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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-K
Mark One
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

    For the fiscal year ended December 31, 1999

[ ] 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 000-28294

                              SILICON GAMING, INC.
             (Exact Name of Registrant as Specified in Its Charter)

              California                                         77-0357939
    (State or Other Jurisdiction                              (I.R.S. Employer
   of Incorporation or Organization)                         Identification No.)


 2800 W. Bayshore Road, Palo Alto, CA                               94303
(Address of Principal Executive Offices)                         (Zip Code)

        (Registrant's Telephone Number, Including Area Code) 650-842-9000

           Securities Registered Pursuant to Section 12(b) of the Act:

Title of Class                         Name of Each Exchange on Which Registered
--------------                         -----------------------------------------
    None                                                 None

           Securities Registered Pursuant to Section 12(g) of the Act:

                          Common Stock, $.001 par value

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

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Aggregate market value of the registrant's  Common Stock held by  non-affiliates
as of February 29, 2000: $5,013,226

Number of shares  outstanding of the issuer's Common Stock,  $.001 par value, as
of February 29, 2000: 30,949,273

                      DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the definitive Proxy Statement for the  Registrant's  Annual Meeting
of Shareholders  to be held on May 25, 2000, are  incorporated by reference into
Part III of this Form 10-K.
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<PAGE>
                                     PART I
ITEM 1: BUSINESS

     Silicon  Gaming,  Inc.  ("SGI" or the  "Company") is engaged in the design,
development,  production,  marketing  and  sale of  interactive,  software-based
products  for the  gaming  industry.  To date it has  deployed  its  product  in
video-based  slot machines that it has designed and developed for use in casinos
and other gaming  establishments.  These  machines  combine a multimedia  gaming
platform with the  software-based  games.  The Company believes its products are
more engaging and entertaining  than other gaming products  currently  available
and will, as a result,  generate  increased  gaming revenue per device ("win per
machine") for the casino operator.

     The Company's games feature  high-quality  animation,  video clips, digital
sound and a level of visual appeal and  interactivity  that the Company believes
is not met by the current  generation  of slot  machines.  To take  advantage of
these features,  the Company's  initial products were deployed in a product that
featured  high  resolution   video  presented  across  the  full  surface  of  a
distinctive,  large touchscreen  display.  The Company is attempting to maximize
the entertainment value offered on the video screen by providing multiple levels
of achievement  within  certain games so that,  through  successful  play over a
period of time, a player may advance to a bonusing  sequence and win  additional
jackpots.  SGI believes  that, by utilizing  these  features,  its products will
encourage  longer and more  frequent  periods of play by existing  slot  machine
customers and attract new gaming customers who are seeking greater entertainment
value than that offered by the current generation of slot machines.  The Company
has also designed its machines with a number of unique player features,  such as
play stoppage entertainmentTM. In addition, the product's modular components and
Machine Management SystemTM software provide easy-to-use diagnostics designed to
minimize  player  inconvenience  and machine  down time.  The Company  currently
offers  several  platforms  for its games,  including  ODYSSEYTM,  a  multi-game
machine that can play up to six different  games on the same machine,  QUEST,  a
single-game upright machine, and a traditional slant top machine.

     The Company was granted product approval for ODYSSEY from the Nevada Gaming
Commission  in  March  1997,   allowing  the  Company  to  commence   commercial
distribution of its products.  The Company  typically places machines in casinos
for an evaluation period prior to sale,  consistent with industry practice.  The
Company sells machines  outright to casinos and also places  machines in casinos
and receives a predetermined  percentage of the net win per machine. The Company
also sells new game titles  periodically  to  existing  customers  which  allows
customers to update their products.

     As of  December  31,  1999,  the Company had 4,050  machines  installed  in
approximately 200 properties throughout Connecticut,  Iowa, Louisiana, Michigan,
Mississippi,  Missouri,  Nevada,  New Mexico,  certain  Canadian  provinces  and
Uruguay.  Of these  machines,  3,702  have  been  sold  outright  or placed on a
revenue-sharing  basis. After returns,  348 machines remain installed on a trial
basis  and the  casino  operators  will be  required  to  purchase  the  machine
outright, participate in SGI's revenue sharing plan or return the machine to the
Company within a defined trial period.

INDUSTRY BACKGROUND

     According to industry  sources,  casino gaming revenue in the United States
in 1993, 1994, 1995, 1996, 1997 and 1998 was approximately $12.6 billion,  $14.0
billion,  $18.0  billion,  $22.4  billion,  $25.8  billion  and  $28.1  billion,
respectively,  and  continued  growth  was  forecast  for  1999 and  2000.  Slot
machines,  video gaming  machines and similar devices are the dominant source of
gaming  revenue for casino  operators  in most U.S.  markets.  Slot revenue as a
percentage  of total gaming  revenue in 1999 was 64 in Nevada and 71 in Atlantic
City.  Jurisdictions where gaming has been legalized more recently have reported
similar  statistics.  For example,  in 1999 slot  machines  accounted  for 76 of
casino revenue in Indiana.  In addition to  constituting  the largest portion of
gaming  revenue,  slot  revenue is more  profitable  than table games for casino
operators, since slot machines require much lower labor costs.

     The Company  believes that slot  machines  offer their owners an attractive
return on investment.  In 1998, the average win per machine per day,  defined as
the  average  amount of money  wagered  on a machine  less the  average  jackpot
payoffs,  on the Las  Vegas  Strip  was $101.  A new slot  machine  from a major
manufacturer,  equipped with player tracking and slot accounting software, costs
approximately $8,000 and generally has a useful life that can exceed five years.
At this price,  a new slot  machine  earning the Las Vegas Strip  average  would
recoup its purchase price in 79 days.  While certain  markets have lower average
wins per day than the Las  Vegas  Strip,  many  other  markets  have win per day
figures that are  significantly  higher.  For example,  in 1998,  Harrahs Marina
Hotel & Casino in  Atlantic  City  reported  win per machine per day of $255 and
Harrah's  riverboat casino in Joliet,  Illinois reported win per machine per day

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of $371. Many of the native American gaming  establishments often have daily win
per machine  numbers  much higher than these  levels,  as  evidenced  by the two
native American casinos in Connecticut  reporting win per machine per day during
December 1999 of $394.

     All casino games offer the same underlying proposition:  the opportunity to
win  money  in  varying  amounts  and  with  varying  frequency,  but  with  the
statistical  certainty of losing money to the casino  operator  over an extended
period of time. With slot machines, the prospect of winning can be varied across
the spectrum from many small  jackpots won  frequently to one very large jackpot
won very rarely.  Players'  risk/reward  appetites  will  determine what type of
machine  they will want to play,  and the nature of the  payoffs  can be deduced
from the "pay table," a chart that  graphically  shows how much can be won based
on various  outcomes and various amounts of money wagered.  Notwithstanding  the
differences in jackpot frequency and size,  however,  all slot machines retain a
net amount of the money wagered  through them over time. This amount is referred
to as the "hold" and is generally  expressed  as a  percentage  of the amount of
money wagered on a machine, which is called the "handle." The hold percentage in
any given machine is preset by the manufacturer based on specifications from the
casino,  subject to legal parameters in some jurisdictions,  and may differ from
machine to machine on a casino floor.

     The  U.S.  gaming  machine  market  has  traditionally  been  dominated  by
reel-based slot machines.  These were broadly  introduced in the 1960s, when the
free-spinning   reel  was  made  possible  by  advances  in   electro-mechanical
circuitry.  The  free-spinning  reel enabled  manufacturers  to create different
versions of the same product by varying such things as the number of reels,  the
number of stops on each reel and the number and variety of payoff  combinations.
The 1980s saw the  introduction  of  virtual  reel  "stepper"  technology  which
allowed for a greater number of stops, or outcomes,  on a reel,  enabling casino
operators to offer larger  jackpots due to the lower  likelihood  of their being
hit. Another  significant  development was the installation of electronic memory
in  machines,  allowing  players to keep an  "account" of credits on the machine
consisting of the initial amount inserted plus winnings minus losses.  Since the
player did not have to reinsert  coins for every pull of the handle,  the number
of pulls per hour was  increased  significantly,  and players  tended to rewager
much of the  amounts  won,  raising  the total win per  machine.  Except for the
addition of features such as bill  acceptors and player  tracking  systems,  the
technology  employed by slot machines in the 1970s and 1980s still  predominates
in current-generation, reel-based slot machines.

     In the 1980s,  hardware and software  advances  allowed for  application of
video graphics to gaming devices.  Using these  techniques,  International  Game
Technology,  Inc. ("IGT") was the first company to introduce video poker.  Video
poker  offered  slot  players  two  important  advantages.  First,  the  game is
interactive,  since the  player  has to decide  which  cards to hold or  discard
during the hand.  This feature  allows the outcome to be influenced  somewhat by
the player, an attribute unavailable on reel-based machines.  Second, the use of
a video screen allows  machine  manufacturers  to develop more  interesting  and
attractive  graphics than are available on reel-based  slot machines.  Since the
mid-1990s,  a number of slot machine  manufacturers have introduced  video-based
products that have expanded the capabilities of video-based  devices,  including
machines  that  offer the player a choice of up to twelve  different  games on a
single machine.  Now video-based  products actually constitute a majority of new
machines  sales in the slot  machine  industry.  The Company  believes  that the
increasing  popularity  of video poker and  multi-game  machines  suggests  that
customers may be receptive to a more complex and interactive slot experience.

     In the mid 1980s,  a category of slot machine  games called  "progressives"
was introduced and became very popular. The progressive  configuration generally
consists  of  traditional  reel-based  machines  linked  together  by a computer
network that allows them to share a common  jackpot which is usually much larger
than the jackpot that a single, unlinked machine could support. Progressives now
include video based products as well. Progressive jackpots are typically several
million  dollars,  and recently have exceeded $35 million.  Progressives  may be
linked  locally  within a bank of a few machines,  across an entire  casino,  or
across an entire  state.  IGT is the  dominant  competitor  in the  progressives
market.

     Growth in demand for slot  machines  has  historically  been  driven by the
opening of new  casinos,  including  casinos in  jurisdictions  where gaming has
recently  been  legalized.   However,   in  recent  years,  the  number  of  new
jurisdictions that have legalized gaming has significantly declined;  therefore,
demand based on new openings will be largely limited to new projects in existing
markets.  Several new projects are under  construction or have been announced in
Las Vegas, Atlantic City, on the Gulf Coast and in the Midwest.

     While the  physical  useful life of a slot machine can be up to a decade or
more,  casino  operators  have tended to replace  machines on a cycle  closer to
every five years.  Also, the development of certain new features which offer the
prospect of  significantly  increased slot earnings,  such as the advent of bill
acceptors in the early 1990s, or more recent  developments  such as tokenization
or cashless operating systems,  can encourage operators to replace machines even
more rapidly.

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STRATEGY

     Although the gaming industry as a whole has enjoyed significant growth over
the past decade,  the Company believes that there has been very little growth in
the slot machine  manufacturing  segment.  The Company believes that most of the
growth and new investment in the gaming  industry over this period has come from
the investment  made in assets such as large hotels and themed  attractions,  or
from the consolidation of property ownership,  and that comparatively little has
been  invested in further  developing  the actual  casino  games  which,  in the
aggregate, account for a majority of the average casino's revenue and profits.

     In contrast,  SGI has focused its resources primarily on developing what it
believes will be more  rewarding  and  entertaining  casino  games.  It has also
developed what it believes to be a new  generation of interactive  slot machines
on  which  to run its  games.  Since  its  inception,  in  addition  to its game
development,  the Company has developed and refined a gaming platform that takes
advantage  of  personal  computer-based  technology  to  offer  a more  visually
appealing and complex gaming experience. The Company believes that its games and
its machines  will  encourage  casino  patrons to play more  frequently  and for
longer periods of time and will also attract new gaming customers,  particularly
younger  patrons who  typically  are not  attracted to current  generation  slot
machines.  The Company believes that, as a result,  its machines will outperform
most existing  machines in win per machine and thus motivate casino operators to
supplement or replace existing slot machines with SGI products.

     The market for slot machines has become increasingly  competitive since the
Company was formed,  and the number of new game and  product  introductions  has
increased significantly from historical levels. The proliferation of new product
offerings  has  benefitted  casino  operators  who are  able to  leverage  their
position with slot machine  manufacturers and who have demanded higher levels of
perfomance  from new  products.  The  casino  operators  are  willing to try new
products or new games for  existing  products  that offer the prospect of higher
win per machine per day. At the same time,  operators  are also much  quicker to
remove or replace a slot machine  whose  performance  is less than that of other
competing  products.  Casino  operators  have also been able to benefit from the
level of competition to keep the average selling price of new slot machines from
increasing   significantly,   despite   the  higher  cost  and   complexity   of
new-generation  products. As a result, the slot machine  manufacturing  industry
can now be characterized by high competition and low levels of profitability.

     Certain slot machine manufacturers have responded to this pressure from the
casino operators by placing machines in casinos and participating in the revenue
stream  generated from the product,  either by  participating in the net win per
machine  or in the  gross  amount  wagered  on the  machine.  This  has  allowed
manufacturers  to achieve a higher  revenue per machine than an outright sale to
the casino  operator.  Casino  operators  are  increasingly  reluctant  to place
machines  in their  casinos on a  participation  basis in the  belief  that this
represents  a  profit  shift  from  the  casino  operator  to the  manufacturer.
Manufacturers  have responded by selling their newest and most successful games,
or games that they think will be highly  successful,  on a  participation  basis
only.  Casino  operators  have  only  tolerated  this  where  the game is highly
successful,  as the net win to the  casino  is still  attractive.  This has also
contributed to the casino operators'  willingness to remove  non-performing slot
machines from their floors.

     The  Company  believes  that  it is  uniquely  placed  among  slot  machine
manufacturers  because of the  potential  to  leverage  the  technology  that is
inherent in its  products.  The Company  believes its products and platforms are
significantly more complex than competing products but at the same time are more
flexible  so that new and  innovative  game  types can be  deployed  on its game
platforms.  This will allow the  Company to develop  game types and game  themes
that can offer  play  characteristics  that  cannot be  easily  imitated  by its
competitors  and that take full  advantage of the  underlying  technology of the
product.  By doing so, the Company  hopes to offer a richer,  more  entertaining
gaming  experience for the casino customer and thereby generate a higher win per
day per machine.  The Company  believes that this will also assist it in placing
machines with casino operators on a participation basis, which should prove more
profitable for the Company than a one-time sale of the machine.

     The flexibility of the Company's  products allow it to customize or develop
new game content much quicker than its  competitors.  The Company  believes that
this will allow it to partner  directly  with casino  operators to develop games
for the  exclusive  use of that  operator,  affording the operator a competitive
advantage  given  the lack of  product  differentiation  between  most  casinos.
Working  directly with  operators to develop  products may also help the Company
overcome the operators  concerns  about  participation  games,  as it aligns the
operator and the  manufacturer to the benefits of product  success.  The Company
believes that there is greater  profit  potential in this type of  collaborative
relationship than in the more traditional  "build and sell" model of the typical
slot machine manufacturer.

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     The  Company  believes  that new  slot  machine  sales  in the  replacement
category will surpass sales for new installations in the near future, due to the
slowing in demand from new casino  projects,  and  because  the large  number of
machines installed during the high growth period of the early 1990s will soon be
reaching their normal replacement time.

     The market for slot machines outside of North America is relatively  small,
with the exception of Australia,  and it is generally difficult to forecast.  In
addition, international markets have often served as an outlet for used machines
for most slot machine  operators.  SGI is currently focussed on establishing and
solidifying  its market  position in North America.  Given the relatively  small
size of the Company compared to certain of its competitors, the Company does not
believe it has adequate  resources to  simultaneously  develop products for both
the  North  American  and  international  markets.  As a  result,  SGI  does not
currently  contemplate entering any international  markets with the exception of
certain   Canadian   provinces.   SGI  remains  open  to  taking   advantage  of
opportunities  in  international  markets,  but only if this can be accomplished
without any adverse impact on its domestic business.

     SGI  currently  sells its products  outright to casino  operators and other
potential  purchasers  offering several pricing  programs.  For the ODYSSEY this
consists of either (i) the sale of the hardware  unit bundled with a single game
or a suite of games and other  software for a fixed  price,  or (ii) the sale of
the hardware unit alone  combined with a renewable  one-year  software  license,
including access to the entire ODYSSEY game library for the term of the license.
The Company's single game upright machine,  QUEST, and its slant top machine are
sold as a bundled  package of the  hardware  unit and a single  game for a fixed
price.  The Company also offers a participation  program where it will place its
product on a casino floor in exchange for a share in the aggregate win generated
by the machine.  Typically, under this program 20% of the aggregate win, subject
to a predetermined minimum, or a fixed daily rental fee, goes to the Company.

     SGI believes that with the ODYSSEY,  it has achieved a leadership  position
within the multi-game segment of the video slot machine market.  Since 1997, the
Company has made a great deal of progress in defining  and  developing  what the
industry refers to as a "successful game". The Company believes that it has been
able to improve its game content as a result of this experience,  and now it has
one of the most successful  blackjack games with TOP HAT 21, a successful  poker
game  with  LUCKY  DRAW  POKER,  and  some of the  more  successful  multi-line,
multi-coin  games  with  EUREKA and BANANA  RAMA.  At the same time the  Company
believes  that it  currently  has  not yet  fully  exploited  the  technological
potential of its game  platform and that many of its game  offerings are in fact
similar to competing products.

     The  introduction of QUEST during 1998 was designed to allow the Company to
increase  its  penetration  of the casino  floor by  offering  a wider  array of
product  and price  points  to the  casino  operator.  The  introduction  of the
wide-area  progressive products in December 1998 further increased the Company's
product  offerings.  In 1999 the Company  also  introduced  a more  traditional,
slant-top  machine that is  physically  similar to  competitors'  products.  The
Company  intends to offer  additional  platform  choices  such as a new  upright
machines during 2000 to further diversify its product offering.

     The  Company  believes  that its  ultimate  success  will come not from the
breadth of platform offerings,  but from the quality of play  characteristics of
the  individual  games  offered on those  platforms,  and from the total  gaming
experience  that it can  provide to patrons  playing  its  products.  Developing
pricing  models that will allow the Company to maximize the revenue from each of
its games will also be critical to the Company's future success.

PRODUCTS

     The Company has developed a family of games and platforms  that it believes
represents the next generation of interactive  gaming devices for use in casinos
and  other  gaming  establishments  in the  United  States  and  worldwide.  The
Company's products utilize multimedia  technologies to present casino games that
it believes will be more  engaging and  entertaining  than other gaming  devices
currently available. The Company's games feature high-resolution video presented
across the full surface of a large touchscreen display. The touchscreen displays
used by the Company are larger and more  distinctive  than those on  competitive
products,  which has helped make the Company's platforms  distinctive and easily
recognizable  within  a  casino   environment.   The  games  themselves  feature

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high-quality  animation,  video  clips,  digital  sound  and  a  level  of  game
attractiveness and interaction that the Company believes is unavailable from and
unachievable   by   current-generation   slot   machines.   Unlike   traditional
"hardware-dominant"  slot  machines,  the Company's  products run games that are
software  based,   allowing  SGI  to  offer  casino  operators  the  benefit  of
flexibility to adapt their game offerings to evolving  technologies and changing
consumer  tastes without  structural  change to, or  replacement  of, the gaming
platform.

GAMES AND OTHER SOFTWARE

     While  SGI  believes  that the  design  of its  machines  and its  hardware
components  are important to its operation and its ability to foster initial and
extended play, it believes that the most important  factor affecting the success
of its  platforms  will be the games  themselves  and the software that controls
those games. The majority of the Company's development efforts to date have been
devoted to  hardware,  system  software  and game  development,  and the Company
expects that, in the future, game development will be its principal  development
activity.

     The Company's games have been designed to present  traditional casino games
with the  benefit  of video  and audio  enhancements  that are  afforded  by the
Company's use of high-end  multimedia  hardware.  While the underlying  game may
consist of a traditional  casino game such as poker,  keno or a reel-based  slot
machine, the game itself is only one aspect of the entertainment experience.

     The   development   cycle  for  the   Company's   games  has  been  reduced
significantly  since the Company's  initial  introduction  of games in 1997. The
Company developed a standard "engine" for each game type that it introduced such
as video-reels, keno, poker, blackjack and multi-line,  multi-coin. In addition,
for every game that is  introduced  the Company  develops a number of  different
percentaging models that each have a different hold percentage. The percentaging
models are  developed  to meet  jurisdictional  regulatory  requirements,  local
market conditions and to offer  flexibility to the casino operators.  The number
of  percentaging  models  vary by game type.  For  example,  ARABIAN  RICHES,  a
reel-based game introduced during 1998 has 38 different percentaging  variations
and PHANTOM BELLE, a poker-based game, has 29 different percentaging variations.
The choice of gaming platform can also affect the  development  cycle for games;
however,  to date the Company has used a common  gaming  platform for all of its
hardware products. Development of a new game engine is a lengthy process but one
that can be leveraged  and used on  subsequent  game  offerings.  The ability to
leverage  existing  game engines and  percentaging  models allows the Company to
develop new game themes and to introduce  these new game titles much faster than
if it  had  to  develop  a  brand  new  game  engine  with  unique  percentaging
requirements.  This has been reflected in the increase in the number of new game
titles that the Company introduced in 1999 as compared to 1998.

     All of SGI's games embed an engaging and  entertaining  theme story to help
attract  patrons to the  Company's  machines.  Some of the games  developed  and
introduced during 1999 include the following:

          EUREKA - This multi-line, multi-coin wagering experience takes players
     deep inside a derelict  coal mine on the way to hidden  fortune.  Featuring
     two separate bonuses embedded in the basic 4 X 4 playing field, players can
     follow a coal cart as it speeds  its way into a  long-sealed  mine shaft on
     their  way to  discovering  riches.  This  game  was  named  one of  Casino
     Journal's Top 20 Most Innovative Games of the Year in 1999.

          HOT REELS - A new game type  developed and patented by Silicon  Gaming
     during 1999, Hot Reels introduces the  player-decision  characteristics  of
     video poker into a 3-reel  traditional  game set to an engaging auto racing
     theme.  Players can select or hold game symbols from one reel across all of
     the reels being played (up to 5 reels simultaneously), and then re-spin for
     a second chance at a match, increasing their opportunities to win.

          STRIKE-IT-RICH  - A multi-line,  multi-coin  game based on the popular
     pasttime of 10-pin bowling,  this game offers players an unusual twist. The
     opportunity to actually bowl a bowling ball for cash. Incorporating a track
     ball, when bonus time comes around, the player can use the track ball to go
     bowling  for  dollars.  Also  named  one of  Casino  Journal's  Top 20 Most
     Innovative  Games of the Year in 1999, this game is sold and distributed on
     the Company's behlf by Anchor Gaming.

         BANANA-RAMA  DELUXE- A multi-line,  multi-coin version of the Company's
     traditional  three-reel  game  BANANA  RAMA,  this game  utilizes  the same
     infectious  jungle  rhythms  and the  on-screen  antics of the  game's  two
     animated host monkeys,  Banana and Clyde. The characters interact with each
     other and with the player and celebrate  jackpots with the player.  A bonus
     feature  takes the player to the Oyster Bar for a  pick-till-you-win  bonus

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     game where  players can select up to twelve  oysters and collect the awards
     lying inside each of the oysters. The players continue doing this until the
     collect symbol appears at which time they return to the game.

         CASH  CRUISE - This  multi-line,  multi-coin  game set to a cruise ship
     theme  takes the player  across the oceans to either of a tropical or artic
     destination  to see the sights and win some cash.  Cash  Cruise is a nickel
     game  that  allows  the  player  to wager up to 50 coins a play.  This game
     features two instant  bonuses that hit with  varying  frequencies.  Players
     select one of a selection  of  different  destinations  and collect  prizes
     based upon the amount wagered and then return to the game.

     The Company  believes  that the  combination  of its  attractive  machines,
high-level  graphics  and  sound,  bonusing  features  and  the  pursuit  of  an
interesting  and   entertaining   story  will  make  SGI's  product   outperform
conventional slot machines. During the last few years, a number of the Company's
competitors  have developed games based upon well known licensed brands that the
manufacturers  have licensed from the holders of the brands.  This has helped in
the  "attract"  stage of the  wagering  experience  in bringing  customers  to a
machine as customers can readily identify with these brands. Many of these games
have been  participation  games,  and have been highly  successful  for both the
casino  operator and the slot machine  manufacturer.  The abilty to use licensed
brands  as  themes  for  slot  games  has to date  been  limited  to the  larger
competitors  in the slot  machine  industry  who have  the  necessary  financial
resources to acquire those brands.  Competition  for well known and  established
brands has intensified,  which has increased the price that a manufacturer  must
pay to acquire the licensed brand. The Company believes that opportunities exist
for it to partner with one or several of the larger  casino  operators to aquire
licensed  brands  during  2000 that will allow it to  compete  in this new,  but
growing segment of the gaming industry.

     The Company  believes that the physical  appearance of its machines is more
attractive  than  conventional  machines and will entice  customers to play.  In
addition to the physical attributes of its machines,  the Company has included a
suite of video  images  that run when the  machine  is not being  played.  These
include short,  animated  vignettes from the Company's games and "help" screens,
as well as a menu page identifying all of the games available on that particular
machine.  Information  regarding  any game can be viewed  through  the push of a
"Help"  button.  These  merchandising  segments  feature  the  same  quality  of
graphics, sound, video and animation that distinguish all of SGI's games.

