UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




Form
10-Q


(Mark
One)


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




For the
quarterly period ended December
31, 2009


OR


 ̈ 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, Building
      B, Fourth Floor
                Austin,
      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 ý  No  ̈




Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such
files):     Yes  ̈  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 ý




Non-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 ý




As of
February 5, 2010, there were 27,319,095 shares of the Registrant’s
common stock, par value $0.01 per share, outstanding.







FORM
10-Q
  INDEX


PART I.  FINANCIAL
      INFORMATIONItem
      1.
              Condensed
      Financial Statements (Unaudited)Consolidated
      Balance Sheets
                (As
      of December 31, 2009and September 30,
      2009)
              3Consolidated
      Statements of Operations
                (For
      the three months ended December 31, 2009 and
    2008)
              4Consolidated
      Statements of Cash Flows
                (For
      the three months ended December 31, 2009 and
    2008)
              5Notes
      to Consolidated Financial Statements
              6Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              18Item
      3.
              Quantitative
      and Qualitative Disclosures about Market Risk
              27Item
      4.
              Controls
      and Procedures
              28PART II.  OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              29Item
      1A.
              Risk
      Factors
              29Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              42Item
      3.
              Defaults
      upon Senior Securities
              42Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              42Item
      5.
              Other
      Information
              42Item
      6.
              Exhibits
              42Signatures
              43Exhibit
      Index




-2-





PART
      I
                  FINANCIAL
      INFORMATION
                  
                  Item 1. Condensed Financial
      Statements
                MULTIMEDIA
      GAMES, INC.
              
              CONSOLIDATED
      BALANCE SHEETS
              As of
      December 31, 2009 and September 30,
      2009
              (In
      thousands, except shares)
              (Unaudited)ASSETS
            
            December 31,
              2009
            
            
            September 30,
              2009CURRENT
      ASSETS:Cash and cash
      equivalents
            
            $
            14,915
            
            
            $
            12,455Accounts receivable, net of
      allowance for doubtful accounts
              of
      $3,783 and $3,676, respectively
            
            
            9,946
            
            
            
            13,424Inventory
            
            
            5,096
            
            
            
            5,742Deferred contract costs,
      net
            
            
            579
            
            
            
            1,826Prepaid expenses and
      other
            
            
            1,835
            
            
            
            2,806Current portion of notes
      receivable, net
            
            
            16,429
            
            
            
            15,780Federal and state income tax
      receivable
            
            
            7,006
            
            
            
            6,246Deferred income
      taxes
            
            
            973
            
            
            
            1,138Total current
      assets
            
            
            56,779
            
            
            
            59,417Restricted
      cash and long-term investments
            
            
            772
            
            
            
            804Leased
      gaming equipment, net
            
            
            34,918
            
            
            
            34,002Property
      and equipment, net
            
            
            31,893
            
            
            
            35,048Long-term
      portion of notes receivable, net
            
            
            35,299
            
            
            
            40,124Intangible
      assets, net
            
            
            31,214
            
            
            
            33,361Other
      assets
            
            
            10,301
            
            
            
            9,895Deferred
      income taxes
            
            
            3,134
            
            
            
            2,969Total
    assets
            
            $
            204,310
            
            
            $
            215,620LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Current portion of long-term
      debt
            
            $
            1,325
            
            
            $
            2,073Accounts payable and accrued
      expenses
            
            
            23,353
            
            
            
            26,878Deferred
revenue
            
            
            3,874
            
            
            
            2,341Total current
      liabilities
            
            
            28,552
            
            
            
            31,292Revolving
      line of credit
            
            
            10,000
            
            
            
            15,000Long-term
      debt, less current portion
            
            
            58,488
            
            
            
            58,675Other
      long-term liabilities
            
            
            772
            
            
            
            789Deferred
      revenue, less current portion
            
            
            1,894
            
            
            
            2,409Total
      liabilities
            
            
            99,706
            
            
            
            108,165Commitments
      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,
              33,207,287
      and 33,121,337 shares issued, and
              27,303,870
      and 27,217,920 shares outstanding, respectively
            
            
            332
            
            
            
            331Additional paid-in
      capital
            
            
            87,159
            
            
            
            86,317Treasury stock, 5,903,417
      common shares at cost
            
            
            (50,128
            )
            
            
            (50,128
            )Retained
    earnings
            
            
            68,674
            
            
            
            72,803Accumulated other comprehensive
      loss, net
            
            
            (1,433
            )
            
            
            (1,868
            )Total stockholders’
      equity
            
            
            104,604
            
            
            
            107,455Total liabilities and
      stockholders’ equity
            
            $
            204,310
            
            
            $
            215,620


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




-3-




CONSOLIDATED
      STATEMENTS OF OPERATIONS
              For
      the Three Months Ended December 31, 2009
      and 2008
              (In
      thousands, except per share data)
              (Unaudited)Three
      Months Ended
              December 31,2009
            
            
            2008REVENUES:Gaming
      operations
            
            $
            22,422
            
            
            $
            26,348Gaming equipment and system
      sales
            
            
            3,250
            
            
            
            1,766Other
            
            
            593
            
            
            
            462Total revenues
            
            
            26,265
            
            
            
            28,576OPERATING
      COSTS AND EXPENSES:Cost of revenues (1)
            
            
            2,110
            
            
            
            1,847Selling, general and
      administrative expenses
            
            
            14,969
            
            
            
            20,264Amortization and
      depreciation
            
            
            13,554
            
            
            
            14,865Total operating costs and
      expenses
            
            
            30,633
            
            
            
            36,976Operating loss
            
            
            (4,368
            )
            
            
            (8,400
            )OTHER
      INCOME (EXPENSE):Interest income
            
            
            1,049
            
            
            
            1,290Interest
expense
            
            
            (1,308
            )
            
            
            (2,135
            )Other income
            
            
            -
            
            
            
            74Loss
      before income taxes
            
            
            (4,627
            )
            
            
            (9,171
            )Income
      tax benefit
            
            
            498
            
            
            
            3,247Net loss
            
            $
            (4,129
            )
            
            $
            (5,924
            )Basic
      and diluted loss per common share
            
            $
            (0.15
            )
            
            $
            (0.22
            )Shares
      used in loss per common share:Basic and
    diluted
            
            
            27,242
            
            
            
            26,624


(1)
                Cost
      of revenues exclude depreciation and amortization of gaming equipment,
      content license rights and other depreciable assets, which are included
      separately in the amortization and depreciation line
  item
 The
accompanying notes are an integral part of the condensed consolidated financial
statements.
  -4-


MULTIMEDIA
      GAMES, INC.
              
              CONSOLIDATED
      STATEMENTS OF CASH FLOWS
              For the Three Months EndedDecember 31, 2009and 2008
              (In
      thousands)
              (Unaudited)Three
      Months Ended
              December 31,CASH
      FLOWS FROM OPERATING ACTIVITIES:
            
            2009
            
            
            2008Net
      loss
            
            $
            (4,129
            )
            
            $
            (5,924
            )Adjustments
      to reconcile net loss to cash provided
              by
      operating activities:Amortization
            
            
            781
            
            
            
            1,388Depreciation
            
            
            12,773
            
            
            
            13,477Accretion of contract
      rights
            
            
            1,741
            
            
            
            1,326Adjustments to long-lived
      assets
            
            
            186
            
            
            
            (1,142
            )Deferred income
      taxes
            
            
            —
            
            
            
            (887
            )Share-based
      compensation
            
            
            625
            
            
            
            654Provision for doubtful
      accounts
            
            
            150
            
            
            
            149Interest income from imputed
      interest
            
            
            (906
            )
            
            
            (1,152
            )Changes in operating assets and
      liabilities:Accounts
      receivable
            
            
            3,328
            
            
            
            684Inventory
            
            
            1,656
            
            
            
            (3,055
            )Deferred contract
      costs
            
            
            1,247
            
            
            
            (456
            )Prepaid expenses and
      other
            
            
            541
            
            
            
            (371
            )Federal and state income tax
      receivable
            
            
            (760
            )
            
            
            (2,586
            )Notes
    receivable
            
            
            1,133
            
            
            
            1,151Accounts payable and accrued
      expenses
            
            
            (4,250
            )
            
            
            9,733Other long-term
      liabilities
            
            
            15
            
            
            
            (16
            )Deferred
    revenue
            
            
            1,018
            
            
            
            277NET
      CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            15,149
            
            
            
            13,250CASH
      FLOWS USED IN INVESTING ACTIVITIES:Acquisition of property and
      equipment and leased gaming equipment
            
            
            (10,066
            )
            
            
            (25,058
            )Acquisition of intangible
      assets
            
            
            (733
            )
            
            
            (845
            )Repayments under development
      agreements
            
            
            4,136
            
            
            
            1,819NET
      CASH USED IN INVESTING ACTIVITIES
            
            
            (6,663
            )
            
            
            (24,084
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds from exercise of stock
      options, warrants,
              and related tax
      benefit
            
            
            218
            
            
            
            61Proceeds from long-term
      debt
            
            
            —
            
            
            
            2,894Principal payments of long-term
      debt
            
            
            (1,043
            )
            
            
            (1,985
            )Proceeds from revolving lines
      of credit
            
            
            —
            
            
            
            6,444Payments on revolving lines of
      credit
            
            
            (5,000
            )
            
            
            (222
            )NET
      CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
            
            
            (5,825
            )
            
            
            7,192EFFECT
      OF EXCHANGE RATES ON CASH
            
            
            (201
            )
            
            
            293Net
      increase (decrease) in cash and cash equivalents
            
            
            2,460
            
            
            
            (3,349
            )Cash
      and cash equivalents, beginning of period
            
            
            12,455
            
            
            
            6,289Cash
      and cash equivalents, end of period
            
            $
            14,915
            
            
            $
            2,940SUPPLEMENTAL
      CASH FLOW DATA:Interest paid
            
            $
            1,
      083
            
            
            $
            681Income tax paid
            
            $
            —
            
            
            $
            208NON-CASH
      TRANSACTIONS:Change
      in contract rights resulting from imputed interest on development
      agreement notes receivable
            
            $
            (187
            )
            
            $
            568Transfer
      of  leased gaming equipment to inventory
            
            $
            261
            
            
            $
            —


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


-5-


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, 2009.




The
unaudited financial statements included herein as of December 31, 2009, and for
each of the three month periods ended December 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 month period ended December 31, 2009 are not necessarily
indicative of the results which will be realized for the year ending
September 30, 2010. References to specific U.S. GAAP within this
report cite topics within the Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”). We have evaluated all subsequent
events through February 9, 2010, the date that the financial statements were
issued.  The condensed consolidated balance sheet as of September 30,
2009 was derived from the audited consolidated financial statements at that
date.




