UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

 

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2006

OR

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

 

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from       to

Commission File Number 0-4281

BALLY TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

NEVADA

 

88-0104066

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

6601 S. Bermuda Rd.

 

 

Las Vegas, Nevada

 

89119

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number: (702) 584-7700

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  o Yes    x No

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

o Large Accelerated Filer

 

x Accelerated Filer

 

o Non-Accelerated Filer

 

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

The number of shares of Common Stock, $0.10 par value, outstanding as of June 15, 2007, according to the records of the registrant’s registrar and transfer agent was 53,972,000 which does not include 587,000 shares held in treasury.

 




EXPLANATORY NOTE

As previously disclosed on the Form 12b-25 of Bally Technologies, Inc. (“Bally,” the “Company,” or “we”), filed with the Securities and Exchange Commission (the “SEC”) on February 12, 2007, the filing of this Quarterly Report on Form 10-Q for the quarter ended December 31, 2006 was originally delayed due to the significant amount of additional time and resources necessary to complete our amended and restated Annual Report on Form 10-K for the fiscal year ended June 30, 2005 (the “2005 10-K/A”), which was filed with the SEC on October 31, 2006.  The filing of this Quarterly Report on Form 10-Q was further delayed by the significant amount of time and resources necessary to complete our Quarterly Reports on Form 10-Q for the quarters ended September 30, 2005, December 31, 2005 and March 31, 2006, as well as our Annual Report on Form 10-K for the fiscal year ended June 30, 2006 (the “2006 10-K”), which was filed with the SEC on March 15, 2007. Furthermore, the preparation of the financial information presented in this Quarterly Report on Form 10-Q required additional time and resources because it was prepared while certain material weaknesses existed in our internal control over financial reporting.

I N D E X

 

 

 

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended December 31, 2006 and 2005

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2006 and 2005

 

 

 

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

 

 

 

 

 

 

SIGNATURES

 

 

 




PART I

BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

December 31,

 

June 30,

 

 

 

2006

 

2006

 

 

 

(in 000s, except share amounts)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

12,432

 

$

16,425

 

Restricted cash

 

15,687

 

14,484

 

Accounts and notes receivable, net of allowances for doubtful accounts of $7,478 and $8,073

 

136,735

 

135,497

 

Inventories

 

70,281

 

69,995

 

Income taxes receivable

 

570

 

266

 

Deferred tax assets, net

 

51,374

 

51,374

 

Other current assets

 

42,708

 

41,313

 

Total current assets

 

329,787

 

329,354

 

Long-term investments (restricted)

 

10,373

 

8,984

 

Long-term receivables

 

5,473

 

6,436

 

Property, plant and equipment, net of accumulated depreciation of $48,106 and $49,756

 

78,635

 

68,464

 

Leased gaming equipment, net of accumulated depreciation of $73,081 and $64,160

 

56,773

 

43,408

 

Goodwill

 

161,590

 

161,303

 

Intangible assets, net of accumulated amortization of $25,971 and $23,963

 

24,873

 

27,656

 

Deferred tax assets, net

 

22,112

 

20,048

 

Other assets, net

 

29,101

 

22,228

 

Total assets

 

$

718,717

 

$

687,881

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

34,379

 

$

39,622

 

Accrued liabilities

 

74,375

 

86,131

 

Jackpot liabilities

 

13,388

 

13,139

 

Deferred revenue

 

63,453

 

47,081

 

Current maturities of long-term debt and capital leases, including $5,219 and $6,600 owed to related parties

 

16,066

 

12,864

 

Total current liabilities

 

201,661

 

198,837

 

Long-term debt and capital leases, net of current maturities, including $8,981 and $7,600 owed to related parties

 

328,115

 

315,482

 

Other liabilities

 

33,859

 

28,800

 

Total liabilities

 

563,635

 

543,119

 

Minority interest

 

1,554

 

684

 

Commitment and Contingencies (Note 9)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Special stock, 10,000,000 shares authorized: Series E, $100 liquidation value; 115 shares issued and outstanding

 

12

 

12

 

Common stock, $.10 par value; 100,000,000 shares authorized; 53,741,000 and 52,880,000 shares issued and 53,210,000 and 52,354,000 outstanding

 

5,368

 

5,283

 

Treasury stock at cost, 531,000 and 526,000 shares

 

(706

)

(665

)

Additional paid-in capital

 

231,851

 

219,472

 

Accumulated other comprehensive income

 

1,118

 

1,351

 

Accumulated deficit

 

(84,115

)

(81,375

)

Total stockholders’ equity

 

153,528

 

144,078

 

Total liabilities and stockholders’ equity

 

$

718,717

 

$

687,881

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

2




BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

Three Months Ended

 

Six Months Ended

 

 

 

December 31,

 

December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s, except per share amounts)

 

Revenues:

 

 

 

 

 

 

 

 

 

Gaming equipment and systems

 

$

140,533

 

$

113,961

 

$

282,496

 

$

208,756

 

Casino operations

 

11,238

 

13,513

 

23,077

 

24,158

 

 

 

151,771

 

127,474

 

305,573

 

232,914

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of gaming equipment and systems

 

70,653

 

65,266

 

143,540

 

114,163

 

Cost of casino operations

 

4,439

 

4,939

 

8,901

 

9,222

 

Selling, general and administrative

 

51,622

 

46,028

 

101,666

 

86,960

 

Research and development costs

 

13,307

 

10,785

 

25,863

 

21,042

 

Depreciation and amortization

 

5,903

 

6,951

 

11,336

 

12,824

 

 

 

145,924

 

133,969

 

291,306

 

244,211

 

Operating income (loss)

 

5,847

 

(6,495

)

14,267

 

(11,297

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

413

 

589

 

1,324

 

1,492

 

Interest expense

 

(10,200)

 

(7,272

)

(18,121

)

(13,204

)

Other, net

 

675

 

(250

)

925

 

(521

)

Loss before income taxes and minority interest

 

(3,265

)

(13,428

)

(1,605

)

(23,530

)

Income tax benefit

 

2,358

 

4,702

 

1,687

 

8,835

 

Minority interest

 

(1,608

)

(177

)

(2,822

)

(2,587

)

Net loss

 

$

(2,515

)

$

(8,903

)

$

(2,740

)

$

(17,282

)

Basic and diluted loss per share

 

$

(0.05

)

$

(0.17

)

$

(0.05

)

$

(0.33

)

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic and diluted

 

53,072

 

52,138

 

52,985

 

52,138

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

3




BALLY TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

 

 

(in 000s)

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(2,740

)

$

(17,282

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

29,330

 

30,938

 

Share-based compensation

 

8,112

 

5,914

 

Deferred income taxes

 

(2,063

)

(9,012

)

Provision for doubtful accounts

 

290

 

680

 

Inventory and other asset write-downs

 

6,215

 

7,983

 

Other

 

9,523

 

6,960

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts and notes receivable

 

(1,036

)

(23,809

)

Inventories

 

(10,719

)

4,446

 

Other current assets

 

(785

)

3,656

 

Accounts payable

 

(6,759

)

(8,847

)

Accrued liabilities, deferred revenue and jackpot liabilities

 

2,901

 

21,540

 

Net cash provided by operating activities

 

32,269

 

23,167

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Additions to property, plant, and equipment

 

(8,778

)

(6,246

)

Additions to leased gaming equipment

 

(47,486

)

(19,933

)

Restricted cash and investments

 

(1,138

)

(866

)

Additions to other long-term assets

 

(1,251

)

(1,804

)

Net cash used in investing activities

 

(58,653

)

(28,849

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from revolving credit facility

 

5,000

 

 

Payments on revolving credit facility

 

(5,000

)

 

Reduction of long-term debt

 

(4,224

)

(3,042

)

Proceeds from sale lease-back arrangements

 

22,303

 

 

Proceeds from exercise of stock options

 

4,311

 

172

 

Net cash provided by (used in) financing activities

 

22,390

 

(2,870

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

1

 

23

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Decrease for period

 

(3,993

)

(8,529

)

Balance, beginning of period

 

16,425

 

33,170

 

Balance, end of period

 

$

12,432

 

$

24,641

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

4




BALLY TECHNOLOGIES, INC.
FORM 10-Q
Notes to Unaudited Condensed Consolidated Financial Statements

1.             BASIS OF PRESENTATION

Principles of presentation and consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and reflect all adjustments, consisting of normal recurring adjustments, which management believes are necessary to fairly present the financial position, results of operations and cash flows of Bally Technologies, Inc., a Nevada corporation, and its subsidiaries (“Bally” or the “Company”) for the respective periods presented.  The results of operations for an interim period are not necessarily indicative of the results that may be expected for any other interim period or the year as a whole. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006 as filed with the SEC on March 15, 2007.

Bally is a diversified, worldwide gaming company that designs, manufactures, distributes and operates gaming machines and computerized monitoring systems for gaming machines and owns and operates one casino.

The Company is the general partner of Rainbow Casino Vicksburg Partnership (“RCVP”), which operates the Rainbow Casino in Vicksburg, Mississippi.  Pursuant to transactions consummated in March 1995, the Rainbow Corporation, which was the former general partner of RCVP, became a limited partner entitled to receive 10% of the net available cash flows of RCVP after debt service and other items, as defined in the limited partnership agreement, which increases to 20% of the incremental amount of revenues in excess of $35.0 million, payable quarterly through December 31, 2010.  The Company holds the remaining economic interest in the partnership.  The Company announced in October 2006 that it is evaluating alternatives with respect to the possible sale of the Rainbow Casino.  The Company consolidates RCVP and records an adjustment to reflect the portion of the earnings of RCVP attributable to the minority shareholders.  As of September 30, 2006, RCVP did not meet the requirements for classification as an asset held for sale or discontinued operations.