     In the initial play period,  SGI believes it is necessary to quickly engage
the  customer  in the story line and to avoid any  confusion,  unfamiliarity  or
negative experience which might cause the customer to discontinue play. For this
reason,  many of the  Company's  game  offerings  to date  consist  of  enhanced
versions of traditional casino games,  including  reel-based slot games, so that
the rules of the game will be well  known.  SGI  intends to present  these games
using enhanced  graphics and sound to enrich the play  experience,  but will not
change the  fundamental  characteristics  or objective of the game. In addition,
the machine will offer traditional game controls for those players unfamiliar or
uncomfortable with the touchscreen interface.

     The  Company  believes  that the  enhancements  it has made to  traditional
casino  games by the  addition  of high level  graphics,  sound,  animation  and
storyline  will  encourage  extended  play, as well as more frequent  play,  and
thereby generate  greater win per machine than the unenhanced  versions of these
games  available in  conventional  machines.  A  significant  feature  which the
Company  believes  will  contribute   significantly  to  extended  play  is  the
introduction  of  advanced  play  levels in which a player,  by virtue of having
played a certain  amount of time or achieved a certain number of jackpots at one
level,  gains  access  to a bonus  sequence  in  which  larger  jackpots  become
available.

     The Company  believes that the principal  events that lead to completion of
play include the player's running out of money, running out of time or achieving
a targeted  jackpot  level.  The Company  believes that the unique  features and
entertainment  value of its games will entice  players to remain in the extended
play phase for longer  periods of time than are  generally  fostered  by current
generation  slot machines.  Moreover,  the design of the Company's  platform and
games is intended to provide an  entertainment  experience  that will  encourage
repeated play.

     In  addition  to features  that are  designed to enhance the  entertainment
value of SGI's machines and its ability to generate  incremental revenue for the
casino,  SGI's platform  incorporates  proprietary features that are designed to
overcome certain hurdles that may be involved in the licensing of a slot machine
design,  as well as to facilitate  easy  maintenance  and  supervision by casino
personnel. These features are as follows:

          RANDOM  NUMBER  GENERATOR.  At the core of every  gaming  machine is a
     random  number  generator  that  determines  the  outcome  of every  gaming
     proposition.  To  eliminate  what  the  Company  believes  are  some of the

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     impediments to randomness that characterize  random number generators,  SGI
     engaged Dr.  Evangelos A. Yfantis,  a recognized  authority in the field of
     random number algorithms,  to develop a proprietary random number generator
     algorithm for the Company. The Company has filed and received a U.S. patent
     with respect to its algorithm.

          SOFTWARE AUTHENTICATION.  A critical element of all gaming machines is
     an  authentication  mechanism to determine  that the software being used is
     identical to the software that has been approved by regulatory  authorities
     and is operating correctly. This is necessary to ensure that the game being
     played  corresponds  exactly  to  that  designed  by the  manufacturer  and
     approved by regulatory  authorities.  Traditional  slot machines need to be
     authenticated  manually,  a process usually  performed only after a sizable
     jackpot award.  The  infrequency of checks offer greater  opportunities  to
     breach the security of  traditional  machines.  The Company has developed a
     proprietary   authentication   process   which   leverages   the   advanced
     capabilities  of the  Company's  machine to verify the  integrity of a game
     each time it is selected  for play.  This  process  combines  sophisticated
     authentication  routines  developed  by  RSA  Data  Security,  Inc.  with a
     proprietary   methodology   developed   by  the  Company.   The   Company's
     authentication   process  provides  continual  checking  of  the  machine's
     software for both accidental corruptions or malicious attempts to cheat the
     machine.  Any detected  anomalies will cause the machine to signal the loss
     of integrity  immediately.  The Company has filed for and  received  patent
     protection for certain aspects of its authentication methodology.

          MACHINE  MANAGEMENT SYSTEM. The Company's Machine Management System is
     designed  to provide  easy  access to the  configuration,  accounting,  and
     diagnostic  capabilities of the machine.  The Machine  Management  System's
     accounting  functions  are  designed to provide a rapid,  easy-to-interpret
     report of all key machine metering data, as well as detailed accounting and
     statistics, on a game-by-game basis. The Machine Management System uses the
     full benefit of the machine's touchscreen to make installation and setup of
     the machine easier than traditional slot machines.  The diagnostic programs
     comprise a user-friendly maintenance and troubleshooting system that allows
     casino  floor  personnel to quickly and  effectively  assess the cause of a
     play stoppage or other malfunctions or to examine transaction history where
     the  validity  of a jackpot  or other  transaction  must be  verified.  For
     example, if a player asserts that the machine has not given full credit for
     a jackpot or has not properly recorded a cash input, a floor manager, using
     the  touchscreen  and a  key,  can  access  comprehensive  data  to  review
     transaction and event history. With this information, the floor manager can
     rapidly  evaluate  the merit of the  player's  claim  and take  appropriate
     action.  In this way,  disputes  can be quickly  resolved at the  machine's
     location  without the  operator  having to consult  back office  records or
     review surveillance videotape.

     PLATFORM, HARDWARE AND OTHER PHYSICAL ATTRIBUTES

     SGI's gaming  platforms so far have been designed to resemble a traditional
slot  machine in many  respects.  Its  machines  occupy the same  footprint as a
traditional  slot  machine and are of roughly the same  general  size and shape,
enabling  casino  operators  to replace  traditional  slot  machines  with SGI's
machines without any  reconfiguration  of the casino floor. The most distinctive
attribute of the upright  products the Company has  introduced  so far are their
vertically-oriented,  26-inch-diagonal  touchscreen  video  monitor.  A player's
sense of  interactivity  is  heightened  by the ability to make all the required
decisions on the screen,  within the game itself.  However,  for players who are
uncomfortable  or unfamiliar with  touchscreen  devices,  all of the traditional
slot machine controls have been included as well. Thus, a player can control the
game by using the  touchscreen,  by pushing a series of buttons similar to those
found on  current  slot or video  poker  machines,  or by pulling a handle as on
traditional  slot  machines.  Coin handling  mechanisms,  bill  acceptors,  card
readers and other  devices  related to cash  deposit,  credit and win payout are
similar to those used in current  gaming  machines.  The music,  voice and other
audible features of the Company's games are played on a digital sound system.

     The  products  that the Company has  introduced  all share a common  gaming
platform.  The principal  electronic  hardware  used in the SGI gaming  platform
consists of multimedia  and personal  computer  ("PC")  components.  The central
processing  unit is an Intel 200-MHz Pentium chip. This processor is accompanied
by a  variety  of video  and  auxiliary  controllers,  some of which  have  been
developed  exclusively  for use with the Company's  products.  To achieve a high
level of multimedia  performance from its system,  the Company's machines use 64
megabytes  of random  access  memory.  Storage  for the audio and  visual  media
elements of the games, as well as the product software itself,  is provided by a
high-density  4 gigabyte  hard disk drive for the  multi-game  machines and by a
smaller  2-gigabyte  hard disk  drive for  single  game  machines.  All of these
components  are connected  internally by a high-speed PCI bus. SGI's reliance on
sophisticated  full-motion video and high-quality audio  presentations  requires
the  use  of  state-of-the-art  technology,  and  SGI  expects  to  upgrade  the
performance of its platform periodically as higher-performance components become
available.  SGI machines are intended to be easily  reconfigurable  in the field

                                       8
<PAGE>
through the replacement of hardware components such as computer motherboards and
video and auxiliary  controllers,  allowing casino operators to upgrade hardware
in a cost-effective manner.

     SGI's gaming platforms  employ modular  construction at almost every level,
facilitating upgrades and minimizing machine down-time.  Such modularity permits
the rapid  exchange of components  for upgrades or to replace  defective  parts.
Using SGI's proprietary  Machine Management  System,  casino personnel can run a
variety of diagnostic programs or review detailed performance data directly from
the gaming platform itself. In the case of a malfunctioning  component, a casino
technician can quickly restore play simply by swapping out the failed  component
with a new one. The modularity of SGI's platform will also  facilitate  upgrades
of  hardware  components  such  as  card  readers  and  bill  validators  as new
components become available.  The Company believes that these features may allow
casino  operators to reduce platform  down-time and shorten the time required to
fix any malfunction,  thereby  increasing the time the platform is available for
play and  reducing  the risk  that a player  will  elect to  terminate  a gaming
session as a result of play stoppage.

     The  Company's   gaming   platforms  are  assembled  almost  entirely  from
off-the-shelf hardware,  which the Company anticipates will reduce the chance of
a parts  shortage  and will enable the Company to  continue to  manufacture  its
devices  using  state-of-the-art  components as PC and  multimedia  technologies
advance. The different platforms share many common components,  making it easier
for the  Company's  games to be played on different  platforms  and for customer
technical staff to work on the Company's different product offerings.  There can
be no  assurance,  however,  that  the  Company  will  continue  to  use  common
components or enjoy a reliable supply of hardware components.  Moreover, certain
components  such as the  touchscreen  display and monitor  are  manufactured  by
single sources and may be particularly  susceptible to  interruptions in supply.
Although  SGI does  develop  proprietary  components  in  order to meet  certain
specialized  requirements of its platform,  the Company intends to primarily use
commercially  available  computer  hardware  components as a regular part of its
product development process.

     SGI's  machines were designed to accept  future  hardware  upgrades to take
advantage of networking  capabilities.  When networked, two or more machines can
be  linked,   facilitating  activities  such  as  group  play,  tournaments  and
progressives.  For example, a particular group of platforms can be configured to
announce to players that a tournament  will begin at a particular time and allow
each player the option to participate. Similarly, platforms can be configured so
that when one  machine  hits a jackpot,  a player at another  machine  can win a
bonus  award;  the  two  affected  platforms  can  then  display  a  coordinated
audio/video  simulation of a coin flying out of one tray and into the other. The
Company  believes  that  features of this kind will  promote  interaction  among
players at adjacent  platforms and thereby  maintain  player interest for longer
periods of time. The Company introduced its first product into the Nevada market
in December 1998, THE BIG WIN, that incorporated this networking capability in a
wide-area progressive system. The Company anticipates  introducing products into
the  market  during  2000  that  will  incorporate  group  play  and  tournament
capabilities.

     SGI has  incorporated  numerous  features into its gaming platform that are
designed  both to attract the player and to maintain his or her interest over an
extended period of time. For example, SGI's gaming platform can be programmed to
allow for a free spin following a specified  number of unsuccessful  attempts in
order to  ensure a  minimum  level of reward  to the  player.  Similarly,  SGI's
machines are capable of running  promotional  or  entertainment  video  programs
during play stoppages  such as those caused by a hopper  refill,  malfunction or
request for change.  These  features have been designed to reduce the likelihood
that a player  will  leave  the  machine  during a play  stoppage  event.  These
features may also provide an  additional  revenue or  promotional  source to the
operator by providing a medium for commercial messages.

PRODUCT DEVELOPMENT

     The  Company's   product   development   efforts,   particularly  its  game
development and  customization  efforts,  will be critical to its success in the
gaming  market.   Research  and   development   (R&D)  expenses  have  increased
significantly since inception. However, given the maturity of the game platform,
the development tools and the software code base, the Company  anticipate higher
levels of  productivity  that will  result in  increased  product  output and an
overall reduction in the level of development expenses. Development efforts will
also likely be focussed on new or custom game  development  during 2000.  During
the years ended  December 31, 1999,  1998 and 1997,  the Company's  research and
development expenses were $4,410,000, $11,853,000 and $9,283,000,  respectively.
The reductions in the Company's headcount in late 1998 and early 1999, driven by
efforts to reduce costs in light of continued  losses,  contributed to the lower
levels of R&D expense  during 1999. At December 31, 1999, 23 of the Company's 90
full-time employees were engaged in research and development.

                                       9
<PAGE>
     Ideas for new games are derived from customer  preferences  as perceived by
the Company or  ascertained  through the  Company's  market  research and direct
feedback  from slot machine  operators.  The initial  designs for the  Company's
games are conceived by a design team, which outlines the appearance and features
of each game. A prototype is  developed  by a  production  team that  includes a
producer,   product   manager,   artists,   computer   graphics   engineers  and
entertainment software engineers.  The game is then evaluated by SGI's marketing
and sales  staff,  after which it is modified  into its final form.  The Company
estimates that the development of a typical game takes  approximately two to six
months and costs approximately $150,000 to $400,000.

     SGI is  seeking to develop a variety of  specific  games  which  management
believes will appeal to casino  operators and their  customers.  Currently,  the
Company is engaged in the development of games based on traditional slot machine
games such as animated  reel slots and video poker,  as well as  developing  its
first  brand based  products.  The Company is also  creating  variations  of the
multi-coin,  multi-line,  Australian  type games which have  proved  popular and
successful in all of the US gaming markets since 1998.

     Some of the games currently under development include the following:

          HITSVILLE - The hits keep coming in this Motown  inspired  multi-line,
     multi-coin  game.  Stylized  characters and soulful sounds come together in
     this nod to Barry  Gordy `s "hit  factory".  The game  features  two unique
     bonuses and stunning graphics, making it a pleasure to play.

          KING PUTTT - Golf and gambling have long gone together and now players
     can test their skills in a true "putt for money"  contest.  This five-reel,
     nine-line payout game brings high hit frequency and a seemingly skill based
     bonus  game   incorporating  the  animated  antics  of  mini-golf  with  an
     entertaining wagering experience.

          3-REEL HOLDUP - This  comic-book  caper set to a 20's gangster  theme,
     complete with wise -cracking "tough guys",  car chases,  armored car heists
     and a swinging soundtrack, is the Company's second unique "multi-spin" reel
     based game.  Targetted to be a quarter  denomination game, success sees the
     lucky particpant choosing a bag of loot from the back of an armored truck.

          STOCK CARDS - This high-speed,  single hand poker game has been set to
     an auto racing theme and is designed to remind you how popular  traditional
     draw poker still is. Stock cards offers the added  challenge of accelerated
     play and experienced  players can rev up the proposition  rate to keep pace
     with their thirst for action.

     Completion of the games under  development  is subject to various risks and
uncertainties.  Such games may be subject to  further  creative  decisions  that
could  alter the game  implementation  or  marketing  considerations  that could
result in a shift of the Company's development focus to different types of games
altogether.  Successful  completion  of any game will also be  subject  to risks
typically  associated  with the  creative  process,  such as the  risk  that the
Company's  creative team will be unable to achieve the desired  results in terms
of the game's entertainment quality.

     The  product  development  strategy  to  date  has  focussed  on  enhancing
traditional  gaming experiences by offering  variations of existing  casino-type
games.  Familiarity with these game types attracts customers to these games. The
company has also taken this strategy a step further by  introducing  games based
on familiar brands or activities, such as the EUREKA mining game. The next phase
in the Company's product development strategy , which it commenced in 1999 is to
introduce  completely new types of wagering  experiences  such as the multi-spin
games offered with HOT REELS or the  interactive  bowling in STRIKE IT RICH. The
Company  intends to  introduce  new game types  that  reflect a broader  kind of
wagering experiences during 2000.

     Over time,  SGI expects to  introduce  additional  games that offer a wider
range  of  gaming   experiences   as  players  become  more  familiar  with  the
capabilities of advanced video gaming  platforms.  For example,  the Company may
introduce  games that utilize new digital  camera  technology  to transform  the
player into the game during a bonus event, to enable the player to "participate"
in the game,  rather than merely  being a spectator  to a  predetermined  random
outcome.  The  Company  also  anticipates  developing  more  of  its  games  for
progressive  formats  in which the  Company's  machines  would be  networked  to
support  a  common  jackpot  that is  significantly  larger  than  that  which a
stand-alone  machine could offer, or to support  additional  networked  features
such as tournaments and peer-to-peer play.

                                       10
<PAGE>
     As internet  technolgies  continue to evolve,  the Company will continue to
monitor the changes in the legal environment  surrounding on-line gaming. To the
extent that it will not jeopardize is existing gaming licenses, the Company will
look at leveraging its software content in the internet  domain,  either through
licensing its content to third parties, developing or operating its own internet
gaming  site for cash or for  prize,  developing  gaming  sites for other  third
parties,  or any  combination  of the  above.  The  Company  believes  that  its
software-based  games  would  translate  easily  into the  internet  world,  and
continues to monitor the evolution of this online gaming market.

SALES AND MARKETING

     The ultimate success of SGI's games and its gaming platforms depends on its
acceptance by casino  operators and casino patrons.  The Company  believes that,
from the point of view of casino  operators,  the  attractiveness of any game or
gaming  platform  depends on win per machine,  ease of upgrade,  maintenance and
game change and  information  management.  The Company  believes that,  from the
casino patron's  perspective,  the attractiveness of a platform is a function of
entertainment value and the perceived likelihood of the customer winning.  SGI's
sales and marketing  strategy is to generate  product sales by highlighting  the
advantages  presented  by its  gaming  platform  to  casino  operators,  such as
potential for increased win per machine;  and by developing processes focused on
key operator  values.  SGI's marketing  strategy also targets casino players and
will focus on developing  brand  recognition for SGI's games,  which the Company
believes can be accomplished  through the development of proprietary  games that
deliver greater entertainment value for the gaming dollar.

     SGI intends to position itself as a partner with either casino operators or
other  slot  manufacturers  in  establishing  the next  generation  of  wagering
entertainment.  The Company  recognizes  that it is a small player in the gaming
industry  at  this  point  and  that it may  have to  leverage  the  skills  and
experience  of these third parties to help in the  development  or deployment of
new  products.  During  1999 the Company  worked  with Anchor  Gaming to jointly
develop and introduce a new game, STRIKE-IT-RICH.  Anchor is responsible for the
sale and support of the product which is manufactured by the Company.

     Because SGI's games are  software-based,  SGI believes that there will be a
significant  opportunity for game customization and the development of games for
the exclusive use of one or more casino customers. It is already commonplace for
casinos to ask that  conventional  slot machines be customized with the casino's
logo or theme.  SGI  believes  that it can  significantly  exceed  this level of
customization  by  inserting  the casino's  logo or theme right in the game,  by
presenting  images of the casino's other games and  amenities,  or by creating a
new game entirely based on the casino's theme. The Company expects that it would
charge fees for any  customization  or development work that it performs for any
other parties. The Company announced in February 2000 that it had entered into a
joint-development  agreement  with a Nevada-based  casino  operator to develop a
licensed brand into an exclusive game for that operator.  The Company expects to
announce  more of these  type of  arrangements  in the  future  as a way to help
defray the cost and risks of new game development and to facilitate distribution
of its products.

     The Company  currently  sells product  through a direct sales force that is
based in Nevada,  Mississippi  and the  mid-west.  The  Company is  planning  to
distribute   product   through  third  parties   including  other  slot  machine
manufacturers  or casino  operators  to help in the  penetration  of new markets
without the need for  additional  hiring.  As at December  31,  1999,  19 of the
Company's 90 full-time employees were engaged in sales and marketing.

     The  successful  introduction  of  the  Company's  product  is  subject  to
substantial  risks  and  uncertainties,  including  the  risk  of  technical  or
manufacturing  difficulties,  the  possibility  that the SGI  platform  will not
receive  the  anticipated  market  acceptance  and  possible  delays or  hurdles
associated with licensing of the Company's product in various jurisdictions.

     The Company is required  to be  licensed in each  jurisdiction  in which it
expects to sell product.  As of December 31, 1999, the Company has received both
corporate  approval  and  approval  to sell its product in  Colorado,  Illinois,
Indiana,  Iowa, Nevada, New Jersey,  Missouri,  Mississippi,  and certain native
American jurisdictions in Connecticut,  Louisiana,  Michigan,  Minnesota and New
Mexico. See "Gaming Regulation and Licensing."

     Although the Company  plans to file  applications  in other  jurisdictions,
there  can be no  assurance  that  the  Company  will be  ready  to file  future
applications or that any licenses will be granted on a timely basis, or at all.

PRICING

     The Company  sells its  products to casino  operators  and other  potential
purchasers  offering several pricing programs.  For the ODYSSEY this consists of
either (i) the sale of the  hardware  unit bundled with a single game or a suite

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<PAGE>
of games and other software for a fixed price,  or (ii) the sale of the hardware
unit alone combined with a renewable one-year software license, including access
to the entire game library for the term of the license.  QUEST and the slant-top
product are sold as a bundled package of the hardware unit and a single game for
a fixed price.

     Similar to several of its  competitors,  the Company  also offers a revenue
sharing plan as an alternative to the above purchase pricing options. Under this
plan, the casino operator is not required to make an upfront capital investment;
rather,  in exchange for placing the machines on the floor,  the casino operator
agrees to share with the Company the  aggregate  win  generated by the machines.
Under this plan,  20% of the  aggregate  win goes to the  Company,  subject to a
predetermined  minimum. In certain  jurisdictions where this type of arrangement
is not  permitted,  the operator  agrees to pay a fixed daily fee for the use of
the machine.  The Company's  plan is unique  because the Company also offers the
casino operator a buyout option at any point after the 90 day minimum evaluation
period,  something  not  currently  offered  in the  industry.  Under the buyout
option,  the operator receives a credit towards the purchase of the hardware and
must  purchase its choice of software at list price.  The Company  believes that
licensing  revenue from game  software may  eventually  constitute a substantial
portion of its revenue.

COMPETITION

     The current slot machine market is highly competitive and is dominated by a
small number of manufacturers, many of whom have significantly greater financial
and other  resources than the Company.  The Company  believes that the principal
competitive  factors in this  market are the appeal of the  machine to  players,
knowledge of customer  requirements and player preferences,  price, ease of use,
service, support and training,  distribution,  and name and product recognition.
The  principal  competitors  in the slot  machine  market  are IGT and  Williams
Industries. IGT may be viewed as a dominant competitor, with a 1999 market share
estimated  at 70%;  William  Industries  1999 market  share is estimated at 15%.
Additional  competitors or potential competitors include  Bally/Alliance Gaming,
Inc.,   Anchor  Gaming,   Inc.,   Aristocrat   Leisure   Industries,   Universal
Distributing,  Sigma Games, Casino Data Systems,  Mikohn Systems, Inc. and Acres
Gaming Inc. There can be no assurance that other  companies in the video game or
multimedia  market  will not  successfully  enter  the  market  for  video  slot
machines,  nor can there be any assurance that the  manufacturers of traditional
slot  machines  will not develop  products that are superior to, or that achieve
greater market acceptance than, the Company's product. A number of the Company's
larger  customers who operate multiple casinos have also indicated that they may
become  involved in the design,  development  and  manufacture of slot machines,
although to date few have actually done so. In general,  the Company's  existing
competitors,  as well as many  potential  new  competitors,  have  significantly
greater  financial and  technical  resources  than the Company,  as well as more
established customer bases and distribution  channels, any of which could afford
them a competitive advantage.  If any of the Company's products or specific game
titles  display  potential to capture a significant  share of the gaming machine
market, the Company's competitors can be expected to employ a variety of tactics
to  limit  erosion  of  their  market  shares,   including   price   reductions,
acceleration  of  technical  development  or  acquisition  of  new,  competitive
technologies.   Any  success  the  Company  might  have  may  benefit   existing
competitors  and induce new  competitors  to enter the  market.  There can be no
assurance that the Company will be a successful competitor in the gaming machine
industry.

PROPRIETARY RIGHTS AND LICENSES

     The Company's  computer programs and technical  know-how are both novel and
proprietary,  and management  believes that they can best be protected by use of
technical  devices  to protect  the  computer  programs  and by  enforcement  of
contracts and  covenants  not to compete with certain  employees and others with
respect to the use of the Company's  proprietary  information and trade secrets.
The Company has  registered  copyrights  with respect to various  aspects of its
games, and has filed several U.S. patent  applications for protection of certain
technology it has created or licensed.  These patent  applications cover various
aspects of the gaming  machine  hardware and software.  Although the Company has
received  certain  patents  and  trademarks  with  respect  to its  intellectual
property, no assurance can be given that the remaining pending applications will
be  granted,  nor can  there  be any  assurance  that  the  patents  will not be
infringed or that others will not develop  technology that does not violate such
patents.

     SGI  has  developed  a  proprietary   method  of  authentication  for  disk
drive-based  gaming machines,  for which it has submitted a patent  application.
Since modern  gaming  technology  requires the handling and  processing of large
amounts of on-line data,  establishing a method for storing and retrieving  data
that meets the approval requirements of the regulatory authorities while meeting
adequate  standards  of internal  performance  requires  use of a  comprehensive
authentication  system to assure both the casino  operator and requisite  gaming
authorities  that the software is an exact copy of what was generated by SGI and
approved by such gaming authorities.

                                       12
<PAGE>
     In addition,  SGI owns  exclusive  rights to the  algorithm  for its random
number  generator,  the key  component  of the  Company's  gaming  machine  that
determines the outcome of each proposition. SGI's algorithm, which may have uses
outside the gaming  industry,  was  developed  by Dr.  Evangelos A.  Yfantis,  a
professor of Computer Science at the University of Nevada, Las Vegas.

     In developing  its games,  the Company  relies on certain  software that it
licenses from Duck Corporation  ("Duck") on a nonexclusive  basis.  This license
may be terminated by Duck only in the event of a material breach of its terms by
the  Company  or in the  event of a  bankruptcy  petition  with  respect  to the
Company.  The Company believes that  alternative  products exist that accomplish
the same functionality as that licensed from Duck.

