** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

###### **WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

 

**ý  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OFTHE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**OR**

** **

 

**o  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OFTHE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002**

 

**Commission File No. 0-23928**

 

 

**PDS GAMING CORPORATION**

(exact name of Registrant asspecified in its charter)

 

 

| **Minnesota**                    |   | **41-1605970**      |
|----------------------------------|--------|---------------------|
| (State or other  Jurisdiction of |   | (I.R.S. Employer    |
| Incorporation or Organization)   |   | Identification No.) |

 

**6171McLeod Drive, Las Vegas, Nevada 89120**

(Address of PrincipalExecutive Offices)

 

**(702) 736-0700**

(Issuer’s TelephoneNumber, Including Area Code)

 

Indicate by check mark whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

                Yes  ý                   Noo

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the last practicable date:

 

| **Class**                    |   | **Outstanding as of August 6,  2002** |
|------------------------------|--------|---------------------------------------|
| Common Stock, $.01 par value |   | 3,797,901                             |

###### ** **

###### ** **

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###### ** **

###### **PDS GAMING CORPORATION AND SUBSIDIARIES**

 

###### **INDEX**

 

 

**PART I****                  FINANCIALINFORMATION**

 
| Item 1.  | Financial Statements:                                                                                |   |
|----------|------------------------------------------------------------------------------------------------------|--------|
|     |                                                                                                 |   |
|     | Consolidated Balance Sheets — June  30, 2002 (Unaudited) and December 31, 2001                  |   |
|     |                                                                                                 |   |
|     | Consolidated Statements of Income  — Three Months Ended June 30, 2002 and 2001 (Unaudited)      |   |
|     |                                                                                                 |   |
|     | Consolidated  Statements of Income — Six Months Ended   June 30, 2002 and 2001 (Unaudited) |   |
|     |                                                                                                 |   |
|     | Consolidated  Statements of Cash Flows — Six Months Ended June 30, 2002 and 2001  (Unaudited)   |   |
|     |                                                                                                 |   |
|     | Notes to  Consolidated Financial Statements (Unaudited)                                              |   |
|     |                                                                                                 |   |
| Item 2.  | Management’s Discussion and  Analysis of Financial Condition and Results of Operations          |   |
|     |                                                                                                 |   |
| Item  3. | Quantitative  and Qualitative Disclosures About Market Risk                                          |   |
|     |                                                                                                 |   |

** **

**PART II****                 OTHER INFORMATION**

 
| Item 1.  | Legal Proceedings                                    |   |
|----------|------------------------------------------------------|--------|
|     |                                                 |   |
| Item 2.  | Changes in Securities and Use of  Proceeds           |   |
|     |                                                 |   |
| Item 3.  | Defaults  Upon Senior Securities                     |   |
|     |                                                 |   |
| Item 4.  | Submission of Matters to a Vote  of Security Holders |   |
|     |                                                 |   |
| Item 5.  | Other Information                                    |   |
|     |                                                 |   |
| Item  6. | Exhibits  and Reports on Form 8-K                    |   |

** **

 

2

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**PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE****SHEETS**

 

 
|                                                                                                                                                                     |   | **June 30,  2002** |       | **December  31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|--------|
| **ASSETS:**                                                                                                                                                              |   | (Unaudited)        |       |                    |   |
|                                                                                                                                                                     |   |               |       |                    |   |
| Cash and cash  equivalents                                                                                                                                               |   | $                  | 2,542,000  |                    | $      | 4,086,000 |   |
| Restricted cash                                                                                                                                                          |   | 3,438,000          |       |                    |   |
| Notes, accounts  and leases receivable, net of allowances                                                                                                                |   | 44,398,000         |       | 44,800,000              |   |
| Equipment under  operating leases, net                                                                                                                                   |   | 34,980,000         |       | 22,613,000              |   |
| Equipment held  for sale or lease                                                                                                                                        |   | 4,171,000          |       | 4,941,000               |   |
| Other assets,  net                                                                                                                                                       |   | 10,360,000         |       | 8,617,000               |   |
|                                                                                                                                                                     |   | $                  | 99,889,000 |                    | $      | 85,057,000 |   |
|                                                                                                                                                                     |   |               |       |                    |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY:**                                                                                                                          |   |               |       |                    |   |
|                                                                                                                                                                     |   |               |       |                    |   |
| Accounts payable                                                                                                                                                         |   | $                  | 20,212,000 |                    | $      | 1,279,000 |   |
| Customer deposits                                                                                                                                                        |   | 2,285,000          |       | 2,147,000               |   |
| Notes payable                                                                                                                                                            |   | 55,132,000         |       | 53,640,000              |   |
| Subordinated  debt                                                                                                                                                       |   | 9,581,000          |       | 11,166,000              |   |
| Accrued expenses  and other                                                                                                                                              |   | 2,540,000          |       | 4,397,000               |   |
|                                                                                                                                                                     |   | 89,750,000         |       | 72,629,000              |   |
|                                                                                                                                                                     |   |               |       |                    |   |
| Stockholders’  equity:                                                                                                                                              |   |               |       |                    |   |
| Common stock, $.01  par value, 20,000,000 shares authorized, 3,796,683 and 3,745,872 shares  issued and outstanding at June 30, 2002 and December 31, 2001, respectively |   | 38,000             |       | 37,000                  |   |
| Additional  paid-in capital                                                                                                                                              |   | 11,808,000         |       | 11,712,000              |   |
| Retained  earnings (deficit)                                                                                                                                             |   | (1,707,000         | )          | 679,000                 |   |
|                                                                                                                                                                     |   | 10,139,000         |       | 12,428,000              |   |
|                                                                                                                                                                     |   | $                  | 99,889,000 |                    | $      | 85,057,000 |   |

