**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

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

 

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**FORM 10-Q**

 

| **ý** |   | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|------------|--------|-----------------------------------------------------------------------------------------|
|       |   |                                                                                    |
|       |   | **FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003**                                        |
|       |   |                                                                                    |
|       |   | **OR**                                                                                  |
|       |   |                                                                                    |
| **o**      |   | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSION FILE NO. 0-23928**

 

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**PDS GAMING CORPORATION**

(Exact name of Registrant as specified in its charter)

 

| **Minnesota**                                                   |   | **41-1605970**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |
| **6171  McLeod Drive, Las Vegas, Nevada 89120**                 |
| (Address of Principal  Executive Offices)                       |
|                                                            |
| **(702)  736-0700**                                             |
| (Issuer’s Telephone  Number, Including Area Code)          |

 

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Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past90 days.         Yes   ý                 No   o

 

Indicate by check mark whetherthe Registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).      Yes   o                 No   ý

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the lastpracticable date:

 

| **Class**                    |   | **Outstanding as of August 1,  2003** |
|------------------------------|--------|---------------------------------------|
| Common Stock, $.01 par value |   | 3,805,299                             |

 

 

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

 

###### **INDEX**

 

 
| **PART  I   FINANCIAL INFORMATION** |
|----------------------------------------------------|
|                                               |
| Item 1.                                            | Financial Statements: |
|                                               |   |
|                                               | Consolidated Balance Sheets  – June 30, 2003 (Unaudited) and December 31, 2002 |
|                                               |   |
|                                               | Consolidated  Statements of Income – Three Months Ended June 30, 2003 and 2002 (Unaudited) |
|                                               |   |
|                                               | Consolidated Statements of  Income – Six Months Ended  June 30,  2003 and 2002 (Unaudited) |
|                                               |   |
|                                               | Consolidated  Statements of Cash Flows – Six Months Ended  June 30, 2003 and 2002 (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 |
|                                               |   |
| Item 4.                                            | Controls and Procedures |
|                                               |
|                                               |
| **PART II   OTHER  INFORMATION**    |
|                                               |
| Item 1.                                            | Legal  Proceedings |
|                                               |   |
| Item 6.                                            | Exhibits and Reports  on Form 8-K |

 

2

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**PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                |   | **June 30,****2003** |        | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|----------------------|-------------|------------------------|--------|
|                                                                                                                |   | **(Unaudited)**      |        |                   |   |
| **ASSETS:**                                                                                                         |   |                 |        |                   |   |
|                                                                                                                |   |                 |        |                   |   |
| Cash  and cash equivalents                                                                                          |   | $                    | 1,199,000   |                   | $      | 115,000 |   |
| Restricted  cash                                                                                                    |   | 2,398,000            |        | 1,377,000              |   |
| Notes,  accounts and leases receivable, net of allowances                                                           |   | 41,691,000           |        | 41,203,000             |   |
| Equipment  under operating leases, net                                                                              |   | 60,390,000           |        | 42,487,000             |   |
| Equipment  held for sale or lease                                                                                   |   | 2,670,000            |        | 3,350,000              |   |
| Other  assets, net                                                                                                  |   | 9,236,000            |        | 9,306,000              |   |
|                                                                                                                |   | $                    | 117,584,000 |                   | $      | 97,838,000 |   |
|                                                                                                                |   |                 |        |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY:**                                                                     |   |                 |        |                   |   |
|                                                                                                                |   |                 |        |                   |   |
| Equipment  vendors payable                                                                                          |   | $                    | 13,941,000  |                   | $      | 14,385,000 |   |
| Accounts  payable                                                                                                   |   | 713,000              |        | 233,000                |   |
| Accrued  expenses and other                                                                                         |   | 3,379,000            |        | 2,599,000              |   |
| Customer  deposits                                                                                                  |   | 4,222,000            |        | 3,440,000              |   |
| Notes  payable                                                                                                      |   | 78,178,000           |        | 59,977,000             |   |
| Subordinated  debt                                                                                                  |   | 8,554,000            |        | 9,054,000              |   |
|                                                                                                                |   | 108,987,000          |        | 89,688,000             |   |
|                                                                                                                |   |                 |        |                   |   |
| Stockholders’  equity:                                                                                         |   |                 |        |                   |   |
| Common  stock, $.01 par value, 20,000,000 shares authorized, 3,803,737 and  3,799,978 shares issued and outstanding |   | 38,000               |        | 38,000                 |   |
| Additional  paid-in capital                                                                                         |   | 11,816,000           |        | 11,812,000             |   |
| Retained  earnings (deficit)                                                                                        |   | (3,257,000           | )           | (3,700,000             | )      |
|                                                                                                                |   | 8,597,000            |        | 8,150,000              |   |
|                                                                                                                |   | $                    | 117,584,000 |                   | $      | 97,838,000 |   |

 

See notes toconsolidated financial statements.

 

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###### **PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME(LOSS)**

**THREE MONTHS ENDED JUNE 30,**

**(Unaudited)**

 
|                                              |   | **2003**  |      | **2002**  |   |
|---------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **REVENUES:**                                     |   |      |      |      |   |
| Equipment  sales and sales-type leases            |   | $         | 1,594,000 |      | $      | 4,089,000 |   |
| Operating  lease rentals                          |   | 6,137,000 |      | 3,059,000 |   |
| Finance  income                                   |   | 1,216,000 |      | 1,097,000 |   |
| Fee  income                                       |   | 668,000   |      | 43,000    |   |
| Casino                                            |   | 226,000   |      | 495,000   |   |
|                                              |   | 9,841,000 |      | 8,783,000 |   |
| **COSTS AND EXPENSES:**                           |   |      |      |      |   |
| Equipment  sales and sales-type leases            |   | 1,322,000 |      | 3,246,000 |   |
| Depreciation  on leased equipment                 |   | 4,390,000 |      | 2,000,000 |   |
| Interest                                          |   | 2,405,000 |      | 1,792,000 |   |
| Casino                                            |   | 331,000   |      | 692,000   |   |
| Selling,  general and administrative              |   | 896,000   |      | 873,000   |   |
| Depreciation  and amortization on other property  |   | 187,000   |      | 198,000   |   |
| Collection  and asset impairment provisions       |   | 25,000    |      | 31,000    |   |
|                                              |   | 9,556,000 |      | 8,832,000 |   |
| Income (loss) before income taxes (benefit)       |   | 285,000   |      | (49,000   | )      |
| Income  taxes (benefit)                           |   | 103,000   |      | (20,000   | )      |
| Income  (loss) from continuing operations         |   | 182,000   |      | (29,000   | )      |
| Discontinued  operations                          |   |      |      | (484,000  | )      |
| Net income (loss)                                 |   | $         | 182,000   |      | $      | (513,000 | ) |
|                                              |   |      |      |      |   |
| **Earnings  (loss) per share:**                   |   |      |      |      |   |
| Continuing  operations - basic and diluted        |   | $         | 0.05      |      | $      | (0.01 | ) |
| Discontinued  operations – basic and diluted |   |      |      | (0.13     | )      |
| Net  income (loss) – basic and diluted       |   | 0.05      |      | (0.14     | )      |
|                                              |   |      |      |      |   |
| **Weighted  average shares outstanding:**         |   |      |      |      |   |
| Basic                                             |   | 3,804,000 |      | 3,797,000 |   |
| Diluted                                           |   | 3,805,000 |      | 3,797,000 |   |