EMPLOYEES

     As of December 31, 1999, the Company had 90 full-time employees,  including
23 in research and development. The Company also retains independent contractors
to  provide  certain   services,   primarily  in  connection  with  its  product
development activities.  The Company and its full-time employees are not subject
to any  collective  bargaining  agreements  and the  Company  believes  that its
relations  with its  employees  are  good.  From  time to time the  Company  has
retained  actors  and/or  "voice  over"  talent to  perform  in  certain  of the
Company's  games and  expects to  continue  this  practice  in the  future.  The
Company's  future  success  depends in large part on its  ability to attract and
retain management and other key personnel.

MANUFACTURING

     The  Company's  manufacturing  process  consists  primarily  of assembly of
components  obtained from third-party  suppliers and testing of software systems
and  applications.  This  activity now takes place at the  Company's  Las Vegas,
Nevada  facility.  As the Company has introduced new product  platforms,  it has
increased its use of subcontractors  and third party vendors to supply completed
sub-assemblies  and  components,   which  has  decreased  its  need  for  direct
manufacturing  labor.  As of December  31,  1999,  the Company had 30  full-time
employees engaged in manufacturing and support-related activities.

GAMING REGULATION AND LICENSING

     GENERAL REGULATION OF SHAREHOLDERS OF PUBLICLY TRADED CORPORATIONS. In most
jurisdictions,  any beneficial owner of the Company's Common Stock is subject on
a  discretionary  basis to  being  required  to file  applications  with  gaming
regulatory authorities, be investigated and found suitable or qualified as such.
In  addition,  shareholders  whose  holdings  of  Common  Stock  exceed  certain
designated  percentages  are  subject to  certain  reporting  and  qualification
requirements   imposed  by  state  and  federal  gaming   regulators   and,  any
shareholder,  if found to be unsuitable,  may be required to immediately dispose
of its holdings of Common Stock.

     NEVADA REGULATORY MATTERS. The Company must obtain a registration, license,
approval or finding of suitability,  and equipment approval in all jurisdictions
before it can offer gaming devices for sale to licensed gaming operations within
those  jurisdictions.  The licensing  process usually  involves the licensing or
approval of certain  officers,  directors,  and shareholders of the corporation,
and approval of the specific  product that the Company  wants to offer for sale.
On June 19,  1996 the Nevada  Commission  registered  SGI as a  publicly  traded
corporation and licensed Silicon  Gaming-Nevada  ("SGI-Nevada"),  a wholly-owned
subsidiary of SGI, as a manufacturer, distributor and operator of a slot machine
route.  The Company's  initial  public  offering was also approved by the Nevada
Commission on June 19, 1996. On March 20, 1997,  the Nevada  Commission  granted
final approval of the Company's product for sale to licensed casinos in Nevada.

     The manufacture, sale and distribution of gaming devices for use or play in
Nevada or for distribution  outside of Nevada,  the manufacture and distribution
of associated  equipment  for use in Nevada,  and the ownership and operation of
slot machine  routes in Nevada are subject to: (i) the Nevada Gaming Control Act
and the regulations  promulgated  thereunder  (collectively,  "Nevada Act"); and
(ii) various local  ordinances and  regulations.  Such activities are subject to
the licensing and regulatory control of the Nevada Commission, the Nevada Board,
and various local, city and county regulatory agencies (collectively referred to
as the "Nevada Gaming Authorities").

     The laws,  regulations  and  supervisory  procedures  of the Nevada  Gaming
Authorities  are based upon  declarations  of public  policy which are concerned
with, among other things:  (i) the prevention of unsavory or unsuitable  persons
from having a direct or indirect  involvement  with gaming,  or manufacturing or
distribution  of gaming devices at any time or in any capacity;  (ii) the strict
regulation of all persons,  locations,  practices,  associations  and activities
related to the operation of licensed gaming  establishments  and the manufacture
or distribution  of gaming devices and equipment;  (iii) the  establishment  and

                                       13
<PAGE>
maintenance  of  responsible  accounting  practices  and  procedures;  (iv)  the
maintenance  of effective  controls over the  financial  practices of licensees,
including the  establishment  of minimum  procedures for internal fiscal affairs
and the  safeguarding of assets and revenue,  providing  reliable record keeping
and requiring the filing of periodic reports with the Nevada Gaming Authorities;
(v) the prevention of cheating and fraudulent practices;  and (vi) the provision
of a source of state and local  revenue  through  taxation and  licensing  fees.
Change in such laws,  regulations and procedures could have an adverse effect on
the Company's operations.

     On June 19, 1996 the Company was  registered by the Nevada  Commission as a
publicly-traded  corporation  (a "Registered  Corporation"),  and SGI-Nevada was
approved as a manufacturer, distributor and operator of a slot machine route. On
March 20, 1997,  the Nevada  Commission  granted final approval of the Company's
product.  Such gaming  approvals  require the periodic payment of fees and taxes
and are not transferable.  As a Registered Corporation,  the Company is required
periodically  to submit detailed  financial and operating  reports to the Nevada
Commission  and furnish any other  information  which the Nevada  Commission may
require.  No person may become a  shareholder  of, or  receive  any profit  from
SGI-Nevada without first obtaining licenses and approvals from the Nevada Gaming
Authorities.  The Company and  SGI-Nevada  have  applied  for, and in some cases
received, the various registrations, approvals, permits and licenses in order to
engage in manufacturing, distribution and slot route activities in Nevada.

     All gaming devices that are  manufactured,  sold or distributed  for use or
play in Nevada, or for distribution  outside of Nevada,  must be manufactured by
licensed  manufacturers  and distributed or sold by licensed  distributors.  All
gaming  devices  manufactured  for use or play in Nevada must be approved by the
Nevada Commission before distribution or exposure for play. The approval process
for gaming devices includes  rigorous testing by the Nevada Board, a field trial
and a  determination  as to whether the gaming  device  meets  strict  technical
standards  that  are set  forth in the  regulations  of the  Nevada  Commission.
Associated  equipment must be  administratively  approved by the Chairman of the
Nevada Board before it is distributed for use in Nevada.

     The Nevada Gaming  Authorities  may  investigate  any  individual who has a
material relationship to, or material involvement with, a Registered Corporation
or its subsidiaries in order to determine whether such individual is suitable or
should be  licensed  as a business  associate  of a gaming  licensee.  Officers,
directors and certain key employees of the Company and  SGI-Nevada  are required
to file applications  with the Nevada Gaming  Authorities and may be required to
be  licensed  or found  suitable by the Nevada  Gaming  Authorities.  The Nevada
Gaming  Authorities  may deny an  application  for licensing for any cause which
they deem reasonable.  A finding of suitability is comparable to licensing,  and
both require submission of detailed personal and financial  information followed
by a  thorough  investigation.  The  applicant  for  licensing  or a finding  of
suitability  must pay all the costs of the  investigation.  Changes in  licensed
positions must be reported to the Nevada Gaming  Authorities  and in addition to
their  authority  to  deny  an  application  for a  finding  of  suitability  or
licensure,  the Nevada  Gaming  Authorities  have  jurisdiction  to disapprove a
change in a corporate position.  On June 19, 1996 SGI's Chief Executive Officer,
Chief Financial  Officer,  the required  directors and SGI-Nevada's sole officer
and director were found suitable by the Nevada Commission.

     If the Nevada Gaming  Authorities were to find an officer,  director or key
employee   unsuitable   for  licensing  or  unsuitable  to  continue   having  a
relationship  with SGI or  SGI-Nevada,  the  Company  would  have to  sever  all
relationships  with such person. In addition,  the Nevada Commission may require
the Company or SGI-Nevada to terminate the  employment of any person who refuses
to file appropriate  applications.  Determination of suitability or of questions
pertaining to licensing are not subject to judicial review in Nevada.

     The Company and SGI-Nevada  will be required to submit  detailed  financial
and  operating  reports to the Nevada  Commission.  Substantially  all  material
loans,  leases,  sales of securities and similar  financing  transactions by the
Company will be required to be reported to or approved by the Nevada Commission.

     If it were  determined  that the Nevada Act was  violated by the Company or
SGI-Nevada,  the  registration  and gaming  licenses  it holds could be limited,
conditioned,  suspended or revoked, subject to compliance with certain statutory
and regulatory procedures. In addition, the Company,  SGI-Nevada and the persons
involved  could be subject to substantial  fines for each separate  violation of
the  Nevada  Act  at  the  discretion  of  the  Nevada  Commission.  Limitation,
conditioning  or suspension of any gaming  license could (and  revocation of any
gaming  license  would)   materially   adversely  affect  the  Company's  gaming
operations.

                                       14
<PAGE>
     Any  beneficial  holder of a Registered  Corporation's  voting  securities,
regardless  of  the  number  of  shares  owned,  may  be  required  to  file  an
application,  be  investigated,   and  have  his  suitability  determined  as  a
beneficial  holder of the  Registered  Corporation's  voting  securities  if the
Nevada  Commission has reason to believe that such ownership  would otherwise be
inconsistent  with the declared  policies of the State of Nevada.  The applicant
must pay all costs of investigation incurred by the Nevada Gaming Authorities in
conducting any such investigation.

     The Nevada Act  requires any person who  acquires  beneficial  ownership of
more than 5% of a  Registered  Corporation's  voting  securities  to report  the
acquisition to the Nevada  Commission.  The Nevada Act requires that  beneficial
owners of more than 10% of a Registered Corporation's voting securities apply to
the Nevada Commission for a finding of suitability  within thirty days after the
Chairman of the Nevada  Board mails the written  notice  requiring  such filing.
Under  certain  circumstances,  an  "institutional  investor," as defined in the
Nevada  Act,  which  acquires  more  than  10% but not  more  than  15%,  of the
Registered  Corporation's  voting  securities may apply to the Nevada Commission
for a waiver of such finding of suitability if such institutional investor holds
the voting  securities for investment  purposes only. An institutional  investor
shall not be deemed to hold voting securities for investment purposes unless the
voting  securities were acquired and are held in the ordinary course of business
as an  institutional  investor  and not for the purpose of causing,  directly or
indirectly,  the election of a majority of the members of the board of directors
of the  Registered  Corporation,  any  change  in the  Registered  Corporation's
corporate charter, bylaws, management,  policies or operations of the Registered
Corporation,  or any of its gaming  affiliates,  or any other  action  which the
Nevada   Commission  finds  to  be  inconsistent  with  holding  the  Registered
Corporation's  voting securities for investment purposes only.  Activities which
are not deemed to be inconsistent  with holding voting securities for investment
purposes only include: (i) voting on all matters voted on by shareholders;  (ii)
making  financial and other inquiries of management of the type normally made by
securities analysts for informational  purposes and not to cause a change in its
management,  policies  or  operations;  and (iii) such other  activities  as the
Nevada Commission may determine to be consistent with such investment intent. If
the  beneficial  holder of voting  securities  who must be found  suitable  is a
corporation,  partnership  or  trust,  it  must  submit  detailed  business  and
financial  information  including a list of beneficial  owners. The applicant is
required to pay all costs of investigation.

     Any person who fails or refuses to apply for a finding of  suitability or a
license within thirty days after being ordered to do so by the Nevada Commission
or  the  Chairman  of the  Nevada  Board,  may be  found  unsuitable.  The  same
restrictions apply to a record owner if the record owner,  after request,  fails
to identify the  beneficial  owner.  Any  shareholder  found  unsuitable and who
holds,  directly or  indirectly,  any  beneficial  ownership of the Common Stock
beyond such period of time as may be prescribed by the Nevada  Commission may be
guilty of a criminal offense. The Company will be subject to disciplinary action
if, after it receives  notice that a person is unsuitable to be a shareholder or
to have any other  relationship with the Company or SGI-Nevada,  the Company (i)
pays that person any dividend or interest upon voting securities of the Company,
(ii) allows that person to exercise,  directly or  indirectly,  any voting right
conferred through securities held by that person, (iii) pays remuneration in any
form to that person for services rendered or otherwise,  or (iv) fails to pursue
all lawful  efforts to require such  unsuitable  person to relinquish his voting
securities  including,  if  necessary,  the  immediate  purchase  of said voting
securities for cash at fair market value.

     The Nevada  Commission  may, in its  discretion,  require the holder of any
debt security of a Registered Corporation to file applications,  be investigated
and be found suitable to own the debt security of a Registered  Corporation.  If
the  Nevada  Commission  determines  that a  person  is  unsuitable  to own such
security,  then pursuant to the Nevada Act, the  Registered  Corporation  can be
sanctioned,  including the loss of its approvals,  if without the prior approval
of the Nevada  Commission,  it: (i) pays to the unsuitable  person any dividend,
interest,  or any distribution  whatsoever;  (ii) recognizes any voting right by
such  unsuitable  person in  connection  with such  securities;  (iii)  pays the
unsuitable  person  remuneration  in any form;  or (iv) makes any payment to the
unsuitable  person  by  way  of  principal,  redemption,  conversion,  exchange,
liquidation, or similar transaction.

     The Company  will be required to maintain a current  stock ledger in Nevada
which may be  examined  by the Nevada  Gaming  Authorities  at any time.  If any
securities are held in trust by an agent or by a nominee,  the record holder may
be required  to disclose  the  identity  of the  beneficial  owner to the Nevada
Gaming  Authorities.  Failure to make such disclosure may be grounds for finding
the record  holder  unsuitable.  The  Company  will also be  required  to render
maximum  assistance in  determining  the identity of the beneficial  owner.  The
Nevada Commission has the power to require the stock certificates of the Company
to bear a legend  indicating  that the securities are subject to the Nevada Act.
However, the Nevada Commission has not imposed such a requirement on the Company
to date,  but it is unknown  whether  the Nevada  Commission  will impose such a
requirement on the Company in the future.

                                       15
<PAGE>
     As a Registered Corporation,  the Company may not make a public offering of
its securities, such as an IPO or follow-on offering, without the prior approval
of the Nevada Commission if the securities or proceeds therefrom are intended to
be used to construct,  acquire or finance  gaming  facilities  in Nevada,  or to
retire or extend  obligations  incurred for such purposes.  Approval of a public
offering, if given, does not constitute a finding, recommendation or approval by
the Nevada  Commission or the Nevada Board as to the accuracy or adequacy of the
Offering  Memorandum or the  investment  merits of the securities  offered.  Any
representation to the contrary is unlawful.

     Changes  in   control  of  a   Registered   Corporation   through   merger,
consolidation, stock or asset acquisitions, management or consulting agreements,
or any act or conduct by a person  whereby  he  obtains  control,  may not occur
without the prior approval of the Nevada Commission. Entities seeking to acquire
control of a Registered Corporation must satisfy the Nevada Board and the Nevada
Commission in a variety of stringent standards prior to assuming control of such
Registered  Corporation.  The Nevada  Commission  may also  require  controlling
shareholders,   officers,   directors  and  other  persons   having  a  material
relationship or involvement with the entity proposing to acquire control,  to be
investigated  and  licensed  as part of the  approval  process  relating  to the
transaction.

     The  Nevada  legislature  has  declared  that some  corporate  acquisitions
opposed by management,  repurchases of voting  securities and corporate  defense
tactics affecting Nevada corporate gaming licensees, and Registered Corporations
that are  affiliated  with  those  operations,  may be  injurious  to stable and
productive  corporate gaming. The Nevada Commission has established a regulatory
scheme to ameliorate the potentially adverse effects of these business practices
upon Nevada's gaming industry and to further  Nevada's policy to: (i) assure the
financial  stability of corporate  gaming licensees and their  affiliates;  (ii)
preserve the beneficial  aspects of conducting  business in the corporate  form;
and (iii) promote a neutral  environment for the orderly governance of corporate
affairs.  Approvals  are,  in certain  circumstances,  required  from the Nevada
Commission before the Registered Corporation can make exceptional repurchases of
voting  securities above the current market price thereof and before a corporate
acquisition  opposed  by  management  can be  consummated.  The  Nevada Act also
requires prior approval of a plan of recapitalization proposed by the Registered
Corporation's  Board of Directors in response to a tender offer made directly to
the Registered Corporation's  shareholders for the purposes of acquiring control
of the Registered Corporation.

     License fees and taxes,  computed in various ways  depending on the type of
gaming or  activity  involved,  are  payable  to the State of Nevada  and to the
counties and cities in which gaming  operations  are to be conducted.  Depending
upon the particular fee or tax involved, these fees and taxes are payable either
monthly,  quarterly or annually and are based upon either:  (i) a percentage  of
the gross  revenue  received;  or (ii) the  number of gaming  devices  operated.
Annual fees are also payable to the State of Nevada for renewal of licenses as a
manufacturer, distributor and operator of a slot machine route.

     Any person who is licensed, required to be licensed,  registered,  required
to be registered,  or is under common  control with such persons  (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of  investigation by
the Nevada Board of their  participation  in such foreign gaming.  The revolving
fund is  subject  to  increase  or  decrease  in the  discretion  of the  Nevada
Commission.  Thereafter, Licensees are required to comply with certain reporting
requirements   imposed  by  the  Nevada  Act.  Licensees  are  also  subject  to
disciplinary  action by the Nevada Commission if they knowingly violate any laws
of the foreign jurisdiction pertaining to the foreign gaming operation,  fail to
conduct the foreign gaming operation in accordance with the standards of honesty
and integrity  required of Nevada gaming  operations,  engage in activities that
are  harmful to the state of Nevada or its ability to collect  gaming  taxes and
fees, or employ a person in the foreign  operation who has been denied a license
or finding of suitability in Nevada on the ground of personal unsuitability.

     In the future, SGI intends to seek the necessary  registrations,  licenses,
approvals,  and findings of  suitability  for the  Company,  its product and its
personnel in other jurisdictions  throughout the world. However, there can be no
assurances  that  such  registrations,   licenses,   approvals  or  findings  of
suitability  will be  obtained.  Many other  jurisdictions  in which the Company
wishes to do business  require  various  licenses,  permits,  and  approvals  in
connection with the manufacture and/or distribution of gaming devices, typically
involving restrictions similar in most respects to those of Nevada.

                                       16
<PAGE>
     MISSOURI REGULATORY MATTERS.  Gaming was originally authorized in the state
of Missouri in November 1992. On April 29, 1993, new legislation  (the "Missouri
Act") was enacted  which  replaced  the 1992  legislation.  In January  1994 the
Missouri  Supreme Court handed down a decision  which held that the operation of
certain games of chance such as traditional  slot machines was prohibited by the
constitution  of the state of  Missouri.  On  November  8,  1994,  the people of
Missouri  voted in favor of an amendment to the Missouri  constitution  to allow
slot machine  gaming in the state.  The Missouri Act provides for the  licensing
and  regulation of excursion  gambling boat  operations on the  Mississippi  and
Missouri  Rivers in the state of Missouri and the  licensing  and  regulation of
persons who distribute  gaming  equipment and supplies to gaming  licensees.  An
excursion  gambling boat is a boat,  ferry or other  floating  facility on which
gaming is  allowed.  The  Missouri  Act limits the loss per  individual  on each
excursion to $500, but does not otherwise  limit the amount which may be wagered
on any bet or the  amount  of space in the  vessel  which  may be  utilized  for
gaming.

     The  Missouri  Act  is to be  implemented  and  enforced  by a  five-member
Missouri  Commission.  The Missouri Commission is empowered to issue such number
of  riverboat  gaming  licenses as it  determines  to be  appropriate.  A gaming
license  cannot be  granted  to any  gaming  operator  unless the voters in such
operator's  "home  dock" city or county have  authorized  gaming  activities  on
gaming riverboats.

     On September 1, 1993, the Missouri Commission adopted rules and regulations
(the   "Missouri   Regulations")   governing   the   licensing,   operation  and
administration  of  riverboat  gaming in the state of  Missouri  and the form of
application for such licensure.  The Missouri Regulations  generally provide for
four types of licenses--a Class A owner's license; a Class B operator's license;
a supplier's license;  and an occupational  license.  In addition,  the Missouri
Regulations  remain  subject to amendment  and  interpretation,  and may further
limit  or  otherwise  adversely  affect  the  Company  and its  Missouri  gaming
operations.

     Directors  and certain  officers and key persons of the Company and Silicon
Gaming-Missouri  ("SGI-Missouri"),  a wholly-owned  subsidiary of SGI, must file
personal  disclosure forms with the gaming license application and must be found
suitable by the Missouri  Commission.  Further, the Missouri Regulations require
that all employees of SGI-Missouri who are involved in gaming operations and who
are employed on the licensed  premises  must file  applications  for and receive
Missouri  gaming  occupational   licenses.   The  Missouri  regulations  require
disclosure by the Company and  SGI-Missouri  of any person or entity holding any
direct or indirect  ownership  interest in  SGI-Missouri.  SGI-Missouri  is also
required  to  disclose  the names of the  holders  of all of the  Company's  and
SGI-Missouri's  debt  including  a  description  of the nature and terms of such
debt. The Missouri  Commission may, in its sole discretion,  request  additional
information with respect to such holders.  Missouri  suppliers'  gaming licenses
must be renewed  annually for a fee of $5,000 or such  greater  amount as may be
determined by the Commission.  On November 8, 1996,  SGI-Missouri  was granted a
temporary supplier's license by the Missouri Commission.

     Under Missouri law,  gaming  licenses are not  transferable,  and under the
Missouri  Regulations the transfer of (i) any ownership  interest in a privately
held  business  entity or (ii) a 5% or greater  interest  in a  publicly  traded
company  directly or indirectly  holding a Missouri gaming license is prohibited
without the  approval of the  Missouri  Commission.  Further,  without the prior
approval  of  the  Missouri   Commission,   the  Missouri  Regulations  prohibit
withdrawals of capital,  loans, advances or distribution of any assets in excess
of 5% of  accumulated  earnings by a license  holder to anyone with an ownership
interest in the license holder.

     The  Missouri  Regulations  specifically  provide  that any  action  of the
Missouri  Commission shall not indicate or suggest that the Missouri  Commission
has  considered  or passed in any way on the  marketability  of the applicant or
licensee's  securities,  or on any other  matter,  other than the  applicant  or
licensee's  suitability  for licensure  under  Missouri  law. A Missouri  gaming
license holder can be disciplined in Missouri for gaming-related  acts occurring
in  another  jurisdiction  which  result  in  disciplinary  action  in the other
jurisdiction.

     The Missouri  Commission has broad powers to require additional  disclosure
by an applicant  during the processing of a gaming  application,  to deny gaming
licensure and to  administratively  fine, suspend or revoke a gaming license for
failure  to  comply  with  or for  violation  of the  Missouri  Act or  Missouri
Regulations.

                                       17
<PAGE>
     NEW JERSEY REGULATORY MATTERS.  Casino gaming in New Jersey,  including the
manufacture,  distribution and operation of gaming devices, is subject to strict
regulation  by the  New  Jersey  Casino  Control  Commission  (the  "New  Jersey
Commission")  pursuant to the New Jersey Casino Control Act and the  regulations
of the New Jersey  Commission  promulgated  thereunder  (collectively,  the "New
Jersey Act"). The New Jersey Commission is authorized to decide all applications
for licensure or other approvals and to promulgate  regulations.  The New Jersey
Act also  established  the New Jersey Division of Gaming  Enforcement  (the "New
Jersey  Division"),  which is responsible for investigating all applications for
licensure or approval and for prosecuting violations of the New Jersey Act.

     Under the New Jersey Act, a company  must be  licensed as a gaming  related
casino service  industry  ("CSI") in order to  manufacture or distribute  gaming
devices to New Jersey  casinos.  In January  of 1997,  the  applications  of the
Company  and  its  wholly-owned  subsidiary,  Silicon  Gaming-New  Jersey,  Inc.
("SGI-NJ"),  for CSI licensure were deemed  complete and accepted for filling by
the New Jersey Commission.  These applications consisted of extensive disclosure
forms  by the  Company,  SGI-NJ,  and  certain  of  their  officers,  directors,
principal employees and security holders.

     The New Jersey  Commission  has broad  discretion  regarding  the issuance,
renewal,  suspension or  revocation  of CSI  licenses.  In order to obtain a CSI
license, the Company and SGI-NJ must demonstrate to the New Jersey Commission by
clear and convincing  evidence that they,  any five percent or greater  security
holders,  certain officers,  directors, and principal employees, and anyone else
whom the New Jersey Commission deems appropriate in its discretion, possess good
character, honesty and integrity, and financial stability and responsibility. If
a person who is required to be found qualified is found  disqualified by the New
Jersey Commission, the license applications may be denied.

     With respect to security  holders,  the New Jersey Commission may waive the
qualification  requirement for "institutional  investors," as defined in the New
Jersey  Act,  of the  Company  in the  absence of a prima  facie  showing by the
Director of the New Jersey  Division that there is any cause to believe that the
institutional  investor may be unqualified,  if the institutional investor holds
less than ten percent of the  outstanding  securities,  provided the  securities
were  acquired for  investment  purposes only and the holder has no intention of
influencing the affairs of the Company,  other than voting its  securities.  The
New Jersey Act defines an  "institutional  investor" as (i) any retirement  fund
administered by a public agency for the exclusive  benefit of federal,  state or
local  public  employees,  (ii)  an  investment  company  registered  under  the
Investment Company Act of 1940, (iii) a collective investment trust organized by
banks under Part Nine of the Rules of the  Comptroller  of the Currency,  (iv) a
closed end investment  trust, (v) a chartered or licensed life insurance company
or property and casualty  insurance  company,  (vi) banking or other licensed or
chartered lending institutions, (vii) an investment advisor registered under the
Investment  Advisors Act of 1940, or (viii) such other persons as the New Jersey
Commission  may  determine for reasons  consistent  with the policies of the New
Jersey Act.

