Inspired Entertainment, Inc. - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2017

For the transition period from __________ to __________

Commission File Number: 001-36689

INSPIRED ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

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

As of May 5, 2017, there were 22,419,069 shares of the Company’s common stock issued and outstanding.

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except share and per share data)

(Unaudited)

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands, except share data)

(Unaudited)

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Company Description and Nature of Operations

Inspired Entertainment, Inc. (f/k/a Hydra Industries Acquisition Corp.) (the “Company,” the “Group,” “we,” “our,” and “us”) is a global gaming technology company, supplying Virtual Sports, Mobile and Server Based Gaming (“SBG”) systems to regulated lottery, betting and gaming operators worldwide. Our strategic focus is the development and sale of software systems and digital terminals.

The Company was originally incorporated in Delaware on May 24, 2014 as a special purpose acquisition company, formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization, recapitalization or other similar business combination with one or more businesses. On December 23, 2016 (the “Closing Date”), the Company consummated its business combination with DMWSL 633 Limited (“Inspired”) pursuant to the Share Sale Agreement (the “Merger”), dated as of July 13, 2016, by and among the Company, the previous owners, Inspired, DMWSL 632 Limited and Gaming Acquisitions Limited (the “Sale Agreement”). In connection with the closing of the Merger, the Company changed its name from Hydra Industries Acquisition Corp. to Inspired Entertainment, Inc. Unless the context otherwise requires, the “Company” refers to the combined company and its subsidiaries following the Merger, “Hydra” refers to the Company prior to the closing of the Merger and “Inspired” refers to Inspired prior to the Merger. See Note 2 for further discussion of the Merger.

Management Liquidity Plans

As of March 31, 2017, the Company’s cash on hand was $13,345 and the Company had working capital of $4,367. The Company recorded net losses of $31,503 and $30,389 for the six months ended March 31, 2017 and 2016, respectively. The net losses arose primarily due to one-time items, primarily acquisition related expenses and interest on shareholder loan notes which are no longer a liability of the Company following the Merger as detailed in Note 2. The Company historically has had positive cash flows from operating activities and has relied on a combination of cash flows provided by operations and the incurrence of additional debt and/or the refinancing of existing debt to fund its obligations. Management 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 borrowings available under the Company’s credit facilities will be sufficient to fund the Company’s net cash requirements through May 2018.

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 (“US GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 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 US 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 Inspired’s consolidated financial statements and notes thereto for the periods ended September 24, 2016, September 26, 2015 and September 27, 2014. The financial information as of September 24, 2016 is derived from the audited consolidated financial statements presented in the Form 8-K filed by the Company with the SEC on December 30, 2016. The interim results for the three and six months ended March 31, 2017 are not necessarily indicative of the results to be expected for the year ending September 30, 2017 or for any future interim periods.

The Merger has been accounted for as a reverse merger in accordance with US GAAP. This determination was primarily based on Inspired’s business comprising the ongoing operations of the Company following the Merger, Inspired’s senior management comprising the senior management of the Company and Inspired’s stockholders having a majority of the voting power of the Company. For accounting purposes, Hydra is considered the “acquired” company and Inspired is considered the “acquirer.” Accordingly, for accounting purposes, the Merger is treated as the equivalent of Inspired issuing stock for the net assets of Hydra, accompanied by a recapitalization. The net assets of Hydra are stated at historical cost, with no goodwill or other intangible assets recorded. The consolidated assets, liabilities and results of operations prior to the Closing Date of the Merger are those of Inspired, and Hydra’s assets, liabilities and results of operations are consolidated with Inspired beginning on the Closing Date. The shares and corresponding capital amounts and earnings per share available to common stockholders, pre-merger, have been retroactively restated as shares reflecting the exchange ratio in the Merger. The historical financial information and operating results of Hydra prior to the Merger have not been separately presented in these condensed consolidated financial statements as they were not significant or meaningful.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Effective September 25, 2016, the Company changed its reporting year end from a 52-week period ending on the last Saturday in September to a September 30 year end, commencing with the year ending September 30, 2017. Accordingly, the period ended March 31, 2017 includes the results of operations for the Company for the period from September 25, 2016 through March 31, 2017. Additionally, the period ended March 31, 2016 includes the results of operations for the Company for the period from September 27, 2015 through March 31, 2016.

Principles of Consolidation

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

Reclassification

Certain prior year amounts were reclassified to conform to the current year’s presentation. These reclassifications have no effect on the financial position or results of operations reported as of and for the three and six months ended March 31, 2016.

