UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC 20549




Form
10-K


(Mark
One)


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




For the
fiscal year endedSeptember 30, 2009




 ̈
            TRANSITION REPORT UNDER SECTION
      13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
  1934




For the
transition period from ___________ to ___________




Commission
file number 000-28318


Multimedia
Games, Inc.


(Exact
Name of Registrant as Specified in Its Charter)




Texas
            74-2611034(State
      or Other Jurisdiction ofIncorporation
      or Organization)
            (IRS
      EmployerIdentification
      No.)206
      Wild Basin Road, Building B,Fourth
      FloorAustin,
      Texas
            78746(Address
      of Principal Executive Offices)
            (Zip
      Code)




Registrant’s Telephone
Number, Including Area Code:(512)
334-7500




Registrant’s
website:www.multimediagames.com




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


None




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


Common
Stock, $0.01 par value






Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes   ̈    No  x




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act.  Yes   ̈    No  x




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   ̈




1




Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T(Section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files):   Yes
 ̈  No
 ̈




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




Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act:




Large Accelerated Filer  ̈                                                 Accelerated
Filer ý




Non Accelerated Filer  ̈                                                   Smaller
reporting company  ̈




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).   Yes   ̈    No  x




The
aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant computed by reference to the price at which
common equity was last sold as of the last business day of the registrant’s most
recently completed second fiscal quarter (March 31, 2009) was $56,098,340
(assuming, for this purpose, that only directors and officers are deemed
affiliates.)




As of
December 10, 2009, the registrant had 27,249,870 outstanding shares of
common stock.




DOCUMENTS
INCORPORATED BY REFERENCE




Certain
portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the 2010 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Form 10-K.




2




This
Annual Report on Form 10-K contains forward-looking statements reflecting
Multimedia Games’ current forecast of certain aspects of our future. It is based
on current information that we have assessed but which by its nature is dynamic
and subject to rapid and even abrupt changes. Forward-looking statements include
statements regarding future operating results, liquidity, capital expenditures,
product development and enhancements, numbers of personnel, customer and
strategic relationships with third parties, our strategy, the ability of the new
management team to further develop, implement, and execute on any newly
identified strategic plan, legal and regulatory uncertainties, including
outcomes of litigation, the effects of such outcomes upon our business, changes
in existing laws and regulations or in the interpretation of such laws and
regulations, the effects of competition in the Class II market from games
that we believe are non-Class II games, and the effects of uneven
enforcement policies by the National Indian Gaming Commission in challenging
such non-Class II games. The forward-looking statements are generally
accompanied by words such as
“plan,” “estimate,” “expect,” “intend,” “believe,” “should,” “would,” “could,” “anticipate,”
or other words that convey the uncertainty of future events or outcomes. Our
actual results could differ materially from those stated or implied by our
forward-looking statements, due to risks and uncertainties associated with our
business. These risks are described throughout this Annual Report on Form 10-K,
which you should read carefully. We particularly refer you to the section under
the heading “Risk Factors” for an extended discussion of certain of the risks
confronting our business. The forward-looking statements in this Annual Report
on Form 10-K should be considered in the context of these risk factors. We
disclaim any intention or obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or
otherwise.






PART
I


ITEM 1.  Business




General




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





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





We derive
the majority of our gaming revenues from participation, or revenue share,
agreements.  Under our participation agreements, we place player
terminals and systems, along with our proprietary and other licensed game
content, at a customer’s facility in return for a share of the revenues that
these terminals and systems generate.  As of September 30, 2009, we
have 16,152 gaming units in operation domestically and internationally which are
installed pursuant to revenue share arrangements.  To a lesser extent,
we generate revenues from the sale of gaming units and systems though we are
seeking to expand our use of for-sale revenues as we expand into additional
gaming jurisdictions and into other segments of the gaming market.  We
also generate revenues from our provision of the central determinant system for
approximately 12,500 video lottery terminals installed at racetracks in the
State of New York and operated by the New York State Division of the
Lottery.




