** **

** **

**UNITED STATES**

**SECURITIES 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  December 31, 2007** |
|------------------------------------------------------------|

 

| **OR** |
|--------|

 

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

 

**For the transition periodfrom       to       **

 

**Commission File Number 0-4281**

 

**BALLY TECHNOLOGIES, INC.**

(Exact name of registrant as specified in itscharter)

 
| **NEVADA**                       | ** ** | **88-0104066**      |
|----------------------------------|------------|---------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer    |
| incorporation or  organization)  |       | Identification No.) |

 

**6601S. Bermuda Rd.**

**LasVegas, Nevada  89119**

(Address of principal executive offices)

 

**(702) 584-7700**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 
| x Yes o No |
|------------|

 

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

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 
| o Yes x No |
|------------|

 

Thenumber of shares of Common Stock, $0.10 par value, outstanding as of February 11,2008, according to the records of the registrant’s registrar and transfer agentwas 54,832,000 which does not include 738,000 shares held in treasury.

 

 

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**I N D E X**

 
| **PART I.**  | ** ** | **FINANCIAL INFORMATION**                                                                                                                 |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                                      |
| Item 1.           |       | Financial Statements                                                                                                                      |
|              |       |                                                                                                                                      |
|              |       | Unaudited Condensed Consolidated Balance Sheets as of  December 31, 2007 and June 30, 2007                                      |
|              |       |                                                                                                                                      |
|              |       | Unaudited Condensed Consolidated Statements of  Operations for the Three and Six Months Ended December 31, 2007 and 2006  (restated) |
|              |       |                                                                                                                                      |
|              |       | Unaudited Condensed Consolidated Statements of Cash  Flows for the Six Months Ended December 31, 2007 and 2006 (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 1A.          |       | Risk Factors                                                                                                                              |
|              |       |                                                                                                                                      |
| Item  2.          |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                              |
|              |       |                                                                                                                                      |
| Item 6.           |       | Exhibits                                                                                                                                  |
|              |       |                                                                                                                                      |
| **SIGNATURES**    |       |                                                                                                                                      |

 

2

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**PART I**

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                       | ** ** | **December ****31,**                                 | ** ** | **June ****30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                       | ** ** | **2007**                                                  | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                       | ** ** | **(in 000s, except  share  amounts)** | ** ** |
| ASSETS                                                                                                                                           |       |                                                      |       |                  |       |
| Current assets:                                                                                                                                  |       |                                                      |       |                  |       |
| Cash and cash equivalents                                                                                                                        |       | $                                                         | 48,316     |                  | $          | 40,842 |   |
| Restricted cash                                                                                                                                  |       | 15,565                                                    |       | 17,201                |       |
| Accounts and notes receivable, net of allowances for doubtful  accounts of $9,771 and $8,481                                                     |       | 189,877                                                   |       | 172,060               |       |
| Inventories                                                                                                                                      |       | 90,060                                                    |       | 81,151                |       |
| Deferred tax assets, net                                                                                                                         |       | 62,896                                                    |       | 59,486                |       |
| Deferred cost of revenue                                                                                                                         |       | 50,201                                                    |       | 36,744                |       |
| Other current assets                                                                                                                             |       | 17,312                                                    |       | 14,399                |       |
| Total current assets                                                                                                                             |       | 474,227                                                   |       | 421,883               |       |
|                                                                                                                                             |       |                                                      |       |                  |       |
| Long-term investments (restricted)                                                                                                               |       | 10,596                                                    |       | 10,455                |       |
| Long-term receivables                                                                                                                            |       | 5,573                                                     |       | 9,840                 |       |
| Property, plant and equipment, net of accumulated depreciation of  $53,725 and $46,320                                                           |       | 73,596                                                    |       | 75,623                |       |
| Leased gaming equipment, net of accumulated depreciation of $83,673  and $73,396                                                                 |       | 86,935                                                    |       | 67,965                |       |
| Goodwill                                                                                                                                         |       | 162,258                                                   |       | 161,708               |       |
| Intangible assets, net of accumulated amortization of $27,670 and $24,543                                                                        |       | 28,064                                                    |       | 24,401                |       |
| Deferred tax assets, net                                                                                                                         |       | 24,129                                                    |       | 18,457                |       |
| Long-term deferred cost of revenue                                                                                                               |       | 39,427                                                    |       | 28,376                |       |
| Other assets, net                                                                                                                                |       | 5,720                                                     |       | 6,187                 |       |
| Total assets                                                                                                                                     |       | $                                                         | 910,525    |                  | $          | 824,895 |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                       |       |                                                      |       |                  |       |
| Current liabilities:                                                                                                                             |       |                                                      |       |                  |       |
| Accounts payable                                                                                                                                 |       | $                                                         | 41,773     |                  | $          | 44,045 |   |
| Accrued liabilities                                                                                                                              |       | 57,858                                                    |       | 56,427                |       |
| Customer deposits                                                                                                                                |       | 23,333                                                    |       | 23,489                |       |
| Jackpot liabilities                                                                                                                              |       | 13,390                                                    |       | 13,414                |       |
| Deferred revenue                                                                                                                                 |       | 109,507                                                   |       | 94,347                |       |
| Income taxes payable                                                                                                                             |       | 9,663                                                     |       | 12,945                |       |
| Current maturities of long-term debt and capital leases, including  $2,381 and $2,381 owed to related parties                                    |       | 12,949                                                    |       | 12,271                |       |
| Total current liabilities                                                                                                                        |       | 268,473                                                   |       | 256,938               |       |
| Long-term debt and capital leases, net of current maturities,  including $7,600 and $7,600 owed to related parties                               |       | 301,533                                                   |       | 321,583               |       |
| Long-term deferred revenue                                                                                                                       |       | 57,389                                                    |       | 36,651                |       |
| Other income tax liability                                                                                                                       |       | 20,285                                                    |       | —                |       |
| Other liabilities                                                                                                                                |       | 9,384                                                     |       | 9,321                 |       |
| Total liabilities                                                                                                                                |       | 657,064                                                   |       | 624,493               |       |
| Minority interest                                                                                                                                |       | 1,882                                                     |       | 948                   |       |
| Commitments and contingencies (Note 10)                                                                                                          |       |                                                      |       |                  |       |
| 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;  55,409,000 and 54,612,000 shares issued and 54,672,000 and 54,025,000  outstanding |       | 5,529                                                     |       | 5,455                 |       |
| Treasury stock at cost, 737,000 and 587,000 shares                                                                                               |       | (7,893                                                    | )          | (1,894                | )          |
| Additional paid-in capital                                                                                                                       |       | 274,430                                                   |       | 253,809               |       |
| Accumulated other comprehensive income                                                                                                           |       | 1,696                                                     |       | 1,119                 |       |
| Accumulated deficit                                                                                                                              |       | (22,195                                                   | )          | (59,047               | )          |
| Total stockholders’ equity                                                                                                                  |       | 251,579                                                   |       | 199,454               |       |
| Total liabilities and stockholders’ equity                                                                                                  |       | $                                                         | 910,525    |                  | $          | 824,895 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

3

----

 

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                              | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,**                | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                          | ** ** |
| ** **                                              | ** ** | **2007**                                            | ** ** | **2006**                                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | ** **                                          | ** ** | **(as restated,  see Note 2)**                    | ** ** | ** ** | ** ** | **(as restated,  see Note 2)** | ** ** |
| ** **                                              | ** ** | ** **                                          | ** ** | **(in 000s, except per share amounts)** | ** ** | ** ** | ** ** |
| Revenues:                                               |       |                                                |       |                                                             |       |   |   |   |   |
| Gaming equipment and systems                            |       | $                                                   | 164,730    |                                                             | $          | 99,288 |   | $ | 288,262 |   | $ | 200,595 |   |
| Gaming operations                                       |       | 54,178                                              |       | 40,420                                                           |       | 108,256 |   | 81,039 |   |
| Casino operations                                       |       | 11,744                                              |       | 11,238                                                           |       | 23,164 |   | 23,077 |   |
|                                                    |       | 230,652                                             |       | 150,946                                                          |       | 419,682 |   | 304,711 |   |
| Costs and expenses:                                     |       |                                                |       |                                                             |       |   |   |   |   |
| Cost of gaming equipment and systems (1)                |       | 76,139                                              |       | 54,403                                                           |       | 130,802 |   | 110,550 |   |
| Cost of gaming operations                               |       | 22,757                                              |       | 17,124                                                           |       | 40,816 |   | 34,666 |   |
| Direct cost of casino operations                        |       | 4,719                                               |       | 4,439                                                            |       | 9,431 |   | 8,901 |   |
| Selling, general and administrative                     |       | 60,992                                              |       | 50,427                                                           |       | 113,263 |   | 99,847 |   |
| Research and development costs                          |       | 14,647                                              |       | 13,307                                                           |       | 27,956 |   | 25,863 |   |
| Depreciation and amortization                           |       | 4,596                                               |       | 5,524                                                            |       | 9,450 |   | 10,875 |   |
|                                                    |       | 183,850                                             |       | 145,224                                                          |       | 331,718 |   | 290,702 |   |
| Operating income                                        |       | 46,802                                              |       | 5,722                                                            |       | 87,964 |   | 14,009 |   |
|                                                    |       |                                                |       |                                                             |       |   |   |   |   |
| Other income (expense):                                 |       |                                                |       |                                                             |       |   |   |   |   |
| Interest income                                         |       | 1,027                                               |       | 413                                                              |       | 2,004 |   | 1,324 |   |
| Interest expense                                        |       | (7,270                                              | )          | (10,200                                                          | )          | (14,507 | ) | (18,121 | ) |
| Other, net                                              |       | 116                                                 |       | 800                                                              |       | 993 |   | 1,183 |   |
|                                                    |       |                                                |       |                                                             |       |   |   |   |   |
| Income (loss) before income taxes and minority interest |       | 40,675                                              |       | (3,265                                                           | )          | 76,454 |   | (1,605 | ) |
| Income tax (expense) benefit                            |       | (15,235                                             | )          | 2,358                                                            |       | (28,344 | ) | 1,687 |   |
| Minority interest                                       |       | (1,024                                              | )          | (1,608                                                           | )          | (2,412 | ) | (2,822 | ) |
|                                                    |       |                                                |       |                                                             |       |   |   |   |   |
| Net income (loss)                                       |       | $                                                   | 24,416     |                                                             | $          | (2,515 | ) | $ | 45,698 |   | $ | (2,740 | ) |
|                                                    |       |                                                |       |                                                             |       |   |   |   |   |
| Basic and diluted earnings (loss) per share:            |       |                                                |       |                                                             |       |   |   |   |   |
| Basic earnings (loss) per share                         |       | $                                                   | 0.45       |                                                             | $          | (0.05 | ) | $ | 0.84 |   | $ | (0.05 | ) |
| Diluted earnings (loss) per share                       |       | $                                                   | 0.42       |                                                             | $          | (0.05 | ) | $ | 0.79 |   | $ | (0.05 | ) |
|                                                    |       |                                                |       |                                                             |       |   |   |   |   |
| Weighted average shares outstanding:                    |       |                                                |       |                                                             |       |   |   |   |   |
| Basic                                                   |       | 54,382                                              |       | 53,072                                                           |       | 54,213 |   | 52,985 |   |
| Diluted                                                 |       | 58,524                                              |       | 53,072                                                           |       | 57,970 |   | 52,985 |   |

 

----

(1)   Cost of gaming equipment and systems excludeamortization related to certain intangibles, including core technology andlicense rights, which are included in depreciation and amortization.

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

4

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                          | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                                                                                          | ** ** | ** **                                        | ** ** | **(as restated,  see Note 2)** | ** ** |
| ** **                                                                                          | ** ** | **(in 000s)**                                | ** ** |
| Cash flows from operating activities:                                                               |       |                                              |       |   |   |
| Net income (loss)                                                                                   |       | $                                                 | 45,698     |   | $ | (2,740 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                                       |       | 29,254                                            |       | 29,330 |   |
| Share-based compensation                                                                            |       | 6,585                                             |       | 8,112 |   |
| Tax benefit of stock option exercises                                                               |       | 77                                                |       | — |   |
| Excess tax benefit of stock option exercises                                                        |       | (2,849                                            | )          | — |   |
| Deferred income taxes                                                                               |       | (2                                                | )          | (2,063 | ) |
| Provision for doubtful accounts                                                                     |       | 2,034                                             |       | 290 |   |
| Inventory and other asset write-downs                                                               |       | 4,993                                             |       | 6,215 |   |
| Other                                                                                               |       | (1,380                                            | )          | 3,137 |   |
| Changes in operating assets and liabilities:                                                        |       |                                              |       |   |   |
| Accounts and notes receivable                                                                       |       | (14,430                                           | )          | (1,036 | ) |
| Inventories                                                                                         |       | (43,204                                           | )          | (49,043 | ) |
| Other current assets                                                                                |       | (2,926                                            | )          | (785 | ) |
| Accounts payable                                                                                    |       | (4,815                                            | )          | (6,759 | ) |
| Accrued liabilities and jackpot liabilities                                                         |       | 1,768                                             |       | (4,727 | ) |
| Deferred revenue                                                                                    |       | 10,515                                            |       | 7,628 |   |
| Net cash provided by (used in) operating activities                                                 |       | 31,318                                            |       | (12,441 | ) |
|                                                                                                |       |                                              |       |   |   |
| Cash flows from investing activities:                                                               |       |                                              |       |   |   |
| Capital expenditures                                                                                |       | (8,416                                            | )          | (11,554 | ) |
| Restricted cash and investments                                                                     |       | 1,582                                             |       | (1,138 | ) |
| Additions to other long-term assets                                                                 |       | (6,710                                            | )          | (1,251 | ) |
| Net cash used in investing activities                                                               |       | (13,544                                           | )          | (13,943 | ) |
|                                                                                                |       |                                              |       |   |   |
| Cash flows from financing activities:                                                               |       |                                              |       |   |   |
| Proceeds from revolving credit facility                                                             |       | —                                            |       | 5,000 |   |
| Payments on revolving credit facility                                                               |       | —                                            |       | (5,000 | ) |
| Reduction of long-term debt                                                                         |       | (19,372                                           | )          | (4,224 | ) |
| Proceeds from sale lease-back arrangements                                                          |       | —                                            |       | 22,303 |   |
| Purchase of treasury stock                                                                          |       | (5,999                                            | )          | — |   |
| Excess tax benefit of stock option exercises                                                        |       | 2,849                                             |       | — |   |
| Proceeds from exercise of stock options                                                             |       | 11,388                                            |       | 4,311 |   |
| Net cash (used in) provided by financing activities                                                 |       | (11,134                                           | )          | 22,390 |   |
|                                                                                                |       |                                              |       |   |   |
| Effect of exchange rate changes on cash                                                             |       | 834                                               |       | 1 |   |
|                                                                                                |       |                                              |       |   |   |
| Cash and cash equivalents:                                                                          |       |                                              |       |   |   |
| Increase (decrease) for period                                                                      |       | 7,474                                             |       | (3,993 | ) |
| Balance, beginning of period                                                                        |       | 40,842                                            |       | 16,425 |   |
| Balance, end of period                                                                              |       | $                                                 | 48,316     |   | $ | 12,432 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

