**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**

| **x**                                              |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
| ** **                                         |   | ** **                                                                                    |
| **For the  quarterly period ended March 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  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

| **6601 S. Bermuda Rd.**                   |   |       |
|-------------------------------------------|--------|------------|
| **Las  Vegas, Nevada**                    |   | **89119**  |
| (Address of  principal executive offices) |   | (Zip Code) |

 

Registrant’s telephonenumber: **(702) 584-7600**

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 x  No

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of 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 x  No

The number of shares of Common Stock, $0.10 par value,outstanding as of March 9, 2007, according to the records of the registrant’sregistrar and transfer agent was 53,206,342, which does not include 531,148shares held in treasury.

 

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**EXPLANATORY NOTE**

As previouslydisclosed on Form 12b-25 of Bally Technologies, Inc. (formerly known asAlliance Gaming Corporation, “Bally,” the “Company,” or “we”), filed with theSecurities and Exchange Commission (the “SEC”) on May 11, 2006, the filing ofthis Quarterly Report on Form 10-Q for the period ended March 31, 2006 wasoriginally delayed due to the significant amount of additional time andresources necessary to complete the preparation and analysis of the financialstatements for the fiscal quarters ended September 30, 2005 and December 31,2005.  The filing of this Quarterly Report on Form 10-Q was furtherdelayed by the restatements discussed in our Annual Report on Form 10-K/A forthe fiscal year ended June 30, 2005, as amended and restated and filed with theSEC on October 31, 2006 (the “2005 10-K”). Furthermore, the preparation of the financial information presented inthis Quarterly Report on Form 10-Q required additional time and resourcesbecause it was prepared while certain material weaknesses existed in ourinternal control over financial reporting.

**INDEX**
| **PART I.**    | ** ** | **FINANCIAL  INFORMATION**                                                                                                                | ** ** | ** ** |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|           |       |                                                                                                                                      |       |       |
| Item 1.        |       | Financial Statements                                                                                                                      |       |       |
|           |       |                                                                                                                                      |       |       |
|           |       | Unaudited  Condensed Consolidated Balance Sheets as of March 31, 2006 and June 30, 2005                                                   |       |       |
|           |       |                                                                                                                                      |       |       |
|           |       | Unaudited  Condensed Consolidated Statements of Operations for the Three Months and Nine  Months Ended March 31, 2006 and 2005 (restated) |       |       |
|           |       |                                                                                                                                      |       |       |
|           |       | Unaudited Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended March 31,  2006 and 2005 (restated)                  |       |       |
|           |       |                                                                                                                                      |       |       |
|           |       | Notes to  Unaudited Condensed Consolidated Financial Statements                                                                           |       |       |
|           |       |                                                                                                                                      |       |       |
| Item 2.        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                               |       |       |
|           |       |                                                                                                                                      |       |       |
| Item 3.        |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                               |       |       |
|           |       |                                                                                                                                      |       |       |
| Item 4.        |       | Controls and  Procedures                                                                                                                  |       |       |
|           |       |                                                                                                                                      |       |       |
| **PART II.**   | ** ** | **OTHER  INFORMATION**                                                                                                                    | ** ** | ** ** |
|           |       |                                                                                                                                      |       |       |
| Item  1.       |       | Legal  Proceedings                                                                                                                        |       |       |
|           |       |                                                                                                                                      |       |       |
| Item 4.        |       | Submission of  Matters to a Vote of Security Holders                                                                                      |       |       |
|           |       |                                                                                                                                      |       |       |
| Item  6.       |       | Exhibits                                                                                                                                  |       |       |
|           |       |                                                                                                                                      |       |       |
| **SIGNATURES** |       |                                                                                                                                      |       |       |

 

1

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**PART I**

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                       | ** ** | **March 31,**                                      | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                       | ** ** | **2006**                                                | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                       | ** ** | **(in 000s, except share amounts)** | ** ** |
| ASSETS                                                                                                                                           |       |                                                    |       |              |       |
| Current assets:                                                                                                                                  |       |                                                    |       |              |       |
| Cash and cash  equivalents                                                                                                                       |       | $                                                       | 32,372     |              | $          | 33,170 |   |
| Restricted cash                                                                                                                                  |       | 14,098                                                  |       | 13,421            |       |
| Accounts and  notes receivable, net of allowances for doubtful accounts of $7,947 and  $10,340                                                   |       | 119,534                                                 |       | 97,679            |       |
| Inventories                                                                                                                                      |       | 60,262                                                  |       | 63,523            |       |
| Income taxes  receivable                                                                                                                         |       | 566                                                     |       | —            |       |
| Deferred tax  assets, net                                                                                                                        |       | 30,851                                                  |       | 30,884            |       |
| Other current  assets                                                                                                                            |       | 42,396                                                  |       | 33,034            |       |
| Total current  assets                                                                                                                            |       | 300,079                                                 |       | 271,711           |       |
| Long-term investments  (restricted)                                                                                                              |       | 8,679                                                   |       | 10,060            |       |
| Long-term receivables,  net of allowance for doubtful accounts of $0 and $11                                                                     |       | 7,435                                                   |       | 7,450             |       |
| Leased gaming  equipment, net of accumulated depreciation of $64,057 and $42,495                                                                 |       | 34,964                                                  |       | 51,850            |       |
| Property, plant and  equipment, net of accumulated depreciation of $51,220 and $40,548                                                           |       | 67,394                                                  |       | 66,811            |       |
| Goodwill                                                                                                                                         |       | 161,056                                                 |       | 161,444           |       |
| Intangible assets, net  of accumulated amortization of $22,275 and $17,356                                                                       |       | 31,205                                                  |       | 49,451            |       |
| Deferred tax assets,  net                                                                                                                        |       | 35,970                                                  |       | 16,548            |       |
| Other assets, net                                                                                                                                |       | 20,415                                                  |       | 19,609            |       |
| Total assets                                                                                                                                     |       | $                                                       | 667,197    |              | $          | 654,934 |   |
|                                                                                                                                             |       |                                                    |       |              |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                       |       |                                                    |       |              |       |
| Current liabilities:                                                                                                                             |       |                                                    |       |              |       |
| Accounts payable                                                                                                                                 |       | $                                                       | 31,564     |              | $          | 36,807 |   |
| Accrued  liabilities                                                                                                                             |       | 69,819                                                  |       | 43,838            |       |
| Deferred revenue                                                                                                                                 |       | 49,123                                                  |       | 40,962            |       |
| Jackpot  liabilities                                                                                                                             |       | 12,603                                                  |       | 13,025            |       |
| Income taxes  payable                                                                                                                            |       | —                                                  |       | 1,752             |       |
| Current  maturities of long-term debt, including $4,800 and $6,006 owed to related  parties                                                      |       | 8,844                                                   |       | 10,163            |       |
| Total current  liabilities                                                                                                                       |       | 171,953                                                 |       | 146,547           |       |
| Long-term debt, net of  current maturities, including $10,400 and $13,200 owed to related parties                                                |       | 319,157                                                 |       | 324,954           |       |
| Other liabilities                                                                                                                                |       | 23,308                                                  |       | 6,931             |       |
| Total  liabilities                                                                                                                               |       | 514,418                                                 |       | 478,432           |       |
| Minority interest                                                                                                                                |       | 840                                                     |       | 479               |       |
|                                                                                                                                             |       |                                                    |       |              |       |
| Commitment and  Contingencies (Note 13)                                                                                                          |       |                                                    |       |              |       |
|                                                                                                                                             |       |                                                    |       |              |       |
| Stockholders’ equity:                                                                                                                       |       |                                                    |       |              |       |
| Special stock,  10,000,000 shares authorized: Series E, $100 liquidation value; 115 shares  issued and outstanding                               |       | 12                                                      |       | 12                |       |
| Common stock,  $.10 par value; 100,000,000 shares authorized; 52,694,000 and 52,649,000  shares issued and 52,168,000 and 52,123,000 outstanding |       | 5,273                                                   |       | 5,268             |       |
| Treasury stock  at cost, 526,000 and 526,000 shares                                                                                              |       | (665                                                    | )          | (665              | )          |
| Deferred  compensation                                                                                                                           |       | —                                                  |       | (6,689            | )          |
| Additional  paid-in capital                                                                                                                      |       | 215,261                                                 |       | 212,182           |       |
| Accumulated  other comprehensive income                                                                                                          |       | 1,403                                                   |       | 1,219             |       |
| Accumulated  deficit                                                                                                                             |       | (69,345                                                 | )          | (35,304           | )          |
| Total  stockholders’ equity                                                                                                                 |       | 151,939                                                 |       | 176,023           |       |
| Total liabilities and  stockholders’ equity                                                                                                 |       | $                                                       | 667,197    |              | $          | 654,934 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

2

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**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                                                 | ** ** | **Three Months Ended  March 31,**                 | ** ** | **Nine Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | ** **                                                       | ** ** | **(as restated,  see Note 2)**   | ** ** | ** ** | ** ** | **(as restated,  see Note 2)** | ** ** |
| ** **                                                                 | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Revenues:                                                                  |       |                                                             |       |                                            |       |   |   |   |   |
| Gaming equipment and systems                                               |       | $                                                                | 141,221    |                                            | $          | 107,955 |   | $ | 349,977 |   | $ | 326,425 |   |
| Casino operations                                                          |       | 15,090                                                           |       | 13,734                                          |       | 41,137 |   | 39,339 |   |
|                                                                       |       | 156,311                                                          |       | 121,689                                         |       | 391,114 |   | 365,764 |   |
| Costs and  expenses:                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Cost of gaming equipment and systems                                       |       | 89,862                                                           |       | 62,573                                          |       | 204,025 |   | 183,410 |   |
| Cost of casino operations                                                  |       | 4,880                                                            |       | 4,857                                           |       | 14,102 |   | 14,248 |   |
| Selling, general and administrative                                        |       | 49,281                                                           |       | 36,650                                          |       | 138,130 |   | 121,054 |   |
| Research and development costs                                             |       | 12,200                                                           |       | 10,589                                          |       | 33,242 |   | 32,719 |   |
| Restructuring charges                                                      |       | —                                                           |       | 2,219                                           |       | — |   | 3,654 |   |
| Impairment charges                                                         |       | 13,953                                                           |       | 3,599                                           |       | 13,953 |   | 3,599 |   |
| Depreciation and amortization                                              |       | 6,383                                                            |       | 5,235                                           |       | 19,207 |   | 14,709 |   |
|                                                                       |       | 176,559                                                          |       | 125,722                                         |       | 422,659 |   | 373,393 |   |
| Operating loss                                                             |       | (20,248                                                          | )          | (4,033                                          | )          | (31,545 | ) | (7,629 | ) |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Other income  (expense):                                                   |       |                                                             |       |                                            |       |   |   |   |   |
| Interest income                                                            |       | 925                                                              |       | 1,355                                           |       | 2,417 |   | 3,212 |   |
| Interest expense                                                           |       | (7,096                                                           | )          | (5,114                                          | )          | (20,300 | ) | (12,865 | ) |
| Loss on extinguishment of debt                                             |       | —                                                           |       | —                                          |       | — |   | (564 | ) |
| Other, net                                                                 |       | 47                                                               |       | 142                                             |       | (474 | ) | 957 |   |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Loss from  continuing operations before income taxes and minority interest |       | (26,372                                                          | )          | (7,650                                          | )          | (49,902 | ) | (16,889 | ) |
| Income tax benefit (expense)                                               |       | 9,839                                                            |       | (521                                            | )          | 18,674 |   | 4,059 |   |
| Minority interest                                                          |       | (226                                                             | )          | (907                                            | )          | (2,813 | ) | (2,551 | ) |
| Loss from  continuing operations                                           |       | (16,759                                                          | )          | (9,078                                          | )          | (34,041 | ) | (15,381 | ) |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Loss from  discontinued operations, net of income taxes                    |       | —                                                           |       | (395                                            | )          | — |   | (4,771 | ) |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Net loss                                                                   |       | $                                                                | (16,759    | )                                               | $          | (9,473 | ) | $ | (34,041 | ) | $ | (20,152 | ) |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Basic and  diluted loss per share:                                         |       |                                                             |       |                                            |       |   |   |   |   |
| Continuing operations                                                      |       | $                                                                | (0.32      | )                                               | $          | (0.18 | ) | $ | (0.65 | ) | $ | (0.31 | ) |
| Discontinued operations                                                    |       | —                                                           |       | (0.01                                           | )          | — |   | (0.09 | ) |
| Total                                                                      |       | $                                                                | (0.32      | )                                               | $          | (0.19 | ) | $ | (0.65 | ) | $ | (0.40 | ) |
|                                                                       |       |                                                             |       |                                            |       |   |   |   |   |
| Weighted average  shares outstanding:                                      |       |                                                             |       |                                            |       |   |   |   |   |
| Basic and  diluted                                                         |       | 52,158                                                           |       | 51,057                                          |       | 52,144 |   | 50,485 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

