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 January 31, 2005

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.

(Exact Name of Company as specified in its charter)

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

2131 Faraday Avenue, Carlsbad, California 92008-7205
(Address of Principal Executive Offices)
(Zip Code)

(760) 931- 4000
(Company’s Telephone Number, Including Area Code)

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 the number of shares outstanding of each of the Issuer’s classes of common stock, as of the latest practicable date.

As of March 15, 2005, 12,943,000 shares of common stock were outstanding.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

INDEX

PART I FINANCIAL INFORMATION		PAGE
Item 1.	Financial Statements (Unaudited)		3-14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3.	Controls and Procedures		22
PART II OTHER INFORMATION
Item 1.	Legal Proceedings		23
Item 5.	Other Information		23
Item 6.	Exhibits		23
	Signatures
EXHIBIT 31
EXHIBIT 32

EXHIBIT 31

EXHIBIT 32

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 “anticipates,” “believes,” “expects,” “future,” “intends” 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.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)
(Amounts in thousands)

	January 31,
	2005
ASSETS
Current assets:
Cash and cash equivalents	$	1,358
Accounts receivable		3,427
Inventories		2,756
Other current assets		93
Total current assets		7,634
Equipment, furniture and fixtures, net		311
Other noncurrent assets		100
Total assets	$	8,045
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	405
Short-term note payable		162
Billings in excess of costs and estimated earnings on uncompleted contracts		978
Accrued payroll and related taxes		496
Warranty reserves		374
Payable to Parent		179
Other current liabilities		334
Total current liabilities		2,928
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; 12,943 shares issued and outstanding		56,350
Accumulated deficit		(50,979	)
Other accumulated comprehensive loss – cumulative foreign currency translation loss		(254	)
Total shareholders’ equity		5,117
Total liabilities and shareholders’ equity	$	8,045

See notes to condensed consolidated financial statements

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	January 31,						January 31,
	2005			2004			2005			2004
Revenues:
Sales of products	$	1,978		$	3,142		$	8,164		$	6,950
Services		139			35			217			194
		2,117			3,177			8,381			7,144
Cost of revenues:
Cost of product sales		1,332			1,474			5,608			4,087
Cost of services		48			10			71			93
		1,380			1,484			5,679			4,180
Gross profit		737			1,693			2,702			2,964
Research and development expenses		356			457			1,229			1,469
Selling, general and administrative expenses		756			872			2,354			2,964
Income (loss) from operations		(375	)		364			(881	)		(1,469	)
Other income (expense):
Interest income (expense), net		7			(49	)		13			(107	)
Other		16			21			29			36
Net income (loss)	$	(352	)	$	336		$	(839	)	$	(1,540	)
Net income (loss) per share:
Basic and diluted	$	(0.03	)	$	0.03		$	(0.06	)	$	(0.12	)
Shares used in computation of net income (loss) per share:
Basic and diluted		12,943			12,943			12,943			12,943

See notes to condensed consolidated financial statements

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in thousands)

	Nine Months Ended
	January 31,
	2005			2004
Cash flows from operating activities:
Net loss	$	(839	)	$	(1,540	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		152			197
Amortization of loan fees		—			101
Loss on disposal of equipment		41			—
Warranty reserve expense		189			51
Changes in operating assets and liabilities:
Accounts receivable		2,080			5,018
Inventories		550			(476	)
Other assets		36			(80	)
Accounts payable		(689	)		(2,692	)
Billings in excess of costs and estimated earnings on uncompleted contracts		(1,297	)		951
Accrued payroll and related taxes		(54	)		(67	)
Warranty reserves		41			(110	)
Payable to Parent		53			67
Other liabilities		(180	)		(97	)
Net cash provided by operating activities		83			1,323
Cash flows from investing activities - additions to equipment		(17	)		(57	)
Cash flows from financing activities:
Payment of line of credit loans		—			(1,500	)
Payment of short-term note payable		(763	)		—
Net cash used in financing activities		(763	)		(1,500	)
Effect of exchange rate changes on cash		(42	)		(56	)
Decrease in cash and cash equivalents		(739	)		(290	)
Cash and cash equivalents at beginning of period		2,097			1,595
Cash and cash equivalents at end of period	$	1,358		$	1,305
Supplemental cash flow information:
Cash paid for interest	$	—		$	10
Cash paid for income taxes	$	6		$	6

See notes to condensed consolidated financial statements

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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. 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 three months lead time before delivery of hardware begins.