5

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATED****SUPPLEMENTALCASH FLOW INFORMATION**

 

Thefollowing supplemental information is related to the unaudited condensedconsolidated statements of cash flows:

 
| ** **                                                                                   | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                                                                                   | ** ** | **(in 000s)**                                | ** ** |
| Cash paid for interest                                                                       |       | $                                                 | 14,421     |   | $ | 16,809 |   |
| Cash paid for income taxes                                                                   |       | 26,641                                            |       | 683 |   |
|                                                                                         |       |                                              |       |   |   |
| Non-cash investing and financing transactions:                                               |       |                                              |       |   |   |
| Transfer of leased gaming equipment to inventory (1)                                         |       | $                                                 | 8,184      |   | $ | 4,000 |   |
| Transfer of inventory to leased gaming equipment (1)                                         |       | 40,248                                            |       | 35,936 |   |
| Capital expenditure accruals                                                                 |       | 769                                               |       | — |   |
| Assets acquired through sale lease-back transactions                                         |       | —                                            |       | 11,681 |   |
| Non-cash aspects of sale lease-back transactions                                             |       | —                                            |       | 3,333 |   |
| Receipt of Company’s common stock as consideration for employee stock  option exercises |       | —                                            |       | 41 |   |
| Consolidation of variable interest entities                                                  |       | 326                                               |       | 1,539 |   |

 

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(1)          The Company has one processto procure raw materials for the assembly of both inventory and leased gamingequipment.  The materials requisitionplanning process considers the number of devices the Company expects to buildfor sale and for use in its gaming operations division during a particularperiod, but it does not separately earmark purchases for leased gamingequipment.  Without such an earmarkingprocess, the Company is unable to determine whether the cash expended toconstruct leased gaming equipment during a particular period came frominventory on hand at the beginning of the period or was constructed frominventory procured during the period of deployment, thus requiring theexpenditure of cash.  As a result of theinability to separately identify the cash flows associated with theconstruction of leased gaming equipment, the Company has included all additionsto leased gaming equipment as a change in inventory under cash provided by(used in) operating activities in the unaudited condensed consolidatedstatement of cash flows.  In addition,cash generated from the sale of used gaming equipment classified as leasedgaming equipment is also included in cash provided by (used in) operatingactivities in the unaudited condensed consolidated statement of cash flows.

 

6

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**BALLY TECHNOLOGIES, INC.**

**FORM 10-Q**

Notesto Unaudited Condensed Consolidated Financial Statements

 

**1.             BASIS OFPRESENTATION**

 

*Principles of presentation and consolidation*

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with generally accepted accounting principles andpursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”) and reflect all adjustments, consisting of normal recurringadjustments, which management believes are necessary to fairly present thefinancial position, results of operations and cash flows of Bally Technologies, Inc.(“Bally” or the “Company”), a Nevada corporation, and its subsidiaries for therespective periods presented as required by Regulation S-X, Rule 10-01.  Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withgenerally accepted accounting principles have been condensed or omittedpursuant to those rules and regulations. The results of operations for an interim period are not necessarilyindicative of the results that may be expected for any other interim period orthe year as a whole.  The accompanyingunaudited condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and notes thereto in theCompany’s Annual Report on Form 10-K for the fiscal year ended June 30,2007, as filed with the SEC on November 2, 2007 (the “2007 10-K”).

 

Bally is adiversified, worldwide gaming company that designs, manufactures, distributesand operates gaming machines and computerized monitoring systems for gamingmachines and owns and operates one casino.

 

The Company is thegeneral partner of Rainbow Casino Vicksburg Partnership (“RCVP”), whichoperates the Rainbow Casino in Vicksburg, Mississippi.  The limited partner of RCVP is entitled toreceive 10% of the net available cash flows of RCVP after debt service andother items, as defined in the limited partnership agreement, which increasesto 20% of the net available cash flows based on 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 consolidates RCVP and records an adjustment to reflect theportion of the earnings of RCVP attributable to the minority shareholders.

 

TheCompany also consolidates certain Atlantic City progressive trusts (the “Trusts”)in accordance with Financial Accounting Standards Board (“FASB”) Interpretation(“FIN”) 46R, *Consolidation of Variable Interest Entities,*which addresses consolidation by a business enterprise of variable interestentities (“VIE’s”).   The Trusts areconsolidated based on the premise they do not have sufficient equity investmentat risk to permit the Trusts to finance their activities without additionalsubordinated financial support from the Company.  As of December 31, 2007 and June 30,2007, the Company consolidated $6.7 million and $6.3 million, respectively, intotal assets and liabilities, primarily consisting of restricted cash accountsand restricted investments (included in other assets in the unaudited condensedconsolidated balance sheets) and related jackpot liabilities.  The following revenues and costs were alsoconsolidated:

 
| ** **                | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                | ** ** | **(in 000s)**                                  | ** ** |
| Gaming operations revenue |       | $                                                   | 1,779      |                                              | $          | 1,655 |   | $ | 3,460 |   | $ | 4,001 |   |
| Cost of gaming operations |       | 1,053                                               |       | 322                                               |       | 1,601 |   | 1,806 |   |
|                           |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

Allintercompany accounts and transactions have been eliminated in consolidation.

 

*Reclassifications*

 

Certainreclassifications have been made to the prior period financial statements toconform to the current period presentation to separately present gamingoperations revenue and cost of gaming operations in the unaudited condensedconsolidated statements of operations. Gaming operations revenues and cost of gaming operations had previouslybeen included in gaming equipment and systems revenue and cost of gaming equipmentand systems.

 

7

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*Inventories*

 

Inventoriesare stated 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, direct labor andmanufacturing overhead.  Inventoriesconsist of the following:

 
| ** **      | ** ** | **December 31,  2007** | ** ** | **June 30,  2007** | ** ** |
|-----------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **      | ** ** | **(in 000s)**          | ** ** |
| Raw materials   |       | $                           | 60,726     |                    | $          | 58,473 |   |
| Work-in-process |       | 813                         |       | 639                     |       |
| Finished goods  |       | 28,521                      |       | 22,039                  |       |
| Total           |       | $                           | 90,060     |                    | $          | 81,151 |   |

 

*Property, plant and equipment and leased gamingequipment*

 

Property,plant and equipment is stated at cost and depreciated over the estimated usefullives or lease term, if less, using the straight line method as follows:buildings and improvements, 10 to 40 years; gaming equipment, 1 to 7 years;furniture, fixtures and equipment, 3 to 7 years; and leasehold improvements,the shorter of the lease term or 10 years. Leased gaming equipment is stated at cost and depreciated over the estimateduseful lives ranging from 2 to 31⁄2 years. Equipment under capital leases is recorded at the lower of the presentvalue of the minimum lease payments or the fair value of the assets.

 

*Deferred Revenue and Deferred Cost of Revenue*

 

Deferred revenue arises from the timing differencesbetween the shipment or installation of gaming equipment and systems productsand the satisfaction of all revenue recognition criteria consistent with ourrevenue recognition policy.  Deferredcost of revenue consists of the direct costs associated with the manufacture ofgaming equipment and systems products for which revenue has been deferred.  Deferred revenue and deferred cost of revenuethat are expected to be realized within one year are classified as currentliabilities and current assets, respectively. In certain cases, deferred cost of revenue is recorded in advance ofdeferred revenue due to the shipment and receipt of the product by the customerin advance of billing.

 

*Recently Issued Accounting Pronouncements*

 

InDecember 2007, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 141 (Revised2007),*Business Combinations.*SFAS No. 141R will significantly change the accounting for businesscombinations.  Under SFAS No.141R, anacquiring entity is required to recognize all the assets acquired andliabilities assumed in a transaction at the acquisition-date fair value withlimited exceptions.   SFAS No.141R alsoincludes a substantial number of new disclosure requirements.  SFAS No.141R applies prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008, and accordingly, the Company expects to adopt SFAS No. 141Rbeginning in fiscal 2010.  The Companyexpects that SFAS No. 141R will have an impact on accounting for businesscombinations once adopted, but the effect is dependent upon acquisitions, ifany, at that time.

 

8

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InDecember 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements - An Amendment of ARB No. 51.* SFAS No.160establishes new accounting and reporting standards for the noncontrollinginterest in a subsidiary and for the deconsolidation of a subsidiary.  Specifically, this statement requires therecognition of a noncontrolling interest (minority interest) as equity in theconsolidated financial statements and separate from the parent’s equity.  The amount of net income attributable to thenoncontrolling interest will be included in consolidated net income on the faceof the income statement.  SFAS No.160clarifies that changes in a parent’s ownership interest in a subsidiary that donot result in deconsolidation are equity transactions if the parent retains itscontrolling financial interest.  Inaddition, this statement requires that a parent recognize a gain or loss in netincome when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of thenoncontrolling equity investment on the deconsolidation date.  SFAS No.160 also includes expanded disclosurerequirements regarding the interests of the parent and its noncontrollinginterest.  SFAS No.160 is effective forfiscal years, and interim periods within those fiscal years, beginning on orafter December 15, 2008, and accordingly, the Company expects to adoptSFAS No.160 beginning in fiscal 2010. The Company is currently in the process of evaluating the impact SFAS No. 160will have on its consolidated results of operations, financial position andcash flows.

 

InFebruary 2007, the FASB issued Statement SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*.  SFAS No.159 provides companies with an optionto report selected financial assets and liabilities at fair value.  It also establishes presentation anddisclosure requirements to facilitate comparisons between companies usingdifferent measurement attributes for similar types of assets andliabilities.  The statement is effectivefor fiscal years beginning after November 15, 2007, and accordingly, theCompany expects to adopt SFAS No. 159 beginning in fiscal 2009.  Earlier application is permitted provided theCompany also applies the provisions of SFAS No. 157, *Fair ValueMeasurements*, which is discussed below.  The Company is currently in the process ofevaluating the impact SFAS No. 159 will have on its consolidated resultsof operations, financial position and cash flows.

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair ValueMeasurements*, which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements,rather it applies to existing accounting pronouncements that require or permitfair value measurements.  SFAS No. 157is effective for fiscal years beginning after November 15, 2007, andaccordingly, the Company expects to adopt SFAS No. 157 beginning in fiscal2009.  The Company is currently in theprocess of evaluating the impact SFAS No. 157 will have on itsconsolidated results of operations, financial position and cash flows.

 

**2.             RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS**

 

Subsequent to the issuanceof the Company’s consolidated financial statements for the year ended June 30,2006 and in connection with the year-end closing process for fiscal 2007, theCompany determined that certain adjustments were required to be made forcorrections of errors in its previously issued unaudited condensed consolidatedfinancial statements for the three-month and six-month periods ended December 31,2006, among others. These errors related to:

 

·                                          Certainexpenses that had been reported in prior periods as selling, general andadministrative expenses, depreciation and amortization expense and otherexpenses which should have been recorded either as cost of sales or ascontra-revenue;

 

·                                          Additions toleased gaming equipment previously reported as cash used in investingactivities in its unaudited condensed consolidated statements of cash flows forall periods prior to March 31, 2007 should have been presented as a changein inventory under cash used in operating activities; and

 

·                                          Certain salessourced from the United States directly to foreign customers were included inrevenue and operating income attributable to the United States and Canadageographic region and should have been classified as Europe or Other Foreignbased on the location of the customer. Specifically, revenue of $7.2 million and $16.0 million and operatingincome of $0.5 million and $3.1 million for the three-month and six-monthperiods ended December 31, 2006, respectively, should not have beenclassified as being attributable to the United States and Canada geographicregion.  See Note 8, Segments andGeographical Information.

 

9

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Asa result of these and other immaterial errors, the unaudited condensedconsolidated statements of operations for the three-month and six-month periodsended December 31, 2006 and statement of cash flows for the six-month period ended December 31,2006, among others, have been restated from the amounts previouslyreported.  The restatement had no effecton the unaudited condensed consolidated balance sheets, or reported net lossfor any period.

 

The following is a summary of the effects of the restatement on theaccompanying unaudited condensed consolidated financial statements:

 
| ** **                                     | ** ** | **Three Months Ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                     | ** ** | **As  previously  reported**                                  | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
| ** **                                     | ** ** | **(in 000s)**                                            | ** ** |
| *Statement of Operations*                      | * *   | * *                                                      | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                       |       |                                                          |       |   |   |   |   |   |   |
| Gaming equipment and systems                   |       | $                                                             | 140,533    |   | $ | (40,420 | ) | $ | (825 | ) | $ | 99,288 |   |
| Gaming operations                              |       | —                                                        |       | 40,420 |   | — |   | 40,420 |   |
| Casino operations                              |       | 11,238                                                        |       | — |   | — |   | 11,238 |   |
| Total revenue                                  |       | 151,771                                                       |       | — |   | (825 | ) | 150,946 |   |
|                                           |       |                                                          |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems (2)       |       | 70,653                                                        |       | (17,124 | ) | 874 |   | 54,403 |   |
| Cost of gaming operations                      |       | —                                                        |       | 17,124 |   | — |   | 17,124 |   |
| Direct cost of casino operations               |       | 4,439                                                         |       | — |   | — |   | 4,439 |   |
| Selling, general and administrative expense    |       | 51,622                                                        |       | — |   | (1,195 | ) | 50,427 |   |
| Depreciation and amortization                  |       | 5,903                                                         |       | — |   | (379 | ) | 5,524 |   |
| Operating income                               |       | 5,847                                                         |       | — |   | (125 | ) | 5,722 |   |
| Other income, net                              |       | 675                                                           |       | — |   | 125 |   | 800 |   |
| Loss before income taxes and minority interest |       | (3,265                                                        | )          | — |   | — |   | (3,265 | ) |
|                                                |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                     | ** ** | **Six Months Ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                     | ** ** | **As  previously  reported**                                | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                     | ** ** | **(in 000s)**                                          | ** ** |
| *Statement of Operations*                      | * *   | * *                                                    | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                       |       |                                                        |       |   |   |   |   |   |   |
| Gaming equipment and systems                   |       | $                                                           | 282,496    |   | $ | (81,039 | ) | $ | (862 | ) | $ | 200,595 |   |
| Gaming operations                              |       | —                                                      |       | 81,039 |   | — |   | 81,039 |   |
| Casino operations                              |       | 23,077                                                      |       | — |   | — |   | 23,077 |   |
| Total revenue                                  |       | 305,573                                                     |       | — |   | (862 | ) | 304,711 |   |
|                                           |       |                                                        |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems (2)       |       | 143,540                                                     |       | (34,666 | ) | 1,676 |   | 110,550 |   |
| Cost of gaming operations                      |       | —                                                      |       | 34,666 |   | — |   | 34,666 |   |
| Direct cost of casino operations               |       | 8,901                                                       |       | — |   | — |   | 8,901 |   |
| Selling, general and administrative expense    |       | 101,666                                                     |       | — |   | (1,819 | ) | 99,847 |   |
| Depreciation and amortization                  |       | 11,336                                                      |       | — |   | (461 | ) | 10,875 |   |
| Operating income                               |       | 14,267                                                      |       | — |   | (258 | ) | 14,009 |   |
| Other income, net                              |       | 925                                                         |       | — |   | 258 |   | 1,183 |   |
| Loss before income taxes and minority interest |       | (1,605                                                      | )          | — |   | — |   | (1,605 | ) |
|                                                |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |

 

10

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----

(1) See Note 1 to the unauditedcondensed consolidated financial statements, Basis of Presentation–Reclassifications.

