**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                                       | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                        |                                                                                                    |
| **For the quarterly period ended  September 30, 2007** |
|                                                        |                                                                                                    |
| **OR**                                                      |
|                                                        |                                                                                                    |
| **o**                                                       | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom       to       **

 

**Commission File Number 0-4281**

 

**BALLY TECHNOLOGIES, INC.**

(Exact name of registrant as specified in 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)

** **

**(702) 584-7700**

(Registrant’s telephone number, including area code)

 

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

 

o  Yes  x  No

 

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

o  Yes  x  No

 

The number of shares ofCommon Stock, $0.10 par value, outstanding as of December 14, 2007,according to the records of the registrant’s registrar and transfer agent was54,549,000 which does not include 738,000 shares held in treasury.

 

 

----

** **

**EXPLANATORY NOTE**

 

As previously disclosedon the Form 12b-25 of Bally Technologies, Inc. (“Bally,” the “Company,”or “we”), filed with the Securities and Exchange Commission (the “SEC”) on November 12,2007, the filing of this Quarterly Report on Form 10-Q for the fiscalquarter ended September 30, 2007 was delayed due to the significant amountof resources dedicated to prepare and file our Quarterly Report on Form 10-Qfor the fiscal quarter ended March 31, 2007 (the “Third Quarter 10-Q”) andour Annual Report on Form 10-K for the fiscal year ended June 30,2007 (the “2007 10-K”), which were filed with the SEC on November 2, 2007.As a result of the delay in filing the Third Quarter 10-Q and the 2007 10-K, werequired additional time to complete this Quarterly Report on Form 10-Q.  Furthermore, the preparation of the financialinformation presented in this Quarterly Report on Form 10-Q requiredadditional time and resources because it was prepared while certain materialweaknesses existed in our internal control over financial reporting, which aredescribed in Part I, Item 4, Controls and Procedures. Unless specificallystated otherwise, information presented in this Quarterly Report on Form 10-Qis as of and for the three-month period ended September 30, 2007.

 

**I N D E X**

 
| **PART I.**  | ** ** | **FINANCIAL INFORMATION**                                                                                                          |
|-------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                               |
| Item 1.           |       | Financial Statements                                                                                                               |
|              |       |                                                                                                                               |
|              |       | Unaudited Condensed Consolidated  Balance Sheets as of September 30, 2007 and June 30, 2007                              |
|              |       |                                                                                                                               |
|              |       | Unaudited Condensed  Consolidated Statements of Operations for the Three Months Ended  September 30, 2007 and 2006 (restated) |
|              |       |                                                                                                                               |
|              |       | Unaudited Condensed Consolidated  Statements of Cash Flows for the Three Months Ended September 30, 2007  and 2006 (restated) |
|              |       |                                                                                                                               |
|              |       | Notes to Unaudited Condensed  Consolidated Financial Statements                                                                    |
|              |       |                                                                                                                               |
| Item 2.           |       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                        |
|              |       |                                                                                                                               |
| Item 3.           |       | Quantitative and Qualitative Disclosures  About Market Risk                                                                        |
|              |       |                                                                                                                               |
| Item 4.           |       | Controls and Procedures                                                                                                            |
|              |       |                                                                                                                               |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                                                              |
| ** **        | ** ** | ** **                                                                                                                         |
| Item 1.           |       | Legal Proceedings                                                                                                                  |
|              |       |                                                                                                                               |
| Item 1A.          |       | Risk Factors                                                                                                                       |
|              |       |                                                                                                                               |
| Item 6.           |       | Exhibits                                                                                                                           |
|              |       |                                                                                                                               |
| **SIGNATURES**    |       |                                                                                                                               |

 

2

----

 

**PART I**

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                       | ** ** | **September ****30,**                          | ** ** | **June ****30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                       | ** ** | **2007**                                            | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                       | ** ** | **(in 000s, except  share amounts)** | ** ** |
| ASSETS                                                                                                                                           |       |                                                |       |                  |       |
| Current assets:                                                                                                                                  |       |                                                |       |                  |       |
| Cash and cash  equivalents                                                                                                                       |       | $                                                   | 51,594     |                  | $          | 40,842 |   |
| Restricted cash                                                                                                                                  |       | 17,533                                              |       | 17,201                |       |
| Accounts and  notes receivable, net of allowances for doubtful accounts of $7,811 and  $8,481                                                    |       | 160,618                                             |       | 172,060               |       |
| Inventories                                                                                                                                      |       | 98,789                                              |       | 81,151                |       |
| Deferred tax  assets, net                                                                                                                        |       | 62,895                                              |       | 59,486                |       |
| Deferred cost of  revenue                                                                                                                        |       | 44,949                                              |       | 36,744                |       |
| Other current  assets                                                                                                                            |       | 15,584                                              |       | 14,399                |       |
| Total current  assets                                                                                                                            |       | 451,962                                             |       | 421,883               |       |
|                                                                                                                                             |       |                                                |       |                  |       |
| Long-term  investments (restricted)                                                                                                              |       | 10,459                                              |       | 10,455                |       |
| Long-term  receivables                                                                                                                           |       | 8,154                                               |       | 9,840                 |       |
| Property, plant  and equipment, net of accumulated depreciation of $50,247 and $46,320                                                           |       | 72,530                                              |       | 75,623                |       |
| Leased gaming  equipment, net of accumulated depreciation of $76,962 and $73,396                                                                 |       | 79,480                                              |       | 67,965                |       |
| Goodwill                                                                                                                                         |       | 162,057                                             |       | 161,708               |       |
| Intangible  assets, net of accumulated amortization of $26,138 and $24,543                                                                       |       | 23,551                                              |       | 24,401                |       |
| Deferred tax  assets, net                                                                                                                        |       | 24,160                                              |       | 18,457                |       |
| Long-term  deferred cost of revenue                                                                                                              |       | 32,840                                              |       | 28,376                |       |
| Other assets,  net                                                                                                                               |       | 5,869                                               |       | 6,187                 |       |
| Total assets                                                                                                                                     |       | $                                                   | 871,062    |                  | $          | 824,895 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                        |       |                                                |       |                  |       |
| Current liabilities:                                                                                                                             |       |                                                |       |                  |       |
| Accounts payable                                                                                                                                 |       | $                                                   | 44,819     |                  | $          | 44,045 |   |
| Accrued  liabilities                                                                                                                             |       | 52,719                                              |       | 56,427                |       |
| Customer  deposits                                                                                                                               |       | 34,692                                              |       | 23,489                |       |
| Jackpot  liabilities                                                                                                                             |       | 13,778                                              |       | 13,414                |       |
| Deferred revenue                                                                                                                                 |       | 100,934                                             |       | 94,347                |       |
| Income taxes  payable                                                                                                                            |       | 11,889                                              |       | 12,945                |       |
| Current  maturities of long-term debt and capital leases, including $2,381 and $2,381  owed to related parties                                   |       | 12,568                                              |       | 12,271                |       |
| Total current  liabilities                                                                                                                       |       | 271,399                                             |       | 256,938               |       |
| Long-term debt  and capital leases, net of current maturities, including $7,600 and $7,600  owed to related parties                              |       | 304,162                                             |       | 321,583               |       |
| Long-term deferred revenue                                                                                                                       |       | 42,717                                              |       | 36,651                |       |
| Other income tax liability                                                                                                                       |       | 19,783                                              |       | —                |       |
| Other liabilities                                                                                                                                |       | 9,183                                               |       | 9,321                 |       |
| Total  liabilities                                                                                                                               |       | 647,244                                             |       | 624,493               |       |
| Minority interest                                                                                                                                |       | 1,237                                               |       | 948                   |       |
| Commitments and contingencies (Note 10)                                                                                                          |       |                                                |       |                  |       |
| Stockholders’ equity:                                                                                                                       |       |                                                |       |                  |       |
| Special stock,  10,000,000 shares authorized: Series E, $100 liquidation value; 115  shares issued and outstanding                          |       | 12                                                  |       | 12                    |       |
| Common stock,  $.10 par value; 100,000,000 shares authorized; 54,936,000 and 54,612,000  shares issued and 54,349,000 and 54,025,000 outstanding |       | 5,487                                               |       | 5,455                 |       |
| Treasury stock  at cost, 587,000 and 587,000 shares                                                                                              |       | (1,894                                              | )          | (1,894                | )          |
| Additional  paid-in capital                                                                                                                      |       | 264,181                                             |       | 253,809               |       |
| Accumulated  other comprehensive income                                                                                                          |       | 1,406                                               |       | 1,119                 |       |
| Accumulated  deficit                                                                                                                             |       | (46,611                                             | )          | (59,047               | )          |
| Total  stockholders’ equity                                                                                                                 |       | 222,581                                             |       | 199,454               |       |
| Total  liabilities and stockholders’ equity                                                                                                 |       | $                                                   | 871,062    |                  | $          | 824,895 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

3

----

 

**BALLY TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                       | ** ** | **Three Months Ended**                                 | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **September 30,**                                           | ** ** |
| ** **                                       | ** ** | **2007**                                                         | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | ** **                                                       | ** ** | **(as restated,  see Note 2)** | ** ** |
|                                             | ** ** | **(in 000s, except per share amounts)** |       |
| Revenues:                                        |       |                                                             |       |   |   |
| Gaming equipment  and systems                    |       | $                                                                | 123,532    |   | $ | 101,307 |   |
| Gaming  operations                               |       | 54,078                                                           |       | 40,619 |   |
| Casino  operations                               |       | 11,420                                                           |       | 11,839 |   |
|                                             |       | 189,030                                                          |       | 153,765 |   |
| Costs and expenses:                              |       |                                                             |       |   |   |
| Cost of gaming  equipment and systems (1)        |       | 54,663                                                           |       | 56,147 |   |
| Cost of gaming  operations                       |       | 18,059                                                           |       | 17,542 |   |
| Direct cost of  casino operations                |       | 4,712                                                            |       | 4,462 |   |
| Selling, general  and administrative             |       | 52,271                                                           |       | 49,420 |   |
| Research and  development costs                  |       | 13,309                                                           |       | 12,556 |   |
| Depreciation and  amortization                   |       | 4,854                                                            |       | 5,351 |   |
|                                             |       | 147,868                                                          |       | 145,478 |   |
| Operating income                                 |       | 41,162                                                           |       | 8,287 |   |
|                                             |       |                                                             |       |   |   |
| Other income (expense):                          |       |                                                             |       |   |   |
| Interest income                                  |       | 977                                                              |       | 911 |   |
| Interest expense                                 |       | (7,237                                                           | )          | (7,921 | ) |
| Other, net                                       |       | 877                                                              |       | 383 |   |
|                                             |       |                                                             |       |   |   |
| Income before income taxes and minority interest |       | 35,779                                                           |       | 1,660 |   |
| Income tax  expense                              |       | (13,109                                                          | )          | (671 | ) |
| Minority  interest                               |       | (1,388                                                           | )          | (1,214 | ) |
|                                             |       |                                                             |       |   |   |
| Net income  (loss)                               |       | $                                                                | 21,282     |   | $ | (225 | ) |
|                                             |       |                                                             |       |   |   |
| Basic and diluted earnings (loss) per share:     |       |                                                             |       |   |   |
| Basic earnings  (loss) per share                 |       | $                                                                | 0.39       |   | $ | (0.00 | ) |
| Diluted earnings  (loss) per share               |       | $                                                                | 0.37       |   | $ | (0.00 | ) |
|                                             |       |                                                             |       |   |   |
| Weighted average shares outstanding:             |       |                                                             |       |   |   |
| Basic                                            |       | 54,043                                                           |       | 52,901 |   |
| Diluted                                          |       | 57,416                                                           |       | 52,901 |   |

----

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

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

4

----

 

