UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




Form
10-Q




(Mark
One)


x
            QUARTERLY REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
quarterly period ended March 31,
2009


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: 000-28318




Multimedia
Games, Inc.


(Exact
name of Registrant as specified in its charter)




Texas
              
              74-2611034(State
      or other jurisdiction of incorporation or organization)
              
              (IRS
      Employer Identification No.)206
      Wild Basin Road South, Building B, Fourth FloorAustin,
      Texas
              
              78746(Address
      of principal executive offices)
              
              (Zip
      Code)





(512)
334-7500


(Registrant’s
telephone number, including area code)




Registrant’s
website: www.multimediagames.com




None


(Former
name, former address and former fiscal year, if changed since last
report)




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:Yes x  No
 ̈




Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act:





Large
      Accelerated Filer  ̈
                    
                    Accelerated
      Filer xNon-Accelerated
      Filer  ̈
                    
                    Smaller
      Reporting Company  ̈




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




As of
May 1, 2009, there were 26,642,942 shares of the Registrant’s common
stock, par value $0.01 per share, outstanding.









FORM
10-Q
  INDEX




PART I.  FINANCIAL
      INFORMATIONItem
      1.
                                  Condensed
      Consolidated Financial Statements (Unaudited)Consolidated
      Balance Sheets(As
      of March 31, 2009and
      September 30, 2008)
                                  3Consolidated
      Statements of Operations(For
      the three months ended March 31, 2009and
      2008)
                                  5Consolidated
      Statements of Operations(For
      the six months ended March 31, 2009and
      2008)
                                  6Consolidated
      Statements of Cash Flows(For
      the six months ended March 31, 2009and
      2008)
                                  7Notes
      to Consolidated Financial Statements
                                  8Item
      2.
                                  Management’s
      Discussion and Analysis of
      Financial Condition and Results of Operations
                                  21Item
      3.
                                  Quantitative
      and Qualitative Disclosures about Market Risk
                                  36Item
      4.
                                  Controls
      and Procedures
                                  37PART II.  OTHER
      INFORMATIONItem
      1.
                                  Legal
      Proceedings
                                  38Item
      1A.
                                  Risk
      Factors
                                  38Item
      2.
                                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                                  48Item
      3.
                                  Defaults
      upon Senior Securities
                                  48Item
      4.
                                  Submission
      of Matters to a Vote of Security Holders
                                  48Item
      5.
                                  Other
      Information
                                  48Item
      6.
                                  Exhibits
                                  48Signatures
                                  49Exhibit
Index




-2-





PART
I


FINANCIAL
INFORMATION


Item
      1.
            Condensed
      Financial Statements


MULTIMEDIA
GAMES, INC.


CONSOLIDATED
BALANCE SHEETS


As of March 31, 2009
and September 30,
2008


(In
thousands, except shares)


(Unaudited)





March 31,
                          2009
                        
                        
                        September 30,
                          2008ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                        
                        $
                        9,249
                        
                        
                        $
                        6,289Accounts
      receivable, net of allowance for doubtful accountsof
      $1,359 and $1,209, respectively
                        
                        
                        27,076
                        
                        
                        
                        23,566Inventory
                        
                        
                        1,680
                        
                        
                        
                        2,445Deferred
      contract costs, net
                        
                        
                        2,002
                        
                        
                        
                        998Prepaid
      expenses and other
                        
                        
                        2,881
                        
                        
                        
                        2,170Current
      portion of notes receivable, net
                        
                        
                        14,692
                        
                        
                        
                        23,072Federal
      and state income tax receivable
                        
                        
                        5,964
                        
                        
                        
                        2,198Deferred
      income taxes
                        
                        
                        8,109
                        
                        
                        
                        6,876Total
      current assets
                        
                        
                        71,653
                        
                        
                        
                        67,614Restricted
      cash and long-term investments
                        
                        
                        804
                        
                        
                        
                        868Leased
      gaming equipment, net
                        
                        
                        42,126
                        
                        
                        
                        36,024Property
      and equipment, net
                        
                        
                        61,210
                        
                        
                        
                        67,329Long-term
      portion of notes receivable, net
                        
                        
                        47,301
                        
                        
                        
                        46,690Intangible
      assets, net
                        
                        
                        32,602
                        
                        
                        
                        37,356Deferred
      income taxes
                        
                        
                        17,493
                        
                        
                        
                        16,902Other
      assets
                        
                        
                        2,462
                        
                        
                        
                        4,157Total
      assets
                        
                        $
                        275,651
                        
                        
                        $
                        276,940LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Current
      portion of long-term debt
                        
                        $
                        2,569
                        
                        
                        $
                        1,544Accounts
      payable and accrued expenses
                        
                        
                        26,999
                        
                        
                        
                        29,248Federal
      and state income tax payable
                        
                        
                        —
                        
                        
                        
                        33Deferred
      revenue
                        
                        
                        4,584
                        
                        
                        
                        2,640Total
      current liabilities
                        
                        
                        34,152
                        
                        
                        
                        33,465Revolving
      line of credit
                        
                        
                        29,000
                        
                        
                        
                        19,000Long-term
      debt, less current portion
                        
                        
                        65,925
                        
                        
                        
                        66,444Other
      long-term liabilities
                        
                        
                        1,052
                        
                        
                        
                        1,131Deferred
      revenue, less current portion
                        
                        
                        5,211
                        
                        
                        
                        6,168Total
      liabilities
                        
                        
                        135,340
                        
                        
                        
                        126,208Commitments
      and contingenciesStockholders’
      equity:Preferred
      stock:Series
      A, $0.01 par value, 1,800,000 shares authorized,
                          no
      shares issued and outstanding
                        
                        
                        —
                        
                        
                        
                        —Series
      B, $0.01 par value, 200,000 shares authorized,
                          no
      shares issued and outstanding
                        
                        
                        —
                        
                        
                        
                        —Common
      stock, $0.01 par value, 75,000,000 shares authorized,
                          32,546,359
      and 32,511,988 shares issued, and
                          26,642,942
      and 26,608,571 shares outstanding, respectively
                        
                        
                        325
                        
                        
                        
                        325




-3-




MULTIMEDIA GAMES, INC.


CONSOLIDATED
BALANCE SHEETS – (Continued)


As
of March 31, 2009 and September 30, 2008


(In
thousands, except shares)


(Unaudited)





March 31,
                    2009
                  
                  
                  September 30,
                    2008Additional
      paid-in capital
                  
                  
                  84,262
                  
                  
                  
                  83,076Treasury
      stock, 5,903,417 common shares at cost
                  
                  
                  (50,128
                  )
                  
                  
                  (50,128
                  )Retained
      earnings
                  
                  
                  108,263
                  
                  
                  
                  117,581Accumulated
      other comprehensive loss, net
                  
                  
                  (2,411
                  )
                  
                  
                  (122
                  )Total
      stockholders’ equity
                  
                  
                  140,311
                  
                  
                  
                  150,732Total
      liabilities and stockholders’ equity
                  
                  $
                  275,651
                  
                  
                  $
                  276,940





The
accompanying notes are an integral part of the condensed consolidated financial
statements.




-4-




MULTIMEDIA
GAMES, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


For
the Three Months Ended March 31, 2009 and 2008


(In
thousands, except per share data)


(Unaudited)





Three
      Months Ended
                          March 31,2009
                        
                        
                        2008REVENUES:Gaming
      revenue:Oklahoma
      compact
                        
                        $
                        15,333
                        
                        
                        $
                        14,138Class II
                        
                        
                        5,168
                        
                        
                        
                        7,546Charity
                        
                        
                        2,874
                        
                        
                        
                        4,396All
      other
                        
                        
                        5,438
                        
                        
                        
                        5,262Gaming
      equipment, system sale and lease revenue
                        
                        
                        4,355
                        
                        
                        
                        378Other
                        
                        
                        702
                        
                        
                        
                        482Total
      revenues
                        
                        
                        33,870
                        
                        
                        
                        32,202OPERATING
      COSTS AND EXPENSES:Cost
      of gaming equipment and systems soldand
      royalty fees
                        
                        
                        2,327
                        
                        
                        
                        414Selling,
      general and administrative expenses
                        
                        
                        20,473
                        
                        
                        
                        16,633Amortization
      and depreciation
                        
                        
                        15,639
                        
                        
                        
                        12,433Total
      operating costs and expenses
                        
                        
                        38,439
                        
                        
                        
                        29,480Operating
      income (loss)
                        
                        
                        (4,569
                        )
                        
                        
                        2,722OTHER
      INCOME (EXPENSE):Interest
      income
                        
                        
                        1,246
                        
                        
                        
                        1,136Interest
      expense
                        
                        
                        (1,891
                        )
                        
                        
                        (2,491
                        )Other
      income
                        
                        
                        —
                        
                        
                        
                        872Income
      (loss) before income taxes
                        
                        
                        (5,214
                        )
                        
                        
                        2,239Income
      tax (expense) benefit
                        
                        
                        1,820
                        
                        
                        
                        (981
                        )Net
      income (loss)
                        
                        $
                        (3,394
                        )
                        
                        $
                        1,258Basic
      earnings (loss) per common share
                        
                        $
                        (0.13
                        )
                        
                        $
                        0.05Diluted
      earnings (loss) per common share
                        
                        $
                        (0.13
                        )
                        
                        $
                        0.05Shares
      used in earnings (loss) per common share:Basic
                        
                        
                        26,643
                        
                        
                        
                        26,271Diluted
                        
                        
                        26,643
                        
                        
                        
                        27,243





The
accompanying notes are an integral part of the condensed consolidated financial
statements.




-5-




MULTIMEDIA
GAMES, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


For
the Six Months Ended March 31, 2009 and 2008


(In
thousands, except per share data)


(Unaudited)





Six
      Months Ended
                        March 31,2009
                      
                      
                      2008REVENUES:Gaming
      revenue:Oklahoma
      compact
                      
                      $
                      29,129
                      
                      
                      $
                      25,699Class II
                      
                      
                      10,175
                      
                      
                      
                      15,586Charity
                      
                      
                      5,417
                      
                      
                      
                      8,253All
      other
                      
                      
                      10,378
                      
                      
                      
                      9,900Gaming
      equipment, system sale and lease revenue
                      
                      
                      6,121
                      
                      
                      
                      2,149Other
                      
                      
                      1,226
                      
                      
                      
                      850Total
      revenues
                      
                      
                      62,446
                      
                      
                      
                      62,437OPERATING
      COSTS AND EXPENSES:Cost
      of gaming equipment and systems soldand
      royalty fees
                      
                      
                      4,174
                      
                      
                      
                      1,204Selling,
      general and administrative expenses
                      
                      
                      40,737
                      
                      
                      
                      32,734Amortization
      and depreciation
                      
                      
                      30,504
                      
                      
                      
                      24,956Total
      operating costs and expenses
                      
                      
                      75,415
                      
                      
                      
                      58,894Operating
      income (loss)
                      
                      
                      (12,969
                      )
                      
                      
                      3,543OTHER
      INCOME (EXPENSE):Interest
      income
                      
                      
                      2,536
                      
                      
                      
                      2,270Interest
      expense
                      
                      
                      (4,026
                      )
                      
                      
                      (4,631
                      )Other
      income
                      
                      
                      74
                      
                      
                      
                      1,210Income
      (loss) before income taxes
                      
                      
                      (14,385
                      )
                      
                      
                      2,392Income
      tax (expense) benefit
                      
                      
                      5,067
                      
                      
                      
                      (735
                      )Net
      income (loss)
                      
                      $
                      (9,318
                      )
                      
                      $
                      1,657Basic
      earnings (loss) per common share
                      
                      $
                      (0.35
                      )
                      
                      $
                      0.06Diluted
      earnings (loss) per common share
                      
                      $
                      (0.35
                      )
                      
                      $
                      0.06Shares
      used in earnings (loss) per common share:Basic
                      
                      
                      26,633
                      
                      
                      
                      26,234Diluted
                      
                      
                      26,633
                      
                      
                      
                      27,283




The
accompanying notes are an integral part of the condensed consolidated financial
statements.




-6-




MULTIMEDIA
GAMES, INC.




CONSOLIDATED
STATEMENTS OF CASH FLOWS


For
the Six
Months Ended March 31, 2009and 2008


(In
thousands)


(Unaudited)





Six Months
      Ended
                            March 31,2009
                          
                          
                          2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
                          
                          $
                          (9,318
                          )
                          
                          $
                          1,657Adjustments
      to reconcile net income (loss) to cash provided by operating
      activities:Amortization
                          
                          
                          2,698
                          
                          
                          
                          2,248Depreciation
                          
                          
                          27,806
                          
                          
                          
                          22,708Accretion
      of contract rights
                          
                          
                          2,912
                          
                          
                          
                          1,944Provisions
      for long lived asset impairment
                          
                          
                          (832
                          )
                          
                          
                          78Deferred
      income taxes
                          
                          
                          (1,824
                          )
                          
                          
                          (1,854
                          )Share-based
      compensation
                          
                          
                          1,124
                          
                          
                          
                          587Provision
      for doubtful accounts
                          
                          
                          397
                          
                          
                          
                          262Interest
      income from imputed interest on development agreements
                          
                          
                          (2,274
                          )
                          
                          
                          (1,822
                          )Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          (6,429
                          )
                          
                          
                          (4,547
                          )Inventory
                          
                          
                          1,583
                          
                          
                          
                          (2,030
                          )Deferred
      contract costs
                          
                          
                          (1,004
                          )
                          
                          
                          129Prepaid
      expenses and other
                          
                          
                          984
                          
                          
                          
                          (1,672
                          )Federal
      and state income tax payable/receivable
                          
                          
                          (3,799
                          )
                          
                          
                          (795
                          )Notes
      receivable
                          
                          
                          303
                          
                          
                          
                          (348
                          )Accounts
      payable and accrued expenses
                          
                          
                          (2,399
                          )
                          
                          
                          (3,215
                          )Other
      long-term liabilities
                          
                          
                          (15
                          )
                          
                          
                          345Deferred
      revenue
                          
                          
                          987
                          
                          
                          
                          1,764NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                          
                          
                          10,900
                          
                          
                          
                          15,439CASH
      FLOWS USED IN INVESTING ACTIVITIES:Acquisition
      of property and equipment and leased gaming equipment
                          
                          
                          (27,319
                          )
                          
                          
                          (17,317
                          )Proceeds
      from disposal of assets
                          
                          
                          —
                          
                          
                          
                          323Acquisition
      of intangible assets
                          
                          
                          (1,488
                          )
                          
                          
                          (2,716
                          )Advances
      under development agreements
                          
                          
                          (1,250
                          )
                          
                          
                          (35,566
                          )Repayments
      under development agreements
                          
                          
                          11,166
                          
                          
                          
                          16,007NET
      CASH USED IN INVESTING ACTIVITIES
                          
                          
                          (18,891
                          )
                          
                          
                          (39,269
                          )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from exercise of stock options, warrants, and related tax
      benefit
                          
                          
                          62
                          
                          
                          
                          150Proceeds
      from long-term debt
                          
                          
                          5,257
                          
                          
                          
                          1,928Proceeds
      from revolving lines of credit
                          
                          
                          10,695
                          
                          
                          
                          26,512Payments
      on long-term debt
                          
                          
                          (4,751
                          )
                          
                          
                          (6,203
                          )Payments
      on revolving lines of credit
                          
                          
                          (695
                          )
                          
                          
                          (3,387
                          )NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                          
                          
                          10,568
                          
                          
                          
                          19,000EFFECT
      OF EXCHANGE RATES ON CASH
                          
                          
                          383
                          
                          
                          
                          (16
                          )Net
      increase (decrease) in cash and cash equivalents
                          
                          
                          2,960
                          
                          
                          
                          (4,846
                          )Cash
      and cash equivalents, beginning of period
                          
                          
                          6,289
                          
                          
                          
                          5,805Cash
      and cash equivalents, end of period
                          
                          $
                          9,249
                          
                          
                          $
                          959SUPPLEMENTAL
      CASH FLOW DATA:Interest
      paid
                          
                          $
                          2,585
                          
                          
                          $
                          3,472Income
      tax paid
                          
                          $
                          253
                          
                          
                          $
                          3,505NON-CASH
      TRANSACTIONS:Contract
      rights resulting from imputed interest on development agreement notes
      receivable
                          
                          $
                          (176
                          )
                          
                          
                          6,129Transfer
      of leased gaming equipment to inventory
                          
                          
                          818
                          
                          
                          
                          —





The
accompanying notes are an integral part of the consolidated financial
statements.




-7-




MULTIMEDIA
GAMES, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





1.
            SIGNIFICANT
      ACCOUNTING POLICIES




The
accompanying condensed consolidated financial statements should be read in
conjunction with Multimedia Games, Inc. (the “Company,” “we,” “us,” or “our”)
consolidated financial statements and footnotes contained within the Company’s
Annual Report on Form 10-K for the year ended September 30, 2008,
as amended by Amendments No. 1 and No. 2 on Form 10-K/A
thereto.




The
unaudited financial statements included herein as of March 31, 2009,
and for each of the three and six month periods ended March 31, 2009
and 2008, have been prepared by the Company pursuant to accounting
principles generally accepted in the United States, and the rules and
regulations of the Securities and Exchange Commission, or SEC. They do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States for complete financial statements. The
information presented reflects all adjustments consisting solely of normal
recurring adjustments which are, in the opinion of management, considered
necessary to present fairly the financial position, results of operations, and
cash flows for the periods. Operating results for the three and six month
periods ended March 31, 2009, are not necessarily indicative of the
results which will be realized for the year ending
September 30, 2009.




Operations –The Company is a supplier
of interactive systems, server-based gaming systems, interactive electronic
games, player terminals, stand-alone player terminals, video lottery terminals,
electronic scratch ticket systems, electronic instant lottery systems, player
tracking systems, casino cash management systems, slot accounting systems, slot
management systems, unified currencies and electronic and paper bingo systems
for Native American, racetrack casino, casino, charity and commercial bingo,
sweepstakes, lottery and video lottery markets and the Company provides support
and services and operations support for its customers and products. The Company
designs and develops networks, software and content that provide its customers
with, among other things, comprehensive gaming systems, some of which are
delivered through a telecommunications network that links its player terminals
with one another, both within and among gaming facilities. The Company’s ongoing
development and marketing efforts focus on Class II and Class III
gaming systems and products for use by Native American tribes; video lottery
terminals, video lottery systems, stand-alone player terminals, electronic
instant scratch systems and other products for domestic and international
lotteries; products for domestic and international charity and commercial bingo
markets; and promotional, sweepstakes and amusement with prize systems.
The Company’s gaming systems are typically provided to customers under
revenue-sharing arrangements, except for video lottery terminals in the
Class III market in Washington State, which are typically sold for an
up-front purchase price. The Company has undertaken a concerted effort to
generate additional revenue through the sale of Class II and Class III
gaming systems and products. The Company offers content for its gaming systems
that has been designed and developed by the Company, as well as game themes the
Company has licensed from others. The Company currently operates in one business
segment.




Consolidation
Principles –The Company’s financial statements include the accounts of
Multimedia Games, Inc. and its wholly-owned subsidiaries: Megabingo, Inc., MGAM
Systems, Inc., Innovative Sweepstakes Systems, Inc., MGAM Services, LLC,
MGAM Systems International, Inc., Megabingo International, LLC,
Multimedia Games de Mexico 1, S. de R.L. de C.V., and
Servicios de Wild Basin S. de R.L. de C.V. Intercompany
balances and transactions have been eliminated.




Accounting
Estimates–The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Examples include share-based compensation,
provisions for doubtful accounts and contract losses, estimated useful lives of
property and equipment and intangible assets, impairment of property and
equipment and intangible assets, deferred income taxes, and the provision for
and disclosure of litigation and loss contingencies. Actual results may differ
materially from these estimates in the future.




-8-


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Reclassification–Reclassifications were made
to the prior-period consolidated statement of cash flows to conform to the
current-period financial statement presentation. This reclassification did not
have an impact on the Company’s previously reported results of
operations.