The Company also consolidates certain Atlantic City progressive trusts in accordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) 46R, Consolidation of Variable Interest Entities, which addresses consolidation by a business enterprise of variable interest entities (“VIE’s”) that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support or (2) hold a significant variable interest in, or have significant involvement with, an existing VIE.  As of December 31, 2006 and June 30, 2006, the Company consolidated $6.2 million and $4.7 million, respectively, in total assets and liabilities, primarily consisting of restricted cash accounts and restricted investments (included in other assets in the condensed consolidated balance sheets) and related jackpot liabilities.  The following revenues and costs were also consolidated:

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s)

 

 

 

 

 

 

 

 

 

 

 

Gaming equipment and systems revenue

 

$

1,655

 

$

1,717

 

$

4,001

 

$

4,337

 

Cost of gaming equipment and systems

 

322

 

2,335

 

1,806

 

3,273

 

 

All intercompany accounts and transactions have been eliminated in consolidation.

Reclassifications

Pursuant to Emerging Issues Task Force (EITF) Issue No. 00-22, Accounting for “Points” and Certain Other Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products or Services to Be Delivered in the Future, and EITF No. 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products), the Company has concluded that certain promotional expenses, representing coupons redeemable for cash incentives, should be presented as an offset against casino operations revenue. Accordingly, we have reclassified $1.0 million and $1.9 million, respectively, for the three and six months ended December 31, 2005,

5




from selling, general and administrative expense as an offset against casino operations revenue to conform to the current period presentation.

Inventories

Inventories are stated at the lower of cost, determined on a first in, first out basis, or market.  Cost elements included in work-in-process and finished goods include raw materials, freight, direct labor and manufacturing overhead.

The Company recorded inventory write-downs totaling approximately $1.8 million and $4.1 million and $6.2 million and $8.0 million for the three and six months ended December 31, 2006 and 2005, respectively.  These charges are classified in cost of gaming equipment and systems in the consolidated statements of operations.

Property, plant and equipment and leased gaming equipment

Property, plant and equipment is stated at cost and depreciated over the estimated useful lives or lease term, if less, using the straight line method as follows: buildings and improvements, 28 to 40 years; gaming equipment, 4 to 7 years; furniture, fixtures and equipment, 3 to 7 years; and leasehold improvements, 5 to 10 years. Leased gaming equipment is stated at cost and depreciated over the estimated useful lives ranging from 2 to 3½ years.

Recently Issued Accounting Pronouncements

In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No.159 provides companies with an option to report selected financial assets and liabilities at fair value. It also establishes presentation and disclosure requirements to facilitate comparisons between companies using different measurement attributes for similar types of assets and liabilities. The statement is effective for fiscal years beginning after November 15, 2007, and accordingly, the Company expects to adopt SFAS No. 159 beginning in fiscal 2009. Earlier application is permitted provided the Company also applies the provisions of SFAS No. 157, Fair Value Measurements. The Company is currently in the process of evaluating the impact SFAS No. 159 will have on its consolidated results of operations, financial position and cash flows.

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

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, providing guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year's financial statements are materially misstated. The provisions of SAB No. 108 were effective beginning with the Company’s fiscal year ending June 30, 2007.  The adoption SAB No. 108 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes, which creates a single model to address uncertainty in income tax positions and prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, and accordingly, the Company expects to adopt FIN 48 beginning in fiscal 2008. The Company is currently in the process of evaluating the impact FIN 48 will have on its consolidated results of operations, financial position and cash flows.

6




2.             EARNINGS (LOSS) PER SHARE

The computation of basic and diluted loss per share applicable to the Company’s common stock is as follows:

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s, except per share amounts)

 

Net loss

 

$

(2,515

)

$

(8,903

)

$

(2,740

)

$

(17,282

)

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic and diluted

 

53,072

 

52,138

 

52,985

 

52,138

 

 

 

 

 

 

 

 

 

 

 

Basic and dilutive loss per share

 

$

(0.05

)

$

(0.17

)

$

(0.05

)

$

(0.33

)

 

For the three and six month periods ended December 31, 2006 and 2005, all potentially dilutive securities were excluded from the diluted per share calculation as their inclusion would have been anti-dilutive due to the net loss reported.  Such securities consist of the following:

 

 

Three Months Ended
December 31, 

 

Six Months Ended
December 31, 

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s)

 

Stock options

 

8,980

 

9,111

 

8,721

 

8,952

 

Warrants

 

100

 

100

 

100

 

100

 

Restricted stock

 

621

 

554

 

593

 

554

 

Total

 

9,701

 

9,765

 

9,414

 

9,606

 

 

As of December 31, 2006 and 2005, the Company also had certain related party debt outstanding which is convertible into common stock at the Company’s discretion.  The potential dilution from this convertible debt has not been included in the diluted loss per share computation for the three and six months ended December 31, 2006 and 2005, due to the reported net loss for the periods.  Assuming the conversion occurred on December 31, 2006 and 2005, an additional 0.6 million and 1.1 million shares, respectively, would have been outstanding as a result of the conversion.

3.             SHARE-BASED COMPENSATION

In December 2001, the Company’s shareholders approved the 2001 Long-Term Incentive Plan (as amended, the “2001 Plan”). The 2001 Plan provides for the issuance of up to 10,550,000 shares of common stock to Company employees, directors and designated paid consultants, which amount consists of up to 900,000 shares of restricted stock or Restricted Stock Units (“RSUs”). Generally, options are granted at the fair value of the Company’s common stock at the date of grant and are exercisable over ten years.

Effective July 1, 2005, the Company adopted the provisions of SFAS No. 123R, Share-Based Payment, which established accounting for equity instruments exchanged for employee services. SFAS No. 123R requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by the Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees.  Under the provisions of SFAS No. 123R, share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant).  In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment, which provided interpretive guidance on SFAS No. 123R valuation methods, assumptions used in valuation models, and the interaction of SFAS No. 123R with existing SEC guidance. SAB No. 107 also requires the classification of share-based compensation expense in the same financial statement line as cash compensation, and therefore, impacted the Company’s cost of gaming equipment and systems, casino operations

7




(and related gross profits and margins), research and development costs, and selling, general and administrative expenses.

The following table presents share-based compensation expense included in the Company’s condensed consolidated statements of operations:

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s)

 

Selling, general and administrative

 

$

3,931

 

$

2,882

 

$

7,277

 

$

5,372

 

Research and development

 

392

 

265

 

767

 

496

 

Cost of gaming and equipment

 

37

 

25

 

68

 

46

 

Share-based compensation expense before tax

 

4,360

 

3,172

 

8,112

 

5,914

 

Income tax benefit

 

1,526

 

1,110

 

2,839

 

2,069

 

Net share-based compensation expense

 

$

2,834

 

$

2,062

 

$

5,273

 

$

3,845

 

 

As of December 31, 2006, there was $26.8 million of total unrecognized compensation expense related to the unvested portion of stock options which will be recognized over the next four years.

The Company estimates the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of the Company’s common stock over the option’s expected term, the risk-free interest rate over the option’s expected term and the Company’s expected annual dividend yield. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of the Company’s stock options granted. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

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

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Weighted Average:

 

 

 

 

 

 

 

 

 

Expected option term (in years)

 

6.14

 

6.25

 

6.18

 

6.37

 

Expected volatility

 

56.82

%

61.56

%

57.41

%

62.01

%

Risk-free interest rate

 

4.70

%

4.18

%

4.76

%

3.74

%

Expected annual dividend yield

 

 

 

 

 

 

Stock option activity as of and for the six months ended December 31, 2006 is summarized below:

 

 

Weighted Average

 

 

 


Shares

 


Exercise

Price

 

Remaining

Contractual

Term

 

Aggregate

Intrinsic

Value

 

 

 

(in 000s)

 

(per share)

 

(years)

 

(in 000s)

 

Balance outstanding as of June 30, 2006

 

9,640

 

$

14.61

 

6.41

 

$

32,290

 

Granted

 

882

 

18.30

 

 

 

 

 

Exercised

 

(756

)

5.75

 

 

 

 

 

Forfeited or expired

 

(581

)

15.48

 

 

 

 

 

Balance outstanding as of December 31, 2006

 

9,185

 

$

15.63

 

6.54

 

$

37,386

 

 

 

 

 

 

 

 

 

 

 

Exercisable as of December 31, 2006

 

5,286

 

$

16.92

 

5.40

 

$

18,306

 

 

8




Restricted stock and RSU activity as of and for the six months ended December 31, 2006 is summarized below:

 

 

 

 

Weighted Average

 

 

 


Shares

 

Grant
Date Fair
Value

 

 

 

(in 000s)

 

(per share)

 

Balance outstanding as of June 30, 2006

 

647

 

$

15.51

 

Granted

 

84

 

16.37

 

Forfeited or expired

 

(2

)

17.00

 

Balance outstanding as of December 31, 2006

 

729

 

$

15.61

 

 

 

 

 

 

 

Vested as of December 31, 2006

 

342

 

$

15.90

 

 

4.             GOODWILL AND INTANGIBLE ASSETS

Finite lived intangible assets

Substantially all of the Company’s recorded intangible assets are subject to amortization.  Finite lived intangible assets are comprised of the following: 

 

 

December 31,
2006

 

June 30,
2006

 

 

 

(in 000s)

 

Amortizable intangible assets:

 

 

 

 

 

Patents and gaming related products

 

$

20,434

 

$

19,583

 

Less: accumulated amortization

 

(8,401

)

(7,061

)

 

 

12,033

 

12,522

 

 

 

 

 

 

 

Licenses and other

 

$

30,410

 

$

32,036

 

Less: accumulated amortization

 

(17,570

)

(16,902

)

 

 

12,840

 

15,134

 

 

 

 

 

 

 

Total

 

$

24,873

 

$

27,656

 

 

Goodwill

The changes in the carrying amount of goodwill for the six month period ended December 31, 2006, are as follows:

 

(in 000s)

 

Balance at June 30, 2006

 

$

161,303

 

Foreign currency translation adjustment

 

287

 

Balance at December 31, 2006

 

$

161,590

 

 

9




5.             LONG-TERM DEBT AND CAPITAL LEASES

Long-term debt and capital leases consist of the following:

 

 

December 31,
2006 

 

June 30,
2006 

 

 

 

(in 000s)

 

Revolving credit facility

 

$

 

$

 

Term loan facility

 

309,632

 

311,382

 

Capital lease obligations

 

20,325

 

2,399

 

Related party debt (see Note 6)

 

14,200

 

14,200

 

Other, generally unsecured

 

24

 

365

 

Long-term debt and capital leases

 

344,181

 

328,346

 

Less current maturities

 

16,066

 

12,864

 

Long-term debt and capital leases, less current maturities

 

$

328,115

 

$

315,482

 

 

The Company’s debt structure at December 31, 2006 consists primarily of a term loan facility and a $75.0 million revolving credit facility, which are limited by a current leverage ratio and debt owed to related parties. The term loan requires principal reductions of approximately 1% per annum paid quarterly, with a balloon payment due in September 2009.  The revolving credit facility commitment reduces annually until it comes due in September 2008.  As of December 31, 2006, the term loan had an interest rate of 8.83%, based on LIBOR plus 3.25%, and the revolving credit facility had an interest rate of 7.87%, based on LIBOR plus 2.50%. On January 4, 2007, the Company initiated its next LIBOR-based term loan interest rate period (for a term of six months) based on the interest rate formula of LIBOR plus 3.25%,  which was 8.61%.

