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ITSI > SEC Filings for ITSI > Form 10-Q on 11-Sep-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


11-Sep-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 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, 2013.


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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, 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 market place, 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 tract 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

(Amounts in thousands)                  Three Months Ended
                                July 31,      July 31,
Revenues                          2013          2012         Change
Products:
Contracts                        $  7,098      $  2,662     $   4,436
Spares                                 28           302          (274 )
Licensing                             184            49           135
Total Products                      7,310         3,013         4,297
Services:
Software Support                      221           201            20
Product Servicing and Support         235            76           159
Total Services                        456           277           179
                                $   7,766     $   3,290     $   4,476

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, 2013 was approximately $7.1 million, compared to $2.7 million for the corresponding period in 2012. The significant increase in contract revenue was primarily due to hardware component sales related to the totalizator industry. The increase is partially offset by the absence of turnkey lottery system sales and decreased contract activities for both the gaming and the voting segments.

Spares revenue for the three months ended July 31, 2013 was $28,000, compared to $302,000 for the corresponding period in 2012. The decrease was primarily due to lower demand for spare parts from an unrelated customer in the gaming segment. Customers' demand for spare parts fluctuates from period to period.

Licensing revenue for the three months ended July 31, 2013 was $184,000, compared to $49,000 in 2012. Higher licensing revenue was primarily due to the additional executed licensing agreements related to the voting segment. We derive licensing revenue from voting and lottery contracts.

Software support revenue for the three months ended July 31, 2013 was $221,000, compared to $201,000 for the same period in 2012. The slight increase was primarily due to higher fees charged to a customer in the gaming segment.

Product servicing and support revenue for the three months ended July 31, 2013 was $235,000, compared to $76,000 for the corresponding period in 2012. The increase was primarily due to higher demand for support services from an unrelated customer in the voting segment, partially offset by lower demand for support services from an unrelated customer in the gaming segment.

Related party revenue of approximately $163,000 accounted for 2% of total revenue in the three months ended July 31, 2013, compared to $2.2 million or 66% of total revenue in the corresponding period in 2012.


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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)         2013                  2012
Revenues:
Products                 $ 7,310        94 %   $ 3,013        92 %
Services                     456         6 %       277         8 %
Total revenues           $ 7,766       100 %   $ 3,290       100 %

Cost of sales:
Products                 $ 5,926        76 %   $ 1,717        52 %
Services                     131         2 %        75         2 %
Total costs of sales     $ 6,057        78 %   $ 1,792        54 %

Gross profit:
Products                 $ 1,384        18 %   $ 1,296        40 %
Services                     325         4 %       202         6 %
Total gross profit       $ 1,709        22 %   $ 1,498        46 %

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 may not be indicative of trends in gross profit margin.

The overall gross profit was 22% for the three months ended July 31, 2013, compared to 46% for the corresponding period in 2012. Significantly lower gross profit margin was primarily due to higher contract cost incurred on a gaming contract. In addition, higher unabsorbed production labor and overhead costs attributed to the lower gross profit margin due to limited contract activities.

Selling, General and Administrative

Selling, general and administrative ("SG&A") expenses for the three months ended July 31, 2013 were $588,000, compared to $579,000 in the same period in 2012. Slightly higher SG&A expenses was primarily related to increased marketing activities, partially offset by lower employee related expenses.

Income Tax Provision

The provision for income taxes was $452,000 or an effective rate of 40.3% for the three months ended July 31, 2013, compared to a minimal effective rate for 2012. The increase in the effective rate for 2013 was due to the reversal of a portion of the valuation allowance and recording of a deferred tax asset at April 30, 2013, of which a portion was recognized in the first quarter of fiscal year end 2014.


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LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our net working capital as of July 31, 2013 was approximately $8.5 million.

Contract backlog as of July 31, 2013 was approximately $11.3 million. Of this amount, approximately $11 million is attributable to a lottery product order from a related customer. The remaining contract backlog amount of approximately $300,000 is related to gaming and voting contracts with unrelated customers. As of July 31, 2013, approximately $3.5 million of the contract backlog has been paid by customers.

Additional sources of cash through July 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 July 31, 2014, 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, 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:

                                                       Three Months Ended
                                             July 31,        July 31,
                                               2013            2012         Decrease
(Amounts in thousands)
Condensed cash flow comparative:
Operating activities                        $     (546 )    $     (285 )   $     (261 )
Investing activities                               (79 )           186           (265 )
Net decrease in cash and cash equivalents   $     (625 )    $      (99 )   $     (526 )

Cash Flow Analysis

Net cash used in operating activities was approximately $546,000 for the three months ended July 31, 2013, compared to $285,000 in 2012. The variability in cash flow from operations was primarily due to decreased deferred revenues and settlement of vendor invoices related to inventory purchases for customer orders. These were partially offset by net income of $670,000, a decrease in inventory reflecting shipments and deferred income taxes.

Net cash used in investing activities was $79,000 for the three months ended July 31, 2013, compared to net cash provided by investing activities of $186,000 in 2012. The net cash used in investing activities in the three months ended July 31, 2013 was due to the increase in capital expenditures related to tooling and computer equipment. Net cash provided by investing activities in 2012 was due to the redemption of a matured certificate of deposit, partially offset by the capital expenditures related to computer and manufacturing equipment.

There were no financing activities during the three months ended July 31, 2013 or 2012.

Capital Resources

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


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