<PAGE>

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-Q

(Mark One)

    X    Quarterly report pursuant to Section 13 or 15(d) of the Securities
 ------
         Exchange Act of 1934 for the quarterly period ended June 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

                         Commission File Number 0-28294


                              SILICON GAMING, INC.

             (Exact name of Registrant as specified in its charter)


                   CALIFORNIA                           77-0357939
          (State or other jurisdiction of            (I.R.S. Employer
           incorporation or organization)         Identification Number)

                             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 July 31, 1999.


<PAGE>

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

                                     INDEX
<TABLE>
<CAPTION>

                                                                                                   Page
                                                                                                 --------

Part I     Financial Information
<S>       <C>                                                                                       <C>
Item 1.    Financial Statements:

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

           Consolidated Statements of Operations--Three months and six months ended June 30, 1999
           and June 30, 1998......................................................................   4

           Consolidated Statements of Cash Flows--Six months ended June 30, 1999 and June 30, 1998   5

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

Item 2.    Management's Discussion and Analysis of Financial Condition and
           Results of Operations..................................................................  10

Part II    Other Information


Item 1.    Legal Proceedings......................................................................  22

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>
                                                                                          June 30,          December 31,
                                                                                            1999                1998
---------------------------------------------------------------------------------------------------------------------------

                                      ASSETS
<S>                                                                                       <C>                 <C>

CURRENT ASSETS:

  Cash and equivalents.............................................................           $  3,194             $  8,399
  Accounts receivable (net of allowances of $1,333 and $1,650).....................              4,329                5,340
  Inventories......................................................................             10,859               12,024
  Investments to fund jackpot winners..............................................                327                  288
  Prepaids and other...............................................................              1,876                1,410
                                                                                   ----------------------------------------
     Total current assets..........................................................             20,585               27,461
PROPERTY AND EQUIPMENT, NET........................................................              6,762               12,922
OTHER ASSETS, NET..................................................................              1,309                1,361
                                                                                   ----------------------------------------
                                                                                              $ 28,656             $ 41,744
                                                                                   ========================================
LIABILITIES AND SHAREHOLDERS' DEFICIENCY

CURRENT LIABILITIES:
  Accounts payable.................................................................           $  1,399             $  1,480
  Accrued liabilities..............................................................              8,322                8,154
  Deferred revenue.................................................................              1,029                1,766
  Line of credit...................................................................              1,943                4,000
  Current portion of long-term obligations.........................................              1,252                1,289
                                                                                   ----------------------------------------
     Total current liabilities.....................................................             13,945               16,689
OTHER LONG-TERM LIABILITIES........................................................              3,084                2,032
LONG-TERM OBLIGATIONS..............................................................             40,423               39,809

REDEEMABLE CONVERTIBLE PREFERRED STOCK--6,884,473 shares
 authorized at June 30, 1999; shares outstanding: June 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: June 30, 1999-- 14,588,571; December 31, 1998--
    14,242,313.....................................................................             58,024               57,398
  Warrants.........................................................................              4,548                4,548
  Notes receivable from shareholders...............................................               (115)                (128)
  Accumulated deficit..............................................................            (92,509)             (80,270)
  Accumulated other comprehensive income...........................................                 --                   --
                                                                                    ----------------------------------------
     Total shareholders' deficiency................................................            (30,052)             (18,452)
                                                                                    ----------------------------------------
                                                                                              $ 28,656             $ 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>





                                                              Three  Months Ended               Six Months Ended
                                                                   June 30,                         June 30,
                                                             1999             1998            1999            1998
                                                        ---------------  --------------  --------------  --------------
REVENUE:
<S>                                                     <C>              <C>             <C>             <C>
   Hardware............................................        $ 3,609          $ 5,462         $ 7,322         $ 7,886
   Software............................................          1,502            1,941           2,888           2,661
   Participation.......................................            616              858           1,178           1,740
                                                               -------          -------         -------         -------
   Total revenue                                               $ 5,727          $ 8,261         $11,388         $12,287

