**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

ý**                                 ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

**For thequarterly period ended December 31, 2004**

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

**For thetransition period from      to**

 

**CommissionFile Number 0-4281**

 

**ALLIANCEGAMING CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

Registrant’stelephone number: **(702) 270-7600**

#### **Registrant’s internet: **www.alliancegaming.com

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12B-2 of theExchange Act).

Yes  ý   No  o

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

ý  Yes   o  No

 

The number of shares ofCommon Stock, $0.10 par value, outstanding as of January 31, 2005, according tothe records of the registrant’s registrar and transfer agent was 51,088,700.

 

 

----

 

**INDEX**

 
| **PART I.**    | **FINANCIAL  INFORMATION**                                                                                           | ** ** | ** ** |
|----------------|----------------------------------------------------------------------------------------------------------------------|------------|------------|
|           |                                                                                                                 |       |       |   |
| Item 1.        | Unaudited Financial  Statements                                                                                      |       |       |
|           |                                                                                                                 |       |       |   |
|           | Unaudited  Condensed Consolidated Balance Sheets as of December 31, 2004 and June 30,  2004                          |       | 3          |
|           |                                                                                                                 |       |       |   |
|           | Unaudited  Condensed Consolidated Statements of Operations for the Three Months Ended  December 31, 2004 and 2003    |       | 4          |
|           |                                                                                                                 |       |       |   |
|           | Unaudited  Condensed Consolidated Statements of Operations for the Six Months Ended  December 31, 2004 and 2003      |       | 4          |
|           |                                                                                                                 |       |       |   |
|           | Unaudited  Condensed Consolidated Statement of Stockholders’ Equity for the Six Months  Ended December 31, 2004 |       | 5          |
|           |                                                                                                                 |       |       |   |
|           | Unaudited Condensed  Consolidated Statements of Cash Flows for the Six Months Ended December 31,  2004 and 2003      |       | 6          |
|           |                                                                                                                 |       |       |   |
|           | Notes to Unaudited Condensed Consolidated  Financial Statements                                                      |       | 7          |
|           |                                                                                                                 |       |       |   |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                          |       | 26         |
|           |                                                                                                                 |       |       |   |
| Item 3.        | Quantitative  and Qualitative Disclosures About Market Risk                                                          |       | 35         |
|           |                                                                                                                 |       |       |   |
| Item 4.        | Controls  and Procedures                                                                                             |       | 36         |
|           |                                                                                                                 |       |       |   |
| **PART  II.**  | **OTHER  INFORMATION**                                                                                               | ** ** | ** ** |
| ** **     | ** **                                                                                                           | ** ** | ** ** | ** ** |
| Item 1.        | Legal Proceedings                                                                                                    |       | 37         |
|           |                                                                                                                 |       |       |   |
| Item 4.        | Submission of Matters to a Vote  of Security Holders                                                                 |       | 37         |
|           |                                                                                                                 |       |       |   |
| Item  6.       | Exhibits                                                                                                             |       | 38         |
|           |                                                                                                                 |       |       |   |
| **SIGNATURES** |                                                                                                                 |       | 39         |

 

2

----

 

## **PART I**

**ALLIANCE GAMING CORPORATION**

** UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS**

**($ In 000’sexcept share and per share data**)

 
| ** **                                                                                                         | ** ** | **As of**              | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                         | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
| ASSETS                                                                                                             |       |                   |       |   |   |
| Current assets:                                                                                                    |       |                   |       |   |   |
| Cash and cash  equivalents                                                                                         |       | $                      | 27,964     |   | $ | 172,726 |   |
| Accounts and  notes receivable, net of allowance for doubtful accounts of $14,399 and  $9,722                      |       | 103,601                |       | 129,779 |   |
| Inventories                                                                                                        |       | 72,462                 |       | 61,135 |   |
| Deferred tax  assets, net                                                                                          |       | 19,982                 |       | 20,054 |   |
| Other current  assets                                                                                              |       | 19,580                 |       | 12,420 |   |
| Total current  assets                                                                                              |       | 243,589                |       | 396,114 |   |
| Long-term  investments (restricted)                                                                                |       | 8,542                  |       | 2,528 |   |
| Long-term  receivables, net of allowance of $12 and $12                                                            |       | 8,757                  |       | 12,518 |   |
| Net investment  in leases                                                                                          |       | 12,626                 |       | 5,614 |   |
| Leased gaming  equipment, net of accumulated depreciation of $40,814 and $31,105                                   |       | 44,273                 |       | 46,634 |   |
| Property, plant  and equipment, net of accumulated depreciation and amortization of $30,164  and $23,127           |       | 76,654                 |       | 75,838 |   |
| Goodwill, net                                                                                                      |       | 177,961                |       | 136,989 |   |
| Intangible  assets, net of accumulated amortization of $14,968 and $12,489                                         |       | 59,474                 |       | 63,623 |   |
| Assets of  discontinued operations held for sale                                                                   |       | —                 |       | 4,442 |   |
| Other assets,  net                                                                                                 |       | 15,286                 |       | 6,354 |   |
| Total assets                                                                                                       |       | $                      | 647,162    |   | $ | 750,654 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                          |       |                   |       |   |   |
| Current  liabilities                                                                                               |       |                   |       |   |   |
| Accounts payable                                                                                                   |       | $                      | 30,478     |   | $ | 37,515 |   |
| Accrued  liabilities                                                                                               |       | 60,991                 |       | 51,469 |   |
| Jackpot  liabilities                                                                                               |       | 10,076                 |       | 12,075 |   |
| Income taxes  payable                                                                                              |       | —                 |       | 7,233 |   |
| Current  maturities of long-term debt                                                                              |       | 5,040                  |       | 5,866 |   |
| Liabilities of  discontinued operations held for sale                                                              |       | —                 |       | 4,337 |   |
| Total current  liabilities                                                                                         |       | 106,585                |       | 118,495 |   |
| Long-term debt,  net of current maturities                                                                         |       | 348,540                |       | 423,089 |   |
| Deferred tax  liabilities                                                                                          |       | 90                     |       | 849 |   |
| Other  liabilities                                                                                                 |       | 6,985                  |       | 6,092 |   |
| Minority  interest                                                                                                 |       | 1,163                  |       | 1,326 |   |
| Total  liabilities                                                                                                 |       | 463,363                |       | 549,851 |   |
| 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; 51,552,000 and 51,426,000  shares issued             |       | 5,158                  |       | 5,145 |   |
| Treasury stock  at cost, 526,600 and 513,000 shares                                                                |       | (665                   | )          | (501 | ) |
| Deferred  compensation                                                                                             |       | (7,858                 | )          | (6,500 | ) |
| Additional  paid-in capital                                                                                        |       | 196,872                |       | 194,040 |   |
| Accumulated  other comprehensive income                                                                            |       | 1,518                  |       | 1,524 |   |
| Retained  earnings (accumulated deficit)                                                                           |       | (11,238                | )          | 7,083 |   |
| Total  stockholders’ equity                                                                                   |       | 183,799                |       | 200,803 |   |
| Total  liabilities and stockholders’ equity                                                                   |       | $                      | 647,162    |   | $ | 750,654 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

3

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

($ In 000s, except share and per share amounts)

** **
| ** **                                                                | ** ** | **Three Months Ended****December 31,** | ** ** | **Six Months Ended****December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                               | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                                 |       |                                   |       |                                 |       |   |   |   |   |
| Gaming equipment  and systems                                             |       | $                                      | 100,933    |                                 | $          | 96,319 |   | $ | 205,010 |   | $ | 184,787 |   |
| Casino  operations                                                        |       | 12,769                                 |       | 12,312                               |       | 25,605 |   | 25,067 |   |
|                                                                      |       | 113,702                                |       | 108,631                              |       | 230,615 |   | 209,854 |   |
| Costs and expenses:                                                       |       |                                   |       |                                 |       |   |   |   |   |
| Cost of gaming  equipment and systems                                     |       | 53,337                                 |       | 38,780                               |       | 104,173 |   | 72,017 |   |
| Cost of casino  operations                                                |       | 4,589                                  |       | 4,884                                |       | 9,391 |   | 9,887 |   |
| Selling, general  and administrative                                      |       | 41,051                                 |       | 21,548                               |       | 84,706 |   | 50,613 |   |
| Research and  development                                                 |       | 10,358                                 |       | 9,440                                |       | 22,130 |   | 15,403 |   |
| Restructuring  charge                                                     |       | —                                 |       | —                               |       | 1,435 |   | — |   |
| Depreciation and  amortization                                            |       | 12,020                                 |       | 6,445                                |       | 22,861 |   | 12,467 |   |
|                                                                      |       | 121,355                                |       | 81,097                               |       | 244,696 |   | 160,387 |   |
| Operating income  (loss)                                                  |       | (7,653                                 | )          | 27,534                               |       | (14,081 | ) | 49,467 |   |
| Other income  (expense)                                                   |       |                                   |       |                                 |       |   |   |   |   |
| Interest income                                                           |       | 318                                    |       | 83                                   |       | 798 |   | 126 |   |
| Interest expense                                                          |       | (3,750                                 | )          | (3,869                               | )          | (7,712 | ) | (9,598 | ) |
| Minority  interest                                                        |       | (1,145                                 | )          | (541                                 | )          | (1,644 | ) | (1,027 | ) |
| Refinancing /  bank amendment charges                                     |       | (564                                   | )          | —                               |       | (564 | ) | (12,293 | ) |
| Other, net                                                                |       | 375                                    |       | (545                                 | )          | 528 |   | (899 | ) |
| Income (loss)  from continuing operations before income taxes             |       | (12,419                                | )          | 22,662                               |       | (22,675 | ) | 25,776 |   |
| Income tax  expense (benefit)                                             |       | (4,879                                 | )          | 8,444                                |       | (8,730 | ) | 9,710 |   |
| Income (loss)  from continuing operations                                 |       | (7,540                                 | )          | 14,218                               |       | (13,945 | ) | 16,066 |   |
| Income (loss)  from discontinued operations                               |       | 15                                     |       | 4,526                                |       | (4,376 | ) | 8,706 |   |
| Net income  (loss)                                                        |       | $                                      | (7,525     | )                                    | $          | 18,744 |   | $ | (18,321 | ) | $ | 24,772 |   |
|                                                                      |       |                                   |       |                                 |       |   |   |   |   |
| Basic earnings  (loss) per share:                                         |       |                                   |       |                                 |       |   |   |   |   |
| Continuing  operations                                                    |       | $                                      | (0.15      | )                                    | $          | 0.29 |   | $ | (0.27 | ) | $ | 0.32 |   |
| Discontinued  operations                                                  |       | —                                 |       | 0.09                                 |       | (0.09 | ) | 0.18 |   |
| Total                                                                     |       | $                                      | (0.15      | )                                    | $          | 0.38 |   | $ | (0.36 | ) | $ | 0.50 |   |
|                                                                      |       |                                   |       |                                 |       |   |   |   |   |
| Diluted earnings  (loss) per share:                                       |       |                                   |       |                                 |       |   |   |   |   |
| Continuing  operations                                                    |       | $                                      | (0.15      | )                                    | $          | 0.28 |   | $ | (0.27 | ) | $ | 0.32 |   |
| Discontinued  operations                                                  |       | —                                 |       | 0.09                                 |       | (0.09 | ) | 0.17 |   |
| Total                                                                     |       | $                                      | (0.15      | )                                    | $          | 0.37 |   | $ | (0.36 | ) | $ | 0.49 |   |
|                                                                      |       |                                   |       |                                 |       |   |   |   |   |
| Weighted average  common shares outstanding                               |       | 51,010                                 |       | 49,741                               |       | 50,988 |   | 49,660 |   |
|                                                                      |       |                                   |       |                                 |       |   |   |   |   |
| Weighted average  diluted common and common share equivalents outstanding |       | 51,010                                 |       | 50,930                               |       | 50,988 |   | 50,814 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

 

4

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

($ In 000s)

 
| ** **                                      | ** ** | **Common Stock** | ** ** | **Series E   Special** | ** ** | **Treasury** | ** ** | **Deferred   Compen-** | ** ** | **Additional   Paid-In** | ** ** | **Accum-   ulated  Other   Compre-   hensive   Income** | ** ** | **Retained   Earnings   (Accum-   ulated** | ** ** | **Total   Stock-   holders’** | ** ** |
|-------------------------------------------------|------------|------------------|------------|------------------------|------------|--------------|------------|------------------------|------------|--------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **Shares**       | ** ** | **Dollars**            | ** ** | **Stock**    | ** ** | **Stock**              | ** ** | **sation**               | ** ** | **Capital**                                             | ** ** | **(Loss)**                                 | ** ** | **Deficit)**                       | ** ** | **Equity** | ** ** |
| Balances at June  30, 2004                      |       | 51,426           |       | $                      | 5,145      |         | $          | 12                     |       | $                        | (501       | )                                                       | $          | (6,500                                     | )          | $                                  | 194,040    |   | $ | 1,524 |   | $ | 7,083 |   | $ | 200,803 |   |
| Net loss                                        |       | —           |       | —                 |       | —       |       | —                 |       | —                   |       | —                                                  |       | —                                     |       | (18,321                            | )          | (18,321 | ) |
| Foreign currency  translation adjustment        |       | —           |       | —                 |       | —       |       | —                 |       | —                   |       | —                                                  |       | (6                                         | )          | —                             |       | (6 | ) |
| Total  comprehensive income                     |       | —           |       | —                 |       | —       |       | —                 |       | —                   |       | —                                                  |       | —                                     |       | —                             |       | (18,327 | ) |
| Restricted stock  units issued                  |       | —           |       | —                 |       | —       |       | —                 |       | (1,900                   | )          | 1,900                                                   |       | —                                     |       | —                             |       | — |   |
| Restricted stock  units amortization            |       | —           |       | —                 |       | —       |       | —                 |       | 542                      |       | —                                                  |       | —                                     |       | —                             |       | 542 |   |
| Repurchase of  common stock for treasury        |       | —           |       | —                 |       | —       |       | (164                   | )          | —                   |       | —                                                  |       | —                                     |       | —                             |       | (164 | ) |
| Shares issued  upon exercise of stock options   |       | 126              |       | 13                     |       | —       |       | —                 |       | —                   |       | 696                                                     |       | —                                     |       | —                             |       | 709 |   |
| Tax benefit of  employee stock option exercises |       | —           |       | —                 |       | —       |       | —                 |       | —                   |       | 236                                                     |       | —                                     |       | —                             |       | 236 |   |
| Balances at  December 31, 2004                  |       | 51,552           |       | $                      | 5,158      |         | $          | 12                     |       | $                        | (665       | )                                                       | $          | (7,858                                     | )          | $                                  | 196,872    |   | $ | 1,518 |   | $ | (11,238 | ) | $ | 183,799 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

5

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

($ In 000s)

 
| ** **                                                                                                                    | ** ** | **Six Months Ended   December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2004**                            | ** ** | **2003** | ** ** |
|                                                                                                                          |       |                                |       |   |   |
| Cash flows from  operating activities of continuing operations:                                                               |       |                                |       |   |   |
| Net income  (loss)                                                                                                            |       | $                                   | (18,321    | ) | $ | 24,772 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities of continuing operations: |       |                                |       |   |   |
| (Income) loss  from discontinued operations                                                                                   |       | 4,376                               |       | (8,706 | ) |
| Depreciation and  amortization                                                                                                |       | 22,861                              |       | 12,467 |   |
| Stock-based  compensation                                                                                                     |       | 542                                 |       | — |   |
| Refinancing /  bank amendment charges                                                                                         |       | 564                                 |       | 12,293 |   |
| Deferred income  taxes                                                                                                        |       | (687                                | )          | 10,433 |   |
| Provision for  losses on receivables                                                                                          |       | 5,154                               |       | 526 |   |
| Inventory and  other discontinued asset write-downs                                                                           |       | 14,088                              |       | — |   |
| Other                                                                                                                         |       | (11,605                             | )          | (1,099 | ) |
| Change in  operating assets and liabilities, net of effects of business acquired:                                             |       |                                |       |   |   |
| Accounts and  notes receivable                                                                                                |       | 17,138                              |       | (2,019 | ) |
| Inventories                                                                                                                   |       | (17,456                             | )          | (2,493 | ) |
| Other current  assets                                                                                                         |       | (4,336                              | )          | (1,023 | ) |
| Accounts payable                                                                                                              |       | (7,169                              | )          | (2,072 | ) |
| Accrued  liabilities and jackpot liabilities                                                                                  |       | (12,853                             | )          | (2,924 | ) |
| Net cash  provided by (used in) operating activities of continuing operations                                                 |       | (7,704                              | )          | 40,155 |   |
| Cash flows from  investing activities of continuing operations:                                                               |       |                                |       |   |   |
| Advances of  notes receivable due from Sierra Design Group                                                                    |       | —                              |       | (61,025 | ) |
| Additions to  property, plant and equipment                                                                                   |       | (5,531                              | )          | (3,815 | ) |
| Additions to  leased gaming equipment                                                                                         |       | (18,183                             | )          | (15,957 | ) |
| Additions to  other long-term assets                                                                                          |       | (1,521                              | )          | (10,414 | ) |
| Acquisitions,  net of cash acquired                                                                                           |       | (12,000                             | )          | (3,879 | ) |
| Proceeds from  sale of net assets of discontinued operations                                                                  |       | 1,911                               |       | 16,500 |   |
| Net cash used in  investing activities of continuing operations                                                               |       | (35,324                             | )          | (78,590 | ) |
| Cash flows from  financing activities of continuing operations:                                                               |       |                                |       |   |   |
| Capitalized debt  issuance costs                                                                                              |       | (1,038                              | )          | (6,954 | ) |
| Premium paid on  early redemption of debt                                                                                     |       | —                              |       | (5,399 | ) |
| Proceeds from  the issuance of long-term debt                                                                                 |       | —                              |       | 350,000 |   |
| Net change in  revolving credit facility                                                                                      |       | —                              |       | 70,000 |   |
| Payoff of debt  due to sale of net assets of discontinued operations                                                          |       | (101,618                            | )          | (337,625 | ) |
| Reduction of  long-term debt                                                                                                  |       | (2,050                              | )          | (1,349 | ) |
| Re-purchase of  treasury shares                                                                                               |       | (164                                | )          | — |   |
| Proceeds from  exercise of stock options                                                                                      |       | 945                                 |       | 2,907 |   |
| Net cash  provided by (used in) financing activities of continuing operations                                                 |       | (103,925                            | )          | 71,580 |   |
|                                                                                                                          |       |                                |       |   |   |
| Effect of  exchange rates changes on cash                                                                                     |       | 487                                 |       | 130 |   |
|                                                                                                                          |       |                                |       |   |   |
| Cash provided by  discontinued operations                                                                                     |       | 1,704                               |       | 95 |   |
|                                                                                                                          |       |                                |       |   |   |
| Cash and cash  equivalents:                                                                                                   |       |                                |       |   |   |
| Increase for the  period                                                                                                      |       | (144,762                            | )          | 33,370 |   |
| Balance,  beginning of period                                                                                                 |       | 172,726                             |       | 38,884 |   |
| Balance, end of  period                                                                                                       |       | $                                   | 27,964     |   | $ | 72,254 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

6

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**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**NOTES****TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

*Principles of presentation andconsolidation*

 

The accompanyingunaudited interim condensed consolidated financial statements reflect alladjustments, consisting of normal recurring adjustments, which managementbelieves are necessary to present fairly the financial position, results ofoperations and cash flows of Alliance Gaming Corporation and its subsidiaries (“Alliance”or the “Company”) for the respective periods presented.  The results of operations for an interimperiod are not necessarily indicative of the results that may be expected forany other interim period or the year as a whole. The accompanying unauditedinterim condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and notes in the Company’sannual report on Form 10-K for the year ended June 30, 2004.