Use of Estimates

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

Common Stock Purchase Warrants and Derivative Financial Instruments

The Company reviews any common stock purchase warrants and other freestanding derivative financial instruments at each balance sheet date and classifies them on the condensed consolidated balance sheet as:

The Company assesses classification of its common stock purchase warrants and other freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company determined that its outstanding common stock purchase warrants satisfied the criteria for classification as equity instruments at March 31, 2017. The Company also determined that its obligation to settle certain management bonuses in either cash or stock satisfied the criteria for classification as a derivative financial instrument at March 31, 2017 (see Note 14).

Share-Based Payment Arrangements

The Company accounts for stock based compensation in accordance with Accounting Standards Codification (“ASC”) 718, “Compensation - Stock Compensation” (“ASC 718”). ASC 718 requires generally that all equity awards be accounted for at their “fair value.” This fair value is measured on the grant date for stock-settled awards, and at subsequent exercise or settlement for cash-settled awards. Fair value is equal to the underlying value of the stock for “full-value” awards such as restricted stock and performance shares, and is estimated using an option-pricing model with traditional inputs for “appreciation” awards such as stock options and stock appreciation rights.

Costs equal to these fair values are recognized ratably over the requisite service period based on the number of awards that are expected to vest, or in the period of grant for awards that vest immediately and have no future service condition. For awards that vest over time, previously recognized compensation cost is reversed if the service or performance conditions are not satisfied and the award is forfeited. The expense resulting from share-based payments is recorded in general and administrative expense in the accompanying consolidated statements of operations.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Subsequent modifications to outstanding awards result in incremental cost if the fair value is increased as a result of the modification.

Customer Concentration

During the three months ended March 31, 2017, there were two customers that represented at least 10% of revenues, accounting for 27% and 13% of the Company’s revenues. During the three months ended March 31, 2016, two customers represented at least 10% of revenues, accounting for 29% and 12% of the Company’s revenues.

During the six months ended March 31, 2017, there were two customers that represented at least 10% of revenues, accounting for 29% and 12% of the Company’s revenues. During the six months ended March 31, 2016, two customers represented at least 10% of revenues, accounting for 30% and 11% of the Company’s revenues.

At March 31, 2017, one customer represented at least 10% of accounts receivable, accounting for 30% of the Company’s accounts receivable. At September 24, 2016, there were no customers that represented at least 10% of accounts receivable.

Recently Issued Accounting Standards

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

In March 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 was issued as part of the FASB’s simplification initiative and affects all entities that issue share-based payment awards to their employees. The amendments in this update cover such areas as the recognition of excess tax benefits and deficiencies, the classification of those excess tax benefits on the statement of cash flows, an accounting policy election for forfeitures, the amount an employer can withhold to cover income taxes and still qualify for equity classification and the classification of those taxes paid on the statement of cash flows. ASU 2016-09 is effective for annual and interim periods beginning after December 15, 2016. This guidance can be applied either prospectively, retrospectively or using a modified retrospective transition method, depending on the area covered in this update. Early adoption is permitted. The Company adopted the methodologies prescribed by ASU 2014-15 as of October 1, 2016. The adoption of ASU 2016-09 did not have a material effect on the Company’s financial position or results of operations.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Clarification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), which eliminates the diversity in practice related to the classification of certain cash receipts and payments in the statement of cash flows, by adding or clarifying guidance on eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for annual and interim periods beginning after December 15, 2017 and early adoption is permitted. ASU 2016-15 provides for retrospective application for all periods presented. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740)” (“ASU 2016-16”), which reduces the complexity in the accounting standards by allowing the recognition of current and deferred income taxes for an intra-entity asset transfer, other than inventory, when the transfer occurs. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted using a modified retrospective transition approach. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805) Clarifying the Definition of a Business” (“ASU 2017-01”). The amendments in ASU 2017-01 is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the impact of adopting this guidance.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 eliminates Step 2 along with amending other parts of the goodwill impairment test. Under ASU 2017-04, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value with the loss not exceeding the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual periods beginning after December 15, 2019, and interim periods therein with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. At adoption, this update will require a prospective approach. The Company is currently evaluating the impact of adopting this guidance.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

In March 2017, the FASB issued ASU 2017-07, “Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”). The new guidance requires companies with sponsored defined benefit pension and/or other postretirement benefit plans to present the service cost component of net periodic benefit cost in the same income statement line item as other compensation costs. The other components of net periodic benefit cost will be presented separately and not included in operating income. In addition, only service costs are eligible to be capitalized as an asset. ASU 2017-07 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those years, and the guidance will generally be applied retroactively, whereas the capitalization of the service cost component will be applied prospectively. Early adoption is permitted with all of the amendments adopted in the same period. If an entity early adopts the guidance in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. The Company is currently assessing the effect that ASU 2017-07 will have on its financial position, results of operations, and disclosures.