OPERATING EXPENSES:
   Cost of sales and related
     manufacturing expenses............................          2,965            5,836           7,184           9,026
   Research and development............................          1,483            2,838           3,831           5,554
   Selling, general and
     administrative....................................          2,587            3,922           5,483           7,873
   Restructuring charges...............................            (35)              --           3,277              --
                                                               -------          -------         -------         -------
   Total costs and expenses                                      7,000           12,596          19,775          22,453
                                                               -------          -------         -------         -------
       Loss from operations............................          1,273            4,335           8,387          10,166
   Interest (income)/expense, net......................          1,926          $ 1,093           3,852         $ 2,026
                                                               -------          -------         -------         -------
NET LOSS                                                       $ 3,199          $ 5,428         $12,239         $12,192
                                                               =======          =======         =======         =======

Basic and diluted net loss per share                             $0.22            $0.39           $0.86           $0.91
                                                               =======          =======         =======         =======

Shares used in computation                                      14,376           13,755          14,275          13,417
                                                               =======          =======         =======         =======

</TABLE>
                See notes to consolidated financial statements.



                                       4
<PAGE>

                              SILICON GAMING, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                  (unaudited)
<TABLE>
<CAPTION>

                                                                                    Six Months Ended
                                                                                        June 30,
                                                                                 1999               1998
                                                                          ------------------  -----------------
<S>                                                                           <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss..............................................................           $(12,239)          $(12,192)
  Reconciliation to net cash used in operating activities:
   Depreciation and amortization........................................              2,570              2,351
   Accrued interest.....................................................              2,251              1,344
   Accretion of debt discount...........................................              1,207                736
   Deferred rent........................................................               (111)               106
   Restructuring charges................................................              3,277                 --
   Provision for bad debt...............................................                (98)               150
   Gain from disposal of property.......................................                 --                (28)
  Changes in assets and liabilities:
   Accounts receivable..................................................              1,109             (2,984)
   Inventories..........................................................              1,165             (7,531)
   Prepaid and other....................................................               (655)               142
   Participation units..................................................              1,628                668
   Accounts payable.....................................................                (80)             2,017
   Accrued liabilities..................................................             (1,808)              (392)
   Other liabilities....................................................                177                 --
   Deferred revenue.....................................................               (737)              (242)
                                                                                   --------           --------
     Net cash used in operating activities..............................             (2,344)           (15,855)
                                                                                   --------           --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of property and equipment.................................               (221)            (1,816)
  Proceeds from disposal of property and equipment......................                 --                 75
  Sales and maturities of short-term investments........................                 --              4,704
  Other assets, net.....................................................                (39)                47
                                                                                   --------           --------
     Net cash provided by (used in) investing activities................               (260)             3,010
                                                                                   --------           --------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Sales of Common Stock, net of notes receivable........................                 74                630
  Collection of note receivable.........................................                 13                 18
  Proceeds from term loans and line of credit...........................                 --              2,897
  Repayment of bank line of credit......................................             (2,057)                --
  Repayment of term loans...............................................               (478)              (137)
  Repayment of capital lease obligations................................               (153)              (139)
                                                                                   --------           --------
     Net cash provided by (used in) financing activities................             (2,601)             3,269
                                                                                   --------           --------
NET DECREASE IN CASH AND EQUIVALENTS....................................             (5,205)            (9,576)
  Beginning of period...................................................              8,399             16,352
                                                                                   --------           --------
  End of period.........................................................           $  3,194           $  6,776
                                                                                   ========           ========

SUPPLEMENTARY DISCLOSURES OF CASH FLOW
 INFORMATION:
  Cash paid during the period for interest..............................           $    313           $     87
                                                                                   ========           ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
  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 June 30, 1999, the
consolidated statements of operations for the three and six months ended June
30, 1999 and 1998, and the consolidated statements of cash flows for the six
months ended June 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 June 30, 1999 had an
accumulated deficit of $92,509,000 and a shareholders' deficiency of
$30,052,000. The Company has been required to obtain additional financing every
year to be able to fund its ongoing operations. As of June 30, 1999 the
Company's cash and equivalents had decreased to $3,194,000. 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, and in the second quarter of 1999 reduced the amount of cash used
in operations to $506,000 from the $1,838,000 used in the first quarter of 1999
and the $5,356,000 used in the fourth quarter of 1998. The Company was also able
to renegotiate the terms of its line of credit with its bank during the second
quarter of 1999 so that this credit facility will remain available to the
Company. (See Note 5).

