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ITSI > SEC Filings for ITSI > Form 10-Q on 13-Mar-2013All Recent SEC Filings

Show all filings for INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INC


13-Mar-2013

Quarterly Report


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 beliefs. 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, 2012.


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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, 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 market, 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 the 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.


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RESULTS OF OPERATIONS

Revenue Analysis
                                       Three Months Ended                   Nine Months Ended
(Amounts in thousands)                    January 31,                          January 31,
Revenues                         2013        2012        Change       2013        2012        Change
Products:
Contracts                       $ 1,567     $ 3,673     $ (2,106 )   $ 5,924     $ 5,291     $    633
Spares                               54         314         (260 )       530         597          (67 )
Licensing                            88          47           41         315         160          155
Total Products                    1,709       4,034       (2,325 )     6,769       6,048          721
Services:
Software Support                    195         198           (3 )       594         581           13
Product Servicing and Support       102         251         (149 )       330         407          (77 )
Total Services                      297         449         (152 )       924         988          (64 )
                                $ 2,006     $ 4,483     $ (2,477 )   $ 7,693     $ 7,036     $    657

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 and fiscal years 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 January 31, 2013 was approximately $1.6 million, compared to $3.7 million for the corresponding period in 2012. The significant decrease was primarily due to the fewer contract activities for the voting segment, compared to the corresponding period in 2012. For the nine months ended January 31, 2013, contract revenue was approximately $5.9 million, compared to $5.3 million for the corresponding period in 2012. Slightly higher contract revenue was primarily due to increased contract activities for the gaming segment, partially offset by decreased contract activities for the voting segment.

Spares revenue for the three months ended January 31, 2013 was $54,000, compared to $314,000 for the same period in 2012. The decrease was primarily due to lower demand for spare parts from customers in the gaming segment. Spares revenue for the nine months ended January 31, 2013 remained relatively constant at $530,000, compared to $597,000 for the corresponding period in 2012. Customers' demand for spare parts fluctuates from period to period.

Licensing revenue for the three months ended January 31, 2013 was $88,000, compared to $47,000 in 2012. For the nine months ended January 31, 2013, licensing revenue was $315,000, compared to $160,000 for the corresponding period in 2012. The higher licensing revenues were primarily due to the additional executed licensing agreements related to the voting segment.

Software support revenue for the three months ended January 31, 2013 was $195,000, compared to $198,000 for the same period in 2012. For the nine months ended January 31, 2013, software support revenue was $594,000, compared to $581,000 in the same period in 2012. Software support revenues remained relatively flat compared to the corresponding periods in 2012.


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Product servicing and support revenue for the three months ended January 31, 2013 was $102,000, compared to $251,000 for the corresponding period in 2012. For the nine months ended January 31, 2013, product servicing and support revenue was $330,000, compared to $407,000 for the same period in the prior year. The decreases were primarily due to lower demand for support services from a customer in the gaming segment, partially offset by slightly higher demand for support services from customers in the voting segment.

Related party revenue of approximately $646,000 accounted for 32% of total revenue in the three months ended January 31, 2013, compared to $2 million or 44% of total revenue in the corresponding period in 2012. For the nine months ended January 31, 2013, related party revenue of approximately $3.7 million accounted for 48% of total revenue, compared to $3.5 million or 50% of total revenue in the corresponding period in 2012.

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                            Nine Months Ended
                                       January 31,                                  January 31,
(Amounts in thousands)         2013                  2012                  2013                  2012
Revenues:
Products                 $ 1,709        85 %   $ 4,034        90 %   $ 6,769        88 %   $ 6,048        86 %
Services                     297        15 %       449        10 %       924        12 %       988        14 %
Total revenues           $ 2,006       100 %   $ 4,483       100 %   $ 7,693       100 %   $ 7,036       100 %

Cost of sales:
Products                 $ 1,372        68 %   $ 2,960        66 %   $ 4,222        55 %   $ 4,931        70 %
Services                     146         7 %       195         4 %       349         5 %       350         5 %
Total costs of sales     $ 1,518        75 %   $ 3,155        70 %   $ 4,571        60 %   $ 5,281        75 %

