**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-K**

 

**ý****ANNUAL REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

**For the fiscal year ended June 30, 2004**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934 (No Fee Required)**

**For the transition period from           to          **

 

**Commission File Number 0-4281**

 

**ALLIANCE GAMING CORPORATION**

(Exact name of registrant as specified in its charter)

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

 

**6601 S. Bermuda Rd. Las Vegas, Nevada 89119**

(Address of principal executive offices)

 

Registrant’s telephone number: **(702)270-7600**

Registrant’s website: **www.alliancegaming.com**

 

Securities registered pursuant toSection 12(b) of the Act:

**None**

 

Securities registered pursuant toSection 12(g) of the Act:

**Common Stock, $0.10 par value**

 

(Title of Class)

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

ý  Yes   o  No

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in the Exchange Act Rule12b-2).

ý  Yes   o  No

 

The aggregate market value ofthe common equity held by non-affiliates of the registrant was approximately$847,446,308 as of September 2, 2004.

 

The number of shares of CommonStock, $0.10 par value, outstanding as of September 2, 2004, according tothe records of registrant’s registrar and transfer agent, was 51,035,660.

 

 

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**ALLIANCE GAMING CORPORATION**

**FORM 10-K**

** **

**Year Ended June 30, 2004**

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of theRegistrant’s definitive Proxy Statement for its Annual Meeting of Stockholderswill be filed with the Securities and Exchange Commission within 120 days ofthe end of our fiscal year and are incorporated by reference into Part III ofthis Form 10-K.

 

# **PARTI**

 

# **ITEM1.**               BUSINESS

 

# **General**

 

Operating under the name *Bally Gaming and Systems*, we are a worldwide leader indesigning, manufacturing and distributing traditional and nontraditional gamingmachines, having marketed over 100,000 gaming machines during the past fiveyears. We define traditional gaming machines as being Class III, casino-stylegames, and nontraditional gaming machines such as games that are centrallydetermined or Video Lottery Terminals (“VLT”). We also design, integrate andsell highly specialized computerized monitoring systems that provide casinos withnetworked accounting and security services for their gaming machines with over270,000 game monitoring units (“GMUs”) installed worldwide.  We also own and operate a dockside casino inVicksburg, Mississippi, which has approximately 12 table games and approximately930 gaming devices (“Casino Operations”). Further information about ourbusiness units is contained in the notes to the Consolidated FinancialStatements.

 

As is more fully discussed below, in July 2003 we announced ourintention to dispose of certain non-core businesses, including our routeoperations in Nevada and Louisiana, and our Bally Wulff wall machine andamusement games business in Germany. InDecember 2003, we also announced our intention to sell Rail City Casino.The sale of Bally Wulff was completed on July 18, 2003; the sale of RailCity Casino was completed on May 3, 2004; and the sale of our Nevada routeoperations was completed on June 30, 2004.

 

During the current fiscal year,we also completed a number of acquisitions to complement our core businessunits.  On December 31, 2003, weacquired 100% of the assets of U.K. based Crown Gaming from Crown LeisureLimited (“Crown”).  The acquisition,which includes Crown’s distributorship agreements for a wide variety ofautomated table games and video bingo machines, strategically builds on theCompany’s focus towards future growth projected in England.

 

On February 19, 2004, we completed the acquisition ofsubstantially all of the assets and liabilities of MindPlay LLC (“MindPlay”), aleading developer of advanced table game technologies. The MindPlay technologies aredesigned to provide casino operators data and information to improve customerservice, provide enhanced security, and increase profitability by lowering costof operation and enhancing the patron experience.

 

On March 2, 2004, theCompany acquired 100% of the shares of privately held Sierra Design Group(“SDG”), a leading supplier of Class II and Class III gaming devices, systemsand technology.   Class II gaming consistsof bingo, pull-tabs and bingo games that are played against other players,rather than against the house as in traditional Class III gaming environments.

 

We were incorporated in Nevadaon September 30, 1968, under the name Advanced Patent Technology. We changedour name to Gaming and Technology, Inc., in 1983, to United Gaming, Inc., in1988 and to Alliance Gaming Corporation on December 19, 1994. We conductour gaming operations through directly and indirectly owned subsidiaries. Theterms “the Company,” “we,” and “our” as used herein refer to Alliance GamingCorporation and subsidiaries unless the context otherwise requires. Ourprincipal executive offices are located at 6601 South Bermuda Road, Las Vegas,Nevada 89119; telephone (702) 270-7600. Our internet address is www.alliancegaming.com.  We make available free of charge through ourwebsite our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and all amendments to those reports as soon asreasonably practicable after such material is electronically filed with orfurnished to the Securities and Exchange Commission.

 

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**Acquisitions**

 

On March 2, 2004, wepurchased 100 percent of the outstanding stock of SDG for consideration ofapproximately $108.6 million in cash and 662,000 shares of our Common Stock. Inaddition, we assumed approximately $8 million of debt, plus transaction feesand expenses, resulting in total initial consideration of $126.4 million.Additional contingent consideration of up to $95.6 million may become payable,in equal portions of cash and stock, over the next three fiscal years upon theSDG business unit achieving certain significant revenue and EBITDA targets.

 

On February 19, 2004, weacquired substantially all of the assets and liabilities of MindPlay.  The consideration consisted of $9 million incash, a note payable totaling $4.0 million, the assumption and subsequentpayment of $2.0 million of long-term debt, warrants to purchase 100,000 sharesof Alliance common stock (valued at $0.9 million), and $0.9 million for thepresent value of the minimum guaranteed earn out payments described below.  The earn out is payable based upon 10% ofgross margin from the sale of MindPlay products for the first seven years, and4.25% of gross margin for the subsequent 6 years, subject to adjustmentspursuant to the conditions contained in the sale agreement.

 

On December 31, 2003, we acquired100 percent of the assets of U.K. based Crown Gaming.  The total cash consideration was $3.9million. The acquisition, which includes distributorship agreements for a widevariety of automated table games and video bingo machines, strategically buildson the Company’s focus towards projected future growth in England.

 

**Dispositionsand Discontinued Operations**

 

During Fiscal Year 2004 wecompleted three divestitures in accordance with our plan to sell our “non-core”businesses, which was a strategy we announced in July 2003.  On July 18, 2003, we completed the saleof Bally Wulff to a private equity investor and received $16.5 million incash.  On June 30, 2004, wecompleted the sale of United Coin Machine Co. (“UCMC”), our Nevada routeoperations, to Century Gaming, Inc. and received approximately $100 million incash and the assumption by Century Gaming of approximately $5 million indebt.    On May 3, 2004, we completed thesale of Rail City Casino to The Sands Regent and received $37.9 million incash.  The sale of our Louisianaroute operations was not consummated pursuant to the previously announced saleterms and the agreement with the proposed buyer was cancelled.  We intend to continue our efforts to divestour interest in this subsidiary and therefore will continue to carry theseassets as a discontinued operation.

 

Bally Gaming and Systems

 

*Overview*

 

The Bally Gaming and Systemsbusiness unit consists of three separate divisions: Gaming Products, GamingOperations and Gaming Systems. The following table sets forth the percentagesof revenues provided by each of these divisions for the periods indicated:

 
| **Revenue by division** | ** ** | **Percentage of Revenues  Years ended June 30,** | ** ** |
|-------------------------|------------|-------------------------------------------------------|------------|
| ** **              | ** ** | **2004**                                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Gaming Products         |       | 54                                                    | %          | 56 | % | 47 | % |
| Gaming Systems          |       | 28                                                    |       | 27 |   | 29 |   |
| Gaming Operations       |       | 18                                                    |       | 17 |   | 24 |   |
|                    |       | 100                                                   | %          | 100 | % | 100 | % |

 

*GamingProducts*

 

We design, manufacture and sella variety of electronic slot, video and centrally determined gaming machines.Gaming machines are differentiated from one another by graphic design andtheme, cabinet style and size, pay table, reel-type

 

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design, betting denominationand minimum/maximum betting amount. Slot machines are normally produced tospecific order, with design and configuration customized to a customer’sparticular requirements. Customers may also change from one gaming model toanother gaming model by ordering a “conversion kit” consisting of artwork, reelstrips, and a computer chip. Our video gaming machines are designed to simulatevarious card games, video reel-spinning games, and keno through a videodisplay, and can offer the player the chance to play a multitude of differentgames. New games and themes are introduced periodically to satisfy customerdemand and to compete with product designs introduced by competitors. Thegaming products created are a result of a comprehensive product developmenteffort. The development process includes extensive testing of the new productsin-house and on casino floors for reliability and player appeal.

 

In March 1998, weintroduced the first major upgrade to our ProSeriesTM game and upgraded the GameMaker® product line that is capable of multi-line video and multi-coinfunctionality. Revenues from sales of ProSeries machines were approximately$103.4 million, $95.4 million and $36.4 million for the years endedJune 30, 2004, 2003 and 2002, respectively.

 

We also offer a variety ofvideo gaming devices which can offer up to ten different video games within onegaming device, or can be configured as a dedicated single title game. The gamescan be selected by the casino from a game library that has over 200 games. Thegames simulate various card games, keno and popular reel-spinning games. Thesevideo machines are available in upright, bar top, slim-line and slant topcabinets.  Revenues from sales of thesemachines were approximately $25.0 million, $17.0 million and $30.4 million forthe years ended June 30, 2004, 2003 and 2002, respectively.

 

We commenced development of anew game platform in January 2000, with the intent of creating enhancedaudio and video capabilities for our video product line. We engaged Microsoftto assist in the development of an NTÔbased graphics and audio package addition to the legacy video game board. Theresult was the Evolution platform, or EVOÔ,that offers improved audio and graphic capabilities on the wealth of Windows®based software and content programmers available in the marketplace.  The first EVOÔproducts were marketed in the mid summer of 2001, with sales totaling $19.0million, $41.4 million and $17.5 million for years ended June 30, 2004,2003 and 2002, respectively.

 

We typically offer a 90-dayparts and labor warranty for new gaming machines sold and are actively involvedin customer service after the original installation. We provide severalafter-sale, value-added services to our customers including customer educationprograms, a 24-hour customer service telephone hot-line, an Internet web sitefor technical support, field service support programs, and spare partsprograms. Our historical warranty expense as a percentage of revenues has beenless than 1%.

 

In addition, we sell andservice used gaming machines and sell parts for existing machines. We oftenaccept used machines as trade-ins toward the purchase of new gaming equipment.While a small secondary market exists in the United States, used machines aretypically resold into the international market. Some used equipment isreconditioned for direct sale, but much is sold in container lots on an “as is”basis through independent brokers. Sale of used equipment was approximately$7.2 million, $7.2 million and $4.8 million for the years ended June 30,2004, 2003 and 2002, respectively.

 

Gaming machines have amechanical life that can exceed ten years. However, in the established markets,our experience is that casino operators usually replace gaming machines after amuch shorter period. The factors that result in replacement of gaming machinesearlier than their mechanical life include technological advances, developmentof new entertaining games, new sound and visual features and changingpreferences of casino patrons. Casinos typically recoup the purchase cost oftheir electronic gaming machines in a few months, which allows casinos toreplace machines with new models that are popular with casino patrons.

 

During 2004, we completed twostrategic acquisitions in the gaming area: Crown, and SDG. The acquisition of Crown, which includesCrown’s distributorship agreements for a wide variety of automated table gamesand video bingo machines, strategically builds on the Company’s focus towardsfuture growth projected in England. SDG is a leading supplier of ClassII and Class III gaming devices, systems and technology. This acquisition has positioned the Company to take advantage ofsignificant opportunities in both the domestic and international markets, fromthe technology advances in traditional casino style gaming to the Class IIenvironments with central determination features.  Revenue from SDG products since theacquisition date of March 2, 2004 totaled $61.5 million.

 

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In fiscal year 2003, BallyGaming and Systems responded to a proposal by the New York Lottery to provideVLT devices at race tracks in the state of New York.  Through the competitive bidding process, wewere awarded approximately 25% of the initial VLT’s to be installed.  The financial model for this market requiresthe manufacturer to build, deploy and maintain the VLT’s in return for a shareof the net win from the VLT’s.  The firstgames were installed at the Saratoga race track in January 2004, and havesince been followed by installations at three additional tracks.  SDG was also a successful bidder in the NewYork Lottery VLT market, having been awarded approximately 27% of theunits.  The successful SDG proposal wasaccomplished in the period before SDG was acquired by Alliance, and thecombined share for Bally and SDG in this market is currently approximately 52%,or approximately 2,610 units.  Certain operationalefficiencies have been realized by combining the service groups in this market.

 

*GamingSystems*

 

We design and sell casinoenterprise systems (“CES”) which provide casino operators integrated modulesacross multiple platforms. Our primary products include slot monitoring, casinomanagement and cashless systems designed to streamline casino businessprocesses through the use of technology. Our slot monitoring products are comprised of (i) hardware consisting ofmicro controller based printed circuit boards installed within the slot machinesas well as card readers, displays and keypads which provide casinos the abilityto track player gaming activity through our casino management systems andmonitor employee access to slot machines, (ii) firmware developed by us, whichprovides access to the slot machines’ and player’s activity data gathered bythe micro controller hardware; and (iii) slot monitoring business applicationsdeveloped by us which manages the slot machine activity including securityevents, revenue, expenses and other financial reporting metrics. Our casinomanagement systems provide casino operators patron loyalty solutions which aresimilar to frequent guest programs offered in other leisure industries; tablegames accounting including the calculation of all revenue and expense relateditems; and cage and credit accountability for all extensions of credit and cagecash balancing functions.  Our cashlesssystems provide a suite of products for casino operators to provide bonusingand cashless gaming activity to casino patrons. Bally products operate on Windows, AS/400 (iSeries), and UNIX platformsallowing our customers to choose a technology solution that meets theirexisting or future infrastructure requirements. Gaming Systems generated revenues of approximately $124.3 million, $91.5million and $64.8 million for the years ended June 30, 2004, 2003 and2002, respectively.

 

During 2002, we completed twostrategic acquisitions in the systems area: Casino Marketplace and AdvancedCasino Systems Corporation (“ACSC”). These acquisitions expanded our productofferings to include player marketing and bonusing software. The ACSC productremains the only fully integrated AS/400 (iSeries) solution available in thecasino industry. This has strategic importance as the AS/400 (iSeries) solutionremains the popular technology platform used in the gaming industry

 

During 2003, we completed threestrategic acquisitions in the systems area: CMS, LLC (“CMS”), Micro CleverConsulting (“MCC”) and Honeyframe Software Development Ltd. (“HSD”). Theseacquisitions again expanded our system product offerings and expanded thenumber of platforms such products operate on.

 

During 2004, the Companycompleted the acquisition of substantially all of the assets and liabilities ofMindPlay, a leading developer of advanced table game technologies. Under theprotection of a number of patents, we envision a series of new table gameproducts that can potentially redefine the market with the advances ofautomation and powerful new gaming features to attract and retain players.

 

*GamingOperations*

 

The proprietary gamingoperations division of offers games which are either linked on a wide-areaprogressive system, operate on a proprietary near-area progressive system orare non-linked niche games, which are games that generally offer more complexfeatures such as bonus rounds. These gaming machines are placed in casinos andearn recurring revenues and cash flows for us rather than being sold on aone-time basis. These gaming machines are generally more

 

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profitable as a result of therecurring nature of the revenue derived from such games, but they require us toinvest capital in the cost of manufacturing the gaming machines, obtainingintellectual property, and in purchasing signs and seating, and are dependenton the success of the game in order for it to stay deployed for an extendedperiod of time. Gaming Operations generated revenues of approximately $79.1million, $55.6 million and $53.2 million for the years ended June 30,2004, 2003 and 2002, respectively.

 

We received regulatory approvalfrom the Nevada Gaming Control Board of our wide-area progressive jackpotsystem named “ThrillionsTM” in November 1998. The Thrillions system hasbeen designed to allow patrons playing nickel, quarter and dollar machines to competefor the same progressive jackpot with the odds of winning the jackpot adjustedbased on the amount wagered. Separate wide-area progressives are being operatedby us in Nevada, Mississippi and Native American lands, and by a separatethird-party trust arrangement in Atlantic City, New Jersey.

 

As of June 30, 2004, thefollowing was the installed base of our wide-area progressive games:

 
| ** **             | ** ** | **Date  Introduced** | ** ** | **Installed Base** | ** ** |
|------------------------|------------|----------------------|------------|--------------------|------------|
| Betty Boop             |       | March 1999      |       | 404                |       |
| Blondie                |       | March 2001      |       | 123                |       |
| Millionaire 777’s |       | June 2001       |       | 386                |       |
| Popeye                 |       | August 2001     |       | 58                 |       |
| Cash For Life          |       | March 2003      |       | 441                |       |
| Quartermillions        |       | March 2004      |       | 314                |       |
|                   |       |                 |       | 1,726              |       |

 

As an alternative to wide-areagames, we also offer customers the option of purchasing gaming devices and ourproviding the customer with near-area progressive technology, allowing thecustomer to create their own branded progressive links, for which we alsocollect a daily fee.  Currently, Caesar’sEntertainment utilizes the Thrillions system as a platform for their near-area progressivenetworks of linked games for their properties in Nevada and Mississippimarkets, as does Isle of Capri in Mississippi. We have also utilized certain web-based technologies, such as virtualprivate networks (“VPN’s”) to be able to monitor wide-area progressivesoperating in non-domestic markets, such as the 160 game link currently beingoperating in Russia.

 

We also offer a variety ofnon-linked daily fee games. These games have been marketed under such titles asPlayboy (Playboy and Rabbit Head Design are marks of Playboy and used underlicense by Bally Gaming, Inc.), Monte CarloÔ,  Saturday Night LiveÔ,and others, all of which are approved in most major gaming markets. We alsoearn recurring revenues from 715 devices deployed at horseracing facilitiesunder agreements with the Delaware State Lottery Commission. As ofJune 30, 2004, we had a total installed base of daily fee games totaling7,985 units.

 

Additionally, our SDG unit hasa base of centrally determined games operating primarily in Washington,Florida, and Oklahoma.  Generally thesegames have been sold to the customer, with SDG retaining a daily fee for itscentral determination software license, although straight participationarrangements are also popular with certain customers.  As of June 30, 2004, the installed basefor such games totaled 17,995 units.

 

*ProductDevelopment*

 

We believe that providing gamesand systems with high entertainment value that are preferred by the casinopatron is a key to meeting the demands of casinos. We believe that the use ofexisting computer technology is accelerating which can give newer gamingmachines and systems that incorporate this technology a competitive advantageover older gaming machines and systems. Total spending on product research and developmentby the Bally Gaming and Systems business unit was approximately $36.6 million,$20.0 million and $15.0 million during the years ended June 30, 2004, 2003and 2002, respectively. The increase in research and development spending inthe year ended June 30, 2004, is a result of the EVOÔplatform development and advance product development efforts.

 

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We develop our products forboth the domestic and international market. Our product development process isdivided into two areas: hardware and software. Major areas of hardwaredevelopment include cabinet style, electronic capability, printer capability,and coin and currency handling. Hardware development efforts are focused onplayer appeal, product reliability and ease of maintenance. Development cyclesfor hardware can range from a few days for simple enhancements to more than ayear for new electronics or new mechanical packages.

 

The software developmentprocess for new games, which includes graphics development, involves acontinuous effort requiring relatively significant human resourceallocations.  Creativity in softwaredevelopment is an important element in product differentiation, as the majormanufacturers tend to deploy similar hardware and related technology. Ideas fornew models are generated internally, from customers and from other thirdparties, many of whom have entered into strategic relationships with us. On anannual basis, we expect to introduce more than ninety new models to the market.However, no assurance can be made with respect to the rate of new modelintroductions or our ability to obtain regulatory approvals for them.

 

All new ormodified hardware and software are designed to satisfy all applicable testingstandards. Typically, new products require regulatory approval for most NorthAmerican jurisdictions, but many jurisdictions outside North America generallydo not require approval. For Nevada, new gaming machine platforms must be filedwith the state gaming laboratory which tests the products for two to threemonths or more before a mandatory 30 to 60 day field test is conducted in acasino. The Nevada State Gaming Control Board and the Nevada Gaming Commissionmust each approve new product platforms at their monthly, public meetings. Formodifications of existing products or casino associated equipment, the processin Nevada is similar to new platforms, except a field test is usually notrequired and the Nevada State Gaming Control Board staff can approve theproduct administratively. Each jurisdiction that requires regulatory approvalof new products has its own filing requirement and process. Once products areapproved by the gaming regulators, customers may require a 30 to 90 day fieldtrial of the product in their casinos with the right to return the product atany time during the field trial period. We do not recognize revenue until thecustomer ends the field trial and accepts the gaming machines.

 

Product development for casinoenterprise systems is also divided into hardware and software. The major areasof hardware development include micro controller circuit board design andprogramming as well as user interface devices such as card readers, keypads,and displays. Systems has developed a modular and extendible hardware andsoftware architecture, which focuses development on achieving greaterfunctionality, product reliability, and ease of maintenance for the casinooperator and ease of use for the slot player. In addition, the architectureallows customers to upgrade existing components or add new components withminimal impact. Development cycles for hardware can vary between a few monthsfor minor revisions to more than a year for major design changes or for changesmade by various slot manufacturers with which Systems’ product must communicateand be physically integrated. Software development results in (i) periodicproduct releases that include new features that extend and enhance casinoenterprise systems; (ii) periodic maintenance releases that enable casinooperators to correct problems or improve the usability of the system; and(iii) documentation needed to install and use the system.

 

We have developed a series ofcashless products marketed under the Bally eSERIES name.  The eSERIES products represent an integratedset of cashless features to enhance the gaming experience of casinopatrons.  These products allow thetransfer of funds using bar coded coupons and/or encrypted pin numbers todownload either restricted or unrestricted credits to the gaming device.  These products allow casino operators toreduce cash and coin handling expenses and minimize overall operatingexpenditures.  Our cashless products arein use in Nevada, Michigan, New Jersey, Mississippi, Louisiana, Iowa, Colorado,Missouri, Indiana and various Native American jurisdictions encompassing manystates.

 

The software developmentprocess for our systems includes the design and development of features to meetvarious regulatory standards.  Theregulatory standards vary by jurisdiction forcing us to develop multiplesoftware settings based on the individual state and tribal gamingstandards.  Each jurisdiction requiresthe approval of any software modifications or new products prior to deployingat casino locations.  Approval processescan vary significantly by jurisdiction, based on the software changesdeveloped, technology enhancements, and regulator resources.

 

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*ProductMarkets*

 

We believe that the domesticinstalled base of traditional Class III gaming devices now exceeds 750,000units. The state of Nevada has the largest installed base, totalingapproximately 200,000 units as of June 30, 2004.

 

The gamingindustry continues to expand in international markets. Our primaryinternational markets are Europe, U.K., Canada, Latin America and, to a lesserextent, the Far East and the Caribbean. We conduct our business in Canadathrough our staff based in the United States. We also distribute gamingmachines, manufactured by Bally Gaming, through direct and indirectsubsidiaries: Bally Gaming International, GmbH (“GmbH”), from our sales officein Hannover, Germany principally to customers in Europe and Russia; BallyGaming de Puerto Rico, Inc., principally to customers in Puerto Rico; and BallyGaming and Systems, SA, in Montevideo, Uruguay and its branches in Peru andArgentina, principally to customers in South America.

 

Presently, Class II gamingdevices are marketed to certain Native American gaming markets.  We believe the domestic installed base ofClass II gaming devices now exceeds 21,000. Class II gambling, specificallyexcludes all banked card games.

 

Casinoenterprise systems are composed of various software and hardware productsaffecting departments throughout the casino. We market our casino enterprisesolutions through Bally Gaming and Systems under the names SDS, ACSC, CMP, CMS,MCC, HSD and MindPlay table games systems.

 

The primary markets for casinoenterprise systems are the United States and, to a lesser extent, Canada, LatinAmerica, Europe and the Caribbean. Markets for systems within the United Statesinclude traditional land-based casinos predominantly in Nevada and AtlanticCity, New Jersey, Native American casinos and riverboats and dockside casinos.Domestically, our market for casino enterprise systems is new casinos andexisting or new customers who either (a) acquire casinos with a competitor’ssystem, which is replaced with our system, or (b) expand their casino floors orupgrade their hardware or software to a new product release. Unlike the UnitedStates market, where most jurisdictions require the implementation of systems,there have been few international markets to do so. Management believes,however, that the international market for such systems is increasing, and if thatexpansion occurs that our Gaming Systems’ sales to such markets are likely toincrease accordingly.

 

*Sales andMarketing*

 

Bally Gaming and Systems uses adirect sales force and, to a lesser extent, an independent distributor networkto distribute our products. Bally Gaming and Systems’ North America sales staffconsists of approximately 44 people in offices in Nevada, New Jersey,Mississippi, Illinois, California and Florida.

 

Bally Gaming and Systems’direct sales force generated approximately, 80%, 98% and 76% of new unit salesfor the years ended June 30, 2004, 2003 and 2002, respectively. On alimited basis, Bally Gaming and Systems uses distributors for sales to certaininternational jurisdictions. The agreements with distributors do not specifyminimum purchases but generally provide that we may terminate such agreementsif certain performance standards are not met. These independent distributorsgenerated approximately, 20%, 2% and 24% of new gaming machine unit sales forthe years ended June 30, 2004, 2003, and 2002, respectively.

 

As ofJune 30, 2004, we had approximately 279,000 game monitoring unitsinstalled in 219 locations, of which approximately 92% are in the UnitedStates. Substantially all of System’s revenues are generated by our direct salesforce.

 

We sell gaming equipment andsystems on normal credit terms (generally 2%, net 30) and also offers financingto qualified customers for periods generally between 6 and 48 months withinterest at rates ranging from 8% to 14%.  International sales are generally consummated on a cash basis backed bya letter of credit or financed over three years or less. In addition, incertain situations we have participated in the financing of othergaming-related equipment manufactured by third parties in emerging markets. Forcasino enterprise system sales, we generally offer limited financing terms,normally less than one year, for sales to new installations. Most sales,however, are invoiced on a net 30-day basis. Management believes that financingof customer sales is an important factor in certain emerging markets.

 

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For casino enterprise systemsales, we offer our customers the option of signing separate hardware andsoftware maintenance agreements at the time of sale. These agreements are forperiods of one year and automatically renew unless otherwise canceled inwriting by the customer or us. After an initial warranty period, typically 90days, the customer is invoiced a monthly hardware and software maintenance feewhich provides essentially for repair or replacement of malfunctioning hardwareand software, software version upgrades, and on-call support for software.

 

*Customers*

 

The demand for slot machinesand video gaming machines varies depending on the level of new construction andrenovation of casinos and other facilities and the corresponding need for newequipment as well as the replacement of existing machines.   These machines generally have an average replacementcycle of three to seven years. For the year ended June 30, 2004, the tenlargest customers (including corporate customers with multiple casinoproperties) accounted for approximately 33% of the Bally Gaming and Systems’new unit sales, with the largest single customer accounting for 6% of new unitsales.

 

In addition we provide games tooriginal equipment manufactures (“OEM’s”) that in turn provide games primarilyto the Class II non-traditional gaming markets. Typically the OEM alsopurchases the rights to certain Bally themes, which entitles them to certainBally proprietary game themes and redesigns these game themes to be compatiblewith its operating system configurations. Sales of base gaming devices to OEM’stotaled approximately $14.4 million, $7.9 million, and $10.7 million for yearsended June 30, 2004, 2003 and 2002, respectively, and sales of game themesto the OEM’s totaled approximately $4.0 million, $3.2 million and $1.2 millionfor the years ended June 30, 2004, 2003 and 2002, respectively.

 

The demand for casino enterprisesystems is driven by regulatory requirements in a given jurisdiction and by acasino operators’ competitive need to properly track machine and playeractivity and to establish and compile individual machine and playerprofitability and other demographic information. All of this enables casinos todevelop or enhance marketing strategies. Revenues for casino enterprise systemsare derived from selling to new installations and to new or existing customerswho either (a) acquire casinos with a competitor’s system, which is replacedwith our system or (b) expand their casino floors or upgrade their hardware toa new product release. For the year ended June 30, 2004, the ten largestcasino enterprise system customers (which include certain multi-site casino operatorsthat have corporate agreements) accounted for approximately 59% of gamemonitoring unit sales revenues.

 

Future growth of Bally Gamingand Systems will be based on continued penetration in the internationalmarkets, further expansion in the established and emerging markets, as well ascontinued development efforts to provide customers with new and innovativehardware and software product offerings.

 

*AssemblyOperations*

 

Bally Gaming and Systems’ LasVegas primary facility was completed in 1990 specifically for the design,assembly and distribution of gaming equipment. The 150,000-square foot facilitywas designed to meet fluctuating product design demands and volumerequirements, and management believes the facility enables Bally Gaming andSystems to increase production without significant capital expenditures.

 

Management believes ourassembly operations allow for rapid generation of different models to fillorders quickly and efficiently. Another major advantage of the existing plantoperation is that machines can be altered in many ways including the size, typeand color of glass, sound and payoff patterns to produce a “customized” productfor each customer. Bally Gaming and Systems keeps an inventory of parts thatallow machines to be altered quickly to conform to a particular customer’sdesign/feature request. Bally Gaming and Systems produces products forindividual customer orders, thereby reducing the risk of a backlog of finishedgoods inventories. Bally Gaming and Systems designs all of the major assembliesthat are incorporated into the final machine configuration.

 

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*Competition*

 

The market for gaming machinesand progressive systems in North America is dominated by a single competitor,International Game Technology, Inc. (“IGT”), with WMS Industries, Inc. (“WMS”)recently launching a progressive system as well. Worldwide there are a numberof other well-established, well-financed and well-known companies producinggaming machines that compete with each of our lines in each of our markets. Theother major competitors are AC Coin and Slot, Aristocrat Leisure Limited(“Aristocrat”), Atronic Casino Technology LTD (“Atronic”), Mikohn GamingCorporation (“Mikohn”), Sigma Games, Inc., Universal Distributing of Nevada,Inc., WMS, Konami Co Ltd (“Konami”), Multimedia Gaming (“MGAM”), and RocketGaming.  Many of these companies look toexpand their market share by decreasing our current market share. Besides BallyGaming, IGT, Aristocrat and Mikohn offer wide-area progressive systems, andothers may enter this market. Competition among gaming product manufacturers,particularly with respect to sales of gaming machines into new and emergingmarkets, is vigorous. The competition is based on which machines generate themost net win to the casinos, competitive customer pricing and financing terms,quality of the product and the existence of an extensive distribution, salesand support network.

 

The main competition in casinoenterprise systems currently consists of IGT, Acres Gaming, Aristocrat, MISGrips and to a lesser extent, Konami and Mikohn. Competition is keen in thismarket due to the number of providers and the limited number of casinos andjurisdictions in which they operate. Pricing, product feature and function,accuracy, and reliability are all key factors in determining a provider’ssuccess in selling its system. Management believes the future success of ouroperations will be determined by our ability to bring new and innovativeproducts to the market while maintaining our base of loyal existing customers.

 

**CasinoOperations**

 

*RainbowCasino*

 

The Rainbow Hotel Casino,located in Vicksburg, Mississippi, began operations in July 1994.  The facility includes a 33,000-square footcasino, with 930** **gaming devices and 12** **table games as well as a 310-seat restaurant/buffetand 20,000-square foot conference center. The facility also includes the89-room Rainbow Hotel, which is owned and operated by a third party. RainbowCasino is marketed as a “locals” casino and draws customers principally fromwithin a 75-mile radius of Vicksburg. The Vicksburg casino market generatedapproximately $243 million in gaming revenue in the twelve months endedJune 30, 2004, representing a growth rate of 2%.

 

We are the general partners ofRainbow Casino Vicksburg Partnership, L.P. (“RCVP”), the limited partnershipthat operates the Rainbow Casino. The limited partner, Rainbow Corporation, anindependent third party, is entitled to receive 10% of the net available cashflows after debt service and other items, as defined (which amount increases to20% of such amount for the proportional revenues above $35.0 million) eachyear through December 31, 2010. The Company holds the remaining economicinterest in the partnership.

 

*Sales andMarketing*

 

The Rainbow Casino targets themid-level gaming customers in the market. We promote the casino primarilythrough direct mail, special promotional events, and by providing quality foodat reasonable prices.

 

*Competition*

 

Gaming of alltypes is available throughout Mississippi in numerous locations, including manylocations that compete directly or indirectly with our casino. The operation ofcasinos is a highly competitive business. The principal competitive factors inthe industry include the quality and location of the facility, the nature andquality of the amenities and customer services offered and the implementationand success of marketing programs. The Rainbow Casino faces substantial directcompetition for gaming customers from the three other gaming facilities inVicksburg, as well as other gaming operations throughout Mississippi.

 

**DiscontinuedOperations**

 

*Rail CityCasino*

 

In April 1990, the Companypurchased, for an aggregate purchase price of $9.5 million, substantiallyall of the assets of the Rail City Casino (formerly the Plantation StationCasino), a 20,000 square-foot casino located near the border between thecities of Reno and Sparks in northern Nevada. The sale of Rail City Casino tothe Sands Regent was completed on May 3, 2004. We received $37.9 million incash.  We reported a gain on the salebefore income taxes of $23.1 million, or $14.3 million after tax.

 

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**RouteOperations**

 

Our route operations involvethe selection, ownership, installation, operation and maintenance of videopoker devices, reel-type slot machines and other electronic gaming machines inlocal establishments such as taverns, restaurants, supermarkets, drug stores,convenience stores and casinos operated by third parties (“localestablishments”).  Our route operationstarget residents who generally frequent local establishments close to theirhomes.

 

*NevadaOperations*

 

In July 2003 we announcedthat we had entered into an agreement to sell our Nevada route operations,UCMC, to Century Gaming, Inc., a privately held route operator based inMontana, which disposition was completed on June 30, 2004.  We received approximately $100 million incash and the assumption by Century Gaming of approximately $5 million indebt.  We reported a gain on the salebefore income taxes of $15.3 million, or $9.1 million after tax.

 

###### *LouisianaOperations*

###### * *

*Overview. *In March 1992we obtained a contract to operate video poker gaming machines in the greaterNew Orleans, Louisiana area through a subsidiary, VSI. VSI operates pursuant toan agreement with Fair Grounds Corporation and its affiliates, Jefferson DownsCorporation and Finish Line Management Corporation (collectively, “FairGrounds”), pursuant to which VSI is the exclusive operator of video pokermachines at the only racetrack in the greater New Orleans area and nineassociated off-track betting parlors (“OTB’s”). We operate the game rooms wherethe video poker machines are located for each of the nine facilities owned byFair Grounds, for which we pay a percentage of the revenue generated by themachines. As of June 30, 2004, we had approximately 740 video pokermachines in Louisiana.

 

Under the Louisiana gaming lawsand regulations, the majority stockholder of any entity operating video pokermachines in Louisiana must be a domiciled resident of the State of Louisiana.As a result, we own 49% of the common stock of VSI and three prominent membersof the Louisiana business and legal community own the remaining 51%. We, however,own all the voting stock of VSI and all of VSI’s officers and directors areCompany employees. We are also entitled to receive 71% of the dividendsdeclared by VSI.

 

We also formed two otherLouisiana subsidiaries, Southern Video Services, Inc. (“SVS”) and VideoDistributing Services, Inc. (“VDSI”). Both SVS and VDSI are structured in a manner similar to VSI except thatwe are entitled to receive 60% of any SVS dividends.  Under the terms of our contract with FairGrounds, we must conduct any additional video poker operations in Louisianaother than gaming at racetracks or OTB parlors through SVS.  To date, SVS and VDSI have not engaged inbusiness in Louisiana.

 

We are prohibited by theLouisiana Video Draw Poker Device Control Law and the rules and regulationspromulgated there under (“the Louisiana Act”) from engaging in both themanufacture and operation of video poker gaming in Louisiana and, therefore, wedo not manufacture our own video poker machines for use in Louisiana.

 

In July 2003 we announced thatwe entered into an agreement to sell our interest in VSI to Gentilly Gaming,LLC to be effective June 30, 2004. Gentilly eventually decided not toproceed with the transaction, resulting in a cancellation of the sale agreementand VSI has obtained another extension of the current operation agreement toJune 30, 2005.  We intend tocontinue our efforts to divest our interest in this subsidiary and as such willcontinue to carry the assets as a discontinued operation.

 

**WallMachines and Amusement Games**

 

On July 18,2003, we completed the sale of our Bally Wulff wall machine and amusement gamebusiness unit to a third party equity investor for $16.5 million in cash, andrecorded a loss on sale totaling $25.4 million.

 

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**Patents,Copyrights and Trade Secrets**

 

Bally Gaming, Inc. is thecopyright owner (or has licenses to use) game software, artwork and videopresentations. Some games, cash handling mechanisms, and other gaming devicemechanisms (either currently used or reserved for future development) arecovered either by pending patent applications or issued patents, both foreignand domestic. The expiration dates of these patents vary and are based on theirfiling or issue dates.  In addition, manyof the games have trademarks registered with the U.S. Patent and TrademarkOffice, state trademark registries, or both. Together with our subsidiaries, wehave over four hundred registered or pending trademark applications in theUnited States and around the world.

 

Bally Gaming, Inc., isobligated under several licensing agreements to pay royalties ranging fromapproximately $10 to $500 per machine depending on the components in the gamingmachines. In addition, we have obtained the rights to certain game ideas andintellectual property that require Bally Gaming and Systems to pay royaltiesbased on either fixed amounts or variable amounts based upon the number ofunits sold or leased. Royalty expense for Bally Gaming and Systems for theyears ended June 30, 2004, 2003 and 2002 was $6.2 million,$4.2 million, and $2.8 million, respectively, and is included in costof gaming and systems in the Consolidated Financial Statements.

 

# **Employeesand Labor Relations**

# ** **

As ofJune 30, 2004, we and our subsidiaries employed approximately 1,735persons (excluding employees of discontinued operations and subsidiaries soldas of June 30, 2004, which include approximately 1,210 persons in Nevada,420 persons in Mississippi, 60 persons in Louisiana, 5 persons in various otherstates and 100 in various foreign countries). These employees are not coveredby collective bargaining agreements. We believe we have satisfactoryrelationships with our employees.

 

**GamingRegulations and Licensing**

 

*General. *The manufacture anddistribution of gaming machines and the operation of gaming facilities aresubject to extensive federal, state, local, and foreign regulation. Althoughthe laws and regulations of the various jurisdictions in which we operate andmay expand our gaming operations vary in their technical requirements and aresubject to amendment from time to time, virtually all of these jurisdictionsrequire licenses, permits, documentation of qualification, including evidenceof financial stability, and other forms of approval for companies engaged inthe manufacture and distribution of gaming machines and the operation of gamingfacilities, as well as the individual licensing of officers, directors, majorstockholders and key personnel of such companies.

 

Any person who acquires acontrolling interest in the Company would have to meet the requirements of allgovernmental bodies that regulate our gaming businesses. A change in themake-up of our board of directors and management may require the various gamingauthorities to examine the qualifications of the new board and management.

 

*Nevada.*Theownership and operation of casino gaming facilities in Nevada are subject to(i) the Nevada Gaming Control Act and the regulations promulgatedthereunder (the “Nevada Act”); and (ii) various local ordinances andregulations. Our gaming, manufacturing, and distributing operations(collectively referred to as “gaming machine operations”) are subject to thelicensing and regulatory control of the Nevada State Gaming Control Board (the“Nevada Board”), the Nevada Gaming Commission (the “Nevada Commission”), theClark County Liquor and Gaming Licensing Board (the “Clark County Board”), andvarious other county and city regulatory agencies, all of which arecollectively referred to as the “Nevada Gaming Authorities.”

 

The laws, regulations, andsupervisory procedures of the Nevada Gaming Authorities are based ondeclarations of public policy concerned with, among other things: (i) theprevention of unsavory and unsuitable persons from having any involvement withgaming; (ii) the strict regulation of all persons, locations, practices,associations and activities

 

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related to the operation oflicensed gaming establishments and the manufacture and distribution of gamingmachines, cashless wagering systems and associated equipment; (iii) theestablishment and maintenance of responsible accounting practices andprocedures; (iv) the maintenance of effective control over the financialpractices of licensees, including the establishment of minimum procedures forinternal fiscal affairs and the safeguarding of assets and revenues, providingreliable record-keeping and requiring the filing of periodic reports with theNevada Gaming Authorities; (v) the prevention of cheating and fraudulentpractices; and (vi) providing a source of state and local revenues throughtaxation and licensing fees. Change in such laws, regulations and procedurescould have an adverse effect on our gaming-related operations.

 

Alliance isregistered with the Nevada Commission as a publicly traded corporation (a“Registered Corporation”). Its direct and indirect subsidiaries thatmanufacture or distribute gaming devices or conduct gaming operations atvarious locations (collectively, the “Nevada Subsidiaries”) are required to belicensed by the Nevada Gaming Authorities. The licenses held by the NevadaSubsidiaries require periodic payments of fees and taxes and are nottransferable. The Company, through registered intermediary companies(individually an “Intermediary Company” and collectively the “IntermediaryCompanies”), has been found suitable to own the stock of the NevadaSubsidiaries, each of which is a corporate licensee (individually a “CorporateLicensee” and collectively the “Corporate Licensees”) under the terms of theNevada Act. As a Registered Corporation, we are required periodically to submitdetailed financial and operating reports to the Nevada Gaming Authorities andfurnish any other information the Nevada Gaming Authorities may require.  No person may become a stockholder of orreceive any percentage of the profits from the Corporate Licensees withoutfirst obtaining licenses and approvals from the Nevada Gaming Authorities. TheCompany, the Intermediary Companies, and the Corporate Licensees have obtainedfrom the Nevada Gaming Authorities the various registrations, findings ofsuitability, approvals, permits, and licenses required to engage in gamingactivities, gaming machine operations, and in the manufacture and distributionof gaming devices for use or play in Nevada or for distribution outside ofNevada.

