**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**
| **x** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------|

** **

**For the quarterly period endedSeptember 30, 2005**

**OR**
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

** **

**For the transition period from          to          **

**Commission File Number 0-4281**

**BALLY TECHNOLOGIES, INC.**

(Exact name of registrant as specified in its charter)

| **NEVADA**                                |   | **88-0104066**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
|  incorporation or organization)      |   | Identification  No.) |
| ** **                                |   | ** **           |
| **6601 S.  Bermuda Rd.**                  |   | ** **           |
| **Las  Vegas, Nevada**                    |   | **89119**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

 

Registrant’s telephonenumber: **(702) 584-7700**

Indicate by check mark whether the registrant: (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

o  Yes  x  No

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer.    Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.  (Check one):

oLarge Accelerated Filer                                  x  Accelerated Filer                           o Non-Accelerated Filer

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

o  Yes  x  No

The number of shares ofCommon Stock, $0.10 par value, outstanding as of December 15, 2006, accordingto the records of the registrant’s registrar and transfer agent was 53,012,913,which does not include 528,648 shares held in treasury.

 

----

 

**EXPLANATORY NOTE**

As previouslydisclosed on Form 12b-25 of Bally Technologies, Inc. (formerly known asAlliance Gaming Corporation, “Bally,” the “Company,” or “we”), filed with theSecurities and Exchange Commission (the “SEC”) on November 10, 2005, the filingof this Quarterly Report on Form 10-Q for the three month period endedSeptember 30, 2005 was originally delayed due to the significant amount ofadditional time and resources necessary to complete the preparation andanalysis of the financial statements for the fiscal year ended June 30,2005.  The filing of this Quarterly Report on Form 10-Q was furtherdelayed by the restatements discussed in our Annual Report on Form 10-K/A forthe fiscal year ended June 30, 2005, as amended and restated and filed with theSEC on October 31, 2006 (the “2005 10-K”). Furthermore, the preparation of the financial information presented inthis Quarterly Report on Form 10-Q required additional time and resourcesbecause it was prepared while certain material weaknesses existed in ourinternal control over financial reporting.

**I N D E X**
| **PART I.**    | **FINANCIAL  INFORMATION**                                                                                                    |   |
|----------------|-------------------------------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                                          |   |
| Item 1.        | Financial Statements                                                                                                          |   |
|           |                                                                                                                          |   |
|           | Unaudited  Condensed Consolidated Balance Sheets as of September 30, 2005 and June 30,  2005                                  |   |
|           |                                                                                                                          |   |
|           | Unaudited  Condensed Consolidated Statements of Operations for the Three Months Ended  September 30, 2005 and 2004 (restated) |   |
|           |                                                                                                                          |   |
|           | Unaudited Condensed  Consolidated Statements of Cash Flows for the Three Months Ended September  30, 2005 and 2004 (restated) |   |
|           |                                                                                                                          |   |
|           | Notes to  Unaudited Condensed Consolidated Financial Statements                                                               |   |
|           |                                                                                                                          |   |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                   |   |
|           |                                                                                                                          |   |
| Item 3.        | Quantitative  and Qualitative Disclosures About Market Risk                                                                   |   |
|           |                                                                                                                          |   |
| Item 4.        | Controls and  Procedures                                                                                                      |   |
|           |                                                                                                                          |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                                         |   |
|           |                                                                                                                          |   |
| Item 1.        | Legal Proceedings                                                                                                             |   |
|           |                                                                                                                          |   |
| Item  6.       | Exhibits                                                                                                                      |   |
|           |                                                                                                                          |   |
| **SIGNATURES** |                                                                                                                          |

 

----

 

**PART I**

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                       | ** ** | **September 30,**                                           | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                       | ** ** | **2005**                                                         | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                       | ** ** | **(in 000s, except per share amounts)** | ** ** |
| ASSETS                                                                                                                                           |       |                                                             |       |              |       |
| Current assets:                                                                                                                                  |       |                                                             |       |              |       |
| Cash and cash  equivalents                                                                                                                       |       | $                                                                | 26,666     |              | $          | 33,170 |   |
| Restricted cash                                                                                                                                  |       | 14,006                                                           |       | 13,421            |       |
| Accounts and  notes receivable, net of allowances for doubtful accounts of $8,746 and  $10,340                                                   |       | 99,782                                                           |       | 97,679            |       |
| Inventories                                                                                                                                      |       | 64,961                                                           |       | 63,523            |       |
| Deferred tax  assets, net                                                                                                                        |       | 30,848                                                           |       | 30,884            |       |
| Other current  assets                                                                                                                            |       | 41,244                                                           |       | 33,034            |       |
| Total current  assets                                                                                                                            |       | 277,507                                                          |       | 271,711           |       |
| Long-term investments  (restricted)                                                                                                              |       | 10,682                                                           |       | 10,060            |       |
| Long-term receivables,  net of allowance for doubtful accounts of $0 and $11                                                                     |       | 6,551                                                            |       | 7,450             |       |
| Leased gaming  equipment, net of accumulated depreciation of $48,036 and $42,495                                                                 |       | 51,072                                                           |       | 51,850            |       |
| Property, plant and  equipment, net of accumulated depreciation of $44,063 and $40,548                                                           |       | 65,996                                                           |       | 66,811            |       |
| Goodwill                                                                                                                                         |       | 161,055                                                          |       | 161,444           |       |
| Intangible assets, net  of accumulated amortization of $19,667 and $17,356                                                                       |       | 48,859                                                           |       | 49,451            |       |
| Deferred tax assets,  net                                                                                                                        |       | 20,672                                                           |       | 16,548            |       |
| Other assets, net                                                                                                                                |       | 17,274                                                           |       | 19,609            |       |
| Total assets                                                                                                                                     |       | $                                                                | 659,668    |              | $          | 654,934 |   |
|                                                                                                                                             |       |                                                             |       |              |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                       |       |                                                             |       |              |       |
| Current liabilities:                                                                                                                             |       |                                                             |       |              |       |
| Accounts payable                                                                                                                                 |       | $                                                                | 27,783     |              | $          | 36,807 |   |
| Accrued  liabilities                                                                                                                             |       | 47,665                                                           |       | 43,838            |       |
| Deferred revenue                                                                                                                                 |       | 55,175                                                           |       | 40,962            |       |
| Jackpot  liabilities                                                                                                                             |       | 12,785                                                           |       | 13,025            |       |
| Income taxes  payable                                                                                                                            |       | 167                                                              |       | 1,752             |       |
| Current  maturities of long-term debt, including $6,006 and $6,006 owed to related  parties                                                      |       | 10,363                                                           |       | 10,163            |       |
| Total current  liabilities                                                                                                                       |       | 153,938                                                          |       | 146,547           |       |
| Long-term debt, net of  current maturities, including $13,200 and $13,200 owed to related parties                                                |       | 323,707                                                          |       | 324,954           |       |
| Other liabilities                                                                                                                                |       | 9,425                                                            |       | 6,931             |       |
| Total  liabilities                                                                                                                               |       | 487,070                                                          |       | 478,432           |       |
| Minority interest                                                                                                                                |       | 1,996                                                            |       | 479               |       |
| Stockholders’ equity:                                                                                                                       |       |                                                             |       |              |       |
| Special stock,  10,000,000 shares authorized: Series E, $100 liquidation value; 115 shares  issued and outstanding                               |       | 12                                                               |       | 12                |       |
| Common stock,  $.10 par value; 100,000,000 shares authorized; 52,663,000 and 52,649,000  shares issued and 52,137,000 and 52,123,000 outstanding |       | 5,269                                                            |       | 5,268             |       |
| Treasury stock  at cost, 526,000 and 526,000 shares                                                                                              |       | (665                                                             | )          | (665              | )          |
| Deferred  compensation (restricted stock units)                                                                                                  |       | —                                                           |       | (6,689            | )          |
| Additional  paid-in capital                                                                                                                      |       | 208,407                                                          |       | 212,182           |       |
| Accumulated  other comprehensive income                                                                                                          |       | 1,262                                                            |       | 1,219             |       |
| Accumulated  deficit                                                                                                                             |       | (43,683                                                          | )          | (35,304           | )          |
| Total  stockholders’ equity                                                                                                                 |       | 170,602                                                          |       | 176,023           |       |
| Total liabilities and  stockholders’ equity                                                                                                 |       | $                                                                | 659,668    |              | $          | 654,934 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

2

----

 

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**
| ** **                                                                 | ** ** | **Three Months Ended  September 30,**             | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                                         | ** ** | **2004** | ** ** |
| ** **                                                                 | ** ** | ** **                                                       | ** ** | **(As restated,  see Note 2)** | ** ** |
| ** **                                                                 | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Revenues:                                                                  |       |                                                             |       |   |   |
| Gaming equipment and systems                                               |       | $                                                                | 94,795     |   | $ | 106,805 |   |
| Casino operations                                                          |       | 11,555                                                           |       | 12,836 |   |
|                                                                       |       | 106,350                                                          |       | 119,641 |   |
| Costs and  expenses:                                                       |       |                                                             |       |   |   |
| Cost of gaming equipment and systems                                       |       | 48,897                                                           |       | 54,864 |   |
| Cost of casino operations                                                  |       | 4,283                                                            |       | 4,802 |   |
| Selling, general and administrative                                        |       | 41,842                                                           |       | 43,639 |   |
| Research and development costs                                             |       | 10,257                                                           |       | 11,772 |   |
| Restructuring charges                                                      |       | —                                                           |       | 1,435 |   |
| Depreciation and amortization                                              |       | 5,873                                                            |       | 4,372 |   |
|                                                                       |       | 111,152                                                          |       | 120,884 |   |
| Operating loss                                                             |       | (4,802                                                           | )          | (1,243 | ) |
|                                                                       |       |                                                             |       |   |   |
| Other income  (expense):                                                   |       |                                                             |       |   |   |
| Interest income                                                            |       | 903                                                              |       | 811 |   |
| Interest expense                                                           |       | (5,932                                                           | )          | (3,962 | ) |
| Other, net                                                                 |       | (271                                                             | )          | 320 |   |
|                                                                       |       |                                                             |       |   |   |
| Loss from  continuing operations before income taxes and minority interest |       | (10,102                                                          | )          | (4,074 | ) |
| Income tax benefit                                                         |       | 4,133                                                            |       | 1,679 |   |
| Minority interest                                                          |       | (2,410                                                           | )          | (499 | ) |
| Loss from continuing  operations                                           |       | (8,379                                                           | )          | (2,894 | ) |
| Loss from  discontinued operations, net of income taxes                    |       | —                                                           |       | (4,391 | ) |
|                                                                       |       |                                                             |       |   |   |
| Net loss                                                                   |       | $                                                                | (8,379     | ) | $ | (7,285 | ) |
|                                                                       |       |                                                             |       |   |   |
| Basic and  diluted loss per share:                                         |       |                                                             |       |   |   |
| Continuing operations                                                      |       | $                                                                | (0.16      | ) | $ | (0.06 | ) |
| Discontinued operations                                                    |       | —                                                           |       | (0.08 | ) |
| Total                                                                      |       | $                                                                | (0.16      | ) | $ | (0.14 | ) |
|                                                                       |       |                                                             |       |   |   |
| Weighted average  shares outstanding:                                      |       |                                                             |       |   |   |
| Basic and  diluted                                                         |       | 52,138                                                           |       | 50,966 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

3

----

 

**BALLY TECHNOLOGIES, INC.AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                                                                                 | ** ** | ** **                                           | ** ** | **(As restated,  see Note 2)** | ** ** |
| ** **                                                                                 | ** ** | **(in 000s)**                                   | ** ** |
| Cash flows from  operating activities:                                                     |       |                                                 |       |   |   |
| Net loss                                                                                   |       | $                                                    | (8,379     | ) | $ | (7,285 | ) |
| Loss from  discontinued operations                                                         |       | —                                               |       | 4,391 |   |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                              |       | 12,556                                               |       | 10,786 |   |
| Share-based compensation                                                                   |       | 2,742                                                |       | — |   |
| Deferred income tax expense (benefit)                                                      |       | (4,088                                               | )          | 2,173 |   |
| Provision for (recovery of) doubtful accounts                                              |       | (1,027                                               | )          | 2,717 |   |
| Operating activities of discontinued operations                                            |       | —                                               |       | 375 |   |
| Inventory and other assets write-downs                                                     |       | 3,858                                                |       | 3,511 |   |
| Other                                                                                      |       | 6,111                                                |       | (649 | ) |
| Changes in  operating assets and liabilities:                                              |       |                                                 |       |   |   |
| Purchase of appeal bond                                                                    |       | —                                               |       | (7,361 | ) |
| Accounts and notes receivable                                                              |       | (12                                                  | )          | 1,729 |   |
| Inventories                                                                                |       | (3,512                                               | )          | (22,375 | ) |
| Other current assets                                                                       |       | (17                                                  | )          | (4,067 | ) |
| Accounts payable                                                                           |       | (9,046                                               | )          | 9,139 |   |
| Accrued liabilities, deferred revenue and jackpot  liabilities                             |       | 8,430                                                |       | (7,055 | ) |
| Net cash  provided by (used in) operating activities                                       |       | 7,616                                                |       | (13,971 | ) |
|                                                                                       |       |                                                 |       |   |   |
| Cash flows from  investing activities:                                                     |       |                                                 |       |   |   |
| Additions to property, plant, and equipment                                                |       | (1,971                                               | )          | (3,200 | ) |
| Additions to leased gaming equipment                                                       |       | (9,035                                               | )          | (8,112 | ) |
| Restricted cash and investments                                                            |       | (534                                                 | )          | 1,179 |   |
| Additions to other long-term assets                                                        |       | (1,705                                               | )          | (1,834 | ) |
| Investing activities of discontinued operations                                            |       | —                                               |       | 22 |   |
| Net cash used in  investing activities                                                     |       | (13,245                                              | )          | (11,945 | ) |
|                                                                                       |       |                                                 |       |   |   |
| Cash flows from  financing activities:                                                     |       |                                                 |       |   |   |
| Payoff of debt due to sale of net assets of  discontinued operations                       |       | (1,054                                               | )          | (1,511 | ) |
| Reduction of long-term debt                                                                |       | —                                               |       | (101,618 | ) |
| Purchase of treasury shares                                                                |       | —                                               |       | (164 | ) |
| Proceeds from exercise of stock options, including  tax benefit                            |       | 173                                                  |       | 873 |   |
| Net cash used in  financing activities                                                     |       | (881                                                 | )          | (102,420 | ) |
|                                                                                       |       |                                                 |       |   |   |
| Effect of  exchange rate changes on cash                                                   |       | 6                                                    |       | 47 |   |
|                                                                                       |       |                                                 |       |   |   |
| Cash and cash  equivalents:                                                                |       |                                                 |       |   |   |
| Decrease for period                                                                        |       | (6,504                                               | )          | (128,289 | ) |
| Balance, beginning of period                                                               |       | 33,170                                               |       | 154,258 |   |
| Balance, end of  period                                                                    |       | $                                                    | 26,666     |   | $ | 25,969 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

4

----

**BALLYTECHNOLOGIES, INC.**

**FORM 10-Q**

Notes to UnauditedCondensed Consolidated Financial Statements

**1.****                                      BASISOF PRESENTATION**

*Principlesof presentation and consolidation*

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles and pursuant to therules and regulations of the Securities and Exchange Commission (the “SEC”) andreflect all adjustments, consisting of normal recurring adjustments, whichmanagement believes are necessary to fairly present the financial position,results of operations and cash flows of Bally Technologies, Inc. (formerlyknown as Alliance Gaming Corporation), a Nevada corporation, and itssubsidiaries (“Bally” or the “Company”) for the respective periodspresented.  The results of operations foran interim period are not necessarily indicative of the results that may beexpected for any other interim period or the year as a whole. The accompanyingunaudited condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and notes thereto in theCompany’s Annual Report on Form 10-K/A for the fiscal year ended June 30, 2005,as amended and restated and filed with the SEC on October 31, 2006 (“200510-K”).

Bally is a diversified, worldwide gaming company thatdesigns, manufactures and distributes gaming machines and computerizedmonitoring systems for gaming machines and owns and operates one casino.

The Company is thegeneral partner of Rainbow Casino Vicksburg Partnership (“RCVP”), whichoperates the Rainbow Casino in Vicksburg, Mississippi.  Pursuant to transactions consummated in March1995, the Rainbow Corporation, which was the former general partner of RCVP,became a limited partner entitled to receive 10% of the net available cashflows of RCVP after debt service and other items, as defined in the limitedpartnership agreement, which amount increases to 20% of such amount for theproportional revenues that exceed $35.0 million each year through December 31,2010.  The Company holds the remainingeconomic interest in the partnership. The Company announced in October 2006 that it is evaluating alternativeswith respect to the possible sale of the Rainbow Casino.  As of the date of this filing, a formal planfor the sale of had not been approved by the Company’s Board of Directors.