Revenue
Recognition–In
accordance with the provision of Staff Accounting Bulletin No. 104,
“Revenue Recognition,” or SAB 104, the Company recognizes revenue when all
of the following have been satisfied:




§
            Persuasive
      evidence of an arrangement exists;




§
            Delivery
      has occurred;




§
            Price
      to the buyer is fixed or determinable;
and




§
            Collectibility
      is probable.




Gaming
Revenue–The
Company derives gaming revenue from the following sources:




·
            Oklahoma
      Compact
            –
            Participation
      revenue generated from its games placed by the Company under the Oklahoma
      Compact·
            Class II
            –
            Participation
      revenue generated from the Company’s Native American Class II
      product·
            Charity
            –
            Participation
      revenue generated from its charity bingo product·
            All
      Other
            –
            Participation
      revenue from Class III back-office systems, New York Lottery system,
      Mexico bingo market, and certain other participation-based
      markets




The
majority of the Company’s gaming revenue is of a recurring nature, and is
generated under lease participation arrangements when the Company provides its
customers with player terminals, player terminal-content licenses and
back-office equipment, collectively referred to as gaming equipment. Under these
arrangements, the Company retains ownership of the gaming equipment installed at
customer facilities, and the Company receives revenue based on a percentage of
the net win per day generated by the gaming equipment. Revenue from lease
participation arrangements are considered both realizable and earned at the end
of each gaming day.




Gaming
Revenue generated by player terminals deployed at sites under development
agreements is reduced by the accretion of contract rights from those development
agreements. Contract rights are amounts allocated to intangible assets for
dedicated floor space resulting from development agreements, described under
“Development Agreements.” The related amortization expense, or accretion of
contract rights, is netted against its respective revenue category in the
consolidated statements of operations.




The
Company also generates gaming revenues from back-office fees with certain
customers. Back-office fees cover the service and maintenance costs for
back-office servers installed in each gaming facility to run its gaming
equipment, as well as the cost of related software updates. Back-office fees are
considered both realizable and earned at the end of each gaming
day.




Gaming Equipment
and System Sales–The Company periodically sells gaming equipment and gaming systems under
independent sales contracts through normal credit terms or may grant extended
credit terms under contracts secured by the related equipment, with interest
recognized at market rates.




For sales
arrangements with multiple deliverables, the Company applies the guidance from
Statement of Position 97-2, or SOP 97-2, “Software Revenue Recognition,” as
amended, and Emerging Issues Task Force, or EITF 00-21, “Revenue Arrangements
with Multiple Deliverables.” Deliverables are divided into separate units of
accounting if: (i) each item has value to the customer on a stand-alone
basis; (ii) there is objective and reliable evidence of the fair value of
the undelivered items; and (iii) delivery of the undelivered item is
considered probable and substantially in the Company’s control.




The
majority of the Company’s multiple element sales contracts are for some
combination of gaming equipment, player terminals, content, system software,
license fees and maintenance. For multiple element contracts considered a single
unit of accounting, the Company recognizes revenues based on the method
appropriate for the last delivered item.




The
Company allocates revenue to each accounting unit based upon its fair value as
determined by Vendor Specific Objective Evidence, or VSOE. VSOE of fair value
for all elements of an arrangement is based upon the normal pricing and
discounting practices for those products and services when sold individually.
The Company recognizes revenue when the product is physically delivered to a
customer controlled location or over the period in which the service is
performed and defers revenue for any undelivered elements.




-9-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




§
            In
      those situations where each element is not essential to the function of
      the other, the “multiple deliverables” are bifurcated into accounting
      units based on their relative fair market value against the total contract
      value and revenue recognition on those deliverables is recorded when all
      requirements of revenue recognition have been
  met.




§
            If
      any element is determined to be essential to the function of the other,
      revenues are generally recognized over the term of the services that are
      rendered.




In those
situations where VSOE does not exist for any undelivered elements of a multiple
element arrangement, the aggregate value of the arrangement, including the value
of products and services delivered or performed, is initially deferred until all
hardware and software is delivered, and then the entire amount of the
arrangement is recognized ratably over the period of the last deliverable,
generally the service period of the contract. Depending upon the elements and
the terms of the arrangement, the Company recognizes certain revenues under the
residual method. Under the residual method, revenue is recognized when VSOE
of fair value exists for all of the undelivered elements in the arrangement, but
does not exist for one or more of the delivered elements in the arrangement.
Under the residual method, the Company defers the fair value of undelivered
elements, and the remainder of the arrangement fee is then allocated to the
delivered elements and is recognized as revenue, assuming the other revenue
recognition criteria are met.




Costs and
Billings on Uncompleted Contract–During fiscal 2008,
the Company entered into a fixed-price contract with a customer, pursuant to
which it will deliver an electronic bingo system. Revenues from this fixed-price
contract will be recognized on the completed-contract method in accordance with
American Institute of Certified Public Accountants Statement of
Position 81-1, or SOP 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts.” In the event that the
Company expected a loss on a contract accounted for under SOP 81-1, the Company
would record the estimated loss in the quarter in which it was determined that a
loss was expected.




Contract
costs include all direct material and labor costs, and those indirect costs
related to contract performance, such as indirect labor, supplies and tools.
General and administrative costs are charged to expense as
incurred.




Costs in
excess of amounts billed are classified as current assets under “Deferred
contract costs, net.”




At
March 31, 2009, the following amounts were recorded in the Company’s
consolidated financial statements:




March 31,
                          2009(in
      thousands)Costs
      incurred on uncompleted contracts
                        
                        $
                        2,654Billings
      on uncompleted contracts
                        
                        
                        (652
                        )Deferred
      contract costs
                        
                        $
                        2,002




Cash and Cash
Equivalents –The Company considers all highly liquid investments (i.e.,
investments which, when purchased, have original maturities of three months or
less) to be cash equivalents.




Restricted Cash
and Long-Term Investments –Restricted cash and long-term investments at
March 31, 2009, amounted to $804,000, representing the fair value of
investments held by the Company’s prize fulfillment firm related to outstanding
MegaBingo® jackpot
prizes.




Allowance for
Doubtful Accounts –The Company maintains an allowance for doubtful
accounts related to its accounts receivable and notes receivable that have been
deemed to have a high risk of uncollectibility. Management reviews its accounts
receivable and notes receivable on a monthly basis to determine if any
receivables will potentially be uncollectible. Management analyzes historical
collection trends and changes in its customer payment patterns, customer
concentration, and creditworthiness when evaluating the adequacy of its
allowance for doubtful accounts. In its overall allowance for doubtful accounts,
the Company includes any receivable balances where uncertainty exists as to
whether the account balance has become uncollectible. Based on the information
available, management believes the allowance for doubtful accounts is adequate;
however, actual write-offs might exceed the recorded allowance.




-10-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Inventory –The Company’s inventory consists primarily of completed player terminals,
related component parts and back-office computer equipment expected to be sold
over the next 12 months. Inventories are stated at the lower of cost (first
in, first out) or market.




Property and
Equipment and Leased Gaming Equipment –Property and equipment and leased
gaming equipment are stated at cost. The cost of property and equipment and
leased gaming equipment is depreciated over their estimated useful lives,
generally using the straight-line method for financial reporting, and regulatory
acceptable methods for income tax reporting purposes. Player terminals placed
with customers under participation arrangements are included in leased gaming
equipment. Leased gaming equipment also includes a “pool” of rental terminals,
i.e., the “rental pool.” Rental pool units are those units that have previously
been placed in the field under participation arrangements, but are currently
back with the Company, being refurbished and/or awaiting redeployment. Routine
maintenance of property and equipment and leased gaming equipment is expensed in
the period incurred, while major component upgrades are capitalized and
depreciated over the estimated remaining useful life of the component. Sales and
retirements of depreciable property are recorded by removing the related cost
and accumulated depreciation from the accounts. Gains or losses on sales and
retirements of property are reflected in the Company’s results of
operations.




Management
reviews long-lived asset classes for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to its fair value, which considers
the future undiscounted cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment recognized is measured
by the amount by which the carrying amount of the assets exceeds their fair
value. Assets to be disposed of are reported at the lower of the carrying amount
or the fair value less costs of disposal. The Company did not record any
impairment charges in the quarter endedMarch 31, 2009.




Deferred Revenue
–Deferred revenue represents amounts from the sale of gaming equipment
and systems that have been billed, or for which notes receivable have been
executed, but which transaction has not met the Company’s revenue recognition
criteria. The cost of the related gaming equipment and systems has been offset
against deferred revenue. Amounts are classified between current and long-term
liabilities, based upon the expected period in which the revenue will be
recognized.




Other Income –The Company had no other income for the three months ended
March 31, 2009 and $74,000 for the six months ended
March 31, 2009. Historically, other income consisted of distributions
from a limited partnership interest, accounted for on the cost
basis.




Other Long-Term
Liabilities –Other long-term liabilities at March 31, 2009,
include investments held at fair value by the Company’s prize-fulfillment firm
related to outstanding MegaBingo jackpot-prize-winner annuities
of $804,000. At March 31, 2009, other long term liabilities also
included $248,000 related to amounts due under a separation agreement with a
former Chief Executive Officer.




Fair Value of
Financial Instruments –The fair value of a financial instrument is the
amount at which the instrument could be exchanged in a current transaction
between willing parties, other than in a forced sale or liquidation. At
March 31, 2009, the carrying amounts for the Company’s financial
instruments, which include accounts and notes receivable, accounts payable, the
Revolving Credit Facility, and long-term debt and capital leases, approximated
fair value.




Segment and
Related Information–Although the Company has
a number of operating divisions, separate segment data has not been presented as
they meet the criteria for aggregation as permitted byStatement of
Financial Accounting Standards, or SFAS No. 131, “Disclosures About
Segments of an Enterprise and Related Information.”




Costs of Computer
Software –Software development costs have been
accounted for in accordance with SFAS No. 86, “Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Under
SFAS No. 86, capitalization of software development costs begins upon
the establishment of technological feasibility and prior to the availability of
the product for general release to customers. The Company capitalized software
development costs of approximately $477,000 and $1.1 million
during the three and six month
periods endedMarch 31, 2009, respectively, and $940,000 and $2.1 million
during the three and six month periods endedMarch 31, 2008,
respectively. Software development
costs primarily consist of personnel costs and rent for related office space.
The Company began to amortize capitalized costs when a product is available for
general release to customers. Amortization expense is determined on a
product-by-product basis at a rate not less than straight-line basis over the
product’s remaining estimated economic life, not to exceed five years.
Amortization of software development costs is included in amortization and
depreciation in the accompanying consolidated statements of
operations.




-11-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Income Taxes –The Company accounts for income taxes using the asset and liability
method and applies the provisions of SFAS, No. 109, “Accounting for
Income Taxes,” as well as the Financial Accounting Standards Board, or
FASB, Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes,” or FIN 48. Under SFAS No. 109, deferred tax liabilities or
assets arise from differences between the tax basis of liabilities or assets and
their bases for financial reporting, and are subject to tests of recoverability
in the case of deferred tax assets. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is provided for deferred tax assets to the extent
realization is not judged to be more likely than not. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with SFAS No. 109. FIN 48 also
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. The new FASB standard also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The Company adopted FIN 48 in the
first quarter of fiscal 2008 and recorded a liability of $295,000
related to uncertain tax positions in the first quarter of fiscal 2008.
There have been no additional reserves recorded related to
FIN 48.




Treasury Stock –The Company utilizes the cost method for accounting for its treasury
stock acquisitions and dispositions.




Share-Based
Compensation – On October 1, 2005, the Company adopted the
provisions of SFAS No. 123(revised), “Share-Based Payment.”
SFAS No. 123(R) is a revision of SFAS No. 123 and supersedes
Accounting Principles Board Opinion, or APB, No. 25, “Accounting for Stock
Issued to Employees”. Among other items, SFAS No. 123(R) eliminated the use
of APB No. 25 and the intrinsic value method of accounting, and
requires the Company to recognize in the financial statements, the cost of
employee services received in exchange for awards of equity instruments, based
on the grant date fair value of those awards. To measure the fair value of stock
options granted to employees, the Company currently utilizes the
Black-Scholes-Merton option-pricing model, consistent with the method used for
pro forma disclosures under SFAS No. 123. SFAS No. 123(R) permits
companies to adopt its requirements using either a “modified prospective”
method, or a “modified retrospective” method. The Company applied the “modified
prospective” method, under which compensation cost is recognized in the
financial statements beginning with the adoption date for all share-based
payments granted after that date, and for all unvested awards granted prior to
the adoption date of SFAS No. 123(R).




The
Black-Scholes-Merton model incorporates various assumptions, including expected
volatility, expected life, and risk-free interest rates. The expected volatility
is based on the historical volatility of the Company’s common stock over the
most recent period commensurate with the estimated expected life of the
Company’s stock options, adjusted for the impact of unusual fluctuations not
reasonably expected to recur. The expected life of an award is based on
historical experience and on the terms and conditions of the stock awards
granted to employees.




There
were 661,000 option grants issued during the quarter ended
March 31, 2009. Total pretax share-based compensation for the three
and six month periods ended March 31, 2009 were $470,000 and
$1.1 million, respectively. The total income tax benefit recognized in the
statement of operations for share-based compensation arrangements
was $152,000 and $295,000 for the three and six month periods ended
March 31, 2009, respectively. As of March 31, 2009,
$5.2 million of unamortized stock compensation expense will be recognized
over the vesting periods of the various option grants.




Foreign
Currency Translation.The
Company accounts for currency translation in accordance with
SFAS No. 52, “Foreign Currency Translation.” Balance sheet accounts
are translated at the exchange rate in effect at each balance sheet date. Income
statement accounts are translated at the average rate of exchange prevailing
during the period. Translation adjustments resulting from this process are
charged or credited to other comprehensive income (loss) a component of
shareholder equity, in accordance with SFAS 130, “Reporting Comprehensive
Income.”




-12-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Recent Accounting
Pronouncements Issued. In
March 2008, the FASB issued SFAS No 161, “Disclosures about Derivative
Instruments and Hedging Activities—An Amendment of FASB Statement No. 133.”
SFAS No. 161 enhances required disclosures regarding derivatives and
hedging activities, including enhanced disclosures regarding how: (a) an
entity uses derivative instruments; (b) derivative instruments and related
hedged items are accounted for under SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities;” and (c) derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. SFAS No. 161 is effective for fiscal
years, and interim periods within those fiscal years, beginning after
November 15, 2008, though earlier application is encouraged. Accordingly,
the Company expects to adopt SFAS No. 161 beginning in fiscal 2010.
The Company expects that SFAS No. 161 will have an impact on accounting for
derivative instruments and hedging activities once adopted, but the significance
of the effect is dependent upon entering into these related transactions, if
any, at that time.




Effective October 1, 2008,
The Company adopted SFAS No. 157, “Fair Value Measurements,” for its
financial assets and financial liabilities, but it has not yet adopted SFAS
No. 157 as it relates to nonfinancial assets and liabilities based on the
February 2008 issuance of FASB Staff Position 157-2, “Effective Date
of FASB Statement No. 157,” which permits a one-year deferral of the
application of SFAS No. 157 for all nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually) to fiscal years
beginning after November 15, 2008. The adoption of SFAS 157 as it
pertains to financial assets and liabilities did not have a material impact on
the Company’s results of operations, financial position or liquidity. The
Company will adopt SFAS 157 for non-financial assets and non-financial
liabilities on October 1, 2009, and the Company is currently
evaluating the effect, if any, the adoption may have on its results of
operations, financial position or liquidity.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities, including an amendment of FASB
Statement No. 115 “Accounting for Certain Investments in Debt and Equity
Securities,” which permits entities to choose to measure many financial
instruments and certain other items at fair value with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. This Statement became effective for the Company beginning in
October 2008. The implementation of SFAS No. 159, effective
October 1, 2008, did not have a material effect on the consolidated
financial statements in the quarter ended March 31, 2009.




In
December 2007, the FASB issued SFAS No. 141 (revised), “Business
Combinations.” SFAS No. 141(R) changes the accounting for business
combinations including the measurement of acquirer shares issued in
consideration for a business combination, the recognition of contingent
consideration, the accounting for preacquisition gain and loss contingencies,
the recognition of capitalized in-process research and development, the
accounting for acquisition-related restructuring cost accruals, the treatment of
acquisition related transaction costs and the recognition of changes in the
acquirer’s income tax valuation allowance. SFAS No. 141(R) is effective for
fiscal years beginning after December 15, 2008, with early adoption
prohibited. The Company is required to adopt SFAS No. 141(R) effective
October 1, 2009, and the Company is currently evaluating the effect,
if any, the adoption may have on its results of operations or financial
position.




In
December 2007, the FASB issued SFAS No. 160, “Non Controlling
Interests in Consolidated Financial Statements,” an amendment of Accounting
Research Bulletin, or ARB No. 51, “Consolidated Financial Statements.” SFAS
No. 160 changes the accounting for non controlling (minority) interests in
consolidated financial statements, including the requirement to classify non
controlling interests as a component of consolidated stockholders’ equity, and
the elimination of “minority interest” accounting in results of operations with
earnings attributable to non controlling interests reported as part of
consolidated earnings. Additionally, SFAS No. 160 revises the accounting
for both increases and decreases in a parent’s controlling ownership interest.
SFAS No. 160 is effective for fiscal years beginning after
December 15, 2008, with early adoption prohibited. The Company is
required to adopt SFAS No. 160 effective October 1, 2009, and the
Company is currently evaluating the effect, if any, the adoption may have on its
results of operations or financial position.




-13-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




2.
            DEVELOPMENT
      AGREEMENTS




The
Company enters into development agreements to provide financing for new gaming
facilities or for the expansion of existing facilities. In return, the facility
dedicates a percentage of its floor space to placement of the Company’s player
terminals, and the Company receives a fixed percentage of those player
terminals’ win per unit over the term of the agreement. The agreements typically
provide for some or all of the advances to be repaid by the customer to the
Company. Amounts advanced in excess of those to be reimbursed by the customer
are allocated to intangible assets and are generally amortized over the life of
the contract, which is recorded as a reduction of revenue generated from the
gaming facility. Certain of the agreements contain player terminal performance
standards that could allow the facility to reduce a portion of the Company’s
floor space. In the past and in the future, the Company may by mutual agreement
and for consideration, amend these contracts to reduce its floor space at the
facilities. Any proceeds received for the reduction of floor space is first
applied as a recovery against the intangible asset or property and development
for that particular development agreement, if any.




In the
third quarter of fiscal 2008, the Company fulfilled a commitment to a
significant, existing Oklahoma tribal customer to provide
approximately 43.8%, or $65.6 million, of the total funding for a
facility expansion. Because of the Company’s commitment to fund the expansion,
it secured the right to place an additional 1,400 gaming units in the
expanded facility in southern Oklahoma. The Company recorded all advances as a
note receivable and imputed interest on the interest free loan. The discount
(imputed interest) was recorded as contract rights, and as of the first quarter
of fiscal 2009 is being amortized over the life of the agreement. The
repayment period of the note will be based on the performance of the facility.
In the second quarter of fiscal 2009, the Company made a commitment of
$7.0 million that consists of both a loan for new unit placements in an
expanded facility and a placement fee for certain units to remain at the current
facility for an extended period of time. As of March 31, 2009, the
Company had advanced $1.25 million toward this commitment. The remaining
commitment of $5.75 million is expected to be paid over the next three
fiscal quarters in the following increments: $2.75 million,
$1.5 million, and $1.5 million, respectively.




Management
reviews intangible assets related to development agreements for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. There were no events or changes in circumstance
during the three or six month periods ended March 31, 2009, which
would require an impairment charge to the assets’ carrying value.