 

The accompanyingconsolidated financial statements include the accounts of Alliance GamingCorporation and its wholly owned and partially owned, controlled subsidiaries.The Company consolidates Rainbow Casino Vicksburg Partnership (“RCVP”) andrecords minority interest expense to reflect the portion of the earnings ofRCVP attributable to the minority shareholders.The Company is the generalpartner of RCVP, the partnership that operates the Rainbow Casino. Pursuant totransactions consummated in March 1995, the Rainbow Corporation, which was theformer general partner of RCVP, became a limited partner entitled to receive10% (which amount increases to 20% of such amount when annual revenues exceed$35.0 million but only on such incremental amount) of the net available cashflows after debt service and other items, as defined, payable quarterly throughDecember 31, 2010. The Company holds the remaining economic interest in thepartnership.

 

For Video Services, Inc.(“VSI”), the Company owned 100% of the voting stock and was entitled to receive71% of dividends declared by VSI, if any, at such time that dividends weredeclared. The sale of VSI was completed during the quarter ended December 31,2004 for a realized gain of $0.8 million, net of tax (included in discontinuedoperations).

 

All significantintercompany accounts and transactions have been eliminated in consolidation.Certain reclassifications have been made to prior year financial statements toconform to the current year presentation, and to present Rail City asdiscontinued operations for all periods presented.

 

*Recently Issue AccountingPronouncements*

* *

In December 2004, theFASB issued Statement 123(R) which revised FASB No. 123.  Statement 123(R) requires all entities torecognize compensation expense in an amount equal to the fair value ofshare-based payments granted to employees for reporting periods beginning afterJune 15, 2005. The first reporting period for the Company will be the quarterended September 30, 2005, and the Company is currently evaluating the impact ofthe adoption, however the pro forma impact is reflected in footnote 2.

 

In November 2004 the FASBissued Statement 151 which revised ARB 43, Chapter 4, which clarifies theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, wasted material (spoilage). This Statement is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005.  The Company does not believe this accounting pronouncementwill have a material impact on its financial condition or results ofoperations.

 

**2.****              STOCK-BASEDCOMPENSATION**

 

The Company accounts forits stock-based employee compensation awards in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (“APB 25”). Under APB 25, because the exercise price of the Company’semployee stock options equals or exceeds the market price on the date of grant,no compensation expense is recognized.

 

As provided under FinancialAccounting Standards Board No. 123 “Accounting for Stock-Based Compensation” (“FASBNo. 123”), companies may continue to account for employee stock-basedcompensation under APB 25, but are required to disclose historical pro-formanet income and earnings per share that would have resulted from the use of thefair value method described in FASB No. 123.

 

In December 2002, theFASB issued FASB No. 148, “Accounting for Stock-Based Compensation-Transitionand Disclosure”. This Statement amends FASB No. 123 to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation. In addition, this Statementamends the disclosure requirements of FASB No. 123 and APB Opinion No. 28 “InterimFinancial Reporting” to require prominent disclosures in both annual andinterim financial statements about the method of accounting for stock-

 

7

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based employeecompensation and the effect of the method used on reported results. Under fairvalue method, compensation costs are measured using an options pricing modeland are amortized over the estimated life of the option, which is generallythree to ten years, with option forfeitures accounted for at the time of theforfeiture, and all amounts are reflected net of tax.

 

The historical and pro forma net income (assuming an after-tax chargefor stock-based compensation) and related per share data are as follows (in000s, except per share data):

 
| ** **                                               | ** ** | **Three Months Ended   December 31,** | ** ** | **Six Months Ended   December 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss)                                       |       |                                  |       |                                |       |   |   |   |   |
| As reported                                              |       | $                                     | (7,525     | )                                   | $          | 18,744 |   | $ | (18,321 | ) | $ | 24,772 |   |
| Stock-based  compensation under FASB No. 123, net of tax |       | (1,701                                | )          | (1,021                              | )          | (3,263 | ) | (1,893 | ) |
| Pro forma net  income (loss)                             |       | $                                     | (9,226     | )                                   | $          | 17,723 |   | $ | (21,584 | ) | $ | 22,879 |   |
|                                                     |       |                                  |       |                                |       |   |   |   |   |
| Earnings per  share:                                     |       |                                  |       |                                |       |   |   |   |   |
| Basic– As  reported                                 |       | $                                     | (0.15      | )                                   | $          | 0.38 |   | $ | (0.36 | ) | $ | 0.50 |   |
| Basic– Pro forma                                    |       | $                                     | (0.18      | )                                   | $          | 0.36 |   | $ | (0.42 | ) | $ | 0.46 |   |
| Diluted– As  reported                               |       | $                                     | (0.15      | )                                   | $          | 0.37 |   | $ | (0.36 | ) | $ | 0.49 |   |
| Diluted– Pro  forma                                 |       | $                                     | (0.18      | )                                   | $          | 0.35 |   | $ | (0.42 | ) | $ | 0.45 |   |

 

On the date of grantusing the Black-Scholes option-pricing model, the following assumptions wereused to estimate the grant-date fair value of the options in the periodsindicated:

 
| ** **                                 | ** ** | **Three Months Ended   December 31,** | ** ** | **Six Months Ended   December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-fee  interest rate (weighted average) |       | 3.5                                   | %          | 3.5                                 | %          | 3.5 | % | 3.5 | % |
| Expected  volatility                       |       | 0.35                                  |       | 0.26                                |       | 0. 35 |   | 0.26 |   |
| Expected  dividend yield                   |       | 0                                     |       | 0                                   |       | 0 |   | 0 |   |
| Expected life                              |       | 3-10 years                            |       | 3-10 years                          |       | 3-10 years |   | 3-10 years |   |

 

Theresulting fair values applied to the options granted were $4.39 and $3.14 pershare for the quarter ended December 31, 2004 and December 31, 2003,respectively and were $5.06 and $3.10 for the six months ended December 31,2004 and 2003, respectively.

 

**3.****              DISCONTINUEDOPERATIONS**

 

The Company has completedseveral divestitures in accordance with our plan to sell our “non-core”businesses, which was a strategy announced in July 2003. In July 2003, wecompleted the sale of Bally Wulff to a private equity investor.  Since the net assets of Bally Wulff werewritten down to the estimated sale price in June 2003, no additional gain orloss was recorded upon the closing of the sale. In May 2004, we completed thesale of Rail City Casino to The Sands Resort. On June 30, 2004, the Companycompleted the sale of United Coin Machine Co. (“UCMC”). On October 15, 2004 the Company completed the sale of its interest in VSIto Churchill Downs Incorporated and received proceeds of approximately $2.0million and realized a gain of $0.8 million, net of tax.

 

The results of thesediscontinued operations are presented net of applicable income taxes indiscontinued operations  in the accompanyingconsolidated statements of operations.

 

8

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Operatingresults for the discontinued operations for the three and six month periodsended December 31, 2004 include VSI, while the results for the three and sixmonth periods ended December 31, 2003 include UCMC, VSI, and Rail City.  Summary operating results are as follows (in000s):

 
| ** **                                  | ** ** | **Three Months Ended   December 31,** | ** ** | **Six Months Ended   December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues                                |       | $                                     | 559        |                                | $          | 64,179 |   | $ | 4,514 |   | $ | 123,533 |   |
|                                        |       |                                  |       |                                |       |   |   |   |   |
| Operating income  (loss)                    |       | (129                                  | )          | 7,947                               |       | 358 |   | 14,746 |   |
| Income tax  expense (benefit)               |       | (38                                   | )          | 2,437                               |       | (2,516 | ) | 4,724 |   |
| Income (loss)  from discontinued operations |       | $                                     | 15         |                                | $          | 4,526 |   | $ | (4,376 | ) | $ | 8,706 |   |

 

**4.****              OTHERCURRENT ASSETS**

 

Other current assetsconsist of the following (in 000s):

 
| ** **                               | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
|------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Prepaid taxes                            |       | $                      | 3,889      |               | $          | 814 |   |
| Prepaid royalty                          |       | 3,126                  |       | 2,623              |       |
| Refundable  deposits                     |       | 1,883                  |       | 3,229              |       |
| Games on trial                           |       | 3,088                  |       | 2,608              |       |
| Deferred cost of  revenue                |       | 3,974                  |       | 208                |       |
| Prepaid  licensing and intellectual fees |       | 685                    |       | 1,090              |       |
| Prepaid  insurance                       |       | 1,122                  |       | 592                |       |
| Prepaid other  expense                   |       | 1,813                  |       | 1,256              |       |
| Total current  assets                    |       | $                      | 19,580     |               | $          | 12,420 |   |

 

The decrease in refundabledeposits of $1.3 million is a result of units purchased from othermanufacturers for which the deposit has now been applied to the accountpayable.  The increase in deferred costsof $3.7 million is due to shipments of games, primarily to the European marketwith F.O.B. destination terms, which will not be recognized as revenue untilthe third quarter of fiscal year 2005.

 

**5.****              INVENTORIES**

 

Inventories are stated atthe lower of cost, determined on a first-in, first-out basis, ormarket.  Cost elements included for work-in-processand finished goods include raw materials, freight, direct labor andmanufacturing overhead.  Inventoriesconsist of the following (in 000s):

 
| ** **      | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
|-----------------|------------|------------------------|------------|--------------------|------------|
| Raw materials   |       | $                      | 24,377     |               | $          | 26,050 |   |
| Work-in-process |       | 4,956                  |       | 3,324              |       |
| Finished goods  |       | 43,129                 |       | 31,761             |       |
| Total           |       | $                      | 72,462     |               | $          | 61,135 |   |

 

The Company performsdetailed inventory valuation procedures at least quarterly. This processincludes examining the carrying values of new and used gaming devices, parts andancillary equipment in comparison to the current fair market values for suchequipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levelsof our inventories, the current and projected sales levels for such products,the projected markets for such products both domestically and internationally,the costs required to sell the products including refurbishment costs andimportation costs for international shipments, and the overall projected demandfor products once the next generation of products are scheduled for release.

 

The Company has faceddeclining demand for its video products. During the quarter ended September 30, 2004, the Company decided thatits legacy V7 video platform would no longer be supported,

 

9

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and the remaining usedgame inventory for such products was targeted for immediate disposal, resultingin a write down of $3.0 million.  Theinventory of new games for this product line was targeted for sale at reducedprices, which were still above the carrying value less cost to sell and thereforewere not written down.

 

During the quarter endedDecember 31, 2004, management completed a three year business planningprocess.  In accordance with this plan,significant development efforts were redirected to the Alpha-based videoplatform and products.  The Company alsomade its existing EVO video games upgradeable to Alpha when approved in eachmarket. The remaining used EVO inventory has been targeted for sale primarilyin non-domestic markets, which traditionally have lower price points for usedgames and have higher importation and delivery costs, resulting insignificantly lower net realizable values. The capitalized regulatory approval costs for the EVO and legacy videoplatform were determined to no longer be recoverable, and were also writtenoff.

 

During the quarter endedDecember 31, 2004, the Company consolidated several warehouses into one centralwarehouse, with the intent to reduce warehouse rental costs.  As part of this consolidation, certain usedgames and related ancillary equipment including signs, were identified forimmediate destruction, scrap, or salvage and this process has continued intothe March 2005 period.

 

As a result of thedecision to move to the new video platform, the targeting of used equipment fornon-domestic markets, and the consolidation of warehouses leading toaccelerated disposals, the Company wrote down its inventory and related assetsby a total of $11.1 million during the quarter ended December 31, 2004, andsuch write downs for the six months ended December 31, 2004 totaled $14.1million. These charges are included in the cost of gaming equipment and systemsin the statement of operations.

 

The Company continues totake certain used games on trade as part of new game sales, and thereforeadditional write-downs may be necessary in future periods depending on a numberof factors impacting the future demand for such used products and the ultimatenet values realized.

 

**6.****              PROPERTY,PLANT AND EQUIPMENT AND LEASED GAMING EQUIPMENT**

 

Property, plant andequipment is stated at cost and depreciated over the estimated useful lives orlease term, if less, using the straight line method as follows: buildings andimprovements, 28-40 years; gaming equipment, 4-7 years; furniture, fixtures andequipment, 3-7 years; and leasehold improvements, 5-10 years.  Leased gaming equipment is stated at cost anddepreciated over estimated useful life ranging from 3-4 years.

 

Significant replacementsand improvements are capitalized; other maintenance and repairs areexpensed.  The cost and accumulateddepreciation of assets retired or otherwise disposed of are eliminated from theaccounts and any resulting gain or loss is credited or charged to income asappropriate.

 

Property, plant andequipment consist of the following (in 000s):

 
| ** **                                      | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Land and land  improvements                     |       | $                      | 12,827     |               | $          | 19,086 |   |
| Buildings and  leasehold improvements           |       | 37,735                 |       | 29,937             |       |
| Gaming equipment                                |       | 33,160                 |       | 29,121             |       |
| Furniture,  fixtures and equipment              |       | 23,096                 |       | 20,821             |       |
| Less accumulated  depreciation and amortization |       | (30,164                | )          | (23,127            | )          |
| Total property,  plant and equipment, net       |       | $                      | 76,654     |               | $          | 75,838 |   |
|                                            |       |                   |       |               |       |
| Leased gaming  equipment                        |       | $                      | 85,087     |               | $          | 77,739 |   |
| Less accumulated  depreciation                  |       | (40,814                | )          | (31,105            | )          |
| Total leased  gaming equipment, net             |       | $                      | 44,273     |               | $          | 46,634 |   |

 

10

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**7.****              INTANGIBLEASSETS AND GOODWILL**

 

In July 2001, the Companyadopted FASB No. 142 “Goodwill and Other Intangible Assets”, which requirescompanies to cease amortizing goodwill and certain intangible assets withindefinite useful lives.  Instead,goodwill and intangible assets deemed to have indefinite useful lives are to bereviewed for impairment annually at the reporting unit level (Gaming equipmentand systems, and casino operations). There was no impairment of goodwill upon adoption of FASB No. 142.   There was no impairment charged to goodwillin the six months ended December 31, 2004 or 2003.

 

The Company evaluates thecarrying value of goodwill for impairment annually during the fourth quarter orwhenever events or changes in circumstances indicate that the carrying value ofgoodwill may not be recoverable. Indicators that could trigger an impairment review include changes inlegal, regulatory, or economic factors, market conditions or operationalperformance.  Impairment is measured asthe difference between the carrying amount and the fair value of the intangibleassets and is recognized as a component of income from operations.

