<PAGE>

================================================================================

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                               ----------------

                                   FORM 10-Q

                               ----------------
<TABLE>
<CAPTION>
(MARK ONE)
<C>        <S>
   [X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
           EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999

                                       OR

   [_]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
           EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________

</TABLE>
                               ----------------

                         COMMISSION FILE NUMBER 0-28294

                               ----------------

                              SILICON GAMING, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                            <C>
                 CALIFORNIA                                      77-0357939
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NUMBER)
</TABLE>

                             2800 W. BAYSHORE ROAD
                              PALO ALTO, CA 94303
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                           TELEPHONE: (650) 842-9000
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

                               ----------------

   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 the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.

   14,588,571 shares of Common Stock, $.001 par value, were outstanding as of
                               October 31, 1999.

================================================================================
<PAGE>

                              SILICON GAMING, INC.
                         QUARTERLY REPORT ON FORM 10-Q
                    FOR THE PERIOD ENDED SEPTEMBER 30, 1999

                                     INDEX

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
 <C>     <S>                                                                <C>
 Part I  Financial Information

 Item 1. Financial Statements:

         Consolidated Balance Sheets--September 30, 1999 and December 31,
         1998............................................................     3

         Consolidated Statements of Operations--Three months and nine
         months ended September 30, 1999 and September 30, 1998..........     4

         Consolidated Statements of Cash Flows--Nine months ended
         September 30, 1999 and September 30, 1998.......................     5

         Notes to Consolidated Financial Statements......................     6

         Management's Discussion and Analysis of Financial Condition and
 Item 2. Results of Operations...........................................    11

 Part II Other Information

 Item 1. Legal Proceedings...............................................    23

 Item 3. Default upon Senior Securities..................................    23

 Item 6. Exhibits and Reports on Form 8-K................................    23

         Signature.......................................................    24
</TABLE>

                                       2
<PAGE>

                         PART I--FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                              SILICON GAMING, INC.

                          CONSOLIDATED BALANCE SHEETS
                       (In thousands, except share data)

<TABLE>
<CAPTION>
                                                     September 30, December 31,
                                                         1999          1998
                                                     ------------- ------------
<S>                                                  <C>           <C>
                       ASSETS
CURRENT ASSETS:
 Cash and equivalents...............................   $  1,102      $  8,399
 Accounts receivable (net of allowances of $1,308
  and $1,650).......................................      1,664         5,340
 Inventories........................................     10,803        12,024
 Investments to fund jackpot winners................        354           288
 Prepaids and other.................................      2,006         1,410
                                                       --------      --------
  Total current assets..............................     15,929        27,461
PROPERTY AND EQUIPMENT, NET.........................      5,300        12,922
OTHER ASSETS, NET...................................      1,167         1,361
                                                       --------      --------
                                                       $ 22,396      $ 41,744
                                                       ========      ========
      LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
 Accounts payable...................................   $    639      $  1,480
 Accrued liabilities................................      9,159         8,154
 Deferred revenue...................................        775         1,766
 Line of credit.....................................        544         4,000
 Current portion of long-term obligations...........      1,204         1,289
                                                       --------      --------
  Total current liabilities.........................     12,321        16,689
OTHER LONG-TERM LIABILITIES.........................      3,089         2,032
LONG-TERM OBLIGATIONS...............................     40,759        39,809
REDEEMABLE CONVERTIBLE PREFERRED STOCK--6,884,473
 shares authorized at September 30, 1999; shares
 outstanding: September 30, 1999--1,111,659;
 December 31, 1998--1,474,641.......................      1,256         1,666
SHAREHOLDERS' DEFICIENCY
 Common Stock, $.001 par value; 50,000,000 shares
  authorized; shares outstanding: September 30,
  1999--14,588,571; December 31, 1998--14,242,313...     58,022        57,398
 Warrants...........................................      4,548         4,548
 Notes receivable from shareholders.................       (110)         (128)
 Accumulated deficit................................    (97,489)      (80,270)
 Accumulated other comprehensive income.............        --            --
                                                       --------      --------
  Total shareholders' deficiency....................    (35,029)      (18,452)
                                                       --------      --------
                                                       $ 22,396      $ 41,744
                                                       ========      ========
</TABLE>

                See notes to consolidated financial statements.

                                       3
<PAGE>

                              SILICON GAMING, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (In thousands, except per share data)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                                  Nine Months
                                             Three Months Ended Ended September
                                               September 30,          30,
                                             ------------------ ---------------
                                               1999     1998     1999    1998
                                             ------------------ ------- -------
<S>                                          <C>      <C>       <C>     <C>
REVENUE:
  Hardware.................................. $    932 $   3,313 $ 8,254 $11,199
  Software..................................      448       849   3,337   3,510
  Participation.............................      619       827   1,796   2,567
                                             -------- --------- ------- -------
  Total revenue.............................    1,999     4,989  13,387  17,276

OPERATING EXPENSES:
  Cost of sales and related manufacturing
   expenses.................................    1,329     8,553   8,513  17,579
  Research and development..................    1,191     3,193   5,023   8,748
  Selling, general and administrative.......    2,484     6,224   7,969  14,097
  Restructuring charges.....................      --        --    3,277     --
                                             -------- --------- ------- -------
  Total costs and expenses..................    5,004    17,970  24,782  40,424
                                             -------- --------- ------- -------
    Loss from operations....................    3,005    12,981  11,395  23,148
Interest (income)/expense, net..............    1,975     1,721   5,824   3,747
                                             -------- --------- ------- -------
NET LOSS.................................... $  4,980 $  14,702 $17,219 $26,895
                                             ======== ========= ======= =======
Basic and diluted net loss per share........ $   0.34 $    1.06 $  1.20 $  1.98
                                             ======== ========= ======= =======
Shares used in computation..................   14,561    13,930  14,361  13,584
                                             ======== ========= ======= =======
</TABLE>


                See notes to consolidated financial statements.