The
following net amounts related to advances made under development agreements and
were recorded in the following balance sheet captions:




March 31,
                          2009
                        
                        
                        September 30,
                          2008(In
      thousands)Included
      in:Notes
      receivable, net
                        
                        $
                        54,285
                        
                        
                        $
                        61,750Intangible
      assets – contract rights,net
      of accumulated amortization
                        
                        
                        26,278
                        
                        
                        
                        29,368




-14-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




3.
            PROPERTY
      AND EQUIPMENT AND LEASED GAMING
EQUIPMENT




The
Company’s property and equipment and leased gaming equipment consisted of the
following:




March 31,
                            2009
                          
                          
                          September
      30,
                            2008
                          
                          Estimated
                            Useful
                            Lives(In
      thousands)Gaming
      equipment and third-party gaming content licenses available for deployment
      (1)
                          
                          $
                          20,924
                          
                          
                          $
                          30,252Deployed
      gaming equipment
                          
                          
                          102,303
                          
                          
                          
                          96,584
                          
                          3-5
      yearsDeployed
      third-party gaming content licenses
                          
                          
                          39,702
                          
                          
                          
                          34,444
                          
                          1.5-3
      yearsTribal
      gaming facilities and portable buildings
                          
                          
                          4,720
                          
                          
                          
                          4,720
                          
                          5-7
      yearsThird-party
      software costs
                          
                          
                          7,827
                          
                          
                          
                          7,732
                          
                          3-5
      yearsVehicles
                          
                          
                          3,485
                          
                          
                          
                          3,502
                          
                          3-10
      yearsOther
                          
                          
                          3,162
                          
                          
                          
                          3,191
                          
                          3-7
      yearsTotal
      property and equipment
                          
                          
                          182,123
                          
                          
                          
                          180,425Less
      accumulated depreciation and amortization
                          
                          
                          (120,913
                          )
                          
                          
                          (113,096
                          )Total
      property and equipment, net
                          
                          $
                          61,210
                          
                          
                          $
                          67,329Leased
      gaming equipment
                          
                          $
                          170,987
                          
                          
                          $
                          165,903
                          
                          3
      yearsLess
      accumulated depreciation
                          
                          
                          (128,861
                          )
                          
                          
                          (129,879
                          )Total
      leased gaming equipment, net
                          
                          $
                          42,126
                          
                          
                          $
                          36,024








(1)Gaming
equipment and third-party gaming content licenses begin depreciating when they
are placed in service.




In
accordance with SFAS 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” the Company (i) recognizes an impairment loss only if
the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows; and (ii) measures an impairment loss as the
difference between the carrying amount and fair value of the asset.




During
the three and six month periods ended March 31, 2009, in the ordinary
course of business activities or upon reviewing the account balances, the
Company disposed of or wrote off $39,000 and $77,000,
respectively of third-party gaming content licenses, tribal gaming facilities
and portable buildings, vehicles, deployed gaming equipment, or other equipment.
In the same periods ended March 31, 2008, the Company disposed of or wrote
off $73,000 and $130,000, respectively.




Leased gaming equipment includes player
terminals placed under participation arrangements that are either at customer
facilities or in the rental pool.




4.
            INTANGIBLE
      ASSETS




The
Company’s intangible assets consisted of the following:




March 31,
                    2009
                  
                  
                  September
      30,
                    2008
                  
                  Estimated
                    Useful
                    Lives(In
      thousands)Contract
      rights under development agreements
                  
                  $
                  41,147
                  
                  
                  $
                  41,325
                  
                  5-7
      yearsInternally-developed
      gaming software
                  
                  
                  27,231
                  
                  
                  
                  26,473
                  
                  1-5
      yearsPatents
      and trademarks
                  
                  
                  8,660
                  
                  
                  
                  8,464
                  
                  1-5
      yearsOther
                  
                  
                  1,054
                  
                  
                  
                  1,054
                  
                  3-5
      yearsTotal
      intangible assets
                  
                  
                  78,092
                  
                  
                  
                  77,316Less
      accumulated amortization – all other
                  
                  
                  (45,490
                  )
                  
                  
                  (39,960
                  )Total
      intangible assets, net
                  
                  $
                  32,602
                  
                  
                  $
                  37,356




Contract rights are amounts allocated to
intangible assets for dedicated floor space resulting from development
agreements. For a description of intangible assets related to development
agreements, see “Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations.” The related amortization expense, or
accretion of contract rights, is netted against its respective revenue category
in the accompanying consolidated statements of operations. In the preceding
table, $157,000 of the $41.1 million in contract rights is not currently
being amortized. The facility is expected to be completed during the quarter
ended June 30, 2009. Therefore, the amortization of these contract
rights is expected to begin during that quarter.




-15-


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Internally developed gaming software is
accounted for under the provisions of SFAS No. 86 and is stated at cost,
which is amortized over the estimated useful life of the software, generally
using the straight-line method. The Company amortizes internally-developed games
over a 12 month period, gaming engines over an 18 month period, gaming
systems over a three-year period and its central management systems over a
five-year period. Software development costs are capitalized once technological
feasibility has been established, and are amortized when the software is placed
into service. Any subsequent software maintenance costs, such as bug fixes and
subsequent testing, are expensed as incurred. Discontinued software development
costs are expensed when the determination to discontinue is made. For the three
and six month periods endedMarch 31, 2009, amortization expense related to
internally-developed gaming software was $1.0 million and
$2.2 million, respectively; $753,000 and $1.5 million, respectively, for
the three and six month periods ended March 31, 2008. During the three
and six month periods endedMarch 31, 2009, the Company wrote off $420,000
and $455,000, respectively, related to internally-developed gaming
software and patents and trademarks, compared to write-offs of $308,000 in
the same periods ended March 31, 2008.




Management reviews intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.




5.
            NOTES
      RECEIVABLE




The
Company’s notes receivable consisted of the following:




March 31,
                        2009
                      
                      
                      September 30,
                        2008(In
      thousands)Notes
      receivable from development agreements
                      
                      $
                      63,785
                      
                      
                      $
                      72,706Less
      imputed interest discount reclassed to contract rights
                      
                      
                      (9,500
                      )
                      
                      
                      (10,956
                      )Notes
      receivable from equipment sales and other
                      
                      
                      7,708
                      
                      
                      
                      8,012Notes receivable,
      net
                      
                      
                      61,993
                      
                      
                      
                      69,762Less
      current portion
                      
                      
                      (14,692
                      )
                      
                      
                      (23,072
                      )Notes receivable –
      non-current
                      
                      $
                      47,301
                      
                      
                      $
                      46,690








Notes receivable from development
agreements are generated from reimbursable amounts advanced under development
agreements.




Notes receivable from equipment sales
consisted of financial instruments issued by customers for the purchase of
player terminals and licenses, and bore interest at 7.47%. All of the
Company’s notes receivable from equipment sales are collateralized by the
related equipment sold, although the value of such equipment, if repossessed,
may be less than the note receivable outstanding.




6.
            CREDIT
      FACILITY, LONG-TERM DEBT AND CAPITAL
LEASES




The
Company’s Credit Facility, long-term debt and capital leases consisted of the
following:




March 31,
                        2009
                      
                      
                      September 30,
                        2008(In
      thousands)Long-term
      revolving lines of credit
                      
                      $
                      29,000
                      
                      
                      $
                      19,000Term
      loan facility
                      
                      $
                      68,494
                      
                      
                      $
                      67,988Less
      current portion
                      
                      
                      (2,569
                      )
                      
                      
                      (1,544
                      )Long-term debt, less current
      portion
                      
                      $
                      65,925
                      
                      
                      $
                      66,444




-16-


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Credit
Facility.On
April 27, 2007, the Company entered into a $150 million Revolving
Credit Facility which replaced its previous Credit Facility in its entirety.
On
October 26, 2007,the Company amended the Revolving Credit
Facility, transferring$75 million of the revolving credit
commitment to a fully funded $75 million term loan due
April 27, 2012. The Term Loan is amortized at an annual amount of
1% per year, payable
in equal quarterly installments beginning January 1, 2008, with the
remaining amount due on the maturity date. The Company entered into a second
amendment to the Revolving Credit Facility on December 20, 2007. The
second amendment (i) extended thehedging arrangement date related to a
portion of the term loan to June 1, 2008; and (ii) modified the
interest rate margin applicable to the Revolving Credit Facility and the term
loan.




The Credit Facility provides the Company
with the ability to finance development agreements and acquisitions and working
capital for general corporate purposes. Amounts under the $75 million
revolving credit commitment and the $75 million term loan mature in
five years, and advances under the term loan and revolving credit commitment
bear interest at the Eurodollar rate plus the applicable spread, tied to various
levels of interest pricing determined by total debt to EBITDA (EBITDA is defined
as earnings before interest, taxes, amortization, depreciation, and accretion of
contract rights). As of March 31, 2009, the $29.0 million drawn
under the revolving credit commitment bore interest at 4.75% and two
tranches of the term loan of $50.0 million and $17.1 million bore
interest at 8.5% and 5.5%, respectively, also included in the
March 31, 2009 and 2008 balances are approximately
$1.2 million and $585,000, respectively, of accrued
interest.




The Credit Facility is collateralized by
substantially all of the Company’s assets, and also contains financial
covenants as defined in the agreement.These covenants include (i) a
minimum fixed-charge coverage-ratio of not less than 1.50 : 1.0;
(ii) a maximum total debt to EBITDA ratio of not more than 2.25 : 1.00
through June 30, 2008, and 1.75 : 1.00 from
September 30, 2008 thereafter; and (iii) a minimum trailing twelve-month
EBITDA of not less than $60million for each quarter. As ofMarch 31, 2009,
the Company is in compliance with its loan covenants. The Credit Facility
requires certain mandatory prepayments be made on the term loan from
the net cash proceeds of
certain asset sales and condemnation proceedings (in each case to the extent not
reinvested, within certain specified time periods, in the replacement or
acquisition of property to be used in its businesses). In the second quarterof 2008, the Company made a
mandatory prepayment of the term loan in the amount of $4.5 million, due to
an early prepayment of a development agreement note receivable. As ofMarch 31, 2009,
the Credit Facility had availability of$44.8 million, subject to covenant
restrictions.




The Credit Facility also required that
the Company enter into hedging arrangements covering at least $50 million
of the term loan for a three-year period by June 1, 2008. Therefore,
on May 29, 2008, the Company purchased, for $390,000, an interest rate cap (5% cap
rate) covering $50 million of the term loan.The Company accounts for this hedge in
accordance with SFAS No. 133 which requires entities to recognize all
derivative instruments as either assets or liabilities in the balance sheet, at
their respective fair values. The Company records changes on a mark to market
basis, changes to the fair value of the interest rate cap on a quarterly basis.
These changes in fair value are recorded in interest expense in the consolidated
statement of operations.




-17-


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




7.
            EARNINGS
      (LOSS) PER COMMON SHARE




Earnings
(loss) per common share is computed in accordance with SFAS No. 128,
“Earnings per Share.” Presented below is a reconciliation of net income (loss)
available to common stockholders and the differences between weighted average
common shares outstanding, which are used in computing basic earnings (loss) per
share, and weighted average common and potential shares outstanding, which are
used in computing diluted earnings (loss) per share.




Three
      months ended March 31,
                            
                            
                            Six
      months ended March 31,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Income
      (loss) available to common stockholders  (in
      thousands)
                            
                            $
                            (3,394
                            )
                            
                            $
                            1,258
                            
                            
                            $
                            (9,318
                            )
                            
                            $
                            1,657Weighted
      average common shares outstanding
                            
                            
                            26,642,911
                            
                            
                            
                            26,271,074
                            
                            
                            
                            26,633,136
                            
                            
                            
                            26,233,574Effect
      of dilutive securities:Options
                            
                            
                            -
                            
                            
                            
                            972,391
                            
                            
                            
                            -
                            
                            
                            
                            1,049,300Weighted
      average common and potential shares outstanding
                            
                            
                            26,642,911
                            
                            
                            
                            27,243,465
                            
                            
                            
                            26,633,136
                            
                            
                            
                            27,282,874Basic
      earnings (loss) per share
                            
                            $
                            (0.13
                            )
                            
                            $
                            0.05
                            
                            
                            $
                            (0.35
                            )
                            
                            $
                            0.06Diluted
      earnings (loss) per share
                            
                            $
                            (0.13
                            )
                            
                            $
                            0.05
                            
                            
                            $
                            (0.35
                            )
                            
                            $
                            0.06




The
Company had the following options to purchase shares of common stock that were
not included in the weighted average common and potential shares outstanding in
the computation of dilutive earnings per share, due to the antidilutive
effects:




Three
      months ended March 31,
                  
                  
                  Six
      months ended March 31,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Common
      Stock Options
                  
                  
                  7,154,893
                  
                  
                  
                  2,482,083
                  
                  
                  
                  6,949,306
                  
                  
                  
                  2,437,274Range
      of exercise price
                  
                  $
                  1.00-18.71
                  
                  
                  $
                  7.40-21.53
                  
                  
                  $
                  1.00-$21.53
                  
                  
                  $
                  7.61-21.53




In the
three and six month periods ended March 31, 2009, options to purchase
approximately 6.7 million and 6.5 million shares of common stock, with
exercise prices ranging from $1.61 to $18.71 per share and
$1.61 to $21.53 per share, respectively, were not included in the
computation of dilutive earnings per share, due to the antidilutive effect, and
approximately 452,000 and 462,000 equivalent shares were not included,
due to the loss generated in the current periods.




8.
            COMMITMENTS
      AND CONTINGENCIES




Litigation




The
Company is subject to the possibility of loss contingencies arising in its
business and such contingencies are accounted for in accordance with SFAS
No. 5, “Accounting for Contingencies.” In determining loss contingencies,
the Company considers the possibility of a loss as well as the ability to
reasonably estimate the amount of such loss or liability. An estimated loss is
recorded when it is considered probable that a liability has been incurred and
when the amount of loss can be reasonably estimated.




-18-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Cory
Investments Ltd.On
May 7, 2008, Cory Investments, LTD., or Cory Investments, filed suit
in the state court in Oklahoma City, Oklahoma against the Company, along with
others, including Clifton Lind; Robert Lannert; Gordon Graves; Video Gaming
Technologies, Inc. or VGT and its president, Jon Yarbrough, and a former VGT
representative, John Marley; Worldwide Gaming Technologies, or WGT; AGS, LLC,
d/b/a American Gaming Systems; AGS Partners, LLC; Ronald Clapper, the owner of
WGT, AGS, LLC and AGS Partners; Sierra Design Group; and Bally Technologies,
Inc. The case asserts that the Company offered allegedly illegal Class III
games on the MegaNanza®and Reel Time Bingo®gaming systems to Native American
tribes in Oklahoma, which had a severely negative impact on Cory Investments’
market for its legal Class II games. Cory Investments also alleges that the
defendants conspired to drive it and other Class II competitors out of the
Class II market in Oklahoma and other states. In addition to the conspiracy
allegations, Cory Investments alleges six causes of action: (i) deceptive
trade practices; (ii) common law unfair competition; (iii) wrongful
interference with business; (iv) malicious wrong/prima facie tort;
(v) intentional interference with contract; and
(vi) unreasonable restraint of trade. Cory Investments is seeking
unspecified actual and punitive damages and equitable
relief.




All of the defendants have filed motions
to dismiss which are currently set for hearing on May 13, 2009. The
Company believes that the claims of Cory Investments are without merit and
intends to defend the case vigorously. Given the inherent uncertainties in this
litigation,the Company is unable to make any prediction as to the
ultimate outcome.




International
Gamco. International Gamco, Inc., or Gamco, claiming certain rights in
U.S. Patent No. 5,324,035, or the ‘035 Patent, brought suit against
the Company on May 25, 2004, in the U.S. District Court for the
Southern District of California alleging that the Company’s central determinant
system, as operated by the New York State Lottery, infringes the
‘035 Patent. Gamco claims to have acquired ownership of the
‘035 Patent from Oasis Technologies, Inc., or Oasis, a previous owner of
the ‘035 Patent. In February 2003, Oasis assigned the ‘035 Patent to
International Game Technology, or IGT. Gamco claims to have received a license
back from IGT for the New York State Lottery. The lawsuit claims that the
Company infringed the ‘035 Patent after the date on which Gamco assigned
the ‘035 Patent to IGT.




The
Company has made a number of challenges to Gamco’s standing to sue for
infringement of the ‘035 Patent. On October 15, 2007, pursuant to
an interlocutory appeal, the federal circuit court reversed the district court’s
order when it held that Gamco did not have sufficient rights in the
‘035 Patent to sue the Company without the involvement of the patent
owner, IGT.




On
December 4, 2007, Gamco and IGT entered into an Amended and
Restated Exclusive License Agreement whereby IGT granted to Gamco exclusive
rights to the ‘035 Patent in the state of New York and the right to
sue for past infringement of the same. On January 9, 2008, Gamco filed
its third amended complaint for infringement of the ‘035 Patent against the
Company. On January 28, 2008, the Company filed an answer to the
complaint denying liability. The Company also filed a third amended counterclaim
against Oasis, Gamco and certain officers of Gamco, for fraud, promise without
intent to perform, negligent misrepresentation, breach of contract, specific
performance and reformation of contract with regard to the Company’s rights
under the Sublicense Agreement for the ‘035 Patent, as well as for
non-infringement and invalidity of the ‘035 Patent. These parties have
filed a motion to dismiss and a motion for summary judgment as to these claims.
The Company has filed a motion for partial summary judgment on its breach of
contract and specific performance claims seeking to enforce the terms of the
Sublicense Agreement. The Company has also moved for summary judgment on Gamco’s
complaint on the ground that it is a licensee. On February 25, 2009,
on its own motion, the court continued the hearing on these motions. All motions
to dismiss and motions for summary judgment are now set to be heard on
July 16, 2009.




On
January 13, 2009, the court held a Markman hearing to construe the
claims of the ‘035 Patent. The Court also heard argument on the Company’s
motion for partial summary judgment to invalidate all of the means-plus-function
claims of the ‘035 Patent
under 35 U.S.C. § 112¶ 6. On
January 15, 2009, the court issued an order granting Gamco leave to
amend its proposed constructions on the means-plus function claims and setting a
schedule for supplemental briefing on amended claims construction, stating that
none of the structures proposed by Gamco in the claim chart considered by the
court referenced an algorithm that was needed to satisfy federal circuit court
standards. The court has not yet issued a claim construction ruling or a
decision on the Company’s motion for partial summary judgment. A telephonic
status conference is currently scheduled to take place on
June 23, 2009. A trial date has not yet been set by the
court.




The
Companycontinues to vigorously
defend this matter. Given the inherent uncertainties in this litigation,the Company is unable to
make any prediction as to the ultimate outcome.




-19-




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 (Unaudited)




Other Litigation.In addition to the threat of litigation relating to the Class II or
Class III status of the Company’s games and equipment, the Company is the
subject of various pending and threatened claims arising out of the ordinary
course of business. The Company believes that any liability resulting from these
various other claims will not have a material adverse effect on its results of
operations or financial condition or cash flows. During its ordinary course of
business, the Company enters into obligations to defend, indemnify and/or hold
harmless various customers, officers, directors, employees and other third
parties. These contractual obligations could give rise additional litigation
cost and involvement in court proceedings.




The
Alabama Governor’s office and the Alabama Attorney General’s office have issued
conflicting public statements regarding the legality of certain types of
equipment commonly used to play charity bingo within the state of Alabama. On
March 9, 2009, the Governor’s Task Force on illegal games raided the
Whitehall Entertainment Center and confiscated games from various gaming
manufacturers, including approximately 34 of the Company’s games. While no
legal proceedings have been initiated against the Company at this point, it is
possible that such proceedings are being contemplated by the Governor’s
Office.




Other.Existing federal and state regulations may also impose civil and criminal
sanctions for various activities prohibited in connection with gaming
operations, including but not limited to: (i) false statements on
applications; (ii) failure or refusal
to obtain required licenses; and / or (iii) the placement of
gaming devices, terminals, player stations, and / or units.




9.
            SUBSEQUENT
      EVENTS




On May
1, 2009, the Company entered into a comprehensive settlement agreement with
Diamond Game Enterprises, Inc., or Diamond Game, to resolve all claims arising
from a  November, 2004 lawsuit filed by Diamond Game against the
Company and several former officers, including Clifton Lind, Robert Lannert and
Gordon Graves. This settlement agreement was reached while the parties were
engaged in federal mediation and the Company did not admit any wrongdoing in
relation to the underlying litigation. The Company incurred an additional
$4.2 million in legal fees and settlement costs, net of expected insurance
proceeds, related to the settlement agreement; these costs are appropriately
included in the Company’s financial statements as of
March 31, 2009.