3





The
following table sets forth our end-of-period installed player terminal base by
quarter and by product line for each of the five most recent
quarters:





Quarter
              Ended
            
            Class III
              Units (1)
            
            
            Total
              Class
      II
              & Other (2)
            
            
            Mexico
              Electronic
              Bingo Units
            
            
            Charity
              Units
            
            
            Total
              Units9/30/09
            
            
            6,413
            
            
            
            2,020
            
            
            
            5,401
            
            
            
            2,318
            
            
            
            16,1526/30/09
            
            
            6,708
            
            
            
            2,486
            
            
            
            5,727
            
            
            
            2,280
            
            
            
            17,2013/31/09
            
            
            6,697
            
            
            
            2,694
            
            
            
            5,125
            
            
            
            2,273
            
            
            
            16,78912/31/08
            
            
            6,605
            
            
            
            2,766
            
            
            
            5,488
            
            
            
            2,379
            
            
            
            17,2389/30/08
            
            
            5,655
            
            
            
            2,778
            
            
            
            5,133
            
            
            
            2,311
            
            
            
            15,877




(1)
            Includes
      50 units installed in Rhode Island. The balance of the unit totals
      for both periods reflects the placement of units pursuant to the approved
      gaming compact between Native American tribes, racetracks and the State of
      Oklahoma, including stand-alone games of Multimedia Games’ and other
      vendors.




(2)
            At
      September 30, 2008, December 31, 2008,
      March 31, 2009, June 30, 2009 includes 252 traditional
      electronic bingo games installed in certain international markets. At
      September 30, 2009, no traditional electronic bingo games were
      installed in certain international
markets.





Additional
financial information relating to industry segments appears in Note 1 of
the notes to our consolidated financialstatements incorporated byreference
herein.




Multimedia
Games, Inc. was incorporated in Texas on August 30, 1991.  Unless
the context otherwise requires, the terms “Company,” “MGAM,” “Multimedia,” “we,”
“us,” and “our” include Multimedia Games, Inc., and our wholly-owned
subsidiaries: MegaBingo, Inc.; MGAM Systems, Inc.; Innovative Sweepstakes
Systems, Inc.; MGAM Services, LLC; MGAM Systems International, Inc.; MegaBingo
International, LLC; Multimedia Games de Mexico 1, S. de R.L. de C.V.;
and Servicios de Wild Basin S. de R.L. de C.V.  Our
executive offices are located at 206 Wild Basin Rd., Bldg. B, Fourth
Floor, Austin, Texas, 78746, and our telephone number
is (512) 334-7500.




MARKETS
AND PRODUCTS




Class III (Oklahoma, Rhode
Island and Market Expansion)





Our
largest Class III market and largest overall market is
Oklahoma.  Class III compacted games in Oklahoma are referred to as
“Oklahoma Compact” games in our consolidated financials.  For the
fiscal year ending September 30, 2009, our operations in Oklahoma accounted for
approximately 64% of our total revenues.  Of the total revenues
generated from our Oklahoma operations, approximately 72% was generated by our
average participation installed base of 6,364 Class III gaming machines in the
state. During the same period of 2008 and 2007, our Class III operations in
Oklahoma accounted for 58% of our total revenues.  Furthermore, 42% of
our total revenue in the fiscal year ending September 30, 2009, was generated by
a single tribe in Oklahoma, the Chickasaw Nation, as compared to 39% and 42% of
our total revenues in the same period of 2008 and 2007,
respectively.





In fiscal
2007, we began to expand the scope of our Class III offerings and embarked on an
initiative to push our Class III offerings into additional Native American
jurisdictions as well as the commercial casino marketplace.  We
currently have 50 Class III units placed in a casino in Rhode Island and are
working to secure licensing approval to place our Class III games and systems in
a number of new jurisdictions across the United States.  The licensing
process includes specific jurisdictional approvals from the appropriate testing
laboratory and from the appropriate regulatory agency.  We currently
have Class III placements in California where we are participating in a number
of trials and have several full-scale deployments.  In addition, we
have, to date, secured licensing to offer Class III gaming units with 53 tribes
in 10 states.  We expect to be licensed in several additional Class
III markets during fiscal 2010 and in more jurisdictions over the next several
years.  We believe that we will successfully deliver player terminals
to new Class III markets throughout fiscal 2010 and beyond and expect
additional placements in the commercial marketplace as well, going
forward.





