Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCFinancial_Report.xls
EX-32 - ILTS FORM 10-Q 1 FY15 EXHIBIT 32 - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCexhibit32.htm
EX-31 - ILTS FORM 10-Q 1 FY15 EXHIBIT 31 - INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INCexhibit31.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, 2014

[ ]           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)
 
 

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     No  o
   
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   ý     No  o

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

The number of shares outstanding of the registrant’s Common Stock, no par value, as of September 12, 2014 was 12,962,999.
 
 
 
 
 
 
 
 

INDEX


PART I
FINANCIAL INFORMATION
 
PAGE
 
Item 1.
     
Item 2. 
     
Item 3.
     
Item 4.
     
           
PART II
OTHER INFORMATION
       
Item 1.
     
Item 1A.
     
Item 2.
     
Item 3.
     
Item 4.
     
Item 5.
     
Item 6.
     
         
EXHIBIT 31
EXHIBIT 32
 
 
 


 
2
 
 

 
 PART I
   
 ITEM 1.
 FINANCIAL STATEMENTS
 
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(Amounts in thousands)
 
   
July 31,
   
April 30,
 
   
2014
   
2014
 
   
(Unaudited)
   
(1)
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
 
$
9,792
   
$
10,444
 
Accounts receivable, net of allowance for doubtful accounts of $75
   
1,788
     
712
 
Deferred cost of revenues
   
19
     
3
 
Inventories
   
1,249
     
1,398
 
Other current assets
   
208
     
217
 
Total current assets
   
13,056
     
12,774
 
Equipment, furniture and fixtures, net
   
589
     
612
 
Other noncurrent assets
   
49
     
49
 
Total assets
 
$
13,694
   
$
13,435
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
 
$
646
   
$
397
 
Accrued payroll and related taxes
   
499
     
640
 
Warranty reserves
   
200
     
188
 
Payable to Parent
   
152
     
152
 
Other current liabilities
   
40
     
41
 
Deferred revenues
   
540
     
470
 
Total current liabilities
   
2,077
     
1,888
 
Long-term liabilities
   
11
     
11
 
Total liabilities
   
2,088
     
1,899
 
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
   
(44,764
)
   
(44,834
)
Total shareholders' equity
   
11,606
     
11,536
 
Total liabilities and shareholders' equity
 
$
13,694
   
$
13,435
 
 
(1) Derived from the consolidated audited financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 2014 filed with the SEC.
 
See notes to condensed consolidated financial statements
 
 
 
 
3
 
 

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

   
Three Months Ended
 
   
July 31,
 
 
2014
   
2013
 
Revenues:
           
Sales of products
 
$
2,557
   
$
7,310
 
Services
   
316
     
456
 
     
2,873
     
7,766
 
Cost of sales:
               
Cost of product sales
   
1,888
     
5,926
 
Cost of services
   
103
     
131
 
     
1,991
     
6,057
 
Gross profit
   
882
     
1,709
 
Research and development expenses
   
150
     
-
 
Selling, general and administrative expenses
   
657
     
588
 
Income from operations
   
75
     
1,121
 
                 
Other income:
               
Interest and dividend income
   
-
     
1
 
Other
   
1
     
-
 
Income before provision for income taxes
   
76
     
1,122
 
Provision for income taxes
   
       6
     
      452
 
Net income
 
$
70
   
$
670
 
Net income per share:
               
Basic
 
$
0.01
   
$
0.05
 
Weighted average shares used in computation of net income per share:
               
Basic
   
12,963
     
12,963
 
                 

See notes to condensed consolidated financial statements
 

 
4
 
 

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


   
Three Months Ended
July 31,
 
   
2014
   
2013
 
Cash flows from operating activities:
           
Net income
 
$
70
   
$
670
 
Adjustments to reconcile net income to net cash used in
               
operating activities:
               
Depreciation and amortization
   
59
     
46
 
Warranty reserve expense
   
23
     
171
 
Loss on disposal of equipment
   
-
     
25
 
Deferred income taxes
   
-
     
405
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(1,076
)
   
276
 
Deferred cost of revenues
   
(16
)
   