 

All gaming machines andcashless wagering systems manufactured, sold, or otherwise distributed for useor play in Nevada or for distribution outside of Nevada must be manufactured bylicensed manufacturers and distributed or sold by licensed distributors. Allgaming machines manufactured for use or play in Nevada must be approved by theNevada Commission before they are distributed or exposed for play. The approvalprocess for gaming machines and cashless wagering systems includes rigoroustesting by the Nevada Board, a field trial, and a determination as to whetherthe gaming machines or cashless wagering systems meet strict technicalstandards set forth in the regulations of the Nevada Commission. Associatedequipment (as defined in the Nevada Act) must be administratively approved bythe chairman of the Nevada Board before it is distributed in Nevada.

 

The Nevada Gaming Authoritiesmay investigate any individual who has a material relationship or materialinvolvement with us, the Intermediary Companies or the Corporate Licensees todetermine whether that individual is suitable or should be licensed as abusiness associate of a gaming licensee. Officers, directors, and key employees of the Company and theIntermediary Companies who are actively and directly involved in the licensedactivities of the Corporate Licensees are or may be required to be licensed orfound suitable by the Nevada Gaming Authorities. A finding of suitability iscomparable to licensing, and both require submission of detailed personal andfinancial information followed by a thorough investigation.  The applicant for licensing or a finding ofsuitability must pay all the costs of the investigation.  Changes in licensed positions must bereported to the Nevada Gaming Authorities, and in addition to their authorityto deny an application for a finding of suitability or licensing, the NevadaGaming Authorities have jurisdiction to disapprove a change in a corporateposition.  The Nevada Gaming Authoritiesmay deny an application for licensing or finding of unsuitability for any causethey deem reasonable.

 

If the Nevada GamingAuthorities were to find an officer, director, or key employee unsuitable forlicensing or unsuitable to continue having a relationship with the IntermediaryCompanies, the Corporate Licensees, or us, the companies involved would have tosever all relationships with that person. In addition, the Nevada Commission may require the Intermediary Companies,the Corporate Licensees or us to terminate the employment of any person whorefuses to file appropriate applications. Licensing and suitability determinations are not subject to judicialreview in Nevada.

 

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We and the Corporate Licenseesthat hold non-restricted licenses are required to submit detailed financial andoperating reports to the Nevada Commission. A non-restricted license is alicense for an operation consisting of sixteen or more slot machines, or forany number of slot machines together with any other game, gaming device, racebook, or sports pool at one establishment. Substantially all material loans,leases, sales of securities, and similar financing transactions by the CorporateLicensees that hold non-restricted licenses must be reported to or approved bythe Nevada Commission.

 

If it were determined that aCorporate Licensee had violated the Nevada Act, the licenses it holds could belimited, conditioned, suspended, or revoked, subject to compliance with certainstatutory and regulatory procedures. In addition, the Company, the IntermediaryCompanies, the Corporate Licensees, and the persons involved could be subjectto substantial fines for each separate violation of the Nevada Act at thediscretion of the Nevada Commission. Further, a supervisor could be appointedby the Nevada Commission to operate any non-restricted gaming establishmentoperated by a Corporate Licensee and, under certain circumstances, earningsgenerated during the supervisor’s appointment (except for reasonable rental ofthe casino property) could be forfeited to the state.  Limitation, conditioning, or suspension ofthe gaming licenses of the Corporate Licensees or the appointment of asupervisor could, and revocation of any gaming license would, materiallyadversely affect the gaming-related operations of the Company.

 

The Gaming Authorities may, attheir discretion, require the holder of any of our securities to fileapplications, be investigated, and be found suitable to own our securities ifthe Nevada Commission has reason to believe that the holder’s ownership wouldbe inconsistent with the declared policies of Nevada.  The applicant must pay all costs ofinvestigation incurred by the Nevada Gaming Authorities in conducting any suchinvestigation.

 

The Nevada Act requires anyperson who acquires more than 5 percent of any class of a RegisteredCorporation’s voting securities to report the acquisition to the NevadaCommission.  The Nevada Act requires thatbeneficial owners of more than 10 percent of any class of a RegisteredCorporation’s voting securities apply to the Nevada Commission for a finding ofsuitability within thirty days after the chairman of the Nevada Boardmails written notice requiring such filing. Under certain circumstances, an“institutional investor,” as defined in the Nevada Act, that acquires more than10 percent, but not more than 15 percent (19 percent if such additionalownership results from a stock repurchase program conducted by the RegisteredCorporation, subject to certain conditions), of a class of a RegisteredCorporation’s voting securities may apply to the Nevada Commission for a waiverof finding of suitability if the institutional investor holds the securitiesfor investment purposes only.  Aninstitutional investor shall not be deemed to hold voting securities forinvestment purposes unless the voting securities were acquired and are held inthe ordinary course of business as an institutional investor and not for thepurpose of causing, directly or indirectly, the election of a majority of themembers of the board of directors of the Registered Corporation, any change inthe corporate charter, bylaws, management, policies, or operations of theRegistered Corporation or any of its gaming affiliates, or any other action theNevada Commission finds to be inconsistent with holding the RegisteredCorporation’s voting securities for investment purposes only.  Activities that are not deemed to beinconsistent with holding voting securities for investment purposes onlyinclude: (i) voting on all matters voted on by stockholders;(ii) making financial and other inquiries of management of the typenormally made by securities analysts for informational purposes and not to causea change in the Registered Corporation’s management, policies, or operations;and (iii) such other activities as the Nevada Commission may determine tobe consistent with investment-only intent. If the beneficial holder of voting securities who must be found suitableis a corporation, partnership, or trust, it must submit detailed business andfinancial information including a list of beneficial owners.  The applicant is required to pay all costs ofinvestigation.

 

Any person who fails or refusesto apply for a finding of suitability or a license within thirty daysafter being ordered to do so by the Nevada Commission or the chairman of theNevada Board may be found unsuitable. The same restrictions apply to a record owner if the record owner, afterrequest, fails to identify the beneficial owner.  Any stockholder found unsuitable and whoholds, directly or indirectly, any beneficial ownership of the common stockbeyond such period of time as may be prescribed by the Nevada Commission may beguilty of a criminal offense.  We aresubject to disciplinary action if, after we receive notice that a person isunsuitable to be a stockholder or to have any other relationship with theCompany, the Intermediary Companies, or the Corporate Licensees, we(i) pay that person any dividend or interest upon voting securities of theCompany; (ii) allow that person to exercise, directly or

 

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indirectly, any voting rightconferred through securities held by that person; (iii) pay remunerationin any form to that person for services rendered or otherwise; or(iv) fail to pursue all lawful efforts to require such unsuitable personto relinquish his or her voting securities, including, if necessary, theimmediate purchase of said voting securities for cash at fair market value.Additionally, the Clark County Board has taken the position that it has theauthority to approve all persons owning or controlling the stock of anycorporation controlling a gaming license.

 

The Nevada Commission may inits discretion require the holder of any debt securities of a RegisteredCorporation to file applications, be investigated, and be found suitable to ownthe debt security if the Nevada Commission has reason to believe that suchownership would be inconsistent with the declared policies of Nevada.  If the Nevada Commission determines that aperson is unsuitable to own such security, then pursuant to the Nevada Act, theRegistered Corporation can be sanctioned, including the loss of its approvalsif, without the prior approval of the Nevada Commission, it (i) pays theunsuitable person any dividend, interest or any distribution whatsoever;(ii) recognizes any voting right by such unsuitable person in connectionwith such securities; (iii) pays the unsuitable person remuneration in anyform; or (iv) makes any payment to the unsuitable person by way ofprincipal, redemption, conversion, exchange, liquidation, or similartransaction.

 

We are required to maintain inNevada a current stock ledger, which may be examined by the Nevada GamingAuthorities at any time. If any securities are held in trust by an agent or bya nominee, the record holder may be required to disclose the identity of thebeneficial owner to the Nevada Gaming Authorities. A failure to make suchdisclosure may be grounds for finding the record holder unsuitable. We are alsorequired to render maximum assistance in determining the identity of thebeneficial owner. The Nevada Commission has the power to impose a requirementthat a Registered Corporation’s stock certificates bear a legend indicatingthat the securities are subject to the Nevada Act. The Nevada Commissionpreviously imposed this requirement on the Company but removed it in June 2004.

 

We may not make a publicoffering of our securities without the prior approval of the Nevada Commissionif the securities or proceeds there from are intended to be used to construct,acquire, or finance gaming facilities in Nevada or to retire or extendobligations incurred for such purposes. In addition, (i) a Corporate Licensee may not guarantee a securityissued by a Registered Corporation pursuant to a public offering without theprior approval of the Nevada Commission; and (ii) restrictions on thetransfer of an equity security issued by a Corporate Licensee or IntermediaryCompany and agreements not to encumber such securities (collectively, “StockRestrictions”) are ineffective without the prior approval of the NevadaCommission.

 

Changes in control of theCompany through merger, consolidation, stock or asset acquisitions, managementor consulting agreements, or any act or conduct whereby a person or entityacquires control may not occur without the prior approval of the NevadaCommission. Entities seeking to acquire control of a Registered Corporationmust satisfy the Nevada Board and Nevada Commission on a variety of stringentstandards before assuming control of the Registered Corporation. The NevadaCommission may also require controlling stockholders, officers, directors, andother persons having a material relationship or involvement with the entityproposing to acquire control to be investigated and licensed as a part of theapproval process relating to the transaction.

 

The Nevada Legislature hasdeclared that some corporate acquisitions opposed by management, repurchases ofvoting securities, and corporate defense tactics affecting Nevada corporategaming licensees and Registered Corporations that are affiliated with thoseoperations may be injurious to stable and productive corporate gaming.  The Nevada Commission has established aregulatory scheme to ameliorate the potentially adverse affects of thesebusiness practices on Nevada’s gaming industry and to promote Nevada’s policyto: (i) assure the financial stability of corporate gaming licensees andtheir affiliates; (ii) preserve the beneficial aspects of conductingbusiness in the corporate form; and (iii) promote a neutral environmentfor orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the NevadaCommission before a Registered Corporation can make exceptional repurchases ofvoting securities above the current market price (commonly called “ greenmail”)and before a corporate acquisition opposed by management can be consummated.The Nevada Act also requires prior approval of a plan of recapitalizationproposed by the Registered Corporation’s board of directors in response to atender offer made directly to the Registered Corporation’s stockholders for thepurpose of acquiring control of the Registered Corporation.

 

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License fees and taxes,computed in various ways depending on the type of gaming or activity involved,are payable to the State of Nevada and to the counties and cities in which thelicensees conduct their operations. Depending upon the particular fee or tax involved, these fees and taxesare payable, either monthly, quarterly, or annually and are based on either(i) a percentage of the gross revenues received; (ii) the number of gamingdevices operated; or (iii) the number of games operated. A casinoentertainment tax is also paid by casino operations where entertainment isfurnished in connection with the selling of food or refreshments. The CorporateLicensees that hold gaming device route operator licenses or manufacturer ordistributor licenses also pay certain fees to Nevada.

 

Any person who is licensed,required to be licensed, registered, required to be registered, or who is undercommon control with such persons (collectively, “Licensees”), and who proposesto become involved in a gaming venture outside of Nevada, is required todeposit with the Nevada Board and thereafter maintain a $25,000 revolving fundto pay the expenses of investigation by the Nevada Board of the Licensee’sparticipation in such foreign gaming. The revolving fund is subject to increaseor decrease in the discretion of the Nevada Commission. Thereafter, Licenseesare required to comply with certain reporting requirements imposed by theNevada Act. Licensees are also subject to disciplinary action by the NevadaCommission if they knowingly violate any laws of the foreign jurisdictionpertaining to the foreign gaming operation, fail to conduct the foreign gamingoperation in accordance with the standards of honesty and integrity required ofNevada gaming operations, engage in activities that are harmful to the State ofNevada or its ability to collect gaming taxes and fees, or employ a person inthe foreign operations who has been denied a license or finding of suitabilityin Nevada on the ground of personal unsuitability.

 

*Mississippi. *The manufacture anddistribution of gaming and associated equipment and the ownership and operationof casino facilities in Mississippi are subject to extensive state and localregulation, but primarily the licensing and regulatory control of theMississippi Gaming Commission (the “Mississippi Commission”).

 

The Mississippi Gaming ControlAct (the “Mississippi Act”), which legalized dockside casino gaming inMississippi, is similar to the Nevada Gaming Control Act. The MississippiCommission has adopted regulations that are also similar in many respects tothe Nevada gaming regulations.

 

The laws, regulations andsupervisory procedures of Mississippi and the Mississippi Commission are basedon declarations of public policy that are concerned with, among other things:(i) the prevention of unsavory or unsuitable persons from having direct orindirect involvement with gaming at any time or in any capacity; (ii) theestablishment and maintenance of responsible accounting practices andprocedures; (iii) the maintenance of effective controls over the financialpractices of licensees, including the establishment of minimum procedures forinternal fiscal affairs and safeguarding of assets and revenues, providing forreliable record keeping and requiring the filing of periodic reports with theMississippi Commission; (iv) the prevention of cheating and fraudulentpractices; (v) providing a source of state and local revenues throughtaxation and licensing fees; and (vi) ensuring that gaming licensees, tothe extent practicable, employ Mississippi residents. The regulations aresubject to amendment and interpretation by the Mississippi Commission. Webelieve our compliance with the licensing procedures and regulatoryrequirements of the Mississippi Commission will not affect the marketability ofour securities. Changes in Mississippi law or regulations may limit orotherwise materially affect the types of gaming that may be conducted, and suchchanges, if enacted, could have an adverse effect on us and our Mississippigaming operations.

 

The Mississippi Act providesfor legalized dockside gaming in each of the fourteen counties that border theGulf Coast or the Mississippi River, but only if the voters in the county havenot voted to prohibit gaming in that county. Currently, dockside gaming ispermissible in nine of the fourteen eligible counties in the state, and gamingoperations have commenced in seven counties. Under Mississippi law, gamingvessels must be located on the Mississippi River or on navigable waters ineligible counties along the Mississippi River, or in the waters of the State ofMississippi lying south of the state in eligible counties along the MississippiGulf Coast. The Mississippi Act permits unlimited stakes gaming on permanentlymoored vessels on a 24-hour basis and does not restrict the percentage of spacethat may be utilized for gaming.

 

The Mississippi Act permitssubstantially all traditional casino games and gaming devices. The Company,RCVP, Bally Gaming, Inc. (“BGI”), and their affiliates are subject to thelicensing and regulatory control of the Mississippi Commission. We areregistered under the Mississippi Act as a publicly traded corporation (a“Registered

 

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Corporation”) and holdingcompany of RCVP and BGI. As a Registered Corporation, we are requiredperiodically to submit detailed financial and operating reports to theMississippi Commission and furnish any other information the MississippiCommission may require. If we are unable to continue to satisfy theregistration requirements of the Mississippi Act, we and our affiliates cannotown or operate gaming facilities or continue to act as a manufacturer and distributorin Mississippi.  No person may become astockholder of, or receive any percentage of profits from, a licensedsubsidiary of a Registered Corporation or a holding company without firstobtaining licenses and approvals from Mississippi Commission. We and ouraffiliates have obtained the necessary licenses and approvals from theMississippi Commission. RCVP must maintain a gaming license from theMississippi Commission to operate a casino in Mississippi and BGI must maintaina manufacturer and distributor license from the Mississippi Commission tomanufacture and distribute gaming products and a wide-area progressive operatorlicense to operate its progressive slot system. Such licenses are issued by theMississippi Commission subject to certain conditions, including continuedcompliance with all applicable state laws and regulations.

 

There are no limitations on thenumber of licenses that may be issued in Mississippi. Gaming and manufacturerand distributor licenses are not transferable, are issued for a three-yearperiod (and may be renewed for two additional three-year periods) and must berenewed or continued thereafter. In June 2003, RCVP was granted athree-year renewal of its gaming license by the Mississippi Commission, and BGIwas granted three-year renewals of its manufacturer and distributor license andits wide-area progressive operator license.

 

Certain of our officers andemployees and the officers, directors, and certain key employees of ourlicensed subsidiaries must be found suitable or be licensed by the MississippiCommission. We believe we have obtained, applied for, or are in the process ofapplying for all necessary findings of suitability with respect to such personsaffiliated with us, RCVP or BGI, although the Mississippi Commission, in itsdiscretion, may require additional persons to file applications for findings ofsuitability. In addition, any person having a material relationship orinvolvement with us may be required to be found suitable, in which case thosepersons must pay the costs and fees associated with such investigation. TheMississippi Commission may deny an application for a finding of suitability forany cause it deems reasonable. Changes in certain licensed positions must bereported to the Mississippi Commission. In addition to its authority to deny an application for findings ofsuitability, the Mississippi Commission can disapprove a change in a licensedposition.  The Mississippi Commission hasthe power to require the Company and its registered or licensed subsidiaries tosuspend or dismiss officers, directors and other key employees or severrelationships with other persons who refuse to file appropriate applications orwhom the authorities find unsuitable to act in such capacities.

 

Determinations of suitabilityor questions pertaining to licensing are not subject to judicial review inMississippi. At anytime, the Mississippi Commission has the power toinvestigate and require the finding of suitability of any record or beneficialstockholder of the Company. The Mississippi Act requires any person whoacquires more than 5 percent of any class of voting securities of a RegisteredCorporation, as reported to the Securities and Exchange Commission (“SEC”), toreport the acquisition to the Mississippi Commission, and such person may berequired to be found suitable. Also, any person who becomes a beneficial ownerof more than 10 percent of any class of voting securities of a RegisteredCorporation, as reported to the SEC, must apply for a finding of suitability bythe Mississippi Commission. The Mississippi Commission generally has exercisedits discretion to require a finding of suitability of any beneficial owner ofmore than 5 percent of any class of voting securities of a RegisteredCorporation. However, the Mississippi Commission has adopted a policy thatpermits certain institutional investors to own beneficially up to 15 percent ofa class of voting securities of a Registered Corporation without a finding ofsuitability. If a stockholder who must be found suitable is a corporation,partnership, or trust, it must submit detailed business and financialinformation including a list of beneficial owners.

 

Any record or beneficialstockholder required to apply for a finding of suitability must pay allinvestigative fees and costs of the Mississippi Commission in connection withthe investigation. Any person who fails or refuses to apply for a finding ofsuitability or a license within 30 days after being ordered to do so by theMississippi Commission may be found unsuitable. The same restrictions apply toa record owner if the record owner, after request, fails to identify thebeneficial owner. Any person found unsuitable and who holds, directly orindirectly, any beneficial ownership of such securities beyond such time as theMississippi Commission prescribes may be guilty of a misdemeanor. We may besubject to disciplinary action if, after receiving notice that a person isunsuitable to be a stockholder or to have any

 

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other relationship with us orour Mississippi gaming subsidiaries, the company involved: (i) pays theunsuitable person any dividend or other distribution on that person’s votingsecurities; (ii) recognizes the exercise, directly or indirectly, of anyvoting rights conferred by securities held by the unsuitable person;(iii) pays the unsuitable person any remuneration in any form for servicesrendered or otherwise, except in certain limited and specific circumstances; or(iv) fails to pursue all lawful efforts to require the unsuitable personto divest himself of the securities, including, if necessary, the immediatepurchase of the securities for cash at a fair market value.

 

We may be required to discloseto the Mississippi Commission on request the identities of the holders of anyof our debt or other securities.  Inaddition, under the Mississippi Act, the Mississippi Commission may in itsdiscretion require the holders of any debt security of a Registered Corporationto file an application, be investigated, and be found suitable to own thedebt security if the Mississippi Commission has reason to believe that theownership would be inconsistent with the declared policies of the state ofMississippi. Although the Mississippi Commission generally does not require theindividual holders of obligations such as notes to be investigated and foundsuitable, the Mississippi Commission retains the discretion to do so for anyreason, including but not limited to a default or where the holder of the debtinstrument exercises a material influence over the gaming operations of theentity in question. Any holder of debt securities required to apply for afinding of suitability must pay all investigative fees and costs of theMississippi Commission in connection with the investigation. If the MississippiCommission determines that a person is unsuitable to own a debt security, thenthe Registered Corporation may be sanctioned, including the loss of itsapprovals, if without the prior approval of the Mississippi Commission it: (i)pays to the unsuitable person any dividend, interest, or any distributionwhatsoever; (ii) recognizes any voting right by the unsuitable person inconnection with those securities; (iii) pays the unsuitable person remunerationin any form; or (iv) makes any payment to the unsuitable person by way ofprincipal, redemption, conversion, exchange, liquidation, or similartransaction.

 

RCVP and BGI must maintain inMississippi a current ledger with respect to the ownership of their equitysecurities, and we must maintain a current list of stockholders in theprincipal office of RCVP, which list must reflect the record ownership of eachoutstanding share of any class of our equity securities. The ledger andstockholder lists must be available for inspection by the MississippiCommission at any time.  If anysecurities are held in trust by an agent or by a nominee, the record holder maybe required to disclose the identity of the beneficial owner to the MississippiCommission. A failure to make such disclosure may be grounds for finding therecord holder unsuitable. We must also render maximum assistance in determiningthe identity of the beneficial owner.

 

The Mississippi Act requiresthat the certificates representing securities of a Registered Corporation beara legend indicating that the securities are subject to the Mississippi Act andthe regulations of the Mississippi Commission. We have received from theMississippi Commission a waiver of this legend requirement. The MississippiCommission has the power to impose additional restrictions on the holders ofour securities at any time.

 

Substantially all materialloans, leases, sales of securities and similar financing transactions by aRegistered Corporation or a licensed gaming subsidiary must be reported to orapproved by the Mississippi Commission. A licensed gaming subsidiary may notmake a public offering of its securities, but may pledge or mortgage casinofacilities. A Registered Corporation may not make a public offering of itssecurities without the prior approval of the Mississippi Commission if any partof the proceeds of the offering is to be used to finance the construction,acquisition or operation of gaming facilities in Mississippi or to retire orextend obligations incurred for one or more such purposes. Such approval, ifgiven, does not constitute a recommendation or approval of the investmentmerits of the securities subject to the offering.

 

Under the regulations of theMississippi Commission, a Mississippi gaming subsidiary may not guarantee asecurity issued by an affiliated company pursuant to a public offering, orpledge its assets to secure payment or performance of the obligations evidencedby the security issued by the affiliated company, without the prior approval ofthe Mississippi Commission.  A pledge ofthe stock of a Mississippi gaming subsidiary and the foreclosure of such apledge are ineffective without the prior approval of the MississippiCommission. Moreover, restrictions on the transfer of an equity security issuedby a Mississippi gaming subsidiary and agreements not to encumber suchsecurities are ineffective without the prior approval of the MississippiCommission.

 

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Changes in control of theCompany through merger, consolidation, acquisition of assets, management orconsulting agreements, or act or conduct by a person by which he or she obtainscontrol, may not occur without the prior approval of the MississippiCommission. Entities seeking to acquire control of a Registered Corporationmust satisfy the Mississippi Commission in a variety of stringent standardsprior to assuming control of the Registered Corporation. The MississippiCommission may also require controlling stockholders, officers, directors, and otherpersons having a material relationship or involvement with the entity proposingto acquire control to be investigated and licensed as part of the approvalprocess relating to the transaction.

 

The Mississippi legislature hasdeclared that some corporate acquisitions opposed by management, repurchases ofvoting securities and other corporate defense tactics that affect corporategaming licensees in Mississippi and Registered Corporations may be injurious tostable and productive corporate gaming. The Mississippi Commission hasestablished a regulatory scheme to ameliorate the potentially adverse effectsof these business practices upon Mississippi’s gaming industry and to promoteMississippi’s policy to: (i) assure the financial stability of corporategaming operators and their affiliates; (ii) preserve the beneficialaspects of conducting business in the corporate form; and (iii) promote aneutral environment for the orderly governance of corporate affairs.

 

Approvals are, in certaincircumstances, required from the Mississippi Commission before a RegisteredCorporation may make exceptional repurchases of voting securities  (such as repurchases that treat holdersdifferently) in excess of the current market price and before a corporateacquisition opposed by management may be consummated. Mississippi’s gamingregulations also require prior approval by the Mississippi Commission of a planof recapitalization proposed by a Registered Corporation’s board of directorsin response to a tender offer made directly to the stockholders for the purposeof acquiring control of the Registered Corporation.

 

Neither we nor any of oursubsidiaries may engage in gaming activities in Mississippi while alsoconducting gaming operations outside of Mississippi without approval of theMississippi Commission. The Mississippi Commission may require determinationsthat, among other things, there are means for the Mississippi Commission tohave access to information concerning the out-of-state gaming operations of theCompany and its affiliates. We have previously obtained a waiver of foreigngaming approval from the Mississippi Commission for operations in other statesand will be required to obtain the approval or a waiver of such approval fromthe Mississippi Commission prior to engaging in any additional future gamingoperations outside of Mississippi.

 

If the Mississippi Commissiondetermined that we or a licensed gaming subsidiary violated a gaming law orregulation, the Mississippi Commission could limit, condition, suspend, or revokeour approvals and the license of the subsidiary. In addition, we, the licensedsubsidiary, and the persons involved could be subject to substantial fines foreach separate violation. Because of such violations, the Mississippi Commissioncould seek to appoint a supervisor to operate our casino facilities.Limitation, conditioning or suspension of any gaming license or approval or theappointment of a supervisor could (and revocation of any gaming license orapproval would) materially adversely affect us and RCVP’s gaming operations orBGI’s manufacturer, distributor, and wide-area progressive operations, as thecase may be.

 

License fees and taxes,computed in various ways depending on the type of gaming involved, are payableto the State of Mississippi and to the counties and cities in which a licensedgaming subsidiary’s operations are conducted. Depending on the particular fee or tax involved, these fees and taxesare payable either monthly, quarterly, or annually and are based on (i) apercentage of the gross gaming revenues received by the casino operation;(ii) the number of gaming devices operated by the casino; or(iii) the number of table games operated by the casino. The license feepayable to the State of Mississippi is based upon “gaming receipts” (generallydefined as gross receipts less payouts to customers as winnings), and equalsfour percent (4%) of gaming receipts of $50,000 or less per month, six percent(6%) of gaming receipts that exceed $50,000 but do not exceed $134,000 per month,and eight percent (8%) of gaming receipts that exceed $134,000 per month.  The foregoing license fees we pay are allowedas a credit against our Mississippi income tax liability paid for the year. Thegross revenue fee imposed by the City of Vicksburg, Mississippi, where RCVP’scasino operations are located, equals approximately 4 percent of gamingreceipts.

 

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The MississippiCommission’s regulations require as a condition of licensing or license renewalthat an existing licensed gaming establishment’s plan include a 500-car parkingfacility in close proximity to the casino complex and infrastructure facilitiesthat amount to at least 25% of the casino cost. We believe the Rainbow Casinois in compliance with this requirement. The Mississippi Commission adopted achange to this regulation increasing the infrastructure requirement to 100percent; however, the regulation grandfathers existing licensees and appliesonly to new casino projects and casinos that are not operating at the time ofacquisition or purchase by new owners.

 

In recent years,certain anti-gaming groups proposed for the adoption, through the initiativeand referendum process, certain amendments to the Mississippi Constitution thatwould prohibit gaming in the state. The proposals were declared illegal by theMississippi courts on constitutional and procedural grounds. The latest rulingwas appealed to the Mississippi Supreme Court, which affirmed the decision ofthe lower court. If another such proposal were to be offered and if asufficient number of signatures were to be gathered to place a legal initiativeon the ballot, it is possible for the voters of Mississippi to consider such aproposal in November 2006.  While weare unable to predict whether such an initiative will appear on a ballot or thelikelihood of such an initiative being approved by the voters, if such aninitiative were passed and gaming were prohibited in Mississippi, it would havea significant adverse effect on us and our Mississippi gaming operations.

 

The sale of alcoholic beveragesby the Rainbow Casino owned and operated by RCVP is subject to the licensing,control and regulation by both the City of Vicksburg and the Alcoholic BeverageControl Division (the “ABC”) of the Mississippi State Tax Commission. TheRainbow Casino area has been designated as a special resort area, which allowsthe Rainbow Casino to serve alcoholic beverages on a 24-hour basis. The ABC hasthe full power to limit, condition, suspend or revoke any license for theserving of alcoholic beverages or to place such a licensee on probation with orwithout conditions. Any such disciplinary action could (and revocation would)have a material adverse effect on the RCVP’s operations. Certain officers and managersof RCVP must be investigated by the ABC in connection with its liquor permits,and changes in certain positions must be approved by the ABC.

 

*New Jersey.*BGI is licensed by the New Jersey Casino ControlCommission (the “New Jersey Commission”) as a gaming-related casino serviceindustry (“CSI”) in accordance with the New Jersey Casino Control Act (the“Casino Control Act”). We are a holding company, as that term is defined by theCasino Control Act, of BGI and thus are a qualifier in connection with BGI’sCSI license and have been approved as such by the New Jersey Commission.

 

The New Jersey Commissionrequires the officers, directors, key personnel, financial sources, andstockholders (in particular those with holdings in excess of 5 percent) of a CSIlicense holder and its holding and intermediary companies to qualify inaccordance with the Casino Control Act. BGI is required to notify the NewJersey Commission of any appointment, nomination, election, resignation,termination, incapacitation, or death of any person or entity otherwiserequired to qualify pursuant to the Casino Control Act. Such persons andentities may be investigated and may be required to make certain regulatoryfilings and to disclose and/or to provide consents to disclose personal andfinancial data. The costs associated with such investigation are typicallyborne by the applicant.

 

*Louisiana.*Themanufacture, distribution, servicing, and operation of video draw poker devices(“Devices”) in Louisiana are subject to the Louisiana Video Draw Poker DevicesControl Law and the rules and regulations promulgated thereunder (the“Louisiana Act”). Licensing and regulatory control is maintained by a singlegaming control board for the regulation of gaming in Louisiana. This Board, createdon May 1, 1996, is called the Louisiana Gaming Control Board (the “LouisianaBoard”) and oversees all licensing for all forms of legalized gaming inLouisiana (including all regulatory enforcement, and supervisory authority thatexists in the state as to gaming on Native American lands). The Video GamingDivision of the Gaming Enforcement Section of the Office of State Policewithin the Department of Public Safety and Corrections (the “Division”)performs the investigative functions for the Louisiana Board. The laws andregulations of Louisiana are based on policies of maintaining the health,welfare, and safety of the general public and protecting the video gamingindustry from elements of organized crime, illegal gambling activities, andother harmful elements, as well as protecting the public from illegal andunscrupulous gaming to ensure the fair play of devices.

 

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Video Services, Inc. VSI, theindirect operating subsidiary for our gaming operations in Louisiana, has beengranted a license as a device owner by the Division. VSI is a LouisianaLicensee under the terms of the Louisiana Act. The license held by VSI expiredat midnight on June 30, 2004, and is subject to renewal for five-yearterms thereafter. Annual fees must be paid on or before July 1 in eachyear regardless of the license expiration date. (Another subsidiary, Southern Video Services, Inc., has been dormant andso the Company allowed its license to lapse.)

 

The Louisiana Board may deny, imposea condition on, or suspend or revoke a license, renewal, or application for alicense for violations of any rules and regulations of the Louisiana Board orany violations of the Louisiana Act. In addition, fines for violations ofgaming laws or regulations may be levied against the Louisiana Licensees andthe persons involved for each violation of the gaming laws. The license isdeemed a pure and absolute privilege and issuance, condition, denial,suspension or revocation of a license is at the discretion of the LouisianaBoard under the provisions of the Louisiana Act. A license is not property or aprotected interest under the constitution of either the United States orLouisiana.

 

The Division has the authorityto conduct overt and covert investigations of any person involved directly orindirectly in the video gaming industry in Louisiana. These investigations haveextended to information regarding a prospective licensee’s and his or herspouse’s immediate family and relatives and their affiliations with certainorganizations or other business entities. The investigation may also extend toany person who has or controls more than a 5 percent ownership of, or interestin income or profits in, an applicant for or holder of a license or who is akey employee or who has the ability to exercise significant influence over thelicensee. All persons or entities investigated must meet all suitabilityrequirements and qualifications for a licensee. The Louisiana Board may deny anapplication for licensing for any cause it may deem reasonable. The applicantfor licensing must pay a filing fee, which applies to the cost of theinvestigation.

 

In order for a corporation tobe licensed as an operator or distributor of video poker gaming devices by theLouisiana Board, a majority of the stock of the corporation must be owned bypersons who have been domiciled in Louisiana for at least two years prior tothe date of the application.

 

Bally Gaming has an applicationpending to renew our license as a manufacturer of devices under the LouisianaGaming Law. In the past, a manufacturer would have to obtain a separate permitto do business with video poker, riverboat, and land-based casino licensees.However, recent changes have been enacted to Louisiana’s Gaming Law to allowmanufacturers to apply for and obtain one permit to be able to conduct businessin the different gaming venues.

 

*FederalRegistration. *Theoperating subsidiaries of the Company that are involved in the manufacture,sale, distribution, or operation of gaming machines are required to registerannually with the Attorney General of the United States. All currently requiredfilings have been made.

 

From time to time,certain legislators have proposed the imposition of a federal tax on grossgaming revenues.  No specific proposalsfor the imposition of such a federal tax are currently pending. However, noassurance can be given that such a tax will not be imposed in the future. Anysuch tax could have a material adverse effect on our businesses, financial conditions,or results of operations.

 

*AdditionalJurisdictions. *We,in the ordinary course of our business, routinely consider businessopportunities to expand our gaming operations into additional jurisdictions.Although the laws and regulations of the various jurisdictions in which weoperate or into which we may expand our gaming operations vary in theirtechnical requirements and are subject to amendment from time to time,virtually all of those jurisdictions require licenses, permits, documentationof qualification, including evidence of financial stability, and other forms ofapproval for companies engaged in the manufacture, distribution and operationof gaming machines as well as for the officers, directors, major stockholders,and key personnel of such companies.

 

We and our key personnel haveobtained, or applied for, all government licenses, registrations, findings ofsuitability, permits, and approvals necessary for the manufacture, distributionand, where permitted, operation of gaming machines in the jurisdictions inwhich we do business. We and the holders of our securities may be subject tothe provisions of the gaming laws of each jurisdiction where we or oursubsidiaries are licensed or are applying for licensing or conduct business,including, without limitation, Arizona, California, Colorado, Connecticut,Delaware, Florida,  Illinois, Indiana,Iowa, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada,New

 

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Jersey, New Mexico, New York,Oklahoma, Pennsylvania, Puerto Rico, South Dakota, Washington, West Virginia,Wisconsin, and the local regulatory authorities within each such state, as wellas Australian, Canadian, and other foreign gaming jurisdictions in which BallyGaming International, Inc. (“BGII”) and its subsidiaries are licensed orconduct business.

 

Holders of common stock of anentity licensed to manufacture and sell gaming machines, and in particularthose with holdings in excess of 5 percent, should note that local laws andregulations may affect their rights regarding the purchase of such common stockand may require such persons or entities to make certain regulatory filings orseek licensing, findings of qualification, or other approvals. In some casesthis process may require the holder or prospective holder to disclose orprovide consents to disclose personal and financial data in connection withnecessary investigations, the costs of which are typically borne by theapplicant. The investigative and approval process can take three to six monthsto complete under normal circumstances.

 

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# **ITEM2.**                             PROPERTIES

 

The following table sets forthinformation regarding our leased properties for our Bally Gaming and Systems businessunit, and our casino operations as of June 30, 2004, all of which arefully utilized unless otherwise noted (dollars in 000s):

 
| **Location**                   | ** ** | **Use**                                      | ** ** | **Building  Square Feet** | ** ** | **Annual  Rental  Payments** | ** ** |
|--------------------------------|------------|----------------------------------------------|------------|---------------------------|------------|------------------------------|------------|
|                           |       |                                         |       |                      |       |                         |       |
| Sparks, NV                     |       | Administrative  offices and warehousing      |       | 33,384                    |       | $                            | 401        |   |
| Atlantic City, NJ              |       | Sales  offices and warehousing               |       | 15,800                    |       | 136                          |       |
| Biloxi, MS                     |       | Sales  offices                               |       | 5,000                     |       | 47                           |       |
| Westchester, IL                |       | Sales  offices                               |       | 4,900                     |       | 44                           |       |
| Hollywood, FL                  |       | Sales  offices                               |       | 3,400                     |       | 8                            |       |
| Temecula, CA                   |       | Sales  offices                               |       | 2,000                     |       | 20                           |       |
| Huntington Beach, CA           |       | Offices                                      |       | 3,340                     |       | 52                           |       |
| Atlantic City, NJ              |       | Administrative  offices                      |       | 750                       |       | 10                           |       |
| San Juan, P R                  |       | Sales  offices                               |       | 2,135                     |       | 27                           |       |
| Las Vegas, NV                  |       | Warehousing                                  |       | 86,300                    |       | 549                          |       |
| Las Vegas, NV                  |       | Offices                                      |       | 20,640                    |       | 273                          |       |
| Absecon, NJ                    |       | Direct mail  office                          |       | 5,300                     |       | 63                           |       |
| Egg Harbor Township, NJ        |       | General and  research and development office |       | 15,500                    |       | 332                          |       |
| Slidell, LA                    |       | Offices                                      |       | 1,250                     |       | 13                           |       |
| Reno, NV                       |       | Office/warehouse                             |       | 30,500                    |       | 412                          |       |
| Reno, NV                       |       | Office                                       |       | 20,284                    |       | 365                          |       |
| Reno, NV                       |       | Warehousing                                  |       | 9,626                     |       | 81                           |       |
| Fife, WA                       |       | Office/warehouse                             |       | 3,105                     |       | 23                           |       |
| Fife, WA                       |       | Warehousing                                  |       | 1,530                     |       | 13                           |       |
| Marysville, WA                 |       | Warehousing                                  |       | 4,400                     |       | 26                           |       |
| Las Vegas, NV                  |       | Office                                       |       | 2,939                     |       | 48                           |       |
| Sommerville, NJ                |       | Warehousing                                  |       | 1,000                     |       | 12                           |       |
| Sommerville, NJ                |       | Lease  terminated 8/1/04                     |       | —                    |       | 73                           |       |
| Bellevue, WA                   |       | Administrative  offices                      |       | 7,581                     |       | 91                           |       |
| Pleasanton, CA                 |       | Office and  storage                          |       | 3,176                     |       | 50                           |       |
| Cheektowage, NY                |       | Offices                                      |       | 1,143                     |       | 7                            |       |
| Vicksburg, MS                  |       | Storage                                      |       | 3,000                     |       | 21                           |       |
| Vicksburg, MS                  |       | Administrative  offices                      |       | 1,500                     |       | 10                           |       |
| Las Vegas, NV (1)              |       | Ground Lease                                 |       | —                    |       | 365                          |       |
| Shropshire, England            |       | Administrative  offices                      |       | 3,000                     |       | 15                           |       |
| Hannover, Germany              |       | Administrative  offices and warehousing      |       | 13,292                    |       | 80                           |       |
| Hannover, Germany              |       | Administrative  offices                      |       | 248                       |       | 10                           |       |
| Graz, Austria                  |       | Administrative  offices                      |       | 1,184                     |       | 11                           |       |
| Nice, France                   |       | Administrative  offices                      |       | 5,500                     |       | 127                          |       |
| Montevideo, Uruguay            |       | Administrative  offices                      |       | 1,367                     |       | 28                           |       |
| Province of Cordoba, Argentina |       | Administrative  offices                      |       | 969                       |       | 4                            |       |
| Lima, Peru                     |       | Administrative  offices                      |       | 2,928                     |       | 15                           |       |
|                                |            |                                              |            |                           |            |                              |            |  |

 

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(1)                                  Leaseconsists of ground lease for parking.

 

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The following table sets forthinformation regarding properties owned by us as of June 30, 2004 for ourcasino operation business unit, all of which are fully utilized unlessotherwise noted:

 
| **Location**   | ** ** | **Use**                 | ** ** | **Building  Square Feet** | ** ** |
|----------------|------------|-------------------------|------------|---------------------------|------------|
| Vicksburg, MS  |       | Casino                  |       | 33,000                    |       |
| Vicksburg,  MS |       | Entertainment  facility |       | 20,000                    |       |
| Vicksburg,  MS |       | Administrative  offices |       | 3,200                     |       |
| Vicksburg,  MS |       | Vacant-Land             |       | —                    |       |

 

See Note 12 to the ConsolidatedFinancial Statements for information as to our lease commitments with respectto the foregoing rental properties. We believe our facilities are suitable forour needs and we have no future expansion plans that would make theseproperties inadequate.

