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EX-31.1 - FORM 10QFY2011Q1 EXH31.1 - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCexhibit31_1.htm
EX-31.2 - FORM 10QFY2011Q1 EXH31.2 - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCexhibit31_2.htm
EX-32 - FORM 10QFY2011Q1 EXH32 - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCexhibit32.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

[x]           QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2010

[ ]           TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________________ to________________________

Commission File Number:  0-10294

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
 
ILTS Logo

California
95-3276269
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)

2310 Cousteau Court
Vista, California
(Address of principal executive offices)
92081-8346
(Zip Code)
(760) 598-1655
(Registrant’s telephone number)

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 ý Noo
   
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)
Yes o Noo
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.

Large accelerated filer
o
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
ý

Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act) 
Yes o     No ý
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
 
 
Outstanding at September 13, 2010
 
Common Stock, no par value per share
 
12,962,999 shares



 
1

 





EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32






 

 

 

 

 

 

 

 

 

 




 
PART I
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
 

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(Amounts in thousands)

   
July 31, 2010
   
April 30, 2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
 
$
2,534
   
$
2,363
 
Certificates of deposit
   
1,497
     
1,745
 
Accounts receivable, net of allowance for doubtful accounts of $75
   
1,385
     
500
 
Costs and estimated earnings in excess of billings on uncompleted contracts
   
26
     
804
 
Inventories, net
   
1,210
     
1,042
 
Other current assets
   
107
     
224
 
Total current assets
   
6,759
     
6,678
 
Equipment, furniture and fixtures, net
   
395
     
405
 
Other noncurrent assets
   
72
     
73
 
Total assets
 
$
7,226
   
$
7,156
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
 
$
502
   
$
622
 
Billings in excess of costs and estimated earnings on uncompleted contracts
   
752
     
440
 
Accrued payroll and related taxes
   
405
     
349
 
Warranty reserves
   
36
     
42
 
Payable to Parent
   
250
     
250
 
Other current liabilities
   
47
     
44
 
Deferred revenues
   
278
     
344
 
Total current liabilities
   
2,270
     
2,091
 
Long-term liabilities
   
-
     
6
 
Total liabilities
   
2,270
     
2,097
 
Commitments and contingencies
               
Shareholders’ equity:
               
Preferred shares, no par value; 20,000 shares authorized; no shares issued or outstanding
   
-
     
-
 
Common shares, no par value; 50,000 shares authorized; 12,963 shares issued and outstanding
   
56,370
     
56,370
 
Accumulated deficit
   
(51,414
)
   
(51,311
)
Total shareholders' equity
   
4,956
     
5,059
 
Total liabilities and shareholders' equity
 
$
7,226
   
$
7,156
 

See notes to condensed consolidated financial statements








INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands, except per share amounts)


   
Three Months Ended
 
   
July 31,
 
 
2010
   
2009
 
Revenues:
           
Sales of products
 
$
1,451
   
$
1,274
 
Services
   
261
     
192
 
     
1,712
     
1,466
 
Cost of sales:
               
Cost of product sales
   
1,156
     
993
 
Cost of services
   
43
     
35
 
     
1,199
     
1,028
 
Gross profit
   
513
     
438
 
                 
Research and development expenses
   
-
     
477
 
Selling, general and administrative expenses
   
629
     
503
 
Loss from operations
   
(116
)
   
(542
)
                 
Other income (expense):
               
Interest and dividend income
   
1
     
5
 
Other
   
12
     
(3
)
Net loss
 
$
(103
)
 
$
(540
)
                 
Net loss per share:
               
Basic and diluted
 
$
(0.01
)
 
$
(0.04
)
Weighted average shares used in computation of net loss per share:
               
Basic and diluted
   
12,963
     
12,963
 

See notes to condensed consolidated financial statements











INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in thousands)


   
Three Months Ended
July 31,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net loss
 
$
(103)
   
$
(540)
 
Adjustments to reconcile net loss to net cash used in
               
operating activities:
               
Depreciation and amortization
   
24
     
36
 
Warranty reserve expense
   
6
     
14
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(885)
     
(248)
 
Costs and estimated earnings in excess of billings on uncompleted contracts
   
778
     
(68)
 
Inventories
   
(168)
     
(190)
 
Other current assets
   
117
     
45
 
Accounts payable
   
(120)
     