(2) Cost of gamingequipment and systems exclude amortization related to certain intangibles,including core technology and license rights, which are included indepreciation and amortization.

 
| ** **                                                                                      | ** ** | **Six Months Ended  December 31, 2006** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **As previously  reported**                            | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                                                                      | ** ** | **(in 000s)**                                          | ** ** |
| *Statement of Cash Flows*                                                                       | * *   | * *                                                    | * *   | * * | * * | * * | * * |
| Other adjustments to reconcile net loss to net cash provided by (used  in) operating activities |       | $                                                           | 9,523      |   | $ | (6,386 | ) | $ | 3,137 |   |
| Change in inventories                                                                           |       | (10,719                                                     | )          | (38,324 | ) | (49,043 | ) |
| Net cash provided by (used in) operating activities                                             |       | 32,269                                                      |       | (44,710 | ) | (12,441 | ) |
|                                                                                            |       |                                                        |       |   |   |   |   |
| Capital expenditures                                                                            |       | (8,778                                                      | )          | (2,776 | ) | (11,554 | ) |
| Additions to leased gaming equipment                                                            |       | (47,486                                                     | )          | 47,486 |   | — |   |
| Net cash used in investing activities                                                           |       | (58,653                                                     | )          | 44,710 |   | (13,943 | ) |
|                                                                                                 |            |                                                             |            |  |  |  |  |  |  |  |

 

**3.             EARNINGS (LOSS) PERSHARE**

 

Thecomputation of basic and diluted earnings (loss) per share applicable to theCompany’s common stock is as follows:

 
|                                                                         |   | **Three Months Ended  December 31,**              |   | **Six Months Ended  December 31,** |   |
|------------------------------------------------------------------------------|--------|------------------------------------------------------------------|--------|---------------------------------------------------|--------|
|                                                                         |   | **2007**                                                         |   | **2006**                                          |   | **2007** |   | **2006** |   |
|                                                                         |   | **(in 000s, except per share amounts)** |   |
| Net income (loss)                                                            |   | $                                                                | 24,416 |                                              | $      | (2,515 | ) | $ | 45,698 |   | $ | (2,740 | ) |
| After tax interest expense on convertible debt                               |   | 82                                                               |   | —                                            |   | 168 |   | — |   |
| Dilutive earnings (loss)                                                     |   | $                                                                | 24,498 |                                              | $      | (2,515 | ) | $ | 45,866 |   | $ | (2,740 | ) |
|                                                                         |   |                                                             |   |                                              |   |   |   |   |   |
| Weighted average common shares outstanding                                   |   | 54,382                                                           |   | 53,072                                            |   | 54,213 |   | 52,985 |   |
| Dilutive effect of:                                                          |   |                                                             |   |                                              |   |   |   |   |   |
| Stock options, Restricted Stock Units (“RSU”) and restricted stock |   | 3,833                                                            |   | —                                            |   | 3,458 |   | — |   |
| Warrants                                                                     |   | 40                                                               |   | —                                            |   | 28 |   | — |   |
| Convertible debt                                                             |   | 269                                                              |   | —                                            |   | 271 |   | — |   |
| Diluted shares outstanding                                                   |   | 58,524                                                           |   | 53,072                                            |   | 57,970 |   | 52,985 |   |
|                                                                         |   |                                                             |   |                                              |   |   |   |   |   |
| Basic earnings (loss) per share                                              |   | $                                                                | 0.45   |                                              | $      | (0.05 | ) | $ | 0.84 |   | $ | (0.05 | ) |
| Diluted earnings (loss) per share                                            |   | $                                                                | 0.42   |                                              | $      | (0.05 | ) | $ | 0.79 |   | $ | (0.05 | ) |

 

11

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Certainsecurities were excluded from the diluted per share calculation for certainperiods because their inclusion would be anti-dilutive.  For the three-month and six-month periodsended December 31, 2006, all potentially dilutive securities were excludedfrom the diluted per share calculation as their inclusion would have beenanti-dilutive due to the net loss reported. There were no potentially dilutivesecurities excluded from the calculation for the three-month and six-monthperiods ended December 31, 2007. Such securities consist of the following:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** |
| ** **                              | ** ** | **2006**                         | ** ** | **2006**                       | ** ** |
| ** **                              | ** ** | **(in 000s)**               | ** ** |
| Stock options, RSU and restricted stock |       | 9,601                            |       | 9,314                          |       |
| Warrants                                |       | 100                              |       | 100                            |       |
| Total                                   |       | 9,701                            |       | 9,414                          |       |

 

Asof December 31, 2006, the Company also had certain related party debtoutstanding which was convertible into common stock at the Company’sdiscretion.  See Note 7, Related PartyTransactions.  The potential dilutionfrom this convertible debt was not included in the diluted loss per sharecomputation for the three-month and six-month periods ended December 31,2006, due to the reported net loss for the periods.  Assuming the conversion occurred on December 31,2006, an additional 0.6 million shares, would have been outstanding as a resultof the conversion.  The effect of theconvertible debt has been included in the diluted per share calculation forthree-month and six-month periods ended December 31, 2007.

 

**4.             SHARE-BASEDCOMPENSATION**

 

The Company accounts for itsshare-based compensation in accordance with the provisions of SFAS No. 123R,*Share-Based Payment*, whichestablished accounting for equity instruments exchanged for employeeservices.  SFAS No. 123R requiresemployee stock options and rights to purchase shares under stock participationplans to be accounted for under the fair value method.  Under the provisions of SFAS No. 123R,share-based compensation cost is measured at the grant date, based on thecalculated fair value of the award, and is recognized as an expense over theemployee’s requisite service period which is generally the vesting period ofthe equity grant.

 

The following table presentsshare-based compensation expense and related effect of the income tax benefitincluded in the Company’s unaudited condensed consolidated statements ofoperations:

 
| ** **                                          | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | ** **                                          | ** ** | **(in 000s)**                                | ** ** | ** ** | ** ** |
| Selling, general and administrative                 |       | $                                                   | 2,375      |                                              | $          | 3,931 |   | $ | 5,625 |   | $ | 7,277 |   |
| Research and development                            |       | 447                                                 |       | 392                                               |       | 897 |   | 767 |   |
| Cost of gaming equipment and systems and operations |       | 29                                                  |       | 37                                                |       | 63 |   | 68 |   |
| Share-based compensation expense before tax         |       | 2,851                                               |       | 4,360                                             |       | 6,585 |   | 8,112 |   |
| Income tax benefit                                  |       | 998                                                 |       | 1,526                                             |       | 2,305 |   | 2,839 |   |
| Net share-based compensation expense                |       | $                                                   | 1,853      |                                              | $          | 2,834 |   | $ | 4,280 |   | $ | 5,273 |   |

 

As of December 31,2007, there was $17.7 million of total unrecognized compensation expenserelated to the unvested portion of stock options which will be recognized overthe subsequent 2.35 years.

 

The Company estimates thefair value of stock options using the Black-Scholes valuation model.  Key input assumptions used to estimate thefair value of stock options include the exercise price of the option, the expectedoption term, the expected volatility of the Company’s common stock over theoption’s expected term, the risk-free interest rate over the option’s expectedterm and the Company’s expected annual dividend yield.  The Company believes that the valuationtechnique and the approach utilized to develop the underlying assumptions areappropriate in calculating the fair values of the Company’s stock optionsgranted.  Estimates of fair value are notintended to predict actual future events, or the value ultimately realized by therecipients of equity awards.

 

12

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The fair value of eachoption granted during the periods referenced below was estimated on the grantdate using the Black-Scholes valuation model with the following assumptions:

 
| ** **                      | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted average:               |       |                                                |       |                                              |       |   |   |   |   |
| Expected option term (in years) |       | 4.96                                                |       | 6.14                                              |       | 6.00 |   | 6.18 |   |
| Expected volatility             |       | 44.88                                               | %          | 56.82                                             | %          | 49.29 | % | 57.41 | % |
| Risk-free interest rate         |       | 4.23                                                | %          | 4.70                                              | %          | 4.75 | % | 4.76 | % |
| Expected annual dividend yield  |       | —                                              |       | —                                            |       | — |   | — |   |

 

Stock option activity as ofand for the six months ended December 31, 2007 is summarized below:

 
| ** **                                       | ** ** | **Weighted Average** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **Shares**                | ** ** | **Exercise  Price** | ** ** | **Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| ** **                                       | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** | **(years)** | ** ** | **(in 000s)** | ** ** |
| Balance outstanding as of June 30, 2007     |       | 8,179                     |       | $ | 15.87 |   | 6.88 |   | $ | 86,328 |   |
| Granted                                          |       | 111                       |       | 30.01 |   |   |   |   |   |
| Exercised                                        |       | (742                      | )          | 15.34 |   |   |   |   |   |
| Forfeited or expired                             |       | (81                       | )          | 16.94 |   |   |   |   |   |
| Balance outstanding as of December 31, 2007 |       | 7,467                     |       | $ | 16.11 |   | 6.43 |   | $ | 250,929 |   |
|                                             |       |                      |       |   |   |   |   |   |   |
| Exercisable as of December 31, 2007         |       | 4,728                     |       | $ | 16.64 |   | 5.57 |   | $ | 156,387 |   |

 

Restricted stock andrestricted stock unit activity as of and for the six months ended December 31,2007 is summarized below:

 
| ** **                                       | ** ** | **Weighted Average** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **Shares**                | ** ** | **Grant Date  Fair Value** | ** ** |
| ** **                                       | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** |
| Balance outstanding as of June 30, 2007     |       | 761                       |       | $ | 16.05 |   |
| Granted                                          |       | 55                        |       | 42.08 |   |
| Exercised                                        |       | (20                       | )          | 17.00 |   |
| Forfeited or expired                             |       | —                    |       | — |   |
| Balance outstanding as of December 31, 2007 |       | 796                       |       | $ | 17.83 |   |
|                                             |       |                      |       |   |   |
| Vested as of December 31, 2007              |       | 550                       |       | $ | 15.69 |   |

 

13

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**5.             GOODWILL ANDINTANGIBLE ASSETS**

 

*Finite lived intangibleassets*

 

Finitelived intangible assets are comprised of the following:

 
| ** **                          | ** ** | **December 31,   2007** | ** ** | **June 30,  2007** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **(in 000s)**                | ** ** |
| Patents and gaming related products |       | $                                 | 16,050     |                    | $          | 16,050 |   |
| Less: accumulated amortization      |       | (6,928                            | )          | (5,992                  | )          |
|                                |       | 9,122                             |       | 10,058                  |       |
|                                |       |                              |       |                    |       |
| Licenses and other                  |       | $                                 | 39,684     |                    | $          | 32,894 |   |
| Less: accumulated amortization      |       | (20,742                           | )          | (18,551                 | )          |
|                                |       | 18,942                            |       | 14,343                  |       |
|                                |       |                              |       |                    |       |
| Total                               |       | $                                 | 28,064     |                    | $          | 24,401 |   |
|                                     |            |                                   |            |                         |            |  |  |  |

*Goodwill*

 

Thechanges in the carrying amount of goodwill for the six-month period ended December 31,2007, are as follows:

 
| ** **                              | ** ** | **(in 000s)** | ** ** |
|-----------------------------------------|------------|--------------------|------------|
| Balance at June 30, 2007           |       | $                  | 161,708    |   |
| Foreign currency translation adjustment |       | 550                |       |
| Balance at December 31, 2007       |       | $                  | 162,258    |   |

 

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

 

Long-termdebt and capital leases consist of the following:

 
| ** **                                                 | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                 | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| ** **                                                 | ** ** | **(in 000s)**    | ** ** |
| Term loan facility                                         |       | $                     | 291,217    |              | $          | 307,882 |   |
| Capital lease obligations                                  |       | 13,233                |       | 15,944            |       |
| Related party debt (see Note 7)                            |       | 9,981                 |       | 9,981             |       |
| Other, generally unsecured                                 |       | 51                    |       | 47                |       |
| Long-term debt and capital leases                          |       | 314,482               |       | 333,854           |       |
| Less current maturities                                    |       | 12,949                |       | 12,271            |       |
| Long-term debt and capital leases, less current maturities |       | $                     | 301,533    |              | $          | 321,583 |   |

 

TheCompany’s debt structure at December 31, 2007 consisted primarily of aterm loan facility and a $75.0 million revolving credit facility, which arelimited by a current leverage ratio and debt owed to related parties.  There were no amounts outstanding under theCompany’s revolving credit facility as of December 31, 2007.  The revolving credit facility is furtherrestricted to the extent of outstanding letters of credit.  Outstanding letters of credit at December 31,2007 were $26.3 million which reduced availability under the revolving creditfacility to approximately $48.7 million. The revolving credit facility commitment reduces annually until itexpires in September 2008.

 

Theterm loan requires principal reductions of approximately 1% per annum paidquarterly, with a balloon payment due in September 2009.  As of December 31, 2007, the term loanhad an interest rate of 8.39%, based on LIBOR plus 3.00%.