 

 

See notes to consolidatedfinancial statements.

 

3

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###### **PDS GAMINGCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**THREEMONTHS ENDED JUNE 30,**

**(Unaudited)**

 

 
|                                              |   | **2002**  |      | **2001**   |   |
|---------------------------------------------------|--------|-----------|-----------|------------|--------|
| **REVENUES****:**                                 |   |      |      |       |   |
| Equipment sales  and sales-type leases            |   | $         | 4,089,000 |       | $      | 4,613,000 |   |
| Operating lease  rentals                          |   | 3,059,000 |      | 2,271,000  |   |
| Finance income                                    |   | 1,097,000 |      | 6,134,000  |   |
| Fee income  (loss)                                |   | 43,000    |      | (87,000    | )      |
| Casino                                            |   | 528,000   |      | 454,000    |   |
|                                              |   | 8,816,000 |      | 13,385,000 |   |
| **COSTS  AND EXPENSES:**                          |   |      |      |       |   |
| Equipment sales  and sales-type leases            |   | 3,395,000 |      | 4,313,000  |   |
| Depreciation on  leased equipment                 |   | 2,000,000 |      | 1,722,000  |   |
| Interest                                          |   | 1,792,000 |      | 2,263,000  |   |
| Casino                                            |   | 725,000   |      | 363,000    |   |
| Selling, general  and administrative              |   | 724,000   |      | 1,523,000  |   |
| Depreciation and  amortization on other property  |   | 198,000   |      | 296,000    |   |
| Collection and  asset impairment provisions       |   | 31,000    |      | 842,000    |   |
|                                              |   | 8,865,000 |      | 11,322,000 |   |
| Income (loss)  before income taxes (benefit)      |   | (49,000   | )         | 2,063,000  |   |
| Income taxes  (benefit)                           |   | (20,000   | )         | 825,000    |   |
| Income (loss)  from continuing operations         |   | (29,000   | )         | 1,238,000  |   |
| Discontinued  operations                          |   | (484,000  | )         | (710,000   | )      |
| Net income  (loss)                                |   | $         | (513,000  | )          | $      | 528,000 |   |
|                                              |   |      |      |       |   |
| **Earnings  (loss) per share:**                   |   |      |      |       |   |
| Continuing  operations:                           |   |      |      |       |   |
| Basic                                             |   | $         | (0.01     | )          | $      | 0.33 |   |
| Diluted                                           |   | (0.01     | )         | 0.32       |   |
| Discontinued  operations — basic and diluted |   | (0.13     | )         | (0.19      | )      |
| Net income  (loss) — basic and diluted       |   | (0.14     | )         | 0.14       |   |
|                                              |   |      |      |       |   |
| **Weighted  average shares outstanding:**         |   |      |      |       |   |
| Basic                                             |   | 3,797,000 |      | 3,721,000  |   |
| Diluted                                           |   | 3,797,000 |      | 3,910,000  |   |

 

 

 

See notes to consolidatedfinancial statements.

 

4

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**PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**SIXMONTHS ENDED JUNE 30,**

**(Unaudited)**

 