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                          | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                                                          | ** ** | ** **                                           | ** ** | **(as restated,  see Note 2)** | ** ** |
| ** **                                                                                          | ** ** | **(in 000s)**                                   | ** ** |
| Cash flows from operating activities:                                                               |       |                                                 |       |   |   |
| Net income (loss)                                                                                   |       | $                                                    | 21,282     |   | $ | (225 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating activities: |       |                                                 |       |   |   |
| Depreciation and  amortization                                                                      |       | 14,115                                               |       | 15,153 |   |
| Share-based  compensation                                                                           |       | 3,734                                                |       | 3,752 |   |
| Tax benefit of  stock option exercises                                                              |       | 30                                                   |       | — |   |
| Excess tax  benefit of stock option exercises                                                       |       | (2,057                                               | )          | — |   |
| Excess tax  liability of stock option exercises                                                     |       | 191                                                  |       | — |   |
| Deferred income  taxes                                                                              |       | (33                                                  | )          | 673 |   |
| Provision for  doubtful accounts                                                                    |       | (316                                                 | )          | 230 |   |
| Inventory and  other asset write-downs                                                              |       | 2,058                                                |       | 4,446 |   |
| Other                                                                                               |       | 1,141                                                |       | 3,218 |   |
| Changes in operating assets and liabilities:                                                        |       |                                                 |       |   |   |
| Accounts and  notes receivable                                                                      |       | 13,103                                               |       | 2,074 |   |
| Inventories                                                                                         |       | (36,459                                              | )          | (25,116 | ) |
| Other current  assets                                                                               |       | (1,053                                               | )          | (3,122 | ) |
| Accounts payable                                                                                    |       | 111                                                  |       | (3,234 | ) |
| Accrued  liabilities and jackpot liabilities                                                        |       | 9,967                                                |       | (645 | ) |
| Deferred revenue                                                                                    |       | (16                                                  | )          | (1,647 | ) |
| Net cash provided by (used in) operating activities                                                 |       | 25,798                                               |       | (4,443 | ) |
|                                                                                                |       |                                                 |       |   |   |
| Cash flows from investing activities:                                                               |       |                                                 |       |   |   |
| Capital  expenditures                                                                               |       | (3,891                                               | )          | (5,669 | ) |
| Restricted cash  and investments                                                                    |       | (267                                                 | )          | (1,033 | ) |
| Additions to  other long-term assets                                                                |       | (754                                                 | )          | (841 | ) |
| Net cash used in investing activities                                                               |       | (4,912                                               | )          | (7,543 | ) |
|                                                                                                |       |                                                 |       |   |   |
| Cash flows from financing activities:                                                               |       |                                                 |       |   |   |
| Proceeds from  revolving credit facility                                                            |       | —                                               |       | 5,000 |   |
| Payments on  revolving credit facility                                                              |       | —                                               |       | (5,000 | ) |
| Reduction of  long-term debt                                                                        |       | (17,125                                              | )          | (1,927 | ) |
| Proceeds from  sale lease-back arrangements                                                         |       | —                                               |       | 9,209 |   |
| Excess tax  benefit of stock option exercises                                                       |       | 2,057                                                |       | — |   |
| Excess tax  liability of stock option exercises                                                     |       | (191                                                 | )          | — |   |
| Proceeds from  exercise of stock options                                                            |       | 4,774                                                |       | 2,327 |   |
| Net cash (used in) provided by financing activities                                                 |       | (10,485                                              | )          | 9,609 |   |
|                                                                                                |       |                                                 |       |   |   |
| Effect of exchange rate changes on cash                                                             |       | 351                                                  |       | 20 |   |
|                                                                                                |       |                                                 |       |   |   |
| Cash and cash equivalents:                                                                          |       |                                                 |       |   |   |
| Increase  (decrease) for period                                                                     |       | 10,752                                               |       | (2,357 | ) |
| Balance,  beginning of period                                                                       |       | 40,842                                               |       | 16,425 |   |
| Balance, end of  period                                                                             |       | $                                                    | 51,594     |   | $ | 14,068 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

5

----

 

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATED****SUPPLEMENTAL CASH FLOWINFORMATION**

 

The followingsupplemental information is related to the unaudited condensed consolidatedstatements of cash flows:

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(in 000s)**                                   | ** ** |
| Cash paid for interest                               |       | $                                                    | 6,961      |   | $ | 6,748 |   |
| Cash paid for income taxes                           |       | 10,969                                               |       | 700 |   |
|                                                 |       |                                                 |       |   |   |
| Non-cash investing and financing transactions:       |       |                                                 |       |   |   |
| Transfer of leased gaming equipment to inventory (1) |       | $                                                    | 3,059      |   | $ | 1,465 |   |
| Transfer of inventory to leased gaming equipment (1) |       | 20,325                                               |       | 14,793 |   |
| Capital expenditure accruals                         |       | 613                                                  |       | — |   |
| Assets acquired through sale lease-back transactions |       | —                                               |       | 5,442 |   |
| Non-cash aspects of sale lease-back transactions     |       | —                                               |       | 1,372 |   |
| Consolidation of variable interest entities          |       | 213                                                  |       | 1,086 |   |

----

(1)          The Company has one process to procure raw materialsfor the assembly of both inventory and leased gaming equipment. The materialsrequisition planning process considers the number of devices the Companyexpects to build for sale and for use in its gaming operations division duringa particular period, but it does not separately earmark purchases for leasedgaming equipment. Without such an earmarking process, the Company is unable todetermine whether the cash expended to construct leased gaming equipment duringa particular period came from inventory on hand at the beginning of the periodor was constructed from inventory procured during the period of deployment,thus requiring the expenditure of cash. As a result of the inability toseparately identify the cash flows associated with the construction of leasedgaming equipment, the Company has included all additions to leased gamingequipment as a change in inventory under cash provided by (used in) operatingactivities in the unaudited condensed consolidated statement of cash flows. Inaddition, cash generated from the sale of used gaming equipment classified asleased gaming equipment is also included in cash provided by (used in)operating activities in the unaudited condensed consolidated statement of cashflows.

 

6

----

 

**BALLY TECHNOLOGIES, INC.**

**FORM 10-Q**

Notesto Unaudited Condensed Consolidated FinancialStatements

 

**1.             BASIS OF PRESENTATION**

 

*Principlesof presentation and consolidation*

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles and pursuant to the rules andregulations of the Securites and Exchange Commission (“SEC”) and reflect alladjustments, consisting of normal recurring adjustments, which managementbelieves are necessary to fairly present the financial position, results ofoperations and cash flows of Bally Technologies, Inc. (“Bally” or the “Company”),a Nevada corporation, and its subsidiaries for the respective periodspresented. Certain information and note disclosures normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to those rules andregulations. The results of operations for an interim period are notnecessarily indicative of the results that may be expected for any otherinterim period or the year as a whole. The accompanying unaudited condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto in the Company’s AnnualReport on Form 10-K for the fiscal year ended June 30, 2007, as filedwith the SEC on November 2, 2007.

 

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

 

The Company is thegeneral partner of Rainbow Casino Vicksburg Partnership (“RCVP”), whichoperates the Rainbow Casino in Vicksburg, Mississippi. The limited partner ofRCVP is entitled to receive 10% of the net available cash flows of RCVP afterdebt service and other items, as defined in the limited partnership agreement,which increases to 20% of the net available cash flows based on the incrementalamount of revenues in excess of $35.0 million, payable quarterly through December 31,2010. The Company holds the remaining economic interest in the partnership. TheCompany consolidates RCVP and records an adjustment to reflect the portion ofthe earnings of RCVP attributable to the minority shareholders.

 

The Company alsoconsolidates certain Atlantic City progressive trusts (the “Trusts”) inaccordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”)46R, *Consolidation of Variable Interest Entities,*which addresses consolidation by a business enterprise of variable interestentities (“VIE’s”).  The Trusts areconsolidated based on the premise they do not have sufficient equity investmentat risk to permit the Trusts to finance their activities without additionalsubordinated financial support from the Company. As of September 30, 2007and June 30, 2007, the Company consolidated $6.6 million and $6.3 million,respectively, in total assets and liabilities, primarily consisting of restrictedcash accounts and restricted investments (included in other assets in theunaudited condensed consolidated balance sheets) and related jackpotliabilities. The following revenues and costs were also consolidated:

 

| ** **                | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|
| ** **                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                | ** ** | **(in 000s)**                                   | ** ** |
| Gaming operations revenue |       | $                                                    | 1,681      |   | $ | 2,346 |   |
| Cost of gaming operations |       | 548                                                  |       | 1,484 |   |
|                           |            |                                                      |            |  |  |  |  |

 

All intercompany accountsand transactions have been eliminated in consolidation.

 

*Reclassifications*

 

Certain reclassificationshave been made to the prior period financial statements to conform to thecurrent period presentation to separately present gaming operations revenue andcost of gaming operations in the unaudited condensed consolidated statements ofoperations.  Gaming operations revenuesand cost of gaming operations had previously been included in gaming equipmentand systems revenue and cost of gaming equipment and systems.

 

7

----

 

*Inventories*

 

Inventories are stated atthe lower of cost, determined on a first in, first out basis, or market. Costelements included in work-in-process and finished goods include raw materials,freight, direct labor and manufacturing overhead. Inventories consist of thefollowing:

 

| ** **      | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|-----------------|------------|------------------------------|------------|-------------------------|------------|
| ** **      | ** ** | **(in 000s)**           | ** ** |
| Raw materials   |       | $                            | 63,280     |                    | $          | 58,473 |   |
| Work-in-process |       | 790                          |       | 639                     |       |
| Finished goods  |       | 34,719                       |       | 22,039                  |       |
| Total           |       | $                            | 98,789     |                    | $          | 81,151 |   |

 

The Company recordedinventory write-downs totaling approximately $2.1 million and $4.4 million forthe three months ended September 30, 2007 and 2006, respectively. Thesecharges are classified in cost of gaming equipment and systems in the unauditedcondensed consolidated statements of operations.

 

*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 to 40 years; gaming equipment, 4 to 7 years; furniture, fixturesand equipment, 3 to 7 years; and leasehold improvements, 5 to 10 years. Leasedgaming equipment is stated at cost and depreciated over the estimated usefullives ranging from 2 to 31⁄2 years. Equipment under capital leases is recorded at the lower of the presentvalue of the minimum lease payments or the fair value of the assets.

 

*DeferredRevenue and Deferred Cost of Revenue*

 

Deferredrevenue arises from the timing differences between the shipment or installationof gaming equipment and systems products and the satisfaction of all revenuerecognition criteria consistent with our revenue recognition policy.  Deferred cost of revenue consists of thedirect costs associated with the manufacture of gaming equipment and systemsproducts for which revenue has been deferred. Deferred revenue and deferred cost of revenue that are expected to berealized within one year are classified as current liabilities and currentassets, respectively.  In certain cases,deferred cost of revenue is recorded in advance of deferred revenue due to theshipment and receipt of the product to the customer in advance of billing.

 

*RecentlyIssued Accounting Pronouncements*

 

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

 

8

----

 

In December 2007,the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated Financial Statements - An Amendment ofARB No. 51.* SFAS No.160 establishes new accounting andreporting standards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary. Specifically, this statement requires therecognition of a noncontrolling interest (minority interest) as equity in theconsolidated financial statements and separate from the parent’s equity. Theamount of net income attributable to the noncontrolling interest will beincluded in consolidated net income on the face of the income statement. SFASNo.160 clarifies that changes in a parent’s ownership interest in a subsidiarythat do not result in deconsolidation are equity transactions if the parentretains its controlling financial interest. In addition, this statementrequires that a parent recognize a gain or loss in net income when a subsidiaryis deconsolidated. Such gain or loss will be measured using the fair value ofthe noncontrolling equity investment on the deconsolidation date. SFAS No.160also includes expanded disclosure requirements regarding the interests of theparent and its noncontrolling interest. SFAS No.160 is effective for fiscal years, and interim periods withinthose fiscal years, beginning on or after December 15, 2008, andaccordingly, the Company expects to adopt SFAS No.160 beginning in fiscal 2010.The Company is currently in the process of evaluating the impact SFAS No. 160will have on its consolidated results of operations, financial position andcash flows.

 

In February 2007,the FASB issued Statement SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*. SFASNo.159 provides companies with an option to report selected financial assetsand liabilities at fair value. It also establishes presentation and disclosurerequirements to facilitate comparisons between companies using differentmeasurement attributes for similar types of assets and liabilities. Thestatement is effective for fiscal years beginning after November 15, 2007,and accordingly, the Company expects to adopt SFAS No. 159 beginning infiscal 2009. Earlier application is permitted provided the Company also appliesthe provisions of SFAS No. 157, *Fair Value Measurements*,which is discussed below. The Company is currently in the process of evaluatingthe impact SFAS No. 159 will have on its consolidated results ofoperations, financial position and cash flows.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, rather it applies to existing accounting pronouncements thatrequire or permit fair value measurements. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007, and accordingly, theCompany expects to adopt SFAS No. 157 beginning in fiscal 2009. TheCompany is currently in the process of evaluating the impact SFAS No. 157will have on its consolidated results of operations, financial position andcash flows.