  In July 1999 the Company announced that it had entered into a non-binding
letter of intent with the holders of its Senior Discount Notes to convert
approximately $40 million of the Senior Discount Notes 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 the letter of intent contemplates that accrued and unpaid interest on
the Senior Discount Notes would be forgiven through July 15, 1999. The amount of
accrued and unpaid interest at June 30, 1999 was $6,517,000. Under the letter of
intent, the Company would also receive additional funding of up to $5 million in
new convertible senior secured notes. The proposed restructuring is subject to a
number of conditions, including the receipt of necessary gaming and regulatory
approvals and the negotiation and execution of definitive documentation.
Management continues to review financing alternatives available to the Company
such as additional share 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 these
steps, satisfactory resolution of its financing and strategic alternatives,
including timely completion of the proposed Senior Discount Note conversion
already announced, plus sales related to new product introductions will provide
sufficient cash and working capital for the Company to meet its ongoing
obligations and to allow it to continue operating as a going concern through at
least the end of 1999. The accompanying consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

                                       6
<PAGE>

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
antidilutive.

  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 ended June 30,     Six months ended June 30
                                                              ----------------------------  -----------------------------
                                                                  1999           1998            1999           1998
                                                              ------------  --------------  --------------  -------------
<S>                                                           <C>           <C>             <C>             <C>
Net Loss (Numerator):
Net Loss, basic and diluted ...........................           $(3,199)        $(5,428)       $(12,239)      $(12,192)
                                                                  =======         =======        ========       ========

Shares (Denominator)
Weighted average common shares outstanding ............            14,437          14,159          14,367         13,866
 Weighted average common shares subject to
    repurchase.........................................               (61)           (404)            (92)          (449)
                                                                  -------         -------        --------       --------
 Shares used in computation                                        14,376          13,755          14,275         13,417
                                                                  =======         =======        ========       ========
Net Loss Per Share, Basic
 and Diluted............................................          $  0.22         $  0.39        $   0.51       $   0.91
                                                                  =======         =======        ========       ========

</TABLE>


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

3.    Inventories

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

                           June 30,  December 31,
                             1999        1998
                           --------  ------------
<S>                        <C>       <C>
        Raw materials....   $ 4,864       $ 4,294
        Work in process..       396            93
        Finished goods...     5,599         7,637
                            -------       -------
                            $10,859       $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 June 30, 1999, one
customer accounted for 28% of accounts receivable. As of December 31, 1998, two
different customers accounted for 16% and 13% of accounts receivable. For the
three months ended June 30, 1999, two customers accounted for 27% and 13% of
revenue and for the six months ended June 30, 1999, one customer accounted for
18% of revenue. For the three months ended June 30, 1998 one customer accounted
for 19% of revenue and for the six months ended June 30, 1998, five different
customers accounted for 26%, 27%, 13%, 10% and 10% of revenue, respectively.

                                       7
<PAGE>

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
  (8.5% at June 30, 1999) plus 3.5%. As of June 30, 1999 the Company had
  $1,943,000 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 June 30,
  1999.

  Borrowing arrangements consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                                   June 30,       December 31,
                                                                                     1999             1998
                                                                                --------------  ----------------
<S>                                                                             <C>             <C>
Senior Discount Notes ($47.25 million principal obligation)..................      $38,923           $37,716
Capital lease obligations....................................................          207               360
Other long-term obligations..................................................        2,545             3,022
                                                                                   -------           -------
                                                                                    41,675            41,098
Current obligation...........................................................       (1,252)           (1,289)
                                                                                   -------           -------
Long-term obligation.........................................................      $40,423           $39,809
                                                                                   =======           =======
</TABLE>


  In July 1999, the Company announced that it had entered into a non-binding
letter of intent for 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 June 30, 1999............                      $  --           $ 125           $    --             $   125
                                                          =====           =====           =======             =======
</TABLE>

  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 the
third quarter, 1999.



                                       8
<PAGE>

7.   Subsequent Events


   In July 1999, the Company announced that it had entered into a non-binding
letter of intent for a proposed restructuring of certain of its long-term
obligations. Under the terms of the proposed restructuring, $39.75 million
principal obligation of Senior Discount Notes would be exchanged for shares of
convertible preferred stock that would be 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 up to the
first five years following the effective date of the restructuring, at which
time the notes would mature. Pursuant to the letter of intent, accrued and
unpaid interest on the Senior Discount Notes remaining outstanding following the
restructuring would be forgiven through July 15, 1999.

