<PAGE>
 
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                                 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, 1997
 
                                      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                 (I.R.S. Employer
   of incorporation or organization)           Identification Number)
 
                             2800 W. BAYSHORE ROAD
                              PALO ALTO, CA 94303
                   (Address of principal executive offices)
 
                           TELEPHONE: (415) 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.
 
  11,266,582 shares of Common Stock, $.001 par value, were outstanding as of
                                July 31, 1997.
 
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<PAGE>
 
                              SILICON GAMING, INC.
 
                         QUARTERLY REPORT ON FORM 10-Q
                       FOR THE PERIOD ENDED JUNE 30, 1997
 
                                     INDEX
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
 <C>     <S>                                                                <C>
 PART I  FINANCIAL INFORMATION
 Item 1. Financial Statements:
         Consolidated Balance Sheets--June 30, 1997 and December 31,
         1996............................................................     3
         Consolidated Statements of Operations--Three Months and Six
         Months Ended June 30, 1997 and 1996.............................     4
         Consolidated Statements of Cash Flows--Six Months Ended June 30,
         1997 and 1996...................................................     5
         Notes to Consolidated Financial Statements......................     6
 Item 2. Management's Discussion and Analysis of Financial Condition and
         Results of Operations...........................................     8
 PART II OTHER INFORMATION
 Item 1. Legal Proceedings...............................................    16
 Item 2. Changes in Securities...........................................    16
 Item 3. Defaults Upon Senior Securities.................................    16
 Item 4. Submission of Matters to a Vote of Security Holders.............    16
 Item 5. Other Information...............................................    16
 Item 6. Exhibits and Reports on Form 8-K................................    17
         Signature.......................................................    18
</TABLE>
 
                                       2
<PAGE>
 
                         PART I--FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                              SILICON GAMING, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                          JUNE 30,  DECEMBER 31,
                                                            1997        1996
                                                          --------  ------------
<S>                                                       <C>       <C>
                         ASSETS
CURRENT ASSETS:
  Cash and equivalents..................................  $  8,794    $ 25,583
  Short term investments................................     6,953       9,683
  Accounts receivable...................................     1,215         --
  Inventories...........................................     6,108         477
  Prepaids and other....................................     1,617         812
                                                          --------    --------
    Total current assets................................    24,687      36,555
PROPERTY AND EQUIPMENT, NET.............................     6,846       3,046
OTHER ASSETS, NET.......................................       203          45
                                                          --------    --------
                                                          $ 31,736    $ 39,646
                                                          ========    ========
          LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
  Accounts payable......................................  $  2,502    $  1,158
  Accrued liabilities...................................     1,549         987
  Deferred revenue......................................       371         --
  Current portion of capital lease obligations..........       258         207
                                                          --------    --------
    Total current liabilities...........................     4,680       2,352
                                                          --------    --------
DEFERRED RENT...........................................       225         133
CAPITAL LEASE OBLIGATIONS...............................       506         645
REDEEMABLE CONVERTIBLE PREFERRED STOCK--6,884,473 shares
 authorized at June 30, 1997; shares outstanding: June
 30, 1997--5,710,293; December 31, 1996--6,384,473......     5,924       6,455
                                                          --------    --------
SHAREHOLDERS' EQUITY
  Common Stock, $.001 par value; 50,000,000 shares
   authorized; shares outstanding: June 30, 1997--
   11,119,766; December 31, 1996--10,608,105............    50,779      49,873
  Notes receivable from shareholders....................      (211)       (221)
  Unrealized gain on investments........................        46          23
  Accumulated deficit...................................   (30,213)    (19,614)
                                                          --------    --------
    Total shareholders' equity..........................    20,401      30,061
                                                          --------    --------
                                                          $ 31,736    $ 39,646
                                                          ========    ========
</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     JUNE               JUNE
                                             30,      30,    JUNE 30,    30,
                                            1997     1996      1997     1996
                                           -------  -------  --------  -------
<S>                                        <C>      <C>      <C>       <C>
REVENUE................................... $ 1,665  $   --   $  1,665  $   --
OPERATING EXPENSES:
  Cost of sales and related manufacturing
   expenses...............................   2,321      383     3,262      706
  Research and development................   2,429    2,297     4,436    3,539
  Selling, general and administrative.....   3,120    1,033     5,246    1,805
                                           -------  -------  --------  -------
  Total costs and expenses................   7,870    3,713    12,944    6,050
                                           -------  -------  --------  -------
    Loss from operations..................  (6,205)  (3,713)  (11,279)  (6,050)
  Interest income, net....................     268       66       680       67
                                           -------  -------  --------  -------
NET LOSS.................................. $(5,937) $(3,647) $(10,599) $(5,983)
                                           =======  =======  ========  =======
NET LOSS PER SHARE........................ $ (0.54) $ (0.32) $  (0.98) $ (0.59)
                                           =======  =======  ========  =======
SHARES USED IN COMPUTATION................  10,979   11,516    10,837   10,222
                                           =======  =======  ========  =======
</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,  JUNE 30,
                                                               1997      1996
                                                             --------  --------
<S>                                                          <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss.................................................. $(10,599) $(5,983)
  Reconciliation to net cash used in operating activities:
    Depreciation and amortization...........................      737      230
    Deferred rent...........................................       92       66
    Stock issued for services...............................       --      263
  Changes in assets and liabilities:
    Accounts receivable.....................................   (1,215)     --
    Inventories.............................................   (5,631)     --
    Prepaids and other......................................     (805)    (482)
    Other assets, net.......................................     (158)       8
    Accounts payable........................................    1,344      577
    Accrued liabilities.....................................      562      (57)
    Deferred revenue........................................      371      --
                                                             --------  -------
      Net cash used in operating activities.................  (15,302)  (5,378)
                                                             --------  -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of property and equipment.....................   (4,537)  (1,057)
  Proceeds from sale of assets..............................      --       --
  Purchase of short-term investments........................   (2,977)     --
  Sales and maturities of short-term investments............    5,730      --
                                                             --------  -------
      Net cash used in investing activities.................   (1,784)  (1,057)
                                                             --------  -------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Sale of common stock, net of notes receivable.............      375        2
  Sale of redeemable convertible preferred stock, net of
   issuance costs...........................................      --    14,457
  Collection of note receivable.............................       10      --
  Proceeds from sale/leaseback of property and equipment....      --       667
  Repayment of capital lease obligations....................      (88)     (59)
                                                             --------  -------
      Net cash provided by financing activities.............      297   15,067
                                                             --------  -------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.............  (16,789)   8,632
  Beginning of period.......................................   25,583    2,399
                                                             --------  -------
  End of period............................................. $  8,794  $11,031
                                                             ========  =======
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
  Cash paid during the period for interest.................. $     51  $    26
                                                             ========  =======
NONCASH INVESTING AND FINANCING ACTIVITIES:
  Issuance of common and preferred stock for notes
   receivable............................................... $    --   $   151
                                                             ========  =======
  Conversion of preferred stock to common stock............. $    531  $   --
                                                             ========  =======
</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, 1997, the
consolidated statements of operations for the three and six months ended June
30, 1997 and 1996, and the consolidated statements of cash flows for the six
months ended June 30, 1997 and 1996, 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, 1996 included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
 