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 tribes,
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.




-6-





Reclassification–Reclassifications were made
to the prior-period financial statements to conform to the current period
presentation.  Specifically, the depiction of revenue on the condensed
consolidated statement of operations was changed to more closely reflect the
manner in which Company management analyzes the performance of the
business.  These reclassifications did not have an impact on the
Company’s previously reported results of operations or earnings(loss) per share
amounts.  Additionally, these reclassifications did not impact
compliance with any applicable debt covenants in the Company’s credit
agreement.




Revenue
Recognition–In
accordance with the provision of ASC Topic 605, “Revenue Recognition”, 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.




Revenue–The Company derives revenue
from the following sources:




§
            Gaming
      Operations
            –
            Participation
      revenue generated from the Company’s games placed under the Oklahoma
      Compact, Native American Class II products, charity bingo and other bingo
      products, lottery systems and Class III back office
  systems§
            Gaming
      equipment and systems sales
            –
            Direct
      sales of player terminals, licenses and back office
  systems§
            Other
            –
            Maintenance
      and service arrangements and other




The
majority of the Company’s gaming revenue 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
condensed 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 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
ASC Topic 985, “Software” and ASC Topic 605, “Revenue
Recognition.”  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.




-7-





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.




§
            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 2009,
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
ASC Subtopic 605-35, “Construction-Type and Production-Type
Contracts.”  In the event that the Company expected a loss on a
contract accounted for under Subtopic 605-35, the Company would record the
entire estimated loss in the quarter in which it was determined that a loss was
expected. At December 31, 2009, no loss provision related to this contract has
been recorded.




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
December 31, 2009 and September 30, 2009, the following amounts were recorded in
the Company’s condensed consolidated balance sheet:




December
      31,
              2009
            
            
            September
      30,
              2009(in
      thousands)Costs
      incurred on uncompleted contracts
            
            $
            4,235
            
            
            $
            3,697Billings
      on uncompleted contracts
            
            
            (3,656
            )
            
            
            (1,871
            )Deferred
      contract costs, net
            
            $
            579
            
            
            $
            1,826




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
December 31, 2009 and September 30, 2009, amounted to $772,000 and $804,000,
respectively, 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 quarterly 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.




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 twelve months. Inventories are stated at average costs, which
approximate the lower of cost (first in, first out) or market.




-8-





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.




Other Assets –Other assets consisted primarily of a receivable from the Mexican
government related to value added taxes (VAT) paid in connection with the
deployment of assets in the Mexican market.  The balance of the VAT
receivable was $7.9 million and $7.5 million as of December 31, 2009 and
September 30, 2009, respectively. At this time management expects to fully
collect any and all outstanding balances; however, the ultimate collectability
is uncertain.




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 Long-Term
Liabilities –Other long-term liabilities at December 31, 2009 include
investments held at fair value by the Company’s prize-fulfillment firm related
to outstanding MegaBingo jackpot-prize-winner annuities.  These
annuities were $772,000 and $800,000 as of December 31, 2009 and September 30,
2009, respectively.




Fair Value of
Financial Instruments –The carrying value of financial instruments
reported in the accompanying condensed consolidated balance sheets for cash,
accounts and notes receivable, accounts payable, and accrued expenses payable
and other liabilities, approximate fair value due to the immediate or short-term
nature or maturity of these financial instruments. The carrying amount for our
credit facility approximates fair value due to the fact that the underlying
instrument includes provisions to adjust interest rates to approximate fair
value.




Segment and
Related Information–Although the Company has a number of operating divisions the company
reports as one segment, as these divisions meet the criteria for aggregation as
permitted by ASC Topic 280, “Segment Reporting.”




Costs of Computer
Software –Software
development costs have been accounted for in accordance with ASC Topic 985,
“Software.”  Under ASC Topic 985, 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
$686,000 and $640,000 during the three month periods ended December 31,
2009 and December 31, 2008, respectively. Software development costs primarily
consist of personnel costs. 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 condensed consolidated statements of
operations.




Income Taxes –The Company accounts for income taxes using the asset and liability
method and applies the provisions of ASC Topic 740, “Income Taxes”. Under ASC
Topic 740, 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.  Additionally, in accordance with ASC Topic 740, we are
required to determine whether it is more likely than not (a likelihood of more
than 50 percent) 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 percent likely of being realized upon ultimate settlement.




-9-





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




Share-Based
Compensation – The Company accounts for share-based compensation under
the provisions of ASC Topic 718, “Compensation – Stock Compensation.” Among
other items, ASC Topic 718 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. 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.  Expense is recognized over the
required service period, which is generally the vesting period of the
options.




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 240,400 option grants issued to employees during the three months
ended December 31, 2009 at an average fair value per share price of $5.27. Total
pretax share-based compensation for the three month periods ended December 31,
2009 and 2008 were $625,000 and $654,000, respectively.  The
Company did not recognize an income tax benefit for stock-based compensation
arrangements in the three months ended December 31, 2009.  The total
income tax benefit recognized in the statement of operations for share-based
compensation arrangements was $143,000 for the three month periods ended
December 31, 2008. As of December 31, 2009, $6.0 million of unamortized
stock compensation expense remained, which will be recognized over the vesting
periods of the various option grants.




Foreign Currency
Translation. The Company accounts for currency translation in accordance
with ASC Topic 830. “Foreign Currency Matters.”  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 ASC Topic 220, “Comprehensive Income.”
Transactional currency gains and losses arising from transactions in currencies
other than the Company’s local functional currency are included in the condensed
consolidated statement of operations in accordance with ASC Topic
830.


Comprehensive
Income(Loss). Comprehensive loss consists of the
following:
  Three
      months ended December 31,2009
              
              
              2008(in
      thousands)Net
      loss
              
              $
              (4,129
              )
              
              $
              (5,924
              )Foreign
      currency translation adjustment
              
              
              435
              
              
              
              (1,918
              )Comprehensive
      loss
              
              $
              (3,694
              )
              
              $
              (7,842
              )





Recent Accounting
Pronouncements Issued. In June 2009, the FASB issued Statement of
Financial Accounting Standards No. 168, “The FASB Accounting Standards
Codification and Hierarchy of Generally Accepted Accounting Principles.” FASB
Accounting Standards Codification (ASC) has become the source of authoritative
generally accepted accounting principles GAAP recognized by the FASB to be
applied by nongovernmental entities.  Rules and interpretive releases
of the SEC under authority of federal securities laws are also sources of
authoritative GAAP for SEC registrants.  On the effective date of this
statement, the codification will supersede all then-existing non-SEC accounting
and reporting standards; and all non-grandfathered, non-SEC accounting
literature not included in the codification will be superseded and deemed
non-authoritative.  The new codification standards have been adopted
by the Company in its annual report on Form 10-K as of September 30,
2009.  Reference to the new ASC topic, subtopic, or section has been
provided in place of historical accounting literature. The adoption of
codification standards did not impact our consolidated financial position,
results of operation or cash flows.





In
October 2009, FASB issued ASU No. 2009-13, “Revenue Recognition(Topic 605),
Multiple-Deliverable Revenue Arrangements” and ASU No. 2009-14, “Software(Topic
985), Certain Revenue Arrangements that Include Software Elements,” both
consensus of the FASB Emerging Issues Task Force.  ASU No. 2009-13
establishes the accounting and reporting guidance for arrangements under which
the vendor will perform multiple revenue-generating activities; specifically,
how to separate deliverables and how to measure and allocate arrangement
consideration to one or more units of accounting.  ASU No. 2009-14
affects vendors that sell or lease tangible products in an arrangement that
contains software that is more than incidental to the tangible product as a
whole and clarifying what guidance should be used in allocating and measuring
revenue.  Upon adoption of these standards, a company can recognize
revenue on delivered elements within a multiple elements arrangement based upon
estimated selling prices, which is a departure from previous guidance. These
standards are required to be implemented by October 1, 2010, but we are
currently evaluating the impact of implementation, as early adoption is
permitted.





-10-





In May
2009, the FASB issued ASC Topic 855, “Subsequent Events”, which establishes
the accounting for and disclosure of events that occur after the balance sheet
date but before the financial statements are issued or are available to be
issued.  It requires the disclosure of the date through which an
entity has evaluated subsequent events and the basis for that date; that is,
whether that date represents the date the financial statements were issued or
were available to be issued. Consistent with ASC Topic 855 requirements for
public entities, we evaluate subsequent events through the date the financial
statements are issued.  ASC Topic 855 should not result in significant
changes in the subsequent events that an entity reports, either through
recognition or disclosure, in its financial statements.  ASC Topic 855
was adopted by the Company as of June 30, 2009.  The adoption of ASC
Topic 855 did not impact our consolidated financial position, results of
operations or cash flows.





In
March 2008, the FASB issued ASC Topic 815, “Derivatives and Hedging.” ASC
Topic 815 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, and (c) derivative instruments and related hedged
items affect an entity's financial position, financial performance, and cash
flows. ASC Topic 815 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 adopted ASC Topic 815
effective October 1, 2009. The adoption of ASC Topic 815 did not have a
significant impact on the Company due to the immaterial nature of our derivative
and hedging activities.





Effective October 1, 2008,
the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures”,
for its financial assets and financial liabilities.  ASC Topic 820
permitted a one-year deferral of its application 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
full adoption of ASC Topic 820, as of October 1, 2009, as it pertains to both
financial and nonfinancial assets and liabilities did not have a material impact
on the Company’s financial position, results of operations or cash
flows.





In
December 2007, the FASB issued ASC Topic 805, “Business
Combinations.”  ASC Topic 805 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. ASC Topic 805 is effective for fiscal
years beginning after December 15, 2008, with early adoption
prohibited. The Company is adopted ASC Topic 805 effective
October 1, 2009, and the adoption did not have a material impact
on our financial position or results of operations.





In
December 2007, the FASB issued ASC Topic 810, “Consolidation.” ASC Topic
810 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, ASC Topic 810 revises the accounting for
both increases and decreases in a parent’s controlling ownership interest. ASC
Topic 810 is effective for fiscal years beginning after
December 15, 2008, with early adoption prohibited. The Company adopted
ASC Topic 810 effective October 1, 2009, and the adoption did not have
a material impact on our financial position or results of
operations.




-11-





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.




