** **

**UNITED STATES****SECURITIES AND EXCHANGECOMMISSION****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 ended December 31, 2006**

**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 checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  o Yes    xNo

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer or a non-accelerated filer.    See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.  (Check one):

| o  Large Accelerated Filer |   | x  Accelerated Filer |   | o  Non-Accelerated Filer |
|----------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).  o Yes  xNo

Thenumber of shares of Common Stock, $0.10 par value, outstanding as of June 15,2007, according to the records of the registrant’s registrar and transfer agentwas 53,972,000 which does not include 587,000 shares held in treasury.

 

----

**EXPLANATORY NOTE**

As previouslydisclosed on the Form 12b-25 of Bally Technologies, Inc. (“Bally,” the “Company,”or “we”), filed with the Securities and Exchange Commission (the “SEC”) onFebruary 12, 2007, the filing of this Quarterly Report on Form 10-Q for thequarter ended December 31, 2006 was originally delayed due to the significantamount of additional time and resources necessary to complete our amended andrestated Annual Report on Form 10-K for the fiscal year ended June 30, 2005(the “2005 10-K/A”), which was filed with the SEC on October 31, 2006.  The filing of this Quarterly Report on Form10-Q was further delayed by the significant amount of time and resourcesnecessary to complete our Quarterly Reports on Form 10-Q for the quarters endedSeptember 30, 2005, December 31, 2005 and March 31, 2006, as well as our AnnualReport on Form 10-K for the fiscal year ended June 30, 2006 (the “2006 10-K”),which was filed with the SEC on March 15, 2007. Furthermore, the preparation ofthe financial information presented in this Quarterly Report on Form 10-Qrequired additional time and resources because it was prepared while certainmaterial weaknesses existed in our internal control over financial reporting.

**I N D E X**
|                | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|----------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I.**    | ** ** | **FINANCIAL INFORMATION**                                                                                                        |       |       |
|           |       |                                                                                                                             |       |       |
| Item 1.        |       | Financial Statements                                                                                                             |       |       |
|           |       |                                                                                                                             |       |       |
|           |       | Unaudited Condensed Consolidated Balance Sheets as of  December 31, 2006 and June 30, 2006                                       |       |       |
|           |       |                                                                                                                             |       |       |
|           |       | Unaudited Condensed Consolidated Statements of  Operations for the Three Months and Six Months Ended December 31, 2006 and  2005 |       |       |
|           |       |                                                                                                                             |       |       |
|           |       | Unaudited Condensed Consolidated Statements of Cash  Flows for the Six Months Ended December 31, 2006 and 2005                   |       |       |
|           |       |                                                                                                                             |       |       |
|           |       | 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 1A.       |       | Risk Factors                                                                                                                     |       |       |
|           |       |                                                                                                                             |       |       |
| Item 6.        |       | Exhibits                                                                                                                         |       |       |
|           |       |                                                                                                                             |       |       |
| **SIGNATURES** |       |                                                                                                                             |

 

----

**PART I**

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES****UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                       | ** ** | **December 31,**                                   | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                       | ** ** | **2006**                                                | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                       | ** ** | **(in 000s, except share amounts)** | ** ** |
| ASSETS                                                                                                                                           |       |                                                    |       |              |       |
| Current assets:                                                                                                                                  |       |                                                    |       |              |       |
| Cash and cash  equivalents                                                                                                                       |       | $                                                       | 12,432     |              | $          | 16,425 |   |
| Restricted cash                                                                                                                                  |       | 15,687                                                  |       | 14,484            |       |
| Accounts and  notes receivable, net of allowances for doubtful accounts of $7,478 and  $8,073                                                    |       | 136,735                                                 |       | 135,497           |       |
| Inventories                                                                                                                                      |       | 70,281                                                  |       | 69,995            |       |
| Income taxes  receivable                                                                                                                         |       | 570                                                     |       | 266               |       |
| Deferred tax  assets, net                                                                                                                        |       | 51,374                                                  |       | 51,374            |       |
| Other current  assets                                                                                                                            |       | 42,708                                                  |       | 41,313            |       |
| Total current  assets                                                                                                                            |       | 329,787                                                 |       | 329,354           |       |
| Long-term investments  (restricted)                                                                                                              |       | 10,373                                                  |       | 8,984             |       |
| Long-term receivables                                                                                                                            |       | 5,473                                                   |       | 6,436             |       |
| Property, plant and  equipment, net of accumulated depreciation of $48,106 and $49,756                                                           |       | 78,635                                                  |       | 68,464            |       |
| Leased gaming  equipment, net of accumulated depreciation of $73,081 and $64,160                                                                 |       | 56,773                                                  |       | 43,408            |       |
| Goodwill                                                                                                                                         |       | 161,590                                                 |       | 161,303           |       |
| Intangible assets, net  of accumulated amortization of $25,971 and $23,963                                                                       |       | 24,873                                                  |       | 27,656            |       |
| Deferred tax assets,  net                                                                                                                        |       | 22,112                                                  |       | 20,048            |       |
| Other assets, net                                                                                                                                |       | 29,101                                                  |       | 22,228            |       |
| Total assets                                                                                                                                     |       | $                                                       | 718,717    |              | $          | 687,881 |   |
|                                                                                                                                             |       |                                                    |       |              |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                       |       |                                                    |       |              |       |
| Current liabilities:                                                                                                                             |       |                                                    |       |              |       |
| Accounts payable                                                                                                                                 |       | $                                                       | 34,379     |              | $          | 39,622 |   |
| Accrued  liabilities                                                                                                                             |       | 74,375                                                  |       | 86,131            |       |
| Jackpot  liabilities                                                                                                                             |       | 13,388                                                  |       | 13,139            |       |
| Deferred revenue                                                                                                                                 |       | 63,453                                                  |       | 47,081            |       |
| Current  maturities of long-term debt and capital leases, including $5,219 and $6,600  owed to related parties                                   |       | 16,066                                                  |       | 12,864            |       |
| Total current  liabilities                                                                                                                       |       | 201,661                                                 |       | 198,837           |       |
| Long-term debt and  capital leases, net of current maturities, including $8,981 and $7,600 owed  to related parties                              |       | 328,115                                                 |       | 315,482           |       |
| Other liabilities                                                                                                                                |       | 33,859                                                  |       | 28,800            |       |
| Total  liabilities                                                                                                                               |       | 563,635                                                 |       | 543,119           |       |
| Minority interest                                                                                                                                |       | 1,554                                                   |       | 684               |       |
| Commitment and  Contingencies (Note 9)                                                                                                           |       |                                                    |       |              |       |
| 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; 53,741,000 and 52,880,000  shares issued and 53,210,000 and 52,354,000 outstanding |       | 5,368                                                   |       | 5,283             |       |
| Treasury stock  at cost, 531,000 and 526,000 shares                                                                                              |       | (706                                                    | )          | (665              | )          |
| Additional  paid-in capital                                                                                                                      |       | 231,851                                                 |       | 219,472           |       |
| Accumulated  other comprehensive income                                                                                                          |       | 1,118                                                   |       | 1,351             |       |
| Accumulated  deficit                                                                                                                             |       | (84,115                                                 | )          | (81,375           | )          |
| Total  stockholders’ equity                                                                                                                 |       | 153,528                                                 |       | 144,078           |       |
| Total liabilities and  stockholders’ equity                                                                                                 |       | $                                                       | 718,717    |              | $          | 687,881 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

2

----

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                      | ** ** | **Three Months Ended**                                 | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **December 31,**                                            | ** ** | **December 31,**          | ** ** |
| ** **                                      | ** ** | **2006**                                                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Revenues:                                       |       |                                                             |       |                           |       |   |   |   |   |
| Gaming equipment and systems                    |       | $                                                                | 140,533    |                           | $          | 113,961 |   | $ | 282,496 |   | $ | 208,756 |   |
| Casino operations                               |       | 11,238                                                           |       | 13,513                         |       | 23,077 |   | 24,158 |   |
|                                            |       | 151,771                                                          |       | 127,474                        |       | 305,573 |   | 232,914 |   |
| Costs and  expenses:                            |       |                                                             |       |                           |       |   |   |   |   |
| Cost of gaming equipment and systems            |       | 70,653                                                           |       | 65,266                         |       | 143,540 |   | 114,163 |   |
| Cost of casino operations                       |       | 4,439                                                            |       | 4,939                          |       | 8,901 |   | 9,222 |   |
| Selling, general and administrative             |       | 51,622                                                           |       | 46,028                         |       | 101,666 |   | 86,960 |   |
| Research and development costs                  |       | 13,307                                                           |       | 10,785                         |       | 25,863 |   | 21,042 |   |
| Depreciation and amortization                   |       | 5,903                                                            |       | 6,951                          |       | 11,336 |   | 12,824 |   |
|                                            |       | 145,924                                                          |       | 133,969                        |       | 291,306 |   | 244,211 |   |
| Operating income  (loss)                        |       | 5,847                                                            |       | (6,495                         | )          | 14,267 |   | (11,297 | ) |
| Other income  (expense):                        |       |                                                             |       |                           |       |   |   |   |   |
| Interest income                                 |       | 413                                                              |       | 589                            |       | 1,324 |   | 1,492 |   |
| Interest expense                                |       | (10,200)                                                         |       | (7,272                         | )          | (18,121 | ) | (13,204 | ) |
| Other, net                                      |       | 675                                                              |       | (250                           | )          | 925 |   | (521 | ) |
| Loss before  income taxes and minority interest |       | (3,265                                                           | )          | (13,428                        | )          | (1,605 | ) | (23,530 | ) |
| Income tax benefit                              |       | 2,358                                                            |       | 4,702                          |       | 1,687 |   | 8,835 |   |
| Minority interest                               |       | (1,608                                                           | )          | (177                           | )          | (2,822 | ) | (2,587 | ) |
| Net loss                                        |       | $                                                                | (2,515     | )                              | $          | (8,903 | ) | $ | (2,740 | ) | $ | (17,282 | ) |
| Basic and  diluted loss per share               |       | $                                                                | (0.05      | )                              | $          | (0.17 | ) | $ | (0.05 | ) | $ | (0.33 | ) |
| Weighted average  shares outstanding:           |       |                                                             |       |                           |       |   |   |   |   |
| Basic and  diluted                              |       | 53,072                                                           |       | 52,138                         |       | 52,985 |   | 52,138 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