Berjaya Lottery Management (H.K.) Ltd. (“BLM” or the “Parent”) owns 71.4% of ILTS’s outstanding voting stock.

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of ILTS and its subsidiaries, all of which are wholly owned. 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 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 our Annual Report on Form 10-KSB for the fiscal year ended April 30, 2004 filed with the SEC on July 29, 2004.

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 revenue and expenses, and the disclosure of contingent assets and liabilities.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

Revenue Recognition

We recognize revenue by applying various relevant revenue recognition policies depending on the nature of the sale and the terms of the contract.

Complete Systems

ILTS’s complete wagering systems include the point-of-sale terminals, a central computer installation and a commercially available operating system used in conjunction with ILTS’s proprietary application software, and the communication network to interface the terminals to the central computer installation. 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.

A complete system is comprised of both hardware and software. The hardware portion includes both central system servers and terminals. The software portion includes the application software for both the central system and terminals.

As directed by Statement of Position 97-2 (“SOP 97-2”) “Software Revenue Recognition”, we follow Statement of Position 81-1 (“SOP 81-1”) “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” in accounting for the sale of complete systems. We recognize revenue by using the percentage-of-completion method when the contracts for complete systems fulfill the following criteria:

1.	Contract performance extends over long periods of time;
2.	The software portion involves significant production, modification or customization;
3.	Reasonably dependable estimates can be made on the progress towards completion, contract revenues and contract costs; and
4.	Each element is essential to the functionality of the other elements of the contracts.

Under the percentage-of-completion method, sales and estimated gross profits are recognized as work progresses. Progress toward completion is measured by the ratio of costs incurred to total estimated costs. Revenue and gross profit may be adjusted prospectively for revisions in estimated total contract costs. If the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is recorded in the period in which they become evident. The total estimated loss includes all costs allocable to the specific contract.

Each complete system contract is reviewed individually to determine the appropriate basis of recognizing revenue. If the contract does not fulfill the above criteria, revenues are recognized only when:

1.	Persuasive evidence of an arrangement exists in the form of signed contracts or purchase orders;
2.	The contract or purchase order contains a fixed or determinable selling price to the buyer;
3.	Collectibility is reasonably assured through due diligence, historical payment practices or upfront payments; and
4.	Delivery has occurred or services have been rendered in accordance with contract terms.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

Software – only

In addition to the software portion of a complete system, we develop software for our customers in accordance with the specifications stipulated in a software supply contract. Generally, these contracts are related to additional features or modules to be added to the application software that we have previously developed for our customers.

Each software contract is reviewed individually to determine the appropriate basis of recognizing revenue.

For software contracts involving significant development efforts that extend over long periods of time and fulfill the criteria as set out in SOP 81-1, the related revenues are recognized by using the percentage-of-completion method.

Other software supply contract revenues are recognized upon delivery when all the conditions specified in SOP 97-2 are met.

Hardware – only

Hardware in the form of assembled terminals, component kits or replacement parts (“spares”) may be sold separately to our customers. Revenues for the sale of hardware are recognized upon shipment in accordance with SEC Staff Accounting Bulletin, Topic 13 “Revenue Recognition.” The Company has evidence that arrangements exist and the price to the buyer is fixed through signed contracts or purchase orders. Shipping documents illustrate that delivery of hardware has occurred, as stipulated in the terms of the customer contract. Collectibility is reasonably assured through one or more of the following: due diligence prior to contract signing; historical payment practices; or required upfront payments.