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
circumstances during the three month period ended December 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:




December
      31,
              2009
            
            
            September 30,
              2009Included
      in:
            
            (In
      thousands)Notes
      receivable, net
            
            $
            47,310
            
            
            $
            50,288Intangible
      assets – contract rights,
              net
      of accumulated amortization
            
            
            26,248
            
            
            
            28,175




3.      PROPERTY
AND EQUIPMENT AND LEASED GAMING EQUIPMENT




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




December
      31,
              2009
            
            
            September
      30,
              2009
            
            Estimated
              Useful
              Lives(In
      thousands)Gaming
      equipment and third-party gaming content licenses available for deployment
      (1)
            
            $
            5,474
            
            
            $
            6,449Deployed
      gaming equipment
            
            
            98,791
            
            
            
            99,522
            
            3-5
      yearsDeployed
      third-party gaming content licenses
            
            
            41,584
            
            
            
            39,512
            
            1.5-3
      yearsNative
      American tribal gaming facilities and portable buildings
            
            
            3,563
            
            
            
            3,563
            
            5-7
      yearsThird-party
      software costs
            
            
            7,720
            
            
            
            7,720
            
            3-5
      yearsVehicles
            
            
            3,064
            
            
            
            3,065
            
            3-10
      yearsOther
            
            
            3,089
            
            
            
            2,991
            
            3-7
      yearsTotal
      property and equipment
            
            
            163,285
            
            
            
            162,822Less
      accumulated depreciation and amortization
            
            
            (131,392
            )
            
            
            (127,774
            )Total
      property and equipment, net
            
            $
            31,893
            
            
            $
            35,048Leased
      gaming equipment
            
            $
            145,928
            
            
            $
            156,474
            
            3
      yearsLess
      accumulated depreciation
            
            
            (111,010
            )
            
            
            (122,472
            )Total
      leased gaming equipment, net
            
            $
            34,918
            
            
            $
            34,002





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




-12-





In
accordance with ASC Topic 360, “Property, Plant, and Equipment,” 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 month period ended December 31, 2009, in the ordinary course of
business activities or upon reviewing the account balances, the Company disposed
of or wrote off $249,000, of third-party gaming content licenses, Native
American tribal gaming facilities and portable buildings, vehicles, deployed
gaming equipment, or other equipment. In the same period ended December
31, 2008, the Company disposed of or wrote off $38,000.




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:




December
      31,
              2009
            
            
            September
      30,
              2009
            
            Estimated
              Useful
              Lives(In thousands)Contract
      rights
            
            $
            46,133
            
            
            $
            46,319
            
            5-7
      yearsInternally-developed
      gaming software
            
            
            28,903
            
            
            
            28,388
            
            1-5
      yearsPatents
      and trademarks
            
            
            8,273
            
            
            
            8,226
            
            1-5
      yearsOther
            
            
            961
            
            
            
            961
            
            3-5
      yearsTotal
      intangible assets
            
            
            84,270
            
            
            
            83,894Less
      accumulated amortization – all other
            
            
            (53,056
            )
            
            
            (50,533
            )Total
      intangible assets, net
            
            $
            31,214
            
            
            $
            33,361




Contract
rights are amounts allocated to intangible assets for dedicated floor space
resulting from development agreements or placement fees. The related
amortization expense, or accretion of contract rights, is netted against its
respective revenue category in the accompanying condensed consolidated
statements of operations.




Internally
developed gaming software is accounted for under the provisions of ASC Topic 985
“Software” 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 twelve month period, gaming
engines over an eighteen 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 month periods ended
December 31, 2009 and 2008, amortization expense related to internally-developed
gaming software was $550,000 and $1.1 million, respectively. During the three
month period ended December 31, 2009, the Company wrote off $171,000, related to
internally-developed gaming software and patents and trademarks, compared to
write-offs of $35,000 in the same period ended December 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.




-13-





5.      NOTES
RECEIVABLE




The
Company’s notes receivable consisted of the following:




December
      31,
              2009
            
            
            September 30,
              2009(In
      thousands)Notes
      receivable from development agreements
            
            $
            53,488
            
            
            $
            57,558Less
      imputed interest discount reclassed to contract rights
            
            
            (6,178
            )
            
            
            (7,270
            )Notes
      receivable from equipment sales and other
            
            
            4,418
            
            
            
            5,616Notes receivable,
      net
            
            
            51,728
            
            
            
            55,904Less
      current portion
            
            
            (16,429
            )
            
            
            (15,780
            )Notes receivable –
      non-current
            
            $
            35,299
            
            
            $
            40,124




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 5.75% as of December 31, 2009. 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:




December
      31,
              2009
            
            
            September 30,
              2009(In
      thousands)Long-term
      revolving lines of credit
            
            $
            10,000
            
            
            $
            15,000Term
      loan facility
            
            $
            59,813
            
            
            $
            60,748Less
      current portion
            
            
            (1,325
            )
            
            
            (2,073
            )Long-term debt, less current
      portion
            
            $
            58,488
            
            
            $
            58,675Total
      indebtedness under Credit Facility
            
            $
            69,813
            
            
            $
            75,748




Credit
Facility. On April 27, 2007, the Company entered into a
$150 million Credit Facility which replaced its previous credit facility in
its entirety. On October 26, 2007, the Company amended the Credit
Facility, and transferred a portion of the revolving credit commitment to a
fully funded term loan. 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 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 Credit Facility.




The
Credit Facility provides the Company with the ability to finance development
agreements and acquisitions and working capital for general corporate purposes.
Advances under the revolving credit commitment and the term loan mature on April
27, 2012, and 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).




On July
22, 2009, the Company entered into a third amendment to the Credit
Facility.  Under the terms of the amended credit agreement, the
calculation of consolidated Adjusted EBITDA (EBITDA, plus certain add-backs as
agreed upon by the lenders) for the purposes of evaluating compliance with the
specified covenants will now reflect the add-back of several items including:
(i) legal costs and settlement fees incurred in the trailing four-quarter period
related to litigation with Diamond Game Enterprises, Inc., or Diamond Game,
which was settled on May 1, 2009; (ii) all non-cash stock-based compensation
expenses; and, (iii) up to $10 million, in aggregate, of additional non-cash
asset impairment charges that we may incur in future periods. In conjunction
with the third amendment, the Company reduced the total borrowing capacity of
the credit facility to $125 million, $65 million under the revolving credit
commitment and $60 million under the term loan, from the previous total
borrowing capacity of $150 million and agreed to a LIBOR floor of 2%. As of
December 31, 2009 the $10 million drawn under the revolving credit
commitment bore interest at 5.75% and the $59.8 million on the term loan
bore interest at 6.5%.




-14-





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 : 1.00; (ii) a maximum total debt to Adjusted
EBITDA ratio of not more than 1.75 : 1.00; and (iii) a minimum
trailing twelve-month Adjusted EBITDA of not less than $60.0 million.
As of December 31, 2009, the Company is in compliance with the 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). As of December 31, 2009, the Company had availability under
the Credit Facility of $55.0 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, 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
ASC Topic 815, “Derivatives and Hedging” which requires entities to recognize
all derivative instruments as either assets or liabilities in the balance sheet,
at their respective fair values. We record, 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 condensed consolidated
statement of operations.




7.      EARNINGS
(LOSS) PER COMMON SHARE




Loss per
common share is computed in accordance with ASC Topic 260, “Earnings Per Share.”
Presented below is a reconciliation of net loss available to common stockholders
and the differences between weighted average common shares outstanding, which
are used in computing basic loss per share, and weighted average common and
potential shares outstanding, which are used in computing diluted loss per
share.  Diluted amounts are not included in the computation of diluted
loss per share, as such amounts would be antidilutive during the three month
periods ended December 31, 2009 and 2008.




Three
      months ended
              December
      31,2009
            
            
            2008Loss
      available to common stockholders
              (in
      thousands)
            
            $
            (4,129
            )
            
            $
            (5,924
            )Weighted
      average common shares outstanding
            
            
            27,242,412
            
            
            
            26,623,573Effect
      of dilutive securities:Options
            
            
            -
            
            
            
            -Weighted
      average common
              and
      potential shares outstanding
            
            
            27,242,412
            
            
            
            26,623,573Basic
      loss per share
            
            $
            (0.15
            )
            
            $
            (0.22
            )Diluted
      loss per share
            
            $
            (0.15
            )
            
            $
            (0.22
            )




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
              December
      31,2009
            
            
            2008Common
      Stock Options
            
            
            6,837,149
            
            
            
            6,779,693Range
      of exercise price
            
            $
            1.00-18.71
            
            
            $
            1.00–21.53




In the
three month periods ended December 31, 2009 and 2008, options to purchase
approximately 4.6 million and 5.9 million shares of common stock, with
exercise prices ranging from $4.18 to $18.71 per share and
$2.33 to $21.53 per share, respectively, were not included in the
computation of dilutive earnings per share, due to the antidilutive effect, and
approximately 2.3 million and 472,000 equivalent shares were not
included, due to the loss generated in the respective periods.




-15-





8.      COMMITMENTS
AND CONTINGENCIES




Litigation
and Regulatory Proceedings




The
Company is subject to the possibility of loss contingencies arising in its
business and such contingencies are accounted for in accordance with ASC Topic
450, “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.