3

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**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                       | ** ** | **Nine Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | ** **                                      | ** ** | **(as restated,  see Note 2)** | ** ** |
| ** **                                                                       | ** ** | **(in 000s)**                              | ** ** |
| Cash flows from  operating activities:                                           |       |                                            |       |   |   |
| Net loss                                                                         |       | $                                               | (34,041    | ) | $ | (20,152 | ) |
| Loss from  discontinued operations                                               |       | —                                          |       | 4,771 |   |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                    |       | 51,759                                          |       | 35,140 |   |
| Share-based compensation                                                         |       | 9,474                                           |       | 1,387 |   |
| Loss on extinguishment of debt                                                   |       | —                                          |       | 564 |   |
| Deferred income tax (benefit) expense                                            |       | (19,389                                         | )          | 2,155 |   |
| Provision for doubtful accounts                                                  |       | 233                                             |       | 5,350 |   |
| Operating activities of discontinued operations                                  |       | —                                          |       | (3,392 | ) |
| Inventory and other asset write-downs                                            |       | 25,930                                          |       | 26,079 |   |
| Other                                                                            |       | 4,368                                           |       | 722 |   |
| Changes in  operating assets and liabilities:                                    |       |                                            |       |   |   |
| Accounts and notes receivable                                                    |       | (21,940                                         | )          | 28,594 |   |
| Inventories                                                                      |       | 1,374                                           |       | (17,309 | ) |
| Other current assets                                                             |       | 1,353                                           |       | 108 |   |
| Purchase of appeal bond                                                          |       | —                                          |       | (7,361 | ) |
| Accounts payable                                                                 |       | (5,177                                          | )          | (12,814 | ) |
| Accrued liabilities, deferred revenue and jackpot  liabilities                   |       | 31,793                                          |       | (25,203 | ) |
| Net cash  provided by operating activities                                       |       | 45,737                                          |       | 18,639 |   |
|                                                                             |       |                                            |       |   |   |
| Cash flows from  investing activities:                                           |       |                                            |       |   |   |
| Additions to property, plant, and equipment                                      |       | (9,990                                          | )          | (9,124 | ) |
| Additions to leased gaming equipment                                             |       | (26,598                                         | )          | (29,947 | ) |
| Settlement of acquisition related contingency                                    |       | —                                          |       | (12,000 | ) |
| Acquisition, net of cash acquired                                                |       | —                                          |       | 1,911 |   |
| Restricted cash and investments                                                  |       | (639                                            | )          | 92 |   |
| Additions to other long-term assets                                              |       | (2,505                                          | )          | (2,177 | ) |
| Net cash used in  investing activities                                           |       | (39,732                                         | )          | (51,245 | ) |
|                                                                             |       |                                            |       |   |   |
| Cash flows from  financing activities:                                           |       |                                            |       |   |   |
| Capitalized debt issuance costs                                                  |       | —                                          |       | (1,053 | ) |
| Payoff of debt due to sale of net assets of  discontinued operations             |       | —                                          |       | (101,618 | ) |
| Reduction of long-term debt                                                      |       | (7,126                                          | )          | (5,283 | ) |
| Purchase of treasury shares                                                      |       | —                                          |       | (164 | ) |
| Proceeds from exercise of stock options, including  tax benefit                  |       | 298                                             |       | 1,068 |   |
| Net cash used in  financing activities                                           |       | (6,828                                          | )          | (107,050 | ) |
|                                                                             |       |                                            |       |   |   |
| Effect of  exchange rate changes on cash                                         |       | 25                                              |       | 385 |   |
|                                                                             |       |                                            |       |   |   |
| Cash and cash  equivalents:                                                      |       |                                            |       |   |   |
| Decrease for period                                                              |       | (798                                            | )          | (139,271 | ) |
| Balance, beginning of period                                                     |       | 33,170                                          |       | 154,258 |   |
| Balance, end of  period                                                          |       | $                                               | 32,372     |   | $ | 14,987 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

4

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**BALLY TECHNOLOGIES, INC.**

**FORM 10-Q**

Notes To Unaudited Condensed Consolidated FinancialStatements

**1.****                                      BASIS OF PRESENTATION**

*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. (formerly known as Alliance Gaming Corporation), a Nevadacorporation, and its subsidiaries (“Bally” or the “Company”) for the respectiveperiods presented.  The results ofoperations for an interim period are not necessarily indicative of the resultsthat may be expected for any other interim period or the year as a whole. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the consolidated financial statements and notesthereto in the Company’s Annual Report on Form 10-K/A for the fiscal year endedJune 30, 2005 as amended and restated and filed with the SEC on October 31,2006 (the “2005 10-K”).

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.  As of the date of this filing, a formal planfor the sale of the Rainbow Casino had not been approved by the Company’s Boardof Directors.

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

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 a businessenterprise of variable interest entities (“VIE’s”) that either: (1) do not havesufficient equity investment at risk to permit the entity to finance itsactivities without additional subordinated financial support or (2) hold asignificant variable interest in, or have significant involvement with, anexisting VIE.  For the periods ended March 31, 2006 and2005, the Company consolidated $4.5 million and $4.9 million,respectively, in total assets and liabilities, primarily consisting ofrestricted cash accounts and restricted investments (included in other assetsin the condensed consolidated balance sheets) and related jackpotliabilities.  The following revenues andcosts were also consolidated:
|                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in 000s)**                                    | ** ** |
| Gaming equipment  and systems revenue |       | $                                                | 1,941      |                                            | $          | 1,858 |   | $ | 6,278 |   | $ | 3,249 |   |
| Cost of gaming  equipment and systems |       | 1,312                                            |       | 1,882                                           |       | 4,585 |   | 2,410 |   |
|                                       |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |  |

 

All intercompany accounts andtransactions have been eliminated in consolidation.

*Reclassifications*

Certain reclassifications havebeen made to the prior period financial statements to conform to the currentperiod presentation, the most significant of which was depreciation on leasedgaming equipment which has been reclassified

5

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from depreciation expense to costof gaming equipment and systems, totaling $7.1 million and $20.4 million,respectively, for the three and nine month periods ended March 31, 2005.

*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 $2.5 million and $10.6million and $7.9 million and $18.0 million, respectively, during the three andnine months ended March 31, 2006 and 2005. These charges are classified in cost of gaming equipment and systems inthe consolidated statements of operations.

*Property,plant and equipment and leased gaming equipment*

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

Based onhistorical data indicating a compression in the length of time certain leasedgaming equipment was deployed, the Company re-evaluated the useful lives duringthe quarter ended December 31, 2005, and reduced the depreciable life forcertain of its products to two years and reduced the salvage values tozero.  This change in estimate wasrecorded prospectively, resulting in a $6.6 million and $13.4 million charge todepreciation expense in the three and nine months ended March 31, 2006, respectively.

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

*Recently Issued AccountingPronouncements*

In February, 2007,FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*. SFAS No.159 providescompanies with an option to report selected financial assets and liabilities atfair value. It also establishes presentation and disclosure requirements tofacilitate comparisons between companies using different measurement attributesfor similar types of assets and liabilities. The statement is effective as ofthe beginning of the first fiscal year beginning after November 15, 2007.Earlier application is permitted provided the Company also applies theprovisions of Statement 157 *Fair Value Measurements*.The Company is currently in the process of evaluating the impact SFAS No. 159will have on our consolidated results of operations, financial position andcash flows.

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

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, providing guidance on how prioryear misstatements should be taken into consideration when quantifyingmisstatements in current year financial statements for purposes of determiningwhether the current year’s financial statements are materially misstated. SABNo. 108 is effective for fiscal years ending on or after November 15, 2006, andaccordingly, the

6

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Company expects toadopt SAB No. 108 beginning in fiscal year 2007. The Company does not expectthat SAB No. 108 will have an impact on its consolidated results of operations,financial position or cash flows.

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

In June 2005,the FASB issued FASB Staff Position (“FSP”) No. 143-1, *Accounting for Electronic Equipment WasteObligations,* toaddress accounting for obligations associated with the European Union’sDirective 2002/96/EC on Waste Electrical and Electronic Equipment. TheDirective, enacted in 2003, requires EU-member countries to adopt legislationto regulate the collection, treatment, recovery, and environmentally sounddisposal of electrical and electronic waste equipment. The Directivedistinguishes between products put on the market after August 13, 2005 asnew waste and before that date as historical waste. FSP No. 143-1 onlyaddresses accounting for historical waste and is required to be applied to thelater of the first reporting period ending after June 8, 2005 or the dateof adoption of the law by the applicable European Union member country.   Adoption of FSP No. 143-1 did not have amaterial impact on the Company’s consolidated results of operations, financialposition or cash flows.

InDecember 2004, the FASB issued SFAS No. 153,  *Exchanges of Nonmonetary Assets*,amending Accounting Principles Board (“APB”) Opinion No. 29, *Accounting for Nonmonetary Transactions*.  APB Opinion No. 29 treated nonmonetaryexchanges of similar productive assets as an exception from fair valuemeasurement.  SFAS No. 153 replaces thisexception with a general exception from fair value measurement for exchanges ofnonmonetary assets that do not have commercial substance. Nonmonetary exchangeshave commercial substance if the future cash flows of an entity are expected tochange significantly as a result of the exchange. SFAS No. 153 was effectivefor nonmonetary asset exchanges occurring in fiscal years beginning afterJune 15, 2005. Adoption of SFAS No. 153 did not have a material impact onthe Company’s consolidated results of operations, financial position or cashflows.

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

**2.****                                      RESTATEMENT**

Subsequent to the issuance of the unaudited condensed consolidated financialstatements for the three and nine month periods ended March 31, 2005, theCompany identified accounting errors that required adjustments to suchpreviously issued financial statements.

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

*Revenue Recognition*

The Companyidentified instances where the timing or amount of revenue recognized was notin accordance with The American Institute of Certified Public Accountants (“AICPA”)Statement of Position (“SOP”) No. 97-2 *Software RevenueRecognition*.  The Companydetermined that certain requirements of SOP No. 97-2 were not met in a numberof instances and therefore, revenue with respect to certain transactions wasrecognized prematurely.  In accountingfor these transactions, the Company has determined that it (1) should havedeferred the revenue and 

7

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related cost ofsales, (2) should have reflected certain goods shipped as consigned inventoryuntil later periods and (3) should not have recognized certain accountsreceivable until later periods.

The specificcircumstances which resulted in adjustments are as follows:

*Persuasive evidence of an arrangement exists*

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

Additionally, theCompany identified one transaction for which revenue was recognized in thethree months ended December 31, 2004 at the time the games were shipped to thecustomer based on a signed sales-type lease agreement.  Subsequently, the customer negotiated a fixedprice payment with a cash discount and other concessions. These circumstancescalled into question whether the original agreement provided adequate evidenceof an arrangement that was sufficiently definitive to support recognition ofrevenue in December 2004.  The Companyconcluded that there was not persuasive evidence of an arrangement at thattime, and therefore, the revenue should have been deferred until the cash wasreceived in July 2005.

*Delivery has occurred*

TheCompany identified instances in which revenue was recognized for sales at thetime the product was shipped to customers when the shipping terms stated orimplied that the risk of loss and/or title did not transfer until the goodswere delivered to the customer’s location. Furthermore, certain transactions were identified that had beenaccounted for on a bill and hold basis that did not satisfy all of theapplicable bill and hold criteria under SAB No. 104, *RevenueRecognition in Financial Statements*, resulting in revenuerecognition prior to the physical delivery of goods to the customer. In both ofthese circumstances, recognition of revenue should have been deferred until thetime the products reached the customer’s location, and therefore, the revenuethat had been previously recorded in connection with these transactions wasadjusted to be recorded in subsequent accounting periods when the deliverycriteria was met.

TheCompany also identified instances in the System division where certain standardsales agreements contained contractual terms creating a non-perpetual softwarelicense rather than a perpetual license. The Company determined that in such circumstances, revenue fornon-perpetual software licenses should not have been recognized in full as ofthe acceptance date, but rather should have been deferred and recognizedratably over the twelve-month period from the date of acceptance.  Consequently, the revenue that had previouslybeen recorded in connection with these transactions was adjusted to be recordedin the appropriate periods.

*The vendor’s fee is fixed or determinable and collectibility isprobable*

The use of extendedpayment terms in a software licensing arrangement may indicate that the fee isnot fixed or determinable and collectibility is not probable.  The Company identified instances whererevenue was recorded upon delivery of both systems and gaming products tocustomers under contracts that contained payment terms in excess of 24months.  At the time the sales wererecorded, the Company did not have sufficient historical evidence of collectionsmade under extended contracts with terms beyond 24 months, as required underSOP No. 97-2.  Therefore, the Companyshould not have concluded that collectibility was probable and it should havedeferred revenue on all contracts with extended payment terms in excess of 24months, and recorded revenue upon receipt of payment from the customer.  Consequently, the revenue that had previouslybeen recorded in connection with these transactions was adjusted to be recordedin the subsequent periods when payment was received.

Inaddition, the Company identified instances in which revenue was recognized atthe time product was shipped to customers who were either thinly capitalized orwere new customers to the Company for which creditworthiness had not been sufficientlyestablished.  Pursuant to SOP No. 97-2,collectibility must be determined to be “probable” at the time of delivery inorder for revenue to be recognized, and therefore, in such circumstances,recognition of revenue should

8

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havebeen deferred until payment from the customer was received.  Therefore, revenue that had previously beenrecorded for these transactions was adjusted to be recorded in subsequentperiods when payment was received.

Inventory

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

OtherMiscellaneous Adjustments

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

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

The Companydetermined that it should have recorded the value of restricted stock unitsbased on the closing price of its common stock on the date of grant and not theaverage closing price for the 20 business days prior to the date ofgrant.  An adjustment was recorded to reflect the fair market value duringthe fiscal year ended June 30, 2005, based on the closing price of the Company’scommon stock on the respective dates of grant of the restricted stock units andan adjustment was recorded during the three and nine month periods ended March31, 2005 for the related stock compensation expense.

Additionally, theCompany determined that interest earned on trade accounts receivable shouldhave been recorded as interest income rather than revenue and recorded anadjustment to change the classification of these amounts to interest income.