On the Closing Date, Hydra and Inspired consummated the Merger contemplated by the Sale Agreement which provided for, among other things, the acquisition of all of the outstanding equity and shareholder loan notes of Inspired by Hydra pursuant to the Merger. In connection with the Merger, Hydra issued 11,815,435 shares of common stock to the prior owners of Inspired.

Immediately following the Merger, there were 20,213,466 shares of common stock outstanding and warrants to purchase 9,539,615 shares of common stock.

Warrants

As of the Closing Date of the Merger, Hydra had 19,079,230 outstanding warrants to purchase an aggregate of 9,539,615 shares of the Company’s common stock, which includes 8,000,000 warrants originally issued as part of the IPO (the “Public Warrants”) and 11,079,230 warrants issued in private placements (the “Private Placement Warrants”). Each warrant entitles its holder to purchase one-half of one share of the Company’s common stock at an exercise price of $11.50 per whole share and will expire on December 23, 2021, or earlier upon liquidation by the Company. The warrants became exercisable 30 days after the Closing Date. The Company may redeem the Public Warrants at a price of $0.01 per warrant if the last sale price of the common stock equals or exceeds $24.00 per share for any 20 trading days within a 30 trading day period. The Company may not redeem the Private Placement Warrants so long as they are held by the initial purchaser or such purchasers’ permitted transferees. If the Private Placement Warrants are held by someone other than the initial purchasers or such purchasers’ permitted transferees, the Private Placement Warrants will be redeemable by the Company and exercisable by such holders on the same basis as the Public Warrants.

Accounts receivable consist of the following:

Inventory consists of the following:

Component parts include parts for gaming terminals. Included in component parts are reserves for excess and slow-moving inventory of $363 and $469 as of March 31, 2017 and September 24, 2016, respectively. Our finished goods inventory primarily consists of gaming terminals which are ready for sale.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Prepaid expenses and other assets consist of the following:

Depreciation and amortization expense amounted to $4,519 and $5,789 for the three months ended March 31, 2017 and 2016, respectively, and $9,157 and $12,073 for the six months ended March 31, 2017 and 2016, respectively.

Software development costs, net consisted of the following:

For the quarter ended March 31, 2017, the Company capitalized $5,158 of software development costs. Amounts in the above table include $2,385 and $1,797 of internal use software at March 31, 2017 and September 24, 2016, respectively.

The total amount of software costs amortized was $2,444 and $2,463 for the three months ended March 31, 2017 and 2016, respectively, and $4,193 and $4,492 for the six months ended March 31, 2017 and 2016, respectively. Software costs written down to net realizable value amounted to $263 for the three and six months ended March 31, 2017. The Company did not have any software costs written down to net realizable value in the three and six months ended March 31, 2016. The weighted average amortization period was 3.2 years for the three and six months ended March 31, 2017 and 2016. The estimated software amortization expense for the six months ending September 30, 2017 is $5,976 and for the years ending September 30, 2018, 2019, 2020, 2021 and 2022 is $12,971, $11,147, $6,808, $3,286 and $912 per annum, respectively.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

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

Aggregate intangible asset amortization expense amounted to $777 and $920 for the three months ended March 31, 2017 and 2016, respectively, and $1,558 and $1,879 for the six months ended March 31, 2017 and 2016, respectively. The estimated intangible asset amortization expense for the period ending September 30, 2017 (six months) is $1,566 and for the years ended September 30, 2018 and 2019 is $3,132 per annum, with a final amortization expense of $2,337 in the year ending September 30, 2020.

Goodwill

The difference in the carrying amount of goodwill at March 31, 2017 and September 24, 2016, as reported in the accompanying unaudited interim condensed consolidated balance sheets is attributable to foreign currency translation adjustments.

Accrued expenses consist of the following:

Other liabilities consist of the following:

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Outstanding Debt and Capital Leases

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

In connection with the Merger, the value of PIK shareholder loan notes was reduced from $291,780 to $116,790. Accordingly, the Company recorded $174,990 as a capital contribution in the accompanying condensed consolidated statement of stockholders’ equity representing the reduction in the value of the PIK shareholder loan notes. The shareholders transferred their rights to the remaining loan balance of $116,790 to Hydra in connection with the Merger, and therefore the $116,790 is eliminated in consolidation. The $116,790 was also accounted for as a capital contribution by the shareholders. These amounts are recorded in the Condensed Consolidated Statements of Stockholders Equity in shares issued in merger.