 

The following table sets forthinformation regarding our discontinued operations leased properties as ofJune 30, 2004 (exclusive of space leases), all of which are fully utilizedunless otherwise noted (dollars in 000s):

 
| **Location**     | ** ** | **Use**                     | ** ** | **Building  Square Feet** | ** ** | **Annual  Rental  Payments** | ** ** |
|------------------|------------|-----------------------------|------------|---------------------------|------------|------------------------------|------------|
| New Orleans,  LA |       | Louisiana  route operations |       | 6,000                     |       | $                            | 72         |   |
| Metairie, LA     |       | OTB  operation              |       | 5,000                     |       | $                            | 57         |   |
| LaPlace, LA      |       | OTB  operation              |       | 2,500                     |       | $                            | 51         |   |
| Harahan, LA      |       | OTB  operation              |       | 2,300                     |       | $                            | 72         |   |

 

# **ITEM3.**                             LEGALPROCEEDINGS

 

***Litigation***

 

OnSeptember 25, 1995, Bally Gaming International Inc, (“BGII”) was named asa defendant in a class action lawsuit filed in Federal District Court inNevada, by Larry Schreirer on behalf of himself and all others similarlysituated. The plaintiffs filed suit against BGII and approximately forty-fiveother defendants. Each defendant is involved in the gaming business as a gamingmachine manufacturer, distributor, or casino operator. The class action lawsuitarises out of alleged fraudulent marketing and operation of casino video pokermachines and electronic slot machines. The plaintiffs allege that thedefendants have engaged in a course of fraudulent and misleading conductintended to induce people into playing their gaming machines based on a falsebelief concerning how those machines actually operate as well as the extent towhich there is actually an opportunity to win on any given play. The plaintiffsallege that the defendants’ actions constitute violations of the RacketeerInfluenced and Corrupt Organizations Act (RICO) and give rise to claims ofcommon law fraud and unjust enrichment. The plaintiffs are seeking monetarydamages in excess of $1.0 billion, and are asking that any damage awards betrebled under applicable Federal law. In June 2002, the Federal districtcourt denied the plaintiffs’ motion for class action certification. OnAugust 10, 2004, the Ninth Circuit Court of Appeals affirmed the districtcourt’s denial of class action certification. Plaintiffs have until earlyNovember 2004 to ask the U.S. Supreme Court to consider the case.Management believes the plaintiffs’ lawsuit to be without merit. We willcontinue to pursue all legal defenses available to us.

 

In June 2004,putative class actions were filed against Alliance Gaming Corporation and itsofficers, Robert Miodunski, Robert Saxton, Mark Lerner, and Steven Des Champs,in the Federal District Court for the District of Nevada.  The nearly identical complaints allegeviolations of the Securities Exchange Act of 1934 stemming from revisedearnings guidance, declines in the stock price, and sales of stock by insiders. Plaintiffs have filed a motion toconsolidate all of the cases and appoint a lead plaintiff.  A hearing date has not been scheduled.  Alliance believes the lawsuits are withoutmerit and intends to vigorously defend itself and its officers.  In addition, in July 2004 two derivativelawsuits were filed in Nevada state court against the members of the board ofdirectors and the officers listed above. The Company is named as a nominal defendant in the derivative lawsuitsas the claims are purportedly asserted for the benefit of the Company.  These lawsuits assert claims for breach offiduciary duty and waste of corporate assets arising out of the same events asthose giving rise to the class actions described above.  These two cases have been consolidated andplaintiffs have until September 20, 2004 to file a consolidated complaint.

 

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

 

# **ITEM4.**                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

**PART II**

 

**ITEM 5.**                             **MARKET FORREGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER****MATTERS**

 

On December 12, 2002 ourcommon stock became listed on the New York Stock Exchange under the symbol“AGI”.  Formerly our common stock wastraded on the NASDAQ Index under the symbol “ALLY”.  The following table sets forth the high andlow closing bid price of the Common Stock as reported by the NYSE or NASDAQ forthe periods indicated.

 
| ** **                               | ** ** | **Price Range of  Common Stock** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **High**                         | ** ** | **Low** | ** ** |
|                                     |       |                             |       |   |   |
| **Fiscal Year Ended June 30, 2004** |       |                             |       |   |   |
| 1st Quarter                              |       | $                                | 23.78      |   | $ | 19.01 |   |
| 2nd Quarter                              |       | 27.37                            |       | 20.72 |   |
| 3rd Quarter                              |       | 33.45                            |       | 23.27 |   |
| 4th Quarter                              |       | 34.00                            |       | 15.63 |   |
|                                     |       |                             |       |   |   |
| **Fiscal Year Ended June 30, 2003** |       |                             |       |   |   |
| 1st Quarter                              |       | $                                | 16.06      |   | $ | 11.55 |   |
| 2nd Quarter                              |       | 18.01                            |       | 13.31 |   |
| 3rd Quarter                              |       | 17.30                            |       | 13.38 |   |
| 4th Quarter                              |       | 19.03                            |       | 14.50 |   |

 

As of****September 1,2004, we had approximately 1,000 holders of record of our Common Stock.

 

We have never declared or paidcash dividends on our Common Stock.  Weintend to follow a policy of retaining earnings, if any, to finance growth ofour business and do not anticipate paying any cash dividends in the foreseeablefuture. The declaration and payment of future dividends on the Common Stockwill be at the sole discretion of our Board of Directors and will depend on ourprofitability, our ability to pay dividends under the terms of our bank creditagreement and our financial condition, capital requirements, statutory andcontractual restrictions, future prospects and other factors deemed relevant.

 

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**EquityCompensation Plans**

 

The following table sets forthinformation as of June 30, 2004 with respect to our equity compensationplans that provides for the issuance of stock options to purchase our commonstock:

 
| ** **                                                  | ** ** | **Number of Securities  to be issued upon  exercise of outstanding  options and restricted  stock units** | ** ** | **Wt. average  exercise price  of outstanding  options, excluding  restricted stock units** | ** ** | **Number of Securities  available for future  issuance under equity  compensation plans  (excluding securities  reflected in the first  column)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                                                      |       |                                                                                        |       |                                                                                                                                              |       |
| Plan Category                                               |       |                                                                                                      |       |                                                                                        |       |                                                                                                                                              |       |
|                                                        |       |                                                                                                      |       |                                                                                        |       |                                                                                                                                              |       |
| Equity compensation plans approved by  security holders     |       | 5,702,733                                                                                                 |       | $                                                                                           | 15.50      |                                                                                                                                              | 2,721,932  |   |
|                                                        |       |                                                                                                      |       |                                                                                        |       |                                                                                                                                              |       |
| Equity compensation plans not approved by  security holders |       | —                                                                                                    |       | —                                                                                      |       | —                                                                                                                                            |       |
| Total                                                       |       | 5,702,733                                                                                                 |       | $                                                                                           | 15.50      |                                                                                                                                              | 2,721,932  |   |

 

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**ITEM 6.****                             SELECTEDFINANCIAL DATA**

 

The following selected financial data has been derived from our auditedconsolidated financial statements.  Thetable should be read in conjunction with “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and the ConsolidatedFinancial Statements and Notes thereto. The amounts shown below have beenrestated to conform to present the route operations, Bally Wulff and Rail CityCasino businesses as discontinued operations.

 
| ** **                                                                                     | ** ** | **Fiscal Years Ended June 30,**    | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                     | ** ** | **2004**                                | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                     | ** ** | **(In 000s, except per share amounts)** | ** ** |
| **Statement of Operations Data**                                                               |       |                                    |       |   |   |   |   |   |   |   |   |
| Total revenues from continuing operations                                                      |       | $                                       | 488,876    |   | $ | 386,381 |   | $ | 275,914 |   | $ | 214,098 |   | $ | 184,005 |   |
| Unusual items (1)                                                                              |       | 12,293                                  |       | — |   | — |   | 6,489 |   | 2,164 |   |
| Operating income                                                                               |       | 98,722                                  |       | 84,972 |   | 52,203 |   | 29,449 |   | 5,789 |   |
| Income (loss) from continuing operations  before income taxes                                  |       | 67,918                                  |       | 57,718 |   | 23,654 |   | (7,627 | ) | (28,232 | ) |
| Income tax expense (benefit) (2)                                                               |       | 24,293                                  |       | 20,556 |   | (38,440 | ) | (1,313 | ) | (940 | ) |
| Net income (loss) from continuing  operations                                                  |       | 43,625                                  |       | 37,162 |   | 62,094 |   | (6,314 | ) | (27,292 | ) |
|                                                                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| Discontinued Operations:                                                                       |       |                                    |       |   |   |   |   |   |   |   |   |
| Loss on sale of wall machines and amusement  games unit, net (3)                               |       | —                                  |       | (25,358 | ) | — |   | — |   | — |   |
| Gain on sale of Rail City Casino, net                                                          |       | 14,329                                  |       | — |   | — |   | — |   | — |   |
| Gain on sale of Nevada Route, net                                                              |       | 9,124                                   |       | — |   | — |   | — |   | — |   |
| Income (loss) from discontinued operations  of wall machines and amusement games unit, net (4) |       | (2,172                                  | )          | (895 | ) | (17,167 | ) | 2,453 |   | (5,740 | ) |
| Income from discontinued operations of  Nevada Route, net                                      |       | 14,539                                  |       | 4,059 |   | 12,580 |   | 12,339 |   | 11,677 |   |
| Income from discontinued operations of  Louisiana Route, net                                   |       | 1,768                                   |       | 1,288 |   | 1,439 |   | 1,540 |   | 2,438 |   |
| Income from discontinued operations of Rail  City, net                                         |       | 3,301                                   |       | 3,267 |   | 4,903 |   | 4,464 |   | 3,882 |   |
| Income (loss) from discontinued operations                                                     |       | 40,889                                  |       | (17,639 | ) | 1,755 |   | 20,796 |   | 12,257 |   |
| Net income (loss)                                                                              |       | $                                       | 84,514     |   | $ | 19,523 |   | $ | 63,849 |   | $ | 14,482 |   | $ | (15,035 | ) |
|                                                                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic earning (loss) per share:(5)                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                          |       | $                                       | 0.87       |   | $ | 0.76 |   | $ | 1.34 |   | $ | (0.14 | ) | $ | (0.66 | ) |
| Discontinued operations                                                                        |       | $                                       | 0.82       |   | $ | (0.36 | ) | $ | 0.04 |   | $ | 0.49 |   | $ | 0.29 |   |
| Total                                                                                          |       | $                                       | 1.69       |   | $ | 0.40 |   | $ | 1.38 |   | $ | 0.35 |   | $ | (0.37 | ) |
|                                                                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| Diluted earning (loss) per share:(5)                                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                          |       | $                                       | 0.85       |   | $ | 0.74 |   | $ | 1.30 |   | $ | (0.14 | ) | $ | (0.66 | ) |
| Discontinued operations                                                                        |       | $                                       | 0.80       |   | $ | (0.35 | ) | $ | 0.04 |   | $ | 0.48 |   | $ | 0.29 |   |
| Total                                                                                          |       | $                                       | 1.65       |   | $ | 0.39 |   | $ | 1.34 |   | $ | 0.34 |   | $ | (0.37 | ) |

 

27

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| ** **                                          | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                          | ** ** | **(In 000s)**           | ** ** |
| **Balance Sheet Data**                              |       |                    |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                           |       | $                       | 172,726    |   | $ | 38,884 |   | $ | 31,800 |   | $ | 29,129 |   | $ | 10,914 |   |
| Working capital (6)                                 |       | 281,956                 |       | 152,965 |   | 101,788 |   | 53,297 |   | 56,914 |   |
| Total assets                                        |       | 750,654                 |       | 525,165 |   | 459,880 |   | 371,017 |   | 352,930 |   |
| Total long term debt, including current  maturities |       | 428,955                 |       | 345,215 |   | 341,793 |   | 339,540 |   | 321,601 |   |
| Total stockholders’ equity (deficiency)        |       | 200,803                 |       | 91,630 |   | 45,986 |   | (39,205 | ) | (50,795 | ) |
|                                                     |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  TheCompany has recorded the following unusual items:

 

•                  During the yearended June 30, 2004, we recorded a refinancing charge of $12.3 millionwhich is more fully disclosed in Note 8 in the Consolidated FinancialStatements.

 

•                  During the yearended June 30, 2001, the Company incurred costs and expenses to sell theNevada route operations totaling $6.5 million consisting primarily of thebreak-up fee paid by the Company to terminate the sale.

 

•                  During the yearended June 30, 2000, gains for the sale of certain gaming management anddevelopment rights totaled $4.0 million.

 

•                  During the yearended June 30, 2000, restructuring and related charges totaledapproximately $6.2  million.  The restructuring and related costs wereincurred pursuant to a plan adopted by the Company for staff reductionsthroughout the Company.

 

(2)                                  Duringthe year ended June 30, 2002, we recorded a tax benefit resulting from thereduction of previously recorded valuation reserves against net deferred taxassets, primarily net operating loss carry forwards, totaling $37 million.

 

(3)                                  InJune 30, 2003, we entered into a definitive agreement for the sale ofBally Wulff and we wrote down the carrying value of the remaining net assets ofBally Wulff to the sale price of $16.5 million, resulting in a charge of $25.4million, net of tax (included in discontinued operations).

 

(4)                                  Duringthe year ended June 30, 2002, we recorded a non-cash charge to write-downgoodwill and other long-lived assets of Bally Wulff, totaling $24.1 million(included in discontinued operations).

 

(5)                                  Theearnings per share amounts have been restated for all periods presented toreflect the two-for-one stock splits effective August 21, 2001 andApril 9, 2002.

 

(6)                                  Excludesassets and liabilities of discontinued operations held for sale.

 

28

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| **ITEM 7.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

**Forward-Looking Statements**

 

Certain matters in this Form10-K and our other filings with the Securities and Exchange Commission,including, without limitation, certain matters discussed in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations and inQuantitative and Qualitative Disclosures about Market Risk, constitute“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended, and are subject to the safe harbor createdthereby.  Those statements reflect theintent, belief or current expectations of the Company, its directors or itsofficers with respect to, among other things, future events and financialtrends affecting the Company.

 

Forward-looking statements aretypically identified by the words “believes,” “expects,” “anticipates,” andsimilar expressions.  In addition, anystatements that refer to expectations or other characterizations of futureevents or circumstances are forward-looking statements.  Readers are cautioned that any suchforward-looking statements are not guarantees of future performance and thatmatters referred to in such forward-looking statements involve known andunknown risks, uncertainties and other factors which may cause actual results,performance or achievements of the Company to be materially different from anyfuture results, performance or achievements expressed or implied by suchforward-looking statements.  Such factorsinclude, among other things, the impact of competition and uncertaintiesconcerning such matters as the Company’s ability to service debt, productdevelopment, customer financing, sales to non-traditional gaming markets,foreign operations, dependence on key personnel, the ability to integratefuture acquisitions, strict regulation by gaming authorities, the outcome ofpending litigation matters including the pending securities class actions,gaming taxes, currency fluctuations and market risk.  Certain of these factors are discussed in the“Risk Factors” section below.  TheCompany undertakes no obligation to publicly update or revise theseforward-looking statements because of new information, future events orotherwise.

 

**Introduction**

 

Operating under the name *Bally Gaming and Systems*,we are a worldwide leader in designing, manufacturing and distributingtraditional and nontraditional gaming machines, having marketed over 100,000gaming machines during the past five years, and computerized monitoring systemsfor gaming facilities. We also own and operate a dockside casino in Vicksburg,Mississippi, which has approximately 12 table games and approximately 930 gamingdevices (“Casino Operations”). Further information about our business units iscontained in the notes to the Consolidated Financial Statements and the“Business” section.

 

**Sources of Revenue**

 

We recognize revenue from the following sources:  sales of gaming machines, operation ofwide-area progressive systems and lease of gaming machines, sales ofcomputerized monitoring systems and related recurring hardware and softwaremaintenance revenue, and from casino operations.

 

Revenue from sales of gaming machines is generally recognized at thetime products are shipped and title has passed to the customer. Games placedwith customers on a trial basis are not recognized as revenue until the trialperiod ends and the customer accepts the games. The Company sells gamingequipment on normal credit terms (generally 2%, net 30) and offers financing toqualified customers for periods generally between 6 and 48 months.

 

Our gaming operations division earns revenues from recurring revenuesources that consist of the operation of wide-area progressive jackpot systemsand revenues from gaming machines placed in a casino on a daily lease or rentalbasis. Revenue from these sources is recognized based on the contractual termsof the participation or rental agreements and is generally based on a share ofmoney wagered, a share of the net winnings, or on a fixed daily rental ratebasis.

 

In fiscal year 2003, BallyGaming and Systems responded to a proposal by the New York Lottery to provideVLT devices at race tracks in the state of New York.  Through the competitive bidding process, wewere awarded approximately 25% of the initial VLT’s to be installed.  The financial model for this market requiresthe manufacturer to build, deploy and maintain the VLT’s in return for a shareof the net win from the VLT’s.  The firstgames were installed at the Saratoga race track in January 2004, and have sincebeen followed by installations at three additional tracks.  SDG was also a successful bidder in the NewYork Lottery VLT market, having been awarded approximately 27% of theunits.  The successful SDG proposal wasaccomplished in the period before SDG was acquired by Alliance, and thecombined share for Bally and SDG in this market is currently approximately 52%.

 

29

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Revenue from sales of computerized monitoring systems is recognized inaccordance with the AICPA’s Statement of Position 97-2 (“SOP 97-2”) “SoftwareRevenue Recognition”, and Emerging Issues Task Force (“EITF”) issue 00-21, “RevenueArrangements with Multiple Deliverables” (“EITF 00-21”).  In accordance with the provisions of SOP 97-2and EITF 00-21, the contracts for the sale of computerized monitoring units areconsidered to have “multiple elements” because they include hardware, software,installation, supervision, training, and post-contract customer support.Accordingly, revenues from the sale of systems are deferred and begin to berecognized at the point when the system is deemed to be functionallyoperational, and the residual method is used to recognize revenue for theremaining elements as they are delivered, each having vendor-specific objectiveevidence of relative fair values. Post-contract customer support revenues arerecognized over the period of the support agreement (generally one year).

 

In accordance with industry practice, we recognize gaming revenues inour casino operations as the net win from gaming machine operations, which isthe difference between coins and currency deposited into the machines andpayments to customers.

 

**Components of Expenses**

 

Our most significant expenses are (1) cost of sales, (2) research anddevelopment expenses, (3) advertising and promotional expenses and (4)administrative expenses.  We strive tocontrol these expenses by working closely with division unit leaders and bycentralizing functions such as finance, accounting, legal, human resources andmanagement information systems.  We alsouse our market presence and purchasing power to negotiate favorable rates withvendors and suppliers.

 

Our research and development costs are driven by the development cyclefor hardware which vary between a few months for minor revisions to more than ayear for major design changes or for changes made by various slot manufacturerswith which Systems’ product must communicate and be physically integrated.Software development results in (i) periodic product releases that includenew features that extend and enhance casino enterprise systems;(ii) periodic maintenance releases that enable casino operators to correctproblems or improve the usability of the system; and (iii) documentationneeded to install and use the system.

 

Depreciation and amortization of tangible and intangible assetshistorically have been significant factors in determining our overallprofitability.  Based on intangibleassets currently held by us and the preliminary allocation of the aggregatepurchase price of acquisitions completed during the year ended June 30, 2004,we expect the total amortization expense incurred will continue to increase.

 

**Basis of Presentation**

 

Our results include the accounts of Alliance Gaming Corporation, andits wholly-owned and partially-owned, controlled subsidiaries.

 

30

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**Overall Consolidated Operating Results**

 
| ** **                                 | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/(Decrease)** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2004**                                             | ** ** | **% Rev**  | ** ** | **2003**   | ** ** | **% Rev**  | ** ** | **2002**   | ** ** | **% Rev**  | ** ** | **04 vs 03**            | ** ** | **03 vs 02** | ** ** |
|                                       |       | **(dollars in millions, except earnings per share)** |       |       |       |       |       |
|                                       |       |                                                 |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Revenues                                   |       | $                                                    | 488.9      |       | 100        | %          | $          | 386.4      |       | 100        | %          | $          | 275.9      |                    | 100        | % | 27 | % | 40 | % |
| Gross profit                               |       | 291.2                                                |       | 60         | %          | 220.8      |       | 57         | %          | 156.2      |       | 57         | %          | 32                      | %          | 41 | % |
| Income from operations                     |       | 98.7                                                 |       | 20         | %          | 85.0       |       | 22         | %          | 52.2       |       | 19         | %          | 16                      | %          | 63 | % |
|                                       |       |                                                 |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Income from continuing operations          |       | $                                                    | 43.6       |       | 9          | %          | $          | 37.2       |       | 10         | %          | $          | 62.1       |                    | 22         | % | 17 | % | (40 | )% |
| Income (loss) from discontinued operations |       | 40.9                                                 |       | 8          | %          | (17.6      | )          | (5         | )%         | 1.8        |       | 1          | %          | 332                     | %          | (1,078 | )% |
| Net income                                 |       | $                                                    | 84.5       |       | 17         | %          | $          | 19.6       |       | 5          | %          | $          | 63.9       |                    | 23         | % | 331 | % | (69 | )% |
|                                       |       |                                                 |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Diluted earnings (loss) per share:         |       |                                                 |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Continuing operations                      |       | $                                                    | 0.85       |       |       |       | $          | 0.74       |       |       |       | $          | 1.30       |                    |       |   |   |   |   |   |
| Discontinued operations                    |       | 0.80                                                 |       |       |       | (0.35      | )          |       |       | 0.04       |       |       |       |                    |       |   |   |
| Net income                                 |       | $                                                    | 1.65       |       |       |       | $          | 0.39       |       |       |       | $          | 1.34       |                    |       |   |   |   |   |   |

 

**Fiscal 2004 vs Fiscal 2003**

 

•                  Revenues from continuing operations increased primarily due to thefollowing:

•                  Acquisition of SDG which contributed $61.5 million in revenues including$49.6 million in game sale revenues, and $11.9 million from its gamingoperations.

•                    Decreasein Bally Gaming new unit sales revenues of $4.7 million primarily due toweaknesses in the European markets (particularly in Russia), partially offsetby stronger domestic unit sales.  Thereduced sales in Europe are due to a variety of factors including changes incertain sales executives who cover this area, and poor performance of certainproduct features which were more successful in domestic markets.  Although we are expending significantresources to improve the product offerings in the non-domestic markets, therecan be no assurance that we will be able to return to historical unit saleslevels in those markets.

•                  Increase in Gaming Systems revenue of $32.8 million driven by stronggrowth in both hardware and software sales driven by strong sales to certainmulti-property operators.  Given the sizeof the investments by casino operators in such systems, there can be noassurances that such sales to multi-property operators will continue at suchlevels in the future.

•                  Increase in Gaming Operations revenue which contributed an incremental$11.6 million driven by the larger installed base of recurring revenue games.

 

•                  Grossprofit improved due to increases in higher margin system sales and gamingoperations sales.

 

•                  Incomefrom operations as a percentage of revenue decreased primarily as a result ofhigher research and development costs.

 

•                  Net Income,including discontinued operations, totaled $84.5 million or $1.65 per dilutedshare, compared to $19.5 million or $0.39 in the prior year which included aloss on the sale of Bally Wulff of $25.4 million, or $0.51 per diluted share.

 

**Fiscal 2003 vs Fiscal 2002**

 

•                  Revenues from continuing operations  increased due to the following:

•      Gaming unit sales revenue increased $111.7 million or 50% due to anincrease in game sale revenues driven by a 49% increase in new units sold.

•      GamingSystemsrevenues increased $26.7 million or 41% driven by higher hardware sales andsales of software licenses for the industry’s leading single-wire ticket-in,ticket out (“TITO”) cashless solution, eTICKETTM.

•      Increase in GamingOperations revenue driven by an increase of 11% in the average installed baseof wide-area progressive (WAP) and daily-fee games deployed.

 

•                  Gross profitincreased primarily due to the increase in higher margin system sales andrecurring revenue through our gaming operations division.

 

31

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•                  Total net incomedecreased to $19.5 million or $0.39 per diluted share in fiscal 2003 from $63.8million or $1.34 per diluted share in fiscal 2002 primarily as a result of aprovision for income taxes of $20.6 million in fiscal 2003 compared to aone-time tax benefit due to the reduction of reserves against its net operatingloss carryforwards of $37.0 million in the fiscal 2002.

 

**Operating Expenses**

 
| ** **                          | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/(Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2004**                  | ** ** | **% Rev**  | ** ** | **2003**   | ** ** | **% Rev**  | ** ** | **2002**   | ** ** | **% Rev**  | ** ** | **04 vs 03**            | ** ** | **03 vs 02** | ** ** |
|                                |       | **(dollars in millions)** |       |       |       |       |       |
|                                |       | ** **                |       |       |       |       |       |
| Selling, general and administrative |       | $                         | 122.0      |       | 25         | %          | $          | 93.9       |       | 24         | %          | $          | 72.5       |                    | 26         | % | 30 | % | 29 | % |
| Depreciation  and amortization      |       | 31.6                      |       | 6          | %          | 20.5       |       | 5          | %          | 13.9       |       | 5          | %          | 54                      | %          | 47 | % |
| Research and development            |       | 36.6                      |       | 7          | %          | 20.0       |       | 5          | %          | 15.0       |       | 5          | %          | 83                      | %          | 33 | % |
| Provision for bad debts             |       | 2.3                       |       | 1          | %          | 1.4        |       | 1          | %          | 2.5        |       | 1          | %          | 64                      | %          | (44 | )% |
| Total                               |       | $                         | 192.5      |       | 39         | %          | $          | 135.8      |       | 35         | %          | $          | 103.9      |                    | 37         | % | 42 | % | 31 | % |

 

**Fiscal 2004 vs Fiscal 2003**

 

Fiscal 2004 operating expenses increased over 2003 primarily due to theacquisitions of SDG, Mindplay and Crown and to the launch of the New YorkLottery resulting in increases in all operating expense categories.  Fiscal 2004 operating expenses also increasedas a result of:

 

•                  Legal costsrelated to the protection of our intellectual property rights.

•                  Higher payrolland payroll related cost primarily in product development and customer service.

•                  Increase in ourinvestment in research and development costs primarily as a result of the EVO TMplatform development and advance product development.

•                  Depreciation andamortization due to an increase in our installed base of proprietary gamingunits.

 

**Fiscal 2003 vs Fiscal 2002**

 

Fiscal 2003 operating expenses increased over 2002 as a result of:

•                  Legal costsrelated to the protection of our intellectual property rights.

•                  Higher payrolland payroll related costs primarily in product development and manufacturing.

•                  Increase in ourinvestment in research and development costs.

 

**OtherIncome (Expense) and Taxes**

 
| ** **                   | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/(Decrease)** | ** ** |
|------------------------------|------------|---------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2004**                  | ** ** | **% Rev**  | ** ** | **2003**   | ** ** | **% Rev**  | ** ** | **2002**   | ** ** | **% Rev**  | ** ** | **04 vs 03**            | ** ** | **03 vs 02** | ** ** |
|                         |       | **(dollars in millions)** |       |       |       |       |       |
|                         |       | ** **                |       |       |       |       |       |
| Interest income              |       | $                         | 2.3        |       | 1          | %          | $          | 0.2        |       | —     |       | $          | 0.4        |                    | —     |   | 1,050 | % | (50 | )% |
| Interest  expense            |       | (17.9                     | )          | (4         | )%         | (25.6      | )          | (7         | )%         | (28.2      | )          | (10        | )%         | (30                     | )%         | (9 | )% |
| Minority interest            |       | (2.3                      | )          | (1         | )%         | (2.0       | )          | (1         | )%         | (1.9       | )          | (1         | )%         | 15                      | %          | 5 | % |
| Refinancing Charge           |       | (12.3                     | )          | (2         | )%         | —     |       | —     |       | —     |       | —     |       | —                  |       | — |   |
| Miscellaneous, net           |       | (0.5                      | )          | —     |       | 0.2        |       | —     |       | 1.2        |       | —     |       | (150                    | )%         | (117 | )% |
| Total other income (expense) |       | (30.7                     | )          | (6         | )%         | (27.2      | )          | (7         | )%         | (28.5      | )          | (11        | )%         | (13                     | )%         | 3 | % |
|                         |       |                      |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Provision for income taxes   |       | 24.3                      |       | 5          | %          | 20.6       |       | 5          | %          | (38.4      | )          | (14        | )%         | 18                      | %          | (153 | )% |
|                         |       |                      |       |       |       |       |       |       |       |       |       |       |       |                    |       |   |   |
| Tax rate                     |       | 35.8                      | %          |       |       | 35.6       | %          |       |       | 6.1        | %          |       |       |                    |       |   |   |
|                              |            |                           |            |            |            |            |            |            |            |            |            |            |            |                         |            |  |  |  |  |  |

 

Fiscal year 2004 other expense increased to $30.7 million from $27.6million in the fiscal year 2003 primarily as a result of refinancing our debtin September 2003 which resulted in a charge of $12.3 million.  This charge was offset by a reduction in interestexpense of $7.7 million as a result of the refinancing.

 

Oureffective income tax rate in fiscal 2003 was 36%.  In fiscal 2002, we reversed the reservesagainst our net operating loss carry forwards, and recorded a one time taxbenefit of $37.0 million.

 

32

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**Liquidityand Capital**

 

As ofJune 30, 2004, we had $173 million in cash and cash equivalents.  In addition we had net working capital ofapproximately $282 million (excluding assets and liabilities of discontinuedoperations), an increase of approximately $129 million from June 30, 2003,which is explained in the working capital section below. Consolidated cash andcash equivalents at June 30, 2004, include approximately $2.1 million of cashutilized in our Casino Operations that is held in vaults, cages or changebanks. Additionally, pursuant to various state gaming regulations, we maintaincertain cash accounts to ensure availability of funds to pay wide-areaprogressive jackpot awards, which totaled approximately $15.6 million at June30, 2004.  In addition, we purchase U.S.Treasury Strip Securities for the benefit of jackpot winners who elect toreceive annual instalment payments. These securities are presented as restricted long-term investments inthe accompanying consolidated balance sheets, and totaled $2.5 million and $0.9million as of June 30, 2004 and 2003, respectively.

 

In September 2003, we completed a refinancing of our senior bank creditfacility, which now consists of a $275.0 million term loan (later increased to$350.0 million), and a $125.0 million revolving credit facility (“theRefinancing”).  Proceeds from the termloan were used to repay our existing bank term loans totaling approximately$188 million, repay $150.0 million of our 10% Senior Subordinated Notes and topay transaction fees and expenses. The new term loan has a 1% per yearmandatory principal amortization, with a 6 year maturity and bears interest atLIBOR plus 2.75% (later reduced to 2.50%). The revolving credit facilitycommitment decreases ratably over the 5 year term of the commitment to a 60%balloon and bears interest at LIBOR plus 2.50%. The bank loan contains certainfinancial and operational covenants, however there are no borrowing baserequirements. As of June 30, 2004 we are in compliance with the covenants.

 

Our new credit facilitycontains a number of significant covenants that, among other things, restrictour ability and certain of our subsidiaries to dispose of assets, incuradditional indebtedness and issue preferred stock, pay dividends or make otherdistributions, enter into certain acquisitions, repurchase equity interests orsubordinated indebtedness, issue or sell equity interests of our subsidiaries,engage in mergers or consolidations, or engage in certain transactions withsubsidiaries and affiliates and otherwise restrict corporate activities. Therecan be no assurance that such restrictions will not adversely affect ourability to finance our future operations or capital needs or engage in otherbusiness activities that may be in our interest. In addition, the bank creditfacility also requires us to maintain compliance with certain financial ratios.Our ability to comply with such ratios may be affected by events beyond ourcontrol. A breach of any of these covenants or our inability to comply with therequired financial ratios could result in a default under the bank creditfacility. In the event of any such default, the lenders under the creditfacility could elect to declare all borrowings outstanding under the bankcredit facility, together with accrued interest and other fees, to be due andpayable and to require us to apply all of our available cash to repay suchborrowings.  If we were unable to repayany such borrowings when due, the lenders could proceed against our collateral.If the indebtedness under the bank credit facility were to be accelerated,there can be no assurance that our assets would be sufficient to repay suchindebtedness in full.

 

Our obligation to makeprincipal and interest payments on outstanding indebtedness, and to comply withthe covenants in the agreements governing borrowings under the bank creditfacility, will have several important effects on our future operationsincluding the following: (i) the portion of our cash flow from operationswhich will be dedicated to the payment of principal and interest on ourindebtedness will not be available for other purposes; (ii) the bankfacility borrowings are at variable rates of interest, which could result in higherexpense in the event of increases in interest rates; (iii) we may be morevulnerable to downturns in our business or in the general economy and may berestricted from making acquisitions, introducing new technologies or exploitingbusiness opportunities; and (iv) our ability to obtain additionalfinancing in the future for working capital, capital expenditures, generalcorporate or other purposes may be impaired. Additionally, our ability to meet our debt service obligations and toreduce our total debt will be dependent upon our future performance, which willbe subject to general economic and regulatory conditions and to financial,business and other factors affecting our operation, many of which are beyondour control.

 

As a result of the sale of UCMC and Rail City, the terms of the bankloan agreement requires us to use approximately 50% of the net proceeds (asdefined in the agreement) to reduce the term loan and revolver principalbalances on a pro rata basis.  See alsoContingent Commitments section.

 

Cash flows from operating activities are derived from the cash receiptsfrom the sale of goods and services, from the operation of wide areaprogressive systems, lease payments and monthly cash receipts from maintenanceagreements for our casino systems customers. In addition, we generate cash through our casino operations.   We utilize our cash to acquire materials forthe manufacture of goods for resale or lease, payroll and all other selling,general and administrative expenses. Management believes that cash flows from operating activities, cash andcash equivalents held and the availability of the revolving credit facilitycommitment will provide us with sufficient capital resources and liquidity. AtJune 30, 2004, we had no material commitments for capital expenditures.

 

***Working Capital***

 

The following table presents the components of consolidated workingcapital at June 30, 2004 and 2003, excluding assets and liabilities ofdiscontinued operations (dollars in 000s):

 
| ** **                           | ** ** | **Balance at June 30,** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                           | ** ** | **2004**                | ** ** | **2003**   | ** ** | **Change** | ** ** |
|                                 |       |                    |       |       |       |   |   |
| Cash and cash equivalents            |       | $                       | 172,726    |       | $          | 38,884 |   | $ | 133,842 |   |
| Accounts and notes receivable, net   |       | 129,779                 |       | 98,368     |       | 31,411 |   |
| Inventories, net                     |       | 61,135                  |       | 32,102     |       | 29,033 |   |
| Deferred tax assets, net             |       | 20,054                  |       | 44,821     |       | (24,767 | ) |
| Other current assets                 |       | 12,420                  |       | 8,010      |       | 4,410 |   |
| Total current assets                 |       | 396,114                 |       | 222,185    |       | 173,929 |   |
|                                 |       |                    |       |       |       |   |   |
| Accounts payable                     |       | 37,515                  |       | 22,726     |       | 14,789 |   |
| Jackpot liabilities                  |       | 12,075                  |       | 10,588     |       | 1,487 |   |
| Accrued liabilities                  |       | 51,469                  |       | 31,438     |       | 20,031 |   |
| Taxes payable                        |       | 7,233                   |       | 931        |       | 6,302 |   |
| Current maturities of long-term debt |       | 5,866                   |       | 3,537      |       | 2,329 |   |
| Total current liabilities            |       | 114,158                 |       | 69,220     |       | 44,938 |   |
| Net working capital                  |       | $                       | 281,956    |       | $          | 152,965 |   | $ | 128,991 |   |

 

33

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The primary fluctuations contributing to the increase in workingcapital were:

 

•                  A net increasein accounts and notes receivable resulting from an increase in revenue and theacquisition of SDG in the Bally Gaming and Systems business unit.

•                  An increase ininventory due to a larger backlog of participation units.

•                  A decrease indeferred tax assets due primarily to the sale of  our Nevada route operations and Rail City.

•                  The impact offoreign exchange fluctuations between the dollar and the euro dollar on allworking capital categories.

•                  Cash receivedupon sale of the Nevada route, Rail City and Bally Wulff.

 

*Cash Flow*

 

Duringthe year ended June 30, 2004, we generated $110.3 million of cash flows fromoperating activities of continuing operations, compared to $38.1 million in theprior year.  This increase in cash flowwas driven by the increased revenue, gross margins, accounts payable, and accrued liabilities in 2004, offsetby the increase in accounts receivable and inventory.

 

During the year ended June 30, 2004, cash flow used in investingactivities totaled $32.8 million due to the following:

 

•                  Cash providedfrom the sale of the Nevada route operations of $100 million, Rail City of$37.9 million and Bally Wulff of $16.5 million.

•                  Cash used inacquisitions as follows (see Note 3 to the Consolidated Financial Statementsfor assets and liabilities assumed in the acquisitions)

•                  SDG totaled$108.6 million

•                  MindPlay totaled$11.0 million

•                  Crown totaled$3.9 million

•                  Capitalexpenditures of $11.8 million

•                  Costs incurredto produce participation games totaling $38.1 million

•                  Additions toother long-term assets of $14.5 million

 

During the year ended June 30, 2004, $73.8 million cash was provided byfinancing activities of continuing operations resulting from a $70 millionincrease in term loans and $350.0 million of proceeds from the issuance oflong-term debt and $7.3 million of cash provided from the exercise of stockoptions, offset by the $337.6 million payoff of debt from refinancing, $7.0million of refinancing costs and $5.4 million of premium paid on the earlyredemption of the subordinated notes and principal payments on long term debttotaling $3.5 million.

 

*Customer Financing*

 

Management believes that customer financing terms and leasing havebecome an increasingly important competitive factor for the Bally Gaming andSystems business units. Competitive conditions sometimes require Bally Gamingand Systems to grant extended payment terms on gaming machines, systems andother gaming equipment, especially for sales in emerging markets. While thesefinancings are normally collateralized by such equipment, the resale value ofthe collateral in the event of default may be less than the amount financed.Accordingly, we have greater exposure to the financial condition of ourcustomers in emerging markets than had historically been the case inestablished markets like Nevada and Atlantic City.

 

*Euro Currency Conversion*

 

Our European subsidiaries use the euro as its functional currency. Theeuro currency replaced the primarily all other European currencies after aphase in period, which began January 1, 1999 and was fully adopted in January2002.

 

34

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**Results of Operations**

 

The following table reconciles our earnings before interest, taxes,depreciation and amortization and refinance charge (“EBITDA”) to ourconsolidated net income from continuing operations (in 000s):

 
| ** **                            | ** ** | **Years ended June 30,** | ** ** |
|---------------------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                  |       |                     |       |   |   |   |   |
| Net income from continuing operations |       | $                        | 43,625     |   | $ | 37,162 |   | $ | 62,094 |   |
| Income tax expense (benefit)          |       | 24,293                   |       | 20,556 |   | (38,440 | ) |
| Other expense                         |       | 2,830                    |       | 1,829 |   | 698 |   |
| Interest expense, net                 |       | 15,681                   |       | 25,425 |   | 27,851 |   |
| Refinancing charge                    |       | 12,293                   |       | — |   | — |   |
| Operating income                      |       | 98,722                   |       | 84,972 |   | 52,203 |   |
| Depreciation and amortization         |       | 31,565                   |       | 20,462 |   | 13,929 |   |
| EBITDA from continuing operations     |       | $                        | 130,287    |   | $ | 105,434 |   | $ | 66,132 |   |

 

The following tables reconcile operating income by business segment toEBITDA:

 

For the year ended June 30, 2004 (in 000s):

 
| ** **                                  | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|------------|------------|
|                                        |       |                          |       |                                |       |       |       |
| Bally Gaming and Systems                    |       | $                             | 96,034     |                                | $          | 27,260     |       | $ | 123,294 |   |
| Casino Operations                           |       | 16,942                        |       | 2,780                               |       | 19,722     |       |
| Corporate expenses                          |       | (14,254                       | )          | 1,525                               |       | (12,729    | )          |
|                                        |       | $                             | 98,722     |                                | $          | 31,565     |       | $ | 130,287 |   |
|                                        |       |                          |       |                                |       |       |       |
| For the year ended June 30, 2003 (in 000s): |       |                          |       |                                |       |       |       |
|                                        |       |                          |       |                                |       |       |       |
| ** **                                  | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|                                        |       |                          |       |                                |       |       |       |
| Bally Gaming and Systems                    |       | $                             | 82,879     |                                | $          | 16,002     |       | $ | 98,881 |   |
| Casino Operations                           |       | 15,306                        |       | 2,174                               |       | 17,480     |       |
| Corporate expenses                          |       | (13,213                       | )          | 2,286                               |       | (10,927    | )          |
|                                        |       | $                             | 84,972     |                                | $          | 20,462     |       | $ | 105,434 |   |
|                                        |       |                          |       |                                |       |       |       |
| For the year ended June 30, 2002 (in 000s): |       |                          |       |                                |       |       |       |
|                                        |       |                          |       |                                |       |       |       |
| ** **                                  | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|                                        |       |                          |       |                                |       |       |       |
| Bally Gaming and Systems                    |       | $                             | 47,172     |                                | $          | 10,236     |       | $ | 57,408 |   |
| Casino Operations                           |       | 17,593                        |       | 1,491                               |       | 19,084     |       |
| Corporate expenses                          |       | (12,562                       | )          | 2,202                               |       | (10,360    | )          |
|                                        |       | $                             | 52,203     |                                | $          | 13,929     |       | $ | 66,132 |   |

 

35

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The following table reconciles our earnings before interest, taxes,depreciation and amortization  (“EBITDA”)to our consolidated net income (loss) from our discontinued operations (in000s):

 
| ** **                                      | ** ** | **Years ended June 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|
| ** **                                      | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                            |       |                     |       |   |   |   |   |
| Net income (loss) from discontinued  operations |       | $                        | 40,889     |   | $ | (17,639 | ) | $ | 1,755 |   |
| Income tax expense (benefit)                    |       | 26,319                   |       | (8,665 | ) | 2,563 |   |
| Other expense                                   |       | (785                     | )          | 654 |   | 825 |   |
| Gain on sale                                    |       | (36,759                  | )          |   |   |   |   |
| Interest (income) expense, net                  |       | 1,004                    |       | (926 | ) | (955 | ) |
| Operating income (loss)                         |       | 30,668                   |       | (26,576 | ) | 4,188 |   |
| Depreciation and amortization                   |       | 565                      |       | 17,892 |   | 17,923 |   |
| EBITDA from discontinued operations             |       | $                        | 31,233     |   | $ | (8,684 | ) | $ | 22,111 |   |

 

In accordance with generally accepted accounting principles,depreciation and amortization for these discontinued operations ceased as ofJuly 1, 2003 as a result of their designation as assets held for sale.