 

**2.             RESTATEMENTOF PREVIOUSLY ISSUED FINANCIAL STATEMENTS**

 

Subsequent to the issuance of the Company’sconsolidated financial statements for the year ended June 30, 2006 and inconnection with the year-end closing process for fiscal 2007, the Companydetermined that certain adjustments were required to be made for corrections oferrors in its previously issued unaudited condensed consolidated financialstatements for the three-month period ended September 30, 2006, amongothers. These errors related to:

 

·                                          Certain expenses that had been reportedin prior periods as selling, general and administrative expenses, depreciationand amortization expense and other expenses which should have been recordedeither as cost of sales or as contra-revenue;

 

·                                          Additions to leased gaming equipmentpreviously reported as cash used in investing activities in its unauditedcondensed consolidated statements of cash flows for all periods prior to March 31,2007 should have been presented as a change in inventory under cash used inoperating activities; and

 

·                                          Certain sales sourced from the UnitedStates directly to foreign customers were included in revenue and operatingincome attributable to the United States and Canada geographic region andshould have been classified as Europe or Other Foreign based on the location ofthe customer. Specifically, revenue of $8.8 million and operating income of$2.4 million for the three months ended September 30, 2006, respectively,should not have been classified as being attributable to the United States andCanada geographic region. See Note 8, Segments and Geographical Information.

 

9

----

 

As a result of these andother immaterial errors, the unaudited condensed consolidated statements ofoperations and statements of cash flows forthe three-month period ended September 30, 2006, among others, havebeen restated from the amounts previously reported. The restatement had noeffect on the unaudited condensed consolidated balance sheets, or reported netincome (loss) for any period.

 

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

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30, 2006** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                 | ** ** | **As  previously  reported**                    | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
| ** **                                                                 | ** ** | **(in 000s)**                              | ** ** |
| *Statement of Operations*                                                  | * *   | * *                                        | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                                                   |       |                                            |       |   |   |   |   |   |   |
| Gaming equipment  and systems                                              |       | $                                               | 141,963    |   | $ | (40,619 | ) | $ | (37 | ) | $ | 101,307 |   |
| Gaming  operations                                                         |       | —                                          |       | 40,619 |   | — |   | 40,619 |   |
| Casino  operations                                                         |       | 11,839                                          |       | — |   | — |   | 11,839 |   |
| Total revenue                                                              |       | 153,802                                         |       | — |   | (37 | ) | 153,765 |   |
|                                                                       |       |                                            |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems (2)                                   |       | 72,887                                          |       | (17,542 | ) | 802 |   | 56,147 |   |
| Cost of gaming operations                                                  |       | —                                          |       | 17,542 |   | — |   | 17,542 |   |
| Direct cost of casino operations                                           |       | 4,462                                           |       | — |   | — |   | 4,462 |   |
| Selling, general and administrative expense                                |       | 50,044                                          |       | — |   | (624 | ) | 49,420 |   |
| Depreciation and amortization                                              |       | 5,433                                           |       | — |   | (82 | ) | 5,351 |   |
| Operating income                                                           |       | 8,420                                           |       | — |   | (133 | ) | 8,287 |   |
| Other income, net                                                          |       | 250                                             |       | — |   | 133 |   | 383 |   |
| Loss from continuing  operations before income taxes and minority interest |       | (225                                            | )          | — |   | — |   | (225 | ) |
|                                                                            |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |

----

(1) See Note 1.

(2) Cost of gaming equipment and systemsexclude amortization related to certain intangibles, including core technologyand license rights, which are included in depreciation and amortization.

 
| ** **                                                                                       | ** ** | **Three Months Ended  September 30, 2006** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **As previously  reported**                               | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                                                                       | ** ** | **(in 000s)**                                             | ** ** |
| *Statement of Cash Flows*                                                                        | * *   | * *                                                       | * *   | * * | * * | * * | * * |
| Other  adjustments to reconcile net loss to net cash provided by (used in) operating  activities |       | $                                                              | 5,497      |   | $ | (2,279 | ) | $ | 3,218 |   |
| Change in inventories                                                                            |       | (8,531                                                         | )          | (16,585 | ) | (25,116 | ) |
| Cash flows provided by (used in) operating  activities                                           |       | 14,421                                                         |       | (18,864 | ) | (4,443 | ) |
|                                                                                             |       |                                                           |       |   |   |   |   |
| Capital expenditures                                                                             |       | (3,968                                                         | )          | (1,701 | ) | (5,669 | ) |
| Additions to leased gaming equipment                                                             |       | (20,565                                                        | )          | 20,565 |   | — |   |
| Cash flows used in investing activities                                                          |       | (26,407                                                        | )          | 18,864 |   | (7,543 | ) |
|                                                                                                  |            |                                                                |            |  |  |  |  |  |  |  |

 

10

----

 

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

 

The computation of basicand diluted earnings (loss) per share applicable to the Company’s common stockis as follows:

 
| ** **                                                                    | ** ** | **Three Months Ended  September 30,**             | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2007**                                                         | ** ** | **2006  (as restated)** | ** ** |
| ** **                                                                    | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Net income (loss)                                                             |       | $                                                                | 21,282     |   | $ | (225 | ) |
| After tax  interest expense on convertible debt                               |       | 86                                                               |       | — |   |
| Dilutive earnings (loss)                                                      |       | $                                                                | 21,368     |   | $ | (225 | ) |
|                                                                          |       |                                                             |       |   |   |
| Weighted average common shares outstanding                                    |       | 54,043                                                           |       | 52,901 |   |
| Dilutive effect  of:                                                          |       |                                                             |       |   |   |
| Stock options,  Restricted Stock Units (“RSU”) and restricted stock |       | 3,083                                                            |       | — |   |
| Warrants                                                                      |       | 16                                                               |       | — |   |
| Convertible debt                                                              |       | 274                                                              |       | — |   |
| Diluted shares  outstanding                                                   |       | 57,416                                                           |       | 52,901 |   |
|                                                                          |       |                                                             |       |   |   |
| Basic earnings (loss) per share                                               |       | $                                                                | 0.39       |   | $ | (0.00 | ) |
| Diluted earnings (loss) per share                                             |       | $                                                                | 0.37       |   | $ | (0.00 | ) |

 

Certain securities wereexcluded from the diluted per share calculation because their inclusion wouldbe anti-dilutive. For the three-month period ended September 30, 2007, alloptions and warrants outstanding with an exercise price that exceeds the fairmarket value of the underlying stock have been excluded. For the three-monthperiod ended September 30, 2006, all potentially dilutive securities wereexcluded from the diluted per share calculation as their inclusion would havebeen anti-dilutive due to the net loss reported. Such securities consist of thefollowing:

 

| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **September 30,**           | ** ** |
| ** **                              | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(in 000s)**               | ** ** |
| Stock options, RSU and restricted stock |       | 3                                |       | 9,366 |   |
| Warrants                                |       | —                           |       | 100 |   |
| Total                                   |       | 3                                |       | 9,466 |   |

 

As of September 30,2006, the Company also had certain related party debt outstanding which wasconvertible into common stock at the Company’s discretion. See Note 7, RelatedParty Transactions.  The potentialdilution from this convertible debt was not included in the diluted loss pershare computation for the three-month period ended September 30, 2006, dueto the reported net loss for the period. Assuming the conversion occurred on September 30,2006, an additional 0.7 million shares, would have been outstanding as a resultof the conversion. The effect of the convertible debt has been included in thediluted per share calculation for three-month period ended September 30,2007.

 

11

----

 

**4.             SHARE-BASED COMPENSATION**

 

The Company accounts for its share-based compensationin accordance with the provisions of SFAS No. 123R, *Share-BasedPayment*, which established accounting for equity instrumentsexchanged for employee services. SFAS No. 123R requires employee stockoptions and rights to purchase shares under stock participation plans to beaccounted for under the fair value method. Under the provisions of SFAS No. 123R, share-basedcompensation cost is measured at the grant date, based on the calculated fairvalue of the award, and is recognized as an expense over the employee’srequisite service period which is generally the vesting period of the equitygrant.

 

The following table presents share-based compensationexpense included in the Company’s unaudited condensed consolidated statementsof operations:

 

| ** **                                          | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(in 000s)**                                        | ** ** |
| Selling, general and administrative                 |       | $                                                    | 3,250      |   | $ | 3,346 |   |
| Research and development                            |       | 450                                                  |       | 375 |   |
| Cost of gaming equipment and systems and operations |       | 34                                                   |       | 31 |   |
| Share-based compensation expense before tax         |       | 3,734                                                |       | 3,752 |   |
| Income tax  benefit                                 |       | 1,307                                                |       | 1,313 |   |
| Net share-based  compensation expense               |       | $                                                    | 2,427      |   | $ | 2,439 |   |

 

As of September 30, 2007, there was $20.2 millionof total unrecognized compensation expense related to the unvested portion ofstock options which will be recognized over the subsequent 2.54 years.

 

The Company estimates the fair value of stock optionsusing the Black-Scholes valuation model. Key input assumptions used to estimatethe fair value of stock options include the exercise price of the award, theexpected option term, the expected volatility of the Company’s common stockover the option’s expected term, the risk-free interest rate over the option’sexpected term and the Company’s expected annual dividend yield. The Companybelieves that the valuation technique and the approach utilized to develop theunderlying assumptions are appropriate in calculating the fair values of theCompany’s stock options granted. Estimates of fair value are not intended topredict actual future events, or the value ultimately realized by therecipients of equity awards.

 

The fair value of each option granted during theperiods referenced below was estimated on the grant date using theBlack-Scholes valuation model with the following assumptions:

 

| ** **                       | ** ** | **Three Months Ended  September 30,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Weighted average:                |       |                                                 |       |   |   |
| Expected option  term (in years) |       | 6.25                                                 |       | 6.25 |   |
| Expected  volatility             |       | 50.35                                                | %          | 58.58 | % |
| Risk-free  interest rate         |       | 4.87                                                 | %          | 4.88 | % |
| Expected annual  dividend yield  |       | —                                               |       | — |   |

 

12

----

 

Stock option activity as of and for the three monthsended September 30, 2007 is summarized below:

 
| ** **                                        | ** ** | **Weighted Average** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **Shares**                | ** ** | **Exercise  Price** | ** ** | **Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| ** **                                        | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** | **(years)** | ** ** | **(in 000s)** | ** ** |
| Balance outstanding as of June 30, 2007      |       | 8,179                     |       | $ | 15.87 |   | 6.88 |   | $ | 86,328 |   |
| Granted                                           |       | 88                        |       | 27.46 |   |   |   |   |   |
| Exercised                                         |       | (320                      | )          | 14.93 |   |   |   |   |   |
| Forfeited or  expired                             |       | (35                       | )          | 17.58 |   |   |   |   |   |
| Balance outstanding as of September 30, 2007 |       | 7,912                     |       | $ | 16.03 |   | 6.69 |   | $ | 153,448 |   |
| Exercisable as of September 30, 2007         |       | 4,921                     |       | $ | 16.57 |   | 5.78 |   | $ | 92,772 |   |

 

Restricted stock and RSU activity as of and for thethree months ended September 30, 2007 is summarized below:

 

| ** **                                        | ** ** | **Weighted Average** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **Shares**                | ** ** | **Grant Date  Fair Value** | ** ** |
| ** **                                        | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** |
| Balance outstanding as of June 30, 2007      |       | 761                       |       | $ | 16.05 |   |
| Granted                                           |       | 5                         |       | 27.26 |   |
| Forfeited or  expired                             |       | —                    |       | — |   |
| Balance outstanding as of September 30, 2007 |       | 766                       |       | $ | 16.13 |   |
|                                              |       |                      |       |   |   |
| Vested as of September 30, 2007              |       | 440                       |       | $ | 15.28 |   |

 

**5.             GOODWILL AND INTANGIBLE ASSETS**

 

*Finite lived intangible assets*

 

Finite lived intangibleassets are comprised of the following:

 

| ** **                          | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|-------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **(in 000s)**           | ** ** |
| Patents and gaming related products |       | $                            | 16,050     |                    | $          | 16,050 |   |
| Less: accumulated amortization      |       | (6,460                       | )          | (5,992                  | )          |
|                                |       | 9,590                        |       | 10,058                  |       |
|                                |       |                         |       |                    |       |
| Licenses and other                  |       | $                            | 33,639     |                    | $          | 32,894 |   |
| Less: accumulated amortization      |       | (19,678                      | )          | (18,551                 | )          |
|                                |       | 13,961                       |       | 14,343                  |       |
|                                |       |                         |       |                    |       |
| Total                               |       | $                            | 23,551     |                    | $          | 24,401 |   |

 

*Goodwill*

 

The changes in thecarrying amount of goodwill for the three-month period ended September 30,2007, are as follows:

 

| ** **                              | ** ** | **(in 000s)** | ** ** |
|-----------------------------------------|------------|--------------------|------------|
| Balance at June 30, 2007           |       | $                  | 161,708    |   |
| Foreign currency translation adjustment |       | 349                |       |
| Balance at September 30, 2007      |       | $                  | 162,057    |   |

 

13

----

 

**6.             LONG-TERM DEBT AND CAPITAL LEASES**

 

Long-termdebt and capital leases consist of the following:

 

| ** **                                                  | ** ** | **September 30** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                  | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| ** **                                                  | ** ** | **(in 000s)**    | ** ** |
| Term loan facility                                          |       | $                     | 292,050    |              | $          | 307,882 |   |
| Capital lease obligations                                   |       | 14,646                |       | 15,944            |       |
| Related party debt (see Note 7)                             |       | 9,981                 |       | 9,981             |       |
| Other, generally unsecured                                  |       | 53                    |       | 47                |       |
| Long-term debt  and capital leases                          |       | 316,730               |       | 333,854           |       |
| Less current maturities                                     |       | 12,568                |       | 12,271            |       |
| Long-term debt  and capital leases, less current maturities |       | $                     | 304,162    |              | $          | 321,583 |   |

 

The Company’sdebt structure at September 30, 2007 consisted primarily of a term loanfacility and a $75.0 million revolving credit facility, which are limited by acurrent leverage ratio and debt owed to related parties. There were no amountsoutstanding under the Company’s revolving credit facility as of September 30,2007.  The revolving line of credit isfurther restricted to the extent of outstanding letters of credit.  Outstanding letters of credit at September 30,2007 were $26.3 million which reduced availability under the revolving creditfacility to approximately $48.7 million. The revolving credit facility commitment reduces annually until it comesdue in September 2008.

