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 October 31, 2009
[ ] 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](https://capedge.com/proxy/10-Q/0000354813-09-000012/logo1.jpg)
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 |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes o Noý |
1
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 December 9, 2009 | |
Common Stock, no par value per share | 12,962,999 shares |
2
PART I | FINANCIAL INFORMATION | PAGE |
Item 1. | 4-12 | |
Item 2. | 13-16 | |
Item 3. | 16 | |
Item 4T. | 17 | |
PART II | OTHER INFORMATION | |
Item 1. | 18 | |
Item 1A. | 18 | |
Item 2. | 18 | |
Item 3. | 18 | |
Item 4. | ||
Item 5. | 18 | |
Item 6. | 19 | |
20 |
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)
October 31, 2009 | April 30, 2009 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 3,951 | $ | 4,041 | ||||
Certificates of deposit | - | 1,803 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $75 | 533 | 116 | ||||||
Costs and estimated earnings in excess of billings on uncompleted contracts | 67 | 3 | ||||||
Inventories, net | 795 | 846 | ||||||
Other current assets | 107 | 170 | ||||||
Total current assets | 5,453 | 6,979 | ||||||
Equipment, furniture and fixtures, net | 376 | 415 | ||||||
Other noncurrent assets | 68 | 71 | ||||||
Total assets | $ | 5,897 | $ | 7,465 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 348 | $ | 328 | ||||
Billings in excess of costs and estimated earnings on uncompleted contracts | - | 482 | ||||||
Accrued payroll and related taxes | 355 | 450 | ||||||
Warranty reserves | 34 | 21 | ||||||
Payable to Parent | 250 | 250 | ||||||
Other current liabilities | 41 | 62 | ||||||
Deferred revenues | 364 | 248 | ||||||
Total current liabilities | 1,392 | 1,841 | ||||||
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 | (51,865 | ) | (50,746 | ) | ||||
Total shareholders' equity | 4,505 | 5,624 | ||||||
Total liabilities and shareholders' equity | $ | 5,897 | $ | 7,465 |
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 | Six Months Ended | |||||||||||||||
October 31, | October 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: | ||||||||||||||||
Sales of products | $ | 1,299 | $ | 2,555 | $ | 2,573 | $ | 3,941 | ||||||||
Services | 165 | 131 | 357 | 232 | ||||||||||||
1,464 | 2,686 | 2,930 | 4,173 | |||||||||||||
Cost of sales: | ||||||||||||||||
Cost of product sales | 1,122 | 848 | 2,115 | 1,702 | ||||||||||||
Cost of services | 26 | 34 | 61 | 62 | ||||||||||||
1,148 | 882 | 2,176 | 1,764 | |||||||||||||
Gross profit | 316 | 1,804 | 754 | 2,409 | ||||||||||||
Research and development expenses | 391 | 496 | 868 | 1,055 | ||||||||||||
Selling, general and administrative expenses | 506 | 474 | 1,009 | 923 | ||||||||||||
Income (loss) from operations | (581 | ) | 834 | (1,123 | ) | 431 | ||||||||||
Other income (expense): | ||||||||||||||||
Interest and dividend income | 2 | 29 | 7 | 59 | ||||||||||||
Other | - | (3 | ) | (3 | ) | (3 | ) | |||||||||
Net income (loss) | $ | (579 | ) | $ | 860 | $ | (1,119 | ) | $ | 487 | ||||||
Net income (loss) per share: | ||||||||||||||||
Basic and diluted | $ | (0.04 | ) | $ | 0.07 | $ | (0.08 | ) | $ | 0.04 | ||||||
Weighted average shares used in computation of net income (loss) per share: | ||||||||||||||||
Basic and diluted | 12,963 | 12,963 | 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)
Six Months Ended October 31, | ||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | (1,119) | $ | 487 | ||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) | ||||||||
operating activities: | ||||||||
Depreciation and amortization | 72 | 119 | ||||||
Warranty reserve expense (adjustments) | 16 | (357) | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (417) | (90) | ||||||
Costs and estimated earnings in excess of billings on | ||||||||
uncompleted contracts | (64) | 57 | ||||||
Inventories | 51 | 457 | ||||||