   The letter of intent also contemplates an additional investment by the
holders of the Senior Discount Notes of up to $5 million in the form of
convertible senior secured notes (the "New Notes"). The New Notes would bear
interest at the rate of 10% per annum, payable in cash, with a maturity of 5
years. The $5 million of New Notes would be convertible into a 40% equity
interest in the Company (subject to the issuance of additional employee equity
incentives as described below). The New Notes would 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 part of the debt restructuring, the Company would allocate 38% of its
equity as of the effective date to be issued as incentive stock-based
compensation to employees. The Company's current equity holders, including all
holders of options, warrants and convertible preferred stock, would own
approximately 5% of the outstanding fully-diluted equity upon the effective date
of the debt restructuring (prior to the issuance of any New Notes). Certain of
the Company's currently outstanding warrants and convertible preferred stock
have anti-dilution rights that may substantially reduce the portion of the 5%
equity interest that would be allocated to holders of the common stock. As
discussed above, $39.75 million of existing Senior Discount Notes would be
convertible into the remaining 57% of the Company's outstanding equity as of the
effective date of the debt restructuring (prior to the issuance of any New
Notes). Upon issuance of any New Notes, the number of shares of common stock
allocated to the employee incentive compensation pool would be increased so that
the incentive pool would remain at 38% of the Company's equity after giving
effect to the dilution of the conversion of the New Notes. In addition, 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, and two independent directors.

   The proposed debt restructuring is 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 that the debt restructuring will be
successfully implemented or that there will not be modifications to the
restructuring terms. The Company expects to finalize and close the above
transactions on or about September 30, 1999.

                                       9
<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. 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, 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.

                                       10
<PAGE>

     Through June 30, 1999, the Company has installed 3,773 Odyssey and Quest
machines in approximately 193 properties throughout Connecticut, Indiana, Iowa,
Louisiana, Michigan, Minnesota, Mississippi, Missouri, Nevada, New Jersey, New
Mexico, certain Canadian provinces and Uruguay.  Of these machines, 3,372 have
been sold outright or placed on a revenue-sharing basis. After returns, 361
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 June 30, 1999 are 16 machines connected
to the wide-area progressive system. The Company began reinstalling machines on
its wide-area progressive system in early July.

  At June 30, 1999 the Company had cash and equivalents of $3,194,000. The
Company has incurred operating losses each year since inception and as of June
30, 1999 had an accumulated deficit of $92,509,000 and a deficiency of
shareholders' equity of $30,052,000. 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 and in
the second quarter of 1999 reduced the amount of cash used in operations to
$506,000 from the $1,838,000 recorded in the first quarter of 1999 and the
$5,356,000 used in the fourth quarter of 1998. The Company was also able to
renegotiate the terms of its line of credit with its bank during the second
quarter of 1999 so that this credit facility will remain available to the
Company.

   In July 1999 the Company announced that it had entered into a non-binding
letter of intent with the holders of its Senior Discount Notes to convert
approximately $40 million of the Senior Discount Notes 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 the letter of intent contemplates that accrued and unpaid interest on
the Senior Discount Notes would be forgiven through July 15, 1999. Under the
letter of intent, the Company would also receive additional funding of up to $5
million in new convertible senior secured notes. The proposed restructuring is
subject to a number of conditions, including the receipt of necessary gaming and
regulatory approvals and the negotiation and execution of definitive
documentation. 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 these steps, satisfactory resolution of its financing and strategic
alternatives, including timely completion of the proposed Senior Discount Note
conversion already announced, plus sales related to new product introductions
will provide sufficient cash and working capital for the Company to meet its
ongoing obligations and to allow it to continue operating as a going concern
through at least the end of 1999.

  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
June 30, 1999 the Company had 78 employees.


                                       11
<PAGE>

 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 June 30,     Six Months Ended June 30,
                            -----------------------------  -----------------------------
                                 1999           1998                1999           1998
                            --------------  -------------  ----------------------  -----
<S>                         <C>       <C>   <C>      <C>   <C>      <C>   <C>      <C>
                                       (in $'000 except for machine numbers)
                          -------------------------------------------------------------
Hardware sales                $3,609   63%   $5,462   66%  $ 7,322   64%  $ 7,886    64%
Software sales                 1,502   26%    1,941   24%    2,888   25%    2,661    22%
Participation revenue            616   11%      858   10%    1,178   11%    1,740    14%
                              ------  ---    ------  ---   -------  ---   -------  ----
   Total revenue              $5,727  100%   $8,261  100%  $11,388  100%  $12,287   100%
                              ======         ======        =======        =======
Total revenue units              468            606            895            847
                              ======         ======        =======        =======
</TABLE>