 
|                                              |   | **2002**   |       | **2001**   |   |
|---------------------------------------------------|--------|------------|------------|------------|--------|
| **REVENUES:**                                     |   |       |       |       |   |
| Equipment sales  and sales-type leases            |   | $          | 9,042,000  |       | $      | 6,285,000 |   |
| Operating lease  rentals                          |   | 5,570,000  |       | 4,061,000  |   |
| Finance income                                    |   | 2,385,000  |       | 7,412,000  |   |
| Fee income                                        |   | 383,000    |       | 2,382,000  |   |
| Casino                                            |   | 903,000    |       | 781,000    |   |
|                                              |   | 18,283,000 |       | 20,921,000 |   |
| **COSTS  AND EXPENSES:**                          |   |       |       |       |   |
| Equipment sales  and sales-type leases            |   | 7,743,000  |       | 5,906,000  |   |
| Depreciation on  leased equipment                 |   | 3,673,000  |       | 3,105,000  |   |
| Interest                                          |   | 3,686,000  |       | 4,324,000  |   |
| Casino                                            |   | 1,229,000  |       | 626,000    |   |
| Selling, general  and administrative              |   | 2,134,000  |       | 2,498,000  |   |
| Depreciation and  amortization on other property  |   | 400,000    |       | 505,000    |   |
| Pre-opening  expenses                             |   | 238,000    |       |       |   |
| Collection and  asset impairment provisions       |   | 59,000     |       | 842,000    |   |
|                                              |   | 19,162,000 |       | 17,806,000 |   |
| Income (loss)  before income taxes (benefit)      |   | (879,000   | )          | 3,115,000  |   |
| Income taxes  (benefit)                           |   | (369,000   | )          | 1,246,000  |   |
| Income (loss)  from continuing operations         |   | (510,000   | )          | 1,869,000  |   |
| Discontinued  operations                          |   | (1,876,000 | )          | (877,000   | )      |
| Net income  (loss)                                |   | $          | (2,386,000 | )          | $      | 992,000 |   |
|                                              |   |       |       |       |   |
| **Earnings  (loss) per share:**                   |   |       |       |       |   |
| Continuing  operations:                           |   |       |       |       |   |
| Basic                                             |   | $          | (0.13      | )          | $      | 0.50 |   |
| Diluted                                           |   | (0.13      | )          | 0.47       |   |
| Discontinued  operations — basic and diluted |   | (0.50      | )          | (0.23      | )      |
| Net income  (loss):                               |   |       |       |       |   |
| Basic                                             |   | (0.63      | )          | 0.27       |   |
| Diluted                                           |   | (0.63      | )          | 0.25       |   |
|                                              |   |       |       |       |   |
| **Weighted  average shares outstanding:**         |   |       |       |       |   |
| Basic                                             |   | 3,790,000  |       | 3,719,000  |   |
| Diluted                                           |   | 3,790,000  |       | 3,937,000  |   |

 

 

 

See notes toconsolidated financial statements.

 

 

5

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###### **PDS GAMINGCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**SIX MONTHS ENDED JUNE 30,**

**(Unaudited)**

 
|                                                    |   | **2002**    |      | **2001**    |   |
|---------------------------------------------------------|--------|-------------|-----------|-------------|--------|
| **OPERATING  ACTIVITIES:**                              |   |        |      |        |   |
| Net cash provided  by continuing operating activities   |   | $           | 9,511,000 |        | $      | 9,102,000 |   |
| Net cash used in  discontinued operating activities     |   | (164,000    | )         | (1,113,000  | )      |
|                                                    |   |        |      |        |   |
| Net cash  provided by operating activities              |   | 9,347,000   |      | 7,989,000   |   |
|                                                    |   |        |      |        |   |
| **INVESTING  ACTIVITIES:**                              |   |        |      |        |   |
| Purchase of  equipment for leasing                      |   | (6,780,000  | )         | (5,996,000  | )      |
| Proceeds from  sale of equipment under operating leases |   | 459,000     |      | 2,697,000   |   |
| Other                                                   |   | (1,081,000  | )         |        |   |
|                                                    |   |        |      |        |   |
| Net cash used in  investing activities                  |   | (7,402,000  | )         | (3,299,000  | )      |
|                                                    |   |        |      |        |   |
| **FINANCING  ACTIVITIES:**                              |   |        |      |        |   |
| Proceeds from  borrowings                               |   | 19,690,000  |      | 10,121,000  |   |
| Repayment of  borrowings                                |   | (17,385,000 | )         | (12,266,000 | )      |
| Increase in  restricted cash                            |   | (3,438,000  | )         |        |   |
| Repayment of  subordinated debt                         |   | (2,453,000  | )         | (70,000     | )      |
| Proceeds from  issuance of common stock                 |   | 97,000      |      | 13,000      |   |
|                                                    |   |        |      |        |   |
| Net cash used in  financing activities                  |   | (3,489,000  | )         | (2,202,000  | )      |
|                                                    |   |        |      |        |   |
| **CHANGE  IN CASH AND CASH EQUIVALENTS:**               |   |        |      |        |   |
| Net increase  (decrease) in cash and cash equivalents   |   | (1,544,000  | )         | 2,488,000   |   |
| Cash and cash  equivalents at beginning of period       |   | 4,086,000   |      | 2,033,000   |   |
|                                                    |   |        |      |        |   |
| Cash and cash  equivalents at end of period             |   | $           | 2,542,000 |        | $      | 4,521,000 |   |

 

 

See notes to consolidated financialstatements.

 

 

 

 

 

 

 

 

6

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**PDS GAMINGCORPORATION AND SUBSIDIARIES**

**NOTES TO****CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

                Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and the instructions to Form 10-Q and Rule 10-01 of RegulationS-X.  Accordingly, they do not includeall of the information and disclosures required by generally accepted accountingprinciples for annual financial statements. In the opinion of management, all adjustments (consisting only of normalrecurring adjustments) considered necessary for a fair presentation have beenincluded.  The results of operations forany interim period are not necessarily indicative of results for the fullyear.  For further information, pleaserefer to the consolidated financial statements of PDS Gaming Corporation (the“Company”), and the related notes, included within the Company’s Annual Reporton Form 10-K for the fiscal year ended December 31, 2001 (the “2001 Form10-K”), previously filed with the Securities and Exchange Commission.