  Through March 31, 1997, the Company was in the development stage and its
financial statements were presented in accordance with Statement of Financial
Accounting Standards No. 7 "Accounting and Reporting by Development Stage
Enterprises." During the quarter ended June 30, 1997, the Company generated
revenue as it commenced commercial sale of its product, Odyssey(TM), and
emerged from the development stage.
 
  Revenues from hardware units and non-renewable software licenses are
recognized upon acceptance by the customer after completion of a trial period,
or upon shipment of the hardware. Renewable software licenses are recognized
ratably over the license period. Amounts due the Company under revenue
participation plans with its customers are recognized as revenue is earned.
Depreciation of units under such arrangements is the greater of the ratio that
current gross revenue bears to total anticipated revenue for such unit or
straight-line over three years.
 
  Certain prior year amounts have been reclassified to conform to the current
year presentation.
 
2. 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,
                                                             1997       1996
                                                           -------- ------------
     <S>                                                   <C>      <C>
     Raw materials........................................ $ 1,914      $307
     Work in process......................................     234       170
     Finished goods.......................................   3,960       --
                                                           -------      ----
                                                           $ 6,108      $477
                                                           =======      ====
</TABLE>
 
  Finished goods includes completed finished goods, units on trial and
participation units.
 
3. NET LOSS PER SHARE
 
  Net loss per share is based on the weighted average number of common shares
outstanding subsequent to the Company's initial public offering in 1996.
Common share equivalents including stock options, warrants and redeemable
convertible preferred stock have been excluded, as their effect would be
antidilutive. Pursuant to rules of the Securities and Exchange Commission, all
common and common equivalent shares issued by the Company at a price less than
the initial public offering price during the 12 months preceding the offering
date (using the treasury stock method until shares are issued) have been
included in the calculation of common and common equivalent shares outstanding
for all periods presented prior to the July 1996 initial public offering.
 
                                       6
<PAGE>
 
                             SILICON GAMING, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
4. RECENTLY ISSUED ACCOUNTING STANDARDS
 
  In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income",
which requires that an enterprise report, by major components and as a single
total, the change in its net assets during the period from nonowner sources;
and, No. 131 "Disclosures about Segments of an Enterprise and Related
Information", which establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas, and major customers. Adoption of these statements
will not impact the Company's consolidated financial position, results of
operations or cash flows. Both statements are effective for fiscal years
beginning after December 15, 1997, with earlier application permitted.
 
