below are on a functional currency (at constant rate) basis, which excludes the impact of any changes in foreign currency exchange rates. Leisure Revenue For the twelve-month period, revenue increased by $21.0 million, or 48.3%, as our business benefitted from fewer COVID closures and social distancing restrictions during the period than in the prior year. Service revenue increased by $21.0 million, to $65.7 million. This was driven primarily by leisure park reopenings and the removal of COVID-19 restrictions. Product revenue remained in line with the prior period. Leisure Operating Loss Operating Loss for the twelve-month period improved by $15.0 million, to a loss of $1.0 million. This was primarily due to the increase in revenue as venues reopened and COVID-19 restrictions were removed, as well as a reduction in depreciation and amortization of $1.9 million. This was partially offset by increases in cost of sales, of $5.2 million, and SG&A expenses, of $2.3 million, due to staff returning from furlough and to full pay. 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. 52 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 income (loss) excluding depreciation and amortization, interest expense, interest income and income tax expense. Adjusted EBITDA is defined as net income (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, dual running costs, costs related to facility closures and integration costs, (2) merger and acquisition costs and (3) gains or losses not in the ordinary course of business. This does not include any adjustments related to COVID-19. 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. Functional Currency at Constant rate. Currency impacts discussed 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 functional currency at constant rate, is calculated as the difference in our functional currency, multiplied by the prior-period average GBP: USD rate, as a proxy for functional currency at constant rate movement. Currency Movement represents the difference between the results in our reporting currency (USD) and the results on a functional currency (at constant rate) basis. 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 by segment for the Twelve Months ended December 31, 2021 (In millions) For the Twelve-Month Period ended December 31, 2021 Total Gaming Virtual Sports Interactive Leisure Corporate Net Income/ (loss) $ (36.7 ) $ 1.8 $ 22.8 $ 9.2 $ (1.0 ) $ (69.5 ) Items Relating to Legacy Activities: Pension charges (1) 0.8 - - - - 0.8 Items outside the normal course of business: Acquisition and integration related transaction expenses (3) 1.6 - - - - 1.6 Refinancing of Company Debt (4) 0.8 - - - - 0.8 Italian tax related costs relating to prior years (5) 1.4 - 1.4 - - - Stock-based compensation expense 13.0 1.8 0.8 0.6 0.6 9.2 Depreciation and amortization 47.0 22.5 3.4 3.2 16.1 1.8 Interest expense net 44.3 - - - - 44.3 Change in fair value of warrant liability (0.9 ) - - - - (0.9 ) Other finance expenses / (income) (5.7 ) - - - - (5.7 ) Income tax (1.6 ) - - - - (1.6 ) Adjusted EBITDA $ 64.0 $ 26.1 $ 28.4 $ 13.0 $ 15.7 $ (19.2 ) Adjusted EBITDA £ 46.7 Exchange Rate - $ to £ (7) 1.37 Note: 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, these are shown in the Corporate category. 53 Reconciliation to Adjusted EBITDA by segment for the Twelve Months ended December 31, 2020 (In millions) For the Twelve-Month Period ended December 31, 2020 Total Gaming Virtual Sports Interactive Leisure Corporate Net Income/ (loss) $ (32.4 ) $ 29.5 $ 21.0 $ 4.9 $ (15.8 ) $ (72.0 ) Items Relating to Legacy Activities: Pension charges (1) 0.6 - - - - 0.6 Items outside the normal course of business: Costs of group restructure (2) 0.8 - - - - 0.8 Acquisition and integration related transaction expenses (3) 7.0 - - - - 7.0 Impairment on interest in equity method investee(6) 0.7 - - - - 0.7 Stock-based compensation expense 4.8 0.8 0.4 0.3 0.1 3.2 Depreciation and amortization 52.3 27.6 3.7 2.3 16.9 1.8 Interest expense net 30.0 - - - - 30.0 Change in fair value of warrant liability 3.2 - - - - 3.2 Other finance expenses / (income) 4.7 - - - - 4.7 Income tax 0.4 - - - - 0.4 Adjusted EBITDA $ 72.1 $ 57.9 $ 25.1 $ 7.5 $ 1.3 $ (19.7 ) Adjusted EBITDA £ 55.5 Exchange Rate - $ to £ (7) 1.30 Note: 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, these are shown in the Corporate category. Notes to Adjusted EBITDA reconciliation tables above: (1) “Pension charges” are profit and loss charges included within selling, general and administrative 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 Corporate Functions. (2) “Costs of group restructure” include redundancy costs, Payments In Lieu of Notice costs, any associated employer taxes and costs associated with onerous property leases. To qualify as being an adjusting item, costs must be part of a large restructuring project, which will net save ongoing future costs. These costs were primarily incurred in connection with the property consolidation. (3) Acquisition and integration related transaction expenses, 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. Total expense, net includes interest income, interest expense, change in fair value of earnout liability, change in fair value of derivative liability and other finance income. (4) In May 2021, the Company refinanced its debt. These are the one-off fees as a result of the refinance. (5) “Italian tax related costs relating to prior years invoicing” relate to a settlement with the Italian Tax Authorities in respect of an audit of the Italian Branch of Inspired Gaming (International) Limited for the period 2015-2017 in respect of the historic VAT treatment of supplies. (6) In April 2020, the Company disposed of its 40% non-controlling equity interest in Innov8 Gaming Limited which resulted in the investment of $0.7 million being written off. (7) Exchange rate in the table is calculated by dividing the USD Adjusted EBITDA by the GBP Adjusted EBITDA, therefore this could be slightly different from the average rate during the period depending on timing of transactions. 