-20-




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




FUTURE
EXPECTATIONS AND FORWARD-LOOKING STATEMENTS




This
Quarterly Report and the information incorporated herein by reference contain
various “forward-looking statements” within the meaning of federal and state
securities laws, including those identified or predicated by the words
“believes,” “anticipates,” “expects,” “plans,” “will,” or similar expressions
with forward-looking connotations. Such statements are subject to a number of
risks and uncertainties that could cause the actual results to differ materially
from those projected. Such factors include, but are not limited to, the
uncertainties inherent in the outcome of any litigation of the type described in
this Quarterly Report under “PART II – Item 1. Legal Proceedings,” trends
and other expectations described in “PART I – Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” risk
factors disclosed in our earnings and other press releases issued to the public
from time to time, as well as those other factors as described under
“PART II – Item 1A. Risk Factors” set forth below. Given these
uncertainties, readers of this Quarterly Report are cautioned not to place undue
reliance upon such statements. All forward-looking statements in this document
are based on information available to us as of the date hereof, and we assume no
obligations to update any such forward-looking statements.




Overview




We are a developer and distributor of
comprehensive systems, content, electronic games and gaming player
terminalsfor the casino, charity, international
bingo, and video lottery markets. Initially, our customers were located
primarily in the Native American gaming sector; however, beginning
around 2003, we began diversifying into broader domestic and international
gaming markets.




Although we continue to develop systems
and products for Native American tribes throughout the United States, we now
intend to further expand our efforts to include the development and marketing of
products and services for: (i) the various commercial casino markets;
(ii) video lottery systems and other products for various domestic and
international lotteries; and (iii) products for various charity and
international bingo and other emerging markets.




Our products cover a broad spectrum of
the gaming industry, including: interactive systems for both server-based and
stand-alone gaming operations; interactive electronic bingo games for the Native
American Class II and charity gaming markets and for the Class III,
stand-alone and video lottery markets; proprietary gaming player terminals in
multiple configurations and formats; electronic instant lottery scratch ticket
systems; casino management systems, including player tracking, cash and cage,
slot accounting, and slot management modules; unified currency systems; and
other electronic and paper bingo systems. In addition, we provide maintenance,
operations support and other services for our customers and
products.




We design and develop networks, software
and content that provide our customers with, among other things, comprehensive
gaming systems, some of which are delivered through a telecommunications network
that links our player terminals with one another, both within a single gaming
facility or among several gaming facilities.




We derive the majority of our gaming
revenue from participation (revenue sharing) agreements, pursuant to which we
place systems, player terminals, proprietary and licensed content operated on
player terminals, and back-office systems and equipment (collectively referred
to as gaming systems) into gaming facilities. To a lesser degree, we earn
revenue from the sale or placement of gaming systems (e.g., the opening of a new
casino, or a change in the law that allows existing casinos to increase the
number of player terminals permitted under prior law) on a lease-purchase basis
and from the back-office fees generated by video lottery systems, principally in
the Washington State, Class III market. We also generate gaming revenue as
consideration for providing the central determinant system for a network of
player terminals operated by the New York State Division of the Lottery. In
addition, we earn a small portion of our revenue from the sale of lottery
systems and the placement of nontraditional gaming products, such as electronic
scratch tickets, or linked interactive paper bingo systems. In fiscal 2006,
we entered the international electronic bingo market and currently supply bingo
systems to four customers in Mexico, whereby we receive fees based on the net
earnings of each system. During fiscal 2009, we intend to generate revenue
from the sale of non-linked Class III player terminals to Class III
Native American markets.




-21-




Class III
Games and Systems for Oklahoma




During 2004, the Oklahoma
Legislature passed legislation authorizing certain forms of gaming at
racetracks, and additional types of games at tribal gaming facilities, pursuant
to a tribal-state compact. The Oklahoma gaming legislation allows the tribes to
sign a compact with the state of Oklahoma to operate an unlimited number of
electronic instant bingo games, electronic bonanza-style bingo games, electronic
amusement games, and non-house-banked tournament card games. In addition,
certain horse tracks in Oklahoma are allowed to operate a limited number of
instant and bonanza-style bingo games and electronic amusement games. All
vendors placing games at any of the racetracks under the compact are required to
be licensed by the state of Oklahoma. Pursuant to the compacts, vendors placing
games at tribal facilities have to be licensed by each tribe. All electronic
games placed under the compact have to be certified by independent testing
laboratories to meet technical specifications. These technical specifications
were published by the Oklahoma Horse Racing Commission and the individual tribal
gaming authorities in the first calendar quarter of 2005. We are fully
licensed in Oklahoma and as ofMarch 31, 2009, we had placed 6,647 player terminals at 42 facilities
that are operating under the Oklahoma gaming compact. We generally receive
a 20% revenue share for the games played under the Oklahoma Gaming
Compact.




Class III
Games and Systems for Native American and Commercial Casino Markets




During fiscal 2007, we began
designing and developing stand-alone Class III player terminals to be sold
or placed on a revenue share basis in the large Class III stand-alone
gaming market for Native American casinos as well as domestic and international
commercial casinos. All player terminals delivered to these markets will have to
receive specific jurisdictional approvals from the appropriate testing
laboratory and from the appropriate regulatory agency. Our first stand-alone
player terminals outside of Oklahoma have been placed in Rhode Island. We
believe that additions to our key senior management personnel will help
accelerate our entrance into new Class III markets and that we will deliver
additional player terminals to other Class III markets this fiscal
year.




As a prerequisite to conducting business
in the major commercial gaming markets, we, our directors, officers, and key
employees are required to secure various licenses. It is difficult to properly
estimate the amount of time and expense that will be necessary to complete the
required licensing process. We are not currently licensed to conduct business in
any major gaming market (international or domestic).




Class II
Market




We derive our Class II gaming
revenues from participation arrangements with our Native American customers.
Under these arrangements, we retain ownership of the gaming equipment installed
at our customers’ tribal gaming facilities, and receive revenue based on a
percentage of the win per unit generated by each gaming system. Our portion of
the win per unit is reported by us as “Gaming revenue – Class II” and
represents the total amount that end users wager, less the total amount paid to
end users for prizes, the amounts retained by the facilities for their share of
the hold and the accretion of contract rights.




As the Class II market has matured,
we have seen new competitors with significant gaming experience and financial
resources enter the market. New tribal-state compacts, such as the Oklahoma
gaming legislation passed by referendum in 2004, have also led to increased
competition. In addition, there has been what we believe to be an extended
period of non enforcement by regulators of existing restrictions on
non-Class II devices, which has forced us to continue competing against
games that do not appear to comply with the published regulatory restrictions on
Class II games. Due to this increased competition in Oklahoma, and because
of continued conversion to games played under the compact, we have and may
continue to experience pressure on our pricing model and win per unit, with the
result that gaming providers, including us, are competing on the basis of price
as well as the entertainment value and technological quality of their products.
We have also experienced and expect to continue to experience a decline in the
number of our Class II games deployed in Oklahoma, in accordance with our
conversion strategy. While we will continue to compete by regularly introducing
new and more entertaining games with technological enhancements that we believe
will appeal to end users, we believe that the level of revenue retained by our
customers from their installed base of player terminals will become a more
significant competitive factor, one that may require us to change the terms of
our participation arrangements with customers. We will continue the deployment
of one-touch, compact-compliant Class III games in Oklahoma, which could
reduce the number of our Class II machines in play in that same
jurisdiction.




Charity
Market




Charity bingo and other forms of charity
gaming are operated by or for the benefit of nonprofit organizations for
charitable, educational and other lawful purposes. These games are typically
only interconnected within the gaming facility where the terminals are located.
Regulation of charity gaming is vested with each individual state, and in some
states, regulatory authority is delegated to county or municipal governmental
units.




-22-




In
Alabama, our largest charity market, constitutional amendments have been passed
authorizing charity bingo in certain locations. The regulation of charity bingo
in Alabama is typically vested with a local governmental authority. However, the
Alabama Governor’s office has recently commissioned a task force to review the
types of games placed in the charitable bingo halls in the state. The Alabama
Governor’s office and the Alabama Attorney General’s office have issued
conflicting public statements regarding the legality of certain types of
equipment commonly used to play charity bingo within the state of
Alabama.




We ordinarily place player terminals
under participation arrangements in the charity market and receive a percentage
of the win per unit generated by each of the player terminals. As ofMarch 31, 2009,
we had 2,273 high-speed, standard bingo games
installed for the charity market in three Alabama
facilities.




All
Other Gaming Markets




Class III
Washington State Market.The majority of our
Class III gaming equipment in Washington State has been sold to customers
outright, for a one-time purchase price, which is reported in our results of
operations as “Gaming equipment, system sale and lease revenue” at the time of
proper revenue recognition. Certain game themes we use in the Class III
market have been licensed from third parties and are resold to customers along
with our Class III player terminals. Historically, revenue from the sale of
Class III gaming equipment is recognized when the units are delivered to
the customer, and the licensed games installed, or over the contract term when
the fair value of undelivered products has not been established. Because we sell
new products, systems and services for which fair value has not been
established, beginning in the third fiscal quarter of 2009, revenue
generated from this market will be recognized over the terms of the contracts.
To a considerably lesser extent, we also enter into either participation
arrangements or lease-purchase arrangements for our Class III player
terminals, on terms similar to those used for our player terminals in the
Class II market.




We also
receive a small back-office fee from both leased and sold gaming equipment in
Washington State. Back-office fees cover the service and maintenance costs for
back-office servers installed in each facility to run our Class III games,
as well as the cost of related software updates.




State Video
Lottery Market. In
January 2004, we installed our central determinant system for the video
lottery terminal network that the New York Lottery operates at licensed New York
State racetrack casinos. As payment for providing and maintaining the central
determinant system, we receive a small portion of the network-wide win per unit.
Our contract with the New York Lottery provides for a three-year term with an
additional three one-year automatic renewal under certain conditions. We are
seeking to take advantage of the recently passed legislation in New York State
that allows the New York Lottery to extend its vendor contracts at its sole
discretion, notwithstanding the automatic renewal provision. We are working to
significantly extend the current contract which is set to expire in the second
fiscal quarter of 2010.




International
Commercial Bingo Market. In
March 2006, we entered into a contract with Apuestas
Internacionales, S.A.
de C.V., or Apuestas, a subsidiary of Grupo Televisa, S.A., to provide
traditional and electronic bingo gaming, technical assistance, and related
services for Apuestas’ locations in Mexico. Apuestas currently has a permit
issued by the Mexican Ministry of the Interior (Secretaria de Gobernación) to
open and operate 65 bingo parlors. Apuestas is projecting that all
65 bingo parlors will be open by May 2014. As ofMarch 31, 2009,
we had installed4,755player terminals
at22bingo
parlors in Mexico under this contract with Apuestas. AtMarch 31, 2009,
all player terminals placed by us in the Apuestas bingo parlors were pursuant to
a revenue share arrangement that is comparable to our Oklahoma market
arrangements.




As ofMarch 31, 2009,
we had entered into separate contracts with three other companies incorporated
in Mexico to provide traditional and electronic bingo gaming, technical
assistance, and related services for bingo parlors in Mexico. As ofMarch 31, 2009,
we had installed370player terminals at
three parlors in Mexico under
these contracts.




Development
Agreements




As we
seek to continue the growth in our customer base and to expand our installed
base of player terminals, a key element of our strategy has become entering into
development agreements with various Native American tribes to assist in the
funding of new or expansion of existing tribal gaming facilities. Pursuant to
these agreements, we advance funds to the tribes for the construction of new
tribal gaming facilities or for the expansion of existing
facilities.




-23-




Amounts
advanced that are in excess of those to be reimbursed by such tribes for real
property and land improvements are allocated to intangible assets and are
generally amortized over the life of the contract on a straight-line
basis.




In return
for the amounts advanced by us, we receive a commitment for a fixed number of
player terminal placements in the facility or a fixed percentage of the
available gaming floor space, and a fixed percentage of the win per unit from
those terminals over the term of the development agreement. Certain of the
agreements contain player terminal performance standards that could allow the
facility to reduce a portion of our floor space. In addition, certain
development agreements allow the facilities to buy out floor space after
advances that are subject to repayment have been repaid.




We have
in the past, and may in the future, reduce the number of player terminals in
certain of our facilities as a result of ongoing competitive pressures faced by
our customers from alternative gaming facilities and pressures faced by our
machines from competitors’ products. We have in the past, and in the future may
also, by mutual agreement and for consideration, amend these contracts in order
to reduce the number of player terminals at these facilities.




In the
third quarter of fiscal 2008, we fulfilled a commitment to a significant,
existing Oklahoma tribal customer to provide approximately 43.8%, or
$65.6 million, of the total funding for a facility expansion. Because of
our commitment to fund the expansion, we secured the right to place an
additional 1,400 gaming units in the expanded facility in southern
Oklahoma. We recorded all advances as a note receivable and imputed interest on
the interest free loan. The discount (imputed interest) was recorded as contract
rights, and as of the first quarter of fiscal 2009 is being amortized over
the life of the agreement. The repayment period of the note will be based on the
performance of the facility. In the quarter ended March 31, 2009, we
made a commitment of $7.0 million that consists of both a loan for new unit
placements in an expanded facility and a placement fee for certain units to
remain at the current facility for an extended period of time. As of
March 31, 2009, we had advanced $1.25 million toward this
commitment. The remaining commitment of $5.75 million is expected to be
paid over the next three fiscal quarters in the following increments:
$2.75 million, $1.5 million and $1.5 million,
respectively.




As of
March 31, 2009, we have placed approximately 4,956 units
in eight facilities in Oklahoma pursuant to development
agreements.




Third-Party
Software and Technology




Our Manufacturing and License Agreement
with WMS Gaming, Inc., which was originally entered into on
May 17, 2004 and amended and restated on June 29, 2005 (the
“Agreement”), will expire under operation of its terms on
June 30, 2009. The Agreement enabled us to distribute, at a discount,
WMS licensed products (i) on an exclusive (except as to WMS) basis in the
Class II and Class III Native American market in Oklahoma;
(ii) on a limited exclusive basis (except as to WMS and subject to WMS’
existing commitments) in the Class II Native American market in North
America, the pull tab and Class II-style bingo market in Mexico, and in the
Charity markets in Alabama; and (iii) on a non exclusive basis for the
Class III market in Washington. After June 30, 2009, we may
continue to distribute WMS products pursuant to certain sell-off rights in
Oklahoma and Mexico and certain limited distribution rights in Washington;
however, we will not have the benefits of a contractual discount or a grant of
exclusivity.




Recent
Developments




In
January 2009, we executed a reduction of 77 full-time and part-time
employees, including two engaged in field operations and business
development, 66 in system and game development, and nine in other
general administrative and executive functions. Severance and other benefits of
approximately $1.1 million were paid in the quarter ended
March 31, 2009.




-24-




RESULTS
OF OPERATIONS




The
following tables outline our end-of-period and average installed base of player
terminals for the three and six months ended March 31, 2009
and 2008.




At
      March 31,2009
                      
                      
                      2008End-of-period
      installed player terminal baseOklahoma
      compact games
                      
                      
                      6,647
                      
                      
                      
                      5,119Class II
      player terminalsNew
      Generation system - Reel Time Bingo®
                      
                      
                      2,153
                      
                      
                      
                      2,223Legacy
      system
                      
                      
                      289
                      
                      
                      
                      311Mexico
                      
                      
                      5,125
                      
                      
                      
                      4,039Other
      player terminals(1)
                      
                      
                      2,575
                      
                      
                      
                      2,771





Three
      Months Ended
                    March 31,
                  
                  
                  Six
      Months Ended
                    March 31,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Average
      installed player terminal base:Oklahoma
      compact games
                  
                  
                  6,463
                  
                  
                  
                  4,564
                  
                  
                  
                  6,179
                  
                  
                  
                  4,411Class II
      player terminalsNew
      Generation System - Reel Time Bingo
                  
                  
                  2,184
                  
                  
                  
                  3,084
                  
                  
                  
                  2,197
                  
                  
                  
                  3,389Legacy
      system
                  
                  
                  296
                  
                  
                  
                  340
                  
                  
                  
                  299
                  
                  
                  
                  343Mexico
                  
                  
                  5,259
                  
                  
                  
                  3,688
                  
                  
                  
                  5,315
                  
                  
                  
                  3,400Other
      player terminals(1)
                  
                  
                  2,637
                  
                  
                  
                  2,774
                  
                  
                  
                  2,670
                  
                  
                  
                  2,755











(1) Other
player terminals include charity, Rhode Island Lottery and
Malta.




Three
Months Ended March 31, 2009, Compared to Three Months Ended
March 31, 2008




Total
revenues for the three months ended March 31, 2009, were $33.9 million, compared
to $32.2 million
for the three months ended March 31, 2008, a $1.7 million or 5.2%
increase.




Gaming
Revenue – Oklahoma Compact




§
            The
      Oklahoma compact games generated revenue of $15.3million in the
      three months ended March 31, 2009, compared to $14.1million during
      the same period of 2008, an increase of $1.2million, or 8.5%.
      The average installed base of the Oklahoma compact games
      increased 41.6%, as the conversion of Class II player terminals
      to compact games continues, while the win per unit decreased 13.5%,
      due to general economic downturn causing a reduction in play. We expect
      the rate of conversion from Class II to compact games to decline in
      the future, as over 87% of the Oklahoma installed base at
      March 31, 2009, consisted of Oklahoma compact units. Accretion of contract rights
      related to development agreements, which is recorded as a reduction of
      revenue, increased $684,000, or 117.9%, to
      $1.3 million, in
      the three months endedMarch 31, 2009, compared to $581,000 in the
      same period of2008.




Gaming
Revenue – Class II




§
            Class II
      gaming revenue was $5.2 million in the
      three months ended March 31, 2009, compared to $7.5million in the
      three months endedMarch 31, 2008,
      a $2.3million
      or 31.5% decrease. We
      expect the number of Class II terminals to continue to decrease as
      they are replaced with higher-earning Oklahoma compact player
      terminals.




§
            Reel
      Time Bingo revenue was $4.7 million for the
      three months ended March 31, 2009, compared to $6.9 million in the
      three months ended March 31, 2008, a $2.2 million or
      32.5% decrease. The
      decrease is primarily attributable to a decrease in the average installed
      base of player terminals of 29.2%. Accretion of contract rights related to
      development agreements, which is recorded as a reduction of revenue,
      decreased $50,000 or 14.4%,
      to $294,000 in
      the three months ended March 31, 2009, compared to $344,000in the three
      months ended March 31, 2008. The reduction in accretion of
      contract rights is the result of allocating the total accretion rights
      across all product lines with the majority being allocated against
      Oklahoma compact revenue.




-25-




§
            Legacy
      revenue decreased $126,000, or 20.2%,
      to $497,000 in the three
      months ended March 31, 2009, from $622,000in the three
      months ended March 31, 2008. The average installed base of
      Legacy player terminals decreased 12.9%, and the win per unit
      decreased by 7.0%, due to general economic downturn causing a
      reduction in play.




Gaming
Revenue – Charity




§
            Charity
      gaming revenues decreased $1.5 million,
      or 34.6%, to $2.9million for the
      three months ended March 31, 2009, compared to $4.4 million
      for the same period of 2008. The average installed base of charity
      player terminals decreased 6.3%, and the win per unit
      decreased 31.6%. The decrease in the win per unit is primarily
      attributable to competitive factors and to a lesser extent, economic
      factors. Competitive factors would include, but not be limited to, a
      significant increase of competitor units added to the gaming floor of our
      largest charity operation, players reward programs not offered on our
      player terminals and location of our player terminals on the gaming
      floor.




Gaming
Revenue – All Other




§
            Class III
      back-office fees decreased $69,000, or 7.9%, to
      $813,000 in the
      three months ended March 31, 2009, from $882,000 during the same
      period of 2008.