Class III
(Washington)




Our Class
III business in Washington is governed by tribal compacts between the Native
American tribes in Washington and the state.  We sell, rent and lease
Class III gaming equipment to Native American customers and also receive a small
fee for the use of our back-office systems.




4




We
provide a growing number of proprietary games to our customers in Washington
State and supplement these offerings with third party titles from several
manufactures.  In addition, our player terminals are available in a
variety of freestanding and cabinet styles.  Backing up our
installations in Washington is our back-office system that allows customers to
maintain end-user information, details of ticket manufacture, distribution and
sales along with monitoring game operation and generating system
reports.




Class II




The Class
II market is associated with Native American gaming in the United
States.  To service this marketplace, Multimedia Games provides its
customers with a variety of linked player terminals, interactive electronic
games and back-office systems.  We currently have Class II gaming
units deployed in Oklahoma, Washington, California, Alabama, Texas, Wisconsin
and New York.  Our products are high-speed and feature a mix of
proprietary and in-demand third party content that enables us to deliver an
entertaining gaming experience.  In addition, we provide innovative
gaming systems that allow us to operate efficiently and deploy new game engines
on a regular basis, game engines that allow us to use differing themes around
the same underlying base game and back-office systems that enable our customers
to track the performance of their slot floor and adjust it to ensure the optimal
gaming experience for their customers.  A nationwide broadband network
links our Class II game, allowing us to deliver games in real-time and lessening
the time needed to establish a quorum since, by definition, a bingo game needs
more than one player to operate.




Based on
our expertise in Class II gaming and our recently implemented game development
process, we believe the Class II market continues to present an opportunity for
Multimedia Games to expand our market share in
Class II jurisdictions.  Our current portfolio of Class II
games demonstrates our cumulative experience and our ability to deliver
entertaining, reliable games that provide our customers with attractive
financial benefits.  Our experience in Class II began in May 1996 when
we introduced our Legacy gaming system and game engines with the launch of
MegaMania®, which was, at the time, the first online, interactive bingo system
played by multiple players in a single casino.  Over time, we began
linking multiple facilities and replaced the live draw with an electronic draw,
reducing the amount of time needed to play a single game from two minutes to one
minute.  We updated our Class II system in January 2001 with the
launch of MegaNanza®, in June 2002 with the launch of Reel Time Bingo®, in
November 2003 with the launch of our Gen IV system and finally in July 2005 with
the launch of our Gen5 product.  The collective knowledge built into
these systems allows us to deliver a Class II experience that we believe is
unique to the industry.





We design
player terminals for the Class II marketplace and also deliver licensed game
themes in addition to our own proprietary titles.





Electronic Bingo
(International)





We
entered into Mexico, our most significant international market, in March 2006 by
providing Apuestas Internacionales, S.A. de C.V., or Apuestas, a subsidiary of
Grupo Televisa, S.A., with traditional and electronic bingo gaming, technical
assistance and related services for Apuestas’ locations in
Mexico.  Under its current permit from the Mexican Ministry of the
Interior (Secretaria de Gobernación), Apuestas may open and operate up to 65
gaming establishments.  As of September 30, 2009, we had installed
5,321 player terminals at 26 gaming establishments, with all player terminals
placed pursuant to a revenue share arrangement which is similar to our revenue
share arrangements with some of our domestic customers.  In addition
to our agreement with Apuestas, we have installed 80 player terminals at an
additional establishment in Mexico, under which we provide traditional and
electronic bingo gaming, technical assistance and related services.  We
derived approximately 8% of our total revenue from our operations in Mexico in
2009, compared to 8% in 2008 and 4% in 2007.