(59
)
Inventories
   
149
     
621
 
Other current and noncurrent assets
   
   9
     
   101
 
Accounts payable
   
249
     
(1,115
)
Accrued payroll and related taxes
   
(141
)
   
57
 
Warranty reserves
   
(11
)
   
(54
)
Other liabilities
   
(1
)
   
30
 
Deferred revenues
   
70
     
(1,720
)
Net cash used in operating activities
   
(616
)
   
(546
)
                 
Cash flows from investing activities:
               
Additions to equipment, furniture and fixtures
   
(36
)
   
(79
)
Net cash used in investing activities
   
(36
   
(79
)
                 
Net decrease in cash and cash equivalents
   
(652
)
   
(625
)
Cash and cash equivalents at beginning of period
   
10,444
     
7,259
 
Cash and cash equivalents at end of period
 
$
9,792
   
$
6,634
 
                 

See notes to condensed consolidated financial statements
 
 

 
5
 
 
 

 
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 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 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.

The Company, through its wholly-owned subsidiary Unisyn Voting Solutions, Inc. (“Unisyn”), has devoted significant resources to developing federally 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 Commission (“EAC”) for its OpenElect® digital optical scan election system – a digital scan voting system built with Java on a streamlined and hardened Linux platform. As part of a jurisdiction’s procurement process, the Company provides 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;
·  
Reduce the cost of ballot printing while offering operational efficiencies;
   
·  
Minimal training required 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.
 
On January 8, 2014, the Company’s board of directors approved (i) the Company’s reincorporation from California to Delaware by means of a merger with and into a wholly-owned Delaware subsidiary (the “Reincorporation”) and (ii) a subsequent amendment to the surviving company’s certificate of incorporation to effect a 9,245,317-for-1 reverse stock split (the “Reverse Stock Split”) on outstanding shares of common stock. On January 8, 2014, BLM, the holder of 9,245,317 shares of the Company’s common stock, representing 71.3% of the Company’s outstanding shares of common stock as of that date, approved the Reincorporation and Reverse Stock Split by written consent. Each shareholder holding less than one full share of common stock following the Reverse Stock Split, being every shareholder of the Company other than BLM, will receive a cash payment from the Company for their fractional share interests equal to $1.33 in cash, without interest, for each share of common stock held by such shareholder immediately prior to the Reverse Stock Split. The Reincorporation and the Reverse Stock Split will be effected on or about the date 20 calendar days following the date on which the Company’s Information Statement on Schedule 14C (the “Information Statement”) relating to the Reincorporation and Reverse Stock Split is mailed to the Company’s shareholders. A preliminary Information Statement has been filed with the SEC and currently remains under review. The transactions are expected to be consummated in the fourth quarter of calendar year 2014, and the Company will thereafter promptly terminate its registration and reporting obligations under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of ILTS and its wholly-owned subsidiary, Unisyn. All significant intercompany accounts and transactions are eliminated in consolidation. 
 

 
6
 
 

 
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, 2014 filed with the SEC on July 11, 2014. The condensed consolidated balance sheet as of April 30, 2014 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 $540,000 as of July 31, 2014 represent prepayments for products and services related to the use of the OpenElect® and PBC voting systems, and other software and technical support services. The Company will recognize the revenues upon the fulfillment of the prescribed criteria for revenue recognition.
 
Warranty Reserves

The Company estimates the warranty costs that may be incurred and records a liability as the products are shipped and 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, 2014 is as follows:

(Amounts in thousands)
     
Balance at May 1, 2014
 
$
188
 
Additional reserves
   
23
 
Charges incurred
   
(11
)
Balance at July 31, 2014
 
$
200
 
 
Income Taxes
 
The Company uses the asset and liability method for financial reporting of income taxes. Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and the tax basis of assets and liabilities, and are measured by applying enacted rates and laws to taxable years in which such differences are expected to be recovered or settled. Any changes in tax rates or laws are recognized in the period when such changes are enacted. Valuation allowances have been established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company records a valuation allowance to reduce its deferred tax assets when uncertainty exists regarding the realizability of the deferred tax assets.
 
The provision for income taxes was $6,000 for the three months ended July 31, 2014, compared to $452,000 in the same period in 2013. The effective rate was 8.09% for 2014, compared to 40.3% for 2013. The significant variance was due to reversal of a portion of the valuation allowance and recording of a deferred tax asset in 2013.
 