The term loan and the revolving credit facility are collateralized by substantially all of the Company’s domestic property and are guaranteed by each of the Company’s domestic subsidiaries, other than the entity that holds the Company’s interest in its Rainbow Casino operations, and are secured by a pledge agreement. The loan agreement governing the term loan and the revolving credit facility (the “Loan Agreement”) contains a number of maintenance and other covenants that, among other things, restrict the ability of the Company and the ability of certain of its subsidiaries to dispose of assets, incur additional indebtedness or issue preferred stock, pay dividends or make other distributions, enter into certain acquisitions, repurchase equity interests or subordinated indebtedness, issue or sell equity interests of the Company’s subsidiaries, engage in mergers or acquisitions or certain transactions with subsidiaries and affiliates, and that otherwise restrict corporate activities.  The Company was in compliance with these covenants as of December 31, 2006.

As of December 31, 2006, the Company was also in compliance with its financial covenants consisting of a leverage ratio, a fixed charges coverage ratio and a minimum of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (as EBITDA is defined in the Loan Agreement). The leverage ratio is computed as total average debt outstanding during the quarter divided by the trailing 12 months EBITDA, excluding certain cash and non-cash charges. The Company’s leverage ratio as of December 31, 2006 was 3.36 times versus a maximum allowable of 3.75 times. The maximum allowable leverage ratio declines to 3.50 as of September 30, 2007, through the remaining term of the Loan Agreement.

In October 2006, the Company executed an amendment to the Loan Agreement, which, among other things, (i) extended the due date for the  delivery of the Company’s audited financial statements for the fiscal year ended June 30, 2006 to December 31, 2006, (ii) provided that the Company deliver its quarterly reports on Form 10-Q for the Fiscal Quarters ended September 30, 2005, December 31, 2005 and March 31, 2006 no later than December 31, 2006, (iii) modified the definition of EBITDA to exclude up to $10.0 million of certain cash charges and (iv) clarified that the definition of EBITDA includes interest income on trade receivables.  In exchange for the concessions granted under the amendment the Company paid an administrative fee of $964,000, which was expensed in the quarter ended December 31, 2006.

In December 2006, the Company executed an additional amendment to the Loan Agreement, which extended the due date for the  delivery of the Company’s quarterly report on Form 10-Q for the Fiscal Quarter ended March 31, 2006 and its audited financial statements for the fiscal year ended June 30, 2006 to March 15, 2007.  In exchange for the concessions granted under the amendment the Company paid an administrative fee of $1.2 million, which was expensed in the quarter ended December 31, 2006.

10




Capital lease obligations represent amounts owed under lease or sale-lease back transactions primarily related to equipment used in the Company’s Gaming Equipment and Systems segment.  The leases are payable in thirty-six equal installments with interest imputed at a weighted average rate of 9.12%.

The Company’s related party debt, which totaled approximately $14.2 million as of December 31, 2006, consists primarily of the debt owed to the former principals of Sierra Design Group (“SDG”) and MindPlay LLC (“MindPlay”). See Note 6, Related Party Transactions, below regarding related party debt.

6.             RELATED PARTY TRANSACTIONS

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

 

 

 

December 31, 2006

 

June 30, 2006

 

 

 

Interest 
Rate

 

Outstanding
Debt

 

Interest
Rate

 

Outstanding 
Debt

 

 

 

(in 000s)

 

SDG

 

6.39

%

$

11,200

 

6.39

%

$

11,200

 

MindPlay

 

6.00

%

3,000

 

6.00

%

3,000

 

Related party debt

 

 

 

14,200

 

 

 

14,200

 

Less current maturities

 

 

 

5,219

 

 

 

6,600

 

Related party debt, less current maturities

 

 

 

$

8,981

 

 

 

$

7,600

 

 

The note payable to the former principals of SDG of $11.2 million is payable in annual installments through 2009.  At the Company’s discretion, the principal and accrued interest thereon can be paid in cash, or can be converted into shares of the Company’s common stock using the average stock price for the 20 business days prior to the delivery of such shares.

In February 2004, the Company acquired substantially all of the assets and liabilities of MindPlay.  The initial purchase price included, among other things, the issuance of a $4.0 million note payable.  As provided for in the acquisition agreement, under certain circumstances, the Company may offset 50% of all damages (including reasonable attorneys’ fees) up to the entire amount due under the promissory note in connection with an indemnification claim against the former shareholders of MindPlay related to the Company’s patent lawsuit with Shuffle Master, Inc. (“Shuffle Master”) and International Game Technology (“IGT”) which is described below in Note 9, Commitments and Contingencies.

The Company leases a warehouse and office facility from an entity owned by Mr. Robert Luciano, a former principal of SDG and the Company’s Chief Technology Officer.  Rental payments totaled $112,041 and $103,000 and $224,082 and $206,000 for the three and six month periods ended December 31, 2006 and 2005, respectively.

7.             SEGMENTS AND GEOGRAPHICAL INFORMATION

The Company operates in two business segments: (i) Bally Gaming Equipment and Systems which designs, manufactures, assembles, distributes and operates gaming machines and computerized monitoring and bonusing systems for gaming machines, and (ii) Casino Operations which owns and operates a casino in Vicksburg, Mississippi. The accounting policies of these segments are consistent with the Company’s policies for the unaudited condensed consolidated financial statements.

11




The table below presents information as to the Company’s revenues and operating income (loss) by segment:

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s)

 

Revenues:

 

 

 

 

 

 

 

 

 

Gaming Equipment and Systems

 

$

140,533

 

$

113,961

 

$

282,496

 

$

208,756

 

Casino Operations

 

11,238

 

13,513

 

23,077

 

24,158

 

Total revenues

 

$

151,771

 

$

127,474

 

$

305,573

 

$

232,914

 

 

 

 

 

 

 

 

 

 

 

Inter-segment revenues:

 

 

 

 

 

 

 

 

 

Gaming Equipment and Systems

 

$

102

 

$

214

 

$

184

 

$

303

 

Casino Operations

 

 

 

 

 

Total inter-segment revenues

 

$

102

 

$

214

 

$

184

 

$

303

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Gaming Equipment and Systems

 

$

9,076

 

$

(4,817

)

$

20,110

 

$

(6,245

)

Casino Operations

 

3,933

 

5,107

 

7,968

 

8,428

 

Corporate/other

 

(7,162

)

(6,785

)

(13,811

)

(13,480

)

Total operating income (loss)

 

$

5,847

 

$

(6,495

)

$

14,267

 

$

(11,297

)

 

The Company’s operations are based primarily in the United States with sales and distribution offices in Europe and South America.

The table below presents information as to the Company’s revenues and operating income (loss) by geographic region:

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in 000s)

 

Revenues:

 

 

 

 

 

 

 

 

 

United States

 

$

141,294

 

$

119,193

 

$

286,514

 

$

219,388

 

Europe

 

5,232

 

4,749

 

8,715

 

8,204

 

Other foreign

 

5,245

 

3,532

 

10,344

 

5,322

 

Total revenues

 

$

151,771

 

$

127,474

 

$

305,573

 

$

232,914

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

United States

 

$

5,223

 

$

(6,028

)

$

13,217

 

$

(10,383

)

Europe

 

89

 

(643

)

(360

)

(1,195

)

Other foreign

 

535

 

176

 

1,410

 

281

 

Total operating income (loss)

 

$

5,847

 

$

(6,495

)

$

14,267

 

$

(11,297

)

 

 

12




8.             SUPPLEMENTAL CASH FLOW INFORMATION

The following supplemental information is related to the condensed consolidated statements of cash flows:

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

 

 

(in 000s)

 

Cash paid for interest

 

$

16,809

 

$

14,041

 

Cash paid for income taxes

 

683

 

2,289

 

 

 

 

 

 

 

Non-cash investing and financing transactions:

 

 

 

 

 

Reclassify property, plant and equipment to inventory

 

$

6,388

 

$

7,891

 

Inventory in transit

 

1,145

 

 

Assets acquired through sale lease-back transactions

 

11,681

 

 

Unrealized gain on sale lease-back transactions

 

3,333

 

 

Receipt of Company’s common stock as consideration for employee stock options exercise

 

41

 

 

Consolidation of variable interest entities

 

1,539

 

313

 

 

9.             COMMITMENTS AND CONTINGENCIES

In June and July 2004, putative class actions were filed against the Company and its officers, Robert Miodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in the United States District Court for the District of Nevada. The nearly identical complaints alleged violations of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), stemming from revised earnings guidance, declines in the stock price and sales of stock by insiders. The complaints sought damages in unspecified amounts. The Federal District Court granted the plaintiffs’ unopposed motions to consolidate the cases and to appoint a lead counsel and a lead plaintiff, and the plaintiffs filed a consolidated complaint, all as is customary in such cases.  The Company and the other defendants moved to dismiss the complaint.  Thereafter, activity in the case was stopped and the parties participated in a mediation process during which the parties agreed on the terms of a settlement. The parties have negotiated and executed settlement documents settling both the consolidated class action and the derivative case discussed below. Under the settlement, which has received preliminary approval from the court, an aggregate of $16.0 million cash, plus certain interest, will be paid to settle the securities class action as well as the derivative litigation as discussed below.  The Company will pay $1.25 million, which was accrued in the Company’s financial statements for the quarter ended December 31, 2005. In addition to certain governance actions the Company has agreed to undertake in connection with the settlement, the Company’s directors and officers insurer will contribute approximately $14.75 million to the settlement.