 

For the year ended June 30, 2004 (in 000s):

 
| ** **                                  | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|------------|------------|
|                                        |       |                          |       |                                |       |       |       |
| Route Operations                            |       | $                             | 25,281     |                                | $          | —     |       | $ | 25,281 |   |
| Rail City Casino                            |       | 5,387                         |       | 565                                 |       | 5,952      |       |
|                                        |       | $                             | 30,668     |                                | $          | 565        |       | $ | 31,233 |   |
|                                        |       |                          |       |                                |       |       |       |
| For the year ended June 30, 2003 (in 000s): |       |                          |       |                                |       |       |       |
|                                        |       |                          |       |                                |       |       |       |
| ** **                                  | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|                                        |       |                          |       |                                |       |       |       |
| Wall Machines and Amusement Games           |       | $                             | (1,875     | )                                   | $          | 2,731      |       | $ | 856 |   |
| Route Operations                            |       | 9,063                         |       | 14,020                              |       | 23,083     |       |
| Rail City Casino                            |       | 4,964                         |       | 1,141                               |       | 6,105      |       |
| Asset impairment charges                    |       | (38,728                       | )          | —                              |       | (38,728    | )          |
|                                        |       | $                             | (26,576    | )                                   | $          | 17,892     |       | $ | (8,684 | ) |

 

During the year ended June 30, 2003, we recorded a charge of $38.7million to write down the assets of Bally Wulff to the sales price.

 

For the year ended June 30, 2002 (in 000s):

 
| ** **                        | ** ** | **Operating  Income  (Loss)** | ** ** | **Depreciation  and  Amortization** | ** ** | **EBITDA** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|------------|------------|
|                              |       |                          |       |                                |       |       |       |
| Wall Machines and Amusement Games |       | $                             | 7,942      |                                | $          | 5,213      |       | $ | 13,155 |   |
| Route Operations                  |       | 15,470                        |       | 12,069                              |       | 27,539     |       |
| Rail City Casino                  |       | 4,905                         |       | 641                                 |       | 5,546      |       |
| Asset impairment charges          |       | (24,129                       | )          | —                              |       | (24,129    | )          |
|                              |       | $                             | 4,188      |                                | $          | 17,923     |       | $ | 22,111 |   |

 

36

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During the year ended June 30, 2002 we recorded a charge of $24.1million to write down the goodwill and other long-lived assets of Bally Wulff.

 

Webelieve that the analysis of EBITDA is a useful adjunct to operating income,net income, cash flows and other GAAP-based measures. However, EBITDA shouldnot be construed as an alternative to net income (loss) or cash flows fromoperating, investing and financing activities determined in accordance withGAAP or as a measure of liquidity. EBITDA is a common measure of performance inthe gaming industry but may not be comparable to similarly titled measuresreported by other companies. We disclose EBITDA primarily because it is a performancemeasure used by management in evaluating the performance of our business unitsand is one of several performance measures used in our management incentiveplan.  Additionally, EBITDA is utilizedas a performance measure in covenants for our bank credit agreement.

 

37

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***Bally Gaming and Systems***

 

Summaryfinancial results and operating statistics:

 
| ** **                          | ** ** | **Year Ended June 30,**   | ** ** | **Increase/(Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2004**                  | ** ** | **% Rev**               | ** ** | **2003** | ** ** | **% Rev** | ** ** | **2002** | ** ** | **%Rev** | ** ** | **04 vs 03** | ** ** | **03 vs 02** | ** ** |
|                                |       | **(dollars in millions)** |       |                    |       |   |   |
| Revenues                            |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Game sales                          |       | $                         | 233.1      |                    | 53         | % | $ | 188.3 |   | 56 | % | $ | 105.7 |   | 47 | % | 24 | % | 78 | % |
| System sales                        |       | 124.3                     |       | 29                      | %          | 91.5 |   | 27 | % | 64.8 |   | 29 | % | 36 | % | 41 | % |
| Gaming operations                   |       | 79.1                      |       | 18                      | %          | 55.6 |   | 17 | % | 53.2 |   | 24 | % | 42 | % | 5 | % |
| Total revenues                      |       | $                         | 436.5      |                    | 100        | % | $ | 335.4 |   | 100 | % | 223.7 |   | 100 | % | 30 | % | 50 | % |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross Margin                        |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Game sales                          |       | $                         | 107.8      |                    | 25         | % | $ | 81.8 |   | 24 | % | $ | 40.7 |   | 18 | % | 32 | % | 101 | % |
| System sales                        |       | 94.4                      |       | 22                      | %          | 70.1 |   | 21 | % | 48.3 |   | 22 | % | 35 | % | 45 | % |
| Gaming operations                   |       | 56.8                      |       | 13                      | %          | 39.2 |   | 12 | % | 36.0 |   | 16 | % | 45 | % | 9 | % |
| Total gross margin                  |       | $                         | 259.0      |                    | 60         | % | $ | 191.1 |   | 57 | % | $ | 125.0 |   | 56 | % | 36 | % | 53 | % |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative |       | $                         | 99.1       |                    | 23         | % | $ | 72.2 |   | 22 | % | $ | 52.6 |   | 23 | % | 37 | % | 37 | % |
| Research and development costs      |       | 36.6                      |       | 8                       | %          | 20.0 |   | 6 | % | 15.0 |   | 7 | % | 83 | % | 33 | % |
| Depreciation and amortization       |       | 27.3                      |       | 6                       | %          | 16.0 |   | 5 | % | 10.2 |   | 5 | % | 71 | % | 57 | % |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income                    |       | $                         | 96.0       |                    | 22         | % | $ | 82.9 |   | 25 | % | $ | 47.2 |   | 21 | % | 16 | % | 76 | % |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating Statistics:               |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| New Gaming Devices Sold             |       | 20,350                    |       |                    |       | 19,634 |   |   |   | 13,183 |   |   |   | 4 | % | 49 | % |
| Game  Monitoring Units Sold         |       | 46,432                    |       |                    |       | 35,500 |   |   |   | 40,545 |   |   |   | 31 | % | (12 | )% |
| End of  period installed base       |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| WAP                                 |       | 1,726                     |       |                    |       | 1,910 |   |   |   | 2,283 |   |   |   | (10 | )% | (16 | )% |
| Daily-fee  games                    |       | 7,985                     |       |                    |       | 2,483 |   |   |   | 1,352 |   |   |   | 222 | % | 84 | % |
| Centrally  determined games         |       | 17,995                    |       |                    |       | — |   |   |   | — |   |   |   | — |   | — |   |

 

**Fiscal 2004 vs Fiscal 2003**

 

Total revenues increased $101.1 million or30% due to the following:

 

•                  Bally Gaming revenue increased by $44.8million or 24% primarily due to the acquisition of SDG which contributed anincremental $49.6 million and higher domestic new unit sales, offset by adecrease in international new unit sales.

 

•                  Bally System revenue increased by $32.8million or 36% primarily as a result of:

•                  Increased salesof software licenses for our TITO solution, as well as its bonusing andpromotions software.

•                  Recurringhardware and software maintenance revenues increased by 23% to $20.7 millionfor the fiscal year, resulting from the larger base of installed units, whichnow stands at approximately 279,000.

 

•                  GamingOperations revenues increased 42% for fiscal 2004 compared to 2003 due to thefollowing:

•                  An increase of  222% in the installed base of daily-fee gamesdeployed, which increased to 7,985 units installed.  This increase is primarily a result of thelaunch of the New York Lottery and the acquisition of SDG.

 

38

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•                  Gross Marginimproved to 60% as a result of higher margin systems sales and gamingoperations revenue as proportion of total sales.

 

•                  Selling, generaland administrative expenses increased 37% in fiscal 2004 over 2003 primarilydue to the acquisitions of SDG, MindPlay and Crown and to the launch of the NewYork Lottery resulting in increases in all operating expense categories exceptbad debt.  In addition, SG&A expensesalso increased as a result of:

 

•                  Legal costsrelated to the protection of our intellectual property rights.

•                  Higher payrolland payroll related costs primarily in customer service.

 

•                  Research anddevelopment costs increased as a result of increased headcount and theacquisition of SDG.

 

•                  Depreciation andamortization increased as a result of our installed base of proprietary gaming units and amortization relatedto the current year acquisitions.

 

**Fiscal 2003 vs Fiscal 2002**

 

Total revenues increased due to thefollowing:

 

•                  Bally Gaming revenue increased $82.6 millionor 78% primarily as a result of an increase in game units sold of 6,451 and theaverage new-unit selling price increased 10% (excluding OEM games).

 

•                  Bally System revenue increased $26.7 millionor 41% primarily as a result of:

•                  Increased salesof software licenses for our cashless software as well as its bonusing andpromotions software and a 32% increase in the average selling price per unit,offset by a 12% decrease in game monitoring units shipped.

•                  BallySystems recurring hardware and software maintenance revenues increased to $16.9million for the fiscal year, resulting from the larger base of installedsystems.

 

•                  Gaming Operations revenues increased $2.4 million or 5% primarily due tothe following:

•                  An increase of  21% in the average installed base ofwide-area progressive (WAP) and daily-fee games deployed, which totaled 1,910and 2,483, respectively, offset by a decrease in the average revenue per unit.

•                  The placementsincluded the continued roll out of “Cash for Life” which in addition to theNevada link, was launched in both Mississippi and Native American casinos inJune 2003.

 

•                  Gross Marginincreased slightly to 57% compared to 56% in the prior year as a result of  higher

margin system revenues.

 

•                  Selling, generaland administrative expenses increased 37% for the year-to-date period primarilydue to:

•                  Legal costsrelated to the protection of our intellectual property rights.

•                  Higher payrolland payroll related costs due to increased headcount.

 

•                  Research anddevelopment costs increased as a result of the increase in hardware andsoftware engineers added during fiscal 2003.

 

•                  Depreciation andamortization expense increased primarily as a result of the increase in theinstalled base of wide-area progressive and daily fee games, which havedisplaced certain fully depreciated games in the field.

 

39

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***Rainbow Casino Operations***

 

Summaryfinancial results and operating statistics:

 
| ** **                          | ** ** | **Year Ended June 30,**   | ** ** | **Increase/(Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2004**                  | ** ** | **% Rev**               | ** ** | **2003** | ** ** | **% Rev** | ** ** | **2002** | ** ** | **%Rev** | ** ** | **04 vs 03** | ** ** | **03 vs 02** | ** ** |
|                                |       | **(dollars in millions)** |       |                    |       |   |   |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                             |       | $                         | 52.3       |                    | 100        | % | $ | 50.9 |   | 100 | % | $ | 52.2 |   | 100 | % | 3 | % | (2 | )% |
| Gross Margin                        |       | 32.2                      |       | 62                      | %          | 29.7 |   | 58 | % | 31.2 |   | 60 | % | 8 | % | (5 | )% |
| Selling, general and administrative |       | 12.5                      |       | 24                      | %          | 12.2 |   | 24 | % | 12.1 |   | 23 | % | 3 | % | 1 | % |
| Depreciation and amortization       |       | 2.8                       |       | 5                       | %          | 2.2 |   | 4 | % | 1.5 |   | 3 | % | 28 | % | 46 | % |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income                    |       | $                         | 16.9       |                    | 32         | % | $ | 15.3 |   | 30 | % | $ | 17.6 |   | 34 | % | 11 | % | (13 | )% |
|                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating Statistics:               |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Average  Number of Gaming Devices   |       | 930                       |       |                    |       | 930 |   |   |   | 975 |   |   |   | — |   | (5 | )% |
| Average Number of Table Games       |       | 12                        |       |                    |       | 15 |   |   |   | 16 |   |   |   | (20 | )% | (6 | )% |

 

**Fiscal 2004 vs Fiscal 2003**

 

•                  Rainbow Casinorevenues increased following the remodeling project completed in fiscal 2003.

 

•                  Gross marginimproved to 62% as a result of increases in slot and table wins per day perunit.

 

•                  The overallselling, general and administrative expenses remained relatively stable yearover year as a percentage of revenue.

 

•                  Depreciation andamortization expense increased 28% for the fiscal 2004 period resulting fromadditional capital improvements made to the Rainbow Casino late in fiscal 2003.

 

**Fiscal 2003 vs Fiscal 2002**

 

•                  Rainbow Casinorevenues decreased as a result of a 5% decrease in the average number of gamingmachines offset by a 2% increase in net win per day to $144 from $141.

 

•                  Gross margindecreased to 58% as a result incremental increases in certain direct costs ofcasino operations.  Costs of casinorevenue include gaming taxes, rental costs and direct labor including payrolltaxes and benefits.

 

•                  The overallselling, general and administrative expenses increased due to a increase inadvertising and promotional expenses.

 

•                  Depreciation andamortization expense increased as a result of additional capital improvementsmade to the Rainbow Casino in the current year.

 

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***Parent Company and other unallocated  income (expense)***

 

Summary financial results:

 
| ** **                    | ** ** | **Year Ended June 30,**   | ** ** | **Increase/(Decrease)** | ** ** |
|-------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **2004**                  | ** ** | **% Rev**               | ** ** | **2003** | ** ** | **% Rev** | ** ** | **2002** | ** ** | **%Rev** | ** ** | **04 vs 03** | ** ** | **03 vs 02** | ** ** |
|                          |       | **(dollars in millions)** |       |                    |       |   |   |
|                          |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| General and administrative    |       | $                         | 12.7       |                    | 3          | % | $ | 10.9 |   | 3 | % | 10.4 |   | 4 | % | 17 | % | 5 | % |
| Depreciation and amortization |       | 1.5                       |       | —                  |       | 2.3 |   | 1 | % | 2.2 |   | 1 | % | (35 | )% | 4 | % |
| Total Parent company expense  |       | $                         | 14.2       |                    | 3          | % | $ | 13.2 |   | 3 | % | $ | 12.6 |   | 5 | % | 8 | % | 5 | % |
|                          |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other  income (expense):      |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income               |       | 2.3                       |       | 1                       | %          | 0.2 |   | — |   | 0.4 |   | — |   | 1050 | % | (50 | )% |
| Interest expense              |       | (17.9                     | )          | (4                      | )%         | (25.6 | ) | (7 | )% | (28.2 | ) | (10 | )% | (30 | )% | (9 | )% |
| Minority interest             |       | (2.3                      | )          | (1                      | )%         | (2.0 | ) | (1 | )% | (1.9 | ) | (1 | )% | 15 | % | 5 | % |
| Refinancing Charge            |       | (12.3                     | )          | (3                      | )%         | — |   | — |   | — |   | — |   | — |   | — |   |
| Other, net                    |       | (0.5                      | )          | —                  |       | 0.2 |   | — |   | 1.2 |   | — |   | (350 | )% | (84 | )% |
| Total other income (expense)  |       | $                         | (30.7      | )                       | (6         | )% | $ | (27.2 | ) | (7.0 | )% | $ | (28.5 | ) | (11 | )% | 13 | % | (5 | )% |
|                          |       |                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income tax expense (benefit)  |       | $                         | 24.3       |                    | 5          | % | $ | 20.6 |   | 5 | % | $ | (38.4 | ) | (14 | )% | 18 | % | (153 | )% |

 

**Fiscal 2004 vs Fiscal 2003**

 

•                  General and administrative expenses increasedprimarily as a result of:

•                  Increase ingeneral corporate legal costs.

•                  Increase ingeneral liability and director and officer insurance costs resulting frommarket conditions.  Such increases ininsurance costs are expected to continue in fiscal 2005.

 

•                  Total otherexpense increased as a result of the refinancing which occurred in September2003.  The refinancing charge of $12.3million was partially offset by decreases in our net interest expense as aresult of the lower interest rates achieved in the refinancing.  Virtually all of our debt is floating rate,therefore future interest expense will be impacted by future changes in theLIBOR which is the base rate for our interest payments.

 

**Fiscal 2003 vs Fiscal 2002**

 

•                  General andadministrative expenses increased 5% for fiscal 2003 period as a result of:

•                  The incurrenceof higher director and officer and general liability insurance premiums, offsetby lower accruals for certain elements of our incentive based compensationsplan.

 

•                  Depreciationexpense increased 4% for the year-to-date period due to increases in technologycapital expenditures.

 

•                  Interest expense(net of interest income) decreased 9% for the year-to-date-period due to lowerinterest rates on our LIBOR-based bank credit facility.

 

•                  Income tax expense (benefit)decreased largely due to:

•                  Management conducts periodic recoverability assessments of these deferredtax assets, which includes evaluating both positive and negative evidentialmatter to determine if it is “more likely than not” that the deferred taxassets will be realizable. On June 30, 2002, management conducted arecoverability assessment and determined that $37 million in previouslyreserved deferred tax assets were realizable due to our profitable operatingresults in 2001 and 2002 and projected future taxable income. Until the fourthquarter of fiscal year 2002, management did not believe

 

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sufficient evidence existed that it was “more likely thannot” that such profitable operating results would allow such deferred taxassets to be realized.

•                  Beginning July 1, 2002, the Companybegan recognizing Federal income tax expense based on 35% of pre-tax domesticincome and state income taxes at a rate of approximately 2% of domestic income.

•                  For the twelve months ended June 30,2002, the domestic earnings were offset against net operating loss carryforwards resulting in no Federal income tax expense.

 

***Unusual Items***

 

•                  During thefiscal year ended June 30, 2004, we recorded the following unusual item:

•                  Refinancing charge of $12.3 million,which is more fully described in Note 8 of the Consolidated Notes to theFinancial Statements.

 

•                  During thefiscal year ended June 30, 2002, we recorded the following unusual item:

•                  The $37.0million tax benefit discussed above.

 

***DiscontinuedOperations***:

 

As previously discussed, during fiscal 2004 we sold our Nevada routeoperations, the Rail City Casino and Bally Wulff.  The sale of VSI, our Louisiana routeoperation, was not consummated pursuant to the previously announced saleagreement and the agreement was cancelled. We intend to continue our efforts to divest of this subsidiary and assuch will continue to carry the assets as a discontinued operation. The Nevadaroute operation (“UCMC”) disposition was completed on June 30, 2004, the RailCity disposition was completed on May 3, 2004 and the Bally Wulff dispositionwas completed in July 2003.

 

The Louisiana route operations revenues totaled $17.0 million, $14.9million and $15.1 million for the years ended June 30, 2004, 2003 and 2002,respectively.  For the same period,operating income totaled $2.8 million, $2.0 million and $2.2 million, respectively.

 

On June 30, 2004, we completed the sale of UCMC to Century Gaming, Inc.and received approximately $100 million in cash and the assumption by CenturyGaming of approximately $5 million in debt. Additionally, Century Gaming has agreed to acquire a certain number ofgaming devices from our Bally Gaming and Systems business unit over a five-yearperiod.  UCMC revenues totaled $220.9million, $202.4 million and $208.9 million for the years ended June 30, 2004,2003 and 2002, respectively.  For thesame periods, operating income totaled $22.5 million, $7.0 million and $13.2million, respectively.  We reported again on the sale before income taxes of $15.3 million, or $9.1 million aftertax.

 

The sale of the Rail City Casino to the Sands Regent was completed onMay 3, 2004. Total consideration was $37.9 million in cash.  Rail City revenues totaled $19.2 million,$21.2 million and $20.2 million for the years ended June 30, 2004, 2003 and2002, respectively.  For the sameperiods, operating income totaled $5.4 million, $5.0 million and $5.0 million,respectively.  We reported a gain on thesale before income taxes of $23.1 million, or $14.3 million after tax.

 

Bally Wulff revenues totaled $60.2 million and $74.7 million for theyears ended June 30, 2003 and 2002, respectively.  For the same periods, operating lossestotaled $40.6 million and $16.2 million.

 

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**Contractual Commitments**

 

We arecommitted to make future payments pursuant to various contracts and agreements.A summary of those contractual obligations existing as of June 30, 2004, is asfollows (in $000s):

 
| ** **                        | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Debt:                             |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Term Loan Facility (a)            |       | $        | 3,312      |     | $          | 3,500    |       | $        | 3,500      |     | $          | 3,500          |       | $         | 3,500      |   | $ | 332,688 |   | $ | 350,000 |   |
| Revolving credit facility         |       | —   |       | —   |       | —   |       | —   |       | —   |       | 70,000         |       | 70,000    |       |
| Other Debt                        |       | 2,553    |       | 3,803    |       | 599      |       | 2,000    |       | —   |       | —         |       | 8,955     |       |
|                              |       | 5,865    |       | 7,303    |       | 4,099    |       | 5,500    |       | 3,500    |       | 402,688        |       | 428,955   |       |
| Other commitments:                |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Net minimum rentals               |       | 2,877    |       | 1,596    |       | 1,323    |       | 721      |       | 553      |       | 33             |       | 7,103     |       |
| SDG earn-out (b)                  |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Mindplay earn-out (c)             |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Purchase commitments (d)          |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Employment agreements (e)         |       | 735      |       | 980      |       | 980      |       | 245      |       | —   |       | —         |       | 2,940     |       |
| Kirkland consulting agreement (f) |       | 600      |       | 600      |       | 600      |       | 300      |       | —   |       | —         |       | 2,100     |       |
| Total commitments                 |       | $        | 10,077     |     | $          | 10,479   |       | $        | 7,002      |     | $          | 6,766          |       | $         | 4,053      |   | $ | 402,721 |   | $ | 441,098 |   |

 

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(a) As a result of the sale of UCMC and Rail City, the terms of the bankloan agreement requires us to use approximately 50% of the net proceeds (asdefined in the agreement) to reduce the term loan and revolver principalbalances on a pro rata basis.  Therevolver commitment of $125 million remains unaffected.  The exact amount of the debt repayment issubject to final adjustment in December 2004, however in August 2004 theCompany made an estimated term loan pay down of $31.6 million, and usedadditional excess cash to reduce the balance of the revolver from $70 million tozero.  These debt paydowns are notreflected in the table above.

 

(b) OnMarch 2, 2004 we completed the acquisition of SDG, the details of the purchaseare more fully described in Note 3 of the Notes to the Consolidated FinancialStatements.  As part of the purchaseagreement additional contingent consideration of up to $95.6 million may becomepayable in equal portions of cash and stock over the next three fiscal yearsupon the SDG business achieving certain significant revenue and EBITDA targets.  Since the timing of such payments if any, arenot known, they are not reflected in the table shown above.

 

(c)Pursuant to the MindPlay purchase agreement, the Company is obligated to makecertain earn-out payments to the former principals of MindPlay LLC.  The Company is required to make guaranteedearn-out payments of at least $1,000,000 over the first two year period of theagreement.

 

(d) Exceptin certain rare instances, Bally Gaming and Systems is not required by itssuppliers to enter into quarterly commitments for products.

 

(e) TheCompany has employment agreements with most of its employees with positions ofVice President or above.  Theseagreements generally provide for an initial rate of pay and the terms of theseverance benefits generally range from three to twelve months salarycontinuation with similar non-compete periods. Almost all such agreements contain language that the employee is stillan “at will” employee, and as such can be terminated at anytime subject to theindividual termination provisions.  Theonly multi-year arrangement is with Richard Haddrill, our CEO effective October1, 2004, which covers a three-year term, with a base salary of $980,000.  Only Mr. Haddrill’s compensation is reflectedin the table above.

 

(f)Pursuant to an original agreement entered into in 1997 between the Company andKirkland Investment Corporation (“Kirkland,” 100% owned by Joel Kirschbaum whois a director of Alliance, and therefore treated as a “related party”),Kirkland provides the Company with certain consulting services.  Pursuant to a new Advisory Agreement datedJuly 1, 2004, the Company agreed to pay Kirkland $600,000 annually for a periodof 3.5 years for consulting services.

 

In additionto the items discussed above, we have cash obligations for interest payments onour debt and for income taxes.  Ourlong-term debt is virtually all floating rate, and therefore future interestpayments will be impacted by future LIBOR rate changes as well as the balanceof debt outstanding in those future periods. Interest payments for fiscal year 2004 totaled $23.8 million.  We have made no significant income taxpayments during the last three years as we utilized our net operating losscarry forwards, which have now been reduced almost completely as of June 30,2004.  We expect to begin makingquarterly Federal income tax payments beginning on September 15, 2004.  The amount of such future income tax paymentsis dependent on the levels of our future taxable income.

 

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The paymentobligations in the above table are based on the contractually scheduled duedates. The only payment acceleration that could be demanded of us wouldgenerally be in the event of a default under the bank credit agreement that wasnot cured within the provisions set forth in that agreement.

 

Pursuant toour bank credit agreement, in certain circumstances we can enter into guaranteeagreements on behalf of customers to third party creditors.  The total of such guarantees currentlyoutstanding is less than $0.2 million as of June 30, 2004.

 

**Critical Accounting Policies and Estimates**

 

We prepareour Consolidated Financial Statements in conformity with accounting principlesgenerally accepted in the United States of America. Certain of our accountingpolicies, including valuations utilized in asset impairment tests, acquisitionsaccounting, revenue recognition, allowance for doubtful accounts, capitalizedcosts, reserves for inventory, and deferred tax reserves require that we applysignificant judgement in defining the appropriate assumptions for calculatingfinancial estimates. These judgements are subject to an inherent degree ofuncertainty. There can be no assurance that the actual results will not differfrom our estimates. Additional information regarding our significant accountingpolicies is presented below.

 

*Inventories*

 

Inventories are stated at the lower of cost, determined on a first-in,first-out basis, or market.  Costelements included for work-in-process and finished goods includeraw materials, freight, direct labor and manufacturing overhead.  Given the size of the account balance, andthe subjective nature of “market” values, management has determined thatinventories represent critical accounting policies.  Accordingly we regularly review inventoryquantities and quality and record charges for both obsolete product and forproduct that may have become impaired for a variety of reasons, includingchanges in technology, product demand, etc. Additional valuation charges could result in the future as a result ofthese factors.

 

###### *Property, plant and equipment and leased gamingequipment*

 

Property, plant and equipment are stated at cost and depreciated overthe estimated useful lives or lease terms, if less, using the straight linemethod.  Leased gaming equipment isstated at cost and depreciated over estimated useful lives ranging from 3-4years.

 

Significant replacements and improvements are capitalized; othermaintenance and repairs are expensed. The cost and accumulated depreciation ofassets retired or otherwise disposed of are eliminated from the accounts andany resulting gain or loss is credited or charged to income as appropriate.

 

Given the size of the accountbalances, the changes in technology, customer preferences and competitiveproducts offered by other suppliers, we regularly review and evaluate therecoverability of our investment in such assets, as well as the estimateduseful lives used to depreciate these assets. There is the potential for acceleration of future depreciation, or evenan asset write-down, if such factors were determined to have an adverse impacton our ability to realize our full investment in such assets.

 

###### *Intangible assets*

 

Intangible assets consist primarily of deferred issuance costs forfinancings which are amortized over the life of the related financing, andacquisition-related software and trademarks, which are amortized over 3-13years, and goodwill which is not amortized. Significant judgement is used inthe estimation of future cash flows of such assets and in determining theirestimated useful lives.

 

We regularly review andevaluate the recoverability of such intangible assets, many of which wereacquired in our various business acquisitions. Some of the intangibles represent products that have been deployed (i.e.SDG’s central-determination games) and others that are just now being deployed(i.e. MindPlay’s table game technology). The success or failure of such products and their ability to generatefuture cash flows will have a significant impact on the timing of amortizationexpense and/or write-downs in those future periods.

 

*Impairment of Long-lived Assets*

 

TheCompany reviews long-lived assets (and goodwill) for impairment annually orwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of long-lived assets to be held and used are measured bya comparison of the carrying amount of an asset to future net cash flowsexpected to be generated by the asset, undiscounted and without interest andsuch estimations involve significant judgements.  If such assets are determined to be impaired,the impairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets.

 

###### *Revenue recognition*

 

Revenuefrom sales of gaming machines is generally recognized at the time products areshipped and title has passed to the customer. Games placed with customers on atrial basis are not recognized as revenue until the trial period ends and

 

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the customer accepts the games. The Company sells gaming equipment onnormal credit terms (generally 2%, net 30) and offers financing to qualifiedcustomers for periods generally between 6 and 48 months.  Game sales to large, multi-propertyoperators, are generally made pursuant to corporate agreements which containstandard sales terms and conditions and therefore generally do not involvesignificant judgments or estimates in recognizing revenue.  Sales to smaller operators are generally madein accordance with individual sales orders with terms and conditions that arenegotiated with the customer, and therefore require additional review to ensurethat revenue is recorded in the proper period. Specific attention is paid to shipping terms (i.e. FOB Las Vegas ordestination), discounting, and payment terms and conditions, and can require asignificant level of review by management. The failure to meet all of the revenue recognition conditions pursuantto the accounting standards would result in deferral of revenue to a futureaccounting period until all such conditions for revenue recognition have beenmet.

 

Revenuefrom sales of computerized monitoring systems is recognized in accordance withthe AICPA’s Statement of Position 97-2 (“SOP 97-2”) “Software RevenueRecognition.”  In accordance with theprovisions of SOP 97-2, the contracts for the sales of computerized monitoringunits are considered to have “multiple elements” because they include hardware,software, installation, supervision, training, and post-contract customersupport. Accordingly, revenues from the sale of systems are deferred and beginto be recognized at the point when the system is deemed to be functionallyoperational, and the residual method is used to recognize revenue for theremaining elements as they are delivered, each having vendor-specific objectiveevidence of relative fair values. Post-contract customer support revenues arerecognized over the period of the support agreement (generally one year).

 

Revenue recognition for systems sales often involve both judgements andestimates, and accordingly such transactions are subjected to additional levelsof internal review each reporting period. Failure to meet all of the revenue recognition criteria in a reportingperiod could result in a deferral of revenue to a future period.

 

*Allowances ForCollection and Other Losses*

 

Allowancesfor losses are maintained at levels determined by the Company’s management toadequately provide for collection losses and any other-than-temporary declinesin other asset values.  In determiningestimated losses, the Company’s management considers economic conditions, theactivity in gaming markets, the financial condition of customers, changes intechnology and other factors which management believes are relevant.  If a loss is indicated, the loss to berecognized is measured by the amount by which the carrying amount of the assetexceeds the estimated net realizable value of the asset.  Asset charge-offs are recorded upon thedisposition of the underlying assets. Management reviews the Company’s assets on a quarterly basis todetermine the adequacy of the allowances for losses.

 

*CapitalizedCosts*

 

Duringfiscal year 2004, Bally Gaming and Systems has experienced an almost four foldincrease in the volume of product submissions to the various domesticregulatory bodies, each of which charges fees for the testing and approval ofeach product. Product testing costs are capitalized once technological feasibilityhas been established and are amortized, generally over a three year period oncethe product is placed in service. Product testing costs related to projectsthat are discontinued are expensed when such determination is made. The year todate fees incurred for such regulatory approvals totaled approximately $8.5million. Of these amounts incurred, the Company capitalized a total of $4.8million that was directly attributable to products.

 

Given the subjective nature ofsuch capitalized costs, we have instituted a strict review process whichincludes a full review of the costs incurred and the nature and prospects ofthe related product.  After costs arecapitalized, they are monitored to ensure that they are earning revenuesthrough product sales.  Future write-offsare possible if such products do not produce adequate cash flows.

 

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*Income taxes*

 

Income taxes are accounted for under the asset and liability method.Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of assets and liabilities and their respective tax bases.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in the periodthat includes the enactment date. Taxes on income of the Company’s foreignsubsidiaries are provided at the tax rates applicable to the tax jurisdictionsin which they are located.

 

The accounting for income taxes involves significant judgements andestimates and deals with complex tax regulations.  The recoverability of certain deferred taxassets is based in part on estimates of future income and the timing oftemporary differences, and the failure to fully realize such deferred taxassets could result in a higher tax provision in future periods.

 

***Risk Factors***

 

***Competition***

 

*Bally Gaming and Systems.*  The market for gaming machines is extremelycompetitive, and there are a number of established, well-financed andwell-known companies producing machines that compete with each of theBally Gaming and Systems product lines in each of the Bally Gaming and Systemsmarkets. The domestic market for gaming machines is dominated by a singlecompetitor, International Game Technology (“IGT”), with a number of smallercompetitors in the field. In addition, certain technology-orientedcompanies have recently entered or may enter the gaming machine market.Management believes that some of these competitors have greater capitalresources than we do. Competition among gaming machine manufacturers, particularlywith respect to sales of gaming machines to new and emerging markets, is basedon competitive customer pricing and financing terms, appeal to the player,product quality, and having an extensive distribution and sales network. Salesto established casinos in Nevada normally require completion of a successfultrial period for the machines in the casino.

 

The competition for casino enterprise systems currently consists ofIGT, Aristocrat, Acres Gaming, Inc., MIS, and, to a lesser extent, Konami andMikohn Gaming Corporation.  Competitionis keen in this market due to the number of providers and the limited number ofcasinos and the jurisdictions in which they operate. Pricing, product featureand function, accuracy, and reliability are all main factors in determining aprovider’s success in selling its system. Bally

 

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Gaming and Systems believes the future success of our operations willbe determined by our ability to bring new and innovative products to themarketplace while at the same time maintaining the base of loyal existingcustomers.

 

*Casino Operations.*  The operation of casinos is also a highlycompetitive business. The principal competitive factors in the industry includethe quality and location of the facility, the nature and quality of theamenities and customer services offered and the implementation and success ofmarketing programs. Our Rainbow Casino in Vicksburg, Mississippi faces intensedirect competition from other gaming facilities serving the Vicksburg market.Competition from casinos in nearby locations may also be reducing the marketfrom which Vicksburg casinos draw most of their patrons. Moreover, additionalpotential gaming sites remain in and around Vicksburg; some of these sites maybe closer to larger population centers and, if developed, might enjoy acompetitive advantage over our casinos.

 

*Route Operations (Discontinued Operations).*  In Louisiana, our route operations at theracetrack and OTBs compete with various truck stops and locations with liquorlicenses throughout the New Orleans area, as well as riverboat gaming and oneland-based casino.

 

***Product Development***

 

Our future success depends to a large extent upon our ability todesign, manufacture and market technologically sophisticated and entertainingproducts that achieve high levels of player acceptance. The development of asuccessful new product or product design by a competitor could adversely affectsales of our products and force us to attempt to respond quickly with our owncompeting products. Response speed is lower in jurisdictions requiring productapprovals prior to commercialization. Our plan with respect to the introductionof more sophisticated technology into the electronic gaming machine market is designedto lead to an increase in market share and profitability for us. However, thereis no assurance that any such products will be developed, or that if developedthey will receive necessary regulatory approvals or be commercially successful.Although we are developing a number of new products, there can be no guaranteeof commercial acceptance of any of our products.

 

The gaming industry is employing new technology in many new areas, andwe and our competitors continue to file for patents protecting suchtechnologies. Although we are not aware of any patent violations, there can beno assurances that patents currently pending will not be determined to haveinfringed upon an existing patent held by a third party.

 

Bally Gaming and Systems continues to deploy new products that areplaced in casinos and earn recurring revenues and cash flows. The amount ofrevenues earned is dependent on the earning power of the game. The games willlikely have a shorter life than more traditional games, and we will have tocontinue to design and deploy successful games to maintain this stream ofrevenue. There can be no assurance that the games recently deployed will besuccessful or that we will be able to design and deploy new recurring revenuegames.

 

***Intellectual Property Litigation***

 

We may incur significantlitigation expenses protecting our intellectual property or defending our useof intellectual property, which may have an adverse effect on our future cashflow and results of operations.

 

Competitors and other thirdparties may infringe on our intellectual property rights or may allege that wehave infringed on their intellectual property rights, resulting in significantlitigation expenses, which would reduce our cash flow.

 

***Sales to Non-Traditional Gaming Markets***

 

The continued growth of the non-traditional markets outside ofNevada and Atlantic City for electronic gaming machines is contingent on thepublic’s acceptance of these markets and an ongoing regulatory approval processby federal, state and local governmental authorities. We cannot predict whichnew jurisdictions or markets, if any, will approve the operation of electronicgaming machines, the timing of any such approval or the level of ourparticipation in any such markets, or whether jurisdictions currentlypermitting gaming will continue to do so in the future.

 

***Customer Financing***

 

Management believes that customer financing terms and leasing havebecome increasingly important competitive factors for Bally Gaming and Systems.Competitive conditions sometimes require Bally Gaming and Systems to grantextended payment terms on gaming machines, systems and other gaming equipment,especially for sales in emerging markets. While such equipment normally collateralizes these financings, theresale value of the collateral in the event of default may be less than theamount financed. Accordingly, we have greater exposure to the financialcondition of our customers in emerging markets than had historically been thecase in established markets like Nevada and Atlantic City.

 

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***Foreign Operations***

 

Our business in foreign markets is subject to the risks customarilyassociated with such activities. These risks include fluctuations in foreigncurrency exchange rates and controls, expropriation, nationalization and othereconomic, tax and regulatory policies of local governments as well as the lawsand policies of the United States affecting foreign trade and investment. As ofJune 30, 2004, Bally Gaming and Systems has $17.8 million of receivables fromcustomers in countries outside of the United States most of which aredenominated in U.S. dollars. We do not generally enter into foreign exchangecontracts to hedge our exposure to foreign exchange rate fluctuations.

 

***Ability to Service Debt, Liquidity***

 

As ofJune 30, 2004, the aggregate outstanding principal amount of our debtoutstanding totaled $429.0 million. Upon the completion of the Refinancingin September 2003, we replaced our existing bank debt and 10% Senior SubordinatedNotes with approximately $275 million of term loans, and $70 million drawn onthe revolving credit facility. During the December 2003 quarter the Companyincreased the term loan by $75 million, to a total of $350 million outstanding.  The proceeds were used primarily to fund theacquisition SDG.  As a result the Companyincurred an additional $1.3 million in debt issuance costs, which have beencapitalized and will be amortized over the remaining term of the loan.

 

As a result of the sale of UCMCand Rail City, the terms of the bank loan agreement requires the useapproximately 50% of the net proceeds (as defined in the agreement) to reducethe term loan and revolver principal balances on a pro rata basis.  The revolver commitment of $125 million remainsunaffected.  The exact amount of the debtrepayment is subject to final adjustment in December 2004, however in August2004 the Company made an estimated term loan pay down of $31.6 million, andused additional excess cash to reduce the balance of the revolver from $70million to zero.

 

Our new credit facility contains a number of significant covenantsthat, among other things, restrict our ability and certain of our subsidiariesto dispose of assets, incur additional indebtedness and issue preferred stock,pay dividends or make other distributions, enter into certain acquisitions,repurchase equity interests or subordinated indebtedness, issue or sell equityinterests of our subsidiaries, engage in mergers or consolidations, or engagein certain transactions with subsidiaries and affiliates and otherwise restrictcorporate activities. There can be no assurance that such restrictions will notadversely affect our ability to finance our future operations or capital needsor engage in other business activities that may be in our interest. Inaddition, the bank credit facility also requires us to maintain compliance withcertain financial ratios. Our ability to comply with such ratios may beaffected by events beyond our control. A breach of any of these covenants orour inability to comply with the required financial ratios could result in adefault under the bank credit facility. In the event of any such default, thelenders under the credit facility could elect to declare all borrowingsoutstanding under the bank credit facility, together with accrued interest andother fees, to be due and payable and to require us to apply all of ouravailable cash to repay such borrowings. If we were unable to repay any such borrowings when due, the lenderscould proceed against our collateral. If the indebtedness under the bank creditfacility were to be accelerated, there can be no assurance that our assetswould be sufficient to repay such indebtedness in full.

 

Our obligation to make principal and interest payments on outstandingindebtedness, and to comply with the covenants in the agreements governingborrowings under the bank credit facility, will have several important effectson our future operations including the following: (i) the portion of ourcash flow from operations which will be dedicated to the payment of principaland interest on our indebtedness will not be available for other purposes;(ii) the bank facility borrowings are at variable rates of interest, whichcould result in higher expense in the event of increases in interest rates;(iii) we may be more vulnerable to downturns in our business or in thegeneral economy and may be restricted from making acquisitions, introducing newtechnologies or exploiting business opportunities; and (iv) our ability toobtain additional financing in the future for working capital, capitalexpenditures, general corporate or other purposes may be impaired.  Additionally, our ability to meet our debtservice obligations and to reduce our total debt will be dependent upon ourfuture performance, which will be subject to general economic and regulatoryconditions and to financial, business and other factors affecting ouroperation, many of which are beyond our control.

 

No assurance can be given that we will be able to generate the cashflow necessary to permit us to meet our fixed charges and repaymentobligations. Any inability of us to service our fixed charges and repaymentobligations would have a significant adverse effect on us.

 

***Dependence on Key Personnel***

 

Our success will be dependent, to a significant extent, on thecontinued services of a relatively small group of executive personnel. The lossor unavailability of one or more of such executive officers or the inability toattract or retain key employees in the future could have an adverse effect onour operations. On July 1, 2004 the Company

 

48

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announced that Richard Haddrill has been appointed President and ChiefExecutive Officer effective October 1, 2004. Mr. Haddrill succeeds RobertMiodunski who will remain CEO until September 30, 2004, and will servethereafter as a consultant to the Board of Directors. The Company has alsoformed of the Office of the Chairman to oversee seamless transition andmanagement succession. The Office of the Chairman consists of Board membersDavid Robbins and Joel Kirschbaum, Mr. Haddrill, and Mr. Miodunski.