 

 
7
 
 

 
Segment Information

The Company reports segment information based on the “management” approach. Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Company’s chief operating decision maker for purposes of evaluating performance and allocating resources.
  
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 lottery and pari-mutuel racing industries worldwide. Presently the voting segment generates revenues from the sales of the voting systems and hardware, software licensing, 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, 2014
 
 
Gaming
Business
 
Voting
Business
 
Totals
 
Total revenues
 
$
278
   
$
2,595
   
$
2,873
 
(Loss) income from operations
   
(759
)
   
834
     
75
 
Depreciation and amortization
   
39
     
20
     
59
 
Segment assets
   
10,494
     
3,200
     
13,694
 
     
 
As of and for the Three Months Ended
July 31, 2013
 
 
Gaming
Business
 
Voting
Business
 
Totals
 
Total revenues
 
$
6,870
   
$
896
   
$
7,766
 
Income from operations
   
1,011
     
110
     
1,121
 
Depreciation and amortization
   
26
     
20
     
46
 
Segment assets
   
13,237
     
1,636
     
14,873
 
 
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.  

Inventories consisted of the following:
   
July 31,
   
April 30,
 
   
2014
   
2014
 
(Amounts in thousands)
           
Raw materials and subassemblies
 
$
1,222
   
$
1,082
 
Work-in-process
   
5
     
13
 
Finished goods
   
22
     
303
 
   
$
1,249
   
$
1,398
 

 
 
 
8
 
 
 
Equipment, Furniture and Fixtures

Net equipment, furniture and fixtures consisted of the following:
   
July 31,
   
April 30,
 
   
2014
   
2014
 
(Amounts in thousands)
           
Plant and machinery
 
$
690
   
$
662
 
Computer equipment
   
1,803
     
1,741
 
Leasehold improvement
   
201
     
201
 
Furniture, fixtures and equipment
   
96
     
96
 
Construction in progress
   
20
     
85
 
     
2,810
     
2,785
 
Accumulated depreciation and amortization
   
(2,221
)
   
(2,173
)
Net equipment, furniture and fixtures 
 
$
589
   
$
612
 
 
Net Income per Share

Basic net income per share is based on the weighted average number of shares outstanding during the periods.  
 
Major Customers
 
The following table summarizes major customers who individually accounted for more than 10% of revenues for the periods presented:
 
 
Three Months Ended
  
July 31, 2014
 
July 31, 2013
Revenue:
     
From unrelated customers
Three customers from the voting segment accounted for 85% of total revenue.
 
One customer from the gaming segment accounted for 86% of total revenue.
       
From related customers
No individual customer accounted for more than 10% of total revenue.
 
No individual customer accounted for more than 10% of total revenue.

Related Party Transactions

During the three months ended July 31, 2014 and 2013, revenues from all related party transactions for the sales of products and services totaled approximately $262,000 (9% of total revenue) and $163,000 (2% of total revenue), respectively. Included in accounts receivable at July 31, 2014 was approximately $110,000 from these customers. Descriptions of the transactions with the Company’s related parties in the three months ended July 31, 2014 and 2013 are presented below.
 
Berjaya Lottery Management (H.K.) Ltd.
 
In 1996, the Company entered into an agreement to purchase specific inventory on behalf of Berjaya Lottery Management (H.K.) Ltd. (“BLM”), the owner of 71.3% of ILTS’s outstanding voting stock as of July 31, 2014.  

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 resulted 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, 2014 and 2013;
 
·
There were no accounts receivable balances from BLM as of July 31, 2014 and April 30, 2014;
 
·  
Liabilities to BLM arising from the sale or use of the BLM inventory, recorded as “Payable to Parent,” were $152,000 as of both July 31, 2014 and April 30, 2014; and
  
·  
There were no inventory balances held for BLM as of July 31, 2014 and April 30, 2014.
 
 
 
 
9
 
 

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

The financial activities and balances related to transactions with STM were as follows:

·  
Revenues recognized on the sale of support services and lottery products during the three months ended July 31, 2014 were approximately $184,000. For the three months ended July 31, 2013, revenue recognized on the support services was $122,000;
 
·
There was deferred revenue of $8,000 on software support services and lottery products as of July 31, 2014, compared to $10,000 as of April 30, 2014; and
 
·  
Accounts receivable totaled $57,000 as of July 31, 2014. There was no accounts receivable balance as of April 30, 2014.
  