  In February 1997, the Financial Accounting Standards Board adopted Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
The Company is required to adopt SFAS 128 in the fourth quarter of 1997 and at
that time will restate earnings per share (EPS) data for prior periods to
conform with SFAS 128. Earlier application is not permitted. SFAS 128 replaces
current EPS reporting requirements and requires a dual presentation of basic
and diluted EPS. Basic EPS excludes dilution and is computed by dividing net
income available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities and other contracts to issue common
stock were exercised or converted into common stock. If SFAS 128 had been in
effect during the current and prior year periods, EPS for the three and six
months ended June 30, 1997 and 1996 would not have been significantly
different than currently reported.
 
5. SUBSEQUENT EVENTS
 
  Certain holders of the Company's Series A1 and Series B1 Nonvoting
Redeemable Convertible Preferred Stock ("Nonvoting Preferred") have notified
the Company of their election to convert shares of Nonvoting Preferred to
Common Stock. Each share of Nonvoting Preferred is convertible into .6667
shares of Common Stock upon 75 days' prior written notice. Pursuant to these
conversion notices, 100,000 shares of Common Stock were issued in July 1997
and an additional 431,579 shares of Common Stock will be issued in August 1997
upon conversion of shares of Nonvoting Preferred.
 
                                       7
<PAGE>
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS
 
 Overview
 
  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.
 
  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.
Since its formation, the Company's principal activities have consisted of
assembling a technical, marketing and executive staff, developing its gaming
platform and related gaming and support software, raising capital, and
initiating applications for regulatory approvals in Nevada and other
jurisdictions to manufacture and distribute its gaming devices, and establish
manufacturing and sales operations. During the quarter ended June 30, 1997,
the Company commenced commercial sale of its product; however, the Company
continues to generate negative operating cash flows.
 
  The Company's first commercial product, Odyssey(TM), was approved for
product field testing in Nevada in December 1996. Following the completion of
field testing, the product was approved for sale to licensed casinos in Nevada
by the Nevada Gaming Commission on March 20, 1997. During the current quarter
ended June 30, 1997, the Company transitioned from the development stage and
generated revenue from the commercial distribution and sale of its product.
The Company plans to limit distribution of its product in 1997, however, in
order to carefully monitor reactions to its platform, game software and
product support features. In 1998, the Company expects to broaden the
marketing and sales of its product; thus, the Company believes that 1998 will
be the first year in which a reasonable assessment can be made of its
product's commercial potential. Future revenue, profits, and cash flows will
depend on market acceptance of the Company's product, the ability of such
product to generate higher revenue for casinos as compared to competitive
products, and the technical performance of the Company's product. The
Company's success will also depend on, among other factors, the Company's
ability to attract, retain and motivate qualified personnel and meet all the
initial and ongoing licensing requirements in key jurisdictions.
 
RESULTS OF OPERATIONS
 
  The Company transitioned from the development stage and has begun to
generate revenue from the commercial sale of its product. The Company had net
losses of $5,937,000 and $3,647,000 for the quarters ended June 30, 1997 and
1996, respectively, and $10,599,000 and $5,983,000 for the six months ended
June 30, 1997 and 1996, respectively. To date, the Company has focused its
resources on product development, including system hardware and software, game
concept development and software coding and hiring additional marketing and
administrative staff. In addition to increasing expenditures in research and
development, the Company will
 
                                       8
<PAGE>
 
need to incur significant expenses and other costs associated with
manufacturing operations and building sales, support and administrative
infrastructure.
 
  The Company is expanding its manufacturing and commercial distribution
operations to meet the anticipated increase in sales and shipment volume
associated with the full product roll-out. During the quarter ended June 30,
1997, the Company opened a 28,000 square foot manufacturing facility in
Mountain View, California. The Company's plan for 1997 is to limit the number
of units it sells so that it can collect feedback from casino operators and
gaming patrons before commencing a full roll-out of its product. Accordingly,
the Company expects only limited revenue in 1997 and expects to incur
substantial losses and negative operating cash flows at least through the
second quarter of 1998.
 
  The Company believes that operating expenses will increase in the future as
it continues to develop its product and increases commercial operations,
including manufacturing, marketing and sales. Accordingly, the Company expects
that future results will differ materially from, and may not be comparable to,
prior periods.
 
 Revenue
 
  During the quarter ended June 30, 1997, the Company commenced sale of its
product and transitioned from the development stage. Prior to this period the
Company had not generated any revenue. In this quarter the Company generated
$1,665,000 in revenue. The Company's initial sales of Odyssey include the
hardware platform bundled with a suite of six games, play stoppage
entertainment and the Machine Management System(TM). The Company offers two
alternative purchase programs, consisting of the sale of hardware bundled with
either (1) a single game or a suite of games or (2) a renewable one-year
software license, including access to the entire game library for the term of
the license. In addition, the Company offers a revenue participation plan that
allows the Company to share with casino operators the aggregate win generated
by the machines, with 20% going to the Company, subject to a predetermined
minimum. The casino accumulates credits which may be applied to the purchase
of the machines after a 90 day minimum evaluation period. In addition to these
arrangements, the Company continues to install units on casino floors on a
trial basis, consistent with industry practice, before a sales decision is
made by the customer. The Company ended the quarter with 460 units installed
in 35 casinos. Of the 460 unit installed base, revenue was recognized on 235
units with the remaining units still on evaluation. Due to the early stage of
the Company's product cycle, the Company believes the revenue generated from
future sales will increase significantly after the full roll-out of the
Company's product planned for 1998.
 