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

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

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

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

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

Pursuant to the Sale Agreement discussed in Note 2, an earnout payment of up to 2,500,000 shares of the Company’s common stock, subject to certain customary anti-dilution adjustments (having a value of $25,000 at an assumed value of $10.00 per share (the “Earnout Consideration”) shall be paid to the previous owners of Inspired (the “Selling Group”) and will be determined based on the financial performance of Inspired’s businesses in six specific countries, China, Colombia, Greece, Norway, Spain and Ukraine (collectively, the “Earnout Jurisdictions”), as measured by earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the twelve months ending September 30, 2018 (the “Earnout Period”). If such EBITDA is equal to or greater than £15,000 ($18,713), the Selling Group will receive an aggregate of 2,500,000 shares. If such EBITDA is less than £15,000 ($18,713), the Selling Group will receive the number of shares equal to the product of (x) 2,500,000 and (y) a fraction, the numerator of which is such EBITDA and the denominator of which is £15,000 ($18,713). For example, if the EBITDA achieved in such countries for the period were £7,500 ($9,356), the Selling Group would receive 1,250,000 shares as the earn-out payment. By contrast, if the EBITDA achieved in such countries for the period were £20,000 ($24,950), the Selling Group would receive 2,500,000 shares as the earn-out payment.

In accordance with ASC 815, “Derivatives and Hedging” (“ASC 815”), the earnout shares are not considered indexed to the Company’s own stock and therefore are accounted for as a liability with fair value changes being recorded in the condensed consolidated statements of operations and comprehensive loss. The fair value of the Earnout Consideration is calculated using a Monte Carlo simulation to estimate the variance and relative risk of achieving future EBITDA during the Earnout Period in the Earnout Jurisdictions. This model is a discrete-time model that allows for sources of uncertainty and simulates the movements of the underlying metric and calculates the resulting derivative value for each trial. Such simulations are performed for a number of trials and the average value across all trials is determined in order to arrive at the concluded value of such derivative. The Earnout Consideration was valued at $9,575 at the date of the Merger and $10,478 at March 31, 2017.  The key assumptions in applying the Monte Carlo simulation included expected Earnout Period EBITDA in the Earnout Jurisdictions, the expected standard deviation of expected Earnout Period EBITDA, the Company's stock price and a normal distribution of Earnout Period EBITDA.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

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

On December 22, 2016, the Company’s Board of Directors approved the Inspired Entertainment, Inc. Second Long-Term Incentive Plan (the “Second Plan”). The Second Plan was adopted principally to provide a mechanism through which certain management bonuses due in cash to certain members of management of Inspired upon consummation of the Merger could be paid partially in stock in order to preserve liquidity in the Company. Under such arrangement, certain members of management entitled to such cash bonuses agreed to accept 50% of the bonuses due in cash at closing and 50% in restricted stock units (“RSUs”) under the Second Plan, subject to the approval of the Second Plan by the Company’s stockholders, which has not been obtained as of March 31, 2017. The maximum number of RSUs that can be granted under the Second Plan is 200,000. The Board of Directors has approved grants totaling 107,914 RSU’s under the Second Plan conditioned on stockholder approval.

If the Second Plan is not approved by stockholders, the balance due will be paid in cash on the three year anniversary of the Merger, based on the average stock price of the Company’s common stock over the prior 30 day period. The obligation to settle the 50% balance due to management was deemed to be a derivative liability due to a potential cash settlement provision which is not within the Company’s control and, as a result, the obligation is accounted for as a derivative liability with fair value changes being recorded in the condensed consolidated statements of operations and comprehensive loss. The fair value of the liability is calculated based on the value of the underlying common stock. Until stockholder approval is obtained, awards under the Second Plan are not considered issued and outstanding.

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

On December 29, 2016, the Company sold 164,536 shares of common stock to certain members of management in private transactions for an aggregate sales price of $1,645, or $10.00 per share.

The Company’s stockholders approved the Inspired Entertainment, Inc. 2016 Long-Term Incentive Plan (the “2016 Incentive Plan”) in connection with the Merger as of the Closing Date. Under the 2016 Incentive Plan, the Compensation Committee is authorized to grant awards to employees, officers, directors and other service providers of the Company and its affiliates and to determine the number and types of such awards and the terms, conditions, vesting and other limitations applicable to each such award. The 2016 Incentive Plan provides for the issuance of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards (including cash-based performance awards), and other cash-based or stock-based awards. As of March 31, 2017, there were 2,778,818 shares authorized for issuance under the 2016 Incentive Plan and 15,285 shares available for issuance.