Philippine Gaming Management Corporation
 
The Company provides lottery products and software development to Philippine Gaming Management Corporation (“PGMC”), a related party and a subsidiary of BLM.

In addition, the Company provides PGMC with terminal spare parts on an ongoing basis and support services on an as-needed basis.

The financial activities and balances related to transactions with PGMC were as follows:

·  
Revenues recognized on the sale of lottery products during the three months ended July 31, 2014 and 2013 totaled $42,000 and $5,000, respectively; 
 
·  
There were no deferred revenue balances as of July 31, 2014 and April 30, 2014; and
 
·
Accounts receivable balance was $42,000 as of July 31, 2014. There was no accounts receivable balance as of April 30, 2014.
  
 
Natural Avenue Sdn. Bhd.

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

The financial activities and balances related to transactions with Natural Avenue were as follows:

·  
Revenues recognized on the sale of support services and licensing during the three months ended July 31, 2014 and 2013 totaled $35,000 and $36,000, respectively;
 
·  
There was no deferred revenue balance as of July 31, 2014. Deferred revenue balance on lottery product licensing totaled $4,000 as of April 30, 2014; and
 
·  
Accounts receivable balances were $11,000 as of July 31, 2014 and April 30, 2014.
  
 
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, 2014 and 2013, the Company incurred services of approximately $68,000 and $51,000, respectively, which are shown as part of cost of sales. 
 
10
 
 


Fair Value of Financial Instruments
 
The Company’s material financial instruments consist of its cash and cash equivalents, accounts receivable, accounts payable and related party payables. The carrying amounts of the Company’s financial instruments generally approximated their fair values as of July 31, 2014 and April 30, 2014 due to the short-term maturity of the instruments.

Recent Accounting Pronouncements

In May 2014, the FASB issued an update to ASC 606, Revenue from Contracts with Customers. This update to ASC 606 provides a five-step process to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue upon transfer of promised goods or services to customers in an amount that reflects the expected consideration to be received in exchange for those goods or services. This update to ASC 606 will also result in enhanced disclosures about revenue, providing guidance for transactions that were not previously addressed comprehensively, and improving guidance for multiple-element arrangements. This update to ASC 606 is effective for the Company beginning in fiscal 2018. The company is currently evaluating the impact of this update on its consolidated financial statements.

 
 
11
 
 

 
 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" and other sections of this report, 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 accordance 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. There have been no material changes to the critical accounting policies outlined in the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2014.
 
 
 
 
12
 
 

 
Revenue Recognition
 
Our revenues are derived primarily from the sales of complete wagering systems, lottery terminals, the OpenElect® and PBC voting systems, other software and software support services. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and the title and risk of loss have been transferred. Service revenues are recognized as the services are rendered, and the related costs of services are recognized on a time and materials basis.

Revenue Recognition for Arrangements with Multiple Deliverables
 
For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software, and undelivered non-software services, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, we use a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of the selling price (“ESP”). VSOE generally exists only when we sell the deliverable separately and VSOE is the price actually charged for that deliverable. TPE is determined based on competitor prices for similar deliverables when sold separately. ESPs reflect our best estimates of what the selling prices of elements would be if they were sold regularly on a standalone basis.

For sales of hardware products, we provide various hardware components containing software essential to the hardware product’s functionality, and other components depending on the customers’ needs. We allocate revenue to these deliverables using the relative selling price method. Because we have not established VSOE or TPE for the hardware, with essential software, revenue is allocated based on ESPs. Determining ESPs requires management’s judgment. Revenue is recognized upon shipment of the hardware and the related essential software, provided the other conditions for revenue recognition have been met. We also provide software support and product support services on a standalone basis from the sales of the hardware. Amounts allocated to software support and product support services are based on VSOE using hourly or daily billing rates. Revenue is deferred until the services are performed. For annual software licenses, we use VSOE. Amounts allocated to annual software licenses are deferred and recognized on a straight-line basis over the service period, which is typically one year.
 