Service Revenues

Service revenues include software support and facility management agreements. Revenues from software support agreements are recognized, provided collectibility is reasonably assured, in accordance with SOP 97-2 depending on the nature of the associated expenses:

1.	If costs are immaterial or incurred on a straight-line basis, revenue is recognized ratably over the term of the agreement;
2.	Otherwise, revenue is recognized over the period of the agreement in proportion to the amounts expected to be charged to expense for the services rendered during the period.

We did not have any facility management agreements as of January 31, 2005 or during fiscal 2005 and 2004, although we have had them at certain times in previous fiscal years.

Allowance for Doubtful Accounts

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

We determine our allowance for doubtful accounts by considering a number of factors:

1.	Length of time trade accounts receivable are past due;
2.	Our previous loss history;
3.	The customer’s current ability to pay its obligation;
4.	Known specific issues or disputes which exist as of the balance sheet date; and
5.	The condition of the general economy and the industry as a whole.

Based on its evaluation as of January 31, 2005, the Company did not record an allowance.

We write off accounts receivable when they become uncollectible. Payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

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 beginning of period, May 1, 2004	$	334
Additional reserves		189
Charges incurred		(149	)
Balance at end of period, January 31, 2005	$	374

Warranty reserves are based on historical trends and are adjusted periodically to reflect actual experience. Customers do not have a right of return, except for defective products. Estimated reserves for warranty obligations are accrued as follows:

1.   Contracts - Contract warranties are specific to the individual contracts. Estimated reserves for warranty obligations are accrued as revenue is recognized. Hardware and software components may be warranted separately:

a.	Hardware -The warranty phase for terminals or terminal kits commences upon shipment and can extend from 90 days to nine months depending on the contract terms.
b.	Software - The warranty phase typically represents a six-month period of time after delivery, as defined by the specific terms of the contract.

2.	Spares - Terminal replacement parts are warranted to be free from defects for 90 days from the date of shipment. Based on historical experience, warranty costs for spares have been immaterial.
3.	Other – Specific provisions have been made to cover a small number of particular replacement parts for specific customers. We use the most recent inventory cost to determine the value of potential returns.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

Foreign Currency

Our reporting currency is the U.S. dollar. Sales are denominated almost exclusively in U.S. dollars. Occasionally, sales have been effected in foreign currencies. Fluctuations in exchange rates from reporting period to reporting period between various foreign currencies and the U.S. dollar may have an impact on revenue and expense. Such effect may be material in any individual reporting period.

The balance sheets of our international subsidiaries are translated into U.S. dollars and consolidated with our balance sheet at period-end exchange rates, while revenues and expenses are translated at average rates during the period. Fluctuations in the U.S. dollar value of the foreign currency denominated assets are accounted for as an adjustment to shareholders’ equity. Therefore, fluctuations from reporting period to reporting period in the exchange rates between various foreign currencies and the U.S. dollar may impact the foreign currency translation component of our reported shareholders’ equity.

Income Taxes and Valuation Allowance

The Company accounts for income taxes pursuant to the asset and liability method which requires deferred income tax assets and liabilities to be computed annually for temporary differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Reclassifications

Certain amounts in the accompanying 2004 condensed consolidated financial statements have been reclassified to conform to the 2005 presentations.

Related Party Transactions

During the three-month periods ended January 31, 2005 and 2004, revenues from all related party agreements for terminals, spare parts and services totaled $710,000 and $1.3 million, respectively. Revenues from related parties during the nine-month periods ended January 31, 2005 and 2004 were $5.9 million and $2.2 million, respectively. At January 31, 2005, accounts receivable included $302,000 from these customers. Descriptions of the transactions with the Company’s related parties for the three and nine-month periods ended January 31, 2005 and 2004 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 71.4% of ILTS’s outstanding voting stock. 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.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

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.

As of January 31, 2005 and for the three-month and nine-month periods ended January 31, 2005 and 2004:

•   There were no related party sales to BLM;

•   There were no accounts receivable balances from BLM;

•   During the three-month and nine-month periods ended January 31, 2005, the sale of BLM inventory to unrelated third parties resulted in increases of $23,000 and $53,000 in the liability to BLM, respectively. During the three-month and nine-month periods ended January 31, 2004, the sale of BLM inventory to unrelated third parties resulted in increases of $9,000 and $67,000 in the liability to BLM, respectively; and

•   Liabilities to BLM, recorded as “Payable to Parent” in the accompanying condensed consolidated balance sheet were $179,000 as of January 31, 2005.