 

See notes toconsolidated financial statements.

 

4

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###### **PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME (LOSS)**

**SIX MONTHS ENDED JUNE 30,**

**(Unaudited)**

 
|                                             |   | **2003**   |       | **2002**   |       |
|--------------------------------------------------|--------|------------|------------|------------|------------|
| **REVENUES:**                                    |   |       | ** ** |       | ** ** |
| Equipment  sales and sales-type leases           |   | $          | 3,499,000  |       | $          | 9,042,000 |   |
| Operating  lease rentals                         |   | 11,542,000 |       | 5,570,000  |       |
| Finance  income                                  |   | 2,202,000  |       | 2,385,000  |       |
| Fee  income                                      |   | 1,643,000  |       | 383,000    |       |
| Casino                                           |   | 389,000    |       | 836,000    |       |
|                                             |   | 19,275,000 |       | 18,216,000 |       |
| **COSTS AND EXPENSES:**                          |   |       |       |       |       |
| Equipment  sales and sales-type leases           |   | 2,843,000  |       | 7,454,000  |       |
| Depreciation  on leased equipment                |   | 8,165,000  |       | 3,673,000  |       |
| Interest                                         |   | 4,637,000  |       | 3,686,000  |       |
| Casino                                           |   | 642,000    |       | 1,400,000  |       |
| Selling,  general and administrative             |   | 1,862,000  |       | 2,423,000  |       |
| Depreciation  and amortization on other property |   | 379,000    |       | 400,000    |       |
| Collection  and asset impairment provisions      |   | 55,000     |       | 59,000     |       |
|                                             |   | 18,583,000 |       | 19,095,000 |       |
| Income (loss) before income taxes (benefit)      |   | 692,000    |       | (879,000   | )          |
| Income  taxes (benefit)                          |   | 249,000    |       | (369,000   | )          |
| Income  (loss) from continuing operations        |   | 443,000    |       | (510,000   | )          |
| Discontinued  operations                         |   |       |       | (1,876,000 | )          |
| Net income (loss)                                |   | $          | 443,000    |       | $          | (2,386,000 | ) |
|                                             |   |       |       |       |       |
| **Earnings  (loss) per share:**                  |   |       |       |       |       |
| Continuing  operations  - basic and diluted |   | $          | 0.12       |       | $          | (0.13 | ) |
| Discontinued  operations - basic and diluted     |   |       |       | (0.50      | )          |
| Net  income (loss) - basic and diluted           |   | 0.12       |       | (0.63      | )          |
|                                             |   |       |       |       |       |
| **Weighted  average shares outstanding:**        |   |       |       |       |       |
| Basic                                            |   | 3,803,000  |       | 3,790,000  |       |
| Diluted                                          |   | 3,804,000  |       | 3,790,000  |       |

 

See notes toconsolidated financial statements.

 

5

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###### **PDSGAMING CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**SIXMONTHS ENDED JUNE 30,**

**(Unaudited)**

 
|                                                            |   | **2003**    |       | **2002**    |   |
|-----------------------------------------------------------------|--------|-------------|------------|-------------|--------|
| **OPERATING ACTIVITIES:**                                       |   |        |       |        |   |
| Net  cash provided by (used in) continuing operating activities |   | $           | (1,706,000 | )           | $      | 9,511,000 |   |
| Net  cash used in discontinued operating activities             |   |        |       | (164,000    | )      |
|                                                            |   |        |       |        |   |
| Net  cash provided by (used in) operating activities            |   | (1,706,000  | )          | 9,347,000   |   |
|                                                            |   |        |       |        |   |
| **INVESTING ACTIVITIES:**                                       |   |        |       |        |   |
| Purchase  of equipment for leasing                              |   | (13,890,000 | )          | (6,780,000  | )      |
| Proceeds  from sale of equipment under operating leases         |   | 50,000      |       | 459,000     |   |
| Other                                                           |   | (55,000     | )          | (1,081,000  | )      |
|                                                            |   |        |       |        |   |
| Net  cash used in investing activities                          |   | (13,895,000 | )          | (7,402,000  | )      |
|                                                            |   |        |       |        |   |
| **FINANCING ACTIVITIES:**                                       |   |        |       |        |   |
| Proceeds  from borrowings                                       |   | 32,162,000  |       | 19,690,000  |   |
| Repayment  of borrowings                                        |   | (13,961,000 | )          | (17,385,000 | )      |
| Increase  in restricted cash                                    |   | (1,021,000  | )          | (3,438,000  | )      |
| Repayment  of subordinated debt                                 |   | (500,000    | )          | (2,453,000  | )      |
| Proceeds  from issuance of common stock                         |   | 5,000       |       | 97,000      |   |
|                                                            |   |        |       |        |   |
| Net  cash provided by (used in) financing activities            |   | 16,685,000  |       | (3,489,000  | )      |
|                                                            |   |        |       |        |   |
| **CHANGE IN CASH AND CASH EQUIVALENTS:**                        |   |        |       |        |   |
| Net  increase (decrease) in cash and cash equivalents           |   | 1,084,000   |       | (1,544,000  | )      |
| Cash  and cash equivalents at beginning of period               |   | 115,000     |       | 4,086,000   |   |
|                                                            |   |        |       |        |   |
| Cash  and cash equivalents at end of period                     |   | $           | 1,199,000  |        | $      | 2,542,000 |   |

 

See notes to consolidated financial statements.