266
 
Billings in excess of costs and estimated earnings on uncompleted contracts
   
312
     
(482)
 
Accrued payroll and related taxes
   
56
     
(42)
 
Warranty reserves
   
(12)
     
-
 
Other current liabilities
   
(3)
     
14
 
Deferred revenues
   
(66)
     
(4)
 
Net cash used in operating activities
   
(64)
     
(1,199)
 
                 
Cash flows from investing activities:
               
Purchases of certificates of deposit
   
(747)
     
-
 
Proceeds from redemption of certificates of deposit
   
995
     
915
 
Additions to equipment, furniture and fixtures
   
(13)
     
(30)
 
Net cash provided by investing activities
   
235
     
885
 
                 
Net increase (decrease) in cash and cash equivalents
   
171
     
(314)
 
Cash and cash equivalents at beginning of period
   
2,363
     
4,041
 
Cash and cash equivalents at end of period
 
$
2,534
   
$
3,727
 
                 

See notes to condensed consolidated financial statements








NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Description of the Business

International Lottery & Totalizator Systems, Inc. (“ILTS” or the “Company,” together with its subsidiary,) designs, manufactures, sells, manages, supports and services computerized wagering systems and terminals for the global online lottery and pari-mutuel racing industries.  The wagering system features include real-time, secure processing of data received from multiple locations, hardware redundancy and complete communications redundancy in order to provide the highest level of fault tolerant operation. In addition, although the Company is not presently doing so, ILTS has demonstrated capability to provide full facilities management services to customer organizations authorized to conduct online lotteries.  The Company is largely dependent upon significant contracts for its revenue, which typically include a deposit upon contract signing and up to six months lead time before delivery of hardware begins.

In recent years, the Company has devoted significant resources in developing certified end-to-end optical scan voting systems and a full-featured Election Management Software that provides precinct tabulation, ballot review and audio voting capability.  In addition to the Inkavote Plus Precinct Ballot Counter (“PBC”) system certified to the National Association of State Election Directors (“NASED”) 2002 Voting System Standards (“VSS”), the Company received the 2005 Voluntary Voting System Guidelines (“VVSG”) certification from the United States Election Assistance Commissions (“EAC”) in January 2010 for its OpenElect® digital optical scan election system - the only digital scan voting system built with Java on a streamlined and hardened Linux platform.  As part of a jurisdiction's procurement process, the Company will provide the OpenElect® products’ source code for independent review.

These efforts leverage the Company’s extensive experience to develop highly secure, mission-critical solutions that meet the NASED 2002 VSS and the EAC 2005 VVSG standards. In addition, the Company’s voting systems offer the following features:
 
•           High level of security and vote encryption to ensure integrity and voter privacy;
•           Electronic and paper audit trails that offer added security and redundancy for recounts;
•           Minimal training for poll workers to set-up and operate; and
•           Minimal voter re-education required.
 
Berjaya Lottery Management (H.K.) Ltd. (“BLM” or the “Parent”) owns 71.3% of the outstanding voting stock of ILTS.

Principles of Consolidation
 
The accompanying condensed consolidated financial statements include the accounts of ILTS and its wholly-owned subsidiary, Unisyn Voting Solutions, Inc.  All significant inter-company accounts and transactions are eliminated in consolidation.

Basis of Presentation

The accompanying 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 with the Securities and Exchange Commission’s (“SEC”) instructions to Form 10-Q.  Accordingly, they do not include all of the information and notes required by US GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows have been included.

The results of operations for the interim periods shown in this report are not necessarily indicative of the results to be expected for the full year.  The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2010 filed with the SEC on July 8, 2010.  The condensed consolidated balance sheet as of April 30, 2010 has been derived from the audited financial statements included in the form 10-K for that year.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions.  Actual results could differ from those estimates.  Estimates may affect the reported amounts of assets and liabilities and revenues and expenses, and the disclosure of contingent assets and liabilities.

Deferred Revenues

Deferred revenues of approximately $278,000 as of July 31, 2010 represent prepayments for software products which were related to the use of the PBC voting system and other software and technical support services.  The Company will recognize the revenues upon its fulfillment of the prescribed criteria for revenue recognition.
 