 

14

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Theterm loan and the revolving credit facility are collateralized by substantiallyall of the Company’s domestic property and are guaranteed by each of theCompany’s domestic subsidiaries, other than the entity that holds the Company’sinterest in its Rainbow Casino operations, and are secured by a pledgeagreement.  The bank loan agreementgoverning the term loan and the revolving credit facility (the “Loan Agreement”)contains a number of maintenance and other covenants that, among other things,restrict the ability of the Company and certain of its subsidiaries to disposeof assets, incur additional indebtedness or issue preferred stock, paydividends or make other distributions, enter into certain acquisitions,repurchase equity interests or subordinated indebtedness, issue or sell equityinterests of the Company’s subsidiaries, engage in mergers or acquisitions orcertain transactions with subsidiaries and affiliates, and that otherwiserestrict corporate activities.  TheCompany was in compliance with these covenants as of December 31, 2007.

 

As of December 31,2007, 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”) asdefined by the Loan Agreement.  Theleverage ratio is computed as total average debt outstanding during the quarterdivided by the trailing 12 months EBITDA, excluding certain cash and non-cashcharges.  The Company’s leverage ratio asof December 31, 2007 was 1.53 times versus the covenant maximum allowableof 3.50 times.

 

Capitallease obligations represent amounts owed under lease or sale-lease backtransactions primarily related to equipment used in the Company’s GamingEquipment and Systems segment.  Based ondifferent installation dates over a four month period, three separate paymentstreams of thirty-six equal installments were created with an aggregate monthlypayment of $655,000 at an average interest rate of 9.11%.

 

TheCompany’s related party debt, which totaled approximately $10.0 million as of December 31,2007, consists primarily of the debt owed to the former principals of SierraDesign Group (“SDG”) and MindPlay LLC (“MindPlay”).  See Note 7, Related Party Transactions,regarding related party debt.

 

**7.             RELATED PARTY TRANSACTIONS**

 

The Company completed theacquisition of all of the assets of SDG during fiscal 2005 and substantiallyall of the assets and liabilities of MindPlay during fiscal 2004.  In each acquisition, the consideration paidincluded subordinated debt issued to the former principals of eachbusiness.  Certain of the formerprincipals are now employees of the Company.

 

Thenotes payable to the former principals of SDG totaled approximately $7.0million as of December 31, 2007 and are payable in annual installmentsplus interest at LIBOR plus 2% (7.33% as of December 31, 2007) through2009.  At the Company’s discretion, theprincipal and accrued interest thereon can be paid in cash, or can be convertedinto shares of the Company’s common stock using the average stock price for the20 business days prior to the delivery of such shares.

 

Theinitial purchase price for Mindplay included, among other things, the issuanceof a $4.0 million note payable with a fixed rate of 6%. As of December 31,2007 the notes payable to the former principals of Mindplay totaled $3.0million.  As provided for in theacquisition agreement, under certain circumstances, the Company may offset50% of all damages (including reasonable attorneys’ fees) up to the entireamount due under the promissory note in connection with an indemnificationclaim against the former shareholders of MindPlay related to the Company’spatent lawsuit with Shuffle Master, Inc. (“Shuffle Master”) andInternational Game Technology (“IGT”). See Note 10, Commitments and Contingencies.

 

15

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In November 2007,the Company repurchased 149,253 shares of common stock for $6.0 million from Mr. RobertLuciano, a former principal of SDG and the Company’s Chief Technology Officer.The shares are included in treasury stock.

 

TheCompany leases a warehouse and office facility from an entity owned by Mr. Luciano. Rental payments totaled $112,041 forboth of the three-month periods ended December 31, 2007 and 2006 and$224,082 for both of the six-month periods ended December 31, 2007 and2006.

 

**8.             SEGMENTS ANDGEOGRAPHICAL INFORMATION**

 

TheCompany operates in two reportable segments: (i) Bally Gaming Equipmentand Systems which designs, manufactures, assembles, distributes and operatesgaming machines and computerized monitoring and bonusing systems for gamingmachines, and (ii) Casino Operations which owns and operates a casino inVicksburg, Mississippi.  The accountingpolicies of these segments are consistent with the Company’s policies for theunaudited condensed consolidated financial statements.

 

Thetable below presents information as to the Company’s revenues and operatingincome by segment:

 
| ** **                   | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                   | ** ** | ** **                                          | ** ** | **(As restated,  See Note 2)**     | ** ** | ** ** | ** ** | **(As restated,  See Note 2)** | ** ** |
| ** **                   | ** ** | ** **                                          | ** ** | **(in 000s)**                                | ** ** | ** ** | ** ** |
| Revenues:                    |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems |       | $                                                   | 218,908    |                                              | $          | 139,708 |   | $ | 396,518 |   | $ | 281,634 |   |
| Casino Operations            |       | 11,744                                              |       | 11,238                                            |       | 23,164 |   | 23,077 |   |
| Total revenues               |       | $                                                   | 230,652    |                                              | $          | 150,946 |   | $ | 419,682 |   | $ | 304,711 |   |
|                         |       |                                                |       |                                              |       |   |   |   |   |
| Inter-segment revenues:      |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems |       | $                                                   | 149        |                                              | $          | 102 |   | $ | 434 |   | $ | 184 |   |
| Casino Operations            |       | —                                              |       | —                                            |       | — |   | — |   |
| Total inter-segment revenues |       | $                                                   | 149        |                                              | $          | 102 |   | $ | 434 |   | $ | 184 |   |
|                         |       |                                                |       |                                              |       |   |   |   |   |
| Operating income (loss):     |       |                                                |       |                                              |       |   |   |   |   |
| Gaming Equipment and Systems |       | $                                                   | 51,190     |                                              | $          | 8,951 |   | $ | 97,892 |   | $ | 19,852 |   |
| Casino Operations            |       | 4,200                                               |       | 3,933                                             |       | 8,042 |   | 7,968 |   |
| Corporate/other              |       | (8,588                                              | )          | (7,162                                            | )          | (17,970 | ) | (13,811 | ) |
| Total operating income       |       | $                                                   | 46,802     |                                              | $          | 5,722 |   | $ | 87,964 |   | $ | 14,009 |   |

 

TheCompany’s operations are based primarily in the United States and Canada withsales and distribution offices in Europe, China and South America.  The table below presents information as tothe Company’s revenues and operating income by geographic region:

 

16

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| ** **               | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **               | ** ** | ** **                                          | ** ** | **(As restated,  See Note 2)**     | ** ** | ** ** | ** ** | **(As restated,  See Note 2)** | ** ** |
| ** **               | ** ** | ** **                                          | ** ** | **(in 000s)**                                | ** ** | ** ** | ** ** |
| Revenues:                |       |                                                |       |                                              |       |   |   |   |   |
| United States and Canada |       | $                                                   | 202,321    |                                              | $          | 134,057 |   | $ | 364,689 |   | $ | 270,473 |   |
| Europe                   |       | 9,457                                               |       | 8,421                                             |       | 19,749 |   | 14,998 |   |
| Other foreign            |       | 18,874                                              |       | 8,468                                             |       | 35,244 |   | 19,240 |   |
| Total revenues           |       | $                                                   | 230,652    |                                              | $          | 150,946 |   | $ | 419,682 |   | $ | 304,711 |   |
|                     |       |                                                |       |                                              |       |   |   |   |   |
| Operating income:        |       |                                                |       |                                              |       |   |   |   |   |
| United States and Canada |       | $                                                   | 43,643     |                                              | $          | 4,707 |   | $ | 77,951 |   | $ | 10,148 |   |
| Europe                   |       | 2,678                                               |       | 2,436                                             |       | 6,621 |   | 3,486 |   |
| Other foreign            |       | 481                                                 |       | (1,421                                            | )          | 3,392 |   | 375 |   |
| Total operating income   |       | $                                                   | 46,802     |                                              | $          | 5,722 |   | $ | 87,964 |   | $ | 14,009 |   |

 

**9.             INCOME TAXES**

 

On July 1,2007, the Companyadopted FIN 48, *Accounting for Uncertaintyin Income Taxes, an Interpretation of FASB Statement No. 109*,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. FIN 48 also providesguidance on derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition.

 

Asa result of the adoption of FIN 48, the Company recorded $22.9 million ofliabilities for unrecognized tax benefits of which $8.8 million were accountedfor as an increase in accumulated deficit on July 1, 2007.  Of this amount, $14.9 million, if recognized,would impact the effective tax rate.  TheCompany recognizes interest and penalties related to unrecognized tax benefitsas tax expense.  As of July 1, 2007,the Company had $1.2 and $0.4 million accrued for the payment of interest andpenalties, respectively. At December 31, 2007, there were no material changesto the amounts recognized upon adoption.

 

The Company files numerousconsolidated and separate income tax returns in the United States federaljurisdiction and in many state and foreign jurisdictions.  With few exceptions, the Company is no longersubject to United States federal income tax examinations for years before 1995and is no longer subject to state and local, or foreign income tax examinationsfor years before 2000.

 

The Internal Revenue Service (“IRS”) commencedexamination of the Company’s United States federal income tax returns for 2003,2004 and 2005 in the fourth quarter of 2006.  To date, the IRS hasproposed, and management has agreed to certain adjustments related to thereturns that have been recorded in the income tax provision.  During 2006,the German tax authorities commenced audits of certain German income taxreturns for years ranging from 2000 through 2003.It is unlikely that theexaminations will be completed in the next twelve months.

 

The Company does notanticipate that total unrecognized tax benefits will significantly change dueto the settlement of audits and the expiration of statute of limitations priorto December 31, 2008.

 

17

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**10.          COMMITMENTS AND CONTINGENCIES**

 

InFebruary 2005, the SEC initiated an informal inquiry and requesteddocuments and information regarding a class action suit which allegedviolations of the Securities Exchange Act of 1934, as amended, stemming fromrevised earnings guidance, declines in the price of the Company’s common stockand sales of stock by insiders and other matters.  In August 2005, the SEC notified theCompany that its investigation had entered a formal phase, and requestedadditional information from the Company covering the same general areas thatwere addressed in the informal inquiry. Management is cooperating fully withthe SEC in this matter.

 

InAugust 2004, Shuffle Master sued the Company in the United States DistrictCourt for the District of Nevada, alleging infringement of various patents inconnection with the Company’s MindPlay product line and seeking injunctiverelief and damages in an unspecified amount. In June 2005, it was announced that IGT had acquired an interest inthe patents at issue in the case, and thereafter, IGT joined the case as aplaintiff. In December 2005, the District Court issued a rulingconstruing the claim terms of all the patents in the suit.  A hearing onthe parties’dispositive motions is set for February 2008.Management believes the plaintiffs’ lawsuit to be without merit, and theCompany is vigorously defending against the lawsuit.

 

OnDecember 7, 2004, IGT filed a patent infringement lawsuit against theCompany in the United States District Court for the District of Nevada.  The complaint asserts that the Company’swheel-based games, such as Monte CarloTM,Lucky WheelTM andCash For LifeTM,its games with a reel in the top box, such as Bonus FrenzyTM,and its iVIEWTMproducts infringe on patents held by IGT, and seeks injunctive relief and damagesin unspecified amounts.  The Company believes IGT’s claims are withoutmerit and is vigorously defending itself against the lawsuit.  As part of its defense, the Company hasasserted counterclaims against IGT, including claims that IGT’s patents areinvalid, unenforceable and not infringed, as well as several claims thatIGT has engaged in anti-competitive conduct in violation of state and federalantitrust laws.  By its counterclaims,the Company is seeking damages and other relief from IGT.  IGT’s motion to dismiss the Company’s antitrustclaims was denied in January 2006, and in March 2007, the courtdenied IGT’s motions for summary judgment with respect to the antitrust claimsdealing with the wheel game market.  Thecourt issued its claims construction rulings in May 2007.  The parties filed assorted motions forsummary judgment on November 16, 2007 and no hearing date has been set todate.  Trial is tentatively scheduled forMay 2008.

 

InSeptember 2006, the Company filed a patent infringement lawsuit againstIGT in the United States District Court for the District of Nevada.  The complaint asserts that certain of IGT’sbonus wheel games infringe a patent held by the Company, and seeks injunctiverelief and damages.  IGT filed an answergenerally denying the claims and has filed a motion for summary judgment, whichthe Company is opposing.  In December 2007,the District Court issued a ruling construing the claim terms of the patent inthe suit.  No trial date has been set.

 

InMay 2006, IGT filed a patent infringement lawsuit against the Company inthe United States District Court for the District of Delaware.  The complaint asserts that the Company’sBally Power BonusingTMproducts infringe patents held by IGT, and seeks injunctive relief and damagesin unspecified amounts.  The court tookIGT’s motion for a preliminary injunction off-calendar and set a November 2008trial date.  The Company believes IGT’sclaims are without merit and is vigorously defending itself against thelawsuit.

 

TheCompany is also a party to various lawsuits relating to routine mattersincidental to our business.  Managementdoes not believe that the outcome of such litigation, including the mattersabove, in the aggregate, will have a material adverse effect on our consolidatedfinancial position, results of operations or cash flows.

 

18

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

 

Webegin this Management’s Discussion and Analysis of Financial Condition andResults of Operations with a summary of the restatement as well as an overviewof our key operating business divisions as of December 31, 2007.  This overview is followed by a detailedanalysis of our results of operations and our financial condition as of, andfor, the three and six months ended December 31, 2007 and 2006.  Thefinancial information set forth in the following Management’s Discussion andAnalysis gives effect to the restatement as discussed in Note 2 to the unauditedcondensed consolidated financial statements, Restatement of Previously IssuedFinancial Statements.

 

**Forward Looking Statements**

 

Certainstatements made or incorporated by reference in this Quarterly Report on Form 10-Q,in our other filings with the SEC, in our press releases and in statements madeby or with the approval of authorized personnel constitute “forward lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”) and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), and are subject to thesafe harbor created thereby.  Forwardlooking statements reflect intent, belief or current expectations with respectto, among other things, future events and financial trends affecting us.Forward looking statements are typically identified by words such as “believes,”“expects,” “anticipates” and similar expressions.

 

Althoughwe believe the expectations reflected in any forward looking statements arereasonable, readers are cautioned that forward looking statements involve knownand unknown risks and uncertainties, are not guarantees of future performanceand that actual results, performance or achievements may differ materiallyfrom any future results, performance or achievements expressed or implied bysuch forward looking statements.  Thesedifferences can arise as a result of the risks described in Item 1A, RiskFactors included in our 2007 10-K, as well as other factors such as the impactof competition, our ability to service debt, product development, foreignoperations, dependence on key personnel, the ability to integrate futureacquisitions, regulation by gaming authorities, the outcome of pendinglitigation matters, gaming taxes, market risks and the potential adverseeffects to our financial condition, results of operations or prospects.