The Companyconsolidates RCVP and records an adjustment to reflect the portion of theearnings of RCVP attributable to the minority shareholders.

TheCompany also consolidates certain Atlantic City progressive trusts inaccordance with Financial Accounting Standards Board (“FASB”) Interpretation(“FIN”) 46R, *Consolidation of Variable Interest Entities,*which addresses consolidation by a business enterprise of variable interestentities (“VIE’s”) that either: (1) do not have sufficient equity investment atrisk to permit the entity to finance its activities without additionalsubordinated financial support or (2) hold a significant variable interest in,or have significant involvement with, an existing VIE.   For the three months ended September 30,2005, the Company consolidated $2.6 million in revenues and $0.9 million inrelated expenses, as well as $6.6 million in total assets and liabilities,primarily consisting of restricted cash accounts and restricted investments(included in other assets in the condensed consolidated balance sheets) andrelated jackpot liabilities. The Atlantic City progressive trusts were notconsolidated for the three months ended September 30, 2004.

All significant intercompany accounts and transactionshave been eliminated in consolidation.

*Reclassifications*

Certain reclassifications have been made to the prior period financialstatements to conform to the current period presentation, the most significantof which was depreciation on leased gaming equipment which has beenreclassified from depreciation expense to cost of gaming equipment and systems,totaling $6.4 million for the three month period ended September 30, 2004.

5

----

*Inventories*

Inventories arestated at the lower of cost, determined on a first in, first out basis, ormarket.  Cost elements included inwork-in-process and finished goods include raw materials, freight, direct laborand manufacturing overhead.

The Companyrecorded inventory write-downs totaling approximately $3.9 million and $3.5million, respectively, during the three months ended September 30, 2005 and 2004.  These charges are classified in cost ofgaming equipment and systems in the consolidated statements of operations.

*Property,plant and equipment and leased gaming equipment*

The Companyhistorically depreciated leased gaming equipment down to its salvage value overestimated useful lives ranging from two to four years.

Based onhistorical data indicating a shortening of the average length of time certainleased gaming equipment was deployed, the Company re-evaluated the useful livesduring the quarter ended December 31, 2005, and reduced the depreciablelife and salvage values to zero for certain of its products to two years andrecorded the change in estimate prospectively. This change in estimate resulted in a $6.8 million charge todepreciation expense in the three months ended December 31, 2005.

*Recently Issued Accounting Pronouncements*

In September 2006,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, *Fair Value Measurements*, which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 does not require any new fair value measurements, rather itapplies under existing accounting pronouncements that require or permit fairvalue measurements.  SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007, and accordingly,the Company expects to adopt SFAS No. 157 beginning in fiscal year 2009. TheCompany is currently in the process of evaluating the impact SFAS No. 157 willhave on its consolidated results of operations, financial position and cashflows.

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, providing guidance on how prioryear misstatements should be taken into consideration when quantifyingmisstatements in current year financial statements for purposes of determiningwhether the current year’s financial statements are materially misstated. SABNo. 108 is effective for fiscal years ending on or after November 15, 2006, andaccordingly, the Company expects to adopt SAB No. 108 beginning in fiscal year2007. The Company does not expect SAB No. 108 will have an impact on itsconsolidated results of operations, financial position or cash flows.

In July 2006,the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes*,which creates a single model to address uncertainty in income tax positions andprescribes the minimum recognition threshold a tax position is required to meetbefore being recognized in the financial statements. It also provides guidanceon derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition. FIN 48 is effectivefor fiscal years beginning after December 15, 2006, and accordingly, theCompany expects to adopt FIN 48 beginning in its fiscal year 2008. The Companyis currently in the process of evaluating the impact FIN 48 will have on itsconsolidated results of operations, financial position and cash flows.

In June 2005,the FASB issued FASB Staff Position (“FSP”) No. FAS 143-1, *Accounting for Electronic Equipment WasteObligations,* toaddress accounting for obligations associated with the European Union’sDirective 2002/96/EC on Waste Electrical and Electronic Equipment. TheDirective, enacted in 2003, requires EU-member countries to adopt legislationto regulate the collection, treatment, recovery, and environmentally sounddisposal of electrical and electronic waste equipment. The Directivedistinguishes between products put on the market after August 13, 2005 asnew waste and before that date as historical waste. FSP No. FAS 143-1 onlyaddresses

6

----

accounting forhistorical waste and is required to be applied the later of the first reportingperiod ending after June 8, 2005 or the date of adoption of the law by theapplicable European Union member country.  Adoption of FSP No. FAS 143-1 did not have a material impact on theCompany’s consolidated results of operations, financial position or cash flows.

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets*,amending APB Opinion No. 29, *Accounting forNonmonetary Transactions*.  APBOpinion No. 29 treated nonmonetary exchanges of similar productive assets as anexception from fair value measurement. SFAS No. 153 replaces this exception with a general exception from fairvalue measurement for exchanges of nonmonetary assets that do not havecommercial substance. Nonmonetary exchanges have commercial substance if thefuture cash flows of an entity are expected to change significantly as a resultof the exchange. SFAS No. 153 was effective for nonmonetary asset exchangesoccurring in fiscal years beginning after June 15, 2005. Adoption of SFASNo. 153 did not have a material impact on the Company’s consolidated results ofoperations, financial position or cash flows.

In November 2004, the FASB issued SFAS No. 151, *Inventory Costs*, revising AccountingResearch Bulletin No. 43, Chapter 4, *InventoryPricing*, which clarifies the accounting for abnormal amounts of idlefacility expense, freight, handling costs and wasted material. SFAS No. 151 waseffective for inventory costs incurred during fiscal years beginning after June15, 2005.  Adoption of SFAS No. 151 didnot have a material impact on the Company’s consolidated results of operations,financial position or cash flows.

**2.****                                      RESTATEMENT**

Subsequent to the issuance of the unaudited condensedconsolidated financial statements for the three month period ended September30, 2004, the Company identified accounting errors that required adjustments tosuch previously issued financial statements.

These errors relatedprimarily to revenue recognition, accounting for inventory costs and othermiscellaneous items as discussed below.

*Revenue Recognition*

The Companyidentified instances where the timing or amount of revenue recognized was notin accordance with The American Institute of Certified Public Accountants(“AICPA”) Statement of Position (“SOP”) No. 97-2 *SoftwareRevenue Recognition*.  TheCompany determined that certain requirements of SOP No. 97-2 were not met in anumber of instances and therefore, revenue with respect to certain transactionswas recognized prematurely.  Inaccounting for these transactions, the Company has determined that it (1)should have deferred the revenue and related cost of sales, (2) should havereflected certain goods shipped as consigned inventory until later periods and(3) should not have recognized certain accounts receivable until later periods.

The specificcircumstances which resulted in adjustments are as follows:

*Persuasiveevidence of an arrangement exists*

The Companyidentified a number of transactions for which certain conditions under theterms of the original agreement were not met or for which an agreement couldnot be found, calling into question whether the original agreement or lackthereof, provided adequate evidence of an arrangement that was sufficientlydefinitive to support revenue recognition. The Company concluded there was not persuasive evidence of anarrangement at the time and, consequently, revenue should have been deferreduntil the cash was received.

*Deliveryhas occurred*

The Company identifiedinstances in which revenue was recognized for sales at the time the product wasshipped to customers when the shipping terms stated or implied that the risk ofloss and/or title did not transfer until the goods were delivered to thecustomer’s location.  Furthermore,certain transactions were identified that had been accounted

7

----

for on a bill and holdbasis that did not satisfy all of the applicable bill and hold criteria underSAB No. 104, *Revenue Recognition in Financial Statements*,resulting in revenue recognition prior to the physical delivery of goods to thecustomer. In both of these circumstances, recognition of revenue should havebeen deferred until the time the products reached the customer’s location, andtherefore, the revenue that had been previously recorded in connection withthese transactions was adjusted to be recorded in subsequent accounting periodswhen the delivery criteria was met.

The Company alsoidentified instances in the System division where certain standard salesagreements contained contractual terms creating a non-perpetual softwarelicense rather than a perpetual license. The Company determined that in suchcircumstances, revenue for non-perpetual software licenses should not have beenrecognized in full as of the acceptance date, but rather should have beendeferred and recognized ratably over the twelve-month period from the date ofacceptance. Consequently, the revenue that had previously been recorded inconnection with these transactions was adjusted to be recorded in theappropriate periods.

*The vendor’sfee is fixed or determinable and collectibility is probable*

The use of extendedpayment terms in a software licensing arrangement may indicate that the fee isnot fixed or determinable and collectibility is not probable.  The Company identified instances whererevenue was recorded upon delivery of both systems and gaming products tocustomers under contracts that contained payment terms in excess of 24months.  At the time the sales wererecorded, the Company did not have sufficient historical evidence ofcollections made under extended contracts with terms beyond 24 months, asrequired under SOP No. 97-2.  Therefore,the Company should not have concluded that collectibility was probable and itshould have deferred revenue on all contracts with extended payment terms inexcess of 24 months, and recorded revenue upon receipt of payment from thecustomer.  Therefore, the revenue thathad previously been recorded in connection with these transactions was adjustedto be recorded in the subsequent periods when payment was received.

In addition, the Companyidentified instances in which revenue was recognized at the time product wasshipped to customers who were either thinly capitalized or were new customersto the Company for which creditworthiness had not been sufficientlyestablished.  Pursuant to SOP No. 97-2,collectibility must be determined to be “probable” at the time of delivery inorder for revenue to be recognized, and therefore, in such circumstances recognitionof revenue should have been deferred until payment from the customer wasreceived.  Therefore, revenue that hadpreviously been recorded for these transactions was adjusted to be recorded insubsequent periods when payment was received.

Inventory

In certain circumstances,standard versus actual raw material costs were recorded in cost of sales ratherthan as adjustments to inventory and fixed assets.  As a result, adjustments have been made toadjust the standard costs to actual costs, resulting in corrections to thecarrying value of certain finished goods and fixed assets and related cost ofsales and depreciation expense.

OtherMiscellaneous Adjustments

The Companydetermined that it should have presented the cash flows from discontinuedoperations within the respective categories of operating, investing andfinancing activities in its statements of cash flows, rather than as a singleline item. The statement of cash flows was also adjusted to reflect a change inthe classification of the jackpot reserve cash accounts to restricted cash.

The Company alsodetermined that certain balance sheet account reconciliations were notperformed timely and therefore necessary adjustments were not identified orrecorded timely.  The Company hascompleted the account reconciliations and made the corresponding corrections tothe unaudited condensed consolidated financial statements.

The Companydetermined that is should have recorded the value of restricted stock unitsbased on the closing price of its common stock on the date of grant and not theaverage closing price for the 20 business days prior to the date

8

----

of grant.  Anadjustment was recorded to reflect the fair market value during the fiscal yearended June 30, 2005, based on the closing price of the Company’s common stockon the respective dates of grant of the restricted stock units and anadjustment was recorded during the three months ended September 30, 2004 forthe related stock compensation expense.

Additionally, theCompany determined that interest earned on trade accounts receivable should havebeen recorded as interest income rather than revenue and recorded an adjustmentto change the classification of these amounts to interest income.

As a result, the unaudited condensed consolidatedfinancial statements for the three month period ended September 30, 2004 havebeen restated from amounts previously reported. The following is areconciliation of the loss from continuing operations as previously reported tothe restated amounts by the categories discussed above, net of tax:
|                                                          | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(in 000s)**                                             | ** ** |
| Loss from  continuing operations, as previously reported |       | $                                                              | (6,405     | ) |
| Revenue recognition adjustments, net                     |       | 3,049                                                          |       |
| Inventory adjustments, net                               |       | 306                                                            |       |
| Other miscellaneous adjustments, net                     |       | 156                                                            |       |
| Loss from continuing  operations, as restated            |       | $                                                              | (2,894     | ) |

 

The following is a summary of the significant effectsof the restatement:
| ** **                                                                 | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **As previously  reported**                               | ** ** | **As restated** | ** ** |
| ** **                                                                 | ** ** | **(in 000s)**                                             | ** ** |
| *Statement  of Operations*                                                 |       |                                                           |       |   |   |
| Revenue:                                                                   |       |                                                           |       |   |   |
| Gaming equipment and systems                                               |       | $                                                              | 104,077    |   | $ | 106,805 |   |
| Casino operations                                                          |       | 12,836                                                         |       | 12,836 |   |
| Total revenue                                                              |       | 116,913                                                        |       | 119,641 |   |
| Cost of gaming  equipment and systems                                      |       | 50,836                                                         |       | 54,864 |   |
| Selling, general  and administrative expense                               |       | 43,655                                                         |       | 43,639 |   |
| Depreciation and  amortization(1)                                          |       | 10,841                                                         |       | 4,372 |   |
|                                                                       |       |                                                           |       |   |   |
| Operating loss                                                             |       | (6,428                                                         | )          | (1,243 | ) |
| Interest income                                                            |       | 480                                                            |       | 811 |   |
| Loss from  continuing operations before income taxes and minority interest |       | (9,757                                                         | )          | (4,074 | ) |
| Income tax  benefit                                                        |       | 3,851                                                          |       | 1,679 |   |
| Loss from  continuing operations                                           |       | (6,405                                                         | )          | (2,894 | ) |
| Net loss                                                                   |       | (10,796                                                        | )          | (7,285 | ) |
|                                                                       |       |                                                           |       |   |   |
| Basic and  diluted loss per share:                                         |       |                                                           |       |   |   |
| Continuing operations                                                      |       | $                                                              | (0.13      | ) | $ | (0.06 | ) |
| Discontinued operations                                                    |       | (0.08                                                          | )          | (0.08 | ) |
| Total                                                                      |       | $                                                              | (0.21      | ) | $ | (0.14 | ) |

 

----

(1)          Depreciationon leased gaming equipment has been reclassified to cost of gaming equipmentand systems (see Note 1).

9

----

 
| ** **                                      | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                      | ** ** | **As previously  reported**                               | ** ** | **As restated** | ** ** |
| ** **                                      | ** ** | **(in 000s)**                                             | ** ** |
| *Statement  of Cash Flows*                      |       |                                                           |       |   |   |
| Cash flows used  in operating activities        |       | $                                                              | (15,541    | ) | $ | (13,971 | ) |
| Cash flows used  in investing activities        |       | (11,980                                                        | )          | (11,945 | ) |
| Cash flows used  in financing activities        |       | (102,420                                                       | )          | (102,420 | ) |
| Cash flows provided by  discontinued operations |       | 397                                                            |       | — |   |
|                                                 |            |                                                                |            |  |  |  |  |

 

**3.****                                      DISCONTINUEDOPERATIONS**

The Companycompleted the sale of United Coin Machine Co. (“United Coin”) in June 2004 andVideo Service Inc. (“VSI”) in October 2004.

The results of these discontinued operations are presented net ofapplicable income taxes within loss from discontinued operations in theaccompanying condensed consolidated statements of operations.

During the three month period ended September 30, 2004, a FederalDistrict Court jury reached a verdict in a patent infringement case filed byAction Gaming, Inc. (“AGI”) and International Game Technology (“IGT”).  The jury awarded AGI and IGT an aggregate ofapproximately $7.4 million in damages related to a single, optional featureoffered in certain multi-hand poker games provided solely by United Coin.   See Note 13, Commitments and Contingencies,for a description of the related litigation.