Gross profit:
Products                 $   337        17 %   $ 1,074        24 %   $ 2,547        33 %   $ 1,117        16 %
Services                     151         8 %       254         6 %       575         7 %       638         9 %
Total gross profit       $   488        25 %   $ 1,328        30 %   $ 3,122        40 %   $ 1,755        25 %

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 25% for the three months ended January 31, 2013, compared to 30% for the corresponding period in 2012. The lower profit margin was primarily due to fewer contract activities and the lower profit margins achieved on the sale of certain spare parts during the three months ended January 31, 2013. For the nine months ended January 31, 2013, overall gross profit margin was 40% compared to 25% for the corresponding period in 2012. Significantly higher gross profit margin was primarily due to lower production overhead costs resulting from the allocation of labor resources to contract activities, partially offset by higher support service costs incurred.

Research and Development Expenses

We did not incur any research and development expenses ("R&D") for the three and nine months ended January 31, 2013. For the three and nine months ended January 31, 2012, R&D expenses were $7,000 and $31,000, respectively. While we continue to enhance our products, we anticipate that R&D expenses will be very minimal, if any, in the remaining quarter of fiscal 2013 as we dedicate our efforts to the marketing and sale of new voting systems.


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Selling, General and Administrative

Selling, general and administrative ("SG&A") expenses for the three months ended January 31, 2013 were $580,000, compared to $596,000 in the same period in 2012. SG&A expenses remained relatively constant, compared to the corresponding period in 2012. For the nine months ended January 31, 2013, SG&A expenses were approximately $1.8 million, compared to $1.9 million for the corresponding period in 2012. Slightly lower SG&A expenses were primarily due to the decreased proposal and trade show activities for both the voting and gaming segments, partially offset by higher employee-related expenses. We anticipate that SG&A expenses will remain relatively constant in the remaining quarter of fiscal 2013.

Income Tax Provision

The provision for income taxes was $20,000 for the nine months ended January 31, 2013. The effective tax rate differed from the statutory tax rate primarily due to valuation allowances and net operating loss carry forwards.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our net working capital as of January 31, 2013 was approximately $6 million.

Contract backlog as of January 31, 2013 was approximately $20.3 million. Of this amount, approximately $11.4 million will be derived from two gaming contracts executed with a related customer. The remaining contract backlog amount of approximately $8.9 million is related to gaming and voting contracts with unrelated customers.

Additional sources of cash through January 31, 2014 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 January 31, 2014, 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 January 31, 2014. 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:

                                                               Nine Months Ended
                                                                  January 31,
                                                        2013        2012       Increase
(Amounts in thousands)
Condensed cash flow comparative:
Operating activities                                   $ 3,734     $ (404 )   $    4,138
Investing activities                                        33       (107 )          140
Net increase (decrease) in cash and cash equivalents   $ 3,767     $ (511 )   $    4,278


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Cash Flow Analysis

Our operating cash flow primarily depends on the timing and amount of cash receipts from our customers, inventory purchases and payments for operating expenses.

Our net cash provided by operating activities was approximately $3.7 million for the nine months ended January 31, 2013, compared to the net cash used in operating activities of $404,000 for the same period in 2012. The primary factors contributing to the change in the reported cash flow amounts related to the increased deferred revenues and the net income of approximately $1.3 million in 2013, compared to the net loss of $170,000 in 2012. In addition, the decrease in inventories contributed to the change in the reported cash flow amounts. Furthermore, the timing of customer contract performance impacted the cost and earnings in excess of billings on an uncompleted contract, and settlement of vendor invoices related to inventory purchases attributed to the change in the reported cash flow amounts.

Net cash provided by investing activities was $33,000 for the nine months ended January 31, 2013, compared to the net cash used in investing activities of $107,000 in 2012. The higher net cash provided by investing activities in the nine months ended January 31, 2013 was primarily due to the redemption of a certificate of deposit, partially offset by an increase in capital expenditures compared to the same period in 2012. Higher capital expenditures in 2013 were related to the purchase of voting rental and computer equipment.

There were no financing activities during the nine months ended January 31, 2013 or 2012.

Capital Resources

As of January 31, 2013, we did not have outstanding credit facilities.


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