Other current assets | 63 | 79 | ||||||
Accounts payable | 20 | (144) | ||||||
Billings in excess of costs and estimated earnings on uncompleted | ||||||||
contracts | (482) | 140 | ||||||
Accrued payroll and related taxes | (95) | (68) | ||||||
Warranty reserves | (3) | (13) | ||||||
Other liabilities | (21) | (13) | ||||||
Deferred revenues | 116 | 2 | ||||||
Net cash provided by (used in) operating activities | (1,863) | 656 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of certificates of deposit | - | (285) | ||||||
Proceeds from redemption of certificates of deposit | 1,803 | 474 | ||||||
Additions to equipment, furniture and fixtures | (30) | (245) | ||||||
Net cash provided by (used in) investing activities | 1,773 | (56) | ||||||
Net increase (decrease) in cash and cash equivalents | (90) | 600 | ||||||
Cash and cash equivalents at beginning of period | 4,041 | 5,049 | ||||||
Cash and cash equivalents at end of period | $ | 3,951 | $ | 5,649 | ||||
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, together with its subsidiaries, the “Company”) 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 to developing a certified end-to-end optical scan voting system consisting of the Inkavote Plus Precinct Ballot Counter (“PBC”) and full-featured Election Management Software that provides precinct tabulation, ballot review and audio voting capability in a single compact unit. These efforts leverage the Company’s extensive experience to develop highly secure, mission-critical solutions that meet all of the Help America Vote Act of 2002 (“HAVA”) and Americans with Disabilities Act (“ADA”) requirements at a much lower cost than direct-recording electronic or touch screen systems. In addition, the Company’s voting system offers 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; |
· | Minimal voter re-education; and |
· | Capability to tally results in real time. |
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, 2009 filed with the SEC on July 8, 2009.
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.
Financial Accounting Standard Board Accounting Standards Codification
During the quarter ended October 31, 2009, we adopted authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) to the authoritative hierarchy of US GAAP. The guidance establishes the FASB Accounting Standards Codification (“Codification” or “ASC”) as the source of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with accounting principles generally accepted in the United States.
Subsequent Events
In accordance with FASB ASC Topic 855, "Subsequent Events," the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the condensed consolidated financial statements through December 10, 2009, the date of filing of this Form 10-Q.
Deferred Revenues
Deferred revenues of approximately $364,000 as of October 31, 2009 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 six months ended October 31, 2009 is as follows:
(Amounts in thousands) | ||||
Balance at May 1, 2009 | $ | 21 | ||
Additional reserves | 34 | |||
Warranty reserve expense adjustments | (18) | |||
Charges incurred | (3) | |||
Balance at October 31, 2009 | $ | 34 |
Income Tax Uncertainties
The Company became subject to the provisions of FASB ASC 740-10 “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109,” as of May 1, 2007. The adoption of FASB ASC 740-10 had no material effect on the Company’s condensed consolidated financial statements for the periods ended October 31, 2009 or 2008.
Segment Information
FASB ASC 280 “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. FASB ASC 280 defines operating segments 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, manufactures and manages computerized wagering systems and terminals for the online lottery and pari-mutuel racing industries worldwide. The voting system business generated licensing revenue, manufacturing and product servicing and support revenue.