                Thebalance sheet at December 31, 2001 was derived from the audited financialstatements included in the Company’s 2001 Form 10-K and reclassifications toconform with the current quarter presentation.

                TheCasino Operations division does not meet the criteria requiring recognition asan operating segment under Statement of Financial Accounting Standards No. 131,*Disclosures about Segments of an Enterprise andRelated Information.*

 

**2.****             ****NOTES PAYABLE**

                Notespayable consist of the following:

 

|                                                                                                                                                                                                     |   | **June 30,  2002** |       | **December  31,  2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|--------|
| Recourse lines  of credit with a maximum aggregate balance of $22,930,000 bearing interest at  rates from 5.75% to 10.50%, secured by related investment in leases and  equipment held for sale or lease |   | $                  | 13,975,000 |                    | $      | 5,440,000 |   |
| Equipment notes  bearing interest at rates from 7.26% to 15.08%, secured by related investment  in leases:                                                                                               |   |               |       |                    |   |
| Recourse                                                                                                                                                                                                 |   | 18,479,000         |       | 21,862,000              |   |
| Non-recourse                                                                                                                                                                                             |   | 23,146,000         |       | 26,723,000              |   |
|                                                                                                                                                                                                     |   | 55,600,000         |       | 54,025,000              |   |
| Unamortized loan  discounts                                                                                                                                                                              |   | (468,000           | )          | (385,000                | )      |
|                                                                                                                                                                                                     |   | $                  | 55,132,000 |                    | $      | 53,640,000 |   |

 

7

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**PDS GAMINGCORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

**3.****             ****DISCONTINUED OPERATIONS**

 

                At the end of thefirst quarter 2002, the Company discontinued operations of its Table Gamesdivision and certain components of its Casino Slot Exchange®division, due to unacceptable operating results resulting from, among otherthings, slower than anticipated customer installations, inadequate profitmargins and the continuing costs of maintaining exclusive rights to certainintellectual property.  Accordingly, theCompany has reclassified these activities as discontinued operations inaccordance with Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*.  As aresult of these decisions, the Company recognized a disposal loss of $993,000in the three months ended March 31, 2002 primarily related to the write-off ofcertain intangibles in the Table Games and Casino Slot Exchange® divisions. In addition, due to the decision to forego further reconditioningactivities, the Company provided a reserve for its related parts inventory of$300,000 in the three months ended March 31, 2002 solely to liquidate theinventory quickly and reduce the associated on-going carrying costs.

 

                Results fromdiscontinued operations, net of income tax benefit, are as follows:

 
|                              |   | **Three  Months Ended June 30** |     | **Six Months  Ended June 30** |   |
|-----------------------------------|--------|---------------------------------|----------|-------------------------------|--------|
|                              |   | **2002**                        |     | **2001**                      |   | **2002** |   | **2001** |   |
| Loss on  discontinued operations: |   |                            |     |                          |   |   |   |   |   |
| Loss on disposal                  |   |                            |     |                          |   | $ | (993,000 | ) |   |   |
| Operating loss                    |   | $                               | (484,000 | )                             | $      | (710,000 | ) | (883,000 | ) | $ | (877,000 | ) |
|                              |   | $                               | (484,000 | )                             | $      | (710,000 | ) | $ | (1,876,000 | ) | $ | (877,000 | ) |
|                              |   |                            |     |                          |   |   |   |   |   |
| Loss per share  (diluted):        |   |                            |     |                          |   |   |   |   |   |
| Loss on disposal                  |   |                            |     |                          |   | $ | (0.26 | ) |   |   |
| Operating loss                    |   | $                               | (0.13    | )                             | $      | (0.19 | ) | (0.24 | ) | $ | (0.23 | ) |
|                              |   | $                               | (0.13    | )                             | $      | (0.19 | ) | $ | (0.50 | ) | $ | (0.23 | ) |

 

 

                As of June 30, 2002,the assets associated with discontinued operations consisted of the Company’sinventory of certain slot machines and table games and its investment inDigiDeal Corporation, with a carrying value of $2.9 million and $700,000,respectively.

 

**4.     CONTINGENCIESAND COMMITMENTS**

 

                In May 2002, theCompany received notification that Tekbilt, Inc. (“Claimant”) has submitted aDemand for Arbitration to the American Arbitration Association in connectionwith the Company’s alleged breach of a Distributor Agreement (the “Agreement”)with Claimant in connection with the Company’s discontinued operations.  In the notification, Claimant alleges thatthe Company is in breach of the terms of the Agreement and that such breach hascaused Claimant to sustain substantial damages.  The monetary damages sought by claimant are unspecified.