54 Liquidity and Capital Resources Twelve Months ended December 31, 2021, compared to Twelve Months ended December 31, 2020 12 Months ended Variance (in millions) Dec 31, Dec 31, 2021 2020 2021 to 2020 Net loss $ (36.7 ) $ (32.4 ) $ (4.3 ) Amortization of debt fees 17.2 3.4 13.8 Change in fair value of derivative and warrant liabilities and stock-based compensation expense 13.6 8.9 4.7 Impairment expense 0.0 0.7 (0.7 ) Foreign currency translation on senior bank debt and cross currency swaps (4.6 ) 5.6 (10.2 ) Depreciation and amortization (incl RoU assets) 50.3 55.9 (5.6 ) Other net cash (utilized)/generated by operating activities (33.6 ) 10.8 (44.4 ) Net cash provided by operating activities 6.2 52.9 (46.7 ) Net cash used in investing activities (38.1 ) (29.9 ) (8.2 ) Net cash generated/(used) by financing activities 31.2 (8.2 ) 39.4 Effect of exchange rates on cash 1.4 3.2 (1.8 ) Net increase in cash and cash equivalents $ 0.7 $ 18.0 $ (17.3 ) Net cash provided by operating activities For the twelve months ended December 31, 2021, net cash inflow provided by operating activities was $6.2 million, compared to a $52.9 million inflow for the twelve months ended December 31, 2020, representing a $46.7 million decrease in cash generation. This decrease was driven primarily by interest timing differences resulting in interest payments of $30.8 million, compared to $13.3 million in the prior period, and that the prior period included $41.9 million of VAT-related income, compared to $3.2 million in 2021. Amortization of debt fees increased by $13.8 million, to $17.2 million, due to the write-off of capitalized debt fees totaling $14.4 million in May 2021 in conjunction with the Company’s refinancing. Change in fair value of derivative and warrant liabilities and stock-based compensation expense increased by $4.7 million, from $8.9 million to $13.6 million. Of the increase, $8.2 million related to stock-based compensation expense and $0.6 million related to the movement in cross-currency swaps. Movements in the fair valuation of warrant liabilities decreased by $4.1 million. Foreign currency translation on senior bank debt and cross currency swaps resulted in a loss of $4.6 million for the twelve months ended December 31, 2021, as a result of the movement in exchange rates during the period, compared to a $5.6 million gain for the twelve months ended December 31, 2020. Depreciation and amortization decreased by $5.6 million, to $50.3 million, with reductions of $3.6 million in machine depreciation, $1.5 million in amortization of intangible assets and $0.3 million in both non-machine deprecation and right of use asset amortization. Other net cash utilized by operating activities decreased by $44.4 million, to a $33.6 million outflow following the impact of the COVID-19 closures. Movements due to different timing of interest payments following the May 2021 refinancing have resulted in a $16.2 million higher outflow in the twelve-months ended December 31, 2021. A higher VAT accrual level at the start of 2021 resulted in a $11.0 million net adverse movement in the twelve-months ended December 31, 2021. Further adverse movements were also seen on income accrual levels ($8.4 million), long term receivables ($2.6 million), prepaid expenses and other current assets ($3.1 million), deferred revenue ($2.9 million) and payroll and corporation taxes ($3.6 million). COVID-19 trading levels have resulted in adverse movements on trade receivables ($2.1 million) but these were offset by favorable movements on trade payables ($5.5 million). 55 Net cash used in investing activities Net cash used in investing activities increased by $8.0 million, to $37.9 million in the twelve-months ended December 31, 2021. This was driven primarily by the $12.5 million acquisition of Sportech Lotteries LLC which was partially offset by lower spend on plant, property and equipment ($3.8 million decrease compared to 2020) and capitalized software ($0.7 million decrease compared to 2020). Net cash generated by financing activities During the twelve-months ended December 31, 2021, net cash generated by financing activities was $31.2 million, compared to a $8.2 million outflow in the twelve-months ended December 31, 2020. The inflow in the twelve-months ended December 31, 2021, related primarily to the proceeds generated from warrant exercise ($30.5 million), the net movement from the May 2021 refinancing and finance lease spend of $0.6 million. During the twelve-months ended December 31, 2020, changes in the level of revolver drawn provided a $4.2 million outflow as well as $3.1 million of debt fees incurred and $0.9 million of finance lease spend. Funding Needs and Sources To fund our obligations, historically we have relied on a combination of