The Company’s segment information is presented below:
As of and for the Three Months Ended | ||||||||||||
October 31, 2009 | ||||||||||||
Gaming Business | Voting Business | Totals | ||||||||||
Total revenues | $ | 1,385 | $ | 79 | $ | 1,464 | ||||||
Income (loss) from operations | 18 | (599) | (581) | |||||||||
Depreciation and amortization | 31 | 5 | 36 | |||||||||
Cost and estimated earnings in excess of billings on uncompleted contracts | 67 | - | 67 | |||||||||
Equipment, furniture and fixtures, net | 197 | 179 | 376 | |||||||||
Capitalized computer software development costs, net | - | 2 | 2 | |||||||||
Intangible assets – patent, net | - | 17 | 17 | |||||||||
Warranty reserves | 34 | - | 34 | |||||||||
Deferred revenues | 8 | 356 | 364 | |||||||||
As of and for the Three Months Ended | ||||||||||||
October 31, 2008 | ||||||||||||
Gaming Business | Voting Business | Totals | ||||||||||
Total revenues | $ | 2,105 | $ | 581 | $ | 2,686 | ||||||
Income from operations | 615 | 219 | 834 | |||||||||
Depreciation and amortization | 31 | 32 | 63 | |||||||||
Equipment, furniture and fixtures, net | 318 | 162 | 480 | |||||||||
Capitalized computer software development costs, net | - | 8 | 8 | |||||||||
Intangible assets – patent, net | - | 21 | 21 | |||||||||
Warranty reserves | 55 | - | 55 | |||||||||
Deferred revenues | 8 | 212 | 220 | |||||||||
As of and for the Six Months Ended | ||||||||||||
October 31, 2009 | ||||||||||||
Gaming Business | Voting Business | Totals | ||||||||||
Total revenues | $ | 2,746 | $ | 184 | $ | 2,930 | ||||||
Income (loss) from operations | 48 | (1,171) | (1,123) | |||||||||
Depreciation and amortization | 62 | 10 | 72 | |||||||||
Cost and estimated earnings in excess of billings on uncompleted contracts | 67 | - | 67 | |||||||||
Equipment, furniture and fixtures, net | 197 | 179 | 376 | |||||||||
Capitalized computer software development costs, net | - | 2 | 2 | |||||||||
Intangible assets – patent, net | - | 17 | 17 | |||||||||
Warranty reserves | 34 | - | 34 | |||||||||
Deferred revenues | 8 | 356 | 364 | |||||||||
As of and for the Six Months Ended | ||||||||||||
October 31, 2008 | ||||||||||||
Gaming Business | Voting Business | Totals | ||||||||||
Total revenues | $ | 3,572 | $ | 601 | $ | 4,173 | ||||||
Income (loss) from operations | 836 | (405) | 431 | |||||||||
Depreciation and amortization | 64 | 55 | 119 | |||||||||
Equipment, furniture and fixtures, net | 318 | 162 | 480 | |||||||||
Capitalized computer software development costs, net | - | 8 | 8 | |||||||||
Intangible assets – patent, net | - | 21 | 21 | |||||||||
Warranty reserves | 55 | - | 55 | |||||||||
Deferred revenues | 8 | 212 | 220 | |||||||||
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:
October 31, | April 30, | |||||||
(Amounts in thousands) | 2009 | 2009 | ||||||
Raw materials and subassemblies | $ | 795 | $ | 846 |
Net Income (Loss) per Share
Basic net income (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 remaining 84,000 options expired. Therefore, there were no outstanding options available at October 31, 2009. At October 31, 2008, the effects of the assumed exercise of options to purchase 86,000 shares of the Company’s common stock, respectively, at the price of $1.00, were not included in the computation of diluted net income per share amounts because they were anti-dilutive for that purpose.
Stock Options
Descriptions of the stock option plans are included in Note 9 of the Company’s Annual Report on Form 10-K for the year ended April 30, 2009. A summary of the status of the Company’s vested stock options including changes related to options that were granted outside the 2000 Plan and related information for the six months ended October 31, 2009 are presented below:
(shares in thousands)
Stock Options | Shares | Weighted -Average Exercise Price | Weighted- Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||
Options outstanding at May 1, 2009 | 84 | $ | 1.00 | 0.48 year | - | ||||||||
Granted | - | - | - | ||||||||||
Exercised | - | - | - | ||||||||||
Forfeited/expired | (84) | - | |||||||||||
Options outstanding and exercisable at October 31, 2009 | - | $ | - | - | - |
The Company did not grant any stock options or warrants to employees in the year ended April 30, 2009 and the six months ended October 31, 2009. Therefore, there was no share-based compensation expense related to employee stock options recognized during the three and six months ended October 31, 2009 and 2008.