 

***Strict Regulation by Gaming Authorities***

 

The manufacture and distribution of gaming machines and the conduct ofgaming operations are subject to extensive federal, state, local, and foreignregulation by various gaming authorities (each, a “Gaming Authority”). Althoughthe laws and regulations of the various jurisdictions in which we operate varyin their technical requirements and are subject to amendment from time to time,virtually all these jurisdictions require licenses, permits, documentation ofthe qualification, including evidence of integrity and financial stability, andother forms of approval for companies engaged in gaming operations and themanufacture and distribution of gaming machines as well as for the officers,directors, major stockholders, and key personnel of such companies. The Companyand our key personnel have obtained, or applied for, all government licenses,registrations, findings of suitability, permits and approvals necessary for themanufacture and distribution, and operation where permitted, of its gamingmachines in the jurisdictions in which it currently does business. However,there can be no assurance those licenses, registrations, findings ofsuitability, permits, or approvals will be given or renewed in the future orthat we will obtain the licenses necessary to operate in emerging markets.

 

Additionally, there can be no assurance that any regulatory agency willnot enact new rules or change regulations that would negatively impact ourability to operate or our financial results.

 

***Gaming Taxes***

 

Gaming operators are typically subject to significant taxes and fees inaddition to corporate and state income taxes, and such taxes and fees aresubject to increase at any time.  Anymaterial increase in these taxes or fees, which could occur prospectively orretroactively, would adversely affect us.

 

We pay and expect to continue to pay taxes and fees in Nevada, and NewJersey. The New Jersey legislature enacted in 2003 an eight percent tax on theproceeds we receive from the operation of wide-area progressive slot machinesin Atlantic City casinos. We expect to pay substantial taxes and fees in anyother jurisdiction in which we conduct gaming operations. There can be noassurance as to future changes in taxation on gaming operations.

 

***Currency Rate Fluctuations***

 

We derive revenues from our non-U.S. subsidiaries, all of whichrevenues are denominated in their local currencies, and their results areaffected by changes in the relative values of non-U.S. currencies and the U.S.dollar.  Most of the currencies incountries in which we have foreign operations strengthened versus the U.S.dollar in 2003 and 2004, which resulted in assets and liabilities denominatedin local currencies being translated into more dollars. We do not currentlyutilize hedging instruments.

 

***Market risks***

 

During the normal course of our business, we are routinely subjected toa variety of market risks, examples of which include, but are not limited to,interest and currency rate movements, collectibility of accounts and notesreceivable, and recoverability of residual values on leased assets. Weconstantly assess these risks and have established policies and practicesdesigned to protect against the adverse effects of these and other potentialexposures.  Although we do not anticipateany material losses in these risk areas, no assurances can be made thatmaterial losses will not be incurred in these areas in the future.

 

49

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We have performed a sensitivity analysis of our financial instruments,which consist of our cash and cash equivalents and debt. We have no derivativefinancial instruments. In performing the sensitivity analysis, we define riskof loss as the hypothetical impact on earnings, of changes in the marketinterest rates or currency exchange rates.

 

The results of the sensitivity analysis at June 30, 2004, are asfollows:

 

Interest Rate Risk:

 

Wehad total debt of approximately $429 million, consisting primarily of the new$350 million term loan and the initial $70 million borrowing on the revolverand other debt at approximately $9.0 million. The bank facility loans are broken into individual loans with varyingterms from one to six months. The interest rate for each loan is set on theborrowing date and is effective for the term outstanding. If the LIBOR rateswere to increase or decrease by 100 basis points, with all other factorsremaining constant, earnings would decrease or increase by approximately $4.3million on a pre-tax basis.

 

Foreign Currency Exchange Rate Risk:

 

Our foreign subsidiaries generally use their domestic currency as theirfunctional currency. A 10% fluctuation in the exchange rates of thesecurrencies against the U.S. dollar would result in a corresponding change inearnings reported in the consolidated group of approximately $0.1 million.

 

#### **Estimates**

 

Our financial statements are prepared using estimates and assumptionsthat affect the reported amounts of assets and liabilities. Actual results maydiffer from these estimates either favorably or unfavorably, which may impactfuture results.

 
| **ITEM 7A.** | **QUANITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** |
|--------------|---------------------------------------------------------------|

 

Refer to Item 7 of this Report- “Risk Factors- Currency RateFluctuations” and “Market Risks.”

 
| **ITEM 8.** | **FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA** |
|-------------|-------------------------------------------------|

 

Our Consolidated Financial Statements, including the notes thereto, andsupplementary financial information are listed in Part IV, Item 15, of thisReport and are included after the signature page beginning at page F-1.

 
| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND  FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

None.

 
| **ITEM 9a.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

The Company’s management, including the Chief Executive Officer andChief Financial Officer, conducted an evaluation of the effectiveness of thedesign and operation of the company’s disclosure controls and procedures asdefined in Exchange Act Rule 13a-15(e) as described at the end of the periodcovered by this report.  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat as of the end of the period covered by this report, the company’sdisclosure controls and procedures were effective.  During the period covered by this reportthere have been no changes in the Company’s internal control over financialreporting that have materially affected, or are reasonably likely to materiallyaffect the Company’s internal control over financial reporting.

 

**PART III**

 
| **ITEM 10.** | **DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT** |
|--------------|---------------------------------------------------------|

 

50

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#### **ITEM 11.**               EXECUTIVECOMPENSATION

 

#### **ITEM 12.**               SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

#### **ITEM 13.**               CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

 

**ITEM 14.****               PRINCIPALACCOUNTANT FEES AND SERVICES**

 

The information required by items 10, 11, 12, 13 and 14 is incorporatedby reference from the Proxy Statement, which will be filed with the Securitiesand Exchange Commission within 120 days of the end of our fiscal year coveredby this report.

 

#### **PART IV**

 

**ITEM 15.****               EXHIBITS ANDFINANCIAL STATEMENT SCHEDULES**

 
|   | Documents filed as part of this report:                                                                             |   |
|--------|---------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                |   |
| 1.     | Financial Statements:                                                                                               |   |
|   |                                                                                                                |   |
|   | Report  of Independent Registered Public Accounting Firm                                                            |   |
|   |                                                                                                                |   |
|   | Consolidated Balance Sheets as of June 30, 2004 and 2003                                                            |   |
|   |                                                                                                                |   |
|   | Consolidated Statements of Operations for  the Years Ended June 30, 2004, 2003 and 2002                             |   |
|   |                                                                                                                |   |
|   | Consolidated Statements of Stockholders’  Equity (Deficiency) for the Years Ended June 30, 2004, 2003 and 2002 |   |
|   |                                                                                                                |   |
|   | Consolidated Statements of Cash Flows for  the Years Ended June 30, 2004, 2003 and 2002                             |   |
|   |                                                                                                                |   |
|   | Notes to Consolidated Financial Statements                                                                          |   |
|   |                                                                                                                |   |
| 2.     | Consolidated Supplemental Schedules:                                                                                |   |
|   | Not applicable.                                                                                                     |   |
|   |                                                                                                                |   |
| 3.     | Exhibits:                                                                                                           |   |

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                       | ** ** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                                                                                                                                                                                  |       |
| 2.1                 |       | Agreement and Plan of Merger among Alliance, BGII Acquisition Corp.  and BGII, dated as of October 18, 1995, as amended and restated (incorporated  herein by reference to Annex I to the prospectus included in Alliance’s Form  S-4, Registration Number 333-02799).                           |       |
|                |       |                                                                                                                                                                                                                                                                                                  |       |
| 2.2                 |       | Basic Agreement, dated as of October 29, 1993, among United Gaming,  Inc., The Rainbow Casino Corporation, John A. Barrett, Jr. and Leigh Seippel,  and exhibits thereto (incorporated herein by reference to Alliance’s Form 8-K  dated October 29, 1993).                                      |       |
|                |       |                                                                                                                                                                                                                                                                                                  |       |
| 2.3                 |       | Consolidation Agreement dated March 29, 1995 among United Gaming  Rainbow, Inc., RCC, RCVP, NGM, HFS, National Gaming Corporation, Rainbow  Development Corporation and Leigh Seippel and John A. Barrett, Jr.  (incorporated herein by reference to Alliance’s Form 8-K dated March 29,  1995). |       |
|                |       |                                                                                                                                                                                                                                                                                                  |       |
| 2.4                 |       | Stock Purchase Agreement for the sale of Bally Wulff (incorporated  herein by reference to Alliance’s Form 8-K filed on August 5, 2003).                                                                                                                                                         |       |

 

51

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                   | ** ** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 2.5                 |       | Amended and restated Stock Purchase Agreement by and among Alliance  Gaming Corporation, Sierra Design Group, and Robert Luciano, as Trustee for  the Robert Luciano Family Trust, dated March 2, 2004 (incorporated by  reference to form 8-K dated March 12, 2004)                                                                                              |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 2.6                 |       | Agreement and plan of merger by and among Alliance Gaming  Corporation, APT Games, Inc., United Coin Machine Co., and Century Gaming,  Inc. dated May 4, 2004 (incorporated by reference to Form 8-K dated July 6,  2004).                                                                                                                                        |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 3.1                 |       | Restated Articles of Incorporation of the Registrant, as amended  (incorporated herein by reference to Alliance’s Form S-8 dated May 7, 2004.)                                                                                                                                                                                                               |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 3.2                 |       | Revised and Amended By-Laws of the Registrant (incorporated herein by  reference to Alliance’s Form 10-Q for the quarter ended December 31, 1997.)                                                                                                                                                                                                           |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 3.3                 |       | Certificate of Designations, Preferences, and Relative, Participating,  Optional and Other Special Rights of Special Stock and Qualifications,  Limitations and Restrictions of 11 1/2% Non-Voting, Pay-in-Kind Special  Stock, Series E (incorporated herein by reference to Exhibit 9(c)(5) to  Amendment No. 1 to Alliance’s Form S-4 dated May 9, 1996). |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.1                 |       | Loan Agreement among Alliance Gaming Corporation and various lenders,  and Bank of America, N.A. (Administrative Agent), dated September 3, 2003  (incorporated by reference to Alliance’s 8-K filed on September 12, 2003).                                                                                                                                 |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.2                 |       | Rights Agreement dated as of March 9, 1998 between the Company and  American Stock Transfer & Trust Company (incorporated herein by reference  to Form 8-A dated March 10, 1998).                                                                                                                                                                             |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.3                 |       | First Amendment to the Rights Agreement dated as of September 15,  1998 between the Company and American Stock Transfer & Trust Company  (incorporated herein by reference to the Company’s annual report on Form 10-K  dated June 30, 1998).                                                                                                            |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.4                 |       | Form of Certificate of Designations with respect to Series F Special  Stock (attached as Exhibit A to the Rights Agreement) (incorporated herein by  reference to Form 8-A dated March 10, 1998).                                                                                                                                                                 |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.5                 |       | Form of Right Certificate (attached as Exhibit B to the Rights  Agreement) (incorporated herein by reference to Form 8-A dated March 10,  1998).                                                                                                                                                                                                                  |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 4.6                 |       | Summary of Rights to Purchase Series F Special Shares (attached as  Exhibit C to the Rights Agreement) (incorporated herein by reference to Form  8-A dated March 10, 1998).                                                                                                                                                                                      |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 10.1                |       | Alliance Gaming Corporation 1996 Long Term Incentive Plan  (incorporated herein by reference to the Company’s Form S-8 filed August 12,  1997 Registration Number 333-34077).*                                                                                                                                                                               |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 10.4                |       | United Gaming, Inc. 1991 Long-Term Incentive Stock Option Plan  (incorporated herein by reference to Alliance’s Form S-8 Registration Number  33-45811 and Registration Number 33-75308).*                                                                                                                                                                   |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                              |       |
| 10.10               |       | Management Agreement, dated as of October 29, 1993, among Rainbow  Casino-Vicksburg Partnership, L.P., Rainbow Casino Corporation and  Mississippi Ventures, Inc., as manager (incorporated herein by reference to  Alliance’s Form 8-K dated October 29, 1993).                                                                                             |       |

 

52

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                       | ** ** |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.11               |       | Letter Agreement, dated as of June 29,1994, among United Gaming, Inc.,  Rainbow Casino Corporation, John A. Barrett, Jr. and Leigh Seippel, consented  to by HFS Gaming Corporation (incorporated herein by reference to Alliance’s  Form 8-K dated August 11, 1994).                                                                                            |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.12               |       | Letter Agreement, dated as of July 16, 1994, among United Gaming,  Inc., Rainbow Casino Corporation, John A. Barrett, Jr. and Leigh Seippel,  consented to by HFS Gaming Corporation (incorporated herein by reference to  Alliance’s Form 8-K dated August 11, 1994).                                                                                           |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.13               |       | Second Amendment to Casino Financing Agreement, dated as of August  11, 1994, among United Gaming, Inc., United Gaming Rainbow, Inc., Rainbow  Casino-Vicksburg Partnership, L.P., Rainbow Casino Corporation, John A.  Barrett, Jr., Leigh Seippel and HFS Gaming Corporation (incorporated herein  by reference to Alliance’s Form 8-K dated August 11, 1994). |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.14               |       | Partnership Agreement of Rainbow Casino-Vicksburg Partnership, L.P.,  dated as of July 8, 1994 (incorporated herein by reference to Alliance’s Form  8-K dated August 11, 1994).                                                                                                                                                                                 |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.15               |       | Second Amended and Restated Agreement of Limited Partnership, dated  March 29,1995, between United Gaming Rainbow and Rainbow Casino Corporation  (incorporated herein by reference to Alliance’s Form 8-K dated March 29,  1995).                                                                                                                               |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.16               |       | Letter Agreement, dated March 29, 1995, among United Gaming Rainbow,  RCC, Leigh Seippel, John A. Barrett, Jr. and Butler, Snow, O’Mara, Stevens  & Cannada  (incorporated herein by  reference to Alliance’s Form 8-K dated March 29, 1995).                                                                                                      |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.17               |       | Trademark License Agreement, dated November 11, 1991 between Bally  Manufacturing Corporation and Bally Gaming International, Inc. (incorporated  herein by reference to exhibit 10(i)(d) included in BGII’s Annual Report on  Form 10-K for the fiscal year ended December 31, 1991).                                                                           |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.18               |       | Amended and Restated Trademark License Agreement dated July 8, 1992,  by and between Bally Gaming International, Inc. and Bally Manufacturing  Corporation (incorporated herein by reference to exhibit 10(i)(d) included in  BGII’s Registration Statement on Form S-1 No. 33-48347 filed on July 9,  1992).                                               |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.19               |       | Second Amendment to Trademark License Agreement and Settlement  Agreement, dated March 31, 1995, by and between Bally Entertainment  Corporation and Bally Gaming International, Inc. (incorporated herein by  reference to Exhibit I, included in BGII’s Current Report on Form 8-K dated  April 3, 1995).                                                      |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.20               |       | Third Amendment to Trademark License Agreement and Settlement  Agreement dated May 10, 1996, by and between Bally Entertainment Corporation,  Alliance Gaming Corporation and BGII Acquisition Corp. (incorporated by  reference to exhibit 10.77 to S-2 Registration Statement No. 333-02147).                                                                  |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.27               |       | Amended and Restated Employment Agreement, effective April 24, 2001,  between the Company and Robert L. Miodunski (incorporated by reference to the  Company’s Annual Report on Form 10-K dated June 30, 2001). *                                                                                                                                                |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.30               |       | Employment Agreement between the Company and Richard Haddrill,  entered into as of June 30, 2004 (incorporated by reference to Form 8-K dated  July 7, 2004).*                                                                                                                                                                                                        |       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |       |
| 10.31               |       | Separation and Consulting Agreement entered into as of June 30,  2004 by and between the Company and Robert L. Miodunski (incorporated by  reference to Form 8-K dated July 7, 2004.)                                                                                                                                                                            |       |

 

53

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                  | ** ** |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                                                                                                             |       |
| 10.33               |       | Alliance Gaming Corporation 2001 Long-Term Incentive Plan, including  amendments No. 1 and  No. 2  (incorporated herein by reference to the Company’s Form S-8 filed January 22,  2002 Registration Number 333-81154). |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.34               |       | Amendment No. 3 to the Alliance Gaming Corporation 2001 Long-Term  Incentive Plan (incorporated herein by reference to the Company’s Form S-8  filed May 8, 2003 Registration Number 333-105087).                           |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.35               |       | Amendment No. 4 to the Alliance Gaming Corporation 2001 Long-Term  Incentive Plan (incorporated herein by reference to the Company’s Form S-8  filed May 7, 2004 Registration Number 333-105087).                           |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.36               |       | Employment Agreement dated July 14, 2000 between the Company and Mark  Lerner (incorporated herein by reference to the Company’s Annual Report on  Form 10-K dated June 30, 2002). *                                        |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.37               |       | Agreement between the Company and David Robbins effective July 1,  2004 (incorporated by reference to Form 8-K dated July 7, 2004).                                                                                              |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.38               |       | Agreement between the Company and Joel Kirschbaum effective July 1,  2004 (incorporated by reference to Form 8-K dated July 7, 2004).                                                                                            |       |
|                |       |                                                                                                                                                                                                                             |       |
| 10.39               |       | Advisory Services agreement between the Company and Kirkland  Investment Corporation effective July 1, 2004 (incorporated by reference to  Form 8-K dated July 7, 2004).                                                         |       |
|                |       |                                                                                                                                                                                                                             |       |
| 21                  |       | Subsidiaries of the Registrant.                                                                                                                                                                                                  |       |
|                |       |                                                                                                                                                                                                                             |       |
| 23.1                |       | Consent of Deloitte & Touche LLP                                                                                                                                                                                             |       |
|                |       |                                                                                                                                                                                                                             |       |
| 31.1                |       | Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of  the Securities Act of 1934, as amended.                                                                                                                 |       |
|                |       |                                                                                                                                                                                                                             |       |
| 31.2                |       | Certification of Chief Financial Officer, pursuant to Rule 13a-14(a)  of the Securities Act of 1934, as amended.                                                                                                                 |       |
|                |       |                                                                                                                                                                                                                             |       |
| 32.1                |       | Certification of Chief Executive Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of  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.                                                                            |       |

 

----

| * |   | Management contract or compensatory plan or arrangement. |   |
|---|--------|----------------------------------------------------------|--------|

 

54

----

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon our behalf by the undersigned, thereunto duly authorized.

 
| ALLIANCE GAMING CORPORATION |                                                    | DATED: September 10**,** 2004 |
|-----------------------------|---------------------------------------------------------|-------------------------------|
|                        |
|                        |
| By                          | /s/ Robert L. Miodunski                                 |                          |
|                        | Robert L. Miodunski                                     |
|                        | President and Chief Executive Officer                   |                          |
|                        | (Principal Executive Officer)                           |                          |
|                        |                                                    |
| By                          | /s/ Robert L. Saxton                                    |                          |
|                        | Robert L. Saxton                                        |
|                        | Executive Vice President, Treasurer and Chief Financial |                          |
|                        | Officer (Principal                                      |                          |
|                        | Financial and  Accounting Officer)                      |                          |
|                             |                                                         |                               |  |  |  |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.

 
| **Name**                | ** ** | **Title**                                   | ** **                                                      | **Date** | ** **         |
|-------------------------|------------|---------------------------------------------|-----------------------------------------------------------------|----------|--------------------|
|                    |       |                                        |                                                            |     |               |
| /s/ Robert L. Miodunski |       |                                        | President and Chief Executive Officer                           |     | September 10, 2004 |   |
| Robert L. Miodunski     |       | (Principal Executive Officer), and Director |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Robert L. Saxton    |       |                                        | Executive Vice President, Treasurer and Chief Financial Officer |     | September 10, 2004 |   |
| Robert L. Saxton        |       | (Principal Financial and                    |                                                            |     |               |
|                    |       | Accounting Officer)                         |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Jacques Andre       |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Jacques Andre           |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Anthony DiCesare    |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Anthony DiCesare        |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Joel Kirschbaum     |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Joel Kirschbaum         |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ David Robbins       |       |                                        | Director and Chairman of the Board                              |     | September 10, 2004 |   |
| David Robbins           |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Robert Miodunski    |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Robert Miodunski        |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Kevin Verner        |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Kevin Verner            |       |                                        |                                                            |     |               |
|                    |       |                                        |                                                            |     |               |
| /s/ Richard Haddrill    |       |                                        | Director                                                        |     | September 10, 2004 |   |
| Richard Haddrill        |       |                                        |                                                            |     |               |
|                         |            |                                             |                                                                 |          |                    |  |  |  |  |  |  |  |  |  |

 

55

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

 

To the Board of Directors and Stockholders of

Alliance Gaming Corporation:

Las Vegas, Nevada

 

We have audited the accompanying consolidated balance sheets ofAlliance Gaming Corporation and Subsidiaries (the “Company”) as of June 30,2004 and 2003, and the related consolidated statements of operations,stockholders’ equity (deficiency), and cash flows for each of the three yearsin the period ended June 30, 2004.  Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonablebasis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of Alliance Gaming Corporationand Subsidiaries as of June 30, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedJune 30, 2004, in conformity with accounting principles generally accepted inthe United States of America.

 

 

DELOITTE & TOUCHE LLP

Las Vegas, Nevada

September 10, 2004

 

F-1

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(In 000s except share amounts)

 
| ** **                                                                                                                        | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ASSETS                                                                                                                            |       |               |       |               |       |
| Current assets:                                                                                                                   |       |               |       |               |       |
| Cash and cash equivalents                                                                                                         |       | $                  | 172,726    |               | $          | 38,884 |   |
| Accounts and notes receivable, net of  allowance for doubtful accounts of $9,722 and $6,962                                       |       | 129,779            |       | 98,368             |       |
| Inventories, net of reserves of $4,914 and  $6,503                                                                                |       | 61,135             |       | 32,102             |       |
| Deferred tax assets, net                                                                                                          |       | 20,054             |       | 44,821             |       |
| Other current assets                                                                                                              |       | 12,420             |       | 8,010              |       |
| Total current assets                                                                                                              |       | 396,114            |       | 222,185            |       |
| Long-term investments (restricted)                                                                                                |       | 2,528              |       | 864                |       |
| Long-term receivables, net of allowance for  doubtful accounts of $12 and $15                                                     |       | 12,518             |       | 14,865             |       |
| Net investment in sales type leases                                                                                               |       | 5,614              |       | —             |       |
| Leased gaming equipment, net of accumulated  depreciation of $31,105 and $15,703                                                  |       | 46,634             |       | 25,792             |       |
| Property, plant and equipment, net of  accumulated depreciation and amortization of $23,127 and $20,495                           |       | 75,838             |       | 56,894             |       |
| Goodwill, net                                                                                                                     |       | 136,989            |       | 63,040             |       |
| Intangible assets, net of accumulated  amortization of $12,489 and $12,109                                                        |       | 63,623             |       | 26,631             |       |
| Assets of discontinued operations held for  sale                                                                                  |       | 4,442              |       | 114,314            |       |
| Other assets, net                                                                                                                 |       | 6,354              |       | 580                |       |
| Total assets                                                                                                                      |       | $                  | 750,654    |               | $          | 525,165 |   |
|                                                                                                                              |       |               |       |               |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                        |       |               |       |               |       |
|                                                                                                                              |       |               |       |               |       |
| Current liabilities:                                                                                                              |       |               |       |               |       |
| Accounts payable                                                                                                                  |       | $                  | 37,515     |               | $          | 22,726 |   |
| Accrued liabilities                                                                                                               |       | 51,469             |       | 31,438             |       |
| Jackpot liabilities                                                                                                               |       | 12,075             |       | 10,588             |       |
| Taxes payable                                                                                                                     |       | 7,233              |       | 931                |       |
| Current maturities of long-term debt                                                                                              |       | 5,866              |       | 3,537              |       |
| Liabilities of discontinued operations held  for sale                                                                             |       | 4,337              |       | 14,000             |       |
| Total current liabilities                                                                                                         |       | 118,495            |       | 83,220             |       |
| Long-term debt, net                                                                                                               |       | 423,089            |       | 341,678            |       |
| Deferred tax liabilities                                                                                                          |       | 849                |       | 3,920              |       |
| Other liabilities                                                                                                                 |       | 6,092              |       | 3,387              |       |
| Minority interest                                                                                                                 |       | 1,326              |       | 1,330              |       |
| Total liabilities                                                                                                                 |       | 549,851            |       | 433,535            |       |
| Commitments and contingencies                                                                                                     |       |               |       |               |       |
| Stockholders’ equity:                                                                                                        |       |               |       |               |       |
| Special stock, 10,000,000 shares  authorized: Series E, $100 liquidation value; 115 shares and 115 shares  issued and outstanding |       | 12                 |       | 12                 |       |
| Common stock, $.10 par value; 100,000,000  shares authorized; 51,426,000 and 49,993,000 shares issued                             |       | 5,145              |       | 4,996              |       |
| Treasury stock at cost, 513,000 shares                                                                                            |       | (501               | )          | (501               | )          |
| Deferred compensation (restricted stock  units)                                                                                   |       | (6,500             | )          |               |       |
| Additional paid-in capital                                                                                                        |       | 194,040            |       | 163,267            |       |
| Accumulated other comprehensive income                                                                                            |       | 1,524              |       | 1,287              |       |
| Retained earnings (accumulated deficit)                                                                                           |       | 7,083              |       | (77,431            | )          |
| Total stockholders’ equity                                                                                                   |       | 200,803            |       | 91,630             |       |
| Total liabilities and stockholders’ equity                                                                                   |       | $                  | 750,654    |               | $          | 525,165 |   |

 

See accompanying notes to consolidated financial statements.

 

F-2

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(In 000s, except per share amounts)

 
| ** **                                                                                          | ** ** | **Years Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                                                                           |       |                     |       |   |   |   |   |
| Gaming equipment and systems                                                                        |       | $                        | 436,596    |   | $ | 335,436 |   | $ | 223,703 |   |
| Casino operations                                                                                   |       | 52,280                   |       | 50,945 |   | 52,211 |   |
|                                                                                                |       | 488,876                  |       | 386,381 |   | 275,914 |   |
| Costs and expenses                                                                                  |       |                     |       |   |   |   |   |
| Cost of gaming equipment and systems                                                                |       | 177,586                  |       | 144,352 |   | 98,720 |   |
| Cost of casino operations                                                                           |       | 20,043                   |       | 21,208 |   | 21,021 |   |
| Selling, general and administrative                                                                 |       | 124,345                  |       | 95,432 |   | 75,029 |   |
| Research and development costs                                                                      |       | 36,615                   |       | 19,955 |   | 15,012 |   |
| Depreciation and amortization                                                                       |       | 31,565                   |       | 20,462 |   | 13,929 |   |
|                                                                                                |       |                     |       |   |   |   |   |
|                                                                                                |       | 390,154                  |       | 301,409 |   | 223,711 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Operating income                                                                                    |       | 98,722                   |       | 84,972 |   | 52,203 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Other income (expense):                                                                             |       |                     |       |   |   |   |   |
| Interest income                                                                                     |       | 2,253                    |       | 220 |   | 378 |   |
| Interest expense                                                                                    |       | (17,934                  | )          | (25,645 | ) | (28,229 | ) |
| Minority interest                                                                                   |       | (2,309                   | )          | (2,009 | ) | (1,935 | ) |
| Refinancing charge                                                                                  |       | (12,293                  | )          | — |   | — |   |
| Other, net                                                                                          |       | (521                     | )          | 180 |   | 1,237 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Income from continuing operations before  income taxes                                              |       | 67,918                   |       | 57,718 |   | 23,654 |   |
| Income tax expense (benefit)                                                                        |       | 24,293                   |       | 20,556 |   | (38,440 | ) |
| Net income from continuing operations                                                               |       | 43,625                   |       | 37,162 |   | 62,094 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Discontinued operations:                                                                            |       |                     |       |   |   |   |   |
| Loss on sale of wall machines and amusement  games unit, net                                        |       | —                   |       | (25,358 | ) | — |   |
| Gain on sale of Rail City Casino, net                                                               |       | 14,329                   |       | — |   | — |   |
| Gain on sale of Nevada Route, net                                                                   |       | 9,124                    |       | — |   | — |   |
| Income (loss) from discontinued operations  of wall machines and amusement games business unit, net |       | (2,172                   | )          | (895 | ) | (17,167 | ) |
| Income from discontinued operations of  Nevada Route, net                                           |       | 14,539                   |       | 4,059 |   | 12,580 |   |
| Income from discontinued operations of  Louisiana Route, net                                        |       | 1,768                    |       | 1,288 |   | 1,439 |   |
| Income from discontinued operations of Rail  City Casino, net                                       |       | 3,301                    |       | 3,267 |   | 4,903 |   |
| Income (loss) from discontinued operations                                                          |       | 40,889                   |       | (17,639 | ) | 1,755 |   |
| Net income                                                                                          |       | $                        | 84,514     |   | $ | 19,523 |   | $ | 63,849 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Basic earnings (loss) per share:                                                                    |       |                     |       |   |   |   |   |
| Continuing operations                                                                               |       | $                        | 0.87       |   | $ | 0.76 |   | $ | 1.34 |   |
| Discontinued operations                                                                             |       | 0.82                     |       | (0.36 | ) | 0.04 |   |
|                                                                                                |       | $                        | 1.69       |   | $ | 0.40 |   | $ | 1.38 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Diluted earnings (loss) per share:                                                                  |       |                     |       |   |   |   |   |
| Continuing operations                                                                               |       | $                        | 0.85       |   | $ | 0.74 |   | $ | 1.30 |   |
| Discontinued operations                                                                             |       | 0.80                     |       | (0.35 | ) | 0.04 |   |
|                                                                                                |       | $                        | 1.65       |   | $ | 0.39 |   | $ | 1.34 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Weighted average common shares outstanding                                                          |       | 50,113                   |       | 49,153 |   | 46,281 |   |
|                                                                                                |       |                     |       |   |   |   |   |
| Weighted average common and common share  equivalents outstanding                                   |       | 51,248                   |       | 50,139 |   | 47,507 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-3

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY (DEFICIENCY)**

(In 000s)

 
| ** **                                                                         | ** ** | ** **  | ** ** | ** ** | ** ** | **Series E  Special  Stock** | ** ** | **Treasury  Stock** | ** ** | **Deferred  Comp.** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accum.  Other  Comprehensive  Income (loss)** | ** ** | **Retained  Earnings  (Accum.  Deficit)** | ** ** | **Total  Stockholders’  Equity  (Deficiency)** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------------------|------------|---------------------|------------|---------------------|------------|----------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | ** **  |
| **Common Stock**                                                                   |
| **Shares**                                                                         | ** ** | **Dollars** |
| ** **                                                                         | ** ** | ** **  | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **          | ** ** | ** **          | ** ** | ** **                       | ** ** | ** **                                      | ** ** | ** **                                | ** ** | ** **                                          | ** ** |
| Balances at June 30, 2001                                                          |       | 21,776      |       | $          | 2,178      |                         | $          | 12                  |       | $                   | (501       | )                                | $          | —                                          |       | $                                         | 147,828    |                                                | $          | (27,919 | ) | $ | (160,803 | ) | $ | (39,205 | ) |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Net income                                                                         |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | —                                          |       | 63,849                                    |       | 63,849                                              |       |
| Foreign currency translation adjustment                                            |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | 8,555                                           |       | —                                    |       | 8,555                                               |       |
| Total comprehensive income                                                         |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       | 72,404                                              |       |
| Shares issued upon exercise of options and  warrants before 2-for-1 stock split    |       | 2,809       |       | 283        |       | —                       |       | —              |       | —              |       | 6,246                            |       | —                                          |       | —                                    |       | 6,529                                               |       |
| Common shares issued upon 2-for-1 stock  split                                     |       | 24,585      |       | 2,461      |       | —                       |       | —              |       | —              |       | (2,461                           | )          | —                                          |       | —                                    |       | —                                              |       |
| Tax benefit of employee stock option  exercises                                    |       | —      |       | —     |       | —                       |       | —              |       | —              |       | 6,081                            |       | —                                          |       | —                                    |       | 6,081                                               |       |
| Shares issued upon exercise of options and  warrants after 2-for-1 stock split     |       | 57          |       | 5          |       | —                       |       | —              |       | —              |       | 172                              |       | —                                          |       | —                                    |       | 177                                                 |       |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Balances at June 30, 2002                                                          |       | 49,227      |       | $          | 4,927      |                         | $          | 12                  |       | $                   | (501       | )                                | $          | —                                          |       | $                                         | 157,866    |                                                | $          | (19,364 | ) | $ | (96,954 | ) | $ | 45,986 |   |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Net income                                                                         |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | —                                          |       | 19,523                                    |       | 19,523                                              |       |
| Foreign currency translation adjustment                                            |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | 8,760                                           |       | —                                    |       | 8,760                                               |       |
| Reversal of foreign currency translation  adjustments for Bally Wulff (see Note 4) |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | 11,891                                          |       | —                                    |       | 11,891                                              |       |
| Total comprehensive income                                                         |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       | 40,174                                              |       |
| Shares issued upon exercise of options                                             |       | 706         |       | 69         |       | —                       |       | —              |       | —              |       | 2,487                            |       | —                                          |       | —                                    |       | 2,556                                               |       |
| Tax benefit of employee stock option  exercise                                     |       | —      |       | —     |       | —                       |       | —              |       | —              |       | 2,914                            |       | —                                          |       | —                                    |       | 2,914                                               |       |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Balances at June 30, 2003                                                          |       | 49,933      |       | $          | 4,996      |                         | $          | 12                  |       | $                   | (501       | )                                | $          | —                                          |       | $                                         | 163,267    |                                                | $          | 1,287 |   | $ | (77,431 | ) | $ | 91,630 |   |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Net income                                                                         |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | —                                          |       | 84,514                                    |       | 84,514                                              |       |
| Foreign currency translation adjustment                                            |       | —      |       | —     |       | —                       |       | —              |       | —              |       | —                           |       | 237                                             |       | —                                    |       | 237                                                 |       |
| Total comprehensive income                                                         |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       | 84,751                                              |       |
| Issuance of Restricted Stock Units                                                 |       |        |       |       |       |                         |       |                |       | (6,500              | )          | 6,500                            |       |                                            |       |                                      |       | —                                              |       |
| Restricted shares issued upon acquisition  of SDG                                  |       | 662         |       | 66         |       |                         |       |                |       | —              |       | 11,883                           |       |                                            |       |                                      |       | 11,949                                              |       |
| Additional paid in capital upon issuance of  warrants                              |       |        |       |       |       |                         |       |                |       |                |       | 886                              |       |                                            |       |                                      |       | 886                                                 |       |
| Shares issued upon exercise of options                                             |       | 831         |       | 83         |       |                         |       |                |       |                |       | 7,205                            |       |                                            |       |                                      |       | 7,288                                               |       |
| Tax benefit of employee stock option  exercise                                     |       |        |       |       |       |                         |       |                |       |                |       | 4,299                            |       |                                            |       |                                      |       | 4,299                                               |       |
|                                                                               |       |        |       |       |       |                         |       |                |       |                |       |                             |       |                                            |       |                                      |       |                                                |       |
| Balances at June 30, 2004                                                          |       | 51,426      |       | $          | 5,145      |                         | $          | 12                  |       | $                   | (501       | )                                | $          | (6,500                                          | )          | $                                         | 194,040    |                                                | $          | 1,524 |   | $ | 7,083 |   | $ | 200,803 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-4

----

 

**ALLIANCE GAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

(In 000s)

 
| ** **                                                                                                  | ** ** | **Years Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                  | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from operating activities of  continuing operations:                                             |       |                     |       |   |   |   |   |
| Net income                                                                                                  |       | $                        | 84,514     |   | $ | 19,523 |   | $ | 63,849 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities of continuing operations: |       |                     |       |   |   |   |   |
| Income from discontinued operations                                                                         |       | (40,889                  | )          | (7,720 | ) | (25,884 | ) |
| Write down of goodwill and other assets                                                                     |       | —                   |       | 38,728 |   | 24,129 |   |
| Depreciation and amortization                                                                               |       | 31,565                   |       | 20,462 |   | 13,929 |   |
| Deferred income taxes                                                                                       |       | 23,946                   |       | 3,351 |   | (37,675 | ) |
| Provision for losses on receivables                                                                         |       | 2,357                    |       | 1,537 |   | 2,498 |   |
| Refinance charge                                                                                            |       | 12,293                   |       | — |   | — |   |
| Other                                                                                                       |       | (1,721                   | )          | 355 |   | (558 | ) |
| Change in operating assets and liabilities,  net of effects of businesses acquired:                         |       |                     |       |   |   |   |   |
| Accounts and notes receivable                                                                               |       | (22,117                  | )          | (50,415 | ) | (9,579 | ) |
| Inventories                                                                                                 |       | (7,060                   | )          | 1,006 |   | (2,034 | ) |
| Other current assets                                                                                        |       | (1,049                   | )          | 1,320 |   | (1,449 | ) |
| Accounts payable                                                                                            |       | 8,720                    |       | 7,278 |   | (4,515 | ) |
| Accrued liabilities and jackpot liabilities                                                                 |       | 19,702                   |       | 2,723 |   | (79 | ) |
| Net cash provided by operating activities  of continuing operations                                         |       | 110,261                  |       | 38,148 |   | 22,632 |   |
|                                                                                                        |       |                     |       |   |   |   |   |
| Cash flows from investing activities of  continuing operations:                                             |       |                     |       |   |   |   |   |
| Additions to property, plant and equipment                                                                  |       | (11,840                  | )          | (9,759 | ) | (6,724 | ) |
| Additions to leased gaming equipment                                                                        |       | (38,109                  | )          | (21,357 | ) | (15,099 | ) |
| Acquisitions, net of cash acquired                                                                          |       | (123,495                 | )          | (11,528 | ) | (15,333 | ) |
| Additions to other long-term assets                                                                         |       | (14,587                  | )          | (3,671 | ) | (132 | ) |
| Proceeds from sales of discontinued  operations                                                             |       | 155,212                  |       | — |   | — |   |
| Net cash used in investing activities of  continuing operations                                             |       | (32,819                  | )          | (46,315 | ) | (37,288 | ) |
|                                                                                                        |       |                     |       |   |   |   |   |
| Cash flows from financing activities of  continuing operations:                                             |       |                     |       |   |   |   |   |
| Capitalized debt issuance costs                                                                             |       | (6,954                   | )          | — |   | (662 | ) |
| Proceeds from issuance of long-term debt                                                                    |       | 350,000                  |       | — |   | — |   |
| Payoff of debt from refinancing                                                                             |       | (337,625                 | )          | — |   | — |   |
| Reduction of long-term debt                                                                                 |       | (3,484                   | )          | (4,735 | ) | (1,826 | ) |
| Net change in revolving credit facility                                                                     |       | 70,000                   |       | — |   | — |   |
| Premium paid on early redemption of debt                                                                    |       | (5,399                   | )          | — |   | — |   |
| Proceeds from exercise of stock options and  warrants                                                       |       | 7,288                    |       | 2,556 |   | 6,706 |   |
| Net cash provided by (used in) financing  activities of continuing operations                               |       | 73,826                   |       | (2,179 | ) | 4,218 |   |
|                                                                                                        |       |                     |       |   |   |   |   |
| Effect of exchange rate changes on cash                                                                     |       | 174                      |       | 286 |   | 709 |   |
|                                                                                                        |       |                     |       |   |   |   |   |
| Cash (used in) provided by discontinued  operations                                                         |       | (17,600                  | )          | 17,144 |   | 12,400 |   |
|                                                                                                        |       |                     |       |   |   |   |   |
| Cash and cash equivalents:                                                                                  |       |                     |       |   |   |   |   |
| Increase for year                                                                                           |       | 133,842                  |       | 7,084 |   | 2,671 |   |
| Balance, beginning of year                                                                                  |       | 38,884                   |       | 31,800 |   | 29,129 |   |
| Balance, end of year                                                                                        |       | $                        | 172,726    |   | $ | 38,884 |   | $ | 31,800 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-5

----

 

**ALLIANCE GAMING CORPORATIONS AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****             SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES AND DESCRIPTION OF BUSINESS**

 

*Description of business*

 

AllianceGaming Corporation (“Alliance” or the “Company”), a Nevada corporation, is adiversified, worldwide gaming company that (i) designs, manufactures anddistributes gaming machines and computerized monitoring systems for gamingmachines and (ii) owns and operates one regional casino.

 

In July 2003, the Company announced that it had entered into definitiveagreements for the sale of its Nevada and Louisiana route operations and BallyWulff. In December 2003 the Companyannounced its intention to sell Rail City Casino. The Company completedthe disposition of its Nevada Route operations, Rail City and Bally Wulffduring the fiscal year ended June 30, 2004. Accordingly, these businesses havebeen classified as discontinued operations (see Note 4).

 

In fiscal year 2004, the Company completed the acquisition of CrownGaming (“Crown”), MindPlay LLC (“MindPlay”) and Sierra Design Group (“SDG”)(see Note 3).

 

*Principles of presentation and consolidation*

 

Theaccompanying consolidated financial statements include the accounts of AllianceGaming Corporation, and its wholly owned and partially owned, controlledsubsidiaries. In the case of Video Services, Inc. (“VSI”) which isconsolidated, the Company owns 100% of the voting stock and is entitled toreceive 71% of dividends declared by VSI, if any, at such time that dividendsare declared.

 

The Company is thegeneral partner of Rainbow Casino Vicksburg Partnership (“RCVP”) thepartnership that operates the Rainbow Casino. Pursuant to transactions consummated in March 1995, the RainbowCorporation, which was the former general partner of RCVP became a limitedpartner entitled to receive 10% of the net available cash flows after debtservice and other items, as defined (which amount increases to 20% of suchamount when annual revenues exceed $35.0 million but only on such incrementalamount), payable quarterly through December 31, 2010.  The Company holds the remaining economicinterest in the partnership.