 

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**PDSGAMING CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information and the instructions to Form 10-Qand Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and disclosuresrequired by generally accepted accounting principles for annual financialstatements.  In the opinion ofmanagement, all adjustments (including normal recurring adjustments) considerednecessary for a fair presentation have been included.  The results of operations for any interim period are notnecessarily indicative of results for the full year.  For further information, please refer to the consolidated financialstatements of PDS Gaming Corporation (the “Company”), and the related notes,included within the Company’s Annual Report on Form 10-K for the fiscal yearended December 31, 2002 (the “2002 Form 10-K”), previously filed with theSecurities and Exchange Commission.

 

The balance sheet at December 31, 2002 was derivedfrom the audited financial statements included in the Company’s 2002 Form 10-K.

 

**2.****              STOCK PLANS**

 

The Company has two stock option plans, the 1993 StockOption Plan and the 2002 Stock Option Plan. The Company applies Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, in accounting for its stock option plans.  Based on the related circumstances, nocompensation expense has been recognized for the stock option plans. TheCompany has adopted the disclosure-only provisions of Statement of FinancialAccounting Standards No. 148, *Accounting forStock-Based Compensation-Transition and Disclosure*, an amendment ofFASB Statement No. 123 (“SFAS No. 148”), therefore, no compensation expense wasrecognized for the Company’s stock option plans.  Had compensation expense for the Company’s stock option plansbeen determined based on the fair value at the grant date for awards underthese plans, consistent with the methodology prescribed under SFAS No. 148, theCompany’s net income (loss) and earnings (loss) per share would haveapproximated the pro forma amounts indicated below:

 
|                                                                   |   | **Three Months Ended June 30** |    | **Six Months Ended June 30** |   |
|------------------------------------------------------------------------|--------|--------------------------------|---------|------------------------------|--------|
|                                                                   |   | **2003**                       |    | **2002**                     |   | **2003** |   | **2002** |   |
| Reported net income  (loss)                                            |   | $                              | 182,000 |                         | $      | (513,000 | ) | $ | 443,000 |   | $ | (2,386,000 | ) |
| Reported earnings  (loss) per share – basic and diluted           |   | 0.05                           |    | (0.14                        | )      | 0.12 |   | (0.63 | ) |
| Adjustment to  compensation expense for stock-based awards, net of tax |   | 41,000                         |    | 114,000                      |   | 81,000 |   | 228,000 |   |
| Pro forma net income  (loss)                                           |   | 141,000                        |    | (627,000                     | )      | 362,000 |   | (2,614,000 | ) |
| Pro forma earnings  (loss) per share – basic and diluted          |   | 0.04                           |    | (0.17                        | )      | 0.10 |   | (0.69 | ) |
|                                                                        |        |                                |         |                              |        |  |  |  |  |  |  |  |  |

 

The weighted-average fairvalue of each stock option included in the preceding pro forma disclosures wasestimated using the Black-Scholes option-pricing model and is amortized overthe vesting period of the underlying options.

 

7

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**3.****              NOTES PAYABLE**

 

Notes payable consist of the following:

 
|                                                                                                                                                                                                                   |   | **June 30,****2003** |       | **December 31,****2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|------------|--------------------------|--------|
| Recourse  lines of credit with a maximum aggregate balance of $14,020,000 bearing  interest at rates from 5.25% to 10.50%, secured by related investment in  leases, equipment held for sale or lease and other assets |   | $                    | 11,008,000 |                     | $      | 12,853,000 |   |
| Equipment  notes bearing interest at rates from 0% to 15.08%, secured by related  investment in leases:                                                                                                                |   |                 |       |                     |   |
| Recourse                                                                                                                                                                                                               |   | 28,390,000           |       | 21,838,000               |   |
| Non-recourse                                                                                                                                                                                                           |   | 39,430,000           |       | 25,726,000               |   |
|                                                                                                                                                                                                                   |   | 78,828,000           |       | 60,417,000               |   |
| Unamortized  loan discounts                                                                                                                                                                                            |   | (650,000             | )          | (440,000                 | )      |
|                                                                                                                                                                                                                   |   | $                    | 78,178,000 |                     | $      | 59,977,000 |   |

 

In July 2003, the Company obtained a recourse bridgeloan of $2,500,000 bearing interest at 12.00%, maturing December31, 2003.  The debt iscollateralized by certain lease schedules, as well as the underlying equipment.  The Company expects to repay the debt withthe proceeds of a long-term financing expected to be completed by December31, 2003.

 

**4.****              DISCONTINUEDOPERATIONS**

 

During the first quarter 2002, the Companydiscontinued operations of its Table Games Division, with the exception ofservicing games currently under lease and selling or leasing games ininventory, and certain components of its Casino Slot Exchange Division.  Accordingly, the Company recorded theseactivities as discontinued operations in accordance with Statement of FinancialAccounting Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*.

 

Results from discontinuedoperations, net of income tax benefit, are as follows for the three and sixmonths ended June 30, 2002:

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

 

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**5.****              CONTINGENCIES**

 

**Litigation. **InMay 2002, the Company received notification that Tekbilt, Inc. (“Claimant”) hadsubmitted a Demand for Arbitration to the American Arbitration Associationalleging breach of a Distributor Agreement (the “Agreement”) with Claimant inconnection with the Company’s discontinued operations.  In the notification, Claimant alleged thatsuch breach has caused Claimant to sustain substantial damages.  The monetary damages sought by claimant areunspecified.  The Company timely filedits Answering Statement and has asserted a Counterclaim against Claimant.  The Company seeks the dismissal of Claimant’sclaims in their entirety, an award of monetary damages and reimbursement of allcosts and expenses incurred by the Company as a result of the case, includingattorneys fees.  Neither party hasspecified its alleged damages.  The caseis in a preliminary stage, and the hearing before the American ArbitrationAssociation panel is expected to occur in 2003.  Although unable to predict the outcome of this matter, managementbelieves the claim to be without merit and will vigorously pursue all legaldefenses available to it.  Management,further, does not believe that the outcome of such arbitration is likely tohave a material adverse effect on the Company. Accordingly, no accounting recognition has been provided for losses, ifany.