Warranty Reserves

Estimated warranty costs are accrued as revenues are recognized.  Included in the warranty cost accruals are costs for basic warranties on products sold.  A summary of product warranty reserve activity for the three months ended July 31, 2010 is as follows:

(Amounts in thousands)
     
Balance at May 1, 2010
 
$
42
 
Additional reserves
   
24
 
Warranty reserve expense adjustments
   
(18)
 
Charges incurred
   
(12)
 
Balance at July 31, 2010
 
$
36
 

Segment Information

Segment Reporting requires companies to report certain information about operating segments in their condensed consolidated financial statements and establishes standards for related disclosures about products and services, geographic areas and major customers.  Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by management in deciding how to allocate resources and in assessing performance.

The Company divides its operations into two operating segments: the gaming business and the voting business.  The gaming segment designs and develops computerized wagering systems and terminals for the online lottery and pari-mutuel racing industries worldwide.   Presently the voting segment generates revenues from product servicing and software support services.
 
The Company’s segment information is presented below (in thousands):

 
As of and for the Three Months Ended July 31, 2010
 
 
Gaming
Business
 
Voting
Business
 
Totals
 
Total revenues
 
$
1,569
   
$
143
   
$
1,712
 
Income (loss) from operations
   
178
     
(294
)
   
(116
)
Depreciation and amortization
   
18
     
6
     
24
 
Cost and estimated earnings in excess of billings on uncompleted contracts
   
26
     
-
     
26
 
Equipment, furniture and fixtures, net
   
149
     
246
     
395
 
Intangible assets – patent, net
   
-
     
23
     
23
 
Warranty reserves
   
36
     
-
     
36
 
Deferred revenues
   
9
     
269
     
278
 
     
 
 
As of and for the Three Months Ended July 31, 2009
 
 
Gaming
Business
 
Voting
Business
 
Totals
 
Total revenues
 
$
1,361
   
$
105
   
$
1,466
 
Income (loss) from operations
   
30
     
(572
)
   
(542
)
Depreciation and amortization
   
31
     
5
     
36
 
Cost and estimated earnings in excess of billings on uncompleted contracts
   
71
     
-
     
71
 
Equipment, furniture and fixtures, net
   
231
     
180
     
411
 
Capitalized computer software development costs, net
   
-
     
2
     
2
 
Intangible assets – patent, net
   
-
     
18
     
18
 
Warranty reserves
   
35
     
-
     
35
 
Deferred revenues
   
8
     
236
     
244
 


Inventories

Inventories are stated at the lower of cost or the current estimated market values.  Cost is determined using the first-in, first-out method.  The Company periodically reviews inventory quantities on hand and records a provision for excess and obsolete inventories based on the following factors:

 
·
Terminal models still currently in the field;
 
·
The average life of the models; and
 
·
The requirement for replacement parts on older models.

Inventories consisted of the following:
   
July 31,
   
April 30,
 
   
2010
   
2010
 
(Amounts in thousands)
           
Raw materials and subassemblies
 
$
1,184
   
$
1,038
 
Work-in-process
   
26
     
4
 
   
$
1,210
   
$
1,042
 

Equipment, Furniture and Fixtures

Equipment, furniture and fixtures are carried at cost.  Depreciation is provided using the straight-line method over the estimated useful lives of the related assets which approximate three to seven years.  Leasehold improvements are amortized over the shorter of the useful lives of the assets or the lease term.  In accordance with FASB ASC 360-10, “Property, Plant, and Equipment,” the Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, or when the net book value of such assets exceeds the future undiscounted cash flow attributed to such assets.  At July 31, 2010 and April 30, 2010, and during the three months ended July 31, 2010 and fiscal year ended April 30, 2010, no indicators of impairment were identified.

Net equipment, furniture and fixtures consisted of the following (in thousands):
   
July 31,
   
April 30,
 
   
2010
   
2010
 
(Amounts in thousands)
           
Plant and machinery
 
$
678
   
$
678
 
Computer equipment
   
1,224
     
1,217
 
Leasehold improvement
   
183
     
183
 
Furniture, fixtures and equipment
   
91
     
91
 
Construction in progress
   
7
     
1
 
     
2,183
     
2,170
 
Accumulated depreciation
   
(1,788
)
   
(1,765
)
Net equipment, furniture and fixtures 
 
$
395
   
$
405
 

Net Loss per Share

Basic net loss per share is based on the weighted average number of shares outstanding during the period.  