On December 29, 2016, the Company granted 950,484 shares of restricted stock and 722,466 RSUs under the 2016 Incentive Plan to certain members of management. The restricted stock awards and RSUs contain both market and service conditions. The weighted average fair value of the common stock on the date of grant was $5.63. The grant date fair value of the awards is being recognized as compensation expense over a three-year vesting period. The aggregate grant date fair value of the restricted stock amounted to $5,351, of which the Company recorded $440 and $460 as compensation expense during the three and six months ended March 31, 2017, respectively. The aggregate grant date fair value of the RSUs amounted to $4,067, of which the Company recorded $334 and $350 as compensation expense during the three and six months ended March 31, 2017, respectively.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

On January 3, 2017, the Company’s Executive Chairman of the Board and the Company’s Chief Strategy Officer were granted 940,583 and 150,000 shares, respectively, of restricted stock under the 2016 Incentive Plan. The weighted average fair value of the common stock on the date of grant was $5.51. The aggregate grant date fair value of the wards amounted to $6,005, which is being recognized as compensation expense over a three-year vesting period. The restricted stock awards contain both market and service conditions. The Company recorded $517 of compensation expense during the three and six months ended March 31, 2017.

Stock-based compensation is recognized as an expense on a straight-line basis over the requisite service period, which is generally the vesting period. As of March 31, 2017, there were 2,763,533 shares of non-vested restricted stock and RSUs outstanding.

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

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

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

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter the Company updates its estimate of the annual effective tax rate and, if the Company’s estimated tax rate changes, it makes a cumulative adjustment in that period.

The effective income tax rate for the three months ended March 31, 2017 and 2016 was (0.4%) and (1.5%), respectively, resulting in a $32 and $203 income tax expense, respectively. The effective income tax rate for the six months ended March 31, 2017 and 2016 was (0.3%) and (1.0%), respectively, resulting in a $83 and $289 income tax expense, respectively. The income tax expense for the three and six months ended March 31, 2017 and 2016 differs from the amount that would be expected after applying the statutory U.S. federal income tax rate primarily due to the changes in the valuation allowance for deferred taxes and the net losses generated by the Company’s non-US foreign subsidiaries. Income tax expense for the three and six months ended March 31, 2016 differs from the amount that would be expected after applying the statutory U.S. federal income tax rate primarily due to changes in the valuation allowance for deferred taxes and the net losses generated by the Company’s foreign subsidiaries.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considered the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on the consideration of these items, management determined that it is more likely than not that the Company will not realize the deferred income tax asset balances and therefore, recorded a full valuation allowance of $33,234 as of March 31, 2017.

The utilization of the Company’s pre-Merger net operating losses may be subject to a substantial limitation due to the “change of ownership provisions” under Section 382 of the Internal Revenue Code and similar state provisions. While the Company has not completed its analysis as to whether an ownership changed occurred, such limitation may result in the expiration of the net operating loss carryforwards before their utilization.

We have agreements with two service companies with respect to which a member of the current board and a member of Inspired’s prior board had a direct or indirect ownership interest at the time of the transaction, and, in some cases, also served as a director of such other entities.

Employment Agreements

A. Lorne Weil

On January 16, 2017, the Company entered into an employment agreement (the “Employment Agreement”) with Mr. Weil, the Company’s Executive Chairman, who began his employment as of December 23, 2016. Under the terms of his employment agreement, Mr. Weil’s annual base salary is $700,000, with a target annual bonus of not less than 100%, and a maximum annual bonus of not more than 200%, of his annual base salary, subject to performance goals determined by the Committee in consultation with Mr. Weil. Mr. Weil will also be eligible to receive additional incentive bonuses and equity on terms that are no less favorable than those offered to any other executive of the Company.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Mr. Weil’s Employment Agreement does not have a set term, and his employment as the Company’s Executive Chairman will be non-exclusive. The Employment Agreement may be terminated without cause on three months’ written notice by either party. Mr. Weil may be terminated by the Company immediately upon written notice for cause, as defined in the Employment Agreement. On the occurrence of an event constituting “good reason” (as defined in the Employment Agreement), Mr. Weil may terminate the agreement immediately at any time within 90 days of such event. Under the Employment Agreement, Mr. Weil will remain subject to certain covenants, including, among other things, a covenant not to enter into a directly competing business or solicit employees of the Company, for a period of twelve months after termination of his employment, as well as a covenant not to disclose certain confidential information of the Company.

Mr. Weil’s Employment Agreement also reflects the grant to Mr. Weil of 940,583 shares of restricted stock pursuant to the 2016 Incentive Plan. The grant of restricted stock was effective as of January 3, 2017 (see Note 16).

Luke Alvarez

On March 23, 2017, Inspired Gaming (Gibraltar) Limited (“Gaming Gibraltar”), a subsidiary of the Company, and Luke Alvarez, the President and Chief Executive Officer of the Company, amended his Service Agreement, dated April 1, 2015, by and between Gaming Gibraltar and Mr. Alvarez, with an effective date of January 1, 2017. Under the terms of such agreement, as amended, Mr. Alvarez’s annual base salary is £478,736 per year, with a target annual bonus of not less than 100%, and a maximum annual bonus of not more than 200%, of £525,000, subject to performance goals determined by the compensation committee of the board of directors of the Company.