Philippine Gaming Management Corporation

In addition to supplying terminals to Philippine Gaming Management Corporation (“PGMC”), a related party and a BLM subsidiary, we provide terminal spare parts to PGMC on an ongoing basis.

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

•   During the three-month and nine-month periods ended January 31, 2005, we recognized revenue of $234,000 and $644,000, respectively. For the same periods in 2004, we recognized revenue of $124,000 and $950,000, respectively;

•   Accounts receivable from PGMC totaled $133,000 at January 31, 2005; and

•   There were no costs and earnings in excess of billings for contracts with PGMC at January 31, 2005.

Sports Toto Malaysia

In February 2004, the Company received a terminal order with a value of $3.9 million from Sports Toto Malaysia (“STM”), a related party and an affiliate of BLM. Delivery of the terminals was completed in the three-month period ended July 31, 2004.

In November 2000, STM executed an agreement to purchase an online lottery system and services for $8.1 million from ILTS. In November 2003, additional functionalities valued at $400,000 were added to the original contract which increased the total contract value to $8.5 million.

In addition to supplying terminals and software products to STM, we provide terminal spare parts and software support services to STM.

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

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

•   During the three-month and nine-month periods ended January 31, 2005, revenues of $251,000 and $5.0 million were recognized, respectively. For the same periods in 2004, we recognized revenues of $1.2 million;

•   Accounts receivable from STM totaled $16,000 at January 31, 2005; and

•   Billings in excess of costs and earnings relating to the abovementioned contract amounted to $128,000 at January 31, 2005.

Natural Avenue

During the three-month period ended January 31, 2005, the Company received from Natural Avenue, a related party from Malaysia and an affiliate of BLM, orders for lottery terminals and various software enhancements with a total value of $430,000. In addition, the Company provided software support services to Natural Avenue. The financial activities and balances related to transactions with Natural Avenue were as follows:

•   During the three-month and nine-month periods ended January 31, 2005, revenues of $225,000 and $266,000 were recognized, respectively. For the same periods in 2004, we recognized revenues of $14,000 and $46,000, respectively;

•   Advance billings on software enhancements orders amounted to $65,000; and

•   Accounts receivable totaled $153,000 at January 31, 2005.

Comprehensive Income (Loss)

The Company accounts for comprehensive income in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income.” The components of comprehensive income (loss) are as follows:

	Three Months Ended						Nine Months Ended
	January 31,						January 31,
(Amounts in thousands)	2005			2004			2005			2004
Net income (loss)	$	(352	)	$	336		$	(839	)	$	(1,540	)
Foreign currency translation adjustment		(20	)		(27	)		(42	)		(56	)
Comprehensive income (loss)	$	(372	)	$	309		$	(881	)	$	(1,596	)

Inventories

Inventories are valued at the lower of actual cost or the current estimated market values. We periodically review inventory quantities on hand and record a provision for excess and obsolete inventories based on the following factors:

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

•   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:

	January 31,
(Amounts in thousands)	2005
Raw materials and subassemblies	$	2,320
Work-in-process		436
	$	2,756

Stock-Based Compensation

The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure.” The Company follows 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 accounts for stock options using the intrinsic value method and no compensation expense is recognized when the exercise price of stock options equals or exceeds the market price of the underlying stock on the date of grant. Options granted to non-employees are recorded at fair value in accordance with SFAS 123. Because no options were granted to employees in the nine-month periods ended January 31, 2005 and 2004, the Company was not required to record any compensation expense in the respective periods. In addition, there was no material difference between the Company’s historical net income (loss) in the three and nine-month periods ended January 31, 2005 and 2004, respectively, and pro forma net income (loss) for such periods assuming compensation cost had been determined based on the fair value at the grant date for all awards and amortized over the vesting period consistent with the provisions of SFAS 123. As a result of amendments to SFAS 123, the Company will be required to expense the fair value of employee stock options beginning with its fourth quarter of fiscal 2006.