We consider multiple factors depending on the unique facts and circumstances related to each deliverable when determining ESPs for deliverables without VSOE or TPE. Key factors considered by the management in developing the ESPs for the hardware include the costs of manufacture and what a customer would reasonably pay based on the features being offered, trends in the marketplace, size of the territory, and competitive prices. If the facts and circumstances underlying the factors change, including the estimated or actual costs incurred to provide the hardware with the essential software, or should future facts and circumstances lead management to consider additional factors, our ESP for the hardware with essential software related to future sales could change.
 
Revenue Recognition for Percentage-of-Completion Method
 
For our complete wagering and lottery systems, we recognize revenue by using the percentage-of-completion method when the contracts for complete systems fulfill the following criteria:
 
1.
Contract performance extends over long periods of time;
     
2.
The software portion involves significant production, modification or customization;
 
3.
Reasonably dependable estimates can be made on the progress towards completion, contract revenues and contract costs; and
4.
Each element is essential to the functionality of the other elements of the contracts.
   
 
Under the percentage-of-completion method, sales and estimated gross profits are recognized as work progresses. Progress toward completion is measured by the ratio of costs incurred to total estimated costs. Revenue and gross profit may be adjusted prospectively for revisions in estimated total contract costs. If the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is recorded in the period in which it becomes evident. The total estimated loss includes all costs allocable to the specific contract.
 
 
 
 
13
 
 

 
RESULTS OF OPERATIONS

Revenue Analysis
     
(Amounts in thousands)
Three Months Ended
 
Revenues
 
July 31,
2014
   
July 31,
2013
   
Change
 
Products:
                 
Contracts
 
 $
 2,152
   
 $
 7,098
   
$
(4,946
)
Spares
   
164
     
28
     
     136
 
Licensing
   
241
     
184
     
57
 
Total Products
   
2,557
     
7,310
     
(4,753
)
Services:
                       
Software Support
   
285
     
221
     
64
 
Product Servicing and Support
   
31
     
235
     
(204
)
Total Services
   
316
     
456
     
(140
)
   
$
2,873
   
$
7,766
   
$
(4,893
)
                         

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, 2014 was approximately $2.2 million, compared to $7.1 million for the corresponding period in 2013. Significantly lower contract revenue was primarily due to completion of hardware component sales related to the gaming segment during the first quarter in 2013. The decrease was partially offset by increased sales related to the voting segment.

Spares revenue for the three months ended July 31, 2014 was $164,000, compared to $28,000 for the same period in 2013. The increase was primarily due to higher demand for spare parts. Customers' demand for spare parts fluctuates from period to period.  

Licensing revenue for the three months ended July 31, 2014 was $241,000, compared to $184,000 in 2013. The increase in licensing revenue was primarily due to additional executed licensing agreements related to the voting segment. We derive licensing revenue from both gaming and voting contracts.
 
Software support revenue for the three months ended July 31, 2014 was $285,000, compared to $221,000 for the same period in 2013. Higher software support revenue was primarily due to increased fees from the software support in the gaming segment.
 

 
14
 
 

 
Product servicing and support revenue for the three months ended July 31, 2014 was $31,000, compared to $235,000 for the same period in 2013. The decrease was primarily due to lower demand for support services compared to prior fiscal year.

Related party revenue of approximately $262,000 accounted for 9% of total revenue in the three months ended July 31, 2014, compared to $163,000 or 2% of total revenue in the corresponding period in 2013.
 
Cost of Sales and Gross Profit Analysis

The following table summarizes the cost of sales and gross profit margins as a percentage of total revenues for each of the periods shown:
 
   
Three Months Ended
 
   
July 31,
   
July 31,
 
(Amounts in thousands)
 
2014
   
2013
 
Revenues:
                       
Products
 
$
2,557
     
89
%
 
$
7,310
     
94
%
Services
   
316
     
11
%
   
456
     
6
%
Total revenues
 
$
2,873
     
100
%
 
$
7,766
     
100
%
                                 
Cost of sales:
                               
Products
 
$
1,888
     
66
%
 
$
5,926
     
76
%
Services
   
103
     
4
%
   
131
     
2
%
Total costs of sales
 
$
1,991
     
70
%
 
$
6,057
     
78
%
                                 
Gross profit:
                               
Products
 
$
669
     
23
%
 
$
1,384
     
18
%
Services
   
213
     
7
%
   
325
     
4
%
Total gross profit
 
$
882
     
30
%
 
$
1,709
     
22
%

In general, individual contracts are significant in value and certain contracts 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 and fiscal years may not be indicative of trends in gross profit margin.
 
