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, 2008

[ ]           TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________________ to

Commission File Number:  0-10294

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

California	95-3276269
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2310 Cousteau Court Vista, California (Address of principal executive offices) 92081-8346 (Zip Code)

(760) 598-1655

(Registrant’s telephone number)

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 ý  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.

Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	o	Smaller reporting company	ý

(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  No ý

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 12, 2008
Common Stock, no par value per share	12,962,999 shares

1

INDEX

PART I	FINANCIAL INFORMATION	PAGE
Item 1.	Financial Statements (Unaudited)	3-11
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12-15
Item 4T.	Controls and Procedures	16
PART II	OTHER INFORMATION
Item 6.	Exhibits	17
	Signatures	18

EXHIBIT 31.1

EXHIBIT 31.2

EXHIBIT 32

2

PART I	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

	October 31, 2008			April 30, 2008
ASSETS	(Unaudited)			Note (a)
Current assets:
Cash and cash equivalents	$	5,649		$	5,049
Short-term investments, available for sale		380			569
Accounts receivable, net		655			565
Costs and estimated earnings in excess of billings on uncompleted contracts		-			57
Inventories, net		789			1,246
Other current assets		183			262
Total current assets		7,656			7,748
Equipment, furniture and fixtures, net		480			324
Capitalized computer software development costs, net		8			36
Intangible assets – patent, net		21			23
Other noncurrent assets		49			49
Total assets	$	8,214		$	8,180
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	141		$	285
Billings in excess of costs and estimated earnings on uncompleted contracts		180			40
Accrued payroll and related taxes		309			377
Warranty reserves		55			425
Payable to Parent		249			249
Other current liabilities		73			69
Deferred revenues		220			218
Total current liabilities		1,227			1,663
Long-term liabilities		3			20
Total liabilities		1,230			1,683
Commitments
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		(49,386	)		(49,873	)
Total shareholders' equity		6,984			6,497
Total liabilities and shareholders' equity	$	8,214		$	8,180

See notes to condensed consolidated financial statements

Note (a): The amounts were derived from the audited financial statements for the fiscal year ended April 30, 2008.

3

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,
	2008			2007			2008			2007
Revenues:
Sales of products	$	2,555		$	1,206		$	3,941		$	2,592
Services		131			46			232			90
		2,686			1,252			4,173			2,682
Cost of sales:
Cost of product sales		848			802			1,702			1,766
Cost of services		34			5			62			19
		882			807			1,764			1,785
Gross profit		1,804			445			2,409			897
Research and development expenses		496			94			1,055			186
Selling, general and administrative expenses		474			447			923			935
Income (loss) from operations		834			(96	)		431			(224	)
Other income (expense):
Interest and dividend income		29			53			59			121
Other		(3	)		5			(3	)		5
Net income (loss)	$	860		$	(38	)	$	487		$	(98	)
Net income (loss) per share:
Basic and diluted	$	0.07		$	(0.00	)	$	0.04		$	(0.01	)
Weighted average shares used in computation of net loss per share:
Basic and diluted		12,963			12,963			12,963			12,963

See notes to condensed consolidated financial statements

4

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Amounts in thousands)

	Six Months Ended October 31,
	2008		2007
Cash flows from operating activities:
Net income (loss)	$	487	$	(98)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization		119		166
Warranty reserve adjustments		(357)		(27)
Changes in operating assets and liabilities:
Accounts receivable		(90)		(481)
Costs and estimated earnings in excess of billings on
uncompleted contracts		57		70
Inventories		457		(644)
Other current assets		79		(204)
Accounts payable		(144)		249
Income taxes payable		-		(89)
Billings in excess of costs and estimated earnings on uncompleted
contracts		140		819
Accrued payroll and related taxes		(68)		44
Warranty reserves		(13)		(150)
Payable to Parent		-		1
Other liabilities		(13)		(21)
Deferred revenues		2		(152)
Net cash provided by (used in) operating activities		656		(517)
Cash flows from investing activities:
Purchases of short-term investments		(285)		(2,691)
Sales of short-term investments		474		7,269
Additions to equipment, furniture and fixtures		(245)		(31)
Net cash provided by (used in) investing activities		(56)		4,547
Net increase in cash and cash equivalents		600		4,030
Cash and cash equivalents at beginning of period		5,049		215
Cash and cash equivalents at end of period	$	5,649	$	4,245
Supplemental cash flow information:
Cash paid for income taxes	$	-	$	127

See notes to condensed consolidated financial statements

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Description of the Business

International Lottery & Totalizator Systems, Inc. (“ILTS” or, 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 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 subsidiaries.  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-KSB for the fiscal year ended April 30, 2008 filed with the SEC on July 14, 2008.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions.  Actual results could differ from those estimates.  Estimates may affect the reported amounts of assets and liabilities and revenues and expenses, and the disclosure of contingent assets and liabilities.