 

On February 24, 2003, the Company announced that ithad entered into a letter of intent (the “Letter of Intent”) with respect to aproposal submitted by a management group consisting of Johan P. Finley, theCompany’s Chairman and Chief Executive Officer, Lona M.B. Finley, the Company’sExecutive Vice President, Secretary and Chief Administrative Officer, and PeterD. Cleary, the Company’s President, Chief Operating Officer and Treasurer(collectively, the “Management Group”), to acquire all of the approximately 69%of the outstanding shares of the Company’s common stock not already owned bythe Management Group (the “Proposed Transaction”).  On July 8, 2003, the Company announced that it had extended theLetter of Intent until August 10, 2003. The Management Group continues to actively negotiate with the SpecialCommittee of the Company’s Board of Directors towards a definitive agreementunder an informal extension of the Letter of Intent.  The Proposed Transaction is subject to, among other things, theexecution of a definitive agreement, approval by the Special Committee,approval by a majority of the Company’s shares not owned by the ManagementGroup, the procuring of all necessary consents of the Company’s commerciallenders and the trustees under the indentures covering the Company’soutstanding debt securities, the securing of required approvals from all gamingregulatory agencies, the obtaining of the necessary financing and the receiptby the Company of a favorable fairness opinion from an investment bank.

 

On July 8, 2003, the Companyannounced that it had been named as a defendant in a purported class actionlawsuit filed by a shareholder in District Court, Clark County, Nevada, inconnection with the Proposed Transaction. The complaint alleged that members of the Company’s Board of Directorsviolated their fiduciary duties in approving the Letter of Intent with respectto the proposal submitted by the Management Group, and sought to enjoin theManagement Group from acquiring the shares. The Company believes the allegations are without merit and intends tovigorously defend the lawsuit.  This isthe third similar complaint against the Company relating to the ProposedTransaction.  Each of the two priorcomplaints was voluntarily dismissed by the respective plaintiffs in responseto the Company’s motions to dismiss.

 

**Residual sharing.**   The Company agreed to share theproceeds from future sales of certain equipment at lease termination, but onlyto the extent, if any, that such proceeds exceed the Company’s originalestimate of residual values of the equipment made at the inception of therespective leases.  The Company’sobligation to assign assets to a residual sharing pool is collateralized byreceivables totaling $10.2 million at June 30, 2003.  The value of the equipment to be assigned to the sharing pool iscalculated based on the present value of the Company’s original anticipatedresidual value in the equipment at lease termination (originally $7.2 million),subject to adjustment as defined.  InJuly 2003, the Company identified and assigned additional equipment to thesharing pool.

 

9

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

 

**OVERVIEW**

 

The Company is engaged in the business of leasing andother financing of gaming equipment and remarketing previously leased gamingdevices to casino operators.  The gamingequipment financed by the Company consists mainly of slot machines, video gamingmachines and other gaming devices.  Inaddition, the Company finances furniture, fixtures and other gaming-relatedequipment, including gaming tables and chairs, restaurant and hotel furniture,vehicles, security and surveillance equipment, computers and other officeequipment.  The Company believes it iscurrently the only independent leasing company licensed in the states ofNevada, New Jersey, California, Colorado, Illinois, Indiana, Iowa, Minnesota,Mississippi, New Mexico and Washington to provide this financing alternative.  In early 2001 the Company received anonrestricted gaming license to operate The Gambler, now known as Rocky’sCasino and Sports Bar (“Rocky’s”), in Reno, Nevada.

 

**STRATEGY**

 

The Company’s strategy is to increase recurringrevenues and cash flows through originations of leases.  In addition to its leasing activities, theCompany also originates note transactions which it generally sells to thirdparties.  In some of its transactions,the Company holds the leases or notes for a period of time after origination orretains a partial ownership interest in the leases or notes.  The Company believes its ability to remarketused gaming devices enhances the gaming devices’ values at the end of anoperating lease and facilitates additional 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’s operating results are also subject toquarterly fluctuations resulting from a variety of other factors, including,but not limited to, (i) variations in the mix of financing transactions betweenoperating leases, direct finance leases and notes receivable, (ii) changes inthe gaming industry which affect the demand for reconditioned gaming devicessold by the Company at lease termination, and (iii) economic conditions, inwhich a detrimental change can cause customers to delay new investments andincrease the Company’s bad debt exposure, and reduce the level of fee incomeobtained through the sale of leases or financing transactions.

 

**ACCOUNTING POLICIES**

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires the Company’s managementto make estimates and assumptions that affect reported amounts and disclosures,some of which may require revision in future periods.  The most significant estimates are those involving residualvalues, collectibility of notes, accounts and leases receivable and valuationof equipment held for sale or lease.

 

The following is a summary of what management believesare the critical accounting policies related to the Company.  The application of these policies, in somecases, requires the Company’s management to make subjective judgments regardingthe effect of matters that are inherently uncertain.  See Note 1, “Summary of Significant Accounting Policies,” to theCompany’s Consolidated Financial Statements included within the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2002,previously filed with the Securities and Exchange Commission, for a moredetailed discussion of the Company’s accounting policies.

 

**Revenue and Cost Recognition. **The Company records revenue, primarily, inaccordance with SFAS No. 13*, Accounting for Leases*,**andSFAS No. 140,*Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities*, along with other related guidanceunder generally accepted accounting principles and other regulatory guidancerelated to revenue recognition.

 

The Company’s leasing activities include operating,direct finance and sales-type leases. For all types of leases, the determination of profit considers theestimated value of equipment at lease termination, referred to as the residualvalue. The issues specific to operating, direct finance and sales-type leasesare as follows:

 

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•                  Foroperating leases, revenue and depreciation on the leased equipment are recordedon the straight-line method over the term of the lease.

 

•                  Directfinance and sales-type leases are similar in that substantially all of thebenefits and risks of ownership of the leased equipment are transferred to thelessee, and finance income is recognized at a constant percentage return on theasset carrying value.  The carryingvalue consists of the present value of the future lease payments plus anyunguaranteed residual, sometimes referred to herein as leases receivable.  A dealer’s profit or loss on the subjectequipment is recognized at the inception of a sales-type lease.

 

After the inception of a lease, the Company maydiscount or sell notes and future lease payments to reduce or recover itsinvestment in the asset.  Initial directcosts related to leases and notes receivable are capitalized as part of therelated asset and amortized over the term of the agreement using the interestmethod, except for operating leases, for which the straight-line method isused.