 

The Company consolidatesRCVP and records minority interest expense to reflect the portion of theearnings of VSI and RCVP attributable to the minority shareholders.

 

Allsignificant intercompany accounts and transactions have been eliminated inconsolidation. Certain reclassifications have been made to prior year financialstatements to conform to the current year presentation, and to present RailCity as discontinued operations for all periods presented.

 

*Cash andcash equivalents*

 

Cash equivalents consist of**highly liquiddebt instruments purchased with an original maturity of three months or less atthe date of purchase and are carried at cost, which approximates market value.Cash and cash equivalents also includes cash utilized in Casino Operations whichis held in vaults, cages or change banks which totaled $2.1 million and $2.2million at June 30, 2004 and 2003, respectively. The Company also maintainsjackpot reserve accounts totaling approximately $15.6 million and $14.5 millionat June 30, 2004 and 2003, respectively, to ensure availability of funds to paywide-area progressive jackpot awards.  Inaddition, the Company purchases U.S. Treasury Strip Securities for the benefitof jackpot winners who elect to receive annual instalment payments.  These securities are presented as restrictedlong-term investments in the consolidated balance sheets, and totaled $2.5million and $0.9 million as of June 30, 2004 and 2003, respectively.

 

The Company’sroute operations and casino operations cash balances, which are included indiscontinued operations, totaled $3.5 million and $28.9 million as of June 30,2004 and 2003, respectively.  Thesebalances are included in assets of discontinued operations held for sale in theaccompanying consolidated balance sheets (see Note 4).

 

F-6

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*Inventories*

 

Inventories are stated at the lower of cost, determined on a first-in,first-out basis, or market.  Costelements included for work-in-process and finished goods include raw materials,freight, direct labor and manufacturing overhead. Inventories, net of valuationreserves, consist of the following (in 000s):

 
| ** **      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
|            |       |     |       |     |       |
| Raw materials   |       | $        | 26,050     |     | $          | 13,720 |   |
| Work-in-process |       | 3,324    |       | 789      |       |
| Finished goods  |       | 31,761   |       | 17,593   |       |
| Total           |       | $        | 61,135     |     | $          | 32,102 |   |

 

*Property,plant and equipment and leased gaming equipment*

* *

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

 

Significant replacements and improvements are capitalized; othermaintenance and repairs are expensed. The cost and accumulated depreciation ofassets retired or otherwise disposed of are eliminated from the accounts andany resulting gain or loss is credited or charged to income as appropriate.

 

Property, plant and equipment consist of thefollowing (in 000s):

 
| ** **                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Land and land improvements                      |       | $        | 19,086     |     | $          | 18,816 |   |
| Buildings and leasehold improvements            |       | 29,937   |       | 25,964   |       |
| Gaming equipment                                |       | 29,121   |       | 20,671   |       |
| Furniture, fixtures and equipment               |       | 20,821   |       | 11,938   |       |
| Less accumulated depreciation and  amortization |       | (23,127  | )          | (20,495  | )          |
| Total property, plant and equipment, net        |       | $        | 75,838     |     | $          | 56,894 |   |
|                                            |       |     |       |     |       |
| Leased gaming equipment                         |       | $        | 77,739     |     | $          | 41,495 |   |
| Less accumulated depreciation                   |       |     | (31,105    | )        |       | (15,703 | ) |
| Total leased gaming  equipment, net             |       | $        | 46,634     |     | $          | 25,792 |   |

 

*Impairment of Long-Lived Assets*

 

The Company reviews long-lived assets for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.  Recoverability oflong-lived assets to be held and used are measured by a comparison of thecarrying amount of an asset to future net cash flows expected to be generatedby the asset, undiscounted and without interest.  If such assets are considered to be impaired,the impairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets.

 

F-7

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*Other Intangible Assets*

 

Intangible assets consist primarily of deferred issuance costs forfinancings which are amortized over the life of the related financing, andacquisition-related software and trademarks, which are amortized over 3-13years. Deferred debt issuance costs are amortized and included in theaccompanying consolidated statements of operations in depreciation andamortization expense.

 

*Use of Estimates*

 

The preparation of the consolidated financial statements in conformitywith generally accepted accounting principles in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

*Revenue recognition*

 

Revenue from sales of gaming machines is generally recognized at thetime products are shipped and title has passed to the customer. Games placedwith customers on a trial basis are not recognized as revenue until the trialperiod ends and the customer accepts the games. The Company sells gamingequipment on normal credit terms (generally 2%, net 30) and offers financing toqualified customers for periods generally between 6 and 48 months.

 

Revenue from sales of computerized monitoring systems is recognized inaccordance with the AICPA’s Statement of Position 97-2 “Software RevenueRecognition” (“SOP 97-2”) and Emerging Issues Task Force (“EITF”) issue 00-21,“Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).  In accordance with the provisions of SOP 97-2and EITF 00-21, the contracts for the sales of computerized monitoring unitsare considered to have “multiple elements” because they include hardware,software, installation, supervision, training, and post-contract customersupport. Accordingly, revenues from the sale of systems are deferred and beginto be recognized at the point when the system is deemed to be functionallyoperational, and the residual method is used to recognize revenue for theremaining elements as they are delivered, each having vendor-specific objectiveevidence of relative fair values. Post-contract customer support revenues arerecognized over the period of the support agreement (generally one year).

 

Our Bally Gaming and Systems business unit earns revenues fromrecurring revenue sources that consist of the operations of the wide-areaprogressive jackpot systems and revenues from gaming machines placed in acasino on a daily lease or rental basis. Revenue from these sources isrecognized based on the contractual terms of the participation or rentalagreement and is generally based on a share of money wagered, a share of thenet winnings, or on a fixed daily rental rate basis.

 

In accordance with industry practice, the Company recognizes gamingrevenues in its discontinued route operations and casino operations as the net winfrom gaming machine operations, which is the difference between coins andcurrency deposited into the machines and payments to customers. The Companyrecognizes total net win from gaming machines as revenues for route operations,which the Company operates pursuant to revenue-sharing arrangements andrevenue-sharing payments (either fixed or variable) as a cost of routeoperations.

 

F-8

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*Capitalized Costs*

 

During fiscal year 2004, Bally Gaming and Systems has experienced analmost four fold increase in the volume of product submissions to the variousdomestic regulatory bodies, each of which charges fees for the testing andapproval of each product. Product testing costs are capitalized oncetechnological feasibility has been established and are amortized, generallyover a three year period once the product is placed in service. Product testingcosts related to projects that are discontinued are expensed when suchdetermination is made. During fiscal year 2004, fees incurred for suchregulatory approvals totaled approximately $8.5 million. Of these amountsincurred, the Company capitalized as an intangible asset, a total of $4.8million that was directly attributable to products that have been approved andamortization expense for the year ended June 30, 2004 totaled $0.8 million.

 

*Promotional allowances*

 

The Company accounts for promotional allowances and other cash basedincentives in accordance with EITF Issue 00-22, “Accounting for ‘Points’ andcertain other Time-Based or Volume-Based Sales Incentive Offers, and Offers ForFree Products or Service to be Delivered in the Future.” EITF 00-22 requiresthat sales incentives such as cash rewards provided to player club members berecorded as a reduction of revenue rather than as an operating expense.

 

*Allowances For Collection and Other Losses*

 

Allowances for losses are maintained at levels determined by theCompany’s management to adequately provide for collection losses and anyother-than-temporary declines in other asset values.  In determining estimated losses, theCompany’s management considers economic conditions, the activity in gamingmarkets, the financial condition of customers, changes in technology and otherfactors which management believes are relevant. If a loss is indicated, the loss to be recognized is measured by theamount by which the carrying amount of the asset exceeds the estimated netrealizable value of the asset.  Assetcharge-offs are recorded upon the disposition of the underlying assets.  Management reviews the Company’s assets on aquarterly basis to determine the adequacy of the allowances for losses.

 

*Unusual items*

 

The Companyseparately discloses certain income and expense items that are unusual.Generally such items are netted together and shown as a separate component ofincome from continuing operations; items reflected elsewhere in theconsolidated statements of operations are separately identified below.

 

Fiscal 2004

 

•      Refinancing charge of $12.3 million, whichis more fully described in Note 8.

 

Fiscal 2003:

 

•                  None

 

Fiscal 2002:

 

•                  A tax benefitresulting from the reduction of previously recorded valuation reserves againstnet deferred tax assets, primarily net operating loss carry forwards, totaling$37.0 million which is included in the income tax provision in the accompanyingconsolidated statement of operations (see Note 10).

 

F-9

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*Warranty expense*

 

Gaming devicesare typically sold with a 90-day parts and labor warranty.  For system sales, the Company providesseveral after-sales, value-added services to customers including customereducation programs, a 24-hour customer service telephone hot-line, an Internetweb site for technical support, field service support programs, and spare partsprograms.  Historical warranty expense asa percentage of Gaming and Systems segment revenues has been less than 1%, andis charged to cost of sales.

 

*Research and development*

 

Research and development costs are charged toexpense as incurred because the establishment of technological feasibility ofproducts and their availability for sale (pending regulatory approval) havesubstantially coincided.

 

*Deferred Revenue*

 

Deferred revenue is included in accruedliabilities on the balance sheet, and consists of amounts collected or billedin excess of recognizable revenue.

 

*Foreign currency translation*

 

The functional currency of the Company’s foreign subsidiaries is theirlocal currency. Assets and liabilities of foreign operations are translated intoU.S. dollars at the rate of exchange at the end of the period, and the incomeand expense accounts are translated at the average rate of exchange for theperiod. Translation adjustments are reflected as a separate component ofstockholders’ equity. Gains and losses on foreign currency transactions areincluded in the accompanying consolidated statements of operations.

 

*Stock split*

 

The Company recorded a 2-for-1 stock split, effective August 21, 2001and again on April 9, 2002. All share and per share information presented inthe Consolidated Financial Statements and notes thereto have been presented toreflect the stock splits.

 

*Fair value of financial instruments*

 

The fair value of a financial instrument is the amount at which theinstrument could be exchanged in a current transaction between willing parties,other than in a forced sale or liquidation. The carrying amounts at June 30,2004 and 2003 for the Company’s financial instruments, which include accountsand notes receivable, accounts payable and long-term debt, approximate fairvalue.

 

*Income taxes*

 

Income taxes are accounted for under the asset and liability method.Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of assets and liabilities and their respective tax bases.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in the periodthat includes the enactment date. Taxes on income of the Company’s foreignsubsidiaries are provided at the tax rates applicable to the tax jurisdictionsin which they are located.

 

*Stock-based compensation*

 

The Company accounts for its stock-based employee compensation awardsin accordance with Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”). Under APB 25, because the exercise priceof the Company’s employee stock options equals or exceeds the market price ondate of grant, no compensation expense is recognized.

 

F-10

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As provided under FASB No. 123 “Accounting for Stock-BasedCompensation” (“FASB No. 123”), companies may continue to account for employeestock-based compensation under APB 25, but are required to disclose historicalpro-forma net income and earnings per share that would have resulted from theuse of the fair value method described in FASB No. 123.

 

In December 2002, the FASB issued FASB No.148, “Accounting forStock-Based Compensation-Transition and Disclosure”. This Statement amends FASBNo. 123, to provide alternative methods of transition for a voluntary change tothe fair value based method of accounting for stock-based employeecompensation. In addition, this Statement amends the disclosure requirements ofFASB No. 123 and APB Opinion No. 28 “Interim Financial Reporting” to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. Under fair value method, compensation costs are measured using anoptions pricing model and are amortized over the estimated life of the option,which is generally three to ten years, with option forfeitures accounted for atthe time of the forfeiture, and all amounts are reflected net of tax.  The historical and pro forma net income(assuming an after-tax charge for stock-based compensation) and related pershare data are as follows (in 000s, except per share data) (see Note 9):

 
| ** **                                  | ** ** | **Fiscal Years ended June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income                                  |       |                            |       |   |   |   |   |
| As reported                                 |       | $                               | 84,514     |   | $ | 19,523 |   | $ | 63,849 |   |
| Stock-based compensation under FASB No. 123 |       | (5,377                          | )          | (3,384 | ) | (3,012 | ) |
| Pro forma net income                        |       | $                               | 79,137     |   | $ | 16,139 |   | $ | 60,837 |   |
|                                        |       |                            |       |   |   |   |   |
| Earnings per share:                         |       |                            |       |   |   |   |   |
| Basic – As reported                    |       | $                               | 1.69       |   | $ | 0.40 |   | $ | 1.38 |   |
| Basic – Pro forma                      |       | $                               | 1.58       |   | $ | 0.33 |   | $ | 1.31 |   |
| Diluted – As reported                  |       | $                               | 1.65       |   | $ | 0.39 |   | $ | 1.34 |   |
| Diluted – Pro forma                    |       | $                               | 1.54       |   | $ | 0.32 |   | $ | 1.28 |   |

 

*Recently issued accounting principles*

 

In January 2003, FASB issuedInterpretation No. 46 (“FIN 46”), “Consolidation of Variable InterestEntities,” which addresses consolidation by business enterprises of variableinterest entities that either:  (1) donot have sufficient equity investment at risk to permit the entity to financeits activities without additional subordinated financial support, or (2) thecompany will hold a significant variable interest in, or have significantinvolvement with, an existing variable interest entity.

 

In December 2003, the Financial Accounting Standards Board publishedFASB Interpretation No. 46, Consolidation of Variable Interest Entities(revised December 2003) (“FIN46-R”), clarifying FIN 46 and exempting certainentities from the provisions of FIN 46. Generally, application of FIN 46-R isrequired in financial statements of public entities that have interests instructures commonly referred to as special-purpose entities for periods ending after December 15, 2003,and, for other types of VIEs, for periods ending after December 15, 2004.  The Company has reviewed this pronouncementand determined that the adoption will not have a material impact on theconsolidated financial statements.

 

In May 2003, the FASB issuedStatement of Financial Accounting Standard No. 150 “Accounting for CertainFinancial Instruments With Characteristics of Both Liability and Equity” (“FASBNo. 150”).  FASB No. 150 establishesstandards for how companies classify and measure certain financial instrumentswith characteristics of both liabilities and equity.  FASB No 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003.  The Company adopted the standardon July 1, 2003.  The Company hasdetermined that FASB No. 150 did not have any significant impact on its resultsof operations or financial position.

 

F-11

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**2.****             EARNINGSPER SHARE**

 

The following computation of basic and diluted earnings (loss) pershare from continuing operations, and income (loss) applicable to common sharesas adjusted for the stock splits, are as follows (in 000s except per shareamounts):

 
| ** **                                              | ** ** | **Fiscal Years ended June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                              | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                    |       |                            |       |   |   |   |   |
| Net income from continuing operations                   |       | $                               | 43,625     |   | $ | 37,162 |   | $ | 62,094 |   |
| Net income (loss) from discontinued operation           |       | 40,889                          |       | (17,639 | ) | 1,755 |   |
| Net Income                                              |       | $                               | 84,514     |   | $ | 19,523 |   | $ | 63,849 |   |
|                                                    |       |                            |       |   |   |   |   |
| Weighted average common shares outstanding              |       | 50,113                          |       | 49,153 |   | 46,281 |   |
| Effect of dilutive securities                           |       | 1,135                           |       | 986 |   | 1,226 |   |
| Weighted average common and dilutive shares outstanding |       | 51,248                          |       | 50,139 |   | 47,507 |   |
|                                                    |       |                            |       |   |   |   |   |
| Earnings (loss) per basic share:                        |       |                            |       |   |   |   |   |
| Income from continued operations                        |       | $                               | 0.87       |   | $ | 0.76 |   | $ | 1.34 |   |
| Income (loss) from discontinued operations              |       | 0.82                            |       | (0.36 | ) | 0.04 |   |
|                                                    |       | $                               | 1.69       |   | $ | 0.40 |   | $ | 1.38 |   |
| Earnings (loss) per diluted share:                      |       |                            |       |   |   |   |   |
| Income from continued operations                        |       | $                               | 0.85       |   | $ | 0.74 |   | $ | 1.30 |   |
| Income (loss) from discontinued operations              |       | 0.80                            |       | (0.35 | ) | 0.04 |   |
|                                                    |       | $                               | 1.65       |   | $ | 0.39 |   | $ | 1.34 |   |

 

Dilutedearnings per share represents the potential dilution that could occur if alldilutive securities outstanding were exercised. Certain securities do not havea dilutive effect because their exercise price exceeds the fair market value ofthe underlying stock. Such securities are excluded from the diluted earningsper share calculation and consist of the following (in 000s):

 
| ** **    | ** ** | **Fiscal Years ended June 30,** | ** ** |
|---------------|------------|---------------------------------|------------|
| ** **    | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
|          |       |                            |       |   |   |   |   |
| Stock options |       | 1,498                           |       | 862 |   | 817 |   |
| Warrants      |       | 100                             |       | — |   | — |   |
|          |       | 1,598                           |       | 862 |   | 817 |   |

 

**3.****                                      BUSINESSCOMBINATIONS**

 

Under the purchase method of accounting, the total purchase price isallocated to the net tangible and intangible assets based upon their estimatedfair market values as of the date of the acquisitions. The allocation of thepurchase price to goodwill and intangibles is subject to change based on finalvaluation of net assets (including inventory and property, plant and equipment)and is based upon management’s assessments of independent third-partyvaluations and management’s estimates.

 

***SIERRA DESIGN GROUP***

 

On March 2, 2004, Alliance completed the acquisition of 100% of theshares of privately held SDG, and the results of SDG are included in theconsolidated results of the Company as of that date.  Consideration totaled $126.4 million, andadditional contingent consideration of up to $95.6 million may become payableover the next three years upon the SDG business unit achieving certain revenueand EBITDA targets (as defined in the sale agreement).

 

The combination of the core products of Bally Gaming and Systems, withthe central-determination technology of SDG should allow the Company to offer afull range of gaming products in the global gaming environment.

 

F-12

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The fair values assigned to the SDG assets and liabilities acquiredwere as follows (in 000s):

 
| Tangible Assets:                |   |   |    |
|---------------------------------|--------|--------|---------|
| Cash                            |   | $      | 1,189   |   |
| Accounts receivable             |   | 6,949  |    |
| Inventories                     |   | 12,088 |    |
| Deposits                        |   | 1,576  |    |
| Other current assets            |   | 2,233  |    |
| Investment in sales-type leases |   | 8,241  |    |
| Property, plant and equipment   |   | 22,071 |    |
| Other assets                    |   | 678    |    |
| Deferred tax assets             |   | 8,421  |    |
| Notes receivable                |   | 103    |    |
|                            |   | 63,549 |    |
| Liabilities:                    |   |   |    |
| Customer deposits               |   | 4,973  |    |
| Accounts payable                |   | 6,110  |    |
| Accrued liabilities             |   | 10,833 |    |
| Notes payable                   |   | 3,704  |    |
|                            |   | 25,620 |    |
| Net tangible assets acquired    |   | 37,929 |    |
| Intangible assets acquired:     |   |   |    |
| Contracts                       |   | 12,320 |    |
| Core technology                 |   | 5,445  |    |
| Trademark                       |   | 5,708  |    |
|                            |   | 23,473 |    |
| Goodwill (a)                    |   | 64,991 |    |
| Total purchase price            |   | $      | 126,393 |   |

 

----

(a) Substantially all of goodwill is non-deductible for tax purposes.

 

F-13

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The purchase price paid for SDG consists of the following (inthousands):

 
| Cash paid to SDG stockholders                                    |   | $      | 29,846  |   |
|------------------------------------------------------------------|--------|--------|---------|--------|
| Fair value of restricted Alliance Gaming  common stock issued    |   | 11,949 |    |
| Deferred consideration                                           |   | 1,350  |    |
| Transaction fees and expenses                                    |   | 4,740  |    |
| Subtotal                                                         |   | $      | 47,885  |   |
| SDG loans to third parties                                       |   | 5,688  |    |
| Pre-acquisition loans from Alliance to SDG  forgiven by Alliance |   | 72,820 |    |
| Acquisition cost                                                 |   | $      | 126,393 |   |

 

The followingintangible assets of SDG are being amortized on a straight-line basis usingwith the following estimated lives:

 
| ** **      | ** ** | **Years** | ** ** |
|-----------------|------------|-----------|------------|
| Contracts       |       | 10        |       |
| Core technology |       | 8         |       |
| Trademark       |       | 5         |       |

 

The valueassigned to the restricted stock totaled $11.95 million, and was determined bymanagement’s assessment of an appraisal by an independent third-party, andresulted in a 30% discount to the average of the stock price two days beforeand after the announcement of the acquisition.

 

The followingunaudited proforma financial information is presented as if the SDG acquisitionhad been completed at the beginning of the periods presented below (in 000s,except per share information):

 
| ** **                                      | ** ** | **Twelve months ended** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **(Unaudited)**         | ** ** |
| ** **                                      | ** ** | **June 30,  2004**      | ** ** | **June 30,  2003** | ** ** |
| Total revenue                                   |       | $                       | 550,495    |   | $ | 492,513 |   |
| Income from continuing  operations before taxes |       | 43,718                  |       | 50,965 |   |
| Income from continuing operations               |       | 27,895                  |       | 30,907 |   |
|                                            |       |                    |       |   |   |
| Earnings per share from continuing  operations  |       |                    |       |   |   |
| Basic                                           |       | $                       | 0.56       |   | $ | 0.62 |   |
| Diluted                                         |       | $                       | 0.54       |   | $ | 0.61 |   |

 

***MINDPLAY***

 

On February19, 2004, Alliance completed the acquisition of substantially all of the assetsand liabilities of MindPlay.  Theconsideration consisted of $9.0 million in cash, a note payable totaling $4.0million, the assumption and subsequent payment of $2.0 million of long-termdebt, warrants to purchase 100,000 shares of Alliance common stock valued at$0.9 million, and $0.9 million for the accrual of the present value of theminimum guaranteed earn out described below. The earn out is payable based upon 10% of gross margin from the sale ofMindPlay products for the first seven years, and 4.25% of gross margin for thesubsequent 6 years, subject to adjustments pursuant to the conditions containedin the sale agreement.

 

F-14

----

 

The fair values assigned to the MindPlay assets and liabilitiesacquired are as follows (in 000s):

 
| Tangible Assets:              |   |   |   |
|-------------------------------|--------|--------|--------|
| Cash                          |   | $      | 22     |   |
| Accounts receivable           |   | 41     |   |
| Inventories                   |   | 110    |   |
| Property, plant and equipment |   | 143    |   |
| Other Assets                  |   | 43     |   |
|                          |   | 359    |   |
| Liabilities:                  |   |   |   |
| Customer deposits             |   | 467    |   |
| Net tangible assets acquired  |   | (108   | )      |
|                          |   |   |   |
| Intangible assets acquired:   |   |   |   |
| Patents                       |   | 9,470  |   |
| Other Intangibles             |   | 1,015  |   |
| Goodwill                      |   | 6,414  |   |
| Total Purchase Price          |   | $      | 16,791 |   |

 

The acquiredpatents, which are classified as intangible assets, are being amortized overthe remaining life of the patents, which is approximately 15 years.

 

***CROWN GAMING***

 

On December 31, 2003, Alliance acquired 100% of the assets ofU.K.-based Crown Gaming from Crown Leisure Limited.   The acquisition, which includes Crown’sdistributorship agreements for a wide variety of automated table games andvideo bingo machines, strategically builds on the Company’s focus towardsfuture growth projected in England.  The total cash consideration was $3.9 millionof which approximately $2.0 million was used to payoff existing notes payable.

 

The fair values assigned to the Crown assets and liabilities are asfollows (in 000s):

 
| Tangible Assets:             |   |   |   |
|------------------------------|--------|--------|--------|
| Inventories                  |   | $      | 2,064  |   |
| Other Assets                 |   | 661    |   |
|                         |   | 2,725  |   |
| Liabilities:                 |   |   |   |
| Accounts payable             |   | 1,295  |   |
| Accrued liabilities          |   | 21     |   |
| Taxes payable                |   | 527    |   |
|                         |   | 1,843  |   |
|                         |   |   |   |
| Net tangible assets acquired |   | 882    |   |
| Intangible assets acquired:  |   |   |   |
| Other Intangible assets      |   | 659    |   |
| Goodwill                     |   | 335    |   |
| Total Purchase Price         |   | $      | 1,876  |   |

 

The acquiredpatents, which are classified as intangible assets, are being amortized overthe remaining life of the patents, which is approximately 15 years.

 

**4.****             DISCONTINUEDOPERATIONS**

 

In July 2003the Company announced it had entered into definitive sale of its routeoperations segment consisting of United Coin Machine Co. (“UCMC”) and VideoServices, Inc. (“VSI”) and its German wall machine and amusement games segment(Alliance Automaten GmbH & Co. KG dba Bally Wulff). In December 2003 theCompany announced its intention to sell Rail City Casino.  In each case, depreciation and amortizationexpense was ceased as of the date each was designated to be a discontinuedoperation.

 

F-15

----

 

On June 30,2004, the Company completed the sale of UCMC to Century Gaming, Inc. andreceived approximately $100 million in cash and the assumption by CenturyGaming of approximately $5 million in debt. The Company reported a gain on the sale before income taxes of $15.3million, or $9.1 million after tax.

 

On May 3,2004, the Company completed the sale of Rail City Casino to The Sands Regentand subsequently received a total of $37.9 million in cash.    The Company reported a gain on the salebefore income taxes of $23.1 million, or $14.3 million after tax.

 

On June 30, 2003 the Company entered into adefinitive agreement for the sale of Bally Wulff to a third party equityinvestor for $16.5 million in cash. The sale was consummated on July 18,2003.  The Company recorded a charge inJune 2003 totaling $25.4 million, net of tax, representing the final write downof the net carrying value of the Bally Wulff assets to the sales price,including the recognition of previously recorded currency translationadjustments totaling $11.9 million.  InJune 2004, the Company was notified by the buyer of a claim made against theCompany pursuant to an indemnity provision contained in the saleagreement.  The Company has paid theclaim totaling $1.7 million, which is included in discontinued operations.  Additionally, the Company accrued $0.5million for potential tax assessments related to the pre-sale period, which theCompany expects to be resolved by September 2004.  Pursuant to the sale agreement, the Companyused $5.6 million of the sale proceeds to purchase a 5 million Euro certificateof deposit as collateral for the tax claim discussed above which is included inother assets at June 30, 2004.

 

During fiscal year 2003, the Company enteredinto a definitive agreement to sell 100 percent of VSI’s stock to GentillyGaming, LLC. The all-cash transaction was subject to customary closingconditions, but did not close on June 30, 2004 as expected.  Concurrent with the sale agreement, VSI hasentered into a 12-month operating agreement extension under terms andconditions that are the same as the existing agreement with the Fair GroundsCorporation which was subsequently extended for an additional 12 month periodended June 30, 2005.  The Company willcontinue its efforts to divest this subsidiary, and as such will continue tocarry the asset as a discontinued operation.

 

As a result of the transactions describedabove, each of the four businesses is now treated as discontinued operations,and as of June 30, 2004 only VSI remains as held for sale. However, all fourbusiness results are presented net of applicable income taxes within incomefrom discontinued operations in the accompanying consolidated statements ofoperations. The net assets of the businesses are classified as assets held forsale in the accompanying consolidated balance sheets.

 

Summary operating results for thediscontinued operations for UCMC, VSI, Rail City and Bally Wulff are as follows(in 000s):

 
| ** **                                  | ** ** | **Fiscal Years ended June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenues                                |       | $                               | 257,142    |   | $ | 298,739 |   | 318,870 |   |
| Asset impairment charges                    |       | —                          |       | 38,728 |   | 24,129 |   |
| Operating income (loss)                     |       | 30,668                          |       | (26,576 | ) | 4,188 |   |
| Income tax expense (benefit)                |       | (26,319                         | )          | (8,665 | )(a) | 2,563 |   |
| Income (loss) from discontinued  operations |       | $                               | 40,889     |   | $ | (17,639 | ) | 1,755 |   |

 

----

(a)                Includes a net deferred tax benefit totaling$13.4 million, which was recorded for the sale of Bally Wulff.

 

F-16

----

 

The following schedule reflects the netassets held for sale, included in the accompanying consolidated balance sheetsconsisting of UCMC, Rail City, VSI and Bally Wulff as of June 30, 2003, and VSIas of June 30, 2004 (in 000’s):

 
| ** **                             | ** ** | **Fiscal Years ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| Cash and cash equivalents              |       | $                               | 3,543      |   | $ | 28,918 |   |
| Accounts and contracts  receivable     |       | 89                              |       | 21,627 |   |
| Other current assets                   |       | 66                              |       | 5,200 |   |
| Property, plant and equipment          |       | 696                             |       | 33,316 |   |
| Intangible assets                      |       | —                          |       | 21,695 |   |
| Other                                  |       | 48                              |       | 3,558 |   |
| Total assets                           |       | 4,442                           |       | 114,314 |   |
|                                   |       |                            |       |   |   |
| Current liabilities                    |       | 4,321                           |       | 9,727 |   |
| Long-term liabilities                  |       | 16                              |       | 4,273 |   |
| Total liabilities                      |       | 4,337                           |       | 14,000 |   |
|                                   |       |                            |       |   |   |
| Net assets of discontinued  operations |       | $                               | 105        |   | $ | 100,314 |   |

 

**5.****             RECEIVABLES**

 

The Gaming Equipment and Systems business unit grants customers paymentterms under contracts of sale. These contracts are generally for terms of oneto four years, with interest at prevailing rates, and are generallycollateralized by the related equipment sold, although the value of suchequipment, if repossessed, may be less than the receivable balance outstanding.See Note 13.

 

The following table represents, at June 30, 2004, scheduled collectionsof accounts receivable, sales type leases, and notes receivable, and (net ofallowances for doubtful accounts) by fiscal year (in 000s):

 

| **Years ending June 30,** |   |
|---------------------------|--------|
|                      |   |   |   |   |
| 2005                      |   |   | $ | 135,731 |   |
| 2006                      |   |   | 5,624 |   |
| 2007                      |   |   | 4,108 |   |
| 2008                      |   |   | 1,313 |   |
| 2009                      |   |   | 453 |   |
| 2010                      |   |   | 682 |   |
| Thereafter                |   |   | — |   |
| Total                     |   |   | $ | 147,911 |   |

 

**6.             INTANGIBLE ASSETSAND GOODWILL**

 

In July 2001, the Company adopted FASB No. 142 “Goodwill and OtherIntangible Assets”, which requires companies to cease amortizing goodwill andcertain intangible assets with indefinite useful lives.  Instead, goodwill and intangible assetsdeemed to have indefinite useful lives are to be reviewed for impairmentannually at the reporting unit level (Gaming equipment and systems, and casinooperations).  There was no impairment ofgoodwill upon adoption of FASB No. 142. No impairment was charged to goodwillin fiscal 2003 or 2004.

 

F-17

----

 

The Company evaluates the carrying value of goodwill for impairmentannually during the fourth quarter or whenever events or changes incircumstances indicate that the carrying value of goodwill may not berecoverable. Indicators that could trigger an impairment review include changesin legal, regulatory, or economic factors, market conditions or operationalperformance. Impairment is measured as the difference between the carryingamount and the fair value of the intangible assets and is recognized as acomponent of income from operations.

 

Intangible assets excluding discontinued operations consist of thefollowing (in 000’s):

 
| ** **                            | ** ** | ** **                        | ** ** | **June 30, 2004**           | ** ** | **June 30, 2003**             | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **Wt. Avg  Useful Life  (years)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| Computer Software                     |       | 3                                 |       | $                           | 23,450     |                          | $          | (5,885 | ) | $ | 17,565 |   | $ | 20,036 |   | $ | (3,207 | ) | $ | 16,829 |   |
| License Rights                        |       | 3-5                               |       | 2,745                       |       | (1,979                        | )          | 766 |   | 2,592 |   | (1,817 | ) | 775 |   |
| Capitalized regulatory approval costs |       | 3                                 |       | 4,767                       |       | (833                          | )          | 3,934 |   | — |   | — |   | — |   |
| CRM Project                           |       | 5                                 |       | 252                         |       | (39                           | )          | 213 |   | 106 |   | (3 | ) | 103 |   |
| PLM Project                           |       | 5                                 |       | 1,585                       |       | —                        |       | 1,585 |   | 845 |   | — |   | 845 |   |
| Trademarks                            |       | 5                                 |       | 6,688                       |       | (288                          | )          | 6,400 |   | 980 |   | (142 | ) | 838 |   |
| Patents                               |       | 13                                |       | 9,470                       |       | (307                          | )          | 9,163 |   | — |   | — |   | — |   |
| Non-Compete Agreements                |       | 6                                 |       | 275                         |       | —                        |       | 275 |   | — |   | — |   | — |   |
| Customer Relationships                |       | 5                                 |       | 740                         |       | —                        |       | 740 |   | — |   | — |   | — |   |
| Core Technology                       |       | 8                                 |       | 5,445                       |       | (227                          | )          | 5,218 |   | — |   | — |   | — |   |
| Deferred Financing Costs              |       | 6                                 |       | 6,910                       |       | (1,017                        | )          | 5,893 |   | 13,511 |   | (6,470 | ) | 7,041 |   |
| Contracts                             |       | 10                                |       | 12,100                      |       | (411                          | )          | 11,689 |   | — |   | — |   | — |   |
| Other Intangibles                     |       | 7                                 |       | 1,685                       |       | (1,503                        | )          | 182 |   | 670 |   | (470 | ) | 200 |   |
| Total                                 |       |                              |       | $                           | 76,112     |                          | $          | (12,489 | ) | $ | 63,623 |   | $ | 38,740 |   | $ | (12,109 | ) | $ | 26,631 |   |

 

Amortization expense totaled $6.8 million, $4.7 million and $3.1million for the fiscal years ended June 30, 2004, 2003 and 2002, respectively.Computer software amortization expense totaled $2.9 million, $1.8 million and$0.8 million for the fiscal year ended June 30, 2004, 2003 and 2002,respectively.

 

Future amortization of intangible assets isscheduled as follows (in 000s):

 
| **Years ending June 30,** |   |
|---------------------------|--------|
|                      |   |   |   |
| 2005                      |   |   | $ | 9,211 |   |
| 2006                      |   |   | 8,636 |   |
| 2007                      |   |   | 6,778 |   |
| 2008                      |   |   | 5,509 |   |
| 2009                      |   |   | 4,882 |   |
| Thereafter                |   |   | 28,607 |   |
| Total                     |   |   | $ | 63,623 |   |

 

F-18

----

 

*Goodwill*

 

The changes in the carrying amount of goodwill for the years ended June30, 2003 and 2004, are as follows (in 000’s):

 
| ** **                                            | ** ** | **Total** | ** ** |
|-------------------------------------------------------|------------|-----------|------------|
|                                                  |       |      |       |
| Balance as of June 30, 2002                           |       | $         | 45,959     |   |
|                                                  |       |      |       |
| Goodwill acquired during year                         |       | 15,729    |       |
| Foreign currency translation adjustment               |       | 1,391     |       |
| Goodwill written off due to sale of Bally  Wulff      |       | (39       | )          |
| Balance as of June 30, 2003                           |       | 63,040    |       |
|                                                  |       |      |       |
| Goodwill acquired during year                         |       | 71,740    |       |
| Adjustments to goodwill from prior year  acquisitions |       | 1,041     |       |
| Foreign currency translation adjustment               |       | 1,168     |       |
| Balance as of June 30, 2004                           |       | $         | 136,989    |   |

 

Adjustments togoodwill from prior year acquisitions primarily represent managements finalallocation and assessment based upon independent third-party valuations ofMicroClever Consulting and Honeyframe Systems Development LTD.

 

**7.             ACCRUED AND JACKPOTLIABILITIES**

 

Accrued liabilities consist of the following (in 000s):

 
| ** **                              | ** ** | **2004**      | ** ** | **2003**   | ** ** |
|-----------------------------------------|------------|---------------|------------|------------|------------|
| ** **                              | ** ** | **(In 000s)** | ** ** | ** ** | ** ** |
|                                    |       |          |       |       |       |
| Payroll and related costs               |       | $             | 11,905     |       | $          | 9,765 |   |
| Interest                                | ** ** | 1,265         |       | 7,125      | ** ** |
| Professional and consulting fees        |       | 3,102         |       | 806        |       |
| Deferred revenues, sales and use taxes  |       | 5,113         |       | 5,545      |       |
| Capitalized regulatory approval costs   |       | 652           |       | —     |       |
| Royalties, rebates, direct mail coupons |       | 6,607         |       | 1,198      |       |
| Customer deposits                       |       | 9,896         |       | 3,407      |       |
| Acquisition related accruals            |       | 3,806         |       | —     |       |
| Divestiture related accruals            |       | 4,377         |       | —     |       |
| Other                                   |       | 4,746         |       | 3,592      |       |
| Subtotal                                |       | 51,469        |       | 31,438     |       |
| Jackpots accrued not yet awarded        |       | 12,075        |       | 10,588     |       |
| Total accrued liabilities               |       | $             | 63,544     |       | $          | 42,026 |   |

 

The Company recognizes liability for Jackpot expense for the cost tofund these jackpots in the future. Generally winners may elect to receive a single lump sum payment or mayopt to receive payments in equal installments over a specified period of time.The most recent history pattern indicates that approximately 85% of winnerswill elect the single payment option. The Company funds jackpot installmentpayments through qualifying U.S. government or agency securities. The presentvalue of the outstanding progressive jackpot liabilities is computed based uponthe payment stream discounted at the applicable discount rate.

 

F-19

----

 

**8.****                                      LONG-TERMDEBT**

 

Long-term debtat June 30, 2004 and 2003 consisted of the following (in 000s):

 
| ** **                                                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Term Loan facility                                                                          |       | $        | 350,000    |     | $          | 187,625 |   |
| Revolving credit facility                                                                   |       | 70,000   |       | —   |       |
| 10 % Senior Subordinated Notes due 2007,  net of unamortized discount of  $0 and  $416 |       | —   |       | 149,663  |       |
| Other, generally unsecured                                                                  |       | 8,955    |       | 7,927    |       |
|                                                                                        |       | 428,955  |       | 345,215  |       |
| Less current maturities                                                                     |       | 5,866    |       | 3,537    |       |
| Long-term debt, less current maturities                                                     |       | $        | 423,089    |     | $          | 341,678 |   |

 

On September 5, 2003, the Company completed a senior bank debtrefinancing transaction (the “Refinancing”) whereby the Company entered into anew $275 million term loan facility and a $125 million revolving creditfacility. Proceeds from the new loans were used to repay the existing bank termloans totaling approximately $188 million, repay the 10% Senior SubordinatedNotes (“Subordinated Notes”), and to pay transaction fees and expenses totaling$5.0 million which have been capitalized and are being amortized on thestraight-line basis, over the remaining term of the loan.  The new term loan had an interest rate ofLIBOR plus 2.75%, which was later reduced to LIBOR + 2.50% (or 3.79% as of June30, 2004), has a 1% per year mandatory principal amortization after the firstyear, and a 6-year maturity. The revolving credit facility has an interest rateof LIBOR plus 2.50% (or 3.79% as June 30, 2004), and the commitment decreasesratably over its 5-year term to a 60% balloon. During the December 2003 quarter the Company increased the term loan by$75 million, to a total of $350 million outstanding.  The proceeds were used primarily to fund theacquisition of SDG.  As a result theCompany incurred an additional $1.3 million in debt issuance costs, which havebeen capitalized and will be amortized on the straight-line basis over theremaining term of the loan.

 

As a result of the sale of UCMC and Rail City, the terms of the bankloan agreement requires the use of approximately 50% of the net proceeds (asdefined in the agreement) to reduce the term loan and revolver principalbalances on a pro rata basis.  Therevolver commitment of $125 million remains unaffected.  The exact amount of the debt repayment issubject to final adjustment in December 2004, however in August 2004 theCompany made an estimated term loan pay down of $31.6 million, and usedadditional excess cash to reduce the balance of the revolver from $70 millionto zero.

 

On August 13,2003, the Company initiated a tender offer and consent solicitation for all ofthe outstanding Subordinated Notes at a price of 103.33% plus a .25% tenderpremium which was contingent on the closing of the new bank facility.  On September 10, 2003, the tender offerperiod expired, with $78.6 million of the Subordinated Notes having beentendered.  On September 11, 2003, theCompany initiated redemption of the remaining Subordinated Notes at a price of103.33%, which was completed on September 16, 2003, at which time theSubordinated Notes were fully redeemed.

 

As a result ofthe Refinancing described above, the Company recorded a pre-tax charge in thequarter ended September 30, 2003 of $12.3 million, which includes a $5.0million charge for the early extinguishment of the Subordinated Notes, $7.0million for the non-cash write off of deferred financing costs, and $0.3million in fees and expenses.

 

The Company’sdebt structure at June 30, 2003 consisted primarily of a $190 million term loanfacility and a $23.7 million undrawn revolving credit facility and $150 millionSubordinated Notes. The term loan had an interest rate of LIBOR plus 3.25%.

 

The new bankfacility is collateralized by substantially all domestic property and isguaranteed by each domestic subsidiary of the Company, other than the entitythat holds the Company’s interest in its Louisiana and Mississippi operations,and is secured by a Pledge Agreement. The bank facility contains a number ofmaintenance covenants and other significant covenants that, among other things,restrict the ability of the Company and the ability of certain of itssubsidiaries to dispose of assets, incur additional indebtedness and issuepreferred stock, pay dividends or make other distributions, enter into certainacquisitions, repurchase equity interests or subordinated indebtedness, issueor sell equity interests of the Company’s subsidiaries, engage in mergers oracquisitions, or engage in certain transactions with subsidiaries andaffiliates, and that otherwise restrict corporate activities.  As of June 30, 2004, the Company is incompliance with these covenants.

