**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For the fiscal year ended June 30,2006**

**OR**

**o**                                 TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom          to         **

**Commission File Number 0-4281**

**BALLY TECHNOLOGIES, INC.**

(Exact name of registrantas specified in its charter)

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

 

**6601 S. Bermuda Rd. LasVegas, Nevada 89119**

(Address of principalexecutive offices)

**Registrant’stelephone number, including area code: (702) 584-7600**

**Securities registeredpursuant to Section 12(b) of the Act:**

**None**

**Securities registeredpursuant to Section 12(g) of the Act:**

**CommonStock, $0.10 par value per share**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.   o Yes   x No

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.   o Yes   x No

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   o Yes   x 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 tothis Form 10-K.   o

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).   o Yes   x No

The aggregate market valueof the common stock, $0.10 par value, held by non-affiliates of the registrant,computed based on the closing sale price as of December 29, 2006 of $18.68per share as reported by the New York Stock Exchange, was approximately $917,300,000.

Accordingto the records of the registrant’s registrar and transfer agent, the number ofshares of the registrant’s common stock outstanding as of March 9, 2007was 53,206,342, which do not include 531,148 shares held in treasury.

 

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**BALLY TECHNOLOGIES, INC.**

**FORM 10-K**

**YearEnded June 30, 2006**

**EXPLANATORY NOTE**

As previously disclosed onthe Form 12b-25 of Bally Technologies, Inc. filed with theSecurities and Exchange Commission (the “SEC”) on September 14, 2006, thefiling of this Annual Report on Form 10-K for the period ended June 30,2006 (this “Annual Report on Form 10-K”), was originally delayed dueto the significant amount of additional time and resources necessary tocomplete the preparation and analysis of the financial statements for thefiscal quarters ended September 30, 2005, December 31, 2005 and March 31,2006. The filing of this Annual Report on Form 10-K was furtherdelayed by the restatements discussed in our Annual Report on Form 10-K/Afor the fiscal year ended June 30, 2005, filed with the SEC on October 31,2006 (the “2005 10-K”). Furthermore, the preparation of the financialinformation presented in this Annual Report on Form 10-K requiredadditional time and resources because it was prepared while certain material weaknessesexisted in our internal control over financial reporting which are described inItem 9A, Controls and Procedures. Unless specifically stated otherwise,information presented in this Annual Report on Form 10-K is as ofand for the periods ended June 30, 2006.

**PART I**

**ITEM1.**                BUSINESS

**General**

We are a leader in thedesign, manufacture, assembly and distribution of technology based products tocommercial gaming markets worldwide. In addition to selling our gaming devices,we also offer our customers a wide range of lease and rental options. Ourprimary technologies include gaming devices for land-based, riverboat andNative American casinos, video lottery and central determination markets andspecialized system based hardware and software products. Our specializedhardware and software products provide casinos with a wide range of marketing,data management, accounting, security and other software applications and toolsto more effectively manage their operations. We also own and operate ariverboat dockside casino in Vicksburg, Mississippi.

You can find furtherinformation regarding our individual business units in the notes to ourconsolidated financial statements included in this Annual Report on Form 10-Kand Item 7. Management’s Discussion and Analysis of financial condition andresults of operations.

We were incorporated inNevada on September 30, 1968, under the name Advanced Patent Technology. Followingtwo other name changes, we became Alliance Gaming Corporation on December 19,1994, and on March 6, 2006, we changed our name to Bally Technologies, Inc.Unless the context requires otherwise, the terms “Bally,” the “Company,” “we”and “our” as used herein refer to Bally Technologies, Inc. andsubsidiaries.

Our principal executiveoffices are located at 6601 South Bermuda Road, Las Vegas, Nevada 89119;telephone (702) 584-7600. Our internet address is www.ballytech.com. OurAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and all amendments to those reports areavailable on our website, free of charge, as soon as reasonably practicableafter such material is electronically filed with or furnished to the SEC. Copiesof these material and the others we furnish to the SEC are publicly availableat the SEC’s Public Reference Room at 100F Street, NE, Washington, DC 20549.Information on the operation of the Public Reference Room may be obtainedby calling the SEC at 1-800-SEC-0330. The SEC maintains anInternet site that contains reports, proxy and information statements, andother information regarding issuers that file electronically with the SEC athttp://www.sec.gov.

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**FinancialInformation**

The financial information required with respect to each ofour business segments and with respect to geographical areas can be found inthe consolidated financial statements included in this Annual Report on Form 10-Kand the related notes.

**BusinessUnits**

Our business consists of twobusiness units, the Bally Gaming and Systems business unit and the RainbowCasino (“Rainbow”) business unit. The Bally Gaming and Systems unit consists ofthree primary sub-groups: Gaming Equipment, which includes the sale of gamingdevices; Gaming Operations, which includes the rent and lease of gaming devices;and Systems, which includes the sale and support of gaming systems. We also ownand operate the Rainbow Casino in Vicksburg, Mississippi. The following tablesets forth the percentage of revenues of the Company’s business units for theperiods indicated:

| ** **               | ** ** | **Revenue by Business Unit  Year Ended June 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **               | ** ** | **(dollars in 000s)**                                                 | ** ** |
| Bally Gaming and Systems |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming  Equipment        |       | $                                                                               | 228.9      |   |   | 42 | % |   | $ | 202.8 |   | 42 | % | $ | 223.3 |   | 47 | % |
| Systems                  |       | 120.5                                                                           |       |   | 22 | % |   | 97.0 |   | 20 | % | 121.9 |   | 26 | % |
| Gaming  Operations       |       | 145.1                                                                           |       |   | 26 | % |   | 131.3 |   | 27 | % | 79.1 |   | 16 | % |
| Rainbow                  |       | 52.6                                                                            |       |   | 10 | % |   | 52.0 |   | 11 | % | 52.3 |   | 11 | % |
|                     |       | $                                                                               | 547.1      |   |   | 100 | % |   | $ | 483.1 |   | 100 | % | $ | 476.6 |   | 100 | % |

 

**BallyGaming and Systems—Gaming Equipment**

We design, manufacture, assemble and sell a full range oftechnology based gaming devices. These devices are not mass produced and arenormally configured under specific order to a customer’s particularrequirements. Gaming devices are differentiated from one another by a number offactors including, but not limited to, graphic design and theme, cabinet style,pay table, game layout, betting denomination and minimum/maximum bettingamount.

Our gaming devices include a variety of game features andlayouts, mechanical reel spinning devices in various reel layouts, as well asother newer products such as multi-game video poker, devices featuring highprofile top boxes with various game features and varying sizes geared towardsspecific market niches. The gaming products we create are the result ofcomprehensive product development efforts which include extensive internal andthird party testing. We also perform market tests of our products with thecooperation of casino operators to assess reliability and player appeal.

Each gaming device typically contains an operating systemtypically referred to as a game platform. The operating system manages thesoftware needed to run the device. Game platforms and the related computersystems are constantly updated and revised to keep pace with theever-increasing complexity of modern game play requirements. The constant changein game play requirements is driven by, among other things, changes in consumerdemand, capacity, security and regulation. In fiscal 2005, we completedthe successful migration from our legacy platforms, including the V7000 andEVOTM, to the Linux-based ALPHA OSTM platform and operating system. In fiscal2006, we also extended the transition to the ALPHA OS to our mechanical reelspinning devices. ALPHA OS is now the platform for each of our gaming deviceproduct offerings and, as a result, marketing of our legacy products hasgenerally been discontinued. The platform’s flexibility allows us to use it intraditional and Native American casinos, as well as lottery, centraldetermination and bingo markets.

The ALPHA OS is designedto separate the gaming operating system from the game layer, which enables gamedevelopment in a much shorter time. ALPHA OS is also designed to incorporatebonusing, free spin, 

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scatter and other advancedgame features, while providing internal and third-party developers with asecure, easy-to-use programming environment that incorporates an advanced setof development tools. Moreover, ALPHA OS is designed to support server-basedgaming initiatives, including download of game results, configuration and gamecontent. Additionally, our layered architecture and modular design allow foradaptability and simplified requirement changes. The operating system, which isLinux-based, is compatible with the most common accounting and ticket systemsand supports 20-plus lines, bonusing, multi-denomination and multi-paytable game configurations. ALPHA OS also supports multi-level local andwide-area progressive products.

ALPHA OS was originallydeveloped by Sierra Design Group (“SDG”), a company we acquired in 2004. Theplatform is the result of a significant investment in hardware and softwareengineering and development efforts. Since the acquisition, we have undertakensignificant development initiatives to make the ALPHA OS platform compliantwith the regulations of the jurisdictions in which we operate. The ALPHA OSplatform has now received approval in virtually all major gaming jurisdictions,including Nevada, Mississippi, New Jersey, Missouri, Florida, Pennsylvania,Washington, New York, Rhode Island as well as various Native Americanjurisdictions. Subsequent to its original regulatory approval, we havedeveloped and launched a series of video and mechanical game themes on ALPHA OSand we will continue to develop new themes to support our cabinet designs andproduct markets.

We also offer certain gametitles in certain jurisdictions that were developed by WMS Industries, Inc.(“WMS”), Aristocrat Leisure Limited (“Aristocrat”), and Konami Co. Ltd. (“Konami”).Our use of these game titles is governed by license agreements we have enteredinto with each of these manufacturers.

Our sales are not limited to our gaming devices. Customersthat purchase or lease our gaming devices typically purchase our replacementparts, upgrades, game conversion kits and other products to keep our devices ingood working order and to enhance the underlying performance of the devices. Certainequipment within gaming devices such as video monitors, bill validators, logicboards and printers are typically replaced, whether as a result of partfailures or new technology offerings by our suppliers. These sales may alsoinclude game conversion kits that provide our customers the opportunity tooffer a new theme or variant on the existing product without the necessity ofpurchasing an entirely new gaming device. Because the average life or wholesalereplacement of gaming devices is not predictable and because customers mayelect to maintain existing equipment for longer periods of time, we cannotaccurately forecast the extent to which conversion or upgrade products maybecome a larger or smaller portion of our gaming equipment sales.

We generally offer a 90-day parts and labor warrantyfor new gaming devices. We also remain actively involved in customer serviceafter the original installation of the device. We provide several after-saleservices to our customers including customer education programs, a 24-hourcustomer service telephone hot-line, an internet web site for technicalsupport, field service support programs and spare parts programs. Ourhistorical warranty expense as a percentage of revenues has been less than 1%.

From time to time, we also sell used gaming devices,including products made by us as well as those produced by our competitors. Generally,we acquire used devices as trade-ins toward the purchase of new gamingdevices. While a small secondary market exists in the United States, useddevices are typically resold into international markets where new devicepurchases often prove to be too costly. Where appropriate, we incur cost torecondition used devices for resale or we elect to destroy the devices. We alsooccasionally sell used equipment in lots on an “as is” basis to used devicebrokers and customers. Used game sales totaled $15.0 million, $14.4 million,and $20.4 million for the years ended June 30, 2006, 2005 and 2004,respectively.

**Bally Gaming and Systems—Gaming Operations**

In additionto selling our gaming devices, we also offer our customers a wide range oflease and rental options. Customers can select one of several economicarrangements, each of which generates recurring 

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revenuesfor us. Specifically, these arrangements are available under four businessmodels: linked progressive systems, centrally determined systems, lotterysystems and rental or lease games. In most cases, operating gaming devicesunder a lease or rental arrangement requires us to invest capital in the costof manufacturing the gaming device and related equipment, purchasing signs andseating, and, in certain cases, acquiring certain intellectual property rights.

*Linked Progressive Systems:*   We offer ourcustomers gaming devices featuring a common jackpot or prize award that can belinked within a casino or among multiple casinos within a market orjurisdiction. We first received regulatory approval of our progressive systemin Nevada in 1998 and now operate linked systems in Nevada, New Jersey,Mississippi and certain Native American jurisdictions. Progressive gamingdevices are typically offered to customers under a daily fee arrangement thatis based on a percentage of the money wagered on the participating gamingdevices. In many cases, we use these revenues to fund the ultimate payment ofthe jackpot awards. As of June 30, 2006, we had a total of 1,053 unitsdeployed on our wide-area progressive networks.

*Centrally Determined Systems:**  *We have a base of centrallydetermined gaming devices operating primarily in Native American casinos inWashington, Florida, Alabama and Oklahoma. With the exception of the gamingdevices in Oklahoma, these games have generally been sold to the customer andwe receive a daily fee for the use of our central determination software. Leasearrangements based on a percentage of the net win are still most prevalent inOklahoma. As of June 30, 2006, the installed base of centrally determinedgames totaled 27,437 units.

We alsobegan selling centrally determined gaming devices that are compliant withMexican regulations. These devices are sold pursuant to a development andsupply agreement we entered into with a large distributor in December 2005.In the Mexican market, we sell gaming devices to our distributor as an originalequipment manufacturer (“OEM”). Our distributor, in turn, places these devicesin locations that house sports betting and pari-mutuel operations. In additionto the revenues from the sale of the devices, we derive a daily fee equal to apercentage of the net win for providing a system network, monitoring andmaintenance, gaming content, consulting, and marketing and promotion services. Asof June 30, 2006 we had 1,864 gaming devices in operation in Mexico.

*Lottery Systems:**  *We provide video lotterydevices to race tracks for the New York State Lottery (“NYSL”). We and SDG(prior to our acquisition in March 2004) were each awarded approximately25% of the initial NYSL terminals to be installed through a competitive biddingprocess. In June 2003, we entered into long term contracts with the NYSLfor an initial term of 3.5 years**.**The financialmodel for this market requires the Company to build, deploy and maintain theterminals as well as provide the related equipment in return for a share of thenet win generated by the terminals. The first of these gaming devices wereinstalled in January 2004, and have since been followed by installationsat several additional tracks. As of June 30, 2006, our installed based was2,682 units.

We alsoearn recurring revenues from 796 devices deployed at horseracing facilitiesunder agreements with the Delaware State Lottery Commission.

In June 2005,we began selling video lottery gaming devices on an OEM basis to a distributorin Iowa. We received daily fee revenue based on the game’s underlyingperformance as well as for technology services and game themes. However, a newlaw was passed during the 2006 Iowa state legislative session banning suchdevices from operation. As a result, the games were removed from operation in May 2006,ending our daily fee revenue. During fiscal 2006, revenues from the daily feetotaled $9.2 million and revenue from the sale of gaming devices totaled $18.3million.

*Rental or Lease Games:*   We offer a variety ofnon-linked daily fee games. We have marketed our daily fee games under suchtitles, among others, as Playboy®, Hot ShotsTM, Reel WinnersTM, Hee Haw®, MonteCarloTM and Saturday Night LiveTM, all of which are approved in most major gamingjurisdictions in which 

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we operate. In most cases, we incur the cost ofmanufacturing the gaming devices we rent or lease, and we often provideadditional equipment such as signage and chairs for the customers’ use. Wetypically retain ownership of these gaming devices and equipment and depreciatethem over their estimated useful lives. As of June 30, 2006, we had atotal installed base of daily fee games of 8,291 units.

**Bally Gaming and Systems—Systems**

We design, program, test, market and support casinoenterprise systems for a wide range of customers of varying size and complexity.These systems typically provide casino operators features such as active,real-time monitoring tools for gaming devices, tools to collect and managecustomer data, security to protect against theft and data loss, and marketingprograms to enhance the gaming experience. The use of system technology ingaming has grown in the past ten years from basic automation of manualactivities to highly integrated mission critical applications. We believe weare the only provider in the industry that offers a selection of technologyplatform options to its customers. Our products operate on platforms such asWindows, AS/400 (iSeries), and UNIX, allowing our customers to choose a technologysolution that meets their existing or future infrastructure requirements. Thefollowing are the primary systems we provide to our customers:

·       *Slot Floor Management*:  Our gaming device monitoring products arecomprised of hardware consisting of micro controller based printed circuitboards installed within the gaming device as well as card readers, displays andkeypads. We also develop proprietary firmware that controls and manages thehardware components of our systems. This equipment provides casinos the abilityto track player gaming activity through our casino management systems andmonitor employee access to gaming devices.

·       *Casino Management*:  Our casino management systems are composed ofvarious hardware and software products that provide casino operators playerloyalty solutions comparable to frequent guest programs offered in otherleisure and retail industries; table game accounting solutions including thecalculation of all revenue and expense related items; and cage and creditaccountability for all extensions of credit and cage cash balancing functions.

·*      **Cashless Systems*:  Our cashless systems provide a suite ofproducts for casino operators to provide bonusing and cashless gaming activityto casino patrons.

We market our system product solutions under the broadcategories of Bally CMS® (Casino Management Systems), Bally SMS® (SlotManagement Systems) and Bally TMS® (Table Management Systems).

**Rainbow—Casino Operation**

The RainbowCasino, located in Vicksburg, Mississippi, began operations in July 1994. Thefacility includes a 33,000-square foot casino with 891 gaming devices and12****table games as well as a 310-seatbuffet-style restaurant, and a 20,000-square foot conference center. TheCasino also includes the 89-room Rainbow Hotel, which is owned andoperated by a third party. Rainbow is marketed as a “locals” casino and drawsmid-level gaming customers principally from within a 75-mile radius ofVicksburg. Our promotions are focused primarily on direct mail and specialpromotional events. The Vicksburg casino market generated approximately $297.2million in gaming revenue in the twelve months ended June 30, 2006,representing a growth rate of approximately 18%.

We are thegeneral partners of Rainbow Casino Vicksburg Partnership, L.P. (“RCVP”), thelimited partnership that operates Rainbow. The limited partner, RainbowCorporation, an unaffiliated third party, is entitled to receive 10% of the netavailable cash flows after debt service and other items, as defined in thelimited partnership agreement, which increases to 20% of the incremental amountof annual revenues 

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in excessof $35.0 million, payable quarterly through December 31, 2010. Wehold the remaining economic interest in the partnership.

Theoperation of casinos is a highly competitive business. Gaming of all types isavailable throughout Mississippi in numerous locations as well as insurrounding markets. 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. Rainbow faces substantial direct competition for gamingcustomers from the three other gaming facilities in Vicksburg, as well as othergaming operations throughout Mississippi and surrounding markets. Additionalcompetitors could emerge in the Vicksburg market. The timing, scale andpotential impact of such competition on our business is not yet known.

In fiscal 2007, we began considering the possible sale ofRainbow to a third party in connection with our plans to focus our efforts onour technology assets. The conditions under which we may sell Rainbow aredynamic and may be impacted by a number of factors including but not limitedto, general market conditions, competition, our financial position, and theinterest of certain buyers who may be strategic to us. If we do not receive afinancially beneficial offer, we may decide not to sell the casino.

**Acquisitions**

On March 2, 2004, we purchased SDG, a leadingsupplier of Class II and Class III gaming devices, systems andtechnology, for aggregate initial consideration of approximately $126.4 million.The initial purchase price consisted of $108.6 million of cash, 662,000 sharesof our common stock valued at $11.9 million, the assumption of approximately$8.0 million of debt and certain transaction fees and expenses. In addition, anearn out provision provided for the payment of up to $95.6 million inadditional consideration upon certain financial targets being achieved in thesubsequent three-year period. In December 2004, we and the sellingshareholders settled the earn out for a fixed amount of $40.0 million,consisting of a one-time cash payment of $12.0 million and the issuance of asubordinated note of $28.0 million, due in annual installments through 2009. InJune 2005, we extinguished $14.0 million of the note and accrued interestthereon by issuing approximately 1.0 million shares of our common stock to thenote holders. The acquisition of SDG provided us with significanttechnology-based assets including the ALPHA OS, intellectual property, andpositioned us to take advantage of certain gaming markets such as the NativeAmerican and video lottery markets that would have required significantinternal product development efforts.

On February 19, 2004, we acquired substantiallyall of the assets and liabilities of MindPlay LLC (“MindPlay”), a leadingdeveloper of advanced table game technologies, for aggregate initialconsideration of approximately $16.8 million. The initial purchase priceincluded $9.0 million cash, a $4.0 million note payable, the assumption ofapproximately $2.0 million of debt and the issuance of warrants to purchase100,000 shares of our common stock, which were valued at approximately $0.9million. In addition, an earn out provision provides for the payment of 10% ofgross margin from the sale of MindPlay products in the first seven yearssubsequent to the acquisition, and 4.25% of gross margin for the next sixyears, subject to adjustments pursuant to the conditions contained in the purchaseagreement. Additionally, the agreementprovided a right offset 50% of all damages (including reasonable attorneys’fees) up to the entire amount due under the promissory note in connection withan indemnification claim against the former shareholders of MindPlay related toour patent lawsuit with Shuffle Master, Inc. (“Shuffle Master”) andInternational Game Technology (“IGT”) which is described in Item 3, LegalProceedings.

TheMindPlay technologies are designed to provide data and information to casinooperators to improve customer service, to provide enhanced security and toincrease profitability by lowering the cost of operation and enhancing thecasino patron experience.

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**Product Development**

We believeproviding games and systems with high entertainment value and key operationaladvantages coupled with a high level of customer service is important togaining market share. We believe that the use of technology within casinos hasaccelerated over the past five years and gives newer gaming devices and systemscompetitive advantages over their more antiquated counterparts. Our totalspending on research and development was $45.1 million, $43.4 million and $36.6million during the years ended June 30, 2006, 2005 and 2004, respectively.The increase in research and development spending over this three year periodreflects our corporate focus towards our technology assets, the expansion oftechnical resources through our acquisitions, and the competitive landscapethat requires a continued need to develop future generations of gaming productsand systems.

We developour products for both the domestic and international markets. Our productdevelopment process for our gaming devices includes both hardware and software.Major areas of hardware development include cabinet style, technicalcapability, interfaces, peripheral devices, and coin and currency handling. Hardwaredevelopment efforts are focused on player appeal, product reliability and easeof maintenance. Development cycles for hardware can range from a few days forsimple enhancements to more than a year for new electronics or new mechanicalpackages.

Thesoftware development process for new games, which includes graphics development,is continuous and requires significant human resources. Creativity in softwaredevelopment is an important element in the market success and player appeal ofour gaming devices. Ideas for new models are generated internally, by customersand by third parties, many of whom have entered into strategic relationshipswith us.

Followingthe completion of development of our products and internal quality testing, ourproducts are subjected to a rigorous and time consuming process of independentand jurisdictional testing by regulatory agencies and their agents. All new ormodified hardware and software are designed to satisfy all applicable testingstandards. Typically, new products require various approvals from numerousregulatory agencies. Many jurisdictions outside North America require a lowerlevel of testing and, in certain cases, do not require any such approvals. Eachjurisdiction that requires regulatory approval of new products has its ownfiling requirement and process. In certain cases, we may receive approvals ifour products are approved in other major gaming jurisdictions. Once productsare approved by the gaming regulators, customers may also require field trialsof our products in their casinos to ensure compatibility and stability whilereserving the right to return the product at any time during the field trialperiod. We do not recognize revenue until the customer ends the field trial andaccepts the gaming devices. The regulatory and licensing processes that we aresubject to are discussed more fully below, under “—Gaming Regulations andLicensing.”

Productdevelopment for casino enterprise systems also includes hardware and software.The major areas of hardware development include controller circuit board designand programming, as well as user interface devices such as card readers,keypads and displays. Software development includes extensive applicationdevelopment, including elements such as databases, interfaces, communication,security and automated backup and failure procedures. We have developed amodular and extendible hardware and software architecture, which focusesdevelopment on achieving greater functionality, product reliability, ease ofmaintenance for the casino operator, and ease of use for the player. Inaddition, the architecture allows customers to upgrade existing components oradd new components with less impact as compared to a complete replacement. Developmentcycles for hardware can vary between a few months for minor revisions to morethan a year for major design changes. Software development results in periodicproduct releases that include new features that extend or enhance the casinoenterprise systems. Less significant revisions such as periodic maintenancereleases are also deployed to enable casino operators to correct problems orimprove the usability of the system.

We have developed a series of cashless and bonusingproducts marketed under the Bally Power BonusingÔname. The Bally Power Bonusing products represent an integrated set of cashlessand 

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bonusing features to enhance the gaming experience ofcasino patrons. These products allow the transfer of funds using bar codedcoupons and/or encrypted PIN numbers to download either restricted orunrestricted credits to the gaming device. These products allow casinooperators to reduce cash and coin handling expenses, minimize overall operatingexpenditures and provide creative marketing incentives to their casino patrons.Our cashless products are in use in most gaming markets, including Nevada,Michigan, New Jersey, Mississippi, Louisiana, Iowa, Colorado, Missouri, Indianaand various Native American and international jurisdictions.

The software development process for our systems includesthe design and development of features to meet various regulatory standards. Theregulatory standards vary by jurisdiction, which forces us to develop multiplesoftware settings based on the individual state and tribal gaming standards. Eachjurisdiction can also require the approval of any software modifications or newproducts prior to their deployment at casino locations within the jurisdiction.The approval processes can vary significantly by jurisdiction, based on thesoftware changes developed, technology enhancements, and regulator resources.

**Product Markets**

We believethat the total installed base of gaming devices in North America, including theUnited States and Canada, now exceeds 780,000 units. This total includes land-based,riverboat, Native American, casino and video lottery markets. New salesopportunities for gaming devices in North America are primarily driven byreplacement of existing units, new casino openings or expansions and new marketlegalization. The gaming industry also continues to expand in internationalmarkets. Europe, the Caribbean, Latin America, and the Pacific Rim arecurrently our primary international markets. We regularly evaluate expandingour business into additional international markets.

Wedistribute our gaming devices through direct sales efforts and through a smallnumber of distribution arrangements. Our international business is conductedprimarily from offices in Manchester, England and Hanover, Germany forcustomers in Europe; Puerto Rico for customers in the Caribbean; Buenos Aires,Argentina for customers in South America; and Macau, China for customers in thePacific Rim.

The primary markets for casino enterprise systems are theUnited States and, to a lesser extent, Canada, Latin America, Europe, thePacific Rim and the Caribbean though additional international markets are beginningto emerge. Markets for systems within the United States include traditionalland-based casinos in markets such as Nevada and New Jersey, NativeAmerican casinos and riverboat casinos. The market for our casino enterprisesystems includes new casino openings, expansion and upgrades of existingfacilities and the competitive replacement of other systems. We also cangenerate new system sales through the introduction of new hardware and softwareproducts. In many cases, domestic regulations require the implementation ofsystems as part of their operational requirements while international marketshave only recently begun the full implementation of such systems. We believe,as international markets begin to mature and become more competitive, the use ofsystems will become more common.

**Sales and Marketing**

We have adirect domestic sales force consisting of approximately 46 employees located inmultiple offices throughout North America. We also, to a lesser extent, utilizean independent distributor network to distribute our products. The agreementswe have with distributors generally specify minimum purchases and also providethat we may terminate the relationship if certain performance standards are notmet.

Our directsales force generated approximately 68%, 69%, and 75% of new gaming devicesales for the years ended June 30, 2006, 2005 and 2004, respectively. Distributorsgenerated approximately 32%, 31%, and 25% of new gaming device sales for theyears ended June 30, 2006, 2005 and 2004, respectively. Substantially allof system revenues are generated by our direct sales force.

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The sale ofgaming devices takes place throughout our fiscal year and can range fromproposals for a small quantity of units to several thousand units. We conductone on one meetings with our customers to demonstrate our products at theirlocations, host customers to private demonstrations in our offices or atoffsite venues, and participate in several trade shows domestically andinternationally each year. In certain cases, we participate in responding tocompetitive requests for proposals from private and public entities who areseeking to purchase gaming equipment.

For casinoenterprise system sales, we offer our customers the option of signing separatehardware and software maintenance agreements at the time of sale. Theseagreements are typically for one-year terms and automatically renew unlessotherwise canceled in writing by either party. After an initial warrantyperiod, typically 90 days, the customer is invoiced monthly for hardware andsoftware maintenance fees that provides for, among other things, repair orreplacement of malfunctioning hardware and software, software version upgrades,and on-call support for software.

The sale ofenterprise systems is normally a long process, at times extending beyond oneyear. Typically, a potential systems customer will participate in a formalevaluation and selection of a system vendor. The level of sales available to usat any point in time can vary materially due to a number of factors, includingthe capital budgets of our customers, availability of new product modules,timing associated with regulatory approvals, and the success and featurescontained in the products sold by our competitors.  The price paid for a full system can varymaterially from customer to customer depending on a number of factors,including but not limited to, the size of the gaming operation, the number offunctions contained in the system specified, and the level of post sale supportprovided.

We sell gaming devices andour computerized monitoring systems either through normal credit terms of 120days or less. In certain circumstances, we may grant credit terms that mayextend up to five years. International sales are either consummated on a cashbasis or financed over no more than two years, depending on credit quality.

**Customers**

The demandfor gaming devices and systems varies depending on the level of newconstruction and renovation of casinos as well as market conditions that mightgenerate the need for new and replacement equipment and product innovation.

Gamingdevices generally have an average replacement cycle of three to seven years. Forthe year ended June 30, 2006, our ten largest customers, includingcorporate customers with multiple casino properties, accounted forapproximately 24% of sales.

In additionto direct commercial transactions with casino customers, we may sell gamingdevices on an OEM basis to other parties who, in turn, sell these products toend user casino customers. In certain cases, these parties may be competingwith us in markets where we also sell our products. In several cases, our OEMsalso purchase the rights to certain Bally themes, entitling them to certainBally proprietary game themes, which are redesigned to be compatible with theiroperating system configurations. Sales of OEM units totaled approximately $4.4million, $16.7 million, and $9.3 million for the years ended June 30,2006, 2005 and 2004, respectively, and sales of licenses to OEMs for the use ofBally game themes totaled approximately $1.2 million, $1.4 million and $3.3million for the years ended June 30, 2006, 2005 and 2004, respectively.

The demandfor casino enterprise systems is driven by regulatory requirements in eachapplicable jurisdiction, by casino operators’ competitive need to properlytrack device and player activity and, to establish and compile individualdevice and player profitability and other demographic information. Thesefeatures enable casinos to develop or enhance marketing strategies. Revenuesfor casino enterprise systems are derived from selling products to new orexisting customers. For the year ended June 30, 2006, 

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the tenlargest casino enterprise system customers, which include certain multi-sitecasino operators that have corporate agreements, accounted for approximately63% of game monitoring unit sales revenues, with the largest single customeraccounting for 18% of game monitoring unit sales revenues.

Future sales of our technology products will be based on,among other elements, continued expansion of our product line, the success ofour game content, the acceptance of our systems, our customer service levels,expansion into additional domestic and international markets, and our abilityto maintain a competitive position against other technology providers who arealso producing innovative products.

**Assembly Operations**

Our primaryoffices, which we own and are located in Las Vegas, were completed in 1990. The150,000 square foot facility was designed and constructed specifically for thedesign, assembly and distribution of gaming equipment and to meet productdesign demands and varying level of volume requirements. We believe our primaryoffices and related facilities in Las Vegas, as well as continuous processimprovements, will enable us to increase production without adding significantfloor space.

We recentlycompleted a substantial change to our product line which is expected to benefitour assembly operations. Historically, we managed a series of game deviceplatforms and product families which required certain dedicated resources andcapacity in our assembly operations. Our consolidation to the ALPHA OS platformand engineering efforts towards common hardware components has provided greaterflexibility in our assembly operations where each product family can now beproduced by an expanded set of assembly lines with fewer internal productdifferences and more streamlined testing.

We generally buy raw material inventory to build our gamingdevices when we receive firm orders from our customers. To the extent possible,we also forecast the demand for our products in order to develop more efficientsupply chains with our vendors. We create specifications and design nearly allof the major assemblies that are incorporated into our gaming devices.

**Competition**

There are a number of domestic and internationalbusinesses who compete in the various geographic markets where we sell ourproducts. Our ability to compete effectively is based on a number of factorsincluding, but not limited to, our product quality, product depth, pricing,financing terms, regulatory approvals, the successful development andprotection of intellectual property as well as the success of our distribution,sales and service levels.

The North American gaming device market is dominatedby a single competitor, IGT.  IGT hassubstantially greater financial resources and more products and intellectualproperty than nearly all of its competitors. Many of our customers derive asignificant portion of their gaming revenues using IGT products. Some of ourother competitors currently include Aristocrat, Atronic, GTECH Corporation,Konami and WMS. These competitors also compete in the international markets weserve, along with well established foreign companies such as Ainsworth, Aruze,Cirsa/Unidesa, Novomatic, and Recreativos Franco.

The competition for casino enterprise systemsis also significant. Product feature and functionality, accuracy, reliability,service level and pricing are all among the key factors in determining aprovider’s success in selling its system. Our principal competition in casinomanagement systems currently consists of, among others, IGT, Aristocrat,Konami, Progressive Gaming and several smaller competitive providers in theinternational market. Competition is keen in this market due to the number ofproviders and the limited number of casinos and jurisdictions in which theyoperate. Management believes the future success of our operations will bedetermined by our ability to bring new and innovative products to the marketwhile maintaining our base of loyal existing customers.

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**Discontinued Operations**

**Route Operations**

*Nevada Operations:*   In June 2004, wesold our Nevada route operations to Century Gaming, Inc., a privately heldroute operator based in Montana. We received approximately $100.0 millionin cash and the assumption by Century Gaming of approximately $5.0 million indebt. We reported a gain on the sale before income taxes of $15.3 million, or$9.1 million after tax. During fiscal 2005, we recorded a litigation charge andwe settled certain indemnity claims raised by Century Gaming, and recorded areduction in the gain on sale of $9.8 million, or $6.3 million net of tax.

*Louisiana Operations:*   In October 2004,we sold our interest in our Louisiana route operations to Churchill DownsIncorporated and received proceeds of approximately $2.0 million and realized again of $1.3 million, or $0.8 million, net of tax.

**Rail City Casino**

In May 2004, we sold our Rail City Casino, a 20,000square-foot facility located between the cities of Reno and Sparks, innorthern Nevada, to the Sands Regent. We received aggregate consideration of$37.9 million. We reported a gain on the sale before income taxes of $23.1million, or $14.3 million after tax.

**Patents, Copyrights and Trade Secrets**

We have been a longstanding participant in the development of intellectual property in ourindustry. We rely on a combination of patents, copyrights, trade secrets,trademarks and proprietary information to maintain and enhance our competitiveposition. We have been granted patents and have patent applications pending inthe United States as well as in many foreign countries. The expiration dates ofthese patents vary and are based on their filing and issuances dates. We intendto continue to actively file for patent protection, where reasonable, withinand outside the United States. We also seek protection for a large number ofour products by filing for copyrights and trademarks in the United States andvarious foreign countries. Under permission or license agreements with thirdparties, we also sell products covered by independently filed copyrights andtrademarks. Typically, these contracts require us to pay royalties to the licensingparty. Royalty expense is included in cost of gaming and systems in ourconsolidated financial statements included in this report.

**Employees and Labor Relations**

As of June 30, 2006, we and our subsidiaries employedapproximately 2,020 individuals worldwide, including approximately 356employees at Rainbow. None of employees are covered by collective bargainingagreements. We believe we have satisfactory relationships with our employees.

**Gaming Regulationsand Licensing**

*General.**  *The manufacture and distribution of gaming devices,systems and the operation of gaming facilities are subject to extensivefederal, state, local, and foreign regulation. Virtually all of thejurisdictions in which we operate, and those jurisdictions which we mightpursue in the future, require licenses, permits, documentation ofqualification, evidence of financial stability, and other requirements forapproval. These jurisdictions also typically require background investigationsfor the individual licensing of officers, directors, major stockholders and keypersonnel.

Any person who acquires a controlling interest in theCompany would have to meet the requirements of all governmental bodies thatregulate our gaming businesses. A change in the make-up of our Board of 

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Directors and management may require the variousgaming authorities to examine the qualifications of the new board andmanagement.

*Nevada.**  *The ownership and operation of casino gamingfacilities in Nevada are subject to (i) the Nevada Gaming Control Act andthe regulations promulgated thereunder (the “Nevada Act”); and (ii) variouslocal ordinances and regulations. Our gaming, manufacturing, and distributionoperations (collectively referred to as “gaming machine operations”) aresubject to the licensing and regulatory control of the Nevada State GamingControl Board (the “Nevada Board”), the Nevada Gaming Commission (the “NevadaCommission”), the Clark County Liquor and Gaming Licensing Board (the “ClarkCounty Board”), and various other county and city regulatory agencies, all ofwhich are collectively referred to as the “Nevada Gaming Authorities.”

The laws, regulations, and supervisory procedures ofthe Nevada Gaming Authorities are based on declarations of public policyconcerned with, among other things: (i) the prevention of unsavory andunsuitable persons from having any involvement with gaming; (ii) thestrict regulation of all persons, locations, practices, associations andactivities related to the operation of licensed gaming establishments and themanufacture and distribution of gaming devices, cashless wagering systems andassociated equipment; (iii) the establishment and maintenance ofresponsible accounting practices and procedures; (iv) the maintenance ofeffective control over the financial practices of licensees, including theestablishment of minimum procedures for internal fiscal affairs and thesafeguarding of assets and revenues, providing reliable record-keeping andrequiring the filing of periodic reports with the Nevada Gaming Authorities; (v) theprevention of cheating and fraudulent practices; and (vi) providing asource of state and local revenues through taxation and licensing fees. Achange in such laws, regulations and procedures, or non-compliance with some,could have an adverse effect on our gaming-related operations.

We are registered with the Nevada Commission as apublicly traded corporation (a “Registered Corporation”). Our direct andindirect subsidiaries that manufacture or distribute gaming devices or conductgaming operations at various locations (collectively, the “Nevada Subsidiaries”)are required to be licensed by the Nevada Gaming Authorities. The licenses heldby the Nevada Subsidiaries require periodic payments of fees and taxes and arenot transferable. We, through our registered intermediary companies(individually an “Intermediary Company” and collectively the “IntermediaryCompanies”), have 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 to periodically submitdetailed financial and operating reports to the Nevada Gaming Authorities andfurnish any other information the Nevada Gaming Authorities may require. Noperson may become a stockholder of or receive any percentage of the profits fromthe Corporate Licensees without first obtaining licenses and approvals from theNevada Gaming Authorities. The Company, the Intermediary Companies, and theCorporate Licensees have obtained from the Nevada Gaming Authorities thevarious registrations, findings of suitability, approvals, permits, andlicenses required to engage in gaming activities, gaming machine operations,and in the manufacture and distribution of gaming devices for use or play inNevada or for distribution outside of Nevada.

All gaming devices and cashless wagering systemsmanufactured, sold, or otherwise distributed for use or play in Nevada or fordistribution outside of Nevada must be manufactured by licensed manufacturersand distributed or sold by licensed distributors. All gaming devicesmanufactured for use or play in Nevada must be approved by the NevadaCommission before they are distributed or exposed for play. The approvalprocess for gaming devices and cashless wagering systems includes rigoroustesting by the Nevada Board, a field trial, and a determination as to whetherthe gaming devices or cashless wagering systems meet strict technical standardsset forth in the regulations of the Nevada Commission. Associated equipment (asdefined in the Nevada Act) must be administratively approved by the chairman ofthe Nevada Board before it is distributed in Nevada.

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The Nevada Gaming Authorities may investigate anyindividual who has a material relationship or material involvement with us, theIntermediary Companies or the Corporate Licensees to determine whether thatindividual is suitable or should be licensed as a business associate of agaming 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 forlicensing or a finding of suitability must pay all the costs of theinvestigation. Changes in licensed positions must be reported to the NevadaGaming Authorities, and in addition to their authority to deny an applicationfor a finding of suitability or licensing, the Nevada Gaming Authorities havejurisdiction to disapprove a change in a corporate position. The Nevada GamingAuthorities may deny an application for licensing or finding of unsuitabilityfor any cause they deem reasonable.

If the Nevada Gaming Authorities were to find anofficer, director, or key employee unsuitable for licensing or unsuitable tocontinue having a relationship with the Intermediary Companies, the CorporateLicensees, or us, the companies involved would have to sever all relationshipswith that person. In addition, the Nevada Commission may require theIntermediary Companies, the Corporate Licensees, or us to terminate theemployment of any person who refuses to file appropriate applications. Licensingand suitability determinations are not subject to judicial review in Nevada.

We and the Corporate Licensees are required to submitdetailed financial and operating reports to the Nevada Commission.Substantially all material loans, leases, sales of securities, and similarfinancing transactions by the Corporate Licensees must be reported to orapproved by the Nevada Commission.

If it were determined that a Corporate Licensee hadviolated the Nevada Act, the licenses it holds could be limited, conditioned,suspended, or revoked, subject to compliance with certain statutory andregulatory procedures. In addition, the Company, the Intermediary Companies,the Corporate Licensees, and the persons involved could be subject tosubstantial fines for each separate violation of the Nevada Act, at thediscretion of the Nevada Commission. Limitation, conditioning, or suspension ofthe gaming licenses of the Corporate Licensees could, and revocation of anygaming license would, materially adversely affect the gaming-relatedoperations of the Company.

The Gaming Authorities may, at their discretion,require the holder of any of our securities to file applications, beinvestigated, and be found suitable to own our securities if the NevadaCommission has reason to believe that the holder’s ownership would beinconsistent with the declared policies of Nevada. The applicant must pay allcosts of investigation incurred by the Nevada Gaming Authorities in conductingany such investigation.

The Nevada Act requires any person who acquires morethan 5% of any class of a Registered Corporation’s voting securities to reportthe acquisition to the Nevada Commission. The Nevada Act requires thatbeneficial owners of more than 10% of any class of a Registered Corporation’svoting securities apply to the Nevada Commission for a finding of suitabilitywithin thirty days after the chairman of the Nevada Board mails writtennotice requiring such filing. Under certain circumstances, an “institutional investor,”as defined in the Nevada Act, that acquires more than 10%, but not more than15% (19% if such additional ownership results from a stock repurchase programconducted by the Registered Corporation, subject to certain conditions), of aclass of a Registered Corporation’s voting securities may apply to the NevadaCommission for a waiver of finding of suitability if the institutional investorholds the securities for investment purposes only. An institutional investorshall not be deemed to hold voting securities for investment purposes unlessthe voting securities were acquired and are held in the ordinary course ofbusiness as an institutional investor and not for the purpose of causing,directly or indirectly, the election of a majority of the members of the Boardof Directors of the Registered 

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Corporation, any change in the corporate charter,bylaws, management, policies, or operations of the Registered Corporation orany of its gaming affiliates, or any other action the Nevada Commission findsto be inconsistent with holding the Registered Corporation’s voting securitiesfor investment purposes only. Activities that are not deemed to be inconsistentwith holding voting securities for investment purposes include: (i) votingon all matters voted on by stockholders; (ii) making financial and otherinquiries of management of the type normally made by securities analysts forinformational purposes and not to cause a change in the Registered Corporation’smanagement, policies, or operations; and (iii) such other activities asthe Nevada Commission may determine to be consistent with investment-onlyintent. If the beneficial holder of voting securities who must be foundsuitable is a corporation, partnership, or trust, it must submit detailedbusiness and financial information including a list of beneficial owners. Theapplicant is required to pay all costs of investigation.

Any person who fails or refuses to apply for a findingof suitability or a license within thirty days after being ordered to doso by the Nevada Commission or the chairman of the Nevada Board may be foundunsuitable. The same restrictions apply to a record owner if the record owner,after request, fails to identify the beneficial owner. Any stockholder foundunsuitable and who holds, directly or indirectly, any beneficial ownership ofthe common stock beyond such period of time as may be prescribed by the NevadaCommission may be guilty of a criminal offense. We are subject to disciplinaryaction if, after we receive notice that a person is unsuitable to be astockholder or to have any other relationship with the Company, theIntermediary Companies, or the Corporate Licensees, we (i) pay that personany dividend or interest upon voting securities of the Company; (ii) allowthat person to exercise, directly or indirectly, any voting right conferredthrough securities held by that person; (iii) pay remuneration in any formto that person for services rendered or otherwise; or (iv) fail to pursueall lawful efforts to require such unsuitable person to relinquish his or hervoting securities, including, if necessary, the immediate purchase of saidvoting securities for cash at fair market value. Additionally, the Clark CountyBoard has taken the position that it has the authority to approve all personsowning or controlling the stock of any corporation controlling a gaminglicense.

The Nevada Commission may in its discretion requirethe holder of any debt securities of a Registered Corporation to fileapplications, be investigated, and be found suitable to own the debt securityif the Nevada Commission has reason to believe that such ownership would beinconsistent with the declared policies of Nevada. If the Nevada Commissiondetermines that a person is unsuitable to own such security, then pursuant tothe Nevada Act, the Registered Corporation can be sanctioned, including theloss of its approvals if, without the prior approval of the Nevada Commission,it (i) pays the unsuitable person any dividend, interest or anydistribution whatsoever; (ii) recognizes any voting right by suchunsuitable person in connection with such securities; (iii) pays theunsuitable person remuneration in any form; or (iv) makes any payment tothe unsuitable person by way of principal, redemption, conversion, exchange,liquidation, or similar transaction.

We are required to maintain in Nevada a current stockledger which may be examined by the Nevada Gaming Authorities at any time. Ifany securities are held in trust by an agent or by a nominee, the record holdermay be required to disclose the identity of the beneficial owner to the NevadaGaming Authorities. A failure to make such disclosure may be grounds forfinding the record holder unsuitable. We are also required to render maximumassistance in determining the identity of the beneficial owner. The NevadaCommission has the power to impose a requirement that a Registered Corporation’sstock certificates bear a legend indicating that the securities are subject tothe Nevada Act. The Nevada Commission previously imposed this requirement onthe Company but removed it in June 2004.

We may not make a public offering of our securitieswithout the prior approval of the Nevada Commission if the securities orproceeds therefrom are intended to be used to construct, acquire, or financegaming facilities in Nevada or to retire or extend obligations incurred forsuch purposes. In addition, (i) a Corporate Licensee may not guarantee asecurity issued by a Registered Corporation pursuant to a public 

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offering without the prior approval of the NevadaCommission; and (ii) restrictions on the transfer of an equity securityissued by a Corporate Licensee or Intermediary Company and agreements not toencumber such securities are ineffective without the prior approval of theNevada Commission.

Changes in control of the Company through merger,consolidation, stock or asset acquisitions, management or consultingagreements, or any act or conduct whereby a person or entity acquires controlmay not occur without the prior approval of the Nevada Commission. Entitiesseeking to acquire control of a Registered Corporation must satisfy the NevadaBoard and Nevada Commission on a variety of stringent standards before assumingcontrol of the Registered Corporation. The Nevada Commission may also requirecontrolling stockholders, officers, directors, and other persons having amaterial relationship or involvement with the entity proposing to acquirecontrol to be investigated and licensed as a part of the approval processrelating to the transaction.

The Nevada Legislature has declared that somecorporate acquisitions opposed by management, repurchases of voting securities,and corporate defense tactics affecting Nevada corporate gaming licensees andRegistered Corporations that are affiliated with those operations may beinjurious to stable and productive corporate gaming. The Nevada Commission hasestablished a regulatory scheme to ameliorate the potentially adverse affectsof these business practices on Nevada’s gaming industry and to promote Nevada’spolicy to: (i) assure the financial stability of corporate gaminglicensees and their affiliates; (ii) preserve the beneficial aspects ofconducting business in the corporate form; and (iii) promote a neutralenvironment for orderly governance of corporate affairs. Approvals are, incertain circumstances, required from the Nevada Commission before a RegisteredCorporation can make exceptional repurchases of voting securities above thecurrent market price (commonly called “greenmail”) and before a corporateacquisition opposed by management can be consummated. The Nevada Act alsorequires prior approval of a plan of recapitalization proposed by theRegistered Corporation’s board of directors in response to a tender offer madedirectly to the Registered Corporation’s stockholders for the purpose ofacquiring control of the Registered Corporation.

License fees and taxes, computed in various waysdepending on the type of gaming or activity involved, are payable to the Stateof Nevada and to the counties and cities in which the licensees conduct theiroperations. Depending upon the particular fee or tax involved, these fees andtaxes are payable, either monthly, quarterly, or annually and are based oneither (i) a percentage of the gross revenues received; (ii) thenumber of gaming devices operated; or (iii) the number of games operated.An excise tax is also paid by the Corporate Licensees engaged in casinooperations on charges for admission to any facility where certain forms of liveentertainment are provided. The Corporate Licensees that hold gaming deviceroute operator licenses or manufacturer or distributor licenses also paycertain fees to Nevada.

Any person who is licensed, required to be licensed,registered, required to be registered, or who is under common control with suchpersons (collectively, “Licensees”), and who proposes to become involved in agaming venture outside of Nevada, is required to deposit with the Nevada Boardand thereafter maintain a $25,000 revolving fund to pay the expenses of investigationby the Nevada Board of the Licensee’s participation in such foreign gaming. Therevolving fund is subject to increase or decrease at the discretion of theNevada Commission. Thereafter, Licensees are required to comply with certainreporting requirements imposed by the Nevada Act. Licensees are also subject todisciplinary action by the Nevada Commission, if they knowingly violate anylaws of the foreign jurisdiction pertaining to the foreign gaming operation,fail to conduct the foreign gaming operations in accordance with the standardsof honesty and integrity required of Nevada gaming operations, engage inactivities that are harmful to the State of Nevada or its ability to collectgaming taxes and fees, or employ a person in the foreign operations who hasbeen denied a license or finding of suitability in Nevada on the ground ofpersonal unsuitability.