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
Company is a party to various material legal proceedings, which are described in
the Company’s Annual Report on Form 10-K filed for the year ended
December 31, 2009 under the caption “Item 3. Legal
Proceeding.” Except as discussed below, during the three month period
covered by this Quarterly Report on Form 10-Q, the Company has not been named in
any new material legal proceeding, and there have been no material developments
in the previously reported legal proceedings.
  Governmental
Regulation.   Existing federal and state regulations may 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.
  The
Company may become subject to litigation related to its charity bingo business
in Alabama.  On November 13, 2009, the Supreme Court of Alabama, in a
6-3 decision, reversed and remanded a trial court’s preliminary injunction in
favor of a charity operating bingo in the Town of White Hall, Lowndes County,
Alabama, referred to herein as the White Hall decision.  The appeal
arose out of a raid conducted by the Governor’s Task Force on Illegal Gambling
on March 19, 2009.  The Governor’s Task Force on Illegal Gambling
seized server-based bingo gaming systems, computers, servers, and
cash.  Included with the equipment seized were approximately 34 of the
Company’s games and certain of the Company’s charity bingo equipment located in
Alabama.  The Governor’s Task Force on Illegal Gambling also filed a
forfeiture action against all of the equipment seized at White
Hall.  The forfeiture action remains pending in the trial
court.  The charity that operates White Hall filed an application for
rehearing with the Supreme Court of Alabama.   On January 29, 2010,
the Supreme Court denied the application for rehearing.
  In the
White Hall decision, the Supreme Court of Alabama established a definition of
“bingo” that included a set of standards that apply to the operation of charity
bingo in Alabama.  We believe that our modified games comply with the
standards established by the recent Alabama Supreme Court decision and have
received certifications and/or formal written opinions from independent gaming
laboratories verifying to us that each game, as modified, is compliant with the
applicable Alabama standards.  Notwithstanding our initiatives to have our
games comply with the specified standards, there can be no assurance that we
will not encounter further legal, regulatory, financial, or competitive issues
related to this matter as the
Alabama Governor continues to take the position that even those games that
purport to comply with the Alabama Supreme Court ruling are
illegal.  We cannot be certain that operators, law enforcement
officials or regulatory bodies in Alabama will decide that our games, as
reintroduced to the Alabama market, are in compliance with the standard set
forth by the Alabama Supreme Court or that a court will not later determine that
the modified equipment does not comply with the standards set forth in the White
Hall decision or other applicable laws.
  Three of
the four facilities in Alabama which have installed charitable bingo units
provided by us, as well as other game manufacturers, have recently voluntarily
ceased operations for a yet to be determined amount of time, following an
unsuccessful attempt by the Governor’s Task Force on Illegal Gambling to raid
certain of those facilities.  On January 29, 2010, the Governor’s Task
Force attempted a raid on two of the facilities in Alabama where the Company has
charitable bingo units installed.  The operator of one of the
facilities obtained a temporary restraining order that stopped the raid on its
facility.  The Governor’s Task Force promptly filed an emergency
motion with the Alabama Supreme Court seeking to vacate the temporary
restraining order.  On February 4, 2010, the Alabama Supreme Court
issued a ruling that vacated the temporary restraining order.
  Further,
three recent lower court decisions by both State and federal trial courts ruled
or implied that electronic bingo was illegal under the particular constitutional
amendments for Madison, Walker and Jefferson counties as examined by those
courts.   We do not have any equipment in these counties and were not
directly affected by these rulings.
  There may
be other cases pending or threatened involving electronic bingo that might have
an impact upon our operations in Alabama and it is possible that further
proceedings will be initiated in the future.


-16-







9.      SUBSEQUENT
EVENTS




The
Company has evaluated subsequent events through February 9, 2010, which is the
date the financial statements were issued, and determined that no events, other
than those disclosed within the footnotes hereto, have occurred subsequent
to December 31, 2009 that warrant additional disclosure or accounting
considerations.


-17-




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




Multimedia
Games, Inc. designs, manufactures and supplies innovative standalone and
networked gaming systems.  Our standalone player terminals,
server-based systems, video lottery terminals, electronic scratch ticket
systems, electronic instant lottery systems, back-office systems and bingo
systems are used by Native American tribes and commercial casino operators as
well as state lottery operators in North America, and our electronic bingo and
lottery systems are deployed in certain international markets.  We
have long been a leading provider of server-based gaming systems known as
central determinant and downloadable systems.  These systems are used
by our Native American gaming operator customers in both Class II and
Class III, as defined below, settings, by our commercial casino customers,
by operators of charity and commercial bingo gaming facilities, and by lottery
jurisdictions for operation of their video lottery systems.





As part
of our networked gaming systems, we also provide customers with access to
proprietary local-area and wide-area telecommunications networks that allow us
to link player terminals with one another inside a single casino, inside an
operator’s multiple casinos and across many casinos nationwide.  Our
games include a mix of proprietary content that has been designed and developed
internally by our own game studios as well as themes that we license from third
parties.  Behind our products and systems is a suite of back-office,
player tracking, slot accounting, slot management and slot monitoring systems
that enable our customers to track their operations and adjust the performance
of their slot floor in real-time to ensure optimum financial
performance.





We derive
the majority of our gaming revenues from participation, or revenue share,
agreements.  Under our participation agreements, we place player
terminals and systems, along with our proprietary and other licensed game
content, at a customer’s facility in return for a share of the revenues that
these terminals and systems generate.  As of December 31, 2009, we
have 16,068 gaming units in operation domestically and internationally which are
installed pursuant to revenue share arrangements.  To a lesser extent,
we generate revenues from the sale of gaming units and systems though we are
seeking to expand our for-sale revenues as we expand into additional gaming
jurisdictions and into other segments of the gaming market.  We also
generate revenues from our provision of the central determinant system for
approximately 12,500 video lottery terminals installed at racetracks in the
State of New York and operated by the New York State Division of the
Lottery.


-18-





RESULTS
OF OPERATIONS




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




Below are
our revenues and costs and expenses for the periods noted above.  This
information should be read in conjunction with our Condensed Consolidated
Financial Statements and notes thereto.  (in thousands)




December 31,2009
            
            
            2008
            
            
            % changeRevenueGaming
    OperationsParticipation
      revenue
            
            $
            20,717
            
            
            $
            24,712
            
            
            
            (16.2
            )%Lottery
            
            
            1,705
            
            
            
            1,636
            
            
            
            4.2
            %Gaming Equipment and Systems
      SalesPlayer
      terminal sales
            
            
            2,565
            
            
            
            1,689
            
            
            
            51.9
            %Systems
      and Licensing
            
            
            685
            
            
            
            77
            
            
            
            789.6
            %Other Revenue
            
            
            593
            
            
            
            462
            
            
            
            28.3
            %Total
      Revenue
            
            
            26,265
            
            
            
            28,576
            
            
            
            (8.1
            )%Costs
      and ExpensesCost
      of revenues
            
            
            2,110
            
            
            
            1,847
            
            
            
            14.2
            %Selling,
      general and administrative
            
            
            14,969
            
            
            
            20,264
            
            
            
            (26.1
            )%Depreciation
      and amortization
            
            
            13,554
            
            
            
            14,865
            
            
            
            (8.8
            )%Other
      expense, net
            
            
            (259
            )
            
            
            (771
            )
            
            
            (66.3
            )%






At December 31,2009
            
            
            2008
            
            
            % changeEnd-of-period
      installed player terminal base:Oklahoma
            
            
            6,927
            
            
            
            7,604
            
            
            
            (8.9
            )%Mexico
            
            
            5,403
            
            
            
            5,488
            
            
            
            (1.5
            )%Alabama(1)
            
            
            2,509
            
            
            
            2,379
            
            
            
            5.5
            %Other
            
            
            1,229
            
            
            
            1,767
            
            
            
            (30.4
            )%Total
      participation units
            
            
            16,068
            
            
            
            17,238
            
            
            
            (6.8
            )%




(1)
              See
      Note 8 of the Notes to Condensed Consolidated Financial
      Statements.  The facilities of the Company’s Alabama customers
      are currently closed and if the facilities of the Company’s Alabama
      customers continue to remain closed, the resulting decrease in our revenue
      and EBITDA for the 2010 fiscal year, as well as any potential write-down
      of assets currently dedicated to the Alabama market may adversely impact
      our financial results.


Total
revenues for the three months ended December 31, 2009, were
$26.3 million, compared to $28.6 million for the three months
ended December31 2008, a $2.3 million or 8%
decrease.




Gaming
Operations – Participation revenue




§
            Oklahoma
      gaming revenues were $14.0 million in the three months ended
      December 31, 2009, compared to $16.8 million in the three
      months ended December 31, 2008, a decrease of
      $2.8 million or 17%. Oklahoma’s end of period unit count as of
      December 31, 2009 was 6,927 compared to 7,604 as of December 31, 2008, a
      677 unit or 8.9% decrease.  This unit reduction was primarily
      caused by two casinos purchasing or returning 892 units from their floor;
      offset by 215 new units. This
      unit reduction resulted in a $1.4 million decrease in revenue in the
      current period compared to the same period last year.The balance
      of the decrease was caused by the change in revenue share arrangements
      between Class II games at 30% and Class III games 20% and construction
      work at our largest casino location during the three month period ended
      December 31, 2009.





§
            Revenues
      from the Mexico bingo market were $2.1 million in the three months
      ended December 31, 2009 and $2.4 million during the
      same period of 2008, a decrease of $314,000 or 13.1%. As of
      December 31, 2009, we had installed 5,403 player terminals
      at 27 bingo parlors in Mexico compared to 5,448 terminals
      installed at 25 bingo parlors at December 31, 2008. The
      reduction in the number of units is directly related to our strategy of
      assisting our customers in effectively managing their floor space and the
      reduction in the win per unit in Mexico is caused by an increased supply
      into the major Mexican markets and
      can also be attributable to a national smoking policy change that affected
      traffic into our customers’ locations during the
      quarter.




-19-




§
            Alabama gaming
      revenues decreased $465,000, or 19%, to $2.0 million for the
      three months ended December 31, 2009, compared to
      $2.5 million for the three months ended December 31, 2008.
      The end of period unit count as of December 31, 2009 was 2,509 compared to
      2,379 as of December 31, 2008. Unit levels are up due to a new facility
      opening during the quarter ended December 31, 2009; however revenue from
      this new facility was not generated for the entire quarter.  The
      overall decrease in revenue in Alabama can be attributed to the
      temporary down time on our units due to our efforts to  modify our
      games in this market in order to voluntarily comply with the applicable
      Alabama standards, as determined by the Alabama Supreme Court, as well aslower
      traffic volumes in our customers’ locations during the current period.
      Notwithstanding
      our initiatives to have our games comply with the specified standards,
      there can be no assurance that we will not encounter further legal,
      regulatory, financial, or competitive issues related to this matter as the
      Alabama Governor continues to take the position that even those games that
      purport to comply with the Alabama Supreme Court ruling are illegal.
       See Note 8 of the Notes to Condensed Consolidated Financial
      Statements.





§
            Other
      gaming operations revenue relates to participation revenue from other
      states, including Washington, Wisconsin, Texas, New York, Minnesota,
      California and Rhode Island.  Gaming revenue from these states
      combined was $2.6 million in the three months ended December 31, 2009
      compared to $3.0 million during the same period of 2008.  The
      end of period unit count for these states decreased to 1,229 as of
      December 31, 2009 from 1,767 as of December 31, 2008.  In
      addition, other gaming operations revenue includes back office fees for
      system installations of $934,000 and $774,000 for the three months ended
      December 31, 2009 and 2008,
respectively.