Each party is required to give twelve months’ notice of termination of employment. If Mr. Alvarez leaves, or is required to leave, his employment as a result of injury, disability, ill-health, retirement or redundancy, or is otherwise dismissed (unless Mr. Alvarez is dismissed for gross misconduct or voluntarily resigns before the end of the current fiscal year), Mr. Alvarez would be entitled to receive a pro-rated annual bonus during the twelve-month contractual notice period as if all of the performance conditions of such bonus had been satisfied.

In addition, on March 23, 2017, Inspired UK and Mr. Alvarez entered into a letter agreement, pursuant to which, effective January 1, 2017, Mr. Alvarez receives an annual fee of £46,264 per year, in connection with Mr. Alvarez’s position as director of Inspired.

Stewart Baker

On March 23, 2017, Inspired Gaming (UK) Limited (“Gaming UK”), a subsidiary of the Company, and Stewart Baker, the Chief Financial Officer of the Company, entered into a new employment contract in connection with Mr. Baker’s recent promotion to the position of Chief Financial Officer. Pursuant to such contract, Mr. Baker’s compensation includes a base salary of £160,000, effective January 2017. In addition, Mr. Baker will have the opportunity to receive a target annual bonus of not less than 75%, and a maximum annual bonus of not more than 100%, of his annual base salary, subject to performance goals determined by the compensation committee of the board of directors of the Company.

Such agreement includes a notice provision that requires the party electing to terminate the agreement to provide twelve months’ notice. Mr. Baker participates in an employer pension program, under which he receives employer contributions equal to 15% of his base salary. In addition, Mr. Baker receives an annual car allowance in the amount of £13,900. Under the employment agreement, Mr. Baker remains subject to certain restrictive covenants, including, among other things, non-solicitation and non-competition provisions for a period of twelve months after termination of his employment and concerning confidentiality.

General Legal Matters

From time to time, the Company is involved in legal matters arising in the ordinary course of business. While the Company believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which the Company is, or could be, involved in litigation, will not have a material adverse effect on its business, financial condition or results of operations.

Performing Rights Society

A claim from the Performing Rights Society is ongoing and relates to the alleged infringement of copyrighted material of the Performing Rights Society's members in certain games on Fixed Odds Betting Terminals in UK Licensed Betting Offices. The UK bookmaker defendants (who have formed a joint defense group) filed a defense to the claim (for circa £7M or $8,733) raised in the High Court in London by the Performing Rights Society on December 22, 2015. The parties have previously undertaken a process of mediation in September 2016 and there have been ongoing settlement discussions among the parties. Although the Company is unable to determine the outcome of the claim and intends to defend it vigorously, the Company has made a provision for $312, which management believes to be adequate to cover the total net exposure to the Company, including professional fees.

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

We operate a scheme which is comprised of a separately managed defined benefit section and a defined contribution section. The defined benefit section is closed to future accruals for services rendered to the Company. We estimate that $3.2 million will be contributed to the pension plan during the year ending September 30, 2017.

The total amount of employer contributions paid during the six months ended March 31, 2017 amounted to $1.6 million. We expect to pay $1.6 million during the remaining part of the fiscal period.

For the six months ended March 31, 2017 and 2016, the components of total periodic benefit costs were as follows:

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

The following tables present revenue, cost of sales, excluding depreciation and amortization, selling, general and administrative expenses, depreciation and amortization, operating profit/(loss) from continuing operations, total assets and total capital expenditures for the three and six months ended March 31, 2017 and 2016, respectively, by business segment. Certain unallocated corporate function costs have not been allocated to the Company’s reportable operating segments because these costs are not allocable and to do so would not be practical. Corporate function costs consist primarily of selling, general and administrative expenses, depreciation and amortization, capital expenditures, cash, prepaid expenses and property and equipment and software development costs relating to corporate/shared functions.

Segment Information

Three Months Ended March 31, 2017

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Three Months Ended March 31, 2016

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Six Months Ended March 31, 2017

Six Months Ended March 31, 2016

INSPIRED ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2017

(in thousands, except share and per share data)

(Unaudited)

Geographic Information

Geographic information for revenue is set forth below:

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.