 Cost of Sales and Related Manufacturing Expenses
 
  Cost of sales and related manufacturing expenses include direct costs of
product sales, payroll and related costs for manufacturing personnel, overhead
costs, reserves against inventory and depreciation. Cost of sales and related
manufacturing expenses were $2,321,000 and $383,000 for the quarters ended
June 30, 1997 and 1996, respectively, and $3,262,000 and $706,000 for the six
months ended June 30, 1997 and 1996, respectively. Due to the Company's
commencement of product sales in the current quarter ended June 30, 1997,
manufacturing costs were matched to the corresponding revenue or were included
in inventory prior to product sale for the three and six month periods ended
June 30, 1997. In the corresponding three and six month periods ended June 30,
1996 the Company was in the development stage, without revenue, and
manufacturing expenses did not include direct cost of product sales. As a
result, the prior periods may differ materially from, and may not be
comparable to, current or future periods. Cost of sales and manufacturing
expenses are expected to increase through 1997 as the Company increases sales
of its product and expands its manufacturing capacity and infrastructure to
produce its product in greater commercial quantities. The Company expects to
obtain efficiencies with the installation of new tooling equipment in 1997 and
thus expects to achieve a reduction in manufacturing costs per unit in future
periods. However, aggregate fixed manufacturing costs are expected to increase
due to the early stage of the Company's manufacturing process.
 
 Research and Development
 
  Research and development ("R&D") expenses include payroll and related costs
of employees engaged in ongoing design and development activities, fees to
outside contractors, early prototype development expenses,
 
                                       9
<PAGE>
 
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 $2,429,000 and $2,297,000 for
the quarters ended June 30, 1997 and 1996, respectively, and $4,436,000 and
$3,539,000 for the six months ended June 30, 1997 and 1996, respectively.
Increases over the periods have resulted from the incremental hiring of
personnel, increased use of engineering consultants and license fees and
similar costs associated with the acquisition of outside technologies. The
Company believes that a significant level of R&D expense is required due to
the technical nature of the product and the elaborate requirements of the game
development process. Accordingly, the Company anticipates devoting substantial
resources, including additional personnel, to R&D and that these costs are
expected to increase in absolute dollars 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 marketing
personnel, overhead costs, legal and associated costs, costs associated with
obtaining corporate and product licenses in various jurisdictions and fees for
professional services. SG&A expenses were $3,120,000 and $1,033,000 for the
quarters ended June 30, 1997 and 1996, respectively, and $5,246,000 and
$1,805,000 for the six months ended June 30, 1997 and 1996, respectively.
Increases over the periods result from the incremental hiring of personnel and
expenses associated with applying for corporate and product licensing in
various jurisdictions and costs associated with the establishment of sales and
marketing organizations as the Company commenced commercial distribution of
its product. SG&A expenses are expected to increase substantially in absolute
dollars as the Company invests in sales and marketing activities to launch its
product and in administrative personnel to support its growing infrastructure
and comply with regulatory requirements.
 
 Interest Income and Expenses
 
  Net interest income and expenses were $268,000 and $66,000 for the quarters
ended June 30, 1997 and 1996, respectively, and $680,000 and $67,000 for the
six months ended June 30, 1997 and 1996, respectively. Increases over the
periods result primarily from increased cash and investments in the current
periods, as compared to the comparable periods in the prior year. The Company
is currently exploring various debt financing alternatives, which, if pursued,
would result in substantial increases in interest expense.
 
 Income Taxes
 
  The Company has not been required to pay income taxes due to its net
operating losses in each period since inception. 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. Due to changes in ownership, as defined by Section 382 of the
Internal Revenue Code, that may have resulted from the sale of Series B and
Series C Redeemable Convertible Preferred Stock in private placements and the
sale of common stock in the Company's initial public offering, the annual
deductibility of a substantial portion of the Company's federal and state net
operating loss and tax credit carryforwards may be limited.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  To date, the Company has financed its operations primarily through the
issuance of common stock in its initial public offering, private placements of
Redeemable Convertible Preferred Stock and loans from shareholders which were
subsequently converted to Redeemable Convertible Preferred Stock. In August
1996, the Company completed its initial public offering in which the Company
received proceeds, net of underwriting discounts and offering expenses, of
$32,855,000. Through June 30, 1997, the amounts raised in the private
placements of Redeemable Convertible Preferred Stock, net of issuance costs,
totaled $22,943,000. Net cash provided by financing activities was $297,000
and $15,067,000 for the six months ended June 30, 1997 and 1996, respectively.
As of June 30, 1997, the Company had $15,747,000 of cash and equivalents and
short-term investments to fund operations, as compared to $35,266,000 as of
December 31, 1996. The decrease in cash
 
                                      10
<PAGE>
 
provided by financing activities and cash on hand is primarily due to
financing proceeds received from the private placements of Redeemable
Convertible Preferred Stock and the initial public offering in the prior year,
which was used in the current year.
 