*Mississippi.**  *The manufacture and distribution of gaming andassociated equipment and the ownership and operation of casino facilities in Mississippiare subject to extensive state and local regulation, but 

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primarily the licensing and regulatory control of theMississippi Gaming Commission (the “Mississippi Commission”).

The Mississippi Gaming Control Act (the “MississippiAct”), which legalized dockside casino gaming in Mississippi, is similar to theNevada Gaming Control Act. The Mississippi Commission has adopted regulationsthat are also similar in many respects to the Nevada gaming regulations.

The laws, regulations and supervisory procedures ofMississippi and the Mississippi Commission are based on declarations of publicpolicy that are concerned with, among other things: (i) the prevention ofunsavory or unsuitable persons from having direct or indirect involvement withgaming at any time or in any capacity; (ii) the establishment andmaintenance of responsible accounting practices and procedures; (iii) themaintenance of effective controls over the financial practices of licensees,including the establishment of minimum procedures for internal fiscal affairsand safeguarding of assets and revenues, providing for reliable record keepingand requiring the filing of periodic reports with the Mississippi Commission; (iv) theprevention of cheating and fraudulent practices; (v) providing a source ofstate and local revenues through taxation and licensing fees; and (vi) ensuringthat gaming licensees, to the extent practicable, employ Mississippi residents.The regulations are subject to amendment and interpretation by the MississippiCommission. We believe our compliance with the licensing procedures andregulatory requirements of the Mississippi Commission will not affect themarketability of our securities. Changes in Mississippi law or regulations maylimit or otherwise materially affect the types of gaming that may be conducted,and such changes, if enacted, could have an adverse effect on us and ourMississippi gaming operations.

The Mississippi Act provides for legalized docksidegaming in each of the fourteen counties that border the Gulf Coast or theMississippi River, but only if the voters in the county have not voted toprohibit gaming in that county. Currently, dockside gaming is permissible innine of the fourteen eligible counties in the state, and gaming operations havecommenced in seven counties. Under Mississippi law, gaming vessels must belocated on the Mississippi River or on navigable waters in eligible countiesalong the Mississippi River, or in the waters of the State of Mississippi lyingsouth of the state in eligible counties along the Mississippi Gulf Coast. TheMississippi Act permits unlimited stakes gaming on permanently moored vesselson a 24-hour basis and does not restrict the percentage of space that maybe utilized for gaming. Recently, the Mississippi Legislature amended theMississippi Act to permit licensees in the three counties along the Gulf Coastto establish land-based casino operations provided the gaming areas do notextend more than 800 feet beyond the nineteen-year mean high water line, exceptin Harrison County where the 800-foot limit can be extended as far as thesouthern boundary of Highway 90.

The Mississippi Act permits substantially alltraditional casino games and gaming devices. The Company, RCVP, Bally Gaming, Inc.(“BGI”), and their affiliates are subject to the licensing and regulatorycontrol of the Mississippi Commission. We are registered under the MississippiAct as a publicly traded corporation (a “Registered 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 unableto continue to satisfy the registration requirements of the Mississippi Act, weand our affiliates cannot own or operate gaming facilities or continue to actas a manufacturer and distributor in Mississippi. No person may become astockholder of, or receive any percentage of profits from, a licensed subsidiaryof a Registered Corporation or a holding company without first obtaininglicenses and approvals from the Mississippi Commission. We and our affiliateshave obtained the necessary licenses and approvals from the MississippiCommission. RCVP must maintain a gaming license from the Mississippi Commissionto operate a casino in Mississippi and BGI must maintain a manufacturer anddistributor license from the Mississippi Commission to manufacture anddistribute gaming products and a wide-area progressive operator license tooperate its progressive system. Such licenses are issued by the MississippiCommission subject to certain conditions, including continued compliance withall applicable state laws and regulations.

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There are no limitations on the number of licensesthat may be issued in Mississippi. Gaming and manufacturer and distributorlicenses are not transferable, are issued for a three-year period (andmay be renewed for two additional three-year periods) and must be renewed orcontinued thereafter. In July 2006, RCVP was granted a three-year renewalof its gaming license by the Mississippi Commission, and BGI was grantedthree-year renewals of its manufacturer and distributor license and itswide-area progressive operator license.

Certain of our officers and employees and theofficers, directors, and certain key employees of our licensed subsidiariesmust be found suitable or be licensed by the Mississippi Commission. We believewe have obtained, applied for, or are in the process of applying for all necessaryfindings of suitability with respect to such persons affiliated with us, RCVPor BGI, although the Mississippi Commission, at its discretion, may requireadditional persons to file applications for findings of suitability. Inaddition, any person having a material relationship or involvement with us maybe required to be found suitable, in which case those persons must pay thecosts and fees associated with such investigation. The Mississippi Commissionmay deny an application for a finding of suitability for any cause it deemsreasonable. Changes in certain licensed positions must be reported to theMississippi Commission. In addition to its authority to deny an application forfindings of suitability, the Mississippi Commission can disapprove a change ina licensed position. The Mississippi Commission has the power to require theCompany and its registered or licensed subsidiaries to suspend or dismissofficers, directors and other key employees or sever relationships with otherpersons who refuse to file appropriate applications or whom the authoritiesfind unsuitable to act in such capacities.

Determinations of suitability or questions pertainingto licensing are not subject to judicial review in Mississippi. At any time,the Mississippi Commission has the power to investigate and require the findingof suitability of any record or beneficial stockholder of the Company. TheMississippi Act requires any person who acquires more than 5% of any class ofvoting securities of a Registered Corporation, as reported to the 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% of any class of voting securities of a Registered Corporation,as reported to the SEC, must apply for a finding of suitability by theMississippi Commission. The Mississippi Commission generally has exercised itsdiscretion to require a finding of suitability of any beneficial owner of morethan 5% of any class of voting securities of a Registered Corporation. If astockholder who must be found suitable is a corporation, partnership, or trust,it must submit detailed business and financial information including a list ofbeneficial owners. Any record or beneficial stockholder required to apply for afinding of suitability must pay all investigative fees and costs of theMississippi Commission in connection with the investigation.

The Mississippi Commission has adopted a regulationwhich provides that under certain circumstances, an “institutional investor,”as defined in the regulation, which acquires more than 10%, but not more than15%, of a Registered Corporation’s voting securities may apply to theMississippi Commission for a waiver of such finding of suitability if suchinstitutional investor holds the voting securities for investment purposes only.An institutional investor shall not be deemed to hold voting securities forinvestment purposes only unless the voting securities were acquired and areheld in the ordinary course of business as an institutional investor and notfor the purpose of causing, directly or indirectly, the election of a majorityof the members of the board of directors of the Registered Corporation, anychange in the Registered Corporation’s corporate charter, bylaws, management,policies or operations of the Registered Corporation or any of its gamingaffiliates, or any other action which the Mississippi Commission finds to beinconsistent with holding the Registered Corporation’s voting securities forinvestment purposes only. Activities which are not deemed to be inconsistentwith holding voting securities for investment purposes include:  (i) voting on all matters voted on bythe stockholders; (ii) making financial and other inquiries of managementof the type normally made by securities analysts for informational purposes andnot to cause 

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a change in management, policies or operations; and (iii) suchother activities as the Mississippi Commission may determine to be consistentwith such investment intent.

Any person who fails or refuses to apply for a findingof suitability 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 other relationship with us or ourMississippi 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) paysthe unsuitable person any remuneration in any form for services rendered orotherwise, except in certain limited and specific circumstances; or (iv) failsto pursue all lawful efforts to require the unsuitable person to divest himselfof the securities, including, if necessary, the immediate purchase of thesecurities for cash at a fair market value.

We may be required to disclose to the MississippiCommission, on request, the identities of the holders of any of our debt orother securities. In addition, under the Mississippi Act, the MississippiCommission may at its discretion require the holders of any debt security of aRegistered Corporation to file an application, be investigated, and befound suitable to own the debt security if the Mississippi Commission hasreason to believe that the ownership would be inconsistent with the declaredpolicies of the state of Mississippi. Although the Mississippi Commissiongenerally does not require the individual holders of obligations such as notesto be investigated and found suitable, the Mississippi Commission retains thediscretion to do so for any reason, including but not limited to a default orwhere the holder of the debt instrument exercises a material influence over thegaming operations of the entity in question. Any holder of debt securitiesrequired to apply for a finding of suitability must pay all investigative feesand costs of the Mississippi Commission in connection with the investigation.If the Mississippi Commission determines that a person is unsuitable to own adebt security, then the Registered Corporation may be sanctioned, including theloss of its approvals, if without the prior approval of the MississippiCommission it: (i) pays to the unsuitable person any dividend, interest,or any distribution whatsoever; (ii) recognizes any voting right by theunsuitable person in connection with those securities; (iii) pays theunsuitable person remuneration in any form; or (iv) makes any payment tothe unsuitable person by way of principal, redemption, conversion, exchange,liquidation, or similar transaction.

RCVP and BGI must maintain in Mississippi a currentledger with respect to the ownership of their equity securities, and we mustmaintain a current list of stockholders in the principal office of RCVP, which mustreflect the record ownership of each outstanding share of any class of ourequity securities. The ledger and stockholder lists must be available forinspection by the Mississippi Commission at any time. If any securities areheld in trust by an agent or by a nominee, the record holder may be required todisclose the identity of the beneficial owner to the Mississippi Commission. Afailure to make such disclosure may be grounds for finding the record holderunsuitable. We must also render maximum assistance in determining the identityof the beneficial owner.

The Mississippi Act requires that the certificatesrepresenting securities of a Registered Corporation bear a legend indicatingthat the securities are subject to the Mississippi Act and the regulations ofthe Mississippi Commission. We have received from the Mississippi Commission awaiver of this legend requirement. The Mississippi Commission has the power toimpose additional restrictions on the holders of our securities at any time.

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Substantially all material loans, leases, sales ofsecurities and similar financing transactions by a Registered Corporation or alicensed gaming subsidiary must be reported to or approved by the MississippiCommission. A licensed gaming subsidiary may not make a public offering of itssecurities, but may pledge or mortgage casino facilities. A RegisteredCorporation may not make a public offering of its securities without the priorapproval of the Mississippi Commission if any part of the proceeds of the offeringis to be used to finance the construction, acquisition or operation of gamingfacilities in Mississippi or to retire or extend obligations incurred for oneor more such purposes. Such approval, if given, does not constitute arecommendation or approval of the investment merits of the securities subjectto the offering.

Under the regulations of the Mississippi Commission, aMississippi gaming subsidiary may not guarantee a security issued by anaffiliated company pursuant to a public offering, or pledge its assets tosecure payment or performance of the obligations evidenced by the securityissued by the affiliated company, without the prior approval of the MississippiCommission. A pledge of the stock of a Mississippi gaming subsidiary and theforeclosure of such a pledge are ineffective without the prior approval of theMississippi Commission. Moreover, restrictions on the transfer of an equitysecurity issued by a Mississippi gaming subsidiary and agreements not toencumber such securities are ineffective without the prior approval of theMississippi Commission.

Changes in control of the Company through merger,consolidation, acquisition of assets, management or consulting agreements, oract or conduct by a person by which he or she obtains control, may not occurwithout the prior approval of the Mississippi Commission. Entities seeking toacquire control of a Registered Corporation must satisfy the MississippiCommission in a variety of stringent standards prior to assuming control of theRegistered Corporation. The Mississippi Commission may also require controllingstockholders, officers, directors, and other persons having a materialrelationship or involvement with the entity proposing to acquire control to beinvestigated and licensed as part of the approval process relating to thetransaction.

The Mississippi legislature has declared that somecorporate acquisitions opposed by management, repurchases of voting securitiesand other corporate defense tactics that affect corporate gaming licensees inMississippi and Registered Corporations may be injurious to stable andproductive corporate gaming. The Mississippi Commission has established aregulatory scheme to ameliorate the potentially adverse effects of thesebusiness 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 certain circumstances, required fromthe Mississippi Commission before a Registered Corporation may make exceptionalrepurchases 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 our subsidiaries may engage ingaming activities in Mississippi while also conducting gaming operationsoutside of Mississippi without approval of the Mississippi Commission. TheMississippi Commission may require determinations that, among other things,there are means for the Mississippi Commission to have access to informationconcerning the out-of-state gaming operations of the Company andits affiliates. We have previously obtained a waiver of foreign gaming approvalfrom the Mississippi Commission for operations in other states and will berequired to obtain the approval or a waiver of such approval from theMississippi Commission prior to engaging in any additional future gamingoperations outside of Mississippi.

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If the Mississippi Commission determined that we, or alicensed gaming subsidiary, violated a gaming law or regulation, theMississippi Commission could limit, condition, suspend, or revoke our approvalsand the license of the subsidiary. In addition, we, the licensed subsidiary,and the persons involved could be subject to substantial fines for eachseparate 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 waysdepending on the type of gaming involved, are payable to the State ofMississippi and to the counties and cities in which a licensed gamingsubsidiary’s operations are conducted. Depending on the particular fee or taxinvolved, these fees and taxes are payable either monthly, quarterly, orannually and are based on (i) a percentage of the gross gaming revenuesreceived by the casino operation; (ii) the number of gaming devicesoperated by the casino; or (iii) the number of table games operated by thecasino. The license fee payable to the State of Mississippi is based upon “gamingrevenues” (generally defined as gross revenues less payouts to customers aswinnings), and equals 4% of gaming revenues of $50,000 or less per month, 6% ofgaming revenues that exceed $50,000 but do not exceed $134,000 per month, and8% of gaming revenues that exceed $134,000 per month. The foregoing licensefees we pay are allowed as a credit against our Mississippi income taxliability paid for the year. The gross revenue fee imposed by the City ofVicksburg, Mississippi, where RCVP’s casino operations are located, equalsapproximately 4% of gaming revenues.

The Mississippi Commission’s regulations require as acondition of licensing or license renewal that an existing licensed gamingestablishment’s plan include a 500-car parking facility in closeproximity to the casino complex and infrastructure facilities that amount to atleast 25% of the casino cost. We believe the Rainbow Casino is in compliancewith this requirement. The Mississippi Commission adopted a change to thisregulation increasing the infrastructure requirement to 100%; however, theregulation grandfathers existing licensees and applies only to new casinoprojects and casinos that are not operating at the time of acquisition orpurchase by new owners.

In recent years, certain anti-gaming groups proposedthe adoption, through the initiative and referendum process, of certainamendments to the Mississippi Constitution that would prohibit gaming in thestate. The proposals were declared illegal by the Mississippi courts onconstitutional and procedural grounds. The latest ruling was appealed to theMississippi Supreme Court, which affirmed the decision of the lower court. Whilewe are unable to predict whether such an initiative will appear on a ballot inthe future or the likelihood of such an initiative being approved by thevoters, if such an initiative were passed and gaming were prohibited inMississippi, it would have a significant adverse effect on us and ourMississippi gaming operations.

The sale of alcoholic beverages by Rainbow is subjectto the licensing, control and regulation by both the City of Vicksburg and theAlcoholic Beverage Control Division (the “ABC”) of the Mississippi State TaxCommission. Rainbow has been designated as a special resort area, which allowsus to serve alcoholic beverages on a 24-hour basis. The ABC has the fullpower to limit, condition, suspend or revoke any license for the serving ofalcoholic beverages or to place such a licensee on probation, with or withoutconditions. Any such disciplinary action could (and revocation would) have amaterial adverse effect on our operations. Certain officers and managers ofRainbow must be investigated by the ABC in connection with its liquor permits,and changes in certain positions must be approved by the ABC.

*NewJersey.**  *BGI islicensed by the New Jersey Casino Control Commission (the “New JerseyCommission”) as a gaming-related casino service industry (“CSI”) in accordancewith the New Jersey Casino Control Act (the “Casino Control Act”). We are aholding company, as that term is defined by the Casino Control Act, of BGI andthus are a qualifier in connection with BGI’s CSI license and have been 

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approved as such by the New Jersey Commission. BGI hasan application pending to renew its CSI license under the Casino Control Act.

The New Jersey Commission requires the officers,directors, key personnel, financial sources, and stockholders (in particularthose with holdings in excess of 5%) of a CSI license holder and its holdingand intermediary companies to qualify in accordance with the Casino ControlAct. BGI is required to notify the New Jersey Commission of any appointment,nomination, election, resignation, termination, incapacitation, or death of anyperson or entity otherwise required to qualify pursuant to the Casino ControlAct. Such persons and entities may be investigated and may be required to makecertain regulatory filings and to disclose and/or to provide consents todisclose personal and financial data. The costs associated with suchinvestigation are typically borne by the applicant.

*Louisiana.**  *The manufacture, distribution, servicing, andoperation of gaming devices (“Devices”) in Louisiana are subject to theLouisiana Gaming Control Law and the rules and regulations promulgatedthereunder (the “Louisiana Act”). Licensing and regulatory control ismaintained by a single gaming control board for the regulation of gaming inLouisiana. This Board, created on May 1, 1996, is called the LouisianaGaming Control Board (the “Louisiana Board”) and oversees all licensing for allforms of legalized gaming in Louisiana (including all regulatory enforcementand supervisory authority that exists in the state as to gaming on NativeAmerican lands). The Louisiana State Police within the Department of PublicSafety and Corrections (the “Division”) performs the investigative functionsfor the Louisiana Board. The laws and regulations of Louisiana are based onpolicies of maintaining the health, welfare, and safety of the general publicand protecting the gaming industry from elements of organized crime, illegalgambling activities, and other harmful elements, as well as protecting thepublic from illegal and unscrupulous gaming to ensure the fair play of devices.

BGI, doing business as Bally Gaming and Systems, holdsthe following permits (licenses): (i) Gaming Supplier Permit; (ii) Manufacturerof Slot Devices and Video Draw Poker Devices Permit; and (iii) Manufacturerof Gaming Equipment other than Slot Devices and Video Draw Poker DevicesPermit.

The Louisiana Board may deny, impose a condition on,or suspend or revoke a permit, renewal, or application for a permit forviolations of any rules and regulations of the Louisiana Board or anyviolations of the Louisiana Act. In addition, fines for violations of gaminglaws, or regulations, may be levied against a Louisiana gaming licensee and thepersons involved for each violation of the gaming laws. The permit is deemed apure and absolute privilege and issuance, condition, denial, suspension orrevocation of a permit is at the discretion of the Louisiana Board under theprovisions of the Louisiana Act. A permit is not property or a protectedinterest under the Louisiana constitution.

The Division has the authority to conduct overt andcovert investigations of any person involved directly or indirectly in thegaming industry in Louisiana. These investigations have extended to informationregarding a prospective permitee’s and his or her spouse’s immediate family andrelatives and their affiliations with certain organizations or other businessentities. The investigation may also extend to any person who has or controlsmore than a 5% ownership of, or interest in income or profits in, an applicantfor or holder of a license or who is a key employee or who has the ability toexercise significant influence over the permitee. All persons or entitiesinvestigated must meet all suitability requirements and qualifications for apermitee. The Louisiana Board may deny an application for permitting for anycause it may deem reasonable. The applicant for permitting must pay a filingfee, which applies to the cost of the investigation.

*FederalRegistration.**  *Theoperating subsidiaries of the Company that are involved in the manufacture,sale, distribution, or operation of gaming devices 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 proposedthe imposition of a federal tax on gross gaming revenues. No specific proposalsfor the imposition of such a federal tax are currently pending. However, no 

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assurance can be given that such a tax will not beimposed in the future. Any such tax could have a material adverse effect on ourbusinesses, financial conditions, or results of operations.

*AdditionalJurisdictions.**  *We, inthe ordinary course of our business, routinely consider business opportunitiesto expand our gaming operations into additional jurisdictions. Although thelaws and regulations of the various jurisdictions in which we operate or intowhich we may expand our gaming operations vary in their technical requirementsand are subject to amendment from time to time, virtually all of thosejurisdictions require licenses, permits, documentation of qualification,including evidence of financial stability, and other forms of approval forcompanies engaged in the manufacture, distribution and operation of gamingdevices as well as for the officers, directors, major stockholders, and keypersonnel of such companies.

We and our key personnel have obtained, or appliedfor, all government licenses, registrations, findings of suitability, permits,and approvals necessary for the manufacture, distribution and, where permitted,operation of gaming devices in the jurisdictions in which we do business. Weand the holders of our securities may be subject to the provisions of thegaming laws of each jurisdiction where we or our subsidiaries are licensed orare 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 Jersey, New Mexico, New York, Oklahoma, Pennsylvania, Puerto Rico,South Dakota, Washington, West Virginia, Wisconsin, and the local regulatoryauthorities within each such state including Native American authorities, aswell as Australian, Canadian, and other foreign gaming jurisdictions in whichthe Company and its subsidiaries are licensed or conduct business.

Holders of common stock ofan entity licensed to manufacture and sell gaming devices, and in particularthose with holdings in excess of 5%, 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 cases,this 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 six to twelve monthsto complete under normal circumstances.

**ITEM 1A.**        RISKFACTORS

Investing in our commonstock involves risks. Prospective investors in our common stock shouldcarefully consider, among other things, the following factors and otherinformation contained in this document, including our financial statements andthe notes to those statements, prior to making an investment decision. We haveidentified the following important factors that could cause actual results todiffer materially from those projected in any forward-looking statements we maymake from time to time.

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**Our success in the gaming industry depends in largepart on our ability to develop innovative products and systems; if we fail tokeep pace with rapid innovations in product design and related marketingstrategies, or if we are unable to quickly adapt our development and manufacturingprocesses to release innovative products or systems, our business could benegatively impacted.**

Our revenues dependon the earning power and life span of our games. Newer game themes tend to havea shorter life span than more traditional game themes, and as a result, we facepressure to design and deploy successful game themes to maintain our revenuestream and to remain competitive. Our future success depends to a large extentupon our ability to continue to design and market technologically sophisticatedand entertaining products that achieve high levels of player acceptance.However, our ability to develop new and innovative products could be adverselyaffected by:

·       adecline in the popularity of our gaming products with players,

·       alack of success in developing new products, services or systems,

·       aninability to roll out new games, services or systems on schedule as a result ofdelays in connection with regulatory product approval in the applicablejurisdictions, or otherwise,

·       anincrease in the popularity of competitors’ games, and

·       anegative change in the trend of consumer acceptance of our newest systemsinnovations.

Our future success alsodepends upon our ability to adapt our manufacturing capabilities and processesto meet the demands of producing new and innovative products. Because our newerproducts are generally more technologically sophisticated than those we haveproduced in the past, we must continually refine our production capabilities tomeet the needs of our continuing product innovation. In addition, the shorterlifespan of newer products means that we must update our productioncapabilities more frequently and rapidly than in the past. If we cannot adaptour manufacturing infrastructure to meet the needs of our product innovations,or if we are unable to make upgrades to our production capacity in a timelymanner, our business could be negatively impacted.

**The gaming industry is intensely competitive. We facecompetition from a number of companies, some of which have greater resources,and if we are unable to compete effectively, our business could be negativelyimpacted.**

*Bally Gaming andSystems*

Competition among gaming machine manufacturers isbased on, among other things, competitive pricing and financing terms madeavailable to customers, appeal of game themes and features to the end playerand product quality, features and functionality of hardware and software. Thereare a number of established, well-financed companies producing machines thatcompete with each Bally Gaming and Systems product line in each of the BallyGaming and Systems markets. While there are a number of competitors in thefield, a single competitor, IGT, dominates the domestic market for gamingmachines. Certain of these competitors have access to greater capital resourcesthan we do, and as a result, may be better positioned to compete in themarketplace.

The casino enterprise systems market iscrowded, with IGT, Aristocrat, and, to a lesser extent, Konami and ProgressiveGaming Corporation comprising the primary competition. The competition isintense due to the number of providers, as well as the limited number of casinooperators and jurisdictions in which they operate. Pricing, product feature andfunction, accuracy and reliability are amongst the factors in determining aprovider’s success in selling its system.

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*Casino Operations*

The principal competitivefactors in the casino industry include the quality and location of thefacility, the nature and quality of the amenities and customer services offered,and the implementation and success of marketing programs. Our Rainbow Casino inVicksburg, Mississippi faces intense direct competition from other gamingfacilities serving the Vicksburg market. As the overall size of the potentialcustomer base is limited, competition from casinos in nearby locations mayfurther dilute the market from which Vicksburg casinos draw most of theirpatrons. Moreover, additional potential gaming sites remain in and aroundVicksburg. Some of these sites may be closer to larger population centers and,if developed, may enjoy a competitive advantage over our casino.

**The unpredictablegrowth of non-traditional gaming markets may affect our business and prospects.**

The continued growth ofnon-traditional gaming markets for gaming machines and systems depends heavilyon the public’s acceptance of gaming in these markets, as well as the ongoingdevelopment of the regulatory approval process by national and localgovernmental authorities. A portion of our growth is directly tied to our abilityto access these new markets. We cannot predict which new jurisdictions ormarkets, if any, will approve the operation of electronic gaming machines, thetiming of any such approval, the public’s acceptance of our gaming machines inthese markets or our market share or profitability in these markets.

**The competitive contract terms required innon-traditional gaming markets may affect our future revenues.**

Management believes thatcustomer leasing and financing terms have become increasingly important competitivefactors for the Company in non-traditional markets such as Class II andother Native American jurisdictions. We sometimes are required to grantextended payment terms on gaming machines, systems and other gaming equipmentto gain entry into a developing market that we would not otherwise extend.While the product normally collateralizes these financings, in an event ofdefault, the resale value of the collateral may be considerably less than theamount financed. Accordingly, we have greater exposure to fluctuations in thefinancial condition of our customers in emerging markets than has historicallybeen the case in the established markets.

**To the extent there is a change in ownership of any ofour customers or consolidation within the casino industry, our business couldbe negatively impacted.**

Casino operators in thegaming industry are currently under going a period of consolidation. The resultof this trend is that a smaller number of companies control a larger percentageof our current and potential customer base. Because a significant portion ofour sales come from repeat customers, to the extent one of our customers issold to or merges with an entity that utilizes the products and services of oneof our competitors or that reduces spending on our products, our business couldbe negatively impacted.

**We may not be able to attract or retain the managementor employees necessary to remain competitive in our industry.**

The competition forqualified personnel in the gaming industry is intense. Our future successdepends on the retention and continued contributions of our key management,finance, marketing, and staff personnel, many of whom would be difficult orimpossible to replace. Our success is also tied to our ability to recruitadditional key personnel in the future. We may not be able to retain ourcurrent personnel or recruit any additional key personnel required. The loss ofservices of any of our personnel could have a material adverse effect on ourbusiness, financial condition, results of operations and prospects.

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**The gaming industry is heavily regulated and changesin regulation by gaming authorities may adversely impact our ability to operatethe business.**

The manufacture anddistribution of gaming machines, development of systems and the conduct ofgaming operations are subject to extensive federal, state, local and foreignregulation by various gaming authorities. Our ability to continue to operate incertain jurisdictions could be adversely affected by:

·       unfavorablepublic referendums,

·       unfavorablelegislation affecting or directed at manufacturers or gaming operators, such asreferendums to increase taxes on gaming revenues,

·       adversechanges in or finding of non-compliance with applicable governmental gamingregulations,

·       delaysin approvals from regulatory agencies,

·       alimitation, conditioning, suspension or revocation of any of our gaminglicenses, and

·       unfavorabledeterminations or challenges of suitability by gaming regulatory authoritieswith respect to our officers, directors, major stockholders or key personnel.

Although the laws,rules and regulations of the various jurisdictions in which we operatevary in their technical requirements, virtually all jurisdictions requireslicenses, permits, qualification documentation, including evidence of integrityand financial stability, and other forms of approval to engage in gamingoperations or the manufacture and distribution of gaming machines. Ourofficers, directors, major stockholders and key personnel are also subject tosignificant regulatory scrutiny. In the event that gaming or governmentalauthorities determine that any person is unsuitable to act in such capacitywith respect to the Company, we could be required to terminate our relationshipwith such person. To our knowledge, the Company and our key personnel haveobtained, or applied for, all government licenses, registrations, findings ofsuitability, permits and approvals necessary to conduct their respectiveactivities in the various jurisdictions that we operate. However, there can beno assurance those licenses, registrations, findings of suitability, permits orapprovals will be renewed in the future, or that new forms of approvalnecessary to operate in emerging or existing markets will be granted.

**Our intellectualproperty protections may be insufficient to properly safeguard our technology.**

The gaming industry isconstantly employing new technologies in both new and existing markets. We relyon a combination of patent and other technical security measures to protect ourproducts, and continue to file for patents protecting such technologies.Notwithstanding these safeguards, our competitors may still be able to obtainour technology or to imitate our products. Furthermore, others mayindependently develop products similar or superior to ours.

**Expenses incurredwith respect to monitoring, protecting and defending our intellectual propertyrights could adversely affect our business.**

Competitors and otherthird parties may infringe on our intellectual property rights, or may allegethat we have infringed on their intellectual property rights. Monitoringinfringement and/or misappropriation of intellectual property can be difficultand expensive, and we may not be able to detect any infringement ormisappropriation of our proprietary rights. We may also incur significantlitigation expenses protecting our intellectual property or defending our useof intellectual property, reducing our ability to fund product initiatives.These expenses could have an adverse effect on our future cash flow and resultsof operations. We are currently subject to litigation regarding patentinfringement which, if resolved adversely to the Company, could have a materialimpact on our business. Litigation can also divert management focus fromrunning the day-to-day operations of the business. There can be no assurancesthat certain of our products, 

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including those withcurrently pending patent applications, will not be determined to have infringedupon an existing third party patent.

**The intellectual property rights of others may preventus from developing new products or entering new markets.**

The gaming industry ischaracterized by the rapid development of new technologies, which requires usto continuously introduce new products using these technologies andinnovations, as well as to expand into new markets that may be created.Therefore, our success depends in part on our ability to continually adapt ourproducts and systems to incorporate new technologies and to expand into newmarkets that may be created by new technologies. However, to the extenttechnologies are protected by the intellectual property rights of others,including our competitors, we may be prevented from introducing products basedon these technologies or expanding into new markets created by these technologies.If the intellectual property rights of others prevent us from taking advantageof innovative technologies, our financial condition, operating results orprospects may be harmed.

**Our gaming operations, particularly our wide areaprogressive networks and centrally determined systems, may experience lossesdue to technical difficulties or fraudulent activities.**

Our success depends on ourability to avoid, detect, replicate and correct software and hardware errorsand fraudulent manipulation of our products and systems. To the extent any ofour gaming machines or software experience errors or fraudulent manipulation,our customers may replace our products and services with those of ourcompetitors. In addition, the occurrence of errors in, or fraudulent manipulationof, our gaming machines or software may give rise to claims for lost revenuesand related litigation by our customers and may subject us to investigation orother action by gaming regulatory authorities, including suspension orrevocation of our gaming licenses or disciplinary action. Additionally, in theevent of such issues with our gaming machines or software, substantialengineering and marketing resources may be diverted from other areas to rectifythe problem.

**Our inability to produce and report current financialinformation in a timely manner could adversely affect**our business, results of operations, andfinancial condition.

As a result of delays inproducing timely financial information, there is limited access to currentfinancial information regarding our business, results of operation or financialcondition. This inability to report current financial information to seniormanagement means that we may not become immediately aware of short term trendsor recent developments in our business. This delay could cause us to misscertain opportunities to make adjustments in response to such trends ordevelopments that would otherwise have been available to us had we had timelyaccess to the financial information. We also may not become aware of a defaultunder the financial covenants set forth in our bank loan agreement until wellafter the default has occurred; thereby eliminating any opportunity we may havehad to cure the default. Until we restore access to current financialinformation, our business, results of operation and financial condition may beadversely affected.

**We have material weaknesses in our internal controlsover financial reporting, which could adversely affect our ability to manageand to report our financial condition, results of operations and cash flowsaccurately.**

As required by Section 404 of the Sarbanes-OxleyAct of 2002, management has conducted an assessment of our internal controlover financial reporting. In performing our assessment, management identifiedmaterial weaknesses in our internal control over financial reporting andconcluded that our internal control over financial reporting was not effectiveas of June 30, 2006. For a detailed description of these materialweaknesses, see Item 9A, Controls and Procedures.

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Material weaknesses in ourinternal control over financial reporting could adversely impact our ability toprovide timely and accurate financial information. We have taken and willcontinue to take certain measures to strengthen our internal controls, as setforth under Item 9A, Controls and Procedures. However, additional work remainsto be done to address the identified material weaknesses. If we areunsuccessful in implementing or following our remediation initiatives plan, orfail to update our internal controls as our business evolves or to integrateacquired businesses into our controls system, we may not be able to reportaccurately our financial condition, results of operations, or cash flows ormaintain effective disclosure controls and procedures. If we are unable toreport financial information accurately or maintain effective disclosurecontrols and procedures, we could be subject to, among other things, anadditional SEC enforcement action, additional securities litigation and ageneral loss of investor confidence, any one of which could adversely affectour business and prospects.

**We face increased costs and have extensive workremaining to remediate the material weaknesses in our internal controls overfinancial reporting.**

We have extensive workremaining to remediate the identified material weaknesses in our internalcontrol over financial reporting. As discussed in Item 9A, Controls andProcedures, this work has extended into the 2007 fiscal year and will continueuntil we are able to remediate the material weaknesses we have identified.These matters have required, and will continue to require, a significant amountof management time and a significant commitment of external resources. Thecosts of these efforts are substantial and could have a material adverse impacton the Company’s financial performance.

**The restatements of our consolidated financialstatements may subject us to actions or additional litigation which could havean adverse effect on our business, results of operations, financial conditionand liquidity.**

We have recently restated our consolidated financialstatements as of June 30, 2005 and 2004, and for each of the three yearsin the period ending June 30, 2005. These restatements may result inadditional scrutiny in our ongoing SEC investigation or to new regulatoryactions or civil litigation which could require us to pay fines or otherpenalties or damages and could have an adverse effect on our business, resultsof operations, financial condition and liquidity. The restatements may alsoresult in negative publicity and we may lose or fail to attract and retain keycustomers, employees and management personnel as a result of these matters.

In some jurisdictions,audited financial statements must be filed with the gaming regulatoryauthorities. The late filing of our Annual Report on Form 10-K forthe fiscal year ended June 30, 2006 could generate inquiries fromregulators, including possible disciplinary action. However, the Company hasbeen keeping regulators informed of the situation and has received noindication that any disciplinary action will be filed in any jurisdiction.

**Wehave recently reached agreements with respect to the settlement of securitiesand derivative litigation; however, these agreements are subject to courtapproval and are not final.**

We have recently reachedagreements, subject to court approval, to settle the federal class actionlawsuits and state derivative lawsuits that have been filed against us, as wellas certain of our current and former officers, alleging violations ofsecurities laws. However, these agreements are subject to court approval, andtherefore are not final. We cannot assure you that the court will approve theagreements. Were the court to reject the agreements reached, we could notdetermine with certainty whether new agreements would be reached, or if newagreements were not reached, what the outcome or resolution of the claims orthe timing of their ultimate resolution would be. In addition to the expenseand burden incurred in connection with these lawsuits, until they are resolved,our management’s efforts and attention will be diverted in part from theordinary business operations. If the agreements are not approved by the court,a 

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court approved settlementis not reached, and the final resolution of any of these lawsuits isunfavorable to us, our financial condition, results of operations, cash flows,and liquidity might be materially adversely affected if our existing insurancecoverage is unavailable or inadequate to resolve the matter.

**Ongoing SEC investigation could adversely affect us.**

The SEC is conducting aformal inquiry into certain matters surrounding the allegations relating to thesecurities class action litigation and our methods of revenue recognition. Inaccordance with its normal practice, the SEC has not advised us when itsinvestigation may be concluded, and we are unable to predict the outcome ofthis investigation. While we are cooperating fully with the investigation,adverse developments in connection with the investigation, including anyexpansion of the scope of the investigation, could negatively impact us andcould divert the efforts and attention of our management team from our ordinarybusiness operations. In connection with any SEC investigation, it is possiblethat we will be required to, among other things, pay fines, consent toinjunctions on future conduct, further restate our financial statements orsuffer other penalties, any of which could have a material adverse effect onour business.

**Certainconsequences of our reporting situation under the federal securities laws mayadversely affect our financial condition and results of operations, includingour ability to raise capital.**

Our failure to meet thereporting requirements of the federal securities laws affects our ability toaccess the capital markets. We are restricted in our ability to make anyregistered offering of securities until we have filed all of our delinquentperiodic reports. We are also ineligible to use “short-form” registration thatallows us to incorporate by reference our Form 10-K, Form 10-Qand other SEC reports into our registration statements, or shelf registrationuntil we have filed all of our periodic reports in a timely manner for a periodof twelve months.

We are also ineligible touse Form S-8 until we have filed all of our delinquent periodicreports. We use Form S-8 to register grants of equity compensationto our employees, including grants in the form of options and restricted stock.The unavailability of Form S-8 reduces our flexibility in grantingoptions and restricted stock to our employees.

In addition, the NYSE hasbroad power to commence delisting proceedings for violations of its rules andmay do so at any time. Because we are late in making our SEC filings, the NYSEcould commence delisting proceedings against the Company; however, they havenot indicated an intention to do so.

**Consumer spending on leisure activities is affected bychanges in the economy and consumer tastes, as well as other factors that aredifficult to predict and beyond our control.**

We cannot assure you thatdemand for our products or services will remain constant. Consumers’willingness to spend money on leisure activities such as gaming is affected bychanges in the economy and consumer tastes, both of which are both difficult topredict and beyond our control. Continued adverse developments affectingeconomies throughout the world, including a general tightening of theavailability of credit, increasing interest rates, increasing energy costs,acts of war or terrorism, natural disasters, declining consumer confidence orsignificant declines in the stock market could lead to a further reduction indiscretionary spending on leisure activities adversely affecting our business.

**International operations, unfavorable politicaldevelopments, weak foreign economies and other foreign risks may negativelyimpact our financial condition and results of operations.**

Our business isdependent on international markets for a portion of our revenues. As of June 30,2006, Bally Gaming and Systems had $17.2 million of receivables, or 13% of ourtotal receivables, from customers in foreign countries. We expect thatreceivables with respect to foreign sales will continue to 

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account for aportion of our total revenues. As a result, our business in these markets issubject to a variety of risks, including:

·       recessionsin foreign economies,

·       expropriation,nationalization and limitation on repatriation of earnings,

·       currencyexchange fluctuations,

·       reducedprotection of intellectual property rights in some countries,

·       longerreceivables collection periods and greater difficulty in collecting accountsreceivable,

·       difficultiesin managing foreign operations,

·       social,political and economic instability,

·       unexpectedchanges in regulatory requirements,

·       abilityto finance foreign operations,

·       changesin consumer tastes and trends,

·       tariffsand other trade barriers,

·       actsof war or terrorism, and

·       U.S.government requirements for export.

There can be no assurancesthat any of these international developments, or others, would not adverselyaffect our financial condition and results of operation.

**Our bank loan agreement imposes significantrestrictions and failure to comply with these restrictions could result in theacceleration of a substantial portion of our debt, which we may not be able torepay or refinance.**

Our bank loanagreement contains a number of covenants that, among other things, restrict ourability and certain of our subsidiaries to:

·       disposeof assets,

·       incuradditional indebtedness and issue preferred stock,

·       paydividends or make other distributions,

·       enterinto certain acquisitions,

·       repurchaseequity interests or subordinated indebtedness,

·       issueor sell equity interests of our subsidiaries, and

·       engagein mergers or consolidations or certain other transactions with subsidiariesand affiliates.

In addition, the bank loan agreement requires us tomaintain compliance with certain financial ratios, including certain leverageratios. Our ability to comply with such ratios, meet our debt serviceobligations or reduce our total debt is dependent upon our future performance,which may be affected by events beyond our control. There can be no assurancethat we will be able to comply with such restrictions and limitations, or thatthey will not adversely affect our ability to finance our future operations orcapital needs, or engage in other business activities that would otherwise bein the Company’s interest.

30

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A breach of any of thesecovenants or our inability to comply with the required financial ratios couldresult in a default under the bank loan agreement. In the event of any suchdefault, the lenders could elect to declare all borrowings outstanding underthe bank loan agreement, together with any accrued interest and other fees, tobe due and payable, as well as require us to apply all available cash to repaythe amounts. If we were unable to repay the indebtedness upon its acceleration,the lenders could proceed against the underlying collateral. There can be noassurance that our assets would be sufficient to repay the amount in full, orthat we would be able to borrow sufficient funds to refinance the indebtedness.

**Virtually all of our debt is subject to variableinterest rates; rising interest rates could negatively impact our business.**

Certain borrowings underour bank loan agreement bear interest at a variable rate. In addition, we mayincur other variable rate indebtedness in the future. Carrying indebtednesssubject to variable interest rates makes the Company more vulnerable toeconomic and industry downturns, as well as reduces our flexibility inresponding to changing business and economic conditions. Increases in interestrates on this indebtedness would increase our interest expense, which couldadversely affect our cash flow, our ability to service our debt and togenerally grow the business.

**Current borrowings, as well as potential futurefinancings, may substantially increase our current indebtedness.**

No assurance can begiven that we will be able to generate the cash flow necessary to permit us tomeet our fixed charges and payment obligations with respect to our debt. Wecould be required to incur additional indebtedness to meet these fixed chargesand payment obligations. Should we incur additional debt, among other things,such increased indebtedness could:

·       adverselyaffect our ability to expand the business, market our products and makeinvestments and capital expenditures;

·       adverselyaffect the cost and availability of funds from commercial lenders, debtfinancing transactions and other sources; and

·       createcompetitive disadvantages compared to other companies with lower debt levels.

Any inability to serviceour fixed charges and payment obligations, or the incurrence of additionaldebt, would have an adverse effect on our cash flows, results of operations andbusiness generally.

**An inability to maintain sufficient liquidity couldnegatively affect expected levels of operations and new product development.**

Future revenue may not besufficient to meet operating, product development and other cash flowrequirements. Sufficient funds to service our debt and maintain new productdevelopment efforts and expected levels of operations may not be available, andadditional capital, if and when needed by us, may not be available on termsacceptable to us. If we cannot obtain sufficient capital on acceptable termswhen needed, we may not be able to carry out our planned product developmentefforts and level of operations, which could harm our business.

**Our financialresults vary from quarter to quarter, which could negatively impact ourbusiness.**

Various factorsaffect our quarterly operating results, some of which are not within our control.These factors include, among others:

·       thefinancial strength of the gaming industry,

·       consumer’swillingness to spend money on leisure activities,

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·       thetiming and introduction of new products and services,

·       themix of products and services sold,

·       thetiming of significant orders from and shipments to customers,

·       productand service pricing and discounts,

·       thetiming of acquisitions of other companies and businesses or dispositions, and

·       generaleconomic conditions.

These and other factors arelikely to cause our financial results to fluctuate from quarter to quarter.Based on the foregoing, we believe that quarter-to-quarter comparisons of ourresults of operations may not be meaningful. In addition, such fluctuationscould cause us to be unable to comply with the financial ratios in our bankloan agreement.

**Certain marketrisks may affect our business, results of operations and prospects.**

In the normal course ofour business, we are routinely subjected to a variety of market risks, examplesof which include, but are not limited to, interest rate movements,collectibility of receivables and recoverability of residual values on leasedassets. Further, some of our payors may experience financial difficulties, ormay otherwise not pay accounts receivable when due, resulting in increasedwrite-offs. Although we do not anticipate any material losses in these riskareas, no assurances can be made that material losses will not be incurred inthese areas in the future.

**We have adopted a shareholder rights plan, which,together with provisions in our restated articles of incorporation and Nevadalaw, could discourage or prevent a potential takeover of our Company that mightotherwise result in you receiving a premium over the market price for your commonstock.**

We adopted a shareholder rights plan pursuant to whichwe distributed one right for each outstanding share of common stock held bystockholders of record as of March 12, 1998. Because the rights maysubstantially dilute the stock ownership of a person or group attempting atake-over of us without the approval of our Board of Directors, even if such achange in control would result in our stockholders receiving a premium fortheir shares, the plan could make it more difficult for a third party to acquireus, or a significant percentage of our outstanding capital stock, without firstnegotiating with our Board of Directors. Additionally, our restated articles ofincorporation permit our Board of Directors to issue special shares from timeto time, with such rights and preferences as they consider appropriate. OurBoard of Directors could authorize the issuance of special shares with termsand conditions and under circumstances that could have an effect ofdiscouraging a takeover or other transaction.

As a Nevada corporation,we are also subject to certain provisions of the Nevada General Corporation Lawthat have anti-takeover effects and may inhibit a non-negotiated merger orother business combination. These provisions are intended to encourage any personinterested in acquiring us to negotiate with, and to obtain the approval of,our Board of Directors in connection with such a transaction. However, certainof these provisions may discourage a future acquisition of the Company,including an acquisition in which the stockholders might otherwise receive apremium for their shares. As a result, stockholders who might desire toparticipate in such a transaction may not have the opportunity to do so.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

Not applicable.

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**ITEM 2.**                PROPERTIES

Thefollowing table sets forth information regarding our leased properties as of June 30,2006, all of which are fully utilized unless otherwise noted (dollars in 000s):

| **Location**                             | ** ** | ** **                                 | ** ** | **Use** | ** ** | **Building  Square  Feet** | ** ** | **Annual  Rental  Payments** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|---------|------------|----------------------------|------------|------------------------------|------------|
| Bally Gaming and Systems  business unit: |       |                                       |       |    |       |                       |       |                         |
| Bellevue, WA                             |       | Administrative  offices                    |       | 7,581   |       |                       | $          | 140                          |       |   |
| Biloxi, MS                               |       | Offices  and warehouse                     |       | 8,288   |       |                       | 50         |                         |       |
| Campbell Hall, NY                        |       | Sales  offices                             |       | 6,900   |       |                       | 128        |                         |       |
| Cheektowaga, NY                          |       | Offices                                    |       | 1,143   |       |                       | 8          |                         |       |
| Chester, NY                              |       | Offices  and warehouse                     |       | 5,000   |       |                       | 37         |                         |       |
| Clifton Park, NY                         |       | Offices                                    |       | 504     |       |                       | 5          |                         |       |
| Dover, DE                                |       | Offices  and warehouse                     |       | 468     |       |                       | 6          |                         |       |
| Egg Harbor Township, NJ                  |       | General,  research and development offices |       | 24,750  |       |                       | 380        |                         |       |
| Egg Harbor Township, NJ                  |       | Offices  and warehouse                     |       | 15,800  |       |                       | 136        |                         |       |
| Fife, WA                                 |       | Offices  and warehouse                     |       | 6,550   |       |                       | 77         |                         |       |
| Huntington Beach, CA                     |       | Research  and development offices          |       | 3,340   |       |                       | 73         |                         |       |
| Urbandale, IA                            |       | Offices                                    |       | 500     |       |                       | 12         |                         |       |
| Las Vegas, NV                            |       | Offices  and warehouse                     |       | 103,000 |       |                       | 658        |                         |       |
| Las Vegas, NV                            |       | Offices  and warehouse                     |       | 90,000  |       |                       | 283        |                         |       |
| Livermore, CA                            |       | Offices  and warehouse                     |       | 43,337  |       |                       | 571        |                         |       |
| Marysville, WA                           |       | Warehouse                                  |       | 4,400   |       |                       | 33         |                         |       |
| Miramar, FL                              |       | Offices  and warehouse                     |       | 3,400   |       |                       | 8          |                         |       |
| Oklahoma City, OK                        |       | Warehouse  and storage                     |       | 16,730  |       |                       | 73         |                         |       |
| Pleasanton, CA                           |       | Offices  and storage                       |       | 3,176   |       |                       | 68         |                         |       |
| Reno, NV                                 |       | Offices  and warehouse                     |       | 30,500  |       |                       | 433        |                         |       |
| Reno, NV                                 |       | Warehouse                                  |       | 20,284  |       |                       | 258        |                         |       |
| Reno, NV                                 |       | Warehouse                                  |       | 3,511   |       |                       | 36         |                         |       |
| Reno, NV                                 |       | Research  and development office           |       | 33,384  |       |                       | 527        |                         |       |
| San Juan, PR                             |       | Sales  offices                             |       | 2,135   |       |                       | 35         |                         |       |
| Slidell, LA                              |       | Offices                                    |       | 1,250   |       |                       | 14         |                         |       |
| Temecula, CA                             |       | Sales  offices                             |       | 1,920   |       |                       | 22         |                         |       |
| Westchester, IL                          |       | Sales  offices                             |       | 2,132   |       |                       | 49         |                         |       |
| Chennai, India                           |       | Research  and development offices          |       | 15,744  |       |                       | 13         |                         |       |
| Hannover, Germany                        |       | Offices  and warehouse                     |       | 13,292  |       |                       | 92         |                         |       |
| Hannover, Germany                        |       | Offices                                    |       | 248     |       |                       | 11         |                         |       |
| Montevideo, Uruguay                      |       | Offices                                    |       | 1,367   |       |                       | 28         |                         |       |
| Nice, France                             |       | Offices                                    |       | 5,844   |       |                       | 137        |                         |       |
| Province of Cordoba, Argentina           |       | Offices                                    |       | 969     |       |                       | 5          |                         |       |
| Shropshire, England                      |       | Offices                                    |       | 1,550   |       |                       | 17         |                         |       |
| Wigan, England                           |       | Offices  and warehouse                     |       | 10,985  |       |                       | 71         |                         |       |
| Casino Operations  business unit:        |       |                                       |       |    |       |                       |       |                         |       |
| Vicksburg, MS                            |       | Storage                                    |       | 3,000   |       |                       | 22         |                         |       |
| Vicksburg, MS                            |       | Administrative offices                     |       | 1,500   |       |                       | 10         |                         |       |
|                                          |            |                                            |            |         |            |                            |            |                              |            |  |  |  |

 

See Note 19 to the consolidated financial statements,Commitments and Contingencies, for information as to our lease commitments withrespect to the foregoing rental properties.

