1 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 June 30, 1996 / / 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.(TM) (Exact Name of Registrant as specified in its charter) CALIFORNIA 95-3276269 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 2131 FARADAY AVENUE, CARLSBAD, CALIFORNIA 92008-7297 (Address of Principal Executive Offices) (Zip Code) (619) 931-4000 (Registrant's Telephone Number, Including Area Code) 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 twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practicable date. As of June 30, 1996, 16,816,211 shares of common stock were outstanding. 1 2 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM) PART I FINANCIAL INFORMATION PAGE - ------ --------------------- ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets June 30, 1996 and December 31, 1995 3 Condensed Consolidated Statements of Operations Three Months Ended June 30, 1996 and 1995 and Six months Ended June 30, 1996 and 1995 4 Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 1996 and 1995 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 PART II OTHER INFORMATION Item 1. Legal Proceedings 8 Item 4. Submission of Matters to a Vote of Security Holders 8 2 3 INTERNATIONAL LOTTERY TOTALIZATOR SYSTEMS, INC.(TM) PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets June 30, December 31, 1996 1995 (Unaudited) (Note) ----------- ----------- (Thousands of dollars) ASSETS Current Assets: Cash and cash equivalents $ 3,117 $ 3,904 Accounts receivable, net of allowance 2,131 1,588 Cost and estimated earnings in excess of billings on uncompleted contracts 5,679 3,665 Inventories at lower of cost (first-in, first-out) or market 4,474 6,820 Other current assets 279 642 ------- ------- Total current assets 15,680 16,619 Non-current accounts receivable 97 52 Investment in lottery service agreements, net 2,793 2,759 Equipment, furniture and fixtures, net 1,253 1,361 Computer software costs, net 641 561 ------- ------- Total assets $20,464 $21,352 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 511 $ 231 Billings in excess of costs and estimated earnings on uncompleted contracts 130 115 Accrued payroll and related taxes 1,285 949 Warranty reserves 266 298 Other current liabilities 2,204 6,238 ------- ------ Total current liabilities 4,396 7,831 Capital lease obligations - long term 75 109 ------- ------ Total Liabilities 4,471 7,940 ------- ------ Shareholders' equity: Common shares 51,087 48,687 Retained earnings (deficit) (35,198) (35,223) Foreign currency translation adjustment 104 (52) ------- ------ Total shareholders' equity 15,993 13,412 ------- ------ Total liabilities and shareholders' equity $20,464 $21,352 ======= ======= Note: The balance sheet at December 31, 1995 has been derived from the audited financial statements at that date. 3 4 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. (TM) Condensed Consolidated Statements of Operations Three Months Ended Six Months Ended June 30, June 30, (Unaudited) (Unaudited) ------------------ ---------------- (Thousands of dollars, except per share amounts) 1996 1995 1996 1995 ------ ------ ------- ------- Contract revenue and sales: $4,382 $4,211 $11,243 $9,451 Costs & expenses: Cost of Sales 3,684 4,817 8,499 9,751 Engineering, research & development 378 262 698 361 Selling, general & administrative 571 2,173 2,482 4,200 ------ ------ ------ ------ Total costs and expenses 4,633 7,252 11,679 14,312 ------ ------ ------ ------ Loss from operations (251) (3,041) (436) (4,861) Other Income (expense), net 412 84 611 174 ------ ------ ------ ------ Income (loss) before income 161 (2,957) 175 (4,687) taxes Provisions for taxes based on income 150 -- 150 -- ------ ------ ------ ------ Net income (loss) $ 11 (2,957) $ 25 (4,687) ====== ====== ====== ====== Net income (loss) per common share: Primary and fully diluted $ 0.00 $(0.18) $ 0.00 $(0.28) ====== ====== ====== ====== Shares used in per share amounts: Primary and fully diluted 17,016 16,810 16,916 16,807 ====== ====== ====== ====== 4 5 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM) Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, (Unaudited) ----------------------- 1996 1995 ------- ------- Cash flow from operating activities: Net income (loss) $ 25 $(4,687) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization 311 488 Changes in assets and liabilities: Accounts receivable (543) 1,062 Costs and estimated earnings in excess of billings on uncompleted contracts (2,014) (843) Inventories 2,346 23 Accounts payable 280 (478) Billings in excess of costs and estimated earnings on uncompleted contracts 15 (532) Accrued payroll and related taxes 336 610 Other (1,831) 1,265 ------- ------- Net cash used for operating activities (1,075) (3,092) ------- ------- Cash flow used for investing activities: Investment in lottery service agreements (34) (26) Lottery service agreement sale proceeds and advance repayments 338 -- Non-current accounts receivable (45) (54) Additions to equipment (147) (149) Additions to computer software cost (136) (150) Proceeds from sale of subsidiary 156 -- ------- ------- Net cash used for investing activities 132 (379) Cash flow provided by (used for) financing activities: Payments on notes payable -- (300) Proceeds from issuance of common shares -- 11 ------- ------- Net cash used for financing activities -- (289) ------- ------- Effect of exchange rate changes on cash 156 144 ------- ------- Decrease in cash and cash equivalents (787) (3,616) Cash and cash equivalents at beginning of year 3,904 9,467 ------- ------- Cash and cash equivalents at end of period $ 3,117 $ 5,851 ======= ======= Supplemental cash flow information: Cash paid during the six months for interest $ 13 $ 14 ======= ======= 5 6 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM) Notes to Condensed Consolidated Financial Statements June 30, 1996 (Thousands of dollars) 1. In the opinion of management, the accompanying unaudited, condensed consolidated financial statements contain all adjustments necessary to present fairly the Registrant's financial position and results of operations at June 30, 1996 and for the three and six months then ended. The accounting policies followed by the Registrant are set forth in Note 1 to the Registrant's consolidated financial statements in the Registrant's 1995 Annual Report. 2. 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. 3. Inventories - The inventory balance at June 30, 1996 is composed entirely of raw materials and work in process totaling $4,474. 4. McKinnie & Associates, Inc. - In March, 1993, the Registrant sold its subsidiary, McKinnie & Associates, Inc. to Shreveport Acquisition for cash and a note. Unrecorded gain and interest of approximately $1,100 will be recognized using the cost recovery method as payments are received over a two year period. 5. Papua New Guinea Lottery - In July 1995, the Registrant sold all interests in its Papua New Guinea lottery operation to the principal shareholders of the lottery licensee for cash and a note. The Registrant is accounting for the sale under the cost recovery method. At June 30, 1996, the Registrant's basis in this asset is zero and all future payments received will be recognized as a gain. The installment payments and the minimum percentage payments are secured by the lottery assets and certain personal guarantees. 6. On June 17, 1996, the court entered a judgement in the Registrant's shareholders' class action litigation. The judgement requires a cash payment, which has been placed in the class shareholders' escrow account, and 1.2 million shares of authorized but unissued common stock of the Registrant. Such shares are included in the calculation of earnings per share for the period ended June 30, 1996. The estimated settlement was accrued as of September 30, 1995 and an adjustment of approximately $1.1 million was recorded during the three months ended June 30, 1996 to reduce the accrual to the actual settlement amount, valued as of the judgement date. 6 7 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Thousands of dollars) RESULTS OF OPERATIONS During the quarter ended June 30, 1996, revenue increased by $171, or 4% as compared to the quarter ended June 30, 1995. Cost of sales, as a percentage of revenue was 84% in 1996 compared to 1995's cost of sales percentage of 114%. The decrease in cost of sales was primarily due to the lack of Russian lottery project expenses during 1996 and cost-saving measures which were implemented during 1995. Engineering, research and development costs increased $116 or 44% from 1995. This represents accelerated development of software for the lottery market. Selling, general and administrative expenses decreased $1,602 from the same period in 1995. This decrease was primarily the result of the reversal of approximately $1.1 million of previously accrued costs relating to the shareholders' class action litigation. The judgement was entered in June 1996. Other income and expense, net, increased $328 or 390% from 1995. This increase primarily relates to the gain recognized under the cost recovery method from the sale of the McKinnie & Associates subsidiary and the Papua New Guinea lottery. During the six month period ended June 30, 1996, revenue increased by $1,792, or 19% as compared to the same period in 1995. This increase reflects higher