 

The other debttotaling approximately $9.0 million as of June 30, 2004, consists primarily ofthe debt owed to the former principles of MCC, MindPlay and CMS totaling $2.4million, $4.0 million, and $0.7 million, respectively.  The loans are due at various dates between2005 and 2006 and bear rates of interest between LIBOR + 2% (3.5% as of June30, 2004) and 6% and are generally unsecured.

 

F-20

----

 

Maturities oflong-term debt, for each of the five fiscal years ending subsequent to June 30,2004, are as follows (in 000s):

 

| **Years ending June 30,** | ** ** |
|---------------------------|------------|
|                      |       |   |   |
| 2005                      |       |   | $ | 5,866 |   |
| 2006                      |       |   | 7,302 |   |
| 2007                      |       |   | 4,099 |   |
| 2008                      |       |   | 5,500 |   |
| 2009                      |       |   | 3,500 |   |
| Thereafter                |       |   | 402,688 |   |
| Total                     |       |   | $ | 428,955 |   |

 

**9.             STOCKHOLDERS’EQUITY, OPTIONS, WARRANTS AND RIGHTS**

 

*Stock Option Plans*

 

In December 2001, the Company’s shareholders approved the 2001Long-Term Incentive Plan (the “2001 Plan”), which provides for the issuance ofup to 7,500,000 shares (as amended in fiscal year 2004) of common stock toCompany employees, directors and designated paid consultants. Generally,options are granted at the fair value of the Company’s common stock at the dateof grant and are exercisable over five to ten years.  The 2001 Plan has also been amended to allowfor the issuance of restricted stock units (“RSU’s”).  A total of 377,030 RSU’s were granted on June30, 2004, as part of the employment agreement of the Company’s new ChiefExecutive Officer.  The RSU’s grantedwere treated as deferred compensation, and accordingly the deferredcompensation charge of $6.5 million was recorded in the Statement ofStockholders’ Equity as of the grant date, which will be amortized over thethree years of Mr. Haddrill’s employment agreement.

 

In April 1997, the Company’s shareholders approved the 1996 Long-TermIncentive Plan (the “1996 Plan”), which provides for the issuance of up to3,428,000 shares of common stock to Company employees, directors and designatedpaid consultants. Generally, options are granted at the fair value of theCompany’s common stock at the date of grant and are exercisable over five toten years.

 

In 1992, the Company created the 1991 Long Term Incentive Plan (the“1991 Plan”) that, as amended, provides for the issuance of up to 3,428,000shares of common stock to Company employees and directors. Generally, optionsare granted at the fair market value of the Company’s Common Stock at the dateof the grant and are exercisable over five to ten years.

 

F-21

----

 

Transactions involving stock options and RSU’s are summarized asfollows:

 
| ** **                     | ** ** | **Options Outstanding** | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **Shares**              | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| Balance, June 30, 2001         |       | 4,898,352               |       | $ | 2.43 |   |
|                           |       |                    |       |   |   |
| Granted                        |       | 1,058,370               |       | 12.62 |   |
| Exercised                      |       | (2,836,254              | )          | 2.24 |   |
| Canceled                       |       | (36,496                 | )          | 4.04 |   |
| Balance, June 30, 2002         |       | 3,083,972               |       | $ | 5.93 |   |
|                           |       |                    |       |   |   |
| Granted                        |       | 1,037,972               |       | 16.32 |   |
| Exercised                      |       | (709,865                | )          | 3.70 |   |
| Canceled                       |       | (102,453                | )          | 11.40 |   |
| Balance, June 30, 2003         |       | 3,309,626               |       | $ | 9.51 |   |
|                           |       |                    |       |   |   |
| Granted                        |       | 2,985,803               |       | 22.16 |   |
| Restricted Stock Units granted |       | 377,030                 |       | — |   |
| Exercised                      |       | (834,705                | )          | 8.74 |   |
| Canceled                       |       | (135,021                | )          | 18.00 |   |
| Balance, June 30, 2004         |       | 5,702,733               |       | $ | 15.50 |   |

 
| ** **              | ** ** | **Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|-------------------------|------------|------------|------------|--------------------------------------|------------|
| Options exercisable at: |       |       |       |                                 |       |
| June 30, 2002           |       | 2,020,650  |       | $                                    | 3.52       |   |
| June 30, 2003           |       | 2,048,132  |       | $                                    | 6.31       |   |
| June 30, 2004           |       | 1,846,942  |       | $                                    | 8.31       |   |

 

At June 30, 2004, the range of exercise prices for options outstandingwas $0.53 to $25.04. The weighted average remaining contractual life, by rangeof exercise price, for options and RSU’s outstanding and exercisable at June30, 2004 is as follows:

 
| ** **                     | ** ** | **Options Outstanding**                        | ** ** | ** ** | ** ** | **Options Exercisable**            | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------------------------------------------|------------|------------|------------|------------------------------------|------------|------------|------------|
| **Range  of  Exercise Prices** | ** ** | **Weighted-Avg.  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-Avg.  Exercise  Price** | ** ** | **Shares** | ** ** |
| $0.00 - $1.00                  |       |                                           | 5.6        |       | 204,620    |                               | $          | 0.81       |       | 204,620 |   |
| $1.01 - $2.00                  |       |                                           | 5.6        |       | 34,012     |                               | 1.44       |       | 34,012     |   |
| $2.01 - $3.00                  |       |                                           | 4.2        |       | 17,144     |                               | 2.63       |       | 17,144     |   |
| $3.01 - $4.00                  |       |                                           | 2.4        |       | 738,696    |                               | 3.13       |       | 738,696    |   |
| $4.01 - $10.00                 |       |                                           | 4.9        |       | 119,624    |                               | 6.79       |       | 99,620     |   |
| $10.01 - $13.00                |       |                                           | 7.8        |       | 104,642    |                               | 12.34      |       | 69,800     |   |
| $13.01 - $14.00                |       |                                           | 7.5        |       | 432,974    |                               | 13.78      |       | 241,726    |   |
| $14.01 - $20.00                |       |                                           | 8.4        |       | 1,357,163  |                               | 16.68      |       | 366,996    |   |
| $20.01 - $33.17                |       |                                           | 9.3        |       | 2,316,828  |                               | 22.16      |       | 74,328     |   |
| All Options                    |       |                                           | 7.0        |       | 5,325,703  |                               | $          | 8.31       |       | 1,846,942 |   |
|                           |       |                                           |       |       |       |                               |       |       |       |   |
| Restricted  Stock Units        |       |                                           | —     |       | 377,030    |                               | —     |       | —     |   |
|                           |       |                                           |       |       | 5,702,733  |                               |       |       | 1,846,942  |   |

 

On the date of grant using the Black-Scholes option-pricing model, thefollowing assumptions were used to estimate the grant-date fair value of theoptions in the periods indicated:

 

F-22

----

 
| ** **                                | ** ** | **Fiscal Years ended June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| Risk-fee interest rate (weighted average) |       | 2.5                             | %          | 3.5 | % | 3.5 | % |
| Expected volatility                       |       | 0.26                            |       | 0.28 |   | 0.70 |   |
| Expected dividend yield                   |       | 0                               | %          | 0 | % | 0 | % |
| Expected life                             |       | 3-10 years                      |       | 3-10 years |   | 3-10 years |   |

 

The resulting fair values applied to the options granted were $8.86,$6.19 and $8.34 per share for the years ended June 30, 2004, 2003 and 2002,respectively.

 

*Warrants*

 

In February 2004, the Company completed the acquisition ofsubstantially all of the assets of MindPlay. A portion of the consideration consisted of 100,000 stock purchasewarrants with a strike price of $24.69, and a term of 7 years.  The warrants were valued at $886,000 and wereincluded as part of the purchase price.

 

*Share Repurchase Plan*

 

In January1999 the Company’s Board of Directors approved a share repurchase plan for upto 4.6 million (post-split) shares of its Common Stock. Under the plan, subjectto price and market conditions, purchases of shares can be made from time totime in the open market or in privately negotiated transactions using availablecash. During the fiscal year ended June 30, 2001 the Company repurchased416,000 shares of common stock and has not purchased any additional shares inthe subsequent fiscal years.

 

*SharesReserved*

 

The followingshares are reserved for options issued and available for issue under theCompany’s stock plans:

 
| Stock options and restricted stock units  issued and currently outstanding |   | 5,702,733 |   |
|----------------------------------------------------------------------------|--------|-----------|--------|
| Stock options available for future issuance                                |   | 2,721,932 |   |
| Shares underlying Series E Special Stock  outstanding                      |   | 2,000     |   |
| Total                                                                      |   | 8,426,665 |   |

 

*Stockholder Rights Plan*

 

In February1998, the Company’s Board of Directors adopted a Stockholder Rights Plan(“Plan”). The Plan is designed to preserve the long-term value of theshareholders’ investment in the Company. Pursuant to the Plan, each shareholderreceived a distribution of one Right for each share of the Company’soutstanding common stock of record on March 12, 1998. Each Right expires onMarch 12, 2008, and entitles the holder to purchase one one-hundredth (1/100)of a share of a Series F Special Stock for $87.50. Initially the Rights arerepresented by the Company’s common stock certificates and are not exercisable.The Rights become exercisable only after a person or group acquires beneficialownership of 10% or more of the Company’s Common Stock (or 15% if the acquireris an institutional investor) or publicly announces its intention to commence atender offer that would result in that beneficial ownership level. Undercertain circumstances involving a buyer’s acquisition of 10% of the Company’sCommon Stock (or 15% in the case of an institutional investor), all Rightsholders except the buyer will be entitled to purchase Common Stock at halfprice. If the Company is acquired through a merger, after such an acquisition,all Rights holders except the buyer will be entitled to purchase stock in thebuyer at half price. The Company may redeem the rights at $0.0035 at any timebefore a buyer acquires 10% (or 15% in the case of an institutional investor)of the Company’s Common Stock.

 

F-23

----

 

*Special Stock*

 

The Company’sArticles of Incorporation authorize the issuance of up to 10,000,000 shares ofspecial stock (“Special Stock”).  Todate, there have been four series of Special Stock authorized for issuance: theInitial Series, the Series B, the Series E and the Series F.  Special Stock consists of non-voting stockwhere no holder of the Special Stock shall be entitled to vote at any meetingof stockholders or otherwise, except as may be specifically provided by law oras approved by the Board of Directors in certain limited circumstances at thetime of the stock issuance. The Special Stock may be issued from time to timein one or more series, each series having such designations, preferences andrelative, participating, optional or other special rights, qualifications,limitations or restrictions as shall be stated and expressed in the resolutionproviding for the issuance of Special Stock or any series thereof adopted bythe Board of Directors.

 

In June 1996, the Company issued sharesof Series E Special Stock to certain holders of the Company’s 71⁄2% ConvertibleSubordinated Debentures (which were retired in 1996) who elected to receivesuch stock in lieu of receiving common stock. The holders of shares of Series ESpecial Stock have no voting rights except as required by law.  A total of 115 shares of Series E SpecialStock remain outstanding.

 

**10.****                               INCOMETAXES**

 

The components of the Company’s income taxexpense (benefit) for continuing operations for the years ended June 30,2004, 2003 and 2002 are as follows (in 000s):

 
| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax expense (benefit):   |       |     |       |     |       |     |       |
| Federal                          |       | $        | (192       | )        | $          | (418     | )          | $ | (292 | ) |
| Foreign                          |       | 683      |       | 1,644    |       | 16       |       |
| State                            |       | 1,303    |       | 982      |       | 663      |       |
|                             |       | 1,794    |       | 2,208    |       | 387      |       |
| Deferred tax expense (benefit):  |       |     |       |     |       |     |       |
| Federal                          |       | 19,099   |       | 17,963   |       | (37,577  | )          |
| Foreign                          |       | —   |       | 17       |       | —   |       |
| State                            |       | 3,400    |       | 368      |       | (1,250   | )          |
|                             |       | 22,499   |       | 18,348   |       | (38,827  | )          |
| Total provision for income taxes |       | $        | 24,293     |     | $          | 20,556   |       | $ | (38,440 | ) |

 

A reconciliation of the Company’s income taxprovision as compared to the tax provision for continuing operations calculatedby applying the statutory federal tax rate (35%) to the income (loss) fromcontinuing operations before income taxes for the years ended June 30,2004, 2003 and 2002 are as follows (in 000s):

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                        |       |     |       |     |       |     |       |
| Computed expected income tax expense at 35% |       | $        | 23,771     |     | $          | 20,201   |       | $ | 9,995 |   |
| Permanent differences                       |       | 1,805    |       | 133      |       | (363     | )          |
| Change in valuation allowance               |       | (1,809   | )          | (943     | )          | (47,470  | )          |
| State income taxes, net of federal benefit  |       | 2,991    |       | 1,007    |       | (819     | )          |
| Tax credits, net change                     |       | (2,106   | )          |     |       |     |       |
| Other, net                                  |       | (359     | )          | 158      |       | 217      |       |
|                                        |       | $        | 24,293     |     | $          | 20,556   |       | $ | (38,440 | ) |

 

F-24

----

 

The major components of the deferred taxassets and liabilities as of June 30, 2004 and 2003 are presented below(in 000s):

 
| ** **                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                                                 |       |     |       |     |       |
| Net operating loss carry forwards                                    |       | $        | 14,717     |     | $          | 15,721 |   |
| Capital loss carry forwards                                          |       | 8,155    |       | 25,375   |       |
| Foreign tax credit carry forwards                                    |       | —   |       | 949      |       |
| Other tax credits                                                    |       | 10,598   |       | 4,165    |       |
| Inventory obsolescence reserves                                      |       | 2,023    |       | 2,033    |       |
| Financing lease assets                                               |       | 708      |       |     |       |
| Bad debt reserves                                                    |       | 2,621    |       | 2,049    |       |
| Accruals not currently deductible for tax  purposes                  |       | 14,607   |       | 9,141    |       |
| Refinancing costs being amortized for tax  purposes                  |       | 175      |       | 2,277    |       |
| Other                                                                |       | 2,685    |       | 1,808    |       |
| Total gross deferred tax assets                                      |       | 56,289   |       | 63,518   |       |
| Less:   Valuation allowance                                     |       | (10,483  | )          | (11,491  | )          |
| Deferred tax assets                                                  |       | $        | 45,806     |     | $          | 52,027 |   |
|                                                                 |       |     |       |     |       |
| Deferred tax liabilities:                                            |       |     |       |     |       |
| Property and equipment, due principally to  depreciation differences |       | $        | 16,397     |     | $          | 7,395 |   |
| Intangible assets                                                    |       | 5,347    |       | 1,557    |       |
| Other                                                                |       | 4,857    |       | 2,174    |       |
| Total gross deferred tax liabilities                                 |       | 26,601   |       | 11,126   |       |
| Net deferred tax assets                                              |       | $        | 19,205     |     | $          | 40,901 |   |

 

Management has considered certain taxplanning strategies as permitted by Statement of Financial Accounting StandardsNo. 109 “Accounting for Income Taxes” (“FASB No. 109”).

 

In connection with the acquisition of SDG inthe fiscal year 2004, the Company recorded net deferred tax asset of $8.4million and a corresponding offset to goodwill (see Note 3 for purchasedetails).

 

In connection with the acquisitions of CasinoManagement Systems, Micro Clever Consulting and Honeyframe Systems Development,LTD, each completed in the fiscal year ended June 30, 2003, the Companyrecorded net deferred tax liabilities of $1.8 million and a correspondingoffset to goodwill.

 

At June 30, 2004, the Company had net operating loss carryforwards for federal income tax purposes of approximately $42 million that areavailable to offset future federal taxable income subject to limitations underSection 382 of the Internal Revenue Code (“IRC Sec. 382”).  As a result of the IRC Sec. 382 limitation, avaluation allowance of approximately ($2.1) million has been placed on the netoperating loss deferred tax asset.  Thisnet operating loss will begin to expire in 2022. At June 30, 2004, theCompany had no foreign tax credit carry forwards, alternative minimum taxcredit (“AMT”) carry forwards of approximately $3.2 million, and a research anddevelopment tax credit carry forward of approximately $7.4 million. Foreign taxcredits were converted to a net operating loss carry forward as ofJune 30, 2003. AMT credits are available to be carried forwardindefinitely and may be utilized against regular U.S. corporate tax to theextent it does not exceed computed AMT calculations.  Research and developmental credits have acarry forward period of 20 years.

 

In connection with its acquisitions of CasinoMarket Place and Advanced Casino Systems Corporation in fiscal year 2002, theCompany recorded net deferred tax liabilities of $4.4 million and acorresponding reduction in its valuation allowance.

 

At June 30, 2002, the Company performedits annual assessment of the recoverability of its net deferred tax assets.Management determined that tax benefits associated with previously reserved netdeferred tax assets were more likely than not realizable through future taxableincome and future reversals of existing taxable temporary differences. Theassessment was based on financial and taxable income forecasts, which werefinalized during the fourth fiscal quarter of 2002. The Company’s assessmentindicated that the forecasted taxable income would be

 

F-25

----

 

sufficient to offset the previously reservednet deferred tax assets. As a result, the Company recorded a tax benefitresulting from the reduction of previously recorded valuation reserves againstnet deferred tax assets, totaling $37.0 million.

 

**11.****                               SUPPLEMENTALCASH FLOW INFORMATION**

 

The following supplemental information isrelated to the consolidated statements of cash flows (in 000s).

 
| ** **                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |     |       |
| Cash paid for interest                                 |       | $        | 23,795     |     | $          | 25,897   |       | $ | 27,299 |   |
| Cash paid for income taxes                             |       | 4,954    |       | 2,751    |       | 378      |       |
|                                                   |       |     |       |     |       |     |       |
| Non-cash investing and financing  transactions:        |       |     |       |     |       |     |       |
| Reclassify property, plant and equipment to  inventory |       | $        | 7,732      |     | $          | 3,765    |       | $ | 2,496 |   |
| (Favorable) unfavorable translation rate  adjustment   |       | (63      | )          | (2,133   | )          | (7,846   | )          |
| Notes payable issued in acquisitions                   |       | 4,000    |       | 8,073    |       | 4,000    |       |
| Value of restricted stock issued in SDG  acquisition   |       | 11,949   |       | —   |       | —   |       |
| Value of warrants issued in MindPlay  acquisition      |       | 886      |       | —   |       | —   |       |

 

**12.****                               COMMITMENTSAND CONTINGENCIES**

 

The Company is obligated under several patentagreements to pay royalties ranging from approximately $10 to $500 perapplicable game depending on the components in the gaming machines. Totalroyalty expense for the Company for the years ended June 30, 2004, 2003and 2002 was $6.2 million, $4.2 million and $2.8 million,respectively, and is included in the cost of gaming equipment and systems inthe accompanying consolidated statement of operations. In addition, the Companyhas obtained the rights to certain game ideas and intellectual property thatcall for payment of royalties based on either fixed amounts or variable amountsbased on game performance.  The Companyalso pays $0.5 million annually for the use of the Bally trademark.

 

The Company leases: (a) certain office space,equipment, warehouse and repair facilities and other property locations undernon-cancelable operating leases (“Equipment and Office Space Leases”) which aregenerally included in the selling, general and administrative expense and (b)Route Operations locations where the Company operates gaming devices (“RouteLocation Leases”), which are included in the cost of route operations. CertainRoute Location Leases provide for sharing of the net gaming win between theCompany and the location owner and are cancelable at any time by either party,and are deemed “Contingent Route Location Leases”. Operating rental expense foryears ended June 30, 2004, 2003 and 2002 was as follows (in 000s):

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Continuing  Operations:**       |       |     |       |     |       |     |       |
| Equipment and Office Space Leases |       | $        | 4,953      |     | $          | 4,047    |       | $ | 5,804 |   |
| Sublease rental income            |       | —   |       | (332     | )          | —   |       |
|                              |       | $        | 4,953      |     | $          | 3,715    |       | $ | 5,804 |   |
|                              |       |     |       |     |       |     |       |
| **Discontinued  Operations:**     |       |     |       |     |       |     |       |
| Contingent Route Location Leases  |       | $        | 147,062    |     | $          | 132,062  |       | $ | 135,338 |   |
| Fixed Route Location Leases       |       | 17,326   |       | 18,786   |       | 19,500   |       |
| Equipment and Office Space Leases |       | 1,170    |       | 2,852    |       | 1,026    |       |
|                              |       | 165,558  |       | 153,700  |       | 155,864  |       |
| Sublease rental income            |       | —   |       | (1,812   | )          | (1,806   | )          |
|                              |       | $        | 165,558    |     | $          | 151,888  |       | $ | 154,058 |   |

 

F-26

----

 

We are committed to make future payments pursuant to various contractsand agreements.  A summary of thosecontractual obligations existing as of June 30, 2004, is as follows (in 000s):

 
| ** **                        | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Debt:                             |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Term Loan Facility(a)             |       | $        | 3,312      |     | $          | 3,500    |       | $        | 3,500      |     | $          | 3,500          |       | $         | 3,500      |   | $ | 332,688 |   | $ | 350,000 |   |
| Revolving credit facility         |       | —   |       | —   |       | —   |       | —   |       | —   |       | 70,000         |       | 70,000    |       |
| Other Debt                        |       | 2,553    |       | 3,803    |       | 599      |       | 2,000    |       | —   |       | —         |       | 8,955     |       |
|                              |       | 5,865    |       | 7,303    |       | 4,099    |       | 5,500    |       | 3,500    |       | 402,688        |       | 428,955   |       |
| Other commitments:                |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Net minimum rentals               |       | 2,877    |       | 1,596    |       | 1,323    |       | 721      |       | 553      |       | 33             |       | 7,103     |       |
| SDG earn-out (b)                  |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Mindplay earn-out (c)             |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Purchase commitments (d)          |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Employment agreements (e)         |       | 735      |       | 980      |       | 980      |       | 245      |       | —   |       | —         |       | 2,940     |       |
| Kirkland consulting agreement (f) |       | 600      |       | 600      |       | 600      |       | 300      |       | —   |       | —         |       | 2,100     |       |
| Interest and income taxes (g)     |       | —   |       | —   |       | —   |       | —   |       | —   |       | —         |       | —    |       |
| Total commitments                 |       | $        | 10,077     |     | $          | 10,479   |       | $        | 7,002      |     | $          | 6,766          |       | $         | 4,053      |   | $ | 402,721 |   | $ | 441,098 |   |

 

----

(a) As aresult of the sale of UCMC and Rail City, the terms of the bank loan agreementrequires the use of approximately 50% of the net proceeds (as defined in theagreement) to reduce the term loan and revolver principal balances on a prorata basis.  The revolver commitment of$125 million remains unaffected.  Theexact amount of the debt repayment is subject to final adjustment in December2004, however in August 2004 the Company made an estimated term loan pay downof $31.6 million, and used additional excess cash to reduce the balance of therevolver from $70 million to zero.  Theseincremental debt paydowns are not reflected in the table above.

 

(b) OnMarch 2, 2004 we completed the acquisition of SDG, the details of thepurchase are more fully described in Note 3. As part of the purchase agreement additional contingent consideration ofup to $95.6 million may become payable in equal portions of cash and stock overthe next three fiscal years upon the SDG business achieving certain significantrevenue and EBITDA targets.  Since thetiming of such payments if any, are not known, they are not reflected in thetable shown above.

 

(c)Pursuant to the MindPlay purchase agreement, the Company is obligated to makecertain earn-out payments to the former principals of MindPlay LLC.  The Company is required to make guaranteedearn-out payments of at least $1,000,000 over the first two year period of theagreement.

 

(d) Exceptin certain rare instances, Bally Gaming and Systems is not required by itssuppliers to enter into quarterly commitments for products.

 

(e) TheCompany has employment agreements with most of its employees with positions ofVice President or above.  Theseagreements generally provide for an initial rate of pay and the terms of theseverance benefits generally range from three to twelve months salarycontinuation with similar non-compete periods. Almost all such agreements contain language that the employee is stillan “at will” employee, and as such can be terminated at anytime subject to theindividual termination provisions.  Theonly multi-year arrangement is with Richard Haddrill, our CEO effectiveOctober 1, 2004, which covers a three-year term, with a base salary of$980,000.  Only Mr. Haddrill’scompensation is reflected in the table above.

 

(f)Pursuant to an original agreement entered into in 1997 between the Company andKirkland Investment Corporation (“Kirkland,” 100% owned by Joel Kirschbaum whois a director of Alliance, and therefore treated as a “related party”),Kirkland provides the Company with certain consulting services.  Pursuant to a new Advisory Agreement dated July 1,2004, the Company agreed to pay Kirkland $600,000 annually for a period of 3.5years for consulting services.

 

(g) Inaddition to the items discussed above, the Company has cash obligations forinterest payments on debt and for income taxes. Long-term debt is virtually all floating rate, and therefore futureinterest payments will be impacted by future LIBOR rate changes as well as thebalance of debt outstanding in those future periods.  Interest payments for fiscal year 2004totaled $23.8 million.  No significantincome tax payments have been made during the last three years as the Companyutilized net operating loss carry forwards, which have now been reduced almostcompletely as of June 30, 2004.  TheCompany expects to begin making quarterly Federal income tax payments beginningon September 15, 2004.  The amountof such future income tax payments is dependent on the levels of future taxableincome.

 

F-27

----

 

During the year ended June 30, 2003 the Companysold a receivable to a third-party financing company, and provided a residualvalue guarantee to the buyer totaling $0.3 million.

 

Liabilities for loss contingencies arising fromclaims, assessments, litigation, fines and penalties, or other sources arerecorded when it is probable that a liability has been incurred and the amountof the liability can be reasonably estimated.

 

On September 25, 1995, Bally GamingInternational, Inc. (which is a wholly-owned subsidiary of the Company) wasnamed as a defendant in a class action lawsuit filed in Federal District Courtin Nevada by Larry Schreirer on behalf of himself and all others similarlysituated. The plaintiffs filed suit against BGII and approximately 45 otherdefendants. Each defendant is involved in the gaming business as a gamingmachine manufacturer, distributor, or casino operator. The class action lawsuitarises out of alleged fraudulent marketing and operation of casino video pokermachines and electronic slot machines. The plaintiffs allege that the defendants’ actions constitute violationsof the Racketeer Influenced and Corrupt Organizations Act (RICO) and give riseto claims of common law fraud and unjust enrichment. The plaintiffs allege thatthe defendants have engaged in a course of fraudulent and misleading conductintended to induce people into playing their gaming machines based on a falsebelief concerning how those machines actually operate as well as the extent towhich there is actually an opportunity to win on any given play. The plaintiffsare seeking monetary damages in excess of $1.0 billion. In July 2002 theFederal judge denied the plaintiff class action status. On August 10,2004, the Ninth Circuit Court of Appeals affirmed the district court’s denialof class action certification. Plaintiffs have until early November 2004to ask the U.S. Supreme Court to consider the case. Management believes theplaintiffs’ lawsuit to be without merit. The Company will continue to pursueall legal defenses available to us.

 

In June 2004,putative class actions were filed against Alliance Gaming Corporation and itsofficers, Robert Miodunski, Robert Saxton, Mark Lerner, and Steven Des Champs,in the Federal District Court for the District of Nevada.  The nearly identical complaints allege violationsof the Securities Exchange Act of 1934 stemming from revised earnings guidance,declines in the stock price, and sales of stock by insiders.  Plaintiffs have filed a motion to consolidateall of the cases and appoint a lead plaintiff. A hearing date has not been scheduled. Alliance believes the lawsuits are without merit and intends tovigorously defend itself and its officers. In addition, in July 2004 two derivative lawsuits were filed inNevada state court against the members of the board of directors and theofficers listed above.  The Company isnamed as a nominal defendant in the derivative lawsuits as the claims arepurportedly asserted for the benefit of the Company.  These lawsuits assert claims for breach offiduciary duty and waste of corporate assets arising out of the same events asthose giving rise to the class actions described above.  These two cases have been consolidated andpalintiffs have until September 20, 2004 to file a consolidated complaint.

 

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

 

**13.****                         CONCENTRATIONOF CREDIT RISK**

 

                                                TheCompany maintains its cash and cash equivalents in high credit qualityfinancial institutions.  In addition,investment policies have been adopted to limit investments to investment gradesecurities.  The financial instrumentsthat potentially subject the Company to concentrations of credit risk consistprincipally of accounts and notes receivable. Each of the Company’s businessunits conducts business in and the resulting receivables are concentrated inspecific legalized gaming regions. The Company also distributes its productsthrough third party distributors resulting in distributor receivables.

 

At June 30, 2004, net accounts and notesreceivable by region as a percentage of total net receivables are as follows:

 
| ** **                        | ** ** | **Continuing Operations**          | ** ** |
|-----------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **Gaming  Equipment  and Systems** | ** ** | **Casino  Operations** | ** ** | **Total** | ** ** |
|                              |       |                               |       |   |   |   |   |
| South America                     |       | 3.3                                |       | — |   | 3.3 |   |
| Other international jurisdictions |       | 1.7                                |       | — |   | 1.7 |   |
| Nevada                            |       | 18.0                               |       | — |   | 18.0 |   |
| Oklahoma                          |       | 9.7                                |       | — |   | 9.7 |   |
| Washington                        |       | 11.4                               |       | — |   | 11.4 |   |
| Canada                            |       | 8.6                                |       | — |   | 8.6 |   |
| New Jersey                        |       | 7.2                                |       | — |   | 7.2 |   |
| Others individually less than 5%  |       | 39.9                               |       | 0.2 |   | 40.1 |   |
|                              |       | 99.8                               | %          | 0.2 | % | 100.0 | % |

 

F-28

----

 

**14.**                               **SEGMENT ANDGEOGRAPHICAL INFORMATION**

 

The Company currently operates in twobusiness segments (exclusive of the route operations business segment includedin discontinued operations): (i) Gaming Equipment and Systems which designs,manufactures and distributes gaming machines and computerized monitoringsystems for gaming machines, and (ii) Casino Operations which owns and operatesone regional casino. The accounting policies of these segments are consistentwith Company’s policies for the Consolidated Financial Statements.

 

The table below presents information as tothe Company’s revenues, operating income, identifiable assets, capitalexpenditures and depreciation and amortization by segment (in 000s):

 
| ** **                          | ** ** | **Years Ended June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                           |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 436,596    |   | $ | 335,436 |   | $ | 223,703 |   |
| Casino Operations                   |       | 52,280                        |       | 50,945 |   | 52,211 |   |
| Total revenues                      |       | $                             | 488,876    |   | $ | 386,381 |   | $ | 275,914 |   |
|                                |       |                          |       |   |   |   |   |
| Intersegment revenues:              |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 578        |   | $ | 1,164 |   | $ | — |   |
| Casino Operations                   |       | —                        |       | — |   | — |   |
| Total intersegment revenues         |       | $                             | 578        |   | $ | 1,164 |   | $ | — |   |
|                                |       |                          |       |   |   |   |   |
| Operating income (loss):            |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 96,034     |   | $ | 82,879 |   | $ | 47,172 |   |
| Casino Operations                   |       | 16,942                        |       | 15,306 |   | 17,593 |   |
| Corporate/other                     |       | (14,254                       | )          | (13,213 | ) | (12,562 | ) |
| Total operating income              |       | $                             | 98,722     |   | $ | 84,972 |   | $ | 52,203 |   |
|                                |       |                          |       |   |   |   |   |
| Identifiable assets:                |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 532,401    |   | $ | 315,446 |   |   |   |
| Casino Operations                   |       | 41,790                        |       | 43,399 |   |   |   |
| Corporate/other                     |       | 172,021                       |       | 52,006 |   |   |   |
| Total identifiable assets           |       | $                             | 746,212    |   | $ | 410,851 |   |   |   |
|                                |       |                          |       |   |   |   |   |
| Goodwill:                           |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 137,889    |   | $ | 63,940 |   |   |   |
| Corporate/other (a)                 |       | (900                          | )          | (900 | ) |   |   |
| Total goodwill                      |       | $                             | 136,989    |   | $ | 63,040 |   |   |   |
|                                |       |                          |       |   |   |   |   |
| Capital expenditures:               |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 8,396      |   | $ | 3,589 |   | $ | 3,370 |   |
| Casino Operations                   |       | 2,716                         |       | 6,068 |   | 3,278 |   |
| Corporate/other                     |       | 728                           |       | 102 |   | 76 |   |
| Total capital expenditures          |       | $                             | 11,840     |   | $ | 9,759 |   | $ | 6,724 |   |
|                                |       |                          |       |   |   |   |   |
| Depreciation and amortization:      |       |                          |       |   |   |   |   |
| Gaming Equipment and Systems        |       | $                             | 27,260     |   | $ | 15,656 |   | $ | 10,202 |   |
| Casino Operations                   |       | 2,780                         |       | 2,174 |   | 1,491 |   |
| Corporate/other                     |       | 1,525                         |       | 2,632 |   | 2,236 |   |
| Total depreciation and amortization |       | $                             | 31,565     |   | $ | 20,462 |   | $ | 13,929 |   |

 

----

(a) Related to the Bally Gaming and Systems acquisition.

 

F-29

----

 

The Company has operations based primarily inthe United States with a significant sales and distribution office based inGermany.

 

The table below presents information as to the Company’srevenues, operating income, identifiable assets capital expenditures anddepreciation and amortization by geographic region (in 000s):

 
| ** **                          | ** ** | **Years Ended June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                           |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 456,973    |   | $ | 342,394 |   | $ | 252,345 |   |
| Germany                             |       | 16,864                        |       | 31,436 |   | 15,482 |   |
| Other foreign                       |       | 15,039                        |       | 12,551 |   | 8,087 |   |
| Total revenues                      |       | $                             | 488,876    |   | $ | 386,381 |   | $ | 275,914 |   |
|                                |       |                          |       |   |   |   |   |
| Operating income:                   |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 97,153     |   | $ | 79,062 |   | $ | 47,034 |   |
| Germany                             |       | 2,427                         |       | 5,127 |   | 3,149 |   |
| Other foreign                       |       | (858                          | )          | 783 |   | 2,020 |   |
| Total operating income              |       | $                             | 98,722     |   | $ | 84,972 |   | $ | 52,203 |   |
|                                |       |                          |       |   |   |   |   |
| Identifiable assets:                |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 702,374    |   | $ | 364,011 | *** *** | *** *** | *** *** |
| Germany                             |       | 18,415                        |       | 22,814 |   |   |   |
| Other foreign                       |       | 25,423                        |       | 24,026 |   |   |   |
| Total identifiable assets           |       | $                             | 746,212    |   | $ | 410,851 |   |   |   |
|                                |       |                          |       |   |   |   |   |
| Goodwill:                           |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 118,815    |   | $ | 47,393 |   |   |   |
| Germany                             |       | 5,341                         |       | 5,044 |   |   |   |
| Other Foreign                       |       | 12,833                        |       | 10,603 |   |   |   |
| Total goodwill                      |       | $                             | 136,989    |   | $ | 63,040 |   |   |   |
|                                |       |                          |       |   |   |   |   |
| Capital expenditures:               |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 11,145     |   | $ | 9,664 |   | $ | 6,677 |   |
| Germany                             |       | 20                            |       | 90 |   | 40 |   |
| Other foreign                       |       | 675                           |       | 5 |   | 7 |   |
| Total capital expenditures          |       | $                             | 11,840     |   | $ | 9,759 |   | $ | 6,724 |   |
|                                |       |                          |       |   |   |   |   |
| Depreciation and amortization:      |       |                          |       |   |   |   |   |
| United States                       |       | $                             | 30,735     |   | $ | 20,116 |   | $ | 13,895 |   |
| Germany                             |       | 52                            |       | 47 |   | 15 |   |
| Other Foreign                       |       | 778                           |       | 299 |   | 19 |   |
| Total depreciation and amortization |       | $                             | 31,565     |   | $ | 20,462 |   | $ | 13,929 |   |

 

F-30

----

 

**15.****                              ****401(k) PLAN**

 

The Company is the sponsor of the AllianceGaming Corporation 401(k) Savings Plan (the “401(k) Plan”).  The 401(k) Plan was adopted for domesticemployees of Alliance Gaming and all its domestic subsidiaries.  Employees may enroll in the plan after meetingcertain age and length of employment criteria, and plan participants may deferup to 25% of their compensation, up to certain IRS imposed limitations,currently $13,000.

 

The Company matches 50% of any participants’contributions, up to the first 6% of their compensation (as the term“compensation” is defined in the 401(k) plan document). Company matchingcontributions totaled approximately, $0.8 million, $1.0 million and $ 0.8million for the fiscal years ended June 30, 2004, 2003 and 2002,respectively.

 

**16.****                              ****CONSOLIDATING FINANCIAL STATEMENTS**

 

The following consolidating financialstatements are presented to provide certain financial information regardingguaranteeing and non-guaranteeing subsidiaries in relation to the Company’s newbank credit agreement.  The financialinformation presented includes Alliance (the “Parent”), its wholly-ownedguaranteeing subsidiaries (“Guaranteeing Subsidiaries”), and thenon-guaranteeing subsidiaries Video Services, Inc., (as reported indiscontinued operations) the Rainbow Casino Vicksburg Partnership, L.P. (dbaRainbow Casino) and the Parent’s non-domestic subsidiaries (together the“Non-Guaranteeing Subsidiaries”). The notes to consolidating financialstatements should be read in conjunction with these consolidating financialstatements.

 

F-31

----

 

**CONSOLIDATINGBALANCE SHEETS**

June 30, 2004

(In 000s)

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

 

See accompanying notes.

 

F-32

----

 

**CONSOLIDATING BALANCE SHEETS**

June 30, 2003

(In 000s)

 

 
| ** **                                       | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| ASSETS                                           |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Current assets:                                  |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash and cash equivalents                        |       | $          | 12,730     |                           | $          | 18,036                               |       | $                                              | 8,118      |                                                 | $          | — |   | $ | 38,884 |   |
| Accounts and notes receivable, net               |       | 738        |       | 70,880                         |       | 27,496                               |       | (746                                           | )          | 98,368                                               |       |
| Inventories, net                                 |       | —     |       | 29,801                         |       | 2,518                                |       | (217                                           | )          | 32,102                                               |       |
| Deferred tax assets, net                         |       | 33,182     |       | 11,639                         |       | —                               |       | —                                         |       | 44,821                                               |       |
| Other current assets                             |       | 404        |       | 7,110                          |       | 496                                  |       | —                                         |       | 8,010                                                |       |
| Total current assets                             |       | 47,054     |       | 137,466                        |       | 38,628                               |       | (963                                           | )          | 222,185                                              |       |
| Long-term investments (restricted)               |       | —     |       | 864                            |       | —                               |       | —                                         |       | 864                                                  |       |
| Long-term receivables, net                       |       | 159,723    |       | 15,113                         |       | 12                                   |       | (159,983                                       | )          | 14,865                                               |       |
| Leased gaming equipment, net                     |       | —     |       | 25,792                         |       | —                               |       | —                                         |       | 25,792                                               |       |
| Property, plant and equipment, net               |       | 74         |       | 20,394                         |       | 36,426                               |       | —                                         |       | 56,894                                               |       |
| Goodwill, net                                    |       | (900       | )          | 48,293                         |       | 15,647                               |       | —                                         |       | 63,040                                               |       |
| Intangible assets, net                           |       | 7,049      |       | 14,550                         |       | 5,032                                |       | —                                         |       | 26,631                                               |       |
| Investments in subsidiaries                      |       | 294,513    |       | 74,990                         |       | —                               |       | (369,503                                       | )          | —                                               |       |
| Deferred tax assets, net                         |       | 3,394      |       | —                         |       | —                               |       | (3,394                                         | )          | —                                               |       |
| Assets of discontinued operations held for  sale |       | 16,539     |       | 93,672                         |       | 4,103                                |       | —                                         |       | 114,314                                              |       |
| Other assets, net                                |       | (84,406    | )          | 99,918                         |       | (14,933                              | )          | 1                                              |       | 580                                                  |       |
|                                             |       | $          | 443,040    |                           | $          | 531,052                              |       | $                                              | 84,915     |                                                 | $          | (533,842 | ) | $ | 525,165 |   |
|                                             |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY        |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Current liabilities:                             |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts payable                                 |       | $          | 1,295      |                           | $          | 19,507                               |       | $                                              | 1,924      |                                                 | $          | — |   | $ | 22,726 |   |
| Accrued liabilities                              |       | 7,278      |       | 20,734                         |       | 4,177                                |       | (751                                           | )          | 31,438                                               |       |
| Jackpot liabilities                              |       | —     |       | 10,446                         |       | 142                                  |       | —                                         |       | 10,588                                               |       |
| Taxes payable                                    |       | 100        |       | (360                           | )          | 1,191                                |       | —                                         |       | 931                                                  |       |
| Current maturities of long-term debt             |       | 2,395      |       | 1,124                          |       | 18                                   |       | —                                         |       | 3,537                                                |       |
| Liabilities of disc. operations held for  sale   |       | 1,000      |       | 12,172                         |       | 828                                  |       | —                                         |       | 14,000                                               |       |
| Total current liabilities                        |       | 12,068     |       | 63,623                         |       | 8,280                                |       | (751                                           | )          | 83,220                                               |       |
|                                             |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Long term debt, net                              |       | 335,388    |       | 166,013                        |       | —                               |       | (159,723                                       | )          | 341,678                                              |       |
| Deferred tax liabilities                         |       | —     |       | 5,679                          |       | 1,635                                |       | (3,394                                         | )          | 3,920                                                |       |
| Other liabilities                                |       | 2,624      |       | 753                            |       | 10                                   |       | —                                         |       | 3,387                                                |       |
| Minority interest                                |       | 1,330      |       | —                         |       | —                               |       | —                                         |       | 1,330                                                |       |
| Total liabilities                                |       | 351,410    |       | 236,068                        |       | 9,925                                |       | (163,868                                       | )          | 433,535                                              |       |
| Commitments and contingencies                    |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Stockholders’ equity:                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Special stock series E                           |       | 12         |       | —                         |       | —                               |       | —                                         |       | 12                                                   |       |
| Common stock                                     |       | 4,996      |       | 478                            |       | 1,027                                |       | (1,505                                         | )          | 4,996                                                |       |
| Treasury stock                                   |       | (501       | )          | —                         |       | —                               |       | —                                         |       | (501                                                 | )          |
| Additional paid-in capital                       |       | 163,267    |       | 190,449                        |       | 33,415                               |       | (223,864                                       | )          | 163,267                                              |       |
| Accumulated other comprehensive income  (loss)   |       | 1,287      |       | 1,290                          |       | 1,267                                |       | (2,557                                         | )          | 1,287                                                |       |
| Retained earnings (accumulated deficit)          |       | (77,431    | )          | 102,767                        |       | 39,281                               |       | (142,048                                       | )          | (77,431                                              | )          |
| Total stockholders’ equity                  |       | 91,630     |       | 294,984                        |       | 74,990                               |       | (369,974                                       | )          | 91,630                                               |       |
|                                             |       | $          | 443,040    |                           | $          | 531,052                              |       | $                                              | 84,915     |                                                 | $          | (533,842 | ) | $ | 525,165 |   |

 

See accompanying notes.

 

F-33

----

 

**CONSOLIDATINGSTATEMENTS OF OPERATIONS**

 

Year ended June 30, 2004

(In 000s)

 
| ** **                                                    | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Revenues:                                                     |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Gaming equipment and systems                                  |       | $          | —     |                           | $          | 424,279                              |       | $                                              | 31,903     |                                                 | $          | (19,586 | ) | $ | 436,596 |   |
| Casino operations                                             |       | —     |       | —                         |       | 58,283                               |       | (6,003                                         | )          | 52,280                                               |       |
|                                                          |       | —     |       | 424,279                        |       | 90,186                               |       | (25,589                                        | )          | 488,876                                              |       |
| Costs and expenses:                                           |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cost of gaming equipment and systems                          |       | —     |       | 178,458                        |       | 18,781                               |       | (19,653                                        | )          | 177,586                                              |       |
| Cost of casino operations                                     |       | —     |       | —                         |       | 20,043                               |       | —                                         |       | 20,043                                               |       |
| Selling, general and administrative                           |       | 12,729     |       | 89,129                         |       | 28,490                               |       | (6,003                                         | )          | 124,345                                              |       |
| Research and development costs                                |       | —     |       | 35,865                         |       | 750                                  |       | —                                         |       | 36,615                                               |       |
| Depreciation and amortization                                 |       | 1,525      |       | 26,430                         |       | 3,610                                |       | —                                         |       | 31,565                                               |       |
|                                                          |       | 14,254     |       | 329,882                        |       | 71,674                               |       | (25,656                                        | )          | 390,154                                              |       |
|                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Operating income (loss)                                       |       | (14,254    | )          | 94,397                         |       | 18,512                               |       | 67                                             |       | 98,722                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Earnings in consolidated subsidiaries                         |       | 87,567     |       | 10,613                         |       | —                               |       | (98,180                                        | )          | —                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Other income (expense):                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Interest income                                               |       | 16,165     |       | 212                            |       | 17                                   |       | (14,141                                        | )          | 2,253                                                |       |
| Interest expense                                              |       | (17,611    | )          | (14,425                        | )          | (39                                  | )          | 14,141                                         |       | (17,934                                              | )          |
| Rainbow royalty                                               |       | 6,351      |       | —                         |       | (6,351                               | )          | —                                         |       | —                                               |       |
| Minority interest                                             |       | (2,309     | )          | —                         |       | —                               |       | —                                         |       | (2,309                                               | )          |
| Refinancing charge                                            |       | (12,293    | )          | —                         |       | —                               |       | —                                         |       | (12,293                                              | )          |
| Other, net                                                    |       | (72        | )          | 300                            |       | (843                                 | )          | 94                                             |       | (521                                                 | )          |
| Income (loss) from continuing operations  before income taxes |       | 63,544     |       | 91,097                         |       | 11,296                               |       | (98,019                                        | )          | 67,918                                               |       |
| Income tax expense                                            |       | 19,919     |       | 3,691                          |       | 683                                  |       | —                                         |       | 24,293                                               |       |
| Net income (loss) from continuing  operations                 |       | 43,625     |       | 87,406                         |       | 10,613                               |       | (98,019                                        | )          | 43,625                                               |       |
|                                                          |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Discontinued Operations:                                      |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Loss on sale of wall machines and amusement  games unit, net  |       | (2,172     | )          | —                         |       | —                               |       | —                                         |       | (2,172                                               | )          |
| Gain on Sale of Rail City                                     |       | 14,329     |       | —                         |       | —                               |       | —                                         |       | 14,329                                               |       |
| Gain on Sale of Nevada Route                                  |       | 9,124      |       | —                         |       | —                               |       | —                                         |       | 9,124                                                |       |
| Income from disc. ops. of Nevada Route, net                   |       | —     |       | 14,539                         |       | —                               |       | —                                         |       | 14,539                                               |       |
| Income from disc. ops. of Louisiana Route,  net               |       | —     |       | —                         |       | 1,768                                |       | —                                         |       | 1,768                                                |       |
| Income from disc. ops. of Rail City, net                      |       | —     |       | 3,301                          |       | —                               |       | —                                         |       | 3,301                                                |       |
| Earnings from consolidated discontinued  operations           |       | 19,608     |       | 1,768                          |       | —                               |       | (21,376                                        | )          | —                                               |       |
| Income (loss) from discontinued operations                    |       | 40,889     |       | 19,608                         |       | 1,768                                |       | (21,376                                        | )          | 40,889                                               |       |
| Net income (loss)                                             |       | $          | 84,514     |                           | $          | 107,014                              |       | $                                              | 12,381     |                                                 | $          | (119,395 | ) | $ | 84,514 |   |

 

See accompanying notes.

 

F-34

----

 

**CONSOLIDATINGSTATEMENTS OF OPERATIONS**

 

Year endedJune 30, 2003

(In 000s)

 
| ** **                                                                                 | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Revenues:                                                                                  |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Gaming equipment and systems                                                               |       | $          | —     |                           | $          | 322,560                              |       | $                                              | 44,057     |                                                 | $          | (31,181 | ) | $ | 335,436 |   |
| Casino operations                                                                          |       | —     |       | —                         |       | 57,257                               |       | (6,312                                         | )          | 50,945                                               |       |
|                                                                                       |       | —     |       | 322,560                        |       | 101,314                              |       | (37,493                                        | )          | 386,381                                              |       |
| Costs and expenses:                                                                        |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cost of gaming equipment and systems                                                       |       | —     |       | 145,262                        |       | 30,193                               |       | (31,103                                        | )          | 144,352                                              |       |
| Cost of casino operations                                                                  |       | —     |       | —                         |       | 21,208                               |       | —                                         |       | 21,208                                               |       |
| Selling, general and administrative                                                        |       | 10,927     |       | 65,874                         |       | 25,013                               |       | (6,382                                         | )          | 95,432                                               |       |
| Research and development costs                                                             |       | —     |       | 18,499                         |       | 1,456                                |       | —                                         |       | 19,955                                               |       |
| Depreciation and amortization                                                              |       | 2,286      |       | 15,656                         |       | 2,520                                |       | —                                         |       | 20,462                                               |       |
|                                                                                       |       | 13,213     |       | 245,291                        |       | 80,390                               |       | (37,485                                        | )          | 301,409                                              |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Operating income (loss)                                                                    |       | (13,213    | )          | 77,269                         |       | 20,924                               |       | (8                                             | )          | 84,972                                               |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Earnings in consolidated subsidiaries                                                      |       | 75,638     |       | 11,660                         |       | —                               |       | (87,298                                        | )          | —                                               |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Other income (expense):                                                                    |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Interest income                                                                            |       | 12,291     |       | —                         |       | 57                                   |       | (12,128                                        | )          | 220                                                  |       |
| Interest expense                                                                           |       | (25,433    | )          | (12,273                        | )          | (67                                  | )          | 12,128                                         |       | (25,645                                              | )          |
| Rainbow royalty                                                                            |       | 6,216      |       | —                         |       | (6,216                               | )          | —                                         |       | —                                               |       |
| Minority interest                                                                          |       | (2,009     | )          | —                         |       | —                               |       | —                                         |       | (2,009                                               | )          |
| Other, net                                                                                 |       | 1,726      |       | (152                           | )          | (1,394                               | )          | —                                         |       | 180                                                  |       |
| Income (loss) from continuing operations  before income taxes                              |       | 55,216     |       | 76,504                         |       | 13,304                               |       | (87,306                                        | )          | 57,718                                               |       |
| Income tax expense                                                                         |       | 18,055     |       | 857                            |       | 1,644                                |       | —                                         |       | 20,556                                               |       |
| Net income (loss) from continuing  operations                                              |       | 37,161     |       | 75,647                         |       | 11,660                               |       | (87,306                                        | )          | 37,162                                               |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Discontinued Operations:                                                                   |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Loss on sale of wall machines and amusement  games unit, net                               |       | (25,358    | )          | —                         |       | —                               |       | —                                         |       | (25,358                                              | )          |
| Income (loss) from discontinued operations  of wall machines and amusement games unit, net |       | 1,593      |       | (13,101                        | )          | (1,278                               | )          | 11,891                                         |       | (895                                                 | )          |
| Income from disc. ops. of Nevada Route, net                                                |       | —     |       | 4,059                          |       | —                               |       | —                                         |       | 4,059                                                |       |
| Income from disc. ops. of Louisiana Route,  net                                            |       | —     |       | —                         |       | 1,288                                |       | —                                         |       | 1,288                                                |       |
| Income from Disc Ops Rail City, net                                                        |       | —     |       | 3,267                          |       | —                               |       | —                                         |       | 3,267                                                |       |
| Earnings from consolidated discontinued  operations                                        |       | 6,127      |       | (36,268                        | )          | —                               |       | 30,141                                         |       | —                                               |       |
| Income (loss) from discontinued operations                                                 |       | (17,638    | )          | (42,043                        | )          | 10                                   |       | 42,032                                         |       | (17,639                                              | )          |
| Net income (loss)                                                                          |       | $          | 19,523     |                           | $          | 33,604                               |       | $                                              | 11,670     |                                                 | $          | (45,274 | ) | $ | 19,523 |   |

 

See accompanying notes.

 

F-35

----

 

**CONSOLIDATINGSTATEMENTS OF OPERATIONS**

 

Year endedJune 30, 2002

(In 000s)

 
| ** **                                                                                 | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Revenues:                                                                                  |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Gaming equipment and systems                                                               |       | $          | —     |                           | $          | 216,844                              |       | $                                              | 23,630     |                                                 | $          | (16,771 | ) | $ | 223,703 |   |
| Casino operations                                                                          |       | —     |       | —                         |       | 58,812                               |       | (6,601                                         | )          | 52,211                                               |       |
|                                                                                       |       | —     |       | 216,844                        |       | 82,442                               |       | (23,372                                        | )          | 275,914                                              |       |
| Costs and expenses:                                                                        |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cost of gaming equipment and systems                                                       |       | —     |       | 100,407                        |       | 15,023                               |       | (16,710                                        | )          | 98,720                                               |       |
| Cost of casino operations                                                                  |       | —     |       | —                         |       | 21,021                               |       | —                                         |       | 21,021                                               |       |
| Selling, general and administrative                                                        |       | 10,360     |       | 49,220                         |       | 22,111                               |       | (6,662                                         | )          | 75,029                                               |       |
| Research and development costs                                                             |       | —     |       | 15,012                         |       | —                               |       | —                                         |       | 15,012                                               |       |
| Depreciation and amortization                                                              |       | 2,202      |       | 10,202                         |       | 1,525                                |       | —                                         |       | 13,929                                               |       |
| Unusual item                                                                               |       | —     |       | —                         |       | —                               |       | —                                         |       | —                                               |       |
|                                                                                       |       | 12,562     |       | 174,841                        |       | 59,680                               |       | (23,372                                        | )          | 223,711                                              |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Operating income (loss)                                                                    |       | (12,562    | )          | 42,003                         |       | 22,762                               |       | —                                         |       | 52,203                                               |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Earnings in consolidated subsidiaries                                                      |       | 55,368     |       | 19,879                         |       | —                               |       | (75,247                                        | )          | —                                               |       |
|                                                                                       |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Other income (expense):                                                                    |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Interest income                                                                            |       | 11,336     |       | —                         |       | 56                                   |       | (11,014                                        | )          | 378                                                  |       |
| Interest expense                                                                           |       | (28,172    | )          | (11,001                        | )          | (70                                  | )          | 11,014                                         |       | (28,229                                              | )          |
| Rainbow royalty                                                                            |       | 6,380      |       | —                         |       | (6,380                               | )          | —                                         |       | —                                               |       |
| Minority interest                                                                          |       | (1,935     | )          | —                         |       | —                               |       | —                                         |       | (1,935                                               | )          |
| Other, net                                                                                 |       | 2,180      |       | 290                            |       | (1,233                               | )          | —                                         |       | 1,237                                                |       |
| Income (loss) from continuing operations  before income taxes                              |       | 32,595     |       | 51,171                         |       | 15,135                               |       | (75,247                                        | )          | 23,654                                               |       |
| Income tax expense (benefit)                                                               |       | (29,499    | )          | (8,957                         | )          | 16                                   |       | —                                         |       | (38,440                                              | )          |
| Net income (loss) from continuing  operations                                              |       | 62,094     |       | 60,128                         |       | 15,119                               |       | (75,247                                        | )          | 62,094                                               |       |
|                                                                                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** **                           | ** ** | ** **                                     | ** ** | ** **                                           | ** ** |
| Discontinued Operations:                                                                   |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Income (loss) from discontinued operations  of wall machines and amusement games unit, net |       | 1,373      |       | —                         |       | (18,540                              | )          | —                                         |       | (17,167                                              | )          |
| Income from disc. ops of Nevada Route, net                                                 |       | —     |       | 11,960                         |       |                                 |       | 620                                            |       | 12,580                                               |       |
| Income from disc. ops. of Louisiana Route,  net                                            |       | —     |       | —                         |       | 1,439                                |       | —                                         |       | 1,439                                                |       |
| Income from disc. ops. of Rail City, net                                                   |       | —     |       | 4,760                          |       | —                               |       | 143                                            |       | 4,903                                                |       |
| Earnings from consolidated discontinued  operations                                        |       | 382        |       | (17,101                        | )          | —                               |       | 16,719                                         |       | —                                               |       |
| Income (loss) from discontinued operations                                                 |       | 1,755      |       | (381                           | )          | (17,101                              | )          | 17,482                                         |       | 1,755                                                |       |
| Net income (loss)                                                                          |       | $          | 63,849     |                           | $          | 59,747                               |       | $                                              | (1,982     | )                                                    | $          | (57,765 | ) | $ | 63,849 |   |

 

See accompanying notes.

 

F-36

----

 

**CONSOLIDATINGSTATEMENTS OF CASH FLOWS**

 

Year ended June 30, 2004

(In 000s)

 
| ** **                                                                                          | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from operating activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net income (loss)                                                                                   |       | $          | 84,514     |                           | $          | 107,014                              |       | $                                              | 12,381     |                                                 | $          | (119,395 | ) | $ | 84,514 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| (Income) loss from discontinued operations                                                          |       | (40,889    | )          | (19,608                        | )          | (1,768                               | )          | 21,376                                         |       | (40,889                                              | )          |
| Depreciation and amortization                                                                       |       | 1,525      |       | 26,430                         |       | 3,610                                |       | —                                         |       | 31,565                                               |       |
| Loss on redemption of debt                                                                          |       | 12,293     |       | —                         |       | —                               |       | —                                         |       | 12,293                                               |       |
| Deferred income taxes                                                                               |       | 23,301     |       | 645                            |       | —                               |       | —                                         |       | 23,946                                               |       |
| Provision for losses on receivables                                                                 |       | —     |       | 2,246                          |       | 111                                  |       | —                                         |       | 2,357                                                |       |
| Other                                                                                               |       | (105       | )          | (1,445                         | )          | (171                                 | )          | —                                         |       | (1,721                                               | )          |
| Change in operating assets and liabilities,  net of effects of businesses acquired:                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts and notes receivable                                                                       |       | (2,641     | )          | (27,379                        | )          | 8,038                                |       | (135                                           | )          | (22,117                                              | )          |
| Intercompany accounts                                                                               |       | (58,818    | )          | (39,546                        | )          | 176                                  |       | 98,188                                         |       | —                                               |       |
| Inventories                                                                                         |       | —     |       | (5,393                         | )          | (1,600                               | )          | (67                                            | )          | (7,060                                               | )          |
| Other current assets                                                                                |       | (340       | )          | (719                           | )          | 10                                   |       | —                                         |       | (1,049                                               | )          |
| Accounts payable                                                                                    |       | (319       | )          | 8,441                          |       | 598                                  |       | —                                         |       | 8,720                                                |       |
| Accrued liabilities and jackpot liabilities                                                         |       | 17,298     |       | 2,699                          |       | (328                                 | )          | 33                                             |       | 19,702                                               |       |
| Net cash provided by (used in) operating  activities                                                |       | 35,819     |       | 53,385                         |       | 21,057                               |       | —                                         |       | 110,261                                              |       |
| Cash flows from investing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Additions to property, plant and equipment                                                          |       | (33        | )          | (6,726                         | )          | (5,081                               | )          | —                                         |       | (11,840                                              | )          |
| Additions to leased gaming equipment                                                                |       | —     |       | (36,233                        | )          | (1,876                               | )          | —                                         |       | (38,109                                              | )          |
| Additions to other long-term assets                                                                 |       | (5,580     | )          | (9,066                         | )          | 59                                   |       | —                                         |       | (14,587                                              | )          |
| Acquisitions, net of cash acquired                                                                  |       | (119,616   | )          | (3,879                         | )          | —                               |       | —                                         |       | (123,495                                             | )          |
| Proceeds from sale of discontinued  operations                                                      |       | 155,212    |       | —                         |       | —                               |       | —                                         |       | 155,212                                              |       |
| Net cash used in investing activities                                                               |       | 29,983     |       | (55,904                        | )          | (6,898                               | )          | —                                         |       | (32,819                                              | )          |
| Cash flows from financing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Capitalized new debt fees                                                                           |       | (6,954     | )          | —                         |       | —                               |       | —                                         |       | (6,954                                               | )          |
| Proceeds from long-term debt                                                                        |       | 350,000    |       | —                         |       | —                               |       | —                                         |       | 350,000                                              |       |
| Payments of long-term debt (due to refi)                                                            |       | (337,625   | )          | —                         |       | —                               |       | —                                         |       | (337,625                                             | )          |
| Reduction of long-term debt                                                                         |       | (495       | )          | (2,971                         | )          | (18                                  | )          | —                                         |       | (3,484                                               | )          |
| Change in lines of credit                                                                           |       | 70,000     |       | —                         |       | —                               |       | —                                         |       | 70,000                                               |       |
| Premium paid on early redemption                                                                    |       | (5,399     | )          | —                         |       | —                               |       | —                                         |       | (5,399                                               | )          |
| Proceeds from exercise of stock options                                                             |       | 7,288      |       | —                         |       | —                               |       | —                                         |       | 7,288                                                |       |
| Dividends received (paid)                                                                           |       | —     |       | 14,588                         |       | (14,588                              | )          | —                                         |       | —                                               |       |
| Net cash provided by (used in) financing  activities                                                |       | 76,815     |       | 11,617                         |       | (14,606                              | )          | —                                         |       | 73,826                                               |       |
| Effect of exchange rate changes on cash                                                             |       | —     |       | —                         |       | 174                                  |       | —                                         |       | 174                                                  |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash provided by (used in) discontinued  operations                                                 |       | —     |       | (19,392                        | )          | 1,792                                |       | —                                         |       | (17,600                                              | )          |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Increase for the year                                                                               |       | 142,617    |       | (10,294                        | )          | 1,519                                |       | —                                         |       | 133,842                                              |       |
| Balance, beginning of year                                                                          |       | 12,730     |       | 18,036                         |       | 8,118                                |       | —                                         |       | 38,884                                               |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Balance, end of year                                                                                |       | $          | 155,347    |                           | $          | 7,742                                |       | $                                              | 9,637      |                                                 | $          | — |   | $ | 172,726 |   |

 

See accompanying notes.

 

F-37

----

 

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

 

Year endedJune 30, 2003

(In 000s)

 
| ** **                                                                                          | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash flows from operating activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net income (loss)                                                                                   |       | $          | 19,523     |                           | $          | 33,604                               |       | $                                              | 11,670     |                                                 | $          | (45,274 | ) | $ | 19,523 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| (Income) loss from discontinued operations                                                          |       | (7,720     | )          | 47,070                         |       | (10                                  | )          | (47,060                                        | )          | (7,720                                               | )          |
| Write down of goodwill and other assets                                                             |       | 38,728     |       | —                         |       | —                               |       | —                                         |       | 38,728                                               |       |
| Depreciation and amortization                                                                       |       | 2,286      |       | 15,656                         |       | 2,520                                |       | —                                         |       | 20,462                                               |       |
| Deferred income taxes                                                                               |       | 3,903      |       | (830                           | )          | 278                                  |       | —                                         |       | 3,351                                                |       |
| Provision for losses on receivables                                                                 |       | —     |       | 1,519                          |       | 18                                   |       | —                                         |       | 1,537                                                |       |
| Other                                                                                               |       | 176        |       | 180                            |       | (1                                   | )          | —                                         |       | 355                                                  |       |
| Change in operating assets and liabilities,  net of effects of businesses acquired:                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts and notes receivable                                                                       |       | 5          |       | (39,553                        | )          | (10,867                              | )          | —                                         |       | (50,415                                              | )          |
| Intercompany accounts                                                                               |       | (49,881    | )          | (53,514                        | )          | 11,003                               |       | 92,392                                         |       | —                                               |       |
| Inventories                                                                                         |       | —     |       | 1,032                          |       | (26                                  | )          | —                                         |       | 1,006                                                |       |
| Other current assets                                                                                |       | (144       | )          | (861                           | )          | 2,325                                |       | —                                         |       | 1,320                                                |       |
| Accounts payable                                                                                    |       | 3,767      |       | 4,392                          |       | (881                                 | )          | —                                         |       | 7,278                                                |       |
| Accrued liabilities and jackpot liabilities                                                         |       | (4,443     | )          | 6,554                          |       | 634                                  |       | (22                                            | )          | 2,723                                                |       |
| Net cash provided by (used in) operating  activities                                                |       | 6,200      |       | 15,249                         |       | 16,663                               |       | 36                                             |       | 38,148                                               |       |
| Cash flows from investing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Additions to property, plant and equipment                                                          |       | (7         | )          | (3,589                         | )          | (6,163                               | )          | —                                         |       | (9,759                                               | )          |
| Additions to leased gaming equipment                                                                |       | —     |       | (21,357                        | )          | —                               |       | —                                         |       | (21,357                                              | )          |
| Acquisitions, net of cash acquired                                                                  |       | —     |       | (11,528                        | )          | —                               |       | —                                         |       | (11,528                                              | )          |
| Additions to other long-term assets                                                                 |       | (240       | )          | (3,386                         | )          | (45                                  | )          | —                                         |       | (3,671                                               | )          |
| Net cash used in investing activities                                                               |       | (247       | )          | (39,860                        | )          | (6,208                               | )          | —                                         |       | (46,315                                              | )          |
| Cash flows from financing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Reduction of long-term debt                                                                         |       | (3,900     | )          | (830                           | )          | (5                                   | )          | —                                         |       | (4,735                                               | )          |
| Bally Austria APIC                                                                                  |       | —     |       | —                         |       | 36                                   |       | (36                                            | )          | —                                               |       |
| Net change in revolving credit facility                                                             |       | —     |       | —                         |       | —                               |       | —                                         |       | —                                               |       |
| Proceeds from exercise of stock options                                                             |       | 2,556      |       | —                         |       | —                               |       | —                                         |       | 2,556                                                |       |
| Dividends received (paid)                                                                           |       | —     |       | 7,179                          |       | (7,179                               | )          | —                                         |       | —                                               |       |
| Net cash provided by (used in) financing  activities                                                |       | (1,344     | )          | 6,349                          |       | (7,148                               | )          | (36                                            | )          | (2,179                                               | )          |
| Effect of exchange rate changes on cash                                                             |       | —     |       | —                         |       | 286                                  |       | —                                         |       | 286                                                  |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash provided by (used in) discontinued  operations                                                 |       | —     |       | 18,884                         |       | (1,740                               | )          | —                                         |       | 17,144                                               |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Increase for the year                                                                               |       | 4,609      |       | 622                            |       | 1,853                                |       | —                                         |       | 7,084                                                |       |
| Balance, beginning of year                                                                          |       | 8,121      |       | 17,414                         |       | 6,265                                |       | —                                         |       | 31,800                                               |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Balance, end of year                                                                                |       | $          | 12,730     |                           | $          | 18,036                               |       | $                                              | 8,118      |                                                 | $          | — |   | $ | 38,884 |   |

 

See accompanying notes.

 

F-38

----

 

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

 

Year endedJune 30, 2002

(In 000s)

 
| ** **                                                                                          | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
| Cash flows from operating activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net income (loss)                                                                                   |       | $          | 63,849     |                           | $          | 59,747                               |       | $                                              | (1,982     | )                                                    | $          | (57,765 | ) | $ | 63,849 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| (Income) loss from discontinued operations                                                          |       | (1,755     | )          | 381                            |       | (7,028                               | )          | (17,482                                        | )          | (25,884                                              | )          |
| Write down of goodwill and other assets                                                             |       | —     |       | —                         |       | 24,129                               |       | —                                         |       | 24,129                                               |       |
| Depreciation and amortization                                                                       |       | 2,202      |       | 10,202                         |       | 1,525                                |       | —                                         |       | 13,929                                               |       |
| Deferred income taxes                                                                               |       | (43,297    | )          | 5,747                          |       | (125                                 | )          | —                                         |       | (37,675                                              | )          |
| Provision for losses on receivables                                                                 |       | —     |       | 2,972                          |       | (474                                 | )          | —                                         |       | 2,498                                                |       |
| Other                                                                                               |       | 6,294      |       | (6,805                         | )          | (47                                  | )          | —                                         |       | (558                                                 | )          |
| Change in operating assets and liabilities,  net of effects of businesses acquired:                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Accounts and notes receivable                                                                       |       | (82        | )          | (4,383                         | )          | (4,268                               | )          | (846                                           | )          | (9,579                                               | )          |
| Intercompany accounts                                                                               |       | (43,097    | )          | (28,679                        | )          | (3,483                               | )          | 75,259                                         |       | —                                               |       |
| Inventories                                                                                         |       | —     |       | (1,608                         | )          | (426                                 | )          | —                                         |       | (2,034                                               | )          |
| Other current assets                                                                                |       | 485        |       | (3,155                         | )          | 1,221                                |       | —                                         |       | (1,449                                               | )          |
| Accounts payable                                                                                    |       | (304       | )          | (4,685                         | )          | 474                                  |       | —                                         |       | (4,515                                               | )          |
| Accrued liabilities and jackpot liabilities                                                         |       | (2,437     | )          | 1,696                          |       | 721                                  |       | (59                                            | )          | (79                                                  | )          |
| Net cash provided by (used in) operating  activities                                                |       | (18,142    | )          | 31,430                         |       | 10,237                               |       | (893                                           | )          | 22,632                                               |       |
| Cash flows from investing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Additions to property, plant and equipment                                                          |       | (28        | )          | (3,296                         | )          | (3,400                               | )          | —                                         |       | (6,724                                               | )          |
| Additions to leased gaming equipment                                                                |       | —     |       | (15,099                        | )          | —                               |       | —                                         |       | (15,099                                              | )          |
| Acquisitions, net of cash acquired                                                                  |       | 4,000      |       | (19,333                        | )          | —                               |       | —                                         |       | (15,333                                              | )          |
| Additions to other long-term assets                                                                 |       | (10        | )          | (165                           | )          | 43                                   |       | —                                         |       | (132                                                 | )          |
| Net cash provided by (used in) investing  activities                                                |       | 3,962      |       | (37,893                        | )          | (3,357                               | )          | —                                         |       | (37,288                                              | )          |
| Cash flows from financing activities:                                                               |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Capitalized debt issuance costs                                                                     |       | (662       | )          | —                         |       | —                               |       | —                                         |       | (662                                                 | )          |
| Reduction of long-term debt                                                                         |       | (1,980     | )          | 165                            |       | (904                                 | )          | 893                                            |       | (1,826                                               | )          |
| Net change in revolving credit facility                                                             |       | —     |       | —                         |       | —                               |       | —                                         |       | —                                               |       |
| Proceeds from exercise of stock options and  warrants                                               |       | 6,706      |       | —                         |       | —                               |       | —                                         |       | 6,706                                                |       |
| Dividends received (paid)                                                                           |       | —     |       | 10,346                         |       | (10,346                              | )          | —                                         |       | —                                               |       |
| Net cash provided by (used in) financing  activities                                                |       | 4,064      |       | 10,511                         |       | (11,250                              | )          | 893                                            |       | 4,218                                                |       |
| Effect of exchange rate changes on cash                                                             |       | —     |       | —                         |       | 709                                  |       | —                                         |       | 709                                                  |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Cash provided by (used in) discontinued  operations                                                 |       | —     |       | 8,188                          |       | 4,212                                |       | —                                         |       | 12,400                                               |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Increase (decrease) for the year                                                                    |       | (10,116    | )          | 12,236                         |       | 551                                  |       | —                                         |       | 2,671                                                |       |
| Balance, beginning of year                                                                          |       | 18,237     |       | 5,178                          |       | 5,714                                |       | —                                         |       | 29,129                                               |       |
|                                                                                                |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Balance, end of year                                                                                |       | $          | 8,121      |                           | $          | 17,414                               |       | $                                              | 6,265      |                                                 | $          | — |   | $ | 31,800 |   |

 

See accompanying notes.

 

F-39

----

 

**Years Ended June 30, 2003 and 2004**

 

**Debt and Lines of Credit**

 

Long-term debt and lines of credit atJune 30, 2004 consist of the following (in 000s):

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

 

Long-term debt and lines of credit atJune 30, 2003 consist of the following (in 000s):

 
| ** **                                                           | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| 10% Senior Subordinated Notes due 2007, net  of unamortized discount |       | $          | 149,663    | ** **                     | $          | **—**                           | ** ** | $                                              | **—** | ** **                                           | $          | **—** |   | $ | 149,663 |   |
| Term Loan Facility                                                   |       | 187,625    |       | —                         |       | —                               |       | —                                         |       | 187,625                                              |       |
| Other subordinated debt                                              | ** ** | 495        |       | —                         |       | —                               |       | —                                         |       | 495                                                  | ** ** |
| Intercompany notes payable                                           | ** ** | —     |       | 159,723                        |       | —                               |       | (159,723                                       | )          | —                                               | ** ** |
| Other                                                                |       | —     |       | 7,414                          |       | 18                                   |       | —                                         |       | 7,432                                                |       |
|                                                                 |       | 337,783    |       | 167,137                        |       | 18                                   |       | (159,723                                       | )          | 345,215                                              |       |
| Less current maturities                                              |       | 2,395      |       | 1,124                          |       | 18                                   |       | —                                         |       | 3,537                                                |       |
| Long-term debt, less current maturities                              |       | $          | 335,388    |                           | $          | 166,013                              |       | $                                              | —     |                                                 | $          | (159,723 | ) | $ | 341,678 |   |

 

F-40

----

 

**Income Taxes**

 

The federal, foreign and state income taxeffects of temporary differences that give rise to significant portions of thedeferred tax assets and liabilities as of June 30, 2004 are as follows (in000s):

 
| ** **                                                           | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Deferred tax assets:                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net operating loss carry forwards                                    |       | $          | —     |                           | $          | 14,717                               |       | $                                              | —     |                                                 | $          | — |   | $ | 14,717 |   |
| Capital loss carry forwards                                          |       | 8,155      |       | —                         |       | —                               |       | —                                         |       | 8,155                                                |       |
| Foreign tax credit carry forwards                                    |       | —     |       | —                         |       | —                               |       | —                                         |       | —                                               |       |
| Other tax credits                                                    |       | 3,210      |       | 7,388                          |       | —                               |       | —                                         |       | 10,598                                               |       |
| Inventory obsolescence reserves                                      |       | —     |       | 2,023                          |       | —                               |       | —                                         |       | 2,023                                                |       |
| Financing lease assets                                               |       | —     |       | 708                            |       | —                               |       | —                                         |       | 708                                                  |       |
| Bad debt reserves                                                    |       | 26         |       | 2,595                          |       | —                               |       | —                                         |       | 2,621                                                |       |
| Accruals not currently deductible for tax  purposes                  |       | 182        |       | 14,425                         |       | —                               |       | —                                         |       | 14,607                                               |       |
| Refinancing costs being amortized for tax  purposes                  |       | 175        |       | —                         |       | —                               |       | —                                         |       | 175                                                  |       |
| Other                                                                |       | 8,114      |       | (5,429                         | )          | —                               |       | —                                         |       | 2,685                                                |       |
| Total gross deferred tax assets                                      |       | 19,862     |       | 36,427                         |       | —                               |       |                                           |       | 56,289                                               |       |
| Less:   Valuation allowance                                     |       | (8,382     | )          | (2,101                         | )          | —                               |       | —                                         |       | (10,483                                              | )          |
| Deferred tax assets                                                  |       | $          | 11,480     |                           | $          | 34,326                               |       | $                                              | —     |                                                 | $          | — |   | $ | 45,806 |   |
|                                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Deferred tax liabilities:                                            |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Property and equipment, principally due to  depreciation differences |       | $          | 13         |                           | $          | 16,384                               |       | $                                              | —     |                                                 | $          | — |   | $ | 16,397 |   |
| Intangibles                                                          |       | (324       | )          | 5,671                          |       | —                               |       | —                                         |       | 5,347                                                |       |
| Other                                                                |       | 242        |       | 2,979                          |       | 1,636                                |       | —                                         |       | 4,857                                                |       |
| Total gross deferred tax liabilities                                 |       | (69        | )          | 25,034                         |       | 1,636                                |       | —                                         |       | 26,601                                               |       |
| Net deferred tax assets                                              |       | $          | 11,549     |                           | $          | 9,292                                |       | $                                              | (1,636     | )                                                    | $          | — |   | $ | 19,205 |   |

 

F-41

----

 

The federal, foreign and state income taxeffects of temporary differences that give rise to significant portions of thedeferred tax assets and liabilities as of June 30, 2003 are as follows (in000s):

 
| ** **                                                           | ** ** | **Parent** | ** ** | **Guaranteeing  Subsidiaries** | ** ** | **Non-  Guaranteeing  Subsidiaries** | ** ** | **Reclas-  sifications  and  Elimina-  tions** | ** ** | **Alliance  Gaming  Corporation  and  Subsidiaries** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Deferred tax assets:                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Net operating loss carry forwards                                    |       | $          | 15,721     |                           | $          | —                               |       | $                                              | —     |                                                 | $          | — |   | $ | 15,721 |   |
| Capital loss carry forwards                                          |       | 25,375     |       | —                         |       | —                               |       | —                                         |       | 25,375                                               |       |
| Foreign tax credit carry forwards                                    |       | —     |       | 949                            |       | —                               |       | —                                         |       | 949                                                  |       |
| Other tax credits                                                    |       | 2,165      |       | 2,000                          |       | —                               |       | —                                         |       | 4,165                                                |       |
| Inventory obsolescence reserves                                      |       | (278       | )          | 2,311                          |       | —                               |       | —                                         |       | 2,033                                                |       |
| Bad debt reserves                                                    |       | 454        |       | 1,595                          |       | —                               |       | —                                         |       | 2,049                                                |       |
| Accruals not currently deductible for tax  purposes                  |       | 1,408      |       | 7,733                          |       | —                               |       | —                                         |       | 9,141                                                |       |
| Refinancing costs being amortized for tax  purposes                  |       | 2,277      |       | —                         |       | —                               |       | —                                         |       | 2,277                                                |       |
| Other                                                                |       | 3,581      |       | (1,773                         | )          | —                               |       | —                                         |       | 1,808                                                |       |
| Total gross deferred tax assets                                      |       | 50,703     |       | 12,815                         |       | —                               |       |                                           |       | 63,518                                               |       |
| Less:   Valuation allowance                                     |       | (11,491    | )          | —                         |       | —                               |       | —                                         |       | (11,491                                              | )          |
| Deferred tax assets                                                  |       | $          | 39,212     |                           | $          | 12,815                               |       | $                                              | —     |                                                 | $          | — |   | $ | 52,027 |   |
|                                                                 |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Deferred tax liabilities:                                            |       |       |       |                           |       |                                 |       |                                           |       |                                                 |       |
| Property and equipment, principally due to  depreciation differences |       | $          | 3,815      |                           | $          | 3,580                                |       | $                                              | —     |                                                 | $          | — |   | $ | 7,395 |   |
| Intangibles                                                          |       | (1,718     | )          | 3,275                          |       | —                               |       | —                                         |       | 1,557                                                |       |
| Other                                                                |       | 539        |       | —                         |       | 1,635                                |       | —                                         |       | 2,174                                                |       |
| Total gross deferred tax liabilities                                 |       | 2,636      |       | 6,855                          |       | 1,635                                |       | —                                         |       | 11,126                                               |       |
| Net deferred tax assets                                              |       | $          | 36,576     |                           | $          | 5,960                                |       | $                                              | (1,635     | )                                                    | $          | — |   | $ | 40,901 |   |

 

F-42

----

 

**17.****                               RESERVESAND ALLOWANCES**

 

The followingtables represent the activity for each of the fiscal years ended June 30,2004, 2003 and 2002 for each of the valuation reserve and allowance accounts(in 000s):

 
| ** **                       | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year** | ** ** |
|----------------------------------|------------|------------------------------------|------------|---------------|------------|----------------|------------|------------------------------|------------|
|                             |       |                               |       |          |       |           |       |                         |       |
| Allowance for doubtful accounts: |       |                               |       |          |       |           |       |                         |       |
| Year ended June 30, 2002    |       | $                                  | 8,607      |          | $          | 2,498          |       | $                            | 2,669      |   | $ | 8,436 |   |
| Year ended June 30, 2003    |       | $                                  | 8,436      |          | $          | 1,537          |       | $                            | 2,996      |   | $ | 6,977 |   |
| Year ended June 30, 2004    |       | $                                  | 6,977      |          | $          | 2,771          |       | $                            | 14         |   | $ | 9,734 |   |

 

**18.****                               INTERIMFINANCIAL INFORMATION (Unaudited)**

 

Following is the unaudited quarterly results of the Company for theyears ended June 30, 2004 and 2003 (in 000s, except per share data).  Amounts for the fiscal year may not agree tothe sum of the quarters due to rounding.

 
| ** **                                 | ** ** | **Quarter** | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **2004**                                   | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|                                       | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                   |       | $           | 101,223    |   | $ | 108,631 |   | $ | 116,239 |   | $ | 162,783 |   |
| Operating income                           |       | 21,933      |       | 27,534 |   | 22,152 |   | 27,104 |   |
| Net income from continuing operations      |       | 1,848       |       | 14,218 |   | 12,241 |   | 15,319 |   |
| Income (loss) from discontinued operations |       | 4,180       |       | 4,526 |   | 1,593 |   | 30,590 |   |
| Basic income per share - continuing        |       | $           | 0.04       |   | $ | 0.29 |   | $ | 0.25 |   | $ | 0.30 |   |
| Diluted income per share - continuing      |       | $           | 0.04       |   | $ | 0.28 |   | $ | 0.24 |   | $ | 0.30 |   |
| Basic income per share                     |       | $           | 0.12       |   | $ | 0.38 |   | $ | 0.28 |   | $ | 0.90 |   |
| Diluted income per share                   |       | $           | 0.12       |   | $ | 0.37 |   | $ | 0.27 |   | $ | 0.88 |   |

 

F-43

----

 
| ** **                                 | ** ** | **Quarter** | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **2003**                                   | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **                                 | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                   |       | $           | 76,206     |   | $ | 98,227 |   | $ | 96,232 |   | $ | 115,716 |   |
| Operating income                           |       | 16,270      |       | 21,241 |   | 20,403 |   | 27,058 |   |
| Net income from continuing operations      |       | 5,523       |       | 8,576 |   | 8,927 |   | 14,135 |   |
| Income (loss) from discontinued operations |       | 735         |       | 3,277 |   | 3,853 |   | (145 | ) |
| Basic income per share - continuing        |       | $           | 0.12       |   | $ | 0.17 |   | $ | 0.18 |   | $ | 0.29 |   |
| Diluted income per share - continuing      |       | $           | 0.12       |   | $ | 0.17 |   | $ | 0.18 |   | $ | 0.28 |   |
| Basic income (loss) per share              |       | $           | 0.13       |   | $ | 0.24 |   | $ | 0.26 |   | $ | 0.28 |   |
| Diluted income (loss) per share            |       | $           | 0.13       |   | $ | 0.24 |   | $ | 0.25 |   | $ | 0.28 |   |

 

The amounts shown in the tables above differ from those previouslyreported in the Company’s Form 10-Q’s due to the Company’s decision inJune 2003 to report its route operations and Bally Wulff segments asdiscontinued operations.  InDecember 2003 the company announced its intention to sell Rail City Casinoand at that time it was classified as discontinued operations.

 

F-44

----