In July 2004, two derivative lawsuits were filed in Nevada state court against the members of the board of directors and the officers listed above. The Company was named as a nominal defendant in the derivative lawsuits as the claims were purportedly asserted for the benefit of Bally Technologies, Inc. These lawsuits asserted claims for breach of fiduciary duty and waste of corporate assets arising out of the same events as those giving rise to the class actions described above, and sought injunctive relief and damages in unspecified amounts. These two cases were consolidated, and the Company and the other defendants moved to dismiss the case. In February 2005, the state district court granted the defendants’ motion and dismissed the case. The plaintiffs appealed the dismissal to the Nevada Supreme Court, which referred the matter to its settlement conference program. The parties met with a court-appointed settlement judge on December 15, 2005, and agreed to settle the case for $8,000, and on February 2, 2006, the Nevada Supreme Court entered its order formally dismissing the appeal, thereby terminating the case. Although management believes the plaintiffs’ lawsuit and appeal were without merit, it determined that the settlement was in the best interests of the Company.

On March 27, 2006, shortly after the aforementioned derivative suit was dismissed in the Nevada state court, another derivative lawsuit was filed in the United States District Court for the District of Nevada against individual

13




defendants Robert Miodunski, Robert Saxton, Steven Des Champs, Mark Lerner, David Robbins, Anthony DiCesare, Joel Kirschbaum, Kevin Verner, Richard Haddrill, Stephen Race, Jacques André and nominal defendant Bally Technologies, Inc.  Based on factual allegations that are similar to those alleged in the federal securities class action complaints and the previous derivative actions that were dismissed by the District Court, the derivative complaint alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and violation of the Sarbanes-Oxley Act of 2002. The parties have reached a settlement agreement as discussed more fully above.

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

In August 2004, Shuffle Master sued the Company in the United States District Court for the District of Nevada, alleging infringement of various patents in connection with the Company’s MindPlay product line and seeking injunctive relief and damages in an unspecified amount. In June 2005, it was announced that IGT had acquired an interest in the patents at issue in the case, and thereafter, IGT joined the case as a plaintiff.  In December 2005, the District Court issued a ruling construing the claim terms of all the patents in the suit. Management believes the plaintiffs’ lawsuit to be without merit, and the Company is vigorously defending against the lawsuit.

In September 2004, a United States District Court jury in the District of Nevada entered a $7.4 million verdict against the Company in a suit filed by Action Gaming (“AGI”) and IGT. The suit alleged that the multi-hand video poker game deployed by the Company’s former subsidiary, United Coin, infringed the plaintiffs’ patents. The Federal District Court ruled on summary judgment that the game did not infringe the patents. However, the court left to the jury the question whether the use of “autohold,” a specific, optional feature of the game, caused it to infringe under the “doctrine of equivalents,” a doctrine of patent law. The jury determined that the game with the autohold option enabled did infringe under the doctrine of equivalents and awarded damages accordingly. The feature has been disabled on all affected games in the field, and the decision permits continued deployment of the game as long as the autohold feature is not included. The Company appealed the decision to the United States Court of Appeals for the Ninth Circuit and posted a cash bond totaling $7.6 million to stay payment of the judgment and accrued interest pending the appeal.   On July 11, 2006, the federal circuit court of appeals affirmed the district court judgment, denying the appeals for both parties, and thereafter, the judgment was satisfied out of the posted bond.

On December 7, 2004, IGT filed a patent infringement lawsuit against the Company in the United States District Court for the District of Nevada. The complaint asserts that the Company’s wheel-based games, such as Monte CarloÔ, Lucky WheelÔ and Cash For LifeÔ, its games with a reel in the top box, such as Bonus FrenzyÔ, and its iViewÔ products infringe on patents held by IGT, and seeks injunctive relief and damages in unspecified amounts. The Company believes IGT’s claims are without merit and is vigorously defending itself against the lawsuit. As part of its defense, the Company has asserted counterclaims against IGT, including claims that IGT’s patents are invalid, unenforceable and not infringed, as well as several claims that IGT has engaged in anti-competitive conduct in violation of state and federal antitrust laws. By its counterclaims, the Company is seeking damages and other relief from IGT. IGT’s motion to dismiss the Company’s antitrust claims was denied in January 2006, and in March 2007, the court denied IGT’s motions for summary judgment with respect to the antitrust claims dealing with the wheel game market.  The court issued claims construction rulings in May 2007.  No trial date has been set.

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

In May 2006, IGT filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware.  The complaint asserts that the Bally Power BonusingÔ products infringe patents held by IGT, and seeks injunctive relief and damages in unspecified amounts.  The Company believes IGT’s claims are without merit and is

14




vigorously defending itself against the lawsuit.

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

15




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

We begin this Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our key operating business divisions and significant trends as of December 31, 2006.  This overview is followed by a detailed analysis of our results of operations and our financial condition as of, and for, the three and six months ended December 31, 2006.

Forward-Looking Statements

Certain matters in this Quarterly Report on Form 10-Q for the three and six month periods ended December 31, 2006 and our other filings with the SEC, including, without limitation, certain matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Quantitative and Qualitative Disclosures about Market Risk, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created thereby.  Those statements reflect the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things, future events and financial trends affecting the Company.

Forward-looking statements are typically identified by the words “believes,” “expects,” “anticipates” and similar expressions.  In addition, any statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements.  Readers are cautioned that any such forward-looking statements are not guarantees of future performance and that matters referred to in such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  Such factors include, among other things, the impact of competition and uncertainties concerning such matters as the Company’s ability to service debt, product development, customer financing, sales to non-traditional gaming markets, foreign operations, dependence on key personnel, the ability to integrate future acquisitions, strict regulation by gaming authorities, the outcome of pending litigation matters including the pending securities class actions, gaming taxes, currency fluctuations and market risk and the potential adverse effects to our financial condition, results of operations or prospects as a result of the restatement of our prior period financial statements. Certain of these factors are discussed in the “Risk Factors” contained in the 2006 10-K.  Unless otherwise required by law, the Company undertakes no obligation to publicly update or revise these forward-looking statements because of new information, future events or otherwise.

Our Business

We are a worldwide leader in the design, manufacture, assembly and distribution of technology based products to commercial gaming markets worldwide.  We also own and operate a riverboat, dockside casino in Vicksburg, Mississippi.

We derive our revenues from the following four sources:

·                  Gaming Equipment - Sale of gaming devices;

·                  Gaming Operations - Operation of wide-area progressive systems and the lease and rental of gaming machines;

·                  Systems - Sales of computerized monitoring systems and related recurring hardware and software maintenance revenue; and

·                  Casino Operations - Operation of the Rainbow Casino.

We design, manufacture, assemble, sell and operate a full range of technology based gaming devices through our Gaming Equipment division.  These devices are not mass produced and are normally configured under specific order to a customer’s particular requirements.  Gaming devices are differentiated from one another by a number of factors including, but not limited to, graphic design and theme, cabinet style, pay table, game layout, betting denomination and minimum/maximum betting amount.  Each gaming device typically contains an operating system referred to as a game platform.  The operating system manages the software needed to run the device.  Game platforms and the

16




related computer systems are constantly updated and revised to keep pace with the ever-increasing complexity of modern game play requirements.  The constant change in game play requirements is driven by, among other things, changes in consumer demand, capacity, security and regulation.  In fiscal 2005, we completed the successful migration from our legacy platforms, including the V7000 and EVO™, to the Linux-based ALPHA OS™ platform and operating system.  In fiscal 2006, we also extended the transition to the ALPHA OS to our mechanical reel spinning devices.  ALPHA OS is now the platform for each of our gaming device product offerings and, as a result, marketing of our legacy products has generally been discontinued.

The ALPHA OS is designed to separate the gaming operating system from the game layer, which enables game development in a much shorter time.  ALPHA OS is also designed to incorporate bonusing, free spin, scatter and other advanced game features, while providing internal and third-party developers with a secure, easy-to-use programming environment that incorporates an advanced set of development tools.  Moreover, ALPHA OS is designed to support server-based gaming initiatives, including download of game results, configuration and game content. Additionally, our layered architecture and modular design allow for adaptability and simplified requirement changes. The operating system, which is Linux-based, is compatible with the most common accounting and ticket systems and supports 20-plus bet lines, bonusing, multi-denomination and multi-pay table game configurations.  ALPHA OS also supports multi-level local and wide-area progressive products.

In addition to selling our gaming devices, we also offer our customers a wide range of lease and rental options through our Gaming Operations division.  We offer several economic arrangements that generate recurring revenues for us.  Specifically, these arrangements are available under four business models: linked progressive systems, centrally determined systems, lottery systems and rental or leased games.  In most cases, operating gaming devices under a lease or rental arrangement requires us to invest capital in the cost of manufacturing the gaming device and related equipment, purchasing signs and seating, and, in certain cases, acquiring certain intellectual property rights.

We believe the growth of the Gaming Equipment and Gaming Operations divisions is dependent on providing new titles, hardware and technologies with high entertainment value to casino patrons.