 

*Intangibles*

 

Intangible assetsexcluding discontinued operations consist of the following (in 000s):

 
| ** **                             | ** ** | ** **                            | ** ** | **December 31, 2004**        | ** ** | **June 30, 2004**                 | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Wt. Avg.   Useful   life  (Years)** | ** ** | **Gross   Carrying  Amount** | ** ** | **Accum-   ulated  Amortization** | ** ** | **Net   Carrying  Amount** | ** ** | **Gross   Carrying  Amount** | ** ** | **Accum-   ulated  Amortization** | ** ** | **Net   Carrying  Amount** | ** ** |
| Computer  software                     |       | 3                                     |       | $                            | 8,996      |                              | $          | (2,622 | ) | $ | 6,374 |   | $ | 8,963 |   | $ | (1,498 | ) | $ | 7,465 |   |
| Computer  software from acquisitions   |       | 9                                     |       | 11,700                       |       | (4,030                            | )          | 7,670 |   | 11,700 |   | (3,380 | ) | 8,320 |   |
| License rights                         |       | 3-5                                   |       | 1,774                        |       | (777                              | )          | 997 |   | 2,745 |   | (1,979 | ) | 766 |   |
| Capitalized  regulatory approval costs |       | 3                                     |       | 3,638                        |       | (1,043                            | )          | 2,595 |   | 4,767 |   | (833 | ) | 3,934 |   |
| CRM project                            |       | 5                                     |       | 3,290                        |       | (1,237                            | )          | 2,053 |   | 3,039 |   | (1,046 | ) | 1,993 |   |
| PLM project                            |       | 5                                     |       | 1,843                        |       | (102                              | )          | 1,741 |   | 1,585 |   | — |   | 1,585 |   |
| Trademarks                             |       | 5                                     |       | 6,688                        |       | (431                              | )          | 6,257 |   | 6,688 |   | (288 | ) | 6,400 |   |
| Patents                                |       | 13                                    |       | 9,470                        |       | (608                              | )          | 8,862 |   | 9,470 |   | (243 | ) | 9,227 |   |
| Non-compete  agreements                |       | 6                                     |       | 275                          |       | (38                               | )          | 237 |   | 275 |   | (15 | ) | 260 |   |
| Customer  relationships                |       | 5                                     |       | 740                          |       | (123                              | )          | 617 |   | 740 |   | (49 | ) | 691 |   |
| Core technology                        |       | 8                                     |       | 5,445                        |       | (567                              | )          | 4,878 |   | 5,445 |   | (227 | ) | 5,218 |   |
| Deferred  financing costs              |       | 6                                     |       | 7,385                        |       | (1,656                            | )          | 5,729 |   | 6,910 |   | (1,017 | ) | 5,893 |   |
| Contracts                              |       | 10                                    |       | 12,100                       |       | (1,016                            | )          | 11,084 |   | 12,100 |   | (411 | ) | 11,689 |   |
| Other  intangibles                     |       | 7                                     |       | 1,098                        |       | (718                              | )          | 380 |   | 1,685 |   | (1,503 | ) | 182 |   |
| Total                                  |       |                                  |       | $                            | 74,442     |                              | $          | (14,968 | ) | $ | 59,474 |   | $ | 76,112 |   | $ | (12,489 | ) | $ | 63,623 |   |

 

Amortizationexpense totaled $2.6 million and $1.4 million for the three months endedDecember 31, 2004 and 2003, respectively. Amortization expense totaled $4.6 million and $2.7 million for the sixmonths ended December 31, 2004 and 2003, respectively.  Computer software amortization expensetotaled $1.1 million and $0.8 million for the three months ended December 31,2004 and 2003, respectively.  Computersoftware amortization totaled $1.6 million and $1.4 million for the six monthsended December 31, 2004 and 2003, respectively.

 

Futureamortization of intangible assets is scheduled as follows (in 000s):

 
| **Period Ending   December 31,** | ** ** | **Amount** | ** ** |
|----------------------------------|------------|------------|------------|
| 2005                             |       | $          | 5,197      |   |
| 2006                             |       | 10,463     |       |
| 2007                             |       | 8,919      |       |
| 2008                             |       | 6,600      |       |
| 2009                             |       | 5,887      |       |
| Thereafter                       |       | 22,408     |       |
| Total                            |       | $          | 59,474     |   |

 

11

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*Goodwill*

 

The changes in thecarrying amount of goodwill are as follows (in 000s):

 
| Balance as of  June 30, 2004             |   | $      | 136,989 |   |
|------------------------------------------|--------|--------|---------|--------|
| Acquired  goodwill                       |   | 40,558 |    |
| Foreign currency  translation adjustment |   | 414    |    |
| Balance as of  December 31, 2004         |   | $      | 177,961 |   |

 

On December 30, 2004 theCompany amended the Sierra Design Group (“SDG”) stock purchase agreementoriginally dated March 3, 2004.  Theamendment terminates the contingent consideration payable over the next threeyears (“the earnout”) which could have totaled $95 million (payable in cash andstock) depending on the achievement of certain SDG financial performancetargets.  The consideration for thetermination of the earnout consisted of a one-time cash payment of $12 millionpaid to the group of former SDG stakeholders and the delivery of a $28 millionunsecured promissory note to that same group of individuals, payable over fiveyears with interest at LIBOR + 2%.  The$40 million of total consideration paid to terminate the earnout, and relatedexpenses has been treated as additional consideration paid for the stock ofSDG, and therefore has been recorded as goodwill.

 

The purchase agreementfor MindPlay LLC calls for future contingent consideration (“earnouts”) to bepaid to its former principals, as more fully described in footnote 14. TheMindPlay earnout is payable based on future revenues and gross margins from thesale of MindPlay products.  No amountshave yet been paid pursuant to this earnout.

 

**8.****              ACCRUEDLIABILITIES AND JACKPOT LIABILITIES**

 

Accrued liabilitiesconsist of the following (in 000s):

 
| ** **                               | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
|------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Payroll and  related costs               |       | $                      | 9,754      |               | $          | 11,905 |   |
| Interest                                 |       | 1,713                  |       | 1,265              |       |
| Professional and  consulting fees        |       | 4,281                  |       | 3,102              |       |
| Deferred  revenues, sales and use taxes  |       | 10,942                 |       | 5,113              |       |
| Regulatory  approval cost accruals       |       | 1,389                  |       | 652                |       |
| Royalties,  rebates, direct mail coupons |       | 8,541                  |       | 7,390              |       |
| Customer  deposits                       |       | 5,748                  |       | 9,896              |       |
| Acquisition  related accruals            |       | 3,906                  |       | 3,806              |       |
| Divestiture  related accruals            |       | 561                    |       | 4,377              |       |
| Litigation accruals                      |       | 9,360                  |       | —             |       |
| Severance  accruals                      |       | 637                    |       | —             |       |
| Other                                    |       | 4,159                  |       | 3,963              |       |
| Subtotal                                 |       | 60,991                 |       | 51,469             |       |
| Jackpots accrued  not yet awarded        |       | 10,076                 |       | 12,075             |       |
| Total accrued  liabilities               |       | $                      | 71,067     |               | $          | 63,544 |   |

 

The Company recognizesliability for jackpot expense for the cost to fund these jackpots in thefuture.  Generally winners may elect toreceive a single lump sum payment or may opt to receive payments in equalinstallments over a specified period of time. The most recent history pattern indicates that approximately 85% ofwinners will elect the single payment option.

 

The Company funds jackpotinstallment payments through qualifying U.S. government or agencysecurities.  The present value of theoutstanding progressive jackpot liabilities is computed based upon the paymentstream discounted at the applicable discount rate.

 

12

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The increase inlitigation accruals of $9.4 million is primarily a result of the patentlitigation discussed in the Commitments and Contingencies section of thisreport.

 

**9.****              LONG-TERMINVESTMENTS (RESTRICTED)**

 

Pursuant to various stategaming regulations, certain cash accounts are maintained to ensure availabilityof funds to pay wide-area progressive jackpot awards, which totaled approximately$12.8 million at December 31, 2004 and which are included in cash and cashequivalents in the accompanying balance sheets. In addition, the Company purchases U.S. Treasury Strip securities forthe benefit of jackpot winners who elect to receive annual or weeklyinstallment payments. These securities are presented as restricted investmentsin the accompanying consolidated balance sheets, and totaled $8.5 million and$2.5 million as of December 31, 2004 and June 30, 2004, respectively.

 

**10.****       LONG-TERMDEBT**

 

Long-term debt consistedof the following (in 000s):

 
| ** **                               | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** |
|------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Term Loan  facility                      |       | $                      | 317,507    |               | $          | 350,000 |   |
| Revolving credit  facility               |       | —                 |       | 70,000             |       |
| Other, generally  unsecured              |       | 36,073                 |       | 8,955              |       |
|                                     |       | 353,580                |       | 428,955            |       |
| Less current  maturities                 |       | 5,040                  |       | 5,866              |       |
| Long-term debt,  less current maturities |       | $                      | 348,540    |               | $          | 423,089 |   |

 

In December 2004, theCompany amended its senior loan agreement. The amendment provides for an increase in the maximum allowable leverageratio (currently 4.25x), a reduction in the revolver from $125 million to $75million which is currently unborrowed, and an increase in the term loaninterest rate to LIBOR + 3.00%.  TheLIBOR rate at December 31, 2004 was 2.65%. The fee incurred for the amendment totaled approximately $1.0 million,which has been capitalized and will be amortized over the life of the amendedloan agreement, and the Company recorded a pre-tax charge of $0.6 million towrite-off a portion of the previously deferred financing costs.

 

The Company’s bank creditagreement, as amended, contains several financial covenants including maximumleverage ratio, minimum cash flow (as that term is defined in the agreement)and fixed charge coverage ratio.  Thecredit agreement also contains a number of maintenance covenants and othersignificant covenants that, among other things, restrict the ability of theCompany and certain of its subsidiaries to dispose of assets, incur additionalindebtedness and issue preferred stock, pay dividends or make otherdistributions, enter into certain acquisitions, repurchase equity interests orsubordinated indebtedness, issue or sell equity interests of the Company’ssubsidiaries, engage in mergers or acquisitions, or engage in certaintransactions with subsidiaries and affiliates, and that otherwise restrictcorporate activities.  As of December 31,2004, the Company is in compliance with the covenants, including the leverageratio which is currently 3.9x.  Pursuantto the recent amendment, the leverage ratio maximum is scheduled to increase to4.50x and to 4.75x as of March 31, 2005 and June 30, 2005, respectively. 

 

The other debt totalingapproximately $36.1 million as of December 31, 2004, consists primarily of thedebt owed to the former principals of SDG, Micro Clever Consulting, andMindPlay, totaling $28.0 million, $1.3 million and $4.0 millionrespectively.  The loans are due atvarious dates between 2005 and 2009 and bear rates of interest between LIBORplus 2% (5.7% as of December 31, 2004) and 6%, and are generally unsecured.

 

13

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In September 2003, the Company refinanced its senior bank debt creditfacility and recorded a pre-tax charge totaling $12.3 million.  This charge includes a $5.0 million chargefor the early extinguishment of the Company’s subordinated notes, $7.0 millionfor the non-cash write-off of deferred financing costs and $0.3 million in feesand expenses.

 

**11.****       EARNINGSPER SHARE**

 

The following computationof basic and diluted earnings (loss) per share from continuing operations, andincome (loss) applicable to common shares are as follows (in 000s except pershare amounts):

 
| ** **                                               | ** ** | **Three Months Ended   December 31,** | ** ** | **Six Months Ended   December 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss) from continuing operations            |       | $                                     | (7,540     | )                                   | $          | 14,218 |   | $ | (13,945 | ) | $ | 16,066 |   |
| Net income  (loss) from discontinued operations          |       | 15                                    |       | 4,526                               |       | (4,376 | ) | 8,706 |   |
| Net income  (loss)                                       |       | $                                     | (7,525     | )                                   | $          | 18,744 |   | $ | (18,321 | ) | $ | 24,772 |   |
|                                                     |       |                                  |       |                                |       |   |   |   |   |
| Weighted average  common shares outstanding              |       | 51,010                                |       | 49,741                              |       | 50,988 |   | 49,660 |   |
| Effect of  dilutive securities                           |       | —                                |       | 1,189                               |       | — |   | 1,154 |   |
| Weighted average  common and dilutive shares outstanding |       | 51,010                                |       | 50,930                              |       | 50,988 |   | 50,814 |   |
|                                                     |       |                                  |       |                                |       |   |   |   |   |
| Earnings (loss)  per basic share:                        |       |                                  |       |                                |       |   |   |   |   |
|                                                     |       |                                  |       |                                |       |   |   |   |   |
| Income (loss)  from continued operations                 |       | $                                     | (0.15      | )                                   | $          | 0.29 |   | $ | (0.27 | ) | $ | 0.32 |   |
| Income (loss)  from discontinued operation               |       | 0.00                                  |       | 0.09                                |       | (0.09 | ) | 0.18 |   |
|                                                     |       | $                                     | (0.15      | )                                   | $          | 0.38 |   | $ | (0.36 | ) | $ | 0.50 |   |
| Earnings (loss)  per diluted share:                      |       |                                  |       |                                |       |   |   |   |   |
| Income (loss)  from continued operations                 |       | $                                     | (0.15      | )                                   | $          | 0.28 |   | $ | (0.27 | ) | 0.32 |   |
| Income (loss)  from discontinued operation               |       | 0.00                                  |       | 0.09                                |       | (0.09 | ) | 0.17 |   |
|                                                     |       | $                                     | (0.15      | )                                   | $          | 0.37 |   | $ | (0.36 | ) | $ | 0.49 |   |

 

Diluted earnings pershare represent the potential dilution that could occur if all dilutivesecurities outstanding were exercised. Certain securities do not have adilutive effect because their exercise price exceeds the fair market value ofthe underlying stock. Such securities are excluded from the diluted earningsper share calculation and consist of the following (in 000s):

** **
| ** **    | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Stock options |       | 3,519                                |       | 3                                  |       | 3,378 |   | 56 |   |
|          |       |                                 |       |                               |       |   |   |   |   |
| Warrants      |       | 100                                  |       | —                             |       | 100 |   | — |   |
|          |       | 3,619                                |       | 3                                  |       | 3,478 |   | 56 |   |

 

For the three and sixmonth periods ended December 31, 2004, a total of 1.2 million in-the-moneyoptions and 0.5 million restricted stock units were also excluded from thedilutive earnings per share calculation as they are antidilutive given thereported net loss for these periods.

 

During the quarter endedDecember 31, 2004 the Company granted an additional 156,507 restricted stockunits valued at $1.9 million.  Therestricted stock units vest on October 1, 2010; however, vesting could beaccelerated under certain circumstances. The $1.9 million has been deferred, and will be amortized ascompensation expense over three years.

 

**12.****                               SEGMENTSAND GEOGRAPHICAL INFORMATION**

 

The Company currentlyoperates in two business segments (exclusive of the business segments includedin discontinued operations): (i) Gaming Equipment and Systems which designs,manufactures and distributes gaming machines and computerized monitoringsystems for gaming machines, and (ii) Casino Operations which currently ownsand operates a casino in Vicksburg, Mississippi. The accounting policies ofthese segments are consistent with Company’s policies for the ConsolidatedFinancial Statements.

 

The table below presentsinformation as to the Company’s revenues and operating income by segment (in000s):

 

14

----

 
| ** **                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                           |       |                                 |       |                               |       |   |   |   |   |
| Revenues:                      |       |                                 |       |                               |       |   |   |   |   |
| Gaming Equipment  and Systems  |       | $                                    | 100,933    |                               | $          | 96,319 |   | $ | 205,010 |   | $ | 184,787 |   |
| Casino  Operations             |       | 12,769                               |       | 12,312                             |       | 25,605 |   | 25,067 |   |
| Total revenues                 |       | $                                    | 113,702    |                               | $          | 108,631 |   | $ | 230,615 |   | 209,854 |   |
| Intersegment  revenues:        |       |                                 |       |                               |       |   |   |   |   |
| Gaming Equipment  and Systems  |       | $                                    | 84         |                               | $          | 212 |   | $ | 256 |   | $ | 341 |   |
|                           |       |                                 |       |                               |       |   |   |   |   |
| Operating income  (loss):      |       |                                 |       |                               |       |   |   |   |   |
| Gaming Equipment  and Systems  |       | $                                    | (6,840     | )                                  | $          | 27,217 |   | $ | (11,327 | ) | $ | 48,575 |   |
| Casino  Operations             |       | 4,082                                |       | 3,814                              |       | 7,878 |   | 7,828 |   |
| Corporate/other                |       | (4,895                               | )          | (3,497                             | )          | (10,632 | ) | (6,936 | ) |
| Total operating  income (loss) |       | $                                    | (7,653     | )                                  | $          | 27,534 |   | $ | (14,081 | ) | $ | 49,467 |   |

 

TheCompany has operations based primarily in the United States with sales anddistribution offices in Europe and South America.