On March 21, 2017, the Company received written notice from the NASDAQ Staff of the Listing Qualifications Department that the Company’s common stock and warrants were not in compliance with the minimum 300 and 400 round lot holder requirements set forth in NASDAQ Listing Rules 5505(a)(3) and 5515(a)(4), respectively, and, therefore, the Company’s securities would be subject to delisting. The Company requested a hearing before a NASDAQ Hearings Panel (the “Panel”). On April 26, 2017, the Company received notice that the Panel had determined to grant its request for the continued listing of its common stock on NASDAQ, pursuant to an extension to evidence compliance with the minimum 300 round lot shareholder requirement by September 17, 2017. The continued listing of the Company’s common stock through September 17, 2017 is subject to the Company’s compliance with certain interim milestones evidencing its progress towards compliance with such rule. In addition, the notice informed the Company that the warrants would be delisted due to the Company having less than 400 round lot warrant holders. On April 28, 2017, the Company’s warrants were delisted from NASDAQ and transitioned to the over-the-counter markets operated by OTC Markets Group.

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

References in this Quarterly Report on Form 10-Q to “we,” “us,” the “group,” “our” or the “Company” refer to Inspired Entertainment, Inc. References to our “management” or our “management team” refer to our officers and directors. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto contained elsewhere in this report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.

Forward-Looking Statements

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

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

Overview

We are a global gaming technology company, supplying Virtual Sports and Server Based Gaming (“SBG”) systems to regulated lottery, betting and gaming operators worldwide.

Our strategic priorities are to:

Segments

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

Foreign exchange

Our results are impacted by changes in foreign currency exchange rates as a result of the translation of foreign functional currencies into US dollars and the re-measurement of foreign currency transactions or balances. The impact of foreign currency exchange rate fluctuations represents the difference between current rates and prior-period rates applied to current activity. The largest geographic region in which we operate is the United Kingdom and the British pound (“GBP”) is considered to be our functional currency. Our reporting currency is the US dollar (“USD”). Our results are translated from the functional currency of GBP into the reporting currency using average rates for profit and loss transactions and the applicable spot rates for period end balances. The effect of translating the functional currency into the reporting currency, as well as translating foreign subsidiaries that have a different functional currency into the functional currency, is reported separately in Accumulated Other Comprehensive Income. We derived approximately 29.0% of our revenue from sales to customers outside of the United Kingdom during the three months ended March 31 2017, compared to 25.6% during the comparable period in 2016. We derived approximately 29.1% of our revenue from sales to customers outside of the United Kingdom during the six months ended March 31, 2017, compared to 26.5% during the comparable period in 2016.

In the section “Results of Operations” below, the currency impact shown has been calculated as current period GBP:USD rate used less the equivalent rate in the prior period, multiplied by the current period amount in the functional currency (USD). The remaining difference is therefore calculated as the difference in the functional currency, multiplied by the prior period average GBP:USD rate. The six month variances are calculated by taking the average of the rates used across the three months ended March 31, 2017 and the three months ended December 31, 2016. This is not a US GAAP measure but one which management believes gives a clearer indication of the results of the Company and its subsidiaries.

Results of Operations

The results of operations have been organized in the following manner:

The three-month financial statement periods presented represent a 90 day period for 2017 and 91 day period for 2016. The balance sheet date of each fiscal period is March 31. Each of the above daily periods presented within these financial statements and footnotes are herein referred to as a “Three-Month Period.”

The six-month financial statement periods presented represent a 188 day period for 2017 and 187 day period for 2016, which are intended to approximate a six month period. The balance sheet date of each fiscal period is March 31. Each of the above daily periods presented within these financial statements and footnotes are herein referred to as a “Six-Month Period.”

Three-Month Period ended March 31, 2017 compared to March 31, 2016

Revenue

Total revenue increased $2.8 million, or 9.1%, on a constant currency basis, offset by an adverse currency impact of $5.2 million, resulting in a decrease in reported revenue of $2.4 million, or 7.8%, from $30.4 million to $28.1 million. See Business Segment Results below for further discussion.

Cost of sales, excluding depreciation and amortization

Cost of sales, excluding depreciation and amortization, which includes machine cost of sales, consumables, content royalties and connectivity costs, increased by $2.1 million on a constant currency basis. Cost of hardware increased by $2.4 million in line within the SBG hardware revenue growth described above, with cost of service declining by $0.3 million. This was partially offset by a favorable currency impact of $1.0 million, resulting in an increase in reported cost of sales, excluding depreciation and amortization, of $1.1 million, from $4.6 million to $5.7 million.

Selling, general and administrative expenses

Selling, general, and administrative (“SG&A) expenses are defined to include staff compensation costs (including outsourced costs), travel, professional fees, technology (including hosting fees, data centers, etc.) and professional services.

On a constant currency basis, SG&A expenses increased $2.5 million, driven by:

SG&A expense, net of adjustments described in the Adjusted EBITDA note below and incremental expenses associated with being a public company were in line with the prior year.