                                       4
<PAGE>

                              SILICON GAMING, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                            Nine Months Ended
                                                                June 30,
                                                            ------------------
                                                              1999      1998
                                                            --------  --------
<S>                                                         <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net loss.................................................. $(17,219) $(26,895)
 Reconciliation to net cash used in operating activities:
  Depreciation and amortization............................    3,663     3,713
  Accrued interest.........................................    3,376     2,470
  Accretion of debt discount...............................    1,825     1,316
  Deferred rent............................................     (105)      159
  Restructuring charges....................................    3,277       --
  Provision for bad debt...................................      (98)    1,105
  Stock compensation expense...............................      --        676
  Gain from disposal of property...........................      --        (27)
 Changes in assets and liabilities:
  Accounts receivable......................................    3,774    (3,416)
  Inventories..............................................    1,221    (8,912)
  Prepaid and other........................................     (752)      (73)
  Participation units......................................    2,123     1,538
  Accounts payable.........................................     (841)      (65)
  Accrued liabilities......................................   (2,098)    2,272
  Other liabilities........................................      177       --
  Deferred revenue.........................................     (991)      (25)
                                                            --------  --------
   Net cash used in operating activities...................   (2,668)  (26,164)
                                                            --------  --------
CASH FLOWS FROM INVESTING ACTIVITIES:
 Acquisition of property and equipment.....................     (238)   (2,730)
 Proceeds from disposal of property and equipment..........      --        118
 Sales and maturities of short-term investments............      --      4,704
 Other assets, net.........................................      (66)      (27)
                                                            --------  --------
   Net cash provided by (used in) investing activities.....     (304)    2,065
                                                            --------  --------
CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from debt financing and issuance of warrants,
  net......................................................      --     14,950
 Proceeds from term loans and line of credit...............      --      4,586
 Repayment of bank line of credit..........................   (3,456)      --
 Sales of Common Stock, net of notes receivable............       72     1,143
 Collection of note receivable.............................       18        28
 Repayment of term loans...................................     (727)     (326)
 Repayment of capital lease obligations....................     (232)     (211)
                                                            --------  --------
   Net cash provided by (used in) financing activities.....   (4,325)   20,170
                                                            --------  --------
NET DECREASE IN CASH AND EQUIVALENTS.......................   (7,297)   (3,929)
 Beginning of period.......................................    8,399    16,352
                                                            --------  --------
 End of period............................................. $  1,102  $ 12,423
                                                            ========  ========
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
 Cash paid during the period for interest.................. $    391  $    203
                                                            ========  ========
 Issuance of common warrants............................... $    --   $  1,466
                                                            ========  ========
 Conversion of preferred stock to Common Stock............. $    410  $  1,399
                                                            ========  ========
</TABLE>

                See notes to consolidated financial statements.

                                       5
<PAGE>

                              SILICON GAMING, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

   The accompanying consolidated balance sheet as of September 30, 1999, the
consolidated statements of operations for the three and nine months ended
September 30, 1999 and 1998, and the consolidated statements of cash flows for
the nine months ended September 30, 1999 and 1998, are unaudited. In the
opinion of management, these financial statements have been prepared on the
same basis as the audited financial statements and include all adjustments,
consisting only of normal recurring adjustments and accruals, necessary for the
fair presentation of the financial position and operating results as of such
dates and for such periods. The unaudited information should be read in
conjunction with the audited consolidated financial statements of Silicon
Gaming, Inc. ("Silicon Gaming" or the "Company") and the notes thereto for the
year ended December 31, 1998 included in the Company's Annual Report on Form
10-K filed with the Securities and Exchange Commission.

   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 September 30,
1999 had an accumulated deficit of $97,489,000 and a shareholders' deficiency
of $35,029,000. The Company has been required to obtain additional financing
every year to be able to fund its ongoing operations. As of September 30, 1999
the Company's cash and equivalents had decreased to $1,102,000. 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 the fourth quarter of 1998 the Company took steps to reduce the level of
operating expenses and made a number of management decisions which resulted in
a reduction of the Company's workforce by approximately 20% and cuts in
expenditures across the Company. The Company continued to evaluate further
possible ways to reduce operating expenses through outsourcing of different
parts of its business and further downsizing of its workforce. In March 1999,
management reduced the size of the Company's workforce by an additional 35% and
made additional cuts to operating expenses. Management also announced in March
1999 the relocation of its manufacturing operations to its Las Vegas, Nevada
facility and the closure of its Mountain View, California manufacturing
facility. The Company has been able to significantly reduce its level of
operating expenses and cash required for operating activities as a result of
the above actions. The amount of cash used in operations was $324,000 for the
current quarter compared to $506,000 in the second quarter of 1999, $1,838,000
used in the first quarter of 1999 and $5,356,000 used in the fourth quarter of
1998.

   In November 1999, the Company announced that it had modified the terms of
the non-binding letter of intent with the holders of the Senior Discount Notes
(the Notes) that it had previously announced in July, 1999 regarding the
restructuring of the Notes. Under the new terms of the restructuring, $39.75
million principal obligation of the Notes would be exchanged for shares of
convertible preferred stock that are convertible into a 57% equity interest in
the Company. The terms of the remaining balance of the Notes would be 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, subject to certain coverage ratio tests, for the five years following
the effective date of the restructuring, at which time the notes will mature.
Pursuant to the restructuring, accrued and unpaid interest on the Notes
remaining outstanding following the restructuring would be forgiven through
July 15, 1999. The amount of interest to be forgiven is approximately $7.6
million.

   Similar to the terms announced in July, the new terms also contemplate an
additional investment by the holders of the Notes of up to $5 million in the
form of e senior secured notes (the "New Notes"). Under the new terms, the New
Notes would not be convertible and would bear interest at the rate of 13% per
annum, with 10% payable in cash monthly and 3% payable in kind, with a maturity
of 5 years. The New Notes will be issuable in tranches, with the first $2.0
million issued on the closing date of the restructuring. To the extent required
by the Company, the remaining $3.0 million of New Notes would be issued upon
the achievement of certain financial and operating hurdles. (See Note 7).

                                       6
<PAGE>

                              SILICON GAMING, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   Management continues to review financing alternatives available to the
Company such as additional equity or debt offerings, joint ventures,
alternative distribution channels, and sale of all or a portion of the
Company's assets to further improve the Company's liquidity position.
Management believes that if the Company is successful in completing that these
steps, and in satisfactorily resolving its financing and strategic alternatives
(including successful completing of the debt restructuring) with, sales related
to new product introductions it 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 for at least the next twelve months. The
accompanying consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

2. Net loss per share

   Basic earnings per share excludes dilution and is computed by dividing net
income by the weighted average of common shares outstanding for the period.
Diluted earnings per share reflect 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 Redeemable Convertible Preferred Stock have been excluded from all periods
presented, as their effect would be anti dilutive.