We also design, program, test, market and support casino enterprise systems for a wide range of customers of varying size and complexity under our Systems division.  These systems typically provide casino operators features such as active, real-time monitoring tools for gaming devices, tools to collect and manage customer data, security to protect against theft and data loss, and marketing programs to enhance the gaming experience.  The use of system technology in gaming has grown in the past ten years from basic automation of manual activities to highly integrated mission critical applications.  We believe we are the only provider in the industry that offers a selection of technology platform options to its customers.  Our products operate on platforms such as Windows, AS/400 (iSeries) and UNIX that allows our customers to choose a technology solution that meets their existing or future infrastructure requirements.  We market our system product solutions under the broad categories of Bally CMS® (Casino Management Systems), Bally SMS® (Slot Management Systems) and Bally TMS® (Table Management Systems).

We spent approximately 9% of revenue generated from our Bally Gaming Equipment and Systems segment for the six months ended December 31, 2006 on research and development to accelerate the use of technology in our gaming products.

Our Rainbow Casino is one of four casinos currently operating in the Vicksburg, Mississippi market and is run through our Casino Operations division. The facility includes a 33,000-square foot casino with 852 gaming devices and 11 table games, a 310-seat buffet-style restaurant and a 20,000-square foot conference center.  The Casino also includes the 89-room Rainbow Hotel, which is owned and operated by a third party.  Rainbow is marketed as a “locals” casino and draws mid-level gaming customers principally from within a 75-mile radius of Vicksburg.  Our promotions are focused primarily on direct mail and special promotional events.   The Company announced in October 2006 that it is evaluating alternatives with respect to the possible sale of the Rainbow Casino.  There can be no assurance that the Company will proceed with or complete the sale of the Rainbow Casino.

17




Results of Operations

Our results of operations include the accounts of Bally Technologies, Inc., and its wholly-owned and partially-owned subsidiaries.  We report our revenue and income in two segments: the Bally Gaming Equipment and Systems segment, which includes our Gaming Equipment, Gaming Operations and Systems divisions, and our Casino Operations segment.  Revenue from our Bally Gaming and Systems segment represents approximately 93% of our total revenues for the six months ended December 31, 2006.

Bally Gaming Equipment and Systems

The summary financial results and operating statistics for our Bally Gaming Equipment and Systems segment for the three and six months ended December 31, 2006 and 2005 are as follows:

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

%
Rev

 

2005

 

%
Rev

 

Favorable/
(Unfavorable
)

 

2006

 

%
Rev

 

2005

 

%
Rev

 

Favorable/
(Unfavorable)

 

 

 

(dollars in millions)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gaming Equipment

 

$

72.7

 

52

%

$

54.1

 

47

%

34

%

$

136.6

 

48

%

$

91.4

 

44

%

49

%

Gaming Operations

 

38.7

 

27

%

34.9

 

31

%

11

%

77.8

 

28

%

71.8

 

34

%

8

%

Systems

 

29.2

 

21

%

25.0

 

22

%

17

%

68.2

 

24

%

45.6

 

22

%

50

%

Total revenues

 

$

140.6

 

100

%

$

114.0

 

100

%

23

%

$

282.6

 

100

%

$

208.8

 

100

%

35

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gaming Equipment

 

$

26.3

 

36

%

$

15.5

 

29

%

70

%

$

47.9

 

35

%

$

24.7

 

27

%

94

%

Gaming Operations

 

22.6

 

58

%

13.6

 

39

%

66

%

44.8

 

58

%

32.6

 

45

%

37

%

Systems

 

21.0

 

72

%

19.6

 

78

%

7

%

46.2

 

68

%

37.3

 

82

%

24

%

Total gross margin

 

$

69.9

 

50

%

$

48.7

 

43

%

44

%

$

138.9

 

49

%

$

94.6

 

45

%

47

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

$

42.7

 

30

%

$

37.1

 

33

%

(15

)%

$

83.9

 

30

%

$

69.5

 

33

%

(21

)%

Research and development costs

 

13.3

 

9

%

10.7

 

9

%

(24

)%

25.9

 

9

%

21.0

 

10

%

(23

)%

Depreciation and amortization

 

4.7

 

3

%

5.7

 

5

%

18

%

9.0

 

3

%

10.3

 

5

%

13

%

Operating income (loss)

 

$

9.2

 

7

%

$

(4.8

)

(4

)%

292

%

$

20.1

 

7

%

$

(6.2

)

(3

)%

424

%

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

Favorable/
(Unfavorable)

 

2006

 

2005

 

Favorable/
(Unfavorable)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Statistics:

 

 

 

 

 

 

 

 

 

 

 

 

 

New gaming devices sold

 

4,672

 

3,663

 

28

%

8,099

 

6,463

 

25

%

OEM units sold

 

460

 

305

 

51

%

1,605

 

326

 

392

%

New unit average selling price

 

$

12,620

 

$

10,921

 

16

%

$

12,363

 

$

10,802

 

14

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gaming monitoring units installed base

 

 

 

 

 

 

 

287,000

 

266,000

 

8

%

Casino management systems installed base

 

 

 

 

 

 

 

563

 

532

 

6

%

Systems managed cashless games

 

 

 

 

 

 

 

231,000

 

161,000

 

43

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

End of period installed base:

 

 

 

 

 

 

 

 

 

 

 

 

 

Wide-area progressive

 

 

 

 

 

 

 

935

 

1,305

 

(28

)%

Local-area progressive

 

 

 

 

 

 

 

544

 

611

 

(11

)%

   Total linked progressive systems

 

 

 

 

 

1,479

 

1,916

 

(23

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental and daily-fee games

 

 

 

 

 

 

 

4,636

 

2,783

 

67

%

Lottery Systems

 

 

 

 

 

 

 

7,164

 

6,713

 

7

%

Centrally determined Systems

 

 

 

 

 

 

 

31,244

 

23,631

 

32

%

 

18




Three Months Ended December 31, 2006 Compared to Three Months Ended December 31, 2005

Total revenues for our Bally Gaming Equipment and Systems segment increased $26.6 million, or 23%, for the three months ended December 31, 2006 as compared to the corresponding period in the prior year.  This increase was the result of higher revenues from our Gaming Equipment, Gaming Operations and Systems divisions of 34%, 11%, and 17%, respectively.  A more detailed description of the fluctuations in revenues of each Bally Gaming Equipment and Systems segment is set forth below.

Gaming Equipment.  Gaming Equipment revenue increased by $18.6 million, or 34%, for the three months ended December 31, 2006, as compared to the corresponding period in the prior year, primarily a result of the following:

·                  An increase in new gaming device sales of 1,009 units, or 28%, to 4,672 units in the three months ended December 31, 2006 from 3,663 units in the corresponding period in the prior year.

·                  A 16% increase in the Average Selling Price (“ASP”) of new gaming units, excluding OEM sales, as ASP in the prior year was negatively affected by introductory pricing related to the roll-out of devices based on the ALPHA OS platform.

·                  An increase in OEM units sold of 155 units to 460 units in the three months ended December 31, 2006 from 305 units in the corresponding period in the prior year. Sales of OEM products vary significantly from period to period based on deployments by our OEM customers, and are typically sold at lower selling prices and margins than sales made directly to casino operators.

Gaming Equipment Gross Margin.  Gaming Equipment gross margin increased to 36% in the three months ended December 31, 2006, from 29% in the corresponding period in the prior year, primarily as a result of:

·                  Introductory pricing in the prior year period related to the roll-out of the ALPHA OS platform.

·                  Inventory write-downs in the prior year period of $4.1 million, or 8% of gaming equipment revenue, compared to $1.8 million, or 2% of gaming revenue, in the current period.

Gaming Operations.  Gaming Operations revenue increased by $3.8 million, or 11%, primarily as a result of the following:

·                  An $8.5 million, or 51%, increase in revenue from rental and daily fee, lottery and centrally determined games resulting from a 30% increase in the installed base of games over the prior year period.

·      A reduction in wide-area progressive revenues of $2.8 million resulting from a 28% decrease in the installed base of games during the period.

Gaming Operations Gross Margin.  Gaming Operations gross margin, which includes depreciation expense of $8.0 million and $11.4 million for the three months ended December 31, 2006 and 2005, respectively, increased to 58%, from 39%, primarily as a result of a reduction in expenditures to fund jackpot liabilities of $1.6 million resulting from a 28% decrease in the installed base of wide-area progressive games during the period. Also, a change in the estimated useful life and salvage values for certain gaming equipment used in the Gaming Operations division resulted in an increase in depreciation expense charged to cost of gaming operations during the prior year period.

Systems.  Systems revenue increased by $4.2 million, or 17%, primarily as a result of the following:

·                  An increase of $1.5 million, or 22%, in systems service and maintenance fees related to certain contracts with major domestic customers.

·                  An increase of $2.3 million, or 102%, in systems hardware sales primarily related our SDS and iView products.

19




Systems Gross Margin.  Systems gross margin declined to 72% in the three months ended December 31, 2006, as compared to 78% in the corresponding period in the prior year, as a result of the increased proportion of hardware sales in the current period, which have lower gross margins compared to software sales.

Selling, General and Administrative Expense.  Selling, general, and administrative expenses increased by $5.6 million, or 15%, primarily as a result of:

·                  An increase in payroll and related expenses and casual labor of $6.4 million in the three months ended December 31, 2006, as compared to the corresponding period of the prior year, to support the increased growth of our business.

·                  An increase in consulting and license fees of $1.6 million due to increased third-party development and engineering services.

Research and Development Costs. Research and development costs increased by $2.6 million, or 24%, primarily as a result of an increase in payroll and related expenses in the three month period ended December 31, 2006 as compared to the corresponding period in the prior year.  The increase in research and development reflects our focus on our technology assets and the competitive landscape that requires a continuous investment in the development of future generations of gaming products and systems.

Depreciation and Amortization Expense.  Depreciation and amortization expense decreased by $1.0 million, or 18%, for the three months ended December 31, 2006, as compared to the corresponding period in the prior year, primarily due to a change in the estimated useful life and salvage values for certain gaming equipment in the prior year.