     The  applications of the Company and SGI-NJ will be investigated by the New
Jersey Division. During the course of the investigation,  the Company and SGI-NJ
are required to provide  additional  information to the New Jersey Division.  At
the conclusion of its investigation,  the New Jersey Division will file a report
with the New Jersey Commission stating its position on the license applications.
After  receipt  of the  report  of the  New  Jersey  Division,  the  New  Jersey
Commission will hold a public hearing on the license applications. No assurances
can be given as to the timing of the completion of the  investigation by the New
Jersey  Division  and the public  hearing by the New  Jersey  Commission  on the
license applications or that the licenses will be obtained.

     In its  discretion,  the New Jersey  Commission  may permit the Company and
SGI-NJ to transact business with New Jersey casinos prior to their licensure. In
order  to do  so,  the  Company  and  SGI-NJ  must  continue  to  have  complete
applications for CSI licensure on file with the New Jersey Commission,  petition
the New Jersey Commission for permission for each transaction,  demonstrate that
good cause exists for granting the petition and the New Jersey Division must not
object to the petition.

     The fee for a CSI  license is a minimum of $5,000 and a maximum of $15,000,
with the actual cost  depending  upon the amount of time spent by the New Jersey
Commission  and  New  Jersey  Division  in   investigating   an  processing  the
applications,  plus the out of pocket expenses of the New Jersey  Commission and
New Jersey Division.

                                       18
<PAGE>
     A CSI license is issued for an initial period of two years and, upon proper
application  and  satisfaction  of the same standards  applicable to the initial
issuance of a CSI license,  is renewable for four year  periods.  The New Jersey
Commission may impose conditions on the issuance of a license. In addition,  the
New Jersey  Commission  has the authority to impose fines or suspend or revoke a
license for  violations of the New Jersey Act,  including the failure to satisfy
the licensure requirements.

     In addition,  gaming devices  manufactured or distributed by the Company or
SGI-NJ  must be approved  by the New Jersey  Commission  based on, at a minimum,
their quality, design, integrity,  fairness, honesty and suitability in order to
be used in New Jersey casinos. The approval process includes the submission of a
model of the gaming device and relevant documentation to the New Jersey Division
for testing,  examination and analysis.  Only a licensed CSI or an applicant for
CSI  licensure  can  submit a gaming  device  for  approval.  All  costs of such
testing, examination and analysis are borne by the Company. Prior to deciding to
approve a  particular  model of gaming  device,  the New Jersey  Commission  may
require  a test of up to 60 days of the  gaming  device  in a  licensed  casino.
During the test period,  the  manufacturer  or  distributor of the gaming device
shall not be entitled to receive revenue of any kind  whatsoever.  Once a gaming
device is  approved  by the New Jersey  Commission,  all gaming  devices of that
model placed in operation in licensed  casinos shall operate in conformity  with
the model  approved  by the New Jersey  Commission.  Any  changes in the design,
function or operation of an approved gaming device are subject to prior approval
by the New Jersey Commission, after testing by the New Jersey Division. In March
of 1997,  ODYSSEY  was  submitted  to the New  Jersey  Division  and New  Jersey
Commission for testing and approval and approval was received in March, 1999, at
which time SGI-NJ commenced sales of its product.

     MISSISSIPPI  REGULATORY MATTERS. The manufacture,  sale and distribution of
gaming  devices for use or play in  Mississippi  are subject to the  Mississippi
Gaming Control Act and the regulations promulgated thereunder (collectively, the
"Mississippi  Act"). Such activities are subject to the licensing and regulatory
control of the Mississippi Gaming Commission (the "Mississippi  Commission") and
the  Mississippi  State  Tax  Commission   (collectively   referred  to  as  the
"Mississippi Gaming Authorities").  Although not identical,  the Mississippi Act
is  similar  to the  Nevada  Gaming  Control  Act  and  regulations  promulgated
thereunder.

     On June 20, 1996 the Company was registered by the  Mississippi  Commission
as a publicly traded  corporation (a "Registered  Corporation")  and the holding
company of Silicon Gaming-Mississippi, Inc. (the "Mississippi Subsidiary"). Also
on June 20, 1996 the Mississippi  Subsidiary was licensed as a manufacturer  and
distributor.  SGI and the  Mississippi  Subsidiary are required to  periodically
submit detailed  financial and operating  reports to the Mississippi  Commission
and furnish any other information which the Mississippi  Commission may require.
The  Company  and  the   Mississippi   Subsidiary   have  received  the  various
registrations,   approvals,   permits  and   licenses  in  order  to  engage  in
manufacturing,  distribution  and gaming  activities  as presently  conducted in
Mississippi.  Such licenses,  registrations  and approvals are not transferable,
are  initially  issued  for a two-year  period and must be renewed  periodically
thereafter.

     Similar to Nevada,  the  Mississippi  Commission may  investigate  and find
suitable  any  individual  who  has a  material  relationship  to,  or  material
involvement with, the Company or the Mississippi Subsidiary, including record or
beneficial  holders of any of the voting  securities of the Company,  holders of
debt obligations,  and officers,  directors and employees of the Company and the
Mississippi Subsidiary.  The Company and the Mississippi Subsidiary are required
to maintain a current stock ledger in  Mississippi  which may be examined by the
Mississippi  Commission  at any time.  The Company  believes  that all  required
findings of  suitability  currently  required have been applied for or obtained.
Any application for a finding of suitability must pay all investigative fees and
costs of the Mississippi Commission in connection with such an investigation.

     The Mississippi Act requires any person who acquires  beneficial  ownership
of more than 5% of a Registered  Corporation's  voting  securities to report the
acquisition to the Mississippi  Commission and such person may be required to be
found suitable. The Mississippi Act requires that beneficial owners of more than
10% of a Registered  Corporation's  voting  securities  apply to the Mississippi
Commission  for  a  finding  of  suitability.  The  Mississippi  Commission  has
generally  exercised its  discretion to require a finding of  suitability of any
beneficial  owner of more than 5% of a Registered  Corporation's  Common  Stock.
Under  certain  circumstances,   an  "institutional  investor,"  as  defined  by
Mississippi  Commission  policy,  which acquires more than 5%, but not more than
10%,  of  the  Registered  Corporation's  voting  securities  may  apply  to the
Mississippi  Commission  for a waiver of such  finding  of  suitability  if such
institutional investor holds the voting securities for investment purposes only.

                                       19
<PAGE>
     The Company may not make a public  offering of its  securities  without the
approval of the Mississippi  Commission if the securities or proceeds  therefrom
are intended to be used to construct,  acquire or finance  gaming  facilities in
Mississippi, or to retire or extend obligations incurred for such purposes.

     If it  were  determined  that  the  Mississippi  Act  was  violated  by the
Mississippi  Subsidiary,  the  licenses it holds could be limited,  conditioned,
suspended  or  revoked,   subject  to  compliance  with  certain  statutory  and
regulatory procedures, which action, if taken, could materially adversely affect
the Company's manufacturing and distribution.

     FEDERAL REGULATION.  The Federal Gambling Devices Act of 1962 (the "Federal
Act") makes it unlawful,  in general,  for a person to manufacture,  deliver, or
receive gaming machines, gaming machine type devices and components across state
lines or to operate gaming machines unless that person has first registered with
the Attorney  General of the United States.  The Company is required to register
and  renew  its  registration  annually.  The  Company  has  complied  with such
registration  requirements.   In  addition,  various  record  keeping  equipment
identification  requirements  are imposed by the Federal  Act.  Violation of the
Federal Act may result in seizure and  forfeiture of the  equipment,  as well as
other penalties.

     NATIVE AMERICAN  GAMING.  Gaming on Native  American  lands,  including the
terms and  conditions  under  which  gaming  equipment  can be sold or leased to
Native American tribes, is or may be subject to regulation under the laws of the
tribes,  the laws of the host state,  the Indian Gaming  Regulatory  Act or 1988
("IGRA"),  which is administered  by the National Indian Gaming  Commission (the
"NIGC")  and  the  Security  of  the  U.S.   Department  of  the  Interior  (the
"Secretary"),  and also may be subject  to the  provisions  of certain  statutes
relating to contracts with Native American tribes, which are administered by the
Secretary.  As a precondition to gaming involving gaming machines, IGRA requires
that  the  tribe  and  the  state  have  entered  into a  written  agreement  (a
"tribal-state  compact") that specifically  authorizes such gaming, and that has
been approved by the  Secretary,  with notice of such approval  published in the
Federal Registrar.  Tribal-state compacts vary from state to state. Many require
that equipment suppliers meet ongoing registration and licensing requirements of
the state and/or the tribe and some impose background check  requirements on the
officers,  directors, and shareholders of gaming equipment supplies. Under IGRA,
tribes are required to regulate all commercial gaming under ordinances  approved
by the NIGC. Such ordinances may impose standards and technical  requirements on
gaming  hardware  and  software,  and may  impose  registration,  licensing  and
background check requirements to gaming equipment  suppliers and their officers,
directors, and shareholders.

     APPLICATION OF FUTURE OR ADDITIONAL REGULATORY REQUIREMENTS. In the future,
the Company intends to seek the necessary registrations, licenses, approvals and
findings of suitability for the Company,  its product and its personnel in other
U.S. and foreign jurisdictions in which the Company identifies significant sales
potential  for  its  product.  However,  there  can be no  assurance  that  such
registrations,  licenses,  approvals or findings of suitability will be obtained
and will not be revoked,  suspended or  conditioned  or that the Company will be
able to obtain  the  necessary  approvals  for its future  products  as they are
developed in a timely manner, or at all. If a registration, license, approval or
finding of  suitability  is required by a regulatory  authority  and the Company
fails to seek or does not receive the necessary registration,  license, approval
or finding of  suitability,  the  Company  may be  prohibited  from  selling its
product for use in the  respective  jurisdiction  or may be required to sell its
product through other licensed entities at a reduced profit to the Company.

                                       20
<PAGE>
ITEM 2: PROPERTIES

     The Company leases a 28,000 square foot facility in Palo Alto,  California.
The Company subleases approximately 16,000 square feet of this facility and uses
the  remainder  for  its  development,   marketing,   sales  and  administrative
personnel.  The lease expires in January 2006.  The Company also leases a 27,000
square  foot  facility  in Las Vegas,  Nevada  that houses its sales and support
organization,  and a 4,000  square foot  facility in Reno,  Nevada that houses a
sales and support organization.

ITEM 3: LEGAL PROCEEDINGS

     In March 2000 the Company  was served  papers in  connection  with a patent
infringement  lawsuit filed against it and another slot machine  manufacturer by
International Game Technology, Inc. (IGT). As disclosed in November 1999, IGT is
alleging infringement of a patent issued to IGT in September 1999 entitled "Game
Machine and Method Using Touch Screen". The Company has not yet responded to the
lawsuit and the Company's management denies the assertions of infringement.  The
Company is presently unable to determine the financial  impact,  if any, of this
litigation.

     In March 2000, a former distributor of the Company's  products,  filed suit
against  the Company in the United  States  District  Court for the  District of
South Carolina.  The distributor seeks repayment of $1 million, plus damages, in
connection  with machines  previously  shipped to the  distributor  in 1998. The
Company  is in the  process  of  arbitration  as  required  by the  Distribution
Agreement,  seeking to recover outstanding receivables from the distributor when
it  received  this  lawsuit.  The  Company  is  in  the  preliminary  stages  of
investigating the allegations contained in the suit and has not yet responded to
the complaint.

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

     Inapplicable.

EXECUTIVE OFFICERS

     The executive officers of the Company are as follows:

         Name             Age                   Position
         ----             ---                   --------
Andrew S. Pascal........  34    Chief Executive Officer, Chief Financial Officer
Charles R. Berg.........  47    Vice President - Engineering
Michael R. Fields.......  39    Vice President - Sales
Paul D. Mathews.........  35    Vice President - Corporate Development &
                                  Government Affairs
Paul D. Miltenberger....  34    Vice President - Development
Betsy B. Sutter.........  39    Vice President - Human Resources

     ANDREW S. PASCAL has served as Chief Executive Officer of the Company since
February,  1999 and as acting Chief Financial Officer since March,  1999. He had
previously  held the title of  Executive  Vice  President -  Marketing  and Game
Development  since  October  1994.  He has  over 14  years  of  gaming  industry
experience  with an  emphasis in slot  marketing,  slot  merchandising  and slot
operations.  He joined SGI in October 1994 from Mirage  Resorts,  Incorporated ,
where he worked from June 1985 to October 1994.  Mr. Pascal held the position of
Director  of Slot  Operations  and  Marketing  at The Mirage  Hotel and  Casino,
managing a division  consisting of 350 employees and annual revenue in excess of
$110  million.  Mr.  Pascal  served  on  The  Mirage's  eight-member   Operating
Committee,  which set operating  policy and established the strategic  direction
for The Mirage and its 7,300  employees,  from  September  1992 to October 1994.
Prior to the opening of The Mirage Hotel and Casino,  Mr.  Pascal  served as the
Director of Slot Marketing for the Golden Nugget Casino-Hotel.

                                       21
<PAGE>
     CHARLES  R. BERG  joined  SGI in  August  1999  from as Vice  president  of
Engineering.  Prior to joining  SGI he was the founder of The  Software  Studio,
Inc., a designer of  engineering  based  software  applications  where for seven
years he was the  Director  of  Development.  Prior to his work at the  Software
Studio,  Inc.,  Mr.  Berg  spent two years at  Document  Technologies,  Inc.  as
Software  Development  Manager,  and prior to that three  years at Anray,  Inc.,
where he was founder and Vice President of Engineering.

     MICHAEL R. FIELDS joined SGI in September  1999 as Vice  President of Sales
from Mikohn Gaming,  a diversified  designer and manufacturer of casino products
and gaming  devices,  where he had worked for three years,  most recently as the
Director  of Western  US sales.  Prior to joining  Mikohn,  Mr.  Fields was Vice
President  and General  Manager for Genasys USA, and prior to that,  Director of
North American Sales for Spectravision, Inc. Both companies were involved in the
sale of entertainment products to hotels.

     PAUL D.  MATHEWS  joined SGI in  November  1995 from  Casino  Data  Systems
("CDS"),  a designer and manufacturer of casino management  information  systems
and gaming  devices,  where from March 1995 to November  1995 he was Director of
Regulatory  Compliance  responsible  for corporate and product  licensing in all
gaming  jurisdictions.  Prior to joining CDS, Mr.  Mathews spent five years with
the  Nevada  State  Gaming  Control  Board  in  the  Corporate   Securities  and
Investigation  Divisions.  Mr Mathews now manages the  Company's  product  sales
operations in addition to his duties with Corporate  Development  and Government
Affairs.

     PAUL D. MILTENBERGER joined SGI in April, 1996 as Business Planning Manager
and in April 1997 became  Director of Sales  Planning,  a position he held until
September 1998 when he was promoted to Vice President of Sales. Mr. Miltenberger
became Vice  President - Development  in August 1999.  Prior to joining SGI, Mr.
Miltenberger  worked at  Tektronics,  a  high-technology  manufacturer  of color
printers  and test  equipment,  where  from June 1995 to April  1996 he held the
position of Strategic Analysis Manager.  Prior to Tektronics,  Mr.  Miltenberger
worked at Conner Peripherals,  Inc. between August 1990 and June 1995 as Manager
of Strategic Reporting.

     BETSY  B.  SUTTER   joined  SGI  in  March  1997  from  Digital   Equipment
Corporation,  where from 1989 she had been the Human Resources Manager for their
Research and Advanced  Technology  Division in Palo Alto. Between 1985 and 1989,
Ms. Sutter had been the Human Resources  Manager at Aehr Test Systems.  Prior to
this she had human resources  experience  with other high  technology  companies
including Hitachi America Ltd. and General Electric Corporation.  Ms. Sutter was
promoted to Vice President -Human Resources in April, 1998.

                                     PART II

ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

STOCK PRICE HISTORY

(Fiscal Year)                            1999                      1998
                                  -------------------      -------------------
                                    High        Low           High        Low
                                    ----        ---           ----        ---
FIRST QUARTER                     1 11/16       7/16       11 3/16       8 1/4
SECOND QUARTER                      13/16       5/16       10 3/8        7 1/2
THIRD QUARTER                       19/32       3/16        9 15/16      3 1/8
FOURTH QUARTER                      11/32       5/64        3 7/8        1 3/8
                                  =======       ====       ========      =====

     The  preceding  table sets forth the high and low  closing  sale  prices as
reported  for the Company  during each of the  quarters in 1999 and 1998.  Until
February 1999 the  Company's  common stock was listed on the Nasdaq Stock Market
under the  symbol  `SGIC'.  In  February  1999 the  Company's  Common  Stock was
delisted from the Nasdaq  National  Market and the Company's stock now trades on
the NASD Over-The-Counter (OTC) bulletin board system under the symbol `SGIC'.

                                       22
<PAGE>
DIVIDEND POLICY

     The Company has never paid cash dividends on its Common stock.  The Company
presently  intends to retain all cash for use in the  operation and expansion of
the Company's  business and does not anticipate paying any cash dividends in the
near future.

ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                                                   Nine
                                                            Years Ended December 31,           Months Ended
                                                --------------------------------------------   December 31,
(in thousands except per share amounts)          1999          1998         1997        1996     1995 (1)
                                                 ----          ----         ----        ----     --------
<S>                                            <C>           <C>           <C>         <C>        <C>
Statement of Operations Data:
  Net sales ..................................  $17,115       $22,281      $ 9,550     $    --    $    --
  Loss from operations .......................   16,436        32,009       22,984      14,533      4,059
  Loss before extraordinary gain .............   24,081            --           --          --         --
  Net loss ...................................   11,765        37,670       22,986      13,634      3,974
  Basic and diluted net loss per share .......  $  0.70       $  2.75      $  2.16     $  2.54    $  2.34
  Loss before extraordinary gain per share ...  $  1.42            --           --          --         --
  Shares used in computation .................   16,906        13,696       10,666       5,364      1,695

                                                                     December 31
                                                ---------------------------------------------------------
(in thousands)                                    1999          1998         1997         1996       1995
                                                  ----          ----         ----         ----       ----
Balance Sheet Data:
  Cash and equivalents .......................  $   877      $  8,399      $16,352     $25,583    $ 2,399
  Short-term investments .....................    1,000            --        4,705       9,683         --
  Working capital ............................    6,394        10,772       25,087      34,203      2,027
  Total assets ...............................   15,581        41,744       49,038      39,646      3,486
  Long-term obligations ......................   16,260        39,809       22,637         778        272
  Redeemable Convertible Preferred Stock .....       --         1,666        3,065       6,455      8,496
  Total shareholders' equity (deficiency) ....   (7,361)      (18,452)      14,432      30,061     (5,946)
</TABLE>

----------
(1)  Effective April 1, 1995, the Company changed its fiscal year end from March
     31 to December 31.

                                       23
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

OVERVIEW

     The  Company  was  incorporated  on  July  27,  1993  to  design,  develop,
manufacture and distribute  interactive  gaming devices that implement  advanced
multimedia technologies using  state-of-the-art,  off-the-shelf  components.  In
1997 the  Company  successfully  introduced  its  first  product,  ODYSSEYTM,  a
multi-game,  video-based slot machine,  into the Nevada market.  Since that time
the  Company  has  rolled  out  ODYSSEY  into  other   jurisdictions   including
Connecticut,  Illinois, Indiana, Iowa, Kansas, Louisiana,  Michigan,  Minnesota,
Mississippi,  Missouri,  New Jersey, New Mexico,  certain Canadian provinces and
Uruguay.  In 1998 the Company  introduced  QUEST,  a  single-game  platform that
utilizes  many of the same  components  as the ODYSSEY,  and in 1999 the Company
introduced a slant-top, single-game platform, to increase its penetration of the
casino floor.

     As of  December  31,  1999,  the Company has 4,050  machines  installed  in
approximately 200 properties.  Of these machines,  3,702 have been sold outright
or placed  on a  revenue-sharing  basis.  After  returns,  348  machines  remain
installed on a trial basis and the casino operators are required to purchase the
machine  outright,  participate  in SGI's  revenue  sharing  plan or return  the
machine to the Company within a defined trial period.

     At December 31, 1999 the Company had cash and  equivalents  and  short-term
investments of $1.9 million. The Company has incurred operating losses each year
since inception, and as of December 31, 1999 had an accumulated deficit of $92.0
million and a deficiency of  shareholders'  equity of $7.4 million.  The Company
has been required to obtain  additional  financing  each year to be able to fund
its ongoing  operations.  Based on  historical  levels of cash usage,  the above
factors raise  substantial  doubt about the  Company's  ability to continue as a
going concern.  In late 1998 and early 1999 the Company took steps to reduce the
level of operating  expenses  and made a number of  management  decisions  which
resulted in total  reductions of the Company's work force by  approximately  70%
and made  significant cuts in expenditures  across the Company.  Management also
announced the relocation of its manufacturing to its Las Vegas,  Nevada facility
and the closure of its Mountain  View,  California  manufacturing  facility.  In
November  1999,  the  Company,  with the  consent  of the  holders of its Senior
Discount Notes, was able to convert  approximately  $40 million principal amount
of debt plus $8.3  million in accrued  interest  into a 57% equity  stake in the
Company,  and to  obtain  commitments  for  additional  financing  from the debt
holders.  The  aforementioned  actions  resulted  in the  Company  reducing  its
operating   expenses  by   approximately   40%,  its  interest   obligations  by
approximately  80%, and reduced the cash used in operations by approximately 80%
from the levels of the prior year.  Management has recently renewed the terms of
a line of credit with a new bank on more favorable  terms so that this financing
source remains available to the Company.  Management is also reviewing financing
alternatives available to the Company such as additional share or debt offerings
in the  Company or  certain of its  subsidiaries,  joint  ventures,  alternative
distribution  channels and sale of all or a portion of the Company's  assets, to
improve the Company's liquidity position.  Management believes that these steps,
plus sales related to new product introductions will provide sufficient cash and
working capital for the Company to meet its ongoing  obligations and to allow it
to continue  operating as a going concern  through at least the end of 2000. See
Note 1 of Notes to Consolidated Financial Statements.

     The Company  spent much of 1999  addressing  its poor  liquidity  position,
restructuring  its balance  sheet,  retaining  its key personnel and taking such
actions necessary to enable the Company to continue  operating.  The uncertainty
surrounding  the Company's  future,  along with the  reductions in the Company's
workforce,  negatively impacted its ability to retain some senior management and
some key employees, especially in its engineering and sales organizations. These
factors also negatively impacted the Company's sales performance,  especially in
the  second  half of  1999 as the  Company  was  forced  to  rebuild  its  sales

                                       24
<PAGE>
organization.  Through  these  difficult  times,  and with less  resources,  the
Company has continued to introduce new game titles into the  marketplace  during
1999.

     Prior to March  1997  the  Company  was in the  development  stage  and its
primary  activities  were  focussed  on product  development,  including  system
hardware and software, game concept development and software coding. Towards the
end of 1996  the  Company  began  manufacturing  slot  machines  for  commercial
distribution.  The  Company  sold  its  first  product  in  May  1997  following
completion of a customer  evaluation period.  Prior to this time the Company did
not generate any revenue from product sales.

     Silicon  Gaming is  headquartered  in Palo Alto,  California  and has sales
offices in Reno and Las Vegas, Nevada, and in Gulfport, Mississippi.  Product is
manufactured at the Company's location in Mountain View, California. At December
31, 1999 the Company had 90 employees.

RESULTS OF OPERATIONS

     The Company had a net loss of $24.1 million for the year ended December 31,
1999 before the $12.3 million  extraordinary  gain recorded on the conversion of
debt in conjunction  with a financial  restructuring  of the Company in November
1999 . This  compared to net losses of $37.7  million and $23.0  million for the
years ended December 31, 1998 and 1997,  respectively.  The significant decrease
in net loss in 1999 was achieved on lower revenues  largely due to the Company's
efforts at reducing its level of operating expenses in early 1999.

REVENUES

     The Company  generates  hardware  revenue from the sale of its products and
related parts and accessories.  All products are sold with licensed software and
customers have the choice of either a paid-up or renewable  annual license.  The
Company  places  products  in casinos  under a  participation  program  where it
receives 20% of the net win  generated by the product as revenue.  Total revenue
units  include  machines  sold  outright  as well as machines  placed  under the
participation programs.

     The Company generated revenues as follows:

                                                 Years Ended December 31,
(in $'000, except for            -----------------------------------------------
 machine numbers)                     1999             1998            1997
                                 --------------   --------------   -------------
Hardware sales                   $10,370    61%   $14,126    63%   $7,636    80%
Software sales                     4,288    25%     4,657    21%      567     6%
Participation revenue              2,457    14%     3,498    16%    1,347    14%
                                 -------   ---    -------   ---    ------   ---
  Total revenue                  $17,115   100%   $22,281   100%   $9,550   100%
                                 =======          =======          ======

Total revenue units                     926             1,622           1,298

     As can be seen from the above  table,  the  Company  had total  revenue  of
$17,115,000  for the year  ended  December  31,  1999.  This was a  decrease  of
$5,166,000 or 23% from the $22,281,000 recorded in 1998. The decrease in revenue
was in part due to a 43% decrease in the total revenue  units  compared to 1998.
This was largely  attributable to uncertainty  surrounding the Company's  future
due to its  liquidity  situation  through  much of  1999,  which  saw  customers
deferring product  purchases until the financial  position of the Company became
clearer.  The loss of the majority of the Company's  sales  organization  during
1999 also  exacerbated  the decrease in sales and the Company  spent much of the
second half of 1999 in rebuilding its sales  organization.  The average  selling
price on machines  sold  outright  decreased  from  $10,230 in 1998 to $8,343 in
1999, reflecting a higher level of sales of used machines, as well as the impact
of higher competition in the gaming-machine industry than in the previous year.