Gaming
Operations – Lottery




§
            Revenues
      from the New York Lottery system increased $69,000, or 4.2%, to
      $1.7 million in the three months ended December 31, 2009,
      from $1.6 million in the three months ended
      December 31, 2008. Currently, eight of the nine planned
      racetrack casinos are operating, with approximately 12,500 total
      terminals.  The increase is attributable to increased activity
      within the New York Lottery system.




Gaming
Equipment and System Sales –Player Terminal and Equipment Sales




§
            Player
      terminal and equipment sales were $2.6 million for the three months
      ended December 31, 2009, and $1.7 million for the three months
      ended December 31, 2008, an increase of $876,000 or 51.9%. Player
      terminal sales for the three months ended December 31, 2009 were $1.7
      million on sales of 132 new proprietary units, compared to $1.7 million on
      sales of third party units for the three month period ended December 31,
      2008.  Gaming equipment sales were $311,000 and $1,000 for the
      three month periods ended December 31, 2009 and 2008,
      respectively.  Generally, gaming equipment sales include
      ancillary equipment necessary for the full functionality of the player
      terminals in a casino; however, in three months ended December 31, 2009
      gaming equipment sales also included $203,000 of used equipment
      sales.  Player terminal and equipment sales also include
      $553,000 related to deferred revenue recognized during the three months
      period ended December 31, 2009 due to contract amendments or final
      execution of deliverables.




Gaming
Equipment and System Sales – Systems and Licensing




§
            Systems
      and licensing sales revenue was $685,000 for the three months ended
      December 31, 2009, and $77,000 for the three months ended
      December 31, 2008. Systems and licensing revenue for the three months
      ended December 31, 2009 relates to $326,000 of licenses associated with
      the player terminal sales during the period, $183,000 of systems and game
      themes sold in prior periods being recognized from deferred revenue during
      the period and $176,000 of license revenue from game
      conversions.




Cost
of Revenues




§
            Total
      cost of revenues, which includes cost of gaming equipment and system sales
      and royalty fees, increased $263,000, to $2.1 million in
      the three months ended December 31, 2009, from $1.8
      million in the three months ended December 31, 2008. Costs
      of sales related to player terminal sales was $1.1 million and $1.4
      million for the three months periods ended December 31, 2009 and 2008,
      respectively, and royalty fees were $459,000 and $396,000 for the same
      periods.  Cost of sales for the three months ended December 31,
      2009 also includes $329,000 of costs from deferred revenue related to
      prior period shipments recognized during the period and $226,000 related
      to the sale of gaming equipment during the
  period.




-20-




Selling,
General and Administrative Expenses





§
            Selling,
      general and administrative expenses, or SG&A, decreased approximately
      $5.3 million, or 26.1%, to $15 million for the three months ended
      December 31, 2009, from $20.3 million in the same period of 2008.
      This decrease was primarily a result of (i)
      a decrease in legal fees and settlement costs of $3.9 million, primarily
      due the settlement of litigation during Fiscal 2009 (ii) a decrease in
      repairs & maintenance of $894,000 (iii) a decrease in salaries and
      wages and the related employee benefits of $483,000 and (iv) a decrease in
      contract labor.  These decreases were partially offset by the
      accrual of an annual incentive of $500,000 during the three month period
      ended December 31, 2009 as compared to no amounts accrued during the three
      month period ended December 31,
2008.





Amortization
and Depreciation





§
            Amortization
      expense decreased $607,000, or 44%, to $781,000 for the three months
      ended December 31, 2009, compared to $1.4 million for the same period
      of 2008.  Depreciation expense decreased $704,000,
      or 5%, to $12.8 million for the three months ended December
      31, 2009 from $13.5 million for the three month period ended December 31,
      2008, primarily as a result of a reduction in capital expenditures and
      assets becoming fully depreciated.





Other
Income and Expense





§
            Interest
      income decreased $241,000, or 19%, to $1 million for the three
      months ended December 31, 2009, from $1.3 million in the same period
      of 2008. We entered into development agreements with a customer under
      which approximately $50.8 million has been advanced and is
      outstanding at December 31, 2009, and for which we impute interest on
      these interest-free loans. For the three months ended December 31, 2009,
      we recorded imputed interest of $906,000 relating to development
      agreements with an imputed interest rate range of 5.75% to 9.0%,
      compared to $1.2 million for the same period in 2008.  In
      addition, interest income of $143,000 was accrued during the three month
      period ended December 31, 2009 on interest bearing
  notes.§
            Interest
      expense decreased $827,000, or 39%, to $1.3 million for the
      three months ended December 31, 2009, from $2.1 million in the same
      period of 2008.§
            We
      had no other income for the three months ended December 31, 2009, compared
      to $74,000 in the same period of 2008. Other income primarily
      decreased due to the last distribution from a partnership
      interest.





Income
tax increased by $2.7 million to a benefit of $498,000 for the three months
ended December 31, 2009, from an income tax benefit of $3.2 million for the
three month period ended December 31, 2008. These figures represent effective
income tax rates of 10.8% and 35.4% for the three months ended
December 31, 2009 and 2008, respectively. During the three month period
ended December 31, 2009, our tax provision is based on actual operating results
before taxes, due to the application of a valuation allowance against gross
deferred tax assets, and the resulting sensitivity of the estimated annual
effective tax rate to changes in the Company’s estimated annual operating
results.




RECENT
ACCOUNTING PRONOUNCEMENTS




We
monitor new, generally accepted accounting principles 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 (Critical
      Assumption #1), 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 (Critical
      Assumption #2).




-21-





Revenue
Recognition.As further discussed in the discussion of our Revenue
Recognition policy in Note 1 of our condensed consolidated financial
statements, revenue from the sale of software is accounted for under ASC Topic
985, “Software”. 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 hardware and
software is 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 $5.8 million being recorded as deferred revenue at
December 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 December 31, 2009.




Share-Based
Compensation Expense. 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 ASC Topic
718, “Compensation-Stock Compensation” and ASC Subtopic 505-50, “Equity-Based
Payments to Non-Employees”. Under the fair value recognition provisions of ASC
Topic 718 and Subtopic 505-50, 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.




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)




-22-





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, 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 three month period ended
December 31, 2009, a significant portion of the $13.6 million 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.  We also reviewed the future undiscounted cash flows
of assets in place at specific locations for further analysis. 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.




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’ hold per day 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
month period ended December 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 used 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 hold per day
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.




-23-





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.




Allowance for
Doubtful Accounts.We
maintain an allowance for doubtful accounts related to our 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 our
overall allowance for doubtful accounts, we include 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 may vary
from the recorded allowance.




Income
Taxes.In
accordance with ASC Topic 740, “Income Taxes”, 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, in accordance with ASC Topic 740, as of December 31,
2009 we have recorded a liability of $334,000 associated with uncertain tax
positions. ASC Topic 740 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 percent) 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 percent 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.




Effect
if Different Assumptions Used:Management, along with
consultation from an independent public accounting firm used in tax
consultation, continually evaluate 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 gross deferred tax assets of $29.1 million, primarily associated with the
tax basis of our leased gaming equipment and property and equipment is largely
dependent upon our ability to generate taxable income in the future or carryback
losses to prior years with taxable income. 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.  As of December 31, 2009, we have recorded a
valuation allowance on a substantial portion of our deferred tax assets in the
amount of $25.0 million.  This reserve was calculated based on our
ability to carryback losses to the prior periods and uncertainty as to our
ability to recover the full extent of these tax differences in future
periods.




LIQUIDITY
AND CAPITAL RESOURCES




As of
December 31, 2009, we had $14.9 million in unrestricted cash and cash
equivalents, compared to $12.5 million as of September 30, 2009.
Our working capital as of December 31, 2009, was $28.2 million, compared to
a working capital of $28.1 million at September 30, 2009. The
increase in working capital was primarily the result of collections on accounts
receivable of $3.4 million, offset by a decrease in accounts payable of
$3.5 million. During the three months ended December 31, 2009, we used
$10.1 million for capital expenditures of property and equipment, and we
collected $4.1 million on development agreements. In addition, we had
$55.0 million available under the Credit Facility, subject to covenant
restrictions.




-24-





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




Payments
      due by periodLess than
              1
      year
            
            
            1-3 years
            
            
            3-5 years
            
            
            TotalRevolving
      Credit Facility(1)
            
            $
            —
            
            
            $
            10,000
            
            
            $
            —
            
            
            $
            10,000Credit
      Facility Term Loan(2)
            
            
            1,325
            
            
            
            58,488
            
            
            
            —
            
            
            
            59,813Operating
      leases(3)
            
            
            1,754
            
            
            
            198
            
            
            
            72
            
            
            
            2,024Purchase
      commitments(4)
            
            
            13,803
            
            
            
            4,247
            
            
            
            —
            
            
            
            18,050Total
            
            $
            16,882
            
            
            $
            72,933
            
            
            $
            72
            
            
            $
            89,887




(1)
            Relating
      to the revolving credit commitment under the Credit Facility, bearing
      interest at the Eurodollar rate plus the applicable spread (5.75% as of
      December 31, 2009).


(2)
            Consists
      of amounts borrowed under the term loan to our Credit Facility at the
      Eurodollar rate plus the applicable spread (6.5% as of December 31,
      2009).


(3)
            Consists
      of operating leases for our facilities and office
    equipment.


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




During
the three months ended December 31, 2009, we generated $15.1 million in
cash from our operations, compared to $13.3 million during the same period
of 2008. This $1.8 million increase in cash generated from operations
over the prior period was primarily due to collections on accounts receivable,
reductions in inventories and prepaids; offset by a decrease in accounts
payable.




Cash used
in investing activities decreased to $6.7 million in the three months ended
December 31, 2009, from $24.1 million in the three month period ended
December 31, 2008. The decrease was primarily the result of a decrease in
capital expenditures of $15.0 million and an increase in repayments under
development agreements of $2.3 million. During the three months ended December
31, 2009, additions to property and equipment consisted of the
following:




Capital Expenditures(In
      thousands)Gaming
      equipment
            
            $
            7,348Third-party
      gaming content licenses
            
            
            2,560Other
            
            
            158Total
            
            $
            10,066




Cash used
in financing activities decreased to a $5.8 million usage in the three
months ended December 31, 2009, from $7.2 million provided by financing
activities in the same period of 2008. The decrease was primarily the
result of increased cash collections on accounts and notes receivable allowing
us to paydown the Credit Facility by $6.0 million during the current
period.




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 $18.1 million.




-25-





Credit
Facility




See
discussion of the Credit Facility and the credit agreement in Note 6 – Credit
Facility, Long-Term Debt and Capital Leases.