 

Forwardlooking statements in this Quarterly Report on Form 10-Q speak only as ofthe date hereof, and forward looking statements in documents incorporated byreference speak only as of the date of those documents.  Unless otherwise required by law, weundertake no obligation to publicly update or revise these forward lookingstatements, whether as a result of new information, future events orotherwise.  In light of these risks anduncertainties, we cannot assure you that the forward looking statementscontained in this Quarterly Report on Form 10-Q will, in fact, transpire.

 

**Restatement**

 

Subsequentto the issuance of our consolidated financial statements for the year ended June 30,2006 and in connection with the year-end closing process for fiscal 2007, wedetermined that certain adjustments were required to be made for corrections oferrors in our previously issued consolidated financial statements for thethree-month and six-month periods ended December 31, 2006, amongothers.  These errors related to:

 

·                                          Certainexpenses that had been reported in prior periods as selling, general andadministrative expenses, depreciation and amortization expense and otherexpenses which should have been recorded either as cost of sales or ascontra-revenue;

 

·                                          Additions toleased gaming equipment previously reported as cash used in investingactivities in our unaudited condensed consolidated statements of cash flows forall periods prior to March 31, 2007 should have been presented as a changein inventory under cash used in operating activities; and

 

·                                          Certain salessourced from the United States directly to foreign customers were included inrevenue and operating income attributable to the United States and Canadageographic region and should have been classified as Europe or Other Foreignbased on the location of the customer. Specifically, revenue of $7.2 millionand $16.0 million and operating income of $0.5 million and $3.1 million for thethree-month and six-month periods ended December 31, 2006, respectively,should not have been classified as being attributable to the United States andCanada geographic region.  See Note 8 tothe unaudited condensed consolidated financial statements, Segments andGeographic Information.

 

19

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As a result of these andother immaterial errors, our unaudited condensed consolidated statements ofoperations for the three-month and six-month periods ended December 31,2006 and statement of cash flows for the six-month period ended December 31,2006, among other periods, have been restated from the amounts previouslyreported.  The restatement had no effecton the unaudited condensed consolidated balance sheets or reported net loss forany period.  See Note 2 to the unauditedcondensed consolidated financial statements, Restatement of Previously IssuedFinancial Statements.

 

The financial information set forth in thefollowing Management’s Discussion and Analysis gives effect to the restatement.The following is a summary of the effects of the restatement on theaccompanying unaudited condensed consolidated financial statements:

 
| ** **                                     | ** ** | **Three Months Ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                     | ** ** | **As  previously  reported**                                  | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
| ** **                                     | ** ** | ** **                                                    | ** ** | **(in 000s)** | ** ** | ** ** | ** ** |
| *Statement of Operations*                      | * *   | * *                                                      | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                       |       |                                                          |       |   |   |   |   |   |   |
| Gaming equipment and systems                   |       | $                                                             | 140,533    |   | $ | (40,420 | ) | $ | (825 | ) | $ | 99,288 |   |
| Gaming operations                              |       | —                                                        |       | 40,420 |   | — |   | 40,420 |   |
| Casino operations                              |       | 11,238                                                        |       | — |   | — |   | 11,238 |   |
| Total revenue                                  |       | 151,771                                                       |       | — |   | (825 | ) | 150,946 |   |
|                                           |       |                                                          |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems (2)       |       | 70,653                                                        |       | (17,124 | ) | 874 |   | 54,403 |   |
| Cost of gaming operations                      |       | —                                                        |       | 17,124 |   | — |   | 17,124 |   |
| Direct cost of casino operations               |       | 4,439                                                         |       | — |   | — |   | 4,439 |   |
| Selling, general and administrative expense    |       | 51,622                                                        |       | — |   | (1,195 | ) | 50,427 |   |
| Depreciation and amortization                  |       | 5,903                                                         |       | — |   | (379 | ) | 5,524 |   |
| Operating income                               |       | 5,847                                                         |       | — |   | (125 | ) | 5,722 |   |
| Other income, net                              |       | 675                                                           |       | — |   | 125 |   | 800 |   |
| Loss before income taxes and minority interest |       | (3,265                                                        | )          | — |   | — |   | (3,265 | ) |
|                                                |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                     | ** ** | **Six Months Ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                     | ** ** | **As  previously  reported**                                | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
| ** **                                     | ** ** | ** **                                                  | ** ** | **(in 000s)** | ** ** | ** ** | ** ** |
| *Statement of Operations*                      | * *   | * *                                                    | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                       |       |                                                        |       |   |   |   |   |   |   |
| Gaming equipment and systems                   |       | $                                                           | 282,496    |   | $ | (81,039 | ) | $ | (862 | ) | $ | 200,595 |   |
| Gaming operations                              |       | —                                                      |       | 81,039 |   | — |   | 81,039 |   |
| Casino operations                              |       | 23,077                                                      |       | — |   | — |   | 23,077 |   |
| Total revenue                                  |       | 305,573                                                     |       | — |   | (862 | ) | 304,711 |   |
|                                           |       |                                                        |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems (2)       |       | 143,540                                                     |       | (34,666 | ) | 1,676 |   | 110,550 |   |
| Cost of gaming operations                      |       | —                                                      |       | 34,666 |   | — |   | 34,666 |   |
| Direct cost of casino operations               |       | 8,901                                                       |       | — |   | — |   | 8,901 |   |
| Selling, general and administrative expense    |       | 101,666                                                     |       | — |   | (1,819 | ) | 99,847 |   |
| Depreciation and amortization                  |       | 11,336                                                      |       | — |   | (461 | ) | 10,875 |   |
| Operating income                               |       | 14,267                                                      |       | — |   | (258 | ) | 14,009 |   |
| Other income, net                              |       | 925                                                         |       | — |   | 258 |   | 1,183 |   |
| Loss before income taxes and minority interest |       | (1,605                                                      | )          | — |   | — |   | (1,605 | ) |
|                                                |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |

 

20

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----

(1) SeeNote 1 to the unaudited condensed consolidated financial statements, Basis ofPresentation-Reclassifications.

(2) Cost of gamingequipment and systems excludes amortization related to certain intangibles,including core technology and license rights, which are included indepreciation and amortization.

 
| ** **                                                                                      | ** ** | **Six Months Ended  December 31, 2006** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **As previously  reported**                                 | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                                                                      | ** ** | **(in 000s)**                                          | ** ** |
| *Statement of Cash Flows*                                                                       | * *   | * *                                                    | * *   | * * | * * | * * | * * |
| Other adjustments to reconcile net loss to net cash provided by (used  in) operating activities |       | $                                                           | 9,523      |   | $ | (6,386 | ) | $ | 3,137 |   |
| Change in inventories                                                                           |       | (10,719                                                     | )          | (38,324 | ) | (49,043 | ) |
| Net cash provided by (used in) operating activities                                             |       | 32,269                                                      |       | (44,710 | ) | (12,441 | ) |
|                                                                                            |       |                                                        |       |   |   |   |   |
| Capital expenditures                                                                            |       | (8,778                                                      | )          | (2,776 | ) | (11,554 | ) |
| Additions to leased gaming equipment                                                            |       | (47,486                                                     | )          | 47,486 |   | — |   |
| Net cash used in investing activities                                                           |       | (58,653                                                     | )          | 44,710 |   | (13,943 | ) |
|                                                                                                 |            |                                                             |            |  |  |  |  |  |  |  |

 

**Our Business**

 

Weare a diversified, worldwide gaming company that designs, manufactures,distributes and operates gaming machines and computerized monitoring systemsfor gaming machines.  In addition toselling our gaming devices, we also offer our customers a wide range of leaseand rental options.  Our primarytechnologies include gaming devices for land based, riverboat and NativeAmerican casinos, video lottery and central determination markets andspecialized system-based hardware and software products.  Our specialized hardware and software productsprovide casinos with a wide-range of marketing, data management, accounting,security and other software applications and tools to more effectively managetheir operations.  We also own andoperate a riverboat, dockside casino in Vicksburg, Mississippi.

 

We derive our revenues from the following foursources:

 
| · | *Gaming Equipment*  | - | Sale of gaming devices;                                                                                                    |
|--------|---------------------|---|----------------------------------------------------------------------------------------------------------------------------|
| · | *Gaming Operations* | - | Operation of wide-area progressive, lottery  and centrally determined systems and the lease and rental of gaming machines; |
| · | *Systems*           | - | Sales of computerized monitoring systems and  related recurring hardware and software maintenance revenue; and             |
| · | *Casino Operations* | - | Operation of the Rainbow Casino.                                                                                           |

 

We design, manufacture, assemble,sell, maintain and operate a full range of technology-based gaming devices.Thesedevices are not mass produced and are normally configured to specificrequirements based on a customer’s particular order.  Gaming devices are differentiated from oneanother by a number of factors including, but not limited to, graphic designand theme, cabinet style, pay table, game layout, betting denomination andminimum/maximum betting amount.

 

Each gaming device contains anoperating system referred to as a game platform.  The operating system manages the softwareneeded to run the device.  Game platformsand the related computer systems are constantly updated and revised to keeppace with the ever-increasing complexity of modern game play requirements.  The change in game play requirements isdriven by, among other things, changes in consumer demand, capacity, securityand regulation.  In fiscal 2005, wecompleted the successful migration from our legacy platforms, including theV7000 and EVOTM, to the Linux-based ALPHA OSTM platform.  In fiscal 2006, we also extended the ALPHA OSplatform to our mechanical reel spinning devices. ALPHA OS is now theplatform for each of our gaming device product offerings and, as a result,marketing of our legacy products has generally been discontinued.

 

21

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The ALPHA OS is designed toseparate the gaming operating system from the game layer, which enables gamedevelopment in a much shorter time.  ALPHAOS is also designed to incorporate bonusing, free spin, scatter and otheradvanced game features, while providing internal and third-party developerswith a secure, easy-to-use programming environment that incorporates anadvanced set of development tools. Moreover, ALPHA OS is designed to support server-based gaminginitiatives, including download of game results, configuration and gamecontent.  Additionally, our layered architectureand modular design allow for adaptability and simplified requirementchanges.  The operating system, which isLinux-based, is compatible with the most common accounting, ticketing andbonusing systems and supports 50-plus bet lines, various game bonusing, topboxes, multi-denomination, multi-game and multi-pay table gameconfigurations.  ALPHA OS also supportsstand alone, local and wide-area progressive products.

 

Inaddition to selling our gaming devices, we also offer our customers a widerange of lease and rental options through our Gaming Operations division.  Specifically, these arrangements areavailable under four business models: linked progressive systems, rental anddaily fee games, lottery systems and centrally determined systems.  In most cases, operating gaming devices undera lease or rental arrangement requires us to invest capital in manufacturingthe gaming device and related equipment, purchasing signs and seating, and, incertain cases, acquiring certain intellectual property rights.

 

Wealso design, program, test, market and support casino enterprise systems for awide range of customers of varying size and complexity through our Systemsdivision.  These systems typicallyprovide casino operators features such as active, real-time monitoring toolsfor gaming devices, tools to collect and manage customer data, security toprotect against theft and data loss, and marketing programs to enhance thegaming experience.  The use of systemtechnology in gaming has grown in the past ten years from basic automation ofmanual activities to highly integrated mission critical applications.  We believe we are the only provider in theindustry that offers a selection of technology platform options to itscustomers.  Our products operate onplatforms such as Windows, AS/400 (iSeries) and UNIX which allow our customersto choose a technology solution that meets their existing or futureinfrastructure requirements.

 

Theprimary systems we sell our customers are products for slot floor management,casino management, cashless systems and iVIEWTM gaming machine displays.  iVIEW is a small, horizontal liquid-crystaldisplay screen and accompanying hardware and software that resides in thegaming devices and serves as a communication tool to players sitting at themachine.  iVIEW is also designed to workwith our Bally Power BonusingTM suite of products and other newtechnologies under development.  Wemarket our system product solutions under the broad categories of Bally CMS®(Casino Management Systems), Bally SMS® (Slot Management Systems) and BallyTMS® (Table Management Systems).

 

We spent approximately 7% ofrevenue generated from our Bally Gaming Equipment and Systems segment for boththe three months and six months ended December 31, 2007 on research anddevelopment to accelerate the use of technology in our gaming products.

 

Our Rainbow Casinois one of four casinos currently operating in the Vicksburg, Mississippi marketand comprises our Casino Operations division. Thefacility includes a 33,000-square foot casino with 835 gaming devices and 10table games, a 224-seat buffet-style restaurant and a 20,000-square footconference center.  The Casino alsoincludes the 89-room Rainbow Hotel, which is owned and operated by a thirdparty. Rainbow is marketed as a “locals” casino and draws mid-level gamingcustomers principally from within a 75-mile radius of Vicksburg.  Our promotions are focused primarily ondirect mail and special promotional events. A new casino project adjacent to the Rainbow Casino is underconstruction and is scheduled to open in November 2008.  There may be other new casinosconstructed in the Vicksburg market in the future as previously existing andnew Gulf Coast properties continue to open in the aftermath of the 2005hurricane season.  These properties willprovide additional competition to our business.

 

**Resultsof Operations**

 

Ourresults of operations include the accounts of Bally Technologies, Inc. andits subsidiaries.  We report our revenueand income in two reportable segments: the Bally Gaming Equipment and Systemssegment, which includes our Gaming Equipment, Systems and Gaming Operationsdivisions, and our Casino Operations segment. Revenue from our Bally Gaming Equipment and Systems segment representedapproximately 95% and 93% of our total revenues for the three months ended December 31,2007 and 2006, respectively, and 94% and 92% of our total revenues for the sixmonths ended December 31, 2007 and 2006, respectively.