     Revenue for the quarter ended June 30, 1999 was $5,727,000, a decrease of
$2,534,000, or 31%, from $8,261,000 for the quarter ended June 30, 1998. This
also represents an increase of $49,000, or 1%, from the $5,661,000 recorded in
the three-month period ended March 31, 1999.  The 1998 results included a one-
time sale of approximately $1.8 million of product to a new distributor and
route operator. The

                                       12
<PAGE>

change in sales mix reflects an increase in direct sales relative to sales on a
participation basis, and the benefit of sales to new jurisdictions. The average
selling price on hardware sales decreased to $7,711 in the quarter ended June
30, 1999 compared to $8,181 in the quarter ended June 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.

     The decrease in software revenues for the three months ended June 30, 1999
of $439,000, or 23%, compared to the same period in 1998 is a direct result of
the lower number of units sold outright and the lower selling prices of used
equipment in the current year. Participation revenues decreased by $242,000, or
28%, 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 six months ended June 30, 1999 was $11,388,000, a decrease
of $899,000, or 7%, from $12,287,000 for the six months ended June 30, 1998. For
the six month period ended June 30, 1999 total software sales increased by
$227,000, or 9%, compared to the same period in 1998 reflecting the higher
installed base of machines from which the company derives annual license fees.
Total participation revenues decreased by $592,000, or 34%, 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 June 30, 1999, two customers accounted
for 27% and 13% of revenue. In the three-month period ended June 30, 1998  one
different customer represented 19% of revenue. For the six month period ended
June 30, 1999 one customer represented 18% of revenue and in the six-months
ended June 30, 1998 five customers represented 26%, 17%, 13%, 10% and 10% 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 $2,965,000, or 52% of revenue, as compared to
$5,836,000, or 71% of revenue, for the quarters ended June 30, 1999 and 1998,
respectively.  Cost of sales was $7,184,000, or 63% of revenue, as compared to
$9,026,000, or 73% of revenue, for the six months ended June 30, 1999 and 1998,
respectively.

     The relative decrease in cost of sales as a percentage of revenue for the
three and six-month periods ended June 30, 1999 compared to the comparable
prior-year periods reflect the lower level of

                                       13
<PAGE>

manufacturing overhead as a result of the closure of the Company's California
manufacturing facility and the relocation of all manufacturing to the Company's
Las Vegas, Nevada facility. The Company also recorded a favorable adjustment to
cost of sales in the three months ended June 30, 1999 of approximately $500,000
as a result of settlement of patent infringement litigation and cancellation of
obligations relating to previously expensed royalties. 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. 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.

     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 $1,483,000,
or 26% of revenue, as compared to $2,838,000, or 34% of revenue, for the
quarters ended June 30, 1999 and 1998, respectively.  R&D expenses were
$3,831,000, or 34% of revenue, as compared to $5,554,000, or 45% of revenue for
the six months ended June 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 has
changed 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. The absolute level of R&D expenses is therefore
expected to increase in future periods.

     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 $2,587,000, or 45% of revenue, as compared to $3,922,000, or
47% of revenue for the quarters ended June 30, 1999 and 1998,

                                       14
<PAGE>

respectively. SG&A expenses were $5,483,000, or 48% of revenue, as compared to
$7,873,000, or 64% of revenue for the six months ended June 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 Company also incurred costs compared to the prior year
periods as it created and established a customer-support organization to support
the rollout of its product into new markets, and as it established a marketing
organization upon the commercial distribution of its products. The costs of
these organizations are reflected in the 1999 expense levels. 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.

     Interest Income and Expense

     Net interest expense was $1,926,000 for the quarter ended June 30, 1999, as
compared to $1,093,000 for the quarter ended June 30, 1998. Net interest expense
was $3,852,000 for the six months ended June 30, 1999, as compared to $2,026,000
for the six months ended June 30, 1998.  Included in these totals was interest
income of $25,000 and $107,000 for the quarter ended June 30, 1999 and 1998,
respectively, and $75,000 and $327,000 for the six months ended June 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 $1,947,000 and $1,200,000 for the quarters ended June
30, 1999 and 1998, respectively, and $3,927,000 and $2,353,000 for the six
months ended June 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

                                       15
<PAGE>

Company's future profitability and the utilization of its net operating loss
carryforwards over a period of time.