 

Theterm loan requires principal reductions of approximately 1% per annum paid quarterly,with a balloon payment due in September 2009. As of September 30,2007, the term loan had an interest rate of 8.64%, based on LIBOR plus 3.25%.

 

Theterm loan and the revolving credit facility are collateralized by substantiallyall of the Company’s domestic property and are guaranteed by each of theCompany’s domestic subsidiaries, other than the entity that holds the Company’sinterest in its Rainbow Casino operations, and are secured by a pledgeagreement. The bank loan agreement governing the term loan and the revolvingcredit facility (the “Loan Agreement”) contains a number of maintenance andother covenants that, among other things, restrict the ability of the Companyand certain of its subsidiaries to dispose of assets, incur additional indebtednessor issue preferred stock, pay dividends or make other distributions, enter intocertain acquisitions, repurchase equity interests or subordinated indebtedness,issue or sell equity interests of the Company’s subsidiaries, engage in mergersor acquisitions or certain transactions with subsidiaries and affiliates, andthat otherwise restrict corporate activities. The Company was in compliancewith these covenants as of September 30, 2007.

 

As of September 30,2007, the Company was also in compliance with its financial covenantsconsisting of a leverage ratio, a fixed charges coverage ratio and a minimum ofEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (asEBITDA is defined in the Loan Agreement). The leverage ratio is computed astotal average debt outstanding during the quarter divided by the trailing 12months EBITDA, excluding certain cash and non-cash charges. The Company’sleverage ratio as of September 30, 2007 was 1.82 times versus a maximumallowable of 3.50 times.

 

Capital lease obligationsrepresent amounts owed under lease or sale-lease back transactions primarilyrelated to equipment used in the Company’s Gaming Equipment and Systemssegment. Based on different installation dates over a four month period, three separatepayment streams of thirty-six equal installments were created with an aggregatemonthly payment of $655,000 at an average interest rate of 9.11%.

 

TheCompany’s related party debt, which totaled approximately $10.0 million as of September 30,2007, consists primarily of the debt owed to the former principals of SierraDesign Group (“SDG”) and MindPlay LLC (“MindPlay”). See Note 7, Related PartyTransactions, regarding related party debt.

 

14

----

 

**7.             RELATED PARTY TRANSACTIONS**

 

The Company completed the acquisition of all of theassets of SDG during fiscal 2005 and substantially all of the assets andliabilities of MindPlay during fiscal 2004. In each acquisition, theconsideration paid included subordinated debt issued to the former principalsof each business. Certain of the former principals are now employees of theCompany, and therefore, such debt is considered to be owed to related parties.The interest rates on the outstanding debt range from a variable rate of LIBORplus 2% to a fixed rate of 6%. The following table presents the outstandingrelated party debt and interest rates as of the periods referenced:

 

| ** **                                   | ** ** | **September 30, 2007** | ** ** | **June 30, 2007** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **Interest  Rate**               | ** ** | **Outstanding  Debt**       | ** ** | **Interest  Rate** | ** ** | **Outstanding  Debt** | ** ** |
| ** **                                   | ** ** | **(in 000s)**               | ** ** |
| SDG                                          |       | 7.33%                            |       | $                           | 6,981      |   | 7.33% |   | $ | 6,981 |   |
| MindPlay                                     |       | 6.00%                            |       | 3,000                       |       | 6.00% |   | 3,000 |   |
| Related party  debt                          |       |                             |       | 9,981                       |       |   |   | 9,981 |   |
| Less current maturities                      |       |                             |       | 2,381                       |       |   |   | 2,381 |   |
| Related party  debt, less current maturities |       |                             |       | $                           | 7,600      |   |   |   | $ | 7,600 |   |

 

The notes payable to theformer principals of SDG are payable in annual installments through 2009. Atthe Company’s discretion, the principal and accrued interest thereon can bepaid in cash, or can be converted into shares of the Company’s common stockusing the average stock price for the 20 business days prior to the delivery ofsuch shares.

 

The initial purchaseprice for Mindplay included, among other things, the issuance of a $4.0 millionnote payable. As provided for in the acquisition agreement, under certaincircumstances, the Company may offset 50% of all damages (includingreasonable attorneys’ fees) up to the entire amount due under the promissorynote in connection with an indemnification claim against the formershareholders of MindPlay related to the Company’s patent lawsuit with ShuffleMaster, Inc. (“Shuffle Master”) and International Game Technology (“IGT”).  See Note 10, Commitments and Contingencies.

 

The Company leases awarehouse and office facility from an entity owned by Mr. Robert Luciano,a former principal of SDG and the Company’s Chief Technology Officer. Rentalpayments totaled $112,000 for both of the three-month periods ended September 30,2007 and 2006.

 

**8.             SEGMENTS AND GEOGRAPHICALINFORMATION**

 

The Company operates intwo reportable segments: (i) Bally Gaming Equipment and Systems whichdesigns, manufactures, assembles, distributes and operates gaming machines andcomputerized monitoring and bonusing systems for gaming machines, and (ii) CasinoOperations which owns and operates a casino in Vicksburg, Mississippi. Theaccounting policies of these segments are consistent with the Company’spolicies for the unaudited condensed consolidated financial statements.

 

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

 

| ** **                    | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **(in 000s)**                                   | ** ** |
| Revenues:                     |       |                                                 |       |   |   |
| Gaming Equipment  and Systems |       | $                                                    | 177,610    |   | $ | 141,926 |   |
| Casino  Operations            |       | 11,420                                               |       | 11,839 |   |
| Total revenues                |       | $                                                    | 189,030    |   | $ | 153,765 |   |
|                          |       |                                                 |       |   |   |
| Inter-segment revenues:       |       |                                                 |       |   |   |
| Gaming Equipment  and Systems |       | $                                                    | 285        |   | $ | 82 |   |
| Casino  Operations            |       | —                                               |       | — |   |
| Total inter-segment revenues  |       | $                                                    | 285        |   | $ | 82 |   |
|                          |       |                                                 |       |   |   |
| Operating income (loss):      |       |                                                 |       |   |   |
| Gaming Equipment  and Systems |       | $                                                    | 46,702     |   | $ | 10,901 |   |
| Casino  Operations            |       | 3,842                                                |       | 4,035 |   |
| Corporate/other               |       | (9,382                                               | )          | (6,649 | ) |
| Total operating income        |       | $                                                    | 41,162     |   | $ | 8,287 |   |

 

15

----

 

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

 

| ** **                | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|
| ** **                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                | ** ** | ** **                                           | ** ** | **(As restated,  See Note 2)** | ** ** |
| ** **                | ** ** | **(in 000s)**                                   | ** ** |
| Revenues:                 |       |                                                 |       |   |   |
| United States  and Canada |       | $                                                    | 162,368    |   | $ | 136,416 |   |
| Europe                    |       | 10,292                                               |       | 6,577 |   |
| Other foreign             |       | 16,370                                               |       | 10,772 |   |
| Total revenues            |       | $                                                    | 189,030    |   | $ | 153,765 |   |
|                      |       |                                                 |       |   |   |
| Operating income:         |       |                                                 |       |   |   |
| United States  and Canada |       | $                                                    | 34,308     |   | $ | 5,441 |   |
| Europe                    |       | 3,943                                                |       | 1,050 |   |
| Other foreign             |       | 2,911                                                |       | 1,796 |   |
| Total operating income    |       | $                                                    | 41,162     |   | $ | 8,287 |   |

 

**9.             INCOME TAXES**

 

The provision for income taxes is based on the currentestimate of the annual effective tax rate and is adjusted as necessary forquarterly events. The effective income tax rate was approximately 37% and 38%for the three months ended September 30, 2007 and 2006, respectively. Thechange resulted primarily from an increase in pretax book income which reducesthe effect of permanent differences.

 

The Company’s effective tax rate has historically notreflected and continues to not reflect a provision related to the undistributedearnings of foreign affiliates. The Company does not record a deferred taxliability for those amounts because of specific plans for the reinvestment of undistributedearnings.

 

In July 2006, the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, anInterpretation of FASB Statement No. 109*, which creates asingle model to address uncertainty in income tax positions and prescribes theminimum recognition threshold a tax position is required to meet before beingrecognized in the financial statements. It also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 was effective for fiscalyears beginning after December 15, 2006, and accordingly, the Companyadopted FIN 48 beginning on July 1, 2007.

 

As a result of the implementation of FIN 48, theCompany recorded $22.9 million of liabilities for unrecognized tax benefits ofwhich $8.8 million were accounted for as an increase in accumulated deficit on July 1,2007.  Of this amount, $14.9 million, ifrecognized, would impact the effective tax rate.  The Company recognizes interest and penaltiesrelated to unrecognized tax benefits as tax expense.  As of July 1, 2007, the Company had $1.2and $0.4 million accrued for the payment of interest and penalties,respectively.  At September 30,2007, there were no material changes to the amounts recognized upon adoption.

 

The Company files numerous consolidated and separateincome tax returns in the United States federal jurisdiction and in many stateand foreign jurisdictions.  With fewexceptions, the Company is no longer subject to United States federal income taxexaminations for years before 1995 and is no longer subject to state and local,or foreign income tax examinations for years before 2000.

 

The Internal Revenue Service (“IRS”) commencedexamination of the Company’s United States federal income tax returns for 2003,2004 and 2005 in the fourth quarter of 2006. To date, the IRS has proposed, and management has agreed to certainadjustments related to the returns that have been recorded in the income taxprovision.  During 2006, the German taxauthorities commenced audits of certain German income tax returns for yearsranging from 2000 through 2003.  To date,there are no proposed adjustments that will have a material impact on theCompany’s financial position or results of operations. It is unlikely that theexaminations will be completed in the next twelve months.

 

The Company does notanticipate that total unrecognized tax benefits will significantly change dueto the settlement of audits and the expiration of statute of limitations priorto September 30, 2008.

 

16

----

 

**10.          COMMITMENTS AND CONTINGENCIES**

 

InJune and July 2004, putative class actions were filed againstthe Company and its officers, Robert Miodunski, Robert Saxton, Mark Lerner andSteven Des Champs, in the United States District Court for the District ofNevada. The nearly identical complaints alleged violations of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), stemming from revisedearnings guidance, declines in the stock price and sales of stock by insiders.The complaints sought damages in unspecified amounts. The Federal DistrictCourt granted the plaintiffs’ unopposed motions to consolidate the cases and toappoint a lead counsel and a lead plaintiff, and the plaintiffs filed aconsolidated complaint, all as is customary in such cases. The Company and theother defendants moved to dismiss the complaint. Thereafter, activity in thecase was stopped and the parties participated in a mediation process duringwhich the parties agreed on the terms of a settlement. The parties negotiatedand executed settlement documents settling both the consolidatedclass action and companion derivative litigation. Under the settlement anaggregate of $16.0 million in cash, plus certain interest, was paid to settlethe securities class action as well as companion derivative litigation.The Company accrued $1.25 million related to the settlement during the yearended June 30, 2006, which was paid in late February 2007. Inaddition to certain governance actions the Company has agreed to undertake inconnection with the settlement, the Company’s directors and officers insurercontributed approximately $14.75 million to the settlement. The courtapproved the settlement on August 9, 2007, ending the case.