The
Credit Facility provides us with the ability to finance development agreements
and acquisitions and working capital for general corporate purposes. Advances
under the revolving credit commitment and the term loan mature on April 27,
2012, and 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).




On July
22, 2009, we entered into a third amendment to the Credit
Facility.  Under the terms of the amended credit agreement, the
calculation of consolidated Adjusted EBITDA (EBITDA, plus certain add-backs as
agreed upon by the lenders) for the purposes of evaluating compliance with the
specified covenants will now reflect the add-back of several items including:
(i) legal costs and settlement fees incurred in the trailing four-quarter period
related to litigation with Diamond Game Enterprises, Inc., or Diamond Game,
which was settled on May 1, 2009; (ii) all non-cash stock-based compensation
expenses; and, (iii) up to $10 million, in aggregate, of additional non-cash
asset impairment charges that we may incur in future periods. In conjunction
with the third amendment, we reduced the total borrowing capacity of the credit
facility to $125 million, $65 million under the revolving credit commitment and
$60 million under the term loan, from the previous total borrowing capacity of
$150 million and agreed to a LIBOR floor of 2%. As of December 31, 2009 the
$10 million drawn under the revolving credit commitment bore interest
at 5.75% and the $59.8 million on the term loan bore interest
at 6.5%.




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 Adjusted
EBITDA ratio of not more than 1.75 : 1.00; and (iii) a minimum
trailing twelve-month Adjusted EBITDA of not less
than $60.0 million.  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). As of December
31, 2009, we had availability under the Credit Facility of
$55.0 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
ASC Topic 815, “Derivatives and Hedging” which requires entities to recognize
all derivative instruments as either assets or liabilities in the balance sheet,
at their respective fair values. We record, 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 condensed consolidated
statement of operations.




We are
currently in compliance with the covenants in our credit agreement. However, 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 our
fiscal 2010. In light of (i) current prevailing economic conditions and the
inherent uncertainty of achieving and recognizing future revenue, and
(ii) the difficulty of making any necessary expense reductions sufficient
to compensate for any revenue shortfall such as a potential shortfall in Alabama
revenues resulting from current regulatory activity in that state, we cannot be
certain that we will be able to achieve our operating objectives for fiscal 2010
and thereby continue to meet the EBITDA covenant, among others.
  While we
recently amended our credit agreement, if we fail to remain in compliance with
the covenants of our credit agreement, we will be required to seek modification
or waiver of the provisions of that agreement and potentially secure additional
sources of capital. We cannot be certain that, if required, we will be able to
successfully negotiate additional changes to or waivers of our credit agreement.
Alternatively, we may incur significant costs related to obtaining requisite
waivers or renegotiation of our credit agreement that could have a material and
adverse effect on our operating results. We are currently in negotiations with
our lender concerning further modification to our credit agreement in order to
provide greater flexibility under our operating covenants.
  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 “Part I – Item 1. Condensed Consolidated
Financial Statements – Note 8 – 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.  See
Item 1A.Risk Factors – “Our Credit Facility contains covenants that limit our
ability to finance future operations or capital needs and to engage in other
business activities.”


-26-


Stock-Based
Compensation
  At
December 31, 2009, we had approximately 6.8 million options outstanding,
with exercise prices ranging from $1.00 to $18.71 per share. At
December 31, 2009, approximately 3.5 million of the outstanding options
were exercisable.


During
the three months ended December
31, 2009, options to purchase 240,400 shares of common stock were
granted at a weighted average exercise price of $5.27 per share, and we issued
85,950 shares of common stock as a result of stock option exercises with a
weighted average exercise price of $1.26.




At
December 31, 2008, we had approximately 6.8 million options outstanding,
with exercise prices ranging from $1.00 to $18.71 per share. At
December 31, 2008, approximately 3.5 million of the outstanding options
were exercisable.




During
the three months ended December 31, 2008, options to purchase
277,000 shares of common stock were granted at a weighted average exercise
price of $3.01 per share, and we issued 33,821 shares of common stock as a
result of stock option exercises with a weighted average exercise price
of $1.21.




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 amended Credit Facility, we may currently borrow up to a total
of $125 million, and our availability is $55 million, subject to
covenant restrictions.




Pursuant
to the development agreements we enter into with many of our Native
American tribal customers, we are required to advance funds to these Native
American tribes for the construction and development of their 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 requires that we enter into hedging arrangements covering
at least $50.0 million of the term loan for a three-year period. On
May 29, 2008, we purchased, for $390,000, an interest rate cap
(5% cap rate) covering $50.0 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 $698,000, based on our
variable debt outstanding of $69.8 million as of December 31,
2009.




We
account for currency translation from our Mexico operations in accordance with
ASC Topic 830, “Foreign Currency Matters.” 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.




-27-




ITEM
      4.
            CONTROLS
      AND PROCEDURES




Evaluation of
Disclosure Control and Procedures.As of the end of the
period covered by this report, 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 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 December 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.There
were no changes in our internal control over financial reporting identified in
management’s evaluation during the first quarter of fiscal 2010 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.




-28-


PART
II


OTHER
INFORMATION




ITEM
      1.
            LEGAL
      PROCEEDINGS




The
Company is a party to various material legal proceedings, which are described in
Note 8 of Notes to Condensed Consolidated Financial Statements included herein
and/or in the Company’s Annual Report on Form 10-K filed for the year ended
December 31, 2009 under the caption “Item 3. 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.  Except as
discussed in Note 8 of the Notes to Consolidated Condensed Financial Statements
included herein, which is incorporated by reference into this item, during the
three month period covered by this Quarterly Report on Form 10-Q, the Company
has not been named in any new material legal proceeding, and there have been no
material developments in the previously reported legal proceedings.


ITEM
      1A.
            RISK
      FACTORS




Investing
in our common stock involves risks.  Prospective investors in our
common stock should carefully consider, among other things, the following risk
factors in connection with the other information and financial statements
contained in this Annual Report, including “PART I – Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” prior
to making an investment decision.  We have identified the following
important factors that could cause actual results to differ materially from
those projected in any forward looking statements we may make from time to
time.  We operate in a continually changing business environment in
which new risk factors emerge from time to time.  We can neither
predict these new risk factors, nor can we assess the impact, if any, of these
new risk factors on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
projected in any forward looking statement.  If any of these risks, or
combination of 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
success in the gaming industry depends in large part on our ability to expand
into new and non-Native American markets.  Our expansion into
non-Native American gaming activities will present new challenges and risks that
could adversely affect our business and 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.
  New
market entry 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 into other 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 because of
      other unforeseen obstacles.






-29-




If
we are unable to keep pace with rapid innovations in new technologies or product
design and deployment, or if we are unable to quickly adapt our development and
manufacturing processes to compete, our business and results of operation could
be negatively impacted.




Our
success is dependent on our ability to develop and sell new products and systems
that are attractive not only to our customers, but also to their customers, the
end players.  If our gaming devices do not appeal to customers, or if
our gaming devices do not meet or sustain revenue and profitability
expectations, our gaming devices may be replaced by our competitor's
devices.  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 in new or existing markets.
Therefore, our future success depends upon our ability to design and market
technologically sophisticated products that meet our customer's needs regarding,
among other things, ease of use and adaptability, but also that are unique and
entertaining such that they achieve high levels of player appeal and
sustainability. If we fail to keep pace with our competitors, our business could
be adversely affected and a decrease in demand for our games could also result
in an increase in our inventory obsolescence charges.




The
demands of our customers and the preferences of the end players are continuously
changing. As a result, there is constant pressure to develop and market new game
content and technologically innovative products. As our revenues are heavily
dependent on the earning power and life span of our games and because newer game
themes tend to have a shorter life span than more traditional game themes, we
face increased pressure to design and deploy new and successful game themes to
maintain our revenue stream and remain competitive. Our ability to develop new
and innovative products could be adversely affected by:




§
            the
      failure of our new gaming products to become popular with end
      players;


§
            a
      decision by our customers or the gaming industry in general to decline to
      purchases our new gaming devices or to cancel or return previous orders,
      content or systems in anticipation of newer
  technologies;


§
            an
      inability to roll out new games, services or systems on schedule as a
      result of delays in regulatory product approval in the applicable
      jurisdictions, or otherwise; and


§
            an
      increase in the popularity of competitors'
  games.




Our newer
products are generally more technologically sophisticated and are of a different
form than those we have produced in the past and we must continually refine our
production capabilities to meet the needs of our product innovation. If we
cannot adapt our manufacturing infrastructure to meet the needs of our product
innovations, or if we are unable to make upgrades to our production capacity in
a timely manner, our business could be negatively impacted.




The
gaming industry is intensely competitive.  We may not be able to
successfully compete in new and existing markets due to research and
development, intellectual property and regulatory challenges, and if we are
unable to compete effectively, our business could be negatively
impacted.




We
operate in an intensely competitive industry against larger companies with
significant financial, research design and development, and marketing resources.
These larger companies, most of whom have greater resources, 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/gaming
markets. Additionally, new smaller competitors may enter our traditional
markets, and these smaller competitors often do not have the same
regulatory and/or compliance restraints that we have. 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.




There are
a number of established, well-financed companies producing gaming devices, game
content and systems that compete with our products. Certain of these competitors
may have access to greater capital resources than we do, and as a result, may be
better positioned to compete in the marketplace. The market is crowded, with
International Game Technology, WMS Industries, Inc., Bally Technologies, Inc.,
Aristocrat Technologies, Inc. and Konami Co. Ltd. comprising the primary
competition. Pricing, accuracy, reliability, product features and functions are
among the factors affecting a provider's success in selling its
system.




-30-





Competition
in the gaming industry is intense due to the number of providers, as well as the
limited number of facilities and jurisdictions in which they operate. As a
result of consolidation among the gaming facilities and the recent cutbacks in
spending by facility operators due to the downturn in the economy, the level of
competition among providers has increased significantly as the number of
potential customers has decreased.  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/actions.




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.




Slow
growth in the establishment of new gaming jurisdictions or the number of new
casinos and declines in the rate of replacement for existing gaming machines
could limit or reduce our future profits.