Six Months Ended December 31, 2006 Compared to Six Months Ended December 31, 2005

Total revenues for our Bally Gaming Equipment and Systems segment increased $73.8 million, or 35%, for the six months ended December 31, 2006 as compared to the corresponding period in the prior year.  This increase was the result of an increase in revenues from our Gaming Equipment, Gaming Operations and Systems divisions of 49%, 8%, and 50%, respectively. A more detailed description of the fluctuations in revenues of each Bally Gaming Equipment and Systems segment is set forth below.

Gaming Equipment.  Gaming Equipment revenue increased by $45.2 million, or 49%, for the six months ended December 31, 2006, as compared to the corresponding period in the prior year, primarily as a result of the following:

·                  An increase in new gaming units sold of 1,636 units, or 25%, to 8,099 units in the six months ended December 31, 2006 from 6,463 units in the corresponding period in the prior year.

·                  A 14% increase in the ASP of new gaming units, excluding OEM sales, as ASP in the prior year was negatively affected by introductory pricing related to the roll-out of devices based on the ALPHA OS platform.

·                  An increase in OEM units sold of 1,279 units to 1,605 units in the six months ended December 31, 2006 from 326 units in the corresponding period in the prior year. Sales of OEM products vary significantly from period to period based on deployments by our OEM customers, and are typically sold at lower selling prices and margins than sales made directly to casino operators.

·                  The recognition of OEM license revenue of $4.9 million in the six months ended December 31, 2006 resulting from the sale of content licenses to an OEM customer.

Gaming Equipment Gross Margin.  Gaming Equipment gross margin improved to 35% for the six months ended December 31, 2006, from 27% in the corresponding period in the prior year, primarily as a result of:

·                  Introductory pricing in the prior year period related to the roll-out of the ALPHA OS platform.

·                  Higher production costs in the prior year period related to the initial manufacture of devices based on the ALPHA OS platform.

·                  Inventory write-downs in the prior year period of $8.0 million, or 9% of gaming equipment revenue, compared to $6.2 million, or 5% of gaming equipment revenue, in the current period.

20




Gaming Operations. Gaming Operations revenues increased by $6.0 million, or 8%, primarily as a result of the following:

·                  A $13.3 million, or 38%, increase in revenue from rental and daily fee, lottery and centrally determined games resulting from a 30% increase in the installed base of games over the prior year period.

·      A reduction in wide area progressive revenue of $6.1 million resulting from a 28% decrease in the installed base of games during the period.

Gaming Operations Gross Margin.  Gaming Operations gross margin, which includes depreciation expense of $17.3 million and $18.1 million for the six months ended December 31, 2006 and 2005, respectively, increased to 58%, from 45%, primarily as a result of a reduction in expenditures to fund jackpot liabilities of $7.1 million due to the decrease in the installed base of wide-area progressive games during the period. Also, a change in the estimated useful life and salvage values for certain gaming equipment used in the Gaming Operations division resulted in an increase in depreciation expense charged to cost of gaming operations during the prior year period.

Systems.  Systems revenue increased by $22.6 million, or 50%, primarily as a result of the following:

·                  An increase of $2.1 million, or 15%, in systems service and maintenance fees related to certain contracts with major domestic customers.

·                  An increase of $21.1 million, or 96%, in systems hardware sales primarily related to sales of our SDS and iView products.

Systems Gross Margin.  Systems gross margin declined to 68% in the six months ended December 31, 2006, from 82% in the corresponding period in the prior year, as a result of the increased proportion of hardware sales in the current period, which have lower gross margins compared to software sales.

Selling, General and Administrative Expense. Selling, general and administrative expenses for the segment increased by $14.4 million, or 21%, primarily as a result of:

·                  An increase in payroll and related expenses and casual labor of $14.0 million in the six months ended December 31, 2006, as compared to the corresponding period of the prior year, to support the increased growth of our business.

·                  An increase in legal expense of $3.3 million due to higher litigation costs and patent costs.

·                  An increase in consulting and license fees of $1.6 million due to increased third-party development and engineering services.

Research and Development Costs.  Research and development costs increased by $4.9 million, or 23%, primarily as a result of an increase in payroll and related expenses in the six month period ended December 31, 2006, as compared to the corresponding period in the prior year.  The increase in research and development reflects our focus on our technology assets and the competitive landscape that requires a continuous investment in the development of future generations of gaming products and systems.

21




Depreciation and Amortization Expense.  Depreciation and amortization expense decreased by $1.3 million, or 13%, for the six months ended December 31, 2006, as compared to the corresponding period last year, primarily due to a change in the estimated useful life and salvage values for certain gaming equipment in the prior year.

Casino Operations

The Rainbow Casino is one of four casinos currently operating in the Vicksburg, Mississippi market. The casino draws customers primarily from a 75-mile radius surrounding Vicksburg, which includes Jackson, Mississippi.  In fiscal 2007, we began considering the possible sale of Rainbow to a third party in connection with our plans to focus our efforts on our technology assets.  The conditions under which we may sell Rainbow are dynamic and may be impacted by a number of factors including, but not limited to, general market conditions, competition, our financial position and the interest of certain buyers who may be strategic to us.  If we do not receive a financially beneficial offer, we may decide not to sell the casino.  The summary of our financial results and operating statistics for our Casino Operation are as follows:

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

%
Rev

 

2005

 

%
Rev

 

Favorable/
(Unfavorable
)

 

2006

 

%
Rev

 

2005

 

%
Rev

 

Favorable/
(Unfavorable)

 

 

 

(dollars in millions)

 

Revenue

 

$

11.2

 

100

%

$

13.5

 

100

%

(17

)%

$

23.1

 

100

%

$

24.2

 

100

%

(5

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

6.8

 

61

%

8.6

 

64

%

(21

)%

14.2

 

61

%

14.9

 

62

%

(5

)%

Selling, general and administrative

 

2.1

 

19

%

2.6

 

19

%

19

%

4.6

 

20

%

4.7

 

19

%

2

%

Depreciation and amortization

 

0.8

 

7

%

0.9

 

7

%

11

%

1.6

 

7

%

1.8

 

7

%

11

%

Operating income

 

$

3.9

 

35

%

$

5.1

 

38

%

(24

)%

$

8.0

 

35

%

$

8.4

 

35

%

(5

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating statistics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average number of gaming devices

 

852

 

 

 

905

 

 

 

(6

)%

893

 

 

 

921

 

 

 

(3

)%

Average number of table games

 

11

 

 

 

12

 

 

 

(8

)%

11

 

 

 

12

 

 

 

(8

)%

 

Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.  Specifically, certain promotional expenses representing coupons redeemable for cash incentives, totaling $1.0 million and $1.9 million for the three and six months ended December 31, 2005, have been reclassified from selling, general and administrative expense and offset against Casino Operations revenue.

Three Months Ended December 31, 2006 Compared to Three Months Ended December 31, 2005

Casino Operations revenue decreased 17% for the three months ended December 31, 2006 as compared to the corresponding period in the prior year.  A portion of the decrease was attributable to a decrease in the average number of gaming devices of 53, or 6%, from 905 during the three months ended December 31, 2005, to 852 during the same period this year. The remainder of the decrease in revenue is due to the fact that revenue in the prior year was positively impacted due to the fact our property, unlike our competitor’s properties, did not sustain any significant damage in connection with the Gulf Coast hurricanes in August and September 2005.

Overall gross margin decreased 21% due to the decrease in revenue coupled with the fixed nature of our direct cost of gaming expenses.

Selling, general and administrative expenses decreased by 19% due to a decline in advertising and promotional expenses for the three months ended December 31, 2006 as compared to the corresponding period in the prior year.

Depreciation and amortization expense, as a percentage of revenue, remained consistent over the corresponding period in the prior year.

22




Six Months Ended December 31, 2006 Compared to Six Months Ended December 31, 2005

Casino Operations revenue decreased 5% for the six months ended December 31, 2006 as compared to the corresponding period in the prior year.  A portion of the decrease was attributable to a decrease in the average number of gaming devices of 28, or 3%, from 921 during the six months ended December 31, 2005, to 893 during the same period this year. The remainder of the decrease in revenue is due to the fact that revenue in the prior year was positively impacted due to the fact our property, unlike our competitor’s properties, did not sustain any significant damage in connection with the Gulf Coast hurricanes in August and September 2005.

Overall gross margin declined 5% due to the decrease in revenue coupled with the fixed nature of our direct cost of gaming expenses.

Selling, general and administrative expenses decreased by 2% primarily due to decreasing advertising and promotional expenses for the six months ended December 31, 2006 as compared to the corresponding period prior year.

Depreciation and amortization expense remained fairly stable for the six months ended December 31, 2006 as compared to the corresponding period in the prior year.

Parent Company

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

Favorable/
(Unfavorable)

 

2006

 

2005

 

Favorable/
(Unfavorable)

 

 

 

(dollars in millions)

 

General and administrative

 

$

6.8

 

$

6.5

 

(5

)%

$

13.1

 

$

12.8

 

(2

)%

Depreciation and amortization

 

0.4

 

0.3

 

(33

)%

0.7

 

0.7

 

%

Total parent company expense

 

$

7.2

 

$

6.8

 

(6

)%

$

13.8

 

$

13.5

 

(2

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

0.4

 

$

0.6

 

(33

)%

$

1.3

 

$

1.5

 

(13

)%

Interest expense

 

(10.2

)

(7.3

)

(40

)%

(18.1

)

(13.2

)

(37

)%

Other, net

 

0.6

 

(0.2

)

400

%

0.9

 

(0.5

)

280

%

Total other expense

 

$

(9.2

)

$

(6.9

)

(33

)%

$

(15.9

)

$

(12.2

)

(30

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax benefit (expense)

 

$

2.4

 

$

4.7

 

(49

)%

$

1.7

 

$

8.8

 

(81

)%

Minority interest

 

$

(1.6

)

$

(0.2

)

(700

)%

$

(2.8

)

$

(2.6

)

(8

)%

 

Three Months Ended December 31, 2006 Compared to Three Months Ended December 31, 2005

General and Administrative Expense.  Our general and administrative expenses at the parent company level remained relatively flat for the three months ended December 31, 2006, increasing $0.3 million as compared to the corresponding period in the prior year.