Major Customers
Three Months Ended October 31, | Six Months Ended October 31, | |||||||
2009 | 2008 | 2009 | 2008 | |||||
Revenue: | ||||||||
From unrelated customers | One customer accounted for 19% of total revenue | Two customers accounted for 41% of total revenue | One customer accounted for 14% of total revenue | Two customers accounted for 49% of total revenue | ||||
From related customers | One customer accounted for 69% of total revenue | One customer accounted for 52% of total revenue | One customer accounted for 70% of total revenue | One customer accounted for 39% of total revenue |
Related Party Transactions
During the three months ended October 31, 2009 and 2008, revenues from all related party agreements for sales of products and services totaled approximately $1.1 million (75% of total revenue) and $1.5 million (56% of total revenue), respectively. Related party revenues for the six months ended October 31, 2009 and 2008 were approximately $2.3 million (78% of total revenue) and $1.8 million (43% of total revenue), respectively. Included in accounts receivable at October 31, 2009 was $395,000 from these customers. Descriptions of the transactions with the Company’s related parties in the three and six months ended October 31, 2009 and 2008 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 October 31, 2009. 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 and six months ended October 31, 2009 or 2008; |
· | There were no accounts receivable balances from BLM as of October 31, 2009; and |
· | Liabilities to BLM arising from the sale or use of the BLM inventory, recorded as “Payable to Parent,” were $250,000 as of October 31, 2009. |
Philippine Gaming Management Corporation
On March 6, 2009, 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 were completed in the first and second quarters of fiscal 2010.
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 shipment of the lottery products during the three and six months ended October 31, 2009 totaled approximately $1.0 million and $2.1 million, respectively. For the three and six months ended October 31, 2008, revenues recognized on the shipment of the lottery products totaled approximately $1.4 million and $1.6 million, respectively; |
· | Costs and estimated earnings in excess of billings relating to the abovementioned lottery product order dated March 6, 2009 and a software development project totaled $67,000 as of October 31, 2009; and |
· | Accounts receivable from the sale of lottery products totaled $356,000 as of October 31, 2009. |
Sports Toto Malaysia Sdn. Bhd.
The Company provides lottery products, software development and software support services to Sports Toto Malaysia (“STM”), a related party.
The financial activities and balances related to transactions with STM were as follows:
· | Revenues of $71,000 and $222,000 were recognized on the sale of software support services and lottery products during the three and six months ended October 31, 2009, respectively. During the three and six months ended October 31, 2008, revenues of $96,000 and $166,000 were recognized on the sale of software support services and lottery products, respectively; |
· | There was deferred revenue of $8,000 on software support services as of October 31, 2009; |
· | There were no net billings in excess of costs and estimated earnings on uncompleted contract as of October 31, 2009; and |
· | Accounts receivable totaled $29,000 as of October 31, 2009. |
Sports Toto Computers Sdn. Bhd.
The Company signed a Consulting and Service Agreement with Sports Toto Computers Sdn. Bhd. (“STC”), a related party, in August 2008 to engage STC in providing consulting, programming and other related services to the Company.
During the three and six months ended October 31, 2009, the Company incurred approximately $45,000 and $90,000, respectively for the consulting and programming STC provided.
Recent Accounting Pronouncements
In October 2009, the FASB issued authoritative guidance on revenue recognition 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 financial statements.
Subsequent Event
On November 16, 2009, the Company received from PGMC, a related party and a subsidiary of BLM, an order valued at $330,000 for software development. The project is scheduled for completion by January 2010.
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
FORWARD LOOKING STATEMENTS
SAFE HARBOR STATEMENT PURSUANT TO SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934 or the "Exchange Act." 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 dependence on business from foreign customers sometimes located and operated in politically unstable regions, political and governmental decisions as to the establishment of lottery and other wagering industries in which our products are marketed, fluctuations in quarter-by-quarter operating results, 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, 2009, 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, inventory valuation, the allowance for doubtful accounts and the deferred tax valuation allowance.
RESULTS OF OPERATIONS
Revenue Analysis
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
(Amounts in thousands) | October 31, | October 31, | ||||||||||||||||||||||
Revenues | 2009 | 2008 | Change | 2009 | 2008 | Change | ||||||||||||||||||
Products: | ||||||||||||||||||||||||
Contracts | $ | 885 | $ | 1,796 | $ | (911) | $ | 1,849 | $ | 2,737 | $ | (888) | ||||||||||||
Licensing | - | 479 | (479) | - | 479 | (479) | ||||||||||||||||||
Spares | 414 | 280 | 134 | 724 | 725 | (1) | ||||||||||||||||||
Total Products | 1,299 | 2,555 | (1,256) | 2,573 | 3,941 | (1,368) | ||||||||||||||||||
Services: | ||||||||||||||||||||||||
Software Support | 159 | 85 | 74 | 327 | 166 | 161 | ||||||||||||||||||
Product Servicing and Support | 6 | 46 | (40) | 30 | 66 | (36) | ||||||||||||||||||
Total Services | 165 | 131 | 34 | 357 | 232 | 125 | ||||||||||||||||||
$ | 1,464 | $ | 2,686 | $ | (1,222) | $ | 2,930 | $ | 4,173 | $ | (1,243) |
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 will 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 October 31, 2009 was $885,000, compared to $1.8 million in the same period in 2008. For the six months ended October 31, 2009, contract revenue was $1.8 million, compared to $2.7 million for the corresponding period in 2008. We generated limited contract sales in fiscal 2009 due to the absence of one contract, compared to the same period in the prior fiscal year.