 

Equipment held for sale or lease, consisting primarilyof gaming devices, is valued at the lower of average unit cost or netrealizable value.  Revenue is recognizedwhen title transfers to the customer upon shipment of used gaming devices orupon the exercise of a purchase option under an operating lease.

 

**Reserves For Losses. **Anallowance for losses is maintained at levels determined by the Company’smanagement to adequately provide for collection losses and anyother-than-temporary declines in other asset values.  In determining losses, the Company’s management considerseconomic conditions, the activity in used equipment markets, the effect ofactions by equipment manufacturers, the financial condition of customers, theexpected courses of action by lessees with regard to leased equipment attermination of the initial lease term, changes in technology and other factorswhich management believes are relevant. Recoverability of an asset value is measured by a comparison of thecarrying amount of the asset to future net cash flows expected to be generatedby the asset.  If a loss is indicated,the loss to be recognized is measured by the amount by which the carryingamount of the asset exceeds the net realizable value of the asset.  Asset charge-offs are recorded upon thedisposition of the underlying assets. Management reviews the Company’s assets on a quarterly basis to assessthe adequacy of the allowances for losses in light of all available information.

 

#### **RESULTS OF OPERATIONS**

 

**Three months ended June 30, 2003 and 2002**

 

The Company reported net income of $182,000 or $0.05per diluted share in the second quarter 2003 compared to a net loss of $513,000or $0.14 per diluted share in the second quarter 2002.  The second quarter 2002 results include aloss from continuing operations of $29,000 and a loss from discontinuedoperations of $484,000.  The Companycompleted $42.6 million in originations in the second quarter 2003 comparedwith $20.4 million in the second quarter 2002. Originations in the second quarter 2003 included $23.0 million sourcedthrough a single customer.  Included inthis amount was a $20.8 million note syndicated by the Company, of which $1.0million was retained by the Company for its portfolio.

 

Total revenues and the mix of revenues and relatedcosts for the comparable periods varied significantly, but this variability isnot unusual given the nature of the Company’s operations (see “Strategy”herein).  Revenues from continuingoperations in the second quarter 2003 totaled $9.8 million compared to $8.8million in the year-earlier quarter, an increase of $1.0 million.  This increase reflects higher levels ofoperating lease revenues and fee income, partially offset by lower revenuesfrom equipment sales and sales-type leases.

 

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Revenues from equipment sales and sales-type leasestotaled $1.6 million in the second quarter of 2003 compared to $4.1 million inthe year-earlier quarter, and are summarized as follows:

 
|                                                                                                                                           |   | **June 30,****2003** |      | **June 30,****2002** |   | **Increase****(Decrease)** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|-----------|----------------------|--------|----------------------------|--------|
| Sales  of equipment from inventory                                                                                                             |   | $                    | 1,142,000 |                 | $      | 1,487,000                  |   | $ | (345,000 | ) |
| Sales  of equipment coming off lease                                                                                                           |   | 250,000              |      | 1,582,000            |   | (1,332,000                 | )      |
| Sales-type  lease revenues, representing sales of equipment at the inception of a lease  in which a dealer’s profit or loss is recognized |   | 85,000               |      | 818,000              |   | (733,000                   | )      |
| Retail  sales of gaming equipment and merchandise                                                                                              |   | 117,000              |      | 202,000              |   | (85,000                    | )      |
|                                                                                                                                           |   | $                    | 1,594,000 |                 | $      | 4,089,000                  |   | $ | (2,495,000 | ) |

 

Costs of equipment sales and sales-type leases totaled$1.3 million and $3.2 million in the quarters ended June 30, 2003 and2002, respectively.  Changes in marginresult from a number of factors, including variations in pricing in the marketsserved by the Company.

 

Rental revenues from operating leases increased by$3.1 million, or 101%, to $6.1 million in the second quarter 2003 from $3.0million in the year-earlier quarter as a result of the Company’s significantlylarger portfolio of operating leases in the current year.  This portfolio increased to an average of$55.7 million in the second quarter 2003 from $29.4 million in theyear-earlier period as a result of the Company’s aggressive sales efforts.  Related depreciation was $4.4 million and$2.0 million for the quarters ended June 30, 2003 and 2002, respectively.  Depreciation on operating leases as apercentage of rental revenues increased from 65% in the prior year quarter to72% in the second quarter 2003.  Thisincrease is due to the Company’s normal recurring quarterly portfolio reviewthat resulted in acceleration of depreciation on certain leases in the currentyear quarter.

 

Finance income increased to$1.2 million in the second quarter 2003 from $1.1 million in the year-earlierquarter.  This nominal increase reflectsthe fact that the Company’s portfolio of notes and direct finance leasesreceivable was relatively unchanged between the two periods.

 

Fee income increased to$668,000 in the second quarter 2003 from $43,000 in the year-earlierquarter.  Included in the current yearquarter was fee income from one customer in the amount of $567,000.  Fee income is non-recurring in nature.

 

Casino revenuesdecreased to $226,000 in the second quarter 2003 from $495,000 in the year-earlierquarter.  Casino costs, excludingdepreciation and amortization, decreased to $331,000 in the current yearquarter compared to $692,000 in the second quarter 2002.  The decreased costs are primarily comprisedof decreased payroll and related costs and advertising.  The decreased loss from casino operationsreflects efforts to reduce costs in light of the continued weakness of theReno, Nevada gaming market as well as strong competition from Native Americancasinos operating in Northern California.

 

Interest expense totaled $2.4 million in the quarterended June 30, 2003 compared to $1.8 million in the second quarter of2002.  This increase results from higheraverage debt levels and a higher weighted average cost of funds in the secondquarter of 2003 compared to the second quarter of 2002.  Average debt levels increased to $79.5million in the quarter ended June 30, 2003 from $65.8 million in the secondquarter of 2002.  The weighted averagecost of funds increased to 12.09% in the quarter ended June 30, 2003 from11.62% in the second quarter of 2002.

 

Selling, general and administrative expenses totaled$896,000 in the second quarter 2003 and $873,000 in the year-earlier quarter,reflecting the Company's successful efforts in controlling overhead costs inthe current year quarter.