During the three months ended October 31, 2009, the 84,000 options outstanding expired.  Therefore, there were no outstanding options at July 31, 2010.  At July 31, 2009, the effects of the assumed exercise of options to purchase 84,000 shares of the Company’s common stock at the price of $1.00 were not included in the computation of diluted net loss per share amounts because they were anti-dilutive for that purpose due to the reported net loss.

Shared-based Compensation

The Company requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.  Stock-based employee compensation expense is recognized on a straight-line basis over the requisite service period.  There was no share-based compensation expense related to employee stock options recognized during the three months ended July 31, 2010 and 2009.




Major Customers

The following table summarizes major customers who individually accounted for more than 10% of revenues for the periods presented.

 
July 31, 2010
 
July 31, 2009
Revenue:
     
From unrelated customers
No individual customer accounted for more than 10% of total revenue.
 
No individual customer accounted for more than 10% of total revenue.
       
From related customers
Two customers accounted for 79% of total revenue or 54% and 25% individually.
 
Two customers accounted for 82% of total revenue or 72% and 10% individually.

Related Party Transactions

During the three months ended July 31, 2010 and 2009, revenues from all related party agreements for sales of products and services totaled approximately $1.4 million (82% of total revenue) and $1.2 million (82% of total revenue), respectively.  Included in accounts receivable at July 31, 2010 was approximately $1.4 million from these customers.  Descriptions of the transactions with the Company’s related parties in the three months ended July 31, 2010 and 2009 are presented below.

Berjaya Lottery Management (H.K.) Ltd.

In 1996, the Company entered into an agreement to purchase specific inventory on behalf of BLM, the owner of 71.3% of ILTS’s outstanding voting stock as of July 31, 2010.  Title to the inventory resides with BLM and is on consignment; therefore, no amounts are reflected in the Company’s condensed consolidated balance sheets for inventory purchased on BLM’s behalf.

Over time, the Company has sold or used portions of the BLM inventory in unrelated third party transactions.  The sale or use of the inventory results in a liability to BLM for the cost of the items utilized.

The financial activities and balances related to BLM were as follows:
 
•  
There were no related party sales to BLM in the three months ended July 31, 2010 and 2009;
•  
There were no accounts receivable balances from BLM as of July 31, 2010 and April 30, 2010; and
•  
Liabilities to BLM arising from the sale or use of the BLM inventory, recorded as “Payable to Parent,” were $250,000 as of July 31, 2010 and April 30, 2010.
  
 
 
Philippine Gaming Management Corporation

On January 11, 2010, the Company received from Philippine Gaming Management Corporation (“PGMC”), a related party and a subsidiary of BLM, an order valued at approximately $1.8 million for lottery products.  Shipments of these products began in the first quarter of fiscal 2011 and are expected to complete in the second quarter of fiscal 2011.

In addition, the Company provides terminal spare parts to PGMC on an ongoing basis.

The financial activities and balances related to transactions with PGMC were as follows:
 
•  
Revenues recognized on the sale of lottery products, software and support service during the three months ended July 31, 2010 totaled approximately $924,000.  For the three months ended July 31, 2009, revenues recognized on the shipment of the lottery products totaled approximately $1.1 million;
•  
Billings in excess of costs and estimated earnings in connection with the lottery product order dated January 11, 2010 mentioned above totaled $220,000 as of July 31, 2010 and $440,000 as of April 30, 2010;
•  
There was no deferred revenue as of July 31, 2010.  Deferred revenue on software support services totaled $6,000 as of April 30, 2010; and    
•  
Accounts receivable from the sale of lottery products and services totaled $298,000 as of July 31, 2010, compared to $10,000 as of April 30, 2010.

Sports Toto Malaysia Sdn. Bhd.

The Company provides lottery products, software development and software support services to Sports Toto Malaysia (“STM”), an affiliate of BLM and a related party.  

The financial activities and balances related to transactions with STM were as follows:
 
•  
Revenue of $78,000 was recognized on the sale of software support services during the three months ended July 31, 2010.  Revenue of $151,000 was recognized on the sale of lottery products and software support services during the three months ended July 31, 2009;
•  
There were deferred revenues of $9,000 on software support services as of July 31, 2010 and April 30, 2010;
•  
There was no accounts receivable balance from STM as of July 31, 2010, compared to $13,000 as of April 30, 2010.