Central Determinant
System





Our
central determinant business began in January 2004 and is principally based with
the New York Lottery.  We provide the New York Lottery with a central
determinant system for the video lottery terminal network that the New York
Lottery operates at licensed New York State racetracks.  This central
determinant system currently connects to approximately 12,500 video lottery
terminals and has the ability to interface with, provide outcomes to, and manage
player terminals provided by third party providers.  Pursuant to our
agreement with the New York Lottery, we receive a portion of the network-wide
hold per day in exchange for our provision and maintenance of the central
determinant system.  In June 2009, the New York Lottery awarded us
with a seven-year contract extension which extends the agreement through
December 2017 and provides us an opportunity to expand our network as the New
York Lottery licenses additional race track gaming facilities in the State of
New York. We believe that we will be able to achieve future growth in the
central determinant market by leveraging our experience in New York, California
and Washington.




5





Electronic Bingo
(Charity)





Charity
gaming consists of bingo and other electronic gaming operated by and/or for the
benefit of nonprofit organizations for charitable, educational and other lawful
purposes.  Our charity gaming units are deployed in Alabama and
Minnesota  Our player terminals and systems in this segment are
generally placed in facilities under participation arrangements and receive a
percentage of the hold per day generated by each of the player
terminals.





The
Alabama Supreme Court, in a recent decision, established a definition of “bingo”
that included a limited set of standards for charity bingo games in
Alabama.  We are in the process
ofmaking
modifications to our gamesin the Alabama
market, which we believe will comply with these standards in advance
of the anticipated, near term mandatory implementation of these
standards.  Notwithstanding our initiatives to have our games comply
with the specified standards, there can be no assurance that we will not
encounter further legal, regulatory, financial, or competitive issues related to
this matter.  We believe that our modified games comply with the
standards established by the recent Alabama Supreme Court decision and have
submitted our games to independent gaming laboratories to have each game
certified as compliant with the standards. See Item 1A. - Risk Factors- "Our charitable bingo
operations in Alabama are subject to legal uncertainty."




OUR
STRATEGY




Seek to diversify
our revenue streams beyond participation placements: Over the course of
our history, revenue generation has primarily been tied to placements of
participation games on the slot floors of our customers’ gaming
facilities.  These placements entitle us to a percentage of the hold
per day generated by each of our player terminals and, as such, tie us closely
to the success of our customers.  As of September 30, 2009, our
installed base of units on participation totaled 16,152 games.  As we
move forward, we are seeking to reduce our reliance on participation placements
by expanding our business model to include the sale of player terminals and game
content, systems and service agreements.  We also continue to analyze
opportunities to work with casino operators on development
agreements.  Historically, we have been successful in establishing
long-term development agreements with several key customers, which have helped
to expand our customer base and installed base of player
terminals.  Typically, we seek contractual commitments regarding the
placement of player terminals under participation agreements at the gaming
facility in question.





Continue to
launch Class III offerings in additional jurisdictions: While we are
expanding our portfolio of Class III games to encompass additional categories
and include new game themes, we are also working to expand our total addressable
market by targeting new gaming jurisdictions across the United States that build
on our efforts in Oklahoma, Rhode Island and Washington.  To
accomplish this goal, we have recently secured licenses in California, Minnesota
and Ontario, and are currently in various stages of pursuing new licenses in a
number of states, including: Connecticut, Florida, Iowa, Louisiana, Michigan,
Mississippi, Missouri, Nevada, New York (tribal), Wisconsin, Indiana and Kansas
(tribal).  In an effort to more effectively address these new
jurisdictions, we are also planning to expand our business model to include
higher levels of unit sales (in addition to our traditional participation
model). Our marketing efforts are focused on providing games that deliver high
levels of performance for our customers.  We believe our newest
products, discussed in more detail below, will help expand our footprint in new
jurisdictions and ultimately increase the total number of machines we can sell
and the total number of customers we can sell to.





