International Lottery & Totalizator Systems, Inc.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2007


o		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.

(Name of small business issuer in its charter)


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

2310 Cousteau Court Vista, California (Address of Principal Executive Offices)		92081-8346 (Zip Code)

(760) 598-1655
(Issuer’s Telephone Number)

Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes o No þ

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of September 13, 2007: 12,963,000 shares of common stock were outstanding.

Transitional Small Business Disclosure Format (check one):

Yes o No þ


PART I		FINANCIAL INFORMATION


ITEM 1.		FINANCIAL STATEMENTS

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited )
(Amounts in thousands)


	July 31, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	2,546
Short-term investments, available for sale		1,866
Accounts receivable		952
Costs and estimated earnings in excess of billings on uncompleted contracts		1
Inventories, net		2,174
Other current assets		160

Total current assets		7,699
Equipment, furniture and fixtures, net		396
Capitalized computer software development costs, net		265
Intangible assets — patent, net		25
Other noncurrent assets		49

Total assets	$	8,434


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	533
Line of credit loans
Billings in excess of costs and estimated earnings on uncompleted contracts		514
Accrued payroll and related taxes		288
Warranty reserves		176
Payable to Parent		248
Other current liabilities		70
Deferred revenues		3,999

Total current liabilities		5,828
Long-term liabilities		43

Total liabilities		5,871

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
Accumulated deficit		(53,807	)

Total shareholders’ equity		2,563

Total liabilities and shareholders’ equity	$	8,434

See notes to condensed consolidated financial statements

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands, except per share amounts)


	Three Months Ended
	July 31,
	2007			2006
Revenues:
Sales of products	$	1,385		$	4,517
Services		45			44

		1,430			4,561

Cost of sales:
Cost of product sales		957			3,163
Cost of services		21			8

		978			3,171

Gross profit		452			1,390

Research and development expenses		92			3
Selling, general and administrative expenses		488			405

Income (loss) from operations		(128	)		982

Other income (expense):
Interest and dividend income		68			60
Other		—			(12	)

Net income (loss)	$	(60	)	$	1,030

Net income (loss) per share:
Basic and diluted	$	(0.00	)	$	0.08

Weighted average shares used in computation of net income (loss) per share:
Basic and diluted		12,963			12,943

See notes to condensed consolidated financial statements

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in thousands)


	Three Months Ended
	July 31,
	2007			2006
Cash flows from operating activities:
Net income (loss)	$	(60	)	$	1,030
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		83			244
Warranty reserve expense		17			71
Changes in operating assets and liabilities:
Accounts receivable		(495	)		2,129
Costs and estimated earnings in excess of billings on uncompleted contracts		74			(43	)
Inventories		(107	)		(646	)
Other current assets		(43	)		233
Accounts payable		347			107
Income taxes payable		(89	)		—
Billings in excess of costs and estimated earnings on uncompleted contracts		(3	)		(3,678	)
Accrued payroll and related taxes		(31	)		(47	)
Warranty reserves		(84	)		—
Payable to Parent		1			—
Other current liabilities		(10	)		20
Deferred revenues		(68	)		(45	)

Net cash used in operating activities		(468	)		(625	)


Cash flows from investing activities:
Purchases of short-term investments		(2,538	)		(5,657	)
Sales of short-term investments		5,347			6,007
Additions to equipment, furniture and fixtures		(10	)		—

Net cash provided by investing activities		2,799			350


Cash flows from financing activities — Payment of short-term note payable		—			(30	)


Effect of exchange rate changes on cash and cash equivalents		—			8

Net increase (decrease) in cash and cash equivalents		2,331			(297	)
Cash and cash equivalents at beginning of period		215			512

Cash and cash equivalents at end of period	$	2,546		$	215


Supplemental cash flow information:
Cash paid for income taxes	$	101		$	—

See notes to condensed consolidated financial statements

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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.

In consideration of net revenue, as defined, ILTS, in accordance with the terms of a strategic arrangement, granted Election Systems & Software, Inc. (“ES&S”) an exclusive worldwide license to manufacture, sell and sublicense ILTS’s intellectual property relating to the PBC and PBC software to ES&S’s end customers. ES&S has agreed to act as ILTS’s exclusive distributor, reseller, on-going service provider and manufacturer of the PBC and PBC software. During the three-month periods ended October 31, 2006 and July 31, 2007, the Company had recognized product sales revenue of $315,000 in connection with the manufacturing of the PBCs and certain PBC system components for ES&S, all of which occurred in the second quarter of fiscal 2007 and first quarter of fiscal 2008. However, the Company has deferred all revenues related to the licensing of the intellectual property pending finalization of the term of the software support agreement with ES&S and fulfillment of all of the prescribed criteria for revenue recognition.