  Net cash used in operating activities was $15,302,000 for the six months
ended June 30, 1997. Cash used in operating activities primarily reflects net
losses, partially offset by depreciation and amortization and changes to
working capital. The increase in cash used in operating activities is
primarily due to increased operating net losses and inventory on hand for the
current period. Net cash used in investing activities was $1,784,000 for the
six months ended June 30, 1997. Cash used in investing activities primarily
reflects the acquisition of fixed assets, primarily computer equipment and
software, which is offset in the current period by proceeds from the sale and
maturity of short-term investments.
 
  In the future, the Company expects to increase cash used in operating
activities in order to increase commercial production and distribution of its
product, enhance manufacturing capabilities, expand sales and support
operations, increase research and development activities and add
administrative infrastructure. The Company believes that its cash on hand,
together with proceeds from additional financing sources which the Company
believes are available, will be sufficient to meet its anticipated cash needs
for working capital, capital expenditures and business expansion until the
Company is capable of generating positive cash flow from operations. Cash flow
from the Company's initial commercial sales has been negatively affected by
the revenue participation plan that the Company is offering to its customers.
This plan allows the Company to share with its customers the aggregate win
generated by the machines, with 20% going to the Company, subject to a
predetermined minimum. The customer accumulates credits which may be applied
to the purchase of the machines after a 90 day minimum evaluation period.
Although the Company expects that this plan will generate significantly higher
revenue per unit than conventional sales, the cash flow generated by sales
under the plan is spread over the life of each machine. Accordingly, the
Company is currently exploring several means of raising capital to finance the
roll-out of its product and the expansion of its operations. No assurance can
be given that additional financing will be available or that, if available, it
will be available on terms acceptable to the Company or its shareholders. If
adequate funds are not available to satisfy either the short-term or long-term
capital requirements, the Company may be required to limit its operations
significantly. The Company's capital requirements will depend on many factors,
including, but not limited to, the rate at which the Company can introduce its
product, the market acceptance and competitive position of such product, the
extent to which the customers choose the revenue participation plan, the
response of competitors to the Company's product and the ability of the
Company to satisfy the licensing requirements in various jurisdictions
applicable to the Company, its product, and in some jurisdictions, its
officers, directors, employees or principal shareholders.
 
RISK FACTORS
 
  Uncertain Market Acceptance; Risk of Technical Errors; Single Product. To
achieve commercial success, the Company's product must be accepted both by
casino operators and gaming patrons. Because acceptance of the product by
casino operators will ultimately depend on win per machine, the Company
believes that its ultimate success will depend on player acceptance. The
Company's first gaming platform, Odyssey, has only been installed in casinos
for a limited period and the Company has only limited market studies and
player data to support its belief that Odyssey will be accepted by slot
players. There can be no assurance that Odyssey will be accepted by casino
patrons. Initial player interest in the product may be affected by its novel
design in addition to any inherent advantages it may have over competing
platforms and may therefore not be indicative of the long-term success of
Odyssey in the marketplace. Player preferences are highly subjective, vary
substantially among geographic and demographic markets and are subject to
unpredictable change. Because the Company's product offers features not found
on traditional slot machines, it may not appeal to players for whom
familiarity and predictability are important considerations.
 
  The Company sells its machines at prices that are substantially higher than
the prices of most competing products. In light of these higher sale prices,
coupled with the Company's status as a new and relatively small entrant in a
market dominated by larger companies, Odyssey's success will require that it
demonstrate superior,
 
                                      11
<PAGE>
 
as opposed to merely comparable, win per machine when compared to traditional
slot machines and other gaming platforms offered by more established
competitors. Although several casinos have agreed to purchase or to install
and evaluate the Company's product, any additional purchases of the product by
these casinos, or others that may conduct similar evaluations in the future,
will be subject to the superior performance of the product on the casino
floor.
 
  Odyssey has been licensed for manufacture, distribution and sale only in
Nevada and the Company has only recently commenced installing its machines on
casino floors. Because of the limited opportunity for the Company to test its
gaming platform under long-term play conditions, there can be no assurance
that a substantial technical difficulty with, or an undetected error in, the
Company's software or hardware will not arise, possibly resulting in
unanticipated costs, production delays or delays in product licensing.
 
