ITEM 1.
BUSINESS
The terms “ILTS,” “the Company,” “we,” “our” and “us” refer to International Lottery & Totalizator Systems, Inc. and its consolidated wholly-owned subsidiary, Unisyn Voting Solutions, Inc. (“Unisyn”), unless otherwise specified.
Organizational History
We are a leading supplier of computerized wagering systems for the lottery and pari-mutuel racing industries. In addition, in recent years, our company has developed certified end-to-end optical scan voting systems and a full-featured Election Management System that provides precinct tabulation, ballot review and audio voting capability.
ILTS was founded in 1978 and completed an initial public offering in 1981. Our subsidiary, Unisyn, was founded in 2003. Our operations and corporate headquarters are located in Vista, California.
Business Overview
We design, develop and provide secure, innovative and dependable gaming and voting processing systems for public and private organizations throughout the world. We provide a complete range of customized and technologically innovative software, hardware, technical support and site management for our customers’ gaming or voting operations. We believe our responsiveness to customer requirements in these mission critical operational areas is efficient, technologically superior, dependable and continuous over time.
Lottery and Pari-Mutuel Segment
We generate revenue by designing, manufacturing, licensing, managing, supporting, and servicing computerized wagering systems and terminals for the lottery and pari-mutuel racing industries worldwide.
Voting Segment
We generate revenue by developing, manufacturing, licensing and supporting voting systems for governmental and non-governmental election jurisdictions in the United States under the name of Unisyn Voting Solutions, Inc.
Products and Services
Wagering Systems
Our wagering systems include the following components:
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A central computer installation that is comprised of computer hardware and commercially available operating systems used
in conjunction with our proprietary DataTrakII application software;
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The Datamark and Intelimark families of point-of-sale terminals; and
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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.
Our DataTrakII gaming system controls the overall lottery operation. Although to date it has been sold only in conjunction with our terminals, DataTrakII can also be sold as a stand-alone system that will interface with third-party terminals. Likewise, the terminals can be, and have been, sold separately to interface with a third-party lottery/tote central system.
The point-of-sale, proprietary components of our systems are the Datamark and Intelimark families of ticketing terminals. These terminals are compact, reliable, microprocessor-based units, which scan bet slips or interpret operator-input data in order to produce a ticket receipt to be retained by the customer.
We sell these terminals separately or as part of a turnkey wagering system, or we modify a terminal's features or configurations and central system software to meet specific customer requirements.
Using commercially available hardware and software, we design the communication network to interface the DataTrakII central system with the wagering terminals to best fit each customer’s specific telecommunications environment.
Our technology can also be modified for use in secure transaction-processing applications outside the gaming industry.
Wagering Application Software
The principal component of our wagering system is the suite of applications that make up our DataTrakII central system. The central system controls the operation of the entire lottery installation, and it performs the following functions:
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Maintains communication with each point-of-sale terminal;
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Ensures complete end-to-end security;
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Logs all activity and wagers in multiple (redundant) locations;
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Populates a commercially available database in real time with high level security;
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Identifies tickets using lottery game draw results;
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Calculates pari-mutuel prize pool amounts that are used to determine the dividend of a given winning ticket;
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Allows the use of other third party software products to analyze and compile management data; and
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Provides mission critical fault tolerance.
Development of this software has been an evolutionary process. We continually strive to incorporate new and improved technologies as they become available in the marketplace. This is intended to allow us to take advantage of the latest technology trends to enhance existing features of our system, and to provide new distribution channels and operational features so that our customers can reach new or expanding markets. Since our software architecture is non-proprietary, it can be interfaced with our customers' choice of third party reporting and analysis software tools. The DataTrakII system employs a client-server architecture. This intended to provide customers the advantage of configuring the system economically to meet current requirements, while maintaining the ability to expand or contract the system as their operation demands.
Datamark and Intelimark Terminals
We have supplied in excess of 60,000 terminal products to the wagering industry since our first unit was sold in 1980. We currently have two families of full feature terminals in production: the Datamark and the Intelimark, both of which are:
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Based on PC architecture and utilize commercially available software operating systems;
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Small, lightweight, and highly reliable; and
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Programmed using standard software languages.
We have developed many models of Datamark terminals throughout our company’s history. One of the versions in the Datamark family which we currently offer is the XClaim terminal. Its optical mark reader and thermal printer require little or no adjustments or maintenance. It is economically priced and extremely easy to use with features that increase operator efficiency and reduce transaction time. The XClaim can be programmed to meet the specific operating requirements of each individual customer. A keyboard is provided for operator input and an LCD displays the wagering details.
The Intelimark family was introduced in 1999 and incorporates commercially available hardware and software from strategic partners. The Intelimark FLX terminal is a modular touch screen lottery terminal packaged to offer maximum flexibility for retailer convenience. All components that make up the complete terminal are freestanding modules that can be arranged to meet the unique physical requirements of each retailer location. Driven by the market demand for enhanced ticket reading capability, the Intelimark FLX is equipped with a high-speed contact image scanner that will accept up to A4 size slips and is capable of character recognition and signature capture. Its modular design, open architecture and PC-based technology provide a flexible platform that is intended to quickly and economically respond to the dynamic needs of both players and retailers.
We have introduced a new Intelimark FLX terminal model, the Intelimark FLX 2. This model is similar to the original Intelimark FLX in terms of quality and technological features. However, it consists of two separate modules: the CPU/Touchscreen and the Scanner/Printer. The FLX 2 scanner is also a high-speed contact image scanner; however, it is an 82.55mm scanner compared to the A4 sized scanner used in the Intelimark FLX. It also incorporates a printhead option in the scanner that allows branding of receipts.
Additionally, ILTS offers customized terminal solutions based on specific customer requirements. This includes the procurement of components that meet customer functional specifications and packaging of these components into an ILTS terminal design.
Spare Parts
In addition to sales of terminals and central system software and hardware systems, we also realize ongoing revenue from the sale of spare parts for use in the repairs and maintenance of the terminal population.
Software and Technical Support Agreements
We offer agreements which feature:
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Telephone hotline, onsite and e-mail support;
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Standard upgrades and patches; and
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Primary technical support for third-party software products purchased through ILTS.
Additionally, we offer software modifications and enhancements to satisfy specific customer requirements.
Voting Systems
In recent years, Unisyn has devoted significant resources in developing certified end-to-end optical scan voting systems and a full-featured Election Management Software (“EMS”) that provides precinct tabulation, ballot review and audio voting capability. In addition to the Inkavote Plus Precinct Ballot Counter (“PBC”) system certified by the National Association of State Election Directors (“NASED”) 2002 Voting System Standards (“VSS”), our company received the 2005 Voluntary Voting System Guidelines (“VVSG”) certification from the Election Assistance Commission (“EAC”) for its OpenElect® digital optical scan election system - a digital scan voting system built with Java on a streamlined and hardened Linux platform. As part of a jurisdiction's procurement process, we provide the OpenElect® products’ source code for independent review.
Our OpenElect® voting systems consist of the following components:
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OpenElect® Central Suite is a Linux-based suite of software applications including the Ballot Layout Manager, Election Manager, Election Server, Software Server, Tabulator Client, Tabulator, Tabulator Reports and Adjudicator. The applications work together to define and configure an election supporting traditional methods of vote tabulation and including ranked choice voting tabulation;
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OpenElect® Voting Optical Scan is a comprehensive and secure paper-based digital optical scan voting system that both validates and tabulates ballots at each precinct or vote center, providing integrity, confidence and high levels of physical and software security;
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OpenElect® Voting Interface is a multi-faceted and robust voting device which has features to accommodate voters with disabilities and facilitate precinct voting, early voting and vote center voting, along with other non-geographical use. This device meets or exceeds all requirements of the Help America Vote Act (“HAVA”); and
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OpenElect® Voting Central Scan is a high-speed digital scan voting unit designed to tabulate election day, early vote, vote center, absentee, provisional and recounted ballots at a jurisdiction’s central operation center.
The OpenElect® voting systems offer the following features:
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High level of security and vote encryption to help ensure integrity and voter privacy;
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Electronic and paper audit trails that offer added security and redundancy for recounts;
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Reduce the cost of ballot printing while offering operational efficiencies;
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Minimal training required for poll workers to set-up and operate; and
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Minimal voter re-education required.
Election Management Software
The EMS, consisting of the Ballot Data Generator and the Vote Tabulator software applications work together to perform the following functions:
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Define and configure an election;
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Program the InkaVote Plus PBCs and the OpenElect products;
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Provide camera ready encrypted ballot pages in PDF format;
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Compile and tabulate vote results; and
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Generate required reports.
The EMS is intended to provide complete control of the election process from ballot layout to report generation. It utilizes streamlined menus and prompts to provide maximum flexibility and customization while guiding the user through each step in the process. The system supports numerous languages in both standard and audible ballots. The EMS creates the election specific database from information that can be imported manually and/or from an XML file. The system easily integrates with other systems in use by the customer.
Product Markets
Our revenue from the sale of lottery and totalizator systems is almost exclusively derived from contracts with international customers. We also derive revenue from selling our voting products and services directly to county election jurisdictions and distributors in the United States.
Revenue for software support and onsite technical support services is derived from providing the services to customers in the voting and gaming segments.
Competitive Business Conditions
Lottery and Pari-Mutuel Segment
We compete primarily in the lottery and totalizator industries by providing high-quality wagering systems and terminals that are reliable, secure and provide high speed transaction processing. In addition, we believe that we offer our customers greater flexibility in design and custom options than our competitors do. The market for lottery system contracts is highly competitive. In general, our competitors have significantly greater resources than we do. Although our sales in the United States have been insignificant, we believe that our company has a substantial share of the market in the international marketplace for lottery systems.
Our principal competitors in the market are as follows:
Voting Segment
The market for our OpenElect® voting systems is highly competitive and saturated. However, the early 2005 EAC certification has given us the advantage of securing various state certifications which our competitors have yet to achieve. We were the first manufacturer to receive the 2005 EAC certification for a precinct based digital based optical scan system. Our enhanced security system has the ability to be modified easily for additional features to the current system. We believe this sets our products apart from the older and less flexible products of our competitors. Our competitors are more established and have solid user bases in the market. Although we are operating in a highly competitive environment, we believe we are well positioned to capture a fair share of the sales of optical scan voting systems.
Our principal competitors in the market are as follows:
Manufacturing Processes
We produce terminals and voting systems, repair modules, and supply spare parts from our domestic facility located in Vista, California. During recent years, the design of certain high-production units has been streamlined. This cost saving measure allows us to easily outsource the assembly of these units to local manufacturers based on production volume, while maintaining control over the materials and quality.
Our manufacturing processes were also inspected by the Election Assistance Commission (“EAC”) in November 2010 to verify compliance with the requirements of Section 8.5 of the EAC Test and Certification Manual. Unisyn passed all inspections and is currently recognized as a manufacturer of voting devices by the EAC.
Materials and Suppliers
For terminal and voting system components, including spare parts, we generally have multiple sources, but a limited number of items are available only from a single supplier. Accordingly, those items could from time to time, be in short supply or on allocation due to their limited availability. For the year ended April 30, 2014, three vendors accounted for approximately 47% of the Company’s lottery and voting product purchases (or 20%, 14%, and 13% individually). For the year ended April 30, 2013, five vendors accounted for approximately 73% of the Company’s lottery and voting product purchases (or 18%, 18%, 15%, 12%, and 10% individually).
Dependence upon a Few Customers
Our business to date has been dependent on major contracts from a specific pool of lottery operators and limited customer base in the voting segment. Failure to obtain new contracts from existing and new customers would have a materially adverse effect on our financial performance.
April 30, 2014
April 30, 2013
Revenue:
From unrelated customers
One customer from the gaming segment accounted for 30% of total revenue and one customer from the voting segment accounted for 10% of total revenue.
One customer from the gaming segment accounted for 30% of total revenue and one customer from the voting segment accounted for 22% of total revenue.
From related customers
One customer from the gaming segment accounted for 52% of total revenue.
Two customers from the gaming segment accounted for 38% of total revenue or 28% and 10% individually.
Patents, Copyrights, Trademarks, and Licenses
We have three U.S. patents issued on our products. Although our intellectual property rights are important to our business, we believe our technical expertise, trade secrets and the creative skills of our personnel are more important to our company’s success. We typically require customers, employees, licensees, subcontractors, strategic partners, and joint venture partners who have access to proprietary information concerning our products to sign nondisclosure agreements. We rely on such agreements, other security measures, and trade-secret law to protect our proprietary information.
International Lottery & Totalizator Systems, Inc.®, ILTS® and Unisyn Voting Solutions, Inc.® are registered trademarks of our company. We have other products that have been trademarked, such as DataTrakII®, Intelimark® and OpenElect®, all mentioned herein.
We have taken steps to protect our trademarks, copyrights, inventions, trade secrets, and other intellectual property.
Regulations
The countries in which we market our products generally implement regulations to govern lottery or totalizator operations, and the appropriate governing body could restrict or ban operations in these countries. Any such action could have a material adverse effect on our company. Additionally, the purchases of voting systems by governments and municipalities are typically conducted through procurement regulations with which we must comply.
Foreign countries often impose restrictions on corporations seeking to do business within their borders, including foreign exchange controls, and in some jurisdictions, requirements for domestic manufacturing content. In addition, laws and legal procedures in these countries may differ from those generally existing in the United States. Conducting business in these countries may involve additional risks in protecting our business and assets, including proprietary information. Changes in foreign business restrictions or laws could have a significant impact on our operations.
Research and Development
We continue to examine new and emerging technologies based upon current industry developments with the intention to increase our customers’ market share, to stay competitive in our market and to explore new markets where our core competencies can be applied. For example, we have in the past invested resources to expand specific applications to run on the Linux operating system. These Linux based applications are targeted at products used in both wagering and voting markets.
We dedicate our efforts to applying cutting-edge technology and developing innovative and secure voting solutions.
For the year ended April 30, 2014, we incurred $139,000 in research and development (“R&D”) expenses, which consisted primarily of labor costs for the development of new products in the lottery segment. None of the R&D expenses were borne by our customers. We did not incur any R&D expenses for the year ended April 30, 2013.
Environment Effects
There were no significant capital expenditures required to comply with laws relating to the protection of the environment.
Employees
As of April 30, 2014, we had 33 employees employed on a full-time equivalent basis. We have no employees that are members of labor unions. We believe our relationship with our employees is satisfactory.
Going-Private Transaction
On January 8, 2014, our board of directors approved (i) our company’s reincorporation from California to Delaware by means of a merger with and into a wholly-owned Delaware subsidiary (the “Reincorporation”) and (ii) a subsequent amendment to the surviving company’s certificate of incorporation to effect a 9,245,317-for-1 reverse stock split (the “Reverse Stock Split”) on outstanding shares of common stock. On January 8, 2014, Berjaya Lottery Management (H.K.) Ltd. (“BLM”), the holder of 9,245,317 shares of our common stock, representing 71.3% of our company’s outstanding shares of common stock as of that date, approved the Reincorporation and Reverse Stock Split by written consent. Each shareholder holding less than one full share of common stock following the Reverse Stock Split, being every shareholder of our company other than BLM, will receive a cash payment from us for their fractional share interests equal to $1.33 in cash, without interest, for each share of common stock held by such shareholder immediately prior to the Reverse Stock Split. The Reincorporation and the Reverse Stock Split will be effected on or about the date 20 calendar days following the date on which our company’s Information Statement on Schedule 14C (the “Information Statement”) relating to the Reincorporation and Reverse Stock Split is mailed to our shareholders. A preliminary Information Statement has been filed with the SEC and currently remains under review. The transactions are expected to be consummated in the fourth quarter of calendar year 2014, and we will thereafter promptly terminate our registration and reporting obligations under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Additional Information
As a public company, we file annual, quarterly and special reports and other information with the Securities and Exchange Commission (“SEC”). Our electronic filings with the SEC (including our Annual Reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to these reports) are available, free of charge, on the SEC’s website at http://www.sec.gov. On the investor relations section of our corporate website, www.ilts.com, we also make available, free of charge, our Annual Reports on Form 10-K, as soon as reasonably practicable, after we electronically file them with the SEC. The contents of and the information on or accessible through our corporate website and our investor relations website is not a part of, and is not incorporated into, this report or any other report or document we file with or furnish to the SEC.
ITEM 1A.
ITEM 1A.
RISK FACTORS
Our business faces risks and uncertainties, including but not limited to, those discussed below and elsewhere in this report. These factors represent risks and uncertainties that could have a material adverse effect on our business, results of operations and financial condition. Additional risks and uncertainties not presently known to us or that we do not presently consider significant may also impair our business or the trading price of our securities.
If we do not execute on our strategic initiatives, there could be a material adverse effect on our results of operations and financial condition.
The future success of our business will depend significantly on our ability to execute effectively and implement the strategic initiatives. These initiatives consist of executing our market strategy including designing products to meet market trends and ensuring that an appropriate infrastructure is in place to meet the needs of customers; continuing to reduce product costs; and further improving the efficiency of operations, including lowering operating costs and enabling higher value services.
Successful execution of these initiatives depends on a number of factors including:
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The ability to attract and retain sufficient number of key technical employees and senior management personnel;
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Retaining customers by providing the necessary levels of support and service our products;
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Our ability to develop and introduce new products or programs because of the inherent risks and uncertainties associated with product development, particularly in response to government regulations;
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The identification and introduction of the proper mix or integration of products that will be embraced by the marketplace;
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Our business may be subject to changes in laws, regulations and certification requirements with respect to our voting products;
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Due to the political nature of our voting business, there is a risk that election jurisdictions may decertify our voting products that had previously been certified; and
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The ability of our products and services to differentiate us from our competitors and for us to demonstrate that our products and services result in enhanced product quality, functionality and reduced costs.
Further, our success will depend upon our ability to maintain proper internal control and to enhance the performance of the existing procedures and processes to adequately support our operations, strategies and business objectives.
We are dependent on a few customers, which include customers which are related parties to the Company.
Our business to date has been dependent on major contracts from a few different customers. During the fiscal year ended April 30, 2014, only three customers accounted for 92% of our total revenue. Additionally, during the fiscal year ended April 30, 2014, one customer that accounted for 52% of our total revenue is a related party to our company. The loss of one or more of these customers or failure to replace completed contracts with new contracts from existing customers would have a material adverse effect on our business.
Should we fail to successfully manage our key vendors, our financial results could be burdened.
Our arrangements with key vendors may make our operations vulnerable if those third parties fail to satisfy their obligations to our company due to changes in their own operations, financial condition, or other matters outside of our control.
If we fail to achieve favorable pricing from our vendors, our profitability could be adversely impacted.
Our profitability is affected by our ability to achieve favorable pricing with our vendors. Our inability to establish a cost and product advantage, or determine alternative means to deliver value to our customers, may adversely affect our revenues, and profitability.
We could experience manufacturing interruptions, delays, or inefficiencies if we are unable to procure in a timely and reliable manner components and products from single-source or limited-source suppliers.
We maintain several single-source or limited-source supplier relationships, either because multiple sources are not available or because the relationships are advantageous to us due to performance, quality, support, delivery, capacity, or price considerations. If the supply of a critical single- or limited-source product or component is delayed or curtailed, we may not be able to ship the related product in desired quantities and in a timely manner. Even where multiple sources of supply are available, qualification of the alternative suppliers and establishment of reliable supplies could result in delays and a possible loss of revenues, which could harm our operating results.
Significant supplier capacity constraints, supplier production disruptions, supplier quality issues or price increases could increase our operating costs and adversely impact the competitive positions of our products.
Our reliance on third-party suppliers for parts and components used in our products exposes us to volatility in the availability of these parts and components. A disruption in deliveries from our third-party suppliers, capacity constraints, production disruptions, price increases, or decreased availability of raw materials or commodities, could have an adverse effect on our ability to meet our commitments to customers or increase our operating costs. Quality issues experienced by third-party providers can also adversely affect the quality and effectiveness of our products and services and result in liability and reputational harm.
If we are unable to develop and introduce new and enhanced products that achieve market acceptance in a timely and cost-effective manner, our operating results and competitive position may be harmed.
Our future success will depend on our ability, in a timely and cost-effective manner, to develop and introduce new products and enhancements to our existing products. We must also achieve market acceptance for these products and enhancements. If we do not successfully develop and achieve market acceptance for new and enhanced products, our ability to maintain or increase revenues will suffer. Even if new and enhanced products are introduced to the market, we may not be able to achieve market acceptance of them in a timely manner. The loss of a key customer, a reduction in sales to any key customer or our inability to attract new significant customers could materially and adversely affect our business, financial condition and results of operations.
Our operating results may fluctuate significantly from period to period.
In the highly competitive industries in which we operate, operating results may fluctuate significantly from period to period. Hence, comparative results between periods may not be indicative of trends in revenue. 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 April 30, 2015. 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.
Interpretations and applications of policies regarding revenue recognition could cause us to defer recognition of revenue or recognize lower revenue and profits.
Revenue associated with the sale and licensing of our company’s voting system products and services will be recognized in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). As our transactions increase in complexity with the sale of multi-element products and services, negotiation of mutually acceptable terms and conditions can extend the sales cycle and, in certain situations, may require us to defer recognition of revenue on such licenses. We believe that we are in compliance with U.S. GAAP; however these future, more complex, multi-product, multi-year license transactions may require additional accounting analysis to account for them accurately could lead to unanticipated changes in our current revenue accounting practices and may contain terms affecting the timing of revenue recognition.
Insurance
We maintain third party insurance coverage against various liability risks and risks of property loss. While we believe these arrangements are an effective way to insure against liability and property damage risks, the potential liabilities associated with those risks or other events could exceed the coverage provided by such arrangements.
The requirements of complying with Section 404 of the Sarbanes-Oxley Act of 2002 may strain our resources and distract management.
Our company is not an accelerated filer as defined under the relevant SEC regulations; thus, we are only required to maintain and periodically certify that we have effective disclosure controls and procedures and internal control over financial reporting.
In order to continuously maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting and comply with Section 404 of the Sarbanes-Oxley Act, significant resources and management oversight may be required as we may need to devote additional time and personnel to legal, financial and accounting activities to ensure ongoing compliance. The costs associated therewith could be significant. In addition, the effort to prepare for these obligations and maintain effective internal controls may divert management’s attention from other business concerns, which could adversely affect our business, financial condition and results of operations.
The voting segment of our business is critically dependent on our ability to obtain federal and state certification for our voting system products.
The markets for our voting products and services are affected by changing technology and regulatory industry standards. Our ability to anticipate or respond to such changes and to develop and introduce new and enhanced products that meet all federal and state certifications on a timely basis will be a significant factor in our ability to expand, remain competitive and attract new customers. We can give no assurance that we will achieve the necessary technological advances or have the financial resources needed to introduce new products or services on a timely basis or that we will otherwise have the ability to compete effectively in the markets we serve.
Our cash and cash equivalents could be adversely affected if the financial institution in which we hold our cash and cash equivalents fail.
Our cash and cash equivalents consist of highly liquid investments and certificates of deposit with original maturities of three months or less at the time of purchase. However, our investments in money market funds are not insured. In addition, our cash balances in financial institutions may exceed the Federal Deposit Insurance Corporation (“FDIC”) limitation for coverage of $250,000. We also reduce our exposure to credit risk by maintaining all of our cash balances with highly rated financial institutions. While we strive to monitor our cash and cash equivalent balances regularly, these balances could be impacted if the financial institution in which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurance that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial and credit markets.
We may not receive significant revenues from our research and development efforts for several years, if at all.
Developing new products is costly, and the investment in product development often involves a long payback cycle. We have and expect to continue investing in research and development and related product opportunities. Enhancing our products and pursuing new product developments require high levels of expenditures for research and development that could adversely affect our operating results if not offset by revenue increases. We believe that we must continue to dedicate resources to our research and development efforts to maintain our competitive position. However, we might not expect to receive significant revenues from these investments for several years, if at all.
Our business competes on the basis of the security and integrity of our systems and products.
We believe that our success depends, in part, on providing secure products and systems to our customers. Attempts to penetrate security measures may come from various combinations of customers, retailers, vendors, employees and others. There can be no assurance that our business will not be affected by a security breach or lapse, which could have a material adverse impact on our results of operations, business or prospects.
Problems with product quality or product performance may cause us to incur substantial warranty expenses and may damage our market reputation and prevent us from achieving increased sales and market share.
Consistent with customary practice in our industry, we warrant our products and/or services to be free from defects in material and workmanship under normal use and service. The possibility of future product failures could cause us to incur substantial expenses to repair or replace defective products. Furthermore, widespread product failures may damage our market reputation and reduce our market share and cause sales to decline.
Changes in domestic and foreign business restrictions or laws could have a significant impact on our operations.
The countries in which we market our products generally have regulations governing lottery or totalizator operations, and the appropriate governing body could restrict or ban operations in these countries. Any such action could have a material adverse effect on our company and our customers’ operations. Foreign countries often impose restrictions on corporations seeking to do business within their borders, including foreign exchange controls, and in some jurisdictions, requirements for domestic manufacturing content. In addition, laws and legal procedures in these countries may differ from those generally existing in the United States. Conducting business in these countries may involve additional risks in protecting our business and assets, including proprietary information. Changes in foreign business restrictions or laws could have a significant impact on our operations.
Competitive pressures we face could harm our revenues and profits.
We compete for business opportunities against many domestic and foreign businesses. In many cases, our competition has greater financial resources which may affect the outcome of a bid, regardless of the products and/or services that we have the capability of providing. Also, in order to be competitive, we may price our products and services to a point where it could translate to lower revenues and profitability for our company.
Our business transactions may be subject to foreign currency 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 could become subject to litigation regarding intellectual property rights, which could seriously harm our business.
Although we have not been the subject of any such actions, third parties may in the future assert against us infringement claims or claims that we have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them. Third parties may in the future assert claims against our suppliers that such suppliers have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them. If such infringement by our suppliers or us were found to exist, a party could seek an injunction preventing the use of their intellectual property or require us to take a license for the use of their intellectual property, either of which would have an adverse impact on our revenues.
Our voting systems might face adverse publicity including legal and political challenges which may negatively impact our operating results.
Due to the sensitivity of the general public to the reliability and security of voting systems, our company might be vulnerable to adverse publicity posed by certain advocacy groups challenging our products’ integrity and dependability. These actions may negatively affect our financial results and customer relations.
Volatility of stock price
Our common stock is currently quoted on the OTC Markets and has previously been quoted on the OTC Bulletin Board. Stocks quoted on the OTC Markets and OTC Bulletin Board generally have limited trading volume and exhibit a wide spread between the bid/ask quotation. Our stock price is affected by a number of factors, including quarterly variations in financial results, the competitive landscape, general economic and market conditions, and estimates and projections by the investment community.
The current global economic slowdown and credit crunch may adversely affect our business and financial condition in ways that we cannot predict.
The current global economic slowdown may have a negative effect on our business and financial condition. We cannot predict the effect that the economic slowdown will have on us as it also impacts our customers, vendors and business partners. We believe that the global credit crunch may negatively impact our potential and existing customers’ ability to obtain financing for lottery and voting projects which in turn may affect our ability to secure new contracts to generate revenue.
Our strategic alliances may not result in the materialization of the anticipated benefits.
Part of our corporate strategy is to pursue growth through strategic alliances to gain access to new and tactically important geographies, and business opportunities and to capitalize on existing business relationships. We may not realize the anticipated benefits of these alliances that we may enter into, or may not realize them in the timeframe expected. These arrangements pose significant risks that could have a negative effect on our operations, including the potential failure to realize anticipated synergies, unanticipated costs and other unanticipated events or circumstances; and our possible inability to achieve the intended objectives of the arrangements.
We may be unable to adequately prevent disclosure of trade secrets and other proprietary information.
In order to protect our proprietary technology, we rely in part on confidentiality agreements with our corporate partners, employees, contractors, and consultants. These agreements may not effectively prevent the disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover our trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
Our common stock is subject to penny stock rules.
Our common stock is subject to Rule 15g-1 through 15g-9 under the Exchange Act, which imposes certain sales practice requirements on broker-dealers who sell our common stock to persons other than established customers and "accredited investors" (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000 (or $300,000 together with their spouse)). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of such common stock. Additionally, our common stock is subject to the SEC regulations for "penny stock." Penny stock includes any non-NASDAQ equity security that has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock, a disclosure schedule set forth by the SEC relating to the penny stock market must be delivered to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for the common stock. The regulations also require that monthly statements be sent to holders of penny stock which disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.
We have never paid dividends on our common stock, and we do not anticipate paying any dividends in the foreseeable future.
We have not paid cash dividends on our common stock to date. We currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of any future debt or credit facility, if any, may preclude us from paying dividends. As a result, capital appreciation, if any, of our common stock will be our stockholders’ sole source of gain for the foreseeable future.
Our board of directors and majority shareholder have approved a “going-private” transaction that would result in all of our outstanding equity securities being held by BLM.
Our board of directors and majority shareholder have approved a “going-private” transaction that would result in all of our outstanding equity securities being held by BLM. On January 8, 2014, our board of directors and majority shareholder approved the Reincorporation and Reverse Stock Split pursuant to which each shareholder holding less than one full share of common stock following the Reverse Stock Split, being every shareholder other than BLM, will receive a cash payment from us for their fractional share interests equal to $1.33 in cash, without interest, for each share of common stock held by such shareholder immediately prior to the Reverse Stock Split. Each shareholder receiving such a cash payment in lieu of fractional share interests will thereafter cease to be our shareholder, will not have any direct or indirect ownership interest in us, and will not be able to participate in any of our future earnings or growth. Further, all shareholders holding fractional shares interests following the Reverse Stock Split will receive $1.33 per pre-Reverse Stock Split share of common stock, regardless of the price paid by such shareholder for shares of our common stock. Following consummation of the Reverse Stock Split, we will promptly terminate our registration and reporting obligations under the Exchange Act and there will not be any trading market for shares of our common stock. We have filed a preliminary Information Statement with the SEC with respect to the Reincorporation and Reverse Stock Split, which currently remains under review. The Reincorporation and the Reverse Stock Split will be effected on or about the date 20 calendar days following the date on which a definitive Information Statement is mailed to our shareholders, which we expect to occur in the fourth quarter of calendar year 2014. However, the timing of the consummation of the Reincorporation and Reverse Stock Split remain uncertain and subject to change.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2.
PROPERTIES
Our headquarter facilities in Vista, California consist of approximately 18,514 square feet of leased office, warehouse and manufacturing space. In April 2012, we executed an amendment agreement to extend the lease for the facility in Vista, California to November 2015. We believe that our facility is suitable and adequate for our purposes.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is currently not a party to any pending legal proceedings, and no such action by or, to the best of its knowledge, against the Company has been threatened as of the date of this report.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded under the symbol ITSI on the OTC Markets. As of April 30, 2014 there were 12,962,999 common shares outstanding and approximately 947 shareholders of record. As of April 30, 2014, Berjaya Lottery Management (H.K.) Ltd. (“BLM”) owned 71.3% of the total outstanding shares while ILTS’s management and directors owned approximately 1% of the outstanding shares.
Solely for the purpose of calculating the aggregate market value of the voting stock held by non-affiliates of ILTS, as set forth on the cover of this report, it has been assumed that all executive officers and directors of ILTS and BLM are affiliated persons. All of ILTS’s common shares, the only voting stock outstanding, beneficially owned by each such person (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) have been assumed to be held by that person for this calculation.
The following table sets forth the quarterly high and low closing sale prices per share of our company’s common stock for fiscal years 2014 and 2013:
Dividends
Our company paid no dividends during the last two fiscal years. We currently intend to retain any earnings for use in the business and therefore do not anticipate paying any dividends in the foreseeable future.
Securities Authorized for Issuance under Equity Compensation Plans
Presently our company does not maintain any stock option plan.
Sales of Unregistered Securities
Our company had no sales of unregistered securities during the past two fiscal years.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Not applicable
ITEM 7.
ITEM 7.
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 period-to-period operating results, the absence of significant contract backlog, and other factors described in section 1A. Risk Factors in this Form 10-K.
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, inventory valuation, the allowance for doubtful accounts and the deferred tax valuation allowance.
Revenue Recognition
Our revenues are derived primarily from the sales of complete wagering systems, lottery terminals, the OpenElect® and PBC voting systems, other software and software support services. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and the title and risk of loss have been transferred. Service revenues are recognized as the services are rendered, and the related costs of services are recognized on a time and materials basis.
Revenue Recognition for Arrangements with Multiple Deliverables
For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software, and undelivered non-software services, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, we use a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of the selling price (“ESP”). VSOE generally exists only when we sell the deliverable separately and VSOE is the price actually charged for that deliverable. TPE is determined based on competitor prices for similar deliverables when sold separately. ESPs reflect our best estimates of what the selling prices of elements would be if they were sold regularly on a standalone basis.
For sales of hardware products, we provide various hardware components containing software essential to the hardware product’s functionality, and other components depending on the customers’ needs. We allocate revenue to these deliverables using the relative selling price method. Because we have not established VSOE or TPE for the hardware, with essential software, revenue is allocated based on ESPs. Determining ESPs requires management’s judgment. Revenue is recognized upon shipment of the hardware and the related essential software, provided the other conditions for revenue recognition have been met. We also provide software support and product support services on a standalone basis from the sales of the hardware. Amounts allocated to software support and product support services are based on VSOE using hourly or daily billing rates. Revenue is deferred until the services are performed. For annual software licenses, we use VSOE. Amounts allocated to annual software licenses are deferred and recognized on a straight-line basis over the service period, which is typically one year.
We consider multiple factors depending on the unique facts and circumstances related to each deliverable when determining ESPs for deliverables without VSOE or TPE. Key factors considered by the management in developing the ESPs for the hardware include the costs of manufacture and what a customer would reasonably pay based on the features being offered, trends in the market place, size of the territory, and competitive prices. If the facts and circumstances underlying the factors change, including the estimated or actual costs incurred to provide the hardware with the essential software, or should future facts and circumstances lead the management to consider additional factors, our ESP for the hardware with essential software related to future sales could change.
Revenue Recognition for Percentage-of-Completion Method
For our complete wagering and lottery systems, we recognize revenue by using the percentage-of-completion method when the contracts for complete systems fulfill the following criteria:
1. Contract performance extends over long periods of time;
2. The software portion involves significant production, modification or customization;
3. Reasonably dependable estimates can be made on the progress towards completion, contract revenues and contract costs; and
4. Each element is essential to the functionality of the other elements of the contracts.
Under the percentage-of-completion method, sales and estimated gross profits are recognized as work progresses. Progress toward completion is measured by the ratio of costs incurred to total estimated costs. Revenue and gross profit may be adjusted prospectively for revisions in estimated total contract costs. If the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is recorded in the period in which it becomes evident. The total estimated loss includes all costs allocable to the specific contract.
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.
Deferred Revenues and Deferred Cost of Revenues
Deferred revenues of approximately $470,000 and $5.4 million as of April 30, 2014 and 2013, respectively, represent prepayments for products and services related to lottery terminals, use of the OpenElect® and PBC voting systems and other software and technical support services. Deferred cost of revenues of $3,000 and $132,000 as of April 30, 2014 and 2013, respectively, consist of the direct costs associated with lottery terminals and voting systems. We will recognize the revenues and related cost of revenues upon fulfillment of the prescribed criteria for revenue recognition.
Allowance for Doubtful Accounts
The estimate for the allowance for doubtful accounts is based primarily upon our company’s historical bad debt experience with individual customers and any known specific issues or disputes that exist as of the balance sheet date.
Warranty Reserves
Estimated warranty costs are accrued as revenues are recognized. Warranty reserves are based on historical trends and are adjusted periodically to reflect actual experience. Customers do not have a right to return, except for defective products. The most recent inventory cost is used to determine the value of potential warranty costs. 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 six months to 12 months depending on the specific contract terms.
b.
Software - The warranty phase typically represents a six to twelve-month period of time after delivery, as defined by the specific contract terms.
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.
Inventory Valuation
We periodically review the inventory quantities on hand and record a provision for excess and obsolete inventories based on the following factors:
Valuation of Deferred Tax Assets
We regularly evaluate our ability to recover the reported amount of our net deferred tax assets. We consider several factors, including our estimate of the likelihood that we will generate sufficient taxable income in future years in which temporary differences will reverse.
Results of Operations
Revenue Analysis
Significant fluctuations in year-to-year revenue are expected in both gaming and voting industries. Individual contracts are generally of considerable value, and the timing of contracts or sales of spare parts does not occur in a predictable trend. Contracts from the same customer may not recur or generally do not recur in the short-term. Accordingly, comparative results between periods may not be indicative of trends in contract revenue.
The current domestic and global economic slowdown and tightening of the credit markets may adversely affect our business and financial condition in ways that we cannot reasonably predict. For the gaming segment, due to the tightening of the credit markets, our potential and existing customers may not be able to secure financing for lottery projects which may effectively impact our revenue potential. For the voting segment, various government entities and jurisdictions have experienced severe budget constraints which could compel them to delay or cancel their purchasing decisions, and hence, impact our ability to generate revenue.
Contract revenue for the year ended April 30, 2014 was approximately $20.4 million, compared to $8.3 million for fiscal 2013. Significantly higher contract revenue was primarily due to lottery product and hardware component sales related to gaming and totalizator industries. The increase was partially offset by completion of a lottery contract.
Spares revenue for the year ended April 30, 2014 was $325,000, compared to $543,000 for fiscal 2013, reflecting lower customer demand for spare parts in fiscal 2014. We derived spares revenue from various customers for shipments of spare orders. Customer demand for spare parts fluctuates from period to period and may not be indicative of trends in spares revenue.
Licensing revenue for the year ended April 30, 2014 was $650,000, compared to $483,000 for fiscal 2013. Higher licensing revenue was primarily due to additional executed licensing agreements related to the voting segment. We derived licensing revenue from executed voting and lottery contracts.
Software support revenue for the year ended April 30, 2014 was $973,000, compared to $776,000 for fiscal 2013. Higher software support revenue was mainly due to increased fees to support a customer in the gaming segment.
Product servicing and support revenue decreased to $365,000 in 2014 from $479,000 in 2013. The decrease was primarily due to lower demand for support services from a customer in the gaming segment, partially offset by higher demand for support services in the voting segment.
Related party revenue of approximately $11.9 million accounted for 52% of total revenue in the year ended April 30, 2014, compared to $4.2 million or 40% of total revenue in fiscal 2013.
Cost of Sales and Gross Profit Analysis
The following table summarizes the cost of sales and gross profit margins as a percentage of total revenues for each of the periods shown:
In general, individual contracts are significant in value and are awarded in a highly competitive bidding process. Gross profit margin varies from one contract to another, depending on the size of the contract and the competitiveness of market conditions. Accordingly, comparative results between periods may not be indicative of trends in gross profit margin.
Overall gross profit margin was 35% for fiscal 2014, compared to 37% for fiscal 2013. Slightly lower gross profit margin in 2014 was primarily due to higher production overhead costs related to both the gaming and voting segments.
Other Operating Expenses Analysis
Research and Development Expenses
For the year ended April 30, 2014, we incurred $139,000 in research and development (“R&D”) expenses. R&D expenses consisted primarily of labor costs for the development of new products in the gaming segment. We did not incur any R&D expenses for the fiscal 2013. We anticipate R&D expenses will increase marginally in the coming fiscal year.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the year ended April 30, 2014 increased by $653,000 compared to those of prior fiscal 2013. Higher SG&A expenses in 2014 were primarily due to increased legal and professional fees, and higher marketing expenses related to the voting segment. We anticipate SG&A expenses will increase moderately in fiscal 2015 as we continue to increase our sales and marketing efforts.
Income Tax Provision
The provision for income tax was approximately $1.8 million for the year ended April 30, 2014. In fiscal 2013, we recorded an income tax benefit of approximately $1.6 million related to a tax benefit for the reduction in the valuation allowance. The increase in income tax provision for 2014 was primarily due to the realization of the tax benefit recorded in fiscal 2013.
Liquidity and Capital Resources
Liquidity
Our net working capital at April 30, 2014 was approximately $10.9 million.
Contract backlog at April 30, 2014 was approximately $2.8 million. The contract backlog was related to voting contracts with unrelated customers. As of April 30, 2014, approximately $215,000 of the contract backlog has been paid by customers.
Additional sources of cash through April 30, 2015 are expected to be derived from spares revenue, software support and election support service revenues. Uses of cash are expected to be for normal operating expenses and costs associated with contract execution.
While we anticipate that we will be successful in obtaining additional product or service contracts to enable us to continue normal operations through April 30, 2015, there can be no assurance 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 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 April 30, 2015. 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.
Cash Flow Analysis
Significant fluctuations in cash flows from operating, investing and financing activities are expected in the gaming and voting industries because factors such as working capital needs, value of contracts, and timing of contracts and payments do not occur in a predictable trend. Accordingly, comparative results between periods are not indicative of trends in cash flow activities.
Operating Activities
Net cash provided by operating activities was approximately $2.1 million in fiscal 2014, compared to $5.6 million in 2013. The primary factors contributing to the change in the reported cash flow amounts related to decreased deferred revenues and accounts payable. These were partially offset by net income of approximately $3.1 million, a decrease in inventory reflecting shipments, a decrease in deferred income taxes, and a decrease in accounts receivable.
Investing and Financing Activities
Net cash provided by investing activities was approximately $1 million in fiscal 2014, compared to net cash used in investing activities of approximately $1.1 million in 2013. The increase in net cash flow from investments was primarily due to the redemption of the matured certificates of deposit. The increase was partially offset by higher capital expenditures incurred in 2014.
Capital expenditures amounted to $233,000 in fiscal 2014, compared to $141,000 in fiscal 2013. Expenditures in fiscal 2014 were primarily related to computer and manufacturing equipment. Capital expenditures in fiscal 2013 were related to voting and computer equipment.
There were no financing activities for the years ended April 30, 2014 and 2013.
Capital Resources
As of April 30, 2014, we did not have outstanding credit facilities.
Foreign Currency 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 our revenue and expense. Such effect may be material in any individual reporting period. No material foreign currency transactions occurred during the years ended April 30, 2014 and 2013.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our balance sheet, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Recent Accounting Pronouncements
In May 2014, the FASB issued an update to ASC 606, Revenue from Contracts with Customers. This update to ASC 606 provides a five-step process to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue upon transfer of promised goods or services to customers in an amount that reflects the expected consideration to be received in exchange for those goods or services. This update to ASC 606 will also result in enhanced disclosures about revenue, providing guidance for transactions that were not previously addressed comprehensively, and improving guidance for multiple-element arrangements. This update to ASC 606 is effective for us beginning in fiscal 2018. We are currently evaluating its impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
International Lottery & Totalizator Systems, Inc.
We have audited the accompanying consolidated balance sheets of International Lottery & Totalizator Systems, Inc. (a 71.3%-owned subsidiary of Berjaya Lottery Management (H.K.) Ltd.) and Subsidiary as of April 30, 2014 and 2013, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. International Lottery & Totalizator Systems, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of International Lottery & Totalizator Systems, Inc. and Subsidiary as of April 30, 2014 and 2013, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ CohnReznick LLP
San Diego, California
July 11, 2014
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of the Business
International Lottery & Totalizator Systems, Inc. (“ILTS” or the “Company,” together with its subsidiary) designs, manufactures, sells, manages, supports and services computerized wagering systems and terminals for the global 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 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.
The Company, through its wholly-owned subsidiary Unisyn Voting Solutions, Inc. (“Unisyn”), has devoted significant resources to developing federally certified end-to-end optical scan voting systems and a full-featured Election Management Software that provides precinct tabulation, ballot review and audio voting capability. In addition to the InkaVote Plus Precinct Ballot Counter (“PBC”) system certified to the National Association of State Election Directors (“NASED”) 2002 Voting System Standards (“VSS”), the Company received the 2005 Voluntary Voting System Guidelines (“VVSG”) certification from the United States Election Assistance Commission (“EAC”) for its OpenElect® digital optical scan election system - a digital scan voting system built with Java on a streamlined and hardened Linux platform. As part of a jurisdiction’s procurement process, the Company provides the OpenElect® products’ source code for independent review.
These efforts leverage the Company’s extensive experience to develop highly secure, mission-critical solutions that meet the NASED 2002 VSS and the EAC 2005 VVSG standards. In addition, the Company’s voting systems offer the following features:
·
High level of security and vote encryption to ensure integrity and voter privacy;
·
Electronic and paper audit trails that offer added security and redundancy for recounts;
·
Reduce the cost of ballot printing while offering operational efficiencies;
·
Minimal training required for poll workers to set-up and operate; and
·
Minimal voter re-education required.
Berjaya Lottery Management (H.K.) Ltd. (“BLM” or the “Parent”) owns 71.3% of the outstanding voting stock of ILTS.
On January 8, 2014, the Company’s board of directors approved (i) the Company’s reincorporation from California to Delaware by means of a merger with and into a wholly-owned Delaware subsidiary (the “Reincorporation”) and (ii) a subsequent amendment to the surviving company’s certificate of incorporation to effect a 9,245,317-for-1 reverse stock split (the “Reverse Stock Split”) on outstanding shares of common stock. On January 8, 2014, Berjaya Lottery Management (H.K.) Ltd. (“BLM”), the holder of 9,245,317 shares of the Company’s common stock, representing 71.3% of the Company’s outstanding shares of common stock as of that date, approved the Reincorporation and Reverse Stock Split by written consent. Each shareholder holding less than one full share of common stock following the Reverse Stock Split, being every shareholder of the Company other than BLM, will receive a cash payment from the Company for their fractional share interests equal to $1.33 in cash, without interest, for each share of common stock held by such shareholder immediately prior to the Reverse Stock Split. The Reincorporation and the Reverse Stock Split will be effected on or about the date 20 calendar days following the date on which the Company’s Information Statement on Schedule 14C (the “Information Statement”) relating to the Reincorporation and Reverse Stock Split is mailed to the Company’s shareholders. A preliminary Information Statement has been filed with the SEC and currently remains under review. The transactions are expected to be consummated in the fourth quarter of calendar year 2014, and the Company will thereafter promptly terminate its registration and reporting obligations under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of ILTS and its wholly-owned subsidiary, Unisyn Voting Solutions, Inc. All significant intercompany accounts and transactions are eliminated in consolidation.
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.
Revenue Recognition
The Company derives its revenues primarily from the sales of complete wagering systems, lottery terminals, the OpenElect® and PBC voting systems, other software and software support services. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and the title and risk of loss have been transferred. Service revenues are recognized as the services are rendered, and the related costs of services are recognized on a time and materials basis.
Revenue Recognition for Arrangements with Multiple Deliverables
For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software, and undelivered non-software services, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) and (iii) best estimate of the selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and VSOE is the price actually charged for that deliverable. TPE is determined based on competitor prices for similar deliverables when sold separately. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a standalone basis.
For sales of hardware products, the Company provides various hardware components containing software essential to the hardware product’s functionality, and other components depending on the customers’ needs. The Company allocates revenue to these deliverables using the relative selling price method. Because the Company has not established VSOE or TPE for the hardware, with essential software, revenue is allocated based on ESPs. Revenue is recognized upon shipment of the hardware and the related essential software, provided the other conditions for revenue recognition have been met. The Company also provides software support and product support services on a standalone basis from the sales of the hardware. Amounts allocated to software support and product support services are based on VSOE using hourly or daily billing rates. Revenue is deferred until the services are performed. For annual software licenses, the Company uses VSOE. Amounts allocated to annual software licenses are deferred and recognized on a straight-line basis over the service period, which is typically one year.
The Company considers multiple factors depending on the unique facts and circumstances related to each deliverable when determining ESPs for deliverables without VSOE or TPE. Key factors considered by the Company in developing the ESPs for the hardware include the costs of manufacture and what a customer would reasonably pay based on the features being offered, trends in the market place, size of the territory, and competitive prices. If the facts and circumstances underlying the factors change, including the estimated or actual costs incurred to provide the hardware with the essential software, or should future facts and circumstances lead the management to consider additional factors, the Company’s ESP for the hardware with essential software related to future sales could change.
Revenue Recognition for Percentage-of-Completion Method
For the complete wagering and lottery systems, the Company recognizes 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 the estimated total contract costs. If the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is recorded in the period in which it becomes evident. The total estimated loss includes all costs allocable to the specific contract.
In addition to the software portion of a complete system, the Company develops software for its 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 the Company has previously developed for its customers. Each software contract is reviewed individually to determine the appropriate basis of recognizing revenue.
Deferred Revenues and Deferred Cost of Revenues
Deferred revenues of approximately $470,000 and $5.4 million as of April 30, 2014 and 2013, respectively, represent prepayments for products and services related to lottery terminals, use of the OpenElect® and PBC voting systems and other software and technical support services. Deferred cost of revenues of approximately $3,000 and $132,000 as of April 30, 2014 and 2013, respectively, consist of direct costs associated with lottery terminals, software support and manufacture of voting systems. The Company will recognize revenues and related cost of revenues upon fulfillment of the prescribed criteria for revenue recognition.
Allowance for Doubtful Accounts
The Company determines its allowance for doubtful accounts by considering a number of factors:
1.
Length of time trade accounts receivable are past due;
2.
The Company’s previous loss history;
3.
The customer’s current ability to pay its obligations;
4.
Known specific issues or disputes which exist as of the balance sheet date; and
5.
The condition of the general economy and industry as a whole.
Based on its evaluation, the Company determined that no additional allowance was required as of April 30, 2014. The Company maintained an allowance for doubtful accounts of $75,000 as of April 30, 2014 and 2013.
Warranty Reserves
Estimated warranty costs are accrued as revenues are recognized. Included in the warranty cost accruals are costs for basic warranties on products sold. A summary of product warranty reserve activity for the fiscal years ended April 30, 2014 and 2013 is as follows:
(Amounts in thousands)
Warranty reserves are based on historical trends and are adjusted periodically to reflect actual experience. Customers do not have a right to return, except for defective products. The most recent inventory cost is used to determine the value of potential warranty costs. 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 six months to twelve months depending on the specific contract terms.
b.
Software - The warranty phase typically represents a six to twelve-month period of time after delivery, as defined by the specific contract terms.
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.
Income Taxes and Valuation Allowance
The Company recognizes tax benefits associated with uncertain tax positions when, in management’s assessment, it is more likely than not that the positions will be sustained upon examination by a taxing authority. For tax positions that meet the more likely than not recognition threshold, the Company measures the tax benefits as the largest amount that the Company evaluates to have a greater than 50% likelihood of being realized upon ultimate settlement. The Company reviewed its tax positions and determined that an adjustment to the tax provision is not considered necessary nor is a reserve for income taxes required.
The Company accounts for income taxes pursuant to the asset and liability method. This 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.
Foreign Currency Fluctuation
The Company’s 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. No material foreign currency transactions occurred during the years ended April 30, 2014 and 2013.
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. Inventories consisted of the following:
Equipment, Furniture and Fixtures
Equipment, furniture and fixtures are carried at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which approximate three to seven years. Leasehold improvements are amortized over the shorter of the useful lives of the assets or the lease term. The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, or when the net book value of such assets exceeds the future undiscounted cash flow attributed to such assets. At April 30, 2014 and 2013, and during the years ended April 30, 2014 and 2013, no indicators of impairment were identified.
Net equipment, furniture and fixtures consisted of the following:
Net Income per Share
Basic net income per share was based on the weighted average number of shares outstanding during April 30, 2014 and 2013.
There were no outstanding options or other dilutive securities at April 30, 2014 and 2013.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less at the purchase date to be cash equivalents.
2. BUSINESS SEGMENTS, GEOGRAPHIC REVENUES, MAJOR CUSTOMERS AND MAJOR VENDORS
Segment Information
The Company reports segment information based on the “management” approach. Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Company’s chief operating decision maker for purposes of evaluating performance and allocating resources.
The Company divides its operations into two operating segments: the gaming business and the voting business. The gaming segment designs and develops computerized wagering systems and terminals for the lottery and pari-mutuel racing industries worldwide. Presently the voting segment generates revenues from the sales of the voting systems and hardware, software licensing, product servicing and software support services.
The Company’s segment information is presented below (in thousands):
Geographic Revenues
Revenues by geographic area are as follows (in thousands):
As of April 30, 2014 and 2013, all of the Company's assets were held in the United States. During the fiscal years ended April 30, 2014 and 2013, a significant portion of the Company’s revenues was derived from exports from the United States to foreign countries.
Major Customers
April 30, 2014
April 30, 2013
Revenue:
From unrelated customers
One customer from the gaming segment accounted for 30% of total revenue and one customer from the voting segment accounted for 10% of total revenue.
One customer from the gaming segment accounted for 30% of total revenue and one customer from the voting segment accounted for 22% of total revenue.
From related customers
One customer from the gaming segment accounted for 52% of total revenue.
Two customers from the gaming segment accounted for 38% of total revenue or 28% and 10% individually.
Major Vendors
For the year ended April 30, 2014, three vendors accounted for approximately 47%, or 20%, 14%, and 13% individually, of the Company’s product purchases. For the year ended April 30, 2013, five vendors accounted for approximately 73%, or 18%, 18%, 15%, 12%, and 10% individually, of the Company’s product purchases.
3. CREDIT RISK
Of the cash and cash equivalents amount of approximately $10.4 million at April 30, 2014, approximately $2.8 million represents highly liquid money market funds which are not Federal Deposit Insurance Corporation (“FDIC”) insured. As of April 30, 2014, such other cash balances exceeded the FDIC limitation for coverage of $250,000 by approximately $7.6 million. The Company maintains its other cash balances primarily in three financial institutions. The Company reduces its exposure to credit risk by maintaining all of its cash balances with highly rated financial institutions.
4. INCOME TAXES
The provision (benefit) for income taxes is as follows (in thousands):
The following is a reconciliation of the expected income tax benefit or provision at the statutory federal income tax rate with the actual provision or benefit:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the carrying amounts used for income tax purposes. As of April 30, 2014 and 2013, the Company had net deferred tax assets of $5.1 million and $6.8 million, respectively, primarily attributable to its net operating loss carryforwards as further described below. At April 30, 2014, the Company has provided a valuation allowance against the entire balance of its net deferred tax assets due to the uncertainty regarding realization. As of April 30, 2013, the Company recorded a valuation allowance against the portion of its deferred tax assets that are more likely than not to be realized.
Significant components of the Company’s deferred tax assets are as follows:
As of April 30, 2014, the Company has approximately $9.5 million in federal net operating loss carryforwards that will begin to expire in 2020, unless previously utilized. In addition, as of April 30, 2014, the Company has approximately $284,000 in federal research and development credit carryforwards that begin to expire in 2020. The Company also has approximately $237,000 in federal alternative minimum tax credits that can be carried forward indefinitely.
Pursuant to the Tax Reform Act of 1986, Internal Revenue Code Section 382, utilization of the Company’s federal credit and net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within any three-year period.
The Company and its subsidiaries are subject to federal income tax as well as income tax from state jurisdictions. With few exceptions, the Company is no longer subject to income tax examination by tax authorities in major jurisdictions for years prior to April 30, 2010. However, to the extent allowed by law, the taxing authorities may have the right to examine prior periods where NOLs were generated and carried forward, and make adjustments up to the amount of the carryforwards. The Company is not currently under examination by the IRS or state taxing authorities.
The Company recognizes interest and penalties as a component of income tax expense. There were no interest and penalties for the years ended April 30, 2014 and 2013.
5. RELATED PARTY TRANSACTIONS
During the years ended April 30, 2014 and 2013, revenues from all related party agreements for sales of products and services totaled approximately $11.9 million (52% of total revenue) and $4.2 million (40% of total revenue), respectively. Accounts receivable balances at April 30, 2014 and 2013 were $11,000 and $411,000, respectively, from these customers. Descriptions of the transactions with the Company’s related parties in the years ended April 30, 2014 and 2013 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 April 30, 2014.
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 resulted in a liability to BLM for the cost of the items utilized.
The financial activities and balances related to BLM were as follows:
Sports Toto Malaysia Sdn. Bhd.
The Company provides lottery products, software development and software support services to Sports Toto Malaysia (“STM”), an affiliate of BLM and a related party.
In January 2013, the Company received from STM, an order valued at approximately $11 million for lottery products. Shipments of these products were completed in fiscal 2014 and the related revenue was recognized.
The financial activities and balances related to transactions with STM were as follows:
·
Revenue of approximately $11.7 million recognized on the sale of lottery products and supporting services during the year ended April 30, 2014. Revenue recognized on the performance of contract deliverables and sale of support services totaled approximately $3 million during the year ended April 30, 2013;
·
There was deferred revenue of $10,000 on lottery products and support services as of April 30, 2014, compared to $3.3 million as of April 30, 2013; and
·
There was no accounts receivable balance as of April 30, 2014. Accounts receivable balance from STM totaled $410,000 as of April 30, 2013.
Philippine Gaming Management Corporation
The Company provides lottery products and software development to Philippine Gaming Management Corporation (“PGMC”), a related party and a subsidiary of BLM.
In addition, the Company provides PGMC with terminal spare parts on an ongoing basis and support services on an as-needed basis.
The financial activities and balances related to transactions with PGMC were as follows:
·
Revenues recognized on the sale of lottery products and support services totaled approximately $72,000 during the year ended April 30, 2014, compared to $1.1 million in 2013;
·
There were no deferred revenue balances as of April 30, 2014 and 2013; and
·
There were no accounts receivable balances as of April 30, 2014 and 2013.
Natural Avenue Sdn. Bhd.
The Company provides Natural Avenue Sdn. Bhd. (“Natural Avenue”), an affiliate of BLM and a related party, with lottery and software products, support services and spare parts.
The financial activities and balances related to transactions with Natural Avenue were as follows:
·
Revenues of $142,000 were recognized on the sale of support services and licensing during the years ended April 30, 2014 and 2013;
·
There were deferred revenue balances of $4,000 on lottery product licensing as of April 30, 2014 and 2013; and
·
Accounts receivable balance was $11,000 as of April 30, 2014, compared to $1,000 as of April 30, 2013.
Sports Toto Computers Sdn. Bhd.
The Company engages Sports Toto Computers Sdn. Bhd. (“STC”), a related party, to provide consulting, programming and other related services to the Company.
During the years ended April 30, 2014 and 2013, the Company incurred approximately $203,000 and $196,000, respectively.
6. LEASES
On April 12, 2012, the Company entered into an amendment agreement to extend the term of its building lease to November 30, 2015. Effective December 1, 2012, the monthly base rent payment was $13,900 for the first year of the lease and the monthly base rent payments will be $14,400 and $15,000 for years two and three, respectively. The agreement also provides for one month of free rent.
Future minimum lease payments for all operating leases are as follows (in thousands):
Rent expense for all operating leases for the years ended April 30, 2014 and 2013 was $174,000 and $170,000, respectively.
7. EMPLOYEE 401(k) PLANS
The Company maintains a 401(k) plan (the “Plan”), qualified under the Internal Revenue Code, in which all eligible employees, as defined in the Internal Revenue Code, may elect to participate. Under the Plan, employees may voluntarily make tax-deferred contributions of up to 15% of their compensation to a trust, which provides the participant with various investment alternatives. In addition, for each fiscal year, the Company, at the discretion of the Board of Directors, may contribute an amount of Company stock with a fair market value that does not exceed 5% of the annual compensation of all participants in the Plan. The Company made no contributions during the years ended April 30, 2014 or 2013. The Company also maintains another 401(k) plan in which long-tenured employees maintain accounts; however, the Company and its employees are no longer contributing to this plan.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company’s material financial instruments consist of its cash and cash equivalents, certificates of deposit, accounts receivable, accounts payable and related party payables. The carrying amounts of the Company’s financial instruments generally approximated their fair values at April 30, 2014 and 2013 due to the short-term maturity of the instruments.
9. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued an update to ASC 606, Revenue from Contracts with Customers. This update to ASC 606 provides a five-step process to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue upon transfer of promised goods or services to customers in an amount that reflects the expected consideration to be received in exchange for those goods or services. This update to ASC 606 will also result in enhanced disclosures about revenue, providing guidance for transactions that were not previously addressed comprehensively, and improving guidance for multiple-element arrangements. This update to ASC 606 is effective for the Company beginning in fiscal 2018. The company is currently evaluating the impact of this update on its consolidated financial statements.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A.
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 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 Principal Executive Officer, who is also Principal 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 Principal Executive Officer, who is also our Principal 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) and 15d-15 (e)) as of the end of the period covered by this report. Based on the foregoing, our Principal Executive Officer (and Principal Financial Officer) concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and (ii) accumulated and communicated to management, including the Principal Executive Officer (and Principal Financial Officer), as appropriate, to allow timely decisions regarding required disclosure.
MANAGEMENT’S REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining an adequate system of internal controls over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”).
Our internal controls over financial reporting include those policies and procedures that:
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of our assets;
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of our business are being made only in accordance with authorizations of our management and directors; and
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Management has conducted, with the involvement of our Principal Executive Officer (and Principal Financial Officer), and our Director of Corporate Affairs, an assessment, including testing of the effectiveness of our internal controls over financial reporting as of April 30, 2014. Management’s assessment of internal controls over financial reporting was based on the framework in Internal Control over Financial Reporting - Guidance for Smaller Public Companies (2006) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that our system of internal controls over financial reporting was effective as of April 30, 2014.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
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 April 30, 2014 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors of the Registrant
The Board presently consists of the following six directors: Theodore A. Johnson, Chan Kien Sing, Martin J. O’Meara, Jr., Alain K. Lee, Ooi Lee Meng and Rayvin Yeong Sheik Tan. There is one vacant board seat as of the date of this report. The current directors will serve until their respective successors have been duly elected and qualified.
Theodore A. Johnson, 74, has been Chairman of the Board since 1994. He is also Chairman of the Executive Committee, Audit Committee and a member of the Executive Compensation Committee, Nominating Committee and Affiliations Committee. Mr. Johnson served as Director from 1979 to 1993. He has been President and Chief Executive Officer of TJ Ventures, Inc., a venture capital consulting company since 1992. Mr. Johnson also holds directorships in other private corporations, including an applied research organization which is run by the University of Minnesota.
Chan Kien Sing, 58, has been Director since 1993. He is Chairman of the Executive Compensation Committee and Nominating Committee. In addition, Mr. Chan is a member of the Executive Committee. He also serves as Director of Berjaya Group Berhad, a Malaysian holding company since July 1993. In addition, he is an Executive Director of Berjaya Corporation Berhad and Berjaya Sports Toto Berhad, a Director of Berjaya Lottery Management H.K. Limited (“BLM”) and holds directorships in several other subsidiaries in the Berjaya Corporation group of companies.
Martin J. O’Meara, Jr., 85, has been Director since 1979. He is Chairman of the Affiliations Committee and a member of the Audit Committee. Mr. O’Meara, Jr. is presently a retired businessman. Previously he served as President of The Budget Plan, Inc., a privately owned company engaged in the consumer loan business for over five years.
Alain K. Lee, 57, has been Director since 1999. He is a member of the Executive Compensation Committee and Audit Committee. Presently, Mr. Lee serves as a business consultant since 2007. He served as Executive Vice President and Director of Roadhouse Grill, Inc. from 1998 to 2007. He has previously served as a member of the Executive Committee of the Company.
Ooi Lee Meng, 53, has been Director since January 2006. He is a member of the Executive Committee and Nominating Committee. Mr. Ooi holds a directorship in Berjaya-ILTS Ltd. He serves as Senior General Manager (Business Development) of Sports Toto Malaysia Sdn Bhd, a related company of ILTS, since October 2005. Previously he served as Executive Vice President of ILTS from September 2002 to April 2005.
Rayvin Yeong Sheik Tan, 34, became Director of the Company on July 15, 2008. He serves as an Executive Director of the Board of Berjaya Corporation Berhad, a diversified business entity based in Kuala Lumpur, Malaysia, since September 2005. Mr. Tan joined the Berjaya Group of Companies in May 2001 as Senior Manager (Corporate Affairs) of Kota Raya Development Sdn Bhd and Noble Circle Management Sdn Bhd. In addition, he is Chairman of Berjaya Sanhe Real Estate Development Co. Ltd. and Berjaya (China) Great Mall Co. Ltd. He is also a Director of Berjaya Lottery Management (HK) Limited.
Director Nomination Process
In evaluating director nominees, our nominating and governance committee considers, among others, the following factors: integrity, independence, diversity of viewpoints and backgrounds, extent of experience, length of service, number of other board and committee memberships, leadership qualities and ability to exercise sound judgment.
Director Qualifications
In addition to the information above regarding each director’s business experience and service on the boards of directors of other companies, our board of directors considered the following experience, qualifications or skills of each of the directors in concluding that each director is qualified to serve on our board. The information below is not intended to be an exhaustive list of the qualifications that the board of directors considered with respect to the directors.
Mr. Johnson has a broad background in managing and serving on the boards of directors of small companies. He has served as Chairman and CEO of another public company in the past and has served on the boards of directors of over 20 companies and venture capital funds. In addition, when he ran a venture capital operation, he was involved in the structuring, managing and financing of over 46 companies during a 20-year period. He is currently CEO and President of TJ Ventures, Inc. which provides consulting services to a variety of early stage companies. Presently, he is on the board of directors of one private company and an applied research organization run by the University of Minnesota.
Mr. Chan has significant business experience with leadership of strategic business groups as senior executive of various public companies in Malaysia. He also has in-depth knowledge of accounting and financial issues related to public companies due to his previous experience as an auditor of public companies. He brings his specialized knowledge of merchant banking and corporate finance to our board and has outside board experience at several subsidiary companies related to ILTS’s parent company. He also has affiliation with the Risk Management Committee of Berjaya Corporation Berhad, a diversified public corporation based in Kuala Lumpur, Malaysia.
Mr. O’Meara, Jr. brings to our board his profound business experience in serving as President of The Budget Plan and Owner and Director of Connecticut Yankee Greyhound Park and New England Harness Raceway. In addition, he has specialized and extensive knowledge and experience in the consumer loan business and automobile dealerships. During his 50-year career in financing business, Mr. O'Meara, Jr. has dealt extensively with purchase agreements, commercial and residential real estate mortgages, unsecured and secured loans.
Mr. Lee has extensive business and leadership experience in an executive and management capacity in both private and public companies including most recently serving as Executive Vice President and Director of Roadhouse Grill, Inc. He is a certified and chartered accountant from the United Kingdom. He brings financial and accounting expertise to our board due to his previous training and experience with big 4 public accounting practices and as a financial executive in both private and public companies.
Mr. Ooi has significant business development and leadership experience in the lottery and related gaming industries in serving as senior executive of ILTS and other related companies. In addition to the in-depth knowledge of finance and accounting due to his educational training and previous experience as an auditor of public companies in the United Kingdom, Mr. Ooi has outside board experience at several subsidiary companies related to ILTS’s parent company.
Mr. Tan has extensive experience in the field of research covering the various sectors of property, commodities, telecommunications and transport. He brings finance and accounting expertise to our board due to his education at the London School of Economics, United Kingdom. In addition to his outside board experience and global business experience in other public and private corporations in Malaysia, Hong Kong, Canada and the U.S., Mr. Tan served as a member of the Risk Management Committee of Berjaya Corporation Berhad, a diversified public corporation based in Kuala Lumpur, Malaysia.
Leadership Structure
The chairman of our board of directors and the president of our company serve different functions. Our board of directors has determined that its leadership structure is appropriate and effective for the size of our company. Our board of directors believes that having the chairman and president serve separate functions provides clear leadership, accountability and promotes strategic development and execution as our company executes our strategy and objectives. Our board of directors and the nominating committee also believe that there is a high degree of transparency among directors and company management. Three of the six members of our board are independent directors and all of those individuals serve on the committees of our board of directors.
Risk Oversight
Our board of directors is responsible for consideration and oversight of the risks facing the Company and its subsidiary. Our board of directors regularly reviews information provided by management in order to ensure that material risks are identified and managed appropriately. Our board considers, as appropriate, risks among other factors in reviewing our strategy, business plan, budgets and major transactions. Our board committees assist the full board of directors’ oversight of our material risks by focusing on risks related to the particular area of concentration of the relevant committee. For example, the compensation committee oversees risks related to our executive compensation plans and arrangements, the audit committee oversees financial reporting and control risks and the nominating committee oversees risks associated with the independence of our board of directors and potential conflicts of interest, the affiliations committee oversees related party activities to ensure fair and equitable pricing strategies. The full board of directors incorporates the insight provided by these reports into its overall risk oversight analysis.
Board Diversity
Although the nominating committee may consider whether nominees assist in achieving a mix of board members that represents a diversity of background and experience, which is not only limited to race, gender or national origin, we have no formal policy regarding board diversity.
Executive Officer of the Registrant
Jeffrey M. Johnson, 53, was appointed as President effective January 2007 and has been the Acting Chief Financial Officer since October 2011. He served as Director of Technical Operations and held various positions in the Technical Operations capacity at ILTS for over 20 years.
There are no family relationships among members of our executive officers or our Board of Directors.
Audit Committee and Audit Committee Financial Expert
The Board of Directors has an Audit Committee consisting of Messrs. Johnson, O’Meara, Jr. and Lee. The Audit Committee held four meetings during the year.
The responsibilities of the Audit Committee include the appointment, compensation, retention and oversight of any independent registered public accounting firm engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services. The Committee reviews with such auditors the periodic SEC filings, the scope and result of their audit and the result of the auditors’ evaluation of internal controls. During fiscal years 2014 and 2013, all services were pre-approved by the Audit Committee. The Chairman of the Audit Committee reviews and approves all engagement services provided by the Company’s Independent Registered Public Accounting Firm.
The Board of Directors has determined that the Audit Committee does not have an “audit committee financial expert” as defined under the applicable SEC rules and regulations because none of the current members of the Audit Committee meet the criteria required for an audit committee financial expert.
Other Committees
The Board of Directors has an Executive Compensation Committee, Executive Committee, Nominating Committee and Affiliations Committee.
Shareholder Communications
The Company has a procedure by which shareholders can communicate with the Board members. Shareholders may communicate with the Board by writing to the Chairman of the Board or individual Board members as follows: International Lottery & Totalizator Systems, Inc., Attention: Corporate Secretary, 2310 Cousteau Court, Vista, CA 92081. The Corporate Secretary will forward any shareholder communications as requested by the shareholder.
Code of Ethics
The Company has adopted an amended and restated Code of Conduct and Ethics that applies to all of its employees, officers, directors and consultants.
Shareholders may obtain a copy of the Code of Conduct and Ethics by writing to the Company: International Lottery & Totalizator Systems, Inc., Attention: Corporate Secretary, 2310 Cousteau Court, Vista, CA 92081.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires our officers and directors, and persons who own more than 10% of a registered class of our equity securities, to file reports of ownership and changes in ownership of our equity securities with the SEC. Officers, directors and greater than 10% shareholders are required by the SEC regulations to furnish us with copies of all Section 16(a) filings. Based solely on our review of the Section 16(a) filings, we believe that all required Section 16(a) reports were timely filed during our most recent fiscal year.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The following table sets forth, for the fiscal years ended April 30, 2014 and 2013, the compensation earned by the principal executive officer, the principal financial officer of the Company, and one other individual earning in excess of $100,000 during such years (the “Named Executive Officers”).
Summary Compensation Table
There were no Company matching contributions to the Named Executive Officers from the 401(k) plan or other Long Term Compensation Awards during the fiscal years 2014 and 2013.
There were no stock options or stock appreciation rights granted to the Named Executive Officers during the fiscal years 2014 and 2013.
Options Exercised During Fiscal Year Ended April 30, 2014
Outstanding Equity Awards as of April 30, 2014
The Company does not have any employment agreements or change in control arrangements with its executive officers.
During the fiscal year ended April 30, 2014, independent Directors received an annual retainer fee of $4,000 and a fee of $750 for each Board meeting attended. In addition, each committee’s Chairman received an annual retainer of $1,000 for services as Chairman of such committee. Directors who were employees of the affiliates of ILTS’ Parent company, BLM, opted not to receive director remuneration and meeting fees for the year ended April 30, 2014. All Directors are reimbursed for reasonable out-of-pocket expenses incurred for travel and attendance for Board meetings.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information regarding the beneficial ownership of the Company’s common shares as of April 30, 2014 by:
i.
each director;
ii.
each executive officer;
iii.
the executive officers and directors of the Company as a group; and
iv.
each person or entity who is a beneficial owner of more than 5% of the Company’s outstanding common shares.
Beneficial ownership of securities is defined in accordance with the rules of the Securities and Exchange Commission and means generally the power to vote or exercise investment discretion with respect to securities, regardless of any economic interests therein. Except as otherwise indicated, the Company believes that the beneficial owners of the securities listed below have sole investment and voting power with respect to such shares, subject to community property laws where applicable.
(a)
Employees of affiliates of BLM. All three individuals disclaim beneficial ownership of such shares.
BLM’s correspondence address is:
Level 12 (East Wing)
Berjaya Times Square
No.1, Jalan Imbi
55100 Kuala Lumpur, Malaysia.
* Less than one percent of the outstanding common shares.
Securities Authorized for Issuance under Equity Compensation Plans
The Company does not currently have any securities authorized for issuance under an equity compensation plan. See the discussion under the heading “Securities Authorized for Issuance under Equity Compensation Plans” in Item 5 of page 17 of this report which is hereby incorporated by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
During the fiscal years ended April 30, 2014 and 2013, the Company derived revenues from sales of products and services under agreements with four related parties which totaled approximately $11.9 million (52% of total revenue) and $4.2 million (40% of total revenue), respectively. The Company also had outstanding accounts receivable at April 30, 2014 and 2013 of $11,000 and $411,000, respectively, from these related customers. A more detailed description of the transactions with the Company’s related parties in the years ended April 30, 2014 and 2013 are presented in Note 5 entitled “RELATED PARTY TRANSACTIONS” in our Consolidated Financial Statements beginning on page 39 of this report.
Parent Company
As of April 30, 2014, Berjaya Lottery Management (H.K.) Ltd. (“BLM”) owned 71.3% of the total outstanding shares of the Company, and is the Parent company of the Company.
Director Independence
The Board has determined that the following directors are not considered to be independent directors under the NASDAQ listing standards: Chan Kien Sing, Ooi Lee Meng and Rayvin Yeong Sheik Tan. The Board has determined that the following directors are independent directors under the NASDAQ listing standards: Theodore A. Johnson, Martin J. O’Meara, Jr. and Alain K. Lee.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the approximate aggregate fees billed for each of the last two fiscal years for professional services rendered by our principal accountant. CohnReznick LLP was the principal accountant for the years ended April 30, 2014 and 2013.
(a) Audit Related Fees in the amount of $3,927 and $5,918 in fiscal 2014 and 2013, respectively, primarily related to the review of the financial information requested by the Parent company’s principal accountant.
(b) The fee in the amount of $13,050 in fiscal 2013 was related to professional services rendered for tax compliance.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
A. Exhibits
(3) (a) Articles of Incorporation, as amended September 13, 1994, reflecting corporate name change, and as amended January 7, 1998, reflecting authorization for 20 million shares of preferred stock and By-laws (incorporated by reference to Form 10-KSB for the year ended December 31, 1994, File No. 0-10294).
(b) Articles of Incorporation as amended June 2, 1998 (incorporated by reference to Form 10-KSB for the year ended December 31, 1998, File No. 0-10294).
(c) A By-law Amendment effective June 2, 1998, relating to officers and directors indemnification and number of directors (incorporated by reference to Form 10-KSB for the year ended December 31, 1998, File No. 0-10294).
(d) Stock Purchase Agreement dated as of September 8, 1999 between ILTS and BLM which increased Berjaya's stock ownership from 38.5% to 71.3% (incorporated by reference from ILTS's Form 8-K filed on October 18, 1999).
(14) The Company’s Amended and Restated Code of Conduct and Ethics (incorporated by reference to Form 10-KSB for the year ended April 30, 2009, File No. 0-10294).
(21) * Subsidiary of the Registrant
(31) * Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32) * Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed as an exhibit to this report
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
By: /s/ Jeffrey M. Johnson
Jeffrey M. Johnson
President (Principal Executive Officer) and Acting Chief Financial Officer (Principal Financial Officer)
Dated: July 11, 2014
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Theodore A. Johnson
Theodore A. Johnson
Chairman of the Board
July 11, 2014
/s/ Martin J. O’Meara, Jr.
Martin J. O’Meara, Jr.
Director
July 11, 2014
/s/ Chan Kien Sing
Chan Kien Sing
Director
July 11, 2014
/s/ Alain K. Lee
Alain K. Lee
Director
July 11, 2014
/s/ Ooi Lee Meng
Ooi Lee Meng
Director
July 11, 2014
/s/ Rayvin Yeong Sheik Tan
Rayvin Yeong Sheik Tan
Director
July 11, 2014
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
EXHIBIT 21
SUBSIDIARY OF ILTS JURISDICTION OF INCORPORATION
Unisyn Voting Solutions, Inc. .......................................................... California, U.S.
2310 Cousteau Court
Vista, CA 92081-8346