Operating results for the discontinued operations include VSI and UnitedCoin.  Summary operating results are asfollows:
|                                              | ** ** | **Three Months Ended  September 30, 2004** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                   | ** ** | **(in 000s)**                                             | ** ** |
| Net revenues                                 |       | $                                                              | 3,955      |   |
| Operating income                             |       | 487                                                            |       |
| Loss on  litigation settlement, Nevada Route |       | (7,356                                                         | )          |
| Income tax  benefit                          |       | 2,478                                                          |       |
| Loss from discontinued  operations           |       | $                                                              | (4,391     | ) |

 

10

----

**4.****                                      EARNINGSPER SHARE**

The computation ofbasic and diluted loss per share from continuing operations and discontinuedoperations and loss applicable to common shares are as follows:
|                                             | ** ** | **Three Months Ended  September 30,**             | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                                         | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Loss from  continuing operations            |       | $                                                                | (8,379     | ) | $ | (2,894 | ) |
| Loss from  discontinued operations          |       | —                                                           |       | (4,391 | ) |
| Net loss                                    |       | $                                                                | (8,379     | ) | $ | (7,285 | ) |
|                                        |       |                                                             |       |   |   |
| Weighted average  common shares outstanding |       | 52,138                                                           |       | 50,966 |   |
|                                        |       |                                                             |       |   |   |
| Loss per basic  and diluted share:          |       |                                                             |       |   |   |
| Continuing operations                       |       | $                                                                | (0.16      | ) | $ | (0.06 | ) |
| Discontinued operations                     |       | —                                                           |       | (0.08 | ) |
| Total                                       |       | $                                                                | (0.16      | ) | $ | (0.14 | ) |

 

Certain securitieswere excluded from the diluted loss per share calculation because theirinclusion would be anti-dilutive due to the reported net loss.  Suchsecurities consist of the following:
|                         | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **              | ** ** | **(in 000s)**                                   | ** ** |
| Stock options           |       | 9,170                                                |       | 5,680 |   |
| Warrants                |       | 100                                                  |       | 100 |   |
| Restricted stock  units |       | 554                                                  |       | 377 |   |
| Total                   |       | 9,824                                                |       | 6,157 |   |

 

As of September30, 2005 the Company also had certain related party debt outstanding which isconvertible into common stock at the Company’s discretion, the potentialdilution from which has not been included in the diluted loss per sharecomputation due to the reported net loss. Assuming the conversion occurred on September 30, 2005, 1.3 millionshares would have been outstanding as a result of the conversion.

**5.****                                      SHARE-BASEDCOMPENSATION**

In December 2001, theCompany’s shareholders approved the 2001 Long-Term Incentive Plan, which hasbeen amended several times (the “2001 Plan”). The 2001 Plan provides for theissuance of up to 10,550,000 shares (as amended in fiscal year 2005) of commonstock to Company employees, directors and designated paid consultants and up to900,000 shares of restricted stock or restricted stock units (“RSUs”).Generally, options are granted at the fair value of the Company’s common stockat the date of grant and are exercisable over five to ten years.

OnJune 13, 2005, the Board of Directors of the Company approved the acceleratedvesting of unvested stock options held by the Company’s employees, officers anddirectors with an exercise price of $15.00 or higher.  This accelerated vesting affected options forapproximately 2.4 million shares of the Company’s common stock.  In order to prevent unintended personalbenefits to individuals resulting from the accelerated vesting of options, theCompany imposed sales restrictions on shares acquired upon exercise of theseoptions that parallel the vesting requirements of the original options.

Thedecision to accelerate vesting of these underwater stock options was madeprimarily to avoid recognizing compensation expense under SFAS No. 123R.  Because the exercise price of the optionssubject to the accelerated vesting was above the market price of the stock onthe date of acceleration, the Company determined that these

11

----

optionsdid not offer a sufficient incentive to employees when compared to thepotential future compensation expense that the Company would incur under SFASNo. 123R with respect to these options.

Effective July 1,2005, the Company adopted the provisions of SFAS No. 123R whichestablished accounting for equity instruments exchanged for employee services.SFAS No. 123R, *Share Based Payment*, requiresemployee stock options and rights to purchase shares under stock participationplans to be accounted for under the fair value method, and eliminates theability to account for these instruments under the intrinsic value methodprescribed by Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*.  In March 2005, the SEC issued SAB No. 107,  *Share-Based Payment,*whichprovided interpretive guidance on SFAS No. 123R valuation methods, assumptionsused in valuation models, and the interaction of SFAS No. 123R with existingSEC guidance. SAB No. 107 also requires the classification of share-basedcompensation expense in the same financial statement line as cash compensation,and therefore, impacted the Company’s cost of gaming equipment and systems,casino operations (and related gross profits and margins), research anddevelopment costs, and selling, general and administrative expenses.  The Company implemented SFAS No. 123R on July1, 2005 using the modified-prospective method.

Under the provisions ofSFAS No. 123R, share-based compensation cost is measured at the grantdate, based on the calculated fair value of the award, and is recognized as anexpense over the employee’s requisite service period (generally the vestingperiod of the equity grant). Prior to July 1, 2005, the Company accountedfor share-based compensation to employees in accordance with APB OpinionNo. 25 and related interpretations. The Company also followed thedisclosure requirements of SFAS No. 123, *Accounting forStock-Based Compensation*, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transition and Disclosure*.The Company elected to adopt SFAS No. 123R using the modified prospectivetransition method, and accordingly, financial statement amounts for the priorperiods presented have not been restated to reflect the fair value method ofexpensing share-based compensation.

The following tablepresents share-based compensation expense included in the Company’s condensedconsolidated statement of operations:
|                                              | ** ** | **Three Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                   | ** ** | **(in 000s)**                                             | ** ** |
| Selling, general  and administrative         |       | $                                                              | 2,490      |   |
| Research and  development                    |       | 231                                                            |       |
| Cost of gaming  and equipment                |       | 21                                                             |       |
| Share-based  compensation expense before tax |       | 2,742                                                          |       |
| Income tax benefit                           |       | 959                                                            |       |
| Net share-based  compensation expense        |       | $                                                              | 1,783      |   |

 

Included in share-basedcompensation expense in the condensed consolidated statements of cash flows forthe three month period ended September 30, 2005, is $0.7 million of restrictedstock unit amortization.

As of September 30, 2005there was $22.6 million of total unrecognized compensation expense related tothe nonvested stock options summarized above which will be recognized over thenext 4.75 years.

The Company estimates thefair value of stock options using the Black-Scholes valuation model. Key inputassumptions used to estimate the fair value of stock options include theexercise price of the award, the expected option term, the expected volatilityof the Company’s common stock over the option’s expected term, the risk-freeinterest rate over the option’s expected term, and the Company’s expectedannual dividend yield. The Company believes that the valuation technique andthe approach utilized to develop the underlying assumptions are appropriate incalculating the fair values of the Company’s stock options granted. Estimatesof fair value are not intended to predict actual future events or the valueultimately realized by persons who receive equity awards.

The fair value of eachoption granted during the corresponding period was estimated on the grant dateusing the

12

----

Black-Scholesoption-pricing model with the following assumptions:
|                                     | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| Weighted Average:                   |       |                                                 |       |   |   |
| Expected option term (in years) (1) |       | 6.38                                                 |       | 6.25 |   |
| Expected volatility factor          |       | 62.03                                                | %          | 62.00 | % |
| Risk-free interest rate             |       | 3.72                                                 | %          | 3.50 | % |
| Expected annual  dividend yield     |       | —                                               | %          | — | % |

 

----

(1)          The option term wasdetermined using the short-cut method for estimating expected option life.

Current periodstock option activity as of and for the three months ended September 30, 2005is summarized below:
|                                               | ** ** | ** **         | ** ** | **Weighted Average** | ** ** | ** **                       | ** ** |
|-----------------------------------------------|------------|--------------------|------------|---------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **Shares**         | ** ** | **Exercise  Price**       | ** ** | **Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| ** **                                    | ** ** | **(in 000s)** | ** ** | **(per share)**      | ** ** | **(years)**                      | ** ** | **(in 000s)** | ** ** |
| Balance  outstanding as of June 30, 2005      |       | 8,196              |       | $                         | 14.72      |                             |       |   | $ | 18,224 |   |
| Granted                                       |       | 1,168              |       | 13.54                     |       |                             |       |   |   |
| Exercised                                     |       | (14                | )          | 12.20                     |       |                             |       |   |   |
| Forfeited or expired                          |       | (180               | )          | 21.57                     |       |                             |       |   |   |
| Balance outstanding  as of September 30, 2005 |       | 9,170              |       | $                         | 14.44      |                             | 6.72       |   | $ | 7,865 |   |
|                                          |       |               |       |                      |       |                             |       |   |   |
| Exercisable as of  September 30, 2005         |       | 5,085              |       | $                         | 16.27      |                             | 5.42       |   | $ | 7,661 |   |

 

Current periodrestricted stock and RSU activity as of and for the three months endedSeptember 30, 2005 is summarized below:
| ** **                                    | ** ** | ** **         | ** ** | **Weighted**

**Average**        | ** ** |
|-----------------------------------------------|------------|--------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **Shares**         | ** ** | **Grant  Date Fair  Value** | ** ** |
| ** **                                    | ** ** | **(in 000s)** | ** ** | **(per share)**             | ** ** |
| Balance  outstanding as of June 30, 2005      |       | 554                |       | $                                | 15.87      |   |
| Granted                                       |       | —             |       | —                           |       |
| Exercised                                     |       | —             |       | —                           |       |
| Forfeited or expired                          |       | —             |       | —                           |       |
| Balance  outstanding as of September 30, 2005 |       | 554                |       | $                                | 15.87      |   |
|                                          |       |               |       |                             |       |
| Exercisable as of  September 30, 2005         |       | 136                |       | $                                | 16.73      |   |

 

13

----

The following isadditional information about stock options exercised, granted and vested duringthe period:
|                                                        | ** ** | **Three Months Ended  September 30,**             | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                                         | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Weighted average  fair value per share:                |       |                                                             |       |   |   |
| Options granted                                        |       | $                                                                | 8.35       |   | $ | 8.61 |   |
| Options vested                                         |       | $                                                                | 8.21       |   | $ | 8.88 |   |
|                                                   |       |                                                             |       |   |   |
| Exercises under  all share-based payment arrangements: |       |                                                             |       |   |   |
| Total intrinsic value                                  |       | $                                                                | 36.0       |   | $ | 860.6 |   |
| Cash received                                          |       | $                                                                | 176.2      |   | $ | 635.5 |   |
| Tax benefit  realized                                  |       | $                                                                | 30.9       |   | $ | 674.5 |   |

 

Prior to July 1, 2005,the Company accounted for share-based compensation to employees in accordancewith APB Opinion No. 25, and accordingly, did not recognize compensationexpense for employee share-based awards for the three months ended September30, 2004, as the exercise price of the Company’s employee stock awards equaledthe market price of the underlying stock on the date of grant.

The Company hadpreviously adopted the provisions of SFAS No. 123, as amended by SFASNo. 148 through disclosure only. The following table illustrates theeffects on net loss and loss per share for the three months endedSeptember 30, 2004, as if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to share-based employee awards: 
|                                                 | ** ** | **Three Months Ended  September 30, 2004**   | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Reported net  loss                              |       | $                                                                | (7,285     | ) |
| Pro forma  share-based compensation, net of tax |       | (1,687                                                           | )          |
| Pro forma net  loss                             |       | $                                                                | (8,972     | ) |
| Basic and  diluted loss per share:              |       |                                                             |       |
| As reported                                     |       | $                                                                | (0.14      | ) |
| Pro forma                                       |       | $                                                                | (0.18      | ) |

 

 **6.****                                   GOODWILLAND INTANGIBLE ASSETS**

*Finite lived intangible assets*

Substantially allof the Company’s recorded intangible assets are subject to amortization. Finite lived intangible assets are comprised of the following:
|                                      | ** ** | **September 30, 2005** | ** ** | **June 30, 2005** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **(in 000s)**               | ** ** |
| Amortizable  intangible assets:      |       |                             |       |                        |       |
| Patents and  gaming related products |       | $                                | 32,040     |                        | $          | 31,083 |   |
| Less:  accumulated amortization      |       | (6,203                           | )          | (5,202                      | )          |
|                                 |       | 25,837                           |       | 25,881                      |       |
|                                 |       |                             |       |                        |       |
| Licenses and  other                  |       | 31,202                           |       | 30,440                      |       |
| Less:  accumulated amortization      |       | (13,464                          | )          | (12,154                     | )          |
|                                 |       | 17,738                           |       | 18,286                      |       |
|                                 |       |                             |       |                        |       |
| Total                                |       | $                                | 43,575     |                        | $          | 44,167 |   |

 

14

----

*Indefinite lived intangible assets*

The carryingamount of indefinite lived intangibles as of June 30, 2005 and September 30,2005 was $5,284,000.

*Goodwill*

Changes in thecarrying amount of goodwill for the three months ended September 30, 2005, areas follows:
|                                          | ** ** | **(in 000s)** | ** ** |
|------------------------------------------|------------|--------------------|------------|
| Balance at June 30,  2005                |       | $                  | 161,444    |   |
| Tax refund  related to an acquisition    |       | (346               | )          |
| Foreign currency  translation adjustment |       | (43                | )          |
| Balance at September 30, 2005            |       | $                  | 161,055    |   |

 

In March 2004, theCompany acquired Sierra Design Group (“SDG”). During the three month period ended September 30, 2005, the Companyreceived a federal tax refund related to SDG’s pre-acquisition operations,which had not previously been recorded as an income tax receivable, andtherefore, the cash received was recorded as an adjustment to goodwill.

*Amortization of Intangibles*

Aggregateamortization expense totaled $2.6 million and $2.0 million for the three monthperiods ended September 30, 2005 and 2004, respectively.  Future amortization of intangible assets isscheduled as follows:

|            | ** ** | **(in 000s)** | ** ** |
|------------|------------|--------------------|------------|
| 2006       |       | $                  | 6,978      |   |
| 2007       |       | 7,961              |       |
| 2008       |       | 5,727              |       |
| 2009       |       | 5,076              |       |
| 2010       |       | 4,749              |       |
| Thereafter |       | 13,084             |       |
| Total      |       | $                  | 43,575     |   |

 

**7.****                                      LONG-TERMDEBT**

Long-term debt consists of the following:
|                                          | ** ** | **September 30, 2005** | ** ** | **June 30, 2005** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **(in 000s)**               | ** ** |
| Term loan  facility                      |       | $                                | 314,007    |                        | $          | 314,882 |   |
| Related party  debt (see Note 8)         |       | 19,206                           |       | 19,206                      |       |
| Other, generally  unsecured              |       | 857                              |       | 1,029                       |       |
| Long-term debt                           |       | 334,070                          |       | 335,117                     |       |
| Less current  maturities                 |       | 10,363                           |       | 10,163                      |       |
| Long-term debt,  less current maturities |       | $                                | 323,707    |                        | $          | 324,954 |   |

 

The Company’s debt structure at September 30, 2005 consists primarily of aterm loan facility, a $75.0 million revolving credit facility, which is limitedby a current leverage ratio and debt owed to related parties. The term loanrequires principal reductions of approximately 1% per annum paid quarterly,with a balloon payment due in September 2009. The revolving credit facility commitment reduces annually until it comesdue in September 2008.  Based on thecurrent leverage ratio at September 30, 2005, the Company had approximately $15.6million of availability under the revolving credit facility; however, therewere no borrowings outstanding under the revolving credit facility.  As of September 30, 2005, the interest ratein effect on the term loan was 6.77%, which was determined based on theinterest rate formula of LIBOR plus 3.25%. On January 3, 2006 and July 3, 2006,the

15

----

Company initiated its next LIBOR-based term loan interest rate periods(for a term of six months) based on the interest rate formula of LIBOR plus3.50% and 3.75%, respectively, which was 8.18% and 9.33%, respectively.

The term loan and the revolving credit facility are collateralized bysubstantially all of the Company’s domestic property and are guaranteed by eachof the Company’s domestic subsidiaries, other than the entity that holds theCompany’s interest in its Mississippi operations, and are secured by a pledgeagreement. The loan agreement governing the term loan and the revolving creditfacility (the “Loan Agreement”) contains a number of maintenance and othersignificant covenants that, among other things, restrict the ability of theCompany and the ability of certain of its subsidiaries to dispose of assets,incur additional indebtedness and issue preferred stock, pay dividends or makeother distributions, enter into certain acquisitions, repurchase equityinterests or subordinated indebtedness, issue or sell equity interests of theCompany’s subsidiaries, engage in mergers or acquisitions or certaintransactions with subsidiaries and affiliates, and that otherwise restrictcorporate activities.  The Company was incompliance with these covenants as of September 30, 2005.

As of September 30, 2005, the Company was also in compliance with itsfinancial covenants consisting of a leverage ratio, a fixed charges coverageratio and a minimum of Earnings Before Interest, Taxes, Depreciation andAmortization (“EBITDA”) (as EBITDA is defined in the Loan Agreement). Theleverage ratio is computed as total average debt outstanding during the quarterdivided by the trailing 12 months EBITDA, excluding certain cash and non-cashcharges. The Company’s leverage ratio as of September 30, 2005 was 4.3 timesversus a maximum allowable of 4.5 times. The maximum allowable leverage ratiodeclines to 4.25 as of March 31, 2006, 4.00 as of September 30, 2006, 3.75 asof December 31, 2006 and 3.50 as of September 30, 2007, through the remainingterm of the Loan Agreement.