During the three and six months ended October 31, 2009, we did not generate any licensing revenue due to limited opportunity. Licensing revenue of $479,000 for the three months and six months ended October 31, 2008 was related to the Prior Agreement between ILTS and Election Systems & Software, Inc. (“ES&S”) whereby ILTS granted ES&S an exclusive worldwide license to manufacture, sell and sublicense to ES&S’s end customers ILTS’s intellectual property relating to the PBC and PBC software it designed.
Spares revenue for the three months ended October 31, 2009 was $414,000, compared to $280,000 for the corresponding period in 2008. For the six months ended October 31, 2009, spares revenue was $724,000, compared to $725,000 for the same period in 2008. We derived spares revenue from relatively the same pool of customers as compared to the same periods in the prior year. Customer demand for spare parts fluctuates from period to period.
Software support revenue for the three months ended October 31, 2009 was $159,000, compared to $85,000 for the corresponding period in 2008. For the six months ended October 31, 2009, software support revenue was $327,000, compared to $166,000 for the same period in 2008. The increase in software support revenue in 2009 is due to one additional software support agreement with an unrelated customer.
Product servicing and support revenue for the periods ended October 31, 2009 and 2008 remained relatively insignificant.
Related party revenue of approximately $1.1 million accounted for 75% of total revenue in the three months ended October 31, 2009, compared to $1.5 million or 56% of total revenue in the corresponding period in 2008. For the six months ended October 31, 2009, related party revenue of approximately $2.3 million accounted for 78% of total revenue, compared to $1.8 million or 43% of total revenue in the corresponding period in 2008.
Cost of Sales and Gross Profit Analysis
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
October 31, | October 31, | October 31, | October 31, | |||||||||||||||||||||||||||||
(Amounts in thousands) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Products | $ | 1,299 | 89 | % | $ | 2,555 | 95 | % | $ | 2,573 | 88 | % | $ | 3,941 | 94 | % | ||||||||||||||||
Services | 165 | 11 | % | 131 | 5 | % | 357 | 12 | % | 232 | 6 | % | ||||||||||||||||||||
Total revenues | $ | 1,464 | 100 | % | $ | 2,686 | 100 | % | $ | 2,930 | 100 | % | $ | 4,173 | 100 | % | ||||||||||||||||
Cost of sales: | ||||||||||||||||||||||||||||||||
Products | $ | 1,122 | 77 | % | $ | 848 | 32 | % | $ | 2,115 | 72 | % | $ | 1,702 | 40 | % | ||||||||||||||||
Services | 26 | 2 | % | 34 | 1 | % | 61 | 2 | % | 62 | 2 | % | ||||||||||||||||||||
Total costs of sales | $ | 1,148 | 79 | % | $ | 882 | 33 | % | $ | 2,176 | 74 | % | $ | 1,764 | 42 | % | ||||||||||||||||
Gross profit: | ||||||||||||||||||||||||||||||||
Products | $ | 177 | 12 | % | $ | 1,707 | 63 | % | $ | 458 | 16 | % | $ | 2,239 | 54 | % | ||||||||||||||||
Services | 139 | 9 | % | 97 | 4 | % | 296 | 10 | % | 170 | 4 | % | ||||||||||||||||||||
Total gross profit | $ | 316 | 21 | % | $ | 1,804 | 67 | % | $ | 754 | 26 | % | $ | 2,409 | 58 | % |
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 21% for the three months ended October 31, 2009, compared to 67% for the corresponding period in 2008. For the six months ended October 31, 2009, overall gross profit margins were at 26%, compared to 58% in the same period in 2008. The reductions in gross profit margins in 2009 are largely due to substantially higher unabsorbed production costs resulting from decreased utilization of labor as there were fewer contract related activities and less research and development efforts expended. The absence of licensing revenue in 2009 and reduced profit margins on the sales of spare parts also contributed to the decline in gross profit margins. In addition, during the three months ended October 31, 2008, we recorded warranty reserve expense adjustment of $357,000 to reflect the expiration of our software warranty obligations with one customer. This adjustment reduced the cost of sales which effectively increased the gross profit margin in 2008.