Major Customers

	Three Months Ended		Nine Months Ended
	January 31,		January 31,
	2005	2004	2005	2004
Revenue:
From unrelated customers	Three customers accounted for 59% of total revenue	One customer accounted for 46% of total revenue	Three customers accounted for 22% of total revenue	Two customers accounted for 61% of total revenue
From related customers	Three customers represented 34% of total revenue	One customer represented 37% of total revenue	Three customers represented 70% of total revenue	Two customers represented 31% of total revenue

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

As of January 31, 2005, the balance receivable from one unrelated, international customer totaled $2.6 million which represented 76% of total accounts receivable and 32% of total assets. The balance receivable, which is unsecured, arose primarily from terminal kits shipped during the last quarter of fiscal 2003 and the first quarter of fiscal of 2004. During the year ended April 30, 2004, the customer agreed to make installment payments through June 2005 to repay the outstanding balance. The Company received scheduled installment payments totaling $3.0 million during the period from May 1, 2004 to February 25, 2005. Nonpayment by the customer of the remaining balance could have a material adverse impact on the Company’s liquidity and results of operations.

Additionally, the Company had approximately $2.0 million in kit inventory related to orders from this customer as of January 31, 2005 which it will not ship to the customer until it receives substantially all of the payments due and which it could sell to other customers.

Stock Options

During the three and nine months ended January 31, 2005, 20,000 options with a weighted average exercise price of $9.00 per share and 53,000 options with a weighted average exercise price of $6.13 per share were cancelled, respectively. During the three and nine months ended January 31, 2004, 53,000 options with a weighted average exercise price of $13.01 per share and 79,000 options with a weighted average exercise price of $9.01 per share were cancelled, respectively. No options were granted during the nine months ended January 31, 2005 and 2004. Options to purchase 440,000 and 519,000 shares of common stock were outstanding at January 31, 2005 and 2004, respectively.

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 (loss) 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 January 31, 2005 and 2004, the effects of the assumed exercise of options to purchase 440,000 and 519,000 shares of the Company’s common stock, at prices ranging from $0.63 to $47.25 per share, were not included in the computation of diluted net income (loss) per share because they were anti-dilutive for that purpose.

Litigation

The Company was not a party to any litigation proceedings as of March 15, 2005.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

The discussion in this filing contains forward-looking statements that 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 factors described in our Annual Report on Form 10-KSB for the year ended April 30, 2004.

CRITICAL ACCOUNTING POLICIES

Use of Estimates

Our 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 and the deferred tax valuation allowance.

RESULTS OF OPERATIONS

Revenue Analysis

	Three Months Ended							Nine Months Ended
(Amounts in thousands)	January 31,							January 31,
Revenues	2005		2004		Change			2005		2004		Change
Products
Spares	$	665	$	1,887	$	(1,222	)	$	2,154	$	3,958	$	(1,804	)
Contracts		1,313		1,255		58			6,010		2,992		3,018
Total Products		1,978		3,142		(1,164	)		8,164		6,950		1,214
Services
SoftwareSupport		139		35		104			217		194		23
Total Services		139		35		104			217		194		23
	$	2,117	$	3,177	$	(1,060	)	$	8,381	$	7,144	$	1,237

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.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

During the three-month period ended January 31, 2005, spares revenue of $665,000 consisted of multiple orders from various customers, while spares revenue of $1.9 million for the same period in 2004 was principally derived from one large order amounting to $1.5 million. For the nine-month period ended January 31, 2005, spares revenue of $2.2 million was attributable to multiple orders from various customers. For the same period in 2004, one single domestic customer accounted for $3.1 million of total spares revenue of $4.0 million.