     SGI sells its products  outright to casino  operators  and other  potential
purchasers  offering several pricing programs.  For the ODYSSEY this consists of
either (i) the sale of the  hardware  unit bundled with a single game or a suite
of games and other software for a fixed price,  or (ii) the sale of the hardware

                                       25
<PAGE>
unit alone combined with a renewable one-year software license, including access
to the entire  ODYSSEY game library for the term of the license.  The  Company's
slant-top  machine and the QUEST are sold as a bundled  package of the  hardware
unit  and  a  single  game  for  a  fixed  price.  The  Company  also  offers  a
participation  program  where it will place its  products  on a casino  floor in
exchange for a share in the aggregate  win generated by the machine.  Typically,
under this program,  20% of the aggregate win goes to the Company,  subject to a
predetermined  minimum.  In  December  1998,  the Company  introduced  its first
wide-area  progressive  product,  THE BIG WIN. Machines placed in casinos on the
progressive  system are priced  such that the Company  receives a  predetermined
share of the gross  amount  wagered  on the  machine.  During  1999 the  Company
modified the game in an attempt to improve the  performance of the game,  before
deciding in the fourth quarter of 1999 to remove all  progressive  machines from
casinos due to unsatisfactory  product performance.  Revenues generated from the
participation program and from the wide-area progressive product are included as
`Participation revenues' in the above table.

     The  decreases  in  participation  revenue and in software  revenue in 1999
compared to 1998 reflect decisions made by management during 1999 to remove poor
performing machines from the participation programs, which reduced the number of
machines on  participation  by almost  50%,  and by a program in 1998 to convert
customers from the renewable annual license program,  which caused a decrease in
software  renewal  revenues in 1999.  Management  believes that  eliminating the
annual  license  program  will  bring  the  Company  more  into  line  with  its
competitors  and will  result  in  increased  future  revenue  opportunities  as
customers  will now  purchase  new game  titles  from the  Company.  The Company
believes that in the future participation  revenues will increase in absolute as
well as relative terms as it places more of its new products on a  participation
basis, and that in relative terms,  hardware and software revenues will decrease
from current levels.

     The Company was able to increase revenue during the year ended December 31,
1998 by 133% to  $22,281,000  from the  $9,550,000  recorded  in the year  ended
December 31, 1997. A large portion of this increase  represents  the increase in
volume in the number of machines  sold or  generating  revenue for the  Company,
which  increased by 25%, or 324 units,  from 1,298 in 1997 to 1,622 in 1998. The
average  selling price on machines sold outright  decreased from $11,050 in 1997
to  $10,230  in 1998  reflecting  the  increased  levels of  competition  in the
industry and a resulting higher level of discounts given to strategic  corporate
customers during 1998.

     The  increases  in  participation  revenue and in software  revenue in 1998
compared  to 1997  reflect  the full  year  impact  in 1998 of  machines  in the
participation  programs,  which were first offered in June 1997,  and the larger
installed base from which the Company derives software license revenue. Software
revenue increased by $4,090,000 or 721% in 1998 as a result of these factors.

     During 1999, one customer  accounted for 16% of revenues.  During 1998, two
different  customers  accounted  for  11%  and 10% of  revenues.  In 1997  three
different  customers  accounted  for 27%,  12% and 12% of  revenue.  The Company
expects  that a  significant  portion of its revenue  will  remain  concentrated
within a limited number of strategic customers within the gaming industry due to
the increasing  consolidation that is taking place among casino operators. As an
equipment vendor to the gaming industry,  the Company sells infrequently to many
customers  and  the  volume  of  sales  to  any  particular  customer  may  vary
significantly from period to period. As a result, there can be no assurance that
the above  strategic  customers  will  continue  to  account  for a  significant
percentage  of the  Company's  revenue in the future.  The loss of any strategic
customer  could have a material  adverse  affect on the  Company's  business and
results of operations.

                                       26
<PAGE>
COST OF SALES

     Cost of sales  includes  the direct  cost of  product  sales as well as the
unabsorbed costs of the Company's manufacturing  operations.  Cost of sales also
includes  license fees and  royalties  paid to third  parties,  depreciation  on
machines  placed on the  participation  programs  as well as the costs  directly
associated with running the wide-area progressive system,  including payments of
jackpot awards. Cost of sales were $13,213,000, $24,062,000, and $10,421,000 for
the years ended December 31, 1999, 1998, and 1997, respectively. The decrease in
cost of sales in 1999 of  $10,849,000  or 45% from 1998  reflects a $3.5 million
reduction  in  manufacturing  expenses  as a result  of  closing  the  Company's
California manufacturing facility during 1999, the lower number of machines sold
, and  significantly  lower royalty  expenses to third  parties  compared to the
prior year.  This was offset  partially  by the higher  costs of  operating  the
progressive  system and a $2.5  million  expense  related to excess and obsolete
inventories   in  the  fourth  quarter  of  1999   following   certain   product
configuration  decisions by management  which affected the salability of certain
parts.

     The  year-to-year  increases  in cost of  sales  between  1998 and 1997 was
largely  driven by the higher  number of  machines  sold or placed on one of the
Company's  participation  programs,  the  absence of product  sales prior to May
1997, royalties of $2,200,000 paid to a third party in 1998 in connection with a
new game  offering,  as well as the cost of operating the wide-area  progressive
system that was  introduced  in the fourth  quarter of 1998.  The  Company  also
recorded  $5,200,000  in expense  during 1998 related to lower of cost or market
and excess and obsolete inventories.

     Cost of sales  represented 77%, 108% and 109% of revenues in 1999, 1998 and
1997,  respectively.  The improvement in 1999 reflects the lower operating costs
of the Company and the absence of large one-time expenses such as those recorded
during 1998. The marginal  decrease in cost of sales as a percentage of revenues
between  1998 and 1997 was a reflection  of the charges that the Company  booked
related to inventory write-offs and due to the royalty payments that the Company
agreed to pay to a third party during 1998. These charges offset the benefits of
efficiencies  gained as manufacturing  volumes  increased,  reflecting the fixed
cost  of  the  manufacturing  facility.  The  per-unit  manufacturing  cost  has
decreased as the Company  began to realize  benefits from the tooling of certain
of its hardware  components,  and from cost reductions in many of the components
included in its machines. Through the end of 1998 the Company was able to reduce
the per-unit  material cost of its products by approximately  50% from the first
products it  produced  in 1996.  Due to  significant  levels of  finished  goods
inventory,  the Company  manufactured  minimal  product during 1999 and this has
prevented it from obtaining further cost reductions in its products. The Company
anticipates  that as it  introduces  more  unique,  fully  integrated  specialty
products, per-unit costs may increase in future periods.

RESEARCH AND DEVELOPMENT

     Research and development ("R&D") expenses include payroll and related costs
of employees  engaged in the ongoing  design and  development  activities of the
Company,   costs  paid  to  outside   contractors  and  specialists,   prototype
development  expenses,  overhead  costs,  equipment  depreciation  and  costs of
supplies.  To date,  the  Company has  expensed  all costs  associated  with the
research,  design and development of its products. R&D expenses were $4,410,000,
$11,853,000 and $9,283,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.

     The significant  decrease in R&D expenses in 1999 is primarily due to lower
salary expense as a direct result of the  reductions in the Company's  workforce
during  1999,  and because of higher  development  costs in 1998  related to the
development of the wide-area  progressive system that were not incurred in 1999.
The increase between 1998 and 1997 was largely the result of incremental  hiring
of personnel,  increased  use of  engineering  consultants  and license fees and
similar costs associated with the acquisition of outside technologies.  Prior to
1997 the  focus  of R&D  activities  was in the  successful  development  of the
Company's  initial  product,  ODYSSEY,  and the initial  suite of games that the
Company  offered.  Since  that time,  R&D  activities  have  focused on new game
development,  the introduction of new product platforms,  and in the development
of new game types  such as the  wide-area  progressive  system.  The  Company is

                                       27
<PAGE>
focussed on ensuring  that it can offer  additional  features  into its products
that will fully  capitalize the underlying  technology used. This is expected to
require  significant  R&D resources to continue the  development  of the product
platform  to  facilitate  the  elaborate  requirements  of the game  development
process  and to enable it to  introduce  new game  types  into the slot  machine
market.

SELLING, GENERAL & ADMINISTRATIVE

     Selling,  general and administrative  ("SG&A") expenses include payroll and
related   costs  for   executive  and   administrative   personnel,   sales  and
customer-support  organization personnel, and marketing and licensing personnel,
corporate  overhead costs,  legal and associated  costs,  costs  associated with
obtaining and retaining corporate and product licenses in various jurisdictions,
and fees for  professional  services.  Approximately  50% of SG&A  expenses  are
headcount related.  SG&A expenses were $12,651,000,  $18,375,000 and $12,830,000
for the years ended December 31, 1999, 1998 and 1997, respectively.

     The  decrease  in SG&A  expenses  in 1999  reflects  the  lower  number  of
employees  following  the  reductions  in the  Company's  workforce in the first
quarter  of 1999 and lower  commissions  reflecting  the lower  revenues.  These
savings were offset by higher legal fees in  connection  with a number of patent
infringement cases that the Company was party to during 1999.  Increases in SG&A
expenses  between  1998 and 1997  were  largely  attributable  to the  hiring of
additional  personnel  and in costs  associated  with applying for corporate and
product  licenses as the Company began selling  product into new  jurisdictions.
The Company also incurred costs as it created and established a customer-support
organization  to support the rollout of its  product,  and as it  established  a
marketing organization upon the commercial distribution of its products in 1997.
A significant  portion of these increases  occurred during 1997 when the Company
commenced  sales of the ODYSSEY and built its  infrastructure  in the Nevada and
Mississippi  markets.  Additional increases in SG&A expenses in 1998 were due to
severance  payments  made  to  senior  management  and  increases  in  bad  debt
provisions of $1,600,000 due to problems with customer collections.  The Company
intends to  restrict  the growth in SG&A  expenses as much as possible in future
periods and expects SG&A  expenses in absolute  dollars and as a  percentage  of
revenue to decline.

RESTRUCTURING

     The Company  recorded  restructuring  expenses of $3,277,000,  in the first
quarter  of 1999,  following  management  decisions  to  reduce  the size of the
Company's  workforce  and to close its  California  manufacturing  facility  and
relocate all of its  manufacturing  and production  operations to its Las Vegas,
Nevada  facility.  This was done as the Company  sought to reduce its  operating
expenses  to a level  more  appropriate  to its  revenue  levels.  Restructuring
expenses  include  employee  severance  costs of $595,000,  costs of  $2,424,000
relating  to   scrapping   and   abandonment   of  assets,   and   $258,000  for
lease-associated expenses. All costs were incurred prior to June 30, 1999.

INTEREST INCOME AND EXPENSE

     Interest  income was $99,000,  $618,000 and  $1,238,000 for the years ended
December 31, 1999,  1998 and 1997,  respectively.  Fluctuations  in the level of
interest  income  are  directly  attributable  to  fluctuations  in the level of
average cash and investment balances that the Company holds. The timing of share
offerings,  issuance  of Senior  Discount  Notes,  and the rate of  spending  on
operations have impacted the average level of cash and investments held.

     Interest  expense was  $7,241,000,  $6,261,000 and $1,240,000 for the years
ended December 31, 1999, 1998 and 1997, respectively.  The increases in interest
expense are due to increases in the  Company's  level of long-term  indebtedness
over the period.  The  Company  raised $25  million in  September  1997 from the
issuance of Senior  Discount Notes (the 1997 Notes) and raised an additional $15
million in June 1998 from the issuance of additional  Senior Discount Notes (the
1998 Notes).  The Company also raised  approximately $3.6 million from equipment
financing  borrowing during 1998. Interest expense was higher in 1999 due to the
full-year  impact of  interest  expense on amounts  borrowed  during  1998.  The
increase in interest expense in 1998 reflects the full year interest cost of the
1997 notes as well as the interest  costs  associated  with the 1998 Notes,  the
repricing of stock warrants and the equipment financing.

                                       28
<PAGE>
GAIN ON CANCELLATION OF DEBT

     In November 1999 the Company completed a restructuring of its balance sheet
with the cooperation of the holders of its Senior Discount Notes. The holders of
the Senior Discount Notes exchanged  $39.75 million  principal notes and accrued
interest of $8.3  million for  Preferred  Stock that is  convertible  into a 57%
voting interest in the Company.  Concurrent with this conversion, the holders of
the  Senior  Discount  Notes  invested  an  additional  $2 million of New Senior
Discount Notes in the Company.  After accruing future  interest  payments on the
restructured  debt (which will result in no interest  expense being recorded for
these  payments  in future  periods),  recording  certain  expenses  related  to
issuance of warrants to the existing equity holders of the Company and the costs
of the  restructuring,  the Company  recorded a gain of $12.3  million  upon the
cancellation of the underlying debt.

INCOME TAXES

     The Company has not been  required to pay income taxes due to the fact that
it has had net operating  losses in each period since the  Company's  inception.
The Tax Reform Act of 1986 and the California Act of 1987 impose restrictions on
the utilization of net operating loss and tax credit  carryforwards in the event
of an "ownership  change" as defined by the Internal  Revenue Code. The Company'
ability to  utilize  its net  operating  loss and tax  credit  carryforwards  is
subject to limitation pursuant to these  restrictions.  The Company underwent an
ownership change as of the date of the debt restructuring in November,  1999. As
a result,  the Company lost the potential tax benefits of the net operating loss
carryforwards and the tax credit carryfowards that existed at that time.

     A valuation  allowance has been recorded for any deferred tax assets due to
uncertainty  regarding the ultimate  realization of these assets  resulting from
the lack of earnings history of the Company.

LIQUIDITY & FINANCIAL CONDITION

     The Company was able to significantly  reduce its level of debt as a result
of the debt  restructuring  completed  in November  1999,  but has  continued to
operate  under  very  tight  liquidity  constraints.  Cash and  equivalents  and
short-term  investments  decreased  by  $6,522,000  and  were  $1,877,000  as at
December 31, 1999 compared to $8,399,000 at December 31, 1998.  This decrease in
resources  is  primarily  due to the  ongoing  losses from  operations  that the
Company  has  incurred  and the need to repay  outstanding  borrowings  that the
Company had previously incurred.

     As of  December  31,  1999  the  Company  had  an  accumulated  deficit  of
$92,035,000,  a  shareholder's  deficiency of  $7,361,000  and has had operating
losses every year since its  inception.  The Company has been required to obtain
additional financing each year to be able to fund its ongoing operations.  Based
on historical  levels of cash usage, the above factors raise  substantial  doubt
about the  Company's  ability to continue as a going  concern.  In late 1998 and
early 1999 the Company took steps to reduce the level of operating  expenses and
made a number of management  decisions which resulted in total reductions of the
Company's  work  force  by  approximately  70%  and  made  significant  cuts  in
expenditures across the Company. Management also announced the relocation of its
manufacturing to its Las Vegas,  Nevada facility and the closure of its Mountain
View, California manufacturing facility. In November 1999, the Company, with the
consent  of the  holders  of its  Senior  Discount  Notes,  was able to  convert
approximately  $40 million principal amount of debt plus $8.3 million in accrued
interest  into a 57%  equity  stake in the  Company,  and to  obtain  additional
financing  from the debt holders.  The  aforementioned  actions  resulted in the
Company  reducing its operating  expenses by  approximately  40% compared to the
prior year, its future interest  obligations by  approximately  80%, and reduced
the cash used in  operations by  approximately  80% from the levels of the prior
year.  Management has recently  entered into a $ 2 million  accounts  receivable
based line of credit with a new bank on more favorable  terms than it previously
had.  Management  is also  reviewing  financing  alternatives  available  to the
Company such as additional  share or debt offerings in the Company or certain of
its subsidiaries,  joint ventures, alternative distribution channels and sale of
all or a portion of the Company's  assets,  to improve the  Company's  liquidity
position.  Management  believes  that these  steps,  plus  sales  related to new

                                       29
<PAGE>
product  introductions  will provide sufficient cash and working capital for the
Company to meet its ongoing obligations and to allow it to continue operating as
a going concern  through at least the end of 2000.  However,  the success of any
new product  introductions  is subject to various risks and  uncertainties,  and
there is no assurance that such new products will generate the amount of revenue
hoped for by the Company.  In the event it is unable to generate sufficient cash
from operations or identify new sources of capital, the Company will be required
to significantly limit or shut down all or some of its operations.

     The net cash used in operating  activities was $3,836,000,  $32,110,000 and
$29,909,000 for the years ended December 31, 1999, 1998 and 1997,  respectively.
The large  decrease  in cash used during  1999 was due to the  reduction  in the
Company's  operating  losses and through  improved  management  of the Company's
working capital. The Company reduced its level of inventories and receivables by
$8,845,000 in 1999 which helped provide cash for the ongoing daily operations of
the Company. The increase in cash used in operating activities in 1998 from 1997
was due to the  increase in net  operating  losses and due to  increases  in the
Company's   working  capital   requirements,   predominantly  in  inventory  and
receivables  during 1998.  This  increase  was offset  partially by increases in
depreciation, amortization, bad debt provisions, and accrued interest. Inventory
levels,  particularly raw materials and finished goods, increased  significantly
in 1998. This increase occurred as the Company ramped up its level of operations
in anticipation of sales demand,  and was unable to reduce these levels once the
anticipated  sales levels did not  materialize.  The increase in receivables was
largely  due to problems  in  collections  from  several  customers,  which also
resulted in the Company having to increase its bad debt reserves  during 1998 by
approximately $1,600,000.  The Company anticipates that in 2000 it will continue
to need to reduce its level of inventory and convert such inventory into cash to
be used for operations, if it is to have sufficient cash resources.

     Net cash used in investing  activities  was  $1,109,000  for the year ended
December  31, 1999  largely  due to the timing of  investment  of the  Company's
surplus  operating cash, with $1 million being held in short-term  investment as
at December 31, 1999. This was offset by the Company's investment in new capital
equipment. The Company has significantly reduced its investment in new equipment
because of the  liquidity  constraints  that the  Company  was forced to operate
under for most of 1999. Net cash provided by investing  activities of $1,245,000
for the year  ended  December  31,  1998 was due  largely to the  redemption  of
short-term  investments,  offset  by  the  amount  of  money  spent  on  capital
expenditure.  Net cash used in investing  activities was $3,077,000 for the year
ended  December 31, 1997.  The decrease in 1998 from 1997 is due to the sale and
maturity of the Company's short-term investments that were redeemed during 1998.
This  offset  the  Company's  increased  investment  in  fixed  assets  in 1998,
particularly  in  relation  to  the  introduction  of  the  Company's  wide-area
progressive system. The Company anticipates continued investment in fixed assets
during 2000 as it continues to develop new delivery systems and channels for its
software based products.

     Net cash used in financing  activities  was  $2,577,000  for the year ended
December  31, 1999  compared to net cash  provided by  financing  activities  of
$22,912,000  and  $23,755,000  for the years ended  December  31, 1998 and 1997,
respectively.  In 1999 the Company was  required to repay  borrowings  under its
bank line of credit and its equipment  financing of approximately  $4.7 million.
This was  offset by the $2 million  received  in New  Senior  Discount  Notes in
November 1999 in connection with the  restructuring  of the Company's  long-term
debt. Fluctuations in net cash provided by financing activities in 1998 and 1997
are due to the timing of the company's various share and debt offerings. In 1998
the Company  raised net  proceeds  of  $14,950,000  from the  issuance of Senior
Discount  Notes and  $3,586,000  from the  proceeds of new  equipment  financing
arrangements.  In 1997 the Company financed its operations primarily through the
proceeds  of  $23,055,000  from the  issuance  of  Senior  Discount  Notes  plus
detachable warrants.

     In  November,  1999  the  Company  along  with  three  other  slot  machine
manufacturers  was named in a lawsuit  filed by  International  Game  Technology
(IGT)  alleging  infringement  of a  particular  patent  relating  to the use of
electronic  buttons on the game play field. The lawsuit has not been served upon
the Company by IGT. The Company,  along with the other defendants,  has provided
certain  information to IGT that it believes  invalidates IGT's patent claim. If
the patent is not served upon the  Company in a timely  manner it will lapse and
no further action will be required.  The costs of defending such lawsuits may be
substantial and may require  significant  amounts of senior management time, and
an adverse result in any such litigation  could  materially and adversely affect
the Company's liquidity and capital resources.

                                       30
<PAGE>
     In March 2000 the Company  received  notification  that it has been sued in
the Federal Court in the District of South  Carolina by a former  distributor of
the Company's  products.  The distributor  seeks  repayment of $1 million,  plus
damages,  in connection with machines  previously  shipped to the distributor in
1998.  The  Company  was  in the  process  of  arbitration  as  required  by the
Distribution  Agreement,  seeking to recover  outstanding  receivables  from the
distributor. The Company has not yet responded to this lawsuit and the Company's
management  vehemently deny the  allegations of the lawsuit.  The Company is not
yet able to determine the likely  outcome of this  litigation  and the financial
impact, if any, on the Company's results of operations or liquidity position.

RECENTLY ISSUED ACCOUNTING STANDARDS

     In June 1998, the FASB issued Statement of Financial  Accounting  Standards
No. 133, "Accounting for Derivative  Instruments and Hedging  Activities".  This
statement  requires  companies  to record  derivatives  on the balance  sheet as
assets or liabilities  measured at fair value.  Adoption of this standard has no
impact upon the Company's consolidated financial position, results of operations
or cash flows as the Company does not currently  have any  derivative  financial
instruments covered by this standard.

OUTLOOK

     This outlook  section and other sections in this Annual Report on Form 10-K
contain  a number of  forward-looking  statements  that  reflect  the  Company's
current views with respect to future events and future  financial  performances.
Because  they relate to future  activities,  there is a high degree of risk that
such events will not  materialize  and readers should not place undue  influence
upon them as actual results may differ materially.

     To date the  Company  has  focussed  many of its  resources  on  creating a
business based on high-volume  manufacturing and placement of slot machines with
a goal of capturing  market  share.  The Company has  struggled in its endeavors
against many competitors who are significantly  larger and who have much greater
resources than the Company. The Company has historically emphasized selling game
platforms and strived to penetrate the market through frequent software releases
of new game titles.  Changes in the competitive  landscape since the Company was
formed have forced the Company to reevaluate  its basic business  strategy.  The
Company has incurred significant expenses in developing a fully integrated, high
overhead  business  that  assumed a much  higher  level of unit  sales  than the
Company  has  been  able  to  achieve,   resulting  in  unacceptable  levels  of
profitability for the Company.

     Since the completion of the  restructuring of its balance sheet in November
1999,  management has spent time  reviewing the basic  business  strategy of the
Company and intends to reorganize the business around the different  product and
market opportunities that it has identified. Management also intends to simplify
the business and focus  resources so that it can continue to reduce the level of
corporate overhead, minimize the level of cash usage, transition the business to
one that takes advantage of revenue-sharing opportunities and focus on achieving
profitability.

                                       31
<PAGE>
     The Company has sold over 3,700 machines to date and  understands  the need
to continue to support its products and the needs of its existing customers.  At
the same time,  the Company needs to focus on how to best exploit the technology
inherent  in  its  game  platforms  and  the  development  capabilities  of  its
development  organization.  This will allow it to provide game  experiences  and
game features that are unique to the Company that cannot be easily  exploited or
imitated  by its  competitors.  By  emphasizing  the  quality  of  the  wagering
attraction,  including  the game  itself,  rather  than the  volume  of new game
titles,  the Company hopes to be able to command  premium floor locations in its
customers'  casinos,  and as a result achieve a premium level of performance and
revenue.  The Company intends to partner with outside parties,  including casino
operators,  other  slot  manufacturers,  and  other  intellectual  property  and
brand-based  content  holders,  to accomplish  these goals.  By partnering  with
outside  parties the Company  believes  it can offset its  development  risk and
costs,  achieve higher revenues and increase the likelihood of product  success.
In 1999 the Company  entered  into a  joint-product  development  and  marketing
agreement  with Anchor  Gaming.  This is the first  example of where the Company
will  seek  external  skills  to  complement  its  own  resources.  The  Company
anticipates  announcing more similar  arrangement  during 2000. In February 2000
the Company announced that it had entered into a product development arrangement
with a  Nevada-based  casino  operator  whereby  the  Company  will  develop  an
exclusive,  brand-based  product  for  the  operator.  The  Company  expects  to
introduce this product into the market in the Summer of 2000.

     The  Company  also  intends  to  continue  its  program  of  improving  and
solidifying its financial position.  This will require that the Company continue
to sell through its existing  inventory to provide  adequate working capital for
the Company to use in its day to day operations. The Company is also considering
raising additional capital in either the parent company or directly into certain
of its subsidiaries, in order to fund new product and system development.

     The Company will continue to introduce new game title releases for sale and
to refresh  the game  offerings  on its  installed  base of  ODYSSEY,  QUEST and
slant-top machines during 2000. The Company intends to change its focus from one
of frequent game releases to one that emphasizes the quality and feature content
of new game titles.  It will also offer  product  extensions  and  variations of
existing  successful  game  titles.  The Company also  understands  that it must
emphasize  more than selling a platform that has a variety of game  applications
upon it. The Company hopes to partner with casino operators to provide a unique,
fully integrated gaming experience which encompasses  packaging,  merchandising,
signage systems and, in some cases,  unique platform packaging as well. By doing
this,  the Company aims to provide a more  complete and feature rich  experience
for the gaming patron that is unique to the Company.  By partnering  with casino
operators the Company hopes to achieve premium placement of its product.