Deferred Revenues

Deferred revenues of approximately $220,000 as of October 31, 2008 represent prepayments for software products which were related to the use of the PBC voting system and prepaid software support services.  The Company will recognize the revenues upon its fulfillment of the prescribed criteria for revenue recognition.

6

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, 2008 is as follows:

(Amounts in thousands)
Balance at May 1, 2008	$	425
Warranty reserve expense adjustments		(357)
Charges incurred		(13)
Balance at October 31, 2008	$	55

The Company recorded a warranty reserve expense adjustment of $357,000 during the three months ended October 31, 2008 to reflect the expiration of its software warranty obligations with one customer. This adjustment reduced the cost of sales which effectively increased the gross profit margin.

Income Tax Uncertainties

In July 2006, the Financial Accounting Standard Board (“FASB”) issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" (“FIN 48”), which clarifies the accounting and disclosure for uncertainty in tax positions by prescribing a minimum probability threshold a tax position must meet to be recognized in the financial statements.  FIN 48 requires that the Company recognize in its financial statements the impact of a tax position if it is more likely than not that the position will be sustained upon examination.

The Company became subject to the provisions of FIN 48 as of May 1, 2007.  The adoption of FIN 48 had no material effect on the Company’s consolidated financial statements.

Segment Information

Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”) 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.  SFAS 131 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 segment designs, develops, manufactures and markets voting equipment including application software and related peripherals.  It also provides support services to voting jurisdictions.

7

The Company’s segment information is presented below:

	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 Three Months Ended
	October 31, 2007
	Gaming Business			Voting Business			Totals
Total revenues		$	1,252		$	-		$	1,252
Income (loss) from operations			399			(495)			(96)
Depreciation and amortization			36			48			84
Equipment, furniture and fixtures, net			306			63			369
Capitalized computer software development costs, net			-			230			230
Intangible assets – patent, net			-			25			25
Warranty reserves			66			-			66
Deferred revenues			32			3,883			3,915
	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
	As of and for the Six Months Ended
	October 31, 2007
	Gaming Business			Voting Business			Totals
Total revenues		$	2,552		$	130		$	2,682
Income (loss) from operations			582			(806)			(224)
Depreciation and amortization			72			94			166
Equipment, furniture and fixtures, net			306			63			369
Capitalized computer software development costs, net			-			230			230
Intangible assets – patent, net			-			25			25
Warranty reserves			66			-			66
Deferred revenues			32			3,883			3,915

8

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)	2008		2008
Raw materials and subassemblies	$	784	$	1,042
Work-in-process		2		14
Finished goods		3		190
	$	789	$	1,246

Net Income Per Share

Basic net income per share is based on the weighted average number of shares outstanding during the period.  

At October 31, 2008 and 2007, the effects of the assumed exercise of options to purchase 86,000 shares of the Company’s common stock, 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-KSB for the year ended April 30, 2008.  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, 2008 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, 2008		86	$	1.00	1.48 years		-
Granted		-		-			-
Exercised		-		-			-
Forfeited/expired		-		-
Options outstanding and exercisable at October 31, 2008		86	$	1.00	0.98 year		-

All stock options previously granted to employees were fully vested as of October 31, 2008.  In addition, the Company did not grant any stock options or warrants to employees in the year ended April 30, 2008 and the six months ended October 31, 2008.  Therefore, there was no share-based compensation expense related to employee stock options recognized during the three and six months ended October 31, 2008.

MAJOR CUSTOMERS

	Three Months Ended October 31,		Six Months Ended October 31,
	2008	2007	2008	2007
Revenue:
From unrelated customers	Two customers accounted for 41% of total revenue	Three customers accounted for 60% of total revenue	Two customers accounted for 49% of total revenue	Three customers accounted for 50% of total revenue
From related customers	One customer accounted for 52% of total revenue	One customer accounted for 30% of total revenue	One customer accounted for 39% of total revenue	Two customers accounted for 43% of total revenue

9

Related Party Transactions

During the three months ended October 31, 2008 and 2007, revenues from all related party agreements for sales of products and services totaled approximately $1.5 million (56% of total revenue) and $495,000 (40% of total revenue), respectively.  Related party revenues for the six months ended October 31, 2008 and 2007 were approximately $1.8 million (43% of total revenue) and $1.2 million (45% of total revenue), respectively.  Included in accounts receivable at October 31, 2008 was $64,000 from these customers.  Descriptions of the transactions with the Company’s related parties in the three and six months ended October 31, 2008 and 2007 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, 2008.  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, 2008 and 2007;

· There were no accounts receivable balances from BLM at October 31, 2008; and

· Liabilities to BLM arising from the sale or use of the BLM inventory, recorded as “Payable to Parent,” were $249,000 as of October 31, 2008.