Natural Avenue Sdn. Bhd.

The Company provides Natural Avenue Sdn. Bhd. (“Natural Avenue”), an affiliate of BLM and a related party, with lottery and software products, support services and spare parts.  

On December 16, 2009, the Company signed a contract with Natural Avenue for a complete online DataTrak lottery system valued at approximately $3.6 million.  The contract is scheduled to be completed by the fourth quarter of fiscal 2011.

The financial activities and balances related to transactions with Natural Avenue were as follows:
 
•  
Revenue of $420,000 was recognized on the performance of contract deliverables and sale of support services during the three months ended July 31, 2010.  During the three months ended July 31, 2009, revenue of $16,000 was recognized on the sale of support services;
•  
Net billings in excess of costs and estimated earnings relating to the abovementioned contract dated December 16, 2009 totaled approximately $532,000 as of July 31, 2010, compared to net costs and estimated earnings in excess of billings of approximately $799,000 as of April 30, 2010; and
•  
Accounts receivable totaled approximately $1.1 million at July 31, 2010, compared to $440,000 as of April 30, 2010.
 
Sports Toto Computers Sdn. Bhd.

The Company engages Sports Toto Computers Sdn. Bhd. (“STC”), a related party, to provide consulting, programming and other related services to the Company.

During the three months ended July 31, 2010 and 2009, the Company incurred approximately $58,000 and $38,000, respectively.  

Fair Value of Financial Instruments

The Company’s material financial instruments consist of its cash and cash equivalents, certificates of deposit, accounts receivable, accounts payable and related party payables.  The carrying amounts of the Company’s financial instruments generally approximated their fair values at July 31, 2010 and April 30, 2010 due to the short-term maturity of the instruments.

Recent Accounting Pronouncements

In October 2009, the FASB issued authoritative guidance on revenue recognition, ASC ASU 2009-14, “Certain Revenue Arrangements that Include Software Elements,” that will become effective for the Company beginning May 1, 2011, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. We believe adoption of this new guidance will not have a material impact on our consolidated financial statements.

The FASB had issued certain other accounting pronouncements as of July 31, 2010 that will become effective in subsequent periods; however, the Company does not believe that any of those pronouncements are germane to our business or would have significantly affected our financial accounting measurements or disclosures had they been in effect during fiscal 2011.

Subsequent Events

On August 17, 2010, the Company signed an agreement to supply an online lottery system and terminals for the Ohwistha Community Lottery, which will be operated in the Kahnawà:ke Mohawk Territory, Canada. Under the terms of the agreement, ILTS will deliver a turnkey system including implementation services.  The contract value approximates $1.0 million.

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

NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
SAFE HARBOR STATEMENT PURSUANT TO SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934

This report contains certain forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under the heading "Risk Factors" and elsewhere in, or incorporated by reference into, this report. In some cases, you can identify forward looking statements by terms such as "may," "intend," "might," "will," "should," "could," "would," "expect," "believe," "anticipate," "estimate," "predict," "potential," or the negative of these terms. These terms and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. The forward-looking statements in this report are based upon management's current expectations and belief, which management believes are reasonable. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are aware of, may cause actual results to differ materially from those contained in any forward looking statements. You are cautioned not to place undue reliance on any forward-looking statements. These statements represent our estimates and assumptions only as of the date of this report. Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
 
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including, such factors, among others, as market acceptance and market demand for our products and services, pricing, the changing regulatory environment, the effect of our accounting policies, potential seasonality, industry trends, adequacy of our financial resources to execute our business plan, our ability to attract, retain and motivate key technical, marketing and management personnel, and other risks described from time to time in periodic and current reports we file with the United States Securities and Exchange Commission, or the "SEC." You should consider carefully the statements under "Item 1A. Risk Factors" described in our Annual Report on Form 10-K for the year ended April 30, 2010 which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.
 
CRITICAL ACCOUNTING POLICIES

Use of Estimates

Our condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States. Accordingly, we are required to make estimates, judgments and assumptions that we believe are reasonable.  We base our estimates on historical experience, contract terms, observance of known trends in our company and the industry as a whole, and information available from other outside sources.  Estimates affect the reported amounts and related disclosures. Actual results may differ from initial estimates.  The areas most sensitive to estimation are revenue recognition, warranty reserves, inventory valuation, the allowance for doubtful accounts and the deferred tax valuation allowance.