§
            Revenues
      from the New York Lottery system increased $133,000, or 7.9%, to $1.9 million in the
      three months ended March 31, 2009, from $1.7 million
      in the three months ended March 31, 2008. Currently, eight of
      the nine planned racetrack casinos are operating, with
      approximately 13,000 total terminals. At the current placement
      levels, we have obtained near break-even operations for the New York
      Lottery system and expect to achieve profitable operations after all of
      the facilities are operating.




§
            Revenues from the Mexico bingo
      market increased $231,000, or 9.4% to $2.7millionin the three months endedMarch 31, 2009, from $2.5 million
      during the same period of2008.As of
      March 31, 2009, we had installed 5,125player terminals at
      25 bingo parlors in Mexico compared to 4,039 terminals installed
      at 16 bingo parlors at March 31, 2008. Our revenue share is
      in the range of the other electronic bingo markets in which we
      operate.




Gaming
Equipment and System Sale and Lease Revenue and Cost of Sales




§
            Gaming
      equipment and system sale and lease revenue increased $4.0 million,
      or 1,051.8%, to $4.4 million for the three months ended
      March 31, 2009, from $378,000 for the same period of 2008.
      Gaming equipment and system sale revenue of $4.3 million for the
      three months ended March 31, 2009, includes the sale of
      $2.7 million for 360 player terminals. The sale of these units
      will result in a quarterly reduction of recurring Oklahoma Compact revenue
      of approximately $850,000. Gaming equipment and system sale revenue
      of $205,000 for the three months ended March 31, 2008, did
      not include player terminal or system sales. License revenues for the
      three months endedMarch 31, 2009,
      were $19,000,
      compared to $173,000for the three months ended March 31, 2008, a decrease
      of $154,000.
      Total cost of sales, which includes cost of royalty fees,
      increased $1.9 million,
      to $2.3 million in the
      three months ended March 31, 2009, from $414,000in the three
      months ended March 31, 2008. The increase primarily relates to
      the increase in revenue discussed
above.




Other
Revenue




§
            Other
      revenues increased $220,000, or 45.6%,
      to $702,000 for the three
      months ended March 31, 2009, from $482,000 during the same
      period of 2008. The increase is primarily due to increased
      maintenance income in the three months ended
      March 31, 2009.




Selling,
General and Administrative Expenses




§
            Selling,
      general and administrative expenses, or SG&A, increased approximately
      $3.8 million,or 23.1%, to $20.5million for the
      three months ended March 31, 2009, from $16.6 million in
      the same period of 2008. This increase was primarily a result of
      (i) an increase due tolegal fees and
      settlement costs, net of expected insurance proceeds of approximately$4.2 million, related
      to the Diamond Game legal matter; (ii)a net increase in personnel
      costs of $405,000; including an increase in stock compensation, an
      accrual under an annual incentive plan and other employee benefits; offset
      by a decrease in salaries and wages due to a reduction in force in
      January 2009; and (iii) an increase in allowance for accounts
      receivable and the write-off of project and patent costs
      totaling $281,000. These increases in expenses were offset by
      decreases in consulting and contract labor of $278,000, travel and
      entertainment of $299,000 and repairs and maintenance
      of $209,000.




-26-




Amortization
and Depreciation




§
            Amortization
      expense increased $264,000, or 25.2%, to
      $1.3million for
      the three-months ended March 31, 2009, compared to
      $1.0 million for the same period of 2008. Depreciation expense
      increased $2.9million,
      or 25.8%, to $14.3 million for the three months ended
      March 31, 2009, from $11.4 million for the
      corresponding three months ended March 31, 2008, primarily as a
      result of additional player terminals for the Oklahoma
    market.




Other
Income and Expense




§
            Interest
      income increased $110,000, or 9.7%, to $1.2million for the
      three months ended March 31, 2009, from $1.1 million in the
      same period of 2008. We entered into development agreements with a
      customer under which approximately $63.8 million has been
      advanced and is outstanding at March 31, 2009, and for which we
      impute interest on these interest-free loans. For the three months ended
      March 31, 2009, we recorded imputed interest of $1.1million relating
      to development agreements with an imputed interest rate range of
      5.5% to 9.0%, compared to $1.0 million for the three months
      ended March 31, 2008.




§
            Interest
      expense decreased $600,000, or 24.1%, to $1.9 million for the
      three months ended March 31, 2009, from $2.5 million in the
      same period of 2008. During April 2007, we entered into a
      $150 million Revolving Credit Facility which replaced our previous Credit
      Facility in its entirety. On October 26, 2007, we amended the
      Revolving Credit Facility,transferring $75 million of
      the revolving credit commitment to a fully funded $75 million term
      loan. We enteredinto
      a second amendment to the Revolving Credit Facility on
      December 20, 2007. The second amendment (i) extended the
      hedging arrangement date related to a portion of the term loan to
      June 1, 2008; and (ii) modified the interest rate margin
      applicable to the Revolving Credit Facility and
      the term loan.




§
            We
      had no other income for the three months ended March 31, 2009,
      compared to $872,000 in the same period of 2008. Other income
      primarily decreased due to the last distribution from a partnership
      interest.




Income
tax decreased by $2.8 million to a benefit of $1.8 million for
the three months ended March 31, 2009, from an income tax expense of
$1.0 millionin the
same period of 2008. These figures represent effective income tax rates
of 34.9%
and 43.8% for the three months ended March 31, 2009
and 2008, respectively. The effective tax rate has been impacted by the tax
treatment of stock compensation expense. To the extent that we experience
volatility in tax deductibility of certain stock compensation expense, there
will remain volatility in the effective tax rate.




-27-




Six
Months Ended March 31, 2009, Compared to Six Months Ended
March 31, 2008




Total
revenues for the six months ended March 31, 2008 and 2009, were
$62.4 million.




Gaming
Revenue – Oklahoma Compact




§
            The
      Oklahoma compact games generated revenue of $29.1million in the
      six months ended March 31, 2009, compared to $25.7million during
      the same period of 2008, an increase of $3.4million,
      or 13.4%. The average installed base of the Oklahoma compact games
      increased 40.1%, as the conversion of Class II player terminals
      to compact games continues, while the win per unit decreased 11.5%,
      due to general economic downturn causing a reduction in play. We expect
      the rate of conversion from Class II to compact games to decline in
      the future, as over 87% of the Oklahoma installed base at
      March 31, 2009, consisted of Oklahoma compact units. Accretion of contract rights
      related to development agreements, which is recorded as a reduction of
      revenue, increased $1.1 million, or 90.5%, to
      $2.3 million, in
      thesixmonths endedMarch 31, 2009, compared
      to $1.2 million in the same period
      of2008.




Gaming
Revenue – Class II




§
            Class II
      gaming revenue was $10.2 million in the
      six months ended March 31, 2009, compared to $15.6million in the
      six months endedMarch 31, 2008,
      a $5.4million
      or 34.7% decrease. We
      expect the number of Class II terminals to continue to decrease as
      they are replaced with higher-earning Oklahoma compact player
      terminals.




§
            Reel
      Time Bingo revenue was $9.2 million for the
      six months ended March 31, 2009, compared to $14.3 million in the
      six months ended March 31, 2008, a $5.2 million or
      36.0% decrease. The
      decrease is primarily attributable to a decrease in the average installed
      base of player terminals of 35.2%. Accretion of contract rights
      related to development agreements, which is recorded as a reduction of
      revenue, decreased $123,000 or 17.6%,
      to $572,000in
      the six months ended March 31, 2009, compared to $695,000in the six months
      ended March 31, 2008. The reduction in accretion of
      contract rights is the result of allocating the total accretion rights
      across all product lines with the majority being allocated against
      Oklahoma compact revenue.During fiscal 2009, we will continue
      to convert Reel Time Bingo player terminals to games played under the
      compact, which are included in “Gaming revenue – Oklahoma compact,” and we
      expect this trend to continue in the future as Reel Time Bingo competes
      with the higher win per unit of compact
games.




§
            Legacy
      revenue decreased $244,000, or 19.6%,
      to $1.0 million in
      the six months ended March 31, 2009, from $1.2 millionin the
      six months ended March 31, 2008. The average installed base of
      Legacy player terminals decreased 12.8%, and the win per unit
      decreased by 8.5%, due to general economic downturn causing a reduction in
      play.




Gaming
Revenue – Charity




§
            Charity
      gaming revenues decreased $2.8 million,
      or 34.4%, to $5.4million for the
      six months ended March 31, 2009, compared to $8.3 million
      for the same period of 2008. The average installed base of charity
      player terminals decreased 6.4%, and the win per unit
      decreased 31.7%. The decrease in the win per unit is primarily
      attributable to competitive factors and to a lesser extent, economic
      factors. Competitive factors would include, but not be limited to, a
      significant increase of competitor units added to the gaming floor of our
      largest charity operation, players reward programs not offered on our
      player terminals and location of our player terminals on the gaming
      floor.




Gaming
Revenue – All Other




§
            Class III
      back-office fees decreased $ 176,000, or 10%, to
      $1.6 million in
      the six months ended March 31, 2009, from $1.8 million
      during the same period
of 2008.




§
            Revenues
      from the New York Lottery system increased $220,000, or 6.8%, to
      $3.5 million in
      the six months ended March 31, 2009, from $3.2 million
      in the six months ended March 31, 2008. Currently, eight of the
      nine planned racetrack casinos are operating, with
      approximately 13,000 total terminals. At the current placement
      levels, we have obtained near break-even operations for the New York
      Lottery system and expect to achieve profitable operations after all of
      the facilities are operating.




§
            Revenues from the Mexico bingo
      market increased $495,000, or 10.8% to $5.1millionin thesixmonths endedMarch 31, 2009, from $4.6 million
      during the same period of2008.As of
      March 31, 2009, we had installed 5,125player terminals
      at 25 bingo parlors in Mexico compared to 4,039 terminals
      installed at16 bingo parlors at March 31, 2008. Our revenue
      share is in the range of the other electronic bingo markets in which we
      operate.




-28-




Gaming
Equipment and System Sale and Lease Revenue and Cost of Sales




§
            Gaming
      equipment and system sale and lease revenue increased $4.0 million,
      or 184.7%, to $6.1 million for the six months ended
      March 31, 2009, from $2.1 million for the same period
      of 2008. Gaming equipment and system sale revenue of
      $6.0 million for the six months ended March 31, 2009,
      includes 460 player terminals sold. The sale of these units will
      result in a quarterly reduction of recurring Oklahoma Compact revenue of
      approximately $850,000. Gaming equipment and system sale revenue of
      $1.3 million for the six months ended March 31, 2008,
      included the sale of 50 player terminals and one system. License
      revenues for the six months endedMarch 31, 2009,
      were $96,000,
      compared to $637,000for the six months ended March 31, 2008, a decrease
      of $541,000.
      Total cost of sales, which includes cost of royalty fees,
      increased $3.0 million,
      to $4.2 million in the
      six months ended March 31, 2009, from $1.2 millionin the
      six months ended March 31, 2008. The increase primarily relates
      to the increase in cost of sales associated with the revenue discussed
      above.




Other
Revenue




§
            Other
      revenues increased $376,000, or 44.2%,
      to $1.2 million for
      the six months ended March 31, 2009, from $850,000 during
      the same period of 2008. The increase is primarily due to increased
      maintenance income in the six months ended
      March 31, 2009.




Selling,
General and Administrative Expenses




§
            Selling,
      general and administrative expenses, or SG&A, increased approximately
      $8.0 million,or 24.5%, to $40.7million for the
      six months ended March 31, 2009, from $32.7 million in the
      same period of 2008. This increase was primarily a result of
      (i) an increase due to legal fees and settlement costs, net of
      expected insurance proceeds of approximately $7.9 million, related to
      the Diamond Game legal matter; (ii) an increase in salaries and wages
      and the related employee benefits of approximately $1.6 million, including
      increases in stock compensation, an accrual under an annual incentive plan
      and other employee benefits; and (iii)an increase in allowance for
      accounts receivable and the write-off of project and patent costs
      totaling $261,000. These increases in expenses were offset by
      decreases in travel and entertainment of $543,000, consulting and
      contract labor of $452,000, and lobbying fees
      of $283,000.




Amortization
and Depreciation




§
            Amortization
      expense increased $450,000, or 20.0%, to
      $2.7million for
      the six months ended March 31, 2009, compared to
      $2.2 million for the same period of 2008. Depreciation expense
      increased $5.1million, or
      22.5%, to $27.8 million for the six months ended
      March 31, 2009, from $22.7 million for the
      corresponding six months ended March 31, 2008, primarily as a
      result of additional player terminals for the Oklahoma
    market.




Other
Income and Expense




§
            Interest
      income increased $266,000, or 11.7%, to $2.5million for the
      six months ended March 31, 2009, from $2.3 million in the
      same period of 2008. We entered into development agreements with a
      customer under which approximately $63.8 million has been
      advanced and is outstanding at March 31, 2009, and for which we
      impute interest on these interest-free loans. For the six months ended
      March 31, 2009, we recorded imputed interest of $2.3million relating
      to development agreements with an imputed interest rate range of
      5.5% to 9.0%, compared to $1.8 million for the six months
      ended March 31, 2008.




§
            Interest
      expense decreased $605,000, or 13.1%, to $4.0 million for the
      six months ended March 31, 2009 from $4.6 million in the
      same period of 2008. During April 2007, we entered into a
      $150 million Revolving Credit Facility which replaced our previous Credit
      Facility in its entirety. On October 26, 2007, we amended the
      Revolving Credit Facility,transferring $75 million of
      the revolving credit commitment to a fully funded $75 million term
      loan. We entered into a secondamendment to the Revolving Credit
      Facility on December 20, 2007. The second amendment
      (i) extended the hedging arrangement date related to a portion of the
      term loan to June 1, 2008; and (ii) modified the interest
      rate margin applicable to the Revolving Credit Facility and the term
      loan.




§
            Other
      income decreased $1.1 million,
      or 93.9%, to $74,000 for the six months
      ended March 31, 2009, compared to $1.2 million in the same
      period of 2008. Other income primarily decreased due to the last
      distribution from a partnership
interest.




Income
tax decreased by $5.8 million to a benefit of $5.1 million for
the six months ended March 31, 2009, from an income tax expense of
$735,000in the same period
of 2008. These figures represent effective income tax rates of 35.2% and 30.7% for the six
months ended March 31, 2009and 2008, respectively. The effective
tax rate has been impacted by the tax treatment of stock compensation expense.
To the extent that we experience volatility in tax deductibility of certain
stock compensation expense, there will remain volatility in the effective tax
rate.




-29-




RECENT
ACCOUNTING PRONOUNCEMENTS




We
monitor new, generally accepted accounting principle and disclosure reporting
requirements issued by the Securities and Exchange Commission, or SEC, and other
standard setting agencies. Recently issued accounting standards affecting our
financial results are described in Note 1 of our unaudited condensed
consolidated financial statements.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES




We
prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States. As such, we are required to
make certain estimates, judgments and assumptions that we believe are reasonable
based on the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the periods
presented. There can be no assurance that actual results will not differ from
those estimates. We believe the following represent our most critical accounting
policies.




Management
considers an accounting estimate to be critical if:




§
            it
      requires assumptions to be made that were uncertain at the time the
      estimate was made, and




§
            changes
      in the estimate or different estimates that could have been selected could
      have a material impact on our consolidated results of operation or
      financial condition.




Revenue
Recognition.As further discussed in the discussion of our revenue
recognition policy in Note 1 of our consolidated financial statements,
revenue from the sale of software is accounted for under Statement of
Position 97-2, “Software Revenue Recognition,” or SOP 97-2, and its various
interpretations. If Vendor-Specific Objective Evidence, or VSOE, of fair value
does not exist, the revenue is deferred until such time that all elements have
been delivered or services have been performed. If any element is determined to
be essential to the function of the other, revenues are generally recognized
over the term of the services that are rendered. In those limited situations
where VSOE does not exist for any undelivered elements of a multiple element
arrangement, then the aggregate value of the arrangement, including the value of
products and services delivered or performed, is initially deferred until all
hardware and software is delivered, and then is recognized ratably over the
period of the last deliverable, generally the service period of the contract.
Depending upon the elements and the terms of the arrangement, we recognize
certain revenues under the residual method. Under the residual method, revenue
is recognized when VSOE of fair value exists for all of the undelivered
elements in the arrangement, but does not exist for one or more of the delivered
elements in the arrangement. Under the residual method, we defer the fair value
of undelivered elements, and the remainder of the arrangement fee is then
allocated to the delivered elements and is recognized as revenue, assuming the
other revenue recognition criteria are met.




Assumptions/Approach
Used: The
determination whether all elements of sale have VSOE is a subjective measure,
where we have made determinations about our ability to price certain aspects of
transactions.




Effect
if Different Assumptions Used: When we have determined
that VSOE does not exist for any undelivered elements of an arrangement, then
the aggregate value of the arrangement, including the value of products and
services delivered or performed, is initially deferred until all products or
services are delivered, and then is recognized ratably over the period of the
last deliverable, generally the service period of the contract. The deferral of
revenue under arrangements where we have determined that VSOE does not exist has
resulted in $9.8million being recorded
as deferred revenue at March 31, 2009. If we had made alternative
assessments as to the existence of VSOE in these arrangements, some or all of
these amounts could have been recognized as revenue prior to
March 31, 2009.




Share-Based
Compensation Expense. Effective October 1, 2005, we adopted the
fair value recognition provisions of SFAS 123(R), using the modified prospective
transition method, and therefore have not restated prior periods’ results. Under
this method, we recognize compensation expense for all share-based payments
granted after October 1, 2005 and prior to but not yet vested as of
October 1, 2005, in accordance with SFAS 123(R). Under the fair
value recognition provisions of SFAS 123(R), we recognize share-based
compensation net of an estimated forfeiture rate, and only recognize
compensation cost for those shares expected to vest on a straight-line basis
over the service period of the award. Prior to SFAS 123(R) adoption, we
accounted for share-based payments under Accounting Principles Board Opinion, or
APB, No. 25, “Accounting for Stock Issued to Employees,” and accordingly
generally recognized compensation expense only if options were granted to
outside consultants with a discounted exercise price.




-30-




Assumptions/Approach
Used: Determining the appropriate fair value model and calculating the
fair value of share-based payment awards requires the input of highly subjective
assumptions, including the expected life of the share-based payment awards, and
stock price volatility. Management determined that volatility is based on
historical volatility trends. In addition, we are required to estimate the
expected forfeiture rate, and only recognize expense for those shares expected
to vest. If our actual forfeiture rate is materially different from our
estimate, the share-based compensation expense could be significantly different
from what we have recorded in the current period.




Effect
if Different Assumptions Used: The assumptions used in calculating the
fair value of share-based payment awards, along with the forfeiture rate
estimation, represent management’s best estimates, but these estimates involve
inherent uncertainties and the application of management’s judgment. As a
result, if factors change and we use different assumptions, our stock-based
compensation expense could be materially different in the future.




Property and
Equipment and Leased Gaming Equipment.Property and equipment and leased
gaming equipment is stated at cost. The cost of property and equipment and
leased gaming equipment is depreciated over their estimated useful lives,
generally using the straight-line method for financial reporting, and regulatory
acceptable methods for tax reporting purposes. Player terminals placed with
customers under participation arrangements are included in leased gaming
equipment. Leased gaming equipment includes a “pool” of rental terminals, i.e.,
the “rental pool.” Rental pool units are those units that have previously been
placed in the field under participation arrangements, but are currently back
with us being refurbished and/or awaiting redeployment. Routine maintenance of
property and equipment and leased gaming equipment is expensed in the period
incurred, while major component upgrades are capitalized and depreciated over
the estimated useful life (Critical Assumption #1) of the component. Sales and
retirements of depreciable property are recorded by removing the related cost
and accumulated depreciation from the accounts. Gains or losses on sales and
retirements of property are reflected in our results of operations.




Management
reviews long-lived asset classes for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. (Critical Assumption #2)




Assumptions/Approach
used for Critical Assumption #1: The carrying value of the asset is
determined based upon management’s assumptions as to the useful life of the
asset, where the assets are depreciated over the estimated life on a straight
line basis, and where the useful life of items in the rental pool has been
determined by management to be three years.