Constant currency SG&A expenses were offset by a favorable currency impact of $2.8 million. This resulted in a decrease in reported SG&A expenses of $0.2 million, from $14.6 million to $14.4 million.

Stock-based compensation

The Company’s stockholders approved the Inspired Entertainment, Inc. 2016 Long-Term Incentive Plan (the “2016 Incentive Plan”) in connection with the Merger as of the Closing Date. Under the 2016 Incentive Plan, the Compensation Committee is authorized to grant awards to employees, officers, directors and other service providers of the Company and its affiliates and to determine the number and types of such awards and the terms, conditions, vesting and other limitations applicable to each such award. As of March 31, 2017, there were 2,778,818 shares authorized for issuance under the 2016 Incentive Plan and 15,285 shares available for issuance. These awards are valued at the time of issuance using Monte Carlo simulation, with the value being spread over the vesting period. As a result, the Company recorded an expense in the current period of $1.3 million. There was no corresponding charge in the prior year.

Acquisition related transaction expenses

Acquisition related transaction expenses increased by $0.4 million to $0.8 million. The expense in both periods relates to the Merger. We believe that all material expenses in relation to the transaction have now been incurred, except for the potential earn-out payments to the prior owners of Inspired.

Depreciation and amortization

Depreciation and amortization expense increased by $0.3 million on a constant currency basis, compared to the prior year period. This was driven by a $0.8 million increase in intangible amortization as a result of new projects going live, partially offset by a $0.5 million decrease in machine related depreciation due to terminals in UK and Italy that became fully depreciated. A decrease of $1.5 million was attributable to a favorable currency impact, resulting in a $1.2 million, or 12.7%, decrease in reported depreciation and amortization expense, from $9.2 million to $8.0 million.

Interest expense

Interest expense decreased by $9.5 million on a constant currency basis. This was primarily due to a $10.0 million reduction in PIK loan note interest as there was no external charge following the completion of the Merger on December 23, 2016. This was partially offset by increases of $0.6 million in senior debt PIK interest due to interest rate (margin) increases and $0.2 million in senior debt cash interest due to compounding debt. Interest expense decreased 69.5%, from $14.9 million to $4.5 million, on a reported basis for the three months ended March 31, 2017, compared to the comparable period in 2016, reflecting a favorable currency impact of $0.8 million.

Change in fair value of earn out liability

These expenses relate to the potential earn out payment to the former owners of Inspired, which is dependent upon performance criteria. As a result of share price movements, the value of the liability increased to $10.5 million, creating an expense in the period of $2.2 million. There was no corresponding liability in the comparative prior year period.

Income Taxes

We recorded a negligible income tax expense for the period ended March 31, 2017 and $0.2 million for the period ended March 31, 2016. The effective tax rate for the period ending March 31, 2017 was 0.4% and for the period ending March 31, 2016 it was 1.5%.

BUSINESS SEGMENT RESULTS

Server Based Gaming

Our Server Based Gaming business segment designs, develops, markets and distributes a comprehensive portfolio of products and services through our fully digital network architecture. Our customers include UK licensed betting offices (“LBOs”), casinos, gaming hall and bingo operators and lotteries, as well as government affiliated and licensed operators.

Revenue is generated from SBG through both product sales and long-term participation agreements with our customers, which includes access to our server based gaming platform and selection of game titles, over a term usually of three to five years. Our participation contracts are typically structured to pay us a percentage of net win (defined as net revenue to our customer, after deducting player winnings and any relevant regulatory levies) from SBG terminals placed in our customers’ facilities, which include retail outlets, casinos and other gaming operations or SBG gaming software used to facilitate customer players through mobile or online devices. Typically, we recognize revenue from these arrangements on a daily basis over the term of the contract.

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

Key events that impacted results for the Three-Month Period ended March 31, 2017

Our UK SBG terminals in LBOs generated Gross Win per unit per day (defined as stake less amounts returned to player in prize, before gaming tax deductions) growth on a constant currency basis of 3.6% year-over-year.

During the quarter we have rolled out nearly 3,500 Universal Cashier units which we believe will result in improved gross win per unit per day and reduced service costs in future periods.

Our first SBG terminal went live in the Greek estate during January 2017. By March 31, 2017, 340 terminals were installed and reporting data. These machines represent the first portion of the expected full deployment of at least 3,960 SBG terminals into the Greek estate in Q1 2018. We believe our games have performed well relative to their competitive set since being installed.

In Italy we went live with our sixth concession, Gamenet. We launched new games into the Italian estate in the quarter and also took a number of new Video Lottery Terminals (“VLT”) products which we intend to rollout in Fiscal 201& through the final stages of the regulatory test process.

Key Performance Indicators