Liquidity and Capital Resources

     Cash and equivalents were $3,149,000 as of June 30, 1999, compared to
$8,399,000 as of December 31, 1998. The decrease in cash in the current period
of $5,205,000 is due to losses from ongoing operations that the Company has
incurred and to the repayment of $2,057,000  against the Company's bank line of
credit during 1999.

     The Company has incurred operating losses each year since inception and as
of June 30, 1999 had an accumulated deficit of $92,509,000 and a deficiency of
shareholders' equity of $30,052,000. 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 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 and in the
second quarter of 1999 reduced the amount of cash used in operations to $506,000
from the $1,838,000 recorded in the first quarter of 1999 and the $5,356,000
used in the fourth quarter of 1998. The Company was also able to renegotiate the
terms of its line of credit with its bank during the second quarter of 1999 so
that this credit facility will remain available to the Company through December
1999.

     In July 1999 the Company announced that it had entered into a non-binding
letter of intent with the holders of its Senior Discount Notes to convert
approximately $40 million of the Senior Discount Notes 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 the letter of intent contemplates that accrued and unpaid interest on
the Senior Discount Notes would be forgiven through July 15, 1999. Under the
letter of intent, the Company would also receive additional funding of up to $5
million in new convertible senior secured notes. The proposed restructuring is
subject to a number of conditions, including the receipt of necessary gaming and
regulatory approvals and the negotiation and execution of definitive
documentation. 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 these steps, satisfactory resolution of its financing and
strategic alternatives, including timely completion of the proposed Senior
Discount Note conversion already announced, plus sales related to new product
introductions will provide sufficient cash and working capital for the Company
to meet its ongoing obligations and to allow it to continue operating as a going
concern through at least the end of 1999.

     The Company's net cash used in operating activities was $2,344,000 and
$15,855,000 for the six months ended June 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 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 six months

                                       16
<PAGE>

ended June 30, 1999 the Company decreased its investment in receivables and
inventory by $2,274,000, compared to an increase of $10,515,000, in these items
in the prior year period.

     Net cash used in investing activities was $260,000 for the six months ended
June 30, 1999 as compared to net cash provided by investing activities of
$3,010,000 for the six months ended June 30, 1998. The change was primarily due
to decreases 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 $2,601,000 for the six months
ended June 30, 1999 as compared to net cash provided by financing activities of
$3,269,000 for the six months ended June 30, 1998. The decrease is related to
the timing of additional borrowings in the 1998 period. In 1998 the Company
received proceeds from 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.

   In July 1999, the Company announced that it had entered into a non-binding
letter of intent for a proposed restructuring of certain of its long-term
obligations. Under the terms of the restructuring, $39.75 million principal
obligation of Senior Discount Notes would be exchanged for shares of convertible
preferred stock that would be convertible into a 57% equity interest in the
Company. The term 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 and subject to certain coverage ratio tests, for up to the first 5 years
following the effective date of the restructuring, at which times the Notes
would mature. Pursuant to the letter of intent, accrued and unpaid interest on
the Senior Discount Notes remaining outstanding following the restructuring
would be forgiven through July 15, 1999.

   The letter of intent also contemplates an additional investment by the
holders of the Senior Discount Notes of up to $5 million in the form of
convertible senior secured notes (the "New Notes"). The New Notes would bear
interest at the rate of 10% per annum, payable in cash, with a maturity of 5
years. The $5 million of New Notes would be convertible into a 40% equity
interest in the Company (subject to the issuance of additional employee equity
incentives as described below). The New Notes would 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 part of the restructuring, the Company would allocate 38% of its equity as
of the effective date to be issued as incentive compensation to employees. The
Company's current equity holders, including all holders of options, warrants and
convertible preferred stock, would own approximately 5% of the outstanding
fully-diluted equity upon the effective date of the restructuring (prior to the
issuance of any New Notes). Certain of the Company's currently outstanding
warrants and convertible preferred stock have anti-dilution rights that may
substantially reduce the portion of such equity interest that would be allocated
to holders of the common stock.  As discussed above, $39.75 million of existing
Senior Discount Notes would be convertible into the remaining 57% of the
Company's outstanding equity as of the effective date of the restructuring
(prior to the issuance of any New Notes). Upon issuance of any New Notes, the
number of shares of common stock allocated to the employee incentive
compensation pool would be increased so that the incentive pool would remain at
38% of the Company's equity after giving effect to the dilution of the
conversion of the New Notes. In addition, upon closing of the restructuring, the
Board of Directors would be reduced to three members, consisting of Andrew
Pascal, the President and Chief Executive Officer of the Company, and two
independent directors.