 

The table below presentsinformation as to the Company’s revenues, operating income, identifiableassets, capital expenditures and depreciation and amortization by geographicregion (in 000s):

 
| ** **                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                           |       |                                 |       |                               |       |   |   |   |   |
| Revenues                       |       |                                 |       |                               |       |   |   |   |   |
| United States                  |       | $                                    | 106,589    |                               | $          | 97,728 |   | $ | 218,271 |   | $ | 190,340 |   |
| Germany                        |       | 1,482                                |       | 5,762                              |       | 2,658 |   | 11,794 |   |
| Other foreign                  |       | 5,631                                |       | 5,141                              |       | 9,686 |   | 7,720 |   |
| Total revenues                 |       | $                                    | 113,702    |                               | $          | 108,631 |   | $ | 230,615 |   | $ | 209,854 |   |
|                           |       |                                 |       |                               |       |   |   |   |   |
| Operating income  (loss)       |       |                                 |       |                               |       |   |   |   |   |
| United States                  |       | $                                    | (5,772     | )                                  | $          | 25,814 |   | $ | (13,168 | ) | $ | 48,693 |   |
| Germany                        |       | (924                                 | )          | 926                                |       | (401 | ) | 1,024 |   |
| Other foreign                  |       | (957                                 | )          | 794                                |       | (512 | ) | (250 | ) |
| Total operating  income (loss) |       | $                                    | (7,653     | )                                  | $          | 27,534 |   | $ | (14,081 | ) | $ | 49,467 |   |

 

**13.****       SUPPLEMENTALCASH FLOW INFORMATION**

 

The followingsupplemental information is related to the consolidated statements of cashflows (in 000s).

 
| ** **                                             | ** ** | **Six Months Ended   December 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Cash paid for  interest                                |       | $                                   | 7,271      |   | $ | 15,227 |   |
| Cash paid for  income taxes                            |       | 3,057                               |       | 1,638 |   |
|                                                   |       |                                |       |   |   |
| Non-cash  investing and financing transactions:        |       |                                |       |   |   |
| Reclassify  property, plant and equipment to inventory |       | $                                   | 3,423      |   | $ | 2,517 |   |
| Unfavorable  translation rate adjustment               |       | $                                   | 493        |   | $ | (2,524 | ) |
| Note payable  issued in acquisition                    |       | $                                   | 28,000     |   | $ | — |   |

 

15

----

**14. RESTRUCTURING CHARGE**

 

The Company undertook anextensive review of its operations and accordingly reduced its workforce whichresulted in a restructuring charge and related accrued liability totaling $1.4million as of and for the quarter ended September 30, 2004.  As of December 31, 2004, no additionalrestructuring charges have been incurred; however, additional staff reductionsmade subsequent to December 31, 2004 are intended to further this expensereduction effort and will result in an additional restructuring charge to bereported in the subsequent quarter.  Thebalance of the accrued liability for unpaid severance costs totaled $0.6million as of December 31, 2004.

 

**15.****       COMMITMENTSAND CONTINGENCIES**

 

On February 19, 2004, theCompany completed the acquisition of MindPlay LLC.  Additional consideration may become payablein cash over the next 13 years upon the MindPlay business unit achievingcertain significant revenue and gross margin targets.  The additional consideration that may becomepayable will be recorded as an additional cost of the acquired entity.

 

In June and July 2004,purported class actions were filed against Alliance Gaming Corporation and itsofficers, Robert Miodunski (the Company’s former Chief Executive Officer),Robert Saxton, Mark Lerner, and Steven Des Champs, in the Federal DistrictCourt for the District of Nevada.  Thenearly identical complaints allege violations of the Securities Exchange Act of1934 stemming from the revision of earnings guidance, and declines in the stockprice.  The plaintiffs’ motions toconsolidate the cases and appoint lead plaintiff counsel are pending and arecustomary in such cases.  The next stepwill be for the plaintiffs to file a consolidated complaint.  The Company believes the lawsuits are withoutmerit and intends to vigorously defend the action.  In addition, in July 2004 two derivativelawsuits were filed in Nevada state court against the members of the board ofdirectors and the officers listed above. The Company is named as a nominal defendant in the derivative lawsuitsas the claims are purportedly asserted for the benefit of the Company.  These lawsuits assert claims for breach offiduciary duty and waste of corporate assets arising out of the same events asthose giving rise to the class actions described above.  These two cases have also been consolidated,and a consolidated complaint has been filed. The defendants’ motions to dismiss or to stay were heard in January 2005and taken under submission by the court.

 

In February 2005, theSecurities and Exchange Commission (the “SEC”) requested documents andinformation regarding matters  related tothe allegations in the class actions and similar matters.  Management is cooperating fully with the SECin this matter.

 

A lawsuit filed againstthe Company in August 2004 by Shuffle Master, Inc. in the U.S. District Court,District of Nevada, alleging infringement of various patents is in thediscovery phase.  A patent infringementlawsuit filed against the Company in December 2004 by IGT in the U.S. DistrictCourt, District of Nevada, is in the pleadings phase.  The Company is vigorously defending bothlawsuits.

 

In September 2004, afederal district court jury entered a $7.4 million verdict against the Companyin a suit filed by Action Gaming, Inc., and IGT. The suit alleged that themulti-hand video poker game deployed by the Company’s former subsidiary, UnitedCoin Machine Co., infringed the plaintiffs’ patents. The district court hadruled on summary judgment that the game does not infringe the patents. However,the court left to the jury the question whether the use of “autohold,” aspecific, optional feature of the game, caused it to infringe under the“doctrine of equivalents,” a doctrine of patent law. After a two-week trial,the jury determined that the game with the autohold option enabled did infringeunder the doctrine of equivalents and awarded damages accordingly. The featurehas been disabled on all affected games in the field, and the decision permitscontinued deployment of the game as long as the autohold feature is notincluded. The Company is pursuing various remedies and has posted a cash bondtotaling $7.4 million to stay payment of the judgment pending post-trialmotions and appeal. The cash bond is included in other non-current assets andthe accrued liability is included in accrued liabilities in the accompanyingbalance sheet.  The expense for thischarge is included in discontinued operations in the accompanying statement ofoperations.

 

The Company is also aparty to various lawsuits relating to routine matters incidental to itsbusiness.  Management does not believethat the outcome of such litigation, in the aggregate, will have a material adverseeffect on the Company’s financial position or results of operations.

 

Management believes thatcash flows from current operating activities and the limited availability underthe revolving credit facility will provide the Company with sufficient capitalresources and liquidity.  At December 31,2004 the Company had no significant material purchase commitments for capitalexpenditures.

 

**16.****       UNAUDITEDCONSOLIDATING FINANCIAL STATEMENTS**

 

The following unauditedcondensed consolidating financial statements are presented to provide certainfinancial information regarding guaranteeing and non-guaranteeing subsidiariesin relation to the Company’s bank credit agreement. The financial informationpresented includes Alliance Gaming Corporation (the “Parent”), its wholly-ownedguaranteeing subsidiaries (“Guaranteeing Subsidiaries”), and thenon-guaranteeing subsidiaries the Rainbow Casino Vicksburg Partnership, L.P.(dba Rainbow Casino) and the Company’s non-domestic subsidiaries (together the “Non-GuaranteeingSubsidiaries”). The notes to the unaudited consolidating financial statementsshould be read in conjunction with these unaudited consolidating financialstatements.

 

16

----

 

#### **UNAUDITED CONSOLIDATING BALANCE SHEETS**

December 31, 2004

(In 000s)

 
| ** **                                     | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance Gaming  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------|------------|
| ASSETS                                         |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Current assets:                                |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Cash and cash equivalents                      |       | $          | 18,992     |                           | $          | 1,196                                |       | $                                           | 7,776      |                                                | $          | — |   | $ | 27,964 |   |
| Accounts and  notes receivable, net            |       | 1,730      |       | 85,649                         |       | 16,901                               |       | (679                                        | )          | 103,601                                             |       |
| Inventories, net                               |       | —     |       | 63,789                         |       | 8,787                                |       | (114                                        | )          | 72,462                                              |       |
| Deferred tax  assets, net                      |       | 1,461      |       | 18,521                         |       | —                               |       | —                                      |       | 19,982                                              |       |
| Other current  assets                          |       | 4,063      |       | 14,297                         |       | 1,220                                |       | —                                      |       | 19,580                                              |       |
| Total current  assets                          |       | 26,246     |       | 183,452                        |       | 34,684                               |       | (793                                        | )          | 243,589                                             |       |
| Long-term  investment (restricted)             |       | —     |       | 8,542                          |       | —                               |       | —                                      |       | 8,542                                               |       |
| Long-term  receivables, net                    |       | 263,626    |       | 6,449                          |       | 22                                   |       | (261,340                                    | )          | 8,757                                               |       |
| Net investment  in leases                      |       | —     |       | 12,626                         |       | —                               |       | —                                      |       | 12,626                                              |       |
| Leased gaming  equipment, net                  |       | —     |       | 48,216                         |       | (3,943                               | )          | —                                      |       | 44,273                                              |       |
| Property, plant  and equipment, net            |       | 74         |       | 33,508                         |       | 43,072                               |       | —                                      |       | 76,654                                              |       |
| Goodwill, net                                  |       | (900       | )          | 160,273                        |       | 18,588                               |       | —                                      |       | 177,961                                             |       |
| Intangible  assets, net                        |       | 5,732      |       | 49,279                         |       | 4,463                                |       | —                                      |       | 59,474                                              |       |
| Investments in  subsidiaries                   |       | 362,983    |       | 69,363                         |       | —                               |       | (432,346                                    | )          | —                                              |       |
| Deferred tax  assets, net                      |       | 6,102      |       | —                         |       | —                               |       | (6,102                                      | )          | —                                              |       |
| Other assets,  net                             |       | (109,868   | )          | 144,035                        |       | (18,850                              | )          | (31                                         | )          | 15,286                                              |       |
|                                           |       | $          | 553,995    |                           | $          | 715,743                              |       | $                                           | 78,036     |                                                | $          | (700,612 | ) | $ | 647,162 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY     |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Current  liabilities:                          |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Accounts payable                               |       | $          | 1,101      |                           | $          | 28,042                               |       | $                                           | 1,335      |                                                | $          | — |   | $ | 30,478 |   |
| Accrued  liabilities                           |       | 16,560     |       | 39,570                         |       | 5,582                                |       | (721                                        | )          | 60,991                                              |       |
| Jackpot  liabilities                           |       | —     |       | 9,950                          |       | 126                                  |       | —                                      |       | 10,076                                              |       |
| Current  maturities of long-term debt          |       | 3,175      |       | 1,865                          |       | —                               |       | —                                      |       | 5,040                                               |       |
| Total current  liabilities                     |       | 20,836     |       | 79,427                         |       | 7,043                                |       | (721                                        | )          | 106,585                                             |       |
|                                           |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Long term debt,  net                           |       | 346,332    |       | 263,548                        |       | —                               |       | (261,340                                    | )          | 348,540                                             |       |
| Deferred tax  liabilities                      |       | —     |       | 4,557                          |       | 1,635                                |       | (6,102                                      | )          | 90                                                  |       |
| Other  liabilities                             |       | 2,574      |       | 4,411                          |       | —                               |       | —                                      |       | 6,985                                               |       |
| Minority  interest                             |       | 454        |       | 709                            |       | —                               |       | —                                      |       | 1,163                                               |       |
| Total  liabilities                             |       | 370,196    |       | 352,652                        |       | 8,678                                |       | (268,163                                    | )          | 463,363                                             |       |
|                                           |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Commitments and  contingencies                 |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Stockholders’  equity:                    |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Special stock  Series E                        |       | 12         |       | —                         |       | —                               |       | —                                      |       | 12                                                  |       |
| Common stock                                   |       | 5,158      |       | 109                            |       | 1,027                                |       | (1,136                                      | )          | 5,158                                               |       |
| Treasury stock                                 |       | (665       | )          | —                         |       | —                               |       | —                                      |       | (665                                                | )          |
| Deferred  compensation                         |       | (7,858     | )          | —                         |       | —                               |       | —                                      |       | (7,858                                              | )          |
| Additional  paid-in capital                    |       | 196,872    |       | 299,667                        |       | 31,959                               |       | (331,626                                    | )          | 196,872                                             |       |
| Accumulated  other comprehensive income (loss) |       | 1,518      |       | 1,521                          |       | 3,448                                |       | (4,969                                      | )          | 1,518                                               |       |
| Retained earnings  (accumulated deficit)       |       | (11,238    | )          | 61,794                         |       | 32,924                               |       | (94,718                                     | )          | (11,238                                             | )          |
| Total  stockholders’ equity               |       | 183,799    |       | 363,091                        |       | 69,358                               |       | (432,449                                    | )          | 183,799                                             |       |
|                                           |       | $          | 553,995    |                           | $          | 715,743                              |       | $                                           | 78,036     |                                                | $          | (700,612 | ) | $ | 647,162 |   |

 

See accompanyingunaudited note.

 

17

----

 

**UNAUDITED CONSOLIDATING BALANCE SHEETS**

June 30, 2004

(In 000s)

 
| ** **                                            | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance Gaming  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------|------------|
| ASSETS                                                |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Current assets:                                       |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Cash and cash  equivalents                            |       | $          | 155,347    |                           | $          | 7,742                                |       | $                                           | 9,637      |                                                | —     |   | $ | 172,726 |   |
| Accounts and  notes receivable, net                   |       | 1,806      |       | 110,693                        |       | 17,984                               |       | (704                                        | )          | 129,779                                             |       |
| Inventories, net                                      |       | —     |       | 55,125                         |       | 6,161                                |       | (151                                        | )          | 61,135                                              |       |
| Deferred tax  assets, net                             |       | 1,461      |       | 18,593                         |       | —                               |       | —                                      |       | 20,054                                              |       |
| Other current  assets                                 |       | 744        |       | 10,531                         |       | 1,145                                |       | —                                      |       | 12,420                                              |       |
| Total current  assets                                 |       | 159,358    |       | 202,684                        |       | 34,927                               |       | (855                                        | )          | 396,114                                             |       |
| Long-term  investment (restricted)                    |       | —     |       | 2,528                          |       | —                               |       | —                                      |       | 2,528                                               |       |
| Long-term  receivables, net                           |       | 254,862    |       | 9,789                          |       | 22                                   |       | (252,155                                    | )          | 12,518                                              |       |
| Net investment  in leases                             |       | —     |       | 5,614                          |       | —                               |       | —                                      |       | 5,614                                               |       |
| Leased gaming  equipment, net                         |       | —     |       | 50,664                         |       | (4,030                               | )          | —                                      |       | 46,634                                              |       |
| Property, plant  and equipment, net                   |       | 70         |       | 33,299                         |       | 42,469                               |       | —                                      |       | 75,838                                              |       |
| Goodwill, net                                         |       | (900       | )          | 119,715                        |       | 18,174                               |       | —                                      |       | 136,989                                             |       |
| Intangible  assets, net                               |       | 5,899      |       | 52,958                         |       | 4,766                                |       | —                                      |       | 63,623                                              |       |
| Investments in  subsidiaries                          |       | 345,560    |       | 74,234                         |       | —                               |       | (419,794                                    | )          | —                                              |       |
| Deferred tax  assets, net                             |       | 5,342      |       | —                         |       | —                               |       | (5,342                                      | )          | —                                              |       |
| Assets of  discontinued operations held for sale      |       | 39         |       | —                         |       | 4,403                                |       | —                                      |       | 4,442                                               |       |
| Other assets,  net                                    |       | (122,036   | )          | 143,833                        |       | (15,443                              | )          | —                                      |       | 6,354                                               |       |
|                                                  |       | $          | 648,194    |                           | $          | 695,318                              |       | $                                           | 85,288     |                                                | $          | (678,146 | ) | $ | 750,654 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY            |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Current  liabilities:                                 |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Accounts payable                                      |       | $          | 974        |                           | $          | 34,017                               |       | $                                           | 2,524      |                                                | —     |   | $ | 37,515 |   |
| Accrued  liabilities                                  |       | 9,744      |       | 37,391                         |       | 5,052                                |       | (718                                        | )          | 51,469                                              |       |
| Jackpot  liabilities                                  |       | —     |       | 11,934                         |       | 141                                  |       | —                                      |       | 12,075                                              |       |
| Income taxes  payable                                 |       | 5,538      |       | 1,140                          |       | 555                                  |       | —                                      |       | 7,233                                               |       |
| Current  maturities of long-term debt                 |       | 3,313      |       | 2,553                          |       | —                               |       | —                                      |       | 5,866                                               |       |
| Liabilities of  discontinued operations held for sale |       | 3,185      |       | —                         |       | 1,152                                |       | —                                      |       | 4,337                                               |       |
| Total current  liabilities                            |       | 22,754     |       | 87,035                         |       | 9,424                                |       | (718                                        | )          | 118,495                                             |       |
| Long term debt,  net                                  |       | 420,687    |       | 254,391                        |       | —                               |       | (251,989                                    | )          | 423,089                                             |       |
| Deferred tax  liabilities                             |       | —     |       | 4,556                          |       | 1,635                                |       | (5,342                                      | )          | 849                                                 |       |
| Other  liabilities                                    |       | 2,624      |       | 3,468                          |       | —                               |       | —                                      |       | 6,092                                               |       |
| Minority  interest                                    |       | 1,326      |       | —                         |       | —                               |       | —                                      |       | 1,326                                               |       |
| Total liabilities                                     |       | 447,391    |       | 349,450                        |       | 11,059                               |       | (258,049                                    | )          | 549,851                                             |       |
| Commitments and  contingencies                        |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Stockholders’  equity:                           |       |       |       |                           |       |                                 |       |                                        |       |                                                |       |
| Special stock  Series E                               |       | 12         |       | —                         |       | —                               |       | —                                      |       | 12                                                  |       |
| Common stock                                          |       | 5,145      |       | 109                            |       | 1,027                                |       | (1,136                                      | )          | 5,145                                               |       |
| Treasury stock                                        |       | (501       | )          | —                         |       | —                               |       | —                                      |       | (501                                                | )          |
| Deferred  compensation                                |       | (6,500     | )          | —                         |       | —                               |       | —                                      |       | (6,500                                              | )          |
| Additional  paid-in capital                           |       | 194,040    |       | 260,813                        |       | 33,415                               |       | (294,228                                    | )          | 194,040                                             |       |
| Accum . other  comprehensive inc (loss)               |       | 1,524      |       | 1,527                          |       | 2,713                                |       | (4,240                                      | )          | 1,524                                               |       |
| Retained earnings  (accumulated deficit)              |       | 7,083      |       | 83,419                         |       | 37,074                               |       | (120,493                                    | )          | 7,083                                               |       |
| Total  stockholders’ equity                      |       | 200,803    |       | 345,868                        |       | 74,229                               |       | (420,097                                    | )          | 200,803                                             |       |
|                                                  |       | $          | 648,194    |                           | $          | 695,318                              |       | $                                           | 85,288     |                                                | $          | (678,146 | ) | $ | 750,654 |   |

 

See accompanyingunaudited note.