     The Company's  future results of operations  and the other  forward-looking
statements  contained in this outlook - in particular the  statements  regarding
potential  partnerships  with  casino  operators  or other  third  parties,  and
possible  raising  of  additional   capital-  involve  a  number  of  risks  and
uncertainties.  In  addition  to the factors  discussed  above,  among the other
factors that could cause actual results to differ  materially are the following:
the success of the  Company's  game titles that it  introduces  into the market,
changes in customer order patterns,  competitive  factors such as new competitor
product or game  introductions or changes in pricing  strategies,  reluctance of
casino  operators  to use  participation-based  products or to partner  with the
Company in product  development,  the Company's level of financial resources and
adequate  cash  flows,  the  stability  of the  Company's  management  team  and
workforce,  and the  ability of the  Company  to meet all  initial  and  ongoing
licensing requirements in the jurisdictions in which it sells products.

     The  Company  believes  that  it has  the  product  offerings,  facilities,
personnel,  and competitive  resources needed for business  success,  but future
revenue,  costs,  margins and profits are all influenced by a number of factors,
including those discussed above and the need for the Company to raise additional
funds, all of which are inherently difficult to predict.

                                       32
<PAGE>
FACTORS AFFECTING FUTURE RESULTS

     MANAGEMENT  OF  CHANGING  BUSINESS  - The  Company  has spent the last year
trying to shift its business strategy from one of high-volume  manufacturing and
placement of slot machines with a goal of capturing  market share, to a strategy
that  emphasizes  the quality  and feature  content of new game titles and takes
advantage  of  revenue-sharing  opportunities.  The  Company  plans on  offering
product extensions and variations of successful  existing games in 2000, however
the  emphasis  will  shift  from  volume-based  to one of  providing  a  unique,
fully-integrated  gaming  experience.  This transition  represents a significant
challenge for the Company and its management and employees, and places increased
demand on its systems and controls.  The Company's ability to manage this change
will  require  the  Company to  continue  to  change,  expand  and  improve  its
operational,  management  and  financial  systems  and  controls  to manage  any
outsourcing or relocation of existing  activities.  Key to effecting this change
in  business is the ability of the  Company to sell its  existing  inventory  of
ODYSSEY  and  QUEST  products  in a timely  manner  and to  resolve  outstanding
collections  issues with customers to provide  sufficient working capital during
this transition  process.  If the Company is not able to generate adequate funds
from its working capital in a timely manner, the Company's  business,  operating
results and financial condition will be materially and adversely affected.

     LIQUIDITY - The Company has funded its operations to date primarily through
private and public  offerings of its equity  securities,  the issuance of Senior
Discount Notes,  term and equipment loans and from bank borrowings.  At December
31, 1999 the Company had an accumulated  deficit of $92,035,000 and a deficiency
of  shareholders'  equity of $7,361,000 and was not in compliance with the terms
of its line of credit that  expired in January  2000.  The Company  subsequently
repaid all amounts due under the line of credit and has negotiated a new line of
credit with a different  financial  institution  on better terms.  Management is
also  reviewing  financing   alternatives  available  to  the  Company  such  as
additional   share  or  debt   offerings  in  the  Company  or  certain  of  its
subsidiaries,  joint ventures, alternative distribution channels and sale of all
or a  portion  of  the  Company's  assets.  If the  plans  that  management  has
undertaken  to improve the  Company's  liquidity  position are not  successfully
completed in a timely manner it is probable that  insufficient  funds will exist
to satisfy the Company's operating requirements. The Company will be required to
make adjustments to its operating  activities to operate within the restrictions
of its  liquidity  and  this  could  have a  material  adverse  affect  upon the
Company's  business,  operating results and financial  condition.  To the extent
that the  Company  sells  additional  shares  or  issues  any  convertible  debt
securities,  this could result in additional dilution to existing  shareholders.
There  can be no  assurance  that  the  Company  will be  able  to  successfully
renegotiate its existing credit  facility or be able to raise  additional  funds
when and if needed.

     VOLATILITY  OF STOCK - The  market  price of the  Company's  stock has been
highly volatile and subject to large fluctuations. The Company's stock price may
be  affected  by factors  such as actual or  unanticipated  fluctuations  in the
Company's results of operations,  new product or technical  introductions by the
Company  or  any of its  competitors,  developments  with  respect  to  patents,
copyrights or proprietary  rights,  conditions or trends in the gaming industry,
changes in or failure by the Company to meet securities analysts'  expectations,
general market  conditions and other factors.  The Company's stock now trades on
the Over The Counter (OTC) Bulletin Board.  This may affect the level of trading
activity in the Company's stock, result in higher bid/ask spreads,  and increase
the cost of  raising  additional  equity for the  Company,  as well as result in
higher levels of volatility in the price of the Company's stock.

     RETENTION OF PERSONNEL - The  operations  of the Company  depend to a great
extent on the management efforts of its officers and other key personnel, and on
the ability to attract new key personnel and retain existing key personnel.  The
Company has experienced  high turnover among its senior  management  during 1998
and 1999. In February 1999 the Company  announced the appointment of a new Chief
Executive  Officer.  The Company also reduced its workforce by approximately 20%
in December  1998 and by a further 40% in March 1999.  These  factors,  combined
with the Company's poor operating  results and the  significant  decrease in the
price of the Company's  Common Stock may have an adverse affect on the Company's
ability to retain and motivate  its key  employees.  Competition  is intense for

                                       33
<PAGE>
highly skilled product  development  employees in particular.  In addition,  the
Company's officers and key employees are not bound by non-competition agreements
that  extend  beyond  their  employment  at the  Company,  and  there  can be no
assurance that employees will leave the Company or compete  against the Company.
The Company's failure to attract additional qualified employees or to retain its
existing  employees  could  have a  material  adverse  affect  on the  Company's
operating results and financial  condition.  Should the Company offer additional
stock  option  grants to its existing  employees  to encourage  them to continue
their  employment  at the  Company,  this may result in  additional  dilution to
existing shareholders.

     CUSTOMER  RETENTION - The Company's ability to sell product may be hampered
due to the financial  position of the Company which  presents risks to customers
that the  Company  may not be able to  fulfill  its  obligations  under  license
agreements or be available to provide  warranty,  repair or upgrade  services on
products that it has already sold.  The Company  experienced  negative  reaction
from customers who held these views during 1999 and who have indicated that they
may  not  purchase  additional  product  from  the  Company.  Completion  of the
Company's debt  restructuring in November 1999 mitigates these risks however the
Company  continues to experience  these negative  sentiments from its customers.
Certain of the Company's  competitors who have  significantly  greater financial
and marketing  resources  than the Company are also trying to take  advantage of
the  Company's  financial  position  and are fueling the  speculation  about the
Company's financial position. To the extent that this results in the loss of any
of  the   Company's   strategic   customers  or  results  in  a  loss  of  sales
opportunities, the Company's business, operating results and financial condition
may be adversely affected.

     INTELLECTUAL   PROPERTY  RIGHTS  -  The  Company  regards  its  product  as
proprietary  and  relies  primarily  on  a  combination  of  patent,  trademark,
copyright  and trade  secret laws and  employee  and  third-party  nondisclosure
agreements to protect its proprietary rights.  Defense of intellectual  property
rights can be costly,  and there can be no  assurance  that the Company  will be
able to effectively protect its technology from misappropriation by competitors.

     As the number of software products in the gaming industry increases and the
functionality  of these  products  further  overlaps,  software  developers  and
publishers  or  competitors  may  increasingly  become  subject to  infringement
claims.  The Company may also become  subject to  infringement  claims,  with or
without merit,  that are brought by competitors  who are motivated with a desire
to disrupt the Company's business. The Company and three of its competitors were
notified  by one of its  competitors,  IGT, of a  potential  infringement  claim
during  November 1999.  This required  senior  management to work with the other
defendants to provide  information to IGT that it believes repudiates the claims
alleged by IGT. The Company has not been served with the actual lawsuit so it is
unable to ascertain the future impact, if any, of this claim. Any such claims or
litigation  can be costly and result in a diversion of  management's  attention,
which  could  have a  material  adverse  effect on the  Company's  business  and
financial condition.  Any settlement of such claims or adverse determinations in
such  litigation  could also have a  material  adverse  effect on the  Company's
business, operating results and financial condition.

     CHANGING  LEGISLATIVE  ENVIRONMENT  -The opening of new casinos,  including
casinos in jurisdictions  where gaming has recently been legalized  historically
has driven growth for demand in slot  machines.  However,  in recent years,  the
legalization  of gaming in new  jurisdictions  has been  significantly  reduced;
therefore  demand based on new openings will be largely  limited to new projects
in existing  markets.  Certain  markets,  which  currently  permit  gaming,  are
contemplating  legislation to limit,  reduce or eliminate  gaming. If successful
such legislation could limit growth  opportunities for the Company.  As a result
of these  factors,  there can be no assurance  that the slot machine market will
sustain the rate of growth that was possible in the first half of this decade.

                                       34
<PAGE>
     RAPIDLY  CHANGING  TECHNOLOGY - The  Company's  products  utilize  hardware
components  that have been  developed  primarily  for the personal  computer and
multimedia industries. These industries are characterized by rapid technological
change and product enhancements. The Company's ability to remain competitive and
retain any technological lead may depend in part upon its ability to continually
develop new slot machine  games that take full  advantage  of the  technological
possibilities  of  state-of-the-art  hardware.  The  Company has not updated its
product offering to take advantage of enhanced  hardware  components since 1998.
Should any current or potential  competitor of the Company succeed in developing
a  competing  software-based  gaming  platform,  such  competitor  could be in a
position to  outperform  the Company in its ability to exploit  developments  in
microprocessor,  video or other multimedia technology.  The emergence of a suite
of slot machine  games that is superior to the  Company's  in any respect  could
substantially  diminish the Company's  product sales and thereby have a material
adverse effect on the Company's operating results.

     DEPENDENCE  ON  SINGLE-SOURCE  SUPPLIERS  - The Company  currently  obtains
certain  systems  components  from  single-source  suppliers.  In particular the
touchscreen  and picture tube that  comprise  the video  display are supplied by
MircoTouch Systems,  Inc. and Philips Display Components Company,  respectively.
The Company does not have long-term  supply  contracts with these  suppliers but
rather obtains these  components on a purchase order basis.  Although the design
of these  components is not unique or proprietary and the Company  believes that
it could identify  alternative sources of supply, if necessary,  there can be no
assurance that the Company would be able to procure,  substitute or produce such
components  without a significant  interruption  in its assembly  process in the
event that these single  sources were unable to supply  these  components.  Even
where the Company has multiple sources of supply for a component,  industry-wide
component  shortages,  such as those that have  occurred  with various  computer
components, could significantly delay productivity,  increase costs or both. The
Company is also considering exclusive outsourcing  arrangements whereby a single
third party contract  manufacturer will assemble all or a significant portion of
new products that the Company is planning to introduce.  The failure or delay by
any  supplier to furnish the Company with the  required  components  or products
would  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.

ITEM 7A

     MARKET RISK  DISCLOSURES:  The  following  discussion  about the  Company's
market risk  disclosures  involves  forward-looking  statements.  Actual results
could differ materially from those projected in the forward-looking  statements.
The Company is exposed to market risk  related to changes in interest  rates and
equity  security  price risk.  The Company  does not have  derivative  financial
instruments for speculative or trading purposes.

     The Company has fixed rate  long-term  debt of  approximately  $9.5 million
outstanding  at December  31, 1999 and a  hypothetical  ten percent  increase or
decrease in interest  rates would not have a material  impact on the fair market
value of this debt. The fair value of the Company's Senior Discount Notes may be
lower than the  recorded  value,  but the Company is unable to estimate the fair
value at this time. The Company does not hedge any interest rate exposures.

                                       35
<PAGE>
FINANCIAL INFORMATION BY QUARTER (UNAUDITED)

<TABLE>
<CAPTION>
(in thousands,                                       Three Months Ended
except per share amounts)          -----------------------------------------
                                   March 31   June 30    Sept. 30    Dec. 31    Total Year
                                   --------   -------    --------    -------    ----------
<S>                                <C>        <C>        <C>         <C>         <C>
1999:
 Sales ........................    $ 5,661    $ 5,928    $  1,999    $  3,527    $ 17,115
 Operating loss ...............    $(7,114)   $(1,273)   $ (3,005)   $ (5,044)   $(16,436)
 Net income (loss) ............    $(9,040)   $(3,199)   $ (4,980)   $  5,454    $(11,765)
 Basic and diluted net
  income (loss) per share(1)...    $ (0.64)   $ (0.22)   $  (0.34)   $   0.24    $  (0.70)
                                   -------    -------    --------    --------    --------
1998:
  Sales .......................    $ 4,026    $ 8,261    $  4,989    $  5,005    $ 22,281
  Net loss ....................    $(6,764)   $(5,428)   $(14,702)   $(10,776)   $(37,670)
  Basic and diluted net loss
   per share(1) ...............    $ (0.51)   $ (0.39)   $  (1.06)   $  (0.77)   $  (2.75)
                                   -------    -------    --------    --------    --------
</TABLE>

----------
(1)  See Note 1 of Notes to Consolidated Financial Statements for an explanation
     of  the  method  used  to  determine  the  number  of  shares  used  in the
     computation of basic and diluted net loss per share

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Index to Financial Statements and Supplementary Data

     Financial Statements:                                                 Page
                                                                           ----
     Consolidated Balance Sheets at December 31, 1999 and 1998              40

     Consolidated Statements of Operations for the years ended
       December 31, 1999, 1998 and 1997                                     41

     Consolidated Statements of Shareholders's Deficiency for
       the years ended December 31, 1999, 1998 and 1997                     42

     Consolidated Statements of Cash Flows for the years ended
       December 31, 1999, 1998 and 1997                                     43

     Notes to Consolidated Financial Statements                             44

     Independent Auditors' Report                                           56

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

     Not applicable.

                                       36
<PAGE>
                                    PART III

     Portions  of the  information  required  by  Part  III  of  Form  10-K  are
incorporated  by  reference  to  portions  of  the  Company's  definitive  Proxy
Statement to be filed with the  Commission  in  connection  with the 2000 Annual
Meeting of Shareholders  (the "Proxy  Statement"),  which the Company intends to
file not more than 120 days  after the end of the  fiscal  year  covered by this
Report.

ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The  information  set  forth in the  Proxy  Statement  under  the  captions
"Proposal  One--Election  of  Directors-Nominees"  and "Section 16(a) Beneficial
Ownership Reporting  Compliance" in the Company's Proxy Statement to be filed in
connection with its 2000 annual meeting of shareholders (the "Proxy  Statement")
and the  information  set  forth  in Item I of this  Report  under  the  caption
"Executive Officers" is incorporated herein by reference.

ITEM 11: EXECUTIVE COMPENSATION

     The  information  set  forth  in the  Proxy  Statement  under  the  caption
"Executive Compensation" is incorporated herein by reference.

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The  information  set  forth  in the  Proxy  Statement  under  the  caption
"Security Ownership of Certain Beneficial Owners and Management" is incorporated
herein by reference.

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information set forth in the Proxy Statement under the caption "Certain
Relationships and Related Transactions" is incorporated herein by reference.

                                     PART IV

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

     (a) The following documents are filed as part of this Form 10-K:

          (1)  Consolidated Financial Statements.  See the Index to Consolidated
               Financial  Statements and  Supplementary  data at page 38 of this
               Form 10-K.

          (2)  Financial Statement Schedule.

               Schedule II - Valuation and Qualifying Accounts and Reserves

          (3)  Exhibits.  The exhibits listed in the accompanying  Exhibit Index
               are filed as part of, or  incorporated  by reference  into,  this
               Report.

     (b) Reports on Form 8-K:

          During the quarter ended  December 31, 1999 the Company filed a report
     on Form 8-K that outlined the terms of a financial  restructuring  that the
     Company  completed  with  the  holders  of  the  $47.25  million  principal
     outstanding Senior Discount Notes. As a result of the restructuring, $39.75

                                       37
<PAGE>
     million of Notes and accrued  interest  thereon were  exchanged  for 39,750
     shares of Series D Preferred  Stock that is  convertible  into a 57% common
     equity interest in the Company.  The terms of the remaining $7.5 million of
     outstanding  Notes were  modified to reduce the interest rate from 12.5% to
     10% per annum  (effective  July 15, 1999) and to provide for interest to be
     payable  in-kind at the  Company's  option and subject to certain  coverage
     tests.  The Notes will  mature 5 years from the date of the  restructuring.
     Accrued  and  unpaid  interest  on the $7.5  million  of Notes  outstanding
     following the restructuring was forgiven through July 15, 1999.

          As a part of the  restructuring,  the holders of the Notes have agreed
     to make an additional  investment in the Company of up to $5 million in the
     form of  Senior  Secured  Notes  (the New  Notes).  The New  Notes  are not
     convertible and bear cash interest at 10% per annum and in-kind interest at
     the rate of 3% per  annum.  The New  Notes  mature  in five  years  and are
     issuable in  tranches.  The first $2.0 million was issued at the closing of
     the  restructuring.  To the extent  required by the Company,  the remaining
     $3.0  million of New Notes will be issued upon the  achievement  of certain
     operating  and  financial  milestones  as  determined by the holders of the
     Notes.

          Effective  upon the  closing of the  restructuring,  a majority of the
     members of the  Company's  Board of Directors  resigned and two new members
     were appointed.

          In addition,  the Company intends to conduct an Exchange Offer whereby
     holders of common stock as of November  24, 1999 who elect to  participate,
     may exchange  their shares of common stock for units  consisting of a share
     of common  stock and a warrant to  purchase  3.59662  additional  shares of
     common  stock.  The exercise  price of the warrants will be at a premium to
     fair market value and will be based on an enterprise  value for the Company
     of $70 million.  In addition,  the warrants would only be exercisable after
     the first  anniversary  of issuance  and would  terminate  four years after
     their  issuance.  The warrants  could  terminate  prior to their  scheduled
     expiration if the  Company's  enterprise  value,  as measured on the Nasdaq
     national market or a national  securities  exchange,  exceeds $100 million.
     Holders  of the  warrants  would  have 180 days to  exercise  prior to such
     termination.

          The Company has allocated 38% of its equity  (calculated  prior to the
     issuance  of  the  out-of-the-money  warrants  described  above)  as of the
     effective date of the restructuring to be issued as incentive  compensation
     to  employees.  Of the  116,190,084  shares of  common  stock  issuable  as
     incentive,  15,657,490  shares were authorized for issuance on November 24,
     1999.

                                       38
<PAGE>
                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned,  in the City of Palo Alto, County of Santa Clara,
State of California, on the 30th day of March, 2000.

                                        SILICON GAMING, INC.

                                        By: /s/ Andrew S. Pascal
                                            ------------------------------------
                                            Andrew S. Pascal
                                            President, Chief Executive Officer,
                                            Acting Chief Financial Officer
                                            (Principal Financial and Chief
                                            Accounting Officer)

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
     report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

Signature                              Title                         Date
---------                              -----                         ----

/s/ Andrew S. Pascal          President ,Chief Executive         March 30, 2000
----------------------------  Officer, Chief Financial Officer
      Andrew S. Pascal        (Principal Financial and
                              Accounting Officer) and director


/s/ Stanford Springel         Director                           March 30, 2000
----------------------------
     Stanford Springel


/s/ Robert Reis               Director                           March 30, 2000
----------------------------
        Robert Reis

                                       39
<PAGE>
                              SILICON GAMING, INC.
                           CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)

                                                               December 31,
                                                         ----------------------
                                                           1999          1998
                                                         --------      --------
                                     ASSETS
CURRENT ASSETS:
 Cash and equivalents ................................   $    877      $  8,399
 Short-term investments ..............................      1,000            --
 Accounts receivable (net of allowances of
  $1,169 in 1999 and $1,650 in 1998) .................      1,188         5,340
 Inventories .........................................      7,331        12,024
 Prepaids and other ..................................      1,069         1,698
                                                         --------      --------
      Total current assets ...........................     11,465        27,461

PROPERTY AND EQUIPMENT, NET ..........................      3,795        12,922
OTHER ASSETS, NET ....................................        321         1,361
                                                         --------      --------
                                                         $ 15,581      $ 41,744
                                                         ========      ========

                    LIABILITIES AND SHAREHOLDERS' DEFICIENCY

CURRENT LIABILITIES:
 Accounts payable ....................................   $  1,389      $  1,480
 Accrued liabilities .................................      1,655         8,154
 Deferred revenue ....................................        240         1,766
 Line of credit ......................................        622         4,000
 Current portion of long-term obligations ............      1,165         1,289
                                                         --------      --------
      Total current liabilities ......................      5,071        16,689

OTHER LONG-TERM LIABILITIES ..........................      1,611         2,032
LONG-TERM OBLIGATIONS ................................     10,428        39,809
LONG-TERM ACCRUED INTEREST ...........................      5,832            --


REDEEMABLE CONVERTIBLE PREFERRED STOCK --
 shares outstanding: December 31, 1999 -- 0;
 December 31, 1998--1,474,641 ........................         --         1,666

SHAREHOLDERS' DEFICIENCY:
 Preferred Stock, $.001 par value;
  6,884,473 shares authorized; 39,750 shares
  outstanding at December 31, 1999; (liquidation
  preference up to $39.75 million) ...................     20,000            --
 Common Stock, $.001 par value; 750,000,000 shares
  authorized; shares outstanding: December 31, 1999 --
  30,949,273; December 31, 1998 -- 14,242,313 ........     64,123        57,398
 Warrants ............................................      5,542         4,548
 Notes receivable from shareholders ..................       (345)         (128)
 Deferred stock compensation .........................     (4,646)           --
 Accumulated deficit .................................    (92,035)      (80,270)
 Accumulated other comprehensive income ..............         --            --
                                                         --------      --------
   Total shareholders' equity (deficiency) ...........     (7,361)      (18,452)
                                                         --------      --------
                                                         $ 15,581      $ 41,744
                                                         ========      ========

                 See Notes to Consolidated Financial Statements.

                                       40
<PAGE>
                              SILICON GAMING, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


                                                    Year Ended December 31,
                                               --------------------------------
                                                 1999        1998        1997
                                               --------    --------    --------
REVENUE:
 Hardware ..................................  $ 10,370     $ 14,126    $  7,636
 Software ..................................     4,288        4,657         567
 Participation .............................     2,457        3,498       1,347
                                              --------     --------    --------

      Total revenue ........................    17,115       22,281       9,550

OPERATING EXPENSES:
 Cost of sales and related manufacturing
  expenses .................................    13,213       24,062      10,421
 Research and development ..................     4,410       11,853       9,283
 Selling, general and administrative .......    12,651       18,375      12,830
 Restructuring .............................     3,277           --          --
                                              --------     --------    --------
      Total costs and expenses .............    33,551       54,290      32,534
                                              --------     --------    --------
      Loss from operations .................    16,436       32,009      22,984
 Interest income ...........................       (99)        (618)     (1,238)
 Interest expense ..........................     7,241        6,261       1,240
 Other expense, net ........................       503           18          --
                                              --------     --------    --------
LOSS BEFORE EXTRAORDINARY ITEMS ............    24,081       37,670      22,986
 Extraordinary gain upon conversion of
  debt (Note 7) ............................   (12,316)          --          --
                                              ========     ========    ========
NET LOSS ...................................  $ 11,765     $ 37,670    $ 22,986
                                              ========     ========    ========
BASIC AND DILUTED NET LOSS PER SHARE:
 Loss before extraodinary items ............  $   1.42     $   2.75    $   2.16
                                              ========     ========    ========
 Net loss ..................................  $   0.70     $   2.75    $   2.16
                                              ========     ========    ========
SHARES USED IN COMPUTATION .................    16,906       13,696      10,666
                                              ========     ========    ========

                 See Notes to Consolidated Financial Statements.