 

The estimated effective income tax rate was 36% in thefirst quarter 2003 and 42% in the first quarter 2002.  In both periods, the estimated effective rate was higher than thefederal statutory tax rate of 34% due primarily to state income taxes andpermanent tax differences.

 

Loss from discontinued operations was $484,000 in thesecond quarter 2002.  This loss was theoperating loss of operations that were classified in the first quarter 2002 asdiscontinued in accordance withStatement of

 

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Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets. *There wasno loss from discontinued operations during the second quarter 2003.

 

See Note 4 to the Consolidated Financial Statementsfor description of the Company’s Discontinued Operations.

 

#### **Six months ended June 30,2003 and 2002**

#### ** **

The Company reported net income of $443,000 or $0.12per diluted share for the six months ended June 30, 2003 compared to a netloss of $2,386,000 or $0.63 per diluted share for the six months ended June 30,2002.  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.  Gross originations of financing transactions were $74.1 millionfor the six months ended June 30, 2003, compared with $29.9 million in theyear-earlier period.  Originations inthe current year period included $51.1 million sourced through twocustomers.  Included in that amount wasa $20.8 million note syndicated by the Company, of which $1.0 million wasretained by the Company for its portfolio.

 

Total revenues and the mix of revenues and relatedcosts for the comparable periods varied significantly, but this variability isnot unusual given the nature of the Company’s operations (see “Strategy”herein).  Revenues from continuingoperations in the six months ended June 30, 2003 totaled $19.3 million comparedto $18.2 million in the year-earlier period. The increase in revenues of $1.1 million is primarily attributable tohigher levels of operating lease revenues and fee income, partially offset bylower revenues from equipment sales and sales-type leases.

 

Revenues from equipment sales and sales-type leasestotaled $3.5 million in the six months ended June 30, 2003 compared to $9.0million in the year-earlier period, and are summarized as follows:

 
|                                                                                                                                           |   | **June 30,****2003** |      | **June 30,****2002** |   | **Increase****(Decrease)** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|-----------|----------------------|--------|----------------------------|--------|
| Sales  of equipment from inventory                                                                                                             |   | $                    | 1,806,000 |                 | $      | 2,211,000                  |   | $ | (405,000 | ) |
| Sales-type  lease revenues, representing sales of equipment at the inception of a lease  in which a dealer’s profit or loss is recognized |   | 1,288,000            |      | 4,524,000            |   | (3,236,000                 | )      |
| Sales  of equipment coming off lease                                                                                                           |   | 180,000              |      | 1,897,000            |   | (1,717,000                 | )      |
| Retail  sales of gaming equipment and merchandise                                                                                              |   | 225,000              |      | 410,000              |   | (185,000                   | )      |
|                                                                                                                                           |   | $                    | 3,499,000 |                 | $      | 9,042,000                  |   | $ | (5,543,000 | ) |

 

Costs of equipment sales and sales-type leases totaled$2.8 million and $7.5 million in the six months ended June 30, 2003 and 2002,respectively, resulting in gross margins of $656,000 and $1.6 million,respectively  Changes in margin resultfrom a number of factors, including variations in pricing in the markets servedby the Company.

 

Rental revenues from operating leases increased by$6.0 million, or 107%, to $11.6 million in the six months ended June 30, 2003from $5.6 million in the year-earlier period as a result of the Company’ssignificantly larger portfolio of operating leases in the current year.  This portfolio increased to a average of$51.2 million in the six months ended June 30, 2003 from $26.3 million in theyear-earlier period as a result of the Company’s aggressive sales efforts.  Related depreciation was $8.2 million and$3.7 million for the six months ended June 30, 2003 and 2002, respectively.

 

Finance income totaled $2.2 million in the six monthsended June 30, 2003 compared to $2.4 million in the year-earlier period, adecrease of $183,000.  This decrease reflects the somewhat smalleraverage portfolio of notes and direct finance leases in the Company’s portfolioduring the six months ended June 30, 2003 as compared to the year-earlierperiod.

 

Fee income totaled $1.7 million in the six monthsended June 30, 2003 compared to $383,000 in the year-earlier period, anincrease of $1.3 million.  The increase is substantially the result ofmultiple 2003 engagements with one customer. Fee income is non-recurring in nature.

 

Casino revenues totaled $389,000 in the six monthsended June 30, 2003 compared to $836,000 in the year-earlier period, a decreaseof $447,000.  Related casino costs,excluding depreciation and amortization, were

 

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$642,000 and $1.4 million in the six months ended June 30, 2003 and2002, respectively.  Included in thecosts for the 2002 period are one-time pre-opening expenses of $238,000.  The 2003 loss from casino operations, beforepre-opening expenses, is less than 2002 and reflects efforts to reduce costs inlight of the continued weakness of the Reno, Nevada gaming market as well asstrong competition from Native American casinos operating in NorthernCalifornia.

 

Interest expense totaled $4.6 million in the sixmonths ended June 30, 2003 compared to $3.7 million in the year-earlierperiod.  This increase reflects higheraverage debt levels and a higher weighted average cost of funds in the firsthalf of 2003 compared to the first half of 2002.  Average debt levels increased to $75.0 million in the six monthsended June 30, 2003 from $65.9 million in the year-earlier period.  The weighted average cost of funds increasedto 12.36% in the six months ended June 30, 2003 from 11.56% in the year-earlierperiod.

 

Selling, general and administrative expenses totaled$1.9 million in the six months ended June 30, 2003 compared to $2.4 million inthe year-earlier period.  The decreaseof $561,000 primarily reflects lower compensation costs accrued in the currentyear period.

 

Loss from discontinued operations was $1.9 million inthe six months ended June 30, 2002.  Theloss consisted of a loss on disposal of $993,000 and an operating loss of$883,000 that were classified in the first quarter 2002 as discontinued in accordance with Statement of FinancialAccounting Standards No. 144, *Accounting forthe Impairment or Disposal of Long-Lived Assets*.  The loss on disposal was primarily related to the write-off of certainintangibles in the Company’s Table Games and Casino Slot Exchangedivisions.  In addition, due to thedecision to forego further reconditioning activities, the Company provided areserve for its related parts inventory of approximately $300,000 to liquidatethe inventory quickly and reduce the associated on-going carrying costs.  There was no loss from discontinued operationsduring the six months ended June 30, 2003.

 

See Note 4 to the Consolidated Financial Statementsfor description of the Company’s Discontinued Operations.