 

18

----

 

**UNAUDITED****CONSOLIDATING STATEMENTS OF OPERATIONS**

Three Months Ended December 31, 2004

(In 000s)

** **
| ** **                                        | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  And  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
| Revenues:                                         |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Gaming equipment  and systems                     |       | $          | —     |                           | $          | 98,324                               |       | $                                           | 7,113      |                                                 | $          | (4,504 | ) | $ | 100,933 |   |
| Casino  operations                                |       | —     |       | —                         |       | 13,955                               |       | (1,186                                      | )          | 12,769                                               |       |
|                                              |       | —     |       | 98,324                         |       | 21,068                               |       | (5,690                                      | )          | 113,702                                              |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Costs and  expenses:                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Cost of gaming  equipment and systems             |       | —     |       | 52,896                         |       | 5,169                                |       | (4,728                                      | )          | 53,337                                               |       |
| Cost of casino  operations                        |       | —     |       | —                         |       | 4,589                                |       | —                                      |       | 4,589                                                |       |
| Selling, general  and administrative              |       | 4,564      |       | 29,738                         |       | 7,934                                |       | (1,185                                      | )          | 41,051                                               |       |
| Research and  development costs                   |       | —     |       | 10,269                         |       | 89                                   |       | —                                      |       | 10,358                                               |       |
| Depreciation and  amortization                    |       | 330        |       | 10,603                         |       | 1,087                                |       | —                                      |       | 12,020                                               |       |
|                                              |       | 4,894      |       | 103,506                        |       | 18,868                               |       | (5,913                                      | )          | 121,355                                              |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Operating income  (loss)                          |       | (4,894     | )          | (5,182                         | )          | 2,200                                |       | 223                                         |       | (7,653                                               | )          |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Earnings in  consolidated subsidiaries            |       | (8,512     | )          | 879                            |       | —                               |       | 7,633                                       |       | —                                               |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Other income  (expense):                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Interest income                                   |       | 4,875      |       | 66                             |       | 69                                   |       | (4,692                                      | )          | 318                                                  |       |
| Interest expense                                  |       | (3,672     | )          | (4,767                         | )          | (3                                   | )          | 4,692                                       |       | (3,750                                               | )          |
| Rainbow royalty                                   |       | 1,592      |       | —                         |       | (1,592                               | )          | —                                      |       | —                                               |       |
| Minority  interest                                |       | (430       | )          | (715                           | )          | —                               |       | —                                      |       | (1,145                                               | )          |
| Refinancing /  bank amendment charges             |       | (564       | )          | —                         |       | —                               |       | —                                      |       | (564                                                 | )          |
| Other, net                                        |       | 533        |       | 20                             |       | (178                                 | )          | —                                      |       | 375                                                  |       |
| Income (loss)  from cont oper before income taxes |       | (11,072    | )          | (9,699                         | )          | 496                                  |       | 7,856                                       |       | (12,419                                              | )          |
| Income tax  expense (benefit)                     |       | (3,532     | )          | (963                           | )          | (384                                 | )          | —                                      |       | (4,879                                               | )          |
| Net income  (loss) from continuing operations     |       | (7,540     | )          | (8,736                         | )          | 880                                  |       | 7,856                                       |       | (7,540                                               | )          |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Income (loss)  from discontinued operations       |       | 15         |       | (310                           | )          | (49                                  | )          | 359                                         |       | 15                                                   |       |
| Net income  (loss)                                |       | $          | (7,525     | )                              | $          | (9,046                               | )          | $                                           | 831        |                                                 | $          | 8,215 |   | $ | (7,525 | ) |

 

See accompanyingunaudited note.

 

19

----

 

**UNAUDITED****CONSOLIDATING STATEMENTS OF OPERATIONS**

Three Months Ended December 31, 2003

(In 000s)

** **
| ** **                                        | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
| Revenues:                                         |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Gaming equipment  and systems                     |       | $          | —     |                           | $          | 92,361                               |       | $                                           | 10,902     |                                                 | $          | (6,944 | ) | $ | 96,319 |   |
| Casino  operations                                |       | —     |       | —                         |       | 13,758                               |       | (1,446                                      | )          | 12,312                                               |       |
|                                              |       | —     |       | 92,361                         |       | 24,660                               |       | (8,390                                      | )          | 108,631                                              |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Costs and  expenses:                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Cost of gaming  equipment and systems             |       | —     |       | 39,293                         |       | 6,371                                |       | (6,884                                      | )          | 38,780                                               |       |
| Cost of casino  operations                        |       | —     |       | —                         |       | 4,884                                |       | —                                      |       | 4,884                                                |       |
| Selling, general  and administrative              |       | 3,124      |       | 13,023                         |       | 6,847                                |       | (1,446                                      | )          | 21,548                                               |       |
| Research and  development costs                   |       | —     |       | 9,287                          |       | 153                                  |       | —                                      |       | 9,440                                                |       |
| Depreciation and  amortization                    |       | 373        |       | 5,196                          |       | 876                                  |       | —                                      |       | 6,445                                                |       |
|                                              |       | 3,497      |       | 66,799                         |       | 19,131                               |       | (8,330                                      | )          | 81,097                                               |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Operating income  (loss)                          |       | (3,497     | )          | 25,562                         |       | 5,529                                |       | (60                                         | )          | 27,534                                               |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Earnings in  consolidated subsidiaries            |       | 25,005     |       | 3,156                          |       | —                               |       | (28,161                                     | )          | —                                               |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Other income  (expense):                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Interest income                                   |       | 3,107      |       | 5                              |       | 3                                    |       | (3,032                                      | )          | 83                                                   |       |
| Interest expense                                  |       | (3,805     | )          | (3,081                         | )          | (15                                  | )          | 3,032                                       |       | (3,869                                               | )          |
| Rainbow royalty                                   |       | 1,541      |       | —                         |       | (1,541                               | )          | —                                      |       | —                                               |       |
| Minority  interest                                |       | (541       | )          | —                         |       | —                               |       | —                                      |       | (541                                                 | )          |
| Other, net                                        |       | 126        |       | (190                           | )          | (481                                 | )          | —                                      |       | (545                                                 | )          |
| Income (loss)  from cont oper before income taxes |       | 21,936     |       | 25,452                         |       | 3,495                                |       | (28,221                                     | )          | 22,662                                               |       |
| Income tax  expense (benefit)                     |       | 7,718      |       | 387                            |       | 339                                  |       | —                                      |       | 8,444                                                |       |
| Net income  (loss) from continuing operations     |       | 14,218     |       | 25,065                         |       | 3,156                                |       | (28,221                                     | )          | 14,218                                               |       |
|                                              |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Income (loss)  from discontinued operations       |       | 4,526      |       | 4,526                          |       | 420                                  |       | (4,946                                      | )          | 4,526                                                |       |
| Net income  (loss)                                |       | $          | 18,744     |                           | $          | 29,591                               |       | $                                           | 3,576      |                                                 | $          | (33,167 | ) | $ | 18,744 |   |

 

See accompanyingunaudited note.

 

20

----

 

**UNAUDITED****CONSOLIDATING STATEMENTS OFOPERATIONS**

Six Months Ended December 31, 2004

(In 000s)

** **
| ** **                                                    | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Revenues:                                                     |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Gaming equipment  and systems                                 |       | $          | —     |                           | $          | 201,418                              |       | $                                           | 12,344     |                                                 | $          | (8,752 | ) | $ | 205,010 |   |
| Casino  operations                                            |       | —     |       | —                         |       | 28,213                               |       | (2,608                                      | )          | 25,605                                               |       |
|                                                          |       | —     |       | 201,418                        |       | 40,557                               |       | (11,360                                     | )          | 230,615                                              |       |
| Costs and  expenses:                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Cost of gaming  equipment and systems                         |       | —     |       | 105,098                        |       | 7,862                                |       | (8,787                                      | )          | 104,173                                              |       |
| Cost of casino  operations                                    |       | —     |       | —                         |       | 9,391                                |       | —                                      |       | 9,391                                                |       |
| Selling, general  and administrative                          |       | 8,544      |       | 62,877                         |       | 15,893                               |       | (2,608                                      | )          | 84,706                                               |       |
| Research and  development costs                               |       | —     |       | 21,938                         |       | 192                                  |       | —                                      |       | 22,130                                               |       |
| Restructuring  charge                                         |       | 1,435      |       | —                         |       | —                               |       | —                                      |       | 1,435                                                |       |
| Depreciation and  amortization                                |       | 653        |       | 20,072                         |       | 2,136                                |       | —                                      |       | 22,861                                               |       |
|                                                          |       | 10,632     |       | 209,985                        |       | 35,474                               |       | (11,395                                     | )          | 244,696                                              |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Operating income  (loss)                                      |       | (10,632    | )          | (8,567                         | )          | 5,083                                |       | 35                                          |       | (14,081                                              | )          |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Earnings in  consolidated subsidiaries                        |       | (15,112    | )          | 2,328                          |       | —                               |       | 12,784                                      |       | —                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Other income  (expense):                                      |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Interest income                                               |       | 9,882      |       | 74                             |       | 193                                  |       | (9,351                                      | )          | 798                                                  |       |
| Interest expense                                              |       | (7,557     | )          | (9,500                         | )          | (6                                   | )          | 9,351                                       |       | (7,712                                               | )          |
| Rainbow royalty                                               |       | 3,205      |       | —                         |       | (3,205                               | )          | —                                      |       | —                                               |       |
| Minority  interest                                            |       | (929       | )          | (715                           | )          | —                               |       | —                                      |       | (1,644                                               | )          |
| Refinancing /  bank amendment charge                          |       | (564       | )          | —                         |       | —                               |       | —                                      |       | (564                                                 | )          |
| Other, net                                                    |       | 673        |       | (24                            | )          | (121                                 | )          | —                                      |       | 528                                                  |       |
| Income (loss) from  continuing operations before income taxes |       | (21,034    | )          | (16,404                        | )          | 1,944                                |       | 12,819                                      |       | (22,675                                              | )          |
| Income tax  expense (benefit)                                 |       | (7,089     | )          | (1,257                         | )          | (384                                 | )          | —                                      |       | (8,730                                               | )          |
| Net income  (loss) from continuing operations                 |       | (13,945    | )          | (15,147                        | )          | 2,328                                |       | 12,819                                      |       | (13,945                                              | )          |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Income (loss)  from discontinued operations                   |       | (4,376     | )          | 261                            |       | 261                                  |       | (522                                        | )          | (4,376                                               | )          |
| Net income  (loss)                                            |       | $          | (18,321    | )                              | $          | (14,886                              | )          | $                                           | 2,589      |                                                 | $          | 12,297 |   | $ | (18,321 | ) |

 

See accompanyingunaudited note.

 

21

----

 

**UNAUDITED****CONSOLIDATING STATEMENTS OFOPERATIONS**

Six Months Ended December 31, 2003

(In 000s)

 
| ** **                                                    | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Revenues:                                                     |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Gaming equipment  and systems                                 |       | $          | —     |                           | $          | 177,370                              |       | $                                           | 19,514     |                                                 | $          | (12,097 | ) | $ | 184,787 |   |
| Casino  operations                                            |       | —     |       | —                         |       | 27,997                               |       | (2,930                                      | )          | 25,067                                               |       |
|                                                          |       | —     |       | 177,370                        |       | 47,511                               |       | (15,027                                     | )          | 209,854                                              |       |
| Costs and  expenses:                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Cost of gaming  equipment and systems                         |       | —     |       | 71,981                         |       | 11,956                               |       | (11,920                                     | )          | 72,017                                               |       |
| Cost of casino  operations                                    |       | —     |       | —                         |       | 9,887                                |       | —                                      |       | 9,887                                                |       |
| Selling, general  and administrative                          |       | 6,057      |       | 34,235                         |       | 13,251                               |       | (2,930                                      | )          | 50,613                                               |       |
| Research and  development costs                               |       | —     |       | 15,028                         |       | 375                                  |       | —                                      |       | 15,403                                               |       |
| Depreciation and  amortization                                |       | 879        |       | 9,865                          |       | 1,723                                |       | —                                      |       | 12,467                                               |       |
|                                                          |       | 6,936      |       | 131,109                        |       | 37,192                               |       | (14,850                                     | )          | 160,387                                              |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Operating income  (loss)                                      |       | (6,936     | )          | 46,261                         |       | 10,319                               |       | (177                                        | )          | 49,467                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Earnings in  consolidated subsidiaries                        |       | 44,757     |       | 5,725                          |       | —                               |       | (50,482                                     | )          | —                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Other income  (expense):                                      |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Interest income                                               |       | 6,177      |       | 5                              |       | 8                                    |       | (6,064                                      | )          | 126                                                  |       |
| Interest expense                                              |       | (9,466     | )          | (6,165                         | )          | (31                                  | )          | 6,064                                       |       | (9,598                                               | )          |
| Rainbow royalty                                               |       | 3,134      |       | —                         |       | (3,134                               | )          | —                                      |       | —                                               |       |
| Minority  interest                                            |       | (1,027     | )          | —                         |       | —                               |       | —                                      |       | (1,027                                               | )          |
| Refinancing /  bank amendment charges                         |       | (12,293    | )          | —                         |       | —                               |       | —                                      |       | (12,293                                              | )          |
| Other, net                                                    |       | 235        |       | (387                           | )          | (747                                 | )          | —                                      |       | (899                                                 | )          |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Income (loss)  from continuing operations before income taxes |       | 24,581     |       | 45,439                         |       | 6,415                                |       | (50,659                                     | )          | 25,776                                               |       |
| Income tax  expense (benefit)                                 |       | 8,515      |       | 505                            |       | 690                                  |       | —                                      |       | 9,710                                                |       |
| Net income  (loss) from continuing operations                 |       | 16,066     |       | 44,934                         |       | 5,725                                |       | (50,659                                     | )          | 16,066                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                        |       |                                                 |       |
| Income (loss)  from discontinued operations                   |       | 8,706      |       | 8,706                          |       | 730                                  |       | (9,436                                      | )          | 8,706                                                |       |
| Net income  (loss)                                            |       | $          | 24,772     |                           | $          | 53,640                               |       | $                                           | 6,455      |                                                 | $          | (60,095 | ) | $ | 24,772 |   |

 

See accompanyingunaudited note.