As a result, the unauditedcondensed consolidated financial statements for the three and nine monthperiods ended March 31, 2005 have been restated from amounts previouslyreported. The following is a reconciliation of the loss from continuingoperations as previously reported to the restated amounts by the categoriesdiscussed above, net of tax:
| ** **                                               | ** ** | **For the Three Months Ended  March 31, 2005** | ** ** | **For the Nine Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(in 000s)**                                                                | ** ** |
| Loss from  continuing operations, as previously reported |       | $                                                                            | (6,449     | )                                                                           | $          | (20,394 | ) |
| Revenue recognition adjustments, net                     |       | (1,476                                                                       | )          | 4,850                                                                       |       |
| Inventory adjustments, net                               |       | 416                                                                          |       | 1,057                                                                       |       |
| Other miscellaneous adjustments, net                     |       | (1,569                                                                       | )          | (894                                                                        | )          |
| Loss from continuing  operations, as restated            |       | $                                                                            | (9,078     | )                                                                           | $          | (15,381 | ) |

 

9

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The following tables summarizethe significant effects of the restatement:
| ** **                                                                 | ** ** | **Three Months Ended  March 31, 2005** | ** ** | **Nine Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **As previously   reported**                     | ** ** | **As restated**                                      | ** ** | **As previously   reported** | ** ** | **As restated** | ** ** |
| ** **                                                                 | ** ** | **(in 000s)**                                         | ** ** |
| *Statement  of Operations*                                                 |       |                                                       |       |                                                      |       |   |   |   |   |
| Revenue:                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| Gaming equipment and systems                                               |       | $                                                          | 111,678    |                                                      | $          | 107,955 |   | $ | 316,688 |   | $ | 326,425 |   |
| Casino operations                                                          |       | 13,734                                                     |       | 13,734                                                    |       | 39,339 |   | 39,339 |   |
| Total revenue                                                              |       | 125,412                                                    |       | 121,689                                                   |       | 356,027 |   | 365,764 |   |
| Cost of gaming  equipment and systems and casino operations                |       | 62,310                                                     |       | 67,430                                                    |       | 175,874 |   | 197,658 |   |
| Selling, general  and administrative expense                               |       | 36,510                                                     |       | 36,650                                                    |       | 121,216 |   | 121,054 |   |
| Depreciation and  amortization  *                                          |       | 12,373                                                     |       | 5,235                                                     |       | 35,234 |   | 14,709 |   |
| Operating loss                                                             |       | (2,188                                                     | )          | (4,033                                                    | )          | (16,269 | ) | (7,629 | ) |
| Interest income                                                            |       | 215                                                        |       | 1,355                                                     |       | 1,013 |   | 3,212 |   |
| Interest expense                                                           |       | (5,073                                                     | )          | (5,114                                                    | )          | (12,785 | ) | (12,865 | ) |
| Loss from continuing  operations before income taxes and minority interest |       | (7,022                                                     | )          | (7,650                                                    | )          | (28,053 | ) | (16,889 | ) |
| Income tax  benefit (expense)                                              |       | (1,480                                                     | )          | 521                                                       |       | 10,210 |   | 4,059 |   |
| Loss from  continuing operations                                           |       | (6,449                                                     | )          | (9,078                                                    | )          | (20,394 | ) | (15,381 | ) |
| Net loss                                                                   |       | (6,844                                                     | )          | (9,473                                                    | )          | (25,165 | ) | (20,152 | ) |
|                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Basic and  diluted loss per share:                                         |       |                                                       |       |                                                      |       |   |   |   |   |
| Continuing operations                                                      |       | $                                                          | (0.13      | )                                                         | $          | (0.18 | ) | $ | (0.41 | ) | $ | (0.31 | ) |
| Discontinued operations                                                    |       | (0.01                                                      | )          | (0.01                                                     | )          | (0.09 | ) | (0.09 | ) |
| Total                                                                      |       | $                                                          | (0.14      | )                                                         | $          | (0.19 | ) | $ | (0.50 | ) | $ | (0.40 | ) |

 

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*Depreciation on leased gaming equipment has been reclassified to cost of gamingequipment and systems (see Note 1).
| ** **                                      | ** ** | **Nine Months Ended  March 31, 2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                      | ** ** | **As previously   reported**                    | ** ** | **As restated** | ** ** |
| ** **                                      | ** ** | **(in 000s)**                                        | ** ** |
| *Statement  of Cash Flows*                      |       |                                                      |       |   |   |
| Cash flows  provided by operating activities    |       | $                                                         | 15,115     |   | $ | 18,639 |   |
| Cash flows used  in investing activities        |       | (51,466                                                   | )          | (51,245 | ) |
| Cash flows used  in financing activities        |       | (107,050                                                  | )          | (107,050 | ) |
| Cash flows provided by  discontinued operations |       | 1,704                                                     |       | — |   |
|                                                 |            |                                                           |            |  |  |  |  |

 

**3. ****                                DISCONTINUED OPERATIONS**

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

The results of these discontinued operationsare presented net of applicable income taxes within loss from discontinuedoperations in the accompanying condensed consolidated statements of operations.

In September, 2004, a Federal District Courtjury reached a verdict in a patent infringement case filed by Action Gaming,Inc. (“AGI”) and International Game Technology (“IGT”). The jury awarded AGIand IGT an aggregate of approximately $7.4 million in damages related to asingle, optional feature offered in certain multi-hand poker games providedsolely by United Coin.  See Note 13, Commitmentsand Contingencies, for a description of the related litigation.

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In March 2006, in another case involvingUnited Coin, the U.S. Court of Appeals for the Ninth Circuit awarded UnitedCoin approximately $1.1 million in damages, fees, and costs in a contractdispute with a customer. Under the terms of the 2004 sale of United Coin, theCompany retained the right to continue to prosecute the case and to receive anyjudgment or other award. In May 2006, the customer paid a total of $1.7 millionin satisfaction of the award plus interest. The payment will be reported asincome from discontinued operations, net of income tax, during the three monthsended June 30, 2006.

Operating results for the discontinuedoperations include VSI and United Coin. Summary operating results are as follows:   
|                                              | ** ** | **Three Months Ended  March 31, 2005** | ** ** | **Nine Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                   | ** ** | **(in 000s)**                                         | ** ** |
| Net revenues                                 |       | $                                                          | —     |                                                      | $          | 4,514 |   |
| Operating income                             |       | —                                                     |       | 358                                                       |       |
| Loss on  litigation settlement, Nevada Route |       | —                                                     |       | (7,361                                                    | )          |
| Income tax  benefit                          |       | 31                                                         |       | 2,485                                                     |       |
| Loss from discontinued  operations           |       | $                                                          | (395       | )                                                         | $          | (4,771 | ) |

 

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

The computation of basic and diluted loss per share from continuingoperations and discontinued operations and loss applicable to common shares areas follows:
|                                                          | ** ** | **Three Months Ended  March 31,**                 | ** ** | **Nine Months Ended  March 31** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Loss from  continuing operations                         |       | $                                                                | (16,759    | )                                              | $          | (9,078 | ) | $ | (34,041 | ) | $ | (15,381 | ) |
| Loss from  discontinued operations                       |       | —                                                           |       | (395                                           | )          | — |   | (4,771 | ) |
| Net loss                                                 |       | $                                                                | (16,759    | )                                              | $          | (9,473 | ) | $ | (34,041 | ) | $ | (20,152 | ) |
| Weighted average  common shares outstanding              |       | 52,158                                                           |       | 51,057                                         |       | 52,144 |   | 50,485 |   |
| Loss per basic  and diluted share: Continuing operations |       | $                                                                | (0.32      | )                                              | $          | (0.18 | ) | $ | (0.65 | ) | $ | (0.31 | ) |
| Discontinued operations                                  |       | —                                                           |       | (0.01                                          | )          | — |   | (0.09 | ) |
| Total                                                    |       | $                                                                | (0.32      | )                                              | $          | (0.19 | ) | $ | (0.65 | ) | $ | (0.40 | ) |

 

Certain securitieswere excluded from the diluted loss per share calculation because theirinclusion would be anti-dilutive due to the reported net loss.  Such securitiesconsist of the following:
|                  | ** ** | **Three Months Ended   March 31,** | ** ** | **Nine Months Ended   March 31,** | ** ** |
|------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **       | ** ** | **2006**                                               | ** ** | **2005**                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **       | ** ** | **(in 000s)**                                     | ** ** |
| Stock options    |       | 9,198                                                  |       | 7,670                                                 |       | 8,986 |   | 6,159 |   |
| Warrants         |       | 100                                                    |       | 100                                                   |       | 100 |   | 100 |   |
| Restricted stock |       | 554                                                    |       | 539                                                   |       | 554 |   | 436 |   |
| Total            |       | 9,852                                                  |       | 8,309                                                 |       | 9,640 |   | 6,695 |   |

 

Asof March 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 which has not been included in the diluted loss pershare computation due to the reported net loss. Assuming the conversion occurred on March 31, 2006 and 2005, anadditional 0.7 million and 2.7 million shares would have been outstanding as aresult of the conversion.

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**5.****                                      SHARE-BASED COMPENSATION**

In December 2001, theCompany’s shareholders approved the 2001 Long-Term Incentive Plan, which hasbeen amended several times (the “2001 Plan”). The 2001 Plan provides for theissuance of up to 10,550,000 shares of common stock to Company employees,directors and designated paid consultants and up to 900,000 shares ofrestricted stock or Restricted Stock Units (“RSUs”). Generally, options aregranted at the fair value of the Company’s common stock at the date of grantand are exercisable over five to ten years.

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

Thedecision to accelerate vesting of these underwater stock options was madeprimarily to avoid recognizing compensation expense under SFAS No. 123R,*Share Based Payment*. Because the exercise price of the options subject to the acceleratedvesting was above the market price of the stock on the date of acceleration,the Company determined that these options did not offer a sufficient incentiveto employees when compared to the potential future compensation expense thatthe Company would incur under SFAS No. 123R with respect to these options.

Effective July 1,2005, the Company adopted the provisions of SFAS No. 123R whichestablished accounting for equity instruments exchanged for employee services.SFAS No. 123R requires employee stock options and rights to purchase sharesunder stock participation plans to be accounted for under the fair valuemethod, and eliminates the ability to account for these instruments under theintrinsic value method prescribed by APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. In March 2005, the SEC issued SAB No. 107,  *Share-Based Payment,*whichprovided interpretive guidance on SFAS No. 123R valuation methods, assumptionsused in valuation models, and the interaction of SFAS No. 123R with existingSEC guidance. SAB No. 107 also requires the classification of share-basedcompensation expense in the same financial statement line as cash compensation,and therefore, impacted the Company’s cost of gaming equipment and systems,casino operations (and related gross profits and margins), research anddevelopment costs, and selling, general and administrative expenses.  The Company implemented SFAS No. 123R on July1, 2005 using the modified-prospective method and accordingly, financialstatement amounts for the prior periods presented have not been restated toreflect the fair value method of expensing share-based compensation.

Under the provisions ofSFAS No. 123R, share-based compensation cost is measured at the grantdate, based on the calculated fair value of the award, and is recognized as anexpense over the employee’s requisite service period (generally the vestingperiod of the equity grant). Prior to July 1, 2005, the Company accountedfor share-based compensation to employees in accordance with APB OpinionNo. 25 and related interpretations. The Company also followed thedisclosure requirements of SFAS No. 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transition and Disclosure*.

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The following tablepresents share-based compensation expense included in the Company’s condensedconsolidated statements of operations: 
|                                              | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Nine Months Ended  March 31, 2006** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                   | ** ** | **(in 000s)**                                         | ** ** |
| Selling, general  and administrative         |       | $                                                          | 3,261      |                                                      | $          | 8,633 |   |
| Research and  development                    |       | 275                                                        |       | 771                                                       |       |
| Cost of gaming  and equipment                |       | 24                                                         |       | 70                                                        |       |
| Share-based  compensation expense before tax |       | 3,560                                                      |       | 9,474                                                     |       |
| Income tax benefit                           |       | 1,246                                                      |       | 3,316                                                     |       |
| Net share-based  compensation expense        |       | $                                                          | 2,314      |                                                      | $          | 6,158 |   |

 

Included in share-basedcompensation expense in the condensed consolidated statements of cash flows forthe nine month period ended March 31, 2006, is $2.6 million of restricted stockunit amortization.

As of March 31, 2006,there was $22.5 million of total unrecognized compensation expense related tothe nonvested stock options which will be recognized over the next 5.0 years.

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

The fair value of eachoption granted during the corresponding period was estimated on the grant dateusing the Black-Scholes option-pricing model with the following assumptions:
|                                      | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted  Average:                   |       |                                             |       |                                            |       |   |   |   |   |
| Expected option  term (in years) (1) |       | 5.79                                             |       | 6.25                                            |       | 6.25 |   | 6.25 |   |
| Expected  volatility factor          |       | 60.06                                            | %          | 62.00                                           | %          | 61.61 | % | 62.00 | % |
| Risk-free  interest rate             |       | 4.35                                             | %          | 3.50                                            | %          | 3.86 | % | 3.50 | % |
| Expected annual dividend  yield      |       | —                                           |       | —                                          |       | — |   | — |   |

 

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

Current periodstock option activity as of and for the nine months ended March 31, 2006 issummarized below:
|                                           | ** ** | **Weighted Average** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **Shares**                | ** ** | **Exercise  Price** | ** ** | **Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| ** **                                | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** | **(years)** | ** ** | **(in 000s)** | ** ** |
| Balance  outstanding as of June 30, 2005  |       | 8,196                     |       | $ | 14.72 |   |   |   | $ | 18,224 |   |
| Granted                                   |       | 1,529                     |       | 13.82 |   |   |   |   |   |
| Exercised                                 |       | (45                       | )          | 6.63 |   |   |   |   |   |
| Forfeited or expired                      |       | (292                      | )          | 18.87 |   |   |   |   |   |
| Balance  outstanding as of March 31, 2006 |       | 9,388                     |       | $ | 14.49 |   | 6.32 |   | $ | 36,509 |   |
|                                      |       |                      |       |   |   |   |   |   |   |
| Exercisable as of March  31, 2006         |       | 5,776                     |       | $ | 15.73 |   | 5.38 |   | $ | 20,267 |   |

 

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Current periodrestricted stock and RSU activity as of and for the nine months ended March 31,2006 is summarized below:
|                                           | ** ** | **Weighted Average** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **Shares**                | ** ** | **Grant  Date Fair  Value** | ** ** |
| ** **                                | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** |
| Balance  outstanding as of June 30, 2005  |       | 554                       |       | $ | 15.58 |   |
| Granted                                   |       | —                    |       | — |   |
| Exercised                                 |       | —                    |       | — |   |
| Forfeited or expired                      |       | —                    |       | — |   |
| Balance  outstanding as of March 31, 2006 |       | 554                       |       | $ | 15.58 |   |
|                                      |       |                      |       |   |   |
| Vested as of March 31,  2006              |       | 214                       |       | $ | 15.10 |   |

 

The following isadditional information about stock options exercised, granted and vested duringthe periods:
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(in  000s, except per share amounts)**         | ** ** |
| Weighted average fair  value per share:                |       |                                             |       |                                            |       |   |   |   |   |
| Options granted                                        |       | $                                                | 8.82       |                                            | $          | 7.18 |   | $ | 8.44 |   | $ | 7.41 |   |
| Options vested                                         |       | $                                                | 7.32       |                                            | $          | 8.46 |   | $ | 7.51 |   | $ | 8.42 |   |
|                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Exercises under all  share-based payment arrangements: |       |                                             |       |                                            |       |   |   |   |   |
| Total intrinsic  value                                 |       | $                                                | 346.1      |                                            | $          | 320.7 |   | $ | 382.1 |   | $ | 1,413.3 |   |
| Cash received                                          |       | $                                                | 122.3      |                                            | $          | 118.0 |   | $ | 298.5 |   | $ | 826.0 |   |
| Tax benefit realized                                   |       | $                                                | 346.1      |                                            | $          | 260.5 |   | $ | 377.0 |   | $ | 1,114.7 |   |

 

Prior to July 1, 2005,the Company accounted for share-based compensation to employees in accordancewith APB Opinion No. 25, and accordingly, did not recognize compensationexpense for employee share-based awards for the three and nine month periodsended March 31, 2005, as the exercise price of the Company’s employee stockawards equaled the market price of the underlying stock on the date of grant.