   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):

<TABLE>
<CAPTION>
                                          Three months     Nine months ended
                                        ended Sept. 30,        Sept. 30
                                        -----------------  ------------------
                                         1999      1998      1999      1998
                                        -------  --------  --------  --------
   <S>                                  <C>      <C>       <C>       <C>
   Net Loss (Numerator):
   Net Loss, basic and diluted......... $(4,980) $(14,702) $(17,219) $(26,895)
                                        =======  ========  ========  ========
   Shares (Denominator)
   Weighted average common shares
    outstanding........................  14,589    14,240    14,433    13,986
   Weighted average common shares
    subject to repurchase..............     (28)     (310)      (72)     (402)
                                        -------  --------  --------  --------
   Shares used in computation..........  14,561    13,930    14,361    13,584
                                        =======  ========  ========  ========
   Net Loss Per Share, Basic and
    Diluted............................ $  0.34  $   1.06  $   1.20  $   1.98
                                        =======  ========  ========  ========
</TABLE>

3. Inventories

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

<TABLE>
<CAPTION>
                                                      September 30, December 31,
                                                          1999          1998
                                                      ------------- ------------
   <S>                                                <C>           <C>
   Raw materials.....................................    $ 4,033      $ 4,294
   Work in process...................................        494           93
   Finished goods....................................      6,276        7,637
                                                         -------      -------
                                                         $10,803      $12,024
                                                         =======      =======
</TABLE>

4. Concentration of Credit Risk

   Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and trade
accounts receivable. The Company invests only in high credit quality short-term
debt with its surplus funds. 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. As of September 30,
1999,

                                       7
<PAGE>

                              SILICON GAMING, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

one customer accounted for 16% of accounts receivable. As of December 31, 1998,
two different customers accounted for 16% and 13% of accounts receivable. For
the three months ended September 30, 1999, one customer accounted for 23% of
revenue and for the nine months ended September 30, 1999, one customer
accounted for 16% of revenue. For the three months ended September 30, 1998 one
customer accounted for 40% of revenue and for the nine months ended September
30, 1998, two different customers accounted for 12% and 11% of revenue,
respectively.

5. Borrowing Arrangements

   In June 1999 the Company entered into a $4 million secured revolving line of
credit agreement based on the Company's eligible accounts receivable which
expires December 31, 1999. Borrowings bear interest at the Bank's prime rate
(8.25% at September 30, 1999) plus 3.5%. As of September 30, 1999 the Company
had $544,000 outstanding under this facility. This agreement requires the
Company to maintain a minimum level of shareholder's equity (as defined in the
agreement) and the Company was in compliance with the agreement as of September
30, 1999.

   Borrowing arrangements consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                    September 30, December 31,
                                                        1999          1998
                                                    ------------- ------------
   <S>                                              <C>           <C>
   Senior Discount Notes ($47.25 million principal
    obligation)....................................    $39,541      $37,716
   Capital lease obligations.......................        128          360
   Other long-term obligations.....................      2,294        3,022
                                                       -------      -------
                                                        41,963       41,098
   Current obligation..............................     (1,204)      (1,289)
                                                       -------      -------
   Long-term obligation............................    $40,759      $39,809
                                                       =======      =======
</TABLE>

   In November 1999, the Company announced that it had modified the terms of
the non-binding letter of intent with the holders of the Senior Discount Notes,
regarding the conversion of $39.75 million principal obligation of Senior
Discount Notes into convertible preferred stock of the Company and the
forgiveness of accrued and unpaid interest on the Senior Discount Notes through
July 15, 1999. See Note 7.

6. Restructuring Charges

   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):

<TABLE>
<CAPTION>
                             Accrued severance,  Facility    Write down
                                 benefits &        lease         of
                                other costs     obligations fixed assets  Total
                             ------------------ ----------- ------------ -------
   <S>                       <C>                <C>         <C>          <C>
   Restructuring
    provision..............        $ 595           $ 293      $ 2,424    $ 3,312
   Adjustment to amounts
    recorded...............          --              (35)         --         (35)
   Non-cash items..........          --              --        (2,424)    (2,424)
   Amounts paid............         (595)           (133)         --        (728)
                                   -----           -----      -------    -------
   Balance at September 30,
    1999...................        $ --            $ 125      $   --     $   125
                                   =====           =====      =======    =======
</TABLE>


                                       8
<PAGE>

                              SILICON GAMING, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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

7. Subsequent Events

   Debt Restructuring

   In November 1999, the Company announced that it had modified the terms of
the non-binding letter of intent with the holders of the Senior Discount Notes
(the Notes) that it had previously announced in July, 1999 regarding the
restructuring of the Notes. Under the new terms of the restructuring, $39.75
million principal obligation of the Notes would be exchanged for shares of
convertible preferred stock that are convertible into a 57% equity interest in
the Company. The terms of the remaining balance of the Notes would be 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, subject to certain coverage ratio tests, for the five years following
the effective date of the restructuring, at which time the notes will mature.
Pursuant to the restructuring, accrued and unpaid interest on the Notes
remaining outstanding following the restructuring would be forgiven through
July 15, 1999.

   Similar to the terms announced in July, the new terms also contemplate an
additional investment by the holders of the Notes of up to $5 million in the
form of senior secured notes (the "New Notes"). Under the new terms, the New
Notes would not be convertible and would bear interest at the rate of 13% per
annum, with 10% payable in cash monthly and 3% payable in kind, with a maturity
of 5 years. The New Notes will be issuable in tranches, with the first $2.0
million issued on the closing date of the restructuring. To the extent required
by the Company, the remaining $3.0 million of New Notes would be issued upon
the achievement of certain financial and operating hurdles.

   As previously contemplated, upon closing of the debt restructuring, the
Board of Directors would be reduced to three members, consisting of Andrew
Pascal, the President and Chief Executive Officer of the Company, Robert Reis
(a consultant to the Company) and Stanford Springel.

   In addition, current holders of the common stock would be given the right to
receive four-year warrants to purchase shares of common stock equal to, in the
aggregate, 15% of the outstanding common stock as of the effective date of the
restructuring (calculated prior to the issuance of these new warrants). 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 prior to their scheduled expiration if the
Company's enterprise value, as measured on the Nasdaq National Market or such
exchange, exceeds $100 million. Holders of the warrants would have 180 days to
exercise prior to such termination.

   As a result of the announced transactions the percentage ownership of the
Company's current equity holders would be reduced from 100% to approximately 5%
of the outstanding fully-diluted common stock upon the effective date of the
restructuring. The Company would allocate 38% of its equity (calculated prior
to issuance of the out of the money warrants described above)as of the
effective date to be issued as incentive stock-based compensation to employees.
As discussed above, $39.75 million of existing Notes would be exchanged for
preferred stock that is convertible into the remaining 57% (calculated prior to
issuance of the out of the money warrants described above) of the Company's
outstanding common stock as of the effective date of the restructuring.

   The capital structure of the Company would change dramatically as a result
of the restructuring. Currently there are approximately 20 million shares of
common stock outstanding on a fully-diluted basis. After the closing of the
restructuring, and giving effect to the conversion of preferred stock issued as
part of the restructuring and exercise of warrants issued to current
stockholders, the total number of shares of common

                                       9
<PAGE>

                              SILICON GAMING, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

stock outstanding on a fully diluted basis would increase to approximately 450
million; or approximately 22 times the current number of shares outstanding on
a fully-diluted basis.