                                       41
<PAGE>
                              SILICON GAMING, INC.
          CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY)
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>

                                     Preferred Stock          Common Stock
                                   -------------------     ---------------------
                                   Shares       Amount      Shares       Amount      Warrants
                                   ------       ------      ------       ------      --------
<S>                                <C>          <C>       <C>           <C>          <C>
BALANCES, January 1, 1997 ........       --          --     10,608,105      49,848          25
Options exercised for cash .......                              49,083         200
Collection of notes receivable ...
Employee stock purchase plan
 issuances .......................                              99,894         696
Repurchase of Common Stock .......                             (17,377)         (3)
Conversion of  Series A1
 Redeemable Preferred Stock ......                           1,219,032       1,371
Conversion of  Series B1
 Redeemable Preferred Stock ......                           1,191,000       2,019
Warrants issued in conjunction
 with Senior Notes ...............                                                       3,082
Other comprehensive income
 (loss) ..........................
Net loss & comprehensive net
 loss ............................
                                     ------     -------     ----------    --------     -------

BALANCES, December 31, 1997 ......       --     $    --     13,149,737    $ 54,131     $ 3,107
Options exercised for cash .......                              97,400         217
Collection of notes receivable ...
Employee stock purchase plan
 issuances .......................                             151,808         935
Repurchase of Common Stock .......                             (54,130)         (6)
Net exercise of warrants .........                              34,309          25         (25)
Conversion of Series A1
 Redeemable Preferred Stock ......                             113,189         128
Conversion of Series B1
 Redeemable Preferred Stock ......                             750,000       1,271
Warrants issued in conjunction
 with Senior Notes ...............                                                       1,466
Stock compensation arrangements...                                             697
Net loss .........................
Other comprehensive income
 (loss) ..........................
Comprehensive loss ...............
                                     ------     -------     ----------    --------     -------

BALANCES, December 31, 1998 ......       --     $    --     14,242,313    $ 57,398     $ 4,548
Debt restructuring transactions:
 Conversion of Series B1
  Preferred Stock ................                             983,093         468
 Issuance of preferred stock         39,750      20,000
 Issuance of warrants ............                                                         994
Options exercised for cash and
 notes receivable ................                          15,722,830       6,202
Amortization of deferred stock
 compensation ....................
Collection of notes receivable ...
Employee stock purchase plan
 issuances .......................                              48,815          62
Repurchase of Common Stock .......                             (47,778)         (7)
Net loss and comprehensive loss...
                                     ------     -------     ----------    --------     -------

BALANCES, December 31, 1999 ......   39,750     $20,000     30,949,273    $ 64,123     $ 5,542
                                     ======     =======     ==========    ========     =======

                                          Notes                                      Accumulated
                                        Receivable       Deferred                       Other
                                          From             Stock      Accumulated   Comprehensive
                                       Shareholders    Compensation     Deficit        Income       Total
                                       ------------    ------------     -------        ------       -----

BALANCES, January 1, 1997 ........        (221)              --         (19,614)         23         30,061
Options exercised for cash .......                                                                     200
Collection of notes receivable ...          14                                                          14
Employee stock purchase plan
 issuances .......................                                                                     696
Repurchase of Common Stock .......                                                                      (3)
Conversion of  Series A1
 Redeemable Preferred Stock ......                                                                   1,371
Conversion of  Series B1
 Redeemable Preferred Stock ......                                                                   2,019
Warrants issued in conjunction
 with Senior Notes ...............                                                                   3,082
Other comprehensive income
 (loss) ..........................                                                      (22)
Net loss & comprehensive net
 loss ............................                                      (22,986)                   (23,008)
                                          ----          -------        --------        ----       --------

BALANCES, December 31, 1997 ......       $(207)         $    --        $(42,600)       $  1       $ 14,432
Options exercised for cash .......                                                                     217
Collection of notes receivable ...          75                                                          75
Employee stock purchase plan
 issuances .......................                                                                     935
Repurchase of Common Stock .......           4                                                          (2)
Net exercise of warrants .........                                                                      --
Conversion of Series A1
 Redeemable Preferred Stock ......                                                                     128
Conversion of Series B1
 Redeemable Preferred Stock ......                                                                   1,271
Warrants issued in conjunction
 with Senior Notes ...............                                                                   1,466
Stock compensation arrangements...                                                                     697
Net loss .........................                                      (37,670)
Other comprehensive income
 (loss) ..........................                                                       (1)
Comprehensive loss ...............                                                                 (37,671)
                                          ----          -------        --------        ----       --------

BALANCES, December 31, 1998 ......       $(128)         $    --        $(80,270)       $ --        (18,452)
Debt restructuring transactions:
 Conversion of Series B1
  Preferred Stock ................                                                                     468
 Issuance of preferred stock                                                                        20,000
 Issuance of warrants ............                                                                     994
Options exercised for cash and
 notes receivable ................        (235)          (5,807)                                       160
Amortization of deferred stock
 compensation ....................                        1,161                                      1,161
Collection of notes receivable ...          11                                                          11
Employee stock purchase plan
 issuances .......................                                                                      62
Repurchase of Common Stock .......           7                                                          --
Net loss and comprehensive loss...                                      (11,765)                   (11,765)
                                          ----          -------        --------        ----       --------

BALANCES, December 31, 1999 ......        (345)         $(4,646)       $(92,035)       $ --       $ (7,361)
                                          ====          =======        ========        ====       ========
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                       42
<PAGE>
                              SILICON GAMING, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                         --------------------------------------
                                                           1999           1998           1997
                                                         --------       --------       --------
<S>                                                      <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss ..........................................    $(11,765)      $(37,670)      $(22,986)
  Reconciliation to net cash used in
   operating activities:
    Gain on debt conversion .........................     (12,316)            --             --
    Depreciation and amortization ...................       4,775          4,700          2,623
    Accrued interest ................................       4,405          3,594            672
    Accretion of debt discount ......................       2,206          1,905            359
    Deferred rent ...................................         (98)           213            202
    Restructuring expenses ..........................       3,277             --             --
    Stock compensation ..............................       1,161            697             --
    Loss (gain) on disposal of property .............         131            (35)            --
  Changes in assets and liabilities:
    Accounts receivable .............................       4,152           (410)        (4,930)
    Inventory .......................................       4,693         (5,689)        (5,858)
    Prepaids and other ..............................        (146)           (64)          (133)
    Participation units .............................       2,252           (361)        (5,325)
    Accounts payable ................................        (591)        (1,671)         1,993
    Deferred revenue ................................      (1,526)           288          1,478
    Accrued and other liabilities ...................      (4,446)         2,389          1,996
                                                         --------       --------       --------
       Net cash used in operating activities ........      (3,836)       (32,110)       (29,909)
                                                         --------       --------       --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of property and equipment .............        (397)        (3,271)        (7,817)
  Proceeds from sale of assets ......................          --            127             --
  Purchases of short-term investments ...............      (1,000)            --         (6,725)
  Sales and maturities of short-term
   investments ......................................          --          4,704         11,681
  Other assets, net .................................         288           (315)          (216)
                                                         --------       --------       --------
       Net cash provided by (used in)
        investing activities ........................      (1,109)         1,245         (3,077)
                                                         --------       --------       --------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from debt financing and
   issuance of warrants, net of costs ...............       2,000         14,950         23,055
  Sale of Common Stock, net .........................          80          1,146            893
  Collection of note receivable .....................          11             79             14
  Proceeds from notes payable .......................          --          3,586             --
  Repayment of notes payable ........................        (985)          (564)            --
  Proceeds (repayment) from line of credi ...........      (3,378)         4,000             --
  Repayment of capital lease obligation .............        (305)          (285)          (207)
                                                         --------       --------       --------
       Net cash provided by (used in)
        financing activities ........................      (2,577)        22,912         23,755
                                                         --------       --------       --------
NET DECREASE IN CASH AND EQUIVALENTS ................      (7,522)        (9,231)        (7,953)
CASH AND EQUIVALENTS:
  Beginning of period ...............................       8,399         16,352         25,583
                                                         --------       --------       --------
  End of period .....................................    $    877       $  8,399       $ 16,352
                                                         ========       ========       ========
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION--
  Cash paid during the period for interest ..........    $    602       $    360       $    106
                                                         ========       ========       ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
  Issuance of Common Stock for notes receivable......    $    235       $     --       $     --
                                                         ========       ========       ========
  Issuance of Common Stock warrants .................    $    994       $  1,466       $  3,082
                                                         ========       ========       ========
  Conversion of Preferred Stock to Common Stock......    $    468       $  1,399       $  3,390
                                                         ========       ========       ========
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                       43
<PAGE>
                              SILICON GAMING, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

     BUSINESS--Silicon Gaming, Inc. (the "Company") was incorporated on July 27,
1993 to develop and market innovative gaming devices through the use of advanced
multimedia and interactive technologies.

     BASIS OF PRESENTATION - The accompanying  consolidated financial statements
have been prepared  assuming that the Company will continue as a going  concern.
The Company has incurred  operating losses every year since its inception and at
December 31, 1999 had an accumulated  deficit of $92,035,000 and a shareholders'
deficiency of  $7,361,000.  The Company has been  required to obtain  additional
financing  every  year to be  able to fund  its  ongoing  operations.  Based  on
historical  levels of cash useage,  the above  factors raise  substantial  doubt
about the  Company's  ability  to  continue  as a going  concern.  In the fourth
quarter  of 1999  the  Company  completed  a  substantial  restructuring  of its
capitalization whereby $39.75 million of Senior Discount Notes and approximately
$8.3 million of accrued  interest were converted into Preferred  Stock,  and the
remaining  terms of the  Senior  Discount  Notes  were  modified  to reduce  the
interest  rate  thereon  and  extend  the  payment  terms.  Concurrent  with the
restructuring,  the Company  borrowed $2 million under new Senior Discount Notes
and established a facility  whereby up to an additional $3 million of new Senior
Discount  Notes may be issued upon meeting  certain  financial  and  operational
milestones.  Management  continues  to  review  financing  and  other  strategic
alternatives  available  to the  Company  such  as  additional  equity  or  debt
offerings  in the  Company  or  certain  of its  subsidiaries,  joint  ventures,
alternative  distribution  channels,  direct  investment  by third  parties into
several of the Company's  strategic  business  opportunities  and sale of all or
part of the  Company's  assets to  improve  the  Company's  liquidity  position.
Management believes that these steps, plus sales related to proposed new product
introductions,  will provide sufficient cash and working capital for the Company
to meet its ongoing obligations and to allow it to continue operating as a going
concern  through  at  least  the  end of  2000.  The  accompanying  consolidated
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty.

     CONSOLIDATION--The  consolidated  financial  statements include the Company
and its wholly-owned subsidiaries after elimination of intercompany accounts and
transactions.

     ESTIMATES--The  preparation  of financial  statements  in  conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions  that affect the reported  amounts of assets and liabilities and
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. Actual results could differ from those estimates.

     CASH EQUIVALENTS--The  Company considers all highly liquid debt instruments
purchased  with  an  original  maturity  of  three  months  or  less  to be cash
equivalents.

     SHORT-TERM  INVESTMENTS - Short-term  investments represent debt securities
which are stated at fair  value.  To the extent  there is a  difference  between
amortized  cost (cost  adjusted for  amortization  of premiums and  accretion of
discounts which are recognized as adjustments to interest income) and fair value
representing the unrealized holding gains or losses, these will will be recorded
as a separate  component  of  shareholders'  equity  until  realized.  While the
Company's intent is to hold debt securities to maturity,  they are classified as
available-for-sale securities because the sale of such securities my be required
prior to  maturity.  Any  gains or  losses  on the sale of debt  securities  are
determined on a specific identification basis.

     FAIR  VALUE  OF  FINANCIAL  INSTRUMENTS--The  estimated  fair  value of the
Company's financial  instruments,  which include cash equivalents and short-term
investments  approximate  their carrying value.  The fair value of the Company's
Senior  Discount  Notes may be lower than the recorded  value but the Company is
unable to estimate the fair value at this time.

                                       44
<PAGE>
     INVENTORIES--Inventories  consist  of raw  materials,  work-in-process  and
finished  goods and are  stated  at the  lower of cost or market on a  first-in,
first-out basis.

     PROPERTY  AND   EQUIPMENT--Property  and  equipment  are  stated  at  cost.
Depreciation and amortization are computed using the  straight-line  method over
estimated  useful  lives  between  eighteen  months and seven  years.  Leasehold
improvements  are amortized using the  straight-line  method over the shorter of
the lease term or the asset's useful life.  The Company  places gaming  machines
and related  equipment in customer  locations on its  participation  program and
receives a portion of the net win from each machine. Depreciation of units under
such  arrangements  is the greater of the ratio that current gross revenue bears
to total  anticipated  revenue for such unit or straight-line  over three years.
Ancillary  gaming  equipment  such as signs and chairs are  depreciated  over an
eighteen-month period.

     REVENUE RECOGNITION--Revenue from hardware units and non-renewable software
licenses is recognized  upon  acceptance by the customer  after  completion of a
trial period, if applicable,  or otherwise upon shipment of the unit.  Renewable
software  licenses are recognized  ratably over the license period.  Amounts due
the Company under revenue  participation plans with its customers are recognized
ratably based on the Company's share of gaming machine play.

     CONCENTRATION  OF CREDIT RISK--  Financial  instruments  which  potentially
subject the Company to  concentrations  of credit risk consist primarily of cash
equivalents, short-term investmements and trade accounts receivable. The Company
performs ongoing credit  evaluations of its customers'  financial  condition and
limits  the  amount of credit  extended  when  deemed  necessary  but  generally
requires no collateral.  The Company maintains reserves for estimated  potential
credit losses. At December 31, 1999, one customer  accounted for 19% of accounts
receivable.  A significant  portion of the Company's  revenues are  concentrated
with a small number of strategic customers. For the year ended December 31, 1999
one customer  accounted  for 16% of revenue and the  Company's  top 10 customers
represented 52% of revenue.  For the year ended December 31, 1998, two customers
accounted  for  11% and  10% of  revenue  and  the  Company's  top 10  customers
represented 67% of revenue. In 1997 three different customers accounted for 27%,
12% and 12% of revenue.

     RESEARCH AND DEVELOPMENT  EXPENSES--Research  and development  expenses are
charged to operations  as incurred.  In  connection  with the Company's  product
development efforts, it develops software applications which are integral to the
operation  of the  product.  The costs to develop  such  software  have not been
capitalized as the Company believes its current software  development process is
essentially   completed  concurrent  with  the  establishment  of  technological
feasibility and/or development of the related hardware.

     INCOME  TAXES--The  Company  accounts for income taxes in  accordance  with
Statement of  Financial  Accounting  Standards  No. 109,  Accounting  for Income
Taxes, which requires an asset and liability approach for financial reporting of
income taxes.

     STOCK-BASED  COMPENSATION--The  Company accounts for stock-based  awards to
employees  using  the  intrinsic  value  method  in  accordance  with APB No. 25
Accounting  for Stock Issued to Employees  ("APB 25").  The Company  adopted the
disclosure  requirements of Statement of Financial  Accounting Standards No.123,
Accounting  for  Stock-Based  Compensation,  ("SFAS  123"),  which  require  the
disclosure  of pro forma net income  and  earnings  per share as if the  Company
adopted the fair value-based method in measuring  compensation expense as of the
beginning of fiscal 1995.

     NET LOSS PER SHARE--Basic EPS excludes dilution and is computed by dividing
net income by the weighted average of common shares  outstanding for the period.
Diluted EPS reflects the  potential  dilution  that would occur if securities or
other  contracts to issue Common Stock were  exercised or converted  into Common
Stock. Common share equivalents including stock options,  warrants and Preferred
Stock have been  excluded  for all periods  presented,  as their effect would be
antidilutive.

                                       45
<PAGE>
     The following is a reconciliation of the numerators and denominators of the
basic and diluted net loss per share computations (in thousands except per share
amounts):

                                                      Year Ended December 31,
                                                    ---------------------------
                                                      1999      1998      1997
                                                    -------   -------   -------
Net Loss (Numerator):
Net loss, basic and diluted ......................  $11,765   $37,670   $22,986
                                                    =======   =======   =======
Shares (Denominator):
Weighted average common shares outstanding .......   16,965    14,047    11,418
Weighted average common shares outstanding
  subject to repurchase ..........................       59       351       752
                                                    -------   -------   -------
Shares used in computation, basic and diluted ....   16,906    13,696    10,666
                                                    =======   =======   =======

Net Loss Per Share, Basic and Diluted ............  $  0.70   $  2.75   $  2.16
                                                    =======   =======   =======

     SEGMENT  DISCLOSURES - Effective  January 1, 1999 the Company  adopted SFAS
No. 131,  "Disclosures about Segments of an Enterprise and Related Information".
The Company  organizes and manages its products and services as a single product
family, and accordingly,  the required  disclosures under SFAS No. 131 regarding
the  Company's  products  and  services  are made to the  face of the  financial
statements. The adoption of SFAS No. 131 had no effect on the financial position
of the Company.

     RECLASSIFICATIONS--  Certain prior year amounts have been  reclassified  to
conform to the current year presentation.

2. SHORT-TERM INVESTMENTS

     Short-term  investments  consist of the  following  debt  securities  as of
December 31, 1999:


                            Amortized    Market    Unrealized       Unrealized
(In Thousands)                Cost       Value    Holding Gains   Holding Losses
                              ----       -----    -------------   --------------
Available-for-sale
  corporate securities ....  $1,000     $1,000        $ --             $ --
                             ======     ======        ====             ====

3. INVENTORIES

     Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following :

                                                         December 31,
                                                      ---------------------
(In Thousands)                                          1999         1998
                                                      -------       -------
Raw materials ..................................      $   849       $ 4,294
Work in process ................................          111            93
Finished goods .................................        6,371         7,637
                                                      -------       -------
                                                      $ 7,331       $12,024
                                                      =======       =======

     Finished  goods  includes units on trial of $ 2,397 and $ 3,462 at December
31, 1999 and 1998, respectively.

                                       46
<PAGE>
4. PROPERTY AND EQUIPMENT

     Property and equipment consists of:

                                                               December 31,
                                                           --------------------
(In Thousands)                                               1999        1998
                                                           --------    --------
Furniture, fixtures and office equipment ..............     $   453    $ 1,586
Computer equipment ....................................       6,876      9,292
Manufacturing equipment ...............................          69      1,954
Gaming machines & equipment ...........................       3,125      6,230
Leasehold improvements ................................         737      1,445
                                                            -------    -------
                                                             11,260     20,507

Accumulated depreciation and amortization                    (7,465)    (7,585)
                                                            -------    -------
                                                            $ 3,795    $12,922
                                                            =======    =======

Included  in property  and  equipment  at December  31, 1999 and 1998 are assets
leased under capital  leases of $1,000,000 net of  accumulated  depreciation  of
$1,000,000 and $792,000 as of December 31, 1999 and 1998, respectively.

5. ACCRUED LIABILITIES AND RESTRUCTURING ACCRUAL

     Accrued liabilities consists of:

                                                               December 31,
                                                           -------------------
    (In Thousands)                                          1999         1998
                                                           ------       ------
Accrued compensation benefits..........................    $  363       $  958
Accrued purchase arrangements..........................       160        1,100
Accrued royalties .....................................        60        1,811
Accrued tax obligations ...............................       550           --
Accrued interest expense ..............................        20        2,782
Other accrued liabilities .............................       502        1,503
                                                           ------       ------
                                                           $1,655       $8,154
                                                           ======       ======

In March 1999 the Company announced the closure of its Mountain View, California
manufacturing facility and the relocation of all of its manufacturing operations
to its Las Vegas,  Nevada  facility.  At the same time the  Company  announced a
reduction in size of its employee  workforce by  approximately  35%. The Company
recorded  restructuring  charges of $3,312,000 in the  three-month  period ended
March 31, 1999. The restructuring charges include severance costs, lease related
costs  of  excess  facilities  and the  write  down  of  specific  fixed  assets
associated with these  facilities and assets rendered surplus as a result of the
reduction  in force.  Details of the  restructuring  charges  are as follows (in
thousands):

                                  Accrued
                                 severance,    Facility     Write down
                                 benefits &     lease          of
                                 other costs  obligations  fixed assets  Total
                                 -----------  -----------  ------------  -----
Restructuring provision ........   $ 595         $ 293       $ 2,424    $ 3,312
Adjustment to amounts
  recorded .....................      --           (35)           --        (35)
Non-cash items .................      --            --        (2,424)    (2,424)
Amounts paid ...................    (595)         (258)           --       (853)
                                   -----         -----       -------    -------
Balance at September 30, 1999 ..   $  --         $  --       $    --    $    --
                                   =====         =====       =======    =======

Termination  benefits were paid to 55 employees and all benefits were paid prior
to May 31, 1999. The Company completed all remaining  restructuring  activities,
including disposal of assets, before the end of 1999.

                                       47
<PAGE>
6. LEASES

     The Company  leases its facilities  under  noncancellable  operating  lease
agreements.  The accompanying statements of operations reflect rent expense on a
straight-line  basis  over  the  term  of the  leases.  The  difference  between
straight-line  rent  expense  and actual  cash  payments is recorded as deferred
rent.

     Future minimum operating commitments at December 31, 1999 are as follows:

                                                                 Operating
                                                                  Leases
                                                                  -------
                                                               (in thousands)
2000........................................................      $ 1,059
2001........................................................          961
2002........................................................          926
2003........................................................          567
2004........................................................          549
Thereafter..................................................          566
                                                                  -------
Total minimum lease payments................................      $ 4,628
                                                                  =======

During 1999 the Company entered into a sublease with respect to a portion of its
Palo Alto  facility.  Pursuant to this  agreement,  which  expires in 2005,  the
Company will receive sublease income approximating $3,912,000.

Rent expense (including  prorated common area maintenance charges and utilities)
for the years ended  December 31, 1999,  1998 and 1997 was $859,000,  $1,310,000
and  $975,000,  respectively.  The 1999 rent expense was net of sublease  income
received of $279,000.

7. LONG-TERM BORROWING OBLIGATIONS

     The Company had a $4 million  secured  revolving  line of credit  agreement
based on the Company's eligible accounts  receivable,  which expired on December
31, 1999.  As of December 31, 1999 the Company had  $622,000  outstanding  under
this  agreement.  As of December 31, 1999 the Company was not in compliance with
the  minimum  net  worth  covenants  of  the  agreement,   however  the  Company
subsequently  repaid all  outstanding  balances under this agreement in February
2000.

     Borrowing arrangements consist of the following (in thousands):

                                                              December 31,
                                                         ----------------------
                                                           1999          1998
                                                         --------      --------
Senior Discount Notes ($9.5 million and $47.25
 million principal obligation, respectively) .......    $  9,500       $ 37,716
Capital lease obligations ..........................           55           360
Other long-term obligations ........................        2,038         3,022
                                                         --------      --------
                                                          11,593        41,098
Current obligation .................................       (1,165)       (1,289)
                                                         --------      --------
Long-term portion ..................................     $ 10,428      $ 39,809
                                                         ========      ========

                                       48
<PAGE>
     Future  minimum  debt  commitments  at December 31, 1999 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                      Senior                  Other
                                                     Discount     Capital    Long Term    Total
                                                      Notes       Leases    Obligations    Debt
                                                     --------    --------    --------    --------
<S>                                                 <C>         <C>         <C>         <C>
2000 .............................................   $  1,037      $  56     $ 1,315    $  2,408
2001 .............................................      1,063         --         788       1,851
2002 .............................................      1,072         --         230       1,302
2003 .............................................      1,082         --          --       1,082
2004 .............................................     10,887         --          --      10,887
Thereafter .......................................         --         --          --          --
                                                     --------      -----     -------    --------
   Total minimum payments ........................     15,141         56       2,333      17,530

Amount representing interest or future discount...     (5,641)        (1)       (295)     (5,937)
                                                     --------      -----     -------    --------
Present value of debt payments ...................      9,500         55       2,038      11,593
Current portion ..................................         --         55       1,110       1,165
                                                     --------      -----     -------    --------
Long-term portion ................................   $  9,500      $  --     $   928    $ 10,428
                                                     ========      =====     =======    ========
</TABLE>

     In  November  1999  the  Company  completed  a  restructuring  of its  then
outstanding  Senior  Discount  Notes whereby  $39.75  million of principal  plus
approximately  $8.3 million of accrued  interest was exchanged for 39,750 shares
of Series D Preferred  Stock (see Note 8) which is  convertible  into 57% of the
fully  diluted  equity of the  Company  and  warrants to purchase up to 60,807.7
shares  of  Series E  Preferred  Stock  at $0.01  per  share.  The  terms of the
remaining  $7.5  million of Senior  Discount  Notes were  modified to reduce the
interest  rate from  12.5% to 10% per  annum  (effective  July 15,  1999) and to
provide for interest to be payable  in-kind  through  the issuance of additional
notes at the Company's  option and subject to certain  coverage ratio tests. The
maturity date of the remaining notes was extended to November 2004.  Accrued and
unpaid interest on the $7.5 million of notes remaining outstanding following the
restructuring was forgiven through July 15, 1999.

     As a part of the debt  restructuring,  the  holders of the Senior  Discount
Notes agreed to make an additional investment in the Company of up to $5 million
in the form of  senior  secured  notes  (the New  Notes).  The New Notes are not
convertible  and bear cash  interest  at the rate of 10% per  annum and  in-kind
interest at the rate of 3% per annum. The New Notes mature in five years and are
issuable  in  tranches.  The first $2 million  was issued at the  closing of the
restructuring on November 24, 1999. To the extent,  required by the Company, the
additional  $3  million  of New Notes  will be issued  upon the  achievement  of
certain financial and operating milestones,  as determined by the holders of the
Notes.

     Also, as part of the debt  restructuring,  the Company entered into certain
other  equity  transactions:  Holders of the  outstanding  Series B1  Redeemable
Preferred Stock were required to convert their shares into Common Stock. Holders
of  outstanding  shares of Common Stock  (subject to the increase in  authorized
common stock which was approved by the  shareholders in February 2000) are to be
granted warrants to purchase  additional  shares of Common Stock for $0.1528 per
share,  at a rate of 3.59662  additional  shares for each share of Common  Stock
held as of November  24, 1999 (54.9  million  additional  shares in total).  See
additional information regarding these equity securities in Notes 8 and 9.

     In  accordance  with  Statement  of  Financial  Accouting  Standard No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings", the gain
on cancellation of debt reflects these related equity  transactions  was reduced
to reflect all future cash  payments  due to the holders of the Senior  Discount
Notes, as well as, future interest payments on these Notes and estimated amounts
under the New Notes.  All such future interest  payments have been recorded as a
liability as of the date of the Company's  debt  restructuring  and are shown as
Long-Term  Accrued Interest on the accompanying  balance sheet. As a result,  in
the future the Company will not record  interest  expense on its Senior Discount
Notes.