Other income (expense).  Other expenses increased $2.3 million, or 33%, primarily as a result of an increase in interest expense for the three months ended December 31, 2006 compared to the corresponding period in the prior year.  The increase in interest expense was a result of higher interest rates in effect in the current period as virtually all our debt is based on variable interest rates, as well as charges of $2.1 million related to amendments to our loan facility.

23




Six Months Ended December 31, 2006 Compared to Six Months Ended December 31, 2005

General and Administrative Expense.  Our general and administrative expenses at the parent company level remained relatively flat for the six months ended December 31, 2006, increasing $0.3 million as compared to the corresponding period in the prior year.

Other income (expense).  Other expenses increased $3.7 million, or 30%, primarily as a result of an increase in interest expense for the three months ended December 31, 2006 compared to the corresponding period in the prior year.  The increase in interest expense was a result of higher interest rates in effect in the current period as virtually all our debt is based on variable interest rates, as well as charges of $2.1 million related to amendments to our loan facility.

The effective income tax rate for the year ended June 30, 2007 is estimated to be 38% as compared to an actual effective tax rate of 36% for the year ended June 30, 2006.  The effective tax rate for the current year will be impacted by non-deductible share based compensation expense recognized for book purposes and reserves applied to certain deferred tax assets from foreign losses.  During the six months ended December 31, 2006, our tax provision benefited from a $1.3 million credit related to the retroactive reinstatement of research and development tax credits.

Financial Condition

Selected balance sheet accounts are as follows:

 

 

December 31,

 

June 30,

 

Increase (decrease)

 

 

 

2006

 

2006

 

Amount

 

%

 

 

 

(in 000s)

 

Cash and cash equivalents

 

$

12,432

 

$

16,425

 

$

(3,993

)

(24

)%

 

 

 

 

 

 

 

 

 

 

Total long-term debt and capital leases

 

$

344,181

 

$

328,346

 

$

15,835

 

5

%

 

 

 

 

 

 

 

 

 

 

Total current assets

 

$

329,787

 

$

329,354

 

$

(433

)

%

Total current liabilities

 

$

201,661

 

$

198,837

 

$

2,824

 

1

%

Net working capital

 

$

128,126

 

$

130,517

 

$

(2,391

)

(2

)%

 

As of December 31, 2006, we had $12.4 million in consolidated cash and cash equivalents which included approximately $3.7 million of cash utilized in our Casino Operations segment that is held in vaults, cages or change banks.   Pursuant to various state gaming regulations, certain cash accounts are maintained to ensure availability of funds to pay wide-area progressive jackpot awards. At December 31, 2006, these accounts had an aggregate value of approximately $15.7 million, which are classified as restricted cash on our condensed consolidated balance sheet.  In addition, we purchase U.S. Treasury Strip Securities for the benefit of jackpot winners who elect to receive winnings as annual or weekly installment payments rather than one lump sum.  These securities are included in restricted long-term investments in the accompanying condensed consolidated balance sheet, and totaled $10.4 million as of December 31, 2006.

Our net working capital decreased $2.4 million for the six months ended December 31, 2006.  Key factors related to the working capital decrease included a $1.2 million net increase in accounts and notes receivable due to the timing of payments by customers, a $17.0 million decrease in accounts payable and accrued liabilities due to the timing of payments to vendors, offset by an increase in deferred revenue of $16.3 million resulting from the deferral of certain system and game sales and an increase in the current maturities of long-term debt of $3.2 million due to the addition new capital leases.

Our debt structure consists primarily of a term loan facility and a $75.0 million revolving credit facility, which is limited by a current leverage ratio, and debt owed to related parties. The term loan requires principal reductions of approximately 1% per annum paid quarterly, with a balloon payment due in September 2009.  The revolving credit

24




facility commitment reduces annually until it comes due in September 2008.  No amounts were outstanding under our revolving credit facility as of December 31, 2006.

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

The financial covenants under the Loan Agreement consist of a leverage ratio, a fixed charges coverage ratio, and a minimum of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (as that term is defined in the loan agreement) ratio.  The leverage ratio is computed as total average debt outstanding during the quarter divided by the trailing 12 months EBITDA, excluding certain cash and non-cash charges, and is further adjusted to remove EBITDA from discontinued operations at the time those operations are sold.  Our leverage ratio as of December 31, 2006 was 3.36 times versus the covenant maximum of 3.75 times.   We were in compliance with all financial covenants as of December 31, 2006.

In October 2006, we executed an amendment to the Loan Agreement, which, among other things, (i) extended the due date for the  delivery of our audited financial statements for the fiscal year ended June 30, 2006 to December 31, 2006, (ii) provided that we deliver our quarterly reports on Form 10-Q for the fiscal quarters ended September 30, 2005, December 31, 2005 and March 31, 2006 no later than December 31, 2006, (iii) modified the definition of EBITDA to exclude up to $10 million of certain cash charges and (iv) clarified that the definition of EBITDA includes interest income on trade receivables.  In exchange for the concessions granted under the amendment, we paid an administrative fee of $964,000, which was expensed in the quarter ended December 31, 2006.

In December 2006, we executed an additional amendment to the Loan Agreement, which extended the due date for the  delivery of our quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2006 and our audited financial statements for the fiscal year ended June 30, 2006 to March 15, 2007.  In exchange for the concessions granted under the amendment we paid an administrative fee of $1.2 million, which was expensed in the quarter ended December 31, 2006.

Management believes that cash flows from current operating activities and the availability under the revolving credit facility will provide us with sufficient capital resources and liquidity to operate our business for at least the next 12 months.  At December 31, 2006, we had no material commitments for capital expenditures.

 Cash Flow Summary

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

Change

 

 

 

(dollars in 000s)

 

Cash flows from:

 

 

 

 

 

 

 

Operating activities

 

$

32,269

 

$

23,167

 

$

9,102

 

Investing activities

 

$

(58,653

)

$

(28,849

)

$

(29,804

)

Financing activities

 

$

22,390

 

$

(2,870

)

$

25,260

 

 

Cash flows from operating activities are derived primarily from the cash receipts from the sale of goods and services, the operation of wide-area progressive systems, lease payments, and monthly cash receipts from maintenance agreements from our casino systems customers.  In addition, we generate cash through our casino operations.  We utilize our cash to acquire materials for the manufacture of goods for resale or lease, to pay payroll and selling, general and administrative expenses, as well as to service our debt.

During the six months ended December 31, 2006, cash flows provided by operating activities totaled $32.3 million as compared to $23.2 million in the corresponding period in the prior year.  This increase was generally attributable

25




to a reduction in the reported net loss for the six months ended December 31, 2006 as compared to the corresponding period in the prior year.

During the six months ended December 31, 2006 cash flows used in investing activities totaled $58.7 million, as compared to $28.8 million for the corresponding period in the prior year.  This change is primarily the result of:

·                  Capital expenditures of $8.8 million in the six months ended December 31, 2006 compared to $6.2 million for the corresponding period in the prior year; and

·                  Costs incurred to deploy additional leased gaming devices totaling $47.5 million in the six months ended December 31, 2006 compared to $19.9 million in the prior year period.

During the six months ended December 31, 2006 cash flows provided by financing activities totaled $22.4 million as compared to the cash flows used in financing activities in the corresponding period in the prior year of $2.9 million.  This change was primarily the result of:

·                  Principal payments on long term debt totaling $4.2 million in the six months ended December 31, 2006 compared to $3.0 million for the corresponding period in the prior year;

·                  Cash provided from the exercise of stock options of $4.3 million in the six months ended December 31, 2006 compared to $0.2 million in the corresponding period in the prior year; and

·                  Cash provided from the sale lease-back of certain assets used in our gaming operations of $22.3 million in the six months ended December 31, 2006.

Contractual Commitments

During the six months ended December 31, 2006, we entered into a capital lease for certain equipment used in our Gaming Operations amounting to approximately $20.7 million.  The lease is payable in thirty-six equal installments of $655,000.

Critical Accounting Policies

A description of our critical accounting policies can be found within management discussion and analysis of financial condition and results of operation in the 2006 10-K. There were no material changes to those policies during the three and six month periods ended December 31, 2006.

Recently Issued Accounting Pronouncements

In February, 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. It also establishes presentation and disclosure requirements to facilitate comparisons between companies using different measurement attributes for similar types of assets and liabilities. The statement is effective for fiscal years beginning after November 15, 2007 and accordingly, we expect to adopt SFAS No. 159 beginning in fiscal 2009. Earlier application is permitted provided we also apply the provisions of SFAS No. 157, Fair Value Measurements. We are currently in the process of evaluating the impact SFAS No. 159 will have on our consolidated results of operations, financial position and cash flows.

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

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, providing guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year's financial statements are materially misstated. The provisions of SAB No. 108 were effective beginning with our fiscal year ending June 30, 2007.  The adoption SAB No. 108 did not have a material impact on our consolidated results of operations, financial position or cash flows.

In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes, which creates a single model to address uncertainty in income tax positions and prescribes the minimum recognition threshold a tax position is required to meet before being

26




recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, and accordingly, the Company expects to adopt FIN 48 beginning in fiscal year 2008. We are currently in the process of evaluating the impact FIN 48 will have on our consolidated results of operations, financial position and cash flows.

ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

As of December 31, 2006, we had total debt of approximately $344.2 million, consisting primarily of the $309.6 million term loan under our senior credit facilities, $14.2 million in related party debt and $20.3 million in capital lease obligations.  The interest rate for the term loan is variable, based on LIBOR, and resets every six months.  Approximately $11.2 million of related party debt is variable and is based on LIBOR.  If the LIBOR rates were to increase or decrease by 100 basis points, with all other factors remaining constant, earnings would decrease or increase by approximately $3.2 million annually, on a pre-tax basis.

Foreign Currency Exchange Rate Risk

Our foreign subsidiaries generally use their domestic currency as their functional currency. A 10% fluctuation in the exchange rates of these currencies against the U.S. dollar would result in a corresponding change in earnings reported in the consolidated group which would have no significant effect on a pre-tax basis.