 

The estimated effective income tax rate was 36% in thesix months ended June 30, 2003 and 42% in the year-earlier period.  The increase and the reason the estimatedeffective rate was higher than the federal statutory tax rate of 34% was dueprimarily to state income taxes and permanent tax differences.

 

#### **LIQUIDITY AND CAPITAL RESOURCES**

 

As of June 30, 2003, the Company had $1.2 million incash and cash equivalents, $3.0 million in availability on lines of credit andrestricted cash of $2.4 million, of which $207,000 was immediately available tofund the originations of leases.  Thefunds necessary to support the Company’s activities have been provided by cashflows generated primarily from operating activities and various forms ofrecourse and non-recourse borrowings from banks, financial institutions andfinancial intermediaries.  Paymentsunder the Company’s borrowings and the maturities of its borrowings aretypically structured to match the payments under the leases and notescollateralizing the borrowings.  TheCompany manages its portfolio to optimize concentration among customers andgeographic markets.  To achieve thisgoal, it will from time to time sell or externally finance transactionsoriginated, including those held in its investment portfolio.  The Company continues to explore otherpossible sources of capital, however, there is no assurance that additionalcapital, if required, can be obtained or will be available on terms acceptableto the Company.

 

Equipment vendors payable at June 30, 2003 is $14.0million.  Amounts due equipment vendorsare generally settled with the proceeds of borrowings utilizing the underlyingleases and related equipment as collateral. Through July 31, 2003, approximately $2.7 million of the balanceoutstanding at June 30, 2003 was paid primarily with the proceeds of debtfinancing.

 

On February 24, 2003, the Company announced that ithad entered into a letter of intent (the “Letter of Intent”) with respect to aproposal submitted by a management group consisting of Johan P. Finley, theCompany’s Chairman and Chief Executive Officer, Lona M.B. Finley, the Company’sExecutive Vice President, Secretary and Chief Administrative Officer, and PeterD. Cleary, the Company’s President, Chief Operating Officer and Treasurer(collectively, the “Management Group”), to acquire all of the approximately 69%of the outstanding shares of the Company’s common stock that is not alreadyowned by the Management Group.  Underthe terms of the letter of intent, the Company will pay certain fees and costsassociated with the transaction, consisting primarily of legal costs and investmentbanking fees.  Management estimates thatsuch costs will be in the range of $500,000 to

 

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$700,000, with said costs being paid from general corporate funds.  On July 8, 2003, the Company announced thatit had extended, until August 10, 2003, the Letter of Intent.  The Management Group continues to activelynegotiate with the Special Committee of the Company’s Board of Directorstowards a definitive agreement under an informal extension of the Letter ofIntent.

 

#### **CASH FLOW**

 

During the six months ended June 30, 2003, cash usedby operating activities totaled $1.7 million compared to cash provided byoperating activities (continuing and discontinued, combined) of $9.3 million inthe first six months 2002.  The decreasein cash provided by operating activities during the first six months 2003primarily results from increased originations of direct finance leases of$13.1 million and increased payments to equipment vendors of $13.2million, partially offset by increased collections on notes and direct financeleases of $9.3 million and increased income from operations of $6.3million.  Cash used in investingactivities totaled $13.9 million in the six months ended June 30, 2003 comparedto cash used in investing activities of $7.4 million in the first six months2002.  The increase in cash used ininvesting activities is primarily the result of increased purchases ofequipment to be placed under operating leases in the amount of $6.9million.  Cash provided by financingactivities totaled $16.7 million in the six months ended June 30, 2003 comparedto cash used in financing activities of $3.5 million in the first six months2003.  The increase primarily reflectsincreases in borrowings to finance higher levels of lease originations in 2003.

 

At June 30, 2003, total borrowings were $86.7 million,compared to $69.0 million at December 31, 2002.  At June 30, 2003, the Company’s revolving credit and workingcapital facilities aggregated approximately $14.0 million at interest ratesranging from 5.25% to 10.50%.  Advancesunder these agreements aggregated approximately $11.0 million at June 30,2003.  The Company’s current financialresources, including estimated cash flows from operations and the revolvingcredit facilities, are expected to be sufficient to fund the Company’santicipated working capital needs.  TheCompany is, from time to time, dependent upon the need to liquidate orexternally finance transactions originated and held in its investmentportfolio.  The Company continues toexplore other possible sources of capital; however, there is no assurance thatadditional capital, if required, can be obtained or will be available on termsacceptable to the Company.

 

Inflation is not expected to have a significant impacton the Company’s operations in the foreseeable future.

 

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

 

#### **Interest Rate Risk**

 

Substantiallyall of the Company’s borrowings are under fixed interest rates, and maturitiesare matched with the cash flows of leased assets and notes receivables.  A changing interest rate environment willnot significantly impact the Company’s margins since the effects of higher orlower borrowing costs would be reflected in the rates for newly originatedleases or collateralized loans. Therefore, consistent with the Company’s strategy and intention to holdmost of its originations to maturity, the Company does not have a significantexposure to interest rate changes for the foreseeable future.

 

#### **Currency Risk**

 

TheCompany does not have a significant exposure to foreign currency risk becauseall of its sales to customers in foreign countries are transacted in UnitedStates dollars.

 

**Forward-Looking Statements**

 

Certain statements contained herein constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  Such forward-lookingstatements may be identified by the use of terminology such as “believe,”“may,” “will,” “expect,” “anticipate,” “intend,”  “designed,” “estimate,” “should” or “continue” or the negativesthereof or other variations thereon or comparable terminology.  Such forward-looking statements involveknown or unknown risks, uncertainties and other factors which may cause theactual results, performance or achievements of the Company, or industryresults, to be materially different from any future results, performance orachievements expressed or implied by such forward-looking statements.  Such factors include, but are not limitedto, the following: strict regulation and changes in regulations imposed bygaming authorities; the limitation, conditioning, suspension or revocation ofgaming licenses and entitlements held by the Company; competition the Companyfaces or may face in the future; the effects of the proposed going privatetransaction; uncertainty of market acceptance of the Company’s products andservices; unproven performance of Rocky’s; a

 

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decline in the public acceptance of gaming; unfavorable publicreferendums or legislation, particularly as they relate to gaming; the abilityof the Company to continue to obtain adequate financing on acceptable terms;the ability of the Company to recover its investment in gaming equipment leasedunder operating leases;  the risk ofdefault by the Company’s customers with respect to its financing transactions;the Company’s dependence on key employees; potential fluctuations in theCompany’s quarterly results; general economic and business conditions and otherfactors detailed from time to time in the Company’s reports filed with theSecurities and Exchange Commission.