   The proposed restructuring is 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

                                       17
<PAGE>

be no assurance that the restructuring will be successfully implemented or
that there will not be modifications to the restructuring terms. The Company
expects to finalize and close the above transactions on or about  September 30,
1999.

Year 2000 Issues.

     The following section represents Year 2000 readiness disclosures.

     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 September, 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 has
not yet determined the status of Year 2000 readiness 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. The Company has developed a solution to this problem
and is upgrading its installed base as needed. As a result, it does not
anticipate any significant problem with its products being Year 2000 compliant.
There can still be no
                                       18
<PAGE>

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 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 and employees, and places increased demand on its systems and
controls. The Company's ability to manage this change will require the Company
to continue to change, expand and improve its operational, management and
financial systems and controls to manage any outsourcing or relocation of
existing activities. Some of the keys to effecting this change are the ability
of the Company to sell its existing inventory of Odyssey and Quest products in a
timely manner, and to resolve outstanding collections issues with customers 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 June 30,
1999 the Company had an accumulated deficit of $92,509,000 and a deficiency of
shareholders' equity of $30,052,000. Management was able to renegotiate the
terms of its

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<PAGE>

line of credit with its bank in June 1999 so that this credit facility
will remain available to the Company through December 1999. In July 1999 the
Company announced that it had entered into a non-binding letter of intent with
the holders of its Senior Discount Notes to convert approximately $40 million of
the Senior Discount Notes 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 the letter of intent
contemplates that accrued and unpaid interest on the Senior Discount Notes would
be forgiven through July 15, 1999. Under the letter of intent, the Company would
also receive additional funding of up to $5 million in new convertible senior
secured notes. The proposed restructuring is subject to a number of conditions,
including the receipt of necessary gaming and regulatory approvals and the
negotiation and execution of definitive documentation. 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
equity 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
renegotiate its existing credit facility 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 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.

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<PAGE>

     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 the first half
of 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. 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 two
intellectual property disputes since September, 1998. The Company has been able
to negotiate a settlement to each of these disputes. 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. There can by 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 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.

                                       21
<PAGE>

  Rapidly Changing Technology - The Company's products utilize hardware
components that have been developed primarily for the personal computer and
multimedia industries. These industries are characterized by rapid technological
change and product enhancements. The Company's ability to remain competitive and
retain any technological lead may depend in part upon its ability to continually
develop new slot machine games that take full advantage of the technological
possibilities of state-of-the-art hardware. 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.


                            PART II--OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS

   In April 1999, the Company announced the settlement of its patent
infringement litigation with International Game Technology, Inc. ("IGT"). Under
the settlement agreement, the Company obtained an exclusive sublicense from IGT
related to the disputed patents, which will allow the Company to continue to
sell its Lucky Draw and Multi Draw poker games without any limitations. The
Company's customers who chose to purchase this product will be required to
exercise a separate license agreement with IGT and to pay daily fees for the use
of the game under the terms of the settlement. The Company also cross licensed
certain of its intellectual property to IGT as part of the settlement and in
consideration IGT will pay a per-unit royalty to the Company for each product
sold that incorporates licensed technology upon the occurrence of certain
events. IGT also granted the Company development rights to create and distribute
games on IGT's future product platforms. As a result of settlement of disputed
royalties payable to IGT, the Company recorded a favorable adjustment to income
approximately $500,000 in the quarter ended June 30, 1999.

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<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

  (a) Exhibits.

          Number    Exhibit Description
          ------    -------------------
          10.40     Amended and Restated Collateral Assignment, Patent Mortgage
                    and Security Agreement between the Company and
                    Silicon Valley Bank dated June 30, 1999
          10.41     Loan and Security Agreement dated June 30, 1999, by and
                    between the Company and  Silicon Valley Bank
          10.42     Loan Modification Agreement dated June 30, 1999, by and
                    between the Company and Silicon Valley Bank
          10.43     Cross-Corporate Continuing Guaranty Agreement dated
                    June 30, 1999, by and between the Company and
                    Silicon Valley Bank
          27.1      Financial Data Schedule

  (b) Reports on Form 8-K.

       None

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<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:   August 16, 1999

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