UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2004

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

ALLIANCE GAMING CORPORATION

(Exact name of registrant as specified in its charter)

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

Registrant’s internet:  www.alliancegaming.com

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12B-2 of the Exchange Act).

Yes  ý   No  o

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.

ý  Yes   o  No

The number of shares of Common Stock, $0.10 par value, outstanding as of January 31, 2005, according to the records of the registrant’s registrar and transfer agent was 51,088,700.

INDEX

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PART I

ALLIANCE GAMING CORPORATION

 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

($ In 000’s except share and per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE GAMING CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

($ In 000s, except share and per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE GAMING CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

($ In 000s)

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE GAMING CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

($ In 000s)

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE GAMING CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.              BASIS OF PRESENTATION

Principles of presentation and consolidation

The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which management believes are necessary to present fairly the financial position, results of operations and cash flows of Alliance Gaming Corporation and its subsidiaries (“Alliance” 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 interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the Company’s annual report on Form 10-K for the year ended June 30, 2004.

The accompanying consolidated financial statements include the accounts of Alliance Gaming Corporation and its wholly owned and partially owned, controlled subsidiaries. The Company consolidates Rainbow Casino Vicksburg Partnership (“RCVP”) and records minority interest expense to reflect the portion of the earnings of RCVP attributable to the minority shareholders.The Company is the general partner of RCVP, the partnership that operates the Rainbow Casino. 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% (which amount increases to 20% of such amount when annual revenues exceed $35.0 million but only on such incremental amount) of the net available cash flows after debt service and other items, as defined, payable quarterly through December 31, 2010. The Company holds the remaining economic interest in the partnership.

For Video Services, Inc. (“VSI”), the Company owned 100% of the voting stock and was entitled to receive 71% of dividends declared by VSI, if any, at such time that dividends were declared. The sale of VSI was completed during the quarter ended December 31, 2004 for a realized gain of $0.8 million, net of tax (included in discontinued operations).

All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year financial statements to conform to the current year presentation, and to present Rail City as discontinued operations for all periods presented.

Recently Issue Accounting Pronouncements

In December 2004, the FASB issued Statement 123(R) which revised FASB No. 123.  Statement 123(R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees for reporting periods beginning after June 15, 2005. The first reporting period for the Company will be the quarter ended September 30, 2005, and the Company is currently evaluating the impact of the adoption, however the pro forma impact is reflected in footnote 2.

In November 2004 the FASB issued Statement 151 which revised ARB 43, Chapter 4, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, wasted material (spoilage). This Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005.  The Company does not believe this accounting pronouncement will have a material impact on its financial condition or results of operations.

2.              STOCK-BASED COMPENSATION

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

As provided under Financial Accounting Standards Board No. 123 “Accounting for Stock-Based Compensation” (“FASB No. 123”), companies may continue to account for employee stock-based compensation under APB 25, but are required to disclose historical pro-forma net income and earnings per share that would have resulted from the use of the fair value method described in FASB No. 123.

In December 2002, the FASB issued FASB No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. This Statement amends FASB No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FASB No. 123 and APB Opinion No. 28 “Interim Financial Reporting” to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-

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based employee compensation and the effect of the method used on reported results. Under fair value method, compensation costs are measured using an options pricing model and are amortized over the estimated life of the option, which is generally three to ten years, with option forfeitures accounted for at the time of the forfeiture, and all amounts are reflected net of tax.

The historical and pro forma net income (assuming an after-tax charge for stock-based compensation) and related per share data are as follows (in 000s, except per share data):

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

The resulting fair values applied to the options granted were $4.39 and $3.14 per share for the quarter ended December 31, 2004 and December 31, 2003, respectively and were $5.06 and $3.10 for the six months ended December 31, 2004 and 2003, respectively.

3.              DISCONTINUED OPERATIONS

The Company has completed several divestitures in accordance with our plan to sell our “non-core” businesses, which was a strategy announced in July 2003. In July 2003, we completed the sale of Bally Wulff to a private equity investor.  Since the net assets of Bally Wulff were written down to the estimated sale price in June 2003, no additional gain or loss was recorded upon the closing of the sale. In May 2004, we completed the sale of Rail City Casino to The Sands Resort. On June 30, 2004, the Company completed the sale of United Coin Machine Co. (“UCMC”). On October 15, 2004 the Company completed the sale of its interest in VSI to Churchill Downs Incorporated and received proceeds of approximately $2.0 million and realized a gain of $0.8 million, net of tax.

The results of these discontinued operations are presented net of applicable income taxes in discontinued operations  in the accompanying consolidated statements of operations.

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Operating results for the discontinued operations for the three and six month periods ended December 31, 2004 include VSI, while the results for the three and six month periods ended December 31, 2003 include UCMC, VSI, and Rail City.  Summary operating results are as follows (in 000s):

4.              OTHER CURRENT ASSETS

Other current assets consist of the following (in 000s):

The decrease in refundable deposits of $1.3 million is a result of units purchased from other manufacturers for which the deposit has now been applied to the account payable.  The increase in deferred costs of $3.7 million is due to shipments of games, primarily to the European market with F.O.B. destination terms, which will not be recognized as revenue until the third quarter of fiscal year 2005.

5.              INVENTORIES

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

The Company performs detailed inventory valuation procedures at least quarterly. This process includes examining the carrying values of new and used gaming devices, parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose).  Some of the factors involved in this analysis include the overall levels of our inventories, the current and projected sales levels for such products, the projected markets for such products both domestically and internationally, the costs required to sell the products including refurbishment costs and importation costs for international shipments, and the overall projected demand for products once the next generation of products are scheduled for release.