RESULTS OF OPERATIONS
Revenue Analysis
                   
 
Three Months Ended
 
(Amounts in thousands)
July 31,
 
Revenues
 
2010
   
2009
   
Change
 
Products:
                 
Contracts
 
 $
1,291
   
 $
964
   
$
327
 
Spares
   
160
     
310
     
(150
)
Total Products
   
1,451
     
1,274
     
177
 
Services:
                       
Software Support
   
182
     
168
     
14
 
Product Servicing and Support
   
79
     
24
     
55
 
Total Services
   
261
     
192
     
69
 
   
$
1,712
   
$
1,466
   
$
246
 
                         
 
Significant fluctuations in period-to-period contract revenue are expected in both gaming and voting industries since individual contracts are generally considerable in value, and the timing of contracts does not occur in a predictable trend. Contracts from the same customer generally may not recur or generally do not recur in the short-term.  Accordingly, comparative results between quarters may not be indicative of trends in contract revenue.

The current domestic and global economic slowdown and tightening of the credit markets may adversely affect our business and financial condition in ways that we cannot reasonably predict.  For the gaming business, due to the tightening of the credit markets, our potential and existing customers may not be able to secure financing for lottery projects which could effectively impact our revenue potential.  For the voting business, various government entities and jurisdictions have experienced severe budget constraints which could compel them to delay or cancel their purchasing decisions, and hence, impact our ability to generate revenue.

Contract revenue for the three months ended July 31, 2010 was $1.3 million, compared to $964,000 in the same period in 2009.  First quarter fiscal 2011 revenue was derived from two relatively significant contracts while first quarter fiscal 2010 revenue was derived from one significant contract.  

Spares revenue for the three months ended July 31, 2010 was $160,000, compared to $310,000 for the corresponding period in 2009.  Lower spare revenue in 2010 was attributable to lower demand for spare parts from the same pool of customers.  Customer demand for spare parts fluctuates from period to period.

Software support revenue for the three months ended July 31, 2010 was $182,000, compared to $168,000 for the same period in 2009.  The slight increase in software support revenue in 2010 is due to one additional software support agreement with an unrelated customer.
 
Product servicing and support revenue for the periods ended July 31, 2010 and 2009 were $79,000 and $24,000, respectively.  The increase is due to a service arrangement with an unrelated customer.

Related party revenue of approximately $1.4 million accounted for 82% of total revenue in the three months ended July 31, 2010, compared to $1.2 million or 82% of total revenue in the corresponding period in 2009.  

Cost of Sales and Gross Profit Analysis
   
Three Months Ended
 
   
July 31,
   
July 31,
 
(Amounts in thousands)
 
2010
   
2009
 
Revenues:
                       
Products
 
$
1,451
     
85
%
 
$
1,274
     
87
%
Services
   
261
     
15
%
   
192
     
13
%
    Total revenues
 
$
1,712
     
100
%
 
$
1,466
     
100
%
                                 
Cost of sales:
                               
Products
 
$
1,156
     
68
%
 
$
993
     
68
%
Services
   
43
     
3
%
   
35
     
2
%
   Total costs of sales
 
$
1,199
     
71
%
 
$
1,028
     
70
%
                                 
Gross profit:
                               
Products
 
$
295
     
17
%
 
$
281
     
19
%
Services
   
218
     
12
%
   
157
     
11
%
   Total gross profit
 
$
513
     
29
%
 
$
438
     
30
%

Individual contracts are generally significant in value and are awarded in a highly competitive bidding process.  The gross profit margin varies from one contract to another, depending on the size of the contract and the competitiveness of market conditions.  Accordingly, comparative results between quarters may not be indicative of trends in gross profit margin.

Overall gross profit margins were at 29% for the three months ended July 31, 2010, compared to 30% for the corresponding period in 2009.   The slight reductions in 2010 are largely due to higher cost of sales associated with contract and spares revenues.

Research and Development Expenses (“R&D”)

For the three months ended July 31, 2010, we did not incur any R&D expenses, compared to $477,000 in the same period in 2009.  We attribute the significant decreases to the completion of the development of new voting system products.  We anticipate that R&D expenses will remain relatively insignificant in the remaining quarters of fiscal 2011 as we focus and dedicate our efforts on the marketing and sale of the new voting system.
 