  The Company's success will depend on the success of a single product.
Because sales of its slot machine and related software will comprise the
Company's only source of revenue in the foreseeable future, any interruption
in these sales due to a technical problem will prevent the Company from
earning revenue unless and until the cause of such interruption can be
remedied. Moreover, should Odyssey fail to win broad acceptance in the market,
the Company's business, financial condition and results of operations would be
materially and adversely affected, and investors would be exposed to the loss
of all or a substantial portion of their investment.
 
  Expectation of Losses; Negative Cash Flows. As of June 30, 1997, the Company
had cumulative net losses and the Company expects to continue to incur
substantial losses and negative cash flows at least through mid-1998. There
can be no assurance that the Company will become profitable or cash flow
positive at any time in the future. The likelihood of the success of the
Company must be considered in light of the expenses, difficulties,
complications and the competitive and regulatory environment in which the
Company must operate. To date, the Company's operations have focused primarily
on product development, and the Company has had limited experience in the
areas of manufacturing, sales, product distribution or customer support.
Accordingly, it is not possible to estimate future operating expenses and
revenue based upon historical operating performance. Operating results will
depend, in part, on matters over which the Company has little or no control,
including, without limitation, the ability of the Company to obtain the
licenses necessary to conduct its business, competition, the actual number of
orders for its product, gaming regulations and taxes.
 
  Capital Requirements. The Company believes that its cash and equivalents and
short-term investments, together with proceeds from additional financing
sources which the Company believes are available, will be sufficient to fund
its capital and operating requirements until the Company is capable of
generating positive cash flow from operations. The Company is currently
seeking to raise additional debt or equity financing to fund its product roll-
out, expand operations, and fund the adoption of its revenue sharing plan. The
cash flow generated under the revenue sharing plan is spread over the life of
each machine, and therefore has an adverse effect on the Company's working
capital compared to other pricing options. In addition to the financing the
Company is currently seeking, the Company may be required to seek additional
financing before it achieves positive cash flow. There can be no assurance
that the Company will be able to obtain such financing, or that, if it is able
to obtain such financing, it will be able to do so on satisfactory terms or on
a timely basis. If additional funds are raised through the issuance of equity,
convertible debt or similar securities, shareholders may experience
substantial dilution, and such securities may have rights or preferences
senior to those of Common Stock. Moreover, if adequate funds are not available
to satisfy the Company's short-term or long-term capital requirements, the
Company may be required to limit or discontinue its revenue sharing plan,
scale back its product roll-out, or limit its operations significantly. The
Company's capital requirements will depend on many factors, including, but not
limited to, the rate at which the Company can introduce its product, the
market acceptance and competitive position of such product, the extent to
which the customers choose the revenue participation plan, the response of
competitors to the product, and the ability of the Company's management and
its product to satisfy the corporate licensing and product licensing
requirements in various jurisdictions.
 
                                      12
<PAGE>
 
  Competition. The gaming machine industry is characterized by intense
competition that is based on, among other things, a device's ability to
generate win per machine through product appeal to players, and knowledge of
customer requirements such as ease of use, quality of service, support and
training, distribution, name recognition and price. In recent years, the
gaming machine market has been dominated by International Game Technology
("IGT") which, according to industry sources, captured approximately 75% of
the market in 1996. Because of its extensive market presence, distribution
capacity, player acceptance and financial, technological and other resources,
IGT represents formidable competition. Several other companies, including
Bally Gaming International, Inc. ("Bally Gaming"), are established in, or are
seeking to enter, the gaming machine business. Companies in historically
unrelated industries, such as Sega Enterprises Ltd. ("Sega"), have
technological resources that could offer them a competitive advantage in
developing multimedia-based gaming machines. In general, the Company's
existing competitors, as well as many potential new competitors, have
significantly greater financial and technical resources than the Company, as
well as more established customer bases and distribution channels, any of
which could afford them a competitive advantage in developing multimedia-based
gaming machines. Any success the Company might have may benefit existing
competitors and induce new competitors to enter the market. If Odyssey
displays a potential to capture a significant share of the gaming machine
market, the Company's competitors can be expected to employ a variety of
tactics to limit erosion of their market share, including price reductions,
acceleration new product development or acquisition of new, competitive
technologies. In the face of such tactics, there can be no assurance that the
Company will be a successful competitor in the gaming machine industry.
 
  Management of Growth. Execution of the Company's plan of operation will
require significant growth. The Company's current plans for growth will place
a significant strain on the Company's financial, managerial and other
resources. The Company's ability to manage its growth effectively will require
it to continue to improve its operational, financial and management
information systems and to attract, motivate and train key employees. If the
Company's executives are unable to manage growth effectively, the Company's
business, operating results and financial condition would be materially and
adversely affected.
 