In October 2006, the Company executed an amendment to its bank facility,which, among other things, (i) extended the due date for the delivery of the Company’s audited financial statements for the fiscalyear ended June 30, 2006 to December 31, 2006, (ii) provided that theCompany shall deliver its quarterly reports on Form 10-Q for the FiscalQuarters ended September 30, 2005, December 31, 2005 andMarch 31, 2006 no later than December 31, 2006, (iii) modified thedefinition of EBITDA to exclude up to $10 million of certain cashcharges and (iv) clarified that the definitionof EBITDA includes interest income on trade receivables. The Company paid an administrative fee of $964,000, which will be expensed in thequarter ended December 31, 2006, in exchange for the concessions granted underthe amendment.

In December 2006,the Company executed an additional amendment to its bank facility, whichextended the due date for the delivery of the Company’s quarterly report onForm 10-Q for the Fiscal Quarter ended March 31, 2006 and its auditedfinancial statements for the fiscal year ended June 30, 2006 to March 15, 2007.The Company paid an administrative fee of $1.2 million, which will be expensedin the quarter ended December 31, 2006, in exchange for the concessions grantedunder the amendment.

The Company’s related party debt, which totaled approximately $19.2million as of September 30, 2005, consists primarily of the debt owed to theformer principals of SDG, Micro Clever Consulting (“MCC”) and MindPlay LLC(“MindPlay”).  See Note 8, Related PartyTransactions, below regarding related party debt.

**8.****                                      RELATEDPARTY TRANSACTIONS**

In the past two years, the Company completed the acquisition of all of theassets of MCC and SDG and substantially all of the assets and liabilities ofMindPlay.  In each acquisition, a portionof the consideration included subordinated debt issued to the former principalsof each business.  Certain of the formerprincipals are now employees of the Company, and therefore, such debt isconsidered to be owed to related parties. The interest rates on the outstanding debt range from a variable rate ofLIBOR plus 2% to a fixed rate of 6%.  Seethe tables below for outstanding debt and interest rates as of September 30,2005 and June 30, 2005.

16

----

 
|                                              | ** ** | **As of  September 30, 2005** | ** ** | **As of  June 30, 2005** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **Interest  rate**                           | ** ** | **Outstanding  debt**                   | ** ** | **Interest  rate** | ** ** | **Outstanding  debt** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                           | ** ** |
| SDG                                          |       | 4.42                                         | %          | $                                       | 14,000     |   | 4.42 | % | $ | 14,000 |   |
| MindPlay                                     |       | 6.00                                         | %          | 4,000                                   |       | 6.00 | % | 4,000 |   |
| MCC                                          |       | 6.44                                         | %          | 1,206                                   |       | 6.00 | % | 1,206 |   |
| Related party debt                           |       |                                         |       | 19,206                                  |       |   |   | 19,206 |   |
| Less current  maturities                     |       |                                         |       | 6,006                                   |       |   |   | 6,006 |   |
| Related party  debt, less current maturities |       |                                         |       | $                                       | 13,200     |   |   |   | $ | 13,200 |   |

 

In June 2005, theCompany issued approximately 1.0 million shares of its common stock inconnection with the conversion of $14.0 million of the subordinated debt andaccrued interest thereon owed to the former principals of SDG.  The remaining note payable to the formerprincipals of SDG of $14.0 million is payable in annual installments through2009.  At the Company’s discretion, theprincipal and accrued interest thereon can be paid in cash, or can be convertedinto shares of the Company’s common stock using the average stock price for the20 business days prior to the delivery of such shares.

In February 2004,the Company acquired substantially all of the assets and liabilities ofMindPlay.  The initial purchase priceincluded, among other things, the issuance of a $4.0 million note payable.  As provided for in the acquisition agreement,the Company offset the entire amount due under the promissory note inconnection with an indemnification claim against the former shareholders ofMindPlay related to the Company’s patent lawsuit with Shuffle Master, Inc.(“Shuffle Master”) and IGT, which are described below in Note 13, Commitmentsand Contingencies.  Pursuant to theacquisition agreement, the Company is entitled to indemnification with respectto 50% of all of the Company’s damages (including reasonable attorneys’ fees)incurred in connection with the lawsuit, and is entitled to offset such amountagainst any amounts due under the $4.0 million note payable. In March 2006, theCompany paid the selling shareholders of MindPlay $1.0 million under thepromissory note and the parties agreed to cancel the note.  The parties agreed to settle the remaining $3.0million obligation pending the outcome of the patent lawsuit.

|            | ** ** | **Total interest expense for the  Three Months Ended September 30,** | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | **2005**                                                                                                     | ** ** | **2004** | ** ** |
| ** ** | ** ** | **(in 000s)**                                                                                           | ** ** |
| SDG        |       | $                                                                                                            | 159        |   | $ | — |   |
| MindPlay   |       | 72                                                                                                           |       | 75 |   |
| MCC        |       | 13                                                                                                           |       | 26 |   |
|            |            |                                                                                                              |            |  |  |  |  |

 

Accrued interesttotaled $0.6 million and $0.3 million as of September 30, 2005 and June 30,2005, respectively.

Pursuant to anadvisory agreement dated July 1, 2004 with Kirkland Investment Corporation,which is 100% owned by Joel Kirschbaum, a director of the Company, andtherefore, treated as a related-party, the Company agreed to pay Kirkland$600,000 annually for a period of 3.5 years for advisory and related services.  In August 2006, the Company made its lastpayment under the advisory agreement as a result of Mr. Kirschbaum’s death.

The Company alsoleases a warehouse and office facility from an entity owned by Mr. RobertLuciano, a former principal of SDG and the Company’s Chief TechnologyOfficer.  Rental payments totaled$103,000 and $103,000, respectively, for each of the three month periods endedSeptember 30, 2005 and 2004.

**9.****                                      SEGMENTSAND GEOGRAPHICAL INFORMATION**

The Companycurrently operates in two business segments (exclusive of the business segmentsincluded in discontinued operations): (i) Bally Gaming Equipment and Systemswhich designs, manufactures, distributes and operates gaming machines andcomputerized monitoring systems for gaming machines, and (ii) Casino Operations

17

----

which currentlyowns and operates a casino in Vicksburg, Mississippi. The accounting policiesof these segments are consistent with the Company’s policies for the unauditedcondensed consolidated financial statements.

The table belowpresents information as to the Company’s revenues and operating loss bysegment:
|                                | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                     | ** ** | **(in 000s)**                                   | ** ** |
| Revenues:                      |       |                                                 |       |   |   |
| Gaming Equipment and Systems   |       | $                                                    | 94,795     |   | $ | 106,805 |   |
| Casino Operations              |       | 11,555                                               |       | 12,836 |   |
| Total revenues                 |       | $                                                    | 106,350    |   | $ | 119,641 |   |
|                           |       |                                                 |       |   |   |
| Inter-segment  revenues:       |       |                                                 |       |   |   |
| Gaming Equipment and Systems   |       | $                                                    | 89         |   | $ | 172 |   |
| Casino Operations              |       | —                                               |       | — |   |
| Total  inter-segment revenues  |       | $                                                    | 89         |   | $ | 172 |   |
|                           |       |                                                 |       |   |   |
| Operating income  (loss):      |       |                                                 |       |   |   |
| Gaming Equipment and Systems   |       | $                                                    | (1,428     | ) | $ | 711 |   |
| Casino Operations              |       | 3,321                                                |       | 3,796 |   |
| Corporate/other                |       | (6,695                                               | )          | (5,750 | ) |
| Total operating income  (loss) |       | $                                                    | (4,802     | ) | $ | (1,243 | ) |

 

The Company’s operations are based primarily in the United States withsales and distribution offices in Europe and South America.

The table below presents information as to the Company’s revenues andoperating loss by geographic region:
|                                | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                     | ** ** | **(in 000s)**                                   | ** ** |
| Revenues:                      |       |                                                 |       |   |   |
| United States                  |       | $                                                    | 101,105    |   | $ | 114,257 |   |
| Europe                         |       | 3,455                                                |       | 2,710 |   |
| Other foreign                  |       | 1,790                                                |       | 2,674 |   |
| Total revenues                 |       | $                                                    | 106,350    |   | $ | 119,641 |   |
|                           |       |                                                 |       |   |   |
| Operating income  (loss):      |       |                                                 |       |   |   |
| United States                  |       | $                                                    | (4,355     | ) | $ | (401 | ) |
| Europe                         |       | (552                                                 | )          | (1,338 | ) |
| Other foreign                  |       | 105                                                  |       | 496 |   |
| Total operating income  (loss) |       | $                                                    | (4,802     | ) | $ | (1,243 | ) |

 

**10.****                               RESTRUCTURINGCHARGE**

During the threemonth period ended September 30, 2004, the Company undertook a review of itsoperations and reduced its workforce. The reduction resulted in a restructuring charge and accrual totaling$1.4 million, of which $0.9 million was recorded at the Gaming Equipment andSystems segment and $0.5 million was recorded at the corporate level.  Thebalance of the accrued liability for unpaid severance costs is as follows:

18

----

 
|                                       | ** ** | **(in 000s)** | ** ** |
|---------------------------------------|------------|--------------------|------------|
| Beginning  balance at June 30, 2005   |       | $                  | 1,290      |   |
| Amounts paid                          |       | (352               | )          |
| Ending balance at  September 30, 2005 |       | $                  | 938        |   |

 

**11.          COMPREHENSIVE LOSS**

The following is a reconciliation of theCompany’s reported comprehensive loss:
|                                   | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in 000s)**                                   | ** ** |
| Net loss                          |       | $                                                    | (8,379     | ) | $ | (7,285 | ) |
| Currency  translation adjustments |       | (43                                                  | )          | 168 |   |
| Comprehensive  loss               |       | $                                                    | (8,422     | ) | $ | (7,117 | ) |

 

**12.          SUPPLEMENTAL CASH FLOW INFORMATION**

The followingsupplemental information is related to the condensed consolidated statements ofcash flows:
|                                                     | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **(in 000s)**                                   | ** ** |
| Cash paid for  interest                             |       | $                                                    | 5,631      |   | $ | 4,317 |   |
| Cash paid for  income taxes                         |       | 1,927                                                |       | 3,057 |   |
| Non-cash  investing and financing transactions:     |       |                                                 |       |   |   |
| Transfer property, plant and equipment to inventory |       | $                                                    | 1,761      |   | $ | 1,193 |   |
| Foreign currency  translation                       |       | (37                                                  | )          | 215 |   |

 

**13.****                              ****COMMITMENTS ANDCONTINGENCIES**

OnSeptember 25, 1995, Bally Gaming Inc., a wholly-owned subsidiary of the Company(“BGI”), was named as a defendant in a class action lawsuit filed in the UnitedStates District Court for the District of Nevada. The plaintiffs filed suitagainst BGI and approximately 45 other defendants, each of which is involved inthe gaming business as a gaming machine manufacturer, distributor or casinooperator. The lawsuit arises out of alleged fraudulent marketing and operationof casino video poker machines and electronic slot machines. The plaintiffsalleged that the defendants have engaged in a course of fraudulent andmisleading conduct intended to induce people into playing their gaming machinesbased on a false belief concerning how those machines actually operate, as wellas the extent to which there is actually an opportunity to win on any givenplay. The plaintiffs allege that the defendants’ actions constitute violationsof the Racketeer Influenced and Corrupt Organizations Act (RICO) and give riseto claims of common law fraud and unjust enrichment. The plaintiffs are seekingmonetary damages in excess of $1.0 billion. In July 2002, the federaldistrict court denied the plaintiffs’ request for class action certification.In August 2004, the United States Court of Appeals for the Ninth Circuitaffirmed the Federal District Court’s denial of class action certification, andthe plaintiffs did not appeal. Subsequently, two of the four named plaintiffselected to continue their cases as individual, non-class actions. However, inSeptember 2005, the court granted the defendants’ motions for summary judgment,resolving all claims in defendants’ favor without a trial. In October 2005, theplaintiffs appealed the District Court’s granting of summary judgment in favorof the defendants to the Ninth Circuit. Thereafter, the

19

----

plaintiffs/appellantsagreed to dismiss their appeal in exchange for the defendants’ agreement not topursue a claim for costs.  The appeal wasdismissed on June 26, 2006.

In June and July2004, putative class actions were filed against Bally and its officers, RobertMiodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in the UnitedStates District Court for the District of Nevada. The nearly identicalcomplaints alleged violations of the Securities Exchange Act of 1934, asamended, stemming from revised earnings guidance, declines in the stock priceand sales of stock by insiders. The complaints sought damages in unspecifiedamounts. The Federal District Court granted the plaintiffs’ unopposed motionsto consolidate the cases and to appoint a lead counsel and a lead plaintiff,and the plaintiffs filed a consolidated complaint, all as is customary in suchcases. Bally and the other defendants have moved to dismiss the complaint.Thereafter, activity in the case was suspended and the parties participated ina mediation process. The parties have reached an agreement in principle and arenegotiating settlement documents, which will require court approval.

Inaddition, in July 2004, two derivative lawsuits were filed in Nevada statecourt against the members of the board of directors and the officers listedabove. The Company was named as a nominal defendant in the derivative lawsuitsas the claims were purportedly asserted for the benefit of Bally. These lawsuitsasserted claims for breach of fiduciary duty and waste of corporate assetsarising out of the same events as those giving rise to the class actionsdescribed above, and sought injunctive relief and damages in unspecifiedamounts. These two cases were consolidated, and Bally and the other defendantsmoved to dismiss the case. In February 2005, the state district court grantedthe defendants’ motion and dismissed the case. The plaintiffs appealed thedismissal to the Nevada Supreme Court, which referred the matter to itssettlement conference program. The parties met with a court-appointedsettlement judge on December 15, 2005, and agreed to settle the case for$8,000, and on February 2, 2006, the Nevada Supreme Court entered its orderformally dismissing the appeal, thereby terminating the case. Althoughmanagement believes the plaintiffs’ lawsuit and appeal were without merit, itdetermined that the settlement was in the best interests of the Company.

OnMarch 27, 2006, shortly after the aforementioned derivative suit was dismissedin the Nevada state court, another derivative lawsuit was filed in the UnitedStates District Court for the District of Nevada against individual defendantsRobert Miodunski, Robert Saxton, Steven Des Champs, Mark Lerner, David Robbins,Anthony DiCesare, Joel Kirschbaum, Kevin Verner, Richard Haddrill, StephenRace, Jacques André and nominal defendant Bally Technologies, Inc., in theUnited States District Court for the District of Nevada.  Based on allegations that are similar to thosealleged in the federal securities class action complaints and the previousderivative actions that were dismissed by the District Court, the derivativecomplaint alleges breach of fiduciary duty, abuse of control, grossmismanagement, waste of corporate assets, unjust enrichment and violation ofthe Sarbanes-Oxley Act of 2002.  The parties have reached an agreement in principle and arenegotiating settlement documents.

During the threemonths ended September 30, 2005, the Company accrued $1.3 million related tothe anticipated settlement of the class action litigation and the March 27,2006 derivative suit.  The Company alsoaccrued approximately $0.2 million for legal fees related to the litigation inthe three months ended September 30, 2005, which totaled $1.9 million for thefiscal year ended June 30, 2006.

In August 2004,Shuffle Master, Inc. sued the Company in the United States District Court forthe District of Nevada, alleging infringement of various patents in connectionwith the Company’s MindPlay product line and seeking injunctive relief anddamages in an unspecified amount. In June 2005, it was announced that IGT hadacquired an interest in the patents at issue in the case, and thereafter IGTjoined the case as a plaintiff. In December 2005, the Court issued aruling construing the claim terms of all the patents in thesuit. Management believes the plaintiffs’ lawsuit to be without merit, andthe Company is vigorously defending against the lawsuit.

InSeptember 2004, a United States District Court jury in the District of Nevadaentered a $7.4 million verdict against the Company in a suit filed by AGI andIGT. The suit alleged that the multi-hand video poker game deployed by theCompany’s former subsidiary, United Coin, infringed the plaintiffs’ patents.The Federal District Court ruled on summary judgment that the game does notinfringe the patents. However, the court left to the jury the question whetherthe use of “autohold,” a specific, optional feature of the game, caused it toinfringe under the “doctrine of equivalents,” a doctrine of patent law. After atwo-week trial, the jury determined that the game with the autohold optionenabled did infringe under the doctrine of equivalents and awarded damagesaccordingly. The feature has

20

----

beendisabled on all affected games in the field, and the decision permits continueddeployment of the game as long as the autohold feature is not included. TheCompany appealed the decision to the United States Court of Appeals for theNinth Circuit and has posted a cash bond totaling $7.6 million to stay paymentof the judgment and accrued interest pending the appeal. The cash bond isincluded in other non-current assets and the accrued liability is included inaccrued liabilities in the accompanying balance sheets. This amount has beenaccrued and the expense for this charge is included in discontinued operationsin the accompanying statement of operations for 2004.  On July 11, 2006, the federal circuit courtof appeals affirmed the district court judgment, denying the appeals for bothparties, and thereafter the judgment was satisfied out of the posted bond.