 

InFebruary 2005, the SEC initiated an informal inquiry and requesteddocuments and information regarding matters related to the allegations in theclass actions and similar matters. In August 2005, the SEC notifiedthe Company that its investigation had entered a formal phase, and requestedadditional information from the Company covering the same general areas thatwere addressed in the informal inquiry. Management is cooperating fully withthe SEC in this matter.

 

InAugust 2004, Shuffle Master sued the Company in the United States DistrictCourt for the District of Nevada, alleging infringement of various patents inconnection with the Company’s MindPlay product line and seeking injunctiverelief and damages in an unspecified amount. In June 2005, it wasannounced that IGT had acquired an interest in the patents at issue in thecase, and thereafter, IGT joined the case as a plaintiff. In December 2005,the District Court issued a ruling construing the claim terms of all thepatents in the suit. A hearing on the parties’dispositivemotions is set for February 2008. Management believes the plaintiffs’lawsuit to be without merit, and the Company is vigorously defending againstthe lawsuit.

 

OnDecember 7, 2004, IGT filed a patent infringement lawsuit against theCompany in the United States District Court for the District of Nevada. Thecomplaint asserts that the Company’s wheel-based games, such as Monte CarloTM,Lucky WheelTM andCash For LifeTM,its games with a reel in the top box, such as Bonus FrenzyTM,and its iVIEWTMproducts infringe on patents held by IGT, and seeks injunctive relief anddamages in unspecified amounts. The Company believes IGT’s claims arewithout merit and is vigorously defending itself against the lawsuit. Aspart of its defense, the Company has asserted counterclaims against IGT,including claims that IGT’s patents are invalid, unenforceable and notinfringed, as well as several claims that IGT has engaged inanti-competitive conduct in violation of state and federal antitrust laws. Byits counterclaims, the Company is seeking damages and other relief from IGT.IGT’s motion to dismiss the Company’s antitrust claims was deniedin January 2006, and in March 2007, the court denied IGT’smotions for summary judgment with respect to the antitrust claims dealing withthe wheel game market. The court issued claims construction rulings in May 2007.  The parties filed assorted motions forsummary judgment on November 16, 2007; no hearing date has been set.  Trial is tentatively scheduled for May 2008.

 

InSeptember 2006, the Company filed a patent infringement lawsuit againstIGT in the United States District Court for the District of Nevada. Thecomplaint asserts that certain of IGT’s bonus wheel games infringe patents heldby the Company, and seeks injunctive relief and damages. IGT filed an answergenerally denying the claims. The case is in the discovery phase and no trialdate has been set.

 

17

----

 

InMay 2006, IGT filed a patent infringement lawsuit against the Company inthe United States District Court for the District of Delaware. The complaintasserts that the Company’s Bally Power BonusingTMproducts infringe patents held by IGT, and seeks injunctive relief and damagesin unspecified amounts. The court took IGT’s motion for a preliminaryinjunction off-calendar and set a November 2008 trial date. The Companybelieves IGT’s claims are without merit and is vigorously defending itselfagainst the lawsuit.

 

TheCompany is also a party to various lawsuits relating to routine mattersincidental to our business. Management does not believe that the outcome ofsuch litigation, including the matters above, in the aggregate, will have amaterial adverse effect on our consolidated financial position, results ofoperations or cash flows.

 

**11.          SUBSEQUENT EVENTS**

 

In November 2007,the Company repurchased 149,253 shares of common stock for $6.0 million from Mr. RobertLuciano, the Company’s Chief Technology Officer.  The purchase price per share of common stock,$40.20, was determined by calculating the average per share closing price ofthe Company’s common stock for the three business days before the closing date.

 

18

----

 

**ITEM 2.****                                                  ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

We begin this Management’sDiscussion and Analysis of Financial Condition and Results of Operations with asummary of the restatement as well as an overview of our key operating businessdivisions as of September 30, 2007. This overview is followed by adetailed analysis of our results of operations and our financial condition asof, and for, the three months ended September 30, 2007 and 2006. The financial information set forth in thefollowing Management’s Discussion and Analysis gives effect to the restatementas discussed in Note 2 to the unaudited condensed consolidated financialstatements, Restatement of Previously Issued Financial Statements.

 

**ForwardLooking Statements**

 

Certain statements madeor incorporated by reference in this Quarterly Report on Form 10-Q, in ourother filings with the SEC, in our press releases and in statements made by orwith the approval of authorized personnel constitute “forward lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”) and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), and are subject to thesafe harbor created thereby. Forward looking statements reflect intent, beliefor current expectations with respect to, among other things, future events andfinancial trends affecting us. Forward looking statements are typicallyidentified by words such as “believes,” “expects,” “anticipates” and similarexpressions.

 

Although we believe theexpectations reflected in any forward looking statements are reasonable,readers are cautioned that forward looking statements involve known and unknownrisks and uncertainties, are not guarantees of future performance and thatactual results, performance or achievements may differ materially from anyfuture results, performance or achievements expressed or implied by such forwardlooking statements. These differences can arise as a result of the risksdescribed in Item 1A, Risk Factors included in on the 2007 10-K, as well asother factors such as the impact of competition, our ability to service debt,product development, foreign operations, dependence on key personnel, theability to integrate future acquisitions, regulation by gaming authorities, theoutcome of pending litigation matters, gaming taxes, market risks and thepotential adverse effects to our financial condition, results of operations orprospects.

 

Forward lookingstatements in this Quarterly Report on Form 10-Q speak only as of the datehereof, and forward looking statements in documents incorporated by referencespeak only as of the date of those documents. Unless otherwise required by law,we undertake no obligation to publicly update or revise these forward lookingstatements, whether as a result of new information, future events or otherwise.In light of these risks and uncertainties, we cannot assure you that the forwardlooking statements contained in this Quarterly Report on Form 10-Q will,in fact, transpire.

 

**Restatement**

 

Subsequent to the issuanceof our consolidated financial statements for the year ended June 30, 2006and in connection with the year-end closing process for fiscal 2007, wedetermined that certain adjustments were required to be made for corrections oferrors in our previously issued consolidated financial statements for the yearsended June 30, 2006 and 2005 and certain periods within such years. On October 29,2007, after consultation with management, our Board of Directors determinedthat a restatement of the unaudited condensed consolidated financial statementsfor the affected periods was required. The restatement related primarily to:

 

·                                          Certain expenses that had been reportedin prior periods as selling, general and administrative expenses, depreciationand amortization expense and other expenses which should have been recordedeither as cost of sales or as contra-revenue;

 

·                                          Additions to leased gaming equipmentpreviously reported as cash used in investing activities in our unauditedcondensed consolidated statements of cash flows for all periods prior to March 31,2007 should have been presented as a change in inventory under cash used inoperating activities; and

 

·                                          Certain sales sourced from the UnitedStates directly to foreign customers were included in revenue and operatingincome attributable to the United States and Canada geographic region andshould have been classified as Europe or Other Foreign based on the location ofthe customer. Specifically, revenue of $8.8 million and operating income of$2.4 million for the three months ended September 30, 2006 should not havebeen classified as being attributable to the United States and Canadageographic region. See Note 8 to the unaudited condensed consolidated financialstatements, Segments and Geographic Information.

 

19

----

 

As a result of these and other immaterial errors, ourunaudited condensed consolidated statements of operations and statements ofcash flows for the three-month period ended September 30, 2006, amongother periods, have been restated from the amounts previously reported. Therestatement had no effect on the unaudited condensed consolidated balance sheetsor reported net income (loss) for any period. See Note 2 to the unauditedcondensed consolidated financial statements, Restatement of Previously IssuedFinancial Statements.

 

Thefinancial information set forth in the following Management’s Discussion andAnalysis gives effect to the restatement. The following is a summary of the effects of therestatement.

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30, 2006** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                 | ** ** | **As  previously  reported**                    | ** ** | **Reclassification (1)** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
|                                                                       |       | **(in  000s)**                                  |       |
| *Statement of Operations*                                                  | * *   | * *                                        | * *   | * * | * * | * * | * * | * * | * * |
| Revenue:                                                                   |       |                                            |       |   |   |   |   |   |   |
| Gaming equipment  and systems                                              |       | $                                               | 141,963    |   | (40,619 | ) | $ | (37 | ) | $ | 101,307 |   |
| Gaming  operations                                                         |       | —                                          |       | 40,619 |   | — |   | 40,619 |   |
| Casino  operations                                                         |       | 11,839                                          |       | — |   | — |   | 11,839 |   |
| Total revenue                                                              |       | 153,802                                         |       | — |   | (37 | ) | 153,765 |   |
|                                                                       |       |                                            |       |   |   |   |   |   |   |
| Cost of gaming equipment and systems(2)                                    |       | 72,887                                          |       | (17,542 | ) | 802 |   | 56,147 |   |
| Cost of gaming operations                                                  |       | —                                          |       | 17,542 |   | — |   | 17,542 |   |
| Direct cost of casino operations                                           |       | 4,462                                           |       | — |   | — |   | 4,462 |   |
| Selling, general and administrative expense                                |       | 50,044                                          |       | — |   | (624 | ) | 49,420 |   |
| Depreciation and amortization                                              |       | 5,433                                           |       | — |   | (82 | ) | 5,351 |   |
| Operating income                                                           |       | 8,420                                           |       | — |   | (133 | ) | 8,287 |   |
| Other income, net                                                          |       | 250                                             |       | — |   | 133 |   | 383 |   |
| Loss from continuing  operations before income taxes and minority interest |       | (225                                            | )          | — |   | — |   | (225 | ) |
|                                                                            |            |                                                 |            |  |  |  |  |  |  |  |  |  |

----

(1) See Note 1 tothe unaudited condensed consolidated financial statements, Basis ofPresentation.

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

 

| ** **                                                                             | ** ** | **Three Months Ended September 30, 2006** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **As previously  reported**                                   | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                                                             | ** ** | **(in 000s)**                                                 | ** ** |
| *Statement of Cash Flows*                                                              | * *   | * *                                                           | * *   | * * | * * | * * | * * |
| Other  adjustments to reconcile net loss to net cash provided by operating  activities |       | $                                                                  | 5,497      |   | $ | (2,279 | ) | $ | 3,218 |   |
| Change in inventories                                                                  |       | (8,531                                                             | )          | (16,585 | ) | (25,116 | ) |
| Cash flows provided by (used in) operating  activities                                 |       | 14,421                                                             |       | (18,864 | ) | (4,443 | ) |
|                                                                                   |       |                                                               |       |   |   |   |   |
| Capital expenditures                                                                   |       | (3,968                                                             | )          | (1,701 | ) | (5,669 | ) |
| Additions to leased gaming equipment                                                   |       | (20,565                                                            | )          | 20,565 |   | — |   |
| Cash flows used in investing activities                                                |       | (26,407                                                            | )          | 18,864 |   | (7,543 | ) |
|                                                                                        |            |                                                                    |            |  |  |  |  |  |  |  |

 

20

----

 

**OurBusiness**

 

We are a diversified,worldwide gaming company that designs, manufactures, distributes and operatesgaming machines and computerized monitoring systems for gaming machines. Inaddition to selling our gaming devices, we also offer our customers a widerange of lease and rental options. Our primary technologies include gamingdevices for land based, riverboat and Native American casinos, video lotteryand central determination markets and specialized system-based hardware andsoftware products. Our specialized hardware and software products providecasinos with a wide-range of marketing, data management, accounting, securityand other software applications and tools to more effectively manage theiroperations. We also own and operate a riverboat, dockside casino in Vicksburg,Mississippi.

 

We derive our revenues from the following foursources:

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

 

We design, manufacture, assemble, sell, maintain andoperate a full range of technology-based gaming devices through our GamingEquipment division. These devices are not mass produced and are normallyconfigured to specific requirements based on a customer’s particular order.Gaming devices are differentiated from one another by a number of factorsincluding, but not limited to, graphic design and theme, cabinet style, paytable, game layout, betting denomination and minimum/maximum betting amount.

 

Each gaming device contains an operating system referred toas a game platform. The operating system manages the software needed to run thedevice. Game platforms and the related computer systems are constantly updatedand revised to keep pace with the ever-increasing complexity of modern gameplay requirements. The change in game play requirements is driven by, amongother things, changes in consumer demand, capacity, security and regulation. Infiscal 2005, we completed the successful migration from our legacy platforms,including the V7000 and EVOTM, to the Linux-based ALPHA OSTM platform. In fiscal2006, we also extended the ALPHA OS platform to our mechanical reel spinningdevices. ALPHA OS is now the platform for each of our gaming deviceproduct offerings and, as a result, marketing of our legacy products hasgenerally been discontinued.