During the three-month period ended January 31, 2005, we recognized $1.3 million of contract revenue primarily from three customers. For the same period in 2004, we recognized $1.3 million of contract revenue primarily from three customers. Contract revenues for the nine months ended January 31, 2005 was $6.0 million, compared to $3.0 million for the corresponding period in 2004. Of the $6.0 million of contract revenue in 2005, $3.9 million was derived from the sale of lottery terminals to one customer.

Software support revenue remained relatively insignificant for the three and nine-month periods ended January 31, 2005 and 2004.

Related party revenue of $710,000 accounted for 34% of total revenue in the three-month period ended January 31, 2005, compared to $1.3 million or 41% of total revenue for the corresponding period in 2004. For the nine-month period ended January 31, 2005, related party revenue of $5.9 million accounted for 70% of total revenue. For the comparable period in 2004, we derived $2.2 million or 31% of total revenue from related customers.

Cost of Sales and Gross Profit Analysis

	Three Months Ended								Nine Months Ended
	January 31,				January 31,				January 31,				January 31,
	2005				2004				2005				2004
Revenues:
Products	$	1,978	93	%	$	3,142	99	%	$	8,164	97	%	$	6,950	97	%
Services		139	7	%		35	1	%		217	3	%		194	3	%
Total revenues		2,117	100	%		3,177	100	%		8,381	100	%		7,144	100	%
Cost of sales:
Products		1,332	63	%		1,474	46	%		5,608	67	%		4,087	57	%
Services		48	2	%		10	1	%		71	1	%		93	2	%
Total costs of sales		1,380	65	%		1,484	47	%		5,679	68	%		4,180	59	%
Gross Profit:
Products		646	30	%		1,668	53	%		2,556	30	%		2,863	40	%
Services		91	5	%		25	0	%		146	2	%		101	1	%
Total gross profit	$	737	35	%	$	1,693	53	%	$	2,702	32	%	$	2,964	41	%

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

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 was 35% for the three months ended January 31, 2005, compared to 53% for the corresponding period of fiscal 2004. The decrease was largely due to reduced business activities which resulted in higher unabsorbed production overhead expenses. In addition, during the three months ended January 31, 2005, we incurred additional contract warranty costs and experienced a slight decrease in spares profit margins.

During the nine months ended January 31, 2005, we experienced a decline of 9% in the overall gross margins, compared to the corresponding period of fiscal 2004. Spares sales during the nine months ended January 31, 2004 generated significantly higher margins compared to those of 2005. However, the higher margins achieved in spares sales during the nine months ended January 31, 2004 were partially offset by lower contract profit margins.

Research and Development Expenses (“R&D”): R&D expenses for the three months ended January 31, 2005 were $356,000 compared to $457,000 for the comparable period of fiscal 2004. We attribute the decrease of $101,000 or 22% to reduced labor costs and material spending on a project that applies our technology in other markets.

For the nine months ended January 31, 2005, R&D spending was $240,000 or 16% lower than the comparable period of fiscal 2004. The decrease in R&D spending was principally attributable to reduced labor costs and material spending on a project that applies our technology in other markets.

We anticipate that R&D expenses will increase as a result of additional material spending, increased testing and certification expenses.

Selling, General and Administrative (“SG&A”): SG&A expenses of $756,000 for the three months ended January 31, 2005 were $116,000 or 13% lower than SG&A expenses reported in the comparable period in 2004. We attribute the significant decrease to a combination of factors including improved cost reduction initiatives, lower marketing expenditures resulting from fewer bidding opportunities and lower professional fees.

For the nine months ended January 31, 2005, SG&A expenses were $610,000 or 21% lower than that of the same period in 2004. Effective cost saving measures along with lower marketing expenditures resulted from fewer bidding opportunities and lower professional fees contributed to the significant reduction in SG&A expenses.

interest expense, net: For the three and nine-month periods ended January 31, 2004, we had net interest expense compared to net interest income in the corresponding periods in fiscal 2005, principally due to the amortized loan origination costs associated with the line of credit facility we had used in fiscal 2004.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our net working capital at January 31, 2005 was $4.7 million. Included in current assets is $3.4 million in accounts receivable of which $2.6 million was due from a single customer. Such receivables arose in the fourth quarter of 2003 and the first quarter of 2004. The customer has remitted scheduled installment payments totaling $3.0 million during the period from May 1, 2004 to February 25, 2005. Management believes the customer will make the remaining payments which are scheduled through June 2005. Nonpayment of the remaining amounts owed could have a significant negative impact on our cash flow and financial position, and our results of operations.