Berjaya Lottery Management (H.K.) Ltd. (“BLM” or the “Parent”) owns 71.3% of the outstanding voting stock of ILTS.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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-QSB. 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, 2007 filed with the SEC on July 30, 2007.

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.

Licensing Revenues

Revenues associated with the licensing of the Company’s PBC system will be recognized in accordance with SOP 97-2. Among other requirements for the recognition of revenue, SOP 97-2 requires all of the following criteria to be met:

	1.		Persuasive evidence of an arrangement exists;

	2.		Delivery has occurred;

	3.		Fee is fixed or determinable; and

	4.		Collectibility is reasonably assured.

Deferred Revenues

Deferred revenues of $4.0 million as of July 31, 2007 consist of amounts received from customers in excess of revenues recognized. Of the $4.0 million, $3.8 million represents hardware and software license fees which were related to the use of the PBC system and were not recognized as of July 31, 2007 due to the fact that, among other requirements for the recognition of revenue, persuasive evidence of an agreement with ES&S is pending finalization of a software support agreement by the Company and ES&S. The Company will recognize the

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

revenues upon its fulfillment of the prescribed criteria for revenue recognition. The remaining $200,000 is related to the payments received for spare parts orders. Revenue will be recognized upon fulfillment of the delivery obligations.

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 activity is as follows:


(Amounts in thousands)
Balance at May 1, 2007	$	243
Additional reserves		17
Charges incurred		(84	)

Balance at July 31, 2007	$	176

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 condensed consolidated financial statements.

Segment Information

Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information” requires companies to report certain information about operating segments in their 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 wagering business and the voting business. The wagering segment designs, manufactures and manages computerized wagering systems and terminals for the online lottery and pari-mutuel racing industries worldwide. The voting segment, in consideration of net revenue, as defined, and in accordance with the terms of the strategic arrangement, granted ES&S an exclusive worldwide license to manufacture, sell and sublicense to ES&S’s end customers ILTS’s intellectual property relating

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

to the PBC and PBC software it designed. The voting system business generated product sales revenue on the manufacturing of certain PBC system components for ES&S, in a one-time arrangement, which it recognized in the three-month periods ended October 31, 2006 and July 31, 2007 as explained above. The Company has deferred all of the license fees it has received for the use of the PBC system pending finalization of its arrangements with ES&S.

The Company’s segment information is presented below:


	As of and for The Three Months Ended
	July 31, 2007
	Wagering		Voting
	Business		Business			Totals
Total revenues	$	1,300	$	130		$	1,430
Income (loss) from operations		183		(311	)		(128	)
Depreciation and amortization		36		47			83

Equipment, furniture and fixtures, net		325		71			396
Capitalized computer software development costs, net		—		265			265
Intangible asset — patent		—		25			25
Deferred revenues		218		3,781			3,999


	As of and for The Three Months Ended
	July 31, 2006
	Wagering		Voting
	Business		Business			Totals
Total revenues	$	4,561	$	—		$	4,561
Income (loss) from operations		1,417		(435	)		982
Depreciation and amortization		31		213			244

Equipment, furniture and fixtures, net		285		108			393
Capitalized computer software development costs, net		—		403			403
Deferred revenues		506		—			506

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.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Inventories consisted of the following:


	July 31,
(Amounts in thousands)	2007
Raw materials and subassemblies	$	1,932
Work-in-process		52
Finished goods		190

	$	2,174

Net Income (Loss) Per Share

Basic net income (loss) per share is based on the weighted average number of shares outstanding during the period. Diluted net income per share is based on the weighted average number of shares outstanding adjusted to include the dilutive effects of the assumed exercise of stock options and the application of the treasury stock method.

At July 31, 2007 and 2006, the effects of the assumed exercise of options to purchase 87,000 and 228,000 shares of the Company’s common stock, at prices ranging from $1.00 to $3.84 per share, were not included in the computation of diluted income (loss) per share amounts because they were anti-dilutive for that purpose.