3

----

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES****UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                       | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | **(in 000s)**                                | ** ** |
| Cash flows from  operating activities:                                           |       |                                              |       |   |   |
| Net loss                                                                         |       | $                                                 | (2,740     | ) | $ | (17,282 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                    |       | 29,330                                            |       | 30,938 |   |
| Share-based compensation                                                         |       | 8,112                                             |       | 5,914 |   |
| Deferred income taxes                                                            |       | (2,063                                            | )          | (9,012 | ) |
| Provision for doubtful accounts                                                  |       | 290                                               |       | 680 |   |
| Inventory and other asset write-downs                                            |       | 6,215                                             |       | 7,983 |   |
| Other                                                                            |       | 9,523                                             |       | 6,960 |   |
| Changes in  operating assets and liabilities:                                    |       |                                              |       |   |   |
| Accounts and notes receivable                                                    |       | (1,036                                            | )          | (23,809 | ) |
| Inventories                                                                      |       | (10,719                                           | )          | 4,446 |   |
| Other current assets                                                             |       | (785                                              | )          | 3,656 |   |
| Accounts payable                                                                 |       | (6,759                                            | )          | (8,847 | ) |
| Accrued liabilities, deferred revenue and jackpot  liabilities                   |       | 2,901                                             |       | 21,540 |   |
| Net cash  provided by operating activities                                       |       | 32,269                                            |       | 23,167 |   |
|                                                                             |       |                                              |       |   |   |
| Cash flows from  investing activities:                                           |       |                                              |       |   |   |
| Additions to property, plant, and equipment                                      |       | (8,778                                            | )          | (6,246 | ) |
| Additions to leased gaming equipment                                             |       | (47,486                                           | )          | (19,933 | ) |
| Restricted cash and investments                                                  |       | (1,138                                            | )          | (866 | ) |
| Additions to other long-term assets                                              |       | (1,251                                            | )          | (1,804 | ) |
| Net cash used in  investing activities                                           |       | (58,653                                           | )          | (28,849 | ) |
|                                                                             |       |                                              |       |   |   |
| Cash flows from  financing activities:                                           |       |                                              |       |   |   |
| Proceeds from revolving credit facility                                          |       | 5,000                                             |       | — |   |
| Payments on revolving credit facility                                            |       | (5,000                                            | )          | — |   |
| Reduction of long-term debt                                                      |       | (4,224                                            | )          | (3,042 | ) |
| Proceeds from sale lease-back arrangements                                       |       | 22,303                                            |       | — |   |
| Proceeds from exercise of stock options                                          |       | 4,311                                             |       | 172 |   |
| Net cash  provided by (used in) financing activities                             |       | 22,390                                            |       | (2,870 | ) |
|                                                                             |       |                                              |       |   |   |
| Effect of  exchange rate changes on cash                                         |       | 1                                                 |       | 23 |   |
|                                                                             |       |                                              |       |   |   |
| Cash and cash  equivalents:                                                      |       |                                              |       |   |   |
| Decrease for period                                                              |       | (3,993                                            | )          | (8,529 | ) |
| Balance, beginning of period                                                     |       | 16,425                                            |       | 33,170 |   |
| Balance, end of  period                                                          |       | $                                                 | 12,432     |   | $ | 24,641 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

4

----

**BALLY TECHNOLOGIES, INC.****FORM 10-Q**Notes to UnauditedCondensed Consolidated Financial Statements

**1.             BASIS OFPRESENTATION**

*Principles of presentation and consolidation*

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesand pursuant to the rules and regulations of the Securities and ExchangeCommission (the “SEC”) and reflect all adjustments, consisting of normalrecurring adjustments, which management believes are necessary to fairlypresent the financial position, results of operations and cash flows of BallyTechnologies, Inc., a Nevada corporation, and its subsidiaries (“Bally” or the “Company”)for the respective periods presented. The results of operations for an interim period are not necessarilyindicative of the results that may be expected for any other interim period orthe year as a whole. The accompanying unaudited condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto in the Company’s AnnualReport on Form 10-K for the fiscal year ended June 30, 2006 as filed with theSEC on March 15, 2007.

Bally is a diversified, worldwide gaming company thatdesigns, manufactures, distributes and operates gaming machines andcomputerized monitoring systems for gaming machines and owns and operates onecasino.

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 increases to 20% of the incremental amount ofrevenues in excess of $35.0 million, payable quarterly 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.  The Company consolidates RCVP and records anadjustment to reflect the portion of the earnings of RCVP attributable to theminority shareholders.  As of September30, 2006, RCVP did not meet the requirements for classification as an assetheld for sale or discontinued operations.

The Company also consolidates certain Atlantic Cityprogressive trusts in accordance with Financial Accounting Standards Board (“FASB”)Interpretation (“FIN”) 46R, *Consolidation of VariableInterest Entities,*which addresses consolidation by abusiness enterprise of variable interest entities (“VIE’s”) that either: (1) donot have sufficient equity investment at risk to permit the entity to financeits activities without additional subordinated financial support or (2) hold asignificant variable interest in, or have significant involvement with, anexisting VIE.  As of December 31, 2006 and June 30, 2006, theCompany consolidated $6.2 million and $4.7 million, respectively, in totalassets and liabilities, primarily consisting of restricted cash accounts andrestricted investments (included in other assets in the condensed consolidatedbalance sheets) and related jackpot liabilities.  The following revenues and costs were alsoconsolidated:
| ** **                            | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in 000s)**                                  | ** ** |
|                                  |       |                                                |       |                                              |       |   |   |   |   |
| Gaming equipment  and systems revenue |       | $                                                   | 1,655      |                                              | $          | 1,717 |   | $ | 4,001 |   | $ | 4,337 |   |
| Cost of gaming  equipment and systems |       | 322                                                 |       | 2,335                                             |       | 1,806 |   | 3,273 |   |
|                                       |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

All intercompany accounts andtransactions have been eliminated in consolidation.

*Reclassifications*Pursuant to Emerging Issues Task Force (EITF) Issue No. 00-22, *Accounting for “Points” and Certain Other Time-Based or Volume-BasedSales Incentive Offers, and Offers for Free Products or Services to BeDelivered in the Future*, and EITF No. 01-09, *Accountingfor Consideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products)*, the Company has concluded that certainpromotional expenses, representing coupons redeemable for cash incentives,should be presented as an offset against casino operations revenue. Accordingly,we have reclassified $1.0 million and $1.9 million, respectively, for the threeand six months ended December 31, 2005, 

5

----

from selling,general and administrative expense as an offset against casino operationsrevenue to conform to the current period presentation.

*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 $1.8 million and $4.1million and $6.2 million and $8.0 million for the three and six months endedDecember 31, 2006 and 2005, respectively. These charges are classified in cost of gaming equipment and systems inthe consolidated statements of operations.

*Property,plant and equipment and leased gaming equipment*

Property,plant and equipment is stated at cost and depreciated over the estimated usefullives or lease term, if less, using the straight line method as follows:buildings and improvements, 28 to 40 years; gaming equipment, 4 to 7 years;furniture, fixtures and equipment, 3 to 7 years; and leasehold improvements, 5to 10 years. Leased gaming equipment is stated at cost and depreciated over theestimated useful lives ranging from 2 to 31⁄2 years.

*Recently Issued AccountingPronouncements*

In February 2007,the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 159, *The Fair Value Option for Financial Assetsand Financial Liabilities*. SFAS No.159 provides companies with anoption to report selected financial assets and liabilities at fair value. Italso establishes presentation and disclosure requirements to facilitatecomparisons between companies using different measurement attributes forsimilar types of assets and liabilities. The statement is effective for fiscalyears beginning after November 15, 2007, and accordingly, the Company expectsto adopt SFAS No. 159 beginning in fiscal 2009. Earlier application ispermitted provided the Company also applies the provisions of SFAS No. 157, *Fair Value Measurements*. The Company is currently in theprocess of evaluating the impact SFAS No. 159 will have on its consolidatedresults of operations, financial position and cash flows.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, rather it applies to existing accounting pronouncements thatrequire or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15,2007, and accordingly, the Company expects to adopt SFAS No. 157 beginning infiscal 2009. The Company is currently in the process of evaluating the impactSFAS No. 157 will have on its consolidated results of operations, financialposition 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. Theprovisions of SAB No. 108 were effective beginning with the Company’s fiscalyear ending June 30, 2007.  The adoptionSAB No. 108 did not have a material impact on the Company’s consolidatedresults 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 fiscal 2008. The Company iscurrently in the process of evaluating the impact FIN 48 will have on itsconsolidated results of operations, financial position and cash flows.

6

----

**2.             EARNINGS (LOSS) PER SHARE**

The computation of basic and diluted loss per share applicable to theCompany’s common stock is as follows:
| ** **                                   | ** ** | **Three Months Ended  December 31,**              | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                         | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Net loss                                     |       | $                                                                | (2,515     | )                                                 | $          | (8,903 | ) | $ | (2,740 | ) | $ | (17,282 | ) |
|                                         |       |                                                             |       |                                              |       |   |   |   |   |
| Weighted average  common shares outstanding: |       |                                                             |       |                                              |       |   |   |   |   |
| Basic and  diluted                           |       | 53,072                                                           |       | 52,138                                            |       | 52,985 |   | 52,138 |   |
|                                         |       |                                                             |       |                                              |       |   |   |   |   |
| Basic and dilutive loss  per share           |       | $                                                                | (0.05      | )                                                 | $          | (0.17 | ) | $ | (0.05 | ) | $ | (0.33 | ) |

 

For the three andsix month periods ended December 31, 2006 and 2005, all potentially dilutivesecurities were excluded from the diluted per share calculation as theirinclusion would have been anti-dilutive due to the net loss reported.  Such securities consist of the following:
| ** **       | ** ** | **Three Months Ended  December 31, ** | ** ** | **Six Months Ended  December 31, ** | ** ** |
|------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **       | ** ** | **2006**                                                  | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **       | ** ** | **(in 000s)**                                        | ** ** |
| Stock options    |       | 8,980                                                     |       | 9,111                                                   |       | 8,721 |   | 8,952 |   |
| Warrants         |       | 100                                                       |       | 100                                                     |       | 100 |   | 100 |   |
| Restricted stock |       | 621                                                       |       | 554                                                     |       | 593 |   | 554 |   |
| Total            |       | 9,701                                                     |       | 9,765                                                   |       | 9,414 |   | 9,606 |   |

 

Asof December 31, 2006 and 2005, the Company also had certain related party debtoutstanding which is convertible into common stock at the Company’s discretion.  The potential dilution from this convertibledebt has not been included in the diluted loss per share computation for thethree and six months ended December 31, 2006 and 2005, due to the reported netloss for the periods.  Assuming theconversion occurred on December 31, 2006 and 2005, an additional 0.6 millionand 1.1 million shares, respectively, would have been outstanding as a resultof the conversion.

**3.             SHARE-BASED COMPENSATION**

In December 2001, theCompany’s shareholders approved the 2001 Long-Term Incentive Plan (as amended,the “2001 Plan”). The 2001 Plan provides for the issuance of up to 10,550,000shares of common stock to Company employees, directors and designated paidconsultants, which amount consists of up to 900,000 shares of restricted stockor Restricted Stock Units (“RSUs”). Generally, options are granted at the fairvalue of the Company’s common stock at the date of grant and are exercisableover ten years.

Effective July 1,2005, the Company adopted the provisions of SFAS No. 123R, *Share-Based Payment*, which established accounting forequity instruments exchanged for employee services. SFAS No. 123R 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 the Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*.  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).  In March2005, the SEC issued Staff Accounting Bulletin (“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 

7

----

(and related grossprofits and margins), research and development costs, and selling, general andadministrative expenses.