 

The ALPHA OS is designed to separate the gaming operatingsystem from the game layer, which enables game development in a much shortertime. ALPHA OS is also designed to incorporate bonusing, free spin, scatter andother advanced game features, while providing internal and third-partydevelopers with a secure, easy-to-use programming environment that incorporatesan advanced set of development tools. Moreover, ALPHA OS is designed to supportserver-based gaming initiatives, including download of game results,configuration and game content. Additionally, our layered architecture andmodular design allow for adaptability and simplified requirement changes. Theoperating system, which is Linux-based, is compatible with the most commonaccounting, ticketing and bonusing systems and supports 50-plus bet lines,various game bonusing, top boxes, multi-denomination, multi-game and multi-paytable game configurations. ALPHA OS also supports stand alone, local andwide-area progressive products.

 

In addition to sellingour gaming devices, we also offer our customers a wide range of lease andrental options through our Gaming Operations division. Specifically, thesearrangements are available under four business models: linked progressivesystems, rental and daily fee games, lottery systems and centrally determinedsystems. In most cases, operating gaming devices under a lease or rentalarrangement requires us to invest capital in manufacturing the gaming deviceand related equipment, purchasing signs and seating, and, in certain cases,acquiring certain intellectual property rights.

 

We alsodesign, program, test, market and support casino enterprise systems for a widerange of customers of varying size and complexity through our Systems division.These systems typically provide casino operators features such as active,real-time monitoring tools for gaming devices, tools to collect and managecustomer data, security to protect against theft and data loss, and marketingprograms to enhance the gaming experience. The use of system technology ingaming has grown in the past ten years from basic automation of manualactivities to highly integrated mission critical applications. We believe weare the only provider in the industry that offers a selection of technologyplatform options to its customers. Our products operate on platforms suchas Windows, AS/400 (iSeries) and UNIX which allow our customers to choose atechnology solution that meets their existing or future infrastructurerequirements.

 

21

----

 

The primarysystems we sell our customers are products for slot floor management, casinomanagement, cashless systems and iVIEWTM gaming machine displays. iVIEW is asmall, horizontal liquid-crystal display screen and accompanying hardware andsoftware that resides in the gaming devices and serves as a communication toolto players sitting at the machine. iVIEW is also designed to work with ourBally Power BonusingTM suite of products and other new technologies underdevelopment. We market our system product solutions under the broad categoriesof Bally CMS® (Casino Management Systems), Bally SMS® (Slot Management Systems)and Bally TMS® (Table Management Systems).

 

We spent approximately 8% of revenue generated fromour Bally Gaming Equipment and Systems segment for the three months ended September 30,2007 on research and development to accelerate the use of technology in ourgaming products.

 

Our Rainbow Casinois one of four casinos currently operating in the Vicksburg, Mississippi marketand comprises our Casino Operations division. The facility includes a33,000-square foot casino with 817 gaming devices and 10 table games, a224-seat buffet-style restaurant and a 20,000-square foot conference center.The Casino also includes the 89-room Rainbow Hotel, which is owned andoperated by a third party. Rainbow is marketed as a “locals” casino and drawsmid-level gaming customers principally from within a 75-mile radius ofVicksburg. Our promotions are focused primarily on direct mail and specialpromotional events. A new casino project adjacent to the Rainbow Casino isunder construction and is scheduled to open in July 2008. Theremay be other new casinos constructed in the Vicksburg market in the futureas previously existing and new Gulf Coast properties continue to open in theaftermath of the 2005 hurricane season. These properties will provideadditional competition to our business.

 

**Resultsof Operations**

 

Our results of operationsinclude the accounts of Bally Technologies, Inc., and its subsidiaries. Wereport our revenue and income in two reportable segments: the Bally GamingEquipment and Systems segment, which includes our Gaming Equipment, GamingOperations and Systems divisions, and our Casino Operations segment. Revenuefrom our Bally Gaming and Systems segment represented approximately 94% of ourtotal revenues for the three months ended September 30, 2007.

 

***Bally Gaming Equipment and Systems***

 

The summary financial results and operatingstatistics for our Bally Gaming Equipment and Systems segment for the threemonths ended September 30, 2007 and 2006 were as follows:

 

| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                                 | ** ** | **% Rev** | ** ** | **2006** | ** ** | **% Rev** | ** ** |
| ** **                          | ** ** | **(dollars in millions)**                                | ** ** |
| Revenues:                           |       |                                                     |       |   |   |   |   |   |   |
| Gaming Equipment                    |       | $                                                        | 84.3       |   | 48% |   | $ | 62.3 |   | 44 | % |
| Gaming Operations                   |       | 54.1                                                     |       | 30% |   | 40.6 |   | 29 | % |
| Systems                             |       | 39.2                                                     |       | 22% |   | 39.0 |   | 27 | % |
| Total revenues                      |       | $                                                        | 177.6      |   | 100% |   | $ | 141.9 |   | 100 | % |
|                                |       |                                                     |       |   |   |   |   |   |   |
| Gross Margin:                       |       |                                                     |       |   |   |   |   |   |   |
| Gaming Equipment (1)                |       | $                                                        | 38.9       |   | 46% |   | $ | 20.0 |   | 32 | % |
| Gaming Operations                   |       | 36.0                                                     |       | 67% |   | 23.1 |   | 57 | % |
| Systems (1)                         |       | 30.0                                                     |       | 77% |   | 25.1 |   | 64 | % |
| Total gross margin                  |       | $                                                        | 104.9      |   | 59% |   | $ | 68.2 |   | 48 | % |
|                                |       |                                                     |       |   |   |   |   |   |   |
| Selling, general and administrative |       | $                                                        | 41.0       |   | 23% |   | $ | 40.5 |   | 29 | % |
| Research and development costs      |       | 13.3                                                     |       | 8% |   | 12.6 |   | 9 | % |
| Depreciation and amortization       |       | 3.9                                                      |       | 2% |   | 4.2 |   | 3 | % |
| Operating income                    |       | $                                                        | 46.7       |   | 26% |   | $ | 10.9 |   | 8 | % |

----

(1)          Gross Margin from Gaming Equipment andSystems excludes amortization related to certain intangibles including coretechnology and license rights, which are included in depreciation andamortization.

 

22

----

 

| ** **                                                    | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Operating Statistics                                          |       |                                                 |       |   |   |
| New gaming  devices sold                                      |       | 5,151                                                |       | 3,427 |   |
| Original  Equipment Manufacturer (“OEM”) units sold |       | —                                               |       | 1,145 |   |
| New unit Average  Selling Price (“ASP”)             |       | $                                                    | 13,275     |   | $ | 12,011 |   |
|                                                          |       |                                                 |       |   |   |
| Gaming monitoring units installed base                        |       | 291,000                                              |       | 276,000 |   |
| Casino management systems installed base                      |       | 558                                                  |       | 530 |   |
| Systems managed cashless games                                |       | 233,000                                              |       | 207,000 |   |
|                                                          |       |                                                 |       |   |   |
| End of period installed base:                                 |       |                                                 |       |   |   |
| Wide-area progressive                                         |       | 936                                                  |       | 1,015 |   |
| Local-area progressive                                        |       | 423                                                  |       | 570 |   |
| Total linked progressive systems                              |       | 1,359                                                |       | 1,585 |   |
|                                                          |       |                                                 |       |   |   |
| Rental and daily-fee games                                    |       | 7,244                                                |       | 4,209 |   |
| Lottery systems                                               |       | 8,004                                                |       | 4,889 |   |
| Centrally determined systems                                  |       | 41,814                                               |       | 29,062 |   |
|                                                               |            |                                                      |            |  |  |  |  |

 

**ThreeMonths Ended September 30, 2007 Compared to Three Months Ended September 30,2006**

 

Total revenues for ourBally Gaming Equipment and Systems segment increased $35.7 million, or 25%, inthe three months ended September 30, 2007, when compared to the sameperiod last year, as a result of the following:

 

*Revenuesand Gross Margin:*

 

*     Gaming Equipment.*Gaming Equipment revenue increased by$22.0 million, or 35%, to approximately $84.3 million primarily as a result of:

 

·              A 50% increase in new gaming device salesto 5,151 units in the three months ended September 30, 2007, when comparedto 3,427 units in the same period last year, offset by a 100% decrease in lowermargin OEM sales with sales of 1,145 units in the same period last year; and

 

·              An 11% increase in the ASP of new gamingdevices, excluding OEM sales, as a result of incentive pricing and discountsoffered to our customers related to the roll-out of our Alpha OS platformproducts in the prior year.  In addition,ASP increased due to product mix and the effect of foreign currency exchangerates on international pricing.

 

*     Gaming Equipment Gross Margin*. Gaming Equipment gross margin increasedto 46% in the three months ended September 30, 2007 from 32%, in the sameperiod last year, primarily as a result of the decrease in lower margin OEMsales and the increase in ASP, discussed above, and:

 

·                  A $1.8 million decrease in inventorycharges in the three months ended September 30, 2007, when compared to thesame period last year. Inventory charges were higher in first quarter of fiscal2007 as a result of the decision to move to a single platform in fiscal2006 and the related disposal of legacy products and inventory during thesubsequent periods;

 

·                  A $2.5 million increase in higher marginconversion kit revenue in the three months ended September 30, 2007 whencompared to the same period last year; and

 

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

 

23

----

 

*     Gaming Operations.*Gaming Operations revenue increased $13.5million, or 33%, to approximately $54.1 million in the three months ended September 30,2007, when compared to the same period last year, primarily as a result of:

 

·                  An increase of $17.4 million, or 71%, inparticipation and rental revenue in the three months ended September 30,2007, when compared to the same period last year, primarily derived from:

 

·                  Our installed base of centrallydetermined games increased 44% from 29,062 units as of September 30, 2006to 41,814 units as of September 30, 2007 primarily due to games added inWashington, Florida, Oklahoma, Wisconsin and Mexico;

 

·                  Our installed base of rental and dailyfee games, including Hot Shot ProgressiveTM units, increased 72% from 4,209 units asof September 30, 2006 to 7,244 units as of September 30, 2007. Thenet change was primarily due to the popularity of our new products; and

 

·                  Our installed based of lottery unitsincreased 64% from 4,889 units as of September 30, 2006 to 8,004 units asof September 30, 2007. The increase was primarily due to additions of unitsdeployed by the New York Lottery.

 

*     Gaming Operations Gross Margin*. Gross margin increased to 67% in thethree months ended September 30, 2007 from 57%, in the same period lastyear, primarily as a result of the increase in participation and rental revenuedue to the popularity of our new products discussed above, and a decrease injackpot expense associated with wide-area progressives.

 

Revenueand gross margin from gaming operations in each of the four quarters of fiscal2007 include certain daily fees that relate to a customer contract which,effective in the first quarter of fiscal 2008, are now being deferred due tonew contractual commitments to the customer. Approximately $3.2 million indaily fees generated during the first quarter of fiscal 2008 were deferredpending delivery of the commitments. Deferral of the daily fees associated withthe contract will continue until the commitments have been delivered to thecustomer, which is not expected for at least six months.

 

*     Systems: *Systems revenue increased $0.2 million, or 1%, toapproximately $39.2 million in the three months ended September 30, 2007when compared to the same period last year. Systems maintenance revenue was $9.4 million, representing an increaseof $1.8 million, or 24%, in the three months ended September 30, 2007 whencompared to $7.6 million in the same period last year.

 

*     Systems Gross Margin.*Systems gross margin increased to 77% inthe three months ended September 30, 2007 from 64%, in the same periodlast year, primarily as a result of an increase in the proportion of software andmaintenance revenue as compared to hardware sales.  Hardware sales have lower gross marginscompared with software and maintenance revenue. In the current quarter, several properties installed Bally Bonusing andother software products whereas in the prior quarter there were several largeiVIEW hardware installations.

 

*Selling,General and Administrative*.   Selling,general and administrative expense increased $0.5 million, or 1%, in the threemonths ended September 30, 2007, when compared to same period last year.

 

*Researchand Development Costs*. Research and development costs increased 6% in the three months endedSeptember 30, 2007, when compared to the same period last year, as a resultof our focus on technology assets and the competitive landscape that requires acontinual investment in future generations of gaming products and systems.

 

Our selling, general andadministrative and research and development costs were favorably impacted bybetter control over costs and savings from our India Development Centers.

 

*Depreciationand Amortization*.Depreciation and amortization expense decreased 9% in the three months ended September 30,2007, when compared to same period last year, primarily as a result of theacceleration of depreciation for certain assets beginning in fiscal 2006 andcertain of those and other assets becoming fully depreciated during fiscal2007.