   The proposed restructuring continues to be subject to a number of
conditions, including receipt by the Company's Board of Directors of a
"fairness opinion" from an investment banking firm, the receipt of all
necessary gaming and regulatory approvals and the negotiation and execution of
definitive documentation. There can be no assurance the restructuring will be
successfully implemented or that there will not be further modifications to the
restructuring terms. The Company anticipates closure of the restructure during
the quarter ended December 31, 1999.

  Patent Litigation

   In November, 1999 the Company received notification that it, together with
three other gaming machine manufacturers, has been sued by International Game
Technology (IGT) in the United States District Court for the District of
Nevada. The suit, which has not been served, alleges infringement of a patent
issued to IGT on September 14, 1999 entitled "Game Machine and Method Using
Touch Screen". While it is too early to evaluate the merits of the case and the
affect it will have on the Company's business, the Company intends to defend
the suit and has retained patent counsel to review the matter, including the
validity of the patent.

                                       10
<PAGE>

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

   THIS DISCUSSION INCLUDES A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH
REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL
PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES, INCLUDING THOSE REFERRED TO IN THE RISK FACTORS SECTION BELOW
AND ELSEWHERE HEREIN AND CONTAINED IN THE COMPANY'S PREVIOUSLY FILED ANNUAL
REPORT ON FORM 10-K, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS DISCUSSION, THE WORDS
"ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND SIMILAR
EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS
OF THE DATE HEREOF.

   The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto included in Part I--Item 1
of this Report and the audited consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission.

Overview

   Silicon Gaming, Inc. ("SGI" or 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 March 1997 the Company introduced its first product,
Odyssey(TM), a multi-game, video-based slot machine, into the Nevada market. In
1998 the Company introduced Quest, a single-game platform that utilizes many of
the same components as the Odyssey, to increase its penetration of the casino
floor. In July 1999 the Company introduced its first slant-top product into the
Nevada market. The Company has since rolled out Odyssey and Quest into other
jurisdictions including Connecticut, Indiana, Iowa, Louisiana, Michigan,
Minnesota, Mississippi, Missouri, New Jersey, New Mexico, certain Canadian
provinces and Uruguay.

   The Company's products feature high-resolution video presented across the
full surface of a large touchscreen display. The games feature high-quality
animation, video clips, digital sound and a level of visual appeal and
interactivity that the Company believes is unattainable by the current
generation of slot machines. 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 and by introducing new
game types, it 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 designed its machines with a number of unique
player features, such as play stoppage entertainment(TM). In addition, the
product's modular components and Machine Management System(TM) software provide
easy-to-use diagnostics designed to minimize player inconvenience and machine
down time. The Company currently offers several products including Odyssey(TM),
a multi-game machine that can play up to six different games on the same
machine, and Quest, a single-game machine.

   In December 1998, the Company introduced its first wide-area progressive
product, The Big Win. Under a wide-area progressive system, numerous slot
machines are linked by computer networks and share a common top award that is
usually much greater than the award that a single, unlinked machine could
support. The network links machines in different casinos, and can be extended
from its current installed base in Las Vegas to include other locations across
Nevada. The Company receives a predetermined percentage of the amounts wagered
on these machines as revenue and is responsible for payment of the game's
progressive jackpot prizes.

                                       11
<PAGE>

   Through September 30, 1999, the Company has installed 3,698 Odyssey and
Quest machines in approximately 185 properties throughout Connecticut, Indiana,
Iowa, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Nevada, New
Jersey, New Mexico, certain Canadian provinces and Uruguay. Of these machines,
3,415 have been sold outright or placed on a revenue-sharing basis. After
returns, 283 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. Included in the Company's revenue and installed base at September
30, 1999 are 31 machines connected to the wide-area progressive system. The
Company began reinstalling machines on its wide-area progressive system in
early July.

   At September 30, 1999 the Company had cash and equivalents of $1,102,000.
The Company has incurred operating losses each year since inception and as of
September 30, 1999 had an accumulated deficit of $97,489,000 and a deficiency
of shareholders' equity of $35,029,000. 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 the fourth quarter of 1998 the Company took steps to reduce the level of
operating expenses and made a number of management decisions which resulted in
a reduction of the Company's work force by approximately 20% and cuts in
expenditures across the Company. The Company continued to evaluate further
possible ways to reduce operating expenses through outsourcing of different
parts of its business and further downsizing of its workforce. In March 1999
management reduced the size of the Company's workforce by a further 35% and
made additional cuts to its operating expenses. Management also announced the
relocation of its manufacturing operations to its Las Vegas, Nevada facility
and the closure of its Mountain View, California manufacturing facility. The
Company has been able to significantly reduce its operating expenses and the
level of cash required for operating activities as a result of the above
actions. The amount of cash used in operations was $324,000 for the current
quarter compared to $506,000 in the second quarter of 1999, $1,838,000 recorded
in the first quarter of 1999 and $5,356,000 used in the fourth quarter of 1998.

   In November 1999, the Company announced that it had modified the terms of
the non-binding letter of intent for the restructuring of certain of its long-
term obligations previously announced in July, 1999. Under the new terms of the
restructuring, $39.75 million principal obligation of Senior Discount Notes
would be exchanged for shares of preferred stock that are convertible into a
57% equity interest in the Company. The terms of the remaining balance of
Senior Discount Notes would be 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, subject to certain coverage ratio
tests, for the five years following the effective date of the restructuring, at
which time the notes will mature. Pursuant to the restructuring, accrued and
unpaid interest on the Senior Discount Notes remaining outstanding following
the restructuring would be forgiven through July 15, 1999. The amount of
interest to be forgiven is approximately $7.6 million.

   Similar to the terms announced in July, 1999 the restructuring also
contemplates an additional investment by the holders of the Senior Discount
Notes of up to $5 million in the form of senior secured notes (the "New
Notes"). Under the new terms, the New Notes would not be convertible and would
bear interest at the rate of 13% per annum, with 10% payable in cash monthly
and 3% payable in kind, with a maturity of 5 years. The New Notes are to be
issued in tranches, with the first $2.0 million issued on the closing date of
the restructuring. To the extent required by the Company, the remaining $3.0
million of New Notes would be issued upon the achievement of certain financial
and operating hurdles.

   In addition, current holders of the common stock would be given the right to
receive four-year warrants to purchase shares of common stock equal to, in the
aggregate, 15% of the outstanding common stock as of the effective date of the
restructuring (calculated prior to the issuance of these new warrants). 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

                                       12
<PAGE>

prior to their scheduled expiration if the Company's enterprise value, as
measured on the Nasdaq National Market or such exchange, exceeds $100 million.
Holders of the warrants would have 180 days to exercise prior to such
termination.

   Management continues to review financing alternatives available to the
Company such as additional equity or debt offerings, joint ventures,
alternative distribution channels, and sale of all or a portion of the
Company's assets to further improve the Company's liquidity position.
Management believes that if the Company is successful in completing these steps
and in satisfactorily resolving its financing and strategic alternatives,
including timely completion of the Senior Discount Note conversion already
announced, with sales related to new product introductions it 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 for at
least the next twelve months.