The following tablepresents share-based compensation expense included in the Company’s condensedconsolidated statements of operations: 
| ** **                                   | ** ** | **Three Months Ended  December 31** | ** ** | **Six Months Ended  December 31** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                           | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                                 | ** ** |
| Selling, general  and administrative         |       | $                                                  | 3,931      |                                             | $          | 2,882 |   | $ | 7,277 |   | $ | 5,372 |   |
| Research and  development                    |       | 392                                                |       | 265                                              |       | 767 |   | 496 |   |
| Cost of gaming  and equipment                |       | 37                                                 |       | 25                                               |       | 68 |   | 46 |   |
| Share-based  compensation expense before tax |       | 4,360                                              |       | 3,172                                            |       | 8,112 |   | 5,914 |   |
| Income tax benefit                           |       | 1,526                                              |       | 1,110                                            |       | 2,839 |   | 2,069 |   |
| Net share-based  compensation expense        |       | $                                                  | 2,834      |                                             | $          | 2,062 |   | $ | 5,273 |   | $ | 3,845 |   |

 

As of December 31, 2006,there was $26.8 million of total unrecognized compensation expense related tothe unvested portion of stock options which will be recognized over the nextfour 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 expected annualdividend yield. The Company believes that the valuation technique and theapproach 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 periods referenced below was estimated on the grant dateusing the Black-Scholes valuation model with the following assumptions:
| ** **                      | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted  Average:              |       |                                                |       |                                              |       |   |   |   |   |
| Expected option term (in years) |       | 6.14                                                |       | 6.25                                              |       | 6.18 |   | 6.37 |   |
| Expected volatility             |       | 56.82                                               | %          | 61.56                                             | %          | 57.41 | % | 62.01 | % |
| Risk-free interest rate         |       | 4.70                                                | %          | 4.18                                              | %          | 4.76 | % | 3.74 | % |
| Expected annual  dividend yield |       | —                                              |       | —                                            |       | — |   | — |   |

 

Stock optionactivity as of and for the six months ended December 31, 2006 is summarizedbelow:
| ** **                                   | ** ** | **Weighted Average** | ** ** |
|----------------------------------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **Shares**                | ** ** | **Exercise**

**Price** | ** ** | **Remaining**

**Contractual**

**Term** | ** ** | **Aggregate**

**Intrinsic**

**Value** | ** ** |
| ** **                                   | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** | **(years)** | ** ** | **(in 000s)** | ** ** |
| Balance  outstanding as of June 30, 2006     |       | 9,640                     |       | $ | 14.61 |   | 6.41 |   | $ | 32,290 |   |
| Granted                                      |       | 882                       |       | 18.30 |   |   |   |   |   |
| Exercised                                    |       | (756                      | )          | 5.75 |   |   |   |   |   |
| Forfeited or expired                         |       | (581                      | )          | 15.48 |   |   |   |   |   |
| Balance  outstanding as of December 31, 2006 |       | 9,185                     |       | $ | 15.63 |   | 6.54 |   | $ | 37,386 |   |
|                                         |       |                      |       |   |   |   |   |   |   |
| Exercisable as of  December 31, 2006         |       | 5,286                     |       | $ | 16.92 |   | 5.40 |   | $ | 18,306 |   |

 

8

----

Restricted stock andRSU activity as of and for the six months ended December 31, 2006 is summarizedbelow:
| ** **                                   | ** ** | ** **         | ** ** | **Weighted Average**        | ** ** |
|----------------------------------------------|------------|--------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **Shares**         | ** ** | **Grant  Date Fair  Value** | ** ** |
| ** **                                   | ** ** | **(in 000s)** | ** ** | **(per share)**             | ** ** |
| Balance  outstanding as of June 30, 2006     |       | 647                |       | $                                | 15.51      |   |
| Granted                                      |       | 84                 |       | 16.37                            |       |
| Forfeited or expired                         |       | (2                 | )          | 17.00                            |       |
| Balance  outstanding as of December 31, 2006 |       | 729                |       | $                                | 15.61      |   |
|                                         |       |               |       |                             |       |
| Vested as of December  31, 2006              |       | 342                |       | $                                | 15.90      |   |

 

**4.             GOODWILL ANDINTANGIBLE 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: 
| ** **                           | ** ** | **December 31,  2006** | ** ** | **June 30,  2006** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **(in 000s)**          | ** ** |
| Amortizable  intangible assets:      |       |                        |       |                    |       |
| Patents and  gaming related products |       | $                           | 20,434     |                    | $          | 19,583 |   |
| Less:  accumulated amortization      |       | (8,401                      | )          | (7,061                  | )          |
|                                 |       | 12,033                      |       | 12,522                  |       |
|                                 |       |                        |       |                    |       |
| Licenses and  other                  |       | $                           | 30,410     |                    | $          | 32,036 |   |
| Less:  accumulated amortization      |       | (17,570                     | )          | (16,902                 | )          |
|                                 |       | 12,840                      |       | 15,134                  |       |
|                                 |       |                        |       |                    |       |
| Total                                |       | $                           | 24,873     |                    | $          | 27,656 |   |

 

*Goodwill*

The changes in the carryingamount of goodwill for the six month period ended December 31, 2006, are asfollows:

|                                         | ** ** | **(in 000s)** | ** ** |
|-----------------------------------------|------------|--------------------|------------|
| Balance at June  30, 2006               |       | $                  | 161,303    |   |
| Foreign currency translation adjustment |       | 287                |       |
| Balance at December 31,  2006           |       | $                  | 161,590    |   |

 

9

----

**5.             LONG-TERM DEBT ANDCAPITAL LEASES**

Long-term debt andcapital leases consist of the following:
| ** **                                                  | ** ** | **December 31,  2006 ** | ** ** | **June 30,  2006 ** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **(in 000s)**                | ** ** |
| Revolving credit  facility                                  |       | $                                 | —     |                          | $          | — |   |
| Term loan  facility                                         |       | 309,632                           |       | 311,382                       |       |
| Capital lease  obligations                                  |       | 20,325                            |       | 2,399                         |       |
| Related party  debt (see Note 6)                            |       | 14,200                            |       | 14,200                        |       |
| Other, generally  unsecured                                 |       | 24                                |       | 365                           |       |
| Long-term debt and capital leases                           |       | 344,181                           |       | 328,346                       |       |
| Less current  maturities                                    |       | 16,066                            |       | 12,864                        |       |
| Long-term debt  and capital leases, less current maturities |       | $                                 | 328,115    |                          | $          | 315,482 |   |

 

The Company’s debtstructure at December 31, 2006 consists primarily of a term loan facility and a$75.0 million revolving credit facility, which are limited by a currentleverage ratio and debt owed to related parties. The term loan requiresprincipal reductions of approximately 1% per annum paid quarterly, with aballoon payment due in September 2009. The revolving credit facility commitment reduces annually until it comesdue in September 2008.  As of December31, 2006, the term loan had an interest rate of 8.83%, based on LIBOR plus3.25%, and the revolving credit facility had an interest rate of 7.87%, basedon LIBOR plus 2.50%. On January 4, 2007, the Company initiated its nextLIBOR-based term loan interest rate period (for a term of six months) based onthe interest rate formula of LIBOR plus 3.25%, which was 8.61%.

The term loan andthe revolving credit facility are collateralized by substantially all of theCompany’s domestic property and are guaranteed by each of the Company’sdomestic subsidiaries, other than the entity that holds the Company’s interestin its Rainbow Casino operations, and are secured by a pledge agreement. Theloan agreement governing the term loan and the revolving credit facility (the “LoanAgreement”) contains a number of maintenance and other covenants that, amongother things, restrict the ability of the Company and the ability of certain ofits subsidiaries to dispose of assets, incur additional indebtedness or issuepreferred stock, pay dividends or make other distributions, enter into certainacquisitions, repurchase equity interests or subordinated indebtedness, issueor sell equity interests of the Company’s subsidiaries, engage in mergers oracquisitions or certain transactions with subsidiaries and affiliates, and thatotherwise restrict corporate activities. The Company was in compliance with these covenants as of December 31,2006.

As of December 31,2006, the Company was also in compliance with its financial covenantsconsisting of a leverage ratio, a fixed charges coverage ratio and a minimum ofEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (asEBITDA is defined in the Loan Agreement). 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. The Company’sleverage ratio as of December 31, 2006 was 3.36 times versus a maximumallowable of 3.75 times. The maximum allowable leverage ratio declines to 3.50as of September 30, 2007, through the remaining term of the Loan Agreement.

In October 2006, the Company executed an amendment tothe Loan Agreement, which, among other things, (i) extended the due datefor the  delivery of the Company’s audited financialstatements for the fiscal year ended June 30, 2006 toDecember 31, 2006, (ii) provided that the Company deliver its quarterly reportson Form 10-Q for the Fiscal Quarters ended September 30, 2005, December 31,2005 and March 31, 2006 no later than December 31, 2006, (iii) modifiedthe definition of EBITDA to exclude up to $10.0 million of certain cashcharges and (iv) clarified that the definitionof EBITDA includes interest income on trade receivables. In exchange for the concessions granted under the amendment the Company paid anadministrative fee of $964,000, which was expensed in the quarter endedDecember 31, 2006.

In December 2006,the Company executed an additional amendment to the Loan Agreement, whichextended the due date for the  delivery of the Company’s quarterly reporton Form 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.  In exchangefor the concessions granted under the amendment the Company paid anadministrative fee of $1.2 million, which was expensed in the quarter endedDecember 31, 2006.

10

----

Capital leaseobligations represent amounts owed under lease or sale-lease back transactionsprimarily related to equipment used in the Company’s Gaming Equipment andSystems segment.  The leases are payablein thirty-six equal installments with interest imputed at a weighted averagerate of 9.12%.

The Company’srelated party debt, which totaled approximately $14.2 million as of December31, 2006, consists primarily of the debt owed to the former principals ofSierra Design Group (“SDG”) and MindPlay LLC (“MindPlay”). See Note 6, RelatedParty Transactions, below regarding related party debt.

**6.             RELATED PARTY TRANSACTIONS**

The Company completedthe acquisition of all of the assets of SDG during fiscal 2005 andsubstantially all of the assets and liabilities of MindPlay during fiscal2004.  In each acquisition, a portion ofthe consideration included subordinated debt issued to the former principals ofeach 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%.  Thefollowing table presents the outstanding related party debt and interest ratesas of the period referenced:

 
| ** **                                   | ** ** | **December 31, 2006** | ** ** | **June 30, 2006** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **Interest   Rate**        | ** ** | **Outstanding  Debt**       | ** ** | **Interest  Rate** | ** ** | **Outstanding   Debt** | ** ** |
| ** **                                   | ** ** | **(in 000s)**              | ** ** |
| SDG                                          |       | 6.39                            | %          | $                           | 11,200     |   | 6.39 | % | $ | 11,200 |   |
| MindPlay                                     |       | 6.00                            | %          | 3,000                       |       | 6.00 | % | 3,000 |   |
| Related party debt                           |       |                            |       | 14,200                      |       |   |   | 14,200 |   |
| Less current  maturities                     |       |                            |       | 5,219                       |       |   |   | 6,600 |   |
| Related party  debt, less current maturities |       |                            |       | $                           | 8,981      |   |   |   | $ | 7,600 |   |

 

The note payableto the former principals of SDG of $11.2 million is payable in annual installments through 2009.  At the Company’s discretion, the principaland accrued interest thereon can be paid in cash, or can be converted intoshares of the Company’s common stock using the average stock price for the 20business days prior to the delivery of such shares.

In February 2004, the Company acquired substantially all of the assetsand liabilities of MindPlay.  The initialpurchase price included, among other things, the issuance of a $4.0 millionnote payable.  As provided for in theacquisition agreement, under certain circumstances, the Company may offset 50%of all damages (including reasonable attorneys’ fees) up to the entire amountdue under the promissory note in connection with an indemnification claimagainst the former shareholders of MindPlay related to the Company’s patentlawsuit with Shuffle Master, Inc. (“Shuffle Master”) and International GameTechnology (“IGT”) which is described below in Note 9, Commitments and Contingencies.

The Company leases a warehouse and office facility from an entity ownedby Mr. Robert Luciano, a former principal of SDG and the Company’s ChiefTechnology Officer.  Rental paymentstotaled $112,041 and $103,000 and $224,082 and $206,000 for the three and sixmonth periods ended December 31, 2006 and 2005, respectively.

**7.             SEGMENTS ANDGEOGRAPHICAL INFORMATION**

The Companyoperates in two business segments: (i) BallyGaming Equipment and Systems which designs, manufactures, assembles,distributes and operates gaming machines and computerized monitoring andbonusing systems for gaming machines, and (ii) Casino Operations which owns andoperates a casino in Vicksburg, Mississippi. The accounting policies of thesesegments are consistent with the Company’s policies for the unaudited condensedconsolidated financial statements.