ITEM 4.          CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15(b) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this report.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2006, our disclosure controls and procedures were not effective due to the existing material weaknesses in our internal control over financial reporting previously identified and discussed in the 2006 10-K and below under “—Internal Control Over Financial Reporting —Material Weakness in Internal Control Over Financial Reporting Previously Reported.”

In view of the fact that the financial information presented in this quarterly report on Form 10-Q for the fiscal quarter ended December 31, 2006, was prepared in the absence of effective internal control over financial reporting, we have devoted a significant amount of time and resources to the analysis of the financial statements contained in this report.  In particular, we have reviewed the significant account balances and transactions reflected in the financial statements contained in this report and otherwise analyzed the transactions underlying our financial statements to verify the accuracy of the financial statements.  Accordingly, management believes that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations, and cash flows.

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

27




Internal Control Over Financial Reporting

Our management acknowledges its responsibility for establishing and maintaining adequate internal control over financial reporting that includes effective accounting policies and procedures. Our continuing progress in establishing adequate internal control over financial reporting is described below.

Certain Changes in Internal Control Over Financial Reporting during the Fiscal Quarter Ended December 31, 2006

During the quarter ended December 31, 2006, management continued its remediation steps to address the material weaknesses known at that time and previously reported.  These remediation steps were developed through investigation and review of the processes and activities surrounding the material weaknesses and include changes to these processes and the development of test and review programs designed to prevent or detect similar future occurrences.  There were no other changes to our internal control over financial reporting during the three months ended December 31, 2006 that management believes have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Material Weakness in Internal Control Over Financial Reporting Previously Reported

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

Ineffective control related to fraud risk assessment.  We concluded that the overall operating effectiveness of our fraud risk assessment did not operate as designed primarily due to delays in our financial closing process as described above.

Inadequate and ineffective control related to revenue recognition, including gaming operations revenue recognition and the associated existence of fixed asset machines, system sales revenue recognition and the processing of customer credits.  We did not have appropriate and/or effective internal controls related to the recognition of revenue for gaming operations, including the lack of comprehensive controls to adequately capture and analyze: (i) the terms and conditions of all contracts to ensure the proper recording of revenue; (ii) the accuracy of authorized daily fees and revenue share percentages; (iii) the security and electronic transmission to and from our network operating center(s) and its subsequent documentation and backup; and (iv) the existence of the related fixed asset machines.

We did not have effective internal control related to the recognition of revenue for system sales pertaining to (i) the review of terms and conditions on contract upgrades and change orders to ensure proper recording of revenue and (ii) the accuracy and authorization of billing amounts for upgrades, change orders and maintenance fees.

We also did not have effective internal control related to the recognition of revenue pertaining to the complete and timely recording of credit memos resulting from customer returns or allowances.

Ineffective control related to the existence and valuation of inventory. We identified several deficiencies related to the existence and valuation of inventory, including those related to: i) year-end adjustments to our raw materials balance due to ineffective periodic counting procedures, inadequate physical safeguards and inadequate control over transaction processing; (ii) the restocking of excess inventory pulled for work orders which was not always properly identified and/or removed from the related bill of materials; (iii) costs associated with the creation of new kits and assemblies that were not effectively calculated and monitored resulting in incorrect valuation of inventories; (iv) lack of adequate review

28




and analysis of certain inventory variances between the perpetual records and the general ledger; and (v) determining allowances for obsolete inventory.

29




PART II

ITEM 1.          LEGAL PROCEEDINGS

Litigation

In June and July 2004, putative class actions were filed against the Company and its officers, Robert Miodunski, Robert Saxton, Mark Lerner and Steven Des Champs, in the United States District Court for the District of Nevada. The nearly identical complaints alleged violations of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), stemming from revised earnings guidance, declines in the stock price and sales of stock by insiders. The complaints sought damages in unspecified amounts. The Federal District Court granted the plaintiffs’ unopposed motions to consolidate the cases and to appoint a lead counsel and a lead plaintiff, and the plaintiffs filed a consolidated complaint, all as is customary in such cases.  The Company and the other defendants moved to dismiss the complaint.  Thereafter, activity in the case was stopped and the parties participated in a mediation process during which the parties agreed on the terms of a settlement. The parties have negotiated and executed settlement documents settling both the consolidated class action and the derivative case discussed below. Under the settlement, which has received preliminary approval from the court, an aggregate of $16 million in cash, plus certain interest, will be paid to settle the securities class action as well as the derivative litigation discussed below.  The Company will pay $1.25 million, which was accrued in the Company’s financial statements for the quarter ended December 31, 2005. In addition to certain governance actions the Company has agreed to undertake in connection with the settlement, the Company’s directors and officers insurer will contribute approximately $14.75 million to the settlement.

In July 2004, two derivative lawsuits were filed in Nevada state court against the members of the board of directors and the officers listed above. The Company was named as a nominal defendant in the derivative lawsuits as the claims were purportedly asserted for the benefit of Bally Technologies, Inc. These lawsuits asserted claims for breach of fiduciary duty and waste of corporate assets arising out of the same events as those giving rise to the class actions described above, and sought injunctive relief and damages in unspecified amounts. These two cases were consolidated, and the Company and the other defendants moved to dismiss the case. In February 2005, the state district court granted the defendants’ motion and dismissed the case. The plaintiffs appealed the dismissal to the Nevada Supreme Court, which referred the matter to its settlement conference program. The parties met with a court-appointed settlement judge on December 15, 2005, and agreed to settle the case for $8,000, and on February 2, 2006, the Nevada Supreme Court entered its order formally dismissing the appeal, thereby terminating the case. Although management believes the plaintiffs’ lawsuit and appeal were without merit, it determined that the settlement was in the best interests of the Company.

On March 27, 2006, shortly after the aforementioned derivative suit was dismissed in the Nevada state court, another derivative lawsuit was filed in the United States District Court for the District of Nevada against individual defendants Robert Miodunski, Robert Saxton, Steven Des Champs, Mark Lerner, David Robbins, Anthony DiCesare, Joel Kirschbaum, Kevin Verner, Richard Haddrill, Stephen Race, Jacques André and nominal defendant Bally Technologies, Inc.  Based on factual allegations that are similar to those alleged in the federal securities class action complaints and the previous derivative actions that were dismissed by the District Court, the derivative complaint alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and violation of the Sarbanes-Oxley Act of 2002. The parties have reached a settlement as discussed more fully above.

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

In August 2004, Shuffle Master sued the Company in the United States District Court for the District of Nevada, alleging infringement of various patents in connection with the Company’s MindPlay product line and seeking injunctive relief and damages in an unspecified amount. In June 2005, it was announced that IGT had acquired an

30




interest in the patents at issue in the case, and thereafter IGT joined the case as a plaintiff.  In December 2005, the District Court issued a ruling construing the claim terms of all the patents in the suit. Management believes the plaintiffs’ lawsuit to be without merit, and the Company is vigorously defending against the lawsuit.

In September 2004, a United States District Court jury in the District of Nevada entered a $7.4 million verdict against the Company in a suit filed by Action Gaming (“AGI”) and IGT. The suit alleged that the multi-hand video poker game deployed by the Company’s former subsidiary, United Coin, infringed the plaintiffs’ patents. The Federal District Court ruled on summary judgment that the game did not infringe the patents. However, the court left to the jury the question whether the use of “autohold,” a specific, optional feature of the game, caused it to infringe under the “doctrine of equivalents,” a doctrine of patent law. The jury determined that the game with the autohold option enabled did infringe under the doctrine of equivalents and awarded damages accordingly. The feature has been disabled on all affected games in the field, and the decision permits continued deployment of the game as long as the autohold feature is not included. The Company appealed the decision to the United States Court of Appeals for the Ninth Circuit and posted a cash bond totaling $7.6 million to stay payment of the judgment and accrued interest pending the appeal.   On July 11, 2006, the federal circuit court of appeals affirmed the district court judgment, denying the appeals for both parties, and thereafter, the judgment was satisfied out of the posted bond.

On December 7, 2004, IGT filed a patent infringement lawsuit against the Company in the United States District Court for the District of Nevada. The complaint asserts that the Company’s wheel-based games, such as Monte CarloÔ, Lucky WheelÔ and Cash For LifeÔ, its games with a reel in the top box, such as Bonus FrenzyÔ, and its iViewÔ products infringe on patents held by IGT, and seeks injunctive relief and damages in unspecified amounts. The Company believes IGT’s claims are without merit and is vigorously defending itself against the lawsuit. As part of its defense, the Company has asserted counterclaims against IGT, including claims that IGT’s patents are invalid, unenforceable and not infringed, as well as several claims that IGT has engaged in anti-competitive conduct in violation of state and federal antitrust laws. By its counterclaims, the Company is seeking damages and other relief from IGT. IGT’s motion to dismiss the Company’s antitrust claims was denied in January 2006, and in March 2007, the court denied IGT’s motions for summary judgment with respect to the antitrust claims dealing with the wheel game market.  The court issued claims construction rulings in May 2007.  No trial date has been set.

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

In May 2006, IGT filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware.  The complaint asserts that the Company’s Bally Power BonusingÔ products infringe patents held by IGT, and seeks injunctive relief and damages in unspecified amounts.  The Company believes IGT’s claims are without merit and is vigorously defending itself against the lawsuit.

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

ITEM 1A.       RISK FACTORS

There have been no material changes to the risk factors presented in Item 1A of the 2006 10-K ..

31




ITEM 6.          EXHIBITS

Exhibits

 

Description

 

 

 

31.1

 

Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

31.2

 

Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

32.1

 

Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

 

32




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto authorized.

BALLY TECHNOLOGIES, INC.                                              Date:  June 20, 2007

 

By

/s/Richard Haddrill

 

 

Richard Haddrill

 

 

President and Chief Executive Officer

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

 

 

 

By

/s/Robert C. Caller

 

 

Robert C. Caller

 

 

Executive Vice President, Chief Financial Officer and Treasurer

 

 

(Principal Financial and Accounting Officer)