Effect
if different assumptions used for Critical Assumption #1: While we
believe that the useful lives that have been determined for our fixed assets are
reasonable, different assumptions could materially affect the carrying value of
the assets, as well as the depreciation expense recorded in each respective
period related to those assets. During the quarter ended
March 31, 2009, a significant portion of the $15.6million of
depreciation and amortization expense related to assets in the rental pool. If
the depreciable life of assets in our rental pool were changed from three years
to another period of time, we could incur a materially different amount of
depreciation expense during the period.




Assumptions/Approach
used for Critical Assumption #2: Recoverability of assets to be held and
used is measured through considerations of the future undiscounted cash flows
expected to be generated by the assets as a group, as opposed to analysis by
individual asset, or assets in place at a specific location. If such assets are
considered to be impaired, the impairment recognized is measured by the amount
by which the carrying amount of the assets exceeds their fair value. Assets to
be disposed of are reported at the lower of the carrying amount or the fair
value less costs of disposal. The carrying value of the asset is determined
based upon management’s assumptions as to the useful life of the asset, where
the assets are depreciated over the estimated life on a straight-line
basis.




Effect
if different assumptions used for Critical Assumption #2: Impairment
testing requires judgment, including estimations of useful lives of the assets,
estimated cash flows, and determinations of fair value. While we believe our
estimates of useful lives and cash flows are reasonable, different assumptions
could materially affect the measurement of useful lives, recoverability and fair
value. If actual cash flows fall below initial forecasts, we may need to record
additional amortization and/or impairment charges. Additionally, while we
believe that analysis of the recoverability of assets in our rental pool is
accurately assessed from a homogenous level, due to the interchangeability of
player stations and parts, if these assets were to be reviewed for impairment
using another approach, there could be different outcomes to any impairment
analysis performed.




-31-




Development
Agreements. We enter into development agreements to provide financing for
new gaming facilities or for the expansion of existing facilities. In return,
the facility dedicates a percentage of its floor space to exclusive placement of
our player terminals, and we receive a fixed percentage of those player
terminals’ win per unit over the term of the agreement. Certain of the
agreements contain player terminal performance standards that could allow the
facility to reduce a portion of our guaranteed floor space. In addition, certain
development agreements allow the facilities to buy out floor space after
advances that are subject to repayment have been repaid. The agreements
typically provide for a portion of the amounts retained by the gaming facility
for their share of the hold to be used to repay some or all of the advances
recorded as notes receivable. Amounts advanced in excess of those to be
reimbursed by the customer for real property and land improvements are allocated
to intangible assets and are generally amortized over the life of the contract,
using the straight-line method of amortization (Critical Assumption #1),
which is recorded as a reduction of revenue generated from the gaming facility.
In the past and in the future, we may by mutual agreement and for consideration,
amend these contracts to reduce our floor space at the facilities. Any proceeds
received for the reduction of floor space is first applied against the
intangible asset for that particular development agreement, if any.




Management
reviews intangible assets related to development agreements for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable (Critical Assumption #2). For the
three-months ended March 31, 2009, there was no impairment to the
assets’ carrying values.




Assumptions/Approach
used for Critical Assumption #1:Amounts advanced in excess
of those to be reimbursed by the customer for real property and land
improvements are allocated to intangible assets and are generally amortized over
the life of the contract, using the straight-line method of amortization, which
is recorded as a reduction of revenue generated from the gaming facility. We use
a straight-line amortization method, as a pattern of future benefits cannot be
readily determined.




Effect
if Different Assumptions used for Critical Assumption #1:While we believe that the
use of the straight-line method of amortization is the best way to account for
the costs associated with the costs of acquiring exclusive floor space rights at
our customers facilities, the use of an alternative method could have a material
effect on the amount recorded as a reduction to revenue in the current reporting
period.




Assumptions/Approach
used for Critical Assumption #2: We estimate cash flows directly
associated with the use of the intangible assets to test recoverability and
remaining useful lives based upon the forecasted utilization of the asset and
expected product revenues. In developing estimated cash flows, we incorporate
assumptions regarding future performance, including estimations of the win per
unit and estimated units. When the carrying amount exceeds the undiscounted cash
flows expected to result from the use and eventual disposition of the asset, we
then compare the carrying amount to its current fair value. We recognize an
impairment loss if the carrying amount is not recoverable and exceeds its fair
value.




Effect
if Different Assumptions used for Critical Assumption #2:Impairment testing requires
judgment, including estimations of cash flows, and determinations of fair value.
While we believe our estimates of future revenues and cash flows are reasonable,
different assumptions could materially affect the measurement of useful lives,
recoverability and fair value. If actual cash flows fall below initial
forecasts, we may need to record additional amortization and/or impairment
charges.




Income
Taxes. In accordance with SFAS, No. 109, we have recorded a
deferred tax assets and liabilities to account for the expected future tax
benefits and consequences of events that have been recognized in our financial
statements and our tax returns. There are several items that result in deferred
tax asset and liability impact to the balance sheet. If we conclude that it is
more likely than not that some portion or all of the deferred tax assets will
not be realized under accounting standards, it is reduced by a valuation
allowance to remove the benefit of recovering those deferred tax assets from our
financial statements. Additionally, as of March 31, 2008, in
accordance with FIN 48, we recorded a liability of $295,000 associated with
uncertain tax positions. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. We are required to
determine whether it is more likely than not (a likelihood of more than 50%)
that a tax position will be sustained upon examination, including resolution of
any related appeals or litigation processes, based on the technical merits of
the position in order to record any financial statement benefit. If that step is
satisfied, then we must measure the tax position to determine the amount of
benefit to recognize in the financial statements. The tax position is measured
at the largest amount of benefit that is greater than 50% likely of being
realized upon ultimate settlement.




Assumptions/Approach
Used: Numerous
judgments and assumptions are inherent in the determination of future taxable
income and tax return filing positions that we take, including factors such as
future operating conditions.




-32-




Effect
if Different Assumptions Used:Management continually
evaluates complicated tax law requirements and their effect on our current and
future tax liability and our tax filing positions. Despite our attempt to make
an accurate estimate, the ultimate utilization of our deferred tax assets
associated with the tax basis of our leased gaming equipment and property and
equipment of $16.3 million is largely dependent upon our ability to
generate taxable income in the future. Our liability for uncertain tax positions
is dependent upon our judgment on the amount of financial statement benefit that
an uncertain tax position will realize upon ultimate settlement and on the
probabilities of the outcomes that could be realized upon ultimate settlement of
an uncertain tax position using the facts, circumstances and information
available at the reporting date to establish the appropriate amount of financial
statement benefit. To the extent that a valuation allowance or uncertain tax
position is established or increased or decreased during a period, we may be
required to include an expense or benefit within income tax expense in the
income statement.




LIQUIDITY
AND CAPITAL RESOURCES




At
March 31, 2009, we had $9.2 million in
unrestricted cash and cash equivalents, compared to $6.3 million at
September 30, 2008. Our working capital at March 31, 2009,
was $37.5million,
compared to a working capital of $34.1 million at
September 30, 2008. The increase in working capital was primarily the
result of increases in cash and accounts receivable of $2.9 million and
$3.5 million, respectively, and a decrease in accounts payable and accrued
expenses of $2.2 million, offset by a decrease in notes receivable of
$8.4 million, due to the paydown of notes from development agreements.
During the six-months ended March 31, 2009, we used $27.2million for capital
expenditures of property and equipment, and we collected $9.9million, net of
advances, on development agreements. As of March 31, 2009, we have
$44.8million
available under the Credit Facility, subject to covenant
restrictions.




As of
March 31, 2009, our total contractual cash obligations were as follows
(in thousands):




Less than
                    1 year
                  
                  
                  1-3 years
                  
                  
                  3-5 years
                  
                  
                  TotalRevolving Credit
      Facility(1)
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  29,000
                  
                  
                  $
                  29,000Credit Facility Term
      Loan(2)
                  
                  
                  3,307
                  
                  
                  
                  1,500
                  
                  
                  
                  63,687
                  
                  
                  
                  68,494Operating leases(3)
                  
                  
                  2,539
                  
                  
                  
                  961
                  
                  
                  
                  —
                  
                  
                  
                  3,500Purchase commitments(4)
                  
                  
                  11,157
                  
                  
                  
                  3,375
                  
                  
                  
                  —
                  
                  
                  
                  14,532Development Agreement(5)
                  
                  
                  5,750
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5,750Total
                  
                  $
                  22,753
                  
                  
                  $
                  5,836
                  
                  
                  $
                  92,687
                  
                  
                  $
                  121,276




(1)
              Relating to the Revolving Credit
      Facility, bearing interest at the Eurodollar rate plus the applicable
      spread (4.75% as ofMarch 31, 2009).


(2)
              Consists of amounts borrowed under
      our Credit Facility at the Eurodollar rate plus the applicable spread
      (8.5% on $50 million and 5.5% on $17.1 million as ofMarch 31, 2009).


(3)
              Consists of operating leases for
      our facilities and office equipment that expire at various times
      through 2011.


(4)
              Consists of commitments to order
      third-party gaming content licenses and for the purchase of player
      terminals.


(5)
              Consists of commitments tofund in accordance with a development
  agreement.




During
the six months ended March 31, 2009, we generated $10.9million in cash from
our operations, compared to $15.4 million during the same period
of 2008. This $4.5million decrease in
cash generated from operations over the prior period was primarily due to the
decrease in accounts payable which is offset by the increase in
inventory.




-33-




Cash used
in investing activities decreased to $19.0million in the six
months ended March 31, 2009, from $39.3 million in the same
period of 2008. The decrease was primarily the result of a decrease in
advances under development agreements offset by the purchase of capital
expenditures of property and equipment. During the six months ended
March 31, 2009, additions to property and equipment consisted of the
following:




Capital Expenditures(In
      thousands)Gaming
      equipment
                  
                  $
                  22,336Third-party
      gaming content licenses
                  
                  
                  4,955Other
                  
                  
                  28Total
                  
                  $
                  27,319




Cash
provided by financing activities decreased to $10.6million in the six
months ended March 31, 2009, from $19.0 million in the same
period of 2008. The decrease was primarily the result of a $8.3million decrease in the
net borrowings under the Credit Facility.




Our
capital expenditures for the next 12 months will depend upon the number of
new player terminals that we are able to place into service at new or existing
facilities and the actual number of repairs and equipment upgrades to the player
terminals that are currently in the field. As a result of the earnings potential
of compact games in the Oklahoma market, it is our strategy to either place
compact games or to convert our Oklahoma Class II games to the compact
games. As part of our strategy, we will offer compact games developed by us, as
well as games from two other gaming suppliers. As a result, we have entered into
purchase commitments for future purchases of player stations and licenses
totaling $11.2 million.




In the
third quarter of fiscal 2008, we fulfilled a commitment to a significant,
existing Oklahoma tribal customer to provide approximately 43.8%, or
$65.6 million, of the total funding for a facility expansion. Because of
our commitment to fund the expansion, we secured the right to place an
additional 1,400 gaming units in the expanded facility in southern
Oklahoma. We recorded all advances as a note receivable and imputed interest on
the interest free loan. The discount (imputed interest) was recorded as contract
rights, and as of the first quarter of fiscal 2009 is being amortized over
the life of the agreement. The repayment period of the note will be based on the
performance of the facility. In the second quarter of fiscal 2009, we made
a commitment of $7.0 million that consists of both a loan for new unit
placements in an expanded facility and a placement fee for certain units to
remain at the current facility for an extended period of time. As of
March 31, 2009, we had advanced $1.25 million toward this
commitment. The remaining commitment of $5.75 million is expected to be paid
over the next three fiscal quarters in the following increments
$2.75 million, $1.5 million and $1.5 million,
respectively.




We are
currently in compliance with our Senior Secured Credit Agreement's covenants.
However, we believe there is substantial risk in our continued satisfaction of
certain operating covenants in that agreement following conclusion of the
quarter ended March 31, 2009. In particular, our ability to remain in
compliance with our trailing twelve month EBITDA covenant is dependent upon our
ability to achieve our current operating plan for the quarter ended
June 30, 2009. In light of (i) current prevailing economic
conditions and the inherent uncertainty of achieving and recognizing future
revenue, and (ii) the difficulty of making short-term expense reductions
sufficient to compensate for a revenue shortfall, we cannot be certain that we
will be able to achieve our operating objectives this quarter and thereby
continue to meet the EBITDA covenant, among others.




If we
fail to remain in compliance with our Senior Secured Credit Agreement covenants,
we will be required to seek modification or waiver of the provisions of that
agreement and potentially secure additional sources of capital. We have held
discussions with our lead agent, and are preparing to meet with them and other
members of our lending syndicate, to discuss alternatives and contingent plans
in the event that we fall out of compliance with the Credit Facility’s operating
covenants. We cannot be certain that, if required, we will be able to
successfully negotiate required changes to or waivers of our Senior Secured
Credit Facility. Alternatively, we may incur significant costs related to
obtaining requisite waivers or renegotiation of our Credit Facility that could
have a material and adverse effect on our operating results.




Our
performance and financial results are, to a certain extent, subject to
(i) general conditions in or affecting the Native American gaming industry,
and (ii) general economic, political, financial, competitive and regulatory
factors beyond our control. If our business does not continue to generate cash
flow at appropriate levels or if we receive a material judgment against us in
one of the various lawsuits (See “Risk Factors – “The ultimate outcome of
pending litigation is uncertain,” and Commitments and Contingencies), we may
need to raise additional financing. Sources of additional financing might
include additional bank debt or the public or private sale of equity or debt
securities. However, sufficient funds may not be available, on terms acceptable
to us or at all, from these sources or any others to enable us to make necessary
capital expenditures and to make discretionary investments in the
future.




-34-




Credit
Facility




On April 27, 2007, we entered
into a $150 million Revolving Credit Facility which replaced our Previous
Credit Facility in its entirety. On October 26, 2007,we amended the Revolving
Credit Facility, transferring$75 million of the
revolving credit commitment
to a fully funded $75 million term loan due April 27, 2012. The
Term Loan is amortized at an annual amount of 1% per year, payable in equal
quarterly installments beginning January 1, 2008, with the remaining
amount due on the maturitydate. We entered into a second
amendment to the Revolving Credit Facility on December 20, 2007. The
second amendment (i) extended the hedging arrangement date related to a
portion of the term loan to June 1, 2008; and (ii) modified the
interest rate margin applicable to the Revolving Credit
Facility and the term loan.




The Credit Facility provides us with the
ability to finance development agreements and acquisitions and working capital
for general corporate purposes. Amounts under the $75 million revolving
credit commitment and the $75 million term loan mature in five years, and
advances under the revolving credit commitment and term loan bear interest at
the Eurodollar rate plus the applicable spread, tied to various levels of
interest pricing determined by total debt to EBITDA. As of
March 31, 2009 the $29 million drawn under the revolving credit
commitment bore interest at 4.75% and two tranches of the term loan of
$50 million and $17.1 million bore interest at 8.5%
and 5.5%, respectively.




The
Credit Facility is collateralized by substantially all of our assets, and also
contains financial covenants as defined in the agreement. These covenants
include (i) a minimum fixed-charge coverage-ratio of not less
than 1.50 : 1.00; (ii) a maximum total debt to EBITDA ratio
of not more than 2.25 : 1.00 through June 30, 2008,
and 1.75 : 1.00 from September 30, 2008 thereafter; and
(iii) a minimum trailing twelve-month EBITDA of not less than
$57 million for the quarter ended September 30, 2007, and
$60 million for each quarter thereafter. During the quarter ended
March 31, 2009 a clarification was made for purposes of calculating
EBITDA. As a result of this clarification, interest income will no longer be
netted against interest expense for the purpose of evaluating compliance with
covenants contained in the Credit Facility. There were no waivers granted or
amendments made to the Credit Facility agreement related to the clarification of
the calculation of adjusted EBITDA. Thus, the trailing twelve-month adjusted
EBIDTA, as computed under the Credit Facility, was $61.2million as of
March 31, 2009. As of March 31, 2009, we are in compliance
with the loan covenants. However, we will need to generate a minimum of
$15.8 million in adjusted EBITDA in the quarter ended
June 30, 2009 in order to remain in compliance with the adjusted
EBITDA covenant (assuming no prior waiver or modification of such
covenant).




If we are
able to achieve our operating objectives in the quarter ended
June 30, 2009, we believe we will remain in compliance with the
financial covenants. Our operating objectives for the quarter include
maintaining current levels of recurring revenue as well as the successful sale
of Class III gaming equipment and recognition of related revenue from such
sales. If our performance does not meet current objectives, we may not meet the
EBITDA covenant, among others (See Risk Factors – “Our Credit Facility contains
covenants that limit our ability to finance future operations or capital needs,
or to engage in other business activities”).




The
Credit Facility requires certain mandatory prepayments be made on the term loan
from the net cash proceeds of certain asset sales and condemnation proceedings
(in each case to the extent not reinvested, within certain specified time
periods, in the replacement or acquisition of property to be used in our
businesses). In the quarter ended March 31, 2008, we made a mandatory
prepayment of the term loan in the amount of $4.5 million, due to an early
prepayment of a development agreement note receivable. As of
March 31, 2009, the Credit Facility had availability of
$44.8 million, subject to covenant restrictions.




The Credit Facility also required that
we enter into hedging arrangements covering at least $50 million of the
term loan for a three-year
period by June 1, 2008. Therefore, on May 29, 2008, we
purchased, for $390,000, an interest rate cap (5% cap rate) covering
$50 million of the term loan.We account for this hedge in accordance
with Statement of Financial Accounting StandardsNo. 133, or SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,” which requires
entities to recognize all derivative instruments as either assets or liabilities
in the balance sheet, at their respective fair values. We record changes on a
mark to market basis reflecting these changes through interest expense in the
statement of operations. The fair value of this hedge was
approximately $11,000 atMarch 31, 2009.




-35-




Stock-Based
Compensation




At
March 31, 2009, we had approximately 7.3million options
outstanding, with exercise prices ranging from $1.00 to $18.71 per
share. At March 31, 2009, approximately 4.0million of the outstanding
options were exercisable.




During
the three months ended March 31, 2009, options to purchase
661,200shares of
common stock were granted at a weighted average exercise price of $2.07 per
share, and we issued 550shares of common stock as a
result of stock option exercises with a weighted average exercise price
of $1.42.




SEASONALITY




We
believe our operations are not materially affected by seasonal factors, although
we have experienced fluctuations in our revenues from period to
period.




CONTINGENCIES




For
information regarding contingencies, see “Item 1. Condensed Financial
Statements – Note 8 - Commitments and Contingencies” and “PART II –
Item 1. Legal Proceedings.”




INFLATION
AND OTHER COST FACTORS




Our
operations have not been nor are they expected to be materially affected by
inflation. However, our domestic and international operational expansion is
affected by the cost of hardware components, which are not considered to be
inflation sensitive, but rather, sensitive to changes in technology and
competition in the hardware markets. In addition, we expect to continue to incur
increased legal and other similar costs associated with regulatory compliance
requirements and the uncertainties present in the operating environment in which
we conduct our business.




ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




We are
subject to market risks in the ordinary course of business, primarily associated
with interest rate fluctuations.




Our
Credit Facility provides us with additional liquidity to meet our short-term
financing needs, as further described under “Item 1. Condensed Financial
Statements - Note 6 – Credit Facility, Long-Term Debt and Capital Leases.”
Pursuant to our Revolving Credit Facility, we may currently borrow up to a total
of $143.0 million, and our availability as of March 31, 2009, is
$44.8 million, subject
to covenant restrictions.




In
connection with the development agreements we enter into with many of our Native
American tribal customers, we are required to advance funds to the tribes for
the construction and development of tribal gaming facilities, some of which are
required to be repaid. As a result of our adjustable-interest-rate notes payable
and fixed-interest-rate-notes receivable described in “Item 1. Condensed
Financial Statements – Note 5 – Notes Receivable and Note 6 – Credit
Facility, Long-Term Debt and Capital Leases,” we are subject to market risk with
respect to interest rate fluctuations. Any material increase in prevailing
interest rates could cause us to incur significantly higher interest
expense.