On December 7,2004, IGT filed a patent infringement lawsuit against Bally in the UnitedStates District Court for the District of Nevada. The complaint asserts thatBally’s wheel-based games, such as Monte Carlo, Lucky Wheel and Cash ForLife, its games with a reel in the top box, such as Bonus Frenzy, and its iViewproducts infringe on patents held by IGT, and seeks injunctive relief anddamages in unspecified amounts. Bally believes IGT’s claims are withoutmerit and is vigorously defending itself against the lawsuit. As part of itsdefense, Bally has asserted counterclaims against IGT, including claims thatIGT’s patents are invalid, unenforceable and not infringed, as well asseveral claims that IGT has engaged in anti-competitive conduct in violation ofstate and federal antitrust laws. By its counterclaims, Bally is seekingdamages and other relief from IGT. IGT’s motion to dismiss Bally’s antitrustclaims was denied on January 10, 2006. The litigation is in the discoveryphase and no trial date has been set.

InFebruary 2005, the SEC initiated an informal inquiry and requested documentsand information regarding matters related to the allegations in the classactions and similar matters. In August 2005, the SEC notified the Company thatits investigation had entered a formal phase, and requested additionalinformation from the Company covering the same general areas that wereaddressed in the informal inquiry. Management is cooperating fully with the SECin this matter.

In May2006, IGT filed a patent infringement lawsuit against Bally in the UnitedStates District Court for the District of Delaware.  The complaint asserts that Bally’s PowerBonusing products infringe patents held by IGT, and seeks injunctive relief anddamages in unspecified amounts.  IGT’smotion for a preliminary injunction is pending. Bally believes IGT’s claims are without merit, including its request forpreliminary relief and is vigorously defending itself against the lawsuit.

InSeptember 2006, Bally filed a patent infringement lawsuit against IGT in theUnited States District Court for the District of Nevada.  The complaint asserts that certain of IGT’sbonus wheel games infringe patents held by Bally, and seeks injunctive reliefand damages.  IGT filed an answergenerally denying the claims.  The caseis in the discovery phase and no trial date has been set.

The Company isalso a party to various lawsuits relating to routine matters incidental to itsbusiness.  Except as described above,management does not believe that the outcome of such litigation, individuallyor in the aggregate, will have a material adverse effect on the Company’sfinancial position or results of operations.

**14.          SUBSEQUENTEVENTS**

During the fiscalquarter ended March 31, 2006, the Company determined certain of its leasedgaming equipment was no longer deployable as a result of a shifting marketdemand towards newer Bally products that incorporate more innovativefeatures.  As a result, the Companycommitted to a plan to abandon certain of these assets.  The Company expects to record a charge of$1.0 million in the quarter ended March 31, 2006 relating to the abandonment.

In accordance withthe Company’s accounting policy, during the fourth quarter of fiscal year 2006,the Company evaluated the carrying value of goodwill and other intangibleassets and determined that certain intangible assets were impaired.  As a result, the Company expects to record animpairment charge of approximately $5.5 to $6.5 million in the fourthquarter of fiscal year 2006.

21

----

Additionally, during the fiscal quarter ended June 30, 2006, theCompany evaluated the carrying value of its prepaid royalties, which areclassified as other assets, and determined that certain amounts were notrecoverable based on expected sales of the related products.  As a result, the Company expects to record acharge of approximately $2.5 to $3.5 million in the fourth quarter offiscal year 2006.

22

----

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

 

We beginManagement’s Discussion and Analysis of Financial Condition and Results ofOperations with a brief description of the restatement, as well as an overviewof our key operating business divisions and significant trends.  This overview is followed by a detailedanalysis of our results of operations and our financial condition as of, andfor, the three months ended September 30, 2005.

**Forward-LookingStatements**

Certain matters inthis Quarterly Report on Form 10-Q for the three month period ended September30, 2005 and our other filings with the SEC, including, without limitation,certain matters discussed in this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and in Quantitative andQualitative Disclosures about Market Risk, constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended,and are subject to the safe harbor created thereby.  Those statementsreflect the intent, belief or current expectations of the Company, itsdirectors or its officers with respect to, among other things, future eventsand financial trends affecting the Company.

Forward-lookingstatements are typically identified by the words “believes,” “expects,”“anticipates” and similar expressions. In addition, any statements that refer to expectations or othercharacterizations of future events or circumstances are forward-lookingstatements.  Readers are cautioned thatany such forward-looking statements are not guarantees of future performanceand that matters referred to in such forward-looking statements involve knownand unknown risks, uncertainties and other factors which may cause actualresults, performance or achievements of the Company to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements.  Suchfactors include, among other things, the impact of competition anduncertainties concerning such matters as the Company’s ability to service debt,product development, customer financing, sales to non-traditional gamingmarkets, foreign operations, dependence on key personnel, the ability tointegrate future acquisitions, strict regulation by gaming authorities, theoutcome of pending litigation matters including the pending securities classactions, gaming taxes, currency fluctuations and market risk and the potentialadverse effects to our financial condition, results of operations or prospectsas a result of the restatement of our prior period financial statements.Certain of these factors are discussed in the “Risk Factors” contained in the2005 10-K.  The Company undertakes noobligation to publicly update or revise these forward-looking statementsbecause of new information, future events or otherwise.

**Restatement**

The condensed consolidated statements of operationsand cash flows for the three month period ended September 30, 2004, have beenrestated. The restatement related primarily to revenue recognition, accountingfor inventory costs and other miscellaneous adjustments that were the result ofcertain accounting errors, as more fully discussed in Note 2 to the unauditedcondensed consolidated financial statements. The financial information set forth in the following Management’sDiscussion and Analysis gives effect to the restatement.

**OurBusiness**

We are a worldwide leaderin designing, manufacturing, distributing and operating gaming machines andcomputerized monitoring systems for gaming facilities.  We also own and operate the Rainbow Casino, adockside casino in Vicksburg, Mississippi.

We derive our revenuesfrom the following four divisions:

*Gaming Equipment - *Sale ofgaming machines;

*Gaming Operations -*Operation ofwide-area progressive systems and lease of gaming machines;

23

----

*Systems -*Sales ofcomputerized monitoring systems and related recurring hardware and softwaremaintenance revenue; and

*Casino Operations -*Operation ofthe Rainbow Casino.

We design, manufacture and sell a variety of electronicslot and video gaming machines through our Gaming Equipment division and havemarketed over 100,000 machines during the past five years.  Each gaming machine contains an operatingsystem, also referred to as a game platform. The machine’s operating system manages the software needed to run the machine.  In the fiscal year ended June 30,2005, we successfully completed our migration from the EVOTM platform to theLinux based ALPHA OSTM platform.  ALPHA OSdistinguishes itself from other industry platforms as an operating systemdesigned for complete separation between the underlying operating system andthe game applications, providing enhanced efficiency in game development andspeed to market. ALPHA OS also incorporates free spin, scatter, bonusing andother advanced game features, while the related game interface providesinternal and third-party developers with a secure, easy-to-use programmingenvironment that incorporates an advanced set of development tools.   Moreover, ALPHA OS was designed to supportserver-based gaming initiatives, including download of game results,configuration and game content.

Our GamingOperations division offers three general types of games that are placed incasinos or other permissible gaming locations. The three general types of games are those that are linked on aproprietary wide-area progressive system, those that operate on a proprietarynear-area progressive system and those that are non-linked niche games.  These gaming machines earn recurring revenuesand cash flows for us rather than being sold on a one-time basis.

We believe thegrowth of the Gaming Equipment and Gaming Operations divisions is dependent onproviding new titles and technologies with high entertainment value to casinopatrons.  We spent approximately 10% ofour revenue for the three months ended September 30, 2005 on research and developmentto accelerate the use of technology in our gaming products.

We also design and sellcasino enterprise systems under our Systems division.  Our primary casino enterprise systemsproducts are designed to streamline casino business processes through the useof technology and include slot monitoring, casino management and cashlesssystems.  We market our casino enterprisesystem product solutions under the broad categories of Bally CMS® (CasinoManagement Systems), Bally SMS® (Slot Management Systems) and Bally TMS® (TableManagement Systems).

Competition in ourSystems division continues to intensify. Our goal is to maintain a first or second position in each of oursoftware product categories and to grow our software revenues faster than ourcompetitors.  We have also continued tofocus on improving the overall quality of our software products and serviceslevels.  In addition, substantially allour customers renew their software licenses updates and product supportcontracts annually, thereby eliminating the need to repurchase new softwarelicenses when new upgrades are released.

Our Rainbow Casinois one of four casinos currently operating in the Vicksburg, Mississippi marketand is run through our Casino Operations division. The casino, which hasapproximately 12 table games and approximately 893 gaming devices, drawscustomers primarily from a 75-mile radius surrounding Vicksburg, which includesJackson, Mississippi.  While a number ofproperties located on the gulf coast sustained heavy damage during the 2005hurricane season, our casino did not sustain any significant damage.  Although it was temporarily closed followingHurricane Katrina, we reopened the property for business within four days ofthe storm, once power was restored to the general area.  The play levels at our casino have generallyincreased following the reopening.  TheCompany announced in October 2006 that it is evaluating alternatives withrespect to the possible sale of the Rainbow Casino.  There can be no assurance that the Companywill complete the sale of the Rainbow Casino.

**Resultsof Operations**

Our results of operationsinclude the accounts of Bally Technologies, Inc., and its wholly-owned andpartially-owned subsidiaries.  We reportour revenue and income in two segments, the Bally Gaming Equipment and Systems segment,which includes our Gaming Equipment, Systems and Gaming Operations divisions,and our Casino Operations segment. Revenue from our Bally Gaming and Systems segment representsapproximately 89% of our 

24

----

totalrevenues.  The table below sets forth ourconsolidated results of operations for the three months ended September 30,2005 and 2004:
|                                    | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                                 | ** ** | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **Increase/  (decrease)** | ** ** |
| ** **                         | ** ** | **(dollars in millions)**                      | ** ** |
| Revenues                           |       | $                                                        | 106.4      |   | 100 | % | $ | 119.6 |   | 100 | % | (11 | )% |
| Gross profit                       |       | $                                                        | 53.1       |   | 50 | % | $ | 60.0 |   | 50 | % | (12 | )% |
| Operating loss                     |       | $                                                        | (4.8       | ) | (5 | )% | $ | (1.2 | ) | (1 | )% | 300 | % |
| Loss from  continuing operations   |       | $                                                        | (8.4       | ) | (8 | )% | $ | (2.9 | ) | (2 | )% | 190 | % |
| Loss from  discontinued operations |       | $                                                        | —     |   | — | % | $ | (4.4 | ) | (4 | )% | (100 | )% |
| Net loss                           |       | $                                                        | (8.4       | ) | (8 | )% | $ | (7.3 | ) | (6 | )% | 15 | % |

 

***Bally Gaming Equipment and Systems***

The summary financial results and operatingstatistics for our Bally Gaming Equipment and Systems segment for the threemonths ended September 30, 2005 and 2004 are as follows:
|                                      | *** *** | **Three Months Ended September 30,** | *** *** |
|--------------------------------------|--------------|----------------------------------------------------------|--------------|
| ** **                           | *** *** | **2005**                                                 | ** **   | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **Increase/  (decrease)** | *** *** |
| ** **                           | *** *** | **(dollars in millions)**                      | *** *** |
| Revenues                             | *** *** | *** ***                                             | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Gaming Equipment                     |         | $                                                        | 37.3         |   | 39 | % | $ | 50.5 |   | 47 | % | (26 | )% |
| Systems                              |         | 20.6                                                     |         | 22 | % | 23.3 |   | 22 | % | (12 | )% |
| Gaming  Operations                   |         | 36.9                                                     |         | 39 | % | 33.0 |   | 31 | % | 12 | % |
| Total revenues                       |         | $                                                        | 94.8         |   | 100 | % | $ | 106.8 |   | 100 | % | (11 | )% |
|                                 |         |                                                     |         |   |   |   |   |   |   |   |   |
| Gross margin                         |         |                                                     |         |   |   |   |   |   |   |   |   |
| Gaming Equipment                     |         | $                                                        | 9.2          |   | 25 | % | $ | 15.5 |   | 31 | % | (41 | )% |
| Systems                              |         | 17.7                                                     |         | 86 | % | 18.8 |   | 81 | % | (6 | )% |
| Gaming  Operations                   |         | 19.0                                                     |         | 51 | % | 17.7 |   | 54 | % | 7 | % |
| Total gross  margin                  |         | $                                                        | 45.9         |   | 48 | % | $ | 52.0 |   | 49 | % | (12 | )% |
|                                 |         |                                                     |         |   |   |   |   |   |   |   |   |
| Selling, general  and administrative |         | $                                                        | 32.4         |   | 34 | % | $ | 35.3 |   | 33 | % | (8 | )% |
| Research and  development costs      |         | 10.3                                                     |         | 11 | % | 11.8 |   | 11 | % | (13 | )% |
| Restructuring  charges               |         | —                                                   |         | — |   | 0.9 |   | 1 | % | (100 | )% |
| Depreciation and  amortization       |         | 4.6                                                      |         | 5 | % | 3.3 |   | 3 | % | 39 | % |
| Operating income (loss)              |         | $                                                        | (1.4         | ) | (1 | )% | $ | 0.7 |   | 1 | % | (300 | )% |

 

25

----

 

 
|                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                                 | ** ** | **2004** | ** ** | **Increase/  (decrease)** | ** ** |
| Operating  Statistics:                    |       |                                                     |       |   |   |   |   |
| New gaming  devices sold                  |       | 2,800                                                    |       | 4,057 |   | (31 | )% |
| OEM units sold                            | ** ** | 21                                                       |       | 250 |   | (92 | )% |
| New unit average  selling price           | ** ** | $                                                        | 10,647     |   | $ | 10,513 |   | 1 | % |
|                                      | ** ** |                                                     |       |   | ** ** | ** ** | ** ** |
| Gaming  monitoring units installed base   | ** ** | 278,000                                                  |       | 281,000 |   | (1 | )% |
| Casino  management systems installed base | ** ** | 535                                                      |       | 502 |   | 7 | % |
| Systems managed  cashless games           | ** ** | 157,000                                                  |       | 98,000 |   | 60 | % |
|                                      | ** ** |                                                     |       |   | ** ** | ** ** | ** ** |
| End of period  installed base:            | ** ** |                                                     |       |   | ** ** | ** ** | ** ** |
| Wide-area progressive                     | ** ** | 1,526                                                    |       | 1,824 |   | (16 | )% |
| Daily-fee games                           | ** ** | 9,112                                                    |       | 8,259 |   | 10 | % |
| Centrally  determined games               | ** ** | 22,123                                                   |       | 17,193 |   | 29 | % |
|                                           |            |                                                          |            |  |  |  |  |  |  |

 

Total revenues forour Bally Gaming Equipment and Systems segment decreased $12.0 million for thethree months ended September 30, 2005, as compared to the corresponding periodin the prior year.  This decrease was theresult of a decrease in revenues from our Gaming Equipment division ofapproximately 26% and our Systems divisions of approximately 12%.  This decrease was offset by a 12% increase inrevenues derived from our Gaming Operations. A more detailed description of the fluctuations in revenues of each BallyGaming Equipment and Systems divisions is set forth below.

Selling, generaland administrative expenses for the segment decreased by $2.9 million for thethree months ended September 30, 2005, as compared to the corresponding periodin the prior year, which included restructuring charges of $0.9 million.  This decrease was primarily the result ofreduced payroll costs due to staff reductions initiated in part in September2004.  The reduction in payroll expensewas offset by an increase in share-based compensation expense charged to thissegment of $1.5 million as a result of the adoption of SFAS No. 123R, as morefully discussed in Note 5 to the unaudited condensed consolidated financialstatements*.*

Research anddevelopment costs for the segment decreased $1.5 million, or 13%, for the threemonths ended September 30, 2005, as compared to the corresponding period in theprior year.  This decrease was the resultof the elimination of certain costs tied to the completion and successfuldeployment of the ALPHA OS products and related game content as well as areduction in spending on legacy products.