 

**ITEM 4.****                              CONTROLSAND PROCEDURES**

 

*Evaluationof disclosure controls and procedures*.    Within90 days prior to the filing date of this Quarterly Report on Form 10-Q (the“Evaluation Date”), the Company evaluated, under the supervision of its ChiefExecutive Officer and its President, Chief Operating Officer, Treasurer andInterim Chief Financial Officer, the effectiveness of the Company’s disclosurecontrols and procedures.  Based on thisevaluation, the Company concluded that its disclosure controls and proceduresare effective to ensure that information the Company is required to disclose inreports that it files or submits under the Securities Exchange Act of 1934 isrecorded, processed, summarized, and reported within the time periods specifiedin SEC rules and forms.

 

*Changesin internal controls*.    Subsequent tothe Evaluation Date, there were no significant changes in the Company’sinternal controls or in other factors that could significantly affect theCompany’s internal controls, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

**PARTII****– OTHER INFORMATION**

 

**ITEM 1.****                              LEGAL PROCEEDINGS**

 

In May 2002, the Company received notification thatTekbilt, Inc. (“Claimant”) had submitted a Demand for Arbitration to theAmerican Arbitration Association alleging breach of a Distributor Agreement(the “Agreement”) with Claimant in connection with the Company’s discontinuedoperations.  In the notification,Claimant alleged that such breach has caused Claimant to sustain substantialdamages.  The monetary damages sought byclaimant are unspecified.  The Companytimely filed its Answering Statement and has asserted a Counterclaim againstClaimant.  The Company seeks thedismissal of Claimant’s claims in their entirety, an award of monetary damagesand reimbursement of all costs and expenses incurred by the Company as a resultof the case, including attorneys fees. Neither party has specified its alleged damages.  The case is in a preliminary stage, and thehearing before the American Arbitration Association panel is expected to occurin 2003.  Although unable to predict theoutcome of this matter, management believes the claim to be without merit andwill vigorously pursue all legal defenses available to it.  Management, further, does not believe thatthe outcome of such arbitration is likely to have a material adverse effect onthe Company.  Accordingly, no accountingrecognition has been provided for losses, if any.

 

On February 24, 2003, the Company announced that ithad entered into a letter of intent (the “Letter of Intent”) with respect to aproposal submitted by a management group consisting of Johan P. Finley, theCompany’s Chairman and Chief Executive Officer, Lona M.B. Finley, the Company’sExecutive Vice President, Secretary and Chief Administrative Officer, and PeterD. Cleary, the Company’s President, Chief Operating Officer and Treasurer (collectively,the “Management Group”), to acquire all of the approximately 69% of theoutstanding shares of the Company’s common stock that is not already owned bythe Management Group (the “Proposed Transaction) and thus becoming aclosely-held company.  Under the termsof the letter of intent, the Company will pay certain fees and costs associatedwith the transaction, consisting primarily of legal costs and investmentbanking fees.  Management estimates thatsuch costs will be in the range of $500,000 to $700,000, with said costs beingpaid from general corporate funds.  OnJuly 8, 2003, the Company announced that it had extended, until August 10,2003, the Letter of Intent.  TheManagement Group continues to actively negotiate with the Special Committee ofthe Company’s Board of Directors towards a definitive agreement under aninformal extension of the Letter of Intent.

 

The Company has been named as adefendant in a class action lawsuit filed by a shareholder in District Court,Clark County, Nevada in connection with the Proposed Transaction.  The complaint alleges that members of theCompany’s Board of Directors violated their fiduciary duties in approving theLetter of Intent with respect to the proposal submitted by the ManagementGroup, and seeks to enjoin the Management Group from acquiring the shares.  The Company believes the allegations arewithout merit and intends to vigorously defend the lawsuit.  This is the third such complaint against theCompany relating to the Proposed Transaction. Each of the two prior complaints was voluntarily dismissed by therespective plaintiffs in response to the defendents’ motions to dismiss.

 

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**ITEM 6.****                              EXHIBITSAND REPORTS ON FORM 8-K**

 

a)              The followingexhibits are included with this quarterly report on Form 10-Q as required byItem 601 of Regulation S-K.

 

                                
| **Exhibit Number** |   | **Description**                                                                                                                                                                                               |
|--------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                                                                                                                          |
| 31.1               |   | Certification by Johan  P. Finley pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18  U.S.C. Section 1350                                                                                          |
|               |   |                                                                                                                                                                                                          |
| 31.2               |   | Certification by Peter  D. Cleary pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18  U.S.C. Section 1350                                                                                          |
|               |   |                                                                                                                                                                                                          |
| 32.1               |   | Certifications pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350                                                                                                        |
|               |   |                                                                                                                                                                                                          |
| 99.1               |   | Press  release, dated July 8, 2003, announcing the extension, until August 10, 2003,  of its letter of intent relating to the proposed management group acquisition  of shares of common stock of the Company |
|               |   |                                                                                                                                                                                                          |
| 99.2               |   | Press  release, dated July 8, 2003, announcing an update on shareholder complaints  relating to the proposed management group acquisition of shares of common  stock of the Company                           |

 

b)             Reports on Form8-K.  A Form 8-K was filed on May 14,2003 announcing the Company’s earnings for the three months ended March 31, 2003.  A Form 8-K was filed on August 14, 2003announcing the Company’s earnings for the three and six months ended June 30,2003.  There were no other reports onForm 8-K during the period from June 30, 2003 to the date of this QuarterlyReport on Form 10-Q.

 

**SIGNATURE**

 

In accordance with therequirements of the Securities Exchange Act of 1934, the registrant caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                         | **PDS GAMING CORPORATION**                                                          |
|------------------------------|-------------------------------------------------------------------------------------|
|                         |                                                                                |
| Dated:  August 14, 2003 | By:                                                                                 | /s/  Peter D.  Cleary |   |
|                         | President, Chief  Operating Officer, Treasurer  and Interim Chief Financial Officer |
|                         | **(a  duly authorized officer)**                                                    |

 

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