  Dependence on Key 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.
Competition is intense for highly skilled product development employees in
particular. There can be no assurance that the Company will be successful in
attracting and retaining such personnel or that it can avoid increased costs
in order to do so. In addition, the Company's officers and key employees are
not bound by noncompetition 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 the services of key personnel
could have a material adverse effect on the Company's operating results and
financial condition. The Company currently maintains a "key-man" life
insurance policy in the amount of $3 million on the life of Andrew S. Pascal,
the Company's Executive Vice President--Marketing and Game Development.
 
  Limited Protection of Intellectual Property Rights; Risk of Litigation. 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 difficult and costly, and there
can be no assurance that the Company will be able effectively to protect its
technology from misappropriation by competitors. In addition, the protections
offered by trademark, copyright and trade secret laws would not prevent a
competitor from designing games having appearance and functionality that
closely resemble the Company's games. At present, the Company's principal
proprietary technology consists of its game authentication algorithm, which is
designed to prevent tampering with the game software that is resident in its
product, and its random number generator algorithm, which determines the
outcome of each gaming proposition. While the Company believes that these
algorithms are unique at present, there can be no assurance that a competitor
of the Company will not succeed in developing an authentication algorithm or a
random number generator algorithm that performs as well as, or better than,
the
 
                                      13
<PAGE>
 
Company's. Moreover, although the Company has applied for and received certain
patents and trademarks for its intellectual property, there can be no
assurance that such patents and trademarks will not be successfully challenged
in subsequent litigation.
 
  As the number of software products in the industry increases and the
functionality of these products further overlaps, software developers and
publishers 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 by a desire to disrupt the
Company's business. Although the Company is not currently aware of any claim
that it is infringing upon any intellectual property rights, there can be no
assurance that the Company will not face claims, with or without merit, in the
future. Any such claims or litigation could be costly and could result in a
diversion of management's attention, which could have a material adverse
effect on the Company's business and financial condition. Any settlement of
such claims or adverse determinations in such litigation could also have a
material adverse effect on the Company's business, operating results and
financial condition.
 
  Rapidly Changing Technology. The Company's product utilizes 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 competitor could be in a
position to outperform the Company in its ability to exploit developments in
microprocessor, video or other multimedia technology. The emergence of a suite
of slot machine games that is superior to the Company's in any respect could
substantially diminish the Company's product sales and thereby have a material
adverse effect on the Company's operating results.
 
  Limited Manufacturing Experience. In order for the Company to be successful,
its product must be manufactured to meet high quality standards in commercial
quantities at competitive prices. The Company has only recently begun to
manufacture Odyssey for commercial distribution and has had no prior
experience in large-scale manufacturing of gaming machines. The transition to
large-scale manufacturing of Odyssey will involve various risks and
uncertainties including unforeseen costs or assembly difficulties and the
possibility that anticipated efficiencies or economies of scale will fail to
materialize as the Company begins manufacturing in greater volumes. A failure
by the Company to successfully manage this transition would have a material
adverse affect on the Company's business, operating results or financial
condition.
 
  Dependence on Single-Source Suppliers. The Company currently obtains a
number of its system's components from single-source suppliers. In particular,
the touchscreen and picture tube that comprise the video display are supplied
by MicroTouch 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 failure or delay by any
supplier to furnish the Company with required components would have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
  Slowing in Trend to Legalize Gaming. Growth in demand for slot machines
historically has been driven by the opening of new casinos, including casinos
in jurisdictions where gaming has recently been legalized. 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. There can be no assurance that the slot
machine industry will sustain the rate of growth that was possible in the
first half of this decade.
 
                                      14
<PAGE>
 
  Regulatory Approval. The Company will be required to obtain and maintain the
necessary licenses, approvals, findings of suitability and product approvals
in all jurisdictions in which it intends to distribute its product. The
licensing and approval processes can involve extensive examination of the
Company and its officers, directors, employees, principal shareholders and
product, and can require significant expenditures of time and resources by the
Company. Distribution of gaming devices in U.S. gaming jurisdictions generally
requires both corporate approval and product approval. The Company and certain
of its subsidiaries have received the requisite corporate approvals in Nevada,
Mississippi, Missouri and Colorado. The Company has also applied for corporate
approval in New Jersey and intends to file for approval in other jurisdictions
where its product can be sold legally. Odyssey was approved for sale in Nevada
on March 20, 1997. The Company has submitted Odyssey for testing in
Mississippi and New Jersey and with Gaming Laboratories International, Inc.,
an independent testing facility. There can be no assurance that Odyssey will
be approved in any additional jurisdiction. The regulations relating to
company and product licensing are subject to change, and other jurisdictions,
including the federal government, may elect to regulate or tax gaming
activities. The Company cannot predict the nature of any such changes or their
impact on the Company. In addition to the initial product approval, the
Company is required to submit all software and hardware modifications to the
various regulatory laboratories. These modifications normally take between 30
and 45 days to process.
 