 

                Although unable topredict the outcome of this matter, management believes the Claimant’s claim tobe without merit and will vigorously pursue all legal defenses available toit.  Management, further, does notbelieve that the outcome of such arbitration is likely to have a materialadverse effect on the Company.

 

 

8

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**ITEM2.    MANAGEMENT’S****DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

                The Company is engaged in thebusiness of financing and leasing gaming equipment to the gaming industry.  The gaming equipment financed by the Companyconsists mainly of slot machines, video gaming machines and other gamingdevices.  In addition, the Companyfinances furniture, fixtures and other gaming-related equipment, includinggaming tables and chairs, restaurant and hotel furniture, vehicles, securityand surveillance equipment, computers and other office equipment.  The Company believes it is currently theonly independent leasing company licensed in the states of Nevada, New Jersey,Colorado, Illinois, Iowa, Indiana, Minnesota, Mississippi, New Mexico andWashington to provide this financing alternative.  In early 2001, the Company received a non-restricted gaminglicense to operate The Gambler casino, now known as Rocky’s Sports Pub andGrill (“Rocky’s”), in Reno, Nevada and formed its Casino Operations Division.

 

                TheCompany’s strategy is to increase recurring revenues and cash flows through itsoperating divisions.  In addition to itsleasing activities, the Company also originates note transactions which itgenerally sells to third parties for fee income.  In some of its transactions, the Company holds the leases ornotes for a period of time after origination, or retains a partial ownershipinterest in the leases or notes.  TheCompany believes its ability to distribute used gaming devices (which itsgaming licenses in the above-referenced states permit it to do) enhances thegaming devices’ values at the end of an operating lease and facilitatesadditional financing transactions.

 

The Company’s quarterly operating results, includingnet income, have historically fluctuated due to the timing of completion oflarge financing transactions, as well as the timing of recognition of theresulting fee income upon subsequent sale. These transactions can be in the negotiation and documentation stage forseveral months, and recognition of the resulting fee income by the Company mayfluctuate greatly from quarter to quarter. Thus, the results of any quarter are not necessarily indicative of theresults which may be expected for any other period.

 

The Company’soperating results are subject to quarterly fluctuations resulting from avariety of factors, including, but not limited to, (i) variations in the mix offinancing transactions between operating leases, direct finance leases andnotes receivable, (ii) changes in the gaming industry which affect the demandfor gaming devices sold by the Company at lease termination, and (iii) economicconditions, in which a detrimental change can cause customers to delay newinvestments and increase the Company’s bad debt exposure, and reduce the levelof fee income obtained through the sale of leases or financing transactions.

 

#### **Results Of Operations**

 

The Company reported a net loss of $513,000 or $0.14per diluted share in the second quarter 2002 compared to net income of $528,000or $0.14 per diluted share in the second quarter 2001.  The second quarter 2002 results include aloss from continuing operations of $29,000 and a loss from discontinuedoperations of $484,000.   The secondquarter results of 2001 include income from continuing operations of $1,238,000and a loss from discontinued operations of $710,000.  Gross originations of financing transactions were $20.4 millionin the second quarter 2002, compared with $14.9 million in the year-earlierquarter (the year-earlier quarter also included the purchase of a leasetransaction from a third party for $17.0 million).  Shipments of gaming devices increased to 2,074 in the secondquarter 2002 from 1,270 in the year-earlier quarter.

 

The Company reported a net loss of $2,386,000 or $0.63per diluted share for the six months ended June 30, 2002 compared to net incomeof $992,000 or $0.25 per diluted share for the six months ended June 30,2001.  The results for the six monthsended June 30, 2002 include a loss from continuing operations of $510,000 and aloss from discontinued operations of $1,876,000.   The results for the six months ended June 30, 2001 includeincome from continuing operations of $1,869,000 and a loss from discontinuedoperations of $877,000.  Grossoriginations of financing transactions were $29.9 million for the six monthsended June 30, 2002, compared with $21.2 million in the year-earlier period(the year-earlier period also included the purchase of a lease transaction froma third party for $17.0 million). Shipments of gaming devices were 3,100 and 3,400 for the six monthsended June 30, 2002 and 2001, respectively.

 

9

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**ThreeMonths ended June 30, 2002 and 2001**

 

**Continuingoperations**

 

                Revenues in the second quarter2002 totaled $8.8 million compared to $13.4 million in the year-earlierquarter, a decrease of $4.6 million. This decline primarily reflects a one-time transaction in the quarterended June 30, 2001 in which the Company recognized $4.8 million of financeincome.

 

Revenues from equipment sales and sales-type leasestotaled $4.1 million in the second quarter of 2002 compared to $4.6 million inthe year-earlier quarter, a decrease of $500,000.  Such revenues include sales of used gaming devices previouslyunder lease and sales of equipment at the inception of a lease in which adealer’s profit or loss on the subject equipment is recognized.  Differences in revenue result from normalvariations in the volume of significant transactions among accounting periods.  Costs of such sales totaled $3.4 million and$4.3 million in the quarters ended June 30, 2002 and 2001, respectively.  Gross margin increased from 7% in the prioryear quarter to 17% in the current year quarter.  This increase primarily reflects more favorable pricing in themarkets served by the Company.