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Thefollowing table sets forth information regarding properties owned by us as of June 30,2006, all of which are fully utilized unless otherwise noted. Except for theLas Vegas, NV property, each of the properties listed below is utilized in ourCasino Operation business unit:

| **Location**  | ** ** | ** **                                         | ** ** | **Use** | ** ** | **Building  Square  Feet** | ** ** |
|---------------|------------|----------------------------------------------------|------------|---------|------------|----------------------------|------------|
| Las Vegas, NV |       | Administrative  offices and manufacturing facility |       | 150,000 |       |
| Vicksburg, MS |       | Casino                                             |       | 33,000  |       |
| Vicksburg, MS |       | Entertainment  facility                            |       | 20,000  |       |
| Vicksburg, MS |       | Administrative  offices                            |       | 3,200   |       |
| Vicksburg, MS |       | Vacant-land                                        |       | —  |       |

 

We believe our facilitiesare suitable for our needs and we have no future expansion plans that wouldmake these properties inadequate.

**ITEM 3.**                LEGALPROCEEDINGS

***Litigation***

On September 25, 1995, Bally Gaming, Inc. (“BGI”),a wholly-owned subsidiary of the Company, was named as a defendant in a classaction lawsuit filed in the United States District Court for the District ofNevada. The plaintiffs filed suit against BGI and approximately 45 otherdefendants, each of which is involved in the gaming business as a gamingmachine manufacturer, distributor or casino operator. The lawsuit arises out ofalleged fraudulent marketing and operation of casino video poker machines andelectronic slot machines. The plaintiffs alleged that the defendants haveengaged in a course of fraudulent and misleading conduct intended to inducepeople into playing their gaming machines based on a false belief concerninghow those machines actually operate, as well as the extent to which there isactually an opportunity to win on any given play. The plaintiffs allege thatthe defendants’ actions constitute violations of the Racketeer Influenced andCorrupt Organizations Act (RICO) and give rise to claims of common law fraudand unjust enrichment. The plaintiffs are seeking monetary damages in excess of$1.0 billion. In July 2002, the Federal District Court denied theplaintiffs’ request for class action certification. In August 2004, theUnited States Court of Appeals for the Ninth Circuit affirmed the Federal DistrictCourt’s denial of class action certification, and the plaintiffs did notappeal. Subsequently, two of the four named plaintiffs elected to continuetheir cases as individual, non-class actions. However, in September 2005,the court granted the defendants’ motions for summary judgment, resolving allclaims in defendants’ favor without a trial. In October 2005, theplaintiffs appealed the District Court’s granting of summary judgment in favorof the defendants to the United States Court of Appeals for the Ninth Circuit.Thereafter, the plaintiffs/appellants agreed to dismiss their appeal inexchange for the defendants’ agreement not to pursue a claim for costs. Theappeal was dismissed on June 26, 2006.

In June and July 2004, putative classactions were filed against the Company and its officers, Robert Miodunski,Robert Saxton, Mark Lerner and Steven Des Champs, in the United States DistrictCourt for the District of Nevada. The nearly identical complaints allegedviolations of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), stemming from revised earnings guidance, declines in the stock price andsales of stock by insiders. The complaints sought damages in unspecifiedamounts. The Federal District Court granted the plaintiffs’ unopposed motionsto consolidate the cases and to appoint a lead counsel and a lead plaintiff,and the plaintiffs filed a consolidated complaint, all as is customary in suchcases. The Company and the other defendants have moved to dismiss the complaint.Thereafter, activity in the case was stopped and the parties participated in amediation process during which the parties agreed on the terms of a settlement.The parties have negotiated and executed settlement documents settling both theconsolidated class action and the derivative case discussed below. Under thesettlement, which is 

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subject to court approval, an aggregate of $16.0million in cash, plus certain interest, will be paid to settle the securitiesclass action as well as the derivative litigation discussed below. The Companywill pay $1.25 million, which was accrued in the Company’s financialstatements for the quarter ended September 30, 2005. The Company alsoincurred approximately $1.9 million in legal fees and related costs in thetwelve months ended June 30, 2006. In addition to certain governanceactions the Company has agreed to undertake in connection with the settlement,the Company’s directors and officers insurer will contribute approximately$14.75 million to the settlement.

In July 2004, two derivative lawsuits were filedin Nevada state court against the members of the board of directors and theofficers listed above. The Company was named as a nominal defendant in thederivative lawsuits as the claims were purportedly asserted for the benefit ofBally Technologies, Inc. These lawsuits asserted 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, and sought injunctiverelief and damages in unspecified amounts. These two cases were consolidated,and the Company and the other defendants moved to dismiss the case. In February 2005,the state district court granted the defendants’ motion and dismissed the case.The plaintiffs appealed the dismissal to the Nevada Supreme Court, whichreferred the matter to its settlement conference program. The parties met witha court-appointed settlement judge on December 15, 2005, and agreed tosettle the case for $8,000, and on February 2, 2006, the Nevada SupremeCourt entered its order formally dismissing the appeal, thereby terminating thecase. Although management believes the plaintiffs’ lawsuit and appeal werewithout merit, it determined that the settlement was in the best interests ofthe Company.

On March 27, 2006, shortly after theaforementioned derivative suit was dismissed in the Nevada state court, anotherderivative lawsuit was filed in the United States District Court for theDistrict of Nevada against individual defendants Robert Miodunski, RobertSaxton, Steven Des Champs, Mark Lerner, David Robbins, Anthony DiCesare, JoelKirschbaum, Kevin Verner, Richard Haddrill, Stephen Race, Jacques André andnominal defendant Bally Technologies, Inc. Based on factual allegationsthat are similar to those alleged in the federal securities class actioncomplaints and the previous derivative actions that were dismissed by theDistrict Court, the derivative complaint alleges breach of fiduciary duty,abuse of control, gross mismanagement, waste of corporate assets, unjustenrichment and violation of the Sarbanes-Oxley Act of 2002. The parties havereached a settlement agreement as discussed more fully above.

In August 2004, Shuffle Master sued the Companyin the United States District Court for the District of Nevada, alleginginfringement of various patents in connection with the Company’s MindPlayproduct line and seeking injunctive relief and damages in an unspecifiedamount. In June 2005, it was announced that IGT had acquired an interestin the patents at issue in the case, and thereafter IGT joined the case as aplaintiff. In December 2005, the District Court issued a rulingconstruing the claim terms of all the patents in the suit. Management believesthe plaintiffs’ lawsuit to be without merit, and the Company is vigorouslydefending against the lawsuit.

In September 2004, a United States District Courtjury in the District of Nevada entered a $7.4 million verdict against theCompany in a suit filed by Action Gaming (“AGI”) and IGT. The suit alleged thatthe multi-hand video poker game deployed by the Company’s former subsidiary,United Coin, infringed the plaintiffs’ patents. The Federal District Courtruled on summary judgment that the game did not infringe the patents. However,the court left to the jury the question whether the use of “autohold,” aspecific, optional feature of the game, caused it to infringe under the “doctrineof equivalents,” a doctrine of patent law. The jury determined that the gamewith the autohold option enabled did infringe under the doctrine of equivalentsand awarded damages accordingly. The feature has been disabled on all affectedgames in the field, and the decision permits continued deployment of the gameas long as the autohold feature is not included. The Company appealed thedecision to the United States Court of Appeals for the Ninth Circuit and posteda cash bond totaling $7.6 million to stay payment of the judgment and accruedinterest pending the appeal. The cash bond is included in other non-currentassets and the accrued liability is included in 

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accrued liabilities in the accompanying balancesheets. This amount has been accrued and the expense for this charge isincluded in discontinued operations in the accompanying statement of operationsfor 2004. On July 11, 2006, the federal circuit court of appeals affirmedthe district court judgment, denying the appeals for both parties, andthereafter, the judgment was satisfied out of the posted bond.

On December 7, 2004, IGT filed a patentinfringement lawsuit against the Company in the United States District Courtfor the District of Nevada. The complaint asserts that the Company’swheel-based games, such as Monte CarloÔ,Lucky WheelÔ and Cash For LifeÔ,its games with a reel in the top box, such as Bonus FrenzyÔ,and its iViewÔ products infringe on patents held by IGT, andseeks injunctive relief and damages in unspecified amounts. The Companybelieves IGT’s claims are without merit and is vigorously defending itselfagainst the lawsuit. As part of its defense, the Company has assertedcounterclaims against IGT, including claims that IGT’s patents are invalid,unenforceable and not infringed, as well as several claims that IGT hasengaged in anti-competitive conduct in violation of state and federal antitrustlaws. By its counterclaims, the Company is seeking damages and other relieffrom IGT. IGT’s motion to dismiss the Company’s antitrust claims wasdenied on January 10, 2006. A Markman hearing took place in December 2006and the Company expects a related claim construction ruling. No trial date hasbeen set.

In February 2005, the SEC initiated an informalinquiry and requested documents and information regarding matters related tothe allegations in the class actions and similar matters. In August 2005,the SEC notified the Company that its investigation had entered a formal phase,and requested additional information from the Company covering the same generalareas that were addressed in the informal inquiry. Management is cooperatingfully with the SEC in this matter.

In May 2006, IGT filed a patent infringementlawsuit against the Company in the United States District Court for theDistrict of Delaware. The complaint asserts that the Company’s Bally PowerBonusingÔ products infringepatents held by IGT, and seeks injunctive relief and damages in unspecifiedamounts. IGT’s motion for a preliminary injunction is pending. The Companybelieves IGT’s claims, including its request for preliminary relief, arewithout merit and is vigorously defending itself against the lawsuit.

In September 2006, the Company filed a patentinfringement lawsuit against IGT in the United States District Court for theDistrict of Nevada. The complaint asserts that certain of IGT’s bonus wheelgames infringe patents held by the Company, and seeks injunctive relief anddamages. IGT filed an answer generally denying the claims. The case is in thediscovery phase and no trial date has been set.

The Company is also aparty to various lawsuits relating to routine matters incidental to ourbusiness. Management does not believe that the outcome of such litigation,including the matters above, in the aggregate, will have a material adverseeffect on our financial position, results of operations or cash flows.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Ourcommon stock is listed on the New York Stock Exchange (the “NYSE”) under thesymbol “BYI”. The following table sets forth the high and low closing bid priceof our common stock as reported by the NYSE for the periods indicated.

| ** **                              | ** ** | **Price Range of  Common Stock** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                              | ** ** | **High**                                        | ** ** | **Low** | ** ** |
| *Fiscal Year Ended June 30,  2007* |       |                                            |       |   |   |
| 1st Quarter                             |       | $                                               | 17.60      |   | $ | 14.83 |   |
| 2nd Quarter                             |       | 20.70                                           |       | 17.25 |   |
| *Fiscal  Year Ended June 30, 2006* |       |                                            |       |   |   |
| 1st Quarter                             |       | $                                               | 15.53      |   | $ | 10.43 |   |
| 2nd Quarter                             |       | 13.85                                           |       | 10.06 |   |
| 3rd Quarter                             |       | 17.00                                           |       | 12.74 |   |
| 4th Quarter                             |       | 17.90                                           |       | 14.69 |   |
| *Fiscal  Year Ended June 30, 2005* |       |                                            |       |   |   |
| 1st Quarter                             |       | $                                               | 16.82      |   | $ | 12.09 |   |
| 2nd Quarter                             |       | 14.07                                           |       | 9.12 |   |
| 3rd Quarter                             |       | 13.21                                           |       | 9.40 |   |
| 4th Quarter                             |       | 15.42                                           |       | 9.48 |   |
| *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 |   |

 

As of****March 9,2007, we had approximately 1,000 holders of record of our common stock.

We have never declared orpaid cash dividends on our common stock. Our bank loan agreement materiallylimits our ability to pay dividends on our common stock, as discussed in Item1A, Risk Factors. We intend to follow a policy of retaining earnings to financethe growth of our business and do not anticipate paying any cash dividends inthe foreseeable future. The declaration and payment of future dividends on ourcommon stock will be at the sole discretion of our Board of Directors and willdepend on our profitability, the terms of our bank credit agreement and ourfinancial condition, capital requirements, statutory and contractualrestrictions, future prospects and other factors the Board of Directors deemsrelevant.

**Share Repurchases**

In January 1999, theCompany’s Board of Directors approved a share repurchase plan for up to 4.6million shares of its common stock. Under the plan, subject to price and marketconditions, purchases of shares can be made from time to time in the openmarket or in privately negotiated transactions using available cash. During theyears ended June 30, 2006 and 2005, the Company repurchased no shares and13,000 shares of common stock, respectively.

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**Equity CompensationPlans**

Thefollowing table sets forth information as of June 30, 2006 with respect toour equity compensation plans that provide for the issuance of options topurchase our common stock:

| ** **                                                     | ** ** | **Number of securities  to be issued upon exercise  of outstanding options,  warrants and rights(1)** | ** ** | **Weighted average  exercise  price of outstanding  options,  warrants and rights(1)** | ** ** | **Number of securities  remaining available for  future issuance  under equity compensation  plans (excluding securities  reflected in the first column)** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| *Plan  Category*                                               |       |                                                                                                                                                    |       |                                                                                                            |       |                                                                                                                                                                                                                        |       |   |   |   |   |   |   |
| Equity  compensation plans approved by security holders        |       |                                                                                                                                                    | 10,110,599 |                                                                                                            |       |                                                                                                                                                                                                                        | $          | 13.63 |   |   |   | 1,120,975 |   |   |
| Equity  compensation plans not approved by security holders(2) |       |                                                                                                                                                    | 175,000    |                                                                                                            |       |                                                                                                                                                                                                                        | 16.99      |   |   |   | — |   |   |
| Total                                                          |       |                                                                                                                                                    | 10,285,599 |                                                                                                            |       |                                                                                                                                                                                                                        | $          | 13.69 |   |   |   | 1,120,975 |   |   |

 

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(1)          Rights include grantsfor Restricted Stock and Restricted Stock Units.

(2)          Options granted toRobert C. Caller, the Company’s Chief Financial Officer, pursuant to hisemployment agreement dated March 7, 2006 as an inducement to acceptemployment with the Company.

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**ITEM 6.**                   SELECTED FINANCIAL DATA

The following selected financial data for fiscal 2006,2005 and 2004 has been derived from the consolidated financial statements whichappear elsewhere in this Annual Report on Form 10-K. The SelectedFinancial Data should be read in conjunction with:

·       Item7, Management’s Discussion and Analysis of Financial Condition and Results ofOperations;

·       Item8, Financial Statements and Supplementary Data; and

·       Note 22 to consolidatedfinancial statements, Selected Quarterly Financial Data (unaudited).

| ** **                                                                          | ** ** | **Year Ended June 30,**                           | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2006**                                                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                          | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Statement of Operations  Data:                                                      |       |                                                             |       |   |   |   |   |   |   |   |   |
| Total revenues  from continuing operations                                          |       | $                                                                | 547,144    |   | $ | 483,107 |   | $ | 476,607 |   | $ | 357,264 |   | $ | 264,357 |   |
| Operating income  (loss)(1)                                                         |       | (43,174                                                          | )          | (4,451 | ) | 88,836 |   | 66,367 |   | 45,176 |   |
| Income (loss)  from continuing operations before income taxes and minority interest |       | (67,300                                                          | )          | (19,370 | ) | 62,412 |   | 43,339 |   | 19,538 |   |
| Income tax  (expense) benefit                                                       |       | 24,012                                                           |       | 5,192 |   | (21,104 | ) | (15,354 | ) | 40,621 |   |
| Minority interest                                                                   |       | (3,907                                                           | )          | (3,731 | ) | (2,309 | ) | (2,009 | ) | (1,935 | ) |
| Income (loss)  from continuing operations                                           |       | (47,195                                                          | )          | (17,909 | ) | 38,999 |   | 25,976 |   | 58,224 |   |
| Income (loss)  from discontinued operations(2)                                      |       | 1,124                                                            |       | (4,654 | ) | 40,889 |   | (17,638 | ) | 1,612 |   |
| Net income (loss)                                                                   |       | $                                                                | (46,071    | ) | $ | (22,563 | ) | $ | 79,888 |   | $ | 8,338 |   | $ | 59,836 |   |
| Basic earning (loss) per  share:                                                    |       |                                                             |       |   |   |   |   |   |   |   |   |
| Continuing  operations                                                              |       | $                                                                | (0.90      | ) | $ | (0.35 | ) | $ | 0.78 |   | $ | 0.53 |   | $ | 1.26 |   |
| Discontinued  operations                                                            |       | 0.02                                                             |       | (0.09 | ) | 0.82 |   | (0.36 | ) | 0.04 |   |
| Total                                                                               |       | $                                                                | (0.88      | ) | $ | (0.44 | ) | $ | 1.60 |   | $ | 0.17 |   | $ | 1.30 |   |
| Diluted earning (loss)  per share:                                                  |       |                                                             |       |   |   |   |   |   |   |   |   |
| Continuing  operations                                                              |       | $                                                                | (0.90      | ) | $ | (0.35 | ) | $ | 0.76 |   | $ | 0.52 |   | $ | 1.23 |   |
| Discontinued  operations                                                            |       | 0.02                                                             |       | (0.09 | ) | 0.80 |   | (0.36 | ) | 0.04 |   |
| Total                                                                               |       | $                                                                | (0.88      | ) | $ | (0.44 | ) | $ | 1.56 |   | $ | 0.16 |   | $ | 1.27 |   |

 

| ** **                                          | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **2006**                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(in 000s)**                | ** ** |
| Balance Sheet Data:                                 |       |                              |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                          |       | $                                 | 16,425     |   | $ | 33,170 |   | $ | 154,258 |   | $ | 24,406 |   | $ | 24,700 |   |
| Restricted cash                                     |       | 14,484                            |       | 13,421 |   | 15,590 |   | 14,478 |   | 7,100 |   |
| Working capital                                     |       | 130,517                           |       | 125,164 |   | 257,217 |   | 135,289 |   | 96,959 |   |
| Total assets                                        |       | 687,881                           |       | 654,934 |   | 773,927 |   | 544,814 |   | 465,900 |   |
| Total long term  debt, including current maturities |       | 328,346                           |       | 335,117 |   | 428,955 |   | 345,215 |   | 341,793 |   |
| Total stockholders’  equity                    |       | 144,078                           |       | 176,023 |   | 180,979 |   | 76,432 |   | 41,973 |   |
|                                                     |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          TheCompany has recorded the following significant items affecting comparability ofoperating income (loss):

·       Share-basedcompensation expense of $12.9 million for fiscal 2006 compared to $2.1 millionfor fiscal 2005 due to our adoption of SFAS 123R, *Share BasedPayment*.See Note 12 to consolidated financial statements, Share-Based Compensation.

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·       Depreciationexpense of $15.4 million from the acceleration of certain assets in fiscal 2006.See Note 1 to consolidated financial statements, Description of Business andSummary of Significant Accounting Principles.

·       Impairmentcharges of $15.6 million and $3.6 million were recorded for fiscal 2006 and2005, respectively. See Note 17 to consolidated financial statements,Impairment Charges.

·       A series of inventorywrite-downs of $15.3 million and $26.4 million were recorded for fiscal 2006and 2005, respectively. See Note 18 toconsolidated financial statements, Inventory and Related Asset Write-downs.

·       Restructuringcharges of $3.7 million were recorded in fiscal 2005. See Note 16 toconsolidated financial statements, Restructuring Charges.

·       A loss of $12.3 million wasrecorded on extinguishment of debt in fiscal 2004.

(2)          We sold our Nevada routeoperations, the Rail City Casino and Bally Wulff during fiscal 2004. The Nevadaroute operation disposition was completed on June 30, 2004, the Rail Citydisposition was completed on May 3, 2004 and the Bally Wulff dispositionwas completed on July 18, 2003. On October 14, 2004, we sold ourinterest in our Louisiana route operations. In March 2006, we received asettlement related to our Nevada route operations (see Note 4 to consolidatedfinancial statements, Discontinued Operations).

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

**Forward-LookingStatements**

Certain matters in this Annual Report on Form 10-Kand our other filings with the SEC, including, without limitation, certainmatters discussed in this Item 7, Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and in Item 7A, Quantitative andQualitative Disclosures about Market Risk, constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”), and Section 21E of the ExchangeAct, and are subject to the safe harbor created thereby. Those statementsreflect the intent, belief or current expectations of the Company, itsdirectors or its officers with respect to, among other things, future eventsand financial trends affecting the Company.

Forward-looking statementsare typically identified by the words “believes,” “expects,” “anticipates” andsimilar expressions. In addition, any statements that refer to expectations orother characterizations of future events or circumstances are forward-lookingstatements. Readers are cautioned that any such forward-looking statements arenot guarantees of future performance and that matters referred to in such forward-lookingstatements involve known and unknown risks, uncertainties and other factorswhich may cause actual results, performance or achievements of the Company tobe materially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Such factors include,among other things, the impact of competition and uncertainties concerning suchmatters as the Company’s ability to service debt, product development, customerfinancing, sales to non-traditional gaming markets, foreign operations,dependence on key personnel, the ability to integrate future acquisitions,strict regulation by gaming authorities, the outcome of pending litigationmatters including the pending securities class actions, gaming taxes, currencyfluctuations and market risk. Certain of these factors are discussed in Item1A, Risk Factors. The Company undertakes no obligation to publicly update orrevise these forward-looking statements because of new information, futureevents or otherwise.

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**Internal Control Over Financial Reporting**

We have identifiedmaterial weaknesses in our internal control over financial reporting which aredescribed in Item 9A, Controls and Procedures. Each of these materialweaknesses also results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. As a result, we have assessed that our internal controlover financial reporting was not effective as of June 30, 2006.

We discuss certain risksassociated with the material weaknesses identified in Item 1A, Risk Factors.

**Our Business**

We are a leader in thedesign, manufacture, assembly and distribution of technology based products tocommercial gaming markets worldwide. Our primary technologies include gamingdevices for land based, riverboat and Native American casinos, video lotteryand central determination markets and specialized system based hardware andsoftware products. Our specialized hardware and software products providecasinos with a wide range of marketing, data management, accounting, securityand other software applications and tools to more effectively manage theiroperations. We also own and operate a riverboat dockside casino in Vicksburg,Mississippi.  We announced in October 2006,that we are evaluating alternatives with respect to the possible sale of theRainbow Casino. As of the date of this filing, a formal plan for the sale ofthe Rainbow Casino has not been approved by our Board of Directors.

We derive our revenuesfrom the following four sources:

*Gaming Equipment**—*Sale of gaming devices

*Systems**—*Sales of computerized monitoring systemsand related recurring hardware and software maintenance revenue

*Gaming Operations**—*Operation of wide-area progressivesystems and the lease and rental of gaming machines

*Casino Operations**—*Operation of the Rainbow Casino

**Critical Accounting Policies and Estimates**

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America. Some of our accountingpolicies require us to make difficult and subjective judgments, often as aresult of the need to make estimates of matters that are inherently uncertain. Ourmost critical accounting estimates include revenue recognition, inventoryvaluation, assumptions utilized in asset impairment tests, allowance fordoubtful accounts, and deferred tax reserves. These judgments are subject to aninherent degree of uncertainty. There can be no assurance that the actualresults will not differ from our estimates. Additional information regardingour significant accounting policies is presented below.

*Revenue recognition*

OurGaming Equipment and Systems revenues are recognized in accordance with theprovisions of the American Institute of Certified Public Accountants (“AICPA”)Statement of Position (“SOP”) No. 97-2 *SoftwareRevenue Recognition* and are generally recognized when:

·       Persuasiveevidence of an arrangement exists

·       Deliveryhas occurred

·       Thevendors’ fee is fixed or determinable

·       Collectibilityis probable

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We sell gaming machines and our computerizedmonitoring systems either through normal credit terms of a 120 days or less, ormay grant extended credit terms of up to five years. Revenue is recorded inaccordance with the terms of sale for contracts with payment terms of 24 monthsor less, or as cash is received for contracts with payment terms in excess of24 months. Games placed with customers on a trial basis are not recognized asrevenue until the trial period ends, the customer accepts the games andcollectibility is deemed probable.

We also sell gaming devices under arrangements inwhich there are multiple elements, as that term is defined in SOP No. 97-2.Contracts may contain multiple elements such as a combination of gamingdevices, central site monitoring equipment, systems software, license fees andtraining. We allocate revenue to each element based upon its fair value asdetermined by “vendor specific objective evidence.”  Vendor specific objective evidence of fairvalue for all elements of an arrangement is based upon the normal pricing anddiscounting practices for those products and services when sold separately. Inaddition, software license updates and product support services are measured bythe renewal rate offered to the customer.

We recognize revenue when the product is delivered, orover the period in which the service is performed and we defer revenue for anyundelivered elements. If we cannot objectively determine the fair value of anyundelivered elements included in the arrangement, the revenues are deferreduntil all elements are delivered and services have been performed, or untilfair value can objectively be determined for any remaining undelivered element.

The majority of our software license arrangements arenon-perpetual and include software license updates and product support whichare recognized ratably over the term of the arrangement, which is typically oneyear. Software license updates provide customers with rights to unspecifiedsoftware product upgrades, maintenance and patches released during the term ofthe support period. The majority of our customers purchase both software andhardware maintenance and support when they purchase the systems. In addition,substantially all customers renew these maintenance agreements annually. Revenuefrom multi-year licensing arrangements are accounted for as subscriptions, withbillings recorded as unearned revenue and recognized as revenue ratably overthe billing coverage period, which is generally one year.

Our Gaming Operations earn recurring revenue from theoperation of wide-area progressive jackpot systems and from gaming machines andthe related systems placed in casinos on a daily lease or rental basis. Revenuefrom these sources is recognized based on the contractual terms of theparticipation or rental agreements and is generally based on a share of moneywagered, a share of the net winnings, or on a fixed daily rental rate basis.

In accordance withindustry practice, we recognize gaming revenues from our Casino Operations asthe net win from gaming machine operations, which is the difference betweencurrency deposited into the machines and the payouts made to the players.

*Inventories*

Inventories are stated at the lower of cost, determinedon a first-in, first-out basis, or market value. Cost elementsincluded in work-in-process and finished goods consist of rawmaterials, freight, direct labor and manufacturing overhead. We regularlyreview inventory quantities and record charges for both obsolete products andproducts that may have become impaired for a variety of reasons, includingchanges in technology, customer preferences and product demand.

As a result of our ongoing analysis of inventoryvaluations, the Company recognized inventory write-downs totaling $14.2 millionand $21.9 million during the years ended June 30, 2006 and 2005,respectively. See Note 18 to consolidated financial statements, Inventory andRelated Asset Write-downs*.*

Additional valuationcharges could result in the future as a result of these factors.

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*Property, plant andequipment and leased gaming equipment*

Property, plant and equipment are stated at cost anddepreciated over the estimated useful lives or lease terms, whichever is less,using the straight line method. Leased gaming equipment is stated at cost anddepreciated over estimated useful lives ranging from two to three and one halfyears.

Significant replacements and improvements arecapitalized while other maintenance and repairs are expensed. The cost andaccumulated depreciation of assets retired or otherwise disposed of areeliminated from the accounts and any resulting gain or loss is credited orcharged to income, as appropriate.

Given changes in technology, customer preferences andproduct demand, we regularly review and evaluate the recoverability of ourinvestment in such assets, as well as the estimated useful lives used todepreciate these assets.

In fiscal 2005, we faced declining demand for gamingdevices based on our legacy platform, and therefore, we reassessed thisparticular portion of our inventory. In October 2004, we made thestrategic decision to move to our new Alpha OS platform, which was madecommercially available in April 2005 in most markets.

This change in estimate was recorded prospectively,resulting in a $15.4 million charge to depreciation expense in the year ended June 30,2006. See Note 1 to consolidated financial statements, Description of Businessand Summary of Significant Accounting Principles.

The Company also recorded a write-down of leasedgaming equipment of $1.0 million and $3.2 million in the years ended June 30,2006 and 2005, respectively. See Note 18 to consolidated financial statements,Inventory and Related Asset Write-downs.

There is the potential foracceleration of future depreciation, or even additional asset impairments, ifsuch factors were determined to have an adverse impact on our ability torealize our full investment in such assets.

*Impairment ofindefinite lived intangible assets, including goodwill*

We review goodwill and indefinite lived intangibleassets for impairment annually, during our fourth fiscal quarter, or wheneverevents or circumstances indicate carrying value may not be recoverable orwarrant a revision to the estimated remaining useful life in accordance withFinancial Accounting Standards Board (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 142, *Goodwill and OtherIntangible Assets*.

During the year ended June 30,2006, the Company recorded an impairment charge of $4.5 million related to anindefinite lived intangible asset. See Note 17 to consolidated financialstatements, Impairment Charges.

*Impairment oflong-lived assets, including finite lived intangible assets*

We review long-lived assets whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable in accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-lived Assets*. Recoverabilityof long-lived assets are measured by a comparison of the carrying amount of theasset to future, undiscounted net cash flows expected to be generated by theasset. Such estimations involve significant judgments. If such assets aredetermined to be impaired, the impairment to be recognized is measured by theamount by which the carrying amount of the assets exceeds the fair value of theassets.

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During the year ended June30, 2006, the Company recorded an impairment charge of $11.1 million related tofinite lived intangible assets. See Note 17 to consolidated financialstatements, Impairment Charges.

*Jackpot liabilities*

We recognize jackpot expense and a related liabilityfor jackpots not yet won for the cost to fund jackpots in the future. Jackpotsare payable in either equal annual or weekly installments over a 20-yearperiod, or immediately in the case of instant win progressive jackpots. Winnersmay elect to receive a single payment for the present value of a jackpotdiscounted at applicable interest rates in lieu of annual installments.

Our jackpot liabilitiestotaled $13.1 million and $13.0 million at June 30, 2006 and 2005,respectively. Changes in our estimates and assumptions, including the number ofjackpot winners who may elect single-payments in the future could impact ourjackpot expense and jackpot liability.

*Allowances fordoubtful accounts*

Allowances for doubtfulaccounts are maintained at levels determined by our management to adequatelyprovide for collection losses. In determining estimated losses, managementconsiders economic conditions, the activity in gaming markets, the financialcondition of customers, changes in technology and other factors whichmanagement believes are relevant.

*Income taxes*

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of assets and liabilities and their respective taxbasis. 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 our foreign subsidiariesare provided at the tax rates applicable to the tax jurisdictions in which theyare located.

The recoverability ofcertain deferred tax assets is based in part on estimates of future income andthe timing of temporary differences, and the failure to fully realize suchdeferred tax assets could result in a higher tax provision in future periods. Ournet deferred tax assets totaled $71.4 million and $47.4 million at June 30,2006 and 2005, respectively. Our accrued income taxes receivable (payable)totaled $0.3 million at June 30, 2006 and $(1.8) million at June 30,2005.

*Recently issuedaccounting pronouncements*

In February, 2007, FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*.SFAS No.159 provides companies with an option to report selected financialassets and liabilities at fair value. It also establishes presentation anddisclosure requirements to facilitate comparisons between companies usingdifferent measurement attributes for similar types of assets and liabilities.The statement is effective as of the beginning of the first fiscal yearbeginning after November 15, 2007. Earlier application is permittedprovided we also apply the provisions of Statement 157 *Fair ValueMeasurements*. We are currently in the process of evaluating theimpact SFAS No. 159 will have on our consolidated results of operations, financialposition and cash flows.

In September 2006, FASB issued SFAS No. 157,*Fair Value Measurements*, which definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. SFAS No. 157 does not require any new fair value 

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measurements, rather it applies to existing accountingpronouncements that require or permit fair value measurements. SFAS No. 157is effective for fiscal years beginning after November 15, 2007, andaccordingly, the Company expects to adopt SFAS No. 157 beginning in fiscal2009. We are currently in the process of evaluating the impact SFAS No. 157will have on our consolidated results of operations, financial position andcash flows.

In September 2006, the SEC issued StaffAccounting Bulletin (“SAB”) No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*, providing guidance on how prior yearmisstatements should be taken into consideration when quantifying misstatementsin current year financial statements for purposes of determining whether thecurrent year’s financial statements are materially misstated. SAB No. 108is effective for fiscal years ending on or after November 15, 2006, andaccordingly, the Company expects to adopt SAB No. 108 beginning in fiscal2007. We do not expect SAB No. 108 will have an impact on our consolidatedresults of operations, financial position or cash flows.

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

In June 2005, the FASB issued FASB Staff Position(“FSP”) No. 143-1, *Accounting forElectronic Equipment Waste Obligations,* to address accounting for obligations associated with theEuropean Union’s Directive 2002/96/EC on Waste Electrical and ElectronicEquipment. The Directive, enacted in 2003, requires EU-member countries toadopt legislation to regulate the collection, treatment, recovery, andenvironmentally sound disposal of electrical and electronic waste equipment.The Directive distinguishes between products put on the market after August 13,2005 as new waste and before that date as historical waste. FSP No. 143-1only addresses accounting for historical waste and is required to be applied tothe later of the first reporting period ending after June 8, 2005, or thedate of adoption of the law by the applicable European Union member country.  Adoption of FSP No. 143-1 did nothave a material impact on our consolidated results of operations, financialposition or cash flows.

In December 2004, the FASB issued SFAS No. 153,  *Exchangesof Nonmonetary Assets*, amending Accounting Principles Board (“APB”)Opinion No. 29, *Accounting forNonmonetary Transactions*. APB Opinion No. 29 treatednonmonetary exchanges of similar productive assets as an exception from fairvalue measurement. SFAS No. 153 replaces this exception with a generalexception from fair value measurement for exchanges of nonmonetary assets thatdo not have commercial substance. Nonmonetary exchanges have commercialsubstance if the future cash flows of an entity are expected to changesignificantly as a result of the exchange. SFAS No. 153 was effective fornonmonetary asset exchanges occurring in fiscal years beginning after June 15,2005. Adoption of SFAS No. 153 did not have a material impact on ourconsolidated results of operations, financial position or cash flows.

In November 2004, theFASB issued SFAS No. 151, *InventoryCosts*, revising Accounting Research Bulletin No. 43, Chapter 4,*Inventory Pricing*, whichclarifies the accounting for abnormal amounts of idle facility expense,freight, handling costs and wasted material. SFAS No. 151 was effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. Adoption of SFAS No. 151 did not have a material impact on ourconsolidated results of operations, financial position or cash flows.

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*Results OfOperations*

Our results of operations include the accounts ofBally Technologies, Inc., and its wholly-owned and partially-owned,controlled subsidiaries.

 

| ** **                                                        | ** ** | **Overall Consolidated Operating Results  Year Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                                                        | ** ** | **2006**                                                                                      | ** ** | **% Rev** | ** ** | **2005** | ** ** | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| ** **                                                        | ** ** | **(dollars in millions)**                                                           | ** ** |
| Revenues                                                          |       | $                                                                                             | 547.1      |   |   | 100 | % |   | $ | 483.1 |   |   | 100 | % |   | $ | 476.6 |   |   | 100 | % |   |   | 13 | % |   |   | 1 | % |   |
| Gross profit                                                      |       | 236.7                                                                                         |       |   | 43 | % |   | 222.9 |   |   | 46 | % |   | 263.8 |   |   | 55 | % |   |   | 6 | % |   |   | (16 | )% |   |
| Operating income  (loss)                                          |       | (43.2                                                                                         | )          |   | (8 | )% |   | (4.5 | ) |   | (1 | )% |   | 88.8 |   |   | 19 | % |   |   | (860 | )% |   |   | (105 | )% |   |
| Income (loss)  from continuing operations                         |       | $                                                                                             | (47.2      | ) |   | (9 | )% |   | $ | (17.9 | ) |   | (4 | )% |   | $ | 39.0 |   |   | 8 | % |   |   | (164 | )% |   |   | (146 | )% |   |
| Income (loss)  from discontinued operations, net of income  taxes |       | 1.1                                                                                           |       |   | — | % |   | (4.7 | ) |   | (1 | )% |   | 40.9 |   |   | 9 | % |   |   | 123 | % |   |   | (111 | )% |   |
| Net income (loss)                                                 |       | $                                                                                             | (46.1      | ) |   | (8 | )% |   | $ | (22.6 | ) |   | (5 | )% |   | $ | 79.9 |   |   | 17 | % |   |   | (104 | )% |   |   | (128 | )% |   |

 

We report ourrevenue and income in two segments:

·       ***Bally Gaming Equipment and Systems***(which includes *Gaming Equipment*, *Systems* and *Gaming Operations*)

·       ***Casino Operations***

Bally Gaming Equipment andSystems revenue represents approximately 90%, 89% and 89% of total revenues forfiscal 2006, 2005 and 2004, respectively. Casino Operations revenue representsapproximately 10%, 11% and 11% of total revenue for fiscal 2006, 2005 and 2004,respectively. Descriptions of the fluctuations between fiscal year ends arediscussed under each respective segment disclosure below.

***Bally Gaming Equipment and Systems***

Through our Bally Gaming Equipment and Systemssegment, we are one of the leading providers of technology to the gamingindustry. Over the past several years the gaming industry has largely moved togames which use ticket-in ticket-out (“TITO”) technology, thereby reducing coinhandling costs and down time for games waiting to be serviced on the casinofloor. As a leading provider of this technology, we have experienced increaseddemand for our products. In fiscal 2006, sales of our new gaming devices in thedomestic market increased 27% primarily as a result of new lottery sales ofapproximately 3,300 units as well as the extended transition to the Linux-basedALPHA OSTM platform.

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Thesummary financial results and operating statistics for Bally Gaming Equipmentand Systems are as follows:

| ** **                          | ** **   | **Year Ended June 30,** | ** **   |
|-------------------------------------|--------------|----------------------------------------|--------------|
| ** **                          | ** **   | ** **                             | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                          | ** **   | **2006**                               | ** **   | **% Rev** | ** ** | **2005** | ** ** | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| ** **                          | ** **   | **(dollars in millions)**    | ** **   |
| Revenues                            | *** *** | *** ***                           | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Gaming Equipment                    |         | $                                      | 228.9        |   |   | 47 | % |   | $ | 202.8 |   |   | 47 | % |   | $ | 223.3 |   |   | 53 | % |   |   | 13 | % |   |   | (9 | )% |   |
| Systems                             |         | 120.5                                  |         |   | 24 | % |   | 97.0 |   |   | 22 | % |   | 121.9 |   |   | 29 | % |   |   | 24 | % |   |   | (20 | )% |   |
| Gaming Operations                   |         | 145.1                                  |         |   | 29 | % |   | 131.3 |   |   | 31 | % |   | 79.1 |   |   | 18 | % |   |   | 11 | % |   |   | 66 | % |   |
| Total revenues                      |         | $                                      | 494.5        |   |   | 100 | % |   | $ | 431.1 |   |   | 100 | % |   | $ | 424.3 |   |   | 100 | % |   |   | 15 | % |   |   | 2 | % |   |
| Gross margin                        |         |                                   |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gaming Equipment                    |         | $                                      | 46.6         |   |   | 20 | % |   | $ | 43.2 |   |   | 21 | % |   | $ | 101.0 |   |   | 45 | % |   |   | 8 | % |   |   | (57 | )% |   |
| Systems                             |         | 89.9                                   |         |   | 75 | % |   | 76.9 |   |   | 79 | % |   | 91.2 |   |   | 75 | % |   |   | 17 | % |   |   | (16 | )% |   |
| Gaming Operations                   |         | 66.1                                   |         |   | 46 | % |   | 69.5 |   |   | 53 | % |   | 39.4 |   |   | 50 | % |   |   | (5 | )% |   |   | 76 | % |   |
| Total gross  margin                 |         | $                                      | 202.6        |   |   | 41 | % |   | $ | 189.6 |   |   | 44 | % |   | $ | 231.6 |   |   | 55 | % |   |   | 7 | % |   |   | (18 | )% |   |
| Selling, general and administrative |         | $                                      | 151.7        |   |   | 31 | % |   | $ | 126.5 |   |   | 29 | % |   | $ | 98.8 |   |   | 23 | % |   |   | (20 | )% |   |   | (28 | )% |   |
| Restructuring  charges              |         | —                                 |         |   | — | % |   | 3.1 |   |   | 1 | % |   | — |   |   | — |   |   |   | 100 | % |   |   | — |   |   |
| Impairment  charges                 |         | 15.6                                   |         |   | 3 | % |   | 3.6 |   |   | 1 | % |   | — |   |   | — |   |   |   | (333 | )% |   |   | — |   |   |
| Research and  development costs     |         | 45.1                                   |         |   | 9 | % |   | 43.4 |   |   | 10 | % |   | 36.6 |   |   | 9 | % |   |   | (4 | )% |   |   | (19 | )% |   |
| Depreciation and  amortization      |         | 20.5                                   |         |   | 4 | % |   | 15.9 |   |   | 4 | % |   | 10.0 |   |   | 2 | % |   |   | (29 | )% |   |   | (58 | )% |   |
| Operating income (loss)             |         | $                                      | (30.3        | ) |   | (6 | )% |   | $ | (2.9 | ) |   | (1 | )% |   | $ | 86.2 |   |   | 20 | % |   |   | (945 | )% |   |   | (103 | )% |   |

 

| ** **                                   | ** **   | **Year Ended June 30,** | ** **   |
|----------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                   | ** **   | ** **                             | ** **   | ** ** | ** ** | ** ** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                                   | ** **   | **2006**                               | ** **   | **2005** | ** ** | **2004** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| Operating Statistics:                        | *** *** | *** ***                           | *** *** | *** *** | *** *** | *** *** | *** *** |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| New gaming  devices sold                     |         | 17,887                                 |         | 14,070 |   | 16,808 |   |   | 27 | % |   |   | (16 | )% |   |
| OEM units sold                               |         | 771                                    |         | 2,990 |   | 2,660 |   |   | (74 | )% |   |   | 12 | % |   |
| New unit average  selling price              |         | $                                      | 10,182       |   | $ | 10,389 |   | $ | 9,328 |   |   | (2 | )% |   |   | 11 | % |   |
| Gaming monitoring units installed base       |         | 261,000                                |         | 276,000 |   | 279,000 |   |   | (5 | )% |   |   | (1 | )% |   |
| Casino management  systems installed base(1) |         | 521                                    |         | 521 |   | 508 |   |   | — | % |   |   | 3 | % |   |
| Systems managed  cashless games              |         | 184,000                                |         | 128,000 |   | 83,000 |   |   | 44 | % |   |   | 54 | % |   |
| End of period installed  base:               |         |                                   |         |   |   |   |   |   |   |   |   |   |   |   |   |
| Wide-area progressive                        |         | 1,053                                  |         | 1,660 |   | 1,726 |   |   | (37 | )% |   |   | (4 | )% |   |
| Daily-fee games                              |         | 8,291                                  |         | 8,804 |   | 7,985 |   |   | (6 | )% |   |   | 10 | % |   |
| Centrally  determined games                  |         | 27,437                                 |         | 18,885 |   | 17,995 |   |   | 45 | % |   |   | 5 | % |   |
|                                              |              |                                        |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Casinomanagement systems installed base includes international locations. For fiscal2005 and 2004, locations were originally reported as 225 and 219, respectively,as international locations were excluded from the presentation.

**Fiscal 2006 vs. Fiscal 2005**

Total revenues for ourBally Gaming Equipment and Systems segment increased $63.4 million, or 15%, infiscal 2006 compared to fiscal 2005 as a result of the following:

*Gaming Equipment.**  *Gaming Equipment revenue increasedby $26.1 million, or 13%, as a result of:

·       Anincrease in new gaming device sales to 17,887 units in fiscal 2006 as comparedto 14,070 units in fiscal 2005. The increase of 3,817 in total new units soldwas primarily attributable to sales of 

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approximately 3,300units in lottery jurisdictions. The remaining increase in unit sales wasrelated to the Company’s new video products and game themes, which were basedon the Company’s new ALPHA OS platform that was introduced in video andmechanical reel spinning devices sold in fiscal 2006.

·       Anincrease in international new gaming device sales in fiscal 2006 in connectionwith our expanded marketing efforts outside the United States. We believe thatforeign markets will likely continue to expand in coming years, and will be animportant source of revenue for the Company. We will continue to dedicateresearch and development efforts to develop products for foreign markets.

*Gaming Equipment GrossMargin:*   Gaming Equipment gross margin decreasedto 20% in fiscal 2006 from 21% in fiscal 2005 as a result of:

·       Awrite-down of prepaid royalties of $3.0 million and inventory write-downs of $14.2 millionin fiscal 2006.

·       Anincreased cost basis for used games due to certain refurbishment costs.

·       Newlottery sales that result in lower margins due to the lower average sellingprices these units provide.

·       Lowermargins resulting from introductory pricing and high initial production costs.

*Systems.**  *Systems revenue increased $23.5million, or 24%, primarily as a result of:

·       Anincrease of $4.7 million, or 35%, in systems software sales primarily relatedto approximately $4.6 million from domestic operations.

·       Anincrease of $17.1 million, or 44%, in systems hardware sales related toapproximately $13.5 million from domestic operations and $3.6 million frominternational operations.

·       Anincrease of $2.0 million, or 7%, in systems service and maintenance feesrelated to new contracts with major domestic customers.

*Systems Gross Margin:*   Systemsgross margin decreased to 75% in fiscal 2006 from 79% in fiscal 2005 as aresult of an increase in the proportion of hardware sales, which have a lowermargin, to software sales.

*Gaming Operations.**  *Gaming Operations revenue increased$13.8 million, or 11%, as a result of:

·       Anincrease of $12.1 million, or 20%, in participation and rental revenues derivedfrom our installed base of centrally determined games, which increased 45%,from 18,885 units as of June 30, 2005 to 27,437 units as of June 30,2006.

·       Anincrease of $10.7 million, or 42%, primarily due to daily fees generated fromdomestic lottery customers.

·       Adecrease in wide-area progressive revenue of $8.1 million, or 19%, due to adecrease in the installed base of games during the year, which decreased 37%,from 1,660 units as of June 30, 2005 to 1,053 units as of June 30,2006.

*Gaming Operations GrossMargin:*   Gross margin declined to 46% in fiscal2006 from 53% in fiscal 2005 as a result of:

·       Achange in the estimated useful life and salvage values for certain gamingequipment used in the Gaming Operations division which resulted in a $13.1million increase in depreciation expense charged to cost of gaming operations.

·       Anincrease of $1.0 million in cost of goods sold due to the write-down of certainleased gaming equipment in fiscal 2006.

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*Selling, General andAdministrative Expense.*   Selling, general andadministrative expense increased 20% year over year primarily as a result of:

·       Anincrease in legal expense of approximately $6.4 million due to higherlitigation costs and patent costs.

·       Anincrease in payroll and related expenses of $7.2 million due to increased stafflevels to support business growth.

·       Anincrease in share-based compensation expense of $6.4 million due to ouradoption of SFAS 123R, *Share Based Payment*.

·       Anincrease in consulting fees of approximately $1.8 million due to increasedthird-party development and engineering services.

·       Anincrease in travel expense of approximately $2.2 million due to expansion intoand development of international markets, coupled with increased staff levels.

*Researchand Development Costs.*   Research and developmentcosts increased as a result of our focus towards technology assets and thecompetitive landscape that requires a continual investment in futuregenerations of gaming products and systems.

*ImpairmentCharges.*   During fiscal 2006, we recordedimpairment charges of $15.6 million as compared to $3.6 million in theprior year primarily related to acquired intangible assets related to tracknames and other intellectual property that were no longer recoverable.

*Depreciation andAmortization Expenses.*   Depreciation andamortization expense increased as a result of higher capital expendituresincurred throughout fiscal 2006.

**Fiscal 2005 vs.Fiscal 2004**

Total revenues for our Bally Gaming Equipment andSystems segment increased $6.8 million, or 2%, as a result of:

*Gaming Equipment.**  *Gaming Equipment revenue decreasedby $20.5 million, or 9%, primarily as a result of:

·       Adecrease in new unit sales to 14,070 units sold in fiscal 2005 as compared to16,808 units sold in fiscal 2004. This decrease in total units sold reflectsthe general casino industry reduction in new unit purchases which followed therapid pace of TITO game replacements which occurred over the prior two years.

·       TheCompany’s legacy video products did not perform as well as competitor productsand there was a reduced number of new casino openings in the United States infiscal 2005.

*GamingEquipment Gross Margin:*   Gaming Equipment grossmargin decreased to 21% in fiscal 2005 from 45% in fiscal 2004 primarily as aresult of inventory obsolescence charges of $21.9 million recorded in fiscal2005.