 

22

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***Bally Gaming Equipment and Systems***

 

The summary financialresults and operating statistics for our Bally Gaming Equipment and Systemssegment for the three months and six months ended December 31, 2007 and2006 were as follows:

 
| ** **                          | ** ** | **Three Months Ended December 31,** | ** ** | **Six Months Ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                                | ** ** | **% Rev**                                        | ** ** | **2006** | ** ** | **% Rev** | ** ** | **2007** | ** ** | **% Rev** | ** ** | **2006** | ** ** | **% Rev** | ** ** |
| ** **                          | ** ** | **(dollars in millions)**                     | ** ** |
| Revenues:                           |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                    |       | $                                                       | 108.4      |                                                  | 49         | % | $ | 70.4 |   | 50 | % | $ | 192.7 |   | 49 | % | $ | 132.7 |   | 47 | % |
| Gaming Operations                   |       | 54.2                                                    |       | 25                                                    | %          | 40.4 |   | 29 | % | 108.3 |   | 27 | % | 81.0 |   | 29 | % |
| Systems                             |       | 56.3                                                    |       | 26                                                    | %          | 28.9 |   | 21 | % | 95.5 |   | 24 | % | 67.9 |   | 24 | % |
| Total revenues                      |       | $                                                       | 218.9      |                                                  | 100        | % | $ | 139.7 |   | 100 | % | $ | 396.5 |   | 100 | % | $ | 281.6 |   | 100 | % |
|                                |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross Margin:                       |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment (1)                |       | $                                                       | 47.7       |                                                  | 44         | % | $ | 24.1 |   | 34 | % | $ | 86.6 |   | 45 | % | $ | 44.1 |   | 33 | % |
| Gaming Operations                   |       | 31.4                                                    |       | 58                                                    | %          | 23.3 |   | 58 | % | 67.4 |   | 62 | % | 46.4 |   | 57 | % |
| Systems (1)                         |       | 40.9                                                    |       | 73                                                    | %          | 20.8 |   | 72 | % | 70.9 |   | 74 | % | 45.9 |   | 68 | % |
| Total gross margin                  |       | $                                                       | 120.0      |                                                  | 55         | % | $ | 68.2 |   | 49 | % | $ | 224.9 |   | 57 | % | $ | 136.4 |   | 48 | % |
|                                |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative |       | $                                                       | 50.6       |                                                  | 23         | % | $ | 41.6 |   | 30 | % | $ | 91.6 |   | 23 | % | $ | 82.1 |   | 29 | % |
| Research and development costs      |       | 14.7                                                    |       | 7                                                     | %          | 13.3 |   | 10 | % | 28.0 |   | 7 | % | 25.9 |   | 9 | % |
| Depreciation and amortization       |       | 3.5                                                     |       | 2                                                     | %          | 4.4 |   | 3 | % | 7.4 |   | 2 | % | 8.6 |   | 3 | % |
| Operating income                    |       | $                                                       | 51.2       |                                                  | 23         | % | $ | 8.9 |   | 6 | % | $ | 97.9 |   | 25 | % | $ | 19.8 |   | 7 | % |

 

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(1)        Gross Margin from GamingEquipment and Systems excludes amortization related to certain intangiblesincluding core technology and license rights, which are included indepreciation and amortization.

 
| ** **                                                   | ** ** | **Three  Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                   | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Operating Statistics                                         |       |                                       |       |                                              |       |   |   |   |   |
| New gaming devices sold                                      |       | 7,144                                      |       | 4,672                                             |       | 12,295 |   | 8,099 |   |
| Original Equipment Manufacturer (“OEM”) units sold |       | —                                     |       | 460                                               |       | — |   | 1,605 |   |
| New unit Average Selling Price (“ASP”)             |       | $                                          | 13,147     |                                              | $          | 12,620 |   | $ | 13,201 |   | $ | 12,363 |   |
|                                                              |            |                                            |            |                                                   |            |  |  |  |  |  |  |  |  |

 
|                                     |   |   |   |   |   | **As of  December 31,** |   |
|------------------------------------------|--------|--------|--------|--------|--------|------------------------------|--------|
|                                     |   |   |   |   |   | **2007**                     |   | **2006** |   |
| Gaming monitoring units installed base   |   |   |   |   |   | 305,000                      |   | 287,000 |   |
| Casino management systems installed base |   |   |   |   |   | 570                          |   | 563 |   |
| Systems managed cashless games           |   |   |   |   |   | 270,000                      |   | 231,000 |   |
|                                     |   |   |   |   |   |                         |   |   |   |
| End of period installed base:            |   |   |   |   |   |                         |   |   |   |
| Wide-area progressive                    |   |   |   |   |   | 973                          |   | 935 |   |
| Local-area progressive                   |   |   |   |   |   | 352                          |   | 544 |   |
| Total linked progressive systems         |   |   |   |   |   | 1,325                        |   | 1,479 |   |
|                                     |   |   |   |   |   |                         |   |   |   |
| Rental and daily-fee games (1)           |   |   |   |   |   | 9,290                        |   | 4,893 |   |
| Lottery systems                          |   |   |   |   |   | 7,851                        |   | 7,164 |   |
| Centrally determined systems (2)         |   |   |   |   |   | 42,773                       |   | 30,987 |   |

 

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(1)        Certain devices previously included in centrallydetermined systems that were converted to standalone devices have beenreclassified to rental and daily-fee games.

(2)   Daily fee  revenue fromapproximately 7,400 units included in the centrally determined systems end ofperiod installed base total as of December 31, 2007 are currently being deferredbased upon the completion of certain contractual commitments necessary torecognize the revenue under the Company’s revenue recognition policy.  There were no similar deferrals as of December 31,2006.

 

23

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**Three Months Ended December 31, 2007 Compared to Three MonthsEnded December 31, 2006**

 

Totalrevenues for our Bally Gaming Equipment and Systems segment increased $79.2million, or 57%, in the three months ended December 31, 2007, whencompared to the same period last year, as a result of the following:

 

*Revenues and Gross Margin:*

 

*     GamingEquipment. *GamingEquipment revenue increased by $38.0 million, or 54%, to approximately $108.4million primarily as a result of:

 

·                  A 53% increase in new gaming device sales to7,144 units in the three months ended December 31, 2007, when compared to4,672 units in the same period last year. The three months ended December 31,2006 included 460 lower margin units which were sold to OEMs.

 

·                  A 4% increase in the ASP of new gamingdevices, excluding OEM sales, as a result of product mix and the effect offoreign currency exchange rates on international pricing.

 

*     Gaming Equipment GrossMargin*.  Gaming Equipment gross marginincreased to 44% in the three months ended December 31,2007 from 34%, inthe same period last year, primarily as a result of the elimination of lowermargin OEM sales and the increase in ASP, discussed above, and improvedpurchasing and manufacturing efficiencies due to increased volumes and lowermanufacturing costs.

 

*     GamingOperations. *GamingOperations revenue increased $13.8 million, or 34%, to approximately $54.2million in the three months ended December 31, 2007, when compared to thesame period last year, primarily as a result of:

 

·                  An increase of $13.4 million, or 39%, inparticipation, rental and license revenue in the three months ended December 31,2007, when compared to the same period last year, primarily derived from:

 

·                  Our installed base of centrally determinedgames increased 38% from 30,987 units as of December 31, 2006 to 42,773units as of December 31, 2007 primarily due to games added in Washington,Florida and Mexico.  Excluding gameswhere revenue is currently being deferred, centrally determined games increasedapproximately 14% as of December 31, 2007 when compared to the same periodlast year;

 

·                  Our installed base of rental and daily feegames, which includes premium titles such as Hot Shot ProgressiveTM, increased 90% from 4,893 units as of December 31,2006 to 9,290 units as of December 31, 2007.  The net change was primarily due to thepopularity of our premium products; and

 

·                  Our installed base of lottery units increased10% from 7,164 units as of December 31, 2006 to 7,851 units as of December 31,2007.  The increase was primarily due toadditions of units deployed by the New York Lottery.

 

*Gaming Operations Gross Margin*. Gross margin remainedconsistent at 58% in both the three months ended December 31, 2007 and inthe same period last year.

 

24

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Revenue and gross margin from Gaming Operations infiscal 2007 include daily fees that relate to certain contracts which are currentlybeing deferred due to new contractual commitments made to the customers.  The margin on the deferred daily fees arehigher than average as they are generated from transactions which require a relativelylow depreciable infrastructure. Approximately $4.4 million in daily fees generated during the secondquarter of fiscal 2008 was deferred pending delivery of the commitments.  Deferral of the daily fees associated withthe contracts will continue until the commitments have been delivered.

 

*     Systems: *Systems revenue increased$27.4 million, or 95%, to $56.3 million in the three months ended December 31,2007 when compared to the same period last year primarily as a result ofcontinued acceptance of the Company’s products and an increase in the number ofgo-lives. Systems maintenance revenue was $9.9 million, representing anincrease of $1.6 million, or 19%, in the three months ended December 31,2007 when compared to $8.3 million in the same period last year.

 

*     Systems Gross Margin.*Systems grossmargin increased slightly to 73% in the three months ended December 31,2007 from 72% in the same period last year.

 

*Selling, General and Administrative*.   Selling, general and administrative expenseincreased $9.0 million, or 22%, in the three months ended December 31,2007, when compared to same period last year. Salaries and related expenses increased $5.0 million, or 16%, in thethree months ended December 31, 2007, when compared to the same periodlast year due primarily to increases in staffing to meet growing demands of thebusiness brought about by an increase in revenue. 

 

*Research and Development Costs*.  Research and development costs increased 10%in the three months ended December 31, 2007, when compared to the sameperiod last year, as a result of our focus on technology assets and thecompetitive landscape that requires a continual investment in futuregenerations of gaming products and systems.

 

*Depreciation and Amortization*.  Depreciation and amortization expensedecreased 19% in the three months ended December 31, 2007, when comparedto same period last year, primarily as a result of the disposal of certain intangibleassets in late fiscal 2007.

 

**Six Months Ended December 31, 2007 Compared to Six Months Ended December 31,2006**

 

Totalrevenues for our Bally Gaming Equipment and Systems segment increased $114.9million, or 41%, in the six months ended December 31, 2007, when comparedto the same period last year, as a result of the following:

 

*Revenues and Gross Margin:*

 

*     GamingEquipment. *GamingEquipment revenue increased by $60.0 million, or 45%, to approximately $192.7million primarily as a result of:

 

·              A 52% increase in new gaming device sales to 12,295units in the six months ended December 31, 2007, when compared to 8,099units in the same period last year. The six months ended December 31, 2006included 1,605 lower margin units which were sold to OEMs.

 

·              A 7% increase in the ASP of new gaming devices,excluding OEM sales, as a result of incentive pricing and discounts offered toour customers related to the roll-out of our Alpha OS platform products in theprior year.  In addition, ASP increaseddue to product mix and the effect of foreign currency exchange rates oninternational pricing.

 

*Gaming Equipment Gross Margin*.  Gaming Equipment gross margin increased to45% in the six months ended December 31, 2007 from 33%, in the same periodlast year, primarily as a result of the decrease in lower margin OEM sales andthe increase in ASP, discussed above, and:

 

25

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·                  A $3.5 million increase in revenues from thesale of conversion kits, which have higher margins, in the six months ended December 31,2007 when compared to the same period last year; and

 

·                  Improved purchasing and manufacturingefficiencies due to increased volumes and lower manufacturing costs.

 

*     GamingOperations.*Gaming Operations revenue increased $27.3 million,or 34%, to approximately $108.3 million in the six months ended December 31,2007, when compared to the same period last year, primarily as a result of:

 

·                  An increase of $27.2 million, or 40%, inparticipation, rental and license revenue in the six months ended December 31,2007, when compared to the same period last year, primarily derived from:

 

·                  Our installed base of centrally determinedgames increased 38% from 30,987 units as of December 31, 2006 to 42,773units as of December 31, 2007 primarily due to games added in Washington,Florida and Mexico.  Excluding gameswhere revenue is currently being deferred, centrally determined games increasedapproximately 14% as of December 31, 2007 when compared to the same periodlast year;

 

·                  Our installed base of rental and daily feegames, which includes premium titles such as Hot Shot ProgressiveTM, increased 90% from 4,893 units as of December 31,2006 to 9,290 units as of December 31, 2007.  The net change was primarily due to thepopularity of our premium products; and

 

·                  Our installed base of lottery units increased10% from 7,164 units as of December 31, 2006 to 7,851 units as of December 31,2007.  The increase was primarily due toadditions of units deployed by the New York Lottery.

 

*Gaming Operations Gross Margin*. Gross margin increased to62% in the six months ended December 31, 2007 from 57%, in the same periodlast year, primarily as a result of the increase in higher margin participationand rental revenue due to the popularity of our premium products discussed aboveoffset by the deferral of certain higher margin daily fees discussed below.

 

Revenue and gross margin from Gaming Operations infiscal 2007 include daily fees that relate to certain contracts which are currentlybeing deferred due to new contractual commitments made to customers.  Approximately $7.6 million in daily feesgenerated during the six months ended December 31, 2007 were deferred pendingdelivery of the commitments.  Deferral ofthe daily fees associated with the contracts will continue until thecommitments have been delivered.

 

*     Systems: *Systems revenue increased$27.6 million, or 41%, to approximately $95.5 million in the six months ended December 31,2007 when compared to the same period last year primarily as a result ofcontinued acceptance of the Company’s products and an increase in the number ofgo-lives, principally in the second quarter of fiscal 2008. Systems maintenancerevenue was $19.3 million, representing an increase of $3.4 million, or 21%, inthe six months ended December 31, 2007 when compared to $15.9 million inthe same period last year.

 

*     Systems Gross Margin.*Systems grossmargin increased to 74% in the six months ended December 31, 2007 from68%, in the same period last year, primarily as a result of an increase in theproportion of software and maintenance revenue as compared to hardwaresales.  Hardware sales have lower grossmargins compared with software and maintenance revenue.

 

*Selling, General and Administrative*.   Selling, general and administrative expenseincreased $9.5 million, or 12%, in the six months ended December 31, 2007,when compared to same period last year. Salaries and related expenses increased $8.0 million, or 13%, in the sixmonths ended December 31, 2007, when compared to the same period last yeardue primarily to increases in staffing to meet growing demands of the businessbrought about by an increase in revenue.

 

26

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*Research and Development Costs*.  Research and development costs increased 8%in the six months ended December 31, 2007, when compared to the sameperiod last year, as a result of our focus on technology assets and thecompetitive landscape that requires a continual investment in futuregenerations of gaming products and systems.

 

*Depreciation and Amortization*.Depreciation and amortization expense decreased 14% in the six months ended December 31,2007, when compared to same period last year, primarily as a result of thedisposal of certain intangible assets in late fiscal 2007.