The Company has faced declining demand for its video products.  During the quarter ended September 30, 2004, the Company decided that its legacy V7 video platform would no longer be supported,

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and the remaining used game inventory for such products was targeted for immediate disposal, resulting in a write down of $3.0 million.  The inventory of new games for this product line was targeted for sale at reduced prices, which were still above the carrying value less cost to sell and therefore were not written down.

During the quarter ended December 31, 2004, management completed a three year business planning process.  In accordance with this plan, significant development efforts were redirected to the Alpha-based video platform and products.  The Company also made its existing EVO video games upgradeable to Alpha when approved in each market. The remaining used EVO inventory has been targeted for sale primarily in non-domestic markets, which traditionally have lower price points for used games and have higher importation and delivery costs, resulting in significantly lower net realizable values.  The capitalized regulatory approval costs for the EVO and legacy video platform were determined to no longer be recoverable, and were also written off.

During the quarter ended December 31, 2004, the Company consolidated several warehouses into one central warehouse, with the intent to reduce warehouse rental costs.  As part of this consolidation, certain used games and related ancillary equipment including signs, were identified for immediate destruction, scrap, or salvage and this process has continued into the March 2005 period.

As a result of the decision to move to the new video platform, the targeting of used equipment for non-domestic markets, and the consolidation of warehouses leading to accelerated disposals, the Company wrote down its inventory and related assets by a total of $11.1 million during the quarter ended December 31, 2004, and such write downs for the six months ended December 31, 2004 totaled $14.1 million. These charges are included in the cost of gaming equipment and systems in the statement of operations.

The Company continues to take certain used games on trade as part of new game sales, and therefore additional write-downs may be necessary in future periods depending on a number of factors impacting the future demand for such used products and the ultimate net values realized.

6.              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, 28-40 years; gaming equipment, 4-7 years; furniture, fixtures and equipment, 3-7 years; and leasehold improvements, 5-10 years.  Leased gaming equipment is stated at cost and depreciated over estimated useful life ranging from 3-4 years.

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

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

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7.              INTANGIBLE ASSETS AND GOODWILL

In July 2001, the Company adopted FASB No. 142 “Goodwill and Other Intangible Assets”, which requires companies to cease amortizing goodwill and certain intangible assets with indefinite useful lives.  Instead, goodwill and intangible assets deemed to have indefinite useful lives are to be reviewed for impairment annually at the reporting unit level (Gaming equipment and systems, and casino operations).  There was no impairment of goodwill upon adoption of FASB No. 142.   There was no impairment charged to goodwill in the six months ended December 31, 2004 or 2003.

The Company evaluates the carrying value of goodwill for impairment annually during the fourth quarter or whenever events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.  Indicators that could trigger an impairment review include changes in legal, regulatory, or economic factors, market conditions or operational performance.  Impairment is measured as the difference between the carrying amount and the fair value of the intangible assets and is recognized as a component of income from operations.

Intangibles

Intangible assets excluding discontinued operations consist of the following (in 000s):

Amortization expense totaled $2.6 million and $1.4 million for the three months ended December 31, 2004 and 2003, respectively.  Amortization expense totaled $4.6 million and $2.7 million for the six months ended December 31, 2004 and 2003, respectively.  Computer software amortization expense totaled $1.1 million and $0.8 million for the three months ended December 31, 2004 and 2003, respectively.  Computer software amortization totaled $1.6 million and $1.4 million for the six months ended December 31, 2004 and 2003, respectively.

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

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Goodwill

The changes in the carrying amount of goodwill are as follows (in 000s):

On December 30, 2004 the Company amended the Sierra Design Group (“SDG”) stock purchase agreement originally dated March 3, 2004.  The amendment terminates the contingent consideration payable over the next three years (“the earnout”) which could have totaled $95 million (payable in cash and stock) depending on the achievement of certain SDG financial performance targets.  The consideration for the termination of the earnout consisted of a one-time cash payment of $12 million paid to the group of former SDG stakeholders and the delivery of a $28 million unsecured promissory note to that same group of individuals, payable over five years with interest at LIBOR + 2%.  The $40 million of total consideration paid to terminate the earnout, and related expenses has been treated as additional consideration paid for the stock of SDG, and therefore has been recorded as goodwill.

The purchase agreement for MindPlay LLC calls for future contingent consideration (“earnouts”) to be paid to its former principals, as more fully described in footnote 14. The MindPlay earnout is payable based on future revenues and gross margins from the sale of MindPlay products.  No amounts have yet been paid pursuant to this earnout.

8.              ACCRUED LIABILITIES AND JACKPOT LIABILITIES

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

The Company recognizes liability for jackpot expense for the cost to fund these jackpots in the future.  Generally winners may elect to receive a single lump sum payment or may opt to receive payments in equal installments over a specified period of time.  The most recent history pattern indicates that approximately 85% of winners will elect the single payment option.

The Company funds jackpot installment payments through qualifying U.S. government or agency securities.  The present value of the outstanding progressive jackpot liabilities is computed based upon the payment stream discounted at the applicable discount rate.

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The increase in litigation accruals of $9.4 million is primarily a result of the patent litigation discussed in the Commitments and Contingencies section of this report.

9.              LONG-TERM INVESTMENTS (RESTRICTED)

Pursuant to various state gaming regulations, certain cash accounts are maintained to ensure availability of funds to pay wide-area progressive jackpot awards, which totaled approximately $12.8 million at December 31, 2004 and which are included in cash and cash equivalents in the accompanying balance sheets.  In addition, the Company purchases U.S. Treasury Strip securities for the benefit of jackpot winners who elect to receive annual or weekly installment payments. These securities are presented as restricted investments in the accompanying consolidated balance sheets, and totaled $8.5 million and $2.5 million as of December 31, 2004 and June 30, 2004, respectively.

10.       LONG-TERM DEBT

Long-term debt consisted of the following (in 000s):