The Credit Facility also required that
we enter into hedging arrangements covering at least $50 million of the term loan for
a three-year period. OnMay 29, 2008, we purchased,
for $390,000, an interest rate cap (5% cap rate) covering
$50 million of the term loan.To the extent that Libor rates
do not exceed the 5% cap rate, we estimate that a hypothetical increase
of 100 basis points in interest rates would increase our annual interest
expense by approximately $1.0 million, based on our variable debt
outstanding of $97.5million as of
March 31, 2009.




We
account for currency translation from our Mexico operations in accordance with
SFAS No. 52, “Foreign Currency Translation.” Balance sheet accounts
are translated at the exchange rate in effect at each balance sheet date. Income
statement accounts are translated at the average rate of exchange prevailing
during the period. Translation adjustments resulting from this process are
charged or credited to other comprehensive income. We do not currently manage
this exposure with derivative financial instruments.




-36-




ITEM
      4.
            CONTROLS
      AND PROCEDURES




Evaluation of
Disclosure Control and Procedures.In the
quarter ending March 31, 2009, an evaluation was carried out under the
supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, of the effectiveness of the
design and operation of management’s disclosure controls and procedures (as
defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934) to ensure information required to be disclosed in our filings under the
Securities Exchange Act of 1934, is (i) recorded, processed, summarized and
reported within the time periods specified in the SEC rules and forms; and
(ii) accumulated and communicated to our senior management, including our
Chief Executive Officer and our Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. Management recognizes that
any controls and procedures, no matter how well designed and operated, can only
provide reasonable assurance of achieving desired control objectives, and
management is necessarily required to apply its judgment when evaluating the
cost-benefit relationship of potential controls and procedures. Based upon the
evaluation, the Chief Executive Officer and our Chief Financial Officer
concluded that the design and operation of these disclosure controls and
procedures were effective as of March 31, 2009.




There
were no significant changes in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.




Changes in
Internal Control over Financial Reporting.On
April 5, 2009, our Board of Directors formally adopted an enhanced
Compliance Program which provided additional guidelines and safeguards to
enhance the Internal Controls over Financial Reporting. The program established
the following committee:




Regulatory Compliance
Committee: To ensure our compliance with gaming regulations for each
jurisdiction in which we do business. Specifically, evaluate and track:
(i) disciplinary actions taken by gaming regulators against us (and our
response thereto); (ii) potential associations with unsuitable persons; and
(iii) our overall compliance with regulatory requirements.




On
April 5, 2009, our Board of Directors revised the SEC Disclosure
Committee’s mission to read as follows:




SEC Disclosure Committee: To
ensure that senior management and the Board of Directors are informed about
material information regarding our business. Additionally, the Disclosure
Committee shall ensure compliance with disclosure requirements inherent to our
obligation to file periodic reports inclusive of: 10-K (Annual Report), 10-Q
(Quarterly Report), 8-K (Current Reports), and Proxy Statements.




Each of
the Regulatory Compliance and SEC Disclosure Committees was directed to enhance
our internal controls by: (i) keeping us on course toward profitability
while minimizing surprises, reducing risk and promoting efficiency; and
(ii) enabling us to react to a rapidly changing economic and competitive
environment.




-37-




PART
II


OTHER
INFORMATION


ITEM
      1.
            LEGAL
      PROCEEDINGS




We are subject to litigation from time
to time in the ordinary course of our business, as well as litigation to which
we are not a party that may establish laws that affect our business (see
“PART I – Item 1. Condensed Financial Statements – Note 8 –
Commitments and Contingencies.”).




On
March 19, 2009, officials with the Alabama Governor’s Task Force
seized certain of our charity bingo equipment located in Alabama. As a result of
a court order issued on March 31, 2009, the State of Alabama was
ordered to return all of our equipment, and the charity bingo facility, located
in Lowndes County, Alabama, was able to resume its operations without threat of
additional legal interference by the Governor’s Task Force, pending the final
outcome of the litigation. The Governor’s Task Force filed an Emergency Motion
to Stay the lower court’s order. On April 17, 2009 the Supreme Court of Alabama
granted the Governor’s Task Force’s emergency motion to stay pending disposition
of the underlying litigation.




ITEM
      1A.
            RISK
      FACTORS




The following risk factors should be
carefully considered in connection with the other information and financial
statements contained in this Quarterly Report, including “PART I – Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” If any of these risks actually occur, our business, financial
condition and results of operations could be seriously and materially harmed,
and the trading price of our common stock could decline.




Our business operations and product
offerings are subject to strict regulatory licenses, findings of suitability,
registrations, permits and/or approvals.




Our ability to conduct our existing
traditional business, expand operations, develop and distribute new products,
games and systems, and expand into new gaming markets is subject to significant
federal, state, local, Native American, and foreign regulations. Specifically,
our company and our officers, directors, key employees, major shareholders, and
products, games and systems are subject to licenses, findings of suitability,
registrations, permits or approvals necessary for the operation of our gaming
activities.




We have received licenses, findings of
suitability, registrations, permits or approvals from a number of state, local,
Native American, and foreign gaming regulatory authorities. Our tribal customers
are empowered to develop their own licensing procedures and requirements, and we
currently have limited, if any, information regarding the ultimate process or
expenses involved with securing or maintaining licensure by the tribes.
Moreover, tribal policies and procedures, as well as tribal selection of gaming
vendors, are subject to the political and governance environment within the
tribe.




We may require new licenses, permits and
approvals in the future, and such licenses, permits or approvals may not be
granted to us. Obtaining and maintaining all required licenses, findings of
suitability, registrations, permits or approvals is time consuming and
expensive. The suspension, revocation, nonrenewal or limitation of any of our
licenses would have a material adverse effect on our business operations,
financial condition and results of operations.




Our ability to effectively compete in
Native American gaming markets is vulnerable to legal and regulatory
uncertainties.




Historically, we have derived most of
our revenue from the placement of Class II player terminals and systems for
gaming activities conducted on Native American lands. These activities are
subject to federal regulation under the Gambling Devices Act, 15 U.S.C. § 1171,et seq,or theJohnson Act, the Indian Gaming
Regulatory Act of 1988 or IGRA, the National Indian Gaming Commission or NIGC,
and the regulatory requirements of various tribal gaming commissions. The
Johnson Act broadly defines “gambling devices” to include any “machine or
mechanical device” designed and manufactured “primarily” for use in connection
with gambling, and that, when operated, delivers money or other property to a
player “as the result of the application of an element of chance.” A government
agency or court that literally applied this definition, and did not give effect
to subsequent congressional legislation or to certain regulatory interpretations
or judicial decisions, could determine that the manufacture and use of our
electronic player terminals, and perhaps other key components of our
Class II gaming systems that rely to some extent upon electronic equipment
to run a game, constitute Class III gaming and, in the absence of a
tribal-state compact, are illegal. Our tribal customers could be subject to
significant fines and penalties if it is ultimately determined they are offering
an illegal game, and an adverse regulatory or judicial determination regarding
the legal status of our products could have material adverse consequences for
our business, operating results and prospects.




-38-




Additionally, our development agreements
could be subject to review by the NIGC at any time. Any review of our
development agreements by the NIGC, or alternative interpretations of applicable
laws and regulations could require substantial modifications to the agreements
or result in their designation as “management contracts,” which could materially
and adversely affect the terms on which we conduct our
business.




Other government enforcement, regulatory
action, judicial decisions, proposed legislative action, rumors that have in the
past and will continue to affect our business, operating results and
prospects, include but are not limited to:




§
            proposed legislation that would
      classify electronic technologic aids used by Native American tribes in
      Class II games, such as bingo, as gambling devices, or require
      certification by the NIGC of the Class II technologic
      aids;




§
            proposed legislation that would
      authorize the NIGC to promulgate regulations regarding the use of
      technologic aids;




§
            proposed rules by the NIGC
      concerning classification standards to distinguish between Class II
      games played with technologic aids and Class III facsimiles of games
      of chance, a revision of the definition of “electronic or
      electromechanical
facsimile”;




§
            proposed legislation or rules that
      would allow the NIGC authority to review contracts between Native American
      tribes and their suppliers;




§
            government enforcement, regulatory
      action, judicial decisions, or the prospects of rumors involving any of
      our games which have not been reviewed or approved as legal Class II games
      by the NIGC (inclusive but not limited to our games placed in both
      Charitable Bingo and International Bingo
  markets);




§
            contractual and regulatory
      interpretations and enforcement actions by state regulators or courts with
      regard to compacts between the state and various tribes, including but not
      limited to tribes with compacts in the states of Washington and
      Oklahoma;




§
            adverse rulings regarding game
      classification by state or federal
  courts;




§
            adverse regulatory decisions by
      tribal gaming commissions;




§
            lack of regulatory or judicial
      enforcement action. In particular, we believe we have lost, and could
      continue to lose, market share to competitors who offer games that do not
      appear to comply with published regulatory restrictions on Class II
      games, and thereby offer features not available in our
      products;




§
            the use of sovereign immunity by
      the tribes to interfere with our ability to enforce our contractual rights
      on Native American land;




§
            new laws and regulations relating
      to Native American gaming that may be enacted, and existing laws and
      regulations that could be amended or reinterpreted in a manner adverse to
      our business;




§
            investigations by the Inspector
      General for the Department of the Interior and the Acting General Counsel
      for the NIGC into the practice of certain tribes conducting gaming on land
      originally acquired in trust for non-gaming purposes;
      and




§
            a determination by the NIGC that
      our development agreements, either by themselves or when taken together
      with other agreements demonstrate a proprietary interest by us in a
      tribe’s gaming activity. Management contracts are subject to additional
      regulatory requirements and oversight, including preapproval by the NIGC,
      that could delay our providing products and services to customers, as well
      as divert customers to our
competitors.




All of the above risk factors could
result in significant and immediate adverse impacts on our business and operating results.
Additionally, each of the above described risk factors increases the cost of
doing business and could take our executives’attention away from operations. The
trading price of our common stock has in the past and may in the future be subject to
significant fluctuations based upon market perceptions of the legal status of
our products and our ability to compete in the Native American markets.
Regulatory action against our customers or equipment in these or in other
markets could result in machine seizures
and significant revenue disruptions, among other adverse consequences.Moreover, tribal policies
and procedures, as well as tribal selection of gaming vendors, are subject to
the political and governance environment within the tribe. Changes in tribal
leadership or tribal political pressure can affect our business relationships
within Native American markets.




-39-




The ultimate outcome of pending
litigation is uncertain.




We are involved in a number of
commercial and intellectual property litigation matters. Current estimates of
loss regarding pending litigation may not be reflective of any particular final
outcome. The results of rulings, judgments or settlements of pending litigation
may result in financial liability that is materially higher than what management
has estimated at this time.We make no assurances that we will not be
subject to liability with respect to current or future litigation. We maintain various forms of insurance
coverage. However, substantial rulings, judgments or settlements could exceed
the amount of insurance coverage (or any cost allocation agreement with an
insurance carrier), or could be excluded under the terms of an existing
insurance policy. Additionally, failure to secure favorable outcomes in pending
litigation could result in adverse consequences to our business, operating
results and/or overall financial condition (including without limitation,
possible adverse effects on compliance with the terms of our Credit
Facility).




We may have difficulty enforcing
contractual rights on Native American land.




Federally recognized Native American
tribes are independent governments, subordinate to the United States, with
sovereign powers, except as those powers may have been limited by treaty or by
the United States Congress. The power of Native Americans tribes to enact their
own laws and to regulate gaming operations and contracts is an exercise of
Native American sovereignty, as recognized by IGRA. Native American tribes
maintain their own governmental systems and often their own judicial systems.
Native American tribes have the right to tax persons and enterprises conducting
business on Native American lands, and also have the right to require licenses
and to impose other forms of regulation and regulatory fees on persons and
businesses operating on their lands.




In the absence of a specific grant of
authority by Congress, states may regulate activities taking place on Native
American lands only if the tribe has a specific agreement or compact with the
state. Our contracts with
Native American customers normally provide that only certain provisions will be
subject to the governing law of the state in which a tribe is located. However,
these choice-of-law clauses may not be enforceable.




Native American tribes generally enjoy sovereign immunity
from lawsuits similar to that of the individual states and the United States. In
order to sue a Native American tribe (or an agency or instrumentality of a
Native American tribe), the tribe must have effectively waivedits sovereign immunity with respect to
the matter in dispute.




Our contracts with some Native American
customers include a limited waiver of each tribe’s sovereign immunity, and generally
provide that any dispute regarding interpretation, performance or
enforcement shall be
submitted to, and resolved by, arbitration in accordance with the Commercial
Arbitration Rules of the American Arbitration Association, and that any award,
determination, order or relief resulting from such arbitration is binding and
maybe entered in any court having
jurisdiction. However, in some instances, there is no limited waiver of
sovereign immunity. Our largest customer, who accounts for over 43% of our
revenue, has not given us a limited waiver of sovereign immunity. In the
instances where tribes have not waived
sovereign immunity, or in the event that a limited waiver of sovereign immunity
is held to be ineffective, we could be precluded from judicially enforcing any
rights or remedies against a tribe. These rights and remediesinclude, but are not limited to, our
right to enter Native American lands to retrieve our property in the event of a
breach of contract by the tribe party to that contract.




If a Native American tribe has
effectively waived its sovereign immunity, there exists an issue as to the forum in which a
lawsuit can be brought against the tribe. Federal courts are courts of limited
jurisdiction and generally do not have jurisdiction to hear civil cases relating
to Native Americans. In addition, contractual provisionsthat purport to grant jurisdiction to a
federal court are not effective. Federal courts may have jurisdiction if a
federal question is raised by the lawsuit, which is unlikely in a typical
contract dispute. Diversity of citizenship, another common basis for federal court jurisdiction, is not
generally present in a lawsuit against a tribe, because a Native American tribe
is not considered a citizen of any state. Accordingly, in most commercial
disputes with tribes, the jurisdiction of the federal courts maybe difficult or impossible to obtain. We
may be unable to enforce any arbitration decision
effectively.




-40-




Our expansion into non-Native American
gaming activities will present new challenges and risks that could adversely
affect our business or results of operations.




As we expand into new markets, we expect
to encounter business, legal, operational and regulatory uncertainties similar
to those we face in our Native American gaming business. As a result, we may
encounter legal and regulatory challenges that are difficult or impossible to foresee and
which could result in an unforeseen adverse impact on planned revenues or costs
associated with the new market opportunity. If we are unable to effectively
develop and operate within these new markets, then our business, operating results and financial
condition would be impaired.For example, on March 19, 2009,
officials with the Alabama Governor’s Task Force seized certain of our charity
bingo equipment located in Alabama. As a result of a court order issued on
March 31, 2009, the State of Alabama was ordered to return all of our
equipment, and the charity bingo facility, located in Lowndes County, Alabama,
was able to resume its operations without threat of additional legal
interference by the Governor’s Task Force, pending the final outcome of the
litigation. The
Governor’s Task Force filed an Emergency Motion to Stay the lower court’s order.
On April 17, 2009 the Supreme Court of Alabama granted the Governor’s Task
Force’s emergency motion to stay pending disposition of the underlying
litigation.If the State of Alabama seizes additional equipment at other
charity bingo sites within the state, it could have a material adverse effect on
our Alabama clients’ businesses, and, ultimately, a material adverse impact on
our results of operations and financial condition.




Successful growth in accordance with our strategy may
require us to make changes to our gaming systems to ensure that they comply with
applicable regulatory requirements, and may require us to obtain additional
licenses. In certain jurisdictions and for certain venues, our ability to enter these markets will
depend on effecting changes to existing laws and regulatory regimes. The ability
to effect these changes is subject to a great degree of uncertainty and may
never be achieved. We may not be successful in entering intoother segments of the gaming
industry.




Generally, our placement of systems,
games and technology into new market segments involves a number of business
uncertainties, including:




§
            whether our resources and
      expertise will enable us to effectively operate and grow in such new
      markets;




§
            whether our internal processes and
      controls will continue to function effectively within these new
      segments;




§
            whether we have enough experience
      to accurately predict revenues and expenses in these new
      markets;




§
            whether the diversion of
      management attention and resources from our traditional business, caused
      by entering into new market segments, will have harmful effects on our
      traditional business;




§
            whether we will be able to
      successfully compete against larger companies who dominate the markets
      that we are trying to enter;
and




§
            whether we can timely perform
      under our agreements in these new
  markets.




Our Credit Facility contains covenants
that limit our ability to finance future operations or capital needs, or to
engage in other business activities.




The operating and financial restrictions
and covenants in our debt agreements, including the Credit Facility, may
adversely affect our ability to finance future operations or capital needs or to
engage in other business activities. Our Credit Facility requires us to maintain
a minimum EBITDA of $60 million on a trailing 12-month basis, a total debt
to EBITDA leverage ratio of no more than 1.75:1.00 and a minimum fixed
charge coverage ratio of at least 1.5:1.0. The Credit Facility contains
certain covenants that, among other things, restrict our ability as well as our
restricted subsidiaries’ ability to:




§
            incur
      additional indebtedness, assume a guarantee or issue preferred
      stock;




§
            pay
      dividends or make other equity distributions or payments to or affecting
      our subsidiaries;




§
            purchase
      treasury stock;




§
            make certain
      investments;




§
            create
    liens;




§
            sell or dispose of assets or
      engage in mergers or
consolidations;




§
            engage in certain transactions
      with subsidiaries and affiliates;
and




§
            enter into sale leaseback
      transactions.




These restrictions could limit our
ability to obtain future financing, make strategic acquisitions or needed
capital expenditures, withstand economic downturns in our business or the
economy in general, conduct operations or otherwise take advantage of business
opportunities that may arise. A failure to comply with the restrictions
contained in the Credit Facility could lead to an event of default, which could
result in an acceleration of our indebtedness. Such acceleration would
constitute an event of default under the indentures governing the senior
unsecured notes. Our future operating results may not be sufficient to enable
compliance with the covenants in the Credit Facility or to remedy any such
default. In addition, in the event of acceleration, we may not have or be able
to obtain sufficient funds to refinance our indebtedness or make any accelerated
payments. Also, we may not be able to obtain new financing. Even if we were able
to obtain new financing, we cannot guarantee that the new financing will be on
commercially reasonable terms or terms that are acceptable to us. If we default
on our indebtedness, our business financial condition and results of operation
could be materially and adversely affected.




-41-




Our expansion into international gaming
markets will present new challenges and risks that could adversely affect our
business or results of operations.




We have only recently begun to develop
international business, and we realized revenue from the sale of an Electronic
Instant Lottery System to the Israel National Lottery during fiscal 2006
and from contracts to supply Electronic Bingo Terminals to casinos in Mexico
during fiscal years 2006, 2007, and 2008. Neither our transactions in
Israel nor in Mexico have been profitable to date or are currently profitable,
and may not lead to future profitable business. To date, we do not have as many
permanent facilities opened in Mexico as we originally projected, and the win
per unit in certain of the open facilities in Mexico has not met our original
expectations. There can be no assurances that our games will gain market
acceptance in Mexico, additional facilities will open in Mexico, or that the win
per unit will increase in those facilities in Mexico currently not meeting our
expectations. International transactions are subject to various risks, including
but not limited to:




§
            currency
      fluctuations;




§
            higher operating costs due to
      local laws or regulations;




§
            unexpected changes in regulatory
      requirements;




§
            tariffs and other trade
      barriers;




§
            costs and risks of localizing
      products for foreign
countries;




§
            difficulties in staffing and
      managing geographically disparate
  operations;




§
            greater difficulty in safeguarding
      intellectual property, licensing and other trade
      restrictions;




§
            challenges negotiating and
      enforcing contractual
provisions;




§
            repatriation of earnings;
      and




§
            anti-American sentiment due to the
      war in Iraq and other American policies that may be unpopular in certain
      regions, particularly in the Middle
East.




Interpretations of federal regulations
by governmental agencies may affect our business.