Philippine Gaming Management Corporation

On September 18, 2007, the Company received an order from Philippine Gaming Management Corporation (“PGMC”), a related partyand a subsidiary of BLM, valued at approximately $2.1 million for lottery terminals.  Final shipments of terminals were completed in the second quarter of fiscal 2009.

On December 9, 2005, the Company signed a contract with PGMC to provide a complete lottery system including central system hardware and software along with 2,000 lottery terminals. Total contract value was approximately $10.0 million. Contract deliverables including lottery terminals and hardware installation and software customization with a contract value of approximately $10.0 million were completed as of October 31, 2007.

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 terminals for the abovementioned lottery terminal contract and sale of spare parts during the three and six months ended October 31, 2008 totaled approximately $1.4 million and $1.6 million, respectively. Revenues recognized on the sale of spare parts and completion of contract deliverables for the abovementioned lottery system contract during the three and six months ended October 31, 2007 totaled approximately $377,000 and $806,000, respectively; and

· Accounts receivable from spare part orders totaled $53,000 at October 31, 2008.

Sports Toto Malaysia

On December 11, 2007, the Company received an order valued at $347,000 for software development and services from Sports Toto Malaysia (“STM”), a related party.  The project is scheduled for completion in the third quarter of fiscal 2009.

In addition to supplying terminals and software products to STM, the Company provides terminal spare parts and software support services to STM.

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

10

· Revenues of $96,000 and $166,000 were recognized on the sale of software support services and spare parts during the three and six months ended October 31, 2008, respectively. Revenues of $104,000 and $343,000 were recognized on the sale of spare parts and support services during the three and six months ended October 31, 2007, respectively;

· There was deferred revenue of $8,000 on software support services at October 31, 2008; and

· Net billings in excess of costs and estimated earnings on uncompleted contract with respect to the software development and services order totaled $174,000.

On November 11, 2008, the Company received an order from STM valued at approximately $800,000 for lottery terminals. Delivery of the terminals is scheduled to begin in the fourth quarter of fiscal 2009.

Natural Avenue

The Company provides Natural Avenue, a related party, with lottery terminals, software products and support services as well as spare parts.  The financial activities and balances related to transactions with Natural Avenue were as follows:

· Revenues of $15,000 and $30,000 were recognized on the sale of support services during the three and six months ended October 31, 2008, respectively.  Revenues of $14,000 and $32,000 were recognized on the sale of support services and spare parts during the three and six months ended October 31, 2007, respectively; and

· Accounts receivable totaled $11,000 at October 31, 2008.

Subsequent Events 

Effective November 1, 2008, the Company entered into an agreement with Election Systems & Software, Inc. (“ES&S”) to provide certain tier two technical and software maintenance support services to ES&S in connection with the existing PBCs presently installed.  The November 1, 2008 Agreement supersedes the Prior Agreement and shall continue until November 1, 2009 with the option of annual renewal upon the mutual written agreement of ILTS and ES&S.

Litigation

The Company was not a party to any litigation proceedings as ofDecember 12, 2008.

11

    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 includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Report are forward-looking.  We use words such as “anticipate,” “believe,” “expect,” “future,” “intend” and similar expressions to identify forward-looking statements.  Forward-looking statements reflect management's current expectations, plans or projections and are inherently uncertain. Our actual results may differ significantly from management's expectations, plans or projections.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  We undertake no obligation to publicly release any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  Readers are urged, however, to review the factors set forth in reports that we file from time to time with the Securities and Exchange Commission.

The forward-looking statements contained in this filing are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by forward-looking statements.  These risks and uncertainties include dependence on business from foreign customers sometimes in politically unstable regions, political and governmental decisions as to the establishment of lotteries and other wagering industries in which our products are marketed, fluctuations in quarter-by-quarter operating results and other risk factors described in our Annual Report on Form 10-KSB for the year ended April 30, 2008.