11

----

The table belowpresents information as to the Company’s revenues and operating income (loss)by segment:
| ** **                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(in 000s)**                                  | ** ** |
| Revenues:                      |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems   |       | $                                                   | 140,533    |                                              | $          | 113,961 |   | $ | 282,496 |   | $ | 208,756 |   |
| Casino Operations              |       | 11,238                                              |       | 13,513                                            |       | 23,077 |   | 24,158 |   |
| Total revenues                 |       | $                                                   | 151,771    |                                              | $          | 127,474 |   | $ | 305,573 |   | $ | 232,914 |   |
|                           |       |                                                |       |                                              |       |   |   |   |   |
| Inter-segment  revenues:       |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems   |       | $                                                   | 102        |                                              | $          | 214 |   | $ | 184 |   | $ | 303 |   |
| Casino Operations              |       | —                                              |       | —                                            |       | — |   | — |   |
| Total  inter-segment revenues  |       | $                                                   | 102        |                                              | $          | 214 |   | $ | 184 |   | $ | 303 |   |
|                           |       |                                                |       |                                              |       |   |   |   |   |
| Operating income  (loss):      |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems   |       | $                                                   | 9,076      |                                              | $          | (4,817 | ) | $ | 20,110 |   | $ | (6,245 | ) |
| Casino Operations              |       | 3,933                                               |       | 5,107                                             |       | 7,968 |   | 8,428 |   |
| Corporate/other                |       | (7,162                                              | )          | (6,785                                            | )          | (13,811 | ) | (13,480 | ) |
| Total operating income  (loss) |       | $                                                   | 5,847      |                                              | $          | (6,495 | ) | $ | 14,267 |   | $ | (11,297 | ) |

 

The Company’soperations are based primarily in the United States with sales and distributionoffices in Europe and South America.

The table belowpresents information as to the Company’s revenues and operating income (loss)by geographic region:
| ** **                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(in 000s)**                                  | ** ** |
| Revenues:                      |       |                                                |       |                                              |       |   |   |   |   |
| United States                  |       | $                                                   | 141,294    |                                              | $          | 119,193 |   | $ | 286,514 |   | $ | 219,388 |   |
| Europe                         |       | 5,232                                               |       | 4,749                                             |       | 8,715 |   | 8,204 |   |
| Other foreign                  |       | 5,245                                               |       | 3,532                                             |       | 10,344 |   | 5,322 |   |
| Total revenues                 |       | $                                                   | 151,771    |                                              | $          | 127,474 |   | $ | 305,573 |   | $ | 232,914 |   |
|                           |       |                                                |       |                                              |       |   |   |   |   |
| Operating income  (loss):      |       |                                                |       |                                              |       |   |   |   |   |
| United States                  |       | $                                                   | 5,223      |                                              | $          | (6,028 | ) | $ | 13,217 |   | $ | (10,383 | ) |
| Europe                         |       | 89                                                  |       | (643                                              | )          | (360 | ) | (1,195 | ) |
| Other foreign                  |       | 535                                                 |       | 176                                               |       | 1,410 |   | 281 |   |
| Total operating income  (loss) |       | $                                                   | 5,847      |                                              | $          | (6,495 | ) | $ | 14,267 |   | $ | (11,297 | ) |

 

 

12

----

**8.             SUPPLEMENTAL CASHFLOW INFORMATION**

The following supplemental information is related to the condensedconsolidated statements of cash flows:
|                                                                                              | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                                                                   | ** ** | **(in 000s)**                                | ** ** |
| Cash paid for  interest                                                                      |       | $                                                 | 16,809     |   | $ | 14,041 |   |
| Cash paid for  income taxes                                                                  |       | 683                                               |       | 2,289 |   |
|                                                                                         |       |                                              |       |   |   |
| Non-cash  investing and financing transactions:                                              |       |                                              |       |   |   |
| Reclassify  property, plant and equipment to inventory                                       |       | $                                                 | 6,388      |   | $ | 7,891 |   |
| Inventory in  transit                                                                        |       | 1,145                                             |       | — |   |
| Assets acquired  through sale lease-back transactions                                        |       | 11,681                                            |       | — |   |
| Unrealized gain  on sale lease-back transactions                                             |       | 3,333                                             |       | — |   |
| Receipt of  Company’s common stock as consideration for employee stock options exercise |       | 41                                                |       | — |   |
| Consolidation of  variable interest entities                                                 |       | 1,539                                             |       | 313 |   |

 

**9.             COMMITMENTS AND CONTINGENCIES**

In June and July2004, putative class actions were filed against the Company and its officers,Robert Miodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in theUnited States District Court for the District of Nevada. The nearly identicalcomplaints alleged violations of the Securities Exchange Act of 1934, asamended (the “Exchange Act”), stemming from revised earnings guidance, declinesin the stock price and sales of stock by insiders. The complaints soughtdamages in unspecified amounts. The Federal District Court granted theplaintiffs’ unopposed motions to consolidate the cases and to appoint a leadcounsel and a lead plaintiff, and the plaintiffs filed a consolidatedcomplaint, all as is customary in such cases. The Company and the other defendants moved to dismiss thecomplaint.  Thereafter, activity in thecase was stopped and the parties participated in a mediation process duringwhich the parties agreed on the terms of a settlement. The parties havenegotiated and executed settlement documents settling both the consolidatedclass action and the derivative case discussed below. Under the settlement,which has received preliminary approval from the court, an aggregate of $16.0million cash, plus certain interest, will be paid to settle the securitiesclass action as well as the derivative litigation as discussed below.  The Company will pay $1.25 million, which wasaccrued in the Company’s financial statements for the quarter ended December31, 2005. In addition to certain governance actions the Company has agreed toundertake in connection with the settlement, the Company’s directors andofficers insurer will contribute approximately $14.75 million to thesettlement.

InJuly 2004, two derivative lawsuits were filed in Nevada state court against themembers of the board of directors and the officers listed above. The Companywas named as a nominal defendant in the derivative lawsuits as the claims werepurportedly asserted for the benefit of Bally Technologies, Inc. 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 the Company and the otherdefendants moved to dismiss the case. In February 2005, the state districtcourt granted the defendants’ motion and dismissed the case. The plaintiffsappealed the dismissal to the Nevada Supreme Court, which referred the matterto its settlement 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

13

----

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.  Based on factual allegations that are similarto those alleged in the federal securities class action complaints and theprevious derivative actions that were dismissed by the District Court, thederivative complaint 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 a settlement agreementas discussed more fully above.

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 August 2004,Shuffle Master sued the Company in the United States District Court for theDistrict of Nevada, alleging infringement of various patents in connection withthe Company’s MindPlay product line and seeking injunctive relief and damagesin an unspecified amount. In June 2005, it was announced that IGT had acquiredan interest in the patents at issue in the case, and thereafter, IGT joined thecase as a plaintiff.  In December 2005, the District 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 ActionGaming (“AGI”) and IGT. The suit alleged that the multi-hand video poker gamedeployed by the Company’s former subsidiary, United Coin, infringed theplaintiffs’ patents. The Federal District Court ruled on summary judgment thatthe game did not infringe the patents. However, the court left to the jury thequestion whether the use of “autohold,” a specific, optional feature of thegame, caused it to infringe under the “doctrine of equivalents,” a doctrine ofpatent law. The jury determined that the game with the autohold option enableddid infringe under the doctrine of equivalents and awarded damages accordingly.The feature has been disabled on all affected games in the field, and thedecision permits continued deployment of the game as long as the autoholdfeature is not included. The Company appealed the decision to the United StatesCourt of Appeals for the Ninth Circuit and posted a cash bond totaling $7.6million to stay payment of the judgment and accrued interest pending theappeal.   On July 11, 2006, the federal circuitcourt of appeals affirmed the district court judgment, denying the appeals forboth parties, and thereafter, the judgment was satisfied out of the postedbond.

On December 7,2004, IGT filed a patent infringement lawsuit against the Company in the UnitedStates District Court for the District of Nevada. The complaint asserts thatthe Company’s wheel-based games, such as Monte CarloÔ,Lucky WheelÔ and Cash For LifeÔ,its games with a reel in the top box, such as Bonus FrenzyÔ,and its iViewÔ products infringe on patents held by IGT, and seeksinjunctive relief and damages in unspecified amounts. The Company believesIGT’s claims are without merit and is vigorously defending itself against thelawsuit. As part of its defense, the Company has asserted counterclaims againstIGT, including claims that IGT’s patents are invalid, unenforceable and notinfringed, as well as several claims that IGT has engaged inanti-competitive conduct in violation of state and federal antitrust laws. Byits counterclaims, the Company is seeking damages and other relief from IGT.IGT’s motion to dismiss the Company’s antitrust claims was deniedin January 2006, and in March 2007, the court denied IGT’s motions forsummary judgment with respect to the antitrust claims dealing with the wheelgame market.  The court issued claimsconstruction rulings in May 2007.  Notrial date has been set.

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

In May2006, IGT filed a patent infringement lawsuit against the Company in the UnitedStates District Court for the District of Delaware.  The complaint asserts that the Bally PowerBonusingÔ products infringepatents held by IGT, and seeks injunctive relief and damages in unspecified amounts.  The Company believes IGT’s claims are withoutmerit and is

14

----

vigorouslydefending itself against the lawsuit.

The Company isalso a party to various lawsuits relating to routine matters incidental to ourbusiness.  Management does not believethat the outcome of such litigation, including the matters above, in theaggregate, will have a material adverse effect on our consolidated financialposition, results of operations or cash flows.

15

----

**ITEM 2.**                    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We begin this Management’s Discussion and Analysis of FinancialCondition and Results of Operations with an overview of our key operatingbusiness divisions and significant trends as of December 31, 2006.  This overview is followed by a detailedanalysis of our results of operations and our financial condition as of, andfor, the three and six months ended December 31, 2006.

**Forward-LookingStatements**

Certain matters in this Quarterly Report on Form 10-Q for the three andsix month periods ended December 31, 2006 and our other filings with the SEC,including, without limitation, certain matters discussed in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations and inQuantitative and Qualitative 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 events andfinancial 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 other characterizations of futureevents or circumstances are forward-looking statements.  Readers are cautioned that any suchforward-looking statements are not guarantees of future performance and thatmatters referred to in such forward-looking statements involve known andunknown risks, uncertainties and other factors which may cause actual results,performance or achievements of the Company to be materially different from anyfuture results, performance or achievements expressed or implied by suchforward-looking statements.  Such factorsinclude, among other things, the impact of competition and uncertaintiesconcerning such matters as the Company’s ability to service debt, productdevelopment, customer financing, sales to non-traditional gaming markets,foreign operations, dependence on key personnel, the ability to integratefuture acquisitions, strict regulation by gaming authorities, the outcome ofpending litigation matters including the pending securities class actions,gaming taxes, currency fluctuations and market risk and the potential adverseeffects to our financial condition, results of operations or prospects as aresult of the restatement of our prior period financial statements. Certain ofthese factors are discussed in the “Risk Factors” contained in the 200610-K.  Unless otherwise required by law,the Company undertakes no obligation to publicly update or revise theseforward-looking statements because of new information, future events orotherwise.

**Our Business**

We are a worldwide leaderin the design, manufacture, assembly and distribution of technology basedproducts to commercial gaming markets worldwide.  We also own and operate a riverboat, docksidecasino in Vicksburg, Mississippi.

Wederive our revenues from the following four sources:

·                  *Gaming Equipment*- Sale of gamingdevices;

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

·                  *Systems* - Sales of computerized monitoring systemsand related recurring hardware and software maintenance revenue; and

·                  *Casino Operations* - Operation ofthe Rainbow Casino.

We design, manufacture, assemble, sell and operate a fullrange of technology based gaming devices through our Gaming Equipmentdivision.  These devices are not massproduced and are normally configured under specific order to a customer’sparticular requirements.  Gaming devicesare differentiated from one another by a number of factors including, but notlimited to, graphic design and theme, cabinet style, pay table, game layout,betting denomination and minimum/maximum betting amount.  Each gaming device typically contains anoperating system referred to as a game platform.  The operating system manages the softwareneeded to run the device.  Game platformsand the

16

----

related computer systems are constantly updated and revisedto keep pace with the ever-increasing complexity of modern game playrequirements.  The constant change ingame play requirements is driven by, among other things, changes in consumerdemand, capacity, security and regulation. In fiscal 2005, we completed the successful migration from our legacyplatforms, including the V7000 and EVOTM, to the Linux-based ALPHA OSTM platformand operating system.  In fiscal 2006, wealso extended the transition to the ALPHA OS to our mechanical reel spinningdevices.  ALPHA OS is now the platformfor each of our gaming device product offerings and, as a result, marketing ofour legacy products has generally been discontinued.