We may face regulatory risks as a result
of interpretations of other federal regulations, such as banking regulations, as
applied to our gaming systems. We may be required to make changes to our games
to comply with such regulations, with attendant costs and delays that could
adversely affect our business. Specifically, the IRS is conductinga BankSecrecy Act audit at one of the tribal
casinos, and the NIGC has deferred a determination of whether the tribal gaming
operations are in compliance with 25 C.F.R.§542.3(c)(2) until the IRS audit is
completed.




We may be unable to develop, enhance or
introduce successful gaming systems and games.




We may be unable to successfully and
cost effectively develop and introduce new and enhanced gaming systems, games
and content that will be widely accepted both by our customers and their end
users. Additionally, we may be unable to enhance existing products in a timely
manner in response to changing regulatory, legal or market conditions or
customer requirements, or new products or new versions of our existing products
may not achieve market acceptance. A decrease in demand for our games could also
result in an increase in our inventory obsolescence charges.




We have limited control over our
customers’ casino operations.




Collectively
our senior management has decades of successful experience in gaming operations.
Where appropriate, we seek to provide assistance to our key customers in the
form of project management, with a focus on facility layout and planning, gaming
floor configuration and customized marketing and promotional initiatives.
However, our key customers are solely responsible for the operations of their
facilities. Our key customers may not take our advice on their operations,
marketing, facility layout, gaming floor configuration, or promotional
initiatives.To the extent
that our machines are not a part of an optimized facility layout or gaming floor
configuration, or to the extent that our machines are not supported by effective
marketing or promotional initiatives, our operating results could
suffer.




-42-




We are dependent upon a few customers
who are based in Oklahoma.




For the
six months ended March 31, 2009 and 2008, approximately 66%
and 58%, respectively, of our gaming revenues were from Native American
tribes located in Oklahoma, and approximately 43% and 41%,
respectively, of our gaming revenues were from one tribe in that state. The significant concentration of our
customers in Oklahoma means that local economic changes may adversely affect our
customers, and therefore our business, disproportionately to changes in national
economic conditions, including more sudden adverse economic declines or slower
economic recovery from prior declines. The loss of any of our Oklahoma tribes as
customers would have a material and adverse effect upon our financial condition
and results of operations. In addition, the legislation allowing tribal-state
compacts in Oklahoma has resulted in increased competition from other vendors,
who we believe have avoided entry into the Oklahoma market due to its uncertain
and ambiguous legal environment. The legislation allows for other types of
gaming, both at tribal gaming facilities and at Oklahoma racetracks. The loss of
significant market share to these new gaming opportunities or the increased
presence of our competitors’ products in Oklahoma could also have a material
adverse effect upon our financial condition and results of
operations.




We believe the introduction of more
aggressive instant bingo machines, with characteristics of traditional slot
machines, into the Oklahoma market, has adversely affected our operating results
and market position in that state and may continue to do so in the
future.




State compacts with our existing Native
American customers to allow Class III gaming could reduce demand for our
Class II games.




As our Class II tribal customers
enter into compacts with the states in which they operate, allowing the tribes
to offer Class III games, we believe the number of our game machine
placements in those customers’ facilities could decline significantly, and our
operating results could be materially and adversely affected. As our tribal
customers make the transition to gaming under compacts with the state, we
believe there will be significant uncertainty in the market for our games that
will make our business more difficult to manage or predict.




As a result, we anticipate further
pressure on our market and revenue share percentages in Oklahoma or the market
could shift from revenue share arrangements to a “for sale” model. We believe
the establishment of state compacts depends on a number of political, social,
and economic factors that are inherently difficult to ascertain. Accordingly,
although we attempt to closely monitor state legislative developments that could
affect our business, we may not be able to timely predict when or if a compact
could be entered into by one or more of our tribal
customers.




We may not realize satisfactory returns
on money lent to new and existing customers to develop or expand gaming
facilities.




We enter into development agreements to
provide financing for construction or remodeling of gaming facilities, primarily
in the state of Oklahoma. Under our development agreements, we secure a
long-term revenue share percentage and a fixed number of player terminal
placements in the facility, in exchange for development and construction
funding. However, we may not realize the anticipated benefits of any of these
strategic relationships or financing. In connection with one or more of these
transactions, and to obtain the necessary development funds, we may issue
additional equity securities which would dilute existing stockholders; extend
secured and unsecured credit to potential or existing tribal customers that may
not be repaid; incur debt on terms unfavorable to us or that we are unable to
repay; and incur contingent liabilities.




Our development efforts or financing
activities may result in unforeseen operating difficulties, financial risks, or
required expenditures that could adversely affect our liquidity. It may also
divert the time and attention of our management that would otherwise be
available for ongoing development of our business. In addition, certain of the
agreements contain performance standards for our player terminals that could
allow the facility to reduce a portion of our player
terminals.




The NIGC has expressed its view that our
development agreements violate the requirements of IGRA and tribal gaming
regulations, which state that the Native American tribes must hold “sole
proprietary interest” in the tribes’ gaming operations, which presents
additional risks for our business (See “Risk Factors – Our ability to
effectively compete in Native American gaming markets is vulnerable to legal and
regulatory uncertainties.”)




In the past we have, and in the future
we expect to, reduce our floor space in certain of our Class II facilities
as a result of ongoing competitive pressures faced by our customers from
alternative gaming facilities and faced by our machines from competitors’
products. In addition, future NIGC decisions could affect our ability to place
our games with these tribes.




-43-




Our industry is intensely
competitive.




We operate in an intensely competitive
industry against larger companies with significant financial, research design
and development, and marketing resources. These larger companies are
aggressively competing against us in our core business operations, including but
not limited to, charity bingo, lottery, Class II, Class III, and international
bingo markets. Additionally, new smaller competitors may enter our traditional
markets. The increased competition will intensify pressure on our pricing model.
We expect to face increased competition as we attempt to enter new markets and
new geographical locations. In the future, gaming providers will compete on the
basis of price as well as the entertainment value and technological superiority
of their products.




Other members of our industry may
independently develop games similar to our games, and competitors may introduce
noncompliant games that unfairly compete in certain markets due to uneven
regulatory enforcement policies.




Additionally, our customers compete with
other providers of entertainment for their end user’s entertainment budget.
Consequently, our customers might not be able to spend new capital on acquiring
gaming equipment. Moreover, our customers might reduce their utilization of
revenue share agreements.




We may not be able to successfully
implement new sales strategies.




As we attempt to generate new streams of
revenue by selling Class III units to new customers we may have difficulty
implementing an effective sales strategy. Our failure to successfully implement
an effective sales strategy could result in our future operating results to vary
materially from what management has forecast.




We may not be successful in protecting
our intellectual property rights, or avoiding claims that we are infringing upon
the intellectual property rights of others.




We rely upon patent, copyright,
trademark and trade secret laws, license agreements and employee nondisclosure
agreements to protect our proprietary rights and technology, but these laws and
contractual provisions provide only limited protection. We rely to a greater
extent upon proprietary know-how and continuing technological innovation to
maintain our competitive position. Insofar as we rely on trade secrets,
unpatented know-how and innovation, others may be able to independently develop
similar technology, or our secrecy could be breached. The issuance of a patent
to us does not necessarily mean that our technology does not infringe upon the
intellectual property rights of others. As we enter into new markets by
leveraging our existing technology, and by developing new technology and new
products, it becomes more and more likely that we will become subject to
infringement claims from other parties. We are currently involved in several
patent disputes. See ”Part I – Item I. Condensed Financial Statements –
Note 8 – Commitments and Contingencies.” Problems with patents or other
rights could increase the cost of our products, or delay or preclude new product
development and commercialization. If infringement claims against us are valid,
we may seek licenses that might not be available to us on acceptable terms or at
all. Litigation would be costly and time consuming, but may become necessary to
protect our proprietary rights or to defend against infringement claims. We
could incur substantial costs and diversion of management resources in the
defense of any claims relating to the proprietary rights of others or in
asserting claims against others. We cannot guarantee that our intellectual
property will provide us with a competitive advantage or that it will not be
circumvented by our competitors.




We rely on software licensed from third
parties, and on technology provided by third-party vendors, the loss of which
could increase our costs and delay deployment or suspend development of our
gaming systems and player terminals.




We integrate various third-party
software products as components of our software. Our business would be disrupted
if this software, or functional equivalents of this software, were either no
longer available to us or no longer offered to us on commercially reasonable
terms. In either case, we would be required to either redesign our software to
function with alternate third-party software, or to develop these components
ourselves, which would result in increased costs and could result in delays in
our deployment of our gaming systems and player terminals. Furthermore, we might
be forced to limit the features available in our current or future software
offerings.




-44-




Our Manufacturing and License Agreement
with WMS Gaming, Inc., which was originally entered into on
May 17, 2004 and amended and restated on June 29, 2005 (the
“Agreement”), will expire under operation of its terms on
June 30, 2009. The Agreement enabled us to distribute, at a discount,
WMS licensed products (i) on an exclusive (except as to WMS) basis in the
Class II and Class III Native American market in Oklahoma;
(ii) on a limited exclusive basis (except as to WMS and subject to WMS’
existing commitments) in the Class II Native American market in North
America, the pull tab and Class II-style bingo market in Mexico, and in the
Charity markets in Alabama; and (iii) on a non exclusive basis for the
Class III market in Washington. After June 30, 2009, we may continue
to distribute WMS products pursuant to certain sell-off rights in Oklahoma and
Mexico and certain limited distribution rights in Washington; however, we
will not have the benefits of a contractual discount or a grant of
exclusivity.




We rely on the content of certain
software that we license from third-party vendors. The software could contain
bugs that could have an impact on our business.




We also rely on the technology of
third-party vendors, such as telecommunication providers, to operate our
nationwide broadband telecommunications network. A serious or sustained
disruption of the provision of these services could result in some of our player
terminals being non-operational for the duration of the disruption, which would
reduce over-all revenue from those player terminals.




We do not rely upon the term of our
customer contracts to retain the business of our customers.




Our contracts with our customers are on
a year-to-year or multi-year basis. Except for customers with whom we have
entered into development agreements, we do not rely upon the stated term of our
customer contracts to retain the business of our customers, as often
noncontractual considerations unique to doing business in the Native American
market override strict adherence to contractual provisions. We rely instead upon
providing competitively superior player terminals, games and systems to give our
customers the incentive to continue doing business with us. At any point in
time, a significant portion of our business is subject to nonrenewal, which may
materially and adversely affect our earnings, financial condition and cash
flows.




If our key personnel leave us, our
business could be materially adversely affected.




We depend on the continued performance
of the members of our senior management team and our technology team. If we were
to lose the services of any of our senior officers, directors, or any key member
of our technology team, and could not find suitable replacements for such
persons in a timely manner, it could have a material adverse effect on our
business.




We may incur prize payouts in excess of
game revenues.




Certain of our contracts with our Native
American customers relating to our Legacy and Reel Time Bingo system games
provide that our customers receive, on a daily basis, an agreed percentage of gross
gaming revenues based upon an assumed level of prize payouts, rather than the
actual level of prize payouts. This arrangement can result in our paying our
customers amounts greater than our customers’percentage share ofthe actual win per unit. In addition,
because the prizes awarded in our games are based upon assumptions as to the
number of players in each game and statistical assumptions as to the frequency
of winners, we may experience on any day, or over short periods of time, a “game deficit,”where the aggregate amount of prizes
paid exceeds aggregate game revenues. If we have to make any excess payments to
customers, or experience a game deficit over any statistically relevant period
of time, we are contractuallyentitled to adjust the rates of prize
payout to end users inorder to recover any deficit. In the future, we may miscalculate our statistical
assumptions, or for other reasons we may experience abnormally high rates of
jackpot prize wins, which could materially and adversely affect our cash flow on
a temporary or long-term basis, and which could materially and adversely affect
our earnings and financial condition.




If we fail to maintain an effective
system of internal controls, we may not be able to accurately report financial
results or prevent fraud.




Effective internal controls are
necessary to provide reliable financial reports and to assist in the effective
prevention of fraud. Any inability to provide reliable financial reports or
prevent fraud could harm
our business. We must annually evaluate our internal procedures to satisfy the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which
requires management and auditors to assess the effectiveness of internal
controls. If we fail to remedy ormaintain the adequacy of our internal
controls, as such standards are modified, supplemented or amended from time to
time, we could be subject to regulatory scrutiny, civil or criminal penalties or
shareholder litigation.




In addition, failure to maintainadequate internal controls
could result in financial statements that do not accurately reflect our
financial condition. There can be no assurance that we will be able to complete
the work necessary to fully comply with the requirements of the
Sarbanes-Oxley Act or that our management and our
independent registered public accounting firm will continue to conclude that our
internal controls are effective.




-45-




Our business prospects and future
success rely heavily upon the integrity of our employees and executives and the
security of our gaming systems.




The integrity and security of our gaming
systems are critical to our ability to attract customers and players. We strive
to set exacting standards of personal integrity for our employees and for system
security involving the gaming systems that we provide to our customers. Our
reputation in this regard is an important factor in our business dealings with
our current and potential customers. For this reason, an allegation or a finding
of improper conduct on our part or on the part of one or more of our employees
that is attributable to us, or of an actual or alleged system security defect or
failure attributable to us could have a material adverse effect upon our
business, financial condition, results and prospects, including our ability to
retain existing contracts or obtain new or renewed
contracts.




Our games and systems may experience
loss based on malfunctions, anomalies or fraudulent
activities.




Our games and systems could produce
false payouts as the result of malfunctions, anomalies or fraudulent activities.
We depend on our security precautions to prevent fraud. We depend on regulatory
safeguards, which may not be available in all jurisdictions or markets, to
protect us against jackpots awarded as a result of malfunctions, anomalies or
fraudulent activities. There can be no guarantee that regulatory safeguards, in
jurisdictions or markets were they do exist, will be sufficient to protect us
from liabilities associated with malfunctions, anomalies or fraudulent
activities.




The occurrence of malfunctions,
anomalies or fraudulent activities could result in litigation against us by our
customers based on lost revenue or other claims based in tort or breach of
contract. Moreover, these occurrences could result in investigations or
disciplinary actions by applicable gaming regulators.




Any disruption in our network or
telecommunications services, or adverse weather conditions in the areas in which
we operate could affect our ability to operate our games, which would result in
reduced revenues and customer down time.




Our network is susceptible to outages
due to fire, floods, power loss, break-ins, cyberattacks and similar events. We
have multiple site back-up for our services in the event of any such occurrence.
Despite our implementation of network security measures, our servers are
vulnerable to computer viruses and break-ins. Similar disruptions from
unauthorized tampering with our computer systems in any such event could have a
material adverse effect on our business, operating results and financial
condition.




Adverse weather conditions, particularly
flooding, tornadoes, heavy snowfall and other extreme weather conditions often
deter our end users from traveling, or make it difficult for them to frequent
the sites where our games are installed. If any of those sites experienced
prolonged adverse weather conditions, or if the sites in Oklahoma, where a
significant number of our games are installed, simultaneously experienced
adverse weather conditions, our results of operations and financial condition
would be materially and adversely affected.




In addition, our agreement with the New
York State Division of the Lottery permits termination of the contract at any
time for failure by us or our system to perform properly. Failure to perform
under this contract or similar contracts could result in substantial monetary
damages, as well as contract termination.




In addition, we enter into certain
agreements that could require us to pay damages resulting from loss of revenues
if our systems are not properly functioning, or as a result of a system
malfunction or an inaccurate pay table.




Worsening economic conditions may
adversely affect our business.




The demand for entertainment and leisure
activities tends to be highly sensitive to consumers’ disposable incomes, and
thus a decline in general economic conditions or an increase in gasoline prices
may lead to our end users having less discretionary income with which to wager.
This situation could cause a reduction in our revenues and have a material
adverse effect on our operating results. The gaming industry is currently
experiencing a period of reduced demand. If, as a result of deteriorating
economic conditions, fewer people gamble in our customers' facilities, or if
amounts spent per person in our customers' facilities are reduced from
historical levels, our business could be materially and adversely
affected.




Additionally, a decline in general
economic conditions might negatively impact our customers’ abilities to pay us
in a timely fashion. Our customers’ failures to make timely payments could
result in an increase in our bad debt provision.




-46-




We could be adversely affected by an
outbreak of a disease that negatively affects our customers.




In mid-April of 2009, there was an
outbreak of the influenza H1N1 virus, or “swine flu,” in Mexico, which caused
the temporary closing of several of our client’s bingo parlors in that country.
Additionally, there have been sporadic outbreaks of swine flu, including in the
southwestern United States and Mexico, where our most significant clients are
located. If the swine flu outbreak, or the outbreak of another disease (such as
SARS or avian flu), discourages people from traveling or causes people to avoid
public places (including casinos and bingo parlors), it could have a material
adverse effect on our clients’ gaming businesses and, ultimately, a material
adverse impact on our results of operations and financial
condition.




Our ability to recognize revenue at the
time of sale and delivery is dependent upon obtainingVendor-Specific
Objective Evidence, or VSOE, for
products yet to be delivered or services yet to be
performed.




We believe future transactions with
existing and future customers may be more complex than transactions entered into
currently. As a result, we
may enter into more complicated business and contractual relationships with
customers which, in turn, can engender increased complexity in the related
financial accounting. Legal and regulatory uncertainty may also affect our
ability to recognizerevenue associated with a particular
project, and therefore the timing and possibility of actual revenue recognition
may differ from our forecast.




The carrying value of our assets in
Mexico is dependent upon our ability to successfully deploy games into
Mexico.




We have excess player stations not
deployed atMarch 31, 2009, which were intended to be deployed at
facilities in Mexico. If the opening of facilities is altered negatively, either
by significant delay, or by cancellation, the realizable value of these assets
could be reduced. In such instances we may be required to recognize increased
expense on our income statement related to the impairment of these
assets.




-47-




ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS




None.




ITEM
      3.
            DEFAULTS
      UPON SENIOR SECURITIES




None.




ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS




None




ITEM
      5.
            OTHER
      INFORMATION




None.




ITEM
      6.
            EXHIBITS




(a)         Exhibits




See
Exhibit Index.




-48-




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
duly authorized.




Date:
      May 8, 2009
                            Multimedia
      Games, Inc.By:
                            /s/    Adam D.
      Chibib†Adam
      D. ChibibChief
      Financial
Officer




†Mr.
Chibib is signing as an authorized officer and as our Principal Financial
Officer and Principal Accounting Officer.




-49-




EXHIBIT
INDEX




EXHIBIT NO.
                  
                  TITLE
                  
                  LOCATION3.1
                  
                  
                  Amended
      and Restated Articles of Incorporation
                  
                  (1)3.2
                  
                  
                  Amendment
      to Articles of Incorporation
                  
                  (2)3.3
                  
                  
                  Second
      Amended and Restated Bylaws, as Amended
                  
                  (3)10.1
                  
                  
                  Employment Agreement executed
      February 2, 2009 between the Company and Adam
      Chibib
                  
                  (4)10.2
                  
                  
                  Employment Agreement executed
      January 12, 2009 between the Company and Mick
      Roemer
                  
                  (*)31.1
                  
                  
                  Certification
      of Principal Executive Officer, pursuant to Section 302 of the Sarbanes
      Oxley Act of 2002
                  
                  (*)31.2
                  
                  
                  Certification
      of Principal Accounting Officer, pursuant to Section 302 of the Sarbanes
      Oxley Act of 2002
                  
                  (*)32.1
                  
                  
                  Certification
      as required by Section 906 of the Sarbanes Oxley Act of
    2002
                  
                  (*)







(1)
            Incorporated
      by reference to our Form 10-QSB filed with the Securities and Exchange
      Commission, or SEC, for the quarter ended March 31,
    1997.


(2)
            Incorporated
      by reference to our Form 10-Q filed with the SEC for the quarter ended
      December 31, 2003.


(3)
            Incorporated
      by reference to our Form 10-K filed with the SEC on
      December 15, 2008.


(4)
            Incorporated by reference to our
      Form 8-K filed with the SEC on
      February 2, 2009.


(*)
Filed herewith.




-50-