 

22

----

 

**UNAUDITED****CONSOLIDATING STATEMENTS OF CASHFLOWS**

Six Months Ended December 31, 2004

(000s)

 
| ** **                                                                                                                    | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Elimi-  nations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Cash flows from  operating activities of continuing operations:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net income (loss)                                                                                                             |       | $          | (18,321    | )                              | $          | (14,886                              | )          | $                                              | 2,589      |                                                 | $          | 12,297 |   | $ | (18,321 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided By (used in) operating  activities of continuing operations: |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| (Income) loss  from discontinued operations                                                                                   |       | 4,376      |       | (261                           | )          | (261                                 | )          | 522                                            |       | 4,376                                                |       |
| Depreciation and  amortization                                                                                                |       | 653        |       | 20,072                         |       | 2,136                                |       | —                                         |       | 22,861                                               |       |
| Stock–based  compensation                                                                                                |       | 542        |       | —                         |       | —                               |       | —                                         |       | 542                                                  |       |
| Refinancing /  bank amendment charges                                                                                         |       | 564        |       | —                         |       | —                               |       | —                                         |       | 564                                                  |       |
| Deferred income  taxes                                                                                                        |       | (760       | )          | 73                             |       | —                               |       | —                                         |       | (687                                                 | )          |
| Provision for  losses on receivables                                                                                          |       | —     |       | 5,028                          |       | 126                                  |       | —                                         |       | 5,154                                                |       |
| Inventory and  other discontinued assets write-downs                                                                          |       | —     |       | 14,088                         |       | —                               |       | —                                         |       | 14,088                                               |       |
| Other                                                                                                                         |       | (9,699     | )          | (1,203                         | )          | (703                                 | )          | —                                         |       | (11,605                                              | )          |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Change in  operating assets and liabilities, net of effects of business acquired:                                             |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts and  notes receivable                                                                                                |       | 665        |       | 15,647                         |       | 1,017                                |       | (191                                           | )          | 17,138                                               |       |
| Intercompany  accounts                                                                                                        |       | (8,369     | )          | 17,550                         |       | 3,407                                |       | (12,588                                        | )          | —                                               |       |
| Inventories                                                                                                                   |       | —     |       | (14,826                        | )          | (2,593                               | )          | (37                                            | )          | (17,456                                              | )          |
| Other current  assets                                                                                                         |       | (430       | )          | (3,833                         | )          | (73                                  | )          | —                                         |       | (4,336                                               | )          |
| Accounts payable                                                                                                              |       | 125        |       | (6,105                         | )          | (1,189                               | )          | —                                         |       | (7,169                                               | )          |
| Accrued  liabilities and jackpot liabilities                                                                                  |       | (4,846     | )          | (7,967                         | )          | (37                                  | )          | (3                                             | )          | (12,853                                              | )          |
| Net cash provided  by (used in) operating activities of continuing operations                                                 |       | (35,500    | )          | 23,377                         |       | 4,419                                |       | —                                         |       | (7,704                                               | )          |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from  investing activities of continuing operations:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Additions to  property, plant and equipment                                                                                   |       | (16        | )          | (3,426                         | )          | (2,089                               | )          | —                                         |       | (5,531                                               | )          |
| Additions to  leased gaming equipment                                                                                         |       | —     |       | (18,183                        | )          | —                               |       | —                                         |       | (18,183                                              | )          |
| Additions to  other long-term assets                                                                                          |       | —     |       | (1,526                         | )          | 5                                    |       | —                                         |       | (1,521                                               | )          |
| Acquisitions, net  of cash acquired                                                                                           |       | —     |       | (12,000                        | )          | —                               |       | —                                         |       | (12,000                                              | )          |
| Proceeds from  sale of net assets of discontinued operations                                                                  |       | 1,911      |       | —                         |       | —                               |       | —                                         |       | 1,911                                                |       |
| Net cash provided  by (used in) investing activities of continuing operations                                                 |       | 1,895      |       | (35,135                        | )          | (2,084                               | )          | —                                         |       | (35,324                                              | )          |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from  financing activities of continuing operations:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Capitalized debt  issuance costs                                                                                              |       | (1,038     | )          | —                         |       | —                               |       | —                                         |       | (1,038                                               | )          |
| Payoff of debt  due to sale of net assets of discontinued operations                                                          |       | (101,618   | )          | —                         |       | —                               |       | —                                         |       | (101,618                                             | )          |
| Reduction of  long-term debt                                                                                                  |       | (875       | )          | (1,175                         | )          | —                               |       | —                                         |       | (2,050                                               | )          |
| Re-purchase of  treasury shares                                                                                               |       | (164       | )          | —                         |       | —                               |       | —                                         |       | (164                                                 | )          |
| Proceeds from  exercise of stock options and warrants                                                                         |       | 945        |       | —                         |       | —                               |       | —                                         |       | 945                                                  |       |
| Dividends  received (paid)                                                                                                    |       | —     |       | 4,837                          |       | (4,837                               | )          | —                                         |       | —                                               |       |
| Net cash provided  by (used in) financing activities of continuing operations                                                 |       | (102,750   | )          | 3,662                          |       | (4,837                               | )          | —                                         |       | (103,925                                             | )          |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Effect of  exchange rate changes on cash                                                                                      |       | —     |       | —                         |       | 487                                  |       | —                                         |       | 487                                                  |       |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash provided by  discontinued operations                                                                                     |       | —     |       | 1,550                          |       | 154                                  |       | —                                         |       | 1,704                                                |       |
|                                                                                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash and cash  equivalents:                                                                                                   |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Increase for the  period                                                                                                      |       | (136,355   | )          | (6,546                         | )          | (1,861                               | )          | —                                         |       | (144,762                                             | )          |
| Balance,  beginning of period                                                                                                 |       | 155,347    |       | 7,742                          |       | 9,637                                |       | —                                         |       | 172,726                                              |       |
| Balance, end of  period                                                                                                       |       | $          | 18,992     |                           | $          | 1,196                                |       | $                                              | 7,776      |                                                 | $          | — |   | $ | 27,964 |   |

 

See accompanyingunaudited note.

 

23

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**UNAUDITED****CONSOLIDATING STATEMENTS OF CASH FLOWS**

Six Months Ended December 31, 2003

(000s)

 
| ** **                                                                                                          | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Elimi-  nations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Cash flows from  operating activities of continuing operations:                                                     |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net income (loss)                                                                                                   |       | $          | 24,772     |                           | $          | 53,640                               |       | $                                              | 6,455      |                                                 | $          | (60,095 | ) | $ | 24,772 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities of  continuing operations: |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| (Income) loss  from discontinued operations                                                                         |       | (8,706     | )          | (8,706                         | )          | (730                                 | )          | 9,436                                          |       | (8,706                                               | )          |
| Depreciation and  amortization                                                                                      |       | 879        |       | 9,865                          |       | 1,723                                |       | —                                         |       | 12,467                                               |       |
| Refinancing  charge                                                                                                 |       | 12,293     |       | —                         |       | —                               |       | —                                         |       | 12,293                                               |       |
| Deferred income  taxes                                                                                              |       | 8,671      |       | 1,762                          |       | —                               |       | —                                         |       | 10,433                                               |       |
| Provision for  losses on receivables                                                                                |       | —     |       | 505                            |       | 21                                   |       | —                                         |       | 526                                                  |       |
| Other                                                                                                               |       | (99        | )          | (1,006                         | )          | 6                                    |       | —                                         |       | (1,099                                               | )          |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Change in  operating assets and liabilities, net of effects of business acquired:                                   |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts and  notes receivable                                                                                      |       | (1,436     | )          | (492                           | )          | 2                                    |       | (93                                            | )          | (2,019                                               | )          |
| Intercompany  accounts                                                                                              |       | (16,285    | )          | (35,946                        | )          | 1,716                                |       | 50,515                                         |       | —                                               |       |
| Inventories                                                                                                         |       | —     |       | (2,155                         | )          | (515                                 | )          | 177                                            |       | (2,493                                               | )          |
| Other current  assets                                                                                               |       | (440       | )          | (588                           | )          | 5                                    |       | —                                         |       | (1,023                                               | )          |
| Accounts payable                                                                                                    |       | (1,035     | )          | (1,345                         | )          | 308                                  |       | —                                         |       | (2,072                                               | )          |
| Accrued  liabilities and jackpot liabilities                                                                        |       | (8,377     | )          | 4,556                          |       | 837                                  |       | 60                                             |       | (2,924                                               | )          |
| Net cash provided  by operating activities of continuing operations                                                 |       | 10,237     |       | 20,090                         |       | 9,828                                |       | —                                         |       | 40,155                                               |       |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from  investing activities of continuing operations:                                                     |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Advances of notes  receivable due from Sierra Design Group                                                          |       | (61,025    | )          | —                         |       | —                               |       | —                                         |       | (61,025                                              | )          |
| Additions to  property, plant and equipment                                                                         |       | (19        | )          | (1,365                         | )          | (2,431                               | )          | —                                         |       | (3,815                                               | )          |
| Additions to  leased gaming equipment                                                                               |       | —     |       | (14,081                        | )          | (1,876                               | )          | —                                         |       | (15,957                                              | )          |
| Additions to  other long-term assets                                                                                |       | (5,974     | )          | (4,504                         | )          | 64                                   |       | —                                         |       | (10,414                                              | )          |
| Acquisitions, net  of cash acquired                                                                                 |       | —     |       | (3,879                         | )          | —                               |       | —                                         |       | (3,879                                               | )          |
| Proceeds from  sale of net assets of discontinued operations                                                        |       | 16,500     |       | —                         |       | —                               |       | —                                         |       | 16,500                                               |       |
| Net cash used in  investing activities of continuing operations                                                     |       | (50,518    | )          | (23,829                        | )          | (4,243                               | )          | —                                         |       | (78,590                                              | )          |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from  financing activities of continuing operations:                                                     |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Capitalized debt  issuance costs                                                                                    |       | (6,954     | )          | —                         |       | —                               |       | —                                         |       | (6,954                                               | )          |
| Premium paid on  early redemption of debt                                                                           |       | (5,399     | )          | —                         |       | —                               |       | —                                         |       | (5,399                                               | )          |
| Proceeds from  issuance of long-term debt                                                                           |       | 350,000    |       | —                         |       | —                               |       | —                                         |       | 350,000                                              |       |
| Net change of  revolving credit facility                                                                            |       | 70,000     |       | —                         |       | —                               |       | —                                         |       | 70,000                                               |       |
| Payoff of debt  due to sale of net assets of discontinued operations                                                |       | (337,625   | )          | —                         |       | —                               |       | —                                         |       | (337,625                                             | )          |
| Reduction of  long-term debt                                                                                        |       | (495       | )          | (842                           | )          | (12                                  | )          | —                                         |       | (1,349                                               | )          |
| Proceeds from  exercise of stock options and warrants                                                               |       | 2,907      |       | —                         |       | —                               |       | —                                         |       | 2,907                                                |       |
| Dividends  received (paid)                                                                                          |       | —     |       | 6,380                          |       | (6,380                               | )          | —                                         |       | —                                               |       |
| Net cash provided  by (used in) financing activities of continuing operations                                       |       | 72,434     |       | 5,538                          |       | (6,392                               | )          | —                                         |       | 71,580                                               |       |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Effect of  exchange rate changes on cash                                                                            |       | —     |       | —                         |       | 130                                  |       | —                                         |       | 130                                                  |       |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash provided by  discontinued operations                                                                           |       | —     |       | (938                           | )          | 1,033                                |       | —                                         |       | 95                                                   |       |
|                                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash and cash  equivalents:                                                                                         |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Increase for the  period                                                                                            |       | 32,153     |       | 861                            |       | 356                                  |       | —                                         |       | 33,370                                               |       |
| Balance,  beginning of period                                                                                       |       | 12,730     |       | 18,036                         |       | 8,118                                |       | —                                         |       | 38,884                                               |       |
| Balance, end of  period                                                                                             |       | $          | 44,883     |                           | $          | 18,897                               |       | $                                              | 8,474      |                                                 | $          | — |   | $ | 72,254 |   |

 

See accompanyingunaudited note.

 

24

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Debt and Revolving CreditFacility

 

Long-term debt and linesof credit at December 31, 2004 consist of the following (in 000s):

 
| ** **                               | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------|------------|------------|------------|--------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
|                                     |       |       |       |                           |       |                                        |       |                                                 |       |
| Term Loan  Facility                      |       | $          | 317,507    |                           | $          | —                                      |       | $                                                    | —     |   | $ | 317,507 |   |
| Intercompany  notes payable              |       | —     |       | 261,340                        |       | (261,340                                    | )          | —                                               |       |
| Other, generally  unsecured              |       | 32,000     |       | 4,073                          |       | —                                      |       | 36,073                                               |       |
|                                     |       | 349,507    |       | 265,413                        |       | (261,340                                    | )          | 353,580                                              |       |
| Less current  maturities                 |       | 3,175      |       | 1,865                          |       | —                                      |       | 5,040                                                |       |
| Long-term debt,  less current maturities |       | $          | 346,332    |                           | $          | 263,548                                     |       | $                                                    | (261,340   | ) | $ | 348,540 |   |

 

Long-termdebt and lines of credit at June 30, 2004 consist of the following (in 000s):

 
| ** **                               | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Reclass-  ifications  and  Eliminations** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------|------------|------------|------------|--------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
|                                     |       |       |       |                           |       |                                        |       |                                                 |       |
| Term Loan  Facility                      |       | $          | 350,000    |                           |       |                                        |       |                                                 | $          | 350,000 |   |
| Revolving credit  facility               |       | 70,000     |       |                           |       |                                        |       | 70,000                                               |       |
| Intercompany  notes payable              |       |       |       | 251,989                        |       | (251,989                                    | )          |                                                 |       |
| Other, generally  unsecured              |       | 4,000      |       | 4,955                          |       |                                        |       | 8,955                                                |       |
|                                     |       | 424,000    |       | 256,944                        |       | (251,989                                    | )          | 428,955                                              |       |
| Less current  maturities                 |       | 3,313      |       | 2,553                          |       | —                                      |       | 5,866                                                |       |
| Long-term debt,  less current maturities |       | $          | 420,687    |                           | $          | 254,391                                     |       | $                                                    | (251,989   | ) | $ | 423,089 |   |
|                                          |            |            |            |                                |            |                                             |            |                                                      |            |  |  |  |  |

 

25

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**ALLIANCE GAMING CORPORATION**

**FORM 10-Q**

** **

**December 31, 2004**

 

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

 

**Forward-LookingStatements**

 

Certain matters in thisForm 10-Q and our other filings with the Securities and Exchange Commission,including, without limitation, certain matters discussed in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations and inQuantitative and Qualitative Disclosures about Market Risk, constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended,and are subject to the safe harbor created thereby.  Those statementsreflect the intent, belief or current expectations of the Company, itsdirectors or its officers with respect to, among other things, future eventsand financial trends affecting the Company.

 

Forward-lookingstatements are typically identified by the words “believes,” “expects,” “anticipates,”and similar expressions.  In addition, any statements that refer toexpectations or other characterizations of future events or circumstances areforward-looking statements.  Readers are cautioned that any suchforward-looking statements are not guarantees of future performance and thatmatters referred to in such forward-looking statements involve known andunknown risks, uncertainties and other factors which may cause actual results,performance or achievements of the Company to be materially different from anyfuture results, performance or achievements expressed or implied by suchforward-looking statements.  Such factors include, among other things, theimpact of competition and uncertainties concerning such matters as the Company’sability to service debt, product development, customer financing, sales tonon-traditional gaming markets, foreign operations, dependence on keypersonnel, the ability to integrate future acquisitions, strict regulation bygaming authorities, the outcome of pending litigation matters including thepending securities class actions, gaming taxes, currency fluctuations andmarket risk.  The Company undertakes no obligation to publicly update orrevise these forward-looking statements because of new information, futureevents or otherwise.

 

**Introduction**

 

Operating under the name *Bally Gaming and Systems*, the Company is aworldwide leader of designing, manufacturing and distributing traditional andnontraditional gaming machines, having marketed over 100,000 gaming machinesduring the past five years, and computerized monitoring systems for gamingfacilities.  The Bally Gaming and Systems business unit consists of threedivisions: Game sales, System sales and Gaming operations. The Company alsoowns and operates a dockside casino in Vicksburg, Mississippi, which hasapproximately 12 table games and approximately 930 gaming devices (“CasinoOperations”). Further information about our business units is contained in thenotes to the Consolidated Financial Statements (“Segments and GeographicalInformation”) and in our annual report filed on Form 10-K.

 

The Company recognizesrevenue from the following sources: sales of gaming machines, operation of wide-area progressive systems andlease of gaming machines, sales of computerized monitoring systems and relatedrecurring hardware and software maintenance revenue, and from casinooperations.  The Company often acceptsused machines as trade-ins toward the purchase of new gaming equipment. Thesetrade-ins are negotiated at the time of sale for that transaction only, andthere are no provisions for rights to future trade-ins contained in thepurchase agreement for the new gaming equipment.  The traded-in gaming machine is accounted foras a discount to the contracted selling price of a new gaming machine.

 

Our most significantexpenses are (1) cost of sales, (2) research and development expenses, (3)advertising and promotional expenses and (4) administrative expenses.  The Company strives to control these expensesby working closely with division unit leaders and by centralizing functionssuch as finance, accounting, legal, human resources and management informationsystems.  The Company also uses itsmarket presence and purchasing power to negotiate favorable rates with vendorsand suppliers.

 

Our research anddevelopment costs are driven by the development cycle for hardware which variesbetween a few months for minor revisions to more than a year for major designchanges or for changes made by various slot 

 

26

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manufacturers with whichour product must communicate and be physically integrated. Software developmentresults in (i) periodic product releases that include new features thatextend and enhance casino enterprise systems; (ii) periodic maintenancereleases that enable casino operators to correct problems or improve theusability of the system; and (iii) documentation needed to install and usethe system.

 

Depreciation andamortization expense for tangible and intangible assets have historically beensignificant factors in determining our overall profitability.  Based on intangible assets currently held byus and the allocation of the aggregate purchase price of acquisitions completedduring the year ended June 30, 2004, the Company expects the total amortizationexpense incurred will increase in fiscal year 2005 compared to fiscal year2004.

 

**Basis of Presentation**

 

Our results include theaccounts of Alliance Gaming Corporation, and its wholly-owned andpartially-owned, controlled subsidiaries.