Depreciation andamortization increased $1.4 million, or 42%, for the three months endedSeptember 30, 2005, as compared to the corresponding period in the prioryear.  This increase is due to anincrease in capital expenditures related to new technological initiatives.

*GamingEquipment.*  Revenuesfrom the Gaming Equipment division decreased by $13.2 million, or 26%, for thethree months ended September 30, 2005, as compared to the corresponding periodin the prior year primarily due to a decrease in new gaming unit sales of 31%,or 1,257 new units. This was the result of a decrease in new unit sales of ourlegacy products resulting from the ramp up to the ALPHA OS product line.  The decrease in new gaming unit sales waspartially offset by an increase of $134 in the average selling price of newgaming units which  reflects higher salesof games built on the ALPHA OS platform, which generally has a higher per unitprice than our legacy products.  Inaddition, contributing to the decrease in revenues was a 92% decrease inoriginal equipment manufacturers (“OEM”) sales, a decrease of 229 units.  Sales of such OEM products vary significantlyfrom period to period based on deployments by our OEM customers.

Gross margin declined to25% for the three months ended September 30, 2005 from 31% in the correspondingprior year period.  The decrease in grossmargin was primarily the result of an increase in OEM sales, which generallyhave a lower margin.

26

----

*Systems*.Revenues from the Systems division decreased by $2.7 million, or 12%, for thethree months ended September 30, 2005, as compared to the corresponding periodin the prior year.  This decrease wasprimarily a result of a decrease in the number of installations at newproperties and resulting in a decline in revenue from approximately $1.9million for the three months ended September 30, 2004, to $1.6 million for thethree months ended September 30, 2005, as well as a $2.2 million decrease inrevenue recognized from previously deferred non-perpetual software licensecontracts.

Thesedecreases were partially offset by an increase of 10% in recurring hardware andsoftware maintenance revenues to $7.0 million for the three month period endedSeptember 30, 2005, as compared to $6.4 million for the three months endedSeptember 30, 2004.  The increase inthese revenues resulted from an increase in the number of cashless games wemanage as a result of single property casino expansions, which now stands atapproximately 157,000 in 535 casinos world-wide.

Grossmargin from the Systems division improved to 86% for the three months endedSeptember 30, 2005 from 81% in the corresponding prior year period.  The increase in gross margin was primarilydue to increases of higher margin software sales and maintenance revenue ascompared to a higher level of lower margin hardware sales in the prior yearperiod.

*GamingOperations*.**Revenues fromthe Gaming Operations division increased by $3.9 million, or 12%, for the threemonths ended September 30, 2005, as compared to the corresponding period in theprior year.  The increase in revenue wasprimarily a result of the following factors:

·                  A $2.3 million,or 19%, increase in revenues derived from centrally determined games resultingfrom an increase in our installed base of Class II machines; and

·                  A$2.6 million increase in revenues derived from the Company’s variable interestentities in Atlantic City.

These increaseswere partially offset by decrease in revenue derived from our wide-areaprogressive games as a result of a 16% decline in our installed base of thesegames.

Gross margin,which included depreciation and amortization expense of $6.7 million and $6.4million for the three months ended September 30, 2005 and 2004, remainedrelatively flat for the three months ended September 30, 2005,  as compared to the corresponding period inthe prior year.

***CasinoOperations***

Our Rainbow Casino is oneof four casinos currently operating in the Vicksburg, Mississippi market. Thecasino draws customers primarily from a 75-mile radius surrounding Vicksburg,which includes Jackson, Mississippi. While a number of properties located on the Gulf Coast sustained heavydamage during the 2005 hurricane season, our casino did not sustain anysignificant damage.  Although it wastemporarily closed, we reopened the property for business within four days ofHurricane Katrina, once power was restored to the general area.  While the play levels at our casino increasedsomewhat during the months following the reopening, the play levels returned toa more typical level once some of the other Gulf Coast casinos reopened.

27

----

The summary of our financial results and operatingstatistics for our Casino Operation segment are as follows:
|                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                                 | ** ** | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **Increase/  (decrease)** | ** ** |
| ** **                           | ** ** | **(dollars in millions)**                      | ** ** |
| Revenue                              |       | $                                                        | 11.6       |   | 100 | % | $ | 12.8 |   | 100 | % | (9 | )% |
|                                 |       |                                                     |       |   |   |   |   |   |   |   |   |
| Gross margin                         |       | $                                                        | 7.3        |   | 63 | % | $ | 8.0 |   | 63 | % | (9 | )% |
| Selling, general  and administrative |       | 3.1                                                      |       | 27 | % | 3.4 |   | 27 | % | (9 | )% |
| Depreciation and  amortization       |       | 0.9                                                      |       | 8 | % | 0.8 |   | 6 | % | 13 | % |
| Operating income                     |       | $                                                        | 3.3        |   | 28 | % | $ | 3.8 |   | 30 | % | (13 | )% |
|                                 |       |                                                     |       |   |   |   |   |   |   |   |   |
| Operating  statistics:               |       |                                                     |       |   |   |   |   |   |   |   |   |
| Average number  of gaming devices    |       | 893                                                      |       |   |   | 903 |   |   |   | (1 | )% |
| Average number of table  games       |       | 12                                                       |       |   |   | 12 |   |   |   | — | % |

 

Revenues for ourCasino Operations segment declined $1.2 million, or 9%, for the three monthsended September 30, 2005, as compared to the corresponding period in the prioryear.  The decrease was primarily due tothe revenues lost because of the decrease in play level resulting from thehurricane season discussed above and a decrease in the number of gaming devicesoperating as a result of reduced floor space due to the addition of a pokerroom.  The poker room was subsequentlyremoved in October 2006.

Overall gross margins andselling, general and administrative expenses as a percentage of revenueremained relatively stable quarter over quarter.

***ParentCompany***

The summary financial results of Bally Technologies,Inc., our parent entity, are set forth below. These results also include certain other income and expenses that areotherwise not allocated to a specific business segment.
|                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                                 | ** ** | **2004** | ** ** | **Increase/  (decrease)** | ** ** |
| ** **                           | ** ** | **(dollars in millions)**                      | ** ** | ** ** | ** ** |
| Selling, general  and administrative |       | $                                                        | 6.3        |   | $ | 5.5 |   | 15 | % |
| Depreciation and  amortization       |       | 0.4                                                      |       | 0.3 |   | 33 | % |
| Total Parent  Company expense        |       | $                                                        | 6.7        |   | $ | 5.8 |   | 16 | % |
|                                 |       |                                                     |       |   |   |   |   |
| Other income  (expense):             |       |                                                     |       |   |   |   |   |
| Interest income                      |       | $                                                        | 0.9        |   | $ | 0.8 |   | 13 | % |
| Interest expense                     |       | (5.9                                                     | )          | (4.0 | ) | 48 | % |
| Other, net                           |       | (0.3                                                     | )          | 0.3 |   | (200 | )% |
| Total other  income (expense)        |       | $                                                        | (5.3       | ) | $ | (2.9 | ) | 83 | % |
|                                 |       |                                                     |       |   |   |   |   |
| Income tax  benefit                  |       | $                                                        | 4.1        |   | $ | 1.7 |   | 141 | % |
| Minority interest                    |       | $                                                        | (2.4       | ) | $ | (0.5 | ) | (380 | )% |

 

Our selling, general andadministrative expenses at the parent company level increased $0.8 million forthe three months ended September 30, 2005, as compared to the correspondingperiod in the prior year.  The increase wasprimarily the result of (i) an increase in legal and litigation fees resultingfrom the accrual of $1.5 million in the first quarter of fiscal 2005 related tothe anticipated settlement of class action litigation offset by a decrease infees associated with prior year litigation with Action Gaming, Inc. (“AGI”) andInternational Gaming Technologies

28

----

(“IGT”) (See PartII, Item 1. Legal Proceedings), (ii) a decrease in payroll and related expensesof $0.1 million as a result of a decrease in severance and bonus accruals of$1.2 million which was partially offset by an increase in share-basedcompensation charge to the parent company of $1.2 million, (iii) a decrease inrelocation expenses of $0.2 million, the aggregate of which was offset by anincrease of $1.0 million in professional fees related to the 2005 audit processand the restatement.

Minority interestincreased primarily as a result of the consolidation of certain variableinterest entities. Finally, interest expense for the three months endedSeptember 30, 2005 totaled $5.9 million compared to $4.0 million in the prioryear period.  The increase in interestexpense was a result of higher interest rates in effect in the current periodas substantially all of our debt is tied to LIBOR rates which increased duringthe year.

The effectiveincome tax rate for the three months ended September 30, 2005 was 33% ascompared to 37% for the corresponding period in the prior year.  The effective tax rate for the three monthsended September 30, 2005 was affected by our adoption of SFAS No. 123R and theresulting non-deductible share-based compensation expense recognized for bookpurposes, the expiration of the research and development tax credits on ourfederal tax return for the last half of fiscal year 2006 and reserves appliedto certain deferred tax assets from foreign losses.

***SignificantItems Affecting Comparability***

Certain significant items affect thecomparability of financial statements from the three month period endedSeptember 30, 2005, to the corresponding period in the previous fiscalyear.  These items are discussed below.

*Inventoryand asset write-downs. *We perform detailedinventory valuation procedures at least quarterly.  This process includes examining the carryingvalues of new and used gaming devices, parts and ancillary equipment incomparison to the current fair market values for such equipment (less costs tosell or dispose).  Some of the factorsinvolved in this analysis include the overall levels of our inventories, thecurrent and projected sales levels for such products, the projected markets forsuch products both domestically and internationally, the costs required to sellthe products including refurbishment costs and importation costs forinternational shipments and the overall projected demand for products.

During fiscal year2005 we faced declining demand for gaming devices based on our legacy platform,and therefore, we continually assessed this particular portion of ourinventory.  In October 2004, we made thestrategic decision to move to our new Alpha video platform, which was madecommercially available in April 2005 in most markets.

The decision tomove our gaming devices to the new video platform, the targeting of usedequipment for non-domestic markets and the consolidation of certain warehousesall led to accelerated disposals of legacy products. This process has requiredcontinual updating of estimates for the net realizable value of inventories dueto the subjectivity involved in projecting sales volumes, used game salesvalues, refurbishment costs, and customer demand in non-domesticjurisdictions.  As a result of ourongoing analysis of inventory valuations, we have recorded inventory andrelated asset write-downs totaling $3.5 million during the three months endedSeptember 30, 2004.  During the three monthperiod ended September 30, 2005, we recorded additional inventory write-downstotaling $3.9 million.  We continue tohold a significant number of used gaming devices, therefore, there can be noassurances that further write-downs will not occur in subsequent periods.

*Severancecharges.*  As part of areview of our operations, we reduced our workforce during the three monthsended September 30, 2004.  As a result ofthese reductions, we incurred severance charges totaling $1.4 million duringthe three month period ended September 30, 2004.  No such severance charges were incurred inthe three months ended September 30, 2005.

*DiscontinuedOperations.* During fiscal year 2004, we disposed ofour Nevada route operations and our Rail City Casino.  In fiscal year 2005, we sold our Louisianaroute operations.

The gainpreviously recorded in June 2004 on the sale of our Nevada route operations wassubsequently adjusted during the three months ended September 30, 2004, forcharges incurred with respect to an adverse outcome in a 

29

----

patent infringement case totaling $4.7 million, net oftax.  This amount is included in thediscontinued operations section of our statement of operations.  Our Louisiana operations also contributed anet profit of $0.3 million for the period ended September 30, 2004, which isalso included in discontinued operations.

**FinancialCondition**

***Liquidity***

As of September 30, 2005, we had$26.7 million in consolidated cash and cash equivalents which includesapproximately $2.7 million of cash utilized in our Casino Operations segmentthat is held in vaults, cages or change banks. We had net working capital ofapproximately $123.6 million, a decrease of approximately $1.6 million, or 1%,from June 30, 2005 levels.  This decreaseis discussed in “—Working Capital” below.

Pursuant to various state gamingregulations, certain cash accounts are maintained to ensure availability offunds to pay wide-area progressive jackpot awards.  As of September 30, 2005, these accounts hadan aggregate value of approximately $14.0 million, which are classified asrestricted cash on our condensed consolidated balance sheets.  In addition, we purchase U.S. Treasury StripSecurities for the benefit of jackpot winners who elect to receive winnings asan annual or weekly installment payments rather than one lump sum.  These securities are included in restrictedlong-term investments in the accompanying condensed consolidated balancesheets, and totaled $10.7 million as of September 30, 2005.

Cashflows from operating activities are derived primarily from the cash receiptsfrom the sale of goods and services, the operation of wide-area progressivesystems, lease payments, and monthly cash receipts from maintenance agreementsfrom our casino systems customers.  Inaddition, we generate cash through our casino operations.  We utilize our cash to acquire materials forthe manufacture of goods for resale or lease, and to pay payroll and selling,general and administrative expenses, as well as to service our debt.

Weentered into a loan agreement that governs our $75.0 million revolving creditfacility as well as our term loan.  Noamounts were outstanding as of September 30, 2005 under the revolving creditfacility.  Our ability to borrow underthe revolving credit facility is based on our leverage ratio limit and ourcompliance with certain other covenants set forth in the loan agreement.  Based on the current leverage ratio, we hadapproximately $15.6 million of availability under the revolving credit facilityas of September 30, 2005, as compared to $26.3 million as of June 30, 2005which reflects the improved operating results in the 12 month measurementperiod ending September 30, 2005.

The financialcovenants under the loan agreement consist of a leverage ratio, a fixed chargescoverage ratio, and a minimum of Earnings Before Interest, Taxes, Depreciationand Amortization (“EBITDA”) (as that term is defined in the loan agreement)ratio.  The leverage ratio is computed astotal average debt outstanding during the quarter divided by the trailing 12months EBITDA, excluding certain cash and non-cash charges, and is furtheradjusted to remove EBITDA from discontinued operations at the time thoseoperations are sold.  Our leverage ratioas of September 30, 2005 was 4.3 times versus the covenant maximum of 4.5times.   We were in compliance with allfinancial covenants as of September 30, 2005.

In October 2006,we executed an amendment to our bank loan agreement, which, among otherthings, (i) extended the due date for the  delivery of our auditedfinancial statements for the fiscal year ended June 30,2006 to December 31, 2006, (ii) provided that we will deliver ourquarterly reports on Form 10-Q for the Fiscal Quarters ended September 30,2005, December 31, 2005 and March 31, 2006 no later thanDecember 31, 2006, (iii) modified the definition of EBITDA to exclude upto $10 million of certain cash charges and (iv) clarified that thedefinition of EBITDA includes interest income on tradereceivables.  We paid an administrative fee of $964,000 which will beexpensed in the quarter ended December 31, 2006, in exchange for theconcessions granted under the amendment.

In December 2006, weexecuted an additional amendment to our bank facility, which extended the duedate for the  delivery of our quarterly report on Form 10-Q for the FiscalQuarter ended March 31, 2006 and its audited financialstatements for the fiscal year ended June 30, 2006 to March15, 2007. We paid an administrative fee of $1.2 million,

30

----

which will beexpensed in the quarter ended December 31, 2006, in exchange for theconcessions granted under the amendment.

Managementbelieves that cash flows from current operating activities and the availabilityunder the revolving credit facility will provide us with sufficient capitalresources and liquidity to operate our business for at least the next 12months.  At September 30, 2005, we had nomaterial commitments for capital expenditures.