Stock-Based Compensation

Prior to May 1, 2006, the Company followed the disclosure-only provisions of SFAS 123, “Accounting for Stock-Based Compensation,” as amended by SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” and, as permitted by SFAS 123, applied the provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its employee stock options. Under APB 25, the Company accounted for employee stock options using the intrinsic value method and no compensation expense was recognized when the exercise price of stock options equaled or exceeded the market price of the underlying stock on the date of grant. Options granted to non-employees were recorded at fair value in accordance with SFAS 123.

As a result of amendments to SFAS 123, effective May 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”) using the modified-prospective transition method. Under this transition method, stock-based compensation cost includes (1) quarterly amortization over the remaining requisite service period for all stock options granted prior to, but not yet vested, as of May 1, 2006, based on the portion of the grant date fair value estimated in accordance with the original provisions of SFAS 123 for which service has not been provided and (2) quarterly amortization over the requisite service period for all stock options granted subsequent to May 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Under the modified-prospective transition method, no restatement is necessary to stock-based compensation cost recognized in prior periods. SFAS 123R required that the Company elect an approved method to calculate the historical pool of windfall tax benefits upon adoption of SFAS 123R within one year of its adoption. During the three months ended July 31, 2007, the Company elected to calculate its historical pool of windfall tax benefits using the “short-cut method” described in FASB Staff Position No. 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” which did not have a material effect on the Company’s financial statements.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

All stock options granted to employees prior to May 1, 2006 were fully vested at the beginning of fiscal 2007. In addition, the Company did not grant any stock options or warrants to employees in the year ended April 30, 2007 and the three months ended July 31, 2007. Therefore, there was no stock-based compensation expense related to employee stock options recognized under SFAS 123R during the three months ended July 31, 2007.

STOCK OPTIONS

Descriptions of the stock option plans are included in the preceding discussion under “Stock-Based Compensation” and in Note 9 of the Company’s Annual Report on Form 10-KSB for the year ended April 30, 2007. 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 three months ended July 31, 2007 are presented below:
(shares in thousands)


						Weighted-
						Average
				Weighted-		Remaining	Aggregate
				Average		Contractual	Intrinsic
Stock Options	Shares			Exercise Price		Term	Value
Options outstanding at May 1, 2007		119		$	1.76	1.83 years		—
Granted		—			—			—
Exercised		—			—			—
Forfeited/expired		(32	)		3.84

Options outstanding and exercisable at July 31, 2007		87		$	1.00	2.23 years		—

MAJOR CUSTOMERS


	Three Months Ended
	July 31,
	2007	2006
Revenue:

From unrelated customers	Two customers accounted for 40% of total revenue	No customer accounted for more than 10% of total revenue

From related customers	Two customers accounted for 47% of total revenue	One customer accounted for 98% of total revenue

As of July 31, 2007, the total receivable balance, all of which was past due, from one unrelated, international customer totaled $205,000 which represented 22% of total accounts receivable and 2% of total assets. The balance receivable, which is unsecured, arose primarily from sales of terminal kits shipped during the last quarter of fiscal 2003 and the first quarter of fiscal 2004.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

During the year ended April 30, 2004, the customer agreed to make installment payments through June 20, 2005 to repay the then outstanding balance of $6.3 million. The Company received payments totaling $962,000 during the period from December 1, 2003 to April 30, 2004. In addition, the Company received payments totaling approximately $3.3 million during the period from May 1, 2004 to June 20, 2005, which was $2.0 million less than the scheduled installment payments. Furthermore, the Company received payments of $900,000 from June 21, 2005 through April 30, 2006, $825,000 from May 1, 2006 through April 30, 2007, $100,000 from May 1, 2007 through July 31, 2007 and $50,000 from August 1, 2007 through September 13, 2007 which reduced the past due balance to $205,000 at July 31, 2007 and $155,000 at September 13, 2007.

Based on discussions with the customer, management of the Company believes that the customer’s reduced payments are a result primarily of temporary factors with lottery regulators in certain areas in which it operates. Management of the Company also believes, but cannot assure, that such problems will be resolved and that the missed payments will be made on an installment basis. Based on the customer’s recent payments and the customer’s commitment to make the remaining aggregate payment of $155,000 by November 30, 2007, the Company believes the outstanding amount will be collected.