   Silicon Gaming is headquartered in Palo Alto, California and has sales
offices in Reno and Las Vegas, Nevada, and in Gulfport, Mississippi. The
Company's products are now manufactured at the Company's location in Las Vegas,
Nevada. At September 30, 1999 the Company had 87 employees.

   Revenue

   The Company generates 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 whereby it
receives 20% of the net win generated by the product as revenue. The Company
also places machines in casinos that are linked to a wide-area progressive
system in exchange for a predetermined share of the gross amount wagered on the
machine. Amounts received from the participation program and the wide area
progressive system are recorded as participation revenues. Total revenue units
includes machines sold outright as well as machines placed under the
participation programs.

   The Company generated revenues as follows:

<TABLE>
<CAPTION>
                                 Three Months Ended        Nine Months Ended
                                    September 30,            September 30,
                               ----------------------- -------------------------
                                  1999        1998         1999         1998
                               ----------- ----------- ------------ ------------
                                     (in $'000 except for machine numbers)
<S>                            <C>    <C>  <C>    <C>  <C>     <C>  <C>     <C>
Hardware sales................ $  932  47% $3,313  66% $ 8,254  62% $11,199  65%
Software sales................    448  22%    849  17%   3,336  25%   3,510  20%
Participation revenue.........    619  31%    827  17%   1,797  13%   2,567  15%
                               ------ ---- ------ ---- ------- ---- ------- ----
  Total revenue............... $1,999 100% $4,989 100% $13,387 100% $17,276 100%
                               ======      ======      =======      =======
Total revenue units...........     43         241          639        1,157
                               ======      ======      =======      =======
</TABLE>

   Revenue for the quarter ended September 30, 1999 was $1,999,000, a decrease
of $2,990,000, or 60%, from $4,989,000 for the quarter ended September 30,
1998. This also represents a decrease of $3,728,000, or 65%, from the
$5,727,000 recorded in the three-month period ended June 30, 1999. The decrease
in sales compared to the prior year and previous period is attributable to
customer concerns regarding the ability of the Company to continue as a going
concern, and the deferral of product purchases until the Company could complete
its proposed debt restructuring. These concerns were exacerbated by the loss of
the majority of the Company's sales force during 1999. Although the Company has
rebuilt its sales team during the current quarter, this has not yet
significantly impacted sales due to the need to offer evaluation periods to
customers for new product purchases. The average selling price on hardware
sales decreased to $9,845 in the quarter ended September 30, 1999 compared to
$10,070 in the quarter ended September 30, 1998, reflecting a much higher level
of competition in the industry and a resulting higher level of discounts given
to strategic corporate customers compared to the prior year period, plus lower
selling prices due to the Company selling used equipment to certain customers
during 1999.

                                       13
<PAGE>

   The decrease in software revenues for the three months ended September 30,
1999 of $401,000, or 47%, compared to the same period in 1998 is a direct
result of the lower number of units sold outright in the current year.
Participation revenues decreased by $208,000, or 25%, compared to the
comparable period in 1998 due largely to a reduction in the number of machines
on participation programs as customers have either purchased those machines
outright or returned them to the Company.

   Revenue for the nine months ended September 30, 1999 was $13,387,000, a
decrease of $3,889,000, or 23%, from $17,276,000 for the nine months ended
September 30, 1998. For the nine month period ended September 30, 1999 total
software sales decreased by $174,000, or 5%, compared to the same period in
1998 reflecting the lower level of machines sales compared to the prior period.
Total participation revenues decreased by $770,000, or 30%, due to the
reductions in the number of machines on participation as the Company has
converted these units to sales or were returned to the Company by its
customers.

   During the three-month period ended September 30, 1999, one customer
accounted for 23% of revenue. In the three-month period ended September 30,
1998 one different customer represented 40% of revenue. For the nine month
period ended September 30, 1999 one customer represented 16% of revenue and in
the nine-months ended September 30, 1998 two customers represented 12% and 11%
of revenue, respectively. The Company expects that a significant portion of its
revenues will remain consolidated 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 would adversely affect the
Company's business and results of operations.

   Cost of Sales

   Cost of sales includes the direct costs 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 systems, including payment of
jackpot awards. Cost of sales was $1,329,000, or 66% of revenue, as compared to
$8,553,000, or 171% of revenue, for the quarters ended September 30, 1999 and
1998, respectively. Cost of sales was $8,513,000, or 64% of revenue, as
compared to $17,579,000, or 102% of revenue, for the nine months ended
September 30, 1999 and 1998, respectively.

   The relative decrease in cost of sales as a percentage of revenue for the
three and nine-month periods ended September 30, 1999 compared to the
comparable prior-year periods reflect the lower level of manufacturing overhead
as a result of the closure of the Company's California manufacturing facility
in May 1999 and the relocation of all manufacturing to the Company's Las Vegas,
Nevada facility. These benefits are partially offset by higher fixed costs
associated with the participation machines and the wide-area progressive
system, as well as the effects of lower average selling prices of product
compared to the prior year period. Cost of sales for the three and nine-month
periods ended September 30, 1998 included a $2.2 million charge for royalty
expense in connection with a patent infringement litigation settlement with a
competitor of the Company, and a $3.3 million charge for inventory write-downs.

   The Company has been able to realize a decrease in per-unit product costs as
a result of reductions in the cost of materials and buying quantities, as well
as redesigns from tooling certain hardware components, although the high levels
of inventory that the Company has maintained for the last year have mitigated
the effects of such lower product costs. The Company does not anticipate that
this rate of cost reduction will continue into future periods, although
management is currently investigating further outsourcing possibilities that
may help to contain future product costs. The Company believes that as it
introduces more unique, fully integrated specialty products, per-unit costs may
actually increase in future periods.


                                       14
<PAGE>

   Gross margins are expected to remain volatile due the product's sensitivity
to volume levels. The Company has yet to commence full scale manufacturing of
its product in its Las Vegas facility due to its current inventory position,
and so commencement of such activities may adversely affect the Company's gross
margin if any difficulties are encountered. Anticipated manufacturing expenses
are subject to a number of risks and uncertainties. See "Factors Affecting
Future Results--Management of Changing Business."

   Research and Development

   Research and development ("R&D") expenses include payroll and related costs
of employees engaged in 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 product. R&D expenses were $1,191,000,
or 60% of revenue, as compared to $3,193,000, or 64% of revenue, for the
quarters ended September 30, 1999 and 1998, respectively. R&D expenses were
$5,023,000, or 38% of revenue, as compared to $8,748,000, or 51% of revenue for
the nine months ended September 30, 1999 and 1998, respectively.