Contract backlog at January 31, 2005 was $5.7 million. Of this amount, $3.2 million is related to a contract with the customer discussed in the previous paragraph. We will deliver the terminal kits upon receiving substantially all of the scheduled payments. The remaining $2.5 million of backlog is expected to be delivered within six months. We anticipate that we will be successful in obtaining additional product or service contracts to enable us to continue normal operations through January 31, 2006. Sources of cash through January 31, 2006 are expected to come from scheduled installment payments of $2.6 million as discussed in the previous paragraph. In addition, we expect to derive our sources of cash from contract sales, spares revenue and contract backlog. Uses of cash will be for normal operating expenses and costs associated with contract execution.

In the highly competitive industry in which we operate, operating results may fluctuate significantly from period to period. While we anticipate that our cash flows from operations and available cash will be sufficient to enable us to meet our liquidity needs through January 31, 2006, we cannot assure that this will be the case. Although we are not aware of any particular trends, in the event that we are unable to secure new business, we may experience reduced liquidity or insufficient cash flows.

The following table summarizes our cash flow activities:

	Nine Months Ended
	January 31,			January 31,			Increase
(Amounts in thousands)	2005			2004			(Decrease)
Condensed cash flow comparative:
Operating activities	$	83		$	1,323		$	(1,240	)
Investing activities		(17	)		(57	)		40
Financing activities		(763	)		(1,500	)		737
Effect of exchange rate		(42	)		(56	)		14
Net decrease in cash and cash equivalents	$	(739	)	$	(290	)	$	(449	)

Cash Flow Analysis – Nine-Month Period Ended January 31, 2005:

Operating activities

During the first nine months of fiscal year 2005, net cash provided by operating activities was

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

$83,000.

Net loss of $839,000 was adjusted by $382,000 of noncash charges including depreciation and amortization, loss on disposal of equipment and warranty reserve expense to arrive at net cash flow provided by operating activities.

Net cash provided by operating activities also reflected positive effects of decreases in accounts receivable and inventories of $2.1 million and $550,000, respectively. A decrease in other assets and increases in warranty reserves and the liability to our Parent company had a $130,000 positive effect on net cash provided by operating activities.

Decreases in accounts payable and billings in excess of costs and earnings on uncompleted contracts had a $689,000 and $1.3 million negative effect on net cash provided by operating activities, respectively. Decreases in accrued payroll and related taxes and other liabilities had a $234,000 negative effect on net cash provided by operating activities.

Financing and investing activities

We invested $17,000 in computer and office equipment during the nine months ended January 31, 2005. In addition, payment of short-term note payable reduced our cash position by $763,000.

Cash Flow Analysis – Nine-Month Period Ended January 31, 2004:
Operating activities

For the first nine months of fiscal year 2004, net cash provided by operating activities was $1.3 million.

Net loss of $1.5 million was adjusted by $349,000 of noncash charges including depreciation and amortization, amortization of loan origination fee and warranty reserve expense to arrive at net cash flow provided by operating activities.

Net cash provided by operating activities also reflected a positive effect of a decrease in accounts receivable of $5.0 million. Increases in billings in excess of costs and estimated earnings on uncompleted contracts and the liability to our Parent company had $951,000 and $67,000 positive effects on net cash provided by operating activities, respectively.

A decrease of $2.7 million in accounts payable and an increase of $476,000 in inventories had negative effects on net cash provided by operating activities. In addition, an increase in other assets coupled with decreases in accrued payroll and related taxes, warranty reserves and other liabilities had a combined $354,000 negative effect on net cash provided by operating activites.