 

***Casino Operations***

 

The summaryof our financial results and operating statistics for our Casino Operations isas follows:

 
| ** **                          | ** ** | **Three  Months Ended December 31,** | ** ** | **Six Months Ended December 31,** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                  | ** ** | **% Rev**                                        | ** ** | **2006** | ** ** | **% Rev** | ** ** | **2007** | ** ** | **% Rev** | ** ** | **2006** | ** ** | **% Rev** | ** ** |
| ** **                          | ** ** | **(dollars in millions)**       | ** ** |
| Revenue                             |       | $                                         | 11.8       |                                                  | 100        | % | $ | 11.2 |   | 100 | % | $ | 23.2 |   | 100 | % | $ | 23.1 |   | 100 | % |
|                                |       |                                      |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative |       | $                                         | 2.2        |                                                  | 18         | % | $ | 2.1 |   | 19 | % | $ | 4.4 |   | 19 | % | $ | 4.6 |   | 20 | % |
| Depreciation and amortization       |       | $                                         | 0.6        |                                                  | 6          | % | $ | 0.8 |   | 7 | % | $ | 1.3 |   | 6 | % | $ | 1.6 |   | 7 | % |
| Operating income                    |       | $                                         | 4.2        |                                                  | 36         | % | $ | 3.9 |   | 35 | % | $ | 8.0 |   | 35 | % | $ | 8.0 |   | 35 | % |
|                                |       |                                      |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating statistics:               |       |                                      |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Average number of gaming devices    |       | 835                                       |       |                                                  |       | 852 |   |   |   | 834 |   |   |   | 893 |   |   |   |
| Average number of table games       |       | 10                                        |       |                                                  |       | 11 |   |   |   | 10 |   |   |   | 11 |   |   |   |

 

**Three Months Ended December 31, 2007Compared to Three Months Ended December 31, 2006**

 

*Casino Operations**. ***CasinoOperations revenue increased 4% for the three months ended December 31,2007 when compared to the same period last year.  Revenue increased due to the removal ofcertain low-revenue producing gaming devices which decreased certain rentalexpenses and increased average win per day per gaming device.  The average number of gaming devices, or slotmachines, decreased by 17 units, or 2%, to 835 units during the three monthsended December 31, 2007 when compared to the same period last year.  The addition of another ramp for an entranceto the new buffet restaurant, which opened in June 2007, resulted inrelocating the pit and reducing it by one table game and removing certaingaming devices from the floor.

 

*Selling, General and Administrative*.  Selling, general and administrative expensesincreased by 3% for the three months ended December 31, 2007, whencompared to the same period last year, primarily as a result of an increase inpromotional offerings to advertise the new buffet restaurant.

 

*Depreciation and Amortization*.  Depreciation and amortization expensedecreased 12% for the three months ended December 31, 2007, when comparedto the same period last year, as a result of the decrease in the number of slotmachines and reduced capital expenditures during the period.

 

**Six Months Ended December 31, 2007Compared to Six Months Ended December 31, 2006**

 

*Casino Operations**. ***CasinoOperations revenue increased less than 1% for the six months ended December 31,2007 when compared to the same period last year.  The average number of gaming devicesdecreased by 59 units, or 7%, to 834 units during the six months ended December 31,2007 when compared to the same period last year.  The addition of another ramp for an entranceto the new buffet restaurant, which opened in June 2007, resulted inrelocating the pit and reducing it by one table game and removing certaingaming devices from the floor.  Inaddition, the removal of certain low-revenue producing gaming devices decreasedsome rental expenses and increased average win per day per gaming device.

 

27

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*Selling, General and Administrative*.  Selling, general and administrative expensesdecreased by 6% for the six months ended December 31, 2007, when comparedto the same period last year, primarily as a result of a reduction inadvertising expenditures for billboards and the reduction of certainpromotional expenses.

 

*Depreciation and Amortization*.  Depreciation and amortization expensedecreased 15% for the six months ended December 31, 2007, when compared tothe same period last year, as a result of the decrease in the number of slotmachines and reduced capital expenditures during the period.

 

***Parent Company***

 

The summaryfinancial results of Bally Technologies, Inc., our parent entity, are setforth below. These results also include certain other income and expenses thatare otherwise not allocated to a specific business segment.

 
| ** **                    | ** ** | **Three  Months Ended December 31,** | ** ** | **Six Months Ended December 31,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                  | ** ** | **2006**                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **(dollars in millions)**       | ** ** |
| General and administrative    |       | $                                         | 8.2        |                                                  | $          | 6.8 |   | $ | 17.3 |   | $ | 13.1 |   |
| Depreciation and amortization |       | 0.4                                       |       | 0.4                                                   |       | 0.7 |   | 0.7 |   |
| Total expense                 |       | $                                         | 8.6        |                                                  | $          | 7.2 |   | $ | 18.0 |   | $ | 13.8 |   |
|                          |       |                                      |       |                                                  |       |   |   |   |   |
| Other income (expense)        |       |                                      |       |                                                  |       |   |   |   |   |
| Interest income               |       | $                                         | 1.0        |                                                  | $          | 0.4 |   | $ | 2.0 |   | $ | 1.3 |   |
| Interest expense              |       | (7.3                                      | )          | (10.2                                                 | )          | (14.5 | ) | (18.1 | ) |
| Other, net                    |       | 0.1                                       |       | 0.9                                                   |       | 1.0 |   | 1.2 |   |
| Total other expense           |       | $                                         | (6.2       | )                                                     | $          | (8.9 | ) | $ | (11.5 | ) | $ | (15.6 | ) |
|                          |       |                                      |       |                                                  |       |   |   |   |   |
| Income tax (expense) benefit  |       | $                                         | (15.2      | )                                                     | $          | 2.4 |   | $ | (28.3 | ) | $ | 1.7 |   |
| Minority interest             |       | $                                         | (1.0       | )                                                     | $          | (1.6 | ) | $ | (2.4 | ) | $ | (2.8 | ) |

 

**Three Months Ended December 31, 2007Compared to Three Months Ended December 31, 2006**

 

*General and Administrative. *General andadministrative expense increased $1.4 million, or 21%, in the three monthsended December 31, 2007, when compared to the same period last year,primarily as a result of an increase in accounting fees of $1.7 million in thethree months ended December 31, 2007, when compared to the same periodlast year, due to the timing of the filing of our 2007 10-K on November 2,2007 and our Form 10-Q for three months ended September 30, 2007  on December 21, 2007.

 

*Depreciation and amortization**. ***Therewas minimal change in depreciation and amortization expense during the threemonths ended December 31, 2007 as compared to the same period last year.

 

*Other Income (Expense).*Otherexpense decreased $2.7 million, or 32%, in the three months ended December 31,2007, when compared to the same period last year, primarily as a result of adecrease in interest expense due to lower rates and a reduction in the amountof debt outstanding.

 

*Minority Interest. *Minority interestdecreased primarily due to reduced earnings from certain variable interestentities. 

 

28

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**Six Months Ended December 31, 2007Compared to Six Months Ended December 31, 2006**

 

*General and Administrative. *General andadministrative expense increased $4.2 million, or 32%, in the six months ended December 31,2007, when compared to the same period last year, primarily as a result of:

 

·                  An increase inaccounting fees of $3.0 million in the six months ended December 31, 2007when compared to the same period last year, due to the timing of the filing ofour 2007 10-K on November 2, 2007 and our Form 10-Q for thethree months ended September 30, 2007 on December 21, 2007; and

 

·                  An increase inpayroll and related costs of $0.8 million in the six months ended December 31,2007, when compared to the same period last year, primarily due to increases inbonuses due to improvements in operating results during the current period.  In addition, there was an increase inheadcount, including additional finance resources, to address our weaknesses ininternal control over financial reporting.

 

*Depreciation and amortization**. ***Therewas minimal change in depreciation and amortization expense during the sixmonths ended December 31, 2007 as compared to the same period last year.

 

*Other Income (Expense).*Otherexpense decreased $4.1 million, or 26%, in the six months ended December 31,2007 when compared to the same period last year, primarily as a result of adecrease in interest expense due to reduced rates and a reduction in the amountof debt outstanding.

 

*Income tax expense.*  Our effective income tax rate for the sixmonths ended December 31, 2007 and 2006 was approximately 37% and 38%,respectively.  At the end of each interimperiod, we make our best estimate of the effective tax rate expected to beapplicable for the full fiscal year and the impact of discrete items, if any,and adjust the quarterly rate, as necessary. During the six months ended December 31,2007 we implemented FASB Interpretation (“FIN”) 48, *Accounting for Uncertainty in Income Taxes, anInterpretation of FASB Statement No. 109.*

 

*Minority Interest. *Minority interestdecreased primarily due to reduced earnings from certain variable interestentities.

 

**FinancialCondition**

 

Selected balance sheet accounts are as follows:

 
| ** **                              | ** ** | **December 31,  2007** | ** ** | **June 30,  2007** | ** ** | **Increase  (decrease)** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                              | ** ** | ** **                  | ** ** | **Amount**              | ** ** | **%**                    | ** ** |
| ** **                              | ** ** | **(in 000s)**          | ** ** |
| Cash and cash equivalents               |       | $                           | 48,316     |                    | $          | 40,842                   |       | $ | 7,474 |   | 18 | % |
|                                    |       |                        |       |                    |       |                     |       |   |   |
| Total long-term debt and capital leases |       | $                           | 314,482    |                    | $          | 333,854                  |       | $ | (19,372 | ) | (6 | )% |
|                                    |       |                        |       |                    |       |                     |       |   |   |
| Total current assets                    |       | $                           | 474,227    |                    | $          | 421,883                  |       | $ | 52,344 |   | 12 | % |
| Total current liabilities               |       | $                           | 268,473    |                    | $          | 256,938                  |       | $ | 11,535 |   | 4 | % |
| Net working capital                     |       | $                           | 205,754    |                    | $          | 164,945                  |       | $ | 40,809 |   | 25 | % |

 

As of December 31, 2007 and June 30, 2007,we had $48.3 million and $40.8 million, respectively, in consolidated cash andcash equivalents which included approximately $4.8 million and $3.7 million,respectively, of cash utilized in our Casino Operations segment that is held invaults, cages or change banks.  Pursuantto various state gaming regulations, certain cash accounts are maintained toensure availability of funds to pay wide-area progressive jackpot awards.  At December 31, 2007 and June 30,2007, these accounts had an aggregate value of approximately $15.6 million and$17.2 million, respectively, and are classified as restricted cash in ourunaudited condensed consolidated balance sheets.  In addition, we purchase U.S. Treasury StripSecurities for the benefit of jackpot winners who elect to receive winnings asannual or weekly installment payments rather than one lump sum.  These securities are included in restrictedlong-term investments in the accompanying unaudited condensed consolidatedbalance sheets, and totaled $10.6 million and $10.5 million as of December 31,2007 and June 30, 2007, respectively.

 

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Our net working capital increased $40.8 million forthe six months ended December 31, 2007. Key factors related to the working capital increase included a $7.5million increase in cash and cash equivalents, an $8.9 million increase ininventory, a $17.8 million increase in accounts receivable and a $13.5 millionincrease in deferred cost of revenue offset by a $15.2 million increase incurrent deferred revenue.

 

Ourdebt structure consists primarily of a term loan facility and a $75.0 millionrevolving credit facility, which is limited by a current leverage ratio, anddebt owed to related parties.  There wereno amounts outstanding under our revolving credit facility as of December 31,2007.  The revolving credit facility isfurther restricted to the extent of outstanding letters of credit.  Outstanding letters of credit at December 31,2007 were $26.3 million which reduced availability under the revolving creditfacility to approximately $48.7 million. The term loan requires principal reductions of approximately 1% perannum paid quarterly, with a balloon payment due in September 2009.  The revolving credit facility commitmentreduces annually until it expires in September 2008.

 

The bank loan agreement governing the term loan andthe revolving credit facility (the “Loan Agreement”) contains a number ofmaintenance and other significant covenants that, among other things, restrictour ability to dispose of assets, incur additional indebtedness or issue preferredstock, pay dividends or make other distributions, enter into certainacquisitions, repurchase equity interests or subordinated indebtedness, issueor sell equity interests of the our subsidiaries, engage in mergers oracquisitions or certain transactions with subsidiaries and affiliates, and thatotherwise restrict corporate activities.

 

Thefinancial covenants under the Loan Agreement consist of a leverage ratio, afixed charges coverage ratio, and a minimum of Earnings Before Interest, Taxes,Depreciation and Amortization (“EBITDA”) as that term is defined in the LoanAgreement.  The leverage ratio iscomputed as total average debt outstanding during the quarter divided by thetrailing 12 months EBITDA, excluding certain cash and non-cash charges, and isfurther adjusted to remove EBITDA from discontinued operations at the timethose operations are sold.  The Company’sleverage ratio as of December 31, 2007 was 1.53 times versus the covenantmaximum allowable of 3.50 times.

 

Management believes that cash flows from currentoperating activities will provide us with sufficient capital resources andliquidity to operate our business for at least the next 12 months. At December 31,2007, we had no material future commitments for capital expenditures.

 

***Cash Flow Summary***

 

Cash flows from operating activities are derivedprimarily from the sale of gaming equipment and systems, the operation ofwide-area progressive systems, daily fee and rental payments, and monthly cashreceipts from maintenance agreements from our casino systems customers.  In addition, we generate cash through ourcasino operations.  We utilize our cashto acquire materials for the manufacture of goods for resale or lease, to paypayroll and selling, general and administrative expenses, to fund research anddevelopment activities, as well as to service our debt.

 

Cash flows from operating activities increased $43.8million in the six months ended December 31, 2007 as compared to the sameperiod last year.  The 2008 increase incash flows provided by operating activities was primarily the result of theincrease in net income during the period as a result of the increase in revenueand the improvement in gross margin previously discussed.

 

Cash used for the purchase of inventory, which isincluded in cash flows from operating activities, was $43.2 million in the sixmonths ended December 31, 2007 as compared to $49.0 million in the sameperiod last year.  We only have oneprocess to procure raw materials for the assembly of both inventory and leasedgaming equipment.  The materialsrequisition planning process considers the number of devices we expect to buildfor sale and for use in our gaming operations division during a particularperiod, but we do not separately earmark purchases for leased gamingequipment.  Without such an earmarkingprocess, we are unable to determine whether the cash expended to constructleased gaming equipment during a particular period came from inventory on handat the beginning of the period or was constructed from inventory procuredduring the period of deployment, thus requiring the expenditure of cash.  As a result of our inability to separatelyidentify the cash flows associated with the construction of leased gamingequipment, we have included all additions to leased gaming equipment as achange in inventory under cash used in operating activities.  During the six months ended December 31,2007 we transferred $40.2 million from inventory to leased gaming equipmentcompared to $35.9 million in the same period last year.

 

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Cash flows used in investing activities totaled $13.5 million in thesix months ended December 31, 2007 as compared to $13.9 million in thesame period last year primarily as a result of:

 

·                  Capitalexpenditures of $8.4 million in the six months ended December 31, 2007 ascompared to $11.6 million in the same period last year; and

 

·                  Decreasesin restricted cash and investments of $1.6 million in the six months ended December 31,2007 as compared to an increase of $1.1 million in same period last year.