*Systems.**  *Systems revenue decreased $24.9million, or 20%, as a result of:

·       Adecrease in new property installations in fiscal 2005. New propertyinstallations represented approximately $18.5 million of systems revenue infiscal 2005 compared to $31.0 million in fiscal 2004. The decrease in newproperty installations resulted from the above mentioned slowdown following theTITO system upgrades in the prior two years, and the reduced number of newcasino openings in fiscal 2005.

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·       Anincrease of $1.2 million in deferred revenue for contracts with non-perpetuallicenses, which is recognized over the license term.

*SystemsGross Margin:*   Systems gross margin increased to79% in fiscal 2005 from 75% in fiscal 2004 as a result an increase in softwaresales, which have a higher margin compared to hardware sales.

*Gaming Operations.**  *Gaming Operations revenue increased66% as a result of:

·       Anincrease in revenue of $40.1 million, or 337%, to $52.0 million from centrallydetermined linked games due to a full year of revenue in fiscal 2005 comparedto four months in the prior year from the acquisition of SDG in March 2004;

·       Anincrease in daily fee games placements of 10% from 7,985 units in fiscal 2004to 8,804 units in fiscal 2005; and

·       Anincrease in average revenue per day for both wide-area progressives and dailyfee games.

*GamingOperations Gross Margin:*   Gross margin increasedto 53% in fiscal 2005 from 50% in fiscal 2004 as a result of an increase in therecurring revenue stream Class II games generate through license feearrangements that have terms of three to five years.

*Selling, General andAdministrative Expense.*   Selling, general andadministrative expense increased 28% primarily as a result of:

·       Theaddition of Class II and central determination operations for a full yearin fiscal 2005 due to the acquisition of SDG in fiscal 2004.

·       Anincrease in legal expense of approximately $4.0 million resulting from higherpatent and litigation costs.

·       Anincrease in the provision for doubtful accounts receivable of $3.4 million,which included a charge for a large customer that declared bankruptcy duringfiscal 2005.

·       Severancecharges of $3.0 million for reductions in the workforce both domestically andin our European operations.

*Researchand Development Costs.*   Research and developmentcosts increased as a result of the increased investment in the development ofthe Alpha OS platform and related game content.

*Depreciation andAmortization Expenses.*   Depreciation andamortization expense increased as a result of the increase inacquisition-related intangible assets and the increased base of wide-area anddaily fee games.

***Casino Operations***

Our Rainbow Casino is one of four casinos currentlyoperating in the Vicksburg, Mississippi market. Our casino primarily draws customersfrom within a 75-mile radius surrounding Vicksburg, which includesJackson, Mississippi. While a number of properties located on the gulf coastsustained heavy damage during the 2005 hurricane season, our casino was notdamaged. Although it was temporarily closed, we reopened the property forbusiness within four days of Hurricane Katrina once power was restored to thegeneral area. While the play levels at our casino increased somewhat during themonths following the reopening, the play levels returned to a more typicallevel once some of the other Gulf Coast casinos reopened.

In fiscal2007 we began considering the possible sale of Rainbow to a third party inconnection with our plans to focus our efforts on our technology assets. Theconditions under which we may sell Rainbow are dynamic and may be impacted by anumber of factors including but not limited to, general market 

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conditions,competition, our financial position, and the interest of certain buyers who maybe strategic to us. If we do not receive a financially beneficial offer, we maydecide not to sell the casino.

Thesummary of our financial results and operating statistics for our CasinoOperation is as follows:

| ** **                           | ** ** | **Year Ended June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                           | ** ** | **2006**                               | ** ** | **% Rev** | ** ** | **2005** | ** ** | **% Rev** | ** ** | **2004** | ** ** | **% Rev** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| ** **                           | ** ** | **(dollars in millions)**    | ** ** |
| Revenue                              |       | $                                      | 52.6       |   |   | 100 | % |   | $ | 52.0 |   |   | 100 | % |   | $ | 52.3 |   |   | 100 | % |   |   | 1 | % |   |   | — | % |   |
| Gross margin                         |       | 34.1                                   |       |   | 65 | % |   | 33.3 |   |   | 64 | % |   | 32.2 |   |   | 62 | % |   |   | 2 | % |   |   | 3 | % |   |
| Selling, general  and administrative |       | 13.3                                   |       |   | 25 | % |   | 13.2 |   |   | 25 | % |   | 12.5 |   |   | 24 | % |   |   | (1 | )% |   |   | (6 | )% |   |
| Depreciation and  amortization       |       | 3.5                                    |       |   | 7 | % |   | 3.3 |   |   | 6 | % |   | 2.8 |   |   | 5 | % |   |   | (6 | )% |   |   | (18 | )% |   |
| Operating income                     |       | $                                      | 17.3       |   |   | 33 | % |   | $ | 16.8 |   |   | 32 | % |   | $ | 16.9 |   |   | 32 | % |   |   | 3 | % |   |   | (1 | )% |   |
| Operating  Statistics:               |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average Number of  Gaming Devices    |       | 891                                    |       |   |   |   |   | 890 |   |   |   |   |   | 930 |   |   |   |   |   |   | — | % |   |   | (4 | )% |   |
| Average Number of Table  Games       |       | 12                                     |       |   |   |   |   | 12 |   |   |   |   |   | 12 |   |   |   |   |   |   | — | % |   |   | — | % |   |

 

**Fiscal 2006 vs.Fiscal 2005**

Rainbow Casino revenue increased slightly by $0.6 millionfrom $52.0 million in fiscal 2005 to $52.6 million in fiscal 2006 as a resultof an increase in gaming revenue from slot machines, keno and table games. Theincreases were attributable to the fact that, unlike in respect of ourcompetitors’ properties, our property did not sustain any significant damage inconnection with the Gulf Coast hurricanes in August and September 2005.

Gross margin improved to 65% in fiscal 2006 due tocontinued improvement in operating cost reductions and increased slot and tablewins per day per unit.

The overall selling, general and administrativeexpenses remained relatively stable year over year as a percentage of revenue.

Depreciation andamortization expense increased $0.2 million resulting from additional capitalexpenditures in connection with new game replacements.

**Fiscal 2005 vs.Fiscal 2004**

Rainbow Casino revenue was relatively flat in fiscal2005 compared to fiscal 2004 in a market that grew 3.9% year over year.

Gross margin improved to 64% in fiscal 2005 due tocontinued improvement in operating cost reductions and increased slot and tablewins per day per unit.

The overall selling, general and administrativeexpenses remained relatively stable year over year as a percentage of revenue.

Depreciation andamortization expense increased $0.5 million due to additional capitalexpenditures relating to new game replacements.

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***Parent Company***

Thesummary financial results of Bally Technologies, Inc., our parent entity,are set forth below. These results also include certain other income andexpenses that are otherwise not allocated to a specific business segment.

| ** **                     | ** ** | **Year Ended June 30,** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|
| ** **                     | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | **Favorable/  (Unfavorable)** | ** ** |
| ** **                     | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| ** **                     | ** ** | **(dollars in millions)**    | ** ** |
| General and  administrative    |       | $                                      | 28.8       |   | $ | 17.1 |   | $ | 12.8 |   |   | (68 | )% |   |   | (34 | )% |   |
| Depreciation and  amortization |       | 1.4                                    |       | 1.3 |   | 1.5 |   |   | (8 | )% |   |   | 12 | % |   |
| Total parent  company expense  |       | $                                      | 30.2       |   | $ | 18.4 |   | $ | 14.3 |   |   | (64 | )% |   |   | (29 | )% |   |
| Other income (expense):        |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                |       | 3.5                                    |       | 3.4 |   | 4.3 |   |   | 3 | % |   |   | (20 | )% |   |
| Interest expense               |       | (27.5                                  | )          | (18.3 | ) | (17.9 | ) |   | (50 | )% |   |   | (2 | )% |   |
| Loss on extinguishment of debt |       | —                                 |       | (0.6 | ) | (12.3 | ) |   | 100 | % |   |   | 95 | % |   |
| Other, net                     |       | (0.1                                   | )          | 0.6 |   | (0.5 | ) |   | (117 | )% |   |   | 223 | % |   |
| Total other  expense           |       | $                                      | (24.1      | ) | $ | (14.9 | ) | $ | (26.4 | ) |   | (62 | )% |   |   | 44 | % |   |
| Income tax benefit(expense)    |       | $                                      | 24.0       |   | $ | 5.2 |   | $ | (21.1 | ) |   | 362 | % |   |   | 125 | % |   |
| Minority interest              |       | $                                      | (3.9       | ) | $ | (3.7 | ) | $ | (2.3 | ) |   | (5 | )% |   |   | (62 | )% |   |

 

**Fiscal 2006 vs.Fiscal 2005**

*General and AdministrativeExpense.*   Generaland administrative expense at the parent company increased $11.7 million, or68%, primarily as a result of:

·       Anincrease in payroll and related expense due to additional restricted stock unitamortization of $1.4 million.

·       Anincrease in share-based compensation expense of $2.9 million related to ouradoption of SFAS 123R.

·       Anincrease in legal fees of $2.8 million due to litigation matters and theongoing SEC investigation and other related matters.

·       Anincrease in accounting fees of $4.7 million due to Sarbanes-Oxley compliance anda restatement of prior periods.

Minority interest increased primarily due to theconsolidation of certain variable interest entities and the partnershipinterest in Rainbow Casino.

*OtherIncome (Expense).*   Other expense increased $9.2million, or 62%, as a result of an increase in interest expense of $9.2 millionin fiscal 2006 compared to fiscal 2005. This was due to higher interest rateson lower total debt outstanding. Virtually all of our debt is based on avariable interest rate; therefore, future interest expense will be impacted byfuture changes in LIBOR, which is the base rate for our interest payments.

Our effective income tax rate from continuingoperations for fiscal 2006 was approximately 36%. This rate reflects a Federaltax benefit computed using a rate of 35% that was offset by reserves applied tocertain deferred tax assets.

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**Fiscal 2005 vs.Fiscal 2004**

*General and AdministrativeExpense.*   Generaland administrative expense at the parent company increased $4.3 million, or34%, primarily as a result of:

·       Anincrease in payroll and related expense during fiscal 2005 due to restrictedstock unit amortization totaling $2.1 million and a $0.6 million charge forseverance benefits resulting from our reorganization; offset by a decrease insalaries and wages of $1.0 million due to reduced corporate headcount and forcertain personnel were reassigned to the gaming equipment and systems segment.

·       Anincrease in legal fees of $1.3 million in fiscal 2005 due to the ongoing SECinvestigation and other related matters.

·       Anincrease in professional fees of $1.4 million due to Sarbanes-Oxley compliance.

·       Asa result of a refinancing completed during fiscal 2004, a pre-tax charge of$12.3 million was recorded. In December 2004, our bank loan agreement wasamended, which resulted in a charge of $0.6 million that was classified as aloss on extinguishment of debt.

Minority interest increased due to the consolidationof certain variable interest entities.

Interest expense was $18.3 million for fiscal 2005,compared to $17.9 million in fiscal 2004 due to higher variable interest rateson lower total debt outstanding.

Our effective income taxrate for continuing operations for fiscal 2005 was approximately 27%. This ratereflects a Federal tax benefit computed using a rate of 35%, offset by a taxcharge for the estimated potential tax liability for the reorganization of ourEuropean distribution operations; as well as reserves applied to certaindeferred tax assets.

***Significant Items Affecting Comparability***

Certain significant items affect the comparability offinancial statements for fiscal 2006, 2005 and 2004, which are discussed below.

*Inventoryand asset write-downs:*   In fiscal 2005, we faceddeclining demand for gaming devices based on our legacy platform, andtherefore, we reassessed this particular portion of our inventory. In October 2004,we made the strategic decision to move to our new Alpha OS platform, which wasmade commercially available in April 2005 in most markets.

The decision to move our gaming devices to the newplatform, the targeting of used equipment for non-domestic markets, and theconsolidation of certain warehouses all led to accelerated disposals of legacyproducts in both fiscal 2006 and 2005. This process has required updatingestimates for the net realizable value of inventories due to the subjectivityinvolved in projecting sales volumes, used game sales values, refurbishmentcosts, and customer demand in non-domestic jurisdictions. As a result of ourongoing analysis of inventory valuations, we have taken a series of inventorywrite-downs totaling $14.2 million and $21.9 million for fiscal 2006 and 2005,respectively.

The Company also recorded a write-down of leasedgaming equipment of $1.0 million and $3.2 in the year ended June 30, 2006and 2005, respectively.

These inventory and asset write-downs have had asignificant impact on Gaming Equipment margins in both fiscal 2006 and 2005. OurGame Equipment margins were 20% and 21% in fiscal 2006 and 2005, respectively,compared to a more normal margin of 45% in fiscal 2004.

We continue to hold a significant number of used gamingdevices, therefore, there can be no assurances that further write-downs willnot occur in future periods.

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*Impairmentcharges:*   During our review of intangible assetsfor impairment in the year ended June 30, 2006, we determined that certainfinite and indefinite lived intangible assets had become impaired. Consequently,we recorded an impairment charge in fiscal 2006 of $15.6 million compared toimpairment charges in fiscal 2005 of $3.6 million.

*Depreciationon leased gaming machines:*   During the secondquarter of fiscal 2006, the Company re-assessed the estimated useful life andsalvage values for certain gaming equipment. This reassessment resulted in areduction of both the useful lives and salvage value of these assets and a$15.4 million increase in depreciation expense charged to the cost of gamingoperations during fiscal 2006.

*Refinancingand loan amendment charges:*   In fiscal 2004, we initiated atender offer for all of our outstanding 10% Senior Subordinated Notes due 2007,which we refer to as our senior subordinated notes, at a price of 103.33% plusa .25% tender premium. The offer was completed on September 16, 2003. As aresult, we recorded a pre-tax charge in fiscal 2004 of $12.3 million, whichincluded a $5.0 million charge for the early extinguishment of the seniorsubordinated notes, $7.0 million for the write off of deferred financing costsand $0.3 million in fees and expenses.

*Restructuring charges:*   Infiscal 2005, we undertook an extensive review of our operations and reduced ourworkforce during the September 2004 quarter and the March 2005quarter. As a result of these reductions in force, we incurred severancecharges totaling $3.6 million in fiscal 2005.

***Discontinued Operations***

As previously discussed, we sold our Nevada routeoperations, the Rail City Casino and Bally Wulff during fiscal 2004.

On June 30, 2004, we completed the sale of UnitedCoin to Century Gaming, Inc. and received approximately $100 million incash and the assumption by Century Gaming of approximately $5.0 million in debt.Additionally, Century Gaming agreed to acquire a certain number of gamingdevices from our Bally Gaming and Systems business unit over a five-year period.United Coin revenue totaled $220.9 million and operating income totaled$22.5 million for the year ended June 30, 2004. In fiscal 2004, we reported a gain on the sale before income taxes of$15.3 million, or $9.1 million after tax. In fiscal 2005, the gain on sale wasadjusted for charges incurred for an adverse outcome in a patent infringementcase and the resolution of certain sale related liabilities, the sum of whichtotaled $6.3 million net of tax, which is included in the discontinuedoperations section of the statement of operations for the fiscal 2005.

In September, 2004, a Federal District Court juryreached a verdict in a patent infringement case filed by Action Gaming, Inc.(“AGI”) and IGT. The jury awarded AGI and IGT an aggregate of approximately$7.4 million in damages related to a single, optional feature offered incertain multi-hand poker games provided solely by United Coin. On July 11,2006, the federal circuit court of appeals affirmed the district courtjudgment, denying the appeals for both parties, and thereafter, the judgmentwas satisfied out of the posted bond.

In March 2006, in another case involving UnitedCoin, the U.S. Court of Appeals for the Ninth Circuit awarded United Coinapproximately $1.1 million in damages, fees, and costs in a contract disputewith a customer. Under the terms of the 2004 sale of United Coin, we retainedthe right to continue to prosecute the case and to receive any judgment orother award. In May 2006, the customer paid a total of $1.7 million insatisfaction of the award.

The sale of the Rail City Casino to the Sands Regentwas completed on May 3, 2004. Total consideration was $37.9 million incash. Rail City revenue totaled $19.2 million and operating income totaled $5.4million for fiscal 2004. We reported a gain on the sale before income taxes of$23.1 million, or $14.3 million after tax.

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The Louisiana routeoperations were sold in October 2004 and had revenues totaled $17.0million and operating income totaled $2.8 million for fiscal 2004. We recordeda gain on the sale of $1.3 million or $0.8 million after taxes in fiscal2005.

**Financial Condition**

***Liquidity***

As of June 30, 2006, we had $16.4 million in cashand cash equivalents. In addition, we had net working capital of approximately$130.5 million, an increase of approximately $5.4 million from June 30,2005, which is discussed in “—Working Capital” below. Consolidated cash andcash equivalents at June 30, 2006 includes approximately $3.6 million ofcash utilized in our Casino Operations that is held in vaults, cages or changebanks. Additionally, pursuant to various state gaming regulations, certain cashaccounts totaling approximately $14.5 million as of June 30, 2006, aremaintained to ensure availability of funds to pay wide-area progressive jackpotawards which are classified as restricted cash on the consolidated balancesheets. In addition, we purchase U.S. Treasury Strip Securities for the benefitof jackpot winners who elect to receive annual or weekly installment payments. Thesesecurities are included in restricted long-term investments in the accompanyingconsolidated balance sheets, and totaled $9.0 million and $10.1 million as of June 30,2006 and 2005, respectively.

On September 5, 2003, we completed a refinancingtransaction whereby we entered into a new $275.0 million term loan and a$125.0 million revolving credit facility. We used the proceeds from therefinancing transaction to (1) repay an aggregate of approximately $188.0million outstanding under our then existing term loan, (2) repurchase the$150.0 million aggregate amount of our senior subordinated notes, and (3) pay$5.0 million in transaction fees and expenses. The fees and expenses werecapitalized and are being amortized on a straight-line basis over the remainingterm of the loan. The term loan has a 1% per year mandatory principalamortization after the first year. Both the term loan and revolving creditfacility mature in September 2009.

In December 2003, we increased the term loan by$75.0 million to $350.0 million. We used the proceeds primarily to fund theacquisition of SDG. As a result of the increase, we incurred an additional $1.6million in debt issuance costs, which has been capitalized and is beingamortized on a straight-line basis over the remaining term of the term loan.

In December 2004, we amended our bank loanagreement governing the term loan and revolving credit facility. The amendmentprovided for (1) an increase in the maximum allowable leverage ratio underthe bank loan agreement to a minimum of 4.75 times at June 30, 2005, whichdeclines thereafter, (2) a reduction in the revolving credit facilitycommitment to $75.0 million and (3) an increase in the term loan interestrate to LIBOR plus 3.00%, which can be adjusted to LIBOR plus 3.75% based oncertain credit rating and leverage ratio criteria. We incurred a fee ofapproximately $1.0 million in connection with the amendment. As of June 30,2006, we had $311.4 million outstanding under our term loan accruing interestat a rate of 8.18%, and no amounts outstanding under the $75.0 millionrevolving credit facility.

As a result of the additional time required tocomplete the year end closing process for fiscal 2005, we failed to deliver toour lenders our 2005 audited financial statements as well as the unaudited interimfinancial statements for the fiscal quarter ended September 30, 2005 in atimely manner, and therefore, were not in compliance with certain of our debtcovenants under the bank loan agreement. Pursuant to an agreement with thelenders, we cured the default in December 2005 by delivering our 2005audited financial statements contained in our 2005 Annual Report on Form 10-Kand our unaudited interim financial statements for the fiscal quarter ended September 30,2005. During the default period through the date of the filing of our 2005Annual Report on Form 10-K, we incurred default interest ofapproximately $0.7 million, which was expensed in the quarter ended December 31,2005.

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In October 2006, we executed an amendment to ourbank loan agreement that (i) extended the due date for the  deliveryof the our audited financial statements for the fiscalyear ended June 30, 2006 to December 31, 2006, (ii) providedthat we deliver our quarterly reports on Form 10-Q for the FiscalQuarters ending on September 30, 2005, December 31, 2005 and March 31,2006 no later than December 31, 2006, (iii) modified the definitionof EBITDA to exclude up to $10.0 million of certain cashcharges, and (iv) clarified that the definitionof EBITDA includes interest income on trade receivables. Inexchange for the concessions granted under the amendment we paid anadministrative fee of $964,000, which will be expensed in the quarter ended December 31,2006.

In December 2006, we executed an additionalamendment to our bank loan agreement, which extended the due date for the delivery of our quarterly report on Form 10-Q for the Fiscal Quarterended March 31, 2006 and the audited financialstatements for the fiscal year ended June 30, 2006 to March 15,2007. In exchange for the concessions granted under the agreement we paid anadministrative fee of $1.2 million, which will be expensed in the quarter endedDecember 31, 2006.

There can be no assurances we will be able to complywith the amended covenants. See Item 1A, Risk Factors  for a discussion of the risks associated withour non-compliance with certain of our debt covenants under our bank loanagreement.

As of June 30, 2006, we were in compliance with ourfinancial covenants under the bank loan agreement, which consist of a leverageratio, a fixed charges coverage ratio, and a minimum EBITDA (as that term isdefined in the bank loan agreement) ratio. The leverage ratio is computed astotal average debt outstanding during the quarter divided by the trailing 12months EBITDA excluding certain cash and non-cash charges, and is furtheradjusted to remove EBITDA from discontinued operations at the time thoseoperations are sold. The Company’s leverage ratio as of June 30, 2006 was4.17 times versus the covenant maximum of 4.25 times.

Cash flows from operating activities are derivedprimarily from the cash receipts from the sale of goods and services, theoperation of wide-area progressive systems, lease payments, and monthly cashreceipts from maintenance agreements for our casino systems customers. Inaddition, we generate cash through our casino operations. We utilize our cashto acquire materials for the manufacture of goods for resale or lease, payroll,interest and all other selling, general and administrative expenses.

Management believes thatcash flows from current operating activities and the availability under therevolving credit facility should provide us with sufficient capital resourcesand liquidity for at least the next twelve months and for the foreseeablefuture. Access to the revolving credit facility in the future will depend onour ability to generate adequate levels of EBITDA, as described above. At June 30,2006, we had no material commitments for capital expenditures.

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***Working Capital***

Thefollowing table presents the components of consolidated working capital atJune 30, 2006 and 2005:

| ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | **Increase (decrease)** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|------------|------------|------------------------------|------------|
| ** **                           | ** ** | **2006**                        | ** ** | **2005**   | ** ** | **Amount**                   | ** ** | **%** | ** ** |
| ** **                           | ** ** | **(dollars in 000s)** | ** ** |
| Current Assets:                      |       |                            |       |       |       |                         |       |   |   |
| Cash and cash equivalents            |       | $                               | 16,425     |       | $          | 33,170                       |       | $ | (16,745 | ) | (50 | )% |
| Restricted cash                      |       | 14,484                          |       | 13,421     |       | 1,063                        |       | 8 | % |
| Accounts and notes receivable, net   |       | 135,497                         |       | 97,679     |       | 37,818                       |       | 39 | % |
| Inventories                          |       | 69,995                          |       | 63,523     |       | 6,472                        |       | 10 | % |
| Income taxes receivable              |       | 266                             |       | —     |       | 266                          |       | — | % |
| Deferred tax assets, net             |       | 51,374                          |       | 30,884     |       | 20,490                       |       | 66 | % |
| Other current                        |       | 41,313                          |       | 33,034     |       | 8,279                        |       | 25 | % |
| Total current  assets                |       | $                               | 329,354    |       | $          | 271,711                      |       | $ | 57,643 |   | 21 | % |
| Current Liabilities:                 |       |                            |       |       |       |                         |       |   |   |
| Accounts payable                     |       | $                               | 39,622     |       | $          | 36,807                       |       | $ | 2,815 |   | 8 | % |
| Accrued liabilities                  |       | 86,131                          |       | 43,838     |       | 42,293                       |       | 96 | % |
| Jackpot liabilities                  |       | 13,139                          |       | 13,025     |       | 114                          |       | 1 | % |
| Deferred revenue                     |       | 47,081                          |       | 40,962     |       | 6,119                        |       | 15 | % |
| Income taxes payable                 |       | —                          |       | 1,752      |       | (1,752                       | )          | (100 | )% |
| Current maturities of long-term debt |       | 12,864                          |       | 10,163     |       | 2,701                        |       | 27 | % |
| Total current  liabilities           |       | 198,837                         |       | 146,547    |       | 52,290                       |       | 36 | % |
| Net working  capital                 |       | $                               | 130,517    |       | $          | 125,164                      |       | $ | 5,353 |   | 4 | % |

 

At June 30,2006, our net working capital increased $5.4 million as compared toJune 30, 2005 primarily related to:

·       Anincrease in accounts and notes receivable, net, of $37.8 million, or 39%, from$97.7 million in fiscal 2005 to $135.5 million in fiscal 2006 due to new unitgame sales from lottery customers and systems hardware and software contractswith major domestic customers.

·       Anincrease in inventories of $6.5 million, or 10%, from $63.5 million in fiscal2005 to $70.0 million in fiscal 2006 due to increased manufacturing levels ofnew products.

·       Anincrease in deferred tax assets, net, of $20.5 million, or 66%, from $30.9million in fiscal 2005 to $51.4 million in fiscal 2006 due to the increasein certain accruals recognized for book but not deductible for tax purposes andthe classification of a portion of our net operating loss carryforwards ascurrent.

·  An increase in other current assets of $8.3million, or 25%, from $33.0 million in fiscal 2005 to $41.3 million infiscal 2006 due to a $7.8 million deposit made related to a patent litigationmatter.

The increase inworking capital was offset by the following:

·       Adecrease in cash and cash equivalents of $16.7 million, or 50%, from $33.2million in fiscal 2005 to $16.4 million in fiscal 2006 due to the pay down ofthe term loan in accordance with our bank loan agreement, as well as cash usedto deploy wide-area and daily-fee gaming devices.

·       An increase in accruedliabilities of $42.3 million, or 96%, from $43.8 million in fiscal 2005 to$86.1 million in fiscal 2006 due to professional and consulting fees ofapproximately $10.6 million related to legal and litigation matters, customerdeposits of approximately $18.6 million and $6.5 of other accrued expenses.

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***Cash Flow***

Cash flows provided by operating activities totaled $52.5million in fiscal 2006 as compared to $52.1 million in fiscal 2005 as a resultof an increase in working capital items of $5.4 million from $125.1 million infiscal 2005 to $130.5 million in fiscal 2006 as discussed above in the workingcapital section.

Cash flows used ininvesting activities totaled $60.7 million in fiscal 2006 as compared to $65.1million in fiscal 2005 as a result of:

·       Capitalexpenditures of $14.0 million in fiscal 2006 as compared to $12.4 million infiscal 2005.

·       Costsincurred to deploy additional leased gaming devices totaling $44.7 million infiscal 2006 as compared to $40.6 million in fiscal 2005.

·       Additionsto restricted cash and investments of $0.9 million in fiscal 2006 as comparedto deletions to restricted cash and investments of $0.1 million in fiscal 2005.

Cash used infinancing activities totaled $8.6 million in fiscal 2006 as compared to $108.1million in fiscal 2005 as a result of:

·       Principalpayments on other long term debt totaling $9.7 million in fiscal 2006 ascompared to $6.3 million in fiscal 2005.

·       Cashprovided from exercise of stock options of $1.1 million in both fiscal 2006 and2005.

·       Cashused to pay-off debt of $31.6 million in fiscal 2005.

·       Decrease in amountsoutstanding under the revolving credit facility of $70.0 million in fiscal2005.

**ContractualCommitments**

We arecommitted to make future payments pursuant to various contracts and agreements.A summary of those contractual obligations existing as of June 30, 2006, groupedaccording to the periods in which such payments are due, is as follows:

| ** **                      | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| ** **                      | ** ** | **Less than  1 year**           | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** | **Total** | ** ** |
| Debt:                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Term loan  facility(a)          |       |                                      | $          | 3,500 |   |   | $ | 7,000 |   | $ | 300,882 |   |   | $ | — |   |   | $ | 311,382 |   |
| Revolving credit  facility(b)   |       |                                      | —     |   |   | — |   | — |   |   | — |   |   | — |   |
| Subordinated debt(c)            |       |                                      | 6,600      |   |   | 7,600 |   | — |   |   | — |   |   | 14,200 |   |
| Other debt                      |       |                                      | 2,764      |   |   | — |   | — |   |   | — |   |   | 2,764 |   |
| Estimated  interest payments(d) |       |                                      | 25,171     |   |   | 50,797 |   | 3,348 |   |   | — |   |   | 79,316 |   |
|                            |       |                                      | 38,035     |   |   | 65,397 |   | 304,230 |   |   | — |   |   | 407,662 |   |
| Other commitments:              |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net minimum  rentals            |       |                                      | 4,977      |   |   | 6,951 |   | 3,916 |   |   | — |   |   | 15,844 |   |
| MindPlay earn-out(e)            |       |                                      | —     |   |   | — |   | — |   |   | — |   |   | — |   |
| Purchase  commitments(f)        |       |                                      | —     |   |   | — |   | — |   |   | — |   |   | — |   |
| Employment  agreements(g)       |       |                                      | 1,498      |   |   | 2,279 |   | 85 |   |   | — |   |   | 3,862 |   |
| Total commitments               |       |                                      | $          | 44,510 |   |   | $ | 74,627 |   | $ | 308,231 |   |   | $ | — |   |   | $ | 427,368 |   |

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(a)           The bankloan agreement governing the term loan facility requires principal payments of$3.5 million per year with the balance due in September 2009.

(b)          There wereno amounts outstanding on the $75.0 million revolving credit facility as of June 30,2006.

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(c)           Representsprincipal payments under subordinated promissory notes payable related to theacquisition of SDG and Mindplay (see Note 11 to consolidated financial statements,Related Party Transactions).

(d)          Our debt is virtuallyall variable rate, which means that it is tied to LIBOR. Therefore, we computedthe estimated future interest payments for our total debt outstanding based onthe average interest rate in effect as of June 30, 2006 of 8.18%.

(e)           Pursuant to theMindPlay purchase agreement, we are obligated to make certain contingentearn-out payments to the former principals of MindPlay, amounts that cannotcurrently be estimated (see Note 3 to consolidated financial statements,Business Combinations).

(f)             Except in certainrare instances, the Company is not required by its suppliers to enter intoquarterly commitments for products.

(g)           We have employmentagreements with most of our employees with positions of Vice President or above.These agreements generally provide for an initial rate of pay and the terms ofthe severance benefits generally range from three to twelve months salarycontinuation with similar non-compete periods. Almost all such agreementscontain language that the employee is still an “at will” employee, and as suchcan be terminated at anytime subject to the individual termination provisions. Theonly multi-year employment arrangements are with Richard Haddrill, our CEO, andMr. Caller, our CFO. Mr. Haddrill’s arrangement provides for a basesalary of $998,000 through January 1, 2009. Mr. Caller’s arrangementprovides for a base salary of $340,000 through September 30, 2009 and aminimum performance bonus of $160,000 for the year ended June 30, 2006 and$51,000 for the years ended June 30, 2007 and 2008. Only thesearrangements are reflected in the table above.

Our long-term debt is virtually all floating rate, andtherefore, future interest payments will be impacted by future LIBOR ratechanges as well as the balance of debt outstanding in those future periods. Interestpayments for fiscal 2006 totaled $21.3 million.

The payment obligations inthe above table are based on the contractually scheduled due dates. The onlypayment acceleration that could be demanded of us would generally be in theevent of a default under our bank loan agreement that was not cured within theprovisions set forth in that agreement.

**Off Balance SheetArrangements**

We are a party tofinancial instruments with off-balance sheet risk, such as performance bondsand other guarantees not reflected in our balance sheet that arise in thenormal course of business.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

*Interest Rate Risk*

We had total debt ofapproximately $328.3 million, consisting primarily of the $311.4 million termloan under our senior credit facilities and the $14.2 million subordinated loanand other debt of approximately $2.8 million. The interest rate for the termloan is reset every six months. If the LIBOR rates were to increase or decreaseby 100 basis points, with all other factors remaining constant, earnings woulddecrease or increase by approximately $3.3 million on a pre-tax basis.

*Foreign CurrencyExchange Rate Risk*

Our foreign subsidiariesgenerally use their domestic currency as their functional currency. A 10%fluctuation in the exchange rates of these currencies against the U.S. dollarwould result in a corresponding change in earnings reported in the consolidatedgroup of approximately $0.1 million.

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**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financialstatements, including the notes thereto, and supplementary financialinformation are listed in Item 15, Exhibits and Financial Statement Schedules,and are included after the signature page beginning at page F-1.

**ITEM9.**                CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

**ITEM9A.**        CONTROLS AND PROCEDURES

**Disclosure Controls and Procedures**

As required by Rule 13a-15(b) promulgatedunder the Exchange Act, our management, with the participation of our ChiefExecutive Officer and Chief Financial Officer, evaluated the design andoperating effectiveness as of June 30, 2006 of our disclosure controls andprocedures, as defined in Rule 13a-15(e) promulgated under theExchange Act. Based on this evaluation our Chief Executive Officer and ChiefFinancial Officer concluded that, because of the material weaknesses in ourinternal control over financial reporting described below, as of June 30,2006 our disclosure controls and procedures were not effective.

Notwithstanding management’sassessment that our internal control over financial reporting wasineffective as of June 30, 2006 and the material weaknesses describedbelow, we believe that the consolidated financial statements included in thisAnnual Report on Form 10-K correctly present our financialcondition, results of operations and cash flows for the fiscal years coveredthereby in all material respects.

**Internal Control Over Financial Reporting**

**Management’s Report on Internal Control Over FinancialReporting**

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as defined in Rule 13a-15(f) promulgatedunder the Exchange Act. Internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of an issuer’s financial statements for externalpurposes in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”). Internal control over financial reportingincludes policies and procedures that:

·       pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of an issuer’s assets;

·       providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with GAAP, and that an issuer’sreceipts and expenditures are being made only in accordance with authorizationsof its management and directors; and

·       providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of an issuer’s assets that could have amaterial effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, the application of any evaluation of effectivenessto future periods is subject to the risk that controls may become inadequatebecause of changes in conditions, or that compliance with the policies orprocedures may deteriorate.

As required by Rule 13a-15(c) promulgatedunder the Exchange Act, our management, with the participation of our ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofour 

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internal control overfinancial reporting as of June 30, 2006. Management’s assessment was basedon criteria set forth by the Committee of Sponsoring Organizations of theTreadway Commission in *Internal Control—IntegratedFramework* (“COSO”). Our assessment identified deficiencies that weredetermined to be material weaknesses.

A material weakness is acontrol deficiency, or combination of control deficiencies, that results inmore than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. Because of thematerial weaknesses described below, management concluded that our internalcontrol over financial reporting was not effective as of June 30, 2006.

The specific materialweaknesses identified by management as of June 30, 2006 are described asfollows:

**Ineffective controlsrelated to the financial closing process.****  **In August 2006, upon discoverythat certain transactions were improperly recorded we determined it wasnecessary to restate our consolidated financial statements as of June 30,2005 and 2004, and for each of the three years in the period ending June 30,2005. This restatement was not completed until the 2005 10-K/A was filedon October 31, 2006. These closing procedures did not include the designedlevel of documentation and review. Consequently, we used abbreviated financialclosing procedures for fiscal 2006 which are not sustainable in our normalfinancial reporting process as they include significant manual procedures andlook back procedures. Additionally, our designed controls over the preparation,review and support of journal entries did not operate effectively. We also did not perform the designed level ofanalytical procedures on the financial statements of non-corporate operations.

**Ineffective controlrelated to fraud risk assessment.****  **Weconcluded that the overall operating effectiveness of our fraud risk assessmentdid not operate as designed primarily due to delays in our financial closingprocess as described above.

**Inadequate and ineffectivecontrol related to revenue recognition, including gaming operations revenuerecognition and the associated existence of fixed asset machines, system salesrevenue recognition and the processing of customer credits.**   We did not have appropriateand/or effective internal controls related to the recognition of revenue forgaming operations, including the lack of comprehensive controls to adequatelycapture and analyze: (i) the terms and conditions of all contracts toensure the proper recording of revenue; (ii) the accuracy of authorizeddaily fees and revenue share percentages; (iii) the security andelectronic transmission to and from our network operating center(s) andits subsequent documentation and backup; and (iv) the existence of therelated fixed asset machines.

We did not have effectiveinternal control related to the recognition of revenue for system salespertaining to (i) the review of terms and conditions on contract upgradesand change orders to ensure proper recording of revenue and (ii) the accuracyand authorization of billing amounts for upgrades, change orders andmaintenance fees.

We also did not haveeffective internal control related to the recognition of revenue pertaining tothe complete and timely recording of credit memos resulting from customerreturns or allowances.

**Ineffective controlrelated to the existence and valuation of inventory.****  **We identified several deficienciesrelated to the existence and valuation of inventory, including those relatedto:****i) year-end adjustments to ourraw materials balance due to ineffective periodic counting procedures,inadequate physical safeguards and inadequate control over transactionprocessing; (ii) the restocking of excess inventory pulled for work orderswhich was not always properly identified and/or removed from the related billof materials; (iii) costs associated with the creation of new kits andassemblies that were not effectively calculated and monitored resulting inincorrect valuation of inventories; (iv) lack of adequate review andanalysis of certain inventory variances between the perpetual records and thegeneral ledger; and (v) determining allowances for obsolete inventory.

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Our independent registeredpublic accounting firm, Deloitte & Touche LLP, has issued anattestation report on management’s assessment of our internal control over financialreporting which is set forth below.

**Changes in Internal Control**

During the third andfourth quarters of the fiscal year ended June 30, 2006, we implemented newcontrol processes which we believe to be effective as of June 30, 2006over certain material weaknesses reported the 2005 10-K/A, as describedbelow. These new controls were developed through investigation and review ofthe processes and activities surrounding the material weaknesses and includechanges to these processes and the development of test and review programsdesigned to prevent or detect similar future occurrences.

**Inadequate staffing andtraining in finance and accounting.****  **We strengthened our financialorganization by hiring several new key members of our management team,increasing our overall staffing levels and providing added training andfinancial discipline to the financial reporting process.

**Ineffective controls relatedto the preparation of certain account analyses, account summaries and accountreconciliations.**** **Weestablished a formal checklist process to ensure that all accounts requiringanalysis before each financial statement close were properly identified and reconciled.We re-evaluated the level of responsibility and review and re-trainedappropriate personnel in the required approach and documentation standard foreach key account analysis to ensure proper and timely account reconciliationswere performed.

**Inadequate controlsrelated to revenue recognition.****  **We redesigned our control structureto analyze and review the revenue on all sales contracts. We formallydocumented our revenue recognition processes to comply with GAAP, including therequirements of AICPA SOP 97-2. We hired additional qualified financialpersonnel, and trained and educated the appropriate personnel in the finance,systems and game sales organizations on our comprehensive revenue recognitionpolicies and requirements. In addition, we engaged an outside firm to reviewsignificant revenue transactions for each accounting period.

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

**Ineffective controlsrelated to income taxes.****  **We enhanced our tax department with a higher levelmanager position. Additionally we engaged qualified outside tax experts toassist in the review of our annual tax provision, disclosures and supportingtax treatments and compilations.

**Ineffective controls atthe entity level.****  **Were-evaluated our entity level control requirements in conjunction with COSO’scomprehensive list of entity wide objectives, taking into considerationobjectives specific to the control environment, risk assessment, monitoringfunction and dissemination of information and communication activities toensure our new design provided distributed coverage. Updates were then made tocontrols that were not previously in place or were not operating effectively.The desired design of identified control activities was reviewed with executiveand other key members of management. We communicated our new control structureto the organization through multiple avenues of communications, including, aweb-cast, a self assessment educational quiz, and utilized mailings, intranet postings and an all managers meeting tore-emphasize our code of ethics, business conduct and anonymous hotline.

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

Tothe Board of Directors and Stockholders of Bally Technologies, Inc.

Las Vegas, Nevada

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl Over Financial Reporting, that Bally Technologies, Inc. andSubsidiaries  (the “Company”) did notmaintain effective internal control over financial reporting as of June 30,2006, because of the effect of the material weaknesses identified in management’sassessment based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”). The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internalcontrol over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financialofficers, or persons performing similar functions, and effected by the company’sboard of directors, management, and other personnel to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherentlimitations of internal control over financial reporting, including thepossibility of collusion or improper management override of controls, materialmisstatements due to error or fraud may not be prevented or detected on atimely basis. Also, projections of any evaluation of the effectiveness of theinternal control over financial reporting to future periods are subject to therisk that the controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weakness is asignificant deficiency, or combination of significant deficiencies, thatresults in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected. Thefollowing material weaknesses have been identified and included in management’sassessment:

**Ineffectivecontrols related to the financial closing process.****  **In August 2006, upon discoverythat certain transactions were improperly recorded the Company determined itwas necessary to restate its consolidated financial statements as of June 30,2005 and 2004, and for each of the three years in the period ending June 30,2005. This restatement was not completed until October 31, 2006. These closing

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procedures did not include the designed level ofdocumentation and review. Consequently, the Company used abbreviated financialclosing procedures for fiscal 2006 which are not sustainable in the Company’snormal financial reporting process as they include significant manualprocedures and look back procedures. Additionally, the Company’s designedcontrols over the preparation, review and support of journal entries did notoperate effectively. The Company alsodid not perform the designed level of analytical procedures on the financialstatements of non-corporate operations.

**Ineffectivecontrol related to fraud risk assessment.****  **The Company concluded that the overall operating effectiveness of itsfraud risk assessment did not operate as designed primarily due to delays inits financial closing process as described above.

**Inadequateand ineffective control related to revenue recognition, including gamingoperations revenue recognition and the associated existence of fixed assetmachines, system sales revenue recognition and the processing of customercredits.**   TheCompany did not have appropriate and/or effective internal controls related tothe recognition of revenue for gaming operations, including the lack ofcomprehensive controls to adequately capture and analyze the: (i) termsand conditions of all contracts to ensure the proper recording of revenue; (ii) accuracyof authorized daily fees and revenue share percentages; (iii) security andelectronic transmission to and from our network operating center(s) andits subsequent documentation and backup; and (iv) the existence of therelated fixed asset machines.

The Company did not have effective internal controlrelated to the recognition of revenue for system sales pertaining to (i) reviewof terms and conditions on contract upgrades and change orders to ensure properrecording of revenue and (ii) accuracy and authorization of billingamounts for upgrades, change orders and maintenance fees.

The Company also did not have effective internalcontrol related to the recognition of revenue pertaining to the complete andtimely recording of credit memos resulting from customer returns or allowances.

**Ineffectivecontrol related to the existence and valuation of inventory.****  **The Company identified severaldeficiencies related to the existence and valuation of inventory, including:****i) year-end adjustments to its rawmaterials balance due to ineffective periodic counting procedures, inadequatephysical safeguards and inadequate control over transaction processing; (ii) therestocking of excess inventory pulled for work orders which was not alwaysproperly identified and/or removed from the related bill of materials; (iii) costsassociated with the creation of new kits and assemblies were not effectivelycalculated and monitored resulting in incorrect valuation of inventories; and (iv) lackof adequate review and analysis of certain inventory variances between theperpetual records and the general ledger and (v) determine allowances forobsolete inventory.

These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the consolidated financial statements as of and for the year ended June 30,2006 of the Company and this report does not affect our report on suchconsolidated financial statements.

In our opinion, management’s assessment that theCompany did not maintain effective internal control over financial reporting asof June 30, 2006, is fairly stated, in all material respects, based on thecriteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Also in our opinion, because of the effect of the materialweaknesses described above on the achievement of the objectives of the controlcriteria, the Company has not maintained effective internal control overfinancial reporting as of June 30, 2006, based on the criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated financial statements as of and for the year ended June 30,2006 of the Company and our report dated March 14, 2007 expressed anunqualified opinion, and includes an 

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explanatory paragraph related to the adoption of SFAS No. 123(R),*Share-Based Payment*, on thoseconsolidated financial statements.

/s/DELOITTE & TOUCHE LLP

LasVegas, Nevada

March 14, 2007

**ITEM 9B.**       OTHERINFORMATION

Not applicable.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

**Directors,Executive Officers and Other Significant Employees**

Thename, age, and present principal occupation or employment of each of ourdirectors and executive officers as of June 30, 2006, is set forth below. Nodirector or executive officer is related by blood, marriage or adoption to anyother director or executive officer.

| **Name**           | ** ** | ** ** | ** ** | **Age** | ** ** | **Position with the Company**                                  | ** ** |
|--------------------|------------|------------|------------|---------|------------|-------------------------------------------------------------------------------|------------|
| Richard Haddrill   |       |       | 53         |    |       | Director,  President, Chief Executive Officer                                 |       |
| Jacques André |       |       | 68         |    |       | Director                                                                      |       |
| Joel Kirschbaum    |       |       | 55         |    |       | Director(1)                                                                   |       |
| Stephen Race       |       |       | 56         |    |       | Director                                                                      |       |
| David Robbins      |       |       | 46         |    |       | Director,  Chairman of the Board of Directors                                 |       |
| Kevin Verner       |       |       | 47         |    |       | Director                                                                      |       |
| Robert Caller      |       |       | 55         |    |       | Executive  Vice President, Chief Financial Officer and Treasurer(2)           |       |
| Steven Des Champs  |       |       | 40         |    |       | Senior  Vice President, Business  Analysis(3)                                 |       |
| Mark Lipparelli    |       |       | 40         |    |       | Executive  Vice President of Operations                                       |       |
| Mark Lerner        |       |       | 56         |    |       | Senior Vice President for Law and Government,  Secretary and  General Counsel |       |
| Robert Luciano     |       |       | 48         |    |       | Chief  Technology Officer                                                     |       |
| Robert Saxton      |       |       | 52         |    |       | Executive  Vice President, Gaming, and Treasurer(4)                           |       |
| Ramesh Srinivasan  |       |       | 46         |    |       | Executive Vice  President, Bally Systems Division                             |       |

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(1)          Mr. Kirschbaumpassed away on August 16, 2006.

(2)          Mr. Caller joinedthe Company on April 1, 2006.

(3)          Mr. Des Champsresigned as Chief Financial Officer of the Company on April 1, 2006, totake the position of Senior Vice President, Business Analysis. On January 31,2007, Mr. Des Champs left the Company.

(4)          Mr. Saxtonretired on July 12, 2006, as more fully described below in Item 11,Executive Compensation—Employment and Severance Agreements.

**Biographies**

***Richard Haddrill.******  ***Mr. Haddrill became a directorin April 2003 and, effective October 1, 2004, was appointed ChiefExecutive Officer. Prior to becoming our CEO, Mr. Haddrill most recentlyserved as CEO and member of the board of directors of Manhattan Associates, Inc.,a global leader in software solutions to the supply chain industry. Hecontinued to serve as vice Chairman of the Board until May 2006. Mr. Haddrillalso served as President and CEO for Powerhouse Technologies, Inc., atechnology and gaming company, from September 1996 to June 1999, whenPowerhouse was acquired by Anchor Gaming. Mr. Haddrill currently serves onthe board of directors of TrueDemand Software, Inc. Mr. Haddrill  previously served on the boards of directorsof Danka Business Products, a digital imaging systems products provider andservices producer from June 2002 to October 2004, and Outlooksoft, aprovider of corporate performance management solutions from May 2003 to June 2005.

***Robert C. Caller.******  ***Mr. Caller joined us asExecutive Vice President, Chief Financial Officer and Treasurer in April 2006.From 1983 to 2006, he was a partner at Ernst & Young (“E&Y”), mostrecently working in the Denver office, where he served several publicly heldcompanies as well as several companies involved in the gaming industry. Hestarted his career with E&Y in the Houston office in 1972, and was the 

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managing partner of E&Y’s Albuquerque office from1990 to 1991 before transferring to the Denver office.

***David Robbins.******  ***Mr. Robbinsrejoined us as a director and Chairman of the Board in December 1997. Mr. Robbinspreviously served as a director from July 1994 to September 1997 andas the Chairman of the Board from February 1997 to September 1997. From1984 to 2004, he practiced corporate, securities and real estate law at variouslaw firms, as an associate, partner and of counsel. Mr. Robbins was alsolicensed as a certified public accountant (inactive status) in the state of NewYork. In addition, Mr. Robbins served as an assistant adjunct professor oflaw at the Benjamin N. Cardozo Law School where he taught courses in corporatefinance, securities and real estate. Since January 1996, Mr. Robbinshas managed funds for private investors, including private investmentpartnerships that invest in public securities, real estate and healthcare.

***Jacques André.******  ***Mr. André became a director in August 1996.Mr. André previously served as a Vice President of A.T. KearneyExecutive Search, a global management consulting firm, from October 2002to February 2005. From 1975 to 2002, Mr. André was a partner and amember of the board of directors with Ray & Berndtson, Inc. aninternational executive search firm. From 1997 to 2003, Mr. André served as a member of the board of directors ofthe Association of Executive Search Consultants.

***Joel Kirschbaum.******  ***Mr. Kirschbaumbecame a director in July 1994 and served as the Chairman of the Boardfrom July 1994 to March 1995. Mr. Kirschbaum was the solestockholder, director and officer of Kirkland Investment Corporation, which isthe sole general partner of Kirkland-Ft. Worth Investment Partners, L.P., aninvestment partnership. Previously, he worked at Goldman, Sachs & Co.for thirteen years, the last six of which he was a General Partner. Mr. Kirschbaumpassed away in August 2006.

