Nektan — Update 19 April 2016

Nektan has continued to see good success with its partner acquisition endeavours. ‘Live’ partners increased from 20 in October 2015 to 30 at the end of January and 11 new partners were signed in Q316. This suggests the company’s business development activity remains healthy. There is a natural lag between partnerships being signed and revenues beginning to ramp up, allowing time for software development work and for effective marketing plans to be implemented. As a result, we expect the strong early-year NGR momentum to continue as more partner sites receive a commercial launch.

While real commercial progress has been made, the company is tracking behind the forecasts in our last published Update report dated 23 October 2015 mainly due to slower than expected acceleration of one large contract, as reported with the interim results on 31 March. The partner has not been disclosed by management but we believe it is a large UK media group which has been reorganising some of its online gaming activities; we continue to believe the partnership offers substantial medium term potential for Nektan. Among its other partnerships, Nektan finds that it is achieving the most success from partners with existing RMG experience and those with smartphone traffic acquisition expertise. As a result, it is directing it efforts towards partnering with more organisations that fit this profile.

Localised offerings: presently, players in continental Europe have only had access to English language versions of Nektan’s games billed in sterling. Nektan expects to launch local language and currency versions of many of its games in the coming weeks, beginning with Sweden. We expect this to have a strong positive effect on its European player conversion rates.

Management change: Nektan has made changes to its senior management team in recent months. CFO David Sparks left the business at the start of December, while CEO David Gosen resigned to pursue other opportunities in mid-January. Executive chairman Gary Shaw has assumed the position of interim CEO, while Jim Wilkinson has moved from being an independent non-executive director to assume the role of non-executive chairman of the company. We believe that the management changes will strengthen the company’s cost focus as it continues to move towards profitability.

Nektan’s interim and Q316 trading statements gave updates on the progress of its equity-accounted US JV Respin. It continues to make excellent progress and now has 54 signed and pending contracts with tribal and commercial casino operators (up from nine in 2014). It has launched its new Rapid Games in-venue mobile gaming product and has become the first company to receive approval from Apple for in-venue mobile gaming for its Evolve platform. On 7 April Respin won the iGaming North America 2016 ‘Best Innovation in North America’ award ahead of a number of major players in the market.

Nektan has previously stated that Respin will fund the roll-out of its Xstraspin and Respin cabinets through finance leases. We believe that much of the development heavy lifting at Respin is now complete. However, Nektan’s interim results did state that Respin may require further capital contributions. Should this be the case, Nektan may need further funding to finance its contribution.

Exhibit 1 shows our revised FY16 estimates and compares them to our previous forecasts, as published in our 23 October 2015 update note.

Revenues: Nektan’s RMG casino business has always been its core offering and, with revenues now starting to build some momentum, this continues to be the case. H116 revenue was £1.63m (£1.59m of NGR, £0.04m from content licensing/software development), up from £0.25m in H115. However, this was below our previous forecast largely due to the slower than expected acceleration of the large contract referred to above. Management estimated that this represented approximately £7m of the reported revenue shortfall. This effectively marks the difference between our October 2015 RMG revenue forecast of £13.0m for FY16 and our revised forecast of £6.2m.

The 18 April trading update reported that Q316 NGR was £2.30m, up from £1.07m in Q216 and £0.56m in Q116 (ie £3.93m for the nine-months). The number of first-time depositors (a useful lead indicator) is also growing, at 15,628 in Q316 up from 11,011 in Q216 and 6,472 in Q116, a very encouraging trend. Our new FY16 revenue forecast of £6.18m implies £2.25m in Q416, which allows for some seasonal softening going into the summer months as people pursue more outdoor-focused leisure activities.

Nektan has understandably focused much of its attention on driving its casino revenues. As a result, it has experienced delays in rolling out additional product lines such as bingo, which we now expect to contribute only nominal revenues in FY16 (£50k), before gaining traction in FY17. The same can be said of the company’s freemium gaming plans, which remain a part of the strategy but have now been pushed back into FY17.

Costs: Nektan’s management has made extensive progress in continuing to cut the cost base to reflect the slower than expected ramp-up in revenues. Management has clearly stated that moving the company to an EBITDA-positive position is a high priority near-term objective. To achieve this, it has reduced the fixed cost base by some 35% to a run rate of around £0.3m a month from April 2016, with the savings coming almost entirely from administrative functions.

Nektan recorded an impairment charge of £745,000 in H116, which related to a reassessment of the recoverability of two debtor balances. This is a non-cash item that is captured in the change in working capital on the balance sheet via a reduction in accounts receivable.

Nektan had a net debt position of £2.1m at end June 2015 and £5.6m at end December 2015. The £2.93m March 2016 fund-raise marked its third in this financial year (2015/16). The first saw it raise £2.75m in October 2015, £2.39m of which came from a convertible loan note issue (10% coupon), and the balance from a placing of 232,258 shares at a price of 155p. An additional £1.36m was raised support the expansion of the Respin opportunity through the placing of 937,929 new ordinary shares at a price of 145p in December.

The most recent fund-raise consisted of a subscription for up to £2.56m of new convertible loan notes and up to 2,560,000 warrants, which was supported by new and existing shareholders together with a number of directors. A further £0.34m has been raised via a subscription of 441,333 new ordinary shares. This brings the total amount raised to £2.93m. The March 2016 subscriptions were unanimously approved by shareholders at an Extraordinary General Meeting held on 29 March 2016 and the new shares began trading on Monday 4 April. Should all of the loan notes and warrants be converted into shares, it would lead to potential 13.5m additional shares, an overall potential dilution of 32.3%.

At the time of the interim results, management stated that it expected the fund-raise to enable it to manage its working capital requirements during key periods over the next 12 months (including gaming taxes, convertible loan note interest and scheduled investments into Respin), provided the group continues to perform in line with expectations. Prudently, however, management is continuing to assess the group’s financing options including “seeking new investors, debt finance or other financial support from key stakeholders; seeking a strategic partner; or seeking to realise value from its trading assets”.