The ALPHA OS is designed to separate the gaming operatingsystem from the game layer, which enables game development in a much shortertime.  ALPHA OS is also designed toincorporate bonusing, free spin, scatter and other advanced game features,while providing internal and third-party developers with a secure, easy-to-useprogramming environment that incorporates an advanced set of developmenttools.  Moreover, ALPHA OS is designed tosupport server-based gaming initiatives, including download of game results,configuration and game content. Additionally, our layered architecture and modulardesign allow for adaptability and simplified requirement changes. The operatingsystem, which is Linux-based, is compatible with the most common accounting andticket systems and supports 20-plus bet lines, bonusing, multi-denomination andmulti-pay table game configurations. ALPHA OS also supports multi-level local and wide-area progressiveproducts.

Inaddition to selling our gaming devices, we also offer our customers a widerange of lease and rental options through our Gaming Operations division.  We offer several economic arrangements thatgenerate recurring revenues for us. Specifically, these arrangements are available under four businessmodels: linked progressive systems, centrally determined systems, lotterysystems and rental or leased games.  Inmost cases, operating gaming devices under a lease or rental arrangementrequires us to invest capital in the cost of manufacturing the gaming deviceand related equipment, purchasing signs and seating, and, in certain cases,acquiring certain intellectual property rights.

We believe thegrowth of the Gaming Equipment and Gaming Operations divisions is dependent onproviding new titles, hardware and technologies with high entertainment valueto casino patrons.

We also design, program, test, market and support casinoenterprise systems for a wide range of customers of varying size and complexityunder our Systems division.  Thesesystems typically provide casino operators features such as active, real-timemonitoring tools for gaming devices, tools to collect and manage customer data,security to protect against theft and data loss, and marketing programs toenhance the gaming experience.  The useof system technology in gaming has grown in the past ten years from basicautomation of manual activities to highly integrated mission criticalapplications.  We believe we are the onlyprovider in the industry that offers a selection of technology platform optionsto its customers.  Our products operateon platforms such as Windows, AS/400 (iSeries) and UNIX that allows ourcustomers to choose a technology solution that meets their existing or futureinfrastructure requirements.  We marketour system product solutions under the broad categories of Bally CMS® (CasinoManagement Systems), Bally SMS® (Slot Management Systems) and Bally TMS® (TableManagement Systems).

We spent approximately 9%of revenue generated from our Bally Gaming Equipment and Systems segment forthe six months ended December 31, 2006 on research and development toaccelerate the use of technology in our gaming products.

Our Rainbow Casinois one of four casinos currently operating in the Vicksburg, Mississippi marketand is run through our Casino Operations division. The facility includes a33,000-square foot casino with 852 gaming devices and 11 table games, a310-seat buffet-style restaurant and a 20,000-square foot conferencecenter.  The Casino also includes the89-room Rainbow Hotel, which is owned and operated by a third party.  Rainbow is marketed as a “locals” casino anddraws mid-level gaming customers principally from within a 75-mile radius ofVicksburg.  Our promotions are focusedprimarily on direct mail and special promotional events.   The Company announced in October 2006 that itis evaluating alternatives with respect to the possible sale of the RainbowCasino.  There can be no assurance thatthe Company will proceed with or complete the sale of the Rainbow Casino.

17

----

**Resultsof Operations**

Our results of operations include the accounts of Bally Technologies,Inc., and its wholly-owned and partially-owned subsidiaries.  We report our revenue and income intwo segments: the Bally Gaming Equipment and Systems segment, which includesour Gaming Equipment, Gaming Operations and Systems divisions, and our CasinoOperations segment.  Revenue from ourBally Gaming and Systems segment represents approximately 93% of our totalrevenues for the six months ended December 31, 2006.

***Bally Gaming Equipment and Systems***

The summary financial results and operatingstatistics for our Bally Gaming Equipment and Systems segment for the three andsix months ended December 31, 2006 and 2005 are as follows:

 
| ** **                          | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                            | ** ** | **%  Rev**                                        | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Favorable/  (Unfavorable**) | ** ** | **2006** | ** ** | **%  Rev** | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                          | ** ** | **(dollars in millions)**                 | ** ** |
| Revenues                            |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                    |       | $                                                   | 72.7       |                                              | 52         | % | $ | 54.1 |   | 47 | % | 34 | % | $ | 136.6 |   | 48 | % | $ | 91.4 |   | 44 | % | 49 | % |
| Gaming Operations                   |       | 38.7                                                |       | 27                                                | %          | 34.9 |   | 31 | % | 11 | % | 77.8 |   | 28 | % | 71.8 |   | 34 | % | 8 | % |
| Systems                             |       | 29.2                                                |       | 21                                                | %          | 25.0 |   | 22 | % | 17 | % | 68.2 |   | 24 | % | 45.6 |   | 22 | % | 50 | % |
| Total revenues                      |       | $                                                   | 140.6      |                                              | 100        | % | $ | 114.0 |   | 100 | % | 23 | % | $ | 282.6 |   | 100 | % | $ | 208.8 |   | 100 | % | 35 | % |
|                                | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross margin                        |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                    |       | $                                                   | 26.3       |                                              | 36         | % | $ | 15.5 |   | 29 | % | 70 | % | $ | 47.9 |   | 35 | % | $ | 24.7 |   | 27 | % | 94 | % |
| Gaming Operations                   |       | 22.6                                                |       | 58                                                | %          | 13.6 |   | 39 | % | 66 | % | 44.8 |   | 58 | % | 32.6 |   | 45 | % | 37 | % |
| Systems                             |       | 21.0                                                |       | 72                                                | %          | 19.6 |   | 78 | % | 7 | % | 46.2 |   | 68 | % | 37.3 |   | 82 | % | 24 | % |
| Total gross margin                  |       | $                                                   | 69.9       |                                              | 50         | % | $ | 48.7 |   | 43 | % | 44 | % | $ | 138.9 |   | 49 | % | $ | 94.6 |   | 45 | % | 47 | % |
|                                | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative |       | $                                                   | 42.7       |                                              | 30         | % | $ | 37.1 |   | 33 | % | (15 | )% | $ | 83.9 |   | 30 | % | $ | 69.5 |   | 33 | % | (21 | )% |
| Research and development costs      |       | 13.3                                                |       | 9                                                 | %          | 10.7 |   | 9 | % | (24 | )% | 25.9 |   | 9 | % | 21.0 |   | 10 | % | (23 | )% |
| Depreciation and amortization       |       | 4.7                                                 |       | 3                                                 | %          | 5.7 |   | 5 | % | 18 | % | 9.0 |   | 3 | % | 10.3 |   | 5 | % | 13 | % |
| Operating income  (loss)            |       | $                                                   | 9.2        |                                              | 7          | % | $ | (4.8 | ) | (4 | )% | 292 | % | $ | 20.1 |   | 7 | % | $ | (6.2 | ) | (3 | )% | 424 | % |

 
| ** **                                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **Favorable/  (Unfavorable)** | ** ** | **2006** | ** ** | **2005** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
|                                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Operating  Statistics:                         |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| New gaming devices sold                        |       | 4,672                                               |       | 3,663                                             |       | 28 | % | 8,099 |   | 6,463 |   | 25 | % |
| OEM units sold                                 |       | 460                                                 |       | 305                                               |       | 51 | % | 1,605 |   | 326 |   | 392 | % |
| New unit average selling price                 |       | $                                                   | 12,620     |                                              | $          | 10,921 |   | 16 | % | $ | 12,363 |   | $ | 10,802 |   | 14 | % |
|                                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Gaming monitoring units installed base         |       |                                                |       |                                              |       |   |   | 287,000 |   | 266,000 |   | 8 | % |
| Casino management systems installed base       |       |                                                |       |                                              |       |   |   | 563 |   | 532 |   | 6 | % |
| Systems managed cashless games                 |       |                                                |       |                                              |       |   |   | 231,000 |   | 161,000 |   | 43 | % |
|                                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| End of period  installed base:                 |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Wide-area progressive                          |       |                                                |       |                                              |       |   |   | 935 |   | 1,305 |   | (28 | )% |
| Local-area progressive                         |       |                                                |       |                                              |       |   |   | 544 |   | 611 |   | (11 | )% |
|    Total linked  progressive systems |       |                                                |       |                                              |       | 1,479 |   | 1,916 |   | (23 | )% |
|                                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Rental and  daily-fee games                    |       |                                                |       |                                              |       |   |   | 4,636 |   | 2,783 |   | 67 | % |
| Lottery Systems                                |       |                                                |       |                                              |       |   |   | 7,164 |   | 6,713 |   | 7 | % |
| Centrally  determined Systems                  |       |                                                |       |                                              |       |   |   | 31,244 |   | 23,631 |   | 32 | % |
|                                                |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

----

**ThreeMonths Ended December 31, 2006 Compared to Three Months Ended December 31, 2005**

Total revenues forour Bally Gaming Equipment and Systems segment increased $26.6 million, or 23%,for the three months ended December 31, 2006 as compared to the correspondingperiod in the prior year.  This increasewas the result of higher revenues from our Gaming Equipment, Gaming Operationsand Systems divisions of 34%, 11%, and 17%, respectively.  A more detailed description of thefluctuations in revenues of each Bally Gaming Equipment and Systems segment isset forth below.

*GamingEquipment.*  GamingEquipment revenue increased by $18.6 million, or 34%, for the three monthsended December 31, 2006, as compared to the corresponding period in the prioryear, primarily a result of the following:

·                  An increase innew gaming device sales of 1,009 units, or 28%, to 4,672 units in the threemonths ended December 31, 2006 from 3,663 units in the corresponding period inthe prior year.

·                  A 16% increasein the Average Selling Price (“ASP”) of new gaming units, excluding OEM sales,as ASP in the prior year was negatively affected by introductory pricingrelated to the roll-out of devices based on the ALPHA OS platform.

·                  Anincrease in OEM units sold of 155 units to 460 units in the three months endedDecember 31, 2006 from 305 units in the corresponding period in the prior year.Sales of OEM products vary significantly from period to period based ondeployments by our OEM customers, and are typically sold at lower sellingprices and margins than sales made directly to casino operators.

*GamingEquipment Gross Margin*. Gaming Equipment gross margin increased to 36% in the three months endedDecember 31, 2006, from 29% in the corresponding period in the prior year,primarily as a result of:

·                  Introductorypricing in the prior year period related to the roll-out of the ALPHA OSplatform.

·                  Inventorywrite-downs in the prior year period of $4.1 million, or 8% of gaming equipmentrevenue, compared to $1.8 million, or 2% of gaming revenue, in the current period.

*GamingOperations. *GamingOperations revenue increased by $3.8 million, or 11%, primarily as a result ofthe following:

·                  An $8.5 million,or 51%, increase in revenue from rental and daily fee, lottery and centrallydetermined games resulting from a 30% increase in the installed base of gamesover the prior year period.

·      Areduction in wide-area progressive revenues of $2.8 million resulting from a28% decrease in the installed base of games during the period.

*GamingOperations Gross Margin*. Gaming Operations gross margin, which includes depreciation expense of$8.0 million and $11.4 million for the three months ended December 31, 2006 and2005, respectively, increased to 58%, from 39%, primarily as a result of areduction in expenditures to fund jackpot liabilities of $1.6 million resultingfrom a 28% decrease in the installed base of wide-area progressive games duringthe period. Also, a change in the estimated useful life and salvage values forcertain gaming equipment used in the Gaming Operations division resulted in anincrease in depreciation expense charged to cost of gaming operations duringthe prior year period.