***Stephen Race.****  *Mr. Race became a director in June 2005.From 1999 to 2004, Mr. Race worked with a variety of private equity groupsanalyzing leveraged buyout opportunities in consumer branded goods andservices, and with venture capital groups on financial restructuring ofselected portfolio companies, often serving as acting CEO. From 1995 to 1998, Mr. Raceserved as CEO of Microprose, Inc., a NASDAQ video game company. From 1993to 1995, Mr. Race served as President of the division of SONY ComputerEntertainment responsible for development and launch of the PlayStation videogame. In 1990, Mr. Race served as General Manager of Reebok at the time ofintroduction and launch of the “PUMP” athletic footwear technology. Mr. Racealso previously served as Chairman and CEO of Homestar International, ExecutiveVice President and one of the founders of Worlds of Wonder, Inc., and asVice President of Marketing and Communications, International Division, ofAtari, Inc.

***Kevin Verner.******  ***Mr. Vernerbecame a director in April 2001. From 1997 to 2000, Mr. Verner heldvarious positions with WMS Industries, Inc. and WMS Gaming, the last ofwhich was Chief Operating Officer. Prior to his employment at WMS, Mr. Vernerwas Vice President of New Business Development at R.J. Reynolds Tobacco Co.,where he held various marketing and senior management positions for sixteenyears. Mr. Verner is currently a consultant and provides interimmanagement to early-stage companies, including, financial planning, securingseed funding, management recruitment and development of operating budgets, andpro forma financial projections. Mr. Verner is also a CEO advisor for theChicago-based venture fund Alpha Capital Fund III, and provides consultation onenterprise valuation and due diligence for consumer products investments.

***Steven Des Champs.******  ***Mr. DesChamps assumed the role of our Senior Vice President of Business Analysis in April 2006.From October 1995 to November 1998, Mr. Des Champs served as ourDirector of Finance. In February 2000, Mr. Des Champs rejoined theCompany as Vice President of Finance. He thereafter was promoted in August 2000to Chief Accounting Officer, in October 2002 he became Senior VicePresident, and in March 2005, he became the Chief Financial Officer. From December 1998to January 2000, Mr. Des Champs was the Chief Financial Officer forPDS Financial, a provider of lease financing for the gaming industry. Mr. DesChamps left the Company in January 2007.

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***Mark Lipparelli.*****  **Mr. Lipparelli assumed the roleof our Executive Vice President of Operations in March 2005. As head ofOperations, he oversaw Manufacturing, Intellectual Property, StrategicPlanning, Product Compliance, Human Resources and Information Technology.Mr. Lipparelli joined us in September 2002 as Executive VicePresident of Bally Systems. Prior to September 2002, Mr. Lipparelliserved as Executive Vice President and then President of Shuffle Master, Inc.,a gaming supply company, prior to which he was Chief Financial Officer of Camco, Inc.,a retail chain holding company. From 1998 to 2000, he was Senior Vice Presidentof Entertainment Systems of Bally Gaming and Systems. Mr. Lipparelli alsopreviously served as Vice President of Finance for Casino Data Systems andworked for the Nevada State Gaming Control Board from 1988 to 1993.

***Mark Lerner.******  ***Mr. Lernerjoined us in December 1996 as Assistant General Counsel. Mr. Lernerhas practiced law since 1980. Over the course of his career, Mr. Lernerhas served as a deputy attorney general for the Nevada Gaming Commission andState of Nevada Gaming Control Board, general counsel to Becker Gaming, Inc.,a Las Vegas gaming company, and, from 1987 to 1994, an attorney at Jones,Jones, Close & Brown (now Jones Vargas), a Las Vegas commercial andlitigation law firm.

***Robert Luciano.******  ***Mr. Lucianojoined us in March 2004 in connection with our acquisition of SDG andbecame our Chief Technology Officer on October 1, 2004. Mr. Lucianofounded SDG in 1996 as a research, development and consulting company focusingon the gaming industry. Prior to founding SDG, Mr. Luciano was employed byIGT in the position of Vice President of Advanced Engineering. Prior to joiningIGT, Mr. Luciano held several engineering positions with a variety ofcompanies including Soabar, a division of Avery International, and Mobil OilCorporation.

***Robert Saxton.*****  **Mr. Saxton was appointed ourExecutive Vice President of Gaming in March 2005. In his capacity asExecutive Vice President of Gaming, Mr. Saxton is responsible for thedaily management of Gaming Operations, Customer Service, and Domestic &International Sales in the Games Division of Bally Gaming, Inc. Mr. Saxtonjoined us in July 1982 as Corporate Controller. Mr. Saxton became aVice President of our subsidiary, United Coin in 1987, was elected VicePresident - Casino Operations of Bally Gaming in December 1993 and SeniorVice President - Casino Group in June 1996. In March 2000, Mr. Saxtonwas appointed Chief Financial Officer and Treasurer. Mr. Saxton alsoserved as President of the Rainbow Casino. Mr. Saxton retired in July 2006and currently serves as a consultant to us.

***Ramesh Srinivasan.******  ***Mr. Srinivasanjoined us in March 2005 as Executive Vice President of Bally Systems.Mr. Srinivasan is responsible for system sales, services and productdevelopment. From 1998 to 2005, Mr. Srinivasan served in several executivepositions, including Executive Vice President, for Manhattan Associates, Inc.

**Audit Committee ofthe Board of Directors**

As of June 30, 2006,the Audit Committee of the Board of Directors was comprised of Messrs. JacquesAndré, Stephen Race, David Robbins and Kevin Verner. The Board of Directors hasdetermined that Mr. Robbins is an audit committee financial expert, asdefined in Item 401(h) of Regulation S-K, as in effect as of June 30,2006. The Board of Directors made this determination based on Mr. Robbins’qualifications and business experience, as briefly described above under “—Biographies.”

**Code of Ethics**

We have a Code of Ethicsand Business Conduct applicable to our chief executive, chief financial andprincipal accounting officers, as well as our directors (the “Code of Ethics”).In the event we make any amendment to, or grant any waiver from, a provision ofthe Code of Ethics that applies to our principal executive officer, principalfinancial officer or principal accounting officer that requires disclosureunder applicable SEC rules, we intend to disclose such amendment or waiver andthe reasons therefor on our website www.ballytech.com. The full text of theCode of Ethics is available by following links to “Investor 

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Relations” and “CorporateGovernance” on our website www.ballytech.com, or upon written request to us. Requestsshould be addressed to: Bally Technologies, Inc., 6601 South Bermuda Road, Las Vegas, Nevada 89119, Attention:Corporate Secretary.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) ofthe Exchange Act requires our directors and executive officers and persons whoown more than 10 percent of a registered class of our equity securities to filewith the SEC and the NYSE initial reports of ownership and reports of changesin ownership of our common stock and other of our equity securities. To ourknowledge, all Section 16(a) filing requirements applicable to theour directors, executive officers and greater than 10 percent beneficial ownerswere complied with on a timely basis during the fiscal year ended June 30,2006, except that:

·       aForm 3 was filed on November 27, 2006, on behalf of Mr. WilliamCurtiss Follmer, a Senior Vice President of Bally Gaming and General Manager ofRainbow Casino, reporting Mr. Follmer’s ownership of 5,240 shares ofcommon stock and options to purchase 110,000 shares of common stock; and

·       aForm 4 was filed on November 28, 2006, on behalf of Mark Lipparelli,an Executive Vice President, reporting Mr. Lipparelli’s receipt of (i) 1,442shares of restricted stock granted on September 12, 2006, and (ii) 35,000stock options granted on July 28, 2005.

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**ITEM 11.**         EXECUTIVECOMPENSATION

**Report on ExecutiveCompensation**

As of the end ofthe fiscal year ended June 30, 2006, the Compensation Committee consistedof Messrs. Jacques André, David Robbins and Kevin Verner, each of whom isan independent director. The Compensation Committee’s duties andresponsibilities are set forth in a formal charter adopted by the Board ofDirectors and include, among others things:

·       Reviewingand approving executive compensation philosophy.

·       Approvingall executive compensation plans and structures.

·       Approvingannual and long-term incentive performance metrics, as well as determine andapprove payouts.

·       Approvingcompensation for the Company’s management executive committee, consisting ofcertain members of senior management, as well as senior management of theCompany’s subsidiaries.

·       Approvingplan payouts to the members of the management executive committee that areoutside of approved parameters.

·       Recommendingapproval for all management incentive plans, including stock options, to theBoard of Directors, and approve new change-in-control or special retentionplans.

·       Approvingbonus criteria, incentives, including stock options and payouts foremployee-directors.

***GeneralCompensation Philosophy.***   The Compensation Committee’s general philosophy has been,and continues to be, providing a compensation package to attract and retain themost highly qualified executive officers while providing incentives to createstockholder value. To accomplish this objective, the Compensation Committeevaries total cash compensation based on the Company’s performance in achievingthe financial and non-financial objectives, and aligns long-term incentivecompensation closely with the stockholders’ interests. However, theCompensation Committee believes that it will continue to be constrained bycompetitive factors as there continues to be demand from competing businessesto attract and retain management talent of the type the Company desires torecruit.

The Compensation Committee believes as a generalmatter, but particularly with respect to senior executive officers, that themost effective method of compensation, and the method that most closely alignsmanagement’s interest with those of the Company’s stockholders, is long-termcompensation tied to the creation of stockholder value. Thus, it has been theCompany’s policy where feasible and consistent with competitive marketconditions, and unless otherwise obligated by contract, to attempt to limitbase cash compensation while providing incentives for management to increasestockholder value. The Company hopes to achieve this goal of focusing onlong-term compensation through the use of stock options and, where appropriate,restricted stock and restricted stock units. The Compensation Committee believesthis compensation philosophy has the greatest probability of achievingsignificant returns to stockholders.

Pearl Meyer & Partners, a Clark ConsultingPractice, has also been retained to advise the Compensation Committee onmatters relating to executive compensation. Pearl Meyer & Partners wasengaged by and reports directly to the Compensation Committee.

***Base Salaries.***   Basesalary levels are the fixed portion of an executive’s compensation package. TheCompensation Committee annually reviews and determines the base salaries ofmembers of senior management, except as limited by pre-existing contractualobligation. Where adjustable, salary levels reflect a combination of factors,including competitive pay levels, the executive’s experience and tenure, andthe Company’s overall annual budget for merit increases and the executive’sindividual performance. 

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In each case, the Compensation Committee takes intoaccount the results achieved by the executive, his or her future potential,scope of responsibilities and experience, and competitive salary practices.

***Bonuses.***   Annualperformance bonuses are tied to the Company’s overall performance, as well asthe performance of each executive and of his or her area of responsibility. TheCompensation Committee sets certain financial and operational objectives thatare designed to promote key Company initiatives, such as achievement ofspecific strategic, operational or financial tasks or targets, includingBusiness Unit performance, operating income and EPS, which the Board ofDirectors believes will result in increases in stockholder value. As a resultof the Company’s performance on many of these metrics during fiscal 2006 theCompany did not pay any cash bonuses for the fiscal year ended June 30,2006, other than as contractually obligated with respect to two executiveofficers. However, at the recommendation of the Company’s Chief ExecutiveOfficer and as approved by the compensation committee, reduced bonuses werepaid to certain individuals in the form of restricted stock that vests over aone-year period.

***Long-Term Compensation.***   Long-termcompensation is provided by stock options and, from time to time, whenappropriate, restricted stock or restricted stock units. The CompensationCommittee believes that long-term compensation tied to stockholder value shouldconstitute a significant portion of an executive’s compensation as options areintended to provide long-term compensation specifically tied to increases inthe price of the Company’s common stock. Options are granted at the marketprice of the Company’s common stock on the date of grant, and providecompensation only to the extent the market price of the common stock increasesbetween the date of grant and the date the option is exercised. Restrictedstock and restricted stock units also tie compensation to the long term appreciationof the Company’s common stock by restricting the holders’ ability to receiveand/or dispose of the related shares of common stock.

The total number of options granted in each year,which may vary, is tied to a number of factors including, but not limited to,overall Company performance, individual performance of the executive, andcompetitive and retention considerations.

The Compensation Committee continues to review itsoverall long-term incentive structure in light of the shifting competitive andregulatory environment. The Compensation Committee, with input from seniormanagement and outside consultants, may decide to make changes to the long-termcompensation program in the future.

***401(k) Plan.***   TheCompany offers a 401(k) plan. Employees are eligible to participate aftercompletion of six months of service. Employees may defer from 1% to 25% ofeligible earnings up to the IRS maximum of $15,000 for 2006. Participatingemployees who have attained age 50 are allowed to contribute an extra $5,000 inthe 401(k) plan as “catch-up” contributions. Employee contributions are100% vested. Participants hired before November 1, 2001, are 100% vestedin both employee and employer contributions. For participants hired on or afterNovember 1, 2001, employer-matching contributions become vested based on afive-year vesting schedule, to vest 20% per year, for each year of service. TheCompany, on a discretionary basis, may make matching contributions at the endof each quarter. Matching contributions may be made each pay period in lieu ofeach quarter. The current match is 50% of the participant’s contribution up to6% of employee compensation. BallyTechnologies, Inc. may make a discretionary Profit Sharing contribution tothe 401(k) plan each year.

***Chief ExecutiveOfficer Compensation.***   On June 30, 2004,Mr. Haddrill and the Company entered into an Employment Agreement pursuantto which Mr. Haddrill began serving as the Company’s Chief ExecutiveOfficer as of October 1, 2004. The Employment Agreement was amended on June 20,2006  pursuant to which (i) Mr. Haddrill’sterm of employment was extended from October 1, 2007, to January 1,2009, (ii) Mr. Haddrill’s salary, beginning July 1, 2006,increased from $980,000 to $998,000, (iii) Mr. Haddrill received anadditional week of vacation time, and (iv) subject to the approval of theCompensation Committee, Mr. Haddrill received a non-statutory stock optionto purchase 200,000 shares of Company common stock at an exercise price pershare equal to the fair market value of a share of Company common 

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stock on the date of grant, as well as a number ofrestricted shares of Company common stock having a value equal to$1.4 million as of the date of grant.

Mr. Haddrill’s contract does not provide for anannual cash bonus. Additionally, during fiscal 2006, under the terms of theHaddrill Agreement, Mr. Haddrill was awarded a stock option grant covering200,000 shares of common stock which vest as set forth under “—Option/SARGrants in Last Fiscal Year” and was also granted $1,400,000 in restrictedstock. The first tranche of the restricted stock (28.6%) vests on July 1,2008 with the remaining vesting on January 1, 2009.

***Deductibility of Compensation Under Internal RevenueCode Section 162(m).***   Section 162(m) ofthe Internal Revenue Code of 1986, as amended (the “Code”) places a limit of$1,000,000 on the amount of compensation that Bally may deduct in any one yearwith respect to its CEO and each of the next four most highly compensatedexecutive officers. If the Company were to seek and obtain approval fromstockholders for certain performance-based compensation, then such compensationwould not be subject to the deduction limitation.

Respectfully submitted,

COMPENSATION COMMITTEE

Kevin Verner, ChairmanJacques AndréDavid Robbins

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**SummaryCompensation Table***

Thefollowing table sets forth the compensation paid or to be paid by us to ourchief executive officer, the four other most highly compensated executiveofficers and two additional executive officers (collectively, the “Named ExecutiveOfficers”) for services rendered in all capacities to us during the fiscalyears ended June 30, 2006, 2005 and 2004.

|                                                  | ** ** | ** ** | ** ** | **Annual Compensation**           | ** ** | **Long-Term Compensation** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|----------------------------------------|------------|---------------------------------|------------|------------|------------|
| **Name & Principal Position** | ** ** | ** ** | ** ** | **Fiscal  Year  Ended  June 30,** | ** ** | **Salary**                      | ** ** | **Bonus**  | ** ** | **Restricted  Stock Awards(1)** | ** ** | **Securities  Underlying  Options(2)** | ** ** | **All  Other  Compensation(3)** | ** ** |
| Richard Haddrill                                 |       |       | 2006       |                                   |       | $                               | 980,000    |       | $          | — |   |   | $ | 1,396,296 | (4) |   |   | 200,000 |   |   |   | $ | 49,663 | (5) |   |
| President and Chief                              |       |       | 2005       |                                   |       | 701,077                         |       | —     |       |   | 2,073,718 | (6) |   |   | 430,000 |   |   |   | 342,970 | (7) |   |
| Executive Officer                                |       |       | 2004       |                                   |       | —                          |       | —     |       |   | 6,469,835 | (8) |   |   | 600,000 |   |   |   | 60,000 | (9) |   |
| Robert Saxton                                    |       |       | 2006       |                                   |       | 370,000                         |       | —     |       |   | — |   |   |   | 20,000 |   |   |   | 7,116 |   |   |
| Executive Vice                                   |       |       | 2005       |                                   |       | 370,000                         |       | —     |       |   | — |   |   |   | 50,000 |   |   |   | 9,108 |   |   |
| President, Gaming                                |       |       | 2004       |                                   |       | 357,307                         |       | 279,240    |       |   | — |   |   |   | 50,000 |   |   |   | 6,328 |   |   |
| Robert Luciano                                   |       |       | 2006       |                                   |       | 250,000                         |       | 50,000     |       |   | — |   |   |   | 600,000 |   |   |   | — |   |   |
| Chief Technology                                 |       |       | 2005       |                                   |       | 250,000                         |       | 50,000     |       |   | — |   |   |   | 600,000 |   |   |   | — |   |   |
| Officer                                          |       |       | 2004       |                                   |       | 57,692                          |       | 49,500     |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Ramesh Srinivasan                                |       |       | 2006       |                                   |       | 261,538                         |       | 50,000     |       |   | — |   |   |   | — |   |   |   | 39,281 | (10) |   |
| Executive Vice                                   |       |       | 2005       |                                   |       | 70,192                          |       | —     |       |   | 226,000 | (11) |   |   | 300,000 |   |   |   | — |   |   |
| President, Bally Systems                         |       |       | 2004       |                                   |       | —                          |       | —     |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Mark Lipparelli                                  |       |       | 2006       |                                   |       | 250,000                         |       | —     |       |   | — |   |   |   | 35,000 |   |   |   | 6,827 |   |   |
| Executive Vice                                   |       |       | 2005       |                                   |       | 250,000                         |       | —     |       |   | — |   |   |   | 105,000 |   |   |   | 9,399 |   |   |
| President, Operations                            |       |       | 2004       |                                   |       | 243,269                         |       | 212,500    |       |   | — |   |   |   | 30,000 |   |   |   | 5,202 |   |   |
| Robert Caller(12)                                |       |       | 2006       |                                   |       | 71,923                          |       | 141,837    | (13)       |   |   |   |   |   | 175,000 | (14) |   |   | 2,146 | (15) |   |
| Executive Vice                                   |       |       | 2005       |                                   |       | —                          |       | —     |       |   | — |   |   |   | — |   |   |   | — |   |   |
| President, Chief                                 |       |       | 2004       |                                   |       | —                          |       | —     |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Financial Officer and  Treasurer                 |       |       |       |                                   |       |                            |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Steven Des Champs                                |       |       | 2006       |                                   |       | 288,077                         |       | —     |       |   |   |   |   |   | 45,000 |   |   |   | 7,202 |   |   |
| Senior Vice President                            |       |       | 2005       |                                   |       | 240,000                         |       | 20,000     |       |   | — |   |   |   | 100,000 |   |   |   | 7,634 |   |   |
| of Business Analysis                             |       |       | 2004       |                                   |       | 237,308                         |       | 116,000    |       |   | — |   |   |   | 25,000 |   |   |   | 5,996 |   |   |
|                                                  |            |            |            |                                        |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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*                    As used in thetables provided under the caption “Executive Compensation,” the character “—”is used to represent zero.

(1)          Constitutes grants ofRestricted Stock and Restricted Stock Units (“RSUs”). Per the requirements ofRegulation S-K Item 402(b)(2)(iv)(A),the dollar value reflected in the table iscalculated by multiplying the closing market price of our common stock on thedate of grant by the number of shares awarded. The closing price of our commonstock on June 30, 2004, December 22, 2004, March 9, 2005, and June 20,2006, the dates of grant, were $17.16, $13.25, $11.30 and $15.07, respectively.See footnotes 4, 6, 8 and 11 below regarding the terms of the grants.

(2)          Unless otherwiseindicated, all grants made pursuant to our Amended and Restated 2001 Long TermIncentive Plan.

(3)          Unless indicatedotherwise, “All Other Compensation” represents contributions made by us to our401(k) Plan.

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(4)          On June 20, 2006,we issued Mr. Haddrill 92,654 restricted shares of common stock. Thenumber of shares granted was determined by dividing $1,400,000 by the averageper share closing price of our common stock on the NYSE for the 20 businessdays prior to the date of grant. The 92,654 shares of restricted stock had anaggregate value of $1,526,011.38 on June 30, 2006, based on the per shareclosing price of our common stock on the NYSE of $16.47. The restricted stockvests as follows:  28.6% of the shares will vest on July 1, 2008 andthe remainder will vest on January 1, 2009, in each case subject to Mr. Haddrill’scontinuous employment as our Chief Executive Officer through each such date. IfMr. Haddrill’s employment is terminated by us other than for cause or by Mr. Haddrillfor Good Reason, as defined in the Haddrill Agreement (defined below), thevesting of the restricted stock shall be pro-rated through the 12-monthperiod following the month in which the date of termination occurs. In theevent of a Change of Control, as defined in the Haddrill Agreement, therestricted stock shall become fully vested effective immediately prior to suchChange of Control. Except as set forth above, any unvested portion of therestricted stock at the time of termination shall terminate as of the date oftermination. No dividends will be paid on the restricted stock unless and untilsuch shares vest, and thereafter, only to the extent dividends are paid on the Company’scommon stock.

(5)          Amount represents$41,316 paid in moving and relocation expenses and $8,346 in contributions madeby us to our 401(k) Plan.

(6)          On December 22,2004, we issued Mr. Haddrill 156,507 RSUs. The number of RSUs granted wasdetermined by dividing $1,900,000 by the average per share closing price of ourcommon stock on the NYSE for the 20 business days prior to the date of grant. The156,507 RSUs had an aggregate value of $2,577,670 on June 30, 2006, basedon the per share closing price of our common stock on the NYSE of $16.47. Inaccordance with the Haddrill Agreement, the vesting of 50% of the award wasaccelerated to October 1, 2005, as a result of the Board of Director’sdetermination that we achieved certain strategic and/or financial objectivesfor the nine month period ending on October 1, 2005 (see “—Chief ExecutiveOfficer Compensation” above). The vesting of the remaining 50% was acceleratedon October 1, 2006. Vested RSUs represents Mr. Haddrill’s right toreceive an equivalent number of shares of our common stock as follows:  (i) 75% of the shares of common stockrepresented by the vested RSUs shall be issued to Mr. Haddrill (1) onthe later of (a) October 1, 2007 or (b) the first date on whichsuch payment or any portion thereof is no longer subject to the limits of Section 162(m) ofthe Internal Revenue Code (the “Code”) in which case that portion of thepayment that is no longer subject to such limits shall be issued to Mr. Haddrillat the time such limits become inapplicable, or (2) in the event that Mr. Haddrill’semployment with the Company is terminated prior to October 1, 2007, on thefirst date in which such payment or any portion thereof is no longer subject tothe limits of Section 162(m) of the Code in which case that portionof the payment that is no longer subject to such limits shall be issued to Mr. Haddrillat the time such limits become inapplicable, and (ii) 25% of the shares ofcommon stock represented by the vested RSUs shall be issued to Mr. Haddrill(1) on the later of (a) October 1, 2008 or (b) the firstdate on which such payment or any portion thereof is no longer subject to thelimits of Section 162(m) of the Code in which case that portion ofthe payment that is no longer subject to such limits shall be issued to Mr. Haddrillat the time such limits become inapplicable, or (2) in the event that Mr. Haddrill’semployment is terminated prior to October 1, 2008, on the first date inwhich such payment or any portion thereof is no longer subject to the limits ofSection 162(m) of the Code in which case that portion of the paymentthat is no longer subject to such limits shall be issued to Mr. Haddrillat the time such limits become inapplicable.  No dividends will be paid on the RSUs unlessand until the underlying shares of common stock have been issued in Mr. Haddrill’sname as described above, and thereafter, only to the extent dividends are paidon theCompany’s common stock. Except as described below under “—Employment andSeverance Arrangements—Haddrill Agreement,” all unvested RSUs shall beimmediately forfeited if Mr. Haddrill ceases to serve as the Company’sChief Executive Officer.

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(7)          Amount represents$337,136 paid in moving and relocation expenses and $5,834 in contributionsmade by us to our 401(k) Plan.

(8)          On June 30, 2004,we issued Mr. Haddrill 377,030 RSUs. The number of RSUs granted wasdetermined by dividing $6,500,000 by the average per share closing price of ourcommon stock on the NYSE for the 20 business days prior to the date of grant. The377,030 RSUs had an aggregate value of $6,209,684 on June 30, 2006, basedon the per share closing price of our common stock on the NYSE of $16.47  The RSUs vest in one-third equal installmentson each of October 1, 2005, October 1, 2006 and October 1, 2007provided that Mr. Haddrill is continuously employed as our Chief ExecutiveOfficer until each such vesting date, except as otherwise provided in theHaddrill Agreement, as described below under “—Employment and SeveranceArrangements—Haddrill Employment Agreement.” Vested RSUs represents Mr. Haddrill’s right to receive anequivalent number of shares of our common stock as follows:  (i) 75% of the shares represented by thevested RSUs shall be issued to Mr. Haddrill (1) on the later of (a) October 1,2007 or (b) the first date on which such payment or any portion thereof isno longer subject to the limits of section 162(m) of the Code in which casethat portion of the payment that is no longer subject to such limits shall beissued to Mr. Haddrill at the time such limits become inapplicable, or (2) inthe event that the Haddrill Agreement is terminated, on the first date in whichsuch payment or any portion thereof is no longer subject to the limits of Section 162(m) ofthe Code in which case that portion of the payment that is no longer subject tosuch limits shall be issued to Mr. Haddrill at the time such limits becomeinapplicable, and (ii) 25% of the shares represented by the vested RSUsshall be issued to Mr. Haddrill (1) on the later of (a) October 1,2008 or (b) the first date on which such payment or any portion thereof isno longer subject to the limits of section 162(m) of the Code in whichcase that portion of the payment that is no longer subject to such limits shallbe issued to Mr. Haddrill at the time such limits become inapplicable, or (2) inthe event that the Haddrill Agreement is terminated, on the first date in whichsuch payment or any portion thereof is no longer subject to the limits of Section 162(m) ofthe Code in which case that portion of the payment that is no longer subject tosuch limits shall be issued to Mr. Haddrill at the time such limits becomeinapplicable. No dividends will be paid on the RSUs unless and until theunderlying shares of common stock have been issued in Mr. Haddrill’s name,and thereafter, only to the extent dividends are paid on the Company’s commonstock. Except as described below under “—Employment and Severance Arrangements—HaddrillEmployment Agreement,” all unvested RSUs shall be immediately forfeited if Mr. Haddrillceases to serve as our Chief Executive Officer.

(9)          Mr. Haddrillreceived compensation as a board member totaling $60,000 for the fiscal yearended June 30, 2004.

(10)   Amount paid for moving andrelocation expenses.

(11)   On March 5, 2005, we issued Mr. Srinivasan 20,000 restrictedshares of common stock. The 20,000 shares of restricted stock had anaggregate value of $329,400 on June 30, 2006, based on the per shareclosing price of our common stock on the NYSE of $16.47. Fifty percent of theshares of restricted stock vested on the date of grant and the remainder vestson September 2, 2008. No dividends will be paid on the shares of restrictedstock unless and until such shares vest, and thereafter, only to the extentdividends are paid on the Company’s common stock.

(12)   Mr. Caller joined theCompany on April 1, 2006.

(13)   Amount includes $100,000signing bonus, pursuant to Mr. Caller’s employment agreement and 2,461shares of restricted common stock, which had an aggregate value of $41,837 on September 12,2006, the grant date. The 2,461 shares of restricted stock had an aggregatevalue of $40,532.67 on June 30, 2006, based on the per share closing priceof our common stock on the NYSE of $16.47. The shares of restricted stockvested on the grant date. Dividends are payable on the shares of restrictedstock to the 

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extent dividends are paidon the Company’s common stock. Mr. Caller opted to receive restrictedstock in lieu of a guaranteed cash bonus under the Caller Agreement.

(14)   Options granted to Robert C.Caller, the Company’s Chief Financial Officer, pursuant to his employmentagreement dated March 7, 2006, as an inducement to accept employment withthe Company.

(15)   Amountspaid for moving and relocation expenses.

**Employment andSeverance Arrangements**

***Haddrill EmploymentAgreement.******  ***On June 30, 2004, we entered intoan Employment Agreement with Mr. Haddrill (the “Haddrill EmploymentAgreement”), pursuant to which Mr. Haddrill began serving as ChiefExecutive Officer as of October 1, 2004. The Haddrill Agreement providesthat if Mr. Haddrill’s employment is terminated by us without cause or by Mr. Haddrillfor good cause, each as defined in the Haddrill Agreement, Mr. Haddrillwill receive severance pay in an amount equal to his base salary for one yearfrom the date of termination or until the expiration of the term of theHaddrill Agreement, whichever occurs first. Further, Mr. Haddrill shall beentitled to retain the rights granted under the RSUs described in footnote 8above, provided that the vesting of the RSUs shall be pro rated through thetwelve-month period following the month in which the termination occurs, andthe sales restrictions on the stock options granted pursuant to the HaddrillAgreement shall lapse as to a pro rata portion of such options through the dateof termination. Upon a Change in Control, as defined in the Haddrill Agreement,Mr. Haddrill will receive a payment of $980,000 and will be entitled toretain all of the RSUs and stock options granted pursuant to the HaddrillAgreement, all of which will vest immediately upon the Change in Control, andthe sale restrictions on the stock options will immediately lapse. The HaddrillAgreement also contains certain non-compete provisions.

The Haddrill Agreement was amended as of December 22,2004. The December 22, 2004 amendment provided for, among other things, agrant of an additional 300,000 stock options and $1,900,000 in RSUs.

The Haddrill Agreement, as amended, was amended for asecond time, effective as of June 13, 2005 documenting the terms andconditions of the acceleration of certain of Mr. Haddrill’s stock options,which was approved by the Board of Directors on June 13, 2005, andclarifying the terms of Mr. Haddrill’s RSUs to comply with Section 409Aof the Code.

On June 21, 2006, we amended the Haddrill Agreementfor a third time, pursuant to which (i) Mr. Haddrill’s term ofemployment was extended from October 1, 2007, to January 1, 2009, (ii) Mr. Haddrill’ssalary, beginning July 1, 2006, was increased from $980,000 to $998,000, (iii) Mr. Haddrillwill receive an additional week of vacation time, and (iv) subject to theapproval of the Compensation Committee, Mr. Haddrill received options topurchase 200,000 shares of common stock, as well as a number of shares ofrestricted common stock having a value equal to $1,400,000 as of the dateof grant. The number of shares of restricted common stock was calculated basedon the average per share closing price of a share of restricted common stockfor the 20 business days immediately prior to the date of grant.

***Caller EmploymentAgreement.******  ***On March 13,2006, we entered into a letter agreement with Robert Caller, effective as of April 1,2006 (the “Caller Agreement”). Pursuant to the Caller Agreement, Mr. Callerreceives an annual salary of $340,000. Mr. Caller will also be entitled toparticipate in our Management Incentive Program, with a target performancebonus of $204,000 per year, but with a maximum of $347,000 per year. For ourfiscal year ending June 30, 2007 only, Mr. Caller will receive aminimum performance bonus of $160,000. For the period from July 1, 2009,to September 30, 2009, we will pay him a minimum bonus of $51,000. Startingin the fiscal year ending June 30, 2007, we may pay up to 30% of theamount of any performance bonus earned in shares of restricted stock.

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If Mr. Caller’s employment is terminated withoutcause, as defined in the Caller Agreement, or if Mr. Caller terminates hisemployment as a result of a diminution of duties occurring within one yearfollowing a change of control, each as defined in the Caller Agreement, heshall continue to receive his salary for one year immediately following suchtermination, unless such termination occurs on or after September 30,2008, in which case we will only make such payments until September 30,2009.

Pursuant to the Caller Agreement, and as a materialinducement to accept his employment, Mr. Caller received 175,000 options,which grant was approved by the Board of Directors.

In the event Mr. Caller terminates his employmentas a result of a diminution of duties occurring within one year following achange of control, each installment of his options granted pursuant to theCaller Agreement that has not vested as of such date will be deemed to havevested on the date of such termination and shall be exercisable for one yearfrom such date. If Mr. Caller’s employment is terminated without cause,any installment that would have vested within one year of the date oftermination will vest and, along with any other previously vested options,shall be exercisable for one year thereafter. If Mr. Caller’s employmentis terminated with cause or if he quits for any reason, he will have 90 days toexercise any options that have vested as of the date of such termination.

Mr. Caller received a one time signing bonuspayment of $100,000, subject to certain relocation conditions, as well asreimbursement for expenses incurred in connection with trips related to hisrelocation to Las Vegas.

***Saxton Separationand Consulting Agreement.******  ***OnJune 14, 2006, we entered into a Separation and Consulting Agreement withRobert Saxton in connection with his retirement. Pursuant to this agreement,Mr. Saxton resigned as Executive Vice President of Bally and President ofRainbow Casino, effective on July 12, 2006, and will receive $400,000 forconsulting services, payable in monthly installments of $8,333.33 for a periodof four years.

***Des ChampsEmployment Agreement.***   On January 28,2000, we entered into a letter agreement with Mr. Des Champs whichprovides for a base salary, which was set at $290,000 per year, participationin our compensation programs for corporate officers, participation in our cashbonus program at amounts determined by the Board of Directors and severancebenefits of six months’ base salary if Mr. Des Champs is terminatedwithout cause, including as a result of or subsequent to a change in control.On April 1, 2006, Mr. Des Champs resigned as Chief Financial Officerand assumed the position of Senior Vice President of Business Analysis. OnJanuary 31, 2007, Mr. Des Champs’ employment with the Company ended.

***Luciano EmploymentAgreement.***   On March 2, 2004, we enteredinto a letter agreement with Robert Luciano (the “Luciano Agreement”) whichprovides for a base salary, which is currently set at $250,000 per year, anannual bonus of $50,000 and participation in our Management Incentive Programat the business unit head level in an amount determined by the Board ofDirectors. If Mr. Luciano is terminated without cause, as defined in theLuciano Agreement, he will receive severance benefits in an amount determinedby annualizing the amount Mr. Luciano would have received in respect ofthe number of full months served in the fiscal year in which he is terminated.

On April 13, 2005, we entered into an amendmentto Mr. Luciano’s letter agreement providing for, among other things, thegrant of 600,000 stock options, effective on July 1, 2005. The amendmentalso provides that if Mr. Luciano is terminated without cause, any stockoptions granted to Mr. Luciano that have vested at the time of terminationshall remain outstanding and exercisable until the first anniversary of thedate of termination, but in no event beyond the original term of such options.

***Srinivasan Employment Agreement.******  ***OnMarch 9, 2005 we entered into an employment agreement withMr. Srinivasan which provides for a base salary, which is currently set at$275,000 per year, an annual bonus of up to 100% of Mr. Srinivasan’ssalary, but in no case less than $50,000, and participation in our ManagementIncentive Program at the business unit head level, a grant of 300,000 optionsand a grant of 

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20,000 shares ofrestricted stock. If Mr. Srinivasan’s employment is terminated withoutcause or resigns following a change of control or material diminution ofduties, each as defined in Mr. Srinivasan’s agreement, Mr. Srinivasanwill receive an amount equal to his base salary for twelve months after thedate of termination, offset by any compensation he receives that is attributableto other employment during the six-month period that begins six months afterthe date of termination. In addition, upon the occurrence of a change ofcontrol, Mr. Srinivasan shall be entitled to receive any additional (otherthan those described above) acceleration in benefits, financial packages, stockoptions and restricted stock, and compensation accorded to our other seniorexecutives, except for those that may be accorded to our chief executiveofficer and chief financial officer.

**Option/SAR Grantsin Last Fiscal Year**

Thefollowing table relates to options granted to the Named Executive Officersduring the fiscal year ended June 30, 2006. 

|                    | ** ** | **Individual Grants** | ** ** | **Potential Realizable  Value at Assumed  Annual Rates of Stock  Price Appreciation for  Option Term(a)** | ** ** |
|--------------------|------------|----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Name**           | ** ** | ** **                 | ** ** | **Number of  Securities  Underlying  Options /SARS  Granted**                                                                                | ** ** | **% of Total  Options/SARS Granted  to Employees  in Fiscal Year** | ** ** | **Exercise  Price** | ** ** | **Expiration  Date** | ** ** | **5%** | ** ** | **10%** | ** ** |
| Richard Haddrill   |       |                       | 200,000    | (b)                                                                                                                                                    |       |   | 9.82 | % |   |   | $ | 15.07 |   |   |   | 6/21/2016 |   |   | $ | 1,895,488 |   | $ | 4,803,540 |   |
| Robert Saxton      |       |                       | 20,000     | (c)                                                                                                                                                    |       |   | 0.98 | % |   |   | 15.31 |   |   |   | 7/29/2015 |   |   | 192,568 |   | 488,004 |   |
| Robert Luciano     |       |                       | 600,000    | (d)                                                                                                                                                    |       |   | 29.45 | % |   |   | 14.27 |   |   |   | 7/1/2015 |   |   | 5,384,596 |   | 13,645,623 |   |
| Ramesh Srinivasan  |       |                       | —     |                                                                                                                                                   |       |   | — |   |   |   | — |   |   |   | — |   |   | — |   | — |   |
| Mark Lipparelli    |       |                       | 35,000     | (e)                                                                                                                                                    |       |   | 1.72 | % |   |   | 15.31 |   |   |   | 7/29/2015 |   |   | 336,993 |   | 854,007 |   |
| Robert Caller      |       |                       | 175,000    | (f)                                                                                                                                                    |       |   | 8.59 | % |   |   | 16.99 |   |   |   | 4/3/2016 |   |   | 1,869,861 |   | 4,738,595 |   |
| Stephen Des Champs |       |                       | 35,000     | (g)                                                                                                                                                    |       |   | 1.72 | % |   |   | 15.31 |   |   |   | 7/29/2015 |   |   | 336,993 |   | 854,007 |   |
|                    |       |                       | 10,000     | (h)                                                                                                                                                    |       |   | 0.49 | % |   |   | 15.21 |   |   |   | 1/31/2016 |   |   | 95,655 |   | 242,408 |   |
|                    |            |                            |            |                                                                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(a)           Amounts shown in thesecolumns are derived by multiplying the exercise price by the annualappreciation rates shown (compounded for the term of the options), multiplyingthis product by the number of shares of common stock covered by the options,and subtracting the aggregate exercise price of the options. The dollar amountsset forth under this heading are the result of calculations at the 5 percentand 10 percent rates set by the SEC, and are not intended to forecast possiblefuture appreciation, if any, of the price of a share of common stock.

(b)          Options vest asfollows:  (i) 66,667 shares willvest on February 28, 2008, (ii) 66,667 shares will vest on July 31,2008, and (iii) the final 66,666 shares will vest on January 1, 2009,in each case subject to Mr. Haddrill’s continuous employment as our ChiefExecutive Officer through each such date except as otherwise provided in Mr. Haddrill’semployment agreement, as described above under “—Employment and SeveranceArrangements—Haddrill Employment Agreement”.

(c)           Options vest asfollows: (i) 10,000 shares will vest on July 29, 2006 and (ii) 10,000shares will vest on July 29, 2007. As a result of Mr. Saxton’sretirement on July 12, 2006, all 20,000 options were forfeited.

(d)          Options vest asfollows:  (i) 120,000 shares vestedon July 1, 2006, (ii) 120,000 shares will vest on July 1, 2007, (iii) 120,000shares will vest on July 1, 2008, (iv) 120,000 shares will vest on July 1,2009 and (v) the final 120,000 shares will vest on April 13, 2010.

(e)           Options vest asfollows:  (i) 11,667 vested on July 29,2006, (ii) 11,666 shares will vest on July 29, 2007 and (iii) 11,667will vest on July 29, 2008.

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(f)             Options vest asfollows:  (i) 20,000 shares vestedon June 30, 2006, (ii) 50,000 shares will vest on June 30, 2007,(iii) 50,000 will vest on June 30, 2008 and (iv) 55,000 willvest on September 9, 2009.

(g)           Options vest asfollows:  (i) 11,667 shares willvest on July 29, 2006, (ii) 11,667 shares will vest on July 29,2007 and (iii) 11,666 on July 29, 2008. As a result of Mr. DesChamps’ departure from the Company on January 31, 2007, only 11,667 optionsvested and 23,333 options were forfeited.

(h)          Optionsvest in their entirety on January 1, 2009. As a result of Mr. DesChamps’ departure from the Company on January 31, 2007, all 10,000 optionswere forfeited.

**AggregatedOption/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values**

Thefollowing table reflects the options exercised during the fiscal year ended asof, and outstanding options held by the Named Executive Officers at, June 30,2006:

| ** **        | ** ** | ** ** | ** ** | ** **                             | ** ** | **Number of securities  underlying unexercised  options at June 30, 2006** | ** ** | **Value of  in-the-money options  at June 30, 2006(1)** | ** ** |
|-------------------|------------|------------|------------|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **Name**          | ** ** | ** ** | ** ** | **Shares  Acquired on  Exercise** | ** ** | **Value  Realized**                                                                                           | ** ** | **Exercisable**                                                                  | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Richard Haddrill  |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 879,997 |   |   |   | 400,003 |   |   |   | $ | 417,491 |   |   |   | $ | 904,009 |   |   |
| Robert Saxton     |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 170,000 |   |   |   | 73,335 |   |   |   | 237,767 |   |   |   | 213,804 |   |   |
| Robert Luciano    |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 120,000 |   |   |   | 1,080,000 |   |   |   | 637,200 |   |   |   | 3,868,800 |   |   |
| Ramesh Srinivasan |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 125,000 |   |   |   | 175,000 |   |   |   | 646,250 |   |   |   | 904,750 |   |   |
| Mark Lipparelli   |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 116,749 |   |   |   | 111,251 |   |   |   | 272,980 |   |   |   | 391,490 |   |   |
| Robert Caller     |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 20,000 |   |   |   | 155,000 |   |   |   | — |   |   |   | — |   |   |
| Steven Des Champs |       |       | —     |                                   |       |                                                                                                          | —     |                                                                             |       |   | 74,586 |   |   |   | 117,917 |   |   |   | 141,717 |   |   |   | 395,388 |   |   |
|                   |            |            |            |                                        |            |                                                                                                               |            |                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Representsthe amount by which the market value of the underlying stock at June 30,2006 ($16.47 per share) exceeds the aggregate exercise price of the options.

**Directors’Compensation**

***Arrangements withDirectors.******  ***Our directors who are also employeesgenerally are not separately compensated for their services as directors. Exceptas set forth below under “—Other Arrangements” with respect to Messrs. Robbinsand Kirschbaum, and excluding Mr. DiCesare, each non-management directorreceives $50,000 per year plus $5,000 per year for each committee on which eachnon-management director serves, except that the chairman of each committeereceives $10,000 for such committee service. Each new non-employee directoralso receives a grant of options to purchase 50,000 shares of common stock uponappointment to the Board of Directors. All options granted to directors remainoutstanding for the full term, whether or not the director continues to be adirector, unless the director resigns or is removed as a director before theexpiration of the term the director is serving at the time of the grant, inwhich event the options expire 60 days after resignation or removal. Directorsare also reimbursed for their reasonable out-of-pocket expenses incurred onCompany business. We may grant both employee and non-employee directorsadditional cash compensation and options as time commitments, responsibilitiesand other circumstances may warrant.

***Director’s ShareOwnership Guidelines.*****  **TheBoard has adopted a formal share ownership policy and guidelines fornon-management directors. The guidelines specify that each non-managementdirector shall acquire and hold common stock valued at twice the annual basecompensation paid to the director at the time of the director’s appointment orelection to the board. The policy further provides that purchases under thepolicy be made within three years of the director’s appointment, election oradoption date of the policy with the director holding at least that amount ofstock during the director’s tenure.

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***Other Arrangements.******  ***EffectiveJuly 1, 2004, we entered into an agreement with Mr. Robbins pursuantto which he agreed to serve as the Chairman of the Board of Directors and as amember of the Office of the Chairman for a period of three and one-half years.Pursuant to this agreement Mr. Robbins receives total fees of $325,000 peryear for such services.

Effective July 1,2004, we entered into an agreement with Mr. Kirschbaum in which he agreedto serve as a member of the Office of the Chairman for a period of three andone-half years. Pursuant to this agreement Mr. Kirschbaum received fees of$100,000 per year for such services. We made our last payment under thisagreement in August 2006 as a result of Mr. Kirschbaum’s death.

**CompensationCommittee Interlocks and Insider Participation**

***During the fiscal year ended June 30, 2006, Messrs. André,Robbins and Verner served on the Compensation Committee of the Board ofDirectors. Mr. Robbins is party to an agreement with us in respect of hisservice as a member of the Office of the Chairman, as described above under “—OtherArrangements.”***

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**Stock PerformanceGraph**

Thefollowing graph compares the Company’s cumulative total stockholder return onits common stock for the five years ending June 30, 2006, with cumulativetotal return, assuming reinvestment of dividends, of (i) the S&P 500, (ii) theRussell 2000 and (iii) an index of peer companies the Company believes arecomparable in terms of their lines of business. The company peer group consistsof IGT, Progressive Gaming International Corporation, Shuffle Master and WMSGaming. The presentation assumes a $100 investment on June 30, 2001, thelast trading day prior to the end of the Company’s 2001 fiscal year. TheCompany has not paid any dividends during the applicable period.

**COMPARISON OF 5YEAR CUMULATIVE TOTAL RETURN**

**Comparison of 60Month Cumulative Return**

| ** **  | ** ** | **6/01** | ** ** | **6/02** | ** ** | **6/03** | ** ** | **6/04** | ** ** | **6/05** | ** ** | **6/06** | ** ** |
|-------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| BYI         |       | 100.00   |       | 127.12   |       | 192.62   |       | 174.79   |       | 142.81   |       | 167.76   |       |
| S&P 500 |       | 100.00   |       | 82.01    |       | 82.22    |       | 97.93    |       | 104.12   |       | 113.11   |       |
| Russell 200 |       | 100.00   |       | 91.33    |       | 89.83    |       | 119.80   |       | 131.12   |       | 150.23   |       |
| Peer group  |       | 100.00   |       | 80.85    |       | 142.89   |       | 222.89   |       | 178.27   |       | 229.11   |       |

 

 

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**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

**BeneficialOwnership**

Thefollowing table sets forth certain information as of March 9, 2007, withrespect to the beneficial ownership of common stock, which constitutes our onlyoutstanding class of voting securities, by (i) each person who, to ourknowledge, beneficially owned more than 5% of the outstanding common stock, (ii) eachdirector, (iii) the Named Executive Officers and (iv) all of ourexecutive officers and directors as a group. Except as indicated, beneficialownership includes the sole power to vote and to dispose of the securities inquestion. The mailing address for each of the beneficial owners listed below isc/o Bally Technologies, Inc., 6601 South Bermuda Road, Las Vegas, Nevada89119, unless noted otherwise. Information with respect to the greater than 5%beneficial owners is based solely on a review of the Schedule 13G filed byFMR Corp. on February 14, 2007 and the Schedule 13G/A filed by ColumbiaWanger Asset Management LP on January 8, 2007.

| **Beneficial Owner**                            | ** ** | ** ** | ** ** | **Amount of Beneficial  Ownership** | ** ** | **Percent of  Class** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------------------------------|------------|----------------------------|------------|
| FMR Corp.(1)                                         |       |       | 5,006,300  | (18)                                          |       |                       | 9.41       | % |   |
| Columbia Wanger  Assets Management LP(2)             |       |       | 3,905,000  |                                          |       |                       | 7.34       | % |   |
| Alfred Wilms(3)                                      |       |       | 3,729,324  |                                          |       |                       | 7.01       | % |   |
| Jacques André(4)                                |       |       | 363,572    |                                          |       |                       | *          |   |   |
| Robert Guido(5)                                      |       |       | 50,000     |                                          |       |                       | *          |   |   |
| Joel  Kirschbaum(6)                                  |       |       | 2,455,602  |                                          |       |                       | 4.58       | % |   |
| Stephen Race(7)                                      |       |       | 70,000     |                                          |       |                       | *          |   |   |
| David Robbins(8)                                     |       |       | 626,434    |                                          |       |                       | 1.17       | % |   |
| Kevin Verner(9)                                      |       |       | 313,781    |                                          |       |                       | *          |   |   |
| Richard  Haddrill(10)                                |       |       | 1,471,255  |                                          |       |                       | 2.72       | % |   |
| Robert Saxton(11)                                    |       |       | 50,004     |                                          |       |                       | *          |   |   |
| Robert  Luciano(12)                                  |       |       | 1,688,313  |                                          |       |                       | 3.15       | % |   |
| Ramesh  Srinivasan(13)                               |       |       | 219,172    |                                          |       |                       | *          |   |   |
| Mark  Lipparelli(14)                                 |       |       | 161,106    |                                          |       |                       | *          |   |   |
| Robert Caller(15)                                    |       |       | 22,461     |                                          |       |                       | *          |   |   |
| Steven Des  Champs(16)                               |       |       | 54,665     |                                          |       |                       | *          |   |   |
| All executive officers  and directors as a group(17) |       |       | 7,743,795  | (19)                                          |       |                       | 13.66      | % |   |

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                           *      Less than 1%

                           (1)   FMR Corp.’s address is 83 Devonshire Street,Boston, Massachusetts 02109.