 

**Results of Operations**

 

***BallyGaming and Systems***

Summary financial resultsand operating statistics (dollars in millions):

 
| ** **                           | ** ** | **Three Months   Ended   December 31,** | ** ** | **Increase/** | ** ** | **%**          | ** ** | **Six Months   Ended   December 31,** | ** ** | **Increase/** | ** ** | **%**    | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|---------------|------------|----------------|------------|---------------------------------------|------------|---------------|------------|----------|------------|
| ** **                           | ** ** | **2004**                                | ** ** | **2003**      | ** ** | **(Decrease)** | ** ** | **Change**                            | ** ** | **2004**      | ** ** | **2003** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Revenues                             |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Game sales                           |       | $                                       | 46.1       |          | $          | 49.6           |       | $                                     | (3.5       | )             | (7         | )%       | $          | 97.5 |   | $ | 92.3 |   | $ | 5.2 |   | 6 | % |
| System sales                         |       | 24.2                                    |       | 30.7          |       | (6.5           | )          | (21                                   | )%         | 43.6          |       | 60.7     |       | (17.1 | ) | (28 | )% |
| Gaming  operations                   |       | 30.6                                    |       | 16.0          |       | 14.6           |       | 91                                    | %          | 63.9          |       | 31.8     |       | 32.1 |   | 101 | % |
| Total revenues                       |       | $                                       | 100.9      |          | $          | 96.3           |       | $                                     | 4.6        |          | 5          | %        | $          | 205.0 |   | $ | 184.8 |   | $ | 20.2 |   | 11 | % |
|                                 |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Gross Margin                         |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Game sales                           |       | $                                       | 4.2        |          | $          | 23.2           |       | $                                     | (19.0      | )             | (82        | )%       | $          | 17.1 |   | $ | 42.9 |   | $ | (25.8 | ) | (60 | )% |
| System sales                         |       | 18.9                                    |       | 22.9          |       | (4.0           | )          | (17                                   | )%         | 34.7          |       | 46.7     |       | (12.0 | ) | (26 | )% |
| Gaming  operations                   |       | 24.6                                    |       | 11.4          |       | 13.2           |       | 115                                   | %          | 49.0          |       | 23.2     |       | 25.8 |   | 111 | % |
| Total gross  margin                  |       | $                                       | 47.7       |          | $          | 57.5           |       | $                                     | (9.8       | )             | (17        | )%       | $          | 100.8 |   | $ | 112.8 |   | $ | (12.0 | ) | (11 | )% |
|                                 |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Selling, general  and administrative |       | 33.2                                    |       | 15.5          |       | 17.7           |       | 114                                   | %          | 69.4          |       | 38.6     |       | 30.8 |   | 80 | % |
| Research and  development costs      |       | 10.4                                    |       | 9.4           |       | 1.0            |       | 11                                    | %          | 22.1          |       | 15.4     |       | 6.7 |   | 44 | % |
| Depreciation and  amortization       |       | 10.9                                    |       | 5.4           |       | 5.5            |       | 102                                   | %          | 20.6          |       | 10.2     |       | 10.4 |   | 102 | % |
|                                 |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Operating inc  (loss)                |       | $                                       | (6.8       | )             | $          | 27.2           |       | $                                     | (34.0      | )             | (125       | )%       | $          | (11.3 | ) | $ | 48.6 |   | $ | (59.9 | ) | (123 | )% |

 

27

----

 

 
| ** **                                            | ** ** | **Three months   Ended   December 31,** | ** ** | **Increase/** | ** ** | **%**          | ** ** | **Six months   Ended   December 31,** | ** ** | **Increase/** | ** ** | **%**    | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|---------------|------------|----------------|------------|---------------------------------------|------------|---------------|------------|----------|------------|
| ** **                                            | ** ** | **2004**                                | ** ** | **2003**      | ** ** | **(Decrease)** | ** ** | **Change**                            | ** ** | **2004**      | ** ** | **2003** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
|                                                  |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Operating Statistics:                                 |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| New Gaming  Devices Sold                              |       | 3,123                                   |       | 4,359         |       | (1,236         | )          | (28                                   | )%         | 5,863         |       | 7,689    |       | (1,826 | ) | (24 | )% |
| Original  Equipment Mfg. (“OEM”) Units Sold |       | 34                                      |       | 242           |       | (208           | )          | (86                                   | )%         | 1,954         |       | 2,105    |       | (151 | ) | (7 | )% |
| New Unit average  selling price - (Excluding OEM)     |       | $                                       | 10,682     |          | $          | 9,050          |       | $                                     | 1,632      |          | 18         | %        | $          | 10,547 |   | $ | 8,782 |   | $ | 1,765 |   | 20 | % |
| Game monitoring  units installed base                 |       | 281,000                                 |       | 244,000       |       | 37,000         |       | 15                                    | %          |          |       |     |       |   |   |   |   |
| Casino  management systems-installed base             |       | 220                                     |       | 199           |       | 21             |       | 11                                    | %          |          |       |     |       |   |   |   |   |
| System managed  cashless games                        |       | 109,000                                 |       | 44,000        |       | 65,000         |       | 148                                   | %          |          |       |     |       |   |   |   |   |
| End of period  installed base:                        |       |                                    |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Wide-area  progressive                                |       | 1,746                                   |       | 1,840         |       | (94            | )          | (5                                    | )%         |          |       |     |       |   |   |   |   |
| Daily-fee games                                       |       | 8,768                                   |       | 3,103         |       | 5,665          |       | 183                                   | %          |          |       |     |       |   |   |   |   |
| Centrally  determined games                           |       | 17,725                                  |       | —        |       | 17,725         |       | 100                                   | %          |          |       |     |       |   |   |   |   |
|                                                       |            |                                         |            |               |            |                |            |                                       |            |               |            |          |            |  |  |  |  |  |  |  |  |  |  |

 

Segmentrevenues increased, and gross margin decreased, in the second quarter and thefirst six months of fiscal year 2005 as a result of the following:

 

•                  Bally Game Sales revenue decreased as aresult of the following:

•                  Total unit sales declined due to a generalslow down of the traditional Class III replacement cycle for casinos and thelack of new casino openings in the current quarter as well as a decliningdemand for our video game products. The decline in games sales was partiallyoffset by an increase in average selling price to $10,682 which reflects thesale of higher priced Class II and centrally determined games.

 

•                  Bally Systems revenue decreased primarily asa result of:

•                   Decreased hardware and software salesdue to the lack of new property openings in the current quarter.

•                  Recurringhardware and software maintenance revenues increased resulting from the largerbase of installed units, which now stands at approximately 281,000 in 220casinos world-wide.  Service revenue alsoincreased due to demand for system implementation and promotions services.

 

•                  Gaming Operations revenues increased as a result of:

•                  Growth in our installed base of daily fee gamesprimarily driven by the placements to the New York and Rhode Island Lotteries,as well as the growth in our Class II and centrally determined games.

•                  Inclusion of the installed base of units as part ofthe SDG acquisition.

 

•                   Gross margin decreased as a result ofthe following:

•                  Game sales gross margin declined primarily due toinventory and related asset write-downs of $3.0 million and $11.1 million forthe first and second quarters of fiscal 2005, respectively. (See discussion listedInventory write-down which follows later in this section.)  Without these charges the gross margin was33% and 31%, for the three and six month periods ended December 31, 2004 respectively,which reflects the lower margin received on certain Class II and centraldetermination games in exchange for a recurring link fee.  Additionally, the lower volume of sales hasresulted in the poor absorption of factory overhead.  The Company believes that if unit sales andplacements increase, the gross margin will be positively impacted and could 

 

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returnto 35% to 40% level or above in the future, but there can be no assurances thatthis level will be achieved.

•                  Systems gross margin improvement is reflective ofthe higher proportion of high margin software maintenance and service revenues.

•                  Gaming operations gross margin increased as a resultof a higher mix of daily fee games and the decline in the frequency of WAPjackpots awarded during the current quarter.

 

•                  Selling,general and administrative expenses increased in the second quarter and the first six months of fiscal 2005 as a resultof the following:

•                  Theaddition of the Class II and central determination operations.

•                  Increasedlegal expense as a result of higher patent and litigation costs.

•                  Higherfield service related costs due to our increase in the base of installed gamesunder gaming operations.

•                  Increasein the provision for doubtful accounts receivable of $2.6 million and $4.4million for the three and six month periods ended December 31, 2004,respectively.  This increase includes acharge for a large customer who recently declared bankruptcy, as well as anincrease in the accounts receivable reserve as the receivable base has agedslightly compared to a year ago.

 

•                  Researchand development costs increased as a result of the increased investment in thedevelopment of the Alpha game platform and related game content, and sustainingdevelopment of multiple existing game platforms and systems.

 

•                  Depreciationand amortization increased as a result of the following:

•                  Increasein acquisition-related intangible assets.

•                  Increasein the base of installed recurring revenue games from 4,943 units in the prioryear to 10,514 units.

•                  Increasein operating capital expenditures relative to new technology initiatives.

 

 

***RainbowCasino Operations***

 

Summary financial results and operating statistics(dollars in millions):

 
| ** **                           | ** ** | **Three months ended   December 31,** | ** ** | **Increase/** | ** ** | **%**          | ** ** | **Six months   ended   December 31,** | ** ** | **Increase/** | ** ** | **%**    | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|---------------|------------|----------------|------------|---------------------------------------|------------|---------------|------------|----------|------------|
| ** **                           | ** ** | **2004**                              | ** ** | **2003**      | ** ** | **(Decrease)** | ** ** | **Change**                            | ** ** | **2004**      | ** ** | **2003** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
|                                 |       |                                  |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Revenue                              |       | $                                     | 12.8       |          | $          | 12.3           |       | $                                     | 0.5        |          | 4          | %        | $          | 25.6 |   | $ | 25.1 |   | $ | 0.5 |   | 2 | % |
|                                 |       |                                  |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Gross Margin                         |       | $                                     | 8.2        |          | $          | 7.4            |       | $                                     | 0.8        |          | 10         | %        | $          | 16.2 |   | $ | 15.2 |   | $ | 1.0 |   | 7 | % |
|                                 |       |                                  |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Selling, general  and administrative |       | 3.3                                   |       | 2.9           |       | 0.4            |       | 14                                    | %          | 6.7           |       | 6.0      |       | 0.7 |   | 12 | % |
| Depreciation and  amortization       |       | 0.8                                   |       | 0.7           |       | 0.1            |       | 14                                    | %          | 1.6           |       | 1.4      |       | 0.2 |   | 14 | % |
| Operating income                     |       | $                                     | 4.1        |          | $          | 3.8            |       | $                                     | 0.3        |          | 8          | %        | $          | 7.9 |   | $ | 7.8 |   | $ | 0.1 |   | 1 | % |
|                                 |       |                                  |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Operating  Statistics:               |       |                                  |       |          |       |           |       |                                  |       |          |       |     |       |   |   |   |   |
| Average No. -  Gaming Devices        |       | 930                                   |       | 910           |       | 20             |       | 2                                     | %          |          |       |     |       |   |   |   |   |
| Average No. -  Table Games           |       | 12                                    |       | 12            |       | —         |       | —                                | %          |          |       |     |       |   |   |   |   |

 

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•                  RainbowCasino revenues have increased at a pace slightly better than the market due toenhanced marketing programs.

•                  Grossmargin increased as a result of decreases in certain operating costs.  Cost of casino revenue includes gaming taxes,rental costs and direct labor including payroll taxes and benefits.

•                  Theoverall selling, general and administrative expenses increased as a result ofincreases in casino promotional expenses.

 

***ParentCompany and other unallocated income (expense)***

Summary financial results(dollars in millions):

 
| ** **                            | ** ** | **Three Months Ended   December 31,** | ** ** | **Increase/** | ** ** | **%**          | ** ** | **Six Months Ended  December 31,** | ** ** | **Increase/** | ** ** | **%**    | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|---------------|------------|----------------|------------|------------------------------------|------------|---------------|------------|----------|------------|
| ** **                            | ** ** | **2004**                              | ** ** | **2003**      | ** ** | **(Decrease)** | ** ** | **Change**                         | ** ** | **2004**      | ** ** | **2003** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
|                                  |       |                                  |       |          |       |           |       |                               |       |          |       |     |       |   |   |   |   |
| General and  administrative           |       | $                                     | 4.6        |          | $          | 3.1            |       | $                                  | 1.5        |          | 48         | %        | $          | 10.0 |   | $ | 6.0 |   | $ | 4.0 |   | 65 | % |
| Depreciation and  amortization        |       | 0.3                                   |       | 0.4           |       | (0.1           | )          | (25                                | )%         | 0.6           |       | 0.9      |       | (0.3 | ) | (27 | )% |
| Total Parent  company expense         |       | $                                     | 4.9        |          | $          | 3.5            |       | $                                  | 1.4        |          | 40         | %        | $          | 10.6 |   | $ | 6.9 |   | $ | 3.7 |   | 53 | % |
|                                  |       |                                  |       |          |       |           |       |                               |       |          |       |     |       |   |   |   |   |
| Other income  (expense):              |       |                                  |       |          |       |           |       |                               |       |          |       |     |       |   |   |   |   |
| Interest income                       |       | $                                     | 0.3        |          | $          | 0.1            |       | $                                  | 0.2        |          | 200        | %        | $          | 0.8 |   | $ | 0.1 |   | $ | 0.7 |   | 700 | % |
| Interest expense                      |       | (3.8                                  | )          | (3.9          | )          | (0.1           | )          | (3                                 | )%         | (7.7          | )          | (9.6     | )          | (1.9 | ) | (20 | )% |
| Minority  interest                    |       | (1.1                                  | )          | (0.5          | )          | 0.6            |       | 112                                | %          | (1.6          | )          | (1.0     | )          | 0.6 |   | 60 | % |
| Refinancing /  bank amendment charges |       | (0.6                                  | )          | —        |       | (0.6           | )          | —                             |       | (0.6          | )          | (12.3    | )          | 11.7 |   | 95 | % |
| Other, net                            |       | 0.4                                   |       | (0.6          | )          | 1.0            |       | 168                                | %          | 0.5           |       | (0.9     | )          | 1.4 |   | (159 | )% |
| Total other  income (expense)         |       | $                                     | (4.8       | )             | $          | (4.9           | )          | $                                  | (0.1       | )             | (2         | )%       | $          | (8.6 | ) | $ | (23.7 | ) | $ | 15.1 |   | (64 | )% |
|                                  |       |                                  |       |          |       |           |       |                               |       |          |       |     |       |   |   |   |   |
| Income tax  expense (benefit)         |       | $                                     | (4.9       | )             | $          | 8.4            |       | $                                  | (13.3      | )             | (158       | )%       | $          | (8.7 | ) | $ | 9.7 |   | $ | (18.4 | ) | (190 | )% |

 

Generaland administrative expenses increased primarily as a result of:

•                  Increasein payroll and related expense primarily due to restricted stock units grantedand severance benefits offset by reallocation of corporate employees to BallyGaming and Systems business segment.

•                  Increasein litigation and general legal costs of approximately $0.8 million relative toprotection of our patents and class action law suits.

•                  Increasein professional fees relative to Sarbanes-Oxley implementations.  The Company expects these additional costs tocontinue through fiscal 2005 and 2006.

•                  Increase in general liability and director and officer insurance costs.  Such increases in insurance costs areexpected to continue in fiscal 2005.

 

•                  Otherincome (expense) decreased as a result of the prior year refinancing, whichresulted in a charge of $12.3 million (consisting of a $5.0 million charge forthe early extinguishment of the Company’s subordinated notes, $7.0 million forthe non-cash write off of deferred financing costs, and $0.3 million in feesand expenses).

•                  Oureffective income tax rate for the six month period ended December 31, 2004 was39% compared to 38% in the prior year period.

 

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***Discontinued Operations***

 

OnOctober 15, 2004, the Company completed the sale of our interest in VSI toChurchill Downs Incorporated. The net proceeds received totaled approximately$2.0 million, resulting in a gain of $0.8 million, net of tax,  and is included in discontinued operations onthe statement of operations.  During thequarter ended December 31, 2004, the Company accrued $2.0 million for variouscontingencies related to the sale of its discontinued operations.

 

***Inventorywrite-down***

 

The Company performsdetailed inventory valuation procedures at least quarterly. This processincludes examining the carrying values of new and used gaming devices, partsand ancillary equipment in comparison to the current fair market values forsuch equipment (less costs to sell or dispose). Some of the factors involved inthis analysis include the overall levels of our inventories, the current andprojected sales levels for such products, the projected markets for suchproducts both domestically and internationally, the costs required to sell theproducts including refurbishment costs and importation costs for internationalshipments, and the overall projected demand for products once the nextgeneration of products are scheduled for release.

 

The Company has faceddeclining demand for its video products. During the quarter ended September 30,2004, the Company decided that its legacy V7 video platform would no longer besupported and the remaining used game inventory for such products was targetedfor immediate disposal, resulting in a write-down of $3.0 million. Theremaining inventory of new games for this product line was targeted for sale atreduced prices, which were still above the carrying value less costs to selland therefore were not written down.

 

During the quarter endedDecember 31, 2004, management completed a three year business planning process.In accordance with this plan, significant development efforts were redirectedto the Alpha-based video platform and products. The Company also made itsexisting EVO video games upgradeable to Alpha when approved in each market. Theremaining used EVO inventory has been targeted for sale primarily innon-domestic markets, which traditionally have lower price points for usedgames and have higher importation and delivery costs, resulting insignificantly lower net realizable values. The capitalized regulatory approvalcosts for the EVO and legacy video platform were determined to no longer berecoverable, and were also written off.