The Company hadpreviously adopted the provisions of SFAS No. 123, as amended by SFASNo. 148 through disclosure only. The following table illustrates theeffects on net loss and loss per share for the three and nine months endedMarch 31, 2005, as if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to share-based employee awards:
|                                                 | ** ** | **Three Months Ended  March 31, 2005** | ** ** | **Nine Months Ended  March 31, 2005** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                      | ** ** | **(in 000s, except per share amounts)**                    | ** ** |
| Reported net  loss                              |       | $                                                          | (9,473     | )                                                         | $          | (20,152 | ) |
| Reported  share-based compensation, net of tax  |       | 642                                                        |       | 1,054                                                     |       |
| Pro forma  share-based compensation, net of tax |       | (3,452                                                     | )          | (7,282                                                    | )          |
| Pro forma net  loss                             |       | $                                                          | (12,283    | )                                                         | $          | (26,380 | ) |
| Basic and  diluted loss per share:              |       |                                                       |       |                                                      |       |
| As reported                                     |       | $                                                          | (0.19      | )                                                         | $          | (0.40 | ) |
| Pro forma                                       |       | $                                                          | (0.24      | )                                                         | $          | (0.52 | ) |

 

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**6.****                                      GOODWILL AND INTANGIBLE ASSETS**

As aresult of a change in the Company’s branding strategy and a review of itsoverall operations, the Company determined that certain of its acquiredintangible assets related to tradenames and other intellectual property used byBally Equipment and Systems were no longer recoverable. The Company evaluatedthe carrying value of these assets and determined that several wereimpaired.  Consequently, the Companyrecorded an impairment charge of $4.5 million related to indefinite livedintangible assets consisting of the SDG tradename and an impairment charge of$9.5 million related to finite lived intangible assets, primarily consisting ofacquired patents.

*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: 
|                                      | ** ** | **March 31,  2006** | ** ** | **June 30,  2005** | ** ** |
|--------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **(in 000s)**       | ** ** |
| Amortizable  intangible assets:      |       |                     |       |                    |       |
| Patents and gaming  related products |       | $                        | 21,626     |                    | $          | 31,083 |   |
| Less:  accumulated amortization      |       | (6,730                   | )          | (5,202                  | )          |
|                                 |       | 14,896                   |       | 25,881                  |       |
|                                 |       |                     |       |                    |       |
| Licenses and  other                  |       | 31,055                   |       | 30,440                  |       |
| Less:  accumulated amortization      |       | (15,545                  | )          | (12,154                 | )          |
|                                 |       | 15,510                   |       | 18,286                  |       |
|                                 |       |                     |       |                    |       |
| Total                                |       | $                        | 30,406     |                    | $          | 44,167 |   |

 

*Indefinite lived intangible assets*

The carrying amount ofindefinite lived intangibles as of March 31, 2006 and June 30, 2005 was $0.8million and $5.3 million, respectively.

*Goodwill*

Changes in the carryingamount of goodwill for the nine month period ended March 31, 2006, are asfollows:

|                                          | ** ** | **(in 000s)** | ** ** |
|------------------------------------------|------------|--------------------|------------|
| Balance at June 30,  2005                |       | $                  | 161,444    |   |
| Tax refund  related to an acquisition    |       | (346               | )          |
| Foreign currency  translation adjustment |       | (42                | )          |
| Balance at March 31, 2006                |       | $                  | 161,056    |   |

 

In March 2004, theCompany acquired Sierra Design Group (“SDG”). During the nine month period ended March 31, 2006, the Company receiveda federal tax refund related to SDG’s pre-acquisition operations, which had notpreviously been recorded as an income tax receivable, and therefore, the cashreceived was recorded as an adjustment to goodwill.

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*Amortization of Intangibles*

Aggregateamortization expense totaled $2.6 million and $2.5 million, and $7.9 millionand $7.1 million for the three and nine month periods ended March 31, 2006 and2005, respectively.  Future amortizationof intangible assets, which includes certain intangibles impaired during thefourth quarter of fiscal 2006 as described further in Note 14, SubsequentEvents, is scheduled as follows:

|            | ** ** | **(in 000s)** | ** ** |
|------------|------------|--------------------|------------|
| 2006       |       | $                  | 2,249      |   |
| 2007       |       | 7,172              |       |
| 2008       |       | 4,995              |       |
| 2009       |       | 4,402              |       |
| 2010       |       | 3,989              |       |
| Thereafter |       | 7,599              |       |
| Total      |       | $                  | 30,406     |   |

 

**7.****                                      LONG-TERM DEBT**

Long-term debtconsists of the following:
|                                          | ** ** | **March 31,  2006** | ** ** | **June 30,  2005** | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **(in 000s)**       | ** ** |
| Term loan  facility                      |       | $                        | 312,257    |                    | $          | 314,882 |   |
| Related party  debt (see Note 8)         |       | 15,200                   |       | 19,206                  |       |
| Other, generally  unsecured              |       | 544                      |       | 1,029                   |       |
| Long-term debt                           |       | 328,001                  |       | 335,117                 |       |
| Less current  maturities                 |       | 8,844                    |       | 10,163                  |       |
| Long-term debt,  less current maturities |       | $                        | 319,157    |                    | $          | 324,954 |   |

 

The Company’s debtstructure at March 31, 2006 consists primarily of a term loan facility, a $75.0million revolving credit facility, which is limited by a current leverage ratioand debt owed to related parties. The term loan requires principal reductionsof approximately 1% per annum paid quarterly, with a balloon payment due inSeptember 2009.  The revolving creditfacility commitment reduces annually until it comes due in September 2008.  Based on the current leverage ratio at March31, 2006, the Company had approximately $2.5 million of availability under therevolving credit facility; however, there were no borrowings outstanding.  As of March 31, 2006, the interest rate ineffect on the term loan was 8.18%. On July 3, 2006 and January 4, 2007, theCompany initiated its next LIBOR-based term loan interest rate periods (for aterm of six months) based on the interest rate formula of LIBOR plus 3.75% and3.25%, respectively, which was 9.33% and 8.61%, respectively.

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 Mississippi operations, and are secured by a pledge agreement. The loanagreement governing the term loan and the revolving credit facility (the “LoanAgreement”) contains a number of maintenance and other significant covenantsthat, among other things, restrict the ability of the Company and the abilityof certain of its subsidiaries 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 Company’ssubsidiaries, engage in mergers or acquisitions or certain transactions withsubsidiaries and affiliates, and that otherwise restrict corporateactivities.  The Company was incompliance with these covenants as of March 31, 2006.

As of March 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 March 31, 2006 was 4.22 times versus a maximum allowableof 4.25 times. The 

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maximum allowableleverage ratio declines to 4.00 as of September 30, 2006, 3.75 as of December31, 2006 and 3.50 as of September 30, 2007, through the remaining term of theLoan Agreement.

In October 2006, the Company executed an amendment toits bank facility, 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 shall deliver its quarterlyreports on 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) modified the definition of EBITDA to exclude up to $10 million ofcertain cash charges and (iv) clarified that the definitionof EBITDA includes interest income on trade receivables. The Company paid an administrative fee of $964,000, which was expensed in thequarter ended December 31, 2006, in exchange for the concessions granted underthe amendment.

In December 2006,the Company executed an additional amendment to its bank facility, whichextended the due date for the  delivery of the Company’s quarterly 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. The Company paid an administrative fee of $1.2million, which was expensed in the quarter ended December 31, 2006, in exchangefor the concessions granted under the amendment.

The Company’srelated party debt, which totaled approximately $15.2 million as of March 31,2006, consists primarily of the debt owed to the former principals of SDG,Micro Clever Consulting (“MCC”) and MindPlay LLC (“MindPlay”). See Note 8,Related Party Transactions, below regarding related party debt.

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

In the past twoyears, the Company completed the acquisition of all of the assets of MCC andSDG and substantially all of the assets and liabilities of MindPlay.  In each acquisition, a portion of theconsideration 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%.  Seethe tables below for outstanding debt and interest rates as of March 31, 2006and June 30, 2005.  
|                                              | ** ** | **As of  March 31, 2006** | ** ** | **As of  June 30, 2005** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **Interest  Rate**                       | ** ** | **Outstanding  Debt**                   | ** ** | **Interest  Rate** | ** ** | **Outstanding  Debt** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                       | ** ** |
| SDG                                          |       | 6.39                                     | %          | $                                       | 11,200     |   | 4.42 | % | $ | 14,000 |   |
| MindPlay                                     |       | 5.00                                     | %          | 4,000                                   |       | 6.00 | % | 4,000 |   |
| MCC                                          |       | —                                   | %          | —                                  |       | 6.00 | % | 1,206 |   |
| Related party debt                           |       |                                     |       | 15,200                                  |       |   |   | 19,206 |   |
| Less current  maturities                     |       |                                     |       | 4,800                                   |       |   |   | 6,006 |   |
| Related party  debt, less current maturities |       |                                     |       | $                                       | 10,400     |   |   |   | $ | 13,200 |   |

 

In June 2005, theCompany issued approximately 1.0 million shares of its common stock inconnection with the conversion of $14.0 million of the subordinated debt andaccrued interest thereon owed to the former principals of SDG.  The remaining note payable to the formerprincipals of SDG of $11.2 million ispayable in annual installments through 2009. At the Company’s discretion, the principal and accrued interest thereoncan be paid in cash, or can be converted into shares of the Company’s commonstock using the average stock price for the 20 business days prior to thedelivery 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, the Company may offset 50% of all damages (includingreasonable attorneys’ fees) up to the entire amount due under the promissorynote in connection with an indemnification claim against the formershareholders of MindPlay

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related to the Company’s patent lawsuit with Shuffle Master, Inc. (“ShuffleMaster”) and IGT which is described below in Note 13, Commitments andContingencies.

Current periodrelated party interest expense is summarized below:
|            | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** ** | ** ** | **(in 000s)**                                   | ** ** |
| SDG        |       | $                                                    | 259        |                                                | $          | 312 |   | $ | 578 |   | $ | 353 |   |
| MindPlay   |       | 72                                                   |       | 72                                                  |       | 215 |   | 230 |   |
| MCC        |       | 23                                                   |       | 26                                                  |       | 25 |   | 82 |   |
|            |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

Accrued related party interest totaled $0.2 million and $0.3 million asof March 31, 2006 and June 30, 2005, respectively.

Pursuant to an advisory agreement dated July 1, 2004 with KirklandInvestment Corporation, which is 100% owned by Joel Kirschbaum, a director ofthe Company, and therefore, treated as a related party, the Company agreed topay Kirkland $600,000 annually for a period of 3.5 years for advisory andrelated services.  In August 2006, theCompany made its last payment under the advisory agreement as a result of Mr.Kirschbaum’s death.

The Company also leases a warehouse and office facility from an entityowned by Mr. Robert Luciano, a former principal of SDG and the Company’s ChiefTechnology Officer.  Rental paymentstotaled $103,000 and $103,000 and $309,000 and $309,000 for the three and ninemonth periods ended March 31, 2006 and 2005, respectively.

**9.****                                      SEGMENTS AND GEOGRAPHICAL INFORMATION**

The Companycurrently operates in two business segments (exclusive of the business segmentsincluded in discontinued operations): (i)Bally Gaming Equipment and Systems which designs, manufactures, distributes andoperates gaming machines and computerized monitoring systems for gamingmachines, and (ii) Casino Operations which currently owns and operates a casinoin Vicksburg, Mississippi. The accounting policies of these segments areconsistent with the Company’s policies for the unaudited condensed consolidatedfinancial statements.