                           (2)   Columbia Wanger Asset Management LP’s addressis 227 West Monroe Street, Suite 3000, Chicago, Illinois 60606.

                           (3)   Mr. Wilms’ mailing address is 2, St.Jansvliet, bus 6-2000 Antwerp, Belgium. Information with respect to Mr. Wilms’beneficial ownership of common stock was taken from Schedule 13D dated January 6,2004.

                           (4)   Includes 36,428 shares of common stock ownedand 327,144 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

                           (5)   Includes 50,000 shares of common stock ownedshares and common stock subject to options that are currently exercisable orwill become exercisable within 60 days.

                           (6)   Includes 2,092,458 shares of common stock ownedand 363,144 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

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                           (7)   Represents shares of common stock subject tooptions that are currently exercisable or will become exercisable within 60days.

                           (8)   Includes 134,286 shares of common stock ownedand 492,148 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days. Excludes 25,714 sharesof common stock held by a trust for the benefit of Mr. Robbins’ childrenfor which Mr. Robbins does not act as a trustee, and for which shares Mr. Robbinshas no voting or investment control or pecuniary interest and thereforedisclaims beneficial ownership.

                           (9)   Includes 13,781 shares of common stock ownedand 300,000 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

                           (10) Includes 161,654 shares of common stock owned,329,606 restricted stock units that are currently vested or will have vestedwithin 60 days and 979,995 shares of common stock subject to options that arecurrently exercisable or will become exercisable within 60 days.

                           (11) Includes 50,004 shares of common stock owned.

                           (12) Includes 1,328,313 shares of common stock ownedand 360,000 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

                           (13) Includes 24,172 shares of common stock ownedand 195,000 shares of common stock subject to options that are currently exercisableor will become exercisable within 60 days.

                           (14) Includes 3,942 shares of common stock owned and157,164 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

                           (15) Includes 2,461 shares of common stock owned and20,000 shares of common stock subject to options that are currently exercisableor will become exercisable within 60 days.

                           (16) Includes 29,635 shares of common stock ownedand 25,030 shares of common stock subject to options that are currentlyexercisable or will become exercisable within 60 days.

                           (17) Includes Mr. Steven Des Champs, a NamedExecutive Officer, who was no longer employed by the Company as ofMarch 9, 2007.

                           (18) FMR Corp. has sole voting power in respect of 1,069,260 sharesof common stock.

                           (19) Includes 3,480,460 shares of common stocksubject to options that are currently exercisable or will become exercisablewithin 60 days. Also includes 54,665 shares of common stock beneficiallyowned by Mr. Steven Des Champs.

**Equity CompensationPlans**

The information requiredby this Item 12 with respect to our equity compensation plans is set forthabove under Item 5, Market for Registrant’s Common Equity, Related ShareholderMatters and Issuer Purchases of Equity Securities—Equity Compensation Plans.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Kirschbaum, a former director of the Company,was the sole stockholder, director and officer of KIC, which, effective July 1,2004, was party to an Advisory Services Agreement with the Company which callsfor the Company to pay KIC $600,000 annually for advisory and related servicesfor a period of three and one-half years. InAugust 2006, the Company made its last payment under the advisoryagreement as a result of Mr. Kirschbaum’s death.

In December 2004, we settled the earn out relatedto the acquisition of SDG with the former shareholders of SDG for an aggregateamount of $40.0 million consisting of a one-time cash payment of $12.0 million 

83

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and the issuance of $28.0 million in subordinateddebt, due in annual installments through 2009. Mr. Luciano, the Company’sChief Technology Officer, was the primary shareholder of SDG. Mr. Lucianoreceived approximately $7.4 million in cash and $17.2 million in subordinated debtin connection with the settlement. On June 28, 2005, the Company convertedan aggregate of $14.0 million in subordinated debt and accrued interest thereoninto approximately 1.0 million shares of common stock. Mr. Lucianoreceived 881,841 of the approximately 1.0 million shares of common stock  Theremaining $14.0 million in subordinated debt payable in connection with thesettlement to the former SDG shareholders, including Mr. Luciano, ispayable in annual installments through 2009. At the Company’s discretion, thenote principal and accrued interest thereon can be paid in cash, or can beconverted into shares of the Company’s common stock using the average stockprice for the 20 business days prior to the delivery of such shares.

We also lease a warehouseand office facility from an entity owned by Mr. Luciano. Rental paymentstotaled $412,000 for each of the fiscal years ended June 30, 2006 and2005.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

**Fees paid toRegistered Public Accounting Firm**

The followingtable presents the aggregate fees billed by Deloitte & Touche LLP, ourprincipal Independent Registered Public Accounting Firm, for services providedduring fiscal years 2006 and 2005:

| ** **             | ** ** | **2006**  | ** ** | **2005** | ** ** |
|------------------------|------------|-----------|------------|----------|------------|
| Audit fees             |       | $         | 4,094,296  |     | $          | 3,077,160 |   |
| Audit-related  fees(1) |       | 2,447,830 |       | 158,115  |       |
| Tax fees(2)            |       | 800,298   |       | 673,523  |       |
| Total Fees             |       | $         | 7,342,424  |     | $          | 3,908,798 |   |

----

(1)          Consists primarily offees paid for accounting and auditing consultation services, audits of theCompany’s employee benefits plans and services related to Sarbanes-Oxleyreadiness.

(2)          Consists primarily offees paid for tax compliance and preparation services and tax consultationrelating to the acquisition or disposition of certain subsidiaries.

The Audit Committeereviews and approves all services to be provided by Deloitte & ToucheLLP. The Audit Committee has considered the effect of non-audit servicesprovided by Deloitte & Touche LLP on Deloitte & Touche LLP’sindependence, and does not believe that such independence has been impaired orotherwise compromised.

**Pre-Approval Policy**

Pursuant to the Audit Committee’s pre-approvalpolicies and procedures for certain audit and non-audit services, the Company’sexternal auditor cannot be engaged to provide any audit and non-audit servicesto the Company unless the engagement is pre-approved by the Audit Committee incompliance with the Sarbanes-Oxley Act of 2002. The audit, audit related, taxand other fees and services described above were pre-approved by the AuditCommittee for 2006 and 2005.

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

Documents filed aspart of this Annual Report on Form 10-K:

1.      FinancialStatements:

·       Reportof Independent Registered Public Accounting Firm

·       ConsolidatedBalance Sheets as of June 30, 2006 and 2005

·       ConsolidatedStatements of Operations for the Years Ended June 30, 2006, 2005 and 2004

·       ConsolidatedStatements of Stockholders’ Equity  forthe Years Ended June 30, 2006, 2005 and 2004

·       ConsolidatedStatements of Cash Flows for the Years Ended June 30, 2006, 2005  and 2004

·       Notes to consolidatedfinancial statements

2.      FinancialStatement Schedules:  Not applicable.

3.      Exhibits:
| Exhibit   Number | ** ** | **Description** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|------------------|------------|-----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             | 2.1        |            | 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, filed on  March 12, 2004 as Exhibit 2.1 to the Current Report on Form 8-K  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                             |   |
|             | 2.2        |            | Amendment  No. 1, dated December 30, 2004, to the Amended and Restated Stock  Purchase Agreement, dated March 2, 2004, by and among Alliance Gaming  Corporation, Sierra Design Group, and Robert Luciano, as Trustee for the  Robert Luciano Family Trust, filed as Exhibit 2.2 to the Annual Report  on Form 10-K for the fiscal year ended June 30, 2005 of  Alliance Gaming Corporation, and incorporated by reference. |   |
|             | 2.3        |            | 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, filed on July 6, 2004 as Exhibit 2.1 to the  Current Report on Form 8-K of Alliance Gaming Corporation, and  incorporated herein by reference.                                                                                                              |   |
|             | 3.1        |            | Restated Articles  of Incorporation of Alliance Gaming Corporation, as amended, filed on  May 7, 2004 as Exhibit 4.6 to the Registration Statement on  Form S-8 (File No. 333-115271) of Alliance Gaming  Corporation, and incorporated herein by reference.                                                                                                                                                                          |   |
|             | 3.2#       |            | Amendment to Amended  and Restated Articles of Incorporation dated March 13, 2006.                                                                                                                                                                                                                                                                                                                                                                   |   |
|             | 3.3        |            | Bylaws of  Alliance Gaming Corporation, filed as Exhibit 3.2 to the Annual Report  on Form 10- for the fiscal year ended June 30, 2005, of  Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                                                             |   |
|             | 4.1        |            | Rights Agreement  dated as of March 9, 1998 between Alliance Gaming Corporation and  American Stock Transfer & Trust Company, filed on March 10,  1998 as Exhibit 1 to the Registration Statement on Form 8-A  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                         |   |

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|        | 4.2   |   | First  Amendment to Rights Agreement dated as of September 15, 1998 between  Alliance Gaming Corporation and American Stock Transfer & Trust  Company, filed as Exhibit 4.2 to the Annual Report on Form 10-K  for the fiscal year ended June 30, 2005 of Alliance Gaming Corporation,  and incorporated herein by reference.                                                                                                                                                                  |   |
|--------|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 10.1  |   | Loan Agreement,  dated as of September 5, 2003 among Alliance Gaming Corporation, the  various lenders named therein, Bank of America, N.A. as Administrative Agent,  CIBC World Markets Corp., as Syndication Agent and Wells Fargo Bank, N.A., as  Documentation Agent, filed On September 12, 2003 as Exhibit 99.2 to  the Current Report on Form 8-K of Alliance Gaming Corporation, and  incorporated herein by reference.                                                                         |   |
|   | 10.2  |   | Amendment  No. 1 dated February 18, 2004 to Loan Agreement, dated as of  September 5, 2003 among Alliance Gaming Corporation, the various lenders  named therein, Bank of America, N.A. as Administrative Agent, CIBC World  Markets Corp., as Syndication Agent and Wells Fargo Bank, N.A., as  Documentation Agent, filed as Exhibit 10.2 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference. |   |
|   | 10.3  |   | Amendment  No. 2 dated December 10, 2004 Loan Agreement, dated as of  September 5, 2003 among Alliance Gaming Corporation, the various lenders  named therein, Bank of America, N.A. as Administrative Agent, CIBC World  Markets Corp., as Syndication Agent and Wells Fargo Bank, N.A., as  Documentation Agent, filed on December 15, 2004 as Exhibit 10.1 to  the Current Report on Form 8-K of Alliance Gaming Corporation, and  incorporated by reference.                              |   |
|   | 10.4  |   | Amendment  No. 3 dated October 6, 2006 to Loan Agreement, dated as of  September 5, 2003 among Bally Technologies, Inc. the various  lenders named therein, Bank of America, N.A. as Administrative Agent, filed  on October 24, 2006 as Exhibit 10.1 to the Current Report on Form 8-K  of Bally Technologies, Inc., and incorporated herein by reference.                                                                                                                         |   |
|   | 10.5  |   | Amendment  No. 4 dated December 14, 2006 to Loan Agreement, dated as of  September 5, 2003 among Bally Technologies, Inc. the various  lenders named therein, Bank of America, N.A. as Administrative Agent, filed  on December 18, 2006 as Exhibit 10.1 to the Current Report on  Form 8-K of Bally Technologies, Inc., and incorporated herein  by reference.                                                                                                                     |   |
|   | 10.6* |   | Alliance Gaming  Corporation 1996 Long Term Incentive Plan, filed on August 21, 1997 with  the Registration Statement on Form S-8 (File No. 333-34077)  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                                                                                                                |   |
|   | 10.7* |   | Restricted Stock  Agreement by and between Alliance Gaming Corporation and Richard Haddrill,  dated as of June 30, 2004, filed as Exhibit 10.5 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                                        |   |
|   | 10.8* |   | Stock Option  Agreement by and between Alliance Gaming Corporation and Richard Haddrill,  dated as of June 30, 2004, filed as Exhibit 10.6 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                                            |   |
|   | 10.9* |   | Stock Option  Agreement by and between Alliance Gaming Corporation and Richard Haddrill,  dated as of October 27, 2004, filed as Exhibit 10.7 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                                         |   |

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|        | 10.10* |   | Alliance  Gaming Corporation Amended and Restated 2001 Long Term Incentive Plan, filed  on November 2, 2004 as Exhibit 4.1 to Post Effective Amendment  No. 1 to Registration Statement on Form S-8 (File  No. 333-115271) of Alliance Gaming Corporation, and incorporated herein  by reference.                                                                                             |   |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 10.11* |   | Restricted Stock  Agreement by and between Alliance Gaming Corporation and Richard Haddrill,  dated as of December 22, 2004, filed as Exhibit 10.9 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference.                                                                                               |   |
|   | 10.12* |   | Amendment  No. 1 to the Alliance Gaming Corporation Amended and Restated 2001 Long  Term Incentive Plan, filed on January 15, 2005 as Exhibit 4.2 to  the Registration Statement on Form S-8 (File No. 333-122064)  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                     |   |
|   | 10.13* |   | Form of  Stock Option Agreement, filed as Exhibit 10.11 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                          |   |
|   | 10.14* |   | Amendment Number  Two to the Company’s Long Term Incentive Plan, effective as of March 6,  2006, filed on May 9, 2006 as Exhibit 10.1 to the Current Report on  Form 8-K of Bally Technologies, Inc., and incorporated herein  by reference.                                                                                                                                             |   |
|   | 10.15* |   | Form of  Director Stock Option Agreement, filed as Exhibit 10.12 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                                                                 |   |
|   | 10.16* |   | Form of  Director Stock Option Agreement dated June 13, 2005, filed as  Exhibit 10.13 to the Annual Report on Form 10-K for the  fiscal year ended June 30, 2005 of Alliance Gaming Corporation, and  incorporated herein by reference.                                                                                                                                                       |   |
|   | 10.17  |   | Casino Management  Agreement, dated as of October 28, 1993, among Rainbow Casino  Partnership—Vicksburg, L.P., Mississippi Ventures, Inc. and The Rainbow  Casino Corporation, filed as Exhibit 10.14 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference.                                  |   |
|   | 10.18  |   | Second Amended  and Restated Agreement of Limited Partnership, dated as of  March 29,1995, by and between United Gaming Rainbow and The Rainbow  Casino Corporation, filed as Exhibit 10.15 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference                                                       |   |
|   | 10.19  |   | Amended and  Restated Trademark License Agreement dated July 8, 1992, by and between Bally  Gaming International, Inc. and Bally Manufacturing Corporation, filed on  July 9, 1992 as Exhibit 10(i)(d) to the Registration Statement  on Form S-1 (File No. 33-48347) of Bally Gaming  International, Inc., and incorporated herein by reference.                              |   |
|   | 10.20  |   | Second Amendment  to Trademark License Agreement and Settlement Agreement, dated March 31,  1995, by and between Bally Entertainment Corporation and Bally Gaming  International, Inc. and Bally Gaming, Inc., filed as  Exhibit 10.17 to the Annual Report on Form 10-K for the  fiscal year ended June 30, 2005 of Alliance Gaming Corporation, and  incorporated herein by reference. |   |

87

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|        | 10.21  |   | 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., filed on May 29, 1996 as  Exhibit 10.17 to Amendment No. 2 to the Registration Statement on  Form S-2 (File No. 333-02145) of Alliance Gaming  Corporation, and incorporated herein by reference. |   |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 10.22* |   | Agreement between  Alliance Gaming Corporation and David Robbins dated July 1, 2004, filed  on July 6, 2004 as Exhibit 10.3 to the Current Report on  Form 8-K of Alliance Gaming Corporation, and incorporated herein  by reference.                                                                                                                                                                              |   |
|   | 10.23* |   | Advisory Services agreement between Alliance Gaming  Corporation and Kirkland Investment Corporation dated July 1, 2004,  filed on July 6, 2004 as Exhibit 10.5 to the Current Report on Form 8-K  of Alliance Gaming Corporation, and incorporated herein by reference.                                                                                                                                           |   |
|   | 10.24  |   | Prepayment  Agreement, dated as of June 28, 2005 by and among Alliance Gaming  Corporation, Robert Luciano, Jr. and Robert Luciano, Jr. as trustee  of the Robert Luciano Family Trust dated February 27, 1995, filed as  Exhibit 10.21 to the Annual Report on Form 10-K for the  fiscal year ended June 30, 2005 of Alliance Gaming Corporation, and  incorporated herein by reference.           |   |
|   | 10.25* |   | Employment  Agreement between Alliance Gaming Corporation and Richard Haddrill, dated as  of June 30, 2004, filed on July 6, 2004 as Exhibit 10.1 to the  Current Report on Form 8-K of Alliance Gaming Corporation, and  incorporated herein by reference.                                                                                                                                                        |   |
|   | 10.26* |   | Amendment dated  December 22, 2004, to the Employment Agreement by and between Alliance  Gaming Corporation and Richard Haddrill, filed on February 9, 2005 as  Exhibit 10.40 to the Quarterly Report on Form 10-Q for the  quarter ended December 31, 2004, and incorporated herein by reference.                                                                                                            |   |
|   | 10.27* |   | Second Amendment  to Employment Agreement by and between Alliance Gaming Corporation and  Richard Haddrill, effective as of June 13, 2005, filed as  Exhibit 10.24 to the Annual Report on Form 10-K for the  fiscal year ended June 30, 2005 of Alliance Gaming Corporation, and  incorporated herein by reference.                                                                                               |   |
|   | 10.28* |   | Form of  Third Amendment to Haddrill Employment Agreement dated June 20, 2006, by  and between the Company and Richard Haddrill, filed on June 22, 2006 as  Exhibit 10.2 to the Current Report on Form 8-K of Bally  Technologies, Inc., and incorporated herein by reference.                                                                                                                           |   |
|   | 10.29* |   | Amended and  Restated Employment Agreement, effective April 24, 2001, between  Alliance Gaming Corporation and Robert L. Miodunski, filed on  September 27, 2001 as Exhibit 10.30 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2001, and  incorporated herein by reference.                                                                                                          |   |
|   | 10.30* |   | Separation and  Consulting Agreement dated as of June 30, 2004 by and between Alliance  Gaming Corporation and Robert L. Miodunski, filed on July 6, 2004 as  Exhibit 10.2 to the Current Report on Form 8-K of Alliance  Gaming Corporation, and incorporated herein by reference.                                                                                                                                |   |
|   | 10.31* |   | Employment  Agreement dated January 28, 2000 between Alliance Gaming Corporation and  Steve Des Champs, filed as Exhibit 10.27 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference.                                                                                                                                   |   |

88

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|        | 10.32* |   | Employment  Agreement dated August 15, 2000 between Alliance Gaming Corporation and  Mark Lerner, filed on September 26, 2002 as Exhibit 10.35 to the  Annual Report on Form 10-K for the fiscal year ended June 30,  2002 of Alliance Gaming Corporation, and incorporated herein by reference. |   |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 10.33* |   | Employment  Agreement dated March 2, 2004 between Alliance Gaming Corporation and  Robert Luciano, filed as Exhibit 10.29 to the Annual Report on  Form 10-K for the fiscal year ended June 30, 2005 of Alliance  Gaming Corporation, and incorporated herein by reference.                           |   |
|   | 10.34* |   | Amendment dated  April 13, 2005 to Employment Agreement between Alliance Gaming  Corporation and Robert Luciano, filed as Exhibit 10.30 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.             |   |
|   | 10.35* |   | Executive  Employment Agreement dated March 9, 2005 by and between Alliance Gaming  Corporation and Ramesh Srinivasan, filed as Exhibit 10.31 to the Annual  Report on Form 10-K for the fiscal year ended June 30, 2005  of Alliance Gaming Corporation, and incorporated herein by reference.       |   |
|   | 10.36* |   | Letter Agreement  by and between the Company and Robert C. Caller, filed on March 14, 2006  as Exhibit 10.1 to the Current Report on Form 8-K of Bally  Technologies, Inc., and incorporated herein by reference.                                                                                     |   |
|   | 10.37* |   | Separation  Agreement by and between Bally Technologies, Inc. and Robert L. Saxton,  dated June 14, 2006, filed on June 15, 2006 as Exhibit 10.1 to  the Current Report on Form 8-K of Bally Technologies, Inc.,  and incorporated herein by reference.                                     |   |
|   | 10.38* |   | Letter Agreement  dated June 19, 2006, by and between the Company and Michael Gavin  Isaacs, filed on June 22, 2006 as Exhibit 10.1 to the Current  Report on Form 8-K of Bally Technologies, Inc., and  incorporated herein by reference.                                                       |   |
|   | 21#    |   | Subsidiaries of  the Registrant                                                                                                                                                                                                                                                                                           |   |
|   | 23.1#  |   | Consent of  Deloitte & Touche LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                                 |   |
|   | 31.1#  |   | Certification of  Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a).                                                                                                                                                                                                                        |   |
|   | 31.2#  |   | Certification of  Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a).                                                                                                                                                                                                                        |   |
|   | 32.1#  |   | Certification of  the Chief Executive Officer pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                    |   |
|   | 32.2#  |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                    |   |

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*                    Denotesmanagement contract or compensatory plan or arrangement.

#                 Filed herewith.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| BALLY TECHNOLOGIES,  INC. | DATED: March 15, 2007                                         |
|---------------------------|--------------------------------------------------------------------|
| By                        | /s/ RICHARD M. HADDRILL                                            |   |
|                      | Richard M. Haddrill                                                |
|                      | *Chief Executive Officer*                                          |
|                      | *(Principal Executive Officer)*                                    |
| By                        | /s/ ROBERT C. CALLER                                               |   |
|                      | Robert C. Caller                                                   |
|                      | *Executive Vice President, Chief Financial Officer  and Treasurer* |
|                      | *(Principal Financial and  Accounting Officer)*                    |
|                           |                                                                    |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
|                         | **Name** | ** **                                              | ** **                                             | ** **           | **Title**            | ** ** | ** ** | ** ** | **Date** | ** ** |   |
|-------------------------|----------|---------------------------------------------------------|--------------------------------------------------------|----------------------|----------------------|------------|------------|------------|----------|------------|--------|
| /s/ RICHARD M. HADDRILL |     | Chief Executive  Officer                                |                                                   | March 15,  2007 |
| Richard M. Haddrill     |     | (Principal Executive  Officer), and Director            |                                                   |                 |                 |
| /s/ ROBERT C. CALLER    |     |                                                    | Executive Vice  President, Chief Financial Officer and |                 | March 15,  2007 |       |
| Robert C. Caller        |     | Treasurer (Principal  Financial and Accounting Officer) |                                                   |                 |                 |
| /s/ JACQUES ANDRÉ  |     |                                                    | Director                                               |                 | March 15,  2007 |       |
| Jacques André      |     |                                                    |                                                   |                 |                 |
| /s/ ROBERT L. GUIDO     |     |                                                    | Director                                               |                 | March 15,  2007 |       |
| Robert L. Guido         |     |                                                    |                                                   |                 |                 |
| /s/ STEPHEN RACE        |     |                                                    | Director                                               |                 | March 15,  2007 |       |
| Stephen Race            |     |                                                    |                                                   |                 |                 |
| /s/ DAVID ROBBINS       |     |                                                    | Director and  Chairman of the Board                    |                 | March 15,  2007 |       |
| David Robbins           |     |                                                    |                                                   |                 |                 |
| /s/ KEVIN VERNER        |     |                                                    | Director                                               |                 | March 15,  2007 |       |
| Kevin Verner            |     |                                                    |                                                   |                 |                 |
|                         |          |                                                         |                                                        |                      |                      |            |            |            |          |            |        |  |  |  |  |  |  |  |  |  |

 

90

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of BallyTechnologies, Inc.:Las Vegas, Nevada

We have audited the accompanying consolidated balancesheets of Bally Technologies, Inc. and Subsidiaries (the “Company”) as of June 30,2006 and 2005, and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the three years in the periodended June 30, 2006. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. 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 reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of BallyTechnologies, Inc. and Subsidiaries as of June 30, 2006 and 2005, andthe results of their operations and their cash flows for each of the threeyears in the period ended June 30, 2006 in conformity with accountingprinciples generally accepted in the United States of America.

As discussed in Note 1, the Company adopted theprovisions of Statement of Financial Accounting Standards No. 123(R),*Share-Based Payment*, on July 1,2005.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of June 30, 2006, based on the criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission,and our report dated March 14, 2007 expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an adverse opinion on the effectiveness of theCompany’s internal control over financial reporting because of material weaknesses.

/s/ DELOITTE & TOUCHE LLP

Las Vegas, NevadaMarch 14, 2007

F-1

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSAS OF JUNE 30, 2006 AND 2005**

| ** **                                                                                                                                              | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------|------------|
| ** **                                                                                                                                              | ** ** | **(in 000s, except  share amounts)** | ** ** |
| ASSETS                                                                                                                                                  |       |                                                |       |     |       |
| Current assets:                                                                                                                                         |       |                                                |       |     |       |
| Cash and cash equivalents                                                                                                                               |       | $                                                   | 16,425     |     | $          | 33,170 |   |
| Restricted cash                                                                                                                                         |       | 14,484                                              |       | 13,421   |       |
| Accounts and notes receivable, net of allowances for  doubtful accounts of $8,073 and $10,340                                                           |       | 135,497                                             |       | 97,679   |       |
| Inventories                                                                                                                                             |       | 69,995                                              |       | 63,523   |       |
| Deferred tax assets, net                                                                                                                                |       | 51,374                                              |       | 30,884   |       |
| Income taxes receivable                                                                                                                                 |       | 266                                                 |       | —   |       |
| Other current assets                                                                                                                                    |       | 41,313                                              |       | 33,034   |       |
| Total current assets                                                                                                                                    |       | 329,354                                             |       | 271,711  |       |
| Long-term investments (restricted)                                                                                                                      |       | 8,984                                               |       | 10,060   |       |
| Long-term receivables, net of allowance for doubtful  accounts of $0 and $11                                                                            |       | 6,436                                               |       | 7,450    |       |
| Property, plant and equipment, net of accumulated  depreciation of $49,756 and $40,548                                                                  |       | 68,464                                              |       | 66,811   |       |
| Leased gaming equipment, net of accumulated  depreciation of $64,160 and $42,495                                                                        |       | 43,408                                              |       | 51,850   |       |
| Goodwill                                                                                                                                                |       | 161,303                                             |       | 161,444  |       |
| Intangible assets, net of accumulated amortization of  $23,963 and $17,356                                                                              |       | 27,656                                              |       | 49,451   |       |
| Deferred tax assets, net                                                                                                                                |       | 20,048                                              |       | 16,548   |       |
| Other assets, net                                                                                                                                       |       | 22,228                                              |       | 19,609   |       |
| Total assets                                                                                                                                            |       | $                                                   | 687,881    |     | $          | 654,934 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                              |       |                                                |       |     |       |
| Current liabilities:                                                                                                                                    |       |                                                |       |     |       |
| Accounts payable                                                                                                                                        |       | $                                                   | 39,622     |     | $          | 36,807 |   |
| Accrued liabilities                                                                                                                                     |       | 86,131                                              |       | 43,838   |       |
| Jackpot liabilities                                                                                                                                     |       | 13,139                                              |       | 13,025   |       |
| Deferred revenue                                                                                                                                        |       | 47,081                                              |       | 40,962   |       |
| Income taxes payable                                                                                                                                    |       | —                                              |       | 1,752    |       |
| Current maturities of long-term debt, including  $6,600 and $6,006 owed to related parties                                                              |       | 12,864                                              |       | 10,163   |       |
| Total current liabilities                                                                                                                               |       | 198,837                                             |       | 146,547  |       |
| Long-term debt, net of current maturities, including  $7,600 and $13,200 owed to related parties                                                        |       | 315,482                                             |       | 324,954  |       |
| Other liabilities                                                                                                                                       |       | 28,800                                              |       | 6,931    |       |
| Total liabilities                                                                                                                                       |       | 543,119                                             |       | 478,432  |       |
| Minority interest                                                                                                                                       |       | 684                                                 |       | 479      |       |
| Commitment and Contingencies (Note 19)                                                                                                             |       |                                                |       |     |       |
| Stockholders’ equity:                                                                                                                              |       |                                                |       |     |       |
| Special stock, 10,000,000 shares authorized:  Series E, $100 liquidation value; 115 shares issued and outstanding                                  |       | 12                                                  |       | 12       |       |
| Common stock, $.10 par value; 100,000,000 shares  authorized; 52,880,000 and 52,649,000 shares issued and 52,354,000 and  52,123,000 shares outstanding |       | 5,283                                               |       | 5,268    |       |
| Treasury stock at cost, 526,000 and 526,000 shares                                                                                                      |       | (665                                                | )          | (665     | )          |
| Deferred compensation                                                                                                                                   |       | —                                              |       | (6,689   | )          |
| Additional paid-in capital                                                                                                                              |       | 219,472                                             |       | 212,182  |       |
| Accumulated other comprehensive income                                                                                                                  |       | 1,351                                               |       | 1,219    |       |
| Accumulated deficit                                                                                                                                     |       | (81,375                                             | )          | (35,304  | )          |
| Total stockholders’ equity                                                                                                                         |       | 144,078                                             |       | 176,023  |       |
| Total liabilities  and stockholders’ equity                                                                                                        |       | $                                                   | 687,881    |     | $          | 654,934 |   |

 

See accompanying notes to consolidated financial statements.

F-2

----

**BALLY TECHNOLOGIES,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFOR THE THREE YEARS ENDED JUNE 30, 2006**

| ** **                                                                          | ** ** | **2006**                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                          | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Revenues:                                                                           |       |                                                             |       |     |       |     |       |
| Gaming equipment and systems                                                        |       | $                                                                | 494,498    |     | $          | 431,070  |       | $ | 424,327 |   |
| Casino operations                                                                   |       | 52,646                                                           |       | 52,037   |       | 52,280   |       |
|                                                                                |       | 547,144                                                          |       | 483,107  |       | 476,607  |       |
| Costs and expenses:                                                                 |       |                                                             |       |     |       |     |       |
| Cost of gaming equipment and systems                                                |       | 291,948                                                          |       | 241,486  |       | 192,751  |       |
| Cost of casino operations                                                           |       | 18,502                                                           |       | 18,727   |       | 20,043   |       |
| Selling, general and administrative                                                 |       | 193,756                                                          |       | 156,275  |       | 124,041  |       |
| Research and development costs                                                      |       | 45,087                                                           |       | 43,366   |       | 36,615   |       |
| Restructuring charges                                                               |       | —                                                           |       | 3,654    |       | —   |       |
| Impairment charges                                                                  |       | 15,581                                                           |       | 3,599    |       | —   |       |
| Depreciation and amortization                                                       |       | 25,444                                                           |       | 20,451   |       | 14,321   |       |
|                                                                                |       | 590,318                                                          |       | 487,558  |       | 387,771  |       |
| Operating income  (loss)                                                            |       | (43,174                                                          | )          | (4,451   | )          | 88,836   |       |
| Other income  (expense):                                                            |       |                                                             |       |     |       |     |       |
| Interest income                                                                     |       | 3,454                                                            |       | 3,401    |       | 4,263    |       |
| Interest expense                                                                    |       | (27,509                                                          | )          | (18,321  | )          | (17,934  | )          |
| Loss on extinguishment of debt                                                      |       | —                                                           |       | (564     | )          | (12,293  | )          |
| Other, net                                                                          |       | (71                                                              | )          | 565      |       | (460     | )          |
| Income (loss)  from continuing operations before income taxes and minority interest |       | (67,300                                                          | )          | (19,370  | )          | 62,412   |       |
| Income tax benefit (expense)                                                        |       | 24,012                                                           |       | 5,192    |       | (21,104  | )          |
| Minority interest                                                                   |       | (3,907                                                           | )          | (3,731   | )          | (2,309   | )          |
| Income (loss)  from continuing operations                                           |       | (47,195                                                          | )          | (17,909  | )          | 38,999   |       |
| Income (loss) from discontinued operations, net of  income taxes                    |       | 1,124                                                            |       | (4,654   | )          | 40,889   |       |
| Net income (loss)                                                                   |       | $                                                                | (46,071    | )        | $          | (22,563  | )          | $ | 79,888 |   |
| Basic earnings  (loss) per share:                                                   |       |                                                             |       |     |       |     |       |
| Continuing operations                                                               |       | $                                                                | (0.90      | )        | $          | (0.35    | )          | $ | 0.78 |   |
| Discontinued operations                                                             |       | 0.02                                                             |       | (0.09    | )          | 0.82     |       |
| Total                                                                               |       | $                                                                | (0.88      | )        | $          | (0.44    | )          | $ | 1.60 |   |
| Diluted earnings  (loss) per share:                                                 |       |                                                             |       |     |       |     |       |
| Continuing operations                                                               |       | $                                                                | (0.90      | )        | $          | (0.35    | )          | $ | 0.76 |   |
| Discontinued operations                                                             |       | 0.02                                                             |       | (0.09    | )          | 0.80     |       |
| Total                                                                               |       | $                                                                | (0.88      | )        | $          | (0.44    | )          | $ | 1.56 |   |
| Weighted average  shares outstanding:                                               |       |                                                             |       |     |       |     |       |
| Basic                                                                               |       | 52,174                                                           |       | 51,114   |       | 50,113   |       |
| Diluted                                                                             |       | 52,174                                                           |       | 51,114   |       | 51,248   |       |

 

See accompanying notes to consolidated financial statements.

F-3

----

**BALLY TECHNOLOGIES,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITYFOR THE THREE YEARS ENDED JUNE 30, 2006**

| ** **                                                                          | ** ** | ** **        | ** ** | ** **  | ** ** | ** **        | ** ** | ** **   | ** ** | ** **       | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------|------------|-------------|------------|-------------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                          | ** ** | ** **        | ** ** | ** **  | ** ** | **Series E** | ** ** | ** **   | ** ** | ** **       | ** ** | **Additional**    | ** ** | **Other**              | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                                          | ** ** | **Common  Stock** | ** ** | **Special** | ** ** | **Treasury**      | ** ** | **Deferred** | ** ** | **Paid-In**      | ** ** | **Comprehensive** | ** ** | **Accumulated**        | ** ** | **Stockholders’** | ** ** |
| ** **                                                                          | ** ** | **Shares**        | ** ** | **Dollars** | ** ** | **Stock**         | ** ** | **Stock**    | ** ** | **Compensation** | ** ** | **Capital**       | ** ** | **Income (loss)** | ** ** | **Deficit**            | ** ** | **Equity** | ** ** |
| ** **                                                                          | ** ** | **(in  000s)**    | ** ** |
| Balances at June 30, 2003                                                      |       | 49,933            |       | $           | 4,996      |              |       | $            | 12         |             |       |              | $          | (501                   | )          |                   |       | $          | —     |   |   | $ | 163,267 |   |   | $ | 1,287 |   |   |   | $ | (92,629 | ) |   |   | $ | 76,432 |   |   |
| Net income                                                                          |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | 79,888 |   |   |   | 79,888 |   |   |
| Foreign currency translation adjustment                                             |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | 237 |   |   |   | — |   |   |   | 237 |   |   |
| Total comprehensive income                                                          |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | — |   |   |   | 80,125 |   |   |
| Restricted stock units issued                                                       |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | (6,500     | )                      |       | 6,500      |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Restricted shares issued upon acquisition of Sierra Design Group  (“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 exercises                                      |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 4,299      |       |   | — |   |   |   | — |   |   |   | 4,299 |   |   |
| Balances at June 30, 2004                                                      |       | 51,426            |       | 5,145       |       |              | 12         |         |       |             | (501       | )                 |       |                   | (6,500     | )                      |       | 194,040    |       |   | 1,524 |   |   |   | (12,741 | ) |   |   | 180,979 |   |   |
| Net loss                                                                            |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | (22,563 | ) |   |   | (22,563 | ) |   |
| Foreign currency translation adjustment                                             |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | (305 | ) |   |   | — |   |   |   | (305 | ) |   |
| Total comprehensive loss                                                            |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | — |   |   |   | (22,868 | ) |   |
| Restricted stock units issued                                                       |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | (2,314     | )                      |       | 2,314      |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Restricted stock amortization                                                       |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | 2,125      |                   |       | —     |       |   | — |   |   |   | — |   |   |   | 2,125 |   |   |
| Repurchase of shares for treasury                                                   |       | —            |       | —      |       |              | —     |         |       |             | (164       | )                 |       |                   | —     |                   |       | —     |       |   | — |   |   |   | — |   |   |   | (164 | ) |   |
| Shares issued upon exercise of stock options                                        |       | 199               |       | 21          |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 1,097      |       |   | — |   |   |   | — |   |   |   | 1,118 |   |   |
| Shares issued upon the partial retirement of subordinated note                      |       | 1,024             |       | 102         |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 14,209     |       |   | — |   |   |   | — |   |   |   | 14,311 |   |   |
| Tax benefit of employee stock option exercises                                      |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 522        |       |   | — |   |   |   | — |   |   |   | 522 |   |   |
| Balances at June 30, 2005                                                      |       | 52,649            |       | 5,268       |       |              | 12         |         |       |             | (665       | )                 |       |                   | (6,689     | )                      |       | 212,182    |       |   | 1,219 |   |   |   | (35,304 | ) |   |   | 176,023 |   |   |
| Net loss                                                                            |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | (46,071 | ) |   |   | (46,071 | ) |   |
| Foreign currency translation adjustment                                             |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | 132 |   |   |   | — |   |   |   | 132 |   |   |
| Total comprehensive loss                                                            |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | —     |       |   | — |   |   |   | — |   |   |   | (45,939 | ) |   |
| Deferred compensation                                                               |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | 6,689      |                   |       | (6,689     | )          |   | — |   |   |   | — |   |   |   | — |   |   |
| Restricted stock issued                                                             |       | 93                |       | 1           |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | (1         | )          |   | — |   |   |   | — |   |   |   | — |   |   |
| Share-based compensation                                                            |       | —            |       | —      |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 12,919     |       |   | — |   |   |   | — |   |   |   | 12,919 |   |   |
| Shares issued upon exercise of stock options                                        |       | 138               |       | 14          |       |              | —     |         |       |             | —     |              |       |                   | —     |                   |       | 1,061      |       |   | — |   |   |   | — |   |   |   | 1,075 |   |   |
| Balances  at June 30, 2006                                                     |       | 52,880            |       | $           | 5,283      |              |       | $            | 12         |             |       |              | $          | (665                   | )          |                   |       | $          | —     |   |   | $ | 219,472 |   |   | $ | 1,351 |   |   |   | $ | (81,375 | ) |   |   | $ | 144,078 |   |   |

 

See accompanying notes to consolidated financial statements.

F-4

----

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE THREE YEARS ENDED JUNE 30, 2006**

| ** **                                                                                | ** ** | **2006**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                                                                                | ** ** | **(in 000s)** | ** ** |
| Cash flows from operating  activities:                                                    |       |               |       |     |       |     |       |
| Net income (loss)                                                                         |       | $                  | (46,071    | )        | $          | (22,563  | )          | $ | 79,888 |   |
| Loss (income) from discontinued operations                                                |       | (1,124             | )          | 4,654    |       | (40,889  | )          |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |               |       |     |       |     |       |
| Depreciation and amortization                                                             |       | 67,162             |       | 47,750   |       | 31,401   |       |
| Share-based compensation                                                                  |       | 12,919             |       | 2,125    |       | —   |       |
| Tax benefit of stock option exercises                                                     |       | —             |       | 522      |       | 4,299    |       |
| Loss on extinguishment of debt                                                            |       | —             |       | 564      |       | 12,293   |       |
| Deferred income tax (benefit) expense                                                     |       | (23,990            | )          | (6,075   | )          | 19,310   |       |
| Provision for doubtful accounts                                                           |       | 1,483              |       | 5,134    |       | 1,753    |       |
| Operating activities of discontinued operations                                           |       | 1,124              |       | (4,172   | )          | 2,587    |       |
| Inventory and other asset write-downs                                                     |       | 33,916             |       | 30,015   |       | —   |       |
| Other                                                                                     |       | 1,647              |       | 3,323    |       | 1,239    |       |
| Change in operating asset  and liabilities:                                               |       |               |       |     |       |     |       |
| Accounts and notes receivable                                                             |       | (38,658            | )          | 32,754   |       | (19,044  | )          |
| Inventories                                                                               |       | (7,017             | )          | (12,278  | )          | (8,943   | )          |
| Other current assets                                                                      |       | (426               | )          | (179     | )          | (4,800   | )          |
| Purchase of appeal bond                                                                   |       | —             |       | (7,361   | )          | —   |       |
| Accounts payable                                                                          |       | 1,337              |       | (876     | )          | 7,382    |       |
| Accrued liabilities, deferred revenue and jackpot  liabilities                            |       | 50,241             |       | (21,199  | )          | 25,528   |       |
| Net cash provided by operating activities                                                 |       | 52,543             |       | 52,138   |       | 112,004  |       |
| Cash flows from investing activities:                                                     |       |               |       |     |       |     |       |
| Additions to property, plant, and equipment                                               |       | (13,961            | )          | (12,430  | )          | (11,840  | )          |
| Additions to leased gaming equipment                                                      |       | (44,677            | )          | (40,589  | )          | (38,109  | )          |
| Settlement of acquisition related contingency                                             |       | —             |       | (12,000  | )          | —   |       |
| Acquisitions, net of cash acquired                                                        |       | —             |       | —   |       | (123,495 | )          |
| Restricted cash and investments                                                           |       | (895               | )          | 116      |       | (2,776   | )          |
| Additions to other long-term assets                                                       |       | (1,198             | )          | (2,157   | )          | (14,956  | )          |
| Investing activities of discontinued operations                                           |       | —             |       | —   |       | (16,001  | )          |
| Proceeds from sale of net assets discontinued  operations                                 |       | —             |       | 1,911    |       | 155,212  |       |
| Net cash used in investing activities                                                     |       | (60,731            | )          | (65,149  | )          | (51,965  | )          |
| Cash flows from financing activities:                                                     |       |               |       |     |       |     |       |
| Capitalized debt issuance costs                                                           |       | —             |       | (1,053   | )          | (6,954   | )          |
| Premium paid on early redemption of debt                                                  |       | —             |       | —   |       | (5,399   | )          |
| Proceeds from issuance of long-term debt                                                  |       | —             |       | —   |       | 350,000  |       |
| Debt extinguished in refinancing                                                          |       | —             |       | —   |       | (337,625 | )          |
| Net change in revolving credit facility                                                   |       | —             |       | (70,000  | )          | 70,000   |       |
| Pay down of term loan due to sale of net assets of  discontinued operations               |       | —             |       | (31,618  | )          | —   |       |
| Reduction of long-term debt                                                               |       | (9,661             | )          | (6,336   | )          | (3,485   | )          |
| Purchase of treasury shares                                                               |       | —             |       | (164     | )          | —   |       |
| Financing activities of discontinued operations                                           |       | —             |       | —   |       | (4,186   | )          |
| Proceeds from exercise of stock options and warrants                                      |       | 1,075              |       | 1,118    |       | 7,288    |       |
| Net cash (used in) provided by financing activities                                       |       | (8,586             | )          | (108,053 | )          | 69,639   |       |
| Effect of exchange rate changes on cash                                                   |       | 29                 |       | (24      | )          | 174      |       |
| Cash and cash equivalents:                                                                |       |               |       |     |       |     |       |
| Increase (decrease) for year                                                              |       | (16,745            | )          | (121,088 | )          | 129,852  |       |
| Balance, beginning of year                                                                |       | 33,170             |       | 154,258  |       | 24,406   |       |
| Balance, end of  year                                                                     |       | $                  | 16,425     |     | $          | 33,170   |       | $ | 154,258 |   |

 

See accompanying notes to consolidated financial statements.

F-5

----

**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. DESCRIPTION OFBUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES**

Bally Technologies, Inc. (“Bally” or the “Company”),a Nevada corporation, is a leader in the design, manufacture, assembly anddistribution of technology based products to commercial gaming marketsworldwide and owns and operates one riverboat dockside casino. The Companyderives revenues from the following sources: 1) sale of gaming machines (GamingEquipment), 2) sales of computerized monitoring systems and related recurringhardware and software maintenance revenue (Systems), 3) operation of wide-areaprogressive systems, and lease of gaming machines (Gaming Operations) and 4)Casino Operations.

During fiscal 2005 and 2004, the Company disposed ofseveral businesses including its Nevada and Louisiana route operations and itsRail City Casino operation. Accordingly, these businesses have been classifiedas discontinued operations for all periods presented (see Note 4).

In fiscal 2004, theCompany completed the acquisitions of Sierra Design Group (“SDG”) and MindPlayLLC (“MindPlay”) (see Note 3).

*Principles ofpresentation and consolidation*

The accompanying consolidated financial statementsinclude the accounts of Bally Technologies, Inc., and its wholly owned andpartially owned, controlled subsidiaries. All intercompany accounts andtransactions have been eliminated in consolidation.

The Company is the general partner of Rainbow CasinoVicksburg Partnership (“RCVP”), the partnership that operates the RainbowCasino. 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 in the limited partnership agreement, whichincreases to 20% of the incremental amount of annual revenues in excess of$35.0 million, payable quarterly through December 31, 2010. The Companyholds the remaining economic interest in the partnership. The Company announcedin October 2006, that it is evaluating alternatives with respect to thepossible sale of the Rainbow Casino. As of the date of this filing, a formalplan for the sale of the Rainbow Casino had not been approved by the Company’sBoard of Directors.

The Company consolidates RCVP and records anadjustment to reflect the portion of the earnings of RCVP attributable to theminority shareholders.

F-6

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

TheCompany also consolidates certain Atlantic City progressive trusts inaccordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46R(“FIN”), *Consolidation of Variable Interest Entities*(“VIE’s”) which addresses consolidation by a business enterprise of VIE’s thateither: (1) do not have sufficient equity investment at risk to permit theentity to finance its activities without additional subordinated financialsupport or (2) will hold a significant variable interest in, or havesignificant involvement with, an existing VIE. For the years ended June 30,2006 and 2005, the Company consolidated $4.7 million and $5.8 million,respectively, in total assets and liabilities, primarily consisting ofrestricted cash accounts and restricted investments (included in other assetsin the consolidated balance sheets) and related jackpot liabilities. Thefollowing revenues and costs were also consolidated:

| ** **                            | ** ** | **Year Ended June 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in 000s)**                     | ** ** |
| Gaming equipment  and systems revenue |       | $                                      | 8,561      |   | $ | 5,467 |   |
| Cost of gaming equipment  and systems |       | 6,023                                  |       | 3,248 |   |
|                                       |            |                                        |            |  |  |  |  |

 

*Cash and cashequivalents*

Cash equivalents consistof**highly liquid debt instrumentspurchased with an original maturity of three months or less at the date ofpurchase and are carried at cost, which approximates market value. Cash andcash equivalents also includes cash utilized in Casino Operations which is heldin vaults, cages or change banks which totaled $3.6 million and $2.7 million atJune 30, 2006 and 2005, respectively.

*Restricted cash*

The Company maintainsjackpot reserve accounts totaling approximately $14.5 million and $13.4 millionat June 30, 2006 and 2005, respectively, to ensure availability of fundsto pay wide-area progressive jackpot awards which are classified as restrictedcash.

*Accounts and NotesReceivable and Allowance for Doubtful Accounts*

Accounts and notesreceivable are stated at face amounts less an allowance for doubtful accounts.Allowances for doubtful accounts are maintained at levels determined by theCompany’s management to adequately provide for collection losses. Indetermining estimated losses, the Company evaluates its receivables andestablishes the allowance for doubtful accounts based on a combination offactors including, but not limited to, economic conditions, the financialcondition of customers, specific customer collection experience and a historyof write-offs and collections. The Company’s receivables are considered pastdue if payments have not been received within agreed upon invoice terms. Withregard to notes receivable, interest income is recognized ratably over the lifeof the note receivable.

F-7

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Inventories*

Inventoriesare stated at the lower of cost, determined on a first in, first out basis, ormarket. Cost elements included in work-in-process and finished goods includeraw materials, freight, direct labor and manufacturing overhead. Inventoriesconsist of the following: 

| ** **      | ** ** | **June 30,**  | ** ** |
|-----------------|------------|--------------------|------------|
| ** **      | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **      | ** ** | **(in 000s)** | ** ** |
| Raw materials   |       | $                  | 40,412     |   | $ | 15,975 |   |
| Work-in-process |       | 7,696              |       | 5,690 |   |
| Finished goods  |       | 21,887             |       | 41,858 |   |
| Total           |       | $                  | 69,995     |   | $ | 63,523 |   |

 

The Company recordedinventory write-downs totaling approximately $14.2 million and $21.9 millionduring the years ended June 30, 2006 and 2005, respectively. These chargesare included in cost of gaming equipment and systems in the consolidatedstatements of operations (see Note 17).