 

24

----

 

***CasinoOperations***

 

The summary of our financial results and operatingstatistics for our Casino Operations is as follows:

 

| ** **                          | ** ** | **Three Months Ended September 30,** |
|-------------------------------------|------------|----------------------------------------------------------|
| ** **                          | ** ** | **2007**                                                 | ** ** | **% Rev** | ** ** | **2006** | ** ** | **% Rev** |
| ** **                          | ** ** | **(dollars in millions)**                      |
| Revenue                             |       | $                                                        | 11.4 |   | 100% |   | $ | 11.8 |   | 100% |
|                                |       |                                                     |   |   |   |   |   |   |
| Selling, general and administrative |       | $                                                        | 2.2 |   | 19% |   | $ | 2.5 |   | 21% |
| Depreciation and amortization       |       | $                                                        | 0.7 |   | 6% |   | $ | 0.8 |   | 7% |
| Operating income                    |       | $                                                        | 3.8 |   | 33% |   | $ | 4.1 |   | 35% |
|                                |       |                                                     |   |   |   |   |   |   |
| Operating statistics:               |       |                                                     |   |   |   |   |   |   |
| Average number of gaming devices    |       | 817                                                      |   |   |   | 886 |   |   |
| Average number of table games       |       | 10                                                       |   |   |   | 12 |   |   |

 

**ThreeMonths Ended September 30, 2007 Compared to Three Months Ended September 30,2006**

 

*CasinoOperations**.***Casino Operations revenue decreased 3% for the threemonths ended September 30, 2007 when compared to the same period last yearprimarily due to an 8% reduction in the average number of gaming devices to 817from 886 in the prior period.  Theaddition of another ramp for an entrance to the new buffet restaurant, whichopened in June 2007, resulted in relocating the pit and reducing it by twotable games and removing certain gaming devices from the floor.  In addition, the removal of certainlow-revenue producing gaming devices decreased some rental expenses andincreased average win per day per gaming device.

 

*Selling,General and Administrative*. Selling, general and administrative expensesdecreased by 13% for the three months ended September 30, 2007, whencompared to the same period last year, primarily as a result of a reduction inadvertising expenditures for billboards and the elimination of certainpromotional expenses.

 

*Depreciationand Amortization*.Depreciation and amortization expense decreased 17% for the three months ended September 30,2007, when compared to the same period last year, as a result of the decreasein the number of slot machines and reduced capital expenditures during theperiod.

 

25

----

 

***ParentCompany***

 

The summary financial results of Bally Technologies, Inc.,our parent entity, are set forth below. These results also include certainother income and expenses that are otherwise not allocated to a specificbusiness segment.

 

| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **(dollars in millions)**                      | ** ** |
| General and administrative    |       | $                                                        | 9.1        |   | $ | 6.3 |   |
| Depreciation and amortization |       | 0.3                                                      |       | 0.3 |   |
| Total expense                 |       | $                                                        | 9.4        |   | $ | 6.6 |   |
|                          |       |                                                     |       |   |   |
| Other income (expense)        |       |                                                     |       |   |   |
| Interest income               |       | $                                                        | 1.0        |   | $ | 0.9 |   |
| Interest expense              |       | (7.2                                                     | )          | (7.9 | ) |
| Other, net                    |       | 0.9                                                      |       | 0.3 |   |
| Total other expense           |       | $                                                        | (5.3       | ) | $ | (6.7 | ) |
|                          |       |                                                     |       |   |   |
| Income tax expense            |       | $                                                        | (13.1      | ) | $ | (0.7 | ) |
| Minority interest             |       | $                                                        | (1.4       | ) | $ | (1.2 | ) |

 

**ThreeMonths Ended September 30, 2007 Compared to Three Months Ended September 30,2006**

 

*Generaland Administrative.*Generaland administrative expense increased $2.8 million, or 43%, in the three monthsended September 30, 2007, when compared to the same period last year,primarily as a result of:

 

·                  An increase in accounting fees of $1.3million in the three months ended September 30, 2007, when compared to thesame period last year, due to additional services as a result of therestatement of our previously issued financial statements; and

 

·                  An increase in payroll and related costsof $1.1 million in the three months ended September 30, 2007, whencompared to the same period last year, primarily due to increases in bonusesdue to improvements in operating results during the current quarter.  In addition, there was an increase inheadcount, including additional finance resources, to address the Company’sinternal control weaknesses.

 

*Depreciationand amortization**.***Depreciation and amortization expense was comparableduring the three months ended September 30, 2007 to the same period lastyear.

 

*OtherIncome (Expense).*Otherexpense decreased $1.4 million, or 19%, in the three months ended September 30,2007, when compared to the same period last year, primarily as a result of adecrease in interest expense due to a reduction in outstanding debt to  $316.7 million in the current quarter from$334.5 million in the prior quarter last year.

 

*Incometax expense.*  Our effective income tax rate for the threemonths ended September 30, 2007 and 2006 was approximately 37% and 38%,respectively.  At the end of each interimperiod, we make our best estimate of the effective tax rate expected to beapplicable for the full fiscal year and the impact of discrete items, if any,and adjust the quarterly rate, as necessary. During the quarter ended September30, 2007 we implemented FASB Interpretation (“FIN”)  48, *Accounting for Uncertaintyin Income Taxes, an Interpretation of FASB Statement No. 109.*

 

*MinorityInterest.*Minorityinterest increased primarily due to earnings from the partnership interest inRainbow Casino and certain variable interest entities.  We consolidate the Rainbow Casino VicksburgPartnership (“RCVP”) and record an adjustment to reflect the portion of RCVP’searnings attributable to minority shareholders.

 

26

----

 

**FinancialCondition**

 

Selected balance sheetaccounts are as follows:

 
| ** **                              | ** ** | **September 30,** | ** ** | **June 30,**  | ** ** | **Increase (decrease)** | ** ** |
|-----------------------------------------|------------|------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **2007**               | ** ** | **2007**           | ** ** | **Amount**              | ** ** | **%** | ** ** |
| ** **                              | ** ** | ** **             | ** ** | **(in 000s)** | ** ** | ** **              | ** ** |
| Cash and cash equivalents               |       | $                      | 51,594     |               | $          | 40,842                  |       | $ | 10,752 |   | 26 | % |
|                                    |       |                   |       |               |       |                    |       |   |   |
| Total long-term debt and capital leases |       | $                      | 316,730    |               | $          | 333,854                 |       | $ | (17,124 | ) | (5 | )% |
|                                    |       |                   |       |               |       |                    |       |   |   |
| Total current assets                    |       | $                      | 451,962    |               | $          | 421,883                 |       | $ | 30,079 |   | 7 | % |
| Total current liabilities               |       | $                      | 271,399    |               | $          | 256,938                 |       | $ | 14,461 |   | 6 | % |
| Net working capital                     |       | $                      | 180,563    |               | $          | 164,945                 |       | $ | 15,618 |   | 9 | % |

 

As of September 30, 2007 and June 30,2007, we had $51.6 million and $40.8 million, respectively, in consolidatedcash and cash equivalents which included approximately $3.7 million, in bothperiods, of cash utilized in our Casino Operations segment that is held invaults, cages or change banks. Pursuant to various state gaming regulations,certain cash accounts are maintained to ensure availability of funds to paywide-area progressive jackpot awards. At September 30, 2007 and June 30,2007, these accounts had an aggregate value of approximately $17.5 million and$17.2 million, respectively, and are classified as restricted cash in ourunaudited condensed consolidated balance sheets.  In addition, we purchase U.S. Treasury StripSecurities for the benefit of jackpot winners who elect to receive winnings asannual or weekly installment payments rather than one lump sum. Thesesecurities are included in restricted long-term investments in the accompanyingunaudited condensed consolidated balance sheets, and totaled $10.5 million asof September 30, 2007 and June 30, 2007.

 

Our net working capital increased $15.6 million forthe three months ended September 30, 2007. Key factors related to theworking capital increase included a $17.6 million increase in inventory and an$8.2 million increase in deferred cost of revenue offset by an $11.2 millionincrease in customer deposits and a $6.6 million increase in deferred revenue(see the unaudited condensed consolidated balance sheets).  Of the $17.6 million increase in inventory,finished goods increased $12.7 million due primarily to the production ofcertain ordered items pending shipment.

 

Ourdebt structure consists primarily of a term loan facility and a $75.0 millionrevolving credit facility, which is limited by a current leverage ratio, anddebt owed to related parties. There were no amounts outstanding under ourrevolving credit facility as of September 30, 2007.  The revolving credit facility is furtherrestricted to the extent of outstanding letters of credit.  Outstanding letters of credit at September 30,2007 were $26.3 million which reduced availability under the revolving creditfacility to approximately $48.7 million. The term loan requires principal reductions of approximately 1% perannum paid quarterly, with a balloon payment due in September 2009. Therevolving credit facility commitment reduces annually until it comes due in September 2008.

 

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

 

The financial covenants under the Loan Agreementconsist of a leverage ratio, a fixed charges coverage ratio, and a minimum ofEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (asthat term is defined in the Loan Agreement) ratio. The leverage ratio iscomputed as total average debt outstanding during the quarter divided by thetrailing 12 months EBITDA, excluding certain cash and non-cash charges, and isfurther adjusted to remove EBITDA from discontinued operations at the timethose operations are sold. Our leverage ratio as of September 30, 2007 was1.82 times versus the covenant maximum of 3.50 times. 

 

Management believes that cash flows from currentoperating activities and the availability under the revolving credit facilitywill provide us with sufficient capital resources and liquidity to operate ourbusiness for at least the next 12 months. At September 30, 2007, we had nomaterial future commitments for capital expenditures.

 

27

----

 

***CashFlow Summary***

 

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

 

Cash flows from operating activities increased $30.2million in the three months ended September 30, 2007 as compared to thesame period last year. The 2008 increase in cash flows provided by operatingactivities was primarily the result of the increase in net income during theperiod as a result of the increase in revenue and the improvement in grossmargin previously discussed.

 

Cash used for the purchase of inventory, which isincluded in cash flows from operating activities, was $36.5 million in thethree months ended September 30, 2007 as compared to $25.1 million in thesame period last year. We only have one process to procure raw materials forthe assembly of both inventory and leased gaming equipment. The materialsrequisition planning process considers the number of devices we expect to buildfor sale and for use in our gaming operations division during a particularperiod, but we do not separately earmark purchases for leased gaming equipment.Without such an earmarking process, we are unable to determine whether the cashexpended to construct leased gaming equipment during a particular period camefrom inventory on hand at the beginning of the period or was constructed frominventory procured during the period of deployment, thus requiring theexpenditure of cash. As a result of our inability to separately identify thecash flows associated with the construction of leased gaming equipment, we haveincluded all additions to leased gaming equipment as a change in inventoryunder cash used in operating activities. During the three months ended September 30,2007 we transferred $20.3 million from inventory to leased gaming equipmentcompared to $14.8 million in the same period last year.

 

Cash flows used ininvesting activities totaled $4.9 million in the three months ended September 30,2007 as compared to $7.5 million in the same period last year primarily as aresult of:

 

·                  Capital expenditures of $3.9 million inthe three months ended September 30, 2007 as compared to $5.7 million inthe same period last year; and 

 

·                  Reductions in restricted cash andinvestments of $0.3 million in the three months ended September 30, 2007as compared to $1.0 million in same period last year.

 

Cash used by financingactivities totaled $10.5 million in the three months ended September 30,2007 as compared to cash provided by financing activities of $9.6 million insame period last year as a result of:

 

·                  Principal payments on capital leases andother long term debt of $17.1 million in the three months ended September 30,2007 as compared to $1.9 million in the same period last year.  We made an unscheduled $15.0 million payment underthe term loan facility during the current quarter;

 

·                  Cash provided from exercise of stockoptions and warrants of $4.8 million in the three months ended September 30,2007 as compared to $2.3 million in the same period last year;

 

·                  Excess net tax benefit from the exerciseof stock options of $1.8 million in the three months ended September 30,2007; and

 

·                  Cash proceeds from the sale andlease-back of certain equipment for Yonkers Raceway of $9.2 million in thethree months ended September 30, 2006.

 

28

----

 

**CriticalAccounting Policies**

 

A description of ourcritical accounting policies can be found within Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operations in the2007 10-K. There were no material changes to those policies during the threemonths ended September 30, 2007.