The table belowpresents information as to the Company’s revenues and operating loss bysegment:
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **(in 000s)**                               | ** ** |
| Revenues:                     |       |                                             |       |                                            |       |   |   |   |   |
| Gaming Equipment  and Systems |       | $                                                | 141,221    |                                            | $          | 107,955 |   | $ | 349,977 |   | $ | 326,425 |   |
| Casino  Operations            |       | 15,090                                           |       | 13,734                                          |       | 41,137 |   | 39,339 |   |
| Total revenues                |       | $                                                | 156,311    |                                            | $          | 121,689 |   | $ | 391,114 |   | $ | 365,764 |   |
| Inter-segment revenues:       |       |                                             |       |                                            |       |   |   |   |   |
| Gaming Equipment  and Systems |       | $                                                | 88         |                                            | $          | 140 |   | $ | 391 |   | $ | 396 |   |
| Casino  Operations            |       | —                                           |       | —                                          |       | — |   | — |   |
| Total inter-segment  revenues |       | $                                                | 88         |                                            | $          | 140 |   | $ | 391 |   | $ | 396 |   |
| Operating income  (loss):     |       |                                             |       |                                            |       |   |   |   |   |
| Gaming Equipment  and Systems |       | $                                                | (18,112    | )                                               | $          | (4,403 | ) | $ | (24,357 | ) | $ | (5,386 | ) |
| Casino  Operations            |       | 5,280                                            |       | 4,812                                           |       | 13,708 |   | 12,690 |   |
| Corporate/other               |       | (7,416                                           | )          | (4,442                                          | )          | (20,896 | ) | (14,933 | ) |
| Total operating loss          |       | $                                                | (20,248    | )                                               | $          | (4,033 | ) | $ | (31,545 | ) | $ | (7,629 | ) |

 

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

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The table belowpresents information as to the Company’s revenues and operating loss bygeographic region:
|                           | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                | ** ** | **(in 000s)**                               | ** ** |
| Revenues:                 |       |                                             |       |                                            |       |   |   |   |   |
| United States             |       | $                                                | 147,450    |                                            | $          | 114,469 |   | $ | 369,205 |   | $ | 346,070 |   |
| Europe                    | ** ** | 2,677                                            |       | 2,786                                           |       | 10,403 |   | 8,959 | ** ** |
| Other foreign             |       | 6,184                                            |       | 4,434                                           |       | 11,506 |   | 10,735 |   |
| Total revenues            |       | $                                                | 156,311    |                                            | $          | 121,689 |   | $ | 391,114 |   | $ | 365,764 |   |
|                      |       |                                             |       |                                            |       |   |   |   |   |
| Operating income  (loss): |       |                                             |       |                                            |       |   |   |   |   |
| United States             | ** ** | $                                                | (20,402    | )                                               | $          | (1,692 | ) | $ | (30,977 | ) | $ | (3,733 | ) |
| Europe                    | ** ** | (426                                             | )          | (3,112                                          | )          | (1,429 | ) | (5,739 | **)** |
| Other foreign             |       | 580                                              |       | 771                                             |       | 861 |   | 1,843 |   |
| Total operating loss      | ** ** | $                                                | (20,248    | )                                               | $          | (4,033 | ) | $ | (31,545 | ) | $ | (7,629 | ) |

 

**10.****                               RESTRUCTURING CHARGE**

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

|                                     | ** ** | **(in 000s)** | ** ** |
|-------------------------------------|------------|--------------------|------------|
| Beginning  balance at June 30, 2005 |       | $                  | 1,290      |   |
| Amounts paid                        |       | (835               | )          |
| Ending balance at March  31, 2006   |       | $                  | 455        |   |

 

**11.****                               COMPREHENSIVE LOSS**

The following is a reconciliation of the Company’s reported comprehensiveloss:
|                                   | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in 000s)**                               | ** ** |
| Net loss                          |       | $                                                | (16,759    | )                                               | $          | (9,473 | ) | $ | (34,041 | ) | $ | (20,152 | ) |
| Currency  translation adjustments |       | (27                                              | )          | 136                                             |       | (184 | ) | 142 |   |
| Comprehensive  loss               |       | $                                                | (16,786    | )                                               | $          | (9,337 | ) | $ | (34,225 | ) | $ | (20,010 | ) |

 

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**12.****                               SUPPLEMENTAL CASH FLOW INFORMATION**

The following supplemental information is related to the condensedconsolidated statements of cash flows:
|                                                      | ** ** | **Nine Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(in 000s)**                              | ** ** |
| Cash paid for  interest                              |       | $                                               | 15,816     |   | $ | 12,383 |   |
| Cash paid for  income taxes                          |       | 2,329                                           |       | 3,077 |   |
|                                                 |       |                                            |       |   |   |
| Non-cash  investing and financing transactions:      |       |                                            |       |   |   |
| Transfer  property, plant and equipment to inventory |       | $                                               | 8,683      |   | $ | 5,728 |   |
| Foreign currency  translation                        |       | (159                                            | )          | 527 |   |
| Note payable issued in  acquisition                  |       | —                                          |       | 28,000 |   |

 

**13.****                               COMMITMENTSAND CONTINGENCIES**

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

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 have 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 is subject to court approval, an aggregate of $16.0 million cash, pluscertain interest, will be paid to settle the securities class action as well asthe derivative litigation as discussed below. The Company will pay $1.25 million, which was accrued in the Company’sfinancial statements for the quarter ended September 30, 2005. The Companyalso incurred approximately $1.2 million for legal fees related to thelitigation in the nine months ended March 31, 2006.  Additionally, the Company incurredapproximately $0.7 million for legal fees related to the litigation in thefourth quarter of fiscal year 2006.  Inaddition to certain governance actions the Company has agreed 

20

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to undertake inconnection with the settlement, the Company’s directors and officers insurer willcontribute approximately $14.75 million to the settlement.

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 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.

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 $7.6 millionto stay payment of the judgment and accrued interest pending the appeal. Thecash bond is included in other non-current assets and the accrued liability isincluded in accrued liabilities in the accompanying balance sheets. This amounthas been accrued and the expense for this charge is included in discontinuedoperations in the accompanying statement of operations for 2004.   On July 11, 2006, the federal circuit courtof appeals affirmed the district court judgment, denying the appeals for bothparties, and thereafter, the judgment was satisfied out of the posted bond.

On December 7,2004, IGT filed a patent infringement lawsuit against the Company in the UnitedStates District Court for the District of Nevada. The complaint asserts thatthe Company’s wheel-based games, such as Monte Carlo, Lucky Wheel and CashFor Life, its games with a reel in the top box, such as Bonus Frenzy, and itsiView products infringe on patents held by IGT, and seeks injunctive relief anddamages in unspecified amounts. The Company believes IGT’s claims arewithout merit and is vigorously defending itself against the lawsuit. As partof its 

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defense, theCompany has asserted counterclaims against IGT, including claims that IGT’spatents are invalid, unenforceable and not infringed, as well as severalclaims that IGT has engaged in anti-competitive conduct in violation of stateand federal antitrust laws. By its counterclaims, the Company is seekingdamages and other relief from IGT. IGT’s motion to dismiss the Company’s antitrustclaims was denied on January 10, 2006. A Markman hearing took place inDecember 2006 and the Company expects a related claim construction ruling.  No trial date has been set.

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

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

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.

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 financial position,results of operations or cash flows.

**14.****                               SUBSEQUENTEVENTS**

During the fiscalquarter ended June 30, 2006, the Company evaluated the carrying value of itsprepaid royalties, which are classified as other assets, and determined thatcertain amounts were not recoverable based on expected sales of the relatedproducts.  As a result, the Companyexpects to record a charge of approximately $2.7 million in the fourth quarterof fiscal year 2006.

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

We begin Management’s Discussion and Analysis of Financial Condition andResults of Operations with an overview of our key operating business divisionsand significant trends.  This overview isfollowed by a detailed analysis of our results of operations and our financialcondition as of, and for, the three and nine month periods ended March 31,2006.

**Forward-LookingStatements**

Certain matters in this Quarterly Report on Form 10-Q for the three andnine month periods ended March 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 eventsand financial trends affecting the Company.

Forward-lookingstatements are typically identified by the words “believes,” “expects,” “anticipates”and similar expressions.  In addition,any statements that refer to expectations or 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 integrate futureacquisitions, strict regulation by gaming authorities, the outcome of pendinglitigation matters including the pending securities class actions, gamingtaxes, currency fluctuations and market risk and the potential adverse effectsto our financial condition, results of operations or prospects as a result ofthe restatement of our prior period financial statements. Certain of thesefactors are discussed in the “Risk Factors” contained in the 2005 10-K/A.  The Company undertakes no obligation topublicly update or revise these forward-looking statements because of newinformation, future events or otherwise.

**Restatement**

The condensed consolidated statements of operationsand cash flows for the three and nine month periods ended March 31, 2005, havebeen restated. The restatement related primarily to revenue recognition,accounting for inventory costs and other miscellaneous adjustments that werethe result of certain accounting errors, as more fully discussed in Note 2 tothe unaudited condensed consolidated financial statements.  The financial information set forth in thefollowing Management’s Discussion and Analysis gives effect to the restatement.

**Our Business**

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

Wederive our revenues from the following four divisions:

*Gaming Equipment - *Sale of gamingmachines;

*Gaming Operations -*Operationof wide-area progressive systems and lease of gaming machines;

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

revenue; and

*Casino Operations -*Operationof the Rainbow Casino.

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We design, manufacture, sell and operate a variety ofelectronic slot and video gaming machines through our Gaming Equipmentdivision.  Each gaming machine containsan operating system, also referred to as a game platform.  The machine’s operating system manages thesoftware needed to run the machine.  Inthe fiscal year ended June 30, 2005, we successfully completed our migrationfrom the EVOTM platform to the Linux-based ALPHA OSTM platform.  ALPHA OS distinguishes itself from otherindustry platforms as an operating system designed for complete separationbetween the underlying operating system and the game applications, providingenhanced efficiency in game development and speed to market. ALPHA OS alsoincorporates free spin, scatter, bonusing and other advanced game features,while the related game interface provides internal and third-party developerswith a secure, easy-to-use programming environment that incorporates anadvanced set of development tools.  Moreover, ALPHA OS was designed to support server-based gaminginitiatives, including download of game results, configuration and gamecontent.

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

We believe thegrowth of the Gaming Equipment and Gaming Operations divisions is dependent onproviding new titles and technologies with high entertainment value to casinopatrons.  We spent approximately 9% ofour revenue for the nine months ended March 31, 2006 on research and developmentto accelerate the use of technology in our gaming products.

We also design and sell casino enterprise systems under ourSystems division.  Our primary casino enterprisesystems products are designed to streamline casino business processes throughthe use of technology and include slot monitoring, casino management andcashless systems.  We market our casinoenterprise system product solutions under the broad categories of Bally CMS®(Casino Management Systems), Bally SMS® (Slot Management Systems) and BallyTMS® (Table Management Systems).

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

Our Rainbow Casinois one of four casinos currently operating in the Vicksburg, Mississippi marketand is run through our Casino Operations division. The casino, which has 12table games and approximately 893 gaming devices, draws customers primarilyfrom a 75-mile radius surrounding Vicksburg, which includes Jackson,Mississippi.  While a number ofproperties located on the gulf coast sustained heavy damage during the 2005hurricane season, our casino did not sustain any significant damage.  Although it was temporarily closed followingHurricane Katrina, we reopened the property for business within four days ofthe storm, once power was restored to the general area.  While the play levels at our casino increasedsomewhat during the months following the reopening, the play levels returned toa more typical level once some of the other Gulf Coast casinos reopened.  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 complete the sale of the Rainbow Casino.

**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, Systems and Gaming Operations divisions, and our CasinoOperations segment.  Revenue from ourBally Gaming and Systems segment represents approximately 89% of our totalrevenues for the nine months ended March 31, 2006.  The table below sets forth ourconsolidated results of operations for the three month and nine month periodsended March 31, 2006 and 2005.

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| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **%  Rev**                                          | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** | **2006** | ** ** | **%  Rev** | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** |
| ** **                         | ** ** | **(dollars in millions)**                  | ** ** |
| Revenues                           |       | $                                                    | 156.3      |                                                | (100       | )% | $ | 121.7 |   | 100 | % | 28 | % | $ | 391.1 |   | 100 | % | $ | 365.8 |   | 100 | % | 7 | % |
| Gross profit                       |       | $                                                    | 61.6       |                                                | 39         | % | $ | 54.3 |   | 45 | % | 13 | % | $ | 173.0 |   | 44 | % | $ | 168.1 |   | 46 | % | 3 | % |
| Operating loss                     |       | $                                                    | (20.2      | )                                                   | (13        | )% | $ | (4.0 | ) | (3 | )% | (405 | )% | $ | (31.5 | ) | (8 | )% | $ | (7.6 | ) | (2 | )% | (314 | )% |
| Loss from continuing  operations   |       | $                                                    | (16.8      | )                                                   | (11        | )% | $ | (9.1 | ) | (7 | )% | (85 | )% | $ | (34.0 | ) | (9 | )% | $ | (15.4 | ) | (4 | )% | (121 | )% |
| Loss from discontinued  operations |       | $                                                    | —     |                                                | —     | % | $ | (0.4 | ) | — | % | 100 | % | $ | — |   | — | % | $ | (4.8 | ) | (1 | )% | 100 | % |
| Net loss                           |       | $                                                    | (16.8      | )                                                   | (11        | )% | $ | (9.5 | ) | (8 | )% | (77 | )% | $ | (34.0 | ) | (9 | )% | $ | (20.2 | ) | (6 | )% | (68 | )% |

 

***Bally GamingEquipment and Systems***

Thesummary financial results and operating statistics for our Bally GamingEquipment and Systems segment for the three month and nine month periods endedMarch 31, 2006 and 2005 are as follows: 
| ** **                           | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **2006**                         | ** ** | **%  Rev**                      | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** | **2006** | ** ** | **%  Rev** | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** |
| ** **                           | ** ** | **(dollars in millions)**        | ** ** |
| Revenues                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                     |       | $                                | 64.4       |                            | 46         | % | $ | 52.1 |   | 48 | % | 24 | % | $ | 155.8 |   | 45 | % | $ | 158.4 |   | 49 | % | (2 | )% |
| Systems                              |       | 38.7                             |       | 27                              | %          | 23.6 |   | 22 | % | 64 | % | 84.3 |   | 24 | % | 72.4 |   | 22 | % | 16 | % |
| Gaming Operations                    |       | 38.1                             |       | 27                              | %          | 32.3 |   | 30 | % | 18 | % | 109.9 |   | 31 | % | 95.7 |   | 29 | % | 15 | % |
| Total revenues                       |       | $                                | 141.2      |                            | 100        | % | $ | 108.0 |   | 100 | % | 31 | % | $ | 350.0 |   | 100 | % | $ | 326.5 |   | 100 | % | 7 | % |
|                                 |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross margin                         |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                     |       | $                                | 11.3       |                            | 18         | % | $ | 10.1 |   | 19 | % | 12 | % | $ | 36.0 |   | 23 | % | $ | 34.1 |   | 22 | % | 6 | % |
| Systems                              |       | 26.3                             |       | 68                              | %          | 19.3 |   | 82 | % | 36 | % | 63.6 |   | 75 | % | 57.8 |   | 80 | % | 10 | % |
| Gaming Operations                    |       | 13.8                             |       | 36                              | %          | 16.1 |   | 50 | % | (14 | )% | 46.4 |   | 42 | % | 51.2 |   | 54 | % | (9 | )% |
| Total gross margin                   |       | $                                | 51.4       |                            | 36         | % | $ | 45.5 |   | 42 | % | 13 | % | $ | 146.0 |   | 42 | % | $ | 143.1 |   | 44 | % | 2 | % |
|                                 |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and  administrative |       | $                                | 38.1       |                            | 27         | % | $ | 29.3 |   | 27 | % | 30 | % | $ | 107.6 |   | 31 | % | $ | 97.7 |   | 30 | % | 10 | % |
| Restructuring charges                |       | —                           |       | —                          | %          | 2.2 |   | 2 | % | (100 | )% | — |   | — | % | 3.1 |   | 1 | % | (100 | )% |
| Impairment charges                   |       | 14.0                             |       | 10                              | %          | 3.6 |   | 3 | % | 289 | % | 14.0 |   | 4 | % | 3.6 |   | 1 | % | 289 | % |
| Research and  development costs      |       | 12.2                             |       | 9                               | %          | 10.6 |   | 10 | % | 15 | % | 33.2 |   | 9 | % | 32.7 |   | 10 | % | 2 | % |
| Depreciation and  amortization       |       | 5.2                              |       | 4                               | %          | 4.1 |   | 4 | % | 27 | % | 15.5 |   | 4 | % | 11.3 |   | 3 | % | 37 | % |
| Operating loss                       |       | $                                | (18.1      | )                               | (13        | )% | $ | (4.3 | ) | (4 | )% | (321 | )% | $ | (24.3 | ) | (7 | )% | $ | (5.3 | ) | (2 | )% | (358 | )% |