   The decreases in R&D expenses are largely the result of lower personnel
costs as a result of the Company's reductions in its workforce and lower use of
outside engineering consultants, offset partially by higher license fees and
similar costs associated with the acquisition of outside technologies. Since
the comparable periods in 1998, the focus of the Company's R&D activities
continues to emphasize new game development, the introduction of new product
platforms, and the introduction of new game types, such as the wide-area
progressive system. The Company is focussed on offering additional features in
its product that will fully utilize the underlying technology used. This is
expected to require an increased investment in R&D activities in future
periods, including additional personnel, to continue the development of the
existing product platforms and new platforms to facilitate the elaborate
requirements of the game development process.

   Selling, General and Administrative

   Selling, general and administrative ("SG&A") expenses include payroll and
related costs for administrative and executive personnel, sales and customer-
support organization personnel, marketing and licensing personnel, 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 $2,484,000, or 124% of revenue, as compared to
$6,224,000, or 125% of revenue for the quarters ended September 30, 1999 and
1998, respectively. SG&A expenses were $7,969,000, or 60% of revenue, as
compared to $14,097,000, or 82% of revenue for the nine months ended September
30, 1999 and 1998, respectively.

   The decrease in SG&A expenses over these periods is largely attributable to
the reduction in personnel and associated costs from the reductions in the
Company's workforce, offset by higher costs associated with applying for
corporate and product licenses as the Company began selling product into new
jurisdictions. The 1998 expenses also included $1.3 million in costs associated
with the severance of prior management and compensation expense for options
granted to new management, and $0.9 million in allowances relating to one
customer receivable. SG&A expenses were also affected during 1999 by higher
legal costs associated with patent infringement disputes and due to higher
product licensing costs as the Company has increased the number of new game
types and platforms for which it is currently seeking approval. SG&A expenses
are expected to increase in absolute dollars as the Company invests in
increased sales and marketing-related activities and in administrative
personnel to support its infrastructure.

                                       15
<PAGE>

   Interest Income and Expense

   Net interest expense was $1,975,000 for the quarter ended September 30,
1999, as compared to $1,721,000 for the quarter ended September 30, 1998. Net
interest expense was $5,824,000 for the nine months ended September 30, 1999,
as compared to $3,747,000 for the nine months ended September 30, 1998.
Included in these totals was interest income of $13,000 and $200,000 for the
quarter ended September 30, 1999 and 1998, respectively, and $88,000 and
$527,000 for the nine months ended September 30, 1999 and 1998, respectively.
Changes in interest income over these periods are directly attributable
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.

   Interest expense was $1,988,000 and $1,921,000 for the quarters ended
September 30, 1999 and 1998, respectively, and $5,912,000 and $4,274,000 for
the nine months ended September 30, 1999 and 1998, respectively. The increases
in interest expense over these periods are due to increases in the Company's
level of long-term indebtedness over the periods. 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 July 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. The substantial increase in interest expense in 1999 compared to
the prior year periods reflects the interest costs associated with the 1998
Notes, the related issuance and repricing of stock warrants and the equipment
financing.

   Income Taxes

   The Company has not been required to pay income taxes due to its net
operating losses in each period since inception. As of December 31, 1998, the
Company had net operating loss carryforwards of approximately $69,100,000 and
$35,800,000 for federal and state income tax purposes, respectively. These loss
carryforwards will expire beginning in the year 2000, if not utilized. As of
December 31, 1998, the Company also has R&D credit carryforwards of
approximately $815,000 and $720,000 for federal and state purposes,
respectively, which expire beginning 2010.

   A valuation allowance has been recorded for any deferred tax assets due to
uncertainties regarding the realization of these assets resulting from the lack
of earnings history of the Company. 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. As of March 31, 1998, approximately $4 million of the
Company's net operating loss carryforwards was subject to such limitation and
this limitation is dependent on the Company's future profitability and the
utilization of its net operating loss carryforwards over a period of time. The
Company anticipates further restriction or loss of all or a significant portion
of its net operating loss carryforwards as a result of the October 1999
restructuring and conversion of long-term debt into equity, although the amount
of such restriction or loss cannot accurately be determined at this time.

Liquidity and Capital Resources

   Cash and equivalents were $1,102,000 as of September 30, 1999, compared to
$8,399,000 as of December 31, 1998. The decrease in cash in the current period
of $7,297,000 is due to losses from ongoing operations that the Company has
incurred and due to the repayment of $3,456,000 against the Company's bank line
of credit during 1999.

   The Company has incurred operating losses each year since inception and as
of September 30, 1999 had an accumulated deficit of $97,489,000 and a
deficiency of shareholders' equity of $35,029,000. 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.

                                       16
<PAGE>

   In the fourth quarter of 1998 the Company took steps to reduce the level of
operating expenses and made a number of management decisions which resulted in
a reduction of the Company's work force by approximately 20% and cuts in
expenditures across the Company. The Company continued to evaluate further
possible ways to reduce operating expenses through outsourcing of different
parts of its business and further downsizing of its workforce. In March 1999
management reduced the size of the Company's workforce by a further 35% and
made additional cuts to its operating expenses. Management also announced the
relocation of its manufacturing to its Las Vegas, Nevada facility and the
closure of its Mountain View, California manufacturing facility. The Company
has been able to significantly reduce its level of operating expenses and cash
required for operating activities as a result of the above actions. The amount
of cash used in operations was $324,000 for the current quarter compared to
$506,000 in the second quarter of 1999, $1,838,000 recorded in the first
quarter of 1999 and $5,356,000 used in the fourth quarter of 1998.

   In November 1999, the Company announced that it had modified the terms of
the non-binding letter of intent for the restructuring of certain of its long-
term obligations previously announced in July, 1999. Under the new terms of the
restructuring, $39.75 million principal obligation of Senior Discount Notes
would be exchanged for shares of preferred stock that are convertible into a
57% equity interest in the Company. The terms of the remaining balance of
Senior Discount Notes would be 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, subject to certain coverage ratio
tests, for the five years following the effective date of the restructuring, at
which time the notes will mature. Pursuant to the restructuring, accrued and
unpaid interest on the Senior Discount Notes remaining outstanding following
the restructuring would be forgiven through July 15, 1999. The amount of
interest to be forgiven is approximately $7.6 million.

   Similar to the terms announced in July, 1999 the restructuring also
contemplates an additional investment by the holders of the Senior Discount
Notes of up to $5 million in the form of senior secured notes (the "New
Notes"). Under the new terms, the New Notes would not be convertible and would
bear interest at the rate of 13% per annum, with 10% payable in cash monthly
and 3% payable in kind, with a maturity of 5 years. The New Notes are to be
issued in tranches, with the first $2.0 million issued on the closing date of
the restructuring. To the extent required by the Company, the remaining $3.0
million of New Notes would be issued upon the achievement of certain financial
and operating hurdles.