 

                Rental revenues from operatingleases increased by $800,000, or 35%, to $3.1 million in the second quarter2002 compared to $2.3 million in the year-earlier quarter as a result of alarger portfolio of operating leases. Related depreciation was $2.0 million and $1.7 million for the quartersended June 30, 2002 and 2001, respectively. Depreciation on operating leases as a percentage of rental revenuesdecreased from 76% in the prior-year quarter to 65% in the second quarter2002.  This decrease is due to ournormal recurring quarterly portfolio review that resulted in acceleration ofdepreciation on certain leases in the prior-year quarter.

 

                Financeincome decreased to  $1.1 million in thesecond quarter 2002 compared to $6.1 million in the year-earlier quarter forthe reason discussed above.

 

                Casino revenuesincreased to $528,000 in the second quarter 2002 from $454,000.  This $74,000 increase reflects revenue fromadditional gaming devices placed in service in 2002.  Casino expenses increased to $725,000 in the current year quartercompared to $363,000 in the second quarter 2001.  The increased expenses are due to expansion of the casino in thefirst quarter 2002 and are primarily comprised of increased payroll and relatedcosts and advertising.  The Reno marketis down approximately 8%, primarily as a result of the economic downturn in theSilicon Valley region, decreased air travel and new Native American casinos inNorthern California.

 

                Interest expense totaled $1.8million in the quarter ended June 30, 2002, compared to $2.3 million in thesecond quarter of 2001. The decrease of $471,000 reflects a general decline ininterest rates.

 

Selling, general and administrative expenses totaled$724,000 in the second quarter 2002 and $1.5 million in the year-earlierquarter.  The decrease of approximately$800,000 reflects an increase of $286,000 of overhead capitalized as initialdirect costs.  Although prior yearoriginations exceeded current year originations, $17.0 million in originationsin the prior year related to a direct finance lease transaction, and thereforeno initial direct costs were recorded. The remaining decrease consists primarily of lower payroll and relatedcosts due to head count reductions and the nonrecurring expenses of the 2001 exchangeoffering related to the Company’s subordinated debt.

 

 Collection andasset impairment provisions were $31,000 and $842,000 for the periods endedJune 30, 2002 and 2001, respectively. During the second quarter of 2001, the Company provided for a possibleloss contingency related to one significant customer.  No such transaction occurred in the current year quarter.

 

**DiscontinuedOperations**

 

                Loss fromdiscontinued operations was $484,000 in the second quarter 2002 compared to$710,000 in the prior year’s quarter. The decrease of  $226,000 is dueprimarily to collection and impairment provisions and inventory reserves.

 

See Note 3 to the Consolidated Financial Statementsfor description of the Company’s Discontinued Operations.

 

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**IncomeTaxes**

 

The estimated effective income tax rate was 42% in thesecond quarter 2002 and 40% in the second quarter 2001.  In both periods, the effective rate washigher than the federal statutory tax rate of 34% due primarily to state incometaxes and permanent tax differences.

 

 

#### **Six months ended June 30, 2002 and 2001**

 

**Continuingoperations**

 

 Revenuesin the six months ended June 30, 2002 totaled $18.3 million compared to $20.9million in the year-earlier period.  Thedecrease in revenues of $2.6 million is primarily attributable to a decrease infinance income of $5.0 million and a decrease in fee income of $2.0 million,partially offset by an increase in operating lease revenues of $1.5 million andan increase in equipment sales and sales-type leases of $2.7 million.

 

Revenues from equipment sales and sales-type leasestotaled $9.0 million in the six months ended June 30, 2002, compared to $6.3million in the year-earlier period, an increase of $2.7 million.  Such revenues include sales of used gamingdevices previously under lease and sales of equipment at the inception of alease in which a dealer’s profit or loss on the subject equipment isrecognized.  Differences in revenue resultfrom normal variations in the volume of significant transactions amongaccounting periods. Costs of such sales totaled $7.7 million and $5.9 million,respectively.  Gross margin increasedfrom 6% in the prior year to 14% in the current year.  This increase primarily reflects more favorable pricing in themarkets served by the Company.

 

Rental revenues from operating leases increased to$5.6 million for the six months ended June 30, 2002 compared to $4.1 million inthe year-earlier period.  This $1.5million increase reflects the increase in the size of the Company’s portfolioof operating leases.  Relateddepreciation was $3.7 million and $3.1 million for the six months ended June30, 2002 and 2001, respectively.

 

                Finance income declined $5.0million for the six months ended June 30, 2002 compared to the year earlierperiod as a result of the non-recurring transactions involving a significantcustomer discussed above.