 
| ** **                                | ** **   | **Three Months Ended March 31,** | ** **   | **Nine Months Ended March 31,** | ** **   |
|-------------------------------------------|--------------|------------------------------------------------------|--------------|-----------------------------------------------------|--------------|
| ** **                                | ** **   | **2006**                                             | ** **   | **2005**                                            | ** **   | **Increase/  (Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** | **Increase/  (Decrease)** | ** ** |
| Operating Statistics:                     | *** *** | *** ***                                         | *** *** | *** ***                                        | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| New gaming devices sold                   |         | 5,901                                                |         | 3,972                                               |         | 49 | % | 12,364 |   | 10,706 |   | 15 | % |
| OEM units sold                            |         | 324                                                  |         | —                                              |         | — | % | 650 |   | 2,907 |   | (78 | )% |
| New unit average  selling price *         |         | $                                                    | 9,082        |                                                | $            | 10,519 |   | (14 | )% | $ | 9,981 |   | $ | 10,460 |   | (5 | )% |
|                                      |         |                                                 |         |                                                |         |   |   |   |   |   |   |   |   |
| Gaming monitoring units  installed base   |         | 262,000                                              |         | 282,000                                             |         | (7 | )% | 262,000 |   | 282,000 |   | (7 | )% |
| Casino management  systems installed base |         | 525                                                  |         | 225                                                 |         | 133 | % | 525 |   | 225 |   | 133 | % |
| Systems managed  cashless games           |         | 174,000                                              |         | 136,000                                             |         | 28 | % | 174,000 |   | 136,000 |   | 28 | % |
|                                      |         |                                                 |         |                                                |         |   |   |   |   |   |   |   |   |
| End of period installed  base:            |         |                                                 |         |                                                |         |   |   |   |   |   |   |   |   |
| Wide-area  progressive                    |         | 1,189                                                |         | 1,662                                               |         | (28 | )% | 1,189 |   | 1,662 |   | (28 | )% |
| Daily-fee games                           |         | 11,536                                               |         | 8,615                                               |         | 34 | % | 11,536 |   | 8,615 |   | 34 | % |
| Centrally determined  games               |         | 25,627                                               |         | 18,716                                              |         | 37 | % | 25,627 |   | 18,716 |   | 37 | % |
|                                           |              |                                                      |              |                                                     |              |  |  |  |  |  |  |  |  |  |  |  |  |

 

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* Excludes new gaming units sold to OriginalEquipment Manufacturers (“OEMs”).

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

Total revenues forour Bally Gaming Equipment and Systems segment increased $33.2 million, or 31%,for the three months ended March 31, 2006, as compared to the correspondingperiod in the prior year.  This increasewas primarily the result of higher revenues from our Gaming Equipment, Systemsand Gaming Operations divisions of 24%, 64%, and 18%, respectively.  A more detailed description of thefluctuations in revenues of each Bally Gaming Equipment and Systems segment isset forth below.

Selling, generaland administrative expenses for the segment increased by $8.8 million for thethree months ended March 31, 2006 as compared to the corresponding period inthe prior year.  A portion of thisincrease was associated with an increase in payroll and related expenses of$4.3 million, $1.6 million of which related to share based compensationexpenses charged to this segment as a result of the adoption of SFAS No. 123R,as more fully discussed in Note 5 to the condensed consolidated financialstatements; with the remaining $2.7 million resulting from an increase inheadcount from 1,677 at March 31, 2005 to 1,858 at March 31, 2006.  Legal fees increased by $2.9 million as aresult of certain litigation matters. Travel and related expense increased $1.1 million due to our focus onthe promotion of international business.

*InpairmentCharges.*  During thethree months ended March 31, 2006, we recorded impairment charges of$14.0 million as compared to $3.6 million in the prior periodprimarily related to acquired intangible assets related to track names andother intellectural property that were no longer recoverable.

Researchand development costs for the segment increased by $1.6 million, or 15%, forthe three months ended March 31, 2006, as compared to the corresponding periodin the prior year.  This was the resultof a 19% increase in the number of employees for the three month period endedMarch 31, 2006, as compared to the corresponding period in the prior year.  The increase in research and developmentreflects our focus towards our technology assets and the competitive landscapethat requires a continued need to develop future generations of gaming productsand systems.

Depreciation andamortization expense increased by $1.1 million, or 27%, for the three monthsended March 31, 2006, as compared to the corresponding period in the prior yearprimarily due to higher capital expenditures incurred during the prior twelvemonth period.

*GamingEquipment.*  Revenuesfrom our Gaming Equipment division increased by $12.3 million, or 24%, for thethree months ended March 31, 2006, as compared to the corresponding period inthe prior year.  This was primarily aresult of a 49% increase in new gaming units sold in the current quarter whichwas offset by a 14% decline in the Average Selling Price (“ASP”) of new gamingunits.  The decline in our ASP was theresult of revenue from the sale of 2,618 lottery units to distributors duringthe current period.  Revenues from ourGaming Equipment division also increased as a result of higher overall sales toOEMs from no units for the three months ended March 31, 2005 to 324 units inthe current quarter.  Sales of OEMproducts vary significantly from period to period based on deployments by ourOEM customers, and are typically sold at lower selling prices and margins thansales made directly to casino operators.

*Systems.*  Revenues from our Systems division increasedby $15.1 million, or 64%, for the three months ended March 31, 2006, ascompared to the corresponding period in the prior year.  This was primarily due to an increase inrevenues of $1.2 million attributable to international markets, coupled with anincrease in system hardware revenue of $1.8 million.

Grossmargin from the Systems division declined to 68% for the three months endedMarch 31, 2006, as compared to 82% for the three months ended March 31,2005.  The decline was primarily due to adecrease in software license sales that produce higher margins as compared toother components such as hardware sales.

*GamingOperations. *Revenuesfrom the Gaming Operation division increased by $5.8 million, or 18%, for thethree months ended March 31, 2006, as compared to the corresponding period inthe prior year.  This was primarily aresult of a $3.8 million, or 21%, increase in both participation and rentalrevenues derived from our installed base of centrally determined games, whichincreased 37% over the prior year period. The increase was partially offset bya reduction in wide-area progressive revenues of $2.4 million resulting from a28% decrease in the installed base of games during the period.

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Gross margin,which includes depreciation expense of $14.4 million and $7.1 million for thethree months ended March 31, 2006 and 2005, respectively, declined to 36% forthe three months ended March 31, 2006, from 50% in the corresponding period in2005.  This was primarily a result of achange in the estimated useful life and salvage values for certain gamingequipment used in the Gaming Operations division.  During the three months ended March 31, 2006,this reassessment resulted in a $6.6 million increase in depreciation expensecharged to cost of gaming equipment and systems.  Excluding depreciation and amortizationexpense margin remained consistent between periods.

**NineMonths Ended March 31, 2006 Compared to Nine Months Ended March 31, 2005**

Total revenues forour Bally Gaming Equipment and Systems segment increased $23.5 million, or 7%,for the nine months ended March 31, 2006, as compared to the correspondingperiod in the prior year.  This increasewas primarily the result of higher revenues from our Systems and GamingOperations divisions of approximately 16% and 15%, respectively.  These increases were offset by lower GamingEquipment division revenues of $2.6 million, or 2%.  A more detailed description of the fluctuationsin revenues of each of Bally Gaming and Systems division is set forth below.

Selling, generaland administrative expenses for the segment increased by $9.9 million, or 10%,for the nine months ended March 31 2006, as compared to the correspondingperiod in the prior year.  A majority ofthe increase was associated with an increase in payroll and related expenses of$7.0 million, $4.8 million of which was attributable to share basedcompensation expenses charged to this segment as a result of the adoption ofSFAS No. 123R, as more fully discussed in Note 5 to the condensed consolidatedfinancial statements, with the remaining $2.2 million resulting from anincrease in headcount from 1,677 at March 31, 2005 to 1,858 at March 31,2006.  Legal fees increased by $3.4million as a result of certain litigation matters.  Travel and entertainment increased $1.7million due to our focus on the promotion of international business.    License fees increased $1.1 million.

*InpairmentCharges.*  During thenine months ended March 31, 2006, we recorded impairment charges of$14.0 million as compared to $3.6 million in the prior periodprimarily related to acquired intangible assets related to track names andother intellectural property that were no longer recoverable.

Depreciation andamortization expense increased by $4.2 million, or 37%, for the nine monthsended March 31, 2006, as compared to the corresponding period of in the prioryear primarily due to higher capital expenditures incurred during the priortwelve month period.

*GamingEquipment.* Revenuesfrom our Gaming Equipment division decreased by $2.6 million, or 2%, for thenine months ended March 31, 2006, as compared to the corresponding period inthe prior year.  The decline waspartially a result of a 78% decrease in sales to OEMs from 2,907 units for thenine months ended March 31, 2005, compared to 650 units in the current yearperiod.  The decrease in revenue was alsoassociated with a reduction in our ASP of new gaming units from $10,460 to$9,981 resulting from revenue from the sale of approximately 2,660 lotteryunits to distributors during the current period.  These decreases were partially offset by anincrease in new gaming units sold of 1,662 units, from 10,277 units in the ninemonths ended March 31, 2005 to 12,725 units in the current year.

*Systems.*  Revenues from our Systems division increasedby $11.9 million, or 16%, for the nine months ended March 31, 2006, as comparedto the corresponding period in the prior year. This was primarily due to a $3.2 million increase in international salesof our systems products.

Grossmargin from our Systems division declined to 75% for the nine months endedMarch 31, 2006, as compared to 80% for the corresponding prior period.  This was primarily due to the decrease insoftware license sales that produce higher margins as compared to other componentssuch as hardware sales.

*GamingOperations.*Revenues from our Gaming Operation divisionincreased by $14.2 million, or 15%, for the nine months ended March 31, 2006,as compared to the corresponding period in the prior year.  This was primarily a result of a $10.1million, or 23%, increase in both participation and rental revenues derivedfrom our installed base of centrally determined games. This was partiallyoffset by a decrease in wide-area progressive revenue of $4.5 million resultingfrom a decrease in the installed base of games during the period.

Grossmargin, which includes depreciation expense of $32.6 million and $20.4 millionfor the nine months ended March 31, 2006 and 2005, declined to 42% for the ninemonths ended March 31, 2006, from 54% in the corresponding period of the prioryear.  This was primarily a result of achange in the estimated useful life and salvage values for certain gamingequipment used in the Gaming Operations division.  During the nine months ended

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March 31, 2006,this reassessment resulted in a $13.4 million increase in depreciation expensecharged to cost of gaming equipment and systems.  Excluding depreciation and amortizationexpense margin remained consistent between periods.

***Casino Operations***

Our Rainbow Casino is oneof four casinos currently operating in the Vicksburg, Mississippi market. Thecasino draws customers primarily from a 75-mile radius surrounding Vicksburg,which includes Jackson, Mississippi.  The summary of ourfinancial results and operating statistics for our Casino Operation are asfollows: 

 
| ** **                           | ** ** | **Three months ended March 31,** | ** ** | **Nine months ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **%  Rev**                                          | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** | **2006** | ** ** | **%  Rev** | ** ** | **2005** | ** ** | **%  Rev** | ** ** | **Increase/  (Decrease)** | ** ** |
| Revenue                              |       | $                                                    | 15.1       |                                                | 100        | % | $ | 13.7 |   | 100 | % | 10 | % | $ | 41.1 |   | 100 | % | $ | 39.3 |   | 100 | % | 5 | % |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross margin                         |       | $                                                    | 10.2       |                                                | 68         | % | $ | 8.9 |   | 65 | % | 15 | % | $ | 27.0 |   | 66 | % | $ | 25.1 |   | 64 | % | 8 | % |
| Selling, general and  administrative |       | $                                                    | 4.1        |                                                | 27         | % | $ | 3.3 |   | 24 | % | 24 | % | $ | 10.7 |   | 26 | % | $ | 10.0 |   | 25 | % | 7 | % |
| Depreciation and  amortization       |       | $                                                    | 0.9        |                                                | 6          | % | $ | 0.8 |   | 6 | % | 13 | % | $ | 2.7 |   | 7 | % | $ | 2.4 |   | 6 | % | 13 | % |
| Operating income                     |       | $                                                    | 5.2        |                                                | 34         | % | $ | 4.8 |   | 35 | % | 8 | % | $ | 13.6 |   | 33 | % | $ | 12.7 |   | 32 | % | 7 | % |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating statistics:                |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average number of gaming  devices    |       | 893                                                  |       |                                                |       | 916 |   |   |   | (3 | )% | 893 |   |   |   | 930 |   |   |   | (4 | )% |
| Average number of table games        |       | 12                                                   |       |                                                |       | 12 |   |   |   | — | % | 12 |   |   |   | 12 |   |   |   | — | % |

 

**Three andNine Months Ended March 31, 2006 Compared to Three and Nine Months Ended March,2005**

Casino Operationsrevenue improved 10% and 5% for the three and nine month periods ended March31, 2006, respectively, as compared to the corresponding periods in the prioryear.  The increases were attributable tothe fact that, unlike in respect of our competitors’ properties, our propertydid not sustain any significant damage in connection with the Gulf Coasthurricanes in August and September 2005.

Overall gross margins,selling, general and administrative expenses and depreciation and amortizationexpense as a percentage of revenue improved for both the three and nine monthperiods ended March 31, 2006, as a result of costs remaining fairly stablewhile revenue improved, as mentioned above.