Research and Development Expenses (“R&D”)
For the three months ended October 31, 2009, R&D expenses were $391,000, compared to $496,000 in the same period in 2008. For the six months ended October 31, 2009, R&D expenses were $868,000, compared to $1.1 million in the same period in 2008. We attribute the decreases to the gradual completion of the development phase of new voting system products. We anticipate that R&D expenses will continue to decrease moderately in coming quarters as we complete development of new voting system products.
Selling, General and Administrative (“SG&A”)
SG&A expenses for the three months ended October 31, 2009 were $506,000, compared to $474,000 in the same period in 2008. For the six months ended October 31, 2009, SG&A expenses were $1.0 million, compared to $923,000 in the same period in 2008. The increases in SG&A expenses are primarily related to higher personnel costs and internal labor costs incurred and allocated for compliance work related to the Sarbanes-Oxley requirements, partially offset by lower legal fees. We anticipate that SG&A expense will remain relatively constant for the remaining quarters of fiscal 2010.
Other Income
Other income in the three and six months ended October 31, 2009 and 2008 consisted of interest and dividend income. We derived interest and dividend income from certificates of deposit and cash and cash equivalent balances during the three and six months periods ended October 31, 2009 and 2008. The significant reduction in interest and dividend income is due primarily to lower cash balances and reduced yield and return on investments as a result of the financial market conditions.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our net working capital at October 31, 2009 was $4.1 million.
Contract backlog at October 31, 2009 was approximately $620,000. Of this amount, approximately $408,000 will be derived from software and technical support services provided to both related and unrelated customers. The remaining contract backlog amount of approximately $212,000 relates to an executed voting contract with an unrelated customer.
Additional sources of cash through October 31, 2010 are expected to be derived from pending contract executions, spares and software support revenues. Uses of cash are expected to be for normal operating expenses and costs associated with contract execution.
While we anticipate that we will be successful in obtaining additional product or service contracts to enable us to continue normal operations through October 31, 2010, 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 October 31, 2010. 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:
Six Months Ended | ||||||||||||
October 31, | October 31, | Increase | ||||||||||
2009 | 2008 | (Decrease) | ||||||||||
(Amounts in thousands) | ||||||||||||
Condensed cash flow comparative: | ||||||||||||
Operating activities | $ | (1,863) | $ | 656 | $ | (2,519) | ||||||
Investing activities | 1,773 | (56) | 1,829 | |||||||||
Net increase (decrease) in cash and cash equivalents | $ | (90) | $ | 600 | $ | (690) |
Cash Flow Analysis
Net cash used in operating activities was $1.9 million for the six months ended October 31, 2009, compared to net cash provided by operating activities of $656,000 for the same period in 2008. The primary factors contributing to the variability in the reported cash flow amounts relate to a net loss of $1.1 million incurred in 2009, compared to a net income of $487,000 in 2008, timing of contract milestone invoicing, receipt of payments and recognition of contract revenue in 2009, which effectively reduced the total billings in excess of costs and estimated earnings on uncompleted contracts. In addition, the reduction in inventory was less significant in 2009, compared to that of 2008, partially offset by a relatively larger increase in deferred revenue in 2009 due to advance billings on a new support service arrangement.
Net cash provided by investing activities was $1.8 million for the six months ended October 31, 2009, compared to net cash used by investing activities of $56,000 in 2008. Net cash provided by investing activities in the six months ended October 31, 2009 resulted primarily from the redemption of matured certificates of deposits. Capital expenditures amounted to $30,000 in the six months ended October 31, 2009, compared to $245,000 in 2008. Higher capital expenditures in 2008 were related to the purchase of test and tooling equipment.
There were no financing activities for the three months ended in October 31, 2009 or 2008.
Capital Resources
As of October 31, 2009, there were no unused credit facilities.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable
ITEM 4T. | 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 October 31, 2009 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, 2009 filed with the SEC on July 8, 2009.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Not applicable
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
Not applicable
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
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: December 10, 2009 | 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 | ||