 

Fee income totaled $383,000 in the six months endedJune 30, 2002 compared to $2.4 million in the year-earlier period, a decreaseof $2.0 million.  Fee income in theyear-earlier period was a nonrecurring fee from a significant customer.

 

                Casino revenues totaled $903,000in the six months ended June 30, 2002 compared to $781,000 in the year-earlierperiod, and increase of $122,000. Related casino costs were $1.2 million and $626,000 in the six monthsended June 30, 2002 and 2001, respectively. In addition, the Company recorded one-time pre-opening expenses of$238,000 in the six months ended June 30, 2002.  The increase in casino revenues reflects the additional casinorevenues from the expansion of Rocky’s at the beginning of 2002.  The increase in expenses reflects delays inconstruction, higher payroll and related costs and advertising associated withthe expansion.

 

                Interest expense totaled $3.7million in the six months ended June 30, 2002 compared to $4.3 million in theyear-earlier period.  The decreasereflects the general decline in interest rates.

 

Selling, general and administrative expenses totaled$2.1 million in the six months ended June 30, 2002 compared to $2.5 million inthe year-earlier period.  As with thequarter ended June 30, 2002, the reduced expenses are primarily due toincreased overhead capitalized as initial direct costs, reduced payroll andrelated costs and the nonrecurring expenses of the 2001 exchange offeringrelated to the Company’s subordinated debt.

 

**DiscontinuedOperations**

 

                Loss fromdiscontinued operations was $1.9 million in the six months ended June 30, 2002compared to $877,000 in the prior year period. The decrease of $1.0 million is due primarily to the write-off of certainintangible assets and inventory reserves, net of reductions in collection andimpairment provisions.

 

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See Note 3 to the Consolidated Financial Statementsfor description of the Company’s Discontinued Operations.

 

**IncomeTaxes**

 

The estimated effective income tax rate was 42% in thesix months ended June 30, 2002 and 40% in the year-earlier period.  The increase and the reason the effectiverate was higher than the federal statutory tax rate of 34% was due primarily tostate income taxes and permanent tax differences.

 

 

**Liquidity and Capital Resources**

 

                The Company’sactivities are principally funded by proceeds from sales-type, direct financeand operating leases, equipment sales, fee income and proceeds from variousforms of non-recourse and recourse debt. Management believes the Company’s ability to generate cash from operationsis sufficient to fund operations.

 

Cash and cash equivalentstotaled $2.5 million at June 30, 2002 and $4.1 million at December 31,2001.  During the six months ended June30, 2002, operating activities provided cash of $9.3 million compared to $8.0million in the year-earlier period.   For the six months ended June 30, 2002, investing activities, consistingprimarily of equipment purchased for leasing, utilized cash of $7.4 million,and $3.5 million was utilized in financing activities, consisting primarily ofrepayment of borrowings.  Restrictedcash represents amounts advanced by lenders to the Company to be used forfunding future leasing transactions.

 

Included in accountspayable at June 30, 2002 is $19.4 million payable to vendors of equipmentpresently under lease with customers. Amounts due equipment vendors are generally settled with the proceeds ofborrowings utilizing the underlying leases and related equipment assecurity.  Subsequent to June 30, 2002,either permanent financing or firm commitments from lenders for such financing hadbeen obtained related to equipment under lease.

 

Effective March 31, 2002, the Company amended a lineof credit, reducing the maximum borrowings under the line from $3.5 million to$2 million, and changed the expiration date to December 31, 2002.  The line of credit is utilized to financegames in inventory.  Borrowings underthe line averaged approximately $350,000 during the six months ended June 30,2002.  The reduction in credit availableunder the line is not expected to have an impact on the Company’s on-goingoperations because the Company has discontinued the operation of its TableGames division and certain components of its Casino Slot Exchange division, andconsequently, the number of games in inventory has declined and is expected tocontinue to decline.

 

At June 30, 2002, total borrowings were $64.7 million,compared to $64.8 million at December 31, 2001.  At June 30, 2002, the Company’s credit and working capitalfacilities aggregated $22.9 million at interest rates ranging from 5.75% to 10.5%.  Advances under these agreements aggregated$14.0 million at June 30, 2002.  TheCompany’s current financial resources, including estimated cash flows fromoperations and the credit facilities, are expected to be sufficient to fund theCompany’s anticipated working capital needs. The Company is, from time to time, dependent upon the need to liquidateor externally finance transactions originated and held in its investmentportfolio.  The Company’s totalinvestment portfolio was $79.4 million at June 30, 2002, compared to $67.4million at December 31, 2001.  TheCompany continues to explore other possible sources of capital; however, thereis no assurance that additional capital, if required, can be obtained or willbe available on terms acceptable to the Company.

 

                Inflation is notexpected to have a significant impact on the Company’s operations.