***WorkingCapital***

The following tablepresents the components of consolidated working capital at September 30, 2005,and June 30, 2005, excluding assets and liabilities of discontinued operations:
|                                      | ** ** | **September 30,** | ** ** | **June 30,**  | ** ** | **Increase (decrease)** | ** ** |
|--------------------------------------|------------|------------------------|------------|--------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **2005**               | ** ** | **2005**           | ** ** | **Amount**                   | ** ** | **%** | ** ** |
| ** **                           | ** ** | ** **             | ** ** | **(in 000s)** | ** ** | ** **                   | ** ** | ** ** | ** ** |
| Current Assets:                      |       |                   |       | ** **         |       |                         |       |   |   |
| Cash and cash equivalents            |       | $                      | 26,666     |               | $          | 33,170                       |       | $ | (6,504 | ) | (20 | )% |
| Restricted cash                      |       | 14,006                 |       | 13,421             |       | 585                          |       | 4 | % |
| Accounts and notes receivable, net   |       | 99,782                 |       | 97,679             |       | 2,103                        |       | 2 | % |
| Inventories                          |       | 64,961                 |       | 63,523             |       | 1,438                        |       | 2 | % |
| Deferred tax assets                  |       | 30,848                 |       | 30,884             |       | (36                          | )          | — | % |
| Other current assets                 |       | 41,244                 |       | 33,034             |       | 8,210                        |       | 25 | % |
| Total current  assets                |       | $                      | 277,507    |               | $          | 271,711                      |       | $ | 5,796 |   | 2 | % |
|                                 |       |                   |       |               |       |                         |       |   |   |
| Current  Liabilities:                |       |                   |       |               |       |                         |       |   |   |
| Accounts payable                     |       | $                      | 27,783     |               | $          | 36,807                       |       | $ | (9,024 | ) | (25 | )% |
| Accrued liabilities                  |       | 47,665                 |       | 43,838             |       | 3,827                        |       | 9 | % |
| Deferred revenue                     |       | 55,175                 |       | 40,962             |       | 14,213                       |       | 35 | % |
| Jackpot liabilities                  |       | 12,785                 |       | 13,025             |       | (240                         | )          | (2 | )% |
| Taxes payable                        |       | 167                    |       | 1,752              |       | (1,585                       | )          | (91 | )% |
| Current maturities of long-term debt |       | 10,363                 |       | 10,163             |       | 200                          |       | 2 | % |
| Total current  liabilities           |       | 153,938                |       | 146,547            |       | 7,391                        |       | 5 | % |
| Net working  capital                 |       | $                      | 123,569    |               | $          | 125,164                      |       | $ | (1,595 | ) | (1 | )% |

 

Our workingcapital for the three month period ended September 30, 2005, decreased $1.6million or 1%.  The decrease wasprimarily as a result of the following:

·                  A $2.1 millionnet increase in accounts and notes receivable primarily resulting from anincrease and overall recognized and deferred games sales.

·                  A $1.4 millionnet increase in inventory, which resulted from the build up of inventory inanticipation of new product introductions.

·                  A decrease inaccounts payable of $9.0 million due to the acceleration of vendor payments.

·                  An increase inaccrued liabilities of $3.8 million resulting primarily from (i) an increase inaccrued professional and consulting fees of $1.7 million related to the costsassociated with the restatement of prior year financial statements, (ii) anincrease of $0.5 million in accrued royalties as a result of an increase inshipments of licensed titled games and (iii) an increase in accrued interest of$0.4 million.

·                  Anincrease in deferred revenue of $14.2 million (and $10.6 million in deferredcost of sales) as a result of an increase in transactions that did not meet therevenue recognition requirements of SOP No. 97-2, and have been deferred tofuture periods.

31

----

***Cash FlowSummary***
|                       | ** ** | **Three Months Ended**    | ** ** | ** **                   | ** ** |
|-----------------------|------------|-------------------------------------|------------|------------------------------|------------|
| ** **            | ** ** | **September 30,**              | ** ** | **Increase (decrease)** | ** ** |
| ** **            | ** ** | **2005**                            | ** ** | **2004**                     | ** ** | **Amount** | ** ** |
| ** **            | ** ** | **(dollars in millions)** | ** ** |
| Cash flows from:      |       |                                |       |                         |       |   |   |
| Operating activities  |       | $                                   | 7.6        |                         | $          | (14.0 | ) | $ | 21.6 |   |
| Investing activities  |       | $                                   | (13.2      | )                            | $          | (11.9 | ) | (1.3 | ) |
| Financing  activities |       | $                                   | (0.9       | )                            | $          | (102.4 | ) | 101.5 |   |
|                       |            |                                     |            |                              |            |  |  |  |  |  |

 

During the threemonth period ended September 30, 2005, cash flows provided by operatingactivities totaled $7.6 million, as compared to $14.0 million used by operatingactivities in the corresponding period in the prior year.  The improvement in net cash flows fromoperations for the three month period is primarily related to:

·                  Cash used in theprior year period to purchase an appeal bond related to patent litigation ($7.4million).

·                  Non-cash itemssuch as depreciation and amortization ($12.6 million which increased by $1.8million) and share-based compensation (which increased by $2.7 million).

·                  An increase inreceivables due to timing of receivable collections.

·                  Timing of vendorpayments as days in accounts payable decreased.

·                  Lowerinventory activity primarily as a result of the prior year inventory build-upwhich included several large orders of gaming devices not delivered until afterthe end of the September 30, 2004 quarter.

During the threemonth period ended September 30, 2005, cash flows used in investing activitiestotaled $13.2 million, as compared to $11.9 million for the correspondingperiod in the prior year.  This change isprimarily the result of:

·                  Capital expendituresof $2.0 million compared to $3.2 million in the prior year three month period,which is the result of a decrease in expenditures related to internal softwareand leasehold improvements.

·                  Costs incurredto deploy additional leased gaming devices totaling $9.0 million compared to$8.1 million in the prior year three month period resulting from an increase inthe total base of recurring games deployed.

·                  Additions toother long-term assets of $1.7 million related to patents and license rights.

·                  Anincrease in restricted investments of $0.6 million as a result of jackpotwinners.

During the threemonth period ended September 30, 2005, cash flows used in financing activitiestotaled $0.9 million, as compared to $102.4 million for the corresponding periodin the prior year. The prior year three month period financing activitiesreflected cash used to repay debt of $101.6 million resulting from the sale ofcertain of our non core assets in the prior year.  The current period cash uses are primarilyrelating to principal payments on long term debt totaling $1.1 million and cashprovided from exercise of stock options of $0.2 million.

***ContractualCommitments***

There were no materialchanges during the three month period ended September 30, 2005, to our contractualobligations and commitments as disclosed in the 2005 10-K.

**CriticalAccounting Policies**

A description of ourcritical accounting policies can be found within management discussion andanalysis of financial condition and results of operation in the 2005 10-K.    There were no material changes to thosepolicies during the three month period ended September 30, 2005.

32

----

*Recently Issued AccountingPronouncements*

In September 2006,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, *Fair Value Measurements*, which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 does not require any new fair value measurements, rather itapplies under existing accounting pronouncements that require or permit fairvalue measurements.  SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007, and accordingly,the Company expects to adopt SFAS No. 157 beginning in fiscal year 2009. We arecurrently in the process of evaluating the impact SFAS No. 157 will have on ourconsolidated results of operations, financial position and cash flows.

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, providing guidance on how prioryear misstatements should be taken into consideration when quantifyingmisstatements in current year financial statements for purposes of determiningwhether the current year’s financial statements are materially misstated. SABNo. 108 is effective for fiscal years ended on or after November 15, 2006,and accordingly, the Company expects to adopt SAB No. 108 beginning in fiscalyear 2007. We do not expect SAB No. 108 will have an impact on our consolidatedresults of operations, financial position or cash flows.

In July 2006,the FASB issued FIN 48, *Accounting forUncertainty in Income Taxes, an interpretation of FASB Statement No. 109**, Accounting for IncomeTaxes*, which creates a single model to address uncertainty in incometax positions and prescribes the minimum recognition threshold a tax positionis required to meet before being recognized in the financial statements. Italso provides guidance on derecognition, measurement, classification, interestand penalties, accounting in interim periods, disclosure and transition. FIN 48is effective for fiscal years beginning after December 15, 2006, and accordingly,the Company expects to adopt FIN 48 beginning in fiscal year 2008. We arecurrently in the process of evaluating the impact FIN 48 will have on ourconsolidated results of operations, financial position and cash flows.

In June 2005,the FASB issued FASB Staff Position (“FSP”) No. FAS 143-1, *Accounting for Electronic Equipment WasteObligations,* toaddress accounting for obligations associated with the European Union’sDirective 2002/96/EC on Waste Electrical and Electronic Equipment. The Directive,enacted in 2003, requires EU-member countries to adopt legislation to regulatethe collection, treatment, recovery, and environmentally sound disposal ofelectrical and electronic waste equipment. The Directive distinguishes betweenproducts put on the market after August 13, 2005 as new waste and beforethat date as historical waste. FSP No. FAS 143-1 only addresses accounting forhistorical waste and is required to be applied the later of the first reportingperiod ending after June 8, 2005 or the date of adoption of the law by theapplicable European Union member country.  Adoption of FSP No. FAS 143-1 did not have a material impact on ourconsolidated results of operations, financial position or cash flows.

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets*,amending APB Opinion No. 29, *Accounting forNonmonetary Transactions*.  APBOpinion No. 29 treated nonmonetary exchanges of similar productive assets as anexception from fair value measurement. SFAS No. 153 replaces this exception with a general exception from fairvalue measurement for exchanges of nonmonetary assets that do not havecommercial substance. Nonmonetary exchanges have commercial substance if thefuture cash flows of an entity are expected to change significantly as a resultof the exchange. SFAS No. 153 was effective for nonmonetary asset exchangesoccurring in fiscal years beginning after June 15, 2005. Adoption of SFASNo. 153 did not have a material impact on our consolidated results of operations,financial position or cash flows.

In November 2004,the FASB issued SFAS No. 151, *InventoryCosts*, revising Accounting Research Bulletin No. 43, Chapter 4, *Inventory Pricing*, which clarifies theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts and wasted material. SFAS No. 151 was effective for inventory costsincurred during fiscal years beginning after June 15, 2005.  Adoption of SFAS No. 151 did not have amaterial impact on our consolidated results of operations, financial positionor cash flows.

33

----

**ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

*Interest Rate Risk*

As of September 30, 2005, we hadtotal debt of approximately $334.1 million, consisting primarily of the $314.0million term loan under our senior credit facilities and approximately $20.1million in other debt.  The interest ratefor the term loan is reset every six months. If the LIBOR rates were to increase or decrease by 100 basis points, withall other factors remaining constant, earnings would decrease or increase byapproximately $3.3  million annually, ona pre-tax basis.

*ForeignCurrency Exchange Rate Risk*

Our foreignsubsidiaries generally use their domestic currency as their functionalcurrency. A 10% fluctuation in the exchange rates of these currencies againstthe U.S. dollar would result in a corresponding change in earnings reported inthe consolidated group which would have no significant effect on a pre-taxbasis.

# **ITEM 4.          CONTROLS AND PROCEDURES**

**DisclosureControls and Procedures**

As required by Rule 13a-15(b) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”), ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Exchange Act Rule13a-15(e), as of the end of the period covered by this report.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of September 30, 2005, ourdisclosure controls and procedures were not effective due to the existingmaterial weaknesses in our internal control over financial reporting that werepreviously identified and  discussed inthe 2005 10-K and below under “—Internal Control Over Financial Reporting—Internal Control Over Financial Reporting Assessment as of the Filing of ThisReport-Update Regarding Remediation Plan.”

In view of the fact that thefinancial information presented in this quarterly report on Form 10-Q for thefiscal quarter ended September 30, 2005, was prepared in the absence ofeffective internal control over financial reporting, we have devoted asignificant amount of time and resources to the analysis of the financialstatements contained in this report.  Inparticular, we have reviewed the significant account balances and transactionsreflected in the financial statements contained in this report and otherwiseanalyzed the transactions underlying our financial statements to verify theaccuracy of the financial statements. Accordingly, management believes that the financial statements includedin this report fairly present, in all material respects, our financialcondition, results of operations, and cash flows.

Nevertheless, there can be noassurance that either this review process or our existing disclosure controlsand procedures will prevent or detect all errors and all fraud, if any, orresult in accurate and reliable disclosure. A control system can provide onlyreasonable and not absolute assurance that the objectives of the control systemare met. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, have been detected. Additionally, judgments indecision-making can be faulty and breakdowns in internal controls can occurbecause of simple errors or mistakes that are not detected on a timely basis.

**Internal ControlOver Financial Reporting**

Our management acknowledges itsresponsibility for establishing and maintaining adequate internal control overfinancial reporting that includes effective accounting policies and procedures.Our continuing progress in establishing adequate internal control overfinancial reporting is described below.

34

----

*Certain Changes in Internal Control Over Financial Reportingduring the Fiscal Quarter Ended September 30, 2005*

During the quarter ended September30, 2005, our management was in the process of identifying the materialweaknesses described in the 2005 10-K. During the quarter ended September 30, 2005, management initiatedpreliminary remediation steps to address the material weaknesses known at thattime.  Specifically, management initiatedthe changes discussed below under “—Internal Control Over Financial ReportingAssessment as of the Filing of This Report - Update Regarding Remediation Plan –Inadequate Controls Related to Revenue Recognition – Contract Administration.” Therewere no other changes to our internal control over financial reporting duringthe three month period ended September 30, 2005 that management believes havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

*Internal Control Over Financial Reporting Assessment as ofthe Filing of This Report – Update Regarding Remediation Plan*

We are including information inthis Quarterly Report on Form 10-Q with respect to our internal control overfinancial reporting for the period subsequent to September 30, 2005, inorder to provide readers with a current understanding of the identifiedweaknesses, as well as how they are being addressed as part of our remediationplan.

Subsequent to June 30,2005, we have undertaken extensive work to remediate the material weaknessesidentified in our internal control over financial reporting described in the2005 10-K including developing the specific remediation initiatives describedbelow. The implementation of these initiatives was a priority for us in fiscal2006 and continues to be a priority in fiscal 2007.  We have begun implementing the actionsdescribed below with respect to the identified material weaknesses; however,there can be no assurances as to when or if, the implementation of theseinitiatives will be completed.  Furthermore, we are in process of evaluating our internal control overfinancial reporting as of June 30, 2006. There can be no assurances that the material weaknesses described in the2005 10-K were cured as of such date, or that we will not identify additionalmaterial weaknesses as a result of such evaluation.  Until such initiatives are implemented, wewill continue to incur the expenses and management burdens associated with theadditional resources required to prepare our consolidated financial statements.

*InadequateStaffing**and Training in Financeand Accounting*

*Inadequate Staffing**.*  We have focusedintensive efforts on improving the overall level and quality of our staffing ina number of finance and accounting areas related to the identified materialweaknesses, including the tax and revenue departments.  These efforts have resulted in the creationof several new positions, as well as the hiring of a number of keyemployees.  As of the date of thisfiling, we have filled the following positions: Chief Financial Officer, Vice President/Corporate Controller, VicePresident of Corporate Accounting, Director of Financial Reporting, ContractAdministrator and a Tax Manager.

*Inadequate Training**.*  We have held anumber of internal meetings with our sales staff to review our revenuerecognition policies and procedures.  Ourgoal is to provide the sales staff with a better understanding of theapplicable accounting rules, the consistency in contractual language that isrequired, as well as the new contract administration procedures discussed belowunder “—Inadequate Controls Related to Revenue Recognition — ContractAdministration.”  We are also educatingthe sales department as to certain standard sales contracts discussed below andwith respect to the types of contractual language that has been reviewed andpre-approved by members of the legal and finance departments.

Additionally, thefinance and accounting department continues to encourage and pay for allpersonnel who enroll in Continuing Professional Education, as well as for anycollege and master’s level courses that relate to their respective jobfunctions.

35

----

*IneffectiveControls related to the Preparation of Certain Account Analyses, AccountSummaries and Account Reconciliations*

As a result of theadjustments made with respect to certain balance sheet accounts and relatedstatement of operations for the fiscal year ended June 30, 2005, we determineda more detailed review for these accounts was necessary in connection with ourquarterly account reconciliation process. The Company completed a thorough review of balance sheet accounts todetermine whether the supporting schedules were adequately prepared and/or reviewed,and that they included adequate supporting documentation.

The finance andaccounting department has also developed a spread sheet management process toensure that various departments are working from the same schedules therebyreducing the likelihood of errors from using outdated files stored onindividual computers.

*InadequateControls Related to Revenue Recognition*

In addition to theadditional internal training of our sales staff discussed above, we have alsotaken the following actions to remediate the issues previously identified withrespect to inadequate controls related to revenue recognition.

*InternalReview of All Game Sale Transactions.*  Management has implemented a procedure toreview each game and system sale transaction for compliance with AICPAStatement of Position No. 97-2, *SoftwareRevenue Recognition*.  Theinitial revenue recognition determination is made by the revenue department,and is then reviewed by a member of our finance department at a director orhigher level.  In addition, our ChiefFinancial Officer reviews both randomly selected contracts, as well as thoserelated to large and/or complex transactions.

*OutsideReview of Game Sale Transactions.*  We engaged an outside consultant to assist usin performing additional review procedures for revenue transactions duringfiscal 2006. The scope of the consultant’s review was designed to ensure acomprehensive review of all large transactions, as well as certain types oftransactions that have previously resulted in adjustments to the timing ofrevenue recognition. The outside consultant’s scope also included reviewing asample of contracts from the remaining population for proper revenuerecognition.