Demand
for our products is driven substantially by the establishment of new gaming
jurisdictions, the addition of new casinos or expansion of existing casinos
within existing gaming jurisdictions and the replacement of existing gaming
machines. The establishment or expansion of gaming in any jurisdiction typically
requires a public referendum or other legislative action. As a result, gaming
continues to be the subject of public debate, and there are numerous active
organizations that oppose gaming. Opposition to gaming, such as
that which we are currently experiencing in Alabama,could result in
restrictions on or even prohibitions of gaming operations or the expansion of
operations in any jurisdiction. In addition, the construction of new casinos or
expansion of existing casinos fluctuates with demand, general economic
conditions and the availability of financing. The rate of gaming growth in North
America has diminished and machine replacements are at historically low levels.
Slow growth in the establishment of new gaming jurisdictions, public protest,
political opposition, delays in the opening of new or expanded casinos and
continued declines in or low levels of demand for machine replacements could
reduce the demand for our products and our future profits.




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, our officers, directors, key
employees, major shareholders, as well as our business partners and certain
suppliers, 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 Native American 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 Native American tribes. Moreover,
Native American tribal policies and procedures, as well as tribal selection of
gaming vendors, are subject to the political and governance environment within
the Native American tribe.




We
require new licenses, permits and approvals in order to meet our expectations
under our product rollout plan, and such licenses, permits or approvals may not
be timely granted to us, or granted to us at all, which could have a material
effect on our business in general and product rollout plan specifically.
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, including the ability to enforce
contractual rights on Native American land.




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.  Because federally recognized Native American tribes are
independent governments with sovereign powers, Native American tribes can enact
their own laws and regulate gaming operations and contracts.  Native
American tribes maintain their own governmental systems and often their own
judicial systems and 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 Native American tribe has a specific agreement
or compact with the state. Our contracts with Native American tribal customers
normally provide that only certain provisions will be subject to the governing
law of the state in which a Native American tribe is
located.  However, these choice-of-law clauses may not be
enforceable.




-31-





Further,
Native American tribes generally enjoy sovereign immunity from lawsuits similar
to that of the individual states and the United States.  In order for
the Company to sue or enforce contract rights with a Native American tribe (or
an agency or instrumentality of a Native American tribe), the Native American
tribe must effectively waive its sovereign immunity with respect to the matter
in dispute, which we are not always able to obtain.  For example, our
largest customer, who accounts for over 47% of our revenue as of December
31, 2009, has not given us a limited waiver of sovereign
immunity.  Without a limited waiver of sovereign immunity or if such
waiver is held to be ineffective, we could be precluded from judicially
enforcing any rights or remedies against a Native American tribe, including the
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.  Even if the
waiver of sovereign immunity by a Native American tribe is deemed effective,
there will be an issue as to the forum in which a lawsuit can be brought against
the Native American tribe.  Federal courts are courts of limited
jurisdiction and generally do not have jurisdiction to hear civil cases relating
to Native American tribes and we may be unable to enforce any arbitration
decision effectively.




Our
agreements with Native American tribes are subject to review by regulatory
authorities.  For example, our development agreements are subject to
review by the NIGC and any such review could require substantial modifications
to our agreements or result in the determination that the Company has a
proprietary interest in a Native American tribe’s gaming activity which could
materially and adversely affect the terms on which we conduct our
business.  The NIGC has previously expressed its view that some of our
development agreements could be in violation of the requirements of the Indian
Gaming Regulatory Act of 1988 and Native American tribal gaming regulations,
which state that the Native American tribes must hold “sole proprietary
interest” in the Native American tribes’ gaming operations, which presents
additional risk for our business.  The NIGC may also reinterpret
applicable laws and regulations, which could affect our agreements with Native
American tribes.




We could
be affected by alternative interpretations of the Gambling Devices Act, 15
U.S.C. § 1171, et seq,or theJohnson Act, as the
customers of our Class II games, the Native American tribes, 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.




Government
enforcement, regulatory action, judicial decisions, and proposed legislative
action have in the past, and will likely continue to affect our business,
operating results and prospects in Native American tribal lands.  We
believe that a number of our competitors have not complied with published
regulation restrictions.  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 therefore offer
features not available in our products.  The legal and regulatory
uncertainties surrounding our Native American tribal agreements could result in
significant and immediate adverse impacts on our business and operating results.
Additionally, such uncertainties could increase our cost of doing business and
could take our executives’ attention away from operations.  The
trading price of our common stock has in the past been, 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,
Native American tribal policies and procedures, as well as tribal selection of
gaming vendors, are subject to the political and governance environment within
the Native American tribe. Changes in tribal leadership or tribal political
pressure can affect our business relationships within Native American
markets.




State
compacts with our existing Native American tribal customers to allow
Class III gaming could reduce demand for our Class II games and our
entry into the Class III market may be difficult as we compete against larger
companies in the Class III market.




Certain
of Class II Native American tribal customers have entered into compacts
with the states in which they operate to permit the operation of Class III
games. We believe the number of our Class II game machine placements in those
customers’ facilities could decline significantly, and our operating results
could be materially and adversely affected.  As our Native American
tribal customers continue their transition to gaming under compacts with the
state, we continue to face significant uncertainty in the market for our games
that makes our business in these states difficult to manage and
predict.




-32-





As a
result, we anticipate that the introduction of Class III games will create
further pressure on our market and revenue share percentages in Oklahoma or a
shift in the market from revenue share arrangements to a “for sale” model.
Additionally, we may be forced to compete with larger companies that specialize
in Class III gaming as they move into these new Class III markets.  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 if or when a compact could be entered into by one or more of our Native
American tribal customers.




We
have limited control over our customers’ casino operations.




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. Our key customers, however,
are solely responsible for the operations of their facilities and are not
required to consult us or take our advice on their operations, marketing,
facility layout, gaming floor configuration, or promotional initiatives.Our customers
have in the past, and will in the future, remodel and expand their facilities.
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 or are scheduled to
be out of service during a facility remodeling, our operating results could
suffer.




We
are largely dependent upon one customer and most of our customers are based in
Oklahoma.




For the
three month periods ended December 31, 2009 and 2008,
approximately 60% and 68%, respectively, of our total revenues were
from Native American tribes located in Oklahoma, and approximately 47%
and 46%, respectively, of our gaming revenues were from one tribe in that
state. The significant concentration of our customers in Oklahoma means that
local economic, regulatory and licensing changes may adversely affect our
customers, and therefore our development agreements and our business,
disproportionately to changes in national economic conditions, including more
sudden adverse economic declines or slower economic recovery from prior
declines. While we continue to seek to diversify the markets in which we
operate, 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 previously avoided entry into the Oklahoma market due to its uncertain
and ambiguous legal environment. Oklahoma permits other types of gaming, both at
Native American tribal gaming facilities and at Oklahoma racetracks, and many of
our competitors may seek entry into this market. 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 that
the introduction of our competitor’s 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.




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, expansion, or
remodeling of gaming facilities, primarily in the state of Oklahoma, but have
since expanded operations to other jurisdictions, such as
Alabama.  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 funding the development and construction of the gaming
facility.  We may not, however, realize the anticipated benefits of
any of these strategic relationships or financings as our success in these
ventures is dependent upon the timely completion of the gaming facility, the
placement of our player terminals, and a favorable regulatory
environment.




Our
development efforts and financing activities may result in unforeseen operating
difficulties, financial risks, or required expenditures that could adversely
affect our liquidity.  In connection with one or more of these
transactions, and to obtain the necessary development funds, we may need to
issue additional equity securities which would dilute existing shareholders;
extend secured and unsecured credit to potential or existing customers that may
not be repaid; incur debt on terms unfavorable to us or that we are unable to
repay; or incur other contingent liabilities.




-33-





The
failure to maintain controls and processes related to billing and collecting
accounts receivable or the deterioration of the financial condition of our
customers could negatively impact our business.  As a result of our
development agreements, the collection of accounts receivable has become a
matter of greater significance. While we believe the increased level of these
specific receivables has allowed us to grow our business, it has also required
direct, additional focus of and involvement by management. Further, and
especially due to the current downturn in the economy, some of our customers may
not pay accounts receivable when due, whether as a result of financial
difficulties, bankruptcy or otherwise, resulting in increased write-offs for
us.




Our
charitable bingo operations in Alabama are subject to legal
uncertainty.
  The
Alabama Supreme Court, in the recent decision related to the White Hall
Entertainment Center, established a definition of “bingo” that included a
limited set of standards for charity bingo games in Alabama.  We
believe that our modified games comply with the standards established by the
recent Alabama Supreme Court decision and have received certifications and/or
formal written opinions from independent gaming laboratories verifying to us
that each game, as modified, is compliant with the applicable Alabama
standards.  Notwithstanding our initiatives to have our games comply
with the specified standards, there can be no assurance that we will not
encounter further legal, regulatory, financial, or competitive issues related to
this matter.  We cannot be certain that operators, law enforcement
officials or regulatory bodies in Alabama will decide that our games, as
reintroduced to the Alabama market, are in compliance with the standard set
forth by the Alabama Supreme Court or that a court will not later determine that
the modified equipment does not comply with the standards set forth in the White
Hall decision or other applicable laws. Furthermore, unfavorable changes in
laws, regulatory requirements or unanticipated enforcement action against us,
our games or customers, and/or adverse decisions by courts, regulators and/or
governmental bodies in Alabama 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, including our revenue and any
money lent pursuant to our development agreements in the State may not be
adequately repaid.  The Alabama Governor continues to take the
position that even those games that purport to comply with the Alabama Supreme
Court ruling are illegal, and he is pursuing enforcement actions against
operators who deploy our games that have resulted in closure of several
facilities.  It therefore remains a possibility  that
certain of our charity bingo equipment located in Alabama could be seized and
made subject to a forfeiture proceeding.  In addition, legal and
regulatory uncertainty in Alabama has introduced new competitive issues as other
equipment manufacturers take different approaches to compliance which may prove
more popular with our customers than the approaches we've taken.  If
our reintroduced machines are not as popular with customers as those of our
competitors, our market share and operating results in Alabama could
suffer.


Interpretations
of regulations by governmental agencies may affect our business.




We may
face regulatory risks as a result of interpretations of other 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.




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. Moreover,
our failure to comply with procedural regulations inherent to our policies may
void coverage.  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).






-34-





Our
Credit Facility contains covenants that limit our ability to finance future
operations or capital needs and 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 Adjusted EBITDA (earnings
(loss) before net interest expense, income taxes, depreciation, amortization and
accretion of contract rights, plus certain add-backs as agreed upon by the
lenders) of $60.0 million on a trailing twelve 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.




Current
borrowings, as well as potential future financings, may substantially increase
our current indebtedness.