   In addition, current holders of the common stock would be given the right to
receive four-year warrants to purchase shares of common stock equal to, in the
aggregate, 15% of the outstanding common stock as of the effective date of the
restructuring (calculated prior to the issuance of these new warrants). The
exercise price of the warrants will be at 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 prior to their scheduled expiration if the Company's
enterprise value, as measured on the Nasdaq National Market or such exchange,
exceeds $100 million. Holders of the warrants would have 180 days to exercise
prior to such termination.

   Management continues to review additional financing alternatives available
to the Company such as additional equity or debt offerings, joint ventures,
alternative distribution channels, and sale of all or a portion of the
Company's assets to further improve the Company's liquidity position.
Management believes that if the Company is successful in completing these steps
and in satisfactorily resolving its financing and strategic alternatives,
including timely completion of the proposed Senior Discount Note conversion
already announced, with sales related to new product introductions, it 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 for at
least the next twelve months.

   The Company's net cash used in operating activities was $2,668,000 and
$26,164,000 for the nine months ended September 30, 1999 and 1998,
respectively. The decrease in cash used in operating activities reflects the
higher amount of non-cash items such as depreciation and amortization,
accretion of debt discount and accrued interest, the non-cash restructuring
related charges recorded in March 1999, and a significant reduction in cash
used for working capital. The Company was able to reduce its investments in
receivables and inventory and

                                       17
<PAGE>

increase its level of payables as it has improved its asset management and
focussed on converting existing assets into cash to improve its liquidity
situation. During the nine months ended September 30, 1999 the Company
decreased its investment in receivables and inventory by $4,995,000, compared
to an increase of $12,328,000, in these items in the prior year period.

   Net cash used in investing activities was $304,000 for the nine months ended
September 30, 1999 as compared to net cash provided by investing activities of
$2,065,000 for the nine months ended September 30, 1998. The change was
primarily due to in the net cash provided by the purchase, sale and maturity of
short-term investments as the Company's available cash balances decreased,
offset by reductions in the acquisition of fixed assets and decreases in other
assets.

   Net cash used in financing activities was $4,325,000 for the six months
ended September 30, 1999 as compared to net cash provided by financing
activities of $20,170,000 for the nine months ended September 30, 1998. The
decrease is related to the timing of additional borrowings in the 1998 period.
In 1998 the Company received proceeds from the issuance of Senior Discount
Notes, term loans and the sale of common stock, but received no new borrowings
in the current period. In 1999 the Company made repayments against its bank
line of credit, capital lease and term loan obligations.

Year 2000 Issues

   The following section represents a Year 2000 readiness disclosure.

   The inability of computers and software programs to recognize and properly
process data fields containing a two-digit year is commonly known as the Year
2000 issue. As the year 2000 approaches, such computer systems may be unable to
accurately process certain date-based information. This could result in system
failures or miscalculations causing disruption of operations including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.

   During 1997 the Company implemented an enterprise-wide management
information system which supports all of the Company's major business
applications including sales and customer service, manufacturing and
distribution, and finance and accounting. Management has determined that the
Year 2000 issue will not pose significant operational problems for its computer
systems. As a result, any costs attributable to the purchase and implementation
of new software will be capitalized and any other costs incurred in connection
with Year 2000 compliance will be expensed as incurred.

   During 1998 the Company established a Year 2000 management committee
comprised of senior management to provide leadership and direction to the Year
2000 effort throughout the Company. The Committee is using a multi-step
approach in managing the Year 2000 project. The major steps include an
inventory of all major systems and devices with potential Year 2000 problems,
assigning priority to identified items, assessing the Year 2000 compliance of
all items deemed material to the Company, repairing or replacing material items
that are not deemed to be Year 2000 compliant, testing material items, and
designing and implementing contingency and business continuation plans. The
Company has completed the inventory of its critical systems, made an assessment
of Year 2000 compliance and has identified all systems to be upgraded and
replaced. The Company commenced the upgrading and replacing of certain systems
during the quarter ended March 31, 1999 and continued these activities through
the current quarter. Due to vendor scheduling limitations, the Company does not
expect to have all such upgrades and replacements completed until November,
1999. The Company continues to communicate with the suppliers and customers
with which it has material contracts to determine the extent to which the
Company is vulnerable to those third parties failure to remediate their own
Year 2000 issues. The Company cannot accurately predict the outcome of other
companies' remediation efforts.

   The Company utilizes third-party vendors for processing data such as
payroll, 401(k) administration and medical benefits processing. The Company is
in the process of communicating to determine the status of

                                       18
<PAGE>

Year 2000 readiness of all of these vendors. Should these vendors not be Year
2000 ready in a timely manner, the Company may be required to process
transactions manually or delay processing until such time the vendors are Year
2000 compliant. No contingency plan has yet been developed, however it is
expected that contingency plans could be developed, if needed, on short notice.

   A number of the Company's customers have contacted the Company to determine
if the Company's products are Year 2000 compliant. The Company has tested its
products and believes that the products will correctly process data such that
the Year 2000 issue will not affect the operation of its products. However,
because the Company's product must run on third party slot management and
tracking systems, there is still a risk that the Company's products will not
work properly with such third party software. This risk is exacerbated because
the Company's products continue to display date fields as a two-digit rather
than a four-digit field, even though internally all date-dependent computations
correctly utilize a four-digit field. The Company has developed a solution to
this display problem and is upgrading its installed base as necessary. As a
result, it does not anticipate any significant problem with its products being
Year 2000 compliant. There can still be no guarantee that the Company's product
will be able to run with third party software after December 31, 1999 however.

   The total cost associated with required product and systems modifications to
become Year 2000 compliant is not expected to be material to the Company's
financial position. The Company spent approximately $450,000 during 1998 in
getting its major business systems upgraded and Year 2000 compliant. The
Company plans on using both internal and external resources during the
remainder of 1999 to continue to replace and test hardware and software for
Year 2000 compliance. Currently the Company does not anticipate spending more
than $200,000 in connection with its Year 2000 projects during 1999. The
majority of this will be spent on the purchase of new or replacement hardware
and software and upgrades, and on updating software code for its products, and
this will be funded from operations. The anticipated costs and scope of the
Year 2000 project are based on management's best estimates using information
currently available and numerous assumptions about future events. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ materially from these plans.

   The failure to correct a material Year 2000 problem could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of
Year 2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Year 2000 project is expected
to reduce the Company's level of uncertainty about the Year 2000 problem, and
in particular, about the Year 2000 compliance and readiness of its products.

   The Company currently obtains a significant amount of its revenue from
relatively few customers. There can be no assurance that the Year 2000 issue
will not pose significant problems for the computer systems of these customers,
which could in turn affect the customers' ability to purchase machines and
generate revenue for the Company. Accordingly, there can be no assurance
revenue generated for the Company will not be affected by the Year 2000 issues
that these customers might have. The Company cannot predict the nature of any
such changes or their impact on the Company.