*Systems.*  Systems revenue increased by $4.2 million, or17%, primarily as a result of the following:

·                  An increase of$1.5 million, or 22%, in systems service and maintenance fees related tocertain contracts with major domestic customers.

·                  Anincrease of $2.3 million, or 102%, in systems hardware sales primarily relatedour SDS and iView products.

19

----

*SystemsGross Margin*.  Systemsgross margin declined to 72% in the three months ended December 31, 2006, ascompared to 78% in the corresponding period in the prior year, as a result ofthe increased proportion of hardware sales in the current period, which havelower gross margins compared to software sales.

*Selling,General and Administrative Expense*.  Selling, general, and administrative expensesincreased by $5.6 million, or 15%, primarily as a result of:

·                  An increase inpayroll and related expenses and casual labor of $6.4 million in the three monthsended December 31, 2006, as compared to the corresponding period of the prioryear, to support the increased growth of our business.

·                  Anincrease in consulting and license fees of $1.6 million due to increased third-partydevelopment and engineering services.

*Researchand Development Costs*. Research and development costsincreased by $2.6 million, or 24%, primarily as a result of an increase in payrolland related expenses in the three month period ended December 31, 2006 ascompared to the corresponding period in the prior year.  The increase in research and developmentreflects our focus on our technology assets and the competitive landscape thatrequires a continuous investment in the development of future generations ofgaming products and systems.

*Depreciationand Amortization Expense*. Depreciation and amortization expense decreased by $1.0 million, or 18%,for the three months ended December 31, 2006, as compared to the correspondingperiod in the prior year, primarily due to a change in the estimated usefullife and salvage values for certain gaming equipment in the prior year.

**SixMonths Ended December 31, 2006 Compared to Six Months Ended December 31, 2005**

Total revenues forour Bally Gaming Equipment and Systems segment increased $73.8 million, or 35%,for the six months ended December 31, 2006 as compared to the correspondingperiod in the prior year.  This increasewas the result of an increase in revenues from our Gaming Equipment, GamingOperations and Systems divisions of 49%, 8%, and 50%, respectively. A moredetailed description of the fluctuations in revenues of each Bally GamingEquipment and Systems segment is set forth below.

*GamingEquipment.* GamingEquipment revenue increased by $45.2 million, or 49%, for the six months endedDecember 31, 2006, as compared to the corresponding period in the prior year,primarily as a result of the following:

·                  An increase innew gaming units sold of 1,636 units, or 25%, to 8,099 units in the six monthsended December 31, 2006 from 6,463 units in the corresponding period in theprior year.

·                  A 14% increasein the ASP of new gaming units, excluding OEM sales, as ASP in the prior yearwas negatively affected by introductory pricing related to the roll-out ofdevices based on the ALPHA OS platform.

·                  An increase inOEM units sold of 1,279 units to 1,605 units in the six months ended December31, 2006 from 326 units in the corresponding period in the prior year. Sales ofOEM products vary significantly from period to period based on deployments byour OEM customers, and are typically sold at lower selling prices and marginsthan sales made directly to casino operators.

·                  Therecognition of OEM license revenue of $4.9 million in the six months endedDecember 31, 2006 resulting from the sale of content licenses to an OEMcustomer.

*GamingEquipment Gross Margin*. Gaming Equipment gross margin improved to 35% for the six months endedDecember 31, 2006, from 27% in the corresponding period in the prior year,primarily as a result of:

·                  Introductorypricing in the prior year period related to the roll-out of the ALPHA OSplatform.

·                  Higherproduction costs in the prior year period related to the initial manufacture ofdevices based on the ALPHA OS platform.

·                  Inventorywrite-downs in the prior year period of $8.0 million, or 9% of gaming equipmentrevenue, compared to $6.2 million, or 5% of gaming equipment revenue, in thecurrent period.

20

----

*GamingOperations.*Gaming Operations revenues increased by $6.0million, or 8%, primarily as a result of the following:

·                  A $13.3 million,or 38%, increase in revenue from rental and daily fee, lottery and centrallydetermined games resulting from a 30% increase in the installed base of gamesover the prior year period.

·      Areduction in wide area progressive revenue of $6.1 million resulting from a 28%decrease in the installed base of games during the period.

*GamingOperations Gross Margin*. Gaming Operations gross margin, which includes depreciation expense of$17.3 million and $18.1 million for the six months ended December 31, 2006 and2005, respectively, increased to 58%, from 45%, primarily as a result of areduction in expenditures to fund jackpot liabilities of $7.1 million due tothe decrease in the installed base of wide-area progressive games during theperiod. Also, a change in the estimated useful life and salvage values forcertain gaming equipment used in the Gaming Operations division resulted in anincrease in depreciation expense charged to cost of gaming operations duringthe prior year period.

*Systems.*  Systems revenue increased by $22.6 million,or 50%, primarily as a result of the following:

·                  An increase of$2.1 million, or 15%, in systems service and maintenance fees related tocertain contracts with major domestic customers.

·                  Anincrease of $21.1 million, or 96%, in systems hardware sales primarily relatedto sales of our SDS and iView products.

*Systems Gross Margin*.  Systems gross margin declined to 68% in thesix months ended December 31, 2006, from 82% in the corresponding period in theprior year, as a result of the increased proportion of hardware sales in thecurrent period, which have lower gross margins compared to software sales.

*Selling,General and Administrative Expense*. Selling, general andadministrative expenses for the segment increased by $14.4 million, or 21%,primarily as a result of:

·                  An increase inpayroll and related expenses and casual labor of $14.0 million in the sixmonths ended December 31, 2006, as compared to the corresponding period of theprior year, to support the increased growth of our business.

·                  An increase inlegal expense of $3.3 million due to higher litigation costs and patent costs.

·                  Anincrease in consulting and license fees of $1.6 million due to increasedthird-party development and engineering services.

*Researchand Development Costs*. Research and development costs increased by $4.9 million, or 23%,primarily as a result of an increase in payroll and related expenses in the sixmonth period ended December 31, 2006, as compared to the corresponding periodin the prior year.  The increase inresearch and development reflects our focus on our technology assets and thecompetitive landscape that requires a continuous investment in the developmentof future generations of gaming products and systems.

21

----

*Depreciationand Amortization Expense*. Depreciation and amortization expense decreased by $1.3 million, or 13%,for the six months ended December 31, 2006, as compared to the correspondingperiod last year, primarily due to a change in the estimated useful life andsalvage values for certain gaming equipment in the prior year.

***Casino Operations***

TheRainbow Casino is one of four casinos currently operating in the Vicksburg,Mississippi market. The casino draws customers primarily from a 75-mile radiussurrounding Vicksburg, which includes Jackson, Mississippi.  In fiscal 2007, we began considering thepossible sale of Rainbow to a third party in connection with our plans to focusour efforts on our technology assets.  The conditions under which we maysell Rainbow are dynamic and may be impacted by a number of factors including,but not limited to, general market conditions, competition, our financialposition and the interest of certain buyers who may be strategic to us. If we do not receive a financially beneficial offer, we may decide not to sellthe casino.  The summary of our financial results andoperating statistics for our Casino Operation are as follows:
| ** **                          | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                            | ** ** | **%  Rev**                                        | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Favorable/  (Unfavorable**) | ** ** | **2006** | ** ** | **%  Rev** | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                          | ** ** | **(dollars in millions)**                 | ** ** |
| Revenue                             |       | $                                                   | 11.2       |                                              | 100        | % | $ | 13.5 |   | 100 | % | (17 | )% | $ | 23.1 |   | 100 | % | $ | 24.2 |   | 100 | % | (5 | )% |
|                                | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross margin                        |       | 6.8                                                 |       | 61                                                | %          | 8.6 |   | 64 | % | (21 | )% | 14.2 |   | 61 | % | 14.9 |   | 62 | % | (5 | )% |
| Selling, general and administrative |       | 2.1                                                 |       | 19                                                | %          | 2.6 |   | 19 | % | 19 | % | 4.6 |   | 20 | % | 4.7 |   | 19 | % | 2 | % |
| Depreciation and amortization       |       | 0.8                                                 |       | 7                                                 | %          | 0.9 |   | 7 | % | 11 | % | 1.6 |   | 7 | % | 1.8 |   | 7 | % | 11 | % |
| Operating income                    |       | $                                                   | 3.9        |                                              | 35         | % | $ | 5.1 |   | 38 | % | (24 | )% | $ | 8.0 |   | 35 | % | $ | 8.4 |   | 35 | % | (5 | )% |
|                                |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating statistics:               |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average number of gaming devices    |       | 852                                                 |       |                                              |       | 905 |   |   |   | (6 | )% | 893 |   |   |   | 921 |   |   |   | (3 | )% |
| Average number of table games       |       | 11                                                  |       |                                              |       | 12 |   |   |   | (8 | )% | 11 |   |   |   | 12 |   |   |   | (8 | )% |

 

Certain reclassifications have been made to the priorperiod financial statements to conform to the current periodpresentation.  Specifically, certain promotional expenses representingcoupons redeemable for cash incentives, totaling $1.0 million and $1.9 millionfor the three and six months ended December 31, 2005, have been reclassifiedfrom selling, general and administrative expense and offset against CasinoOperations revenue.

T**hree Months Ended December 31, 2006 Compared to Three Months EndedDecember 31, 2005**

Casino Operationsrevenue decreased 17% for the three months ended December 31, 2006 as comparedto the corresponding period in the prior year. A portion of the decrease was attributable to a decrease in the averagenumber of gaming devices of 53, or 6%, from 905 during the three months endedDecember 31, 2005, to 852 during the same period this year. The remainder ofthe decrease in revenue is due to the fact that revenue in the prior year waspositively impacted due to the fact our property, unlike our competitor’sproperties, did not sustain any significant damage in connection with the GulfCoast hurricanes in August and September 2005.

Overall gross margindecreased 21% due to the decrease in revenue coupled with the fixed nature ofour direct cost of gaming expenses.

Selling, general andadministrative expenses decreased by 19% due to a decline in advertising andpromotional expenses for the three months ended December 31, 2006 as comparedto the corresponding period in the prior year.

Depreciation andamortization expense, as a percentage of revenue, remained consistent over thecorresponding period in the prior year.

22

----

**SixMonths Ended December 31, 2006 Compared to Six Months Ended December 31, 2005**

Casino Operationsrevenue decreased 5% for the six months ended December 31, 2006 as compared tothe corresponding period in the prior year. A portion of the decrease was attributable to a decrease in the averagenumber of gaming devices of 28, or 3%, from 921 during the six months endedDecember 31, 2005, to 893 during the same period this year. The remainder ofthe decrease in revenue is due to the fact that revenue in the prior year waspositively impacted due to the fact our property, unlike our competitor’sproperties, did not sustain any significant damage in connection with the GulfCoast hurricanes in August and September 2005.

Overall gross margindeclined 5% due to the decrease in revenue coupled with the fixed nature of ourdirect cost of gaming expenses.

Selling, general andadministrative expenses decreased by 2% primarily due to decreasing advertisingand promotional expenses for the six months ended December 31, 2006 as comparedto the corresponding period prior year.

Depreciation andamortization expense remained fairly stable for the six months ended December31, 2006 as compared to the corresponding period in the prior year.