  Any beneficial holder of the Company's Common Stock may be subject to
investigation by any gaming authority in any jurisdiction in which the Company
does business if such authorities have reason to believe that such ownership
may be inconsistent with the gaming policies of that jurisdiction. Persons who
acquire beneficial ownership of more than certain designated percentages of
the Common Stock may be subject to certain reporting and qualification
procedures. In addition, changes in control of the Company and certain other
corporate transactions may not be effected without the prior approval of
gaming authorities in other jurisdictions in which the Company plans to do
business. Such provisions could adversely affect the marketability of the
Company's Common Stock or prevent certain corporate transactions, including
mergers or other business combinations.
 
  In order to comply with the existing technical standards in certain gaming
jurisdictions including Nevada and Colorado, the Company currently stores its
game software and Machine Management System on an internal hard disk drive
which is not alterable through the circuitry or programming of the gaming
device itself. In the future, the Company intends to pursue the use of a
writeable internal disk drive in order to facilitate the electronic
distribution of software and to retain large quantities of game play history.
The interpretation of this feature in Odyssey will require a modification of a
technical standard by the Nevada gaming authorities to permit the use of
writeable game storage media in slot machines. Although the Company believes
that the Nevada gaming authorities may eventually modify this technical
standard in such manner, there can be no assurance that such modification will
occur in the near future or at all, or that a similar modification will be
made to the regulations of any other jurisdiction.
 
  No Dividends. The Company has not paid any cash dividends in the past and
does not expect to do so in the foreseeable future.
 
                                      15
<PAGE>
 
                          PART II--OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
  Inapplicable.
 
ITEM 2. CHANGES IN SECURITIES
 
  Certain holders of the Company's Series A1 and Series B1 Nonvoting
Redeemable Convertible Preferred Stock ("Nonvoting Preferred") have converted
an aggregate of 674,180 shares of Nonvoting Preferred to an aggregate of
449,453 of Common Stock during the quarter ended June 30, 1997.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
  Inapplicable.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  The Company's 1996 Annual Meeting of Shareholders was held on May 20, 1997.
At the meeting the following six persons nominated by management were elected
to serve as directors of the Company:
 
<TABLE>
<CAPTION>
                                                                    SHARES
                                                              ------------------
     NOMINEE                                                  VOTED FOR WITHHELD
     -------                                                  --------- --------
     <S>                                                      <C>       <C>
     Donald J. Massaro....................................... 8,459,527  10,783
     Robert M. Fell.......................................... 8,421,995  48,315
     William Hart............................................ 8,459,227  11,083
     Kevin R. Harvey......................................... 8,459,527  10,783
     David S. Morse.......................................... 8,459,527  10,783
     Joseph T. Piemont....................................... 8,459,027  11,283
     Thomas J. Volpe......................................... 8,459,527  10,783
</TABLE>
 
  The following additional items were voted upon at the meeting:
 
    1. A proposal to amend the Company's 1994 Stock Option Plan to increase
  the number of shares of Common Stock reserved for issuance thereunder by
  500,000 shares, to increase the maximum number of shares of Common Stock
  available for issuance upon exercise of incentive stock options and to
  limit to 500,000 shares the number of shares of Common Stock subject to
  options that may be granted to any employee of the Company during any
  fiscal year was approved by a vote of 7,345,689 shares for, 1,018,317
  shares against, 23,470 shares abstaining and 82,834 broker non-votes.
 
    2. A proposal to ratify the appointment of Deloitte & Touche, LLP as
  independent auditors of the Company for the fiscal year ending December 31,
  1996 was approved by a vote of 8,461,100 shares for, 6,175 shares against,
  3,035 shares abstaining and 0 broker non-votes.
 
ITEM 5. OTHER INFORMATION
 
  Certain holders of the Company's Series A1 and Series B1 Nonvoting
Redeemable Convertible Preferred Stock ("Nonvoting Preferred") have notified
the Company of their election to convert shares of Nonvoting Preferred to
Common Stock. Each share of Nonvoting Preferred is convertible into .6667
shares of Common Stock upon 75 days' prior written notice. Pursuant to these
conversion notices, 100,000 shares of Common Stock were issued in July 1997
and an additional 431,579 shares of Common Stock will be issued in August 1997
upon conversion of shares of Nonvoting Preferred.
 
                                      16
<PAGE>
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
  (a) Exhibits.
 
<TABLE>
<CAPTION>
     NUMBER EXHIBIT DESCRIPTION
     ------ -------------------
     <C>    <S>
      11.1  Statement Regarding Computation of Pro Forma Loss Per Share
      27    Financial Data Schedule
</TABLE>
 
  (b) Reports on Form 8-K.
 
    None.
 
                                       17
<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.
 
                                                   /s/ Thomas E. Carlson
                                          By __________________________________
                                                     THOMAS E. CARLSON
                                              VICE PRESIDENT--CHIEF FINANCIAL
                                                          OFFICER
                                              (PRINCIPAL FINANCIAL AND CHIEF
                                                    ACCOUNTING OFFICER)
 
Date: August 14, 1997
 
                                       18