Additionally, the Company had approximately $1.9 million in kit inventory related to orders from this customer as of July 31, 2007 which it will not ship to the customer until it receives substantially all of the payments due. The Company has the right to sell such inventory to other customers. The model related to this inventory remains in continuous use presently in several jurisdictions and is being marketed to several additional prospective customers. Nonpayment by the customer or the Company’s inability to sell the products to other customers could also have a material adverse impact on the Company’s liquidity and results of operations.

RELATED PARTY TRANSACTIONS

During the three months ended July 31, 2007 and 2006, revenues from all related party agreements for sales of products and services totaled approximately $687,000 (48% of total revenue) and $4.5 million (99% of total revenue), respectively. Included in accounts receivable at July 31, 2007 was $74,000 from these customers. Descriptions of the transactions with the Company’s related parties in the three months ended July 31, 2007 and 2006 are presented below.

Berjaya Lottery Management (H.K.) Ltd.

In 1996, the Company entered into an agreement to purchase specific inventory on behalf of Berjaya Lottery Management (H.K.) Ltd. (“BLM”), the owner of 71.3% of ILTS’s outstanding voting stock as of July 31, 2007. Title to the inventory resides with BLM and is on consignment; therefore, no amounts are reflected in the Company’s 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.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The financial activities and balances related to BLM were as follows:

	•		There were no related party sales to BLM in the three months ended July 31, 2007 and 2006;

	•		There were no accounts receivable balances from BLM at July 31, 2007; and

	•		Liabilities to BLM arising from the sale or use of the BLM inventory, recorded as “Payable to Parent,” were $248,000 as of July 31, 2007.

Philippine Gaming Management Corporation

On December 9, 2005, the Company signed a contract with Philippine Gaming Management Corporation (“PGMC”), a related party and a subsidiary of BLM, 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 July 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:

	•		Revenue recognized on the performance of lottery system software customization, delivery and installation of contract hardware and sale of spare parts during the three months ended July 31, 2007 and 2006 totaled approximately $429,000 and $4.5 million, respectively;

	•		Billings in excess of costs and estimated earnings relating to the abovementioned contract totaled $51,000 at July 31, 2007; and

	•		Accounts receivable from spare part orders and software enhancement services totaled $69,000 at July 31, 2007.

Sports Toto Malaysia

On November 17, 2005, the Company received from Sports Toto Malaysia (“STM”), a related party and an affiliate of BLM, a software enhancement order with a value of $210,000. Delivery of the software product is expected to be completed in the second quarter of fiscal 2008.

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:

	•		Revenues of $239,000 and $30,000 were recognized on the sale of spare parts and support services during the three months ended July 31, 2007 and 2006, respectively;

	•		There was deferred revenue of $218,000 on spare part orders at July 31, 2007;

	•		Billings in excess of costs and estimated earnings relating to the abovementioned contract totaled $139,000 at July 31, 2007; and

	•		There were no accounts receivable balances from STM at July 31, 2007.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

On August 20, 2007, the Company received from STM a purchase order for online lottery terminals with a value of $2.4 million. Delivery of the terminals is expected to begin in the third quarter of fiscal 2008.

Natural Avenue

The Company provides Natural Avenue, a related party from Malaysia and an affiliate of BLM, 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 $18,000 and $14,000 were recognized on the sale of support services and spare parts during the three months ended July 31, 2007 and 2006, respectively;

	•		Accounts receivable totaled $5,000 at July 31, 2007; and

	•		There were no billings in excess of costs and estimated earnings at July 31, 2007.

LITIGATION

The Company was not a party to any litigation proceedings as of September 13, 2007.


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, 2007.

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
(Amounts in thousands)	July 31,
Revenues	2007		2006		Change
Products
Spares	$	822	$	459	$	363
Contracts		563		4,058		(3,495	)

Total Products		1,385		4,517		(3,132	)

Services
Software Support		45		44		1

Total Services		45		44		1

	$	1,430	$	4,561	$	(3,131	)

Significant fluctuations in period-to-period contract revenue are expected in the gaming industry 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.

Spares revenue for the three months ended July 31, 2007 was $822,000, compared to $459,000 for the corresponding period in 2006. The increase in spares revenue in 2007 is due to a significant spare part order from an unrelated party. We derived spares revenue from various customers on the shipment of spares orders.

Contract revenue for the three months ended July 31, 2007 was $563,000, compared to $4.1 million in the same period in 2006. The significant reduction in contract revenue in 2007 was principally due to the substantial completion of one lottery contract with a related party as of April 30, 2007.

Software support revenues remained consistent and relatively insignificant for the three months ended July 31, 2007 and 2006.