Factors Affecting Future Results

   Management of Changing Business--The Company is currently in the process of
shifting 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 custom game and revenue-sharing opportunities. It will offer
product extensions and variations of successful existing games, however the
emphasis will shift from volume-based to one of providing a unique, fully-
integrated gaming experience. The Company has also relocated its manufacturing
operations from California to Nevada. This transition represents a significant
challenge for the Company and its management

                                       19
<PAGE>

and employees, and places increased demand on its systems and controls. The
Company has not yet been required to commence full-scale manufacturing in
Nevada due to its excess inventory position. The Company's ability to manage
this change in strategy 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. Some of the keys
to effecting this change are the continued 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 in order 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
or able to successfully manage the relocation of its manufacturing activities,
the Company's business, operating results and financial condition could be
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 September
30, 1999 the Company had an accumulated deficit of $97,489,000 and a deficiency
of shareholders' equity of $35,029,000. In November 1999 the Company announced
modifications to the proposed terms of the restructuring of its Senior Discount
Notes previously announced in July 1999. Under the terms of the restructuring,
approximately $40 million of the Senior Discount Notes would be converted into
a new class of convertible preferred stock. The Company had previously
announced that it would not make the scheduled July 1, 1999 interest payment on
the Senior Discount Notes, and under the restructuring, accrued and unpaid
interest on the Senior Discount Notes would be forgiven through July 15, 1999.
The amount of accrued and unpaid interest to be forgiven is approximately $7.6
million. Under the restructuring, the Company will also receive additional
funding of up to $5 million in new convertible senior secured notes, with $2
million being received upon the closing. Management is continuing to review
financing alternatives available to the Company, such as additional equity or
debt offerings, joint ventures, alternative distribution channels, conversion
of some or all of its debt to equity and sale of all or a portion of the
Company's assets. If the plans that management have 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 adversely affect the Company's business, operating results and
financial condition. To the extent that the Company sells additional shares or
issues any convertible debt securities, or converts any existing debt into
equity, this could result in additional dilution to existing shareholders.
There can be no assurance that the Company will be able to successfully
complete the restructuring or be able to raise additional funds when and if
needed.

   Volatility of Stock Price--The market price of the Company's stock has been
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 is likely to reduce 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. The Company's stock
price is expected to be adversely affected due to the announced restructuring
that, if consummated, would result in a significant reallocation of the
Company's equity ownership. As a result, the volatility of the Company's stock
price may increase, however there can be no certainty as to how the public
markets will react in both the short and long-term to this proposed
transaction.

   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 experienced high turnover among its senior management during the
second half of 1998 and in the first half of 1999. The Company also reduced its
workforce by approximately 20% in December 1998 and by an additional 35% in
March 1999. Subsequent to these reductions, the Company has

                                       20
<PAGE>

continued to lose additional employees, particularly in its sales and
engineering organizations. These factors, combined with the Company's poor
operating results, its current liquidity situation 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 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 not 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 has been hampered
due to the current 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 has experienced
negative reaction from customers who have had these views during 1999 and who
have indicated that they may not purchase additional product from the Company
or who have deferred purchase decisions until the uncertainties surrounding the
Company's liquidity position has been resolved. This had a material impact upon
the Company's sales during the three-month period ended September 30, 1999.
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. 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 has been involved in three
intellectual property disputes since September, 1998. The Company has been able
to negotiate a settlement to two of these disputes and is undergoing
preliminary discovery with respect to the most recent dispute. The September
1998 dispute resulted in the Company entering into a license and royalty
agreement with the competitor and incurring an expense of $2,200,000. The
second dispute, in March 1999, resulted in the Company entering into a cross-
licensing arrangement with the same competitor so that the Company was able to
continue selling its product and resulted in a favorable adjustment to income
of approximately $500,000 in the second quarter of 1999. The Company was
notified in November of another potential patent infringement dispute which
names the Company and three of its competitors for an alleged patent
infringement. There can be no assurance that similar claims will not arise in
the future or that the Company will be able to successfully negotiate a
settlement to such claims. Any such claims or litigation that may arise can be
costly and result in a diversion of management's attention, which could have a
material adverse 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 affect on the Company's business, operating
results and financial condition.

   Changing Legislative Environment--In May 1999 the Nevada Legislature passed
legislation that negatively impacts the ability of slot machine manufacturers
to derive profit from machines that it has on a participation basis in customer
casinos. The legislation requires slot manufacturers to pay a proportionate
share

                                       21
<PAGE>

of state gaming taxes related to their share of revenue from the participation
products. This will reduce the profitability of the participation machines to
the manufacturers. This legislation may require the Company to review its
business strategy of placing its premium products on a participation basis with
casino operators and require it to end its practice of placing machines in
casinos and sharing in the net win with the casino operators. Adoption of
similar legislation in additional jurisdictions that attempt to restrict or
prohibit slot machine manufacturers from receiving a percentage of profits or
revenues from a gaming machine placed on a casino floor may have a material
adverse impact upon the Company's business, operating results and financial
condition.

   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 that 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.

   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. Should any
current or potential competitor of the Company succeed in developing a
competing software-based gaming platform, such a 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 adversely affect
the Company's operating results.

   Dependence on Single-Source Suppliers--The Company currently obtains a
number of its 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 adversely affect the Company's business,
financial condition and results of operations.

                                       22
<PAGE>

                           PART II--OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

   In November, 1999 the Company received notification that it, together with
three other gaming machine manufacturers, has been sued by International Game
Technology (IGT) in the United States District Court for the District of
Nevada. The suit, which has not been served, alleges infringement of a patent
issued to IGT on September 14, 1999 entitled "Game Machine and Method Using
Touch Screen". While it is too early to evaluate the merits of the case and the
affect it will have on the Company's business, the Company intends to defend
the suit and has retained patent counsel to review the matter, including the
validity of the patent.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

   The Company previously announced that it did not make its scheduled interest
payment on July 1, 1999 to the holders of the Senior Discount Notes (the
Notes). The amount of payment not made was approximately $3 million. The
Company did not make the payment and is in default of the terms of the Notes.
The Company has been engaged in a consensual restructuring of the terms of the
Notes with the holders of the Notes since April, 1999 but has not yet
consummated a transaction. No other interest payments have become due under the
Notes since July 1, 1999.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

   (a) Exhibits.

<TABLE>
<CAPTION>
     Number Exhibit Description
     ------ -------------------
     <C>    <S>
     27.1   Financial Data Schedule
</TABLE>

   (b) Reports on Form 8-K.

     None

                                       23
<PAGE>

                                   SIGNATURE

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

                                          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)

Date: November 10, 1999

                                       24