 

Cash used by financing activities totaled $11.1 million in the sixmonths ended December 31, 2007 as compared to cash provided by financingactivities of $22.4 million in same period last year as a result of:

 

·                  Principalpayments on capital leases and other long term debt of $19.4 million in the sixmonths ended December 31, 2007 as compared to $4.2 million in the sameperiod last year.  We made an unscheduled$15.0 million payment under the term loan facility during the first quarter infiscal 2008;

 

·                  Cashprovided from exercise of stock options and warrants of $11.4 million in thesix months ended December 31, 2007 as compared to $4.3 million in the sameperiod last year;

 

·                  Purchaseof treasury stock for $6.0 million in the six months ended December 31,2007 as discussed below in Item 2, Unregistred Sales of Equity Securities andUse of Proceeds;

 

·                  Excesstax benefit from the exercise of stock options of $2.8 million in the sixmonths ended December 31, 2007; and

 

·                  Cashproceeds from the sale and lease-back of certain equipment for Yonkers Racewayof $22.3 million in the six months ended December 31, 2006.

 

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**Critical Accounting Policies**

 

A description of our critical accounting policies can be found withinItem 7, Management’s Discussion and Analysis of Financial Condition and Resultsof Operations in our 2007 10-K.  Therewere no material changes to those policies during the six months ended December 31,2007.

 

***Recently Issued Accounting Pronouncements***

 

In December 2007, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(Revised 2007),*Business Combinations.*SFAS No. 141R will significantly change the accounting for businesscombinations. Under SFAS No.141R, an acquiring entity is required to recognizeall the assets acquired and liabilities assumed in a transaction at theacquisition-date fair value with limited exceptions.   SFAS No.141R also includes a substantialnumber of new disclosure requirements. SFAS No.141R applies prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008, and accordingly, we expect to adopt SFAS No. 141R beginning infiscal 2010. We expect that SFAS No. 141R will have an impact onaccounting for business combinations once adopted, but the effect is dependentupon acquisitions, if any, at that time.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements - An Amendment of ARB No. 51.* SFAS No.160establishes new accounting and reporting standards for the noncontrollinginterest in a subsidiary and for the deconsolidation of a subsidiary.Specifically, this statement requires the recognition of a noncontrollinginterest (minority interest) as equity in the consolidated financial statementsand separate from the parent’s equity. The amount of net income attributable tothe noncontrolling interest will be included in consolidated net income on theface of the income statement. SFAS No.160 clarifies that changes in a parent’sownership interest in a subsidiary that do not result in deconsolidation areequity transactions if the parent retains its controlling financial interest.In addition, this statement requires that a parent recognize a gain or loss innet income when a subsidiary is deconsolidated. Such gain or loss will bemeasured using the fair value of the noncontrolling equity investment on thedeconsolidation date. SFAS No.160 also includes expanded disclosurerequirements regarding the interests of the parent and its noncontrollinginterest.  SFAS No.160 is effective forfiscal years, and interim periods within those fiscal years, beginning on orafter December 15, 2008, and accordingly, we expect to adopt SFAS No.160beginning in fiscal 2010. We are currently in the process of evaluating theimpact SFAS No. 160 will have on our consolidated results of operations,financial position and cash flows.

 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*.SFAS No.159 provides companies with an option to report selected financialassets and liabilities at fair value. It also establishes presentation anddisclosure requirements to facilitate comparisons between companies usingdifferent measurement attributes for similar types of assets and liabilities.The statement is effective for fiscal years beginning after November 15,2007 and accordingly, we expect to adopt SFAS No. 159 beginning in fiscal2009. Earlier application is permitted provided we also apply the provisions ofSFAS 157, *Fair Value Measurements*, which isdiscussed below.  We are currently in theprocess 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 SFAS No. 157, *Fair Value Measurements*, which defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. SFAS No. 157does not require any new fair value measurements, rather it applies to existingaccounting pronouncements that require or permit fair value measurements. SFAS No. 157is effective for fiscal years beginning after November 15, 2007, andaccordingly, we expect to adopt SFAS No. 157 beginning in fiscal2009.  We are currently evaluating theimpact SFAS No. 157 will have on our consolidated results of operations,financial position and cash flows.

 

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

** **

*Interest Rate Risk*

 

As of December 31, 2007, we had total debtoutstanding of approximately $314.5 million, consisting primarily of the $291.2million outstanding under a term loan under our senior credit facility, $10.0million in related party debt and $13.3 million in capital lease obligationsand other debt.  The interest rate forthe term loan is variable, based on LIBOR, and resets every six months.Approximately $7.0 million of related party debt is variable and is based onLIBOR.  If the LIBOR rates were toincrease or decrease by 100 basis points, with all other factors remainingconstant, earnings would decrease or increase by approximately $3.0 millionannually, on a pre-tax basis.

 

*Foreign Currency Exchange Rate Risk*

 

Our foreign subsidiaries generally use their domestic currency as theirfunctional currency.  A 10% fluctuationin the exchange rates of these currencies against the U.S. dollar would resultin a corresponding change in earnings reported in the consolidated group ofapproximately $3.8 million.

 

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**ITEM 4.  CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

Asrequired by Rule 13a-15(b) promulgated under 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 Rule 13a-15(e),as of the end of the period covered by this Quarterly report on Form 10-Q.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of December 31,2007, our disclosure controls and procedures were not effective due to theexisting material weaknesses in our internal control over financial reportingpreviously identified and discussed in our 2007 10-K and below under “—InternalControl Over Financial Reporting —Material Weakness in Internal Control OverFinancial Reporting Previously Reported.”

 

Inview of the fact that the financial information presented in this QuarterlyReport on Form 10-Q for the fiscal quarter ended December 31, 2007,was prepared in the absence of effective internal control over financialreporting, we have devoted a significant amount of time and resources to theanalysis 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 transactions underlyingour financial statements to verify the accuracy of the financialstatements.  Accordingly, managementbelieves that the financial statements included in this report fairly present,in all material respects, our financial condition, results of operations, andcash flows.

 

Nevertheless,there can be no assurance that either this review process or our existingdisclosure controls and procedures will prevent or detect all errors and allfraud, if any, or result in accurate and reliable disclosure.  A control system can provide only reasonableand not absolute assurance that the objectives of the control system aremet.  Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, have beendetected.  Additionally, judgments indecision-making can be faulty and breakdowns in controls can occur because ofsimple errors or mistakes that are not detected on a timely basis.

 

**Internal Control Over Financial Reporting**

 

Ourmanagement acknowledges its responsibility for establishing and maintainingadequate internal control over financial reporting that includes effectiveaccounting policies and procedures.  Ourcontinuing progress in establishing adequate internal control over financialreporting is described below.

 

***Certain Changes in Internal Control OverFinancial Reporting during the Fiscal Quarter Ended December 31, 2007***

 

Although we continued ourefforts to remediate the previously reported material weaknesses and initiatedcertain updated remediation activities, as described below, there were nochanges in our internal control over financial reporting that occurred inthe  fiscal quarter ended December 31,2007 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting, and the materialweakness conditions previously disclosed in our 2007 Form 10-K continue toexist as of December 31, 2007.

 

**MaterialWeakness in Internal Control Over Financial Reporting Previously Reported**

 

Duringthe second quarter of fiscal 2008, management updated its remediation plan forthe previously reported material weaknesses. The updated remediation plan was developed through investigations andreviews of the processes and activities surrounding the previously reportedmaterial weaknesses and include changes in the design of these processes toprevent or detect similar future occurrences. We have begun implementing the remediation plan with respect to the previouslyreported material weaknesses, as discussed immediately below, however, therecan be no assurances as to when, or if, the implementation of these initiativeswill be completed.

 

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Thefollowing discussion is an overview of the previously reported materialweaknesses as well as each of the updated remediation activities we haveidentified and/or begun to implement in respect of each such material weakness:

 

**Inadequateand ineffective control related to revenue recognition. **The Company did notmaintain appropriate internal controls related to the recognition of revenuefor the sale of games, systems and parts. The Company’s controls were not adequate to capture and analyze theterms and conditions of all contracts and agreements, or to timely determinethat collectibility was probable in order to ensure the proper recording ofrevenue related to game and system sales. The internal controls include those related to the systematic trackingof contract terms and amendments.  Gameand system sales are accounted for in accordance with American Institute ofCertified Public Accountants Statement of Position No. 97-2, *Software Revenue Recognition*, whichincludes complex revenue recognition criteria that were not always adequatelyevaluated.  The review process is manualand the resources dedicated to the process are not adequate to address all ofthe accounting considerations on a timely basis given the increased volume ofbusiness.

 

For parts sales, theCompany’s internal controls did not ensure that the terms of the shipments andsales were captured and accounted for in accordance with the terms of the saleagreements, contracts, or shipping documents.

 

Theseweaknesses were the result of a material deficiency in the design of internalcontrols over financial reporting and resulted in material adjustments to theconsolidated financial statements for the fiscal year ended June 30, 2007.

 

Remediationactivities:

 

·      Training personnel on revenue recognitionguidelines and updating internal reference materials, adding additionalqualified revenue accounting resources and designing a contract review processbased on complexity of transactions, each on a worldwide basis.

 

·      Publishing a new worldwide customer creditpolicy based upon management’s current objectives and assessment of risk.

 

·      Increasing the standardization of contractlanguage that can be altered only with designated approvals as well asenhancing the controls over reviews of changes to this standardized language asit relates to revenue recognition.

 

·      Redesigning the customer order entry processso that customer orders are reviewed prior to shipment by finance andaccounting for collectability and terms or conditions that may impact revenuerecognition.

 

·      Designing parts and systems sales processesto address completeness and timeliness of shipping, billing and go-liveactivities consistent with the terms of sale agreements, contracts and shippingdocuments.

 

**Ineffectivecontrol related to the existence and valuation of inventory. **The Company did notmaintain appropriate and or effective controls related to the existence andvaluation of inventory.  As a result, theCompany identified several deficiencies including: (i) adjustments to itsraw materials balance resulting from ineffective periodic counting procedures; (ii) partsissued to and restocked from work orders which were not always properlyrecorded in raw materials or the related open work order bill of materials; (iii) differencesbetween the general ledger and perpetual inventory, which lacked theappropriate level of documentation for timely review and analysis; (iv) theinaccurate recording of parts shipments to outer warehouses; (v) inadequatecontrol over transaction processing; and (vi) lack of effective changemanagement for modifications made to the inventory system and processes.

 

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This weakness was theresult of a material deficiency in the operation of internal controls overfinancial reporting and resulted in material adjustments to the consolidatedfinancial statements for the fiscal year ended June 30, 2007.

 

Remediationactivities:

 

·                  In conjunction with the implementation of anew warehouse management system:

 

·                  Implementing a workflow application thatautomates controls over timely and accurate raw material transaction processingand on hand balances in the perpetual inventory system; and

 

·                  Launching a reliable cycle counting processfor continuous, real time, validation of raw material on hand balances.

 

·                  Performingtimely monitoring, analysis and reconcilition of perpetual inventory system transactionsto the general ledger to eliminate manual journal entries.

 

·                  Implementinga new production work order review process to monitor the accuracy of completedproduct cost and returns to stock of unused parts prior to the closing of workorders. 

 

**Insufficientpersonnel resources to adequately perform analytical review procedures. **The Company did not havesufficient qualified personnel to adequately analyze revenue and expenditureactivities for proper classification of amounts in the consolidated statementsof operations and statements of cash flows. This resulted in: (i) certain charges originally classified asselling, general and administrative expenses being restated to reflect anincrease to cost of sales or reduction of revenue; (ii) certain gamingoperations transactions being reclassified between investing and operatingactivities in the consolidated statements of cash flows; and (iii) certainrevenue and operating income (loss) amounts previously presented under theUnited States and Canada in the segment and geographic footnote disclosurebeing reclassified to Europe or Other foreign regions.  These adjustments resulted in the restatementof prior consolidated financial statements.

 

In addition, the lack ofsufficient qualified personnel contributed to the other material weaknessesdescribed above.

 

Remediationactivities:

 

·                  Strengtheningpolicies and procedures surrounding changes to significant financial processes,including the underlying systems and applications, to ensure adequate review,testing and approval prior to implementation.

 

·                  Deployingadditional qualified accounting staff and consultants in the areas of inventoryand cost accounting, financial analysis and process improvement.

 

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**PART II**

 

# **ITEM1.**  LEGAL PROCEEDINGS

# ** **

Fora description of our legal proceedings, see Note 10 to the unauditedcondensed consolidated financial statements, Commitment and Contingencies, which is incorporated by reference inresponse to this item.

 

**ITEM 1A.               RISK FACTORS**

 

The Company is subject to risks and uncertaintiesthat could cause our actual results to differ materially from the expectationsexpressed in the forward looking statements. Factors that could cause our actual results to differ from expectationsare described under “Item 1A. Risk Factors” in the 2007 10-K, to whichthere were no material changes during the period covered by this QuarterlyReport on Form 10-Q.

 

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 
| **Period**                                     | ** ** | **Total Number  of Shares (or  Units)  Purchased** | ** ** | **Average Price  Paid Per Share  (Per Unit)** | ** ** | **Total Number of Shares (or  Units) Purchased as Part of  Publicly Announced Plans  or Programs** | ** ** | **Maximum Number (or  Approximate Dollar Value) of  Shares (or Units) That May Be  Purchased Under the Plans or  Programs** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1 – October 31, 2007    |       | —                                                            |       | —                                                            |       | —                                                                                                                                                    |       | —                                                                                                                                                                                            |       |
| November 1  – November 30, 2007 |       | 149,253                                                           | (1)        | $                                                                 | 40.20      |                                                                                                                                                      | —     |                                                                                                                                                                                              | —     |   |
| December 1  – December 31, 2007 |       | —                                                            |       | —                                                            |       | —                                                                                                                                                    |       | —                                                                                                                                                                                            |       |
|                                                |            |                                                                   |            |                                                                   |            |                                                                                                                                                           |            |                                                                                                                                                                                                   |            |  |

 

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(1) In November 2007,the Company repurchased 149,253 shares of common stock for $6.0 million from Mr. RobertLuciano, the Company’s Chief Technology Officer pursuant to a stock purchaseagreement.  The purchase price per shareof common stock was determined by calculating the average per share closingprice of the Company’s common stock for the three business days before theclosing date.

 

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**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,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| BALLY TECHNOLOGIES, INC. | Date: February 14, 2008                                     |   |   |
|-------------------------------|------------------------------------------------------------------|--------|--------|
|                          |                                                             |   |   |
|                          |                                                             |
| 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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