No
assurance can be given that we will be able to generate the cash flows necessary
to permit us to meet our fixed charges and payment obligations with respect to
our debt. We could be required to incur additional indebtedness to meet these
fixed charges and payment obligations. Should we incur additional debt, among
other things, such increased indebtedness could:




§
              adversely
      affect our ability to expand our business, market our products and make
      investments and capital
expenditures;
 §
                adversely
      affect the cost and availability of funds from commercial lenders, debt
      financing transactions and other sources;
  and
 §
                  create
      competitive disadvantages compared to other companies with lower debt
      levels.


Any
inability to service our fixed charges and payment obligations, or the
incurrence of additional debt, would have an adverse effect on our cash flows,
results of operations and business generally.




An
inability to maintain sufficient liquidity could negatively affect expected
levels of operations and new product development.




Future
revenue may not be sufficient to meet operating, product development and other
cash flow requirements. Sufficient funds to service our debt and maintain new
product development efforts and expected levels of operations may not be
available, and additional capital, if and when needed by us, may not be
available on terms acceptable to us. If we cannot obtain sufficient capital on
acceptable terms when needed, we may not be able to carry out our planned
product development efforts and level of operations, which could harm our
business.




-35-





Our
financial results vary from quarter to quarter, which could negatively impact
our business.




Various
factors affect our quarterly operating results, some of which are not within our
control. These factors include, among others:




§
              the
      financial strength of the gaming
industry;
 §
                consumers'
      willingness to spend money on leisure
  activities;
 §
                  the
      timing and introduction of new products and
  services;
 §
                    the
      mix of products and services
sold;
 §
                      the
      timing of significant orders from and shipments to
      customers;
 §
                        product
      and service pricing and discounts;
and
 §
                          the
      timing of acquisitions of other companies and businesses or
      dispositions.




Our
current international businesses and potential expansion into other
international gaming markets may present new challenges and risks that could
adversely affect our business or results of operations.




In recent
years, we have expanded our business into several countries, including Malta,
Israel, and Mexico and Canada.  The Maltese operations have ceased and
the Israeli operations are immaterial to us; the Mexican business has grown
significantly since inception.  We now operate over 5,400 units in
Mexico, primarily across numerous facilities operated by one
customer.  Although the revenue results in Mexico have not met
original expectations, we plan to continue to operate in the country but there
can be no assurances that either revenues will grow or that we will continue
supplying new products to that market.  Furthermore our agreement with
our largest customer in Mexico terminates in April of 2010,
although we are currently in negotiations with this customer for a new
agreement, which, as currently contemplated between the parties, would be
effective until December 31, 2013.  In addition, we have
generated several value added tax favorable balances in Mexico and are currently
seeking a refund, which, if we fail to receive, could have a negative impact on
our financial condition.  International business is inherently subject
to various risks, including, but not limited to:




§
            currency
      fluctuations;


§
            difficulty
      in enforcing agreements;


§
            higher
      operating costs due to local laws or
  regulations;


§
            unexpected
      changes in regulatory requirements;


§
            tariffs,
      taxes and other trade barriers, including value added
  tax;


§
            general
      government instability;


§
            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 as a result of perceived cultural, social, religious and/or
      political differences.




Specifically,
we have a receivable from the Mexican government related to value added taxes
paid in connection with the deployment of assets in the Mexican
market.  Management expects to fully collect any and all outstanding
balances; however, the ultimate collectability of the entire amount is
uncertain.




The
carrying value of our assets is dependent upon our ability to successfully
deploy games into new or existing markets.




We have
player stations not deployed as of December 31, 2009, which are considered part
of our rental pool. If the opening of new facilities or the expansion of
existing facilities is altered negatively, either by significant delay or by
cancellation, the realizable value of these assets could be adversely impacted.
In such instances we may be required to recognize impairment charges on these
assets.




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




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




-36-





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
a patent dispute with a competitor. See “Part II – Item I.
Financial Statements – Note 11 – 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.




Some of
our products may incorporate open source software.  Open source
licenses typically mandate that software developed based on source code that is
subject to the open source license, or combined in specific ways with such open
source software, become subject to the open source license.  Open
source licenses typically require that source code subject to the license be
released or made available to the public.  We take steps to ensure
that proprietary software we do not wish to disclose is not combined with, or
does not incorporate, open source software in ways that would require such
proprietary software to be subject to an open source
license.  However, few courts have interpreted the open source
licenses, and the manner in which these licenses may be interpreted and enforced
is therefore subject to some uncertainty.




We
rely on software and games 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.




We rely
on the content of certain software that we license from third-party vendors and
often distribute and sell such software to our customers. The software could
contain “open source” code, require a resale license or 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.




In
addition, we license certain other manufacturers’ games to our
customers.  Should such licenses terminate, our business would be
adversely affected.  Our agreement with one of our major licensors,
WMS, is set to expire according to its terms on June 30, 2010, which, if
terminated, would affect our product portfolio with our largest customer, the
Chickasaw Nation.




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 non-contractual considerations, such  as
verbal understandings, 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.  In addition, certain of our customer contracts have "buy out"
provisions enabling our customer to purchase machines formerly under revenue
participation arrangements.  To the extent our customers exercise their buy
out rights pursuant to these provisions, we recognize revenue from equipment
sales in the current period while losing future participation revenue from
purchased machines.  This could have the effect of reducing our overall
future revenues from these customers and thereby adversely affect our future
operating results.




-37-





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 to assist in the Company’s new strategic direction. 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.




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 or
maintain 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 maintain adequate 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.




Any
unauthorized, and potentially improper, actions of our personnel could adversely
affect our business, operating results and financial condition.




The
recognition of our revenue depends on, among other things, the terms negotiated
in our contracts with our customers. Our personnel may act outside of their
authority and negotiate additional terms without our knowledge. We are
implementing policies to help prevent and discourage such conduct, but there can
be no assurance that such policies will be followed. For instance, in the event
that our sales personnel negotiate terms that do not appear in the contract and
of which we are unaware, whether the additional terms are written or verbal, we could be prevented from
recognizing revenue in accordance with our plans. Furthermore, depending on when
we learn of unauthorized actions and the size of transactions involved, we may
have to restate revenue for a previously reported period, which would seriously
harm our business, operating results and financial condition.




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 as well
as state licensing boards. 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.




-38-




In
the event gaming authorities determine that any of our officers, directors, key
employees, shareholders or any other person of the Company is unsuitable to act
in such a capacity, we will either be required to terminate our relationship
with such person, which termination could have a material adverse effect on our
business, or may not be able to terminate such relationship, which could impact
our ability to obtain such license or approval.




We do not
currently have the right to redeem shares of an unsuitable shareholder, and a
finding of unsuitability could have a material adverse effect on our
business.  In some jurisdictions, the gaming authority may determine
that any of our officers, directors, key employees, shareholders or any other
person of the Company is unsuitable to act in such capacity. There can be no
assurance that we will obtain all the necessary licenses and approvals or that
our officers, directors, key employees, their affiliates and certain other
shareholders will satisfy the suitability requirements in each jurisdiction in
which we seek to operate. The failure to obtain such licenses and approvals in
one jurisdiction may affect our licensure and/or approvals in other
jurisdictions. In addition, a significant delay in obtaining such licenses and
approvals could have a material adverse effect on our business
prospects.




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 of the 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 contractually entitled to
adjust the rates of prize payout to end users in order to recover any deficit.
In
addition, a “game deficit” generates a receivable and we may be unable to offset
such receivable against a “game surplus” payable.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, which could
materially and adversely affect our earnings and financial
condition.




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




Our games
and systems, and games and systems we license or distribute from third parties,
could produce false payouts as the result of malfunctions, anomalies or
fraudulent activities, which we may be required to pay. 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.
Additionally, in the event of such issues with our gaming devices or software,
substantial engineering and marketing resources may be diverted from other areas
to rectify the problem.




Any
disruption in our network or telecommunications services, adverse weather
conditions or other catastrophic events 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 customer’s 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.




-39-





We are
parties to 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.  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.




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




If the
outbreak of a communicable disease (such as the H1N1 virus, 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.




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 frequent 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 provision for bad debt.




Current
environmental laws and regulations, or those enacted in the future, could result
in additional liabilities and costs.




The
manufacturing of our products may require the use of materials that are subject
to a variety of environmental, health and safety laws and regulations.
Compliance with these laws could increase our costs and impact the availability
of components required to manufacture our products. Violation of these laws may
subject us to significant fines, penalties or disposal costs, which could
negatively impact our results of operations, financial position or cash
flows.




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




We
believe future transactions with both 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 recognize
revenue associated with a particular project, and therefore the timing and
possibility of actual revenue recognition may differ from our
forecast.




The
ability of the Board of Directors to issue preferred stock or anti-takeover
provisions of Texas law and our governing documents could discourage a merger or
other type of corporate reorganization or a change in control even if it could
be favorable to the interests of our shareholders.





Our Board
of Directors has the authority to issue 2,000,000 shares of preferred stock and
determine the terms of such preferred stock without shareholder
approval.  While we currently do not have any preferred stock issued
and our board has no current plans, agreements or commitments to issue any
shares of preferred stock, the issuance of such preferred stock may delay, defer
or prevent a change in control because the terms of any issued preferred stock
could potentially prohibit our consummation of any acquisition, reorganization,
sale of substantially all of our assets, liquidation or other extraordinary
corporate transaction.  In addition, the issuance of preferred stock
could have a dilutive effect on our shareholders and affect the price of our
common stock.





Other
provisions of Texas law and our Articles of Incorporation and Bylaws may have
the effect of delaying or preventing a change in control or acquisition of the
Company, whether by means of a tender offer, business combination, proxy
contest, or otherwise.  Our Articles of Incorporation and Bylaws
include purported limits on shareholder action by written consent in lieu of a
meeting and certain procedural requirements governing the nomination of
directors by shareholders and shareholder meetings. These provisions could have
the effect of delaying or preventing a change in control of the
Company.


-40-




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.


-41-




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.




Multimedia
      Games, Inc.Date:
      February 9, 2010
              By:
              /s/ Adam
      D. Chibib†Adam
      D. Chibib
                Chief
      Financial Officer







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





-42-




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)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 for the quarter ended
      March 31, 1997, as filed with the Securities and Exchange
      Commission, or SEC, on May 15,
1997.


(2)
            Incorporated
      by reference to our Form 10-Q for the quarter ended
      December 31, 2003, as filed with the SEC on February 17,
      2004.


(3)
            Incorporated
      by reference to our Form 10-K for the fiscal year ended September 30,
      2008, as filed with the SEC on December 15,
  2008.


(*)
            Filed
      herewith.