Overall gross profit margin was 30% for the three months ended July 31, 2014, compared to 22% for the corresponding period in 2013. Higher gross profit margin in 2014 was primarily due to lower cost structures compared to the corresponding period in 2013.

 
 
15
 
 


Research and Development Expenses
 
We incurred $150,000 in research and development ("R&D") expenses for the three months ended July 31, 2014. We did not incur any R&D expenses for the same period in 2013. R&D expenses consisted primarily of labor costs for the development of new products in the gaming segment.
 
Selling, General and Administrative

Selling, general and administrative ("SG&A") expenses for the three months ended July 31, 2014 were $657,000, compared to $588,000 in the same period in 2013. Higher SG&A expenses in 2014 were primarily due to increased marketing, employee related and trade show expenses.
 
Income Tax Provision
 
The provision for income taxes was $6,000 for the three months ended July 31, 2014, compared to $452,000 in the same period in 2013. The effective rate was 8.09% for 2014, compared to 40.3% for 2013. The significant variance was due to reversal of a portion of the valuation allowance and recording of a deferred tax asset in 2013.

LIQUIDITY AND CAPITAL RESOURCES
 
Liquidity
 
Our net working capital as of July 31, 2014 was approximately $11 million.

Contract backlog as of July 31, 2014 was $644,000. Contract backlog is primarily related to voting contracts with unrelated customers. As of July 31, 2014, $215,000 of the contract backlog has been paid by customers.

Additional sources of cash through July 31, 2015 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, 2015, there can be no assurance that we will be able to acquire new contracts.

In the highly competitive industries 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, 2015. 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
 
   
2014
   
2013
   
(Decrease)
 
(Amounts in thousands)
                 
Condensed cash flow comparative:
                 
Operating activities
 
$
(616
)
 
$
(546
)
 
$
(70
)
Investing activities
   
(36
)
   
(79
)
   
43
 
Net decrease in cash and cash equivalents
 
$
(652
)
 
$
(625
)
 
$
(27
)
 
 
 
16
 
 

 
Cash Flow Analysis

Net cash used in operating activities was $616,000 for the three months ended July 31, 2014, compared to $546,000 in 2013. The principal component of the change in cash flow from operations was an increase in accounts receivable. This was partially offset by an increase in accounts payable and a decrease in inventory reflecting shipments to customers.

Net cash used in investing activities was $36,000 for the three months ended July 31, 2014, compared to $79,000 in 2013. Lower capital expenditures incurred in 2014 attributed to the decrease in net cash used in investing activities.

There were no financing activities during the three months ended July 31, 2014 or 2013.

Capital Resources

As of July 31, 2014, we did not have outstanding credit facilities.
 
 
 
 
 
 
17
 
 

 
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 Principal Executive Officer, who is also our Principal 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 Principal Executive Officer (and Principal 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 Principal Executive Officer (and Principal 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, 2014 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
 
There have been no material changes to the risk factors relating to our business as disclosed in our Form 10-K for the fiscal year ended April 30, 2014 filed with the SEC on July 11, 2014.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable  
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

Not applicable

ITEM 4.
MINE SAFETY DISCLOSURES
 
Not applicable
 
ITEM 5.
OTHER INFORMATION

Not applicable
 
 
 

 
18
 
 

 
ITEM 6.
EXHIBITS

A.          Exhibits

Exhibit Number
 
Document Description
 
31
 
 
Certification of the Principal Executive Officer and Principal 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.
 
101.INS
 
XBRL Instance Document
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
       
 
 
 

 
19
 
 

 
SIGNATURES

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 12, 2014
   
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
   
                                          /s/
 
Jeffrey M. Johnson
Jeffrey M. Johnson
President (Principal Executive Officer) and Acting Chief Financial Officer (Principal Financial Officer)