*Other currentassets*

Deferred costs are chargedto cost of gaming equipment and systems when the related deferred revenue isrecognized. Prepaid and deferred royalties consist mainly of royalty andlicense fees paid for the use of third party trade names, celebrity likenesses,content, and other intellectual property rights. Royalties are expensed to costof gaming equipment and systems over the estimated period of expectedconsumption based on forecasted sales and placement schedules ranging from oneto five years. If a pattern cannot be reliably determined, such costs areexpensed using the straight-line method over the contract life.

*Restrictedlong-term investments*

The Company purchases U.S.Treasury Strip Securities for the benefit of jackpot winners who elect toreceive annual or weekly installment payments. These securities are held tomaturity and recorded at cost plus interest accretion to date in accordancewith FASB Statement of Financial Accounting Standards (“SFAS”) No. 115, *Accounting for Certain Investments in Debt and Equity Securities.*Suchsecurities are included in**restrictedlong-term investments in the consolidated balance sheets, and totaled $9.0million and $10.1 million as of June 30, 2006 and 2005, respectively.

*Property, plant andequipment and leased gaming equipment*

Property, plant and equipment is stated at cost anddepreciated over the estimated useful lives or lease term, if less, using thestraight line method as follows: buildings and improvements, 28 to 40 years;gaming equipment, 4 to 7 years; furniture, fixtures and equipment, 3 to 7years; and leasehold improvements, 5 to 10 years. Leased gaming equipment isstated at cost and depreciated over the estimated useful lives ranging from 2to 31⁄2 years.

Basedon historical data indicating a compression in the length of time certainleased gaming equipment was deployed, the Company re-evaluated the useful livesduring the fiscal quarter ended December 31, 2005, and reduced theremaining depreciable lives for certain of its products to two years andreduced the salvage values to zero. This change in estimate was recordedprospectively, resulting in an acceleration of 

F-8

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

$15.4million in depreciation expense during the year ended June 30, 2006. Property, plant and equipment and leased gamingequipment consist of the following:

| ** **                            | ** ** | **June 30,**  | ** ** |
|---------------------------------------|------------|--------------------|------------|
| ** **                            | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in 000s)** | ** ** |
| Land and land  improvements           |       | $                  | 19,476     |   | $ | 19,335 |   |
| Buildings and  leasehold improvements |       | 39,151             |       | 34,710 |   |
| Gaming equipment                      |       | 31,263             |       | 29,421 |   |
| Furniture,  fixtures and equipment    |       | 28,330             |       | 23,893 |   |
| Less accumulated  depreciation        |       | (49,756            | )          | (40,548 | ) |
| Property, plant and equipment, net    |       | $                  | 68,464     |   | $ | 66,811 |   |
| Leased gaming equipment               |       | $                  | 107,568    |   | $ | 94,345 |   |
| Less accumulated  depreciation        |       | (64,160            | )          | (42,495 | ) |
| Leased gaming  equipment, net         |       | $                  | 43,408     |   | $ | 51,850 |   |

 

*Depreciation andAmortization Expense*

For the fiscal years endedJune 30, 2006, 2005 and 2004, depreciation and amortization expensetotaled $67.2 million, $47.8 million and $31.4 million, respectively. Of theseamounts, $41.7 million, $27.3 million and $17.1 million of depreciation andamortization expense were included in cost of gaming equipment and systems inthe consolidated statements of operations.

*Impairment ofLong-Lived Assets*

The Company reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Recoverabilityof long-lived assets are measured by a comparison of the carrying amount of anasset to future net cash flows expected to be generated by the asset,undiscounted and without interest. If such assets are considered to beimpaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. TheCompany evaluates the carrying value of goodwill for impairment annually duringthe fourth quarter of each fiscal year, 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 goodwill and is recognized as a component ofincome from operations.

*Other IntangibleAssets*

Intangible assets consistprimarily of acquisition-related software and trademarks, which are amortizedover three to 13 years (see Note 6).

*Jackpot Liabilitiesand Expenses*

The Company recognizes aliability for jackpots not yet won and jackpot expense for the cost to fundjackpots in the future. Jackpots are payable either in weekly or annualinstallments over 20 years, or immediately in the case of instant winprogressive jackpots. Winners may elect to receive a single payment for thepresent value of a jackpot discounted at applicable interest rates in lieu ofannual installments. 

F-9

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Interest rates eligiblefor use in the single payment calculation vary by jurisdiction and are impactedby market forces and other economic conditions.

*Use of Estimates*

The preparation of theconsolidated financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates.

*Revenue recognition*

The Company derives revenues from the followingsources: 1) sale of gaming machines (Gaming Equipment), 2) sales ofcomputerized monitoring systems and related recurring hardware and softwaremaintenance revenue (Systems), 3) operation of wide-area progressive systems,and lease of gaming machines (Gaming Operations) and 4) Casino Operations.

Gaming and systemsrevenue is recognized in accordance with the provisions of The AmericanInstitute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”)No. 97-2, *Software RevenueRecognition,*as amended, and is recognized when all of the followinghave been satisfied:

·       Persuasiveevidence of an arrangement exists;

·       Deliveryhas occurred;

·       Thevendors’ fee is fixed or determinable; and

·       Collectibilityis probable.

The Company sells gaming machines and computerizedmonitoring systems either through credit terms of 120 days or less or withcredit terms that may extend up to five years under contracts of sale securedby the related equipment, with interest recognized at market rates. The Companyperforms a review of contracts, with extended payment terms in excess of sixmonths, to determine if there is sufficient history to conclude that theCompany has a history of collecting under the original payment terms. TheCompany has concluded that sufficient history exists to deem collectibilityprobable for extended payment term contracts of 24 months or less. Accordingly,revenue is recorded in accordance with the terms of sale for contracts withterms of 24 months or less, or as cash is received for contracts with paymentterms in excess of 24 months.

The Company also sells gaming devices underarrangements in which there are multiple elements, as that term is defined inSOP No. 97-2. Contracts may contain multiple elements such as acombination of gaming devices, central site monitoring equipment, systemssoftware, license fees and training.  TheCompany allocates revenue to each element based upon its fair value as determinedby “vendor specific objective evidence.” Vendor specific objective evidence of fair value for all elements of anarrangement is based upon the normal pricing and discounting practices forthose products and services, when sold separately. In addition, softwarelicense updates and product support services are measured by the renewal rateoffered to the customer.

F-10

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The Company recognizes revenue when the product isphysically delivered to a customer controlled location or over the period inwhich the service is performed and defers revenue for any undelivered elements.If the Company cannot objectively determine the fair value of any undeliveredelements included in the arrangement, all revenues are deferred until all ofthe elements are delivered and services have been performed, or until fairvalue can objectively be determined for any remaining undelivered element.

The majority of the Company’s software licensearrangements are non-perpetual and include software license updates and productsupport which are recognized ratably over the term of the arrangement,typically one year. Software license updates provide customers with rights tounspecified software product upgrades, maintenance and patches released duringthe term of the support period.  Themajority of the Company’s customers purchase both software and hardwaremaintenance and product support when they purchase the system. In addition,substantially all customers renew these maintenance agreements annually.  Revenue from multi-year licensing arrangementsare accounted for as subscriptions, with billings recorded as unearned revenueand recognized as revenue ratably over the billing coverage period, generallyone year.

The gaming operation division earns recurring revenuethat consists of the operation of wide-area progressive jackpot systems andrevenues from gaming machines placed in casinos 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 accordance withindustry practice, gaming revenues in our casino operations are recognized asthe net win from gaming machine operations, which is the difference betweencurrency deposited into the machines and the payouts made to the players.

*CapitalizedRegulatory Approval Costs*

In accordance with SFAS No. 86, *Accounting for the Costs of Computer Software to be Sold, Leased, orOtherwise Marketed,* internally generated software development costsassociated with new products and significant enhancements to existing softwareproducts are expensed as incurred until technological feasibility has beenestablished.

Bally Gaming and Systems incurs significant regulatoryapproval costs for its products. Such costs are capitalized once technologicalfeasibility has been established and are amortized generally over three yearsreflective of the estimated product life cycle. Product testing costs relatedto projects that are discontinued are expensed when such determination is made.Fees incurred for such regulatory approvals totaled approximately $7.7 millionand $8.9 million for the fiscal years ended June 30, 2006 and 2005,respectively. Of these amounts incurred, during the fiscal years ended June 30,2006 and 2005, the Company capitalized $0.03 million and $2.0 million,respectively, which was directly attributable to products. Amortization expensefor previously capitalized amounts totaled $1.4 million and $0.9 million,respectively.

The Company has a reviewprocess which includes a full review of the costs incurred and the nature andprospects of the related product. After costs are capitalized, they aremonitored to ensure they are earning revenues through product sales. Futurewrite-offs are possible if such products do not produce adequate cash flows.

F-11

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Promotionalallowances*

The Company accounts forpromotional allowances and other cash based incentives in accordance withEmerging Issues Task Force (“EITF”) Issue 00-22, “Accounting for ‘Points’and certain other Time-Based or Volume-Based Sales Incentive Offers, and OffersFor Free Products or Service to be Delivered in the Future.” EITF Issue 00-22requires that sales incentives such as cash rewards provided to player clubmembers be recorded as a reduction of revenue rather than as an operatingexpense. These incentives totaled $2.4 million, $3.2 million and $3.8 millionfor the years ended June 30, 2006, 2005 and 2004, respectively.

*Advertising costs*

The Company expensesadvertising costs as incurred, which totaled $10.8 million, $12.2 million and$11.3 million for the years ended June 30, 2006, 2005 and 2004,respectively.

*Warranty expense*

Gaming devices are typically sold with a 90-dayparts and labor warranty. For system sales, the Company provides severalafter-sale, value-added services to customers including customer educationprograms, a 24-hour customer service telephone hot-line, an Internet website for technical support, field service support programs, and spare partsprograms. Historical warranty expense as a percentage of Bally Gaming and Systemssegment revenues has been less than 1%, and is charged to cost of sales.Warranty expense is calculated using historical statistical data, and totaled$3.0 million, $1.0 million and $1.7 million for the years ended June 30,2006, 2005 and 2004, respectively.

Theactivity in the accrued warranty account, which is included in accruedliabilities on the balance sheet, is as follows:

| ** **                         | ** ** | **June 30,**  | ** ** |
|------------------------------------|------------|--------------------|------------|
| ** **                         | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(in 000s)** | ** ** |
| Balance at  beginning of year      |       | $                  | 489        |   | $ | 508 |   |
| Warranty costs  incurred           |       | (1,645             | )          | (813 | ) |
| Accrual for new  warranties issued |       | 2,609              |       | 794 |   |
| Balance at end of year             |       | $                  | 1,453      |   | $ | 489 |   |

 

*Research anddevelopment*

Research and developmentcosts are charged to expense as incurred.

*Deferred Revenue*

Deferred revenue consistsof amounts collected or billed in excess of recognizable revenue (see Note 8).

*Foreign currencytranslation*

The functional currency ofthe Company’s foreign subsidiaries is their local currency. Assets andliabilities of foreign operations are translated into U.S. dollars at the rateof exchange at the end of the period, and the income and expense accounts aretranslated at the average rate of exchange for the period. Translation 

F-12

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

adjustments are reflectedas a separate component of stockholders’ equity. Gains and losses on foreigncurrency transactions are included in the accompanying consolidated statementsof operations.

*Fair value offinancial instruments*

The fair value of afinancial instrument is the amount at which the instrument could be exchangedin a current transaction between willing parties, other than in a forced saleor liquidation. The carrying amounts reflected in the accompanying consolidatedbalance sheets for cash equivalents, accounts and notes receivable, investmentto fund jackpot liabilities, accounts payable, jackpot liabilities, accruedliabilities and variable rate long-term debt approximate their respective fairvalues.

*Income taxes*

Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of assets and liabilities andtheir respective tax basis. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in the period that includes the enactment date. Taxes on income ofthe Company’s foreign subsidiaries are provided at the tax rates applicable tothe tax jurisdictions in which they are located.

*Share-basedcompensation*

The Company adopted the provisions of SFAS No. 123R,*Share-Based Payment,* whichestablished accounting for equity instruments exchanged for employee serviceson July 1, 2005. SFAS No. 123R requires employee stock options andrights to purchase shares under stock participation plans to be accounted forunder the fair value method, and eliminates the ability to account for theseinstruments under the intrinsic value method prescribed by AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*. In March 2005, the Securitiesand Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107,*Share-Based Payment,*whichprovided interpretive guidance on SFAS No. 123R valuation methods,assumptions used in valuation models, and the interaction of SFAS No. 123Rwith existing SEC guidance. SAB No. 107 also requires the classificationof share-based compensation expense in the same financial statement line ascash compensation, and therefore, impacted the Company’s cost of gamingequipment and systems, casino operations (and related gross profits andmargins), research and development costs, and selling, general andadministrative expenses. The Company implemented SFAS No. 123R using themodified-prospective method and accordingly, financial statement amounts forthe prior periods presented have not been restated to reflect the fair valuemethod of expensing share-based compensation.

Additionally, SFAS No. 123Rrequires the excess tax benefit from stock-option exercises—tax deductions inexcess of compensation cost recognized—to be classified as a financing activity.Previously, all tax benefits from stock option exercises were classified asoperating activities. The Company has evaluated the provisions of SFAS No. 123R-3,*Transition Election Related to Accounting for TaxEffects of Share-Based Payment Awards*,**andhas elected the alternative method for establishing the Additional Paid-InCapital (“APIC”) pool. See Note 12 for further information on share-basedcompensation.

F-13

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Recently issuedaccounting pronouncements*

In February, 2007, FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*.SFAS No.159 provides companies with an option to report selected financialassets and liabilities at fair value. It also establishes presentation anddisclosure requirements to facilitate comparisons between companies usingdifferent measurement attributes for similar types of assets and liabilities.The statement is effective as of the beginning of the first fiscal yearbeginning after November 15, 2007. Earlier application is permittedprovided the Company also applies the provisions of Statement 157 *Fair Value Measurements*. The Company is currently in theprocess of evaluating the impact SFAS No. 159 will have on ourconsolidated results of operations, financial position and cash flows.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, which definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. SFAS No. 157 does not require any new fair valuemeasurements, rather it applies to existing accounting pronouncements thatrequire or permit fair value measurements. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007, and accordingly, the Companyexpects to adopt SFAS No. 157 beginning in fiscal 2009. The Company iscurrently evaluating the impact SFAS No. 157 will have on the consolidatedresults of operations, financial position and cash flows.

In September 2006, the SEC issued SAB No. 108,*Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*,providing guidance on how prior year misstatements should be taken intoconsideration when quantifying misstatements in current year financialstatements for purposes of determining whether the current year’s financialstatements are materially misstated. SAB No. 108 is effective for fiscalyears ending on or after November 15, 2006, and accordingly, the Companyexpects to adopt SAB No. 108 beginning in fiscal 2007. The Company doesnot expect SAB No. 108 will have an impact on the consolidated results ofoperations, financial position or cash flows.

In July 2006, the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, an interpretationof FASB Statement No. 109**, Accounting for Income Taxes*, which creates asingle model to address uncertainty in income tax positions and prescribes theminimum recognition threshold a tax position is required to meet before beingrecognized in the financial statements. It also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 is effective for fiscalyears beginning after December 15, 2006, and accordingly, the Companyexpects to adopt FIN 48 beginning in fiscal 2008. The Company is currentlyevaluating the impact FIN 48 will have on the consolidated results ofoperations, financial position and cash flows.

In June 2005, the FASB issued FASB Staff Position(“FSP”) No. 143-1, *Accounting forElectronic Equipment Waste Obligations,* to address accounting for obligations associated with theEuropean Union’s Directive 2002/96/EC on Waste Electrical and ElectronicEquipment. The Directive, enacted in 2003, requires EU-member countries toadopt legislation to regulate the collection, treatment, recovery, andenvironmentally sound disposal of electrical and electronic waste equipment.The Directive distinguishes between products put on the market after August 13,2005 as new waste and before that date as historical waste. FSP No. 143-1only addresses accounting for historical waste and is required to be applied tothe later of the first reporting period ending after June 8, 2005, or thedate of adoption of the law by the applicable European Union member country.  Adoption of FSP No. 143-1 did nothave a material impact on the consolidated results of operations, financialposition or cash flows.

F-14

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

In December 2004, the FASB issued SFAS No. 153,  *Exchangesof Nonmonetary Assets*, amending APB Opinion No. 29, *Accounting for Nonmonetary Transactions*. APBOpinion No. 29 treated nonmonetary exchanges of similar productive assetsas an exception from fair value measurement. SFAS No. 153 replaces thisexception with a general exception from fair value measurement for exchanges ofnonmonetary assets that do not have commercial substance. Nonmonetary exchangeshave commercial substance if the future cash flows of an entity are expected tochange significantly as a result of the exchange. SFAS No. 153 waseffective for nonmonetary asset exchanges occurring in fiscal years beginningafter June 15, 2005. Adoption of SFAS No. 153 did not have a materialimpact on the consolidated results of operations, financial position or cashflows.

In November 2004, theFASB issued SFAS No. 151, *InventoryCosts*, revising Accounting Research Bulletin No. 43, Chapter 4,*Inventory Pricing*, whichclarifies the accounting for abnormal amounts of idle facility expense,freight, handling costs and wasted material. SFAS No. 151 was effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. Adoption of SFAS No. 151 did not have a material impact on theconsolidated results of operations, financial position or cash flows.

**2. EARNINGS (LOSS) PERSHARE**

The Company calculates earnings per share inaccordance with SFAS No. 128, *Earnings Per Share*.Basic earnings per share is computed by dividing reported earnings by theweighted average number of common shares outstanding during the period. Dilutedearnings per share reflect the additional dilution from all potentiallydilutive securities such as stock options, restricted stock and warrants.

Thefollowing computation of basic and diluted earnings (loss) per share fromcontinuing operations and discontinued operations and income (loss) applicableto common shares for all periods presented is as follows:

| ** **                                               | ** ** | **Year Ended June 30,**                           | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(in 000s, except per share amounts)** | ** ** |
| Income (loss) from continuing operations                 |       | $                                                                | (47,195    | ) | $ | (17,909 | ) | $ | 38,999 |   |
| Income (loss)  from discontinued operations              |       | 1,124                                                            |       | (4,654 | ) | 40,889 |   |
| Net income (loss)                                        |       | $                                                                | (46,071    | ) | $ | (22,563 | ) | $ | 79,888 |   |
| Weighted average common shares outstanding               |       | 52,174                                                           |       | 51,114 |   | 50,113 |   |
| Effect of  dilutive securities                           |       | —                                                           |       | — |   | 1,135 |   |
| Weighted average  common and dilutive shares outstanding |       | 52,174                                                           |       | 51,114 |   | 51,248 |   |
| Earnings (loss)  per basic share:                        |       |                                                             |       |   |   |   |   |
| Income (loss)  from continued operations                 |       | $                                                                | (0.90      | ) | $ | (0.35 | ) | $ | 0.78 |   |
| Income (loss)  from discontinued operations              |       | 0.02                                                             |       | (0.09 | ) | 0.82 |   |
| Net income (loss)                                        |       | $                                                                | (0.88      | ) | $ | (0.44 | ) | $ | 1.60 |   |
| Earnings (loss)  per diluted share:                      |       |                                                             |       |   |   |   |   |
| Income (loss)  from continued operations                 |       | $                                                                | (0.90      | ) | $ | (0.35 | ) | $ | 0.76 |   |
| Income (loss)  from discontinued operations              |       | 0.02                                                             |       | (0.09 | ) | 0.80 |   |
| Net income (loss)                                        |       | $                                                                | (0.88      | ) | $ | (0.44 | ) | $ | 1.56 |   |

 

F-15

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Certainsecurities were excluded from the diluted per share calculation because theirinclusion would be anti-dilutive. For fiscal 2004, all options and warrantsoutstanding with an exercise price that exceeds the fair market value of theunderlying stock have been excluded. For fiscal 2006 and 2005, all potentiallydilutive securities were excluded from the calculation as the effect would havebeen anti-dilutive due to the net loss reported. Such securities consist of thefollowing: 

| ** **       | ** ** | **Year Ended June 30,** | ** ** |
|------------------|------------|----------------------------------------|------------|
| ** **       | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **       | ** ** | **(in 000s)**                     | ** ** |
| Stock options    |       | 8,913                                  |       | 6,342 |   |   | 680 |   |   |
| Warrants         |       | 100                                    |       | 100 |   |   | 100 |   |   |
| Restricted stock |       | 556                                    |       | 465 |   |   | — |   |   |
|             |       | 9,569                                  |       | 6,907 |   |   | 780 |   |   |

 

As of June 30, 2006and 2005, the Company also had certain related party debt outstanding which isconvertible into common stock at the Company’s discretion, the potentialdilution from which has not been included in the diluted loss per sharecomputation due to the reported net loss. No convertible debt was outstandingas of June 30, 2004. Assuming the conversion occurred on June 30,2006 and 2005, an additional 0.7 million and 1.0 million shares, respectively,would have been outstanding as a result of the conversion.

**3. BUSINESSCOMBINATIONS**

Under the purchase methodof accounting, the total purchase price of an acquisition is allocated to thenet tangible and intangible assets based upon their estimated fair marketvalues as of the date of the acquisition. The allocation of the purchase priceto goodwill and intangibles is based on a valuation of net assets (includinginventory and property, plant and equipment) and is based upon management’sestimates, including independent third-party valuations when necessary.

***SIERRA DESIGN GROUP (“SDG”)***

On March 2, 2004, theCompany purchased SDG, a supplier of Class II and Class III gamingdevices, systems and technology, for aggregate initial consideration ofapproximately $126.4 million. The initial purchase price consisted of $108.6million cash, 662,000 shares of common stock valued at $11.9 million, theassumption of approximately $8.0 million of debt and certain transaction feesand expenses. In addition, an earn out provision provided for the payment of upto $95.6 million in additional consideration upon certain financial targetsbeing achieved in the subsequent three-year period. In December 2004, theCompany and the selling shareholders renegotiated the earn out for a fixedamount of $40.0 million, consisting of a one-time cash payment of $12.0 millionand the issuance of a subordinated note of $28.0 million, due in annualinstallments through 2009. In June 2005, the Company extinguished $14.0 millionof the note and accrued interest thereon, by issuing approximately 1.0 millionshares of common stock to the note holders. The Company believes that theacquisition of SDG in March 2004 positions the Company to take advantageof significant opportunities in both the domestic and international markets,from the technological advances in traditional casino style gaming to the Class IIenvironments with central determination features.

F-16

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***MINDPLAY***

On February 19, 2004, the Company acquiredsubstantially all of the assets and liabilities of MindPlay LLC (“MindPlay”), aleading developer of advanced table game technologies, for aggregate initialconsideration of approximately $16.8 million. The initial purchase priceincluded $9.0 million cash, a $4.0 million note payable, the assumption ofapproximately $2.0 million of debt and the issuance of warrants to purchase100,000 shares of the Company’s common stock which were valued at approximately$0.9 million. In addition, an earn out provision provided for the payment of10% of the gross margin from the sale of MindPlay products in the first sevenyears subsequent to the acquisition, and 4.25% of the gross margin for the nextsix years, subject to adjustments pursuant to the conditions contained in thesale agreement. Additionally, the agreementprovided a right of offset of 50% of all damages (including reasonableattorneys’ fees) up to the entire amount due under the promissory note inconnection with an indemnification claim against the former shareholders ofMindPlay related to the Company’s patent lawsuit with Shuffle Master, Inc.(“Shuffle Master”) and International Game Technology (“IGT”) (see Note 19).

The MindPlay technologiesare designed to provide data and information to casino operators to improvecustomer service, provide enhanced security and increase profitability bylowering the cost of operation and enhancing the casino patron’s experience. Todate, the technologies have failed to meet management’s expectations in themarketplace (See Note 17).

**4. DISCONTINUEDOPERATIONS**

On October 14, 2004, the Company completed thesale of its interest in Video Services, Inc. (“VSI”) to Churchill DownsIncorporated. The net proceeds received totaled approximately $2.0 million,resulting in a gain of $0.8 million after tax.

On June 30, 2004, the Company completed the saleof United Coin Machine Co. (“United Coin”) to Century Gaming, Inc. andreceived approximately $100 million in cash and the assumption by CenturyGaming of approximately $5.0 million in debt. The Company reported a gain onthe sale before income taxes of $15.3 million, or $9.1 million after tax.

In September, 2004, a Federal District Court juryreached a verdict in a patent infringement case filed by Action Gaming, Inc.(“AGI”) and IGT. The jury awarded AGI and IGT an aggregate of approximately$7.4 million in damages related to a single, optional feature offered incertain multi-hand poker games provided solely by United Coin.

In March 2006, in another cased involving UnitedCoin, the U.S. Court of Appeals for the Ninth Circuit awarded United Coinapproximately $1.1 million in damages, fees, and costs in a contract disputewith a customer. Under the terms of the 2004 sale of United Coin, the Companyretained the right to continue to prosecute the case and to receive anyjudgment or other award. In May 2006, the customer paid a total of $1.7million in satisfaction of the award.

On May 3, 2004, the Company completed the sale ofthe Rail City Casino to The Sands Regent and received a total of $37.9 millionin cash. The Company reported a gain on the sale before income taxes of $23.1million, or $14.3 million after tax.

On June 30, 2003, the Company entered into adefinitive agreement for the sale of Bally Wulff for $16.5 million incash. The sale was consummated on July 18, 2003. The Company recorded acharge in June 2003 totaling $25.4 million, net of tax, representing thewrite down of the net carrying value of the Bally Wulff assets to the salesprice, including the recognition of previously recorded currency translation 

F-17

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

adjustments totaling $11.9 million. In June 2004,the Company was notified by the buyer of a claim made against the Companypursuant to an indemnity provision contained in the sale agreement. During theyear ended June 30, 2006, the Company paid claims totaling $2.0 million. Additionally,the Company has a remaining accrual of $0.9 million for potential taxassessments related to the pre-sale period, which the Company expects to beresolved by June 2007. Pursuant to the sale agreement, the Company isrequired to maintain a certificate of deposit as collateral for the tax claimdiscussed above which is included in other long-term assets, net. As of June 30,2006 and 2005 the amount of the deposit was approximately $1.2 million. Forthe year ended June 30, 2005, the Company reduced the deposit byapproximately $0.5 million and recognized a reduction in tax expenserelated to discontinued operations. The deposit was returned in February 2007.

All discontinued operations discussed above arepresented net of applicable income (loss) taxes within income from discontinuedoperations in the accompanying consolidated statements of operations.

Summaryoperating results for the discontinued operations for United Coin, VSI, RailCity and Bally Wulff are as follows:

| ** **                                   | ** ** | **Year Ended June 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                     | ** ** |
| Net revenues                                 |       | $                                      | —     |   | $ | 4,514 |   | $ | 257,142 |   |
| Operating income                             |       | —                                 |       | 358 |   | 30,668 |   |
| Loss on  litigation settlement, Nevada Route |       | —                                 |       | (7,361 | ) | — |   |
| Gain on  litigation settlement, Nevada Route |       | 1,729                                  |       | — |   | — |   |
| Income tax  (benefit) expense                |       | 605                                    |       | (3,350 | ) | 26,319 |   |
| Income (loss) from discontinued  operations  |       | $                                      | 1,124      |   | $ | (4,654 | ) | $ | 40,889 |   |

 

**5. ACCOUNTS ANDNOTES RECEIVABLE**

The Gaming Equipment and Systems business unit grantscustomers payment terms in the related sales contract. These credit terms arefor periods of 120 days to five years, with interest at prevailing rates, andare generally collateralized by the related equipment sold, although the valueof such equipment, if repossessed, may be less than the receivable balanceoutstanding. Contracts with credit terms beyond 24 months are deferred andrevenue is recognized as the payments are received.

Thefollowing table represents the activity for each of the years ended June 30,2006, 2005 and 2004 for each of the valuation reserve and allowance accounts:

| ** **                        | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions** | ** ** | **Net  Write-offs/  (Recoveries)** | ** ** | **Balance at  End of  Year** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|---------------|------------|------------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **(in 000s)**                           | ** ** |
| Allowance for doubtful  accounts: |       |                                         |       |          |       |                               |       |                                   |       |   |   |   |   |   |   |   |   |
| Year Ended  June 30, 2006    |       |                                         | $          | 10,340        |       |                               |       | $                                      | 1,483      |   |   |   | $ | 3,750 |   |   |   | $ | 8,073 |   |   |
| Year Ended  June 30, 2005    |       |                                         | $          | 9,035         |       |                               |       | $                                      | 5,134      |   |   |   | $ | 3,829 |   |   |   | $ | 10,340 |   |   |
| Year Ended June 30,  2004    |       |                                         | $          | 6,417         |       |                               |       | $                                      | 1,753      |   |   |   | $ | (865 | ) |   |   | $ | 9,035 |   |   |

 

 

F-18

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**6. GOODWILL ANDOTHER INTANGIBLE ASSETS**

In accordance with theCompany’s accounting policy, during the fiscal quarter ended June 30,2006, the Company evaluated the carrying value of goodwill and intangibleassets and determined that certain intangible assets were impaired and recordedan impairment charge of $15.6 million (see Note 17).

*Intangibles*

Intangibleassets consist of the following:

| ** **                             | ** ** | **Weighted  Average**           | ** ** | **June 30, 2006** | ** ** | **June 30, 2005**   | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Useful  Life  (Years)**       | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| ** **                             | ** ** | **(dollars in 000s)** | ** ** |
| Computer software                      |       |                            | 3-9        |                        |       | $                             | 27,067     |   |   | $ | (14,634 | ) |   | $ | 12,433 |   | $ | 25,864 |   |   | $ | (10,338 | ) |   | $ | 15,526 |   |
| License rights                         |       |                            | 3-5        |                        |       | 1,836                         |       |   | (876 | ) |   | 960 |   | 1,338 |   |   | (506 | ) |   | 832 |   |
| Capitalized  regulatory approval costs |       |                            | 3          |                        |       | 4,095                         |       |   | (3,122 | ) |   | 973 |   | 4,068 |   |   | (1,703 | ) |   | 2,365 |   |
| Trademarks                             |       |                            | 5          |                        |       | 2,203                         |       |   | (810 | ) |   | 1,393 |   | 6,688 |   |   | (574 | ) |   | 6,114 |   |
| Patents                                |       |                            | 13         |                        |       | —                        |       |   | — |   |   | — |   | 9,470 |   |   | (971 | ) |   | 8,499 |   |
| Non-compete  agreements                |       |                            | 6          |                        |       | —                        |       |   | — |   |   | — |   | 275 |   |   | (61 | ) |   | 214 |   |
| Customer  relationships                |       |                            | 5          |                        |       | —                        |       |   | — |   |   | — |   | 740 |   |   | (197 | ) |   | 543 |   |
| Core technology                        |       |                            | 8          |                        |       | 5,445                         |       |   | (1,588 | ) |   | 3,857 |   | 5,445 |   |   | (907 | ) |   | 4,538 |   |
| Contracts                              |       |                            | 10         |                        |       | 10,045                        |       |   | (2,351 | ) |   | 7,694 |   | 12,100 |   |   | (1,621 | ) |   | 10,479 |   |
| Other intangibles                      |       |                            | 7          |                        |       | 928                           |       |   | (582 | ) |   | 346 |   | 819 |   |   | (478 | ) |   | 341 |   |
| Total                                  |       |                            |       |                        |       | $                             | 51,619     |   |   | $ | (23,963 | ) |   | $ | 27,656 |   | $ | 66,807 |   |   | $ | (17,356 | ) |   | $ | 49,451 |   |

 

Amortization expense totaled $8.9 million, $8.6million and $5.8 million for the years ended June 30, 2006, 2005 and 2004,respectively. Computer software amortization expense totaled $4.3 million, $3.7million and $2.9 million for the years ended June 30, 2006, 2005 and 2004,respectively.

Futureamortization of intangible assets is scheduled as follows:

| **Year Ended June 30,** | ** ** | ** ** | ** ** | **(in 000s)** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|
| 2007                                   |       | 7,173      |       |
| 2008                                   |       | 4,977      |       |
| 2009                                   |       | 4,450      |       |
| 2010                                   |       | 3,955      |       |
| 2011                                   |       | 2,933      |       |
| Thereafter                             |       | 4,168      |       |
| Total                                  |       | $          | 27,656     |               |
|                                        |            |            |            |                    |            |  |

 

F-19

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Goodwill*

Thechanges in the carrying amount of goodwill for the years ended June 30,2006 and 2005 are as follows:

| ** **                                           | ** ** | **Total**          | ** ** |
|------------------------------------------------------|------------|--------------------|------------|
| ** **                                           | ** ** | **(in 000s)** | ** ** |
| Balance as of  June 30, 2004                    |       | $                  | 127,672    |   |
| Buyout of the SDG earn out (see Note 3)              |       | 40,000             |       |
| Tax effect of the  buyout of the earn out            |       | (4,070             | )          |
| Adjustments to  goodwill from prior year acquisition |       | (2,108             | )          |
| Foreign currency  translation adjustment             |       | (50                | )          |
| Balance as of  June 30, 2005                    |       | $                  | 161,444    |   |
| Adjustments to goodwill from prior year acquisition  |       | (346               | )          |
| Foreign currency  translation adjustment             |       | 205                |       |
| Balance as of  June 30, 2006                    |       | $                  | 161,303    |   |

 

Adjustments to goodwillduring fiscal 2005 primarily related to management’s final allocation andassessment based upon independent third-party valuations of the net assets ofacquired companies. Adjustments to goodwill in fiscal 2006 relate primarily toadjustments to certain acquisition-related deferred tax assets.

**7.OTHER CURRENT AND LONG-TERM ASSETS**

Othercurrent assets consist of the following:

| ** **                                   | ** ** | **June 30,**  | ** ** |
|----------------------------------------------|------------|--------------------|------------|
| ** **                                   | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in 000s)** | ** ** |
| Deferred cost of  revenues                   |       | $                  | 23,044     |   | $ | 18,277 |   |
| Prepaid expenses                             |       | 2,072              |       | 4,721 |   |
| Games placed on  trial at customer locations |       | 2,531              |       | 4,822 |   |
| Certificates of  deposit                     |       | 3,219              |       | 2,775 |   |
| Refundable  deposits                         |       | 774                |       | 1,358 |   |
| Other                                        |       | 9,673              |       | 1,081 |   |
| Total other  current assets                  |       | $                  | 41,313     |   | $ | 33,034 |   |

 

F-20

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Other long-term assetsconsist of the following:

| ** **                                                                           | ** ** | **June 30,**  | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                           | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                                                                           | ** ** | **(in 000s)** | ** ** |
| Long-term  deposits                                                                  |       | $                  | 781        |   | $ | 8,289 |   |
| Restricted cash                                                                      |       | 1,486              |       | 6,253 |   |
| Deferred debt  issuance costs (net of accumulated amortization of $3,683 and $2,332) |       | 3,717              |       | 5,067 |   |
| Deferred cost of  revenue                                                            |       | 14,659             |       | — |   |
| Royalties                                                                            |       | 737                |       | — |   |
| Other                                                                                |       | 848                |       | — |   |
| Total other  assets                                                                  |       | $                  | 22,228     |   | $ | 19,609 |   |

 

Deferred cost of revenuerelates primarily to the cost of game and system sales for which revenue isdeferred in accordance with SOP No. 97-2.

**8. DEFERRED REVENUE**

Deferred revenue relatesprimarily to revenue from games and system sales that is deferred in accordancewith SOP No. 97-2. Deferred revenue totaled $47.1 million and $41.0million, as of June 30, 2006 and 2005, respectively. The related deferred cost of such revenue isincluded in other current assets (see Note 7).

**9. ACCRUED ANDJACKPOT LIABILITIES**

Accruedliabilities and jackpot liabilities consist of the following:

| ** **                               | ** ** | **June 30,**  | ** ** |
|------------------------------------------|------------|--------------------|------------|
| ** **                               | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                               | ** ** | **(in 000s)** | ** ** |
| Payroll and  related costs               |       | $                  | 9,918      |   | $ | 7,635 |   |
| Interest                                 |       | 6,612              |       | 1,755 |   |
| Professional and  consulting fees        |       | 12,439             |       | 1,824 |   |
| Regulatory  approval cost accruals       |       | 1,697              |       | 944 |   |
| Royalties,  rebates, direct mail coupons |       | 5,853              |       | 4,929 |   |
| Customer deposits                        |       | 27,340             |       | 8,706 |   |
| Acquisition  related accruals            |       | 379                |       | 1,686 |   |
| Divestiture  related accruals            |       | 202                |       | 386 |   |
| Litigation  accruals (see Note 18)       |       | 7,701              |       | 7,360 |   |
| Severance  accruals (see Note 15)        |       | 198                |       | 1,290 |   |
| Other                                    |       | 13,792             |       | 7,323 |   |
| Subtotal                                 |       | 86,131             |       | 43,838 |   |
| Jackpots accrued  not yet awarded        |       | 13,139             |       | 13,025 |   |
| Total accrued  liabilities               |       | $                  | 99,270     |   | $ | 56,863 |   |

 

The Company recognizes a liability for jackpot expensefor the cost to fund jackpots in the future based on the theoretical liabilityincurred to date. Winners may elect to receive a single lump sum payment or may

F-21

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

opt to receive payments in equal installments over aspecified period of time. The Company currently estimates that approximately70% of winners will elect the single payment option.

The Company funds jackpotinstallment payments through qualifying United States government or agency securities.The present value of the outstanding progressive jackpot liabilities iscomputed based upon the payment stream, discounted at the applicable discountrate.

**10. LONG-TERM DEBT**

Long-termdebt consists of the following:

| ** **                               | ** ** | **June 30,**  | ** ** |
|------------------------------------------|------------|--------------------|------------|
| ** **                               | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                               | ** ** | **(in 000s)** | ** ** |
| Term loan  facility                      |       | $                  | 311,382    |   | $ | 314,882 |   |
| Related party  debt (see Note 11)        |       | 14,200             |       | 19,206 |   |
| Other, generally  unsecured              |       | 2,764              |       | 1,029 |   |
|                                     |       | 328,346            |       | 335,117 |   |
| Less current  maturities                 |       | 12,864             |       | 10,163 |   |
| Long-term debt,  less current maturities |       | $                  | 315,482    |   | $ | 324,954 |   |

 

On September 5, 2003, the Company completed asenior bank debt refinancing transaction (the “Refinancing”) whereby theCompany entered into a new $275.0 million term loan facility and a $125.0 millionrevolving credit facility. Proceeds from the financing were used to repay theexisting bank term loans totaling approximately $188.0 million, repay theCompany’s 10% Senior Subordinated Notes (“Subordinated Notes”), and to paytransaction fees and expenses totaling $5.0 million, which have beencapitalized and are being amortized over the remaining term of the loan. Theterm loan has a 1% per year mandatory principal amortization after the firstyear, and matures in September 2009. The revolving credit facility maturesin September 2009.

In December 2003, the Company increased the termloan by $75.0 million, to a total of $350.0 million outstanding. The proceedswere used primarily to fund the acquisition of SDG. As a result, the Companyincurred an additional $1.6 million in debt issuance costs, which werecapitalized and are being amortized over the remaining term of the loan.

As a result of the Refinancing described above, theCompany recorded a pre-tax charge in fiscal 2004 of $12.3 million, whichincluded a $5.0 million charge for the early extinguishment of the SubordinatedNotes, $7.0 million for the write off of deferred financing costs, and $0.3million in fees and expenses, which is classified as a loss on extinguishmentof debt in the accompanying statement of operations.

As a result of the sale of United Coin and Rail City,approximately 50% of the net proceeds (as defined in the loan agreementgoverning the term loan and revolving credit facility (the “Loan Agreement”))were used to reduce the term loan and revolver principal balances on a pro ratabasis. Accordingly, during fiscal 2005, the Company used the sale proceeds toreduce the term loan by $31.6 million and used additional excess cash to reducethe balance of the revolver from $70.0 million to zero.

In December 2004, the Company sought and receivedconsents from a majority of the holders of its bank debt which allowed it tocomplete the buyout of the SDG earn out (including the issuance of a $28.0 millionnote payable to former SDG shareowners), and to increase the maximum allowedleverage ratio to 

F-22

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

a maximum of 4.75 as of June 30, 2005, 4.50 as ofSeptember 30, 2005, 4.25 as of March 31, 2006, 4.00 as of September 30,2006, 3.75 as of December 31, 2006 and 3.50 as of September 30, 2007and through the remaining term of the loan agreement. The amendment alsoprovided for a reduction in the revolving credit facility commitment to $75.0million and an increase in the term loan interest rate to LIBOR plus 3.00%,which can be adjusted to LIBOR plus 3.75% based on certain credit rating andleverage ratio criteria. The fees incurred for the bank amendment totaled $1.0million, and the Company recorded a charge of $0.6 million to write off aportion of the previously capitalized fees, which is classified as a loss onextinguishment of debt. As of June 30, 2006, the term loan facility had aninterest rate of 8.18%, based on LIBOR plus 3.50%, and the revolving creditfacility had an interest rate of 7.43%, based on LIBOR plus 2.75%. As of June 30,2006, no borrowings were outstanding under the revolving credit facility.

The facility is collateralized by substantially alldomestic property and is guaranteed by each domestic subsidiary of the Company,other than the entity that holds the Company’s interest in its Louisiana andMississippi operations, and is secured by a pledge agreement. The LoanAgreement contains a number of maintenance covenants and other significantcovenants that, among other things, restrict the ability of the Company and theability of certain of its subsidiaries to dispose of assets, incur additionalindebtedness and issue preferred stock, pay dividends or make otherdistributions, enter into certain acquisitions, repurchase equity interests orsubordinated indebtedness, issue or sell equity interests of the Company’ssubsidiaries, engage in mergers or acquisitions, or engage in certaintransactions with subsidiaries and affiliates, and that otherwise restrict corporateactivities. The Company was in compliance with these covenants as of June 30,2006.

The Company was also in compliance with its financialcovenants consisting of leverage ratio, fixed charges coverage ratio, andminimum EBITDA (as that term is defined in the Loan Agreement). The leverageratio is computed as total average debt outstanding during the quarter dividedby the trailing 12 months EBITDA excluding certain cash and non-cash charges.The Company’s leverage ratio as of June 30, 2006 was 4.17 times versus anamended covenant maximum of 4.25 times.

Maturitiesof long-term debt, for each of the five fiscal years ending subsequent to June 30,2006, are as follows:

| **Year Ended June 30,** | ** ** | ** ** | ** ** | **(in 000s)** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|
| 2007                                   |       | $          | 12,864     |               |
| 2008                                   |       | 8,300      |       |
| 2009                                   |       | 6,300      |       |
| 2010                                   |       | 300,882    |       |
| Total                                  |       | $          | 328,346    |               |

 

In October 2006, the Company executed anamendment to its facility, which, among other things, (i) extendedthe due date for the  delivery of the Company’s audited financialstatements for the fiscal year ended June 30, 2006 to December 31,2006, (ii) provided that the Company delivered its quarterly reports on Form 10-Qfor the Fiscal Quarters ending on September 30, 2005, December 31,2005 and March 31, 2006 no later than December 31, 2006, (iii) modifiedthe definition of EBITDA to exclude up to $10.0 million of certain cashcharges, and (iv) clarified that the definition of EBITDA includesinterest income on trade receivables. The Company paid an administrative fee of$964,000, which was expensed in the quarter ended December 31, 2006, inexchange for the concessions granted under the amendment.

F-23

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

In December 2006, theCompany executed an additional amendment to its the facility, which extendedthe due date for the  delivery of the Company’s quarterly report onForm 10-Q for the Fiscal Quarter ended March 31, 2006 and itsaudited financial statements for the fiscal year endedJune 30, 2006 to March 15, 2007. The Company paid anadministrative fee of $1.2 million, which will be expensed in the quarter endedDecember 31, 2006, in exchange for the concessions granted under theamendment.

**11. RELATED PARTYTRANSACTIONS**

Asdiscussed in Note 3, the Company completed two acquisitions (MindPlay and SDG)in fiscal 2004. In each acquisition, a portion of the consideration includedsubordinated debt owed to the former principals of each business. The formerprincipals are now employees of the Company, and therefore, such debt isconsidered owed to related parties. The interest rates on the outstanding debtrange from a variable rate of LIBOR plus 2% to a fixed rate of 6%. See thetables below for outstanding debt and interest rates and total interest expensefor related party debt.

| ** **                                   | ** ** | **As of June 30,** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **Interest  Rate**                | ** ** | **Outstanding  Debt** | ** ** | **Interest  Rate** | ** ** | **Outstanding  Debt** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                | ** ** |
| SDG                                          |       |                              | 6.39       | % |   |   | $ | 11,200 |   |   |   | 4.42 | % |   |   | $ | 14,000 |   |   |
| MindPlay                                     |       |                              | 5.00       | % |   |   | 3,000 |   |   |   | 6.00 | % |   |   | 4,000 |   |   |
| MCC                                          |       |                              | 6.84       | % |   |   | — |   |   |   | 6.00 | % |   |   | 1,206 |   |   |
|                                         |       |                              |       |   |   |   | 14,200 |   |   |   |   |   |   |   | 19,206 |   |   |
| Less current  maturities                     |       |                              |       |   |   |   | 6,600 |   |   |   |   |   |   |   | 6,006 |   |   |
| Related party debt, less  current maturities |       |                              |       |   |   |   | $ | 7,600 |   |   |   |   |   |   |   | $ | 13,200 |   |   |

 

In March 2004, the Company purchased SDG. Theinitial purchase price included, among other consideration, the issuance of asubordinated note of $28.0 million. On June 28, 2005, the Company issuedapproximately 1.0 million shares of its common stock in connection with theconversion of $14.0 million of the subordinated debt and accrued interestthereon owed to the former principals of SDG. The remaining note payable to theformer SDG shareholders of $14.0 million is payable in installments through2009. At the Company’s discretion, the note principal and accrued interestthereon can be paid in cash, or can be converted into shares of the Company’scommon stock using the average stock price for the 20 business days prior tothe delivery of such shares.

In February 2004, the Company acquiredsubstantially all of the assets and liabilities of MindPlay. The initialpurchase price included, among other consideration, the issuance of a $4.0million note payable. As provided for in the acquisition agreement, the Companymay offset 50% of all damages (including reasonable attorneys’ fees) up to theentire amount due under the promissory note in connection with anindemnification claim against the former shareholders of MindPlay related tothe Company’s patent lawsuit with Shuffle Master and IGT which is describedbelow in Note 19, Commitments and Contingencies.

F-24

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Currentperiod related party interest expense is summarized below:

| ** ** | ** ** | **Year Ended June 30,** | ** ** |
|------------|------------|----------------------------------------|------------|
| ** ** | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** ** | ** ** | **(000s)**                             | ** ** |
| SDG        |       | $                                      | 761        |   | $ | 624 |   |   | $ | — |   |   |
| MindPlay   |       | 273                                    |       | 241 |   |   | 87 |   |   |
| MCC        |       | 25                                     |       | 95 |   |   | 35 |   |   |
|            |            |                                        |            |  |  |  |  |  |  |  |  |  |

 

Accrued related party interest totaled $0.5 millionand $0.3 million as of June 30, 2006 and 2005, respectively.

Maturities of related party debt, for each of the fivefiscal years ending subsequent to June 30, 2006, are as follows:

| **Year Ended June 30,** | ** ** | ** ** | ** ** | **(in 000s)** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|
| 2007                                   |       | $          | 6,600      |               |
| 2008                                   |       | 4,800      |       |
| 2009                                   |       | 2,800      |       |
| Total                                  |       | $          | 14,200     |               |

 

Pursuant to an Advisory Agreement with KirklandInvestment Corporation (100% owned by Joel Kirschbaum, a director of Bally atthe time the agreement was operative, and therefore, treated as arelated-party) dated July 1, 2004, the Company agreed to pay Kirkland$600,000 annually for a period of 3.5 years for advisory and related services. InAugust 2006, the Company made its last payment under the advisory agreementas a result of Mr. Kirschbaum’s death.

The Company also leases awarehouse and office facility from an entity owned by the Company’s ChiefTechnology Officer. Rental payments totaled $412,000 for each of the yearsended June 30, 2006 and 2005.

**12. SHARE-BASEDCOMPENSATION**

*Adoption of SFAS No. 123R,Share-Based Payment*

Effective July 1, 2005, the Company adopted theprovisions of SFAS No. 123R which established accounting for equityinstruments exchanged for employee services. SFAS No. 123R requires employeestock options and rights to purchase shares under stock participation plans tobe accounted for under the fair value method, and eliminates the ability toaccount for these instruments under the intrinsic value method prescribed byAPB Opinion No. 25. In March 2005, the SEC issued SAB No. 107, *which* provided interpretive guidance on SFAS No. 123Rvaluation methods, assumptions used in valuation models, and the interaction ofSFAS No. 123R with existing SEC guidance. SAB No. 107 also requiresthe classification of share-based compensation expense in the same financialstatement line as cash compensation, and therefore, impacted the Company’s costof gaming equipment and systems, casino operations (and, related gross profitsand margins), research and development costs, and selling, general andadministrative expenses. The Company implemented SFAS No. 123R on July 1,2005 using the modified-prospective method, and accordingly, financialstatement amounts for the prior periods presented have not been restated toreflect the fair value method of expensing share-based compensation.

F-25

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Additionally, SFAS No. 123Rrequires the excess tax benefit from stock-option exercises—tax deductions inexcess of compensation cost recognized—to be classified as a financing activity.Previously, all tax benefits from stock option exercises were classified asoperating activities. The Company has evaluated the provisions of SFAS No. 123R-3,*Transition Election Related to Accounting for TaxEffects of Share-Based Payment Awards*,**andhas elected the alternative method for establishing the APIC pool.

*Share-Based AwardPlans*

In December 2001, the Company’s shareholdersapproved the 2001 Long-Term Incentive Plan, which has been amended severaltimes (the “2001 Plan”). The 2001 Plan, as amended, provides for the issuanceof up to 10,550,000 shares of common stock to Company employees, directors anddesignated paid consultants, up to 900,000 of which shares may be granted inthe form of restricted stock or Restricted Stock Units (“RSUs”).

On June 13, 2005, the Board of Directors of theCompany approved the accelerated vesting of unvested stock options held by theCompany’s employees, officers and directors with an exercise price of $15.00 orhigher. This accelerated vesting affected options for approximately 2.4 millionshares of the Company’s common stock. In order to prevent unintended personalbenefits to individuals resulting from the accelerated vesting of options, theCompany imposed sales restrictions on shares acquired upon exercise of theseoptions that parallel the vesting requirements of the original options.

The decision to accelerate vesting of these underwaterstock options was made primarily to avoid recognizing compensation expenseunder SFAS No. 123R. Because the exercise price of the options subject tothe accelerated vesting was above the market price of the stock on the date ofacceleration, the Company determined that these options did not offer asufficient incentive to employees when compared to the potential futurecompensation expense that the Company would incur under SFAS No. 123R withrespect to these options.

Currentperiod stock option activity as of and for the year ended June 30, 2006 issummarized below:

| ** **                                    | ** ** | **Weighted Average** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|
| ** **                                    | ** ** | **Shares**                | ** ** | **Exercise  Price** | ** ** | **Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| ** **                                    | ** ** | **(in 000s)**        | ** ** | **(per share)** | ** ** | **(years)** | ** ** | **(in 000s)** | ** ** |
| Balance  outstanding as of June 30, 2005 |       |                      | 8,196      |   |   |   | $ | 14.72 |   |   |   |   |   |   |   | $ | 18,224 |   |   |
| Granted                                       |       |                      | 2,037      |   |   |   | 14.39 |   |   |   |   |   |   |   | — |   |   |
| Exercised                                     |       |                      | (138       | ) |   |   | 7.83 |   |   |   |   |   |   |   | — |   |   |
| Forfeited or expired                          |       |                      | (455       | ) |   |   | 17.76 |   |   |   |   |   |   |   | — |   |   |
| Balance  outstanding as of June 30, 2006 |       |                      | 9,640      |   |   |   | $ | 14.61 |   |   |   | 6.41 |   |   |   | $ | 32,290 |   |   |
| Exercisable as of  June 30, 2006         |       |                      | 5,686      |   |   |   | $ | 15.80 |   |   |   | 5.28 |   |   |   | $ | 18,073 |   |   |

 

F-26

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Currentperiod restricted stock and RSU activity as of and for the year ended June 30,2006 is summarized below:

| ** **                                    | ** ** | ** **         | ** ** | **Weighted Average**        | ** ** |
|-----------------------------------------------|------------|--------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **Shares**         | ** ** | **Grant  Date Fair  Value** | ** ** |
| ** **                                    | ** ** | **(in 000s)** | ** ** | **(per share)**             | ** ** |
| Balance  outstanding as of June 30, 2005 |       |               | 554        |                             |       |   | $ | 15.58 |   |   |
| Granted                                       |       |               | 93         |                             |       |   | 15.07 |   |   |
| Exercised                                     |       |               | —     |                             |       |   | — |   |   |
| Forfeited or expired                          |       |               | —     |                             |       |   | — |   |   |
| Balance  outstanding as of June 30, 2006 |       |               | 647        |                             |       |   | $ | 15.51 |   |   |
| Vested as of  June 30, 2006              |       |               | 214        |                             |       |   | $ | 15.10 |   |   |

 

The following isadditional information about stock options exercised, granted and vested duringthe periods:

| ** **                                             | ** ** | **Year Ended June 30,**                       | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(in 000s, except per share  amounts)** | ** ** |
| Weighted average  fair value per share:                |       |                                                         |       |   |   |   |   |
| Options granted                                        |       | $                                                            | 8.76       |   | $ | 7.49 |   | $ | 9.03 |   |
| Options vested                                         |       | $                                                            | 7.59       |   | $ | 8.49 |   | $ | 7.53 |   |
| Restricted stock  and RSU’s vested                |       | $                                                            | 15.28      |   | $ | 11.30 |   | $ | — |   |
| Exercises under all share-based payment  arrangements: |       |                                                         |       |   |   |   |   |
| Total intrinsic value                                  |       | $                                                            | 1,138      |   | $ | 1,601 |   | $ | 13,424 |   |
| Cash received                                          |       | $                                                            | 1,074      |   | $ | 1,099 |   | $ | 7,298 |   |
| Tax benefit  realized                                  |       | $                                                            | 1,133      |   | $ | 1,215 |   | $ | 11,628 |   |

 

*Shares Reserved*

Thefollowing shares are reserved for options issued and available for issue underthe Company’s stock plans (in 000s):        

| Stock options,  restricted stock and RSU’s issued and currently outstanding |   | 10,287 |   |
|----------------------------------------------------------------------------------|--------|--------|--------|
| Stock options  available for future issuance                                     |   | 1,121  |   |
| Warrants                                                                         |   | 100    |   |
| Total                                                                            |   | 11,508 |   |

 

 

F-27

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Share-BasedCompensation*

Under the provisions of SFAS No. 123R,share-based compensation cost is measured at the grant date, based on thecalculated fair value of the award, and is recognized as an expense over theemployee’s requisite service period (generally the vesting period of the equitygrant). Prior to July 1, 2005, the Company accounted for share-basedcompensation to employees in accordance with APB Opinion No. 25 andrelated interpretations. The Company also followed the disclosure requirementsof SFAS No. 123, *Accounting forStock-Based Compensation*, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*.

Thefollowing table presents share-based compensation expense included in theCompany’s consolidated statements of operations: 

| ** **                                   | ** ** | **Year Ended June 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(in 000s)**                     | ** ** |
| Selling, general  and administrative         |       | $                                      | 11,747     |   | $ | 2,125 |   |   | $ | — |   |   |
| Research and  development                    |       | 1,077                                  |       | — |   |   | — |   |   |
| Cost of gaming  and equipment                |       | 95                                     |       | — |   |   | — |   |   |
| Share-based  compensation expense before tax |       | 12,919                                 |       | 2,125 |   |   | — |   |   |
| Income tax benefit                           |       | 4,522                                  |       | 510 |   |   | — |   |   |
| Net share-based  compensation expense        |       | $                                      | 8,397      |   | $ | 1,615 |   |   | $ | — |   |   |

 

Included in share-based compensation expense in thecondensed consolidated statements of operations for the years ended June 30,2006 and 2005 of restricted stock unit amortization is $3.5 million and $2.1million, respectively.

As of June 30, 2006, there was $24.7 million oftotal unrecognized compensation expense related to the stock options that havenot vested which will be recognized over the next 4.75 years.

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

The fair value of each option granted during thecorresponding period was estimated on the grant date using the Black-Scholesoption-pricing model with the following assumptions:

| ** **                       | ** ** | **Year Ended June 30,** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted Average:                |       |                                   |       |   |   |   |   |
| Expected option  term (in years) |       | 6.21                                   |       | 6.25 |   | 8.73 |   |
| Expected  volatility             |       | 61.00                                  | %          | 62.00 | % | 26.00 | % |
| Risk-free  interest rate         |       | 4.13                                   | %          | 3.5 | % | 2.5 | % |
| Expected annual dividend  yield  |       | 0                                      | %          | 0 | % | 0 | % |

 

F-28

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Expected option term was determined using theshort-cut method for estimating expected option life.  Expected volatility is based on historicalmarket factors related to the Company’s common stock. Risk-free interest rateis based on U.S. Treasury rates appropriate for the expected term.

Prior to July 1, 2005, the Company accounted forshare-based compensation to employees in accordance with APB Opinion No. 25,and accordingly, did not recognize compensation expense for employeeshare-based awards for the years ended June 30, 2006 and 2005, as theexercise price of the Company’s employee stock awards equaled the market priceof the underlying stock on the date of grant.

Priorto fiscal 2006, the Company had previously adopted the provisions of SFAS No. 123,as amended by SFAS No. 148 through disclosure only. The following tableillustrates the effects on net loss and loss per share for the years ended June 30,2005 and 2004, as if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to share-based employee awards:

| ** **                                      | ** ** | **Year Ended June 30,**                        | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                                      | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in 000s, except per share data)** | ** ** |
| Reported net  income (loss)                     |       | $                                                             | (22,563    | ) | $ | 79,888 |   |
| Reported  stock-based compensation, net of tax  |       | 1,615                                                         |       | — |   |
| Pro forma  stock-based compensation, net of tax |       | (25,147                                                       | )          | (5,377 | ) |
| Pro forma net income (loss)                     |       | $                                                             | (46,095    | ) | $ | 74,511 |   |
| Earnings (loss)  per share:                     |       |                                                          |       |   |   |
| Basic—as reported                          |       | $                                                             | (0.44      | ) | $ | 1.60 |   |
| Basic—pro forma                            |       | $                                                             | (0.90      | ) | $ | 1.49 |   |
| Diluted—as reported                        |       | $                                                             | (0.44      | ) | $ | 1.56 |   |
| Diluted—pro forma                          |       | $                                                             | (0.90      | ) | $ | 1.45 |   |

 

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

*Warrants*

In February 2004, theCompany completed the acquisition of substantially all of the assets ofMindPlay. 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 warrantswere valued at $886,000, and were included as part of the purchase price.

*Share RepurchasePlan*

In January 1999, theCompany’s Board of Directors approved a share repurchase plan for up to 4.6million shares of its common stock. Under the plan, subject to price and marketconditions, purchases of shares can be made from time to time in the openmarket or in privately negotiated transactions using available cash. During theyears ended June 30, 2006 and 2005, the Company repurchased no shares and13,000 shares of common stock, respectively.

*Stockholder RightsPlan*

In February 1998, theCompany’s Board of Directors adopted a Stockholder Rights Plan (the “Plan”).The Plan is designed to preserve the long-term value of the shareholders’investment in the Company. Pursuant to the Plan, each shareholder received adistribution of one right for each share of the Company’s outstanding commonstock of record on March 12, 1998. Each right expires on March 12,2008, and entitles 

F-29

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

the holder to purchase oneone-hundredth (1/100) of a share of a Series F Special Stock for $87.50.Initially the rights are represented by the Company’s common stock certificatesand are not exercisable. The rights become exercisable only after a person orgroup acquires beneficial ownership of 10% or more of the Company’s commonstock (or 15%, if the acquirer is an institutional investor) or publiclyannounces its intention to commence a tender offer that would result in thatbeneficial ownership level. Under certain circumstances involving a buyer’sacquisition of 10% of the Company’s common stock (or 15%, in the case of aninstitutional investor), all rights holders except the buyer will be entitledto purchase common stock at half price. If the Company is acquired through amerger, after such an acquisition, all rights holders, except the buyer, willbe entitled to purchase stock in the buyer at half price. The Company mayredeem the rights at $0.0035 at any time before a buyer acquires 10% (or 15%,in the case of an institutional investor) of the Company’s common stock.

*Special Stock*

The Company’s Articles of Incorporation authorize theissuance of up to 10,000,000 shares of special stock (“Special Stock”). The SpecialStock may be issued from time to time in one or more series, each having suchdesignations, preferences and relative, participating, optional or otherspecial rights, qualifications, limitations or restrictions as shall be statedand expressed in the resolution providing for the issuance of Special Stock orany series thereof adopted by the Board of Directors. Special Stock consists ofnon-voting stock where no holder of the Special Stock shall be entitled to voteat any meeting of stockholders or otherwise, except as may be specificallyprovided by law or as approved by the Board of Directors in certain limitedcircumstances at the time of the stock issuance.

To date, there have beenfour series of Special Stock authorized for issuance:  the Initial Series, the Series B, the Series Eand the Series F. In June 1996, the Company issued shares of Series ESpecial Stock to certain holders of the Company’s 71⁄2% Convertible SubordinatedDebentures (which were retired in 1996) who elected to receive such stock inlieu of receiving common stock. The holders of shares of Series E SpecialStock have no voting rights except as required by law. A total of 115 shares ofSeries E Special Stock remain outstanding.

**14. INCOME TAXES**

The components ofthe Company’s income tax benefit (expense) from continuing operations are asfollows:

| ** **                                               | ** ** | **Year Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(in 000s)**                     | ** ** |
| Current tax benefit  (expense):                          |       |                                   |       |   |   |   |   |
| Federal                                                  |       | $                                      | 123        |   | $ | (611 | ) | $ | 192 |   |
| Foreign                                                  |       | (647                                   | )          | (999 | ) | (683 | ) |
| State                                                    |       | (59                                    | )          | 727 |   | (1,303 | ) |
|                                                     |       | (583                                   | )          | (883 | ) | (1,794 | ) |
| Deferred tax benefit  (expense):                         |       |                                   |       |   |   |   |   |
| Federal                                                  |       | 23,508                                 |       | 5,965 |   | (15,913 | ) |
| Foreign                                                  |       | 715                                    |       | (229 | ) | — |   |
| State                                                    |       | 372                                    |       | 339 |   | (3,397 | ) |
|                                                     |       | 24,595                                 |       | 6,075 |   | (19,310 | ) |
| Income tax benefit  (expense) from continuing operations |       | $                                      | 24,012     |   | $ | 5,192 |   | $ | (21,104 | ) |

 

F-30

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Areconciliation of the Company’s income tax provision as compared to the taxprovision for continuing operations calculated by applying the statutory federaltax rate (35%) to the income (loss) from continuing operations before incometaxes are as follows:

| ** **                                               | ** ** | **Year Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(in 000s)**                     | ** ** |
| Computed expected  income tax (benefit) expense at 35%   |       | $                                      | (23,555    | ) | $ | (6,779 | ) | $ | 21,844 |   |
| Partnership  income attributable to minority interest    |       | (557                                   | )          | (1,306 | ) | (808 | ) |
| State income  taxes, net of federal benefit              |       | (897                                   | )          | (149 | ) | 2,987 |   |
| Foreign earnings  subject to U.S. tax                    |       | 835                                    |       | 572 |   | 463 |   |
| Change in  valuation allowance                           |       | 175                                    |       | 2,149 |   | (1,809 | ) |
| Net increase in  accrual for potential tax contingencies |       | —                                 |       | 3,049 |   | 564 |   |
| Tax credits                                              |       | (198                                   | )          | (3,018 | ) | (3,120 | ) |
| Extraterritorial  income deduction                       |       | (1,392                                 | )          | (105 | ) | — |   |
| Other, net                                               |       | 1,577                                  |       | 395 |   | 983 |   |
|                                                     |       | $                                      | (24,012    | ) | $ | (5,192 | ) | $ | 21,104 |   |

 

Themajor components of the deferred tax assets and liabilities are as follows:

| ** **                                          | ** ** | **June 30,**  | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **2006**           | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **(in 000s)** | ** ** |
| Deferred tax assets:                                |       |               |       |   |   |
| Net operating loss  carryforwards                   |       | $                  | 20,490     |   | $ | 23,789 |   |
| Capital loss  carryforwards                         |       | 8,990              |       | 9,025 |   |
| Foreign tax credit carryforwards                    |       | 410                |       | 231 |   |
| Other tax credits                                   |       | 11,841             |       | 11,811 |   |
| Deferred revenue, net of  cost of goods sold        |       | 10,154             |       | 8,509 |   |
| Inventory obsolescence  reserves                    |       | 5,326              |       | 4,050 |   |
| Deferred compensation for  tax purposes             |       | 4,730              |       | 4,780 |   |
| Share-based compensation                            |       | 5,031              |       | — |   |
| Financing lease assets                              |       | 1,808              |       | 1,827 |   |
| Bad debt reserves                                   |       | 2,370              |       | 4,227 |   |
| Intangible assets                                   |       | 5,645              |       | — |   |
| Accruals not currently  deductible for tax purposes |       | 21,420             |       | 13,471 |   |
| Other                                               |       | 1,652              |       | 2,511 |   |
| Total gross deferred tax  assets                    |       | 99,867             |       | 84,231 |   |
| Less: Valuation allowance                           |       | (11,350            | )          | (11,174 | ) |
| Deferred tax assets                                 |       | $                  | 88,517     |   | $ | 73,057 |   |
| Deferred tax liabilities:                           |       |               |       |   |   |
| Property and equipment                              |       | $                  | 4,905      |   | $ | 6,677 |   |
| Intangible assets                                   |       | 9,001              |       | 10,811 |   |
| Deferred lease revenue                              |       | 61                 |       | 5,130 |   |
| Other                                               |       | 3,128              |       | 3,007 |   |
| Total gross deferred tax  liabilities               |       | 17,095             |       | 25,625 |   |
| Net deferred tax assets                             |       | $                  | 71,422     |   | $ | 47,432 |   |

 

F-31

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The Company has not provided income taxes onapproximately $2.6 million of undistributed earnings from certain foreignsubsidiaries. The Company plans to invest the earnings in the foreignsubsidiaries and therefore has not recorded a deferred tax liability associatedwith the undistributed earnings.

At June 30, 2006, the Company had net operatingloss carryforwards for U.S. federal income tax purposes of approximately $53.7million subject to limitations under Section 382 of the Internal RevenueCode (“Section 382”). Section 382 limits the amount of lossesavailable per year for use against future taxable income. Based on the Company’sprojections of taxable income, the Company expects to utilize 100% of its netoperating loss carryforwards. The Company also has capital loss carryforwardsof approximately $25.4 million. Capital losses can be carried forward5 years and offset future fixable capital gains. The Company’s capitalloss carryforwards begin to expire in 2007.

The Company’s net operating loss carryforwards willbegin to expire in 2022. At June 30, 2006, the Company had $0.4 million inforeign tax credit carryforwards, Alternative Minimum Tax (“AMT”) creditcarryforwards of approximately $3.6 million, and a research and development taxcredit carry forward of approximately $11.2 million. Foreign tax credits have a100% valuation allowance as the Company does not expect to be able to utilizethese credits before their expiration. AMT credits are available to be carriedforward indefinitely and may be utilized against regular U.S. corporate tax tothe extent it does not exceed computed AMT calculations. Research and developmentalcredits have a carry forward period of 20 years and begin to expire in 2015. TheCompany expects to utilize all of its AMT and research and development taxcredits.

F-32

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**15. SUPPLEMENTALCASH FLOW INFORMATION**

Thefollowing supplemental information is related to the consolidated statements ofcash flows:

| ** **                                                                                           | ** ** | **Year Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                           | ** ** | **(in 000s)**                     | ** ** |
| Cash paid for  interest                                                                              |       | $                                      | 22,333     |   | $ | 17,509 |   | $ | 23,967 |   |
| Cash paid for  income taxes                                                                          |       | 2,322                                  |       | 1,901 |   | 4,954 |   |
| Non-cash  investing and financing transactions:                                                      |       |                                   |       |   |   |   |   |
| Reclassify  property, plant and equipment to inventory                                               |       | 12,127                                 |       | 9,923 |   | 7,732 |   |
| Inventory in  transit                                                                                |       | 1,563                                  |       | — |   | — |   |
| Capital leases                                                                                       |       | 2,881                                  |       | — |   | — |   |
| Notes payable  issued in acquisitions                                                                |       | —                                 |       | 28,000 |   | 4,000 |   |
| Value of  restricted stock issued in partial satisfaction of subordinated debt and  accrued interest |       | —                                 |       | 14,312 |   | — |   |
| Value of  restricted stock issued in SDG acquisition                                                 |       | —                                 |       | — |   | 11,949 |   |
| Value of restricted  stock issued to employees                                                       |       | 3,491                                  |       | 2,314 |   | 6,500 |   |
| Value of warrants  issued in MindPlay acquisition                                                    |       | —                                 |       | — |   | 886 |   |
| Consolidation of  variable interest entities                                                         |       | (1,098                                 | )          | 6,044 |   | — |   |
| Deferred taxes/goodwill  adjustments related to SDG acquisition                                      |       | —                                 |       | 6,124 |   | — |   |
|                                                                                                      |            |                                        |            |  |  |  |  |  |  |  |

 

**16. RESTRUCTURINGCHARGES**

During fiscal 2005, the Company undertook a review ofits operations and reduced its workforce during the September 2004 quarterand the March 2005 quarter. As a result of these reductions in workforce,the Company incurred charges totaling $3.7 million for the year ended June 30,2005, which is primarily related to the Gaming and Systems segment. The balanceof the accrued liability for unpaid severance costs is as follows:

| ** **                | ** ** | **2006**           | ** ** | **2005** | ** ** |
|---------------------------|------------|--------------------|------------|----------|------------|
| ** **                | ** ** | **(in 000s)** | ** ** |
| Beginning balance         |       | $                  | 1,290      |     | $          | — |   |
| Additions to the  accrual |       | —             |       | 3,654    |       |
| Amounts paid              |       | 835                |       | 2,364    |       |
| Ending balance            |       | $                  | 455        |     | $          | 1,290 |   |

 

The workforce reductioncompleted in the March 2005 quarter included a change in the Company’sEuropean distribution operations. The Company has accrued a tax liability of$1.4 million for the estimated tax obligation resulting from thisrestructuring.

**17.  **IMPAIRMENT CHARGES

As a result of a change in the Company’s brandingstrategy and a review of its overall operations during the year ended June 30,2006, the Company determined that certain of its acquired intangible assetsrelated to tradenames and other intellectual property used by Bally Equipmentand Systems were no longer recoverable. TheCompany evaluated the carrying value of these assets and determined thatseveral were impaired. Consequently, the Company recorded an impairmentcharge of $4.5 million related to indefinite 

F-33

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

lived intangible assets, consisting of the SDG trade name,and an impairment charge of $11.1 million related to finite lived intangibleassets, primarily consisting of acquired patents.

During the year ended June 30, 2005, the Companyperformed a review of its intellectual property rights for various games usedon certain legacy platforms. This review resulted from the declining sales ofthese legacy games during fiscal 2005. The Company evaluated the carrying valueof certain intellectual property assets and determined that several were nolonger recoverable and were, therefore, deemed to be impaired. The impairmentcharge totaled $1.3 million.

The Company entered intoan agreement during fiscal 2004 to provide a development loan to a NativeAmerican tribe to further their pursuit of developing a gaming facility. Theamounts advanced under the terms of the loan totaled $1.5 million, and theCompany was not obligated for any additional advances. During the quarter endedMarch 31, 2005, the tribe received an adverse court ruling which theCompany determined materially impaired the tribe’s ability to repay the loan. Therefore,the Company recorded an impairment charge for the full amount of the loanduring the year ended June 30, 2005.

**18. INVENTORY ANDRELATED ASSET WRITE-DOWNS**

In fiscal 2005, the Company faced declining demand forgaming devices based on our legacy platform, and therefore, reassessed thisparticular portion of our inventory. In October 2004, a strategic decisionwas made to move to our new Alpha OS platform, which was made commerciallyavailable in April 2005 in most markets.

The decision to move to the a new technology platform,the targeting of used equipment for non-domestic markets, and the consolidationof certain warehouses all led to accelerated disposals of legacy products inboth fiscal 2006 and 2005. The Company regularly updates estimates for the netrealizable value of inventories due to the subjectivity involved in projectingsales volumes, used game sales values, refurbishment costs, and customer demandin non-domestic jurisdictions.

We regularly review inventory quantities and values. Thisprocess includes examining the carrying values of new and used gaming devices,parts and ancillary equipment in comparison to the current fair market valuesfor such equipment (less costs to sell or dispose). Some of the factorsinvolved in this analysis include the overall levels of our inventories, thecurrent and projected sales levels for such products, the projected markets forsuch products both domestically and internationally, the costs required to sellthe products, including refurbishment costs and importation costs forinternational shipments, and the overall projected demand for products once thenext generation of products are scheduled for release.

**As aresult of the Company’s ongoing analysis of inventory valuations, the Company recognizedinventory write-downs totaling $14.2 million and $21.9 million during the yearended June 30, 2006 and 2005, respectively, which are included in cost ofgaming equipment and systems in the accompanying consolidated statements ofoperations.**

During the quarter ended March 31, 2006, theCompany determined certain of its leased gaming equipment was no longerdeployable as a result of a shifting market demand towards newer products thatincorporate more innovative features. As a result, the Company committed to aplan to abandon certain of these assets. The Company recorded an abandonmentcharge of $1.0 million.

The Company also recordeda write-down of leased gaming equipment totaling $3.2 million during the yearended June 30, 2005.

F-34

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**19. COMMITMENTS ANDCONTINGENCIES**

*Commitments*

The Company is obligated under several agreements topay certain royalties ranging from approximately $100 to $2,300 per applicablegame depending on the components in the gaming machines. Total royalty expensefor the Company for the years ended June 30, 2006, 2005 and 2004 was $19.9million, $16.7 million and $9.4 million, respectively, and isincluded in the cost of gaming equipment and systems in the accompanyingconsolidated statements of operations. In addition, the Company has obtainedthe rights to certain game themes and intellectual property that call forpayment of royalties based on either fixed amounts or variable amounts based ongame performance. The Company also pays approximately $0.7 millionannually for the use of the Bally trademark.

TheCompany leases certain office space, equipment, warehouse and repair facilitiesand other property locations under non-cancelable operating leases which aregenerally included in the selling, general and administrative expense. Operatingrental expense is as follows:  

| ** **                        | ** ** | **Year Ended June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in 000s)**                     | ** ** |
| Continuing Operations:            |       |                                   |       |   |   |   |   |
| Equipment and office space leases |       | $                                      | 4,820      |   | $ | 6,257 |   | $ | 4,953 |   |
| Sublease rental income            |       | (434                                   | )          | — |   | — |   |
| ** **                        |       | $                                      | 4,386      |   | $ | 6,257 |   | $ | 4,953 |   |

 

| ** **                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discontinued Operations:          |       |     |       |     |       |     |       |   |   |   |   |
| Contingent route location leases  |       |     | $          | —   |       |     |       | $ | — |   |   | $ | 147,062 |   |
| Fixed route location leases       |       |     | —     |     |       |     | —     |   |   | 17,326 |   |
| Equipment and office space leases |       |     | —     |     |       |     | —     |   |   | 1,170 |   |
|                              |       |     | —     |     |       |     | —     |   |   | 165,558 |   |
| Sublease rental income            |       |     | —     |     |       |     | —     |   |   | — |   |
| ** **                        |       |     | $          | —   |       |     |       | $ | — |   |   | $ | 165,558 |   |

 

During fiscal 2005 and 2004, the Company had locationswhere the Company operated gaming devices (“Route Location Leases”), which wereincluded in the cost of route operations. Such leases provided for sharing ofthe net gaming win between the Company and the location owner and werecancelable at any time by either party. Such leases were part of the net assetssold as part of the disposition of the Company’s Nevada and Louisiana routeoperations.

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Thecontractual lease commitments for each of the five fiscal years subsequent to June 30,2006 are as flows:

| **Year Ended June 30,** | ** ** | ** ** | ** ** | **(in 000s)** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|
| 2007                                   |       | $          | 4,977      |               |
| 2008                                   |       | 3,867      |       |
| 2009                                   |       | 3,084      |       |
| 2010                                   |       | 2,142      |       |
| 2011                                   |       | 1,774      |       |
| Total                                  |       | $          | 15,844     |               |

 

Liabilities for losscontingencies arising from claims, assessments, litigation, fines andpenalties, or other sources are recorded when it is probable that a liabilityhas been incurred and the amount of the liability can be reasonably estimated.

*Litigation*

On September 25, 1995, Bally Gaming Inc. (“BGI”),a wholly-owned subsidiary of the Company, was named as a defendant in a classaction lawsuit filed in the United States District Court for the District ofNevada. The plaintiffs filed suit against BGI and approximately 45 otherdefendants, each of which is involved in the gaming business as a gamingmachine manufacturer, distributor or casino operator. The lawsuit arises out ofalleged fraudulent marketing and operation of casino video poker machines and electronicslot machines. The plaintiffs alleged that the defendants have engaged in acourse of fraudulent and misleading conduct intended to induce people intoplaying their gaming machines based on a false belief concerning how thosemachines actually operate, as well as the extent to which there is actually anopportunity to win on any given play. The plaintiffs allege that the defendants’actions constitute violations of the Racketeer Influenced and CorruptOrganizations Act (RICO) and give rise to claims of common law fraud and unjustenrichment. The plaintiffs are seeking monetary damages in excess of$1.0 billion. In July 2002, the Federal District Court denied theplaintiffs’ request for class action certification. In August 2004, theUnited States Court of Appeals for the Ninth Circuit affirmed the FederalDistrict Court’s denial of class action certification, and the plaintiffs didnot appeal. Subsequently, two of the four named plaintiffs elected to continuetheir cases as individual, non-class actions. However, in September 2005,the court granted the defendants’ motions for summary judgment, resolving allclaims in defendants’ favor without a trial. In October 2005, theplaintiffs appealed the District Court’s granting of summary judgment in favorof the defendants to the United States Court of Appeals for the Ninth Circuit.Thereafter, the plaintiffs/appellants agreed to dismiss their appeal inexchange for the defendants’ agreement not to pursue a claim for costs. Theappeal was dismissed on June 26, 2006.

In June and July 2004, putative classactions were filed against the Company and its officers, Robert Miodunski,Robert Saxton, Mark Lerner and Steven Des Champs, in the United States DistrictCourt for the District of Nevada. The nearly identical complaints allegedviolations of the Securities Exchange Act of 1934, as amended, stemming fromrevised earnings guidance, declines in the stock price and sales of stock byinsiders. The complaints sought damages in unspecified amounts. The Federal DistrictCourt granted the plaintiffs’ unopposed motions to consolidate the cases and toappoint a lead counsel and a lead plaintiff, and the plaintiffs filed aconsolidated complaint, all as is customary in such cases. The Company and theother defendants have moved to dismiss the complaint. Thereafter, activity inthe case was stopped 

F-36

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

and the parties participated in a mediation processduring which the parties agreed on the terms of a settlement. The parties havenegotiated and executed settlement documents settling both the consolidatedclass action and the derivative case discussed below. Under the settlement,which is subject to court approval, an aggregate of $16 million in cash,plus certain interest, will be paid to settle the securities class action as wellas the derivative litigation discussed below. The Company will pay $1.25million, which was accrued in the Company’s financial statements for thequarter ended September 30, 2005. The Company also incurred approximately$1.9 million in legal fees and related costs in the twelve months ended June 30,2006. In addition to certain governance actions the Company has agreed toundertake in connection with the settlement, the Company’s directors andofficers insurer will contribute $14.75 million to the settlement.

In July 2004, two derivative lawsuits were filedin Nevada state court against the members of the board of directors and theofficers listed above. The Company was named as a nominal defendant in thederivative lawsuits as the claims were purportedly asserted for the benefit ofBally Technologies, Inc. These lawsuits asserted 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, and sought injunctiverelief and damages in unspecified amounts. These two cases were consolidated,and the Company and the other defendants moved to dismiss the case. In February 2005,the state district court granted the defendants’ motion and dismissed the case.The plaintiffs appealed the dismissal to the Nevada Supreme Court, whichreferred the matter to its settlement conference program. The parties met witha court-appointed settlement judge on December 15, 2005, and agreed tosettle the case for $8,000 and on February 2, 2006, the Nevada SupremeCourt entered its order formally dismissing the appeal, thereby terminating thecase. Although management believes the plaintiffs’ lawsuit and appeal werewithout merit, it determined that the settlement was in the best interests ofthe Company.

On March 27, 2006, shortly after theaforementioned derivative suit was dismissed in the Nevada state court, anotherderivative lawsuit was filed in the United States District Court for theDistrict of Nevada against individual defendants Robert Miodunski, RobertSaxton, Steven Des Champs, Mark Lerner, David Robbins, Anthony DiCesare, JoelKirschbaum, Kevin Verner, Richard Haddrill, Stephen Race, Jacques André andnominal defendant Bally Technologies, Inc. Based on factual allegationsthat are similar to those alleged in the federal securities class actioncomplaints and the previous derivative actions that were dismissed by theDistrict Court, the derivative complaint alleges breach of fiduciary duty,abuse of control, gross mismanagement, waste of corporate assets, unjustenrichment and violation of the Sarbanes-Oxley Act of 2002. The parties havereached a settlement agreement as discussed more fully above.

In August 2004, Shuffle Master sued the Companyin the United States District Court for the District of Nevada, alleginginfringement of various patents in connection with the Company’s MindPlayproduct line and seeking injunctive relief and damages in an unspecified amount.In June 2005, it was announced that IGT had acquired an interest in thepatents at issue in the case, and thereafter IGT joined the case as a plaintiff.In December 2005, the District Court issued a ruling construing theclaim terms of all the patents in the suit. Management believes theplaintiffs’ lawsuit to be without merit, and the Company is vigorouslydefending against the lawsuit.

In September 2004, a United States District Courtjury in the District of Nevada entered a $7.4 million verdict against theCompany in a suit filed by Action Gaming (“AGI”) and IGT. The suit alleged thatthe multi-hand video poker game deployed by the Company’s former subsidiary,United Coin, infringed the plaintiffs’ patents. The Federal District Courtruled on summary judgment that the game did not infringe 

F-37

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

the patents. However, the court left to the jury thequestion whether the use of “autohold,” a specific, optional feature of thegame, caused it to infringe under the “doctrine of equivalents,” a doctrine ofpatent law. The jury determined that the game with the autohold option enableddid infringe under the doctrine of equivalents and awarded damages accordingly.The feature has been disabled on all affected games in the field, and thedecision permits continued deployment of the game as long as the autoholdfeature is not included. The Company appealed the decision to the United StatesCourt of Appeals for the Ninth Circuit and posted a cash bond totaling $7.6million to stay payment of the judgment and accrued interest pending theappeal. The cash bond is included in other non-current assets and the accruedliability is included in accrued liabilities in the accompanying balancesheets. This amount has been accrued and the expense for this charge isincluded in discontinued operations in the accompanying statement of operationsfor 2004.  On July 11, 2006, thefederal circuit court of appeals affirmed the district court judgment, denyingthe appeals for both parties, and thereafter, the judgment was satisfied out ofthe posted bond.

On December 7, 2004, IGT filed a patentinfringement lawsuit against the Company in the United States District Courtfor the District of Nevada. The complaint asserts that the Company’swheel-based games, such as Monte Carlo, Lucky Wheel and Cash For Life, itsgames with a reel in the top box, such as Bonus Frenzy, and its iView productsinfringe on patents held by IGT, and seeks injunctive relief and damages inunspecified amounts. The Company believes IGT’s claims are without meritand is vigorously defending itself against the lawsuit. As part of its defense,the Company has asserted counterclaims against IGT, including claims that IGT’spatents are invalid, unenforceable and not infringed, as well as severalclaims that IGT has engaged in anti-competitive conduct in violation of stateand federal antitrust laws. By its counterclaims, the Company is seekingdamages and other relief from IGT. IGT’s motion to dismiss the Company’s antitrustclaims was denied on January 10, 2006. A Markman hearing took placein December 2006 and the Company expects a related claim constructionruling. No trial date has been set.

In February 2005, the SEC initiated an informalinquiry and requested documents and information regarding matters related tothe allegations in the class actions and similar matters. In August 2005,the SEC notified the Company that its investigation had entered a formal phase,and requested additional information from the Company covering the same generalareas that were addressed in the informal inquiry. Management is cooperatingfully with the SEC in this matter.

In May 2006, IGT filed a patent infringementlawsuit against the Company in the United States District Court for theDistrict of Delaware. The complaint asserts that the Company’s Power Bonusingproducts infringe patents held by IGT, and seeks injunctive relief and damagesin unspecified amounts. IGT’s motion for a preliminary injunction is pending. TheCompany believes IGT’s claims, including its request for preliminary relief,are without merit and is vigorously defending itself against the lawsuit.

In September 2006, the Company filed a patentinfringement lawsuit against IGT in the United States District Court for theDistrict of Nevada. The complaint asserts that certain of IGT’s bonus wheelgames infringe patents held by the Company, and seeks injunctive relief anddamages. IGT filed an answer generally denying the claims. The case is in thediscovery phase and no trial date has been set.

The Company is also aparty to various lawsuits relating to routine matters incidental to ourbusiness. Management does not believe that the outcome of such litigation,including the matters above, in the aggregate, will have a material adverseeffect on our financial position, results of operations or cash flows.

F-38

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**20.SEGMENT AND GEOGRAPHICAL INFORMATION**

The Company currently operates in two businesssegments: (i) Bally Gaming and Systems which includes the 1) sale ofgaming machines (Gaming Equipment), 2) sales of computerized monitoringsystems and related recurring hardware and software maintenance revenue(Systems) and 3) operation of wide-area progressive systems, and lease ofgaming machines (Gaming Operations) and (ii) Casino Operations which ownsand operates one regional casino. The accounting policies of these segments areconsistent with Company’s policies for the consolidated financial statements.

F-39

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The table belowpresents information as to the Company’s revenues, operating income (loss),identifiable assets, capital expenditures and depreciation and amortization bysegment:

| ** **                          | ** ** | **Year Ended June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **(in 000s)**                     | ** ** |
| Revenues:                           |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 494,498    |   | $ | 431,070 |   | $ | 424,327 |   |
| Casino Operations                   |       | 52,646                                 |       | 52,037 |   | 52,280 |   |
| Total revenues                      |       | $                                      | 547,144    |   | $ | 483,107 |   | $ | 476,607 |   |
| Inter-segment revenues:             |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 746        |   | $ | 518 |   | $ | 578 |   |
| Casino Operations                   |       | —                                 |       | — |   | — |   |
| Total inter-segment  revenues       |       | $                                      | 746        |   | $ | 518 |   | $ | 578 |   |
| Gross profit:                       |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 202,550    |   | $ | 189,584 |   | $ | 231,576 |   |
| Casino Operations                   |       | 34,144                                 |       | 33,310 |   | 32,237 |   |
| Total gross profit                  |       | $                                      | 236,694    |   | $ | 222,894 |   | $ | 263,813 |   |
| Operating income (loss):            |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | (30,307    | ) | $ | (2,724 | ) | $ | 86,148 |   |
| Casino Operations                   |       | 17,408                                 |       | 16,775 |   | 16,942 |   |
| Corporate/other                     |       | (30,275                                | )          | (18,502 | ) | (14,254 | ) |
| Total operating (loss)  income      |       | $                                      | (43,174    | ) | $ | (4,451 | ) | $ | 88,836 |   |
| Identifiable assets:                |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 572,156    |   | $ | 550,611 |   | $ | 542,958 |   |
| Casino Operations                   |       | 44,635                                 |       | 43,094 |   | 41,790 |   |
| Corporate/other                     |       | 71,090                                 |       | 61,229 |   | 184,737 |   |
| Total identifiable  assets          |       | $                                      | 687,881    |   | $ | 654,934 |   | $ | 769,485 |   |
| Goodwill:                           |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 161,303    |   | $ | 161,444 |   | $ | 127,672 |   |
| Casino Operations                   |       | —                                 |       | — |   | — |   |
| Corporate/other                     |       | —                                 |       | — |   | — |   |
| Total goodwill                      |       | $                                      | 161,303    |   | $ | 161,444 |   | $ | 127,672 |   |
| Capital expenditures:               |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 8,478      |   | $ | 6,942 |   | $ | 8,396 |   |
| Casino Operations                   |       | 5,069                                  |       | 4,325 |   | 2,716 |   |
| Corporate/other                     |       | 414                                    |       | 1,163 |   | 728 |   |
| Total capital  expenditures         |       | $                                      | 13,961     |   | $ | 12,430 |   | $ | 11,840 |   |
| Depreciation and amortization:      |       |                                   |       |   |   |   |   |
| Gaming Equipment and  Systems       |       | $                                      | 20,577     |   | $ | 15,813 |   | $ | 10,016 |   |
| Casino Operations                   |       | 3,481                                  |       | 3,296 |   | 2,780 |   |
| Corporate/other                     |       | 1,386                                  |       | 1,342 |   | 1,525 |   |
| Total depreciation and amortization |       | $                                      | 25,444     |   | $ | 20,451 |   | $ | 14,321 |   |

 

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The Company hasoperations based primarily in the United States with a significant sales anddistribution office based in Europe.

Thetable below presents information as to the Company’s revenues, operating income(loss), identifiable assets capital expenditures and depreciation andamortization by geographic region determined based upon the location of thecustomer:

| ** **                           | ** ** | **Year Ended June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(in 000s)**                     | ** ** |
| Revenues:                            |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 516,137    |   | $ | 456,078 |   | $ | 445,318 |   |
| Europe                               |       | 15,188                                 |       | 13,314 |   | 24,817 |   |
| Other foreign                        |       | 15,819                                 |       | 13,715 |   | 6,472 |   |
| Total revenues                       |       | $                                      | 547,144    |   | $ | 483,107 |   | $ | 476,607 |   |
| Gross profit:                        |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 223,449    |   | $ | 214,333 |   | $ | 251,194 |   |
| Europe                               |       | 7,655                                  |       | 4,249 |   | 10,975 |   |
| Other foreign                        |       | 5,590                                  |       | 4,312 |   | 1,644 |   |
| Total gross margin                   |       | $                                      | 236,694    |   | $ | 222,894 |   | $ | 263,813 |   |
| Operating income (loss):             |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | (42,674    | ) | $ | 155 |   | $ | 87,769 |   |
| Europe                               |       | (1,179                                 | )          | (6,863 | ) | 1,686 |   |
| Other foreign                        |       | 679                                    |       | 2,257 |   | (619 | ) |
| Total operating income (loss)        |       | $                                      | (43,174    | ) | $ | (4,451 | ) | $ | 88,836 |   |
| Identifiable assets:                 |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 632,343    |   | $ | 604,453 |   | $ | 714,219 |   |
| Europe                               |       | 32,482                                 |       | 33,336 |   | 43,661 |   |
| Other foreign                        |       | 23,056                                 |       | 17,145 |   | 11,605 |   |
| Total identifiable assets            |       | $                                      | 687,881    |   | $ | 654,934 |   | $ | 769,485 |   |
| Goodwill:                            |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 143,145    |   | $ | 143,491 |   | $ | 109,498 |   |
| Europe                               |       | 18,158                                 |       | 17,953 |   | 18,174 |   |
| Other Foreign                        |       | —                                 |       | — |   | — |   |
| Total goodwill                       |       | $                                      | 161,303    |   | $ | 161,444 |   | $ | 127,672 |   |
| Capital expenditures:                |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 13,588     |   | $ | 11,283 |   | $ | 11,145 |   |
| Europe                               |       | 309                                    |       | 1,140 |   | 684 |   |
| Other foreign                        |       | 64                                     |       | 7 |   | 11 |   |
| Total capital expenditures           |       | $                                      | 13,961     |   | $ | 12,430 |   | $ | 11,840 |   |
| Depreciation and amortization:       |       |                                   |       |   |   |   |   |
| United States                        |       | $                                      | 23,587     |   | $ | 19,098 |   | $ | 13,491 |   |
| Europe                               |       | 772                                    |       | 737 |   | 636 |   |
| Other Foreign                        |       | 1,085                                  |       | 616 |   | 194 |   |
| Total  depreciation and amortization |       | $                                      | 25,444     |   | $ | 20,451 |   | $ | 14,321 |   |

** **

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**21.**401(k) PLAN

The Company is the sponsor of the Bally Technologies, Inc.401(k) Savings Plan (the “401(k) Plan”). The 401(k) Plan wasadopted for domestic employees of Bally Technologies, Inc. and all itsdomestic subsidiaries. Employees may enroll in the plan after meeting certainage and length of employment criteria, and plan participants may defer up to 25%of their compensation, up to certain IRS imposed limitations.

The Company matches 50% of any participant’scontributions, up to the first 6% of their compensation (as the term “compensation”is defined in the 401(k) plan document). Company matching contributionstotaled approximately $1.3 million, $1.5 million and $0.8 million for thefiscal years ended June 30, 2006, 2005 and 2004, respectively.

For participants hiredthrough December 31, 2000, employee and employer matching contributionswere 100% vested immediately. For employees hired on or after January 1,2001, vesting of the employer match is on a 20%, 5-year vesting schedule.Employer profit sharing contributions are 100% vested after the completion ofthree years of service.

F-42

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**BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**22.**SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)

Thefollowing tables set forth unaudited quarterly financial information for theyears ended June 30, 2006 and 2005.

| ** **                                                                 | ** ** | **Fiscal Year 2006  Quarterly Results**        | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **September 30,**                                        | ** ** | **December 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
| ** **                                                                 | ** ** | **(in 000s, except per share data)** | ** ** |
| Statement of Operations  Data:                                             |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                                   |       |                                                          | $          | 106,350 |   |   |   | $ | 128,453 |   |   | $ | 156,311 |   | $ | 156,030 |   |
| Cost of gaming  equipment, systems and casino operations                   |       |                                                          | 53,180     |   |   |   | 70,205 |   |   | 94,742 |   | 92,323 |   |
| Selling, general and  administrative                                       |       |                                                          | 41,842     |   |   |   | 47,007 |   |   | 49,281 |   | 55,626 |   |
| Loss from  continuing operations before income taxes and minority interest |       |                                                          | (10,102    | ) |   |   | (13,428 | ) |   | (26,372 | ) | (17,398 | ) |
| Income tax  benefit                                                        |       |                                                          | 4,133      |   |   |   | 4,702 |   |   | 9,839 |   | 5,338 |   |
| Loss from  continuing operations                                           |       |                                                          | (8,379     | ) |   |   | (8,903 | ) |   | (16,759 | ) | (13,154 | ) |
| Income from  discontinued operations                                       |       |                                                          | —     |   |   |   | — |   |   | — |   | 1,124 |   |
| Net loss                                                                   |       |                                                          | $          | (8,379 | ) |   |   | $ | (8,903 | ) |   | $ | (16,759 | ) | $ | (12,030 | ) |
| Basic and diluted loss per share from continuing  operations               |       |                                                          | $          | (0.16 | ) |   |   | $ | (0.17 | ) |   | $ | (0.32 | ) | $ | (0.25 | ) |
| Basic and diluted  loss per share from discontinued operations             |       |                                                          | —     |   |   |   | — |   |   | — |   | 0.02 |   |
| Basic and diluted  loss per share                                          |       |                                                          | $          | (0.16 | ) |   |   | $ | (0.17 | ) |   | $ | (0.32 | ) | $ | (0.23 | ) |

 

| ** **                                                                 | ** ** | **Fiscal Year 2005  Quarterly Results**        | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **September 30,**                                        | ** ** | **December 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
| ** **                                                                 | ** ** | **(in 000s, except per share data)** | ** ** |
| Statement of Operations  Data:                                             |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                                   |       |                                                          | $          | 119,641 |   |   |   | $ | 124,435 |   |   | $ | 121,689 |   | $ | 117,342 |   |
| Cost of gaming  equipment, systems and casino operations                   |       |                                                          | 59,666     |   |   |   | 70,562 |   |   | 67,430 |   | 62,555 |   |
| Selling, general  and administrative                                       |       |                                                          | 45,074     |   |   |   | 40,765 |   |   | 38,869 |   | 35,221 |   |
| Loss from  continuing operations before income taxes and minority interest |       |                                                          | (4,074     | ) |   |   | (5,165 | ) |   | (7,650 | ) | (2,481 | ) |
| Income tax  benefit (expense)                                              |       |                                                          | 1,679      |   |   |   | 2,901 |   |   | (521 | ) | 1,133 |   |
| Loss from  continuing operations                                           |       |                                                          | (2,894     | ) |   |   | (3,409 | ) |   | (9,078 | ) | (2,528 | ) |
| Income (loss)  from discontinued operations                                |       |                                                          | (4,391     | ) |   |   | 15 |   |   | (395 | ) | 117 |   |
| Net loss                                                                   |       |                                                          | $          | (7,285 | ) |   |   | $ | (3,394 | ) |   | $ | (9,473 | ) | $ | (2,411 | ) |
| Basic and Diluted loss per share from continuing  operations               |       |                                                          | $          | (0.06 | ) |   |   | $ | (0.07 | ) |   | $ | (0.18 | ) | $ | (0.05 | ) |
| Basic and Diluted  loss per share from discontinuing operations            |       |                                                          | (0.08      | ) |   |   | — |   |   | (0.01 | ) | — |   |
| Basic and Diluted  loss per share                                          |       |                                                          | $          | (0.14 | ) |   |   | $ | (0.07 | ) |   | $ | (0.19 | ) | $ | (0.05 | ) |

 

F-43

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