***Parent Company***

The summaryfinancial results of Bally Technologies, Inc., our parent entity, are set forthbelow.  These results also includecertain other income and expenses that are otherwise not allocated to aspecific business segment.

 
| ** **                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **Favorable/  (Unfavorable)** | ** ** | **2006** | ** ** | **2005** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                     | ** ** | **(dollars in millions)**                 | ** ** |
| General and  administrative    |       | $                                                   | 6.8        |                                              | $          | 6.5 |   | (5 | )% | $ | 13.1 |   | $ | 12.8 |   | (2 | )% |
| Depreciation and  amortization |       | 0.4                                                 |       | 0.3                                               |       | (33 | )% | 0.7 |   | 0.7 |   | — | % |
| Total parent  company expense  |       | $                                                   | 7.2        |                                              | $          | 6.8 |   | (6 | )% | $ | 13.8 |   | $ | 13.5 |   | (2 | )% |
|                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Other income (expense)         |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest income                |       | $                                                   | 0.4        |                                              | $          | 0.6 |   | (33 | )% | $ | 1.3 |   | $ | 1.5 |   | (13 | )% |
| Interest expense               |       | (10.2                                               | )          | (7.3                                              | )          | (40 | )% | (18.1 | ) | (13.2 | ) | (37 | )% |
| Other, net                     |       | 0.6                                                 |       | (0.2                                              | )          | 400 | % | 0.9 |   | (0.5 | ) | 280 | % |
| Total other  expense           |       | $                                                   | (9.2       | )                                                 | $          | (6.9 | ) | (33 | )% | $ | (15.9 | ) | $ | (12.2 | ) | (30 | )% |
|                           |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Income tax  benefit (expense)  |       | $                                                   | 2.4        |                                              | $          | 4.7 |   | (49 | )% | $ | 1.7 |   | $ | 8.8 |   | (81 | )% |
| Minority interest              |       | $                                                   | (1.6       | )                                                 | $          | (0.2 | ) | (700 | )% | $ | (2.8 | ) | $ | (2.6 | ) | (8 | )% |

 

**ThreeMonths Ended December 31, 2006 Compared to Three Months Ended December 31, 2005**

*Generaland Administrative Expense*. Our general and administrative expenses at the parent company levelremained relatively flat for the three months ended December 31, 2006,increasing $0.3 million as compared to the corresponding period in the prioryear.

*Otherincome (expense*). Other expenses increased $2.3 million, or 33%, primarily as a result ofan increase in interest expense for the three months ended December 31, 2006compared to the corresponding period in the prior year.  The increase in interest expense was a resultof higher interest rates in effect in the current period as virtually all ourdebt is based on variable interest rates, as well as charges of $2.1 millionrelated to amendments to our loan facility.

23

----

**SixMonths Ended December 31, 2006 Compared to Six Months Ended December 31, 2005**

*Generaland Administrative Expense*. Our general and administrative expenses at the parent company levelremained relatively flat for the six months ended December 31, 2006, increasing$0.3 million as compared to the corresponding period in the prior year.

*Otherincome (expense*). Other expenses increased $3.7 million, or 30%, primarily as a result ofan increase in interest expense for the three months ended December 31, 2006compared to the corresponding period in the prior year.  The increase in interest expense was a resultof higher interest rates in effect in the current period as virtually all ourdebt is based on variable interest rates, as well as charges of $2.1 millionrelated to amendments to our loan facility.

The effectiveincome tax rate for the year ended June 30, 2007 is estimated to be 38% ascompared to an actual effective tax rate of 36% for the year ended June 30, 2006.  The effective tax rate for the current yearwill be impacted by non-deductible share based compensation expense recognizedfor book purposes and reserves applied to certain deferred tax assets fromforeign losses.  During the six monthsended December 31, 2006, our tax provision benefited from a $1.3 million creditrelated to the retroactive reinstatement of research and development taxcredits.

**FinancialCondition**

Selectedbalance sheet accounts are as follows:
| ** **                               | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | **Increase (decrease)** | ** ** |
|------------------------------------------|------------|-----------------------|------------|-------------------|------------|------------------------------|------------|
| ** **                               | ** ** | **2006**              | ** ** | **2006**          | ** ** | **Amount**                   | ** ** | **%** | ** ** |
| ** **                               | ** ** | **(in 000s)**    | ** ** |
| Cash and cash  equivalents               |       | $                     | 12,432     |              | $          | 16,425                       |       | $ | (3,993 | ) | (24 | )% |
|                                     |       |                  |       |              |       |                         |       |   |   |
| Total long-term  debt and capital leases |       | $                     | 344,181    |              | $          | 328,346                      |       | $ | 15,835 |   | 5 | % |
|                                     |       |                  |       |              |       |                         |       |   |   |
| Total current  assets                    |       | $                     | 329,787    |              | $          | 329,354                      |       | $ | (433 | ) | — | % |
| Total current  liabilities               |       | $                     | 201,661    |              | $          | 198,837                      |       | $ | 2,824 |   | 1 | % |
| Net working capital                      |       | $                     | 128,126    |              | $          | 130,517                      |       | $ | (2,391 | ) | (2 | )% |

 

As of December 31, 2006, we had $12.4 million in consolidated cash and cashequivalents which included approximately $3.7 million of cash utilized in ourCasino Operations segment that is held in vaults, cages or change banks.   Pursuant to various state gamingregulations, certain cash accounts are maintained to ensure availabilityof funds to pay wide-area progressive jackpot awards. At December 31, 2006,these accounts had an aggregate value of approximately $15.7 million, which areclassified as restricted cash on our condensed consolidated balance sheet.  In addition, we purchase U.S. Treasury StripSecurities for the benefit of jackpot winners who elect to receive winnings asannual or weekly installment payments rather than one lump sum.  These securities are included in restrictedlong-term investments in the accompanying condensed consolidated balance sheet,and totaled $10.4 million as of December 31, 2006.

Our net working capital decreased $2.4 million for thesix months ended December 31, 2006.  Keyfactors related to the working capital decrease included a $1.2 million netincrease in accounts and notes receivable due to the timing of payments bycustomers, a $17.0 million decrease in accounts payable and accrued liabilitiesdue to the timing of payments to vendors, offset by an increase in deferredrevenue of $16.3 million resulting from the deferral of certain system and gamesales and an increase in the current maturities of long-term debt of $3.2million due to the addition new capital leases.

Our debt structureconsists primarily of a term loan facility and a $75.0 million revolving creditfacility, which is limited by a current leverage ratio, and debt owed torelated parties. The term loan requires principal reductions of approximately1% per annum paid quarterly, with a balloon payment due in September2009.  The revolving credit

24

----

facility commitmentreduces annually until it comes due in September 2008.  No amounts were outstanding under ourrevolving credit facility as of December 31, 2006.

The loan agreementgoverning the term loan and the revolving credit facility (the “Loan Agreement”)contains a number of maintenance and other significant covenants that, amongother things, restrict our ability to dispose of assets, incur additionalindebtedness or issue preferred stock, pay dividends or make otherdistributions, enter into certain acquisitions, repurchase equity interests orsubordinated indebtedness, issue or sell equity interests of the oursubsidiaries, engage in mergers or acquisitions or certain transactions withsubsidiaries and affiliates, and that otherwise restrict corporate activities.

The financial covenantsunder the Loan Agreement consist of a leverage ratio, a fixed charges coverageratio, and a minimum of Earnings Before Interest, Taxes, Depreciation andAmortization (“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 December 31, 2006 was 3.36 times versus the covenant maximum of 3.75times.   We were in compliance with allfinancial covenants as of December 31, 2006.

In October 2006, we executed an amendment to the Loan Agreement,which, among other things, (i) extended the due date for the delivery of our audited financial statements for the fiscalyear ended June 30, 2006 to December 31, 2006, (ii) provided that wedeliver our quarterly reports on Form 10-Q for the fiscal quarters endedSeptember 30, 2005, December 31, 2005 and March 31, 2006 nolater than December 31, 2006, (iii) modified the definition of EBITDA toexclude up to $10 million of certain cash charges and (iv) clarifiedthat the definition of EBITDA includes interest income on tradereceivables.  In exchange for the concessions granted under the amendment,we paid an administrative fee of $964,000, which was expensed in the quarterended December 31, 2006.

In December 2006,we executed an additional amendment to the Loan Agreement, which extended thedue date for the  delivery of our quarterly report on Form 10-Q for thefiscal quarter ended March 31, 2006 and our audited financialstatements for the fiscal year ended June 30, 2006 to March15, 2007.  In exchange for theconcessions granted under the amendment we paid an administrative fee of $1.2million, which was expensed in the quarter ended December 31, 2006.

Management believes that cash flows from currentoperating activities and the availability under the revolving credit facilitywill provide us with sufficient capital resources and liquidity to operate ourbusiness for at least the next 12 months. At December 31, 2006, we had no material commitments for capitalexpenditures.

*** CashFlow Summary***
|                       | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------|------------|---------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **            | ** ** | **(dollars in 000s)**                   | ** ** |
| Cash flows from:      |       |                                              |       |   |   |   |   |
| Operating activities  |       | $                                                 | 32,269     |   | $ | 23,167 |   | $ | 9,102 |   |
| Investing activities  |       | $                                                 | (58,653    | ) | $ | (28,849 | ) | $ | (29,804 | ) |
| Financing  activities |       | $                                                 | 22,390     |   | $ | (2,870 | ) | $ | 25,260 |   |

 

Cash flows from operatingactivities are derived primarily from the cash receipts from the sale of goodsand services, the operation of wide-area progressive systems, lease payments,and monthly cash receipts from maintenance agreements from our casino systemscustomers.  In addition, we generate cashthrough our casino operations.  Weutilize our cash to acquire materials for the manufacture of goods for resaleor lease, to pay payroll and selling, general and administrative expenses, aswell as to service our debt.

During the sixmonths ended December 31, 2006, cash flows provided by operating activitiestotaled $32.3 million as compared to $23.2 million in the corresponding periodin the prior year.  This increase wasgenerally attributable

25

----

to a reduction inthe reported net loss for the six months ended December 31, 2006 as compared tothe corresponding period in the prior year.

During the sixmonths ended December 31, 2006 cash flows used in investing activities totaled$58.7 million, as compared to $28.8 million for the corresponding period in theprior year.  This change is primarily theresult of:

·                  Capitalexpenditures of $8.8 million in the six months ended December 31, 2006 comparedto $6.2 million for the corresponding period in the prior year; and

·                  Costsincurred to deploy additional leased gaming devices totaling $47.5 million inthe six months ended December 31, 2006 compared to $19.9 million in the prioryear period.

During the sixmonths ended December 31, 2006 cash flows provided by financing activitiestotaled $22.4 million as compared to the cash flows used in financingactivities in the corresponding period in the prior year of $2.9 million.  This change was primarily the result of:

·                  Principalpayments on long term debt totaling $4.2 million in the six months endedDecember 31, 2006 compared to $3.0 million for the corresponding period in theprior year;

·                  Cash providedfrom the exercise of stock options of $4.3 million in the six months endedDecember 31, 2006 compared to $0.2 million in the corresponding period in theprior year; and

·                  Cashprovided from the sale lease-back of certain assets used in our gamingoperations of $22.3 million in the six months ended December 31, 2006.

***ContractualCommitments***

During the six monthsended December 31, 2006, we entered into a capital lease for certain equipmentused in our Gaming Operations amounting to approximately $20.7 million. The lease is payable in thirty-six equal installments of $655,000.

**CriticalAccounting Policies**

A description ofour critical accounting policies can be found within management discussion andanalysis of financial condition and results of operation in the 2006 10-K.There were no material changes to those policies during the three and six monthperiods ended December 31, 2006.