Related party revenue of approximately $687,000 accounted for 48% of total revenue in the three months ended July 31, 2007, compared to $4.5 million or 99% of total revenue in the corresponding period in 2006.

Cost of Sales and Gross Profit Analysis


	Three Months Ended
	July 31,				July 31,
(Amounts in thousands)	2007				2006
Revenues:
Products	$	1,385	97	%	$	4,517	99	%
Services		45	3	%		44	1	%

Total revenues	$	1,430	100	%	$	4,561	100	%


Cost of sales:
Products	$	957	67	%	$	3,163	69	%
Services		21	1	%		8	0	%

Total costs of sales	$	978	68	%	$	3,171	69	%


Gross profit:
Products	$	428	30	%	$	1,354	30	%
Services		24	2	%		36	1	%

Total gross profit	$	452	32	%	$	1,390	31	%

Individual contracts are generally significant in value and are awarded in a highly competitive bidding process. The gross profit margin varies from one contract to another, depending on the size of the contract and the competitive market conditions. Accordingly, comparative results between quarters are not indicative of trends in gross profit margin.

Overall gross profit margins were at 32% for the three months ended July 31, 2007, compared to 31% for the corresponding period in 2006. In the three months ended July 31, 2007, increased spare part sales related to ILTS custom design components, lower production overhead costs and lower amortization of capitalized software development costs contributed to higher profit margin which was substantially offset by reduced contract sales activities.

Research and Development Expenses (“R&D”)

For the three months ended July 31, 2007, R&D expenses were $92,000, compared to $3,000 in the same period in 2006. We attribute the significant increase to the development and enhancement of the products relating to the voting, lottery and related industries. We anticipate that R&D expenses will increase in coming quarters as we continue with 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 July 31, 2007 were $488,000, compared to $405,000 in the same period in 2006. We attribute the increase of 20% principally to the increased headcount and resulting payroll costs due to increased activities in the voting segment and increased marketing expenses for both lottery and voting segments. We anticipate that SG&A expense will remain relatively constant for the remaining quarters of the fiscal 2008.

Other Income (Expense)

Other income and expense in the three months ended July 31, 2007 and 2006 primarily 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 July 31, 2007 was $1.9 million.

Contract backlog at July 31, 2007 was approximately $8.3 million. Of this amount, approximately $5.1 million will be derived from the executed voting contracts. On February 26, 2006, we announced that our strategic partner, Election Systems & Software, Inc. (“ES&S”) has signed an agreement with Jackson County, Missouri and will use technology developed by ILTS’s wholly-owned subsidiary, Unisyn Voting Solutions, Inc. In addition, on May 1, 2006, we announced that ES&S has signed a contract with Los Angeles County to supply the Precinct Ballot Counters (“PBC”) and related software and services. In February 2007, Los Angeles County ordered additional 750 PBCs from ES&S. In consideration of net revenue, as defined, ILTS granted ES&S an exclusive worldwide license to manufacture, sell and sublicense ILTS’s intellectual property relating to the PBC and PBC software to ES&S’s end customers. The remaining contract backlog amount of approximately $3.2 million relates to lottery terminal orders from various customers.

In addition, sources of cash through July 31, 2008 are expected to come from at least a portion of the scheduled installment payments of $155,000 due from the single customer as discussed in the previous paragraph. Additional cash is expected to be derived from spares revenue. 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 July 31, 2008, 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 July 31, 2008. 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,			Increase
(Amounts in thousands)	2007			2006			(Decrease)
Condensed cash flow comparison:
Operating activities	$	(468	)	$	(625	)	$	157
Investing activities		2,799			350			2,449
Financing activities		—			(30	)		30
Effect of exchange rate		—			8			(8	)

Net increase (decrease) in cash and cash equivalents	$	2,331		$	(297	)	$	2,628

Cash Flow Analysis — Three-Month Period Ended July 31, 2007:

Operating Activities

Net cash used in operating activities was $468,000.

Net loss of $60,000 was adjusted by $100,000 of noncash charges including depreciation and amortization and warranty reserve expense to arrive at net cash used in operating activities.

Net cash used in operating activities reflected positive effects of the following factors:

	•		Increase of $347,000 in accounts payable;

	•		Decrease of $74,000 in costs and estimated earnings in excess of billings on uncompleted contracts; and

	•		Increase of $1,000 in the liability to our Parent company.