***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 March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **Increase/  (Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** | **Increase/  (Decrease)** | ** ** |
| ** **                           | ** ** | **(dollars in millions)**                  | ** ** |
| Selling, general  and administrative |       | $                                                    | 7.0        |                                                | $          | 4.1 |   | 71 | % | $ | 19.8 |   | $ | 13.9 |   | 42 | % |
| Depreciation and  amortization       |       | 0.3                                                  |       | 0.3                                                 |       | — | % | 1.0 |   | 1.0 |   | — | % |
| Total Parent  Company expense        |       | $                                                    | 7.3        |                                                | $          | 4.4 |   | 66 | % | $ | 20.8 |   | $ | 14.9 |   | 40 | % |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Operating income  (expense)          |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Interest income                      |       | $                                                    | 0.9        |                                                | $          | 1.3 |   | (31 | )% | $ | 2.4 |   | $ | 3.2 |   | (25 | )% |
| Interest expense                     |       | (7.1                                                 | )          | (5.1                                                | )          | (39 | )% | (20.3 | ) | (12.9 | ) | (57 | )% |
| Loss on extinguishment of debt       |       | —                                               |       | —                                              |       | — | % | — |   | (0.6 | ) | 100 | % |
| Other, net                           |       | —                                               |       | 0.2                                                 |       | (100 | )% | (0.5 | ) | 1.0 |   | (150 | )% |
| Total other  income (expense)        |       | $                                                    | (6.2       | )                                                   | $          | (3.6 | ) | (72 | )% | $ | (18.4 | ) | $ | (9.3 | ) | (98 | )% |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income tax  benefit (expense)        |       | $                                                    | 9.8        |                                                | $          | (0.5 | ) | 2,060 | % | $ | 18.6 |   | $ | 4.1 |   | 354 | % |
| Minority interest                    |       | $                                                    | (0.2       | )                                                   | $          | (1.0 | ) | 80 | % | $ | (2.8 | ) | $ | (2.6 | ) | (8 | )% |

 

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**Three Monthand Nine Months Ended March 31, 2006 Compared to Three Month and Nine MonthsEnded March 31, 2005**

Our selling,general and administrative expenses at the parent company level increased $2.9million and $5.9 million, respectively, for the three and nine month periodsended March 31, 2006, as compared to the corresponding periods in the prioryear.  These increases were a result ofthe following:

·                  The accrual of$0.6 million and $2.4 million respectively, related to the legal fees and theanticipated settlement of class action litigation;

·                  An increase inaccounting and professional fees of $0.9 million and $3.3 million,respectively, primarily attributable to the restatement of previously issuedfinancial statements; and

·                  Sharebased compensation expense charged to this segment of $1.9 million and $4.6million, respectively, as a result of the adoption of SFAS No. 123R.

Interest expensefor the three and nine month periods ended March 31, 2006 totaled $7.1 millionand $20.3 million, respectively, compared to $5.1 million and $12.9 million inthe prior year periods.  The increase ininterest expense was a result of higher interest rates in effect in therespective periods as well as a charge of $0.6 million in default interestduring the nine months ended March 31, 2006 (see Note 7 Long-Term Debt, of theNotes to Condensed Consolidated Financial Statements).

The effectiveincome tax rate for the nine month period ended March 31, 2006 was 37% ascompared to 21% for the corresponding period in 2005.  The effective tax rate for the nine monthsended March 31, 2006 was affected by our adoption of SFAS No. 123R and theresulting non-deductible share based compensation expense recognized for bookpurposes, the expiration of the research and development tax credits on ourfederal tax return for the last half of fiscal year 2006, and reserves appliedto certain deferred tax assets from foreign losses.

***SignificantItems Affecting Comparability***

Certain significant items affect the comparability of financialstatements from the three month and nine month periods ended March 31, 2006, tothe corresponding periods in the previous fiscal year.  These items are discussed below.

*Inventoryand asset write-downs*: In fiscal 2005, we faced declining demand for gaming devices based onour legacy platform, and therefore, we reassessed this particular portion ofour inventory.  In October 2004, we madethe strategic decision to move to our new Alpha OS platform, which was madecommercially available in April 2005 in most markets.

The decision tomove our gaming devices to the new platform, the targeting of used equipmentfor non-domestic markets, and the consolidation of certain warehouses all ledto accelerated disposals of legacy products in both fiscal 2006 and 2005.  This process has required updating estimatesfor the net realizable value of inventories due to the subjectivity involved inprojecting sales volumes, used game sales values, refurbishment costs, andcustomer demand in non-domestic jurisdictions. As a result of our ongoing analysis of inventory valuations, we havetaken a series of inventory write-downs totaling $2.5 million and $7.9 millionand $10.6 million and $18.0 million for the three and nine month periods endedMarch 31, 2006 and 2005, respectively.

The Company alsorecorded a write-down of leased gaming equipment of $1.0 million and $3.2million in the nine months ended March 31, 2006 and 2005, respectively.

We continue tohold a significant number of used gaming devices, therefore, there can be noassurances that further write-downs will not occur in future periods.

*Impairment charges*: During our review ofintangible assets for impairment, we determined that certain finite andindefinite lived intangible assets had become impaired.  Consequently, we recorded an impairmentcharge of $14.0 million compared to impairment charges in fiscal 2005 of $3.6million in the three and nine month periods ended March 31, 2006 and 2005,respectively.

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*Depreciation on leased gamingmachines*:   During the second quarter offiscal 2006, the Company re-assessed the estimated useful life and salvagevalues for certain gaming equipment. This reassessment resulted in a reduction of both the useful lives andsalvage value of these assets and a $6.6 million and $13.4 million increase indepreciation expense charged to the cost of gaming operations during the threeand nine month periods ended March 31, 2006.

*Severancecharges.*  As part of areview of our operations, we reduced our workforce during the nine months endedMarch 31, 2005 and incurred severance charges totaling $3.7 million.  No such severance charges were incurred inthe nine months ended March 31, 2006.

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

The gain previously recorded in June 2004 on the saleof our Nevada route operations was subsequently adjusted during the threemonths ended September 30, 2004, for charges incurred with respect to anadverse outcome in a patent infringement case totaling $4.7 million, net oftax.  This amount is included in thediscontinued operations section of our statement of operations.  Our Louisiana operations also contributed anet profit of $0.7 million and $1.1 million for the three and nine monthperiods ended March 31, 2005, which is also included in discontinuedoperations.

**FinancialCondition**

***Liquidity***

As of March 31, 2006, we had $32.3 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.  We had net working capital of approximately$128.1 million, an increase of approximately $3.0 million from June 30, 2005levels.  This decrease is discussed in “—WorkingCapital” below.

Pursuant to various state gamingregulations, certain cash accounts are maintained to ensure availabilityof funds to pay wide-area progressive jackpot awards. At March 31, 2006, theseaccounts had an aggregate value of approximately $14.1 million, which areclassified as restricted cash on our condensed consolidated balancesheets.  In addition, we purchase U.S.Treasury Strip Securities for the benefit of jackpot winners who elect toreceive winnings as annual or weekly installment payments rather than one lumpsum.  These securities are included inrestricted long-term investments in the accompanying condensed consolidatedbalance sheets, and totaled $8.7 million as of March 31, 2006.

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, and to pay payroll and selling, general and administrative expenses,as well as to service our debt.

We entered into a loanagreement that governs our $75.0 million revolving credit facility as well asour term loan.  No amounts wereoutstanding as of March 31, 2006 under the revolving credit facility.  Our ability to borrow under the revolvingcredit facility is limited by our leverage ratio and our compliance withcertain other covenants set forth in the loan agreement.  Based on the current leverage ratio, we hadapproximately $2.5 million of availability under the revolving credit facilityas of March 31, 2006, as compared to $26.3 million as of June 30, 2005 whichreflects the improved operating results in the 12 month measurement periodending March 31, 2006.

The financialcovenants under the loan agreement consist of a leverage ratio, a fixed chargescoverage ratio, and a minimum of Earnings Before Interest, Taxes, Depreciationand Amortization (“EBITDA”) (as that term is defined in the loan agreement)ratio.  The leverage ratio is computed astotal average debt outstanding during the quarter divided by the trailing 12months EBITDA, excluding certain cash and non-cash charges, and is furtheradjusted to remove EBITDA from discontinued operations at the time thoseoperations are sold.  Our leverage ratioas of March

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31, 2006 was 4.22times versus the covenant maximum of 4.25 times.   We were in compliance with all financialcovenants as of March 31, 2006.

In October 2006, we executed an amendment to our bankloan agreement, which, among other things, (i) extended the due date forthe  delivery of our audited financial statements for the fiscalyear ended June 30, 2006 to December 31, 2006, (ii) provided that wewill deliver 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.  We paid an administrative fee of $964,000, which will beexpensed in the quarter ended December 31, 2006, in exchange for theconcessions granted under the amendment.

In December 2006,we executed an additional amendment to our bank facility, 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. We paid an administrative fee of $1.2 million, which will be expensedin the quarter ended December 31, 2006, in exchange for the concessions grantedunder the amendment.

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 March 31, 2006, we had no material commitments for capitalexpenditures.

***Working Capital***

Thefollowing table presents the components of consolidated working capital atMarch 31, 2006, and June 30, 2005, excluding assets and liabilities ofdiscontinued operations:

 
| ** **                           | ** ** | **March 31,**              | ** ** | **June 30,** | ** ** | **Increase (decrease)** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **2006**                        | ** ** | **2005**          | ** ** | **Amount**                   | ** ** | **%** | ** ** |
| ** **                           | ** ** | **(dollars in 000s)** | ** ** |
| Current assets:                      |       |                            |       |              |       |                         |       |   |   |
| Cash and cash equivalents            |       | $                               | 32,372     |              | $          | 33,170                       |       | $ | (798 | ) | (2 | )% |
| Restricted cash                      |       | 14,098                          |       | 13,421            |       | 677                          |       | 5 | % |
| Accounts and notes receivable, net   |       | 119,534                         |       | 97,679            |       | 21,855                       |       | 22 | % |
| Inventories                          |       | 60,262                          |       | 63,523            |       | (3,261                       | )          | (5 | )% |
| Income taxes receivable              |       | 566                             |       | —            |       | 566                          |       | 100 | % |
| Deferred tax assets                  |       | 30,851                          |       | 30,884            |       | (33                          | )          | — | % |
| Other current assets                 |       | 42,396                          |       | 33,034            |       | 9,362                        |       | 28 | % |
| Total current  assets                |       | $                               | 300,079    |              | $          | 271,711                      |       | $ | 28,368 |   | 10 | % |
|                                 |       |                            |       |              |       |                         |       |   |   |
| Current  liabilities:                |       |                            |       |              |       |                         |       |   |   |
| Accounts payable                     |       | $                               | 31,564     |              | $          | 36,807                       |       | $ | (5,243 | ) | (14 | )% |
| Accrued liabilities                  |       | 69,819                          |       | 43,838            |       | 25,981                       |       | 59 | % |
| Deferred revenue                     |       | 49,123                          |       | 40,962            |       | 8,161                        |       | 20 | % |
| Jackpot liabilities                  |       | 12,603                          |       | 13,025            |       | (422                         | )          | (3 | )% |
| Taxes payable                        |       | —                          |       | 1,752             |       | (1,752                       | )          | (100 | )% |
| Current maturities of long-term debt |       | 8,844                           |       | 10,163            |       | (1,319                       | )          | (13 | )% |
| Total current  liabilities           |       | 171,953                         |       | 146,547           |       | 25,406                       |       | 17 | % |
| Net working  capital                 |       | $                               | 128,126    |              | $          | 125,164                      |       | $ | 2,962 |   | 2 | % |

 

For the nine monthperiod ended March 31, 2006, working capital increased $3.0 million primarilyas a result of the following:

·                  A $21.9 millionnet increase in accounts and notes receivable relating to higher revenue levels(both recognized and deferred), driven by the sales of the ALPHA OS-basedproducts;

·                  A $3.3 millionnet decrease in inventory, which resulted from an increase in new unit sales(both recognized and deferred) driven by the sales of the ALPHA OS-basedproducts;

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·                  An increase inother current assets of $9.4 million, primarily as a result of a $7.7 millionincrease in deferred costs directly related to deferred revenues discussedbelow and the reclassification to current assets of approximately $7.8 millionand related costs previously classified as long term assets associated with alitigation bond in a case settled in July 2006 further discussed in Part II.Item 1. Legal Proceedings, offset by a decrease in trial games of $2.4 millionresulting from the conversion to sale of games previously on trial;

·                  An overallincrease in accounts payable and accrued liabilities of $20.7 million due tothe timing of certain vendor payments; and

·                  Anincrease in current deferred revenue of $8.2 million (and $7.7 million inrelated deferred cost of sales) as a result of an increase in transactions thatdid not meet the revenue recognition requirements of SOP No. 97-2. 

***CashFlow Summary***
|                       | ** ** | **Nine Months Ended**     | ** ** | ** **                   | ** ** |
|-----------------------|------------|-------------------------------------|------------|------------------------------|------------|
| ** **            | ** ** | **March 31,**                  | ** ** | **Increase (decrease)** | ** ** |
| ** **            | ** ** | **2006**                            | ** ** | **2005**                     | ** ** | **Amount** | ** ** |
| ** **            | ** ** | **(dollars in millions)** | ** ** |
| Cash flows from:      |       |                                |       |                         |       |   |   |
| Operating activities  |       | $                                   | 45,737     |                         | $          | 18,639 |   | $ | 27,098 |   |
| Investing activities  |       | (39,732                             | )          | (51,245                      | )          | 11,513 |   |
| Financing  activities |       | (6,828                              | )          | (107,050                     | )          | 100,222 |   |
|                       |            |                                     |            |                              |            |  |  |  |  |  |

 

During the ninemonth period ended March 31, 2006, cash flows provided by operating activitiestotaled $45.7 million, as compared to $18.6 million provided by operatingactivities in the corresponding period in the prior year.  The improvement in net cash flows fromoperations for the nine month period is primarily related to:

·                  The use of cashin the prior year period to purchase an appeal bond related to patentlitigation ($7.4 million);

·                  Anincrease in deferred revenue of $21.1 million (and $17.5 million in deferredcost of sales) as a result of an increase in transactions that did not meet therevenue recognition requirements of SOP No. 97-2.