 

***RecentlyIssued Accounting Pronouncements***

 

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

 

In December 2007,the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated Financial Statements - An Amendment ofARB No. 51.* SFAS No.160 establishes new accounting andreporting standards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary. Specifically, this statement requires therecognition of a noncontrolling interest (minority interest) as equity in theconsolidated financial statements and separate from the parent’s equity. Theamount of net income attributable to the noncontrolling interest will beincluded in consolidated net income on the face of the income statement. SFASNo.160 clarifies that changes in a parent’s ownership interest in a subsidiarythat do not result in deconsolidation are equity transactions if the parentretains its controlling financial interest. In addition, this statementrequires that a parent recognize a gain or loss in net income when a subsidiaryis deconsolidated. Such gain or loss will be measured using the fair value ofthe noncontrolling equity investment on the deconsolidation date. SFAS No.160also includes expanded disclosure requirements regarding the interests of theparent and its noncontrolling interest. SFAS No.160 is effective for fiscal years, and interim periods withinthose fiscal years, beginning on or after December 15, 2008, andaccordingly, we expect to adopt SFAS No.160 beginning in fiscal 2010. We arecurrently in the process of evaluating the impact SFAS No. 160 will haveon our consolidated results of operations, financial position and cash flows.

 

In February 2007,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*. SFAS No.159 providescompanies with an option to report selected financial assets and liabilities atfair value. It also establishes presentation and disclosure requirements tofacilitate comparisons between companies using different measurement attributesfor similar types of assets and liabilities. The statement is effective forfiscal years beginning after November 15, 2007 and accordingly, we expectto adopt SFAS No. 159 beginning in fiscal 2009. Earlier application is permittedprovided we also apply the provisions of SFAS 157, *Fair ValueMeasurements*, which is discussed below.  We are currently in the process of evaluatingthe impact SFAS No. 159 will have on our consolidated results ofoperations, financial position and cash flows.

 

29

----

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, rather it applies to existing accounting pronouncements thatrequire or permit fair value measurements. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007, and accordingly, we expectto adopt SFAS No. 157 beginning in fiscal 2009.  We are currently evaluating the impact SFAS No. 157will have on our consolidated results of operations, financial position and cashflows.

 

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

 

*Interest Rate Risk*

 

As of September 30, 2007, we had total debtoutstanding of approximately $316.7 million, consisting primarily of the $292.0million outstanding under a term loan under our senior credit facilities, $10.0million in related party debt and $14.7 million in capital lease obligations.The interest rate for the term loan is variable, based on LIBOR, and resetsevery six months. Approximately $7.0 million of related party debt is variableand is based on LIBOR. If the LIBOR rates were to increase or decrease by 100basis points, with all other factors remaining constant, earnings woulddecrease or increase by approximately $3.2 million annually, on a pre-tax basis.

 

*ForeignCurrency Exchange Rate 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 earnings reported in the consolidatedgroup of approximately $0.4 million.

 

30

----

# ** **

# **ITEM 4.  CONTROLS ANDPROCEDURES**

# ** **

**Disclosure Controls and Procedures**

 

Asrequired by Rule 13a-15(b) promulgated under the Exchange Act, ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e),as of the end of the period covered by this Quarterly report on Form 10-Q.Based on this evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that, as of September 30, 2007, our disclosure controlsand procedures were not effective due to the existing material weaknesses inour internal control over financial reporting previously identified anddiscussed in the 2007 10-K and below under “—Internal Control OverFinancial Reporting —Material Weakness in Internal Control Over FinancialReporting Previously Reported.”

 

Inview of the fact that the financial information presented in this QuarterlyReport on Form 10-Q for the fiscal quarter ended September 30, 2007,was prepared in the absence of effective internal control over financialreporting, we have devoted a significant amount of time and resources to theanalysis of the financial statements contained in this report. In particular,we have reviewed the significant account balances and transactions reflected inthe financial statements contained in this report and otherwise analyzed thetransactions underlying our financial statements to verify the accuracy of thefinancial statements. Accordingly, management believes that the financialstatements included in this report fairly present, in all material respects,our financial condition, results of operations, and cash flows.

 

Nevertheless,there can be no assurance that either this review process or our existingdisclosure controls and procedures will prevent or detect all errors and allfraud, if any, or result in accurate and reliable disclosure. A control systemcan provide only reasonable and not absolute assurance that the objectives ofthe control system are met. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, have been detected. Additionally,judgments in decision-making can be faulty and breakdowns in controls can occurbecause of simple errors or mistakes that are not detected on a timely basis.

 

**Internal Control Over Financial Reporting**

 

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

 

***Certain Changes in Internal Control OverFinancial Reporting during the Fiscal Quarter Ended September 30, 2007***

 

While management hasinitiated certain remediation activities, there were no changes in our internalcontrol over financial reporting that occurred in the first quarter of fiscal2008 that have materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting and the material weaknessconditions previously disclosed in the 2007 Form 10-K continue to exist as ofSeptember 30, 2007.

 

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

 

The specific materialweaknesses identified by management as of June 30, 2007 were as follows:

 

**Inadequateand ineffective control related to revenue recognition.**The Company did not maintain appropriateinternal controls related to the recognition of revenue for the sale of games,systems and parts. The Company’s controls were not adequate to capture andanalyze the terms and conditions of all contracts and agreements, or to timelydetermine that collectibility was probable in order to ensure the properrecording of revenue related to game and system sales. The internal controlsinclude those related to the systematic tracking of contract terms andamendments. Game and system sales are accounted for in accordance with AmericanInstitute of Certified Public Accountants Statement of Position No. 97-2, *Software Revenue Recognition*, whichincludes complex revenue recognition criteria that were not always adequatelyevaluated. The review process is manual and the resources dedicated to theprocess are not adequate to address all of the accounting considerations on atimely basis given the increased volume of business.

 

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

 

31

----

 

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

 

**Ineffectivecontrol related to the existence and valuation of inventory.**The Company did not maintain appropriateand or effective controls related to the existence and valuation of inventory.As a result, the Company identified several deficiencies including: (i) adjustmentsto its raw materials balance resulting from ineffective periodic countingprocedures; (ii) parts issued to and restocked from work orders which werenot always properly recorded in raw materials or the related open work orderbill of materials; (iii) differences between the general ledger andperpetual inventory, which lacked the appropriate level of documentation fortimely review and analysis; (iv) the inaccurate recording of partsshipments to outer warehouses; (v) inadequate control over transactionprocessing; and (vi) lack of effective change management for modificationsmade to the inventory system and processes.

 

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

 

**Insufficientpersonnel resources to adequately perform analytical review procedures.**The Company did not have sufficientqualified personnel to adequately analyze revenue and expenditure activitiesfor proper classification of amounts in the consolidated statements ofoperations and statements of cash flows. This resulted in: (i) certaincharges originally classified as selling, general and administrative expenses beingrestated to reflect an increase to cost of sales or reduction of revenue; (ii) certaingaming operations transactions being reclassified between investing andoperating activities in the consolidated statements of cash flows; and (iii) certainrevenue and operating income (loss) amounts previously presented under theUnited States and Canada in the segment and geographic footnote disclosurebeing reclassified to Europe or Other foreign regions. These adjustmentsresulted in the restatement of prior consolidated financial statements.

 

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

 

 

32

----

 

**PART II**

 

# **ITEM1.**  LEGAL PROCEEDINGS

# ** **

***Litigation***

 

InJune and July 2004, putative class actions were filed againstthe Company and its officers, Robert Miodunski, Robert Saxton, Mark Lerner andSteven Des Champs, in the United States District Court for the District ofNevada. The nearly identical complaints alleged violations of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), stemming from revisedearnings guidance, declines in the stock price and sales of stock by insiders.The complaints sought damages in unspecified amounts. The Federal DistrictCourt granted the plaintiffs’ unopposed motions to consolidate the cases and toappoint a lead counsel and a lead plaintiff, and the plaintiffs filed aconsolidated complaint, all as is customary in such cases. The Company and theother defendants moved to dismiss the complaint. Thereafter, activity in thecase was stopped and the parties participated in a mediation process duringwhich the parties agreed on the terms of a settlement. The parties negotiatedand executed settlement documents settling both the consolidatedclass action and companion derivative litigation. Under the settlement anaggregate of $16.0 million in cash, plus certain interest, was paid to settlethe securities class action as well as companion derivative litigation.The Company accrued $1.25 million related to the settlement during the yearended June 30, 2006, which was paid in late February 2007. Inaddition to certain governance actions the Company has agreed to undertake inconnection with the settlement, the Company’s directors and officers insurercontributed approximately $14.75 million to the settlement. The courtapproved the settlement on August 9, 2007, ending the case.

 

InFebruary 2005, the SEC initiated an informal inquiry and requesteddocuments and information regarding matters related to the allegations in theclass actions and similar matters. In August 2005, the SEC notifiedthe Company that its investigation had entered a formal phase, and requestedadditional information from the Company covering the same general areas thatwere addressed in the informal inquiry. Management is cooperating fully withthe SEC in this matter.

 

InAugust 2004, Shuffle Master sued the Company in the United States DistrictCourt for the District of Nevada, alleging infringement of various patents inconnection with the Company’s MindPlay product line and seeking injunctiverelief and damages in an unspecified amount. In June 2005, it wasannounced that IGT had acquired an interest in the patents at issue in thecase, and thereafter, IGT joined the case as a plaintiff. In December 2005,the District Court issued a ruling construing the claim terms of all thepatents in the suit. A hearing on the parties’dispositivemotions is set for February 2008. Management believes the plaintiffs’lawsuit to be without merit, and the Company is vigorously defending againstthe lawsuit.

 

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

 

InSeptember 2006, the Company filed a patent infringement lawsuit againstIGT in the United States District Court for the District of Nevada. The complaintasserts that certain of IGT’s bonus wheel games infringe patents held by theCompany, and seeks injunctive relief and damages. IGT filed an answer generallydenying the claims. The case is in the discovery phase and no trial date hasbeen set.

 

InMay 2006, IGT filed a patent infringement lawsuit against the Company inthe United States District Court for the District of Delaware. The complaintasserts that the Company’s Bally Power BonusingTMproducts infringe patents held by IGT, and seeks injunctive relief and damagesin unspecified amounts. The court took IGT’s motion for a preliminaryinjunction off-calendar and set a November 2008 trial date. The Companybelieves IGT’s claims are without merit and is vigorously defending itselfagainst the lawsuit.

 

TheCompany is also a party to various lawsuits relating to routine mattersincidental to our business. Management does not believe that the outcome ofsuch litigation, including the matters above, in the aggregate, will have amaterial adverse effect on our consolidated financial position, results ofoperations or cash flows.

 

33

----

 

**ITEM 1A.               RISK FACTORS**

 

The Company is subject to risks and uncertaintiesthat could cause our actual results to differ materially from the expectationsexpressed in the forward looking statements. Factors that could cause ouractual results to differ from expectations are described under “Item 1A. RiskFactors” in the 2007 10-K, to which there were no material changes duringthe period covered by this Quarterly Report on Form 10-Q.

 

34

----

 

**ITEM 6.  EXHIBITS**

 
| **Exhibits**   | ** ** | **Description**                                                                                                                                                 |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |       |                                                                                                                                                            |
| 3.1            |       | Amendment to Articles of Incorporation dated  April 16, 2002.                                                                                              |
|           |       |                                                                                                                                                            |
| 31.1           |       | Certification of Chief Executive Officer, pursuant  to Rule 13a-14(a) of the Securities Exchange Act of 1934, as  amended.                            |
|           |       |                                                                                                                                                            |
| 31.2           |       | Certification of Chief Financial Officer, pursuant  to Rule 13a-14(a) of the Securities Exchange Act of 1934, as  amended.                            |
|           |       |                                                                                                                                                            |
| 32.1           |       | Certification of Chief Executive Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of  the Sarbanes-Oxley Act of 2002. |
|           |       |                                                                                                                                                            |
| 32.2           |       | Certification of Chief Financial Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of  the Sarbanes-Oxley Act of 2002. |
|                |
| Filed herewith |

 

35

----

 

**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 thereunto dulyauthorized.

 
| BALLY  TECHNOLOGIES, INC. | Date:  December 21, 2007                                    |
|--------------------------------|------------------------------------------------------------------|
|                           |                                                             |   |
|                           |                                                             |   |
| By                             | /s/Richard  Haddrill                                             |   |
|                           | Richard Haddrill                                                 |   |
|                           | President and  Chief Executive Officer                           |   |
|                           | (Principal  Executive Officer)                                   |   |
|                           |                                                             |   |
|                           |                                                             |   |
| By                             | /s/Robert C.  Caller                                             |   |
|                           | Robert C. Caller                                                 |   |
|                           | Executive Vice  President, Chief Financial Officer and Treasurer |
|                           | (Principal  Financial and Accounting Officer)                    |   |

 

36

----