Financing and investing activities

On April 3, 2003, a major financial institution extended a $5.5 million line of credit to us to be used for a specific project. This transaction specific working capital line was 90% guaranteed by the United States Export-Import Bank. The line provided for advances of 90% on accounts

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

receivable collateralized by letters of credit in hand from the customer or 65% of inventory backed by a letter of credit. Borrowings under the line bore interest at the prime rate plus ¹/2 %. We had granted a security interest in rights to collections and inventory as collateral.

The most significant impact on cash for the period was the payment of an advance on the Company’s line of credit. Payment during the nine-month period ended January 31, 2004 was $1.5 million. At January 31, 2004, there was no amount drawn on the line of credit.

On January 29, 2004, prior to the expiration date, we terminated the line of credit, because it was no longer required.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” requiring that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be measured and recognized in the financial statements using the fair value of the compensation awards. The provisions of SFAS 123R are effective for us for the first interim or annual reporting period that begins after December 15, 2005; therefore, the Company will adopt the new requirements no later than the beginning of its fourth quarter of fiscal 2006. Adoption of the expensing requirements will reduce the Company’s reported earnings. Management is currently evaluating the two methods of adoption allowed by FAS 123R; the modified-prospective transition method, and the modified-retrospective transition method.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.

FOREIGN EXCHANGE FLUCTUATION

Our reporting currency is the U.S. dollar. Sales are denominated almost exclusively in U.S. dollars. Occasionally, sales have been effected in foreign currencies. Fluctuations in exchange rates from reporting period to reporting period between various foreign currencies and the U.S. dollar may have an impact on revenue and expense. Such effect may be material in any individual reporting period.

We are exposed to risks associated with changes in foreign exchange rates, principally exchange rates between the U.S. dollar, the Australian dollar and the British pound. Due to the insignificant level of operating activities in our foreign subsidiaries, we do not consider our existing foreign currency translation exposure to be material.

The balance sheets of our international subsidiaries are translated into U.S. dollars and consolidated with our balance sheet at period end exchange rates, while revenues and expenses are

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

translated at average rates during the period. Fluctuations in the U.S. dollar value of the foreign currency denominated assets are accounted for as an adjustment to stockholders’ equity. Therefore, fluctuations from reporting period to reporting period in the exchange rates between various foreign currencies and the U.S. dollar may impact the foreign currency translation component of our reported stockholders’ equity.

Due to the weakening of the U.S. dollar, we recorded foreign currency translation losses of $20,000 and $27,000 for the three-month periods ended January 31, 2005 and 2004, respectively. For the nine-month periods ended January 31, 2005 and 2004, we incurred foreign currency translation losses of $42,000 and $56,000, respectively. The foreign currency translation losses were accounted for as increases in the other accumulated loss component of shareholders’ equity.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
Other Information

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 Exchange Act reports 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 Acting 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.

As required by Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of design and operation of our disclosure controls and procedures as of January 31, 2005. Based on the foregoing, our Chief Executive Officer and Acting Chief Financial Officer concluded that our disclosure controls and procedures were effective for gathering, analyzing and disclosing the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms.

Changes In Internal Controls Over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting during the nine months ended January 31, 2005 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

We are currently undergoing a comprehensive effort to ensure compliance with Section 404 of the Sarbanes – Oxley Act of 2002. As a non-accelerated filer with a fiscal year end of April 30, we must first begin to comply with the requirements of Section 404 for the fiscal year ending April 30, 2007. 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, during the remaining periods through April 30, 2007, we will continue to review, and where necessary, enhance our internal control design and documentation, management review, and ongoing risk assessment as part of our internal control program.

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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
Other Information

Part II            OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     The Company was not a party to any litigation proceedings as of March 15, 2005.

ITEM 5. OTHER INFORMATION

     There was no other information.

ITEM 6. EXHIBITS

A. Exhibits

Exhibit Number	Document Description
31	Certification 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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INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
Other Information

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.

INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.

/s/ M. Mark Michalko

M. Mark Michalko

President and

Acting Chief Financial Officer

Date: March 15, 2005

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