These amounts werepartially offset by an increase in accounts and notes receivable relating tohigher revenue (both recognized and deferred) driven by sales of the ALPHAOS-based products, as well as the timing of receivable collections cycleincreased;

During the ninemonth period ended March 31, 2006, cash flows used in investing activities totaled$39.7 million, as compared to $51.2 million for the corresponding period in theprior year.  This change is primarily theresult of:

·                  Capitalexpenditures of $10.0 million compared to $9.1 million for the correspondingperiod in the prior year which is the result of a decrease in expenditures forinternal software and leasehold improvements;

·                  Costs incurredto deploy additional leased gaming devices totaling $26.6 million compared to$29.9 million in the prior year period resulting from an increase in the totalbase of recurring games deployed; and

·                  Anearn-out cash payment of $12.0 million during the nine month period ended March31, 2005.

During the ninemonth period ended March 31, 2006, cash flows used in financing activitiestotaled $6.8 million as compared to $107.1 million for the corresponding periodin the prior year. The prior year’s financing activities reflected $101.6million in cash used to repay debt resulting from the sale of certain of ournon core assets in the prior year.  Thecurrent period cash uses primarily relate to principal payments on long termdebt totaling $7.1 million compared to $5.3 million for the correspondingperiod in the prior year .

***ContractualCommitments***

There were no materialchanges during the three and nine month periods ended March 31, 2006, to thecontractual obligations and commitments disclosed in the 2005 10-K.

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**CriticalAccounting Policies**

A description ofour critical accounting policies can be found within management discussion andanalysis of financial condition and results of operation in the 2005 10-K.There were no material changes to those policies during the three month periodended March 31, 2006.

*Recently Issued AccountingPronouncements*

In February, 2007,FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*. SFAS No.159 providescompanies with an option to report selected financial assets and liabilities atfair value. It also establishes presentation and disclosure requirements tofacilitate comparisons between companies using different measurement attributesfor similar types of assets and liabilities. The statement is effective as ofthe beginning of the first fiscal year beginning after November 15, 2007.Earlier application is permitted provided we also apply the provisions ofStatement 157 *Fair Value Measurements*. We arecurrently in the process of evaluating the impact SFAS No. 159 will have on ourconsolidated results of operations, financial position and cash flows.

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

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

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

In June 2005,the FASB issued FASB Staff Position (“FSP”) No. 143-1, *Accounting for Electronic Equipment WasteObligations,* toaddress accounting for obligations associated with the European Union’sDirective 2002/96/EC on Waste Electrical and Electronic Equipment. TheDirective, enacted in 2003, requires EU-member countries to adopt legislationto regulate the collection, treatment, recovery, and environmentally sounddisposal of electrical and electronic waste equipment. The Directivedistinguishes between products put on the market after August 13, 2005 asnew waste and before that date as historical waste. FSP No. 143-1 onlyaddresses accounting for historical waste and is required to be applied to thelater of the first reporting period ending after June 8, 2005 or the dateof adoption of the law by the applicable European Union member country.   Adoption of FSP No. 143-1 did not have amaterial impact on our consolidated results of operations, financial position orcash flows.

InDecember 2004, the FASB issued SFAS No. 153,  *Exchanges of Nonmonetary Assets*,amending APB Opinion No. 29, *Accounting forNonmonetary Transactions*.  APBOpinion No. 29 treated nonmonetary exchanges of similar productive assets as anexception from fair value measurement. SFAS No. 153 replaces this exception with a general exception from fairvalue measurement for exchanges of nonmonetary assets that do not havecommercial substance. 

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Nonmonetaryexchanges have commercial substance if the future cash flows of an entity areexpected to change significantly as a result of the exchange. SFAS No. 153 waseffective for nonmonetary asset exchanges occurring in fiscal years beginningafter June 15, 2005. Adoption of SFAS No. 153 did not have a materialimpact on our consolidated results of operations, financial position or cashflows.

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

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

*Interest Rate Risk*

As of March 31, 2006, we had totaldebt of approximately $328.0 million, consisting primarily of the $312.3million term loan under our senior credit facilities and approximately $15.7million in other debt.  The interest ratefor the term loan is reset every six months. If the LIBOR rates were to increase or decrease by 100 basis points,with all other factors remaining constant, earnings would decrease or increaseby approximately $3.3 million annually, 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 March 31, 2006, ourdisclosure controls and procedures were not effective due to the existingmaterial weaknesses in our internal control over financial reporting that werepreviously identified and  discussed inthe 2005 10-K and below under “—Internal Control Over Financial Reporting —CertainChanges in Internal Control over Financial Reporting during the Fiscal QuarterEnded March 31, 2006.”

In view of the fact that the financial informationpresented in this quarterly report on Form 10-Q for the fiscal quarter endedMarch 31, 2006, was prepared in the absence of effective internal control overfinancial reporting, we have devoted a significant amount of time and resourcesto the analysis of the financial statements contained in this report.  In particular, we have reviewed thesignificant account balances and transactions reflected in the financialstatements contained in this report and otherwise analyzed the transactionsunderlying our 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 internal controls can occur because of simple errorsor mistakes that are not detected on a timely basis.

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**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 March 31, 2006*

During the quarter ended March 31, 2006, management continuedits remediation steps to address the material weaknesses known at that time andpreviously reported. These remediation steps were developed throughinvestigation and review of the processes and activities surrounding thematerial weaknesses and include changes to these processes and the developmentof test and review programs designed to prevent or detect similar futureoccurrences.  There were no other changesto our internal control over financial reporting during the three month periodended March 31, 2006 that management believes have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

*Material Weakness in Internal Control Over Financial ReportingPreviously Reported*

**Inadequatestaffing and training in finance and accounting.**Westrengthened our financial organization by hiring several new key members ofour management team, increasing our overall staffing levels and providing addedtraining and financial discipline to the financial reporting process.

**Ineffectivecontrols related to the preparation of certain account analyses, accountsummaries and account reconciliations.**We established aformal checklist process to ensure that all accounts requiring analysis beforeeach financial statement close were properly identified and reconciled. We re-evaluated the level of responsibility and review and re-trainedappropriate personnel in the required approach and documentation standard foreach key account analysis to ensure proper and timely account reconciliationswere performed.

**Inadequatecontrols related to revenue recognition.**We redesigned ourcontrol structure to analyze and review the revenue on all salescontracts.  We formally documented our revenue recognition processes tocomply with GAAP, including the requirements of AICPA SOP 97-2.  We hiredadditional qualified financial personnel, and trained and educated theappropriate personnel in the finance, systems and game sales organizations onour comprehensive revenue recognition policies and requirements.  Inaddition, we engaged an outside firm to review significant revenue transactionsfor each accounting period.

**Inadequatecontrols related to inventory valuation.** We expanded ourreview of inventory by senior management. Management reviews supportingschedules prepared by the cost accounting manager and selects various accountsfor additional analysis. We had previously identified an issue regarding theaccounting for excess inventory issued for work orders but subsequentlyrestocked. We currently record manual adjustments to correctly account forrestocked items. We have also increased the number of physical counts of ourinventories during fiscal 2006 including certain sites located outside of LasVegas. We will continue to perform physical counts during fiscal 2007. Weperform quarterly analyses of any purchase price variances that may occur whenthere is a deviation from our standard prices and make any necessaryadjustments.

**Ineffectivecontrols related to income taxes.**We enhanced our taxdepartment with a higher level manager position.  Additionally we engagedqualified outside tax experts to assist in the review of our annual taxprovision, disclosures and supporting tax treatments and compilations.

**Ineffectivecontrols at the entity level.**We re-evaluated our entitylevel control requirements in conjunction with COSO’s comprehensive list ofentity wide objectives, taking into consideration objectives specific to thecontrol environment, risk assessment, monitoring function and dissemination ofinformation and communication activities to ensure our new design provideddistributed coverage.  Updates were thenmade to controls that were not previously in place or were not operatingeffectively. The desired design of identified control activities was reviewedwith executive and other key members of management.  We communicated our new control structure tothe organization through multiple avenues of communications, including aweb-cast, a self assessment educational quiz, and utilized mailings, intranet postings and an all managers meeting tore-emphasize  our code of ethics,business conduct and anonymous hotline.

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**PART II**

# **ITEM 1.          LEGAL PROCEEDINGS**

***Litigation***

OnSeptember 25, 1995, Bally Gaming, Inc. (“BGI”), a wholly-owned subsidiary ofthe Company, was named as a defendant in a class action lawsuit filed in theUnited States District Court for the District of Nevada. The plaintiffs filedsuit against BGI and approximately 45 other defendants, each of which isinvolved in the gaming business as a gaming machine manufacturer, distributoror casino operator. The lawsuit arises out of alleged fraudulent marketing andoperation of casino video poker machines and electronic slot machines. Theplaintiffs alleged that the defendants have engaged in a course of fraudulentand misleading conduct intended to induce people into playing their gamingmachines based on a false belief concerning how those machines actuallyoperate, as well as the extent to which there is actually an opportunity to winon any given play. The plaintiffs allege that the defendants’ actionsconstitute violations of the Racketeer Influenced and Corrupt Organizations Act(RICO) and give rise to claims of common law fraud and unjust enrichment. Theplaintiffs are seeking monetary damages in excess of $1.0 billion. In July2002, the Federal District Court denied the plaintiffs’ request for classaction certification. In August 2004, the United States Court of Appeals forthe Ninth Circuit affirmed the Federal District Court’s denial of class actioncertification, and the plaintiffs did not appeal. Subsequently, two of the fournamed plaintiffs elected to continue their cases as individual, non-classactions. However, in September 2005, the court granted the defendants’ motionsfor summary judgment, resolving all claims in defendants’ favor without atrial. In October 2005, the plaintiffs appealed the District Court’s grantingof summary judgment in favor of the defendants to the United States Court ofAppeals for the Ninth Circuit. Thereafter, the plaintiffs/appellants agreed todismiss their appeal in exchange for the defendants’ agreement not to pursue aclaim for costs.  The appeal wasdismissed on June 26, 2006.

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 have 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 is subject to court approval, an aggregate of $16 million in cash, pluscertain interest, will be paid to settle the securities class action as well asthe derivative litigation discussed below. The Company will pay $1.25 million, which was accrued in the Company’sfinancial statements for the quarter ended September 30, 2005. The Companyalso incurred approximately $1.2 million in legal fees and related costs in thenine months ended March 31, 2006. Additionally, the Company incurred approximately $0.7 million for legalfees related to the litigation in the fourth quarter of fiscal year 2006. Inaddition to certain governance actions the Company has agreed to undertake inconnection with the settlement, the Company’s directors and officers insurerwill contribute approximately $14.75 million to the settlement.

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. Although

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managementbelieves the plaintiffs’ lawsuit and appeal were without merit, it determinedthat 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 onfactual allegations that are similar to those alleged in the federal securitiesclass action complaints and the previous derivative actions that were dismissedby the District Court, the derivative complaint alleges breach of fiduciaryduty, abuse of control, gross mismanagement, waste of corporate assets, unjustenrichment and violation of the Sarbanes-Oxley Act of 2002. The parties havereached a settlement as discussed more fully above.

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 enabled didinfringe under the doctrine of equivalents and awarded damages accordingly. Thefeature has been disabled on all affected games in the field, and the decisionpermits continued deployment of the game as long as the autohold feature is notincluded. The Company appealed the decision to the United States Court ofAppeals for the Ninth Circuit and posted a cash bond totaling $7.6 million tostay payment of the judgment and accrued interest pending the appeal. The cashbond is included in other non-current assets and the accrued liability isincluded in accrued liabilities in the accompanying balance sheets. This amounthas been accrued and the expense for this charge is included in discontinuedoperations in the accompanying statement of operations for 2004.   On July 11, 2006, the federal circuit courtof appeals affirmed the district court judgment, denying the appeals for bothparties, and thereafter, the judgment was satisfied out of the posted bond.

On December 7,2004, IGT filed a patent infringement lawsuit against 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 on January 10, 2006. A Markman hearing took place in December 2006and the Company expects a related claim construction ruling.  No trial date has been set.

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

In May2006, IGT filed a patent infringement lawsuit against the Company in the UnitedStates District Court for the District of Delaware.  The complaint asserts that the Company’sBally Power BonusingÔ products infringepatents

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heldby IGT, and seeks injunctive relief and damages in unspecified amounts.  IGT’s motion for a preliminary injunction ispending.  The Company believes IGT’sclaims, including its request for preliminary relief, are without merit and isvigorously defending itself against the lawsuit.

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.

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 financial position,results of operations or cash flows.

**ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

On March 6, 2006,the Company held its annual shareholders meeting at which the shareholdersvoted on the following:

·                  Theelection of Joel Kirschbaum and Kevin Verner to serve as director for terms ofthree years each, each to serve until his respective successor has been electedand has been qualified.  Of the52,137,666 shares outstanding, 33,535,686 were voted for and 6,314,855 withheldfrom Mr. Joel Kirschbaum and 37,696,449 were voted for and 2,154,092 werewithheld from Mr. Kevin Verner.

·                  Anamendment to the Company’s Restated Certificate of Incorporation, as amended,to change the Company’s name to Bally Technologies, Inc.  With respect to this amendment, 39,754,421shares were voted for, 56,492 shares against, 39,627 shares abstained and therewere 2,085,735 broker non-votes.

·                  Anamendment to the Company’s Amended and Restated 2001 Long Term Incentive Plan,as amended, to increase the number of shares of Bally common stock issuablethereunder by 550,000 shares.  Withrespect to the approval of the amendment to the Plan, 23,743,768 shares werevoted for, 10,600,859 shares against, 37,388 shares abstained and there were7,554,260 broker non-votes.

·      Theratification of the Board of Director’s appointment of Deloitte & ToucheLLP to act as independent public accountants of the Company for the fiscal yearending June 30, 2006. With respect to the approval of the ratification ofDeloitte & Touche LLP to act as independent accountants for theCompany for the fiscal year ending June 30, 2006, 39,164,241 shares werevoted for, 628,996 shares against, and 57,303 shares abstained.

**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. |

 

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**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: March 15, 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)                     |
|                          |        |                                                                  |        |  |  |  |  |

 

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