We have also reviewedcertain complex transactions and new proposed contracts with our consultants toidentify any accounting issues prior to the final contract execution.

*Implementation of Standard SalesContract**.*  As part of the pre-review processes,discussed above under “―Internal Review of All Game Sale Transactions,”we have created a standard contract for domestic game sales. This contract wasintroduced to the sales force in draft form in January 2006, and wasimplemented in February 2006.  We arealso reviewing our system sales contracts and international sales contracts todetermine the feasibility of developing standardized contracts for all thosemarkets.

*Contract Administration**.*We have designed a multiple step actionplan to develop a contract administration process that is well defined, wellunderstood and efficient in its operation. Our previous contract administrationprocess could not be relied upon to produce consistently prepared contracts asdocuments could be edited by a number of individuals at anytime prior toexecution.

Beginning in September2005, we implemented Phase I of our plan which required each sales contract tofollow the contract approval flow chart process.  Phase I includes a review of all terms andconditions of each contract, and requires formal sign off as well as executionof the sales agreement by certain levels of management based on a predeterminedapproval process.  We have alsoestablished procedures that will now require approval by our Chief ExecutiveOfficer for certain contracts. The contract is then returned to the salesperson for delivery and sign off by the customer.  Any further edits would then be re-reviewedby members of our finance and accounting department to gauge their accounting impactto ensure proper revenue recognition.

36

----

In February 2006 webegan Phase II of our process and hired a Contract Administrator.  Phase II of the contract administrationprocess involves the establishment of a Contract Administrator position, andrelated enhanced policies and procedures. This individual reports directly tothe legal department. Members of our Senior Management team have also agreed tocertain contractual terms that have been defined as “standard” and,consequently, we developed standard game sales contracts discussed above under“―Implementation of Standard Sales Contract.”  If the draft contract uses these standardterms, it will receive only limited review by our finance and accountingdepartment.  If the contract goes beyondthese standard terms, then the Contract Administrator must follow a newlycreated decision tree which involves review and approval by various members ofthe finance and legal departments, depending on the issue identified.

Phase III of the processintroduces a new contract management and work flow software to better managethe decision tree and track contract approvals.

Quarterly Certifications.  We have expanded our quarterly Sarbanes-Oxleycertification procedures and disclosure controls.  In addition to the internal certifications wepreviously required from the Executive Vice President of each business divisionand the Vice President/Corporate Controller, our process now requires internalsub-certifications from all sales directors and Vice Presidents, including theExecutive Vice President of Sales.  Theseadditional internal sub-certifications include a number of representationsregarding the various signatories’ respective duties and responsibilities.

*InadequateControls Related to Inventory Valuation*

We have taken thefollowing actions to remediate the issues previously identified with respect toour inadequate controls related to inventory valuation.

*Expanded review by SeniorManagement**.*Members ofour senior management team have met with members of the manufacturingmanagement team, cycle counters, and warehouse supervisors, as well asperformed expanded reviews of the supporting schedules prepared by the costaccounting manager in regards to inventory valuation, and have selected variousaccounts for additional analysis.  Wehave also filled the new role of Accounting Manager – Inventory.  This individual’s entire focus will be oninventory related issues.

*Game Inventory – Live Data**. *TheCompany’s intra-net site is in the process of being upgraded to include realtime data for game inventory; both for new and used games. This upgrade hasallowed for increased accounting for the game inventory, as well as greaterawareness by a greater number of individuals of the inventory levels and theavailability of certain finished goods.

*Negative Bill of Materials**.*  We identified anissue regarding the accounting for excess inventory that was issued withrespect to work orders but was subsequently restocked.  Ultimately, the manufacturing system will beprogrammed to perform these entries automatically; however, until theprogramming is complete, we will continue to make manual adjustments withrespect thereto.

*Physical Inventories**. *We utilize aperpetual inventory system with a substantial portion of our inventory beingsubjected to daily cycle counts. Management performed added physical countsduring fiscal year 2006 and the Inventory Accounting Manager and members of thecycle count teams visited certain of our offsite warehouses to performadditional detailed physical counts and tests during fiscal 2006.  We will continue to perform additionaldetailed physical counts at our offsite warehouses during fiscal 2007.

*Quarterly Adjustments of PurchasePrice Variances**.*Our VicePresident/Corporate Controller and our Inventory Accounting Manager areperforming quarterly analyses of any purchase price variances that may occurwhen there is a deviation from our standard prices and are making the necessaryadjustments to properly value our cost of sales, inventory and fixed assets.

37

----

*IneffectiveControls Related to Income Taxes*

We have increasedour internal capabilities in the income tax area with the addition of our ChiefFinancial Officer, Vice President of Corporate Accounting and Manager of Tax,as well as with the continued assistance of third party consultants. These individualsperform significant internal reviews of our income tax provision eachquarter.  We continue to use the servicesof large local law firms and accounting firms in foreign jurisdictions in orderto ensure that we are in compliance with local tax laws. We are also performingan annual R&D tax study and consulting with a nationally recognizedaccounting firm on certain transfer pricing studies as well.

*IneffectiveControls at the Entity Level*

We have taken thefollowing actions to remediate the issues previously identified with respect toour ineffective controls at the entity level.

*IT Systems**.*  We continue toaddress areas of our IT system that require additional investment. Consultantsfrom the IT Systems provider (MAPICS) have been engaged to perform a review ofour current usage of our system, and the cost benefits of upgrades that areavailable.

*Control Environment**.* OnDecember 1, 2006, our Board of Directors appointed Mr. Robert Guido as anindependent director to fill a vacancy on the board.  Mr. Guido will alsoserve on the Audit Committee.  The Board of Directors affirmativelydetermined that Mr. Guido is an Audit Committee financial expert under therules of the SEC.

*Internal Audit.* In addition to the personnel changes discussedabove, we have hired a new Vice President to head our Internal Auditdepartment. This individual led our Sarbanes-Oxley testing for fiscal year 2006as well as coordinated efforts with the outside firm we hired in the 2005compliance effort.  To better utilize the resources of the outside firmduring fiscal year 2007 and 2006, several changes have been made to itsengagement, including changing the protocols and personnel on the engagementteam.

38

----

**PART II**

# **ITEM 1.****                             LEGALPROCEEDINGS**

***Litigation***

On September 25, 1995,Bally Gaming Inc, a wholly-owned subsidiary of the Company (“BGI”), was namedas a defendant in a class action lawsuit filed in the United States DistrictCourt for the District of Nevada. The plaintiffs filed suit against BGI andapproximately 45 other defendants, each of which is involved in the gamingbusiness as a gaming machine manufacturer, distributor or casino operator. Thelawsuit arises out of alleged fraudulent marketing and operation of casinovideo poker machines and electronic slot machines. The plaintiffs alleged thatthe defendants have engaged in a course of fraudulent and misleading conductintended to induce people into playing their gaming machines based on a falsebelief concerning how those machines actually operate, as well as the extent towhich there is actually an opportunity to win on any given play. The plaintiffsallege that the defendants’ actions constitute violations of the RacketeerInfluenced and Corrupt Organizations Act (RICO) and give rise to claims ofcommon law fraud and unjust enrichment. The plaintiffs are seeking monetarydamages in excess of $1.0 billion. In July 2002, the Federal DistrictCourt denied the plaintiffs’ request for class action certification. In August2004, the United States Court of Appeals for the Ninth Circuit affirmed theFederal District Court’s denial of class action certification, and theplaintiffs did not appeal. Subsequently, two of the four named plaintiffselected to continue their cases as individual, non-class actions. However, inSeptember 2005, the court granted the defendants’ motions for summary judgment,resolving all claims in defendants’ favor without a trial. In October 2005, theplaintiffs appealed the District Court’s granting of summary judgment in favorof the defendants to the Ninth Circuit. Thereafter, the plaintiffs/appellantsagreed to dismiss their appeal in exchange for the defendants’ agreement not topursue a claim for costs.  The appeal wasdismissed on June 26, 2006.

In June and July2004, putative class actions were filed against Bally and its officers, RobertMiodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in the UnitedStates District Court for the District of Nevada. The nearly identicalcomplaints alleged violations of the Securities Exchange Act of 1934, asamended, stemming from revised earnings guidance, declines in the stock priceand sales of stock by insiders. The complaints sought damages in unspecifiedamounts. The Federal District Court granted the plaintiffs’ unopposed motionsto consolidate the cases and to appoint a lead counsel and a lead plaintiff,and the plaintiffs filed a consolidated complaint, all as is customary in suchcases. Bally and the other defendants have moved to dismiss the complaint.Thereafter, activity in the case was suspended and the parties participated ina mediation process.  The parties havereached an agreement in principle and are negotiating settlement documents,which will require court approval.

Inaddition, in July 2004, two derivative lawsuits were filed in Nevada statecourt against the members of the board of directors and the officers listedabove. The Company was named as a nominal defendant in the derivative lawsuitsas the claims were purportedly asserted for the benefit of Bally. Theselawsuits asserted claims for breach of fiduciary duty and waste of corporateassets arising out of the same events as those giving rise to the class actionsdescribed above, and sought injunctive relief and damages in unspecifiedamounts. These two cases were consolidated, and Bally and the other defendantsmoved to dismiss the case. In February 2005, the state district court grantedthe defendants’ motion and dismissed the case. The plaintiffs appealed the dismissalto the Nevada Supreme Court, which referred the matter to its settlementconference program. The parties met with a court-appointed settlement judge onDecember 15, 2005, and agreed to settle the case for $8,000, and on February 2,2006, the Nevada Supreme Court entered its order formally dismissing theappeal, thereby terminating the case. Although management believes theplaintiffs’ lawsuit and appeal were without merit, it determined that thesettlement was in the best interests of the Company.

OnMarch 27, 2006, shortly after the aforementioned derivative suit was dismissedin the Nevada state court, another derivative lawsuit was filed in the UnitedStates District Court for the District of Nevada against individual defendantsRobert Miodunski, Robert Saxton, Steven Des Champs, Mark Lerner, David Robbins,Anthony DiCesare, Joel Kirschbaum, Kevin Verner, Richard Haddrill, StephenRace, Jacques André and nominal defendant Bally Technologies, Inc., in theUnited States District Court for the District of Nevada.  Based on factual allegations 

39

----

thatare similar to those alleged in the federal securities class action complaintsand the previous derivative actions that were dismissed by the District Court,the derivative complaint alleges breach of fiduciary duty, abuse of control,gross mismanagement, waste of corporate assets, unjust enrichment and violationof the Sarbanes-Oxley Act of 2002. The parties have reached an agreement inprinciple and are negotiating settlement documents.

During the threemonths ended September 30, 2005, the Company accrued $1.3 million related tothe anticipated settlement of the class action litigation and the March 27,2006 derivative suit.  The Company alsoaccrued approximately $0.2 million for legal fees related to the litigation inthe three months ended September 30, 2005, which totaled $1.9 million for thefiscal year ended June 30, 2006.

In August 2004,Shuffle Master, Inc. sued the Company in the United States District Court forthe District of Nevada, alleging infringement of various patents in connectionwith the Company’s MindPlay product line and seeking injunctive relief anddamages in an unspecified amount. In June 2005, it was announced thatInternational Gaming Technology (“IGT”) had acquired an interest in the patentsat issue in the case, and thereafter IGT joined the case as a plaintiff.  In December 2005, the DistrictCourt issued a ruling construing the claim terms of all the patents in thesuit. Management believes the plaintiffs’ lawsuit to be without merit, andthe Company is vigorously defending against the lawsuit.

In September 2004, aUnited States District Court jury in the District of Nevada entered a $7.4million verdict against the Company in a suit filed by AGI and IGT. The suitalleged that the multi-hand video poker game deployed by the Company’s formersubsidiary, United Coin Machine Co. (“United Coin”), infringed the plaintiffs’patents. The Federal District Court ruled on summary judgment that the gamedoes not infringe the patents. However, the court left to the jury the questionwhether the use of “autohold,” a specific, optional feature of the game, causedit to infringe under the “doctrine of equivalents,” a doctrine of patent law.After a two-week trial, the jury determined that the game with the autoholdoption enabled did infringe under the doctrine of equivalents and awardeddamages accordingly. The feature has been disabled on all affected games in thefield, and the decision permits continued deployment of the game as long as theautohold feature is not included. The Company appealed the decision to theUnited States Court of Appeals for the Ninth Circuit and has posted a cash bondtotaling $7.6 million to stay payment of the judgment and accrued interestpending the appeal. The cash bond is included in other non-current assets andthe accrued liability is included in accrued liabilities in the accompanyingbalance sheets. This amount has been accrued and the expense for this charge isincluded in discontinued operations in the accompanying statement of operationsfor 2004.   On July 11, 2006, the federalcircuit court of appeals affirmed the district court judgment, denying theappeals for both parties, and thereafter the judgment was satisfied out of theposted bond.

On December 7, 2004,IGT filed a patent infringement lawsuit against Bally in the United StatesDistrict Court for the District of Nevada. The complaint asserts that Bally’swheel-based games, such as Monte Carlo, Lucky Wheel and Cash For Life, itsgames with a reel in the top box, such as Bonus Frenzy, and its iView productsinfringe on patents held by IGT, and seeks injunctive relief and damages inunspecified amounts. Bally believes IGT’s claims are without merit and isvigorously defending itself against the lawsuit. As part of its defense, Ballyhas asserted counterclaims against IGT, including claims that IGT’s patents areinvalid, unenforceable and not infringed, as well as several claims thatIGT has engaged in anti-competitive conduct in violation of state and federalantitrust laws. By its counterclaims, Bally is seeking damages and other relieffrom IGT. IGT’s motion to dismiss Bally’s antitrust claims was deniedon January 10, 2006. The litigation is in the discovery phase and no trialdate has been set.

InFebruary 2005, the SEC initiated an informal inquiry and requested documentsand information regarding matters related to the allegations in the classactions and similar matters. In August 2005, the SEC notified the Company thatits investigation had entered a formal phase, and requested additionalinformation from the Company covering the same general areas that wereaddressed in the informal inquiry. Management is cooperating fully with the SECin this matter.

In May2006, IGT filed a patent infringement lawsuit against Bally in the UnitedStates District Court for the District of Delaware.  The complaint asserts that Bally’s PowerBonusing products infringe patents held by IGT, and seeks injunctive relief anddamages in unspecified amounts.  IGT’smotion for a preliminary injunction is pending. Bally believes IGT’s claims are without merit, including its request forpreliminary relief and is vigorously defending itself against the lawsuit.

40

----

InSeptember 2006, Bally filed a patent infringement lawsuit against IGT in theUnited States District Court for the District of Nevada.  The complaint asserts that certain of IGT’sbonus wheel games infringe patents held by Bally, and seeks injunctive reliefand damages.  IGT filed an answergenerally denying the claims.  The caseis in the discovery phase and no trial date has been set.

The Company is also a party to various lawsuits relating to routinematters incidental to our business. Management does not believe that the outcome of such litigation,including the matters above, in the aggregate, will have a material adverseeffect on our financial position.

41

----

**ITEM 6.****                                  Exhibits**
| Exhibits | ** ** | **Description**                                                                                                                                       |
|----------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |       |                                                                                                                                                  |
| 31.1     |       | Certification of Chief Executive Officer, pursuant  to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                             |
|     |       |                                                                                                                                                  |
| 31.2     |       | Certification of Chief Financial Officer, pursuant  to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                             |
|     |       |                                                                                                                                                  |
| 32.1     |       | Certification of Chief Executive Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the  Sarbanes-Oxley Act of 2002. |
|     |       |                                                                                                                                                  |
| 32.2     |       | Certification of Chief Financial Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the  Sarbanes-Oxley Act of 2002. |

 

42

----

SIGNATURES

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto authorized.

 
| BALLY TECHNOLOGIES, INC. | Date: December 21, 2006                                          |
|--------------------------|------------------------------------------------------------------|
|                     |                                                             |
|                     |                                                             |
| By                       | /s/ Richard Haddrill                                             |   |   |
|                     | Richard Haddrill                                                 |   |
|                     | President and Chief Executive Officer                            |   |
|                     | (Principal Executive Officer)                                    |   |
|                     |                                                             |   |
|                     |                                                             |   |
| By                       | /s/ Robert C. Caller                                             |   |   |
|                     | Robert C. Caller                                                 |   |
|                     | Executive Vice President, Chief Financial Officer  and Treasurer |   |
|                     | (Principal Financial and Accounting Officer)                     |   |
|                          |                                                                  |  |  |  |

 

43

----