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, warranty reserves, the allowance for doubtful accounts, the amortization period for capitalized software development costs 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	2008		2007		Change			2008		2007		Change
Products:
Contracts	$	1,796	$	265	$	1,531		$	2,737	$	829	$	1,908
Licensing		479		-		479			479		-		479
Spares		280		941		(661	)		725		1,763		(1,038	)
Total Products		2,555		1,206		1,349			3,941		2,592		1,349
Services:
Software Support		85		46		39			166		90		76
Product Servicing and Support		46		-		46			66		-		66
Total Services		131		46		85			232		90		142
	$	2,686	$	1,252	$	1,434		$	4,173	$	2,682	$	1,491

12

Significant fluctuations in period-to-period contract revenue are expected in the 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 do not recur in the short-term.  Accordingly, comparative results between quarters are not indicative of trends in contract revenue.

Contract revenue for the three months ended October 31, 2008 was $1.8 million, compared to $265,000 in the same period in 2007.  For the six months ended October 31, 2008, contract revenue was $2.7 million, compared to $829,000 for the corresponding period in 2007.  The significant increase in contract revenue in 2008 was principally due to the completion of a lottery system contract with an unrelated customer and the shipment of lottery terminals to a related customer.

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 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.  There was no licensing revenue generated for the same periods in 2007.  

Spares revenue for the three months ended October 31, 2008 was $280,000, compared to $941,000 for the corresponding period in 2007.  For the six months ended October 31, 2008, spares revenue was $725,000, compared to $1.8 million for the same period in 2007.  Higher spares revenue in 2007 was due to a significant one-time spares order from an unrelated customer. We derived spares revenue from various customers on the shipment of spares orders.  Customer demand for spare parts fluctuates from period to period.

Software support revenue for the three months ended October 31, 2008 was $85,000, compared to $46,000 for the corresponding period in 2007. For the six months ended October 31, 2008, software support revenue was $166,000, compared to $90,000 for the same period in 2007. The increase in software support revenue in 2008 is due to one additional software support agreement from a related customer.

Product servicing and support revenues for the three and six months ended October 31, 2008 of $46,000 and $66,000, respectively, were generated from the servicing of the PBCs voting units for ES&S in a one-time arrangement and providing periodic election support to ES&S’ end customers.  There was no product servicing and support revenue generated for the same periods in 2007.

Related party revenue of approximately $1.5 million accounted for 56% of total revenue in the three months ended October 31, 2008, compared to $495,000 or 40% of total revenue in the corresponding period in 2007.  For the six months ended October 31, 2008, related party revenue of approximately $1.8 million accounted for 43% of total revenue, compared to $1.2 million or 45% of total revenue in the corresponding period in 2007.

Cost of Sales and Gross Profit Analysis

	Three Months Ended								Six Months Ended
	October 31,				October 31,				October 31,				October 31,
(Amounts in thousands)	2008				2007				2008				2007
Revenues:
Products	$	2,555	95	%	$	1,206	96	%	$	3,941	94	%	$	2,592	97	%
Services		131	5	%		46	4	%		232	6	%		90	3	%
Total revenues	$	2,686	100	%	$	1,252	100	%	$	4,173	100	%	$	2,682	100	%
Cost of sales:
Products	$	848	32	%	$	802	64	%	$	1,702	40	%	$	1,766	66	%
Services		34	1	%		5	0	%		62	2	%		19	1	%
Total costs of sales	$	882	33	%	$	807	64	%	$	1,764	42	%	$	1,785	67	%
Gross profit:
Products	$	1,707	63	%	$	404	32	%	$	2,239	54	%	$	826	31	%
Services		97	4	%		41	4	%		170	4	%		71	2	%
Total gross profit	$	1,804	67	%	$	445	36	%	$	2,409	58	%	$	897	33	%

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Individual contracts are generally significant in value and are awarded in a highly competitive bidding process.  The gross profit or loss 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 are not indicative of trends in gross profit or loss margin. Overall gross profit margins were at 67% for the three months ended October 31, 2008, compared to 36% for the corresponding period in 2007.  For the six months ended October 31, 2008, overall gross profit margins were at 58%, compared to 33% in the same period in 2007.   This improvement is attributable to the completion of two lottery contracts and the allocation of production labor resources to extensive research and development projects.Licensing revenue associated with the voting segment also contributed to the improved gross profit margins in 2008.   In addition, we recorded warranty reserve expense adjustment of $357,000 during the three months ended October 31, 2008 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.