 

During the quarter endedDecember 31, 2004, the Company also consolidated several warehouses into onecentral warehouse, with the intent to reduce warehouse rental costs. As part ofthis consolidation, certain used games and related ancillary equipmentincluding signs, were identified for immediate destruction, scrap, or salvage,and this process continued into the March 2005 period.

 

As a result of thedecision to move to the new video platform, the targeting of used equipment fornon-domestic markets, and the consolidation of warehouses leading toaccelerated disposals, the Company wrote down its inventory and related assetsby a total of $11.1 million during the quarter ended December 31, 2004, and suchwrite downs for the six months ended December 31, 2004 totaled $14.1 million.The Company continues to take certain used games on trade as part of new gamesales, and therefore additional write downs may be necessary in future periodsdepending on a number of factors impacting the future demand for such productsand the ultimate net values realized.

 

**Liquidityand Capital Resources**

 

As of December 31, 2004, cash andcash equivalents totaled $28.0 million. In addition net working capital was approximately $137 million(excluding assets and liabilities of discontinued operations), a decrease ofapproximately $145 million from June 30, 2004, which is explained in theworking capital section below. Consolidated cash and cash equivalents at December 31, 2004 includeapproximately $2.7 million of cash utilized in our Casino Operations that isheld in vaults, cages or change banks. Additionally, pursuant to various stategaming regulations, certain cash accounts are maintained to ensure availabilityof funds to pay wide-area progressive jackpot awards, which totaledapproximately $12.8 million at December 31, 2004.  In addition, the Company purchases U.S.Treasury Strip securities for the benefit of jackpot winners who elect toreceive annual or weekly installment payments. These securities are presentedas restricted investments in the accompanying consolidated balance sheets, andtotaled $8.5 million and $2.5 million as of December 31, 2004 and June 30,2004, respectively.

 

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The sale of Rail City was completedin May 2004 and the sale of UCMC was completed in June 2004. As a result of thesale of these assets, the terms of our bank loan agreement (the “Loan Agreement”)required the use of approximately 50% of the net proceeds (as defined in theagreement) to reduce the term loan and revolver principal balances on a prorata basis. Accordingly, in August 2004 the Company made an initial reductionin our term loan of $31.6 million and the revolver was paid down from $70.0million to zero.

 

During December 2004, the Companyamended its Loan Agreement.  Theamendment provides for an increase in the maximum allowable leverage ratio(currently 4.25x the trailing four quarter’s EBITDA, as defined in the LoanAgreement), a reduction in the revolver from $125 million to $75 million, andan increase in the term loan interest rate to LIBOR + 3.00%. The fee incurredfor the amendment totaled approximately $1.0 million. The Company is currentlyin compliance with its covenants consisting of leverage ratio, fixed chargescoverage ratio, and minimum EBITDA (as that term is defined in the LoanAgreement).  As of December 31, 2004, theCompany’s leverage ratio was 3.9x. Pursuant to the recent amendment, the leverage ratio maximum is scheduledto increase to 4.50x and to 4.75x as of March 31, 2005 and June 30, 2005,respectively.

 

Management believes that cash flowsfrom current operating activities and the availability under the revolvingcredit facility will provide the Company with sufficient capital resources andliquidity.  Given the current leverageratio, the Company had approximately $18 million of availability on itsrevolving credit facility as of December 31, 2004, which increased toapproximately $40 million beginning on January 1, 2005, resulting from the 25basis point increase in the maximum leverage ratio referred to above.  Continued access to the revolving creditfacility will require the Company to increase its EBITDA (as defined in theLoan Agreement) to levels in excess of those generated in the six-month periodended December 31, 2004.  At December 31,2004, there were no material commitments for capital expenditures.

 

***WorkingCapital***

 

The following tablepresents the components of consolidated working capital at December 31, 2004and June 30, 2004, excluding assets and liabilities of discontinued operations(dollars in 000s):

 
| ** **                            | ** ** | **December 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Change** | ** ** |
|---------------------------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| Current assets:                       |       |                   |       |               |       |       |       |
| Cash and cash  equivalents            |       | $                      | 27,964     |               | $          | 172,726    |       | $ | (144,762 | ) |
| Accounts and  notes receivable        |       | 103,601                |       | 129,779            |       | (26,178    | )          |
| Inventories                           |       | 72,462                 |       | 61,135             |       | 11,327     |       |
| Deferred tax  assets                  |       | 19,982                 |       | 20,054             |       | (72        | )          |
| Other current  assets                 |       | 19,580                 |       | 12,420             |       | 7,160      |       |
| Total current  assets                 |       | 243,589                |       | 396,114            |       | (152,525   | )          |
|                                  |       |                   |       |               |       |       |       |
| Current  liabilities:                 |       |                   |       |               |       |       |       |
| Accounts payable                      |       | 30,478                 |       | 37,515             |       | (7,037     | )          |
| Jackpot  liabilities                  |       | 10,076                 |       | 12,075             |       | (1,999     | )          |
| Accrued  liabilities                  |       | 60,991                 |       | 51,469             |       | 9,522      |       |
| Taxes payable                         |       | —                 |       | 7,233              |       | (7,233     | )          |
| Current  maturities of long-term debt |       | 5,040                  |       | 5,866              |       | (826       | )          |
| Total current  liabilities            |       | 106,585                |       | 114,158            |       | (7,573     | )          |
| Net working  capital                  |       | $                      | 137,004    |               | $          | 281,956    |       | $ | (144,952 | ) |

 

For the six month periodended December 31, 2004, working capital, excluding cash, changed less than $0.2million on a net basis.  The decrease incash of $144.7 million was driven by the $101.6 million of sale proceeds usedto pay down our term loans in accordance with the Loan Agreement, as well ascash used to deploy wide-area and daily-fee gaming devices.

 

The other fluctuationscontributing to changes in working capital were:

 

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•                  Anet decrease in accounts and notes receivable resulting from the overallreduction in game and systems sales.

 

•                  Anincrease in inventory due to the acquisition of games for the centraldetermination markets, as well as inventory for the new line of video products.

 

•                  Anincrease in other assets as a result of the following:

•                                    Increasein deferred costs due to shipments of games to the European market that willnot be installed until the second quarter of 2005.

•                                    Increasein prepaid taxes and prepaid royalties.

 

•                  Anincrease in accrued liabilities primarily as a result of the following:

•                                    Anaccrual of $7.4 million for damages awarded to Action Gaming and IGT for patentinfringement.

 

***CashFlow***

 

During the six months endedDecember 31, 2004, cash flows used in operating activities totaled $8.2 millionas a result of:

•                  Reported net loss of $(18.2) million, which includescertain non-cash charges.

•                  Increases in inventory of $17.5 million.

•                  Timing of receivables collections.

•                  Timing of payments made for accounts payable andjackpot liabilities.

 

During the six monthsended December 31, 2004, cash flows used in investing activities totaled $35.3million due to the following:

•                  Capitalexpenditures of $5.5 million.

•                  Costsincurred to produce participation games totaling $18.2 million.

•                  Additionsto other long-term assets of $1.5 million.

•                  SDGearnout buyout of $12 million.

 

During the six monthsended December 31, 2004, $103.4 million of cash was used in financingactivities of continuing operations resulting from:

•                  Paydown on the term loan and revolver of $101.6 million.

•                  Principalpayments on other long term debt totaling $2.1 million.

•                  Cashprovided from exercise of stock options of $0.9 million.

•                  Cashused for the Loan Agreement amendment fees totaling $1.0 million.

 

*Contractual Commitments*

 

A description of theCompany’s contractual commitments can be found in Item 7 of the Company’s AnnualReport on Form 10-K for the year ended June 30, 2004.  For a more extensive discussion of theCompany’s contractual commitments, see note 15 “Commitments and Contingencies”in the Notes to the Consolidated Financial Statements in the Company’s 2004 AnnualReport on Form 10-K for the year ended June 30, 2004.

 

**Critical Accounting Policies andEstimates**

 

The Consolidated Financial Statements were preparedin conformity with accounting principles generally accepted in the UnitedStates of America. Certain of our accounting policies, including valuationsutilized in asset impairment tests, acquisitions accounting, revenuerecognition, allowance for doubtful accounts, capitalized costs, reserves forinventory, 

 

33

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and deferred tax reserves require the Company toapply significant judgment in defining the appropriate assumptions forcalculating financial estimates. These judgments are subject to an inherentdegree of uncertainty. There can be no assurance that the actual results willnot differ from our estimates.

 

A description of the Company’s critical accountingpolicies and estimates can be found in Item 7 of the Company’s Annual Report onForm 10-K for the year ended June 30, 2004. For a more extensive discussion of the Company’s accounting policies,see Note 1, “Summary of Significant Accounting Policies,” in the Notes to theConsolidated Financial Statements in the Company’s 2004 Annual Report on Form10-K for the year ended June 30, 2004.

 

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

 

***CurrencyRate Fluctuations***

 

Revenues and results ofoperations derived from our non-U.S. subsidiaries are denominated in theirlocal currencies and are affected by changes in the relative values of non-U.S.currencies and the U.S. dollar.  Most ofthe currencies in countries in which we have foreign operations werestrengthened versus the U.S. dollar, which resulted in assets and liabilitiesdenominated in local currencies being translated into more dollars.  The Company does not currently utilizehedging instruments.

 

***Marketrisks***

 

During the normal courseof  business, the Company is routinelysubjected to a variety of market risks, examples of which include, but are notlimited to, interest and currency rate movements, collectibility of accountsand notes receivable, and recoverability of residual values on leased assets.We constantly assess these risks and have established policies and practices designedto protect against the adverse effects of these and other potential exposures.Although we do not anticipate any material losses in these risk areas, noassurances can be made that material losses will not be incurred in these areasin the future.

 

The Company has performeda sensitivity analysis of its financial instruments, which consists of cash andcash equivalents and debt. The Company has no derivative financial instruments.In performing the sensitivity analysis, the Company defined risk of loss as thehypothetical impact on earnings of changes in the market interest rates orcurrency exchange rates.

 

The results of thesensitivity analysis at December 31, 2004, are as follows:

 

Interest Rate Risk:

 

The Company had total debt ofapproximately $353.6 million, consisting primarily of the new $317.5 millionoutstanding term loan, the SDG earnout buyout of $28.0 million and other debtof approximately $8.1 million.  The bankfacility borrowings each have a term of six months at which time the interestrate is subject to adjustment to the then current rate. If the LIBOR rates wereto increase or decrease by 100 basis points, with all other factors remainingconstant, earnings would decrease or increase by approximately $3.5 millionannually on a pre-tax basis.

 

Foreign Currency ExchangeRate Risk:

 

Our foreign subsidiariesgenerally use their domestic currency as their functional currency. A 10%fluctuation in the exchange rates of these currencies against the U.S. dollarwould result in a corresponding change in annual earnings reported in theconsolidated group of approximately $0.2 million net of tax.

#### ** **

#### **Estimates:**

 

Our financial statementsare prepared using estimates and assumptions that affect the reported amountsof assets and liabilities. Actual results may differ from these estimateseither favorably or unfavorably, which may impact future results.

 

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# **ITEM 4**.                             CONTROLS AND PROCEDURES

 

The Company’s management, includingthe Chief Executive Officer and Chief Financial Officer, conducted anevaluation of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) asdescribed at the end of the period covered by this report.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that as of the end of the periodcovered by this report, the Company’s disclosure controls and procedures wereeffective.  During the period covered bythis report there have been no changes in the Company’s internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect the Company’s internal control over financial reporting.

 

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**PART II**

 

**ITEM 1.****     Legal Proceedings**

 

In September 2004, a federaldistrict court jury entered a $7.4 million verdict against the Company in asuit filed by Action Gaming, Inc., and IGT. The suit alleged that themulti-hand video poker game deployed by the Company’s former subsidiary, UnitedCoin Machine Co., infringed the plaintiffs’ patents. The district court hadruled on summary judgment that the game does not infringe the patents. However,the court left to the jury the question whether the use of “autohold,” aspecific, optional feature of the game, caused it to infringe under the “doctrineof equivalents,” a doctrine of patent law. After a two-week trial, the jurydetermined that the game with the autohold option enabled did infringe underthe doctrine of equivalents and awarded damages accordingly. The feature hasbeen disabled on all affected games in the field, and the decision permitscontinued deployment of the game as long as the autohold feature is notincluded. The Company is pursuing various remedies and has posted a cash bondto stay payment of the judgment pending post-trial motions and appeal.

 

In June and July 2004, purported class actions werefiled against Alliance Gaming Corporation and its officers, Robert Miodunski(the Company’s former Chief Executive Officer), Robert Saxton, Mark Lerner, andSteven Des Champs, in the Federal District Court for the District ofNevada.  The nearly identical complaintsallege violations of the Securities Exchange Act of 1934 stemming from therevision of earnings guidance, and declines in the stock price.  The plaintiffs’ motions to consolidate thecases and appoint lead plaintiff counsel are pending and are customary in suchcases.  The next step will be for theplaintiffs to file a consolidated complaint. The Company believes the lawsuits are without merit and intends tovigorously defend the action.  Inaddition, in July 2004 two derivative lawsuits were filed in Nevada state courtagainst the members of the board of directors and the officers listedabove.  The Company is named as a nominaldefendant in the derivative lawsuits as the claims are purportedly asserted forthe benefit of the Company.  These lawsuitsassert claims for breach of fiduciary duty and waste of corporate assets arisingout of the same events as those giving rise to the class actions describedabove. These two cases have also been consolidated, and a consolidatedcomplaint has been filed.  The defendants’motions to dismiss or to stay were heard in January 2005 and taken undersubmission by court.

 

In February 2005, the Securities and ExchangeCommission (the “SEC”) requested documents and information regarding mattersrelated to the allegations in the class actions and similar matters.  Management is cooperating fully with the SECin this matter.

 

A lawsuit filed against the Company in August 2004 byShuffle Master, Inc. in the U.S. District Court of Nevada, alleginginfringement of various patents is in the discovery phase.  A patent infringement lawsuit filed againstthe Company in December 2004 by IGT in the U.S. District Court of Nevada, is inthe pleadings phase.  The Company isvigorously defending both lawsuits.

 

The Company is also a party tovarious lawsuits relating to routine matters incidental to our business.  Management does not believe that the outcomeof such litigation, including the matters above, in the aggregate, will have amaterial adverse effect on our financial position.

 

**ITEM 4.  Submissionof Matters to a Vote of Security Holders**

 

On December 8, 2004, the Companyheld its annual shareholders meeting at which the shareholders were asked tovote on the election of two directors and the approval of an amendment to theCompany’s Amended and Restated 2001 Long Term Incentive Plan  (the “Plan”) to increase the number of sharesthat can be issued under the Plan.  Ofthe 51,003,578 shares outstanding, 38,324,440 were voted for and 5,774,287withheld from Mr. Jacques Andre: and 40,497,293 were voted for and 3,601,434withheld from Mr. Richard Hadrill.  Withrespect to the approval of the amendment to the Plan, 16,873,536 shares werevoted for, 9,562,696 shares against, 979,187 shares abstained and there were16,683,308 broker non-votes resulting in the approval of the amendment to thePlan.  Additionally, the shareholdersratified the Board of Director’s appointment of Deloitte and Touche LLP to actas independent public accountants of the Company for the fiscal year endingJune 30, 2005.

 

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**ITEM 6.****                  Exhibits**

a.                                       Exhibits

 
| 2.7    |   | Amendment dated  December 30, 2004, to the Amended and Restated Stock Purchase Agreement by  and among Alliance Gaming Corporation, Sierra Design Group, and Robert  Luciano, as Trustee for the Robert Luciano Family Trust, dated March 2, 2004. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                               |
| 10.40  |   | Amendment as of  December 22, 2004, to the Employment Agreement between the Company and  Richard Haddrill, entered into as of June 30, 2004.                                                                                                       |
|   |   |                                                                                                                                                                                                                                               |
| 10.41  |   | Alliance Gaming  Corporation Amended and Restated 2001 Long-Term Incentive Plan including Amendment  #1 (incorporated by reference to Form S-8 filed January 14, 2005,  Registration Number 333-122064).                                           |
|   |   |                                                                                                                                                                                                                                               |
| 31.1   |   | Certification of Chief  Executive Officer, pursuant to Rule 13a-14(a) of the Securities Act of 1934,  as amended.                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                               |
| 31.2   |   | Certification of Chief  Financial Officer, pursuant to Rule 13a-14(a) of the Securities 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 2004.                                                                                              |
|   |   |                                                                                                                                                                                                                                               |
| 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 2004.                                                                                              |

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934 the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereuntoauthorized.

 

 
| ALLIANCE GAMING  CORPORATION |   | Date: February  9, 2005 |
|------------------------------|--------|-------------------------|
| (Registrant)                 |   |                    |

 
|   |                                                     |   |
|--------|----------------------------------------------------------|--------|
| By     | /s/ Richard Haddrill                                     |   |   |
|   | Richard Haddrill                                         |   |
|   | President and Chief  Executive Officer                   |   |
|   | (Principal Executive  Officer)                           |   |
|   |                                                     |   |
|   |                                                     |   |
| By     | /s/ Robert L. Saxton                                     |   |   |
|   | Robert L. Saxton                                         |   |
|   | Executive Vice  President, Treasurer and Chief Financial |   |
|   | Officer (Principal  Financial and Accounting Officer)    |   |
|        |                                                          |        |  |  |

 

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