*Recently Issued AccountingPronouncements*

In February, 2007,the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 159, *The Fair Value Option for Financial Assetsand Financial Liabilities*. SFAS No. 159 provides companies with anoption to report selected financial assets and liabilities at fair value. Italso establishes presentation and disclosure requirements to facilitatecomparisons between companies using different measurement attributes forsimilar types of assets and liabilities. The statement is effective for fiscalyears beginning after November 15, 2007 and accordingly, we expect to adoptSFAS No. 159 beginning in fiscal 2009. Earlier application is permittedprovided we also apply the provisions of SFAS No. 157, *Fair ValueMeasurements*. We are currently in the process of evaluating theimpact SFAS No. 159 will have on our consolidated results of operations,financial position and cash flows.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, rather it applies existing accounting pronouncements that requireor permit fair value measurements.  SFASNo. 157 is effective for fiscal years beginning after November 15, 2007, andaccordingly, the Company expects to adopt SFAS No. 157 beginning in fiscal2009. We are currently in the process of evaluating the impact SFAS No. 157will have on our consolidated results of operations, financial position andcash 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. Theprovisions of SAB No. 108 were effective beginning with our fiscal year endingJune 30, 2007.  The adoption SAB No. 108did not have a material impact on our consolidated results 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

26

----

recognized in thefinancial statements. It also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006, and accordingly, the Company expects to adopt FIN 48beginning in fiscal year 2008. We are currently in the process of evaluatingthe impact FIN 48 will have on our consolidated results of operations,financial position and cash flows.

**ITEM 3.          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

*Interest Rate Risk*

As of December 31, 2006, we hadtotal debt of approximately $344.2 million, consisting primarily of the $309.6million term loan under our senior credit facilities, $14.2 million in relatedparty debt and $20.3 million in capital lease obligations.  The interest rate for the term loan is variable,based on LIBOR, and resets every six months. Approximately $11.2 million of related party debt is variable and isbased on LIBOR.  If the LIBOR rates wereto increase or decrease by 100 basis points, with all other factors remainingconstant, earnings would decrease or increase by approximately $3.2 millionannually, on a 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**

**Disclosure Controls 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 December 31, 2006,our disclosure controls and procedures were not effective due to the existingmaterial weaknesses in our internal control over financial reporting previouslyidentified and discussed in the 2006 10-K and below under “—Internal ControlOver Financial Reporting —Material Weakness in Internal Control Over Financial ReportingPreviously Reported.”

In view of the fact that the financial informationpresented in this quarterly report on Form 10-Q for the fiscal quarter endedDecember 31, 2006, was prepared in the absence of effective internal controlover financial reporting, we have devoted a significant amount of time andresources to the analysis of the financial statements contained in thisreport.  In particular, we have reviewedthe significant account balances and transactions reflected in the financialstatements contained in this report and otherwise analyzed the transactions underlyingour financial statements to verify the accuracy of the financialstatements.  Accordingly, managementbelieves that the financial statements included in this report fairly present,in all material respects, our financial condition, results of operations, andcash flows.

Nevertheless, there can be no assurance that eitherthis review process or our existing disclosure controls and procedures willprevent or detect all errors and all fraud, if any, or result in accurate andreliable disclosure. A control system can provide only reasonable and notabsolute assurance that the objectives of the control system are met. Becauseof the inherent limitations in all control systems, no evaluation of controlscan provide absolute assurance that all control issues and instances of fraud,if any, have been detected. Additionally, judgments in decision-making can befaulty and breakdowns in controls can occur because of simple errors ormistakes that are not detected on a timely basis.

27

----

**Internal Control Over FinancialReporting**

Our management acknowledges its responsibility forestablishing and maintaining adequate internal control over financial reportingthat includes effective accounting policies and procedures. Our continuingprogress in establishing adequate internal control over financial reporting isdescribed below.

*CertainChanges in Internal Control Over Financial Reporting during the Fiscal QuarterEnded December 31, 2006*

During the quarter ended December 31, 2006, managementcontinued its remediation steps to address the material weaknesses known atthat time and previously reported.  Theseremediation steps were developed through investigation and review of theprocesses and activities surrounding the material weaknesses and includechanges to these processes and the development of test and review programsdesigned to prevent or detect similar future occurrences.  There were no other changes to our internalcontrol over financial reporting during the three months ended December 31,2006 that management believes have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

*Material Weakness in Internal Control OverFinancial Reporting Previously Reported*

**Ineffective controls related to the financial closing process.** In August 2006, upon discovery that certaintransactions were improperly recorded we determined it was necessary to restateour consolidated financial statements as of June 30, 2005 and 2004, and foreach of the three years in the period ending June 30, 2005.  This restatementwas not completed until the 2005 10-K/A was filed on October 31,2006.    These closing procedures did not include the designedlevel of documentation review. Consequently, we used abbreviated financial closing procedures forfiscal 2006 which are not sustainable in our normal financial reporting processas they include significant manual procedures and look back procedures. Additionally, our designed controls over the preparation, review and support ofjournal entries did not operate effectively. We also did not perform the designed level of analytical procedures onthe financial statements of non-corporate operations.

**Ineffectivecontrol related to fraud risk assessment.**  We concluded that the overall operatingeffectiveness of our fraud risk assessment did not operate as designedprimarily due to delays in our financial closing process as described above.

**Inadequate and ineffective control related to revenue recognition,including gaming operations revenue recognition and the associated existence offixed asset machines, system sales revenue recognition and the processing ofcustomer credits.**  Wedid not have appropriate and/or effective internal controls related to therecognition of revenue for gaming operations, including the lack ofcomprehensive controls to adequately capture and analyze: (i) the terms andconditions of all contracts to ensure the proper recording of revenue; (ii) theaccuracy of authorized daily fees and revenue share percentages; (iii) thesecurity and electronic transmission to and from our network operatingcenter(s) and its subsequent documentation and backup; and (iv) the existenceof the related fixed asset machines.

We did not have effective internal control related to the recognition ofrevenue for system sales pertaining to (i) the review of terms and conditionson contract upgrades and change orders to ensure proper recording of revenueand (ii) the accuracy and authorization of billing amounts for upgrades, changeorders and maintenance fees.

We also did not have effective internal control related to therecognition of revenue pertaining to the complete and timely recording ofcredit memos resulting from customer returns or allowances.

**Ineffective control relatedto the existence and valuation of inventory.** We identified several deficiencies related to theexistence and valuation of inventory, including those related to: i) year-endadjustments to our raw materials balance due to ineffective periodic countingprocedures, inadequate physical safeguards and inadequate control overtransaction processing; (ii) the restocking of excess inventory pulled for workorders which was not always properly identified and/or removed from the relatedbill of materials; (iii) costs associated with the creation of new kits andassemblies that were not effectively calculated and monitored resulting inincorrect valuation of inventories; (iv) lack of adequate review

28

----

and analysis of certain inventoryvariances between the perpetual records and the general ledger; and (v)determining allowances for obsolete inventory.

29

----

**PART II**

# **ITEM 1.          LEGAL PROCEEDINGS**

***Litigation***

In June and July2004, putative class actions were filed against the Company and its officers,Robert Miodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in theUnited States District Court for the District of Nevada. The nearly identicalcomplaints alleged violations of the Securities Exchange Act of 1934, asamended (the “Exchange Act”), stemming from revised earnings guidance, declinesin the stock price and sales of stock by insiders. The complaints soughtdamages in unspecified amounts. The Federal District Court granted theplaintiffs’ unopposed motions to consolidate the cases and to appoint a leadcounsel and a lead plaintiff, and the plaintiffs filed a consolidatedcomplaint, all as is customary in such cases. The Company and the other defendants moved to dismiss thecomplaint.  Thereafter, activity in thecase was stopped and the parties participated in a mediation process duringwhich the parties agreed on the terms of a settlement. The parties havenegotiated and executed settlement documents settling both the consolidatedclass action and the derivative case discussed below. Under the settlement,which has received preliminary approval from the court, an aggregate of $16million in cash, plus certain interest, will be paid to settle the securitiesclass action as well as the derivative litigation discussed below.  The Company will pay $1.25 million, which wasaccrued in the Company’s financial statements for the quarter ended December31, 2005. In addition to certain governance actions the Company has agreed toundertake in connection with the settlement, the Company’s directors andofficers insurer will contribute approximately $14.75 million to thesettlement.

InJuly 2004, two derivative lawsuits were filed in Nevada state court against themembers of the board of directors and the officers listed above. The Companywas named as a nominal defendant in the derivative lawsuits as the claims werepurportedly asserted for the benefit of Bally Technologies, Inc. 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 unspecified amounts.These two cases were consolidated, and the Company 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.  Based on factual allegations that are similarto those alleged in the federal securities class action complaints and theprevious derivative actions that were dismissed by the District Court, thederivative complaint 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 a settlement asdiscussed more fully above.

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 August 2004,Shuffle Master sued the Company in the United States District Court for theDistrict of Nevada, alleging infringement of various patents in connection withthe Company’s MindPlay product line and seeking injunctive relief and damagesin an unspecified amount. In June 2005, it was announced that IGT had acquiredan

30

----

interest in thepatents at issue in the case, and thereafter IGT joined the case as a plaintiff. In December 2005, the District Court issued a ruling construing theclaim terms of all the patents in the suit. Management believes theplaintiffs’ lawsuit to be without merit, and the Company is vigorouslydefending 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 ActionGaming (“AGI”) and IGT. The suit alleged that the multi-hand video poker gamedeployed by the Company’s former subsidiary, United Coin, infringed theplaintiffs’ patents. The Federal District Court ruled on summary judgment thatthe game did not infringe the patents. However, the court left to the jury thequestion whether the use of “autohold,” a specific, optional feature of thegame, caused it to infringe under the “doctrine of equivalents,” a doctrine ofpatent law. The jury determined that the game with the autohold option enableddid infringe under the doctrine of equivalents and awarded damages accordingly.The feature has been disabled on all affected games in the field, and thedecision permits continued deployment of the game as long as the autoholdfeature is not included. The Company appealed the decision to the United StatesCourt of Appeals for the Ninth Circuit and posted a cash bond totaling $7.6million to stay payment of the judgment and accrued interest pending theappeal.   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 the Company in the UnitedStates District Court for the District of Nevada. The complaint asserts thatthe Company’s wheel-based games, such as Monte CarloÔ,Lucky WheelÔ and Cash For LifeÔ,its games with a reel in the top box, such as Bonus FrenzyÔ,and its iViewÔ products infringe on patents held by IGT, andseeks injunctive relief and damages in unspecified amounts. The Companybelieves IGT’s claims are without merit and is vigorously defending itselfagainst the lawsuit. As part of its defense, the Company has assertedcounterclaims against IGT, including claims that IGT’s patents are invalid,unenforceable and not infringed, as well as several claims that IGT hasengaged in anti-competitive conduct in violation of state and federal antitrustlaws. By its counterclaims, the Company is seeking damages and other relieffrom IGT. IGT’s motion to dismiss the Company’s antitrust claims wasdenied in January 2006, and in March 2007, the court denied IGT’s motionsfor summary judgment with respect to the antitrust claims dealing with thewheel game market.  The court issuedclaims construction rulings in May 2007. No trial date has been set.

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

In May2006, IGT filed a patent infringement lawsuit against the Company in the UnitedStates District Court for the District of Delaware.  The complaint asserts that the Company’sBally Power BonusingÔ products infringepatents held by IGT, and seeks injunctive relief and damages in unspecifiedamounts.  The Company believes IGT’sclaims are without merit and is vigorously defending itself against thelawsuit.

The Company isalso a party to various lawsuits relating to routine matters incidental to ourbusiness.  Management does not believethat the outcome of such litigation, including the matters above, in theaggregate, will have a material adverse effect on our consolidated financialposition, results of operations or cash flows.

**ITEM 1A.       RISK FACTORS**

There have been nomaterial changes to the risk factors presented in Item 1A of the 2006 10-K..

31

----

**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. |
|     |       |                                                                                                                                                  |

 

32

----

**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto authorized.

BALLY TECHNOLOGIES, INC.                                              Date:  June 20, 2007

 
| 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)                     |   |

 

 

----