Net cash used in operating activities reflected negative effects of the following factors:

	•		Increase of $495,000 in accounts receivable;

	•		Increase of $107,000 in inventory;

	•		Increase of $43,000 in other current assets;

	•		Decrease of $89,000 in income tax payable;

	•		Decrease of $84,000 in warranty reserves;

	•		Decrease of $68,000 in deferred revenues;

	•		Decrease of $31,000 in accrued payroll and related taxes; and

	•		Decreases of $13,000 in billings in excess of costs and estimated earnings on uncompleted contracts and other current liabilities.

Investing and Financing Activities

During the three months ended July 31, 2007, we received proceeds of $2.8 million from net sales of short-term investments and invested $10,000 in computer equipment.

Cash Flow Analysis — three-Month Period Ended July 31, 2006:

Operating Activities

Net cash used in operating activities was $625,000.

Net income of $1.0 million was adjusted by $315,000 of noncash charges including depreciation and amortization and warranty reserve expense to arrive at net cash used in operating activities.

Net cash used in operating activities reflected positive effects of the following factors:

	•		Decrease of $2.1 million in accounts receivable;

	•		Decrease of $233,000 in other current assets;

	•		Increase of $107,000 in accounts payable; and

	•		Increase of $20,000 in other current liabilities.

Net cash used in operating activities reflected negative effects of the following factors:

	•		Decrease of $3.7 million in billings in excess of costs and estimated earnings on uncompleted contracts;

	•		Increase of $646,000 in inventory;

	•		Decrease of $47,000 in accrued payroll and related taxes;

	•		Decrease of $45,000 in deferred revenue; and

	•		Increase of $43,000 in costs and estimated earnings in excess of billings.

Investing and Financing Activities

We had $350,000 of proceeds from net sales of short-term investments.

Payment of a short-term note payable reduced our cash position by $30,000.

Capital Resources

As of July 31, 2007, there were no unused credit facilities.

Subsequent Events

On August 20, 2007, we received from Sports Toto Malaysia, a related party and an affiliate of BLM, a purchase order for online lottery terminals with a value of $2.4 million. Delivery of the terminals is expected to begin in the third quarter of fiscal 2008.


ITEM 3.		CONTROLS AND PROCEDURES

Evaluation Of Disclosure Controls And Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible 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 July 31, 2007. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of July 31, 2007.

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 July 31, 2007 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

We continue to document procedures and to enhance controls in our comprehensive effort to comply with the Sarbanes-Oxley Act of 2002. Under the latest extension, non-accelerated filers have to comply with the Section 404 provisions of the Act for the first fiscal year ending on or after December 15, 2008. As a non-accelerated filer with a fiscal year end of April 30, we must first begin to comply with the attestation requirements for the fiscal year ending April 30, 2009. In addition, as required by Section 404 of Sarbanes-Oxley, we will be required to provide a management attestation regarding our internal controls for the fiscal year ending April 30, 2008.

We believe that our present internal control program has been effective at a reasonable assurance level to ensure that our financial reporting has not been materially misstated. Nonetheless, we will continue to review, and where necessary, enhance our internal control design and documentation, ongoing risk assessment, and management review as part of our internal control program.


		PAGE

PART I FINANCIAL INFORMATION			3

Item 1.	Financial Statements (Unaudited)		3-14

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15-20

Item 3.	Controls and Procedures		21

PART II OTHER INFORMATION

Item 6.	Exhibits		22

	Signatures		23
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32


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.



Dated: September 14, 2007	/s/ Jeffrey M. Johnson
	Jeffrey M. Johnson
	President


	/s/ T. Linh Nguyen
	T. Linh Nguyen
	Chief Financial Officer and Corporate Secretary

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to ILTS, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Evaluated the effectiveness of ILTS’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(c)		Disclosed in this report any change in ILTS’s internal control over financial reporting that occurred during ILTS’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, ILTS’s internal control over financial reporting; and

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect ILTS’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in ILTS’s internal control over financial reporting.

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	1.		I have reviewed this quarterly report on Form 10-QSB of International Lottery & Totalizator Systems, Inc. (“ILTS”);

	2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of ILTS as of, and for, the periods presented in this report;

	4.		ILTS’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for ILTS and have:

	(i)		the Quarterly Report on Form 10-QSB of the Company for the period ended July 31, 2007 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

	(ii)		the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


ITEM 6.		EXHIBITS