cash flows provided by operations and the incurrence of additional debt or the refinancing of existing debt. As of December 31, 2021, we had liquidity consisting of $47.6 million in cash and cash equivalents and a further $27.0 million of undrawn revolver facility. This compares to $47.1 million of cash and cash equivalents as of December 31, 2020, with a further $27.2 million of revolver facilities undrawn. We had a working capital outflow of $33.6 million for the twelve-months ended December 31, 2021, compared to an $10.9 million inflow for the twelve-months ended December 31, 2020. The level of our working capital surplus or deficit varies with the level of machine production we are undertaking and our capitalization as well as the seasonality evident in some of the businesses purchased as part of the NTG Acquisition. In periods with minimal machine volumes and capital spend, our working capital is typically more stable. In periods where significant numbers of machines are being produced, the levels of inventory and creditors are typically higher 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 which have been seen during 2020 and 2021 following the COVID-19 closures, 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. Some of our business operations require cash to be held within the machines. As of December 31, 2021, $2.7 million of our $47.6 million of cash and cash equivalents were held as operational floats within the machines. Management currently believes that the Company’s cash balances on hand, cash flows expected to be generated from operations, and the ability to control and defer capital projects will be sufficient to fund the Company’s net cash requirements through March 2023. Long Term and Other Debt See Note 13 Long Term and Other Debt of the Financial Statements for detail of the debts held during 2020 and 2021. Debt Covenants Under our debt facilities in place as of December 31, 2021, we are not subject to covenant testing on the Senior Secured Notes. We are, however, subject to covenant testing at the level of Inspired Entertainment Inc., the ultimate holding company, on our Super Senior Revolving Credit Facility which requires the Company to maintain a maximum consolidated senior secured net leverage ratio of 6.25x on the test date for the relevant period ending June 30, 2021, stepping down to 6.0x on March 31, 2022, 5.75x on March 31, 2023 and 5.50x from March 31, 2024 and thereafter (the “RCF Financial Covenant”). The RCF Financial Covenant is calculated as the ratio of consolidated senior secured net debt to consolidated pro forma EBITDA (defined as net loss excluding depreciation and amortization, interest expense, interest income and income tax expense) for the 12-month period preceding the relevant quarterly testing date and is tested quarterly on a rolling basis, subject to the Initial Facility (as defined in the RCF Agreement) being drawn on the relevant test date. The RCF Financial Covenant does not include a minimum interest coverage ratio or other financial covenants. Covenant testing at December 21, 2021 showed covenant compliance. 56 Under our debt facilities in place as of December 31, 2020, we were subject to covenant testing on the Senior Secured Notes. The covenant testing was set at the level of Inspired Entertainment Inc., the ultimate holding company, and consisted of a test on Leverage (Consolidated Total Net Debt/Consolidated Pro Forma EBITDA) and a test on the level of capital expenditure. These were measured under U.S. GAAP. Leverage was tested at quarterly intervals commencing for the period ending June 30, 2020, and capital expenditure was tested annually commencing on December 31, 2019. Prior to reaching our first leverage covenant test on June 30, 2020, the covenants were reset as a direct result of the impact of COVID-19 on the global economy and subsequent loss of trading as a result of government lockdowns in many key trading countries around the world. Formal agreement of the revised covenants was achieved on June 25, 2020. There were no breaches of the debt covenants in the periods ended December 31, 2021 or December 31, 2020. Liens and Encumbrances As of December 31, 2021, 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 December 31, 2021, our contractual obligations were as follows: Less than More than Contractual Obligations (in millions) Total 1 yr 1-3 years 3-5 years 5 yrs Operating activities Interest on long term debt $ 112.2 $ 24.9 $ 49.8 $ 37.5 $ - Financing activities Senior bank debt - principal repayment 316.7 - - 316.7 - Finance lease payments 2.8 1.0 1.3 0.5 - Operating lease payments 10.7 3.3 3.7 1.8 1.9 Interest on non-utilisation fees 1.6 0.4 0.8 0.4 - Total $ 444.0 $ 29.6 $ 55.6 $ 356.9 $ 1.9 Off-Balance Sheet Arrangements As of December 31, 2021, there were no off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, promulgated by the U.S. Securities and Exchange Commission. 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 make estimates and assumptions. 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 revenue 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. 57 For a discussion of other recently issued accounting standards, and assessments as to their impacts on the Company, see Nature of Operations, Management’s Plans and Summary of Significant Accounting Policies, Note 1 to the consolidated financial statements included elsewhere in this report.