contract volume in 1996. Cost of sales as a percentage of revenue decreased to 76% for the six month period ended June 30, 1996, as compared to 103% for the same period in 1995. The decrease in cost of sales was primarily due to the lack of Russian lottery project expenses during 1996 and cost-saving measures which were implemented during 1995. Engineering, research and development costs increased $337, or 93% for the six month period ended June 30, 1996, as compared to the same period in 1995. As explained above, 1996 costs were primarily attributable to the accelerated development of software for the lottery market. Selling, general and administrative costs decreased $1,718 or 41% from the same period in 1995 due primarily to the reversal of approximately $1.1 million of previously accrued costs relating to the shareholders' class action litigation. The judgement was entered in June 1996. Other income and expense, net, increased $437 or 251% from 1995. This increase primarily relates to the gain recognized under the cost recovery method from the sale of the McKinnie & Associates subsidiary and the Papua New Guinea lottery. LIQUIDITY AND CAPITAL RESOURCES During the six months ended June 30, 1996, the Registrant's working capital increased by $2,496 due primarily to the reduction of inventory balances for current orders, and a reclassification of an accrued liability for the settlement of the shareholders' class action litigation into equity. There were no bank borrowings at June 30, 1996. As of June 30, 1996, there were no material commitments for capital expenditures. 7 8 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. (TM) Part II OTHER INFORMATION Item 1. Legal Proceedings Shareholder Class Action Litigation - The Registrant and certain of its officers and directors who were defendants in the shareholders' consolidated class action litigation filed in June and July 1994, reached a settlement of the litigation. The settlement included a cash payment, which has been placed in the class shareholders' escrow account, and 1.2 million authorized but unissued common shares of the Registrant. On June 17, 1996 the Federal District Court entered a final order and judgement in the litigation without objection from any class shareholder as to the settlement. The Registrant valued the shares to be issued in the settlement as of that date. Walters v ILTS - On November 3, 1995, Mr. James T. Walters, the former chairman and president of the Registrant, who retired in 1994, filed an action in the San Diego County Superior Court against the Registrant, its current president, Frederick A. Brunn, a publishing company and an author alleging that certain statements in a magazine article were slander per se by ILTS and Brunn and libel by the publishing company and the author, and that Mr. Walters suffered an invasion of privacy by all defendants. In addition, Mr. Walters alleged that information in the Registrant's 1995 proxy statement relating to Mr. Walters' compensation and retirement date was erroneous, resulting in two other magazine articles publishing alleged incorrect information. Mr. Walters seeks general and special damages of $9 million and punitive damages. The Registrant and Mr. Brunn deny all allegations in Mr. Walters' complaint and will defend the litigation accordingly. The publishing company and the author have reached a settlement with Mr. Walters. Since the outcome of the case is not expected to result in any liability to the Registrant, no provision for any liability that may result has been included in the consolidated financial statements. On July 19, 1996, ILTS and Mr. Brunn filed a motion for summary judgement which is scheduled to be decided on September 20, 1996. A trial date has been set for November 15, 1996. Item 4. Submission of Matters to a Vote of Security Holders. On June 6, 1996, the Registrant held its 1996 Annual Meeting of Shareholders. At the Annual Meeting, the following persons were elected as directors of the Registrant: Frederick A. Brunn, Theodore A. Johnson, M. Mark Michalko, Ng Aik Chin, Ng Foo Leong, Martin J. O'Meara Jr., and Sir Michael G.R. Sandberg. The following is the results of the voting on this matter: 1. The election of directors was conducted by the Inspector of Elections. For all nominees, at least 15,011,410 -or- 96% of the votes cast; Withheld total or partial authority 574,381 -or- 4% of the votes cast. 8 9 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. (TM) Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. (TM) /s/ WILLIAM A. HAINKE __________________________________ William A. Hainke Chief Financial Officer, Corporate Secretary and Treasurer Dated: July 30, 1996 9