Selling, General and Administrative (“SG&A”)

SG&A expenses for the three months ended July 31, 2010 were $629,000, compared to $503,000 in the same period in 2009.    The increases in SG&A expenses are primarily related to higher expenses incurred in marketing activities for the voting and gaming segments, higher personnel costs associated with increased headcount and higher consulting fees associated with the voting segment. We anticipate that SG&A expense will increase moderately in the remaining quarters of fiscal 2011.

Other Income

Other income in the three months ended July 31, 2010 and 2009 remained relatively insignificant.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our net working capital at July 31, 2010 was $4.5 million.

Contract backlog at July 31, 2010 was approximately $2.8 million.  Of this amount, approximately $1.4 million will be derived from gaming contracts executed with related customers.  The remaining contract backlog amount of approximately $1.4 million relates to voting and gaming contracts with unrelated customers.

Additional sources of cash through July 31, 2011 are expected to be derived from spares, software and technical support and licensing revenues.  Uses of cash are expected to be for normal operating expenses and costs associated with contract deliverables.

While we anticipate that we will be successful in obtaining additional product or service contracts to enable us to continue normal operations through July 31, 2011, there can be no assurance that we will be able to acquire new contracts.

In the highly competitive industry in which we operate, operating results may fluctuate significantly from period to period.  We anticipate that our cash flows from operations, expected contract payments and available cash will be sufficient to enable us to meet our liquidity needs through at least July 31, 2011.  Although we are not aware of any particular trends, in the event that we are unable to secure new business, we may experience reduced liquidity or insufficient cash flows.

The following table summarizes our cash flow activities:
   
Three Months Ended
 
   
July 31,
   
July 31,
   
Increase
 
   
2010
   
2009
   
(Decrease)
 
(Amounts in thousands)
                 
Condensed cash flow comparative:
                 
Operating activities
 
$
(64)
   
$
(1,199)
   
$
1,135
 
Investing activities
   
235
     
885
     
(650)
 
Net increase (decrease) in cash and cash equivalents
 
$
171
   
$
(314)
   
$
485
 

Cash Flow Analysis

Net cash used in operating activities was $64,000 for the three months ended July 31, 2010, compared to $1.2 million for the same period in 2009.  The primary factors contributing to the variability in the reported cash flow amounts relate to the timing of customer contract performance and milestone invoicing which effectively impacted accounts receivable and billings in excess of costs and estimated earnings on uncompleted contracts.  In addition, the timing of customer contract related purchases and the lower net loss incurred in 2010 also contributed to the variability in the reported cash flow amounts.

Net cash provided by investing activities was $235,000 for the three months ended July 31, 2010, compared to $885,000 in 2009.  The lower net cash provided by investing activities in the three months ended July 31, 2010 resulted from the purchases of certificates of deposits.  Capital expenditures for computer equipment amounted to $13,000 in the three months ended July 31, 2010, compared to $30,000 in 2009.

There were no financing activities for the three months ended in July 31, 2010 or 2009.

Capital Resources

As of July 31, 2010, there were no unused credit facilities.


ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

 
ITEM 4.
CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in SEC Rule 13a-15(e) and 15d-15 (e)) as of the end of the period covered by this report.  Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and (ii) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There have not been any changes in the Company’s internal control over financial reporting during the quarter ended July 31, 2010 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.





 
PART II
OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 

The Company is currently not a party to any pending legal proceedings, and no such action by or, to the best of its knowledge, against the Company has been threatened as of the date of this report.
 
ITEM 1A.
 
RISK FACTORS
 
The discussion of risk factors relating to our business is disclosed in our Form 10-K for the fiscal year ended April 30, 2010 filed with the SEC on July 8, 2010.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable  
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

Not applicable

ITEM 4.
 
Not applicable
 
ITEM 5.
OTHER INFORMATION

Not applicable






ITEM 6.

A.          Exhibits

Exhibit Number
Document Description
31.1
Certification of the Chief Executive Officer of the Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Chief Financial Officer of the Company Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32
Certification Pursuant to 18 United States Code Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.













Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Dated:      September 13, 2010
 
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
 
 
/s/
 
 
Jeffrey M. Johnson
Jeffrey M. Johnson
 
President
   
/s/
T. Linh Nguyen
 
T. Linh Nguyen
 
Chief Financial Officer and Corporate Secretary