Research and Development Expenses (“R&D”)

For the three months ended October 31, 2008, R&D expenses were $496,000, compared to $94,000 in the same period in 2007.  For the six months ended October 31, 2008, R&D expenses were $1.1 million, compared to $186,000 in the same period in 2007.  We attribute the significant increases to the development of new voting products.  We anticipate that R&D expenses will continue to increase in coming quarters as we maintain the development of new voting system products and enhancement of existing lottery technologies.

Selling, General and Administrative (“SG&A”)

SG&A expenses for the three months ended October 31, 2008 were $474,000, compared to $447,000 in the same period in 2007.   The rise in SG&A expenses, partially offset by reduced professional accounting related fees, is primarily due to increased spending in sales and marketing activities.  For the six months ended October 31, 2008, SG&A expenses were $923,000, compared to $935,000 in the same period in 2007.  The reduction in SG&A expenses, partially offset by increased spending in sales and marketing activities, is attributable to reduced personnel costs and professional accounting related fees related to the then recently issued accounting requirements.  We anticipate that SG&A expense will remain relatively constant for the remaining quarters of the fiscal 2009.

Other Income (Expense)

Other income in the six months ended October 31, 2008 and 2007 consisted of interest and dividend income.  We derived interest and dividend income from short-term investments and cash balances.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our net working capital at October 31, 2008 was $6.4 million.

Contractbacklog at October 31, 2008 was approximately $1.4 million.  Of this amount, approximately $1.2 million will be derived from the shipment of lottery terminals to a related customer and the completion of a software development project.  The remaining contract backlog amount of approximately $200,000 relates to executed voting contracts.

Additional sources of cash through October 31, 2009 are expected to be derived from 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, 2009, 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, 2009.  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.

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The following table summarizes our cash flow activities:

	Six Months Ended
	October 31,		October 31,		Increase
	2008		2007		(Decrease)
(Amounts in thousands)
Condensed cash flow comparative:
Operating activities	$	656	$	(517)	$	1,173
Investing activities		(56)		4,547		(4,603)
Net increase (decrease) in cash and cash equivalents	$	600	$	4,030	$	(3,430)

Cash Flow Analysis - Six-Month Periods Ended October 31, 2008 and 2007:

Operating Activities

Net cash provided by operating activities was $656,000 for the six months ended October 31, 2008, compared to net cash used in operating activities of $517,000 for the same period in 2007.  The following factors contribute significantly to the period-to-period change in operating cash flow:

·   We generated a net income of $487,000 for the six months ended October 31, 2008, compared to a net loss of $98,000 for the same period in 2007;

·   Decrease of $457,000 in inventory in the six months ended October 31, 2008, compared to an increase of $644,000 in 2007;

·   Increase of $90,000 in accounts receivable in the six months ended October 31, 2008, compared to an increase of $481,000 in 2007;

·   Decrease of $79,000 in other current assets in the six months ended October 31, 2008, compared to an increase of $204,000 in 2007; and

·   Increase of $2,000 in deferred revenues in the six months ended October 31, 2008, compared to a decrease of $152,000 in 2007.

The abovementioned factors were partially offset by the negative effects of the following items:

·   Increase of $140,000 in billings in excess of costs and estimated earnings on uncompleted contracts in the six months ended October 31, 2008, compared to an increase of $819,000 in 2007; and

·   Decrease of $144,000 in accounts payable in the six months ended October 31, 2008, compared to an increase of $249,000 in 2007.

Investing and Financing Activities

Net cash used in investing activities was $56,000 for the six months ended October 31, 2008, compared to net cash provided by investing activities of $4.5 million in 2007.  Net cash provided by investing activities in the six months ended October 31, 2007 resulted from the sale of short-term investments in auction rate securities and redemption of matured certificates of deposits.  Capital expenditures amounted to $245,000 in the six months ended October 31, 2008, compared to $31,000 in 2007.  The significant increase is attributable to the purchase of tooling equipment and lottery test equipment.

There were no financing activities for the six months ended in October 31, 2008 or 2007.

Capital Resources

As of October 31, 2008, there were no unused credit facilities.

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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)) 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.

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, 2008 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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ITEM 6. EXHIBITS

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.

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated:      December 12, 2008		INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
	/s/	Jeffrey M. Johnson Jeffrey M. Johnson
		President and Chief Executive Officer
	/s/	T. Linh Nguyen
		T. Linh Nguyen
		Chief Financial Officer and Corporate Secretary

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