                                       49
<PAGE>
     The components of the gain on conversion of debt consist of (in thousands):

     Carrying value of debt and related accrued interest .........    $ 39,098
     Fair value of Series D Preferred Stock and Series E
      Preferred Stock warrants issued ............................     (20,000)
     Future expected interest on modified debt and New Notes .....      (5,832)
     Gain on conversion of preferred stock to common stock .......       1,198
     Fair value of warrants issued to common stockholders ........        (994)
     Legal and other costs of restructuring ......................      (1,154)
                                                                      --------
     Net gain ....................................................    $ 12,316
                                                                      ========

     In June 1998, the Company entered into a secured equipment loan. Borrowings
bear interest at 14% per annum for a term of 42 months. As of December 31, 1999,
the Company had borrowed $1,562,000 under this agreement. The agreement requires
the Company to comply with certain financial  covenants,  with which the Company
was in compliance as of December 31, 1999.

     In  March  1998,  the  Company  entered  into  a  secured  equipment  term.
Borrowings  bear  interest  at 11%  per  annum  for a term of 36  months.  As of
December 31, 1999 the Company had borrowed $1,698,000 under this agreement.  The
agreement requires the Company to comply with certain financial covenants,  with
which the Company was not in in compliance as of December 31, 1999.

8. PREFERRED STOCK

     At December 31, 1999,  the Company had 39,750  shares of Series D Preferred
Stock and  warrants to purchase  up to  60,807.731  shares of Series E Preferred
Stock  outstanding.  In  connection  with the increase in  authorized  shares of
Common Stock  approved by the  shareholders  in February  2000, the terms of the
preferred  stock  was  amended.  The  significant  terms  of the  Series D and E
Preferred Stock, as amended, are as follows:

*    Each share of Series D Preferred Stock is convertible  into 4,384.53 shares
     of Common Stock (subject to adjustment for anti-dilution) and each share of
     Series E Preferred  Stock is convertible  into 1,000 shares of Common Stock
     (subject to adjustment for anti-dilution).
*    The  holders of the Series D and E  Preferred  Stock will have the right to
     vote the number of shares of Common  Stock into which all of such  holder's
     shares are  convertible,  only if such holder has first  received all prior
     approvals  required under  applicable  gaming laws for conversion of all of
     the shares of Series D held by such holder
*    Dividends may be paid at the discretion of the Board of Directors, however,
     cash  dividends  must be paid in an amount equal to the  as-converted  rate
     based on any cash dividends paid on common stock.
*    In the event of liquidation, the holders of the Series D are first entitled
     to receive varying amounts based upon the aggregate  transaction  proceeds.
     If such  proceeds  are less than $20  million,  the  Series D  holders  are
     entitled to 100% of the proceeds.  If such transaction  proceeds exceed $30
     million, the Series D holders would be entitled to the amount that would be
     paid if such Series D stock were  converted  into Common Stock  immediately
     prior to the liquidation event. For aggregate  transaction proceeds between
     $20 and $30 million, a pro rata fomula applies.  Notwithstanding  this, the
     holders of the Series D Preferred  Stock shall not receive more than $1,000
     per share as a result of a  liquidation  event.  Series E holders will then
     receive an amount equal to the as-converted  amount to be received for each
     share of Common Stock.
*    The Company may redeem the  outstanding  shares of Series D, in whole or in
     part,  at any time for cash at a  redemption  price equal to the greater of
     $1,000 per share or the amount  which is equal to the fair market  value of
     the Common Stock into which a share of Series D could be converted.
*    In the event of a Change in Control (as defined), the holders of a majority
     of the  Series D  Preferred  Stock may  require  the  Company to redeem the
     outstanding  shares of Series D Preferred Stock at a redemption price equal
     to the greater of $1,000 per share or the amount which is equal to the fair
     market  value of the Common  Stock into which a share of Series D Preferred
     Stock could be converted.

                                       50
<PAGE>
*    So long as at least 100 shares of Series D or 200 shares of Series E remain
     outstanding,  the prior written  consent of the holders of the Series D and
     Series E will be required prior to certain corporate actions including, but
     not limited to, issuing  additional capital stock or debt with a preference
     to or equal to the Series D or E in the Company or any of its subsidiaries,
     payment  of  dividends,   incurring  additional   indebtedness   (excluding
     refinancing and the Company's bank borrowings),  entering into transactions
     with  affiliates,  issuing  or  disposing  of  the  capital  stock  of  its
     subsidiaries,  disposing of assets of the Company or its subsidiaries,  and
     merging  or  consolidating  with any  other  entity  or  entering  into any
     transaction which would have the effect of a change in control.

     The  warrants  to purchase  up to  60,807.731  shares of Series E Preferred
Stock  at  $0.01  per  share  are to be  issued  in  connection  with  the  debt
restructuring  and are directly  related to the common stock warrants  issued to
the Common  Shareholders  of record as of  November  24,  1999 (see Note 7). The
Series E warrants become exercisable in proportion to the number of Common Stock
warrants exercised. The warrants expire in May 2004.

9. COMMON STOCK

     In February  2000 the  Company's  shareholders  approved an increase in the
authorized  capital of the  Company to  750,000,000  shares.  This will  provide
suffficient shares for the conversion of the Preferred Shares into Common Stock,
the issuance of warrants to the  existing  equity  holders,  and the granting of
stock options to management and employees of the Company as  contemplated in the
November  1999  debt  restructuring.  At the same  time the  Board of  Directors
increased  the number of shares  authorized in the 1999  Long-Term  Compensation
Plan from 15,657,490 to 116,190,084.

     At December 31, 1999,  Common Stock  (including  the effect of the February
2000 increases noted above) was reserved for issuance as follows:

Conversion of outstanding shares of Series D Preferred Stock .....   174,285,127
Conversion upon exercise of Series E Preferred Stock warrants ....    60,807,731
Common stock warrants issued to shareholders of record as of
  November 24, 1999 in connection with the debt restructuring ....    54,985,667
Issuable under other stock purchase warrants .....................       919,443
Stock Option Plans ...............................................   105,904,165
Employee Stock Purchase Plans ....................................       449,483
                                                                     -----------
                                                                     397,351,616
                                                                     ===========

WARRANTS

     Holders of  outstanding  shares of Common Stock (subject to the increase in
authorized common stock which was approved by the shareholders in February 2000)
are to be granted  warrants to purchase  additional  shares of Common  Stock for
$0.1528  per  share,  at a rate of 3.59662  additional  shares for each share of
Common Stock held as of November 24, 1999.  These  warrants  become  exercisable
beginning in February  2001 and expire in February  2004.  In the event that the
Company's stock price exceeds $0.2346 per share for twenty consecutive days, the
expiration  date of the  warrant  is  accelerated  to a date 180 days after that
event.

     During 1998,  the Company  issued  warrants to purchase  250,000  shares of
Common Stock at $8.00 per share in conjunction with the issuance and sale of the
Company's 1998 Senior  Discount  Notes.  These warrants  expire on September 30,
2002.  During 1997,  the Company issued  warrants to purchase  375,000 shares of
Common Stock at $15.4375 per share in conjunction  with the issuance and sale of
the Company's 1997 Senior Discount Notes.  These warrants were repriced to $8.00
per share in connection  with the issuance of the Company's 1998 Senior Discount
Notes.  The warrants  expire on September  30,  2002.  During 1996,  the Company
issued  warrants to certain  financial  advisors in connection with its Series C
Redeemable Convertible Preferred Stock financing. These warrants are exercisable
for 116,666  shares of Common Stock at an exercise  price of $7.50 per share and
expire in 2001.  In connection  with the initial  public  offering in 1996,  the
Company  issued  5-year  warrants to purchase an aggregate of 177,777  shares of
Common  Stock to other  financial  advisors at an  exercise  price of $12.60 per
share.  All  warrants  remain  outstanding  after  the debt  restructuring  that
occurred during the fourth quarter of 1999.

                                       51
<PAGE>
STOCK OPTION PLANS

     Under the 1994 Stock Option Plan (the "1994 Option Plan"),  the Company may
grant incentive or nonstatutory  stock options up to 4,563,077  shares of Common
Stock to  employees,  directors  and  consultants  at prices  not less than fair
market value for  incentive  stock  options and not less than 85% of fair market
value for nonstatutory stock options. These options generally expire five to ten
years  from the date of  grant.  Options  normally  vest at a rate of 25% on the
first  anniversary  of the grant date and 1/48 per month  thereafter  and may be
exercised at any time,  subject to the Company's  right to  repurchase  unvested
shares at the original exercise price upon termination.

     In 1996, the Board of Directors  adopted the 1996 Outside  Directors  Stock
Option Plan (the "Directors Plan"). Under this plan,  non-employee  directors of
the Company are automatically  granted initial options to purchase 15,000 shares
of Common Stock and additional  options to purchase 5,000 shares of Common Stock
in each  subsequent  year that such person  remains a director  of the  Company.
Options  under the  Directors  Plan have an exercise  price equal to fair market
value at the grant date, vest ratably over three years and expire ten years from
the date of grant. The number of shares authorized under this plan is 200,000.

     In 1997, the Board of Directors adopted the 1997 Nonstatutory  Stock Option
Plan  (the  "1997  Option  Plan").  Under  this  plan,  the  Company  may  grant
nonstatutory  stock  options  for up to  2,350,000  shares  of  Common  Stock to
employees  and  consultants  at prices not less than 85% of fair market value on
the effective date of the grant.  These options  generally expire ten years from
the date of grant and are immediately exercisable.

     In 1999,  the Board of Directors  adopted the 1999  Long-Term  Compensation
Plan  (the  "1999  Plan")  as a part  of the  debt  restructuring.  A  total  of
15,657,490  shares were  authorized  for issuance under this plan and 15,657,490
shares were sold to  officers in the year ended  December  31,  1999.  Under the
terms of the restricted stock purchase  agreement,  the Company has the right to
repurchase  up to 80% of these  shares at the  original  sale price; this  right
lapses over a four-year period based on continued  employment.  Under this plan,
the Company may grant options or restricted shares of Common Stock to employees,
and  directors at prices not less than 85% of fair market value on the effective
date of the grant.  The terms of the options may vary but  generally  expire ten
years from the date of grant and are immediately  exercisable.  In February 2000
the  authorized  number of shares in the 1999 Plan was increased to  116,190,094
shares  following  the increase in the  Company's  authorized  capital.  Also in
February,  2000 the Company issued an additional  85,090,492 shares to employees
and directors.

     Option activity under the Company's option plans is as follows:

                                                                        Weighted
                                                         Number         Average
                                                           of           Exercise
                                                         Shares          Price
                                                       ----------       -------
Outstanding, January 1, 1997 ......................       835,403       $ 6.35
Granted (weighted average fair value of $7.49) ....     1,150,385        15.02
Exercised .........................................       (49,083)        4.13
Cancelled .........................................       (39,529)       12.01
                                                      -----------       ------
Outstanding, December 31, 1997 ....................     1,897,176        11.36
Granted (weighted average fair value of $4.29) ....     3,759,563         5.85
Exercised .........................................       (97,400)        2.23
Cancelled .........................................    (3,605,166)        9.84
                                                      -----------       ------
Outstanding, December 31, 1998 ....................     1,954,173         4.09
Granted  at market value (weighted average fair
 value of $0.13) ..................................     3,437,751         0.58
Granted below market value (weighted average fair
 value of $0.01) ..................................    15,657,490         0.02
Exercised .........................................   (15,722,830)        0.45
Cancelled .........................................    (1,920,039)        2.69
                                                      -----------       ------
Outstanding, December 31, 1999 ....................     3,406,545       $ 1.58
                                                      ===========       ======

                                       52
<PAGE>
     Additional  information  regarding  options  outstanding as of December 31,
1999, is as follows:

                             Options Outstanding            Options Exercisable
                       ----------------------------------  ---------------------
                                     Weighted
                         Number      Average     Weighted     Number    Weighted
                      Outstanding   Remaining     Average  Exercisable  Average
       Range of          as of     Contractual   Exercise     as of     Exercise
    Exercise Prices    12/31/99     Life (yrs)    Price      12/31/99    Price
    ---------------    --------     ----------    -----      --------    -----
   $ 0.105 - $ 0.452     176,512       8.77      $  0.43      176,512   $  0.43
   $ 0.500 - $ 0.500   1,337,375       2.98         0.50    1,337,375      0.50
   $ 0.562 - $ 0.719     139,128       4.41         0.62      139,128      0.62
   $ 0.750 - $ 0.750     804,500        9.2         0.75      804,500      0.75
   $ 1.500 - $ 3.750     268,819       8.31         1.84      268,819      1.90
   $ 4.000 - $ 4.000     576,445       7.57         4.00      576,445      4.00
   $ 4.250 - $10.500      72,666       7.10         9.55       63,218      9.58
   $11.750 - $11.750       1,100       7.38        11.75        1,100     11.75
   $12.250 - $12.250      15,000       7.39        12.25       12,915     12.25
   $18.750 - $18.750      15,000       7.18        18.75       13,750     18.75
   -----------------      ------       ----        -----       ------     -----
   $ 0.105 - $18.750   3,406,545       6.13      $  1.58    3,393,762   $  1.55
   =================   =========       ====      =======    =========   =======

     At December 31, 1999, 1,111,317, 105,000, and 748,699 shares were available
for future grants under the 1994 Option Plan,  Directors  Plan,  and 1997 Option
Plan respectively. At December 31, 1999, 13,212 shares exercised were subject to
repurchase.  As of December 31, 1998 and 1997,  1,915,974 and  1,826,896  shares
respectively  were  exercisable  with a weighted average exercise price of $3.94
and $11.27, respectively.

EMPLOYEE STOCK PURCHASE PLAN

     Under the 1998 Purchase Plan,  eligible employees are permitted to purchase
shares of Common Stock through salary withholding at a price equal to 85% of the
lower of the  market  value  of the  stock  at the  beginning  or the end of the
6-month offering period,  subject to certain limitations.  At December 31, 1999,
300,517  shares had been  issued  under both of the  Purchase  Plans and 449,483
shares were reserved for further  issuance.  The weighted  average fair value of
those purchase rights granted in 1999, 1998 and 1997 was $1.28, $3.73 and $3.52,
respectively.  The  Company's  calculations  were made  using the  Black-Scholes
option pricing model with the following weighted average  assumptions:  expected
life of one year for all years;  expected  interest rate of 6.0%,  5.7% and 6.2%
for 1999, 1998 and 1997, respectively;  expected volatility of 115% in 1999, 75%
in 1998 and 65% in 1997; and no dividends during the expected term.

ADDITIONAL STOCK PLAN INFORMATION

     As  discussed  in  Note  1,  the  Company  continues  to  account  for  its
stock-based  awards using the intrinsic  value method in accordance with APB No.
25 and its related  interpretations.  Accordingly,  no compensation  expense has
been recognized in the financial statements for employee stock arrangements.

     SFAS 123 requires the  disclosure  of pro forma net income and earnings per
share had the  Company  adopted  the fair value  method as of the  beginning  of
fiscal 1995.  Under SFAS 123, the fair value of stock-based  awards to employees
is calculated  through the use of the minimum value method for all periods prior
to the  initial  public  offering,  and  subsequently  through the use of option
pricing  models,  even though such models were  developed  to estimate  the fair
value  of  freely   tradable,   fully   transferable   options  without  vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective  assumptions,  including future stock price
volatility  and expected time to exercise,  which greatly  affect the calculated
values.   The  Company's   stock  option   calculations   were  made  using  the
Black-Scholes   option  pricing  model  with  the  following   weighted  average
assumptions:  expected life, 12 months following vesting; stock volatility, 115%

                                       53
<PAGE>
in 1999, 75% in 1998 and 65% in 1997;  risk-free  interest rates,  6.0% in 1999,
5.7% in 1998, and 6.2% in 1997;  and no dividends  during the expected term. The
Company's  calculations  are based on a multiple option  valuation  approach and
forfeitures  are  recognized  as they occur.  If the computed fair values of the
stock-based awards (including awards under the Purchase Plan) had been amortized
to expense over the vesting period of the awards,  pro forma net loss would have
been  $13,763,000  ($0.81 loss per share) in 1999,  $44,673,000  ($3.15 loss per
share) in 1998, and $26,815,000 ($2.51 loss per share) in 1997.

10. INCOME TAXES

     The Company has had losses since  inception  and therefore has not provided
for income taxes.

     Deferred income taxes reflect the net tax effects of temporary  differences
between the carrying amount of assets and  liabilities  for financial  reporting
purposes and the amounts used for income tax purposes, as well as operating loss
and tax credit carryforwards.  Significant  components of the Company's deferred
income tax assets as of December 31, 1999 and 1998 are as follows:

                                                            December 31,
                                                        ----------------------
(in thousands)                                            1999          1998
                                                        --------      --------
Net deferred tax assets:
  Net operating losses .............................    $     --      $ 25,596
  Research and development credits .................          --         1,140
  Capitalized research and development costs .......          --           895
  Accruals deductible in different periods .........       6,160         4,204
  Depreciation and amortization ....................         258          (250)
                                                        --------      --------
                                                           6,418        31,585
Valuation allowance ................................      (6,418)      (31,585)
                                                        --------      --------
Total                                                   $     --      $     --
                                                        ========      ========

     Due to the  uncertainty  surrounding the realization of the benefits of its
favorable tax  attributes in future tax returns,  the Company has fully reserved
its net deferred tax assets as of December 31, 1999 and 1998, respectively.

     The  Tax  Reform  Act  of  1986  and  the  California  Act of  1987  impose
restrictions   on  the   utilization  of  net  operating  loss  and  tax  credit
carryforwards  in the event of an "ownership  change" as defined by the Internal
Revenue Code.  The Company's  ability to utilize its net operating  loss and tax
credit  carryforwards is subject to limitation  pursuant to these  restrictions.
The  Company  underwent  an  ownership  change  as  of  the  date  of  the  debt
restructuring in November, 1999. As a result, the Company lost the potential tax
benefits of the net operating loss  carryforwards  and tax credit  carryforwards
tha existed at that time.

11. SUBSEQUENT EVENTS

     In March 2000 the Company  entered into a secured  revolving line of credit
with a new bank based upon eligible accounts receivable. Under the terms of this
borrowing arrangement which will expire in March 2001, the Company may borrow up
to $2  million.  Borrowings  will bear  interest  at the bank's  prime rate plus
1.50%.  The Company will issue the bank  warrants to acquire  100,000  shares of
Common  Stock at a per  share  price  of $0.30  which  may be  exercised  over a
five-year period.

                                       54
<PAGE>
     In March 2000 the Company  was served  papers in  connection  with a patent
infringement lawsuit filed against it and one other slot machine manufacturer by
International Game Technology, Inc. (IGT). As disclosed in November 1999, IGT is
alleging infringement of a patent issued to IGT in September 1999 entitled "Game
Machine and Method Using Touch Screen". The Company has not yet responded to the
lawsuit and the Company's management denies the assertions of infringement.  The
Company is presently unable to determine the financial  impact,  if any, of this
litigation.  The costs of  defending  this  lawsuit may be  substantial  and may
require  significant  amounts of senior management time. Any adverse result from
such litigation could  materially and adversely  affect the Company's  liquidity
and  capital  resources.  No  adjustments  have  been  made in the  accompanying
consolidated financial statements relating to this litigation.

     In March 2000, a former distributor of the Company's  products,  filed suit
against  the Company in the United  States  District  Court for the  District of
South Carolina.  The distributor seeks repayment of $1 million, plus damages, in
connection  with machines  previously  shipped to the  distributor  in 1998. The
Company  is in the  process  of  arbitration  as  required  by the  Distribution
Agreement,  seeking to recover outstanding receivables from the distributor when
it  received  this  lawsuit.  The  Company  is  in  the  preliminary  stages  of
investigating the allegations contained in the suit and has not yet responded to
the complaint.

                                       55
<PAGE>
                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of Silicon Gaming, Inc.:

We have audited the accompanying  consolidated balance sheets of Silicon Gaming,
Inc.  and  subsidiaries  as of  December  31,  1999 and  1998,  and the  related
consolidated  statements of operations,  shareholders'  equity  (deficiency) and
cash flows for each of the three years in the period  ended  December  31, 1999.
Our audits also included the consolidated financial statement schedule listed in
Item 14(a)2.  These financial statements are the responsibility of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  such consolidated  financial  statements present fairly, in all
material  respects,   the  financial  position  of  Silicon  Gaming,   Inc.  and
subsidiaries at December 31, 1999 and 1998, and the results of their  operations
and their cash flows for each of the years in the period ended December 31, 1999
in conformity with generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated   financial   statements,   the  Company's  recurring  losses  from
operations  and  shareholders'  deficiency  raise  substantial  doubt  about its
ability to continue as a going  concern.  Management's  plans  concerning  these
matters are also  described in Note 1. The  financial  statements do not include
any adjustments that might result from the outcome of this uncertainty.


/s/ Deloitte & Touche LLP
San Jose, California

February  15, 2000
(March 22, 2000
  as to Note 11)

                                       56
<PAGE>
                                   SCHEDULE II

                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                        FOR THE YEARS ENDED DECEMBER 31,
                             (DOLLARS IN THOUSANDS)


                                                Additions
                                   Balance at   charged to            Balance at
                                   Beginning    costs and               end of
        Description                of period    expenses   Deductions   period
        -----------                ---------    --------   ----------   ------
YEAR ENDED DECEMBER 31, 1999:
Allowance for doubtful accounts     $1,650       $  200       $681      $1,169

YEAR ENDED DECEMBER 31, 1998:
Allowance for doubtful accounts     $   50       $1,600       $ --      $1,650

YEAR ENDED DECEMBER 31, 1997:
Allowance for doubtful accounts     $   --       $   50       $ --      $   50
<PAGE>
                               INDEX TO EXHIBITS

Exhibit        Description
-------        -----------
3.1 (1)        Amended and Restated Articles of Incorporation of the Registrant.

3.2 (2)        Bylaws of the Registrant.

4.1 (4)        Amendment No. 2 to Securities Purchase Agreement, by and between
               the Company and B III Capital Partners L.P., a Delaware
               partnership dated as of September 30, 1997

4.2 (4)        Form of Certificate of Determination for Series D Preferred Stock
               dated as of November 24, 1999

4.3 (4)        Form of Certificate of Determination for Series E Preferred Stock
               dated as of November 24, 1999

4.4 (4)        Series E Warrant Agreement dated November 24, 1999

4.5 (4)        Securities Purchase Agreement by and between the Company and BIII
               Capital Partners L.P., a Delaware partnership dated as of
               November 24, 1999

4.6 (4)        Form of Senior Discount Notes due November 24, 2004 dated as of
               November 24, 1999

10.1 (2)       Amended and Restated 1994 Stock Option Plan, as amended.

10.2 (2)       Lease Agreement dated September 14, 1995, between the Registrant
               and Demmon Family Partnership.

10.7 (2)       Second Amended and Restated Rights Agreement dated as of
               March 21, 1996.

10.8 (3)       Master Equipment Lease Agreement dated October 6, 1995, between
               the Registrant and Lighthouse Capital Partners, L.P.

10.10 (2)      Side Letter Agreement dated March 21, 1996, between the
               Registrant and the Interpublic Group of Companies, Inc.

10.11 (2)      Side Letter Agreement dated March 21, 1996, between the
               Registrant and Station Casinos, Inc.

10.15 (2)      OEM Master License Agreement dated April 17, 1996, between the
               Registrant and RSA Data Security, Inc.

10.19 (2)      1996 Employee Stock Purchase Plan.

10.20 (2)      1996 Outside Directors Stock Option Plan.

10.21 (3)      Software License Agreement dated June 20, 1996 between the
               Registrant and Duck Corporation.

10.22 (5)      Lease Agreement dated August 14, 1996, between the Registrant and
               Interactive Technologies, Inc.

10.24 (5)      Lease Agreement dated January 23, 1997, between the Registrant
               and Johnny Ribeiro

10.25 (5)      Lease Agreement dated January 23, 1997, between the Registrant
               and The Ribeiro Corporation
<PAGE>
10.26 (6)      Lease Agreement dated October 7, 1997 between the Registrant and
               Battle Born Development, LLC.

10.27 (6)      1997 Nonstatutory Stock Option Plan

10.41 (4)      Restructuring Agreement by and between the Registrant and BIII
               Capital Partners, L.P., a Delaware partnership, dated
               November 24, 1999

10.42 (4)      1999 Long-Term Compensation Plan

10.43 (4)      Stockholders Agreement by and between the Registrant, management
               stockholders and BIII Capital Partners, L.P., a Delaware
               partnership, dated November 24, 1999

21.1           Subsidiaries of the registrant.

23.1           Consent of Deloitte & Touche LLP.

27             Financial Data Schedule.

----------
(1)  Incorporated  by  reference  to Exhibit  3.3 to  Registrant's  Registration
     Statement on Form S-1 (no.333-4793) which became effective on July 30, 1996
     (the "Form S-1").

(2)  Incoporated by reference to identically  numbered  exhibit to  Registrant's
     Registration Statement on Form 10 (No.0-28294) filed with the Commission on
     April 24, 1996 (the "Form 10").

(3)  Incorporated by reference to identically numbered exhibit to the Form S-1.

(4)  Incoporated by reference to exhibits in the Registrants Form 8-K filed with
     the Commision on November 24, 1999.

(5)  Incorporated by reference to identically  numbered exhibits to Registrant's
     Annual Report on Form 10-K for the year ended December 31, 1996.

(6)  Incorporated  by  reference  to  identically   numbered   exhibits  to  the
     Registrant's  Quarterly  Report on Form 10-Q for the quarter ended June 30,
     1998.