Focus on niche
products for Class III markets: We are looking to build on the early
success of our entry into the Class III market with a growing line of new
products, including:





§
            The Player
      HDTM cabinet.  The Player HDTM cabinet series, launched in
      2008, is our premium player terminalIt features cutting-edge technology in
      a compact depth unit, including a pair of high-resolution 23-inch LCD
      video displays and a premium “focused sound” system that features 3-way
      speakers from Cambridge SoundWorks® for an immersive, entertaining gaming
      experience that can take advantage of our newest proprietary gaming
      content.




§
            Community
      games. We are expanding our portfolio of Class III products to
      include offerings for the emerging community gaming segment of the slot
      floor.





6




§
            TournEventTM.  TournEventTM,
      formerly known as Casino Commander® Tournament System, helps transform the
      traditional process through which operators converted their slot floors
      into tournament venues.





§
            Class III
      video and mechanical reel games.  We have 13 proprietary
      Class III video reel game titles.  These titles include specific
      proven performers in the Class II market that have been modified for Class
      III and a growing line of titles developed specifically for Class
      III.  We also recently introduced our first 5-reel mechanical
      reel games with three themes.  Our Class III games are typically
      offered in the Player HD gaming
cabinet.





Focus and improve
the efficiency of game development. We have incorporated a new game
development strategy and our studios are now more efficiently focused on quality
over quantity, incorporating customer and player feedback in the process and
developing significantly fewer, but more researched, games per year (in the
fiscal year ending September 30, 2009, we developed 29 new Class III
titles).  We believe this strategy will ultimately result in more
entertaining content for our players and improved performance for our
customers.





Provide superior
customer service through our back-office systems:We plan to continue to
provide innovative customer service though our back-office systems and
technology.  All of our player terminals and central determinant
systems include our MGAMe® back-office systems that
provide accounting, management and information services to our customers, who
are then able to monitor all aspects of their gaming activities in real-time at
the player terminal, game and gaming facility level.  Our systems
normally include a database server that archives details of distribution and
sales, as well as end-user information used by the gaming facilities for
marketing and player tracking.  Our typical system also includes a
management terminal that can monitor game-system operation and generate system
reports.  As part ofMGAMe®, we also offer a player-tracking system that allows facilities to
track the playing preferences of those individual end users who have elected to
participate in that facility’s player-tracking program which also provides us
with valuable design insights into game features that may be added to future
games and terminals.  In this way, our customers often use MGAMe® as a marketing tool
since it allows them to know which patrons are playing games in their facility,
all in real-time.





Continually
improve our product portfolio: We are working to improve our leadership
position through a variety of avenues.  First, we are focusing on
updating our existing product portfolio to incorporate the latest in
technology.  Second, we are working in our game development studios to
expand our proprietary game library to incorporate the needs and desires of slot
players in an effort to deliver to them an experience they will find both
exciting and entertaining.  Third, our development studios are focused
on innovation with new products that enhance the customer
experience.





Establish a
studio model for our game development organization and increase our reliance on
concept testing: At the core of our efforts to develop a wider range of
Class III games and systems for tribal and commercial casinos and improved Class
II product offerings lies our game development organization.  In an
effort to improve the quality of the proprietary games we can offer, expand our
capabilities and organize those capabilities by product line, we have revamped
our development studios in order to allow such studios to work hand-in-hand with
our expanded game development efforts and a newly established model for the
testing of game concepts.  We believe that creating a process which
links idea generation, theme testing, prototype creation, beta testing and
commercialization will help us deliver games that are more attractive, more
entertaining and ultimately, better for our customers.





Offer
new Class II products that benefit our tribal customers:
Historically, our business has been reliant on our efforts in the Class II
gaming space and this market remains an important part of our focus on product
excellence.  We continue to work on new Class II products and
plan to leverage third-party offerings, where appropriate, to support expanding
or retaining customer relationships.  Furthermore, we plan to further
enhance the overall level of gaming solutions we provide to our Class II
gaming customers with the overriding goal of enhancing our net gaming
revenue.  In particular, we are developing a Class II version of our
TournEvent tournament
system which we believe offers an attractive solution for our
customers.  While we are directing an increasing amount of effort
towards the development of Class III products, we believe it is vital to
continue to support our Class II installed base and Class II
customers.





Expand presence in
the video lottery terminal market with our system-based
products: We currently provide video lottery technologies to Native
American tribes in the state of Washington and provide the central determinant
system for the New York State Lottery’s video lottery terminal offerings at
eight racetracks in the state.  Pursuant to the terms of the New York
State Lottery agreement, we do not provide games but rather receive a portion of
the network-wide hold per day in exchange for our provision and maintenance of
the central determinant system.  We plan to leverage our expertise in
the operation of video lottery systems to pursue agreements in other markets, as
such markets and jurisdictions become available to us.




7





COMPETITION





We
compete in a variety of gaming markets with equipment suppliers who vary in size
from small to large.  Competition in our markets is generally on the
basis of the amount of profits our products generate for our customers relative
to the amount of profits generated by the products offered by our competitors as
well as the prices and/or fees we and our competitors charge for products and
services offered.  We believe that in addition to economic
considerations, the most important factor influencing our customers’ product
selection is their appeal to end users.  This appeal has a direct
effect on the volume of play by end users and drives the amount of revenue
generated for our customers.  To drive customer demand and improve
product attractiveness to end users, we are continually working to develop new
game themes, gaming engines, hardware platforms and systems, all while releasing
these new products to the marketplace in a timely manner.  See Item 1A - Risk
Factors.





As we
move more deeply into the Native American and commercial Class III casino
markets, we expect competition for our products and services to increase, which
will have a direct impact on our ability to control our pricing
model.  To offset this increased competition, we plan to regularly
introduce a variety of new gaming platforms and systems, new proprietary content
and new proprietary stand-alone player terminals that we believe will appeal to
our customers’ end users.  However, we believe that the net revenue
retained by our customers from their installed base of player terminals will
remain the most significant factor in the competitive environment, one that may
require us to change the terms of our participation arrangements with customers
to remain competitive.





Competition
in our industry includes Video Gaming Technologies, Inc. (VGT), International
Game Technology (IGT), the leader in the North American gaming equipment supply
market, WMS Industries, Inc. (WMS), Bally Technologies, Inc. (Bally), Aristocrat
Technologies, Inc. (Aristocrat) and Konami Co. Ltd (Konami).





RESEARCH
AND DEVELOPMENT





We
conduct research and development activities primarily to develop new gaming
systems, gaming engines, player tracking systems, casino data management
systems, central video lottery systems, gaming platforms and content and to add
enhancements to our existing product lines.  We believe our ability to
deliver differentiated, appealing products and services to the marketplace is
based in our research and development investments and we expect to continue to
make such investments in the future.  These research and development
costs consist primarily of salaries and benefits, consulting fees and an
allocation of corporate facilities costs related to these
activities.  Once the technological feasibility of a project has been
established, it is transferred from research to development, and capitalization
of development costs begins until the product is available for general
release.





For the
year ended September 30, 2009, research and development expense
decreased by 36% to $10.3 million, from $16.2 million in the same
period of 2008 and $18.1 million for the same period of 2007.





INTELLECTUAL
PROPERTY





We rely
on patents, copyrights, trademarks, trade secret laws, license agreements and
employee nondisclosure agreements to protect our various proprietary rights and
technologies.  Since these laws and contractual agreements provide us
with limited protection, we actively rely on our proprietary expertise and
technological innovation to continually develop new products and systems in
order to maintain our competitive position.  While we also rely on
trade secrets, un-patented know-how and innovation, we cannot be certain that
others will not independently develop similar technology or that our secrecy
will not be breached.





We have
47 patents issued and 58 patents pending in the United States.  In
addition, we also have a number of patents pending overseas that correspond to
some of our patents and patents pending applications in the United
States.  We have 240 registered trademarks and 22 pending in the
United States.  See Item 1A - Risk Factors –
“We may not be successful in protecting our intellectual property rights, or
avoiding claims that we are infringing upon the intellectual property rights of
others.”





EMPLