UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549





FORM
      10-QSB





x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934





For
      the
      quarterly period ended December 31, 2006




o
              TRANSITION
                  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT





For
      the
      transition period from _______ to
      ______________


Commission
      file number 0-21831




Interactive
      Systems Worldwide Inc.


(Exact
      name of Small Business Issuer as specified in its charter)





Delaware
            22-3375134(State
                or other jurisdiction of incorporation or organization)
            (IRS
                Employer Identification No.)





2
      Andrews Drive, West Paterson, NJ 07424


(Address
      of principal executive offices)





(973)
      256-8181


(Issuer's
      telephone number, including area code)





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirement for the past 90 days.


Yes x No o




Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange
        Act)
 Yes o No x





There
      were 12,202,738 shares of Common Stock outstanding at February 7,
      2007.




Transitional
      Small Business Disclosure Format (Check one):


Yes o No x





Interactive
      Systems Worldwide Inc.


December
      31, 2006


FORM
      10-QSB





IndexPagePart
                I:
            
            Financial
                InformationItem
                1.
            
            Financial
                Statements,Condensed
                Consolidated Balance Sheets at December 31, 2006 (Unaudited) and
                September
                30, 2006
            
            2Condensed
                Consolidated Statements of Operations for the Three Months Ended
                December
                31, 2006 and 2005 (Unaudited)
            
            3Condensed
                Consolidated Statement of Stockholders’ Equity for the Three Months Ended
                December 31, 2006 (Unaudited)
            
            4Condensed
                Consolidated Statements of Cash Flows for the Three Months Ended
                December
                31, 2006 and 2005 (Unaudited)
            
            5Notes
                to Condensed Consolidated Financial Statements (Unaudited)
            
            6-11Item
                2.
            
            Management’s
                Discussion and Analysis or Plan of Operations
            
            12-19Item
                3.
            
            Controls
                and Procedures
            
            20Part
                II:
            
            Other
                Information
            
            20Item
                2.
            
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            20Item
                5.
            
            Other
                Information
            
            20Item
                6.
            
            Exhibits
            
            21Signatures
            
            
            
            22








Part
      I:
      Financial Information





Item
      1.
      Financial Statements





Interactive
      Systems Worldwide Inc.


Condensed
      Consolidated Balance Sheets





(Amounts
      in thousands except share data)




December
                      31,
                    2006
                    (Unaudited)
                
                September
                      30,
                    2006
                    Note
                      1Current
                    assets:Cash
                    and cash equivalents
                
                $
                739
                
                $
                1,207Accounts
                    receivable
                
                
                26
                
                
                46Investments
                    in marketable securities
                
                
                500
                
                
                975Other
                    receivables
                
                
                44
                
                
                57Prepaid
                    expenses and other current assets
                
                
                215
                
                
                138Total
                    current assets
                
                
                1,524
                
                
                2,423Property
                    and equipment, net
                
                
                10
                
                
                16Capitalized
                    software, net of accumulated amortization of $985 and $957,
                    respectively
                
                
                489
                
                
                428Other
                    assets
                
                
                320
                
                
                305Total
                    assets
                
                $
                2,343
                
                $
                3,172


Liabilities
                  and Stockholders' EquityCurrent
                  liabilities:Accounts
                  payable
              
              $
              382
              
              $
              205Accrued
                  expenses and other
              
              
              765
              
              
              794Total current liabilities
              
              
              1,147
              
              
              999Stockholders'
                  Equity:Preferred
                  stock, par value $.001 per share; 2,000,000 shares authorized,60,000
                  Series A outstanding 3,742 and 4,000 Series C outstanding, respectively,
                  with a liquidation preference of $3,742 and $4,000,
                  respectively
              
              
              –
              
              
              –Common
                  stock par value $.001 per share; 20,000,000 shares authorized;12,414,755
                  and 12,296,173 issued, respectively
              
              
              12
              
              
              12Additional
                  paid-in capital
              
              
              28,325
              
              
              28,142Treasury
                  stock, at cost, 242,000 common shares
              
              
              (441
              )
              
              (441
              )Accumulated
                  other comprehensive (loss) income
              
              
              (55
              )
              
              34Accumulated
                  deficit
              
              
              (26,645
              )
              
              (25,574
              )Total stockholders' equity
              
              
              1,196
              
              
              2,173Total
                  liabilities and stockholders' equity
              
              $
              2,343
              
              $
              3,172




See
      accompanying notes to condensed consolidated financial
      statements


2


Interactive
      Systems Worldwide Inc.


Condensed
      Consolidated Statements of Operations


(Unaudited)





(Amounts
      in thousands except share and per share data)





Three
                  Months Ended
                  December
                    31,2006
            
            2005Revenues
            
            $
            55
            
            $
            30Costs
                and expenses:Cost
                of revenues
            
            
            126
            
            
            168Research
                and development expense
            
            
            111
            
            
            269General
                and administrative expense
            
            
            860
            
            
            7811,097
            
            
            1,218Operating
                loss
            
            
            (1,042
            )
            
            (1,188
            )Interest
                (income) expense, net
            
            
            (21
            )
            
            49Other
                income
            
            
            –
            
            
            (1
            )Net
                loss
            
            
            (1,021
            )
            
            (1,236
            )Preferred
                Stock dividends
            
            
            (67
            )
            
            (67
            )Net
                loss applicable to common stock
            
            $
            (1,088
            )
            $
            (1,303
            )Net
                loss per share applicable to common stock - basic and
                diluted
            
            $
            (0.09
            )
            $
            (0.11
            )Weighted
                average basic and diluted common shares outstanding
            
            
            12,119,290
            
            
            11,658,479





See
      accompanying notes to condensed consolidated financial statements




3


Interactive
      Systems Worldwide Inc.


Condensed
      Consolidated Statement of Stockholders’ Equity


For
      the
      Three Months Ended December 31, 2006


(Unaudited)





(Amounts
      in thousands except number of shares)





AccumulatedAdditional
            
            
            
            OtherPreferred
                stock
            
            Common
                stock
            
            Paid-In
            
            Treasury
            
            Comprehensive
            
            AccumulatedShares
            
            Amount
            
            Shares
            
            Amount
            
            Capital
            
            Stock
            
            (Loss)
                Income
            
            Deficit
            
            TotalBalance
                atSeptember
                30, 2006
            
            
            64,000
            
            $
            –
            
            
            12,296,173
            
            $
            12
            
            $
            28,142
            
            $
            (441
            )
            $
            34
            
            $
            (25,574
            )
            $
            2,173Cumulative
                effect of change in accounting for registration rights
                liability
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            27
            
            
            27Dividends
                on Series C Preferred Stock
            
            
            –
            
            
            –
            
            
            49,782
            
            
            –
            
            
            77
            
            
            –
            
            
            –
            
            
            (77
            )
            
            –Issuance
                of common stock through conversion of Series C Preferred
                Stock
            
            
            (258
            )
            
            –
            
            
            68,800
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –Issuance
                of common stock to consultant
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            42
            
            
            –
            
            
            –
            
            
            –
            
            
            42Compensation
                cost associated with stock options and warrants
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            64
            
            
            –
            
            
            –
            
            
            –
            
            
            64Net
                loss
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            (1,021
            )
            
            (1,021
            )Foreign
                currency translation loss
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            –
            
            
            (89
            )
            
            –
            
            
            (89
            )Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,110
            )Balance
                atDecember
                31, 2006
            
            
            63,742
            
            $
            –
            
            
            12,414,755
            
            $
            12
            
            $
            28,325
            
            $
            (441
            )
            $
            (55
            )
            $
            (26,645
            )
            $
            1,196





See
      accompanying notes to condensed consolidated financial
      statements


4


Interactive
      Systems Worldwide Inc.


Condensed
      Consolidated Statements of Cash Flows


(Unaudited)


(Amounts
      in thousands)





Three
                Months EndedDecember
                31,2006
            
            2005Cash
                flows from operating activities:Net
                loss
            
            $
            (1,021
            )
            $
            (1,236
            )Adjustments
                to reconcile net lossto
                net cash used in operating activities:Depreciation
                  and amortization
            
            
            35
            
            
            110Non-cash
                interest expense
            
            
            –
            
            
            84Non-cash
                common stock, option and warrant charges
            
            
            106
            
            
            47Non-cash
                amortization of debt issuance costs
            
            
            –
            
            
            21Non-cash
                other income
            
            
            –
            
            
            (1
            )Changes
                in assets and liabilities:Accounts
                receivable
            
            
            20
            
            
            37Other
                receivables
            
            
            13
            
            
            (23
            )Prepaid
                expenses and other current assets
            
            
            (77
            )
            
            (85
            )Other
                assets
            
            
            (15
            )
            
            –Accounts
                payable
            
            
            177
            
            
            5Accrued
                expenses
            
            
            (29
            )
            
            (27
            )Netcash used in operating activities
            
            
            (791
            )
            
            (1,068
            )Cash
                flows from investing activities:Purchase
                of investments
            
            
            –
            
            
            (500
            )Proceeds
                from sales of investments
            
            
            475
            
            
            285Purchase
                of property and equipment
            
            
            (9
            )
            
            (1
            )Capitalized
                software
            
            
            (89
            )
            
            –Net
                cash provided by (used by) investing activities
            
            
            377
            
            
            (216
            )Net
                decrease in cash and cash equivalents
            
            
            (414
            )
            
            (1,284
            )Effect
                of exchange rate on cash
            
            
            (54
            )
            
            (8
            )Cash
                and cash equivalents, beginning of period
            
            
            1,207
            
            
            5,655Cash
                and cash equivalents, end of period
            
            $
            739
            
            $
            4,363Non-cash
                investing and financing activity:Issuance
                of common stock in relation to principal payments on Debentures
            
            $
            –
            
            $
            188Issuance
                of common stock in relation to dividend paymentson
                Series B and Series C Preferred Stock
            
            $
            77
            
            $
            43





See
      accompanying notes to condensed consolidated financial
      statements


5


Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)




Note
      l
      - Basis of Presentation:





The
      information at December 31, 2006 and for the three months ended December 31,
      2006 and 2005, is unaudited, but includes all adjustments (consisting only
      of
      normal recurring adjustments) which in the opinion of management, are necessary
      to present fairly the financial information set forth therein in accordance
      with
      accounting principles generally accepted in the United States of America. The
      interim results are not necessarily indicative of results to be expected for
      the
      full fiscal year period. Certain information and footnote disclosures have
      been
      omitted pursuant to rules and regulations published by the Securities and
      Exchange Commission (“SEC”), although the Company believes that the disclosures
      that are made are adequate to make the information presented not misleading.
      The
      consolidated financial statements include the accounts of Interactive Systems
      Worldwide Inc. and its wholly owned subsidiaries, ISW Acquisition Co., LLC
      and
      Global Interactive Gaming Limited (“GIG”) (collectively the “Company”). All
      significant intercompany balances and transactions have been eliminated. Certain
      amounts in the prior years’ financial statements have been reclassified to
      conform to the current year presentation. These condensed consolidated financial
      statements should be read in conjunction with the audited financial statements
      for the year ended September 30, 2006 included in the Company’s Annual Report on
      Form 10-KSB filed with the SEC.




The
      Company's revenue during the three months ended December 31, 2006 and 2005
      consisted of license fees and service charges from agreements with companies
      located in the United Kingdom, Gibraltar and Mexico. Revenue consists primarily
      of license fees, technical assistance fees and service charges calculated based
      on a percentage share of the net wagering revenue after payment of winnings
      and
      taxes. Revenue may be reduced for certain pool imbalance risks that arise from
      being a part of the house. The Company recognizes revenue as it is earned
      according to the terms of the related agreement.





Note
      2
      - Basis of Preparation:





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. The Company has incurred net losses and used
      cash in its operating activities during the quarter ended December 31, 2006
      and
      the years ended September 30, 2006 and 2005. In addition, the Company requires
      additional financing to meet its forecasted cash requirements and continue
      operations during fiscal 2007. These events and conditions raise substantial
      doubt about the Company’s ability to continue as a going concern. Management has
      developed and is attempting to implement a plan to address these issues and
      allow the Company to continue as a going concern through at least the fiscal
      year ending September 30, 2007. The plan includes (i) a program to reduce costs,
      (ii) seeking equity financing and (iii) pursuing other strategic
      transactions. There is no assurance, however, that the Company will be able
      to
      raise equity financing or execute a strategic transaction on commercially
      reasonable terms, if at all, or that the Company will be able to meet its future
      contractual obligations.


6


Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)





Note
      2
      - Basis of Preparation (continued):





The
      Company’s ability to continue as a going concern is contingent upon obtaining
      adequate financing to meet its funding requirements and ultimately generating
      sufficient revenue and achieving profitability. The financial statements do
      not
      include any adjustments that might result from the outcome of this uncertainty.





Note
      3
      - Private Placements:





On
      August
      3, 2005, the Company entered into a financing agreement relating to a $4.0
      million private placement with institutional investors consisting of
      4,000 shares of the Company’s newly issued Series C Convertible Preferred Stock
      (“Series C”). Series C has


a
      stated
      value of $1,000 per share, is non-voting and is initially convertible into
      the
      Company’s Common Stock at $3.75 per share, subject to adjustment. The investors
      also received warrants that expire in August 2010 to purchase 557,103 shares
      of
      Common Stock at $3.95 per share, subject to adjustment which were valued at
      $929,000 using the Black-Scholes option pricing model. Net proceeds from the
      financing after costs and expenses were approximately $3.7 million.





The
      Series C is initially convertible into an aggregate of 1,066,667 shares of
      Common Stock. In connection with the issuance of the Series C, the Company
      recorded a dividend to Series C shareholders of $777,000 representing the
      beneficial conversion feature resulting from the difference between the
      effective conversion price and the quoted market price of the Company’s Common
      Stock at the date of issuance. In addition, holders of Series C are entitled
      to
      receive a cumulative 6% annual dividend, payable quarterly in cash or, subject
      to certain conditions, shares of Common Stock at the Company’s option. During
      the three months ended December 31, 2006, a holder of the Series C converted
      258
      shares of Series C into 68,800 shares of Common Stock and there are currently
      3,742 remaining Series C outstanding. As of December 31, 2006, unpaid cumulative
      dividends on the Series C amounted to $56,000. A placement agent in this
      transaction received a cash fee of $120,000 and warrants to purchase 65,753
      shares of the Company’s Common Stock expiring in August 2010 which are
      exercisable at $4.38 per share. The warrants were valued at $132,000 using
      the
      Black-Scholes option pricing model.





Under
      the
      terms of the private placement, and subject to certain conditions, the Company
      has the right to force conversion of all or a portion of the Series C into
      Common Stock. The Series C also provides that if certain events (all of which
      are within the control of the Company) occur such holder would have the right
      to
      require the Company to redeem the Series C for cash. Upon the occurrence of
      certain other events, each holder of Series C would have the right to require
      the Company to redeem the Series C for the Company’s Common Stock or increase
      the dividend on the Series C to 12% per annum. In addition, the Series C
      investor warrants and placement agent warrants are subject to certain anti-dilution
      protection. The Series C contains certain negative covenants including
      limitations with respect to borrowings and prohibition on payment by the Company
      of dividends and distributions on Common Stock.


7


Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)


Note
        3
        - Private Placements (continued):




Registration
      rights agreements were entered into in connection with private placements which
      required the Company to file registration statements for the resale of the
      common shares issuable upon conversion of debentures and Series B Preferred
      Stock (all of which have been converted or repaid) and Series C Preferred Stock
      and upon the exercise of warrants issued in connection with the private
      placements and to use commercially reasonable efforts to have the registration
      statements declared effective by the end of a specified grace period. In
      addition, the Company is required to use commercially reasonable efforts to
      maintain the effectiveness of the registration statements until all such common
      shares have been sold or may be sold without volume restrictions pursuant to
      Rule 144(k) of the Securities Act. If the Company fails to have the registration
      statement declared effective within the grace period or if effectiveness is
      not
      maintained, the agreements require cash payments of liquidated damages by the
      Company to the investors of 2.0% per month or 1.5% per month of the amounts
      invested by the investors until the failure is cured with no limitation on
      the
      maximum liquidated damages. Registration statements were filed and declared
      effective within the specified periods with respect to the three private
      placements. See Note 5 - Accounting Change regarding a change in accounting
      principle associated with the liquidated damages provisions of these
      registration rights agreements.




Note
      4
      - Preferred Stock:




The
      designations, rights, and preferences of the Company's Preferred Stock are
      to be
      determined by the Board of Directors at the time of issuance. In connection
      with
      the acquisition of GIG, the Company issued 60,000 shares of a new class of
      Series A Preferred Stock ("Series A"). Each share of Series A has
      one vote, is convertible through July 31, 2009 into 10 shares of the
      Company’s Common Stock at $15 per common share on a cashless basis and is
      redeemable by the Company on such date for nominal consideration if not
      previously converted into Common Stock. The holder of Series A is entitled
      to a non-cumulative dividend of 6% per annum if and when declared by the Board
      of Directors. Series A has no liquidation preference. See Note 3 - Private
      Placements regarding the Company’s Series C Preferred Stock.




8





Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)





Note
      5
      - Accounting Change:





As
      described in Note 3 - Private Placements, registration rights agreements were
      entered into in connection with three of the Company’s private placements. Prior
      to October 1, 2006, the Company accounted for the registration rights agreements
      as a separate free-standing instrument and accounted for the liquidated damages
      provision as a derivative liability subject to SFAS 133, “Accounting for
      Derivative Instruments and Hedging Activities.” Accordingly, the liability was
      recorded at estimated fair value based on an estimate of the probability and
      costs of cash penalties being incurred and is revalued at each balance sheet
      date with changes in value recorded in other income. As of September 30, 2006,
      the liability amounted to $27,000 and was included in accrued expenses.





In
      December 2006, FASB Staff Position EITF 00-19-2 was issued which specified
      that
      the contingent obligation to make future payments under a registration payment
      arrangement should be separately recognized and measured in accordance with
      SFAS
      5, “Accounting for Contingencies” which states that a liability is recorded if
      the obligation is probable and can be reasonably estimated. In addition, SFAS
      133 was amended to exclude registration payment arrangements from its scope.
      As
      of December 31, 2006, as the obligation was not considered probable, the Company
      has recorded no liability associated with these arrangements. Effective October
      1, 2006, the Company adopted EITF 00-19-2 and reported a change in accounting
      principle through a reversal of the liability and as a decrease to the opening
      balance of accumulated deficit.




Note
      6
      - Stock Options:





Activity
      related to stock option plans for the three months ended December 31, 2006
      is as
      follows:




Options
            
            Shares
            
            Weighted
                Average ExercisePrice
            
            Weighted
                Average Remaining ContractualTerm
            
            Aggregate
                IntrinsicValueOutstanding
                at October 1, 2006
            
            
            1,064,191
            
            $
            1.58Granted
            
            
            –
            
            
            N/AExercised
            
            
            –
            
            
            N/AForfeited
                or expired
            
            
            (28,000
            )
            
            2.03Outstanding
                at December 31, 2006
            
            
            1,036,191
            
            
            1.56
            
            
            4.0
            
            $
            831,096Vested
                or expected to vest
            
            
            1,010,191
            
            
            1.52
            
            
            3.9
            
            $
            831,096Exercisable
                at December 31, 2006
            
            
            876,191
            
            
            1.39
            
            
            3.1
            
            $
            831,096




9





Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)





Note
      6
      -Stock Options (continued):





On
      October 1, 2005, the Company adopted SFAS 123(R) and began recognizing
      compensation expense for the fair value of employee stock options over the
      applicable vesting period. The fair value of the stock options granted is
      estimated at grant date using the Black-Scholes option pricing model. SFAS
      123(R) applies to new awards and to awards modified, repurchased, or cancelled
      after the required effective date, as well as to the unvested portion of awards
      outstanding as of the adoption date. During the three months ended December
      31,
      2006 and 2005, the Company recognized compensation expense of $21,000 and
      $44,000, respectively, which was charged to general and administrative expense
      as a result of implementing SFAS 123(R).





As
      of
      December 31, 2006, there was $216,000 of total unrecognized compensation cost
      related to nonvested options granted under the Plans. That cost is expected
      to
      be recognized over a weighted-average period of 2 years. During the quarter
      ended December 31, 2005, the Company effectively extended the contractual life
      of 90,691 fully vested share options held by an officer by canceling existing
      options and replacing them with new options at the same exercise price. As
      a
      result of that modification, the Company recognized additional compensation
      expense of $4,000 for the three months ended December 31, 2005, measured as
      the
      excess of the fair value of the new options over the fair value of the cancelled
      options as of the cancellation date.





The
      Company accounts for equity awards issued as compensation to non-employees
      at
      fair value as measured on the date that vesting occurs or performance is
      complete. During the three months ended December 31, 2006 and 2005, the Company
      recognized compensation expense of $84,000 and $3,000, respectively, which
      was
      charged to general and administrative expense in relation to options, warrants
      and common stock issued to non-employees.




10


Interactive
      Systems Worldwide Inc.


Notes
      To
      Condensed Consolidated Financial Statements


(Unaudited)





Note
      7
      - Basic and Diluted Net Loss per Share:





Basic
      and
      diluted net loss per common share is presented in accordance with SFAS 128,
      “Earnings Per Share”. Basic net loss per common share is computed by dividing
      net loss increased by preferred stock dividends by the weighted average number
      of common shares outstanding during the applicable reporting periods. Diluted
      net loss per share reflects the potential dilution that would occur if
      convertible debentures and preferred stock were converted and outstanding
      options and warrants were exercised and Common Stock was issued utilizing the
      treasury stock method.





The
      Company’s computation of dilutive net loss per share for the three months ended
      December 31, 2006 and 2005 does not assume any exercise of options or warrants
      to purchase 2,802,016 and 2,716,304 common shares, respectively, or the
      conversion of debentures or preferred stock to acquire 1,066,667 and 1,098,508
      common shares, respectively, as their effect is antidilutive.





Note
      8
      - Concentration of revenues:





Revenues
      from Interactive Sports Limited, a wholly-owned subsidiary of Sportingbet Plc,
      represented approximately 8% and 83% of revenues in the three months ended
      December 31, 2006 and 2005, respectively. Revenues from Hipodromo de Agua
      Caliente S.A. de C.V., represented approximately 86% and 0% of revenues in
      the
      three months ended December 31, 2006 and 2005, respectively. The Company expects
      a significant portion of its future revenues to continue to be generated by
      a
      limited number of bookmakers. The loss of any of these bookmakers or any
      substantial reduction in betting activity by any of their customers could
      materially and adversely affect the Company’s operating
      results.


11





Item
      2.
      Management‘s Discussion and Analysis or Plan of Operations




**Description
      of Business**




Interactive
      Systems Worldwide Inc. (“ISWI” or the “Company”) has designed, developed and
      patented an interactive hardware and proprietary software system (the
“SportXction ® System”)
      that enables users to wager at fixed prices during the course of a sporting
      event, such as soccer, football, baseball, basketball, golf, tennis, rugby,
      cricket and snooker, among many others. The SportXction ® System
      accepts bets not only on the outcome of a sporting event, but also on discrete
      parts of the event and on specific game situations. These include such wagers
      as
      will a team make a first down, which player will score next, will a batter
      get
      on base or will a penalty shot be successful. The SportXction ® System
      is unique in that it permits betting continuously while the game is in progress,
      or between game events, such as downs, pitches, changes in ball possession
      and
      similar situations, permitting more frequent placing and cashing of
      wagers.




On
      July
      31, 2002, ISWI, through a wholly-owned subsidiary, acquired all of the
      outstanding share capital of Global Interactive Gaming Limited (“GIG”), a
      British interactive gaming service provider which was previously ISWI’s
      exclusive licensee. GIG markets its services to interactive television carriers
      which employ satellite, cable and terrestrial programming, mobile telephone
      operators, licensed bookmakers and casinos and is located in London, England.




Since
      the
      acquisition, which transformed ISWI from a licensor to an operator of the
      SportXction ® System,
      the Company has diligently formed strategic partnerships primarily with
      bookmakers in the U.K. A factor which will be critical to our success will
      be
      the ability of the Company and its business partners to market the SportXction®
System to individuals who place wagers through the System. To achieve commercial
      success, the SportXction ® System
      must be accepted by a significant number of users.





During
      the three months ended December 31, 2006 (“Fiscal 2007”) and 2005 (“Fiscal
      2006”), the Company’s revenue primarily consisted of license fees, technical
      assistance fees and service charges from providing interactive gaming services
      using the SportXction ® System
      to business partners such as licensed bookmakers and others located in the
      United Kingdom, Gibraltar, and Mexico.





**Going
      Concern Considerations**





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. The Company has incurred recurring losses
      from
      operations during the quarter ended December 31, 2006 and the years ended
      September 30, 2006 and 2005 and has not generated positive net cash flows from
      operations. There can be no assurance that the Company will generate sufficient
      cash flows to meet its cash flow and working capital needs. The Company requires
      additional financing or the execution of a strategic transaction to continue
      operations, meet its operational goals and to pursue its long term strategy.
      Management has developed and is attempting to implement a plan to address these
      issues and allow the Company to continue as a going concern through at least
      the
      fiscal year ending September 30, 2007. The plan includes (i) a program to
      reduce costs, (ii) seeking equity financing and (iii) considering
      other strategic alternatives, including a possible merger, sale of assets or
      other business combination or restructuring transactions.


12





There
      is
      no assurance, however, that the Company will be able to raise equity financing
      or execute a strategic transaction on commercially reasonable terms, if at
      all,
      or that the Company will be able to meet its future contractual obligations.
      The
      failure to raise equity or execute a strategic transaction will negatively
      impact the Company and its growth plans and its financial condition and results
      of operations, and could force the Company to cease operations. The financial
      statements do not include any adjustments that might result from the outcome
      of
      this uncertainty.





The
      Company received a deficiency letter from NASDAQ dated January 19, 2007
      regarding the Company’s failure to satisfy the $2.5 million stockholders’ equity
      requirement for continued listing on the NASDAQ Capital Market, as required
      by
      NASDAQ Marketplace Rule 4310(c)(2)(B). The Company submitted its plan to achieve
      and sustain compliance with the NASDAQ Capital Market stockholders’ equity
      requirement to NASDAQ on February 5, 2007. However, there can be no assurance
      that the NASDAQ Staff will accept our plan of compliance and grant us additional
      time to complete it. If the NASDAQ Staff determines not to accept the plan,
      NASDAQ will provide written notification that the Company’s securities are
      subject to delisting. At that time, the Company may appeal the NASDAQ Staff’s
      decision to a NASDAQ Listing Qualifications Panel. The filing of an appeal
      would
      stay the delisting of the Company’s securities until such time as the Panel
      issues a written determination following the hearing.





**Critical
      Accounting Policies and Estimates**





The
      Company prepares its Financial Statements in conformity with accounting
      principles generally accepted in the United States of America. Certain of the
      Company’s accounting policies, including accounting for software development
      costs; depreciation, amortization of long-lived assets, including intangible
      assets; and deferred income taxes require that the Company apply significant
      judgment in defining the appropriate assumptions for calculating financial
      estimates. These estimates and judgments are subject to an inherent degree
      of
      uncertainty and are evaluated by the Company on an ongoing basis. The Company
      bases its estimates and judgments on its historical experience and other
      relevant factors, the results of which form the basis in making judgments about
      the carrying values of assets and liabilities that are not readily apparent
      from
      others sources.


13





The
      Company accounts for software development costs in accordance with Statement
      of
      Financial Accounting Standards ("SFAS") No. 86 “Computer Software To Be
      Sold, Leased, or Otherwise Marketed”. Such costs are expensed prior to a product
      or product enhancement’s achievement of technological feasibility and thereafter
      are capitalized. The Company defines a product enhancement as an improvement
      to
      an existing product that is intended to extend the life or improve significantly
      the marketability of the original product. In order to meet the requirements
      for
      capitalization, a product enhancement should involve considerable development
      resources, requires a product design and may require a redesign of all or part
      of the existing product. During Fiscal 2007, the Company capitalized $89,000
      of
      software development costs. Amortization expense, which has been computed on
      a
      straight-line basis and an estimated economic life of three years, amounted
      to
      $28,000 and $69,000 during the three months ended December 31, 2006 and 2005,
      respectively.





At
      each
      balance sheet date, the Company compares unamortized capitalized software costs
      to net realizable value on a project-by-project basis and writes off any excess
      of the unamortized cost over the net realizable value. The net realizable value
      is the estimated future gross revenues for that product or product enhancement
      reduced by the estimated future costs of completing and disposing of that
      product or product enhancement, including the costs of performing maintenance
      and support.




On October 1, 2005, the Company adopted SFAS 123(R) and began recognizing
      compensation expense for the fair value of employee stock options over the
      applicable vesting period. The fair value of the stock options granted is
      estimated at grant date using the Black-Scholes option pricing model. SFAS
      123(R) applies to new awards and to awards modified, repurchased, or cancelled
      after the required effective date, as well as to the unvested portion of awards
      outstanding as of the adoption date. During the three months ended December
      31,
      2006 and 2005, the Company recognized compensation expense of $21,000 and
      $44,000, respectively, which was charged to general and administrative expense
      as a result of implementing SFAS 123(R).




See
      Note
      3 to the Company’s Form 10-KSB for the year ended September 30, 2006 for a full
      discussion of the Company’s critical accounting policies and estimates.




**Financial
      Results**





**Three
      Months Ended December 31, 2006 and 2005**





Revenue
      for the three months ended December 31, 2006 was $55,000, as compared to $30,000
      during the same period in the prior year. The increase was due to the recent
      agreement with Hipodromo de Agua Caliente S.A. de C.V. (“Caliente”). On December
      5, 2006, the Company announced the launch of an enhanced fully-integrated
      product with Sportingbet. Subsequent to the end of the quarter, the Company
      also
      announced the launch of its enhanced product with Ladbrokes eGaming Ltd. The
      Company is encouraged by the early results and expects this enhanced product
      will result in a significant increase to revenues.




14




Cost
      of
      revenues for the three months ended December 31, 2006 was $126,000, as compared
      to $168,000 during the same period in the prior year. The decrease in Fiscal
      2007 was primarily due to lower amortization expenses associated with
      capitalized product enhancements that had become fully amortized.




Research
      and development expense for the three months ended December 31, 2006 was
      $111,000, as compared to $269,000 during the same period in the prior year.
      The
      decrease in Fiscal 2007 was primarily due to certain development costs which
      met
      the criteria for capitalization and lower payroll costs.




General
      and administrative expenses for the three months ended December 31, 2006 were
      $860,000, as compared to $781,000 during the same period in the prior year.
      The
      increase was primarily due to a provision for anticipated costs associated
      with
      GIG’s terminated office lease and increased non-cash compensation expense
      associated with warrants and common stock which were issued to consultants
      during the second half of Fiscal 2006, partially offset by lower payroll
      costs.




Interest
      income for the
      three
      months ended December 31, 2006 was
      $21,000, as compared to interest expense of $49,000 during
      the same period in the prior year .
      In
      Fiscal 2007, interest earned represents interest earned from cash and short-term
      investments. In Fiscal 2006, the Company incurred non-cash
      interest expense
      from its outstanding Debentures which was satisfied through the issuance of
      shares of Common Stock.





Other
      income for the
      three
      months ended December 31, 2005 represents the change in value of the Company’s
      liability associated with the registration rights agreements entered in
      connection with its private placements.





Net
      loss
      applicable to common shareholders and net loss per share applicable to common
      shareholders (basic and diluted) for the
      three
      months ended December 31, 2006 was
      $1,088,000 and $0.09, respectively, as compared to $1,303,000 and $0.11,
      respectively, during the same period in the prior year. The decrease was
      primarily due to lower costs and increased interest income (as described
      above).




**Liquidity
      and Capital Resources**




As
      of
      December 31, 2006, the Company had  liquid
      resources totaling $1,239,000. These include cash and cash equivalents in the
      amount of $739,000 and investments in the amount of $500,000. Investments at
      December 31, 2006 consist of Auction Rate Securities issued by corporate
      entities with remaining auction days less than 28 days.





The
      Company’s operations currently do not generate positive cash flow and are not
      expected to do so during the fiscal year ending September 30, 2007. The Company
      has taken a number of steps over recent months to reduce operating costs in
      the
      areas of payroll, rent, professional fees and consultants. The Company estimates
      that its cash costs will be approximately $200,000 per month over the upcoming
      quarter. The Company anticipates that, based on its current level of revenues
      and costs and without any proceeds from an equity financing or strategic
      transaction, its existing resources will be adequate to fund its capital and
      operating requirements through May 2007.


15




On
      February 5, 2007, the Company announced that it had signed a Letter of Intent
      (“LOI”) with Techmatics Inc. to jointly develop and market a new product that
      enables fixed-odds exotic race betting while satisfying pari-mutuel regulations.
      Barry Mindes, the founder and former CEO of ISWI, is the President of
      Techmatics. Under the terms of the LOI, Techmatics will provide the design
      of
      the product, and ISWI will provide the programming services required to develop
      the software. Both companies will retain certain marketing rights. ISWI will
      be
      entitled to certain royalty payments for the future use of its developed
      software. As part of this proposed transaction, Techmatics would invest $1.8
      million in ISWI, in exchange for 2.4 million shares of Common Stock. The LOI
      is
      non-binding and is subject to the entering into of a definitive agreement by
      the
      parties, and the raising of the necessary capital by Techmatics. It is
      anticipated that the definitive agreement will be signed by March 7, 2007.
      If
      the $1.8 million investment from Techmatics is received, this would provide
      adequate capital to fund the Company’s current operations through at least
      calendar 2007.





The
      Company cannot provide assurance that it will be able to successfully consummate
      the proposed transaction with Techmatics Inc. If we cannot successfully
      consummate the proposed transaction with Techmatics Inc., we may not be able
      to
      obtain the required additional capital or execute an alternative strategic
      transaction, on favorable terms, or at all. If we cannot successfully implement
      our plans, our liquidity, financial condition and business prospects will be
      materially and adversely affected and we may have to cease
      operations.





Capital
      expenditures which primarily consist of additional computer equipment are not
      expected to be significant and are expected to be funded from existing
      resources. The Company’s capital requirements may vary materially from those now
      planned due to a number of factors, including the rate at which the Company
      can
      introduce its system, the market acceptance and competitive position of the
      System and the response of competitors to the System.




On
      August
      3, 2005, the Company entered into a financing agreement relating to a $4.0
      million private placement with institutional investors consisting of
      4,000 shares of the Company’s newly issued Series C Convertible Preferred Stock
      (“Series C”). Series C has a
      stated
      value of $1,000 per share, is non-voting and is initially convertible into
      the
      Company’s Common Stock at $3.75 per share subject to adjustment. During the
      three months ended December 31, 2006, a holder of the Series C converted 258
      shares of Series C into 68,800 shares of Common Stock and there are currently
      3,742 remaining Series C shares outstanding. The investors also received
      warrants that expire in August 2010 to purchase 557,103 shares of Common Stock
      at $3.95 per share, subject to adjustment. Net proceeds from the financing
      after
      costs and expenses were approximately $3.7 million.





The
      Series C is initially convertible into an aggregate of 1,066,667 shares of
      Common Stock. In connection with the issuance of the Series C, the Company
      recorded a dividend to Series C shareholders of $777,000 representing the
      beneficial conversion feature resulting from the difference between the
      effective conversion price and the quoted market price of the Company’s Common
      Stock at the date of issuance. In addition, holders of Series C are entitled
      to
      receive a cumulative 6% annual dividend, payable quarterly in cash or, subject
      to certain conditions, shares of Common Stock at the Company’s option. As of
      December 31, 2006, unpaid cumulative dividends on the Series C amounted to
      $56,000. A placement agent in this transaction received a cash fee of $120,000
      and warrants to purchase 65,753 shares of the Company’s Common Stock expiring in
      August 2010 which are exercisable at $4.38 per share.


16




Under
      the
      terms of the private placement, and subject to certain conditions, the Company
      has the right to force conversion of all or a portion of the Series C into
      Common Stock. The Series C also provides that if certain events (all of which
      are within the control of the Company) occur such holder would have the right
      to
      require the Company to redeem the preferred stock for cash. For certain other
      events, each holder would have the right to require the Company to redeem the
      preferred stock for the Company’s Common Stock or increase the dividend of the
      preferred stock to 12% per annum. In addition, the Series C and investor
      warrants are subject to certain anti-dilution protection. The Series C contains
      certain negative covenants including limitations with respect to borrowings
      and
      prohibition on payment by the Company of dividends and distributions on Common
      Stock.





**Off
      Balance Sheet Arrangements**





None





System
      DeploymentStatus




***Internet***





The
      Company has several non-exclusive agreements with bookmakers in the UK and
      Gibraltar, which provide the Company with a share of the wagering revenue
      generated by its SportXction ® System.
      Under these agreements, GIG furnishes the technology and operates the system,
      and the partner is responsible for marketing the product, first level customer
      support and for processing customer financial transactions.





The
      Company currently offers both a fully integrated and stand-alone product
      configuration. These products are provided on a white-label basis branded by
      the
      Company’s wagering partners. In the fully integrated configuration, the
      Company’s play-by-play betting propositions are placed seamlessly within our
      business partners’ betting offerings, thus maintaining a consistent “look and
      feel”. The user can then place wagers from its existing account in the same
      manner as all other bets made with that partner.





On
      December 5, 2006, the Company announced that it had launched the integrated
      version of its SportXction ® System
      with Interactive Sports Limited, a wholly-owned subsidiary of Sportingbet.
      On
      January 9, 2007, the Company announced that it had launched the integrated
      version of its SportXction ® System
      with Ladbrokes eGaming Ltd. The Company is currently in discussions with other
      existing and new partners regarding this approach.





In
      addition, the Company continues to offer its stand-alone product configuration
      accessable through a link on the partner’s website, which launches a pop-up
      window, and the user is able to place play-by-play bets after entering a
      username and password and transferring funds into his or her
      account.


17




The
      stand-alone product is currently in operation with the following
      partners:





**Partner**
            **Websites**BetShop
                Group (Europe) Ltd.
            betshop.comVictor
                Chandler UK Ltd
            victorchandler.co.uk,
                vcbet.co.ukVictor
                Chandler International
            victorchandler.com,
                vcbet.com





***Hand-held
      devices***





On
      August
      11, 2006, the Company announced that GIG had entered into an agreement with
      Caliente, one of Latin America’s largest gaming companies. Caliente owns and/or
      provides services to 160 betting shops, known as Race & Sports Books,
      throughout Mexico, Central and South America and the Caribbean.





Under
      the
      terms of this three year agreement, GIG provides software and services that
      enable Caliente to offer an enhanced play-by-play sports betting service in
      all
      of its Race & Sports Books locations. On September 7, 2006, the Company
      announced the SportXction ® System
      was successfully deployed in ten locations using hand held, touch screen
      devices. The SportXction ® system
      is expected to be rolled out throughout Caliente’s Race & Sports Books
      during 2007. The enhanced betting capabilities are also expected to be available
      on Caliente’s website in 2007.





Caliente
      is operating the play-by-play betting service using its own personnel. GIG
      has
      provided initial set-up support and some software customization and training,
      and will provide on-going technical assistance. The agreement specifies monthly
      service fees for technical assistance, as well as monthly license fees based
      on
      the handle derived from the enhanced play-by-play betting service.





***Non-wagering
      product***





The
      Company has a non-gambling version of its SportXction ® System
      which allows users to predict the outcome of events during a sporting event.
      This product was successfully introduced in the U.K. during fiscal 2004. Users
      earn points for correct predictions, bonuses for strings of successful
      predictions and for correct answers to sport’s trivia questions and compete on
      the basis of their scores for a variety of prizes. The Company is currently
      marketing the contest product to professional leagues, professional teams and
      sports rights holders in the United States, the U.K. and Europe.





***Racing
      product***





The
      Company is also developing a fixed-odds / pari-mutuel hybrid racing product
      for
      the U.S. market. The Company has filed a patent application with the intent
      of
      commercializing a product that will combine the advantages of fixed-odds
      wagering while satisfying the current US pari-mutuel rules and regulations.
      The
      Company believes that this offering will provide an improved alternative to
      traditional pari-mutuel wagering in the interstate horse racing market.


18


**Safe
      Harbor Statement**





Except
      for the historical information contained herein, this Quarterly Report on Form
      10-QSB contains forward-looking statements within the meaning of Section 27A
      of
      the Securities Act of 1933, as amended, and Section 21E of the Securities
      Exchange Act of 1934, as amended. Such forward-looking statements include,
      but
      are not limited to: whether the Company’s available resources will be adequate
      to fund its requirements through May 2007 and whether the Company will be able
      to meet its cash requirements; whether the Company will consummate the proposed
      transaction with Techmatics Inc.; the ability of the Company to raise funds
      or
      execute a strategic transaction and if it does raise additional funds, the
      terms
      on which it can be raised and the dilutive impact on existing shareholders;
      the
      number of shares of stock that will be required to pay dividends on the Series
      C
      Preferred Stock and dilutive impact to existing shareholders; whether or not
      any
      new financing would trigger the full ratchet anti-dilution provisions of the
      Series C Preferred Stock or the anti-dilution provisions of any outstanding
      warrants; whether the Company’s revenue will increase in future quarters; the
      likelihood that the Company’s securities will continue to be listed on NASDAQ;
      whether the Company will be able to enter into agreements regarding an
      integrated offering with new or existing partners, and if so whether it can
      be
      launched in a timely manner or at all, and whether the integrated offering
      will
      result in increased revenues; how long the Company will continue to incur
      significant losses and negative cash flow; and
      whether the Company or its Internet, interactive television, mobile phone and
      betting shop partners will gain a sufficient number of customers to generate
      meaningful revenue. Investors are cautioned that forward-looking statements
      are
      inherently uncertain. Actual performance and results of operations may differ
      materially from those projected or suggested in the forward-looking statements
      due to certain risks and uncertainties, including, without limitation, the
      ability of the Company and its partners to attract adequate numbers of players
      to its wagering system and the ability of the Company to develop and market
      other opportunities for its products. Additional information concerning certain
      risks or uncertainties that would cause actual results to differ materially
      from
      those projected or suggested in the forward-looking statements is contained
      in
      the Company’s filings with the Securities and Exchange Commission, including
      those risks and uncertainties discussed in its Form 10-KSB for the fiscal year
      ended September 30, 2006. The forward-looking statements contained herein
      represent the Company’s judgment as of the date of this report, and the Company
      cautions the reader not to place undue reliance on such matters.


19


Item
      3.  Controls
      and Procedures





(a)
      Disclosure Controls and Procedures. The Company's management, with the
      participation of the Company's Chief Executive Officer and Chief Financial
      Officer, has evaluated the effectiveness of the Company's disclosure controls
      and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
      the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of
      the
      end of the period covered by this report. Based on such evaluation, the
      Company's Chief Executive Officer and Chief Financial Officer have concluded
      that, as of the end of such period, the Company's disclosure controls and
      procedures are effective to ensure that information relating to the Company
      (including its consolidated subsidiaries) required to be disclosed in the
      Company's periodic SEC filings is recorded, processed, summarized and reported
      within the time periods specified in the rules and forms of the
      SEC.





(b)
      Internal Control Over Financial Reporting. There have not been any changes
      in
      the Company's internal control over financial reporting (as such term is defined
      in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal
      quarter to which this report relates that have materially affected, or are
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





PART
      II -
      OTHER INFORMATION





Item
      2.
      Unregistered Sales of Equity Securities and Use of Proceeds





On
      October 4, 2006, the Company issued 47,563 shares of Common Stock to the holders
      of its outstanding privately placed Series C Preferred Stock to satisfy the
      dividend due thereunder. This issuance was made in reliance on the exemption
      provided by Section 4(2) of the Securities Act of 1933, as amended (the “Act”),
      for transactions by an issuer not involving any public offering.





On
      December 7, 2006, the Company issued 68,800 shares of Common Stock upon
      conversion of 258 shares of Series C Preferred Stock by the holder thereof
      and
      2,219 shares of Common Stock to satisfy the dividend due thereunder. This
      issuance was made in reliance on the exemptions provided by Section 3(a)(9)
      of
      the Act for securities exchanged by the issuer with its existing security
      holders exclusively and by Section 4(2) of the Act.




Item
      5.
      Other Information




On
      February 5, 2007, the Company announced that it had signed a Letter of Intent
      (“LOI”) with Techmatics Inc. to jointly develop and market a new product that
      enables fixed-odds exotic race betting while satisfying pari-mutuel regulations.
      Barry Mindes, the founder and former CEO of ISWI, is the President of
      Techmatics. Under the terms of the LOI, Techmatics will provide the design
      of
      the product, and ISWI will provide the programming services required to develop
      the software. Both companies will retain certain marketing rights. ISWI will
      be
      entitled to certain royalty payments for the future use of its developed
      software. As part of this proposed transaction, Techmatics would invest $1.8
      million in ISWI, in exchange for 2.4 million shares of Common Stock. The LOI
      is
      non-binding and is subject to the entering into of a definitive agreement by
      the
      parties, and the raising of the necessary capital by Techmatics. It is
      anticipated that the definitive agreement will be signed by March 7, 2007.




20




Item
      6.  Exhibits





NUMBER
            
            DESCRIPTION31.01
            
            Certification
                of Bernard Albanese, Chief Executive Officer of Interactive Systems
                Worldwide Inc., pursuant to Section 302 of the Sarbanes-Oxley Act
                of
                2002.31.02
            
            Certification
                of James McDade, Chief Financial Officer of Interactive Systems Worldwide
                Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.32.01
            
            Certification
                of Bernard Albanese, Chief Executive Officer of Interactive Systems
                Worldwide Inc., pursuant to Section 906 of the Sarbanes-Oxley Act
                of 2002
                (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18,
                United
                States Code).32.02
            
            Certification
                of James McDade, Chief Financial Officer of Interactive Systems Worldwide
                Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18,
                United
                States Code).


21


SIGNATURES





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned thereunto duly
      authorized.




Interactive
                Systems Worldwide Inc.Dated:February
              14, 2007
            By:
            /s/
              Bernard AlbaneseBernard Albanese
              Chief
                  Executive Officer
                (Principal
                  Executive Officer) Dated:February
              14, 2007
            By:
            /s/
              James McDadeJames
                McDade, Chief FinancialOfficer
              (Principal
                  Financial Officer)




22