 

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

#### **Interest Rate Risk**

 

                Substantially all of the Company’s borrowings are under fixed interestrates, and maturities are matched with the cash flows of leased assets andnotes receivables.  A changing interestrate environment will not significantly impact the Company’s margins since theeffects of higher or lower borrowing costs would be reflected in the rates fornewly originated leases or collateralized loans.  Therefore, consistent with the Company’s strategy and intentionto hold most of its lease and loan originations to maturity, the Company doesnot have a significant exposure to interest rate changes.

 

#### **Currency Risk**

 

               The Company does not have anyexposure to foreign currency risk because all of its sales to customers inforeign countries are transacted in United States dollars.

 

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**Forward-LookingStatements**

 

                Certain statements containedherein constitute “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995.  Such forward-looking statements may be identified by the use ofterminology such as “believe,” “may,” “will,” “expect,” “anticipate,”“intend,”  “designed,” “estimate,”“should” or “continue” or the negatives thereof or other variations thereon orcomparable terminology.  Suchforward-looking statements involve known or unknown risks, uncertainties andother factors which may cause the actual results, performance or achievementsof the Company, or industry results, to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements.  Suchfactors include, but are not limited to, the following: strict regulation andchanges in regulations imposed by gaming authorities; the limitation,conditioning, suspension or revocation of gaming licenses and entitlements heldby the Company; competition the Company faces or may face in the future; thecontinued acceptance of the Company’s products and services; the inability tocomplete currently anticipated finance and lease transactions; worse than expectedresults from the Company’s casino operations; a decline in the publicacceptance of gaming; unfavorable public referendums or legislation,particularly as they relate to gaming; the ability of the Company to continueto obtain adequate financing on acceptable terms; changes in interest rates;the ability of the Company to recover its investment in gaming equipment leasedunder operating leases; the risk of default by the Company’s customers withrespect to its financing transactions; the Company’s dependence on keyemployees; potential fluctuations in the Company’s quarterly results; generaleconomic and business conditions; and other factors detailed from time to timein the Company’s reports filed with the Securities and Exchange Commission.

 

 

**PART II — OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS.**

 

                  InMay 2002, the Company received notificationthat Tekbilt, Inc. (“Claimant”) has submitted a Demand for Arbitration to theAmerican Arbitration Association in connection with the Company’s allegedbreach of a Distributor Agreement (the “Agreement”) with Claimant in connectionwith the Company’s discontinued operations. In the notification, Claimant alleges that the Company is in breach ofthe terms of the Agreement and that such breach has caused Claimant to sustainsubstantial damages.  The monetarydamages sought by claimant are unspecified.

                  Although unable to predict the outcome of thismatter, management believes the Claimant’s claim to be without merit and willvigorously pursue all legal defenses available to it.  Management, further, does not believe that the outcome of sucharbitration is likely to have a material adverse effect on the Company.

**ITEM 2.  CHANGES IN SECURITIES AND USE OFPROCEEDS.**

 

                  Notapplicable.

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.**

 

                  Notapplicable.

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS.**

 

                  Notapplicable.

**ITEM 5.  OTHER INFORMATION.**

 

                  OnJuly 12, 2002, the Company announced that Martha Vlcek, its Chief FinancialOfficer and Treasurer, tendered her resignation in order to pursue otherinterests.  While the Company searchesfor a replacement, Peter D. Cleary, President and Chief Operating Officer, hasassumed the role of Interim Chief Financial Officer and Treasurer.

 

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**ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

a)              The following exhibits are included with thisquarterly report on Form 10-Q as required by Item 601 of Regulation S-K.

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                     |   |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.1                |   | Master Loan Agreement, dated as of May 14, 2002, by  and among PDS Gaming Corporation, PDS Gaming Corporation-Nevada, PDS Gaming  Corporation-  Mississippi, PDS Gaming Corporation-Colorado, and First State Bank of  Thermopolis. |   |

 

b)             Reports on Form 8-K. A Form 8-K was filed in July 2002 to report the termination of Johan P.Finley’s (the Company’s Chief Executive Officer) Rule 10b5-1 Stock Sales Planeffective July 11, 2002.  A Form 8-K wasfiled contemporaneously with the filing of this Quarterly Report on Form 10-Qto report the submission to the Securities and Exchange Commission of thecertification required by its chief executive officer and chief financialofficer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002, with respect to this Quarterly Report onForm 10-Q.  There were no other reportson Form 8-K during the quarter ended June 30, 2002 or during the period fromJune 30, 2002 to the filing date of this Quarterly Report on Form 10-Q.

**Signature**

 

In accordance with the requirements of the Securities Exchange Act of1934, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

**                                                                               **

 
|                          | **PDS GAMING CORPORATION**                                                            |   |
|-------------------------------|---------------------------------------------------------------------------------------|--------|
|                          |                                                                                  |   |
|                          |                                                                                  |   |
|                          |                                                                                  |   |
| Dated:   August 14, 2002 | By:/s/  Peter  D. Cleary                                                         |   |
|                          | President, Chief Operating Officer and Interim Chief  Financial Officer and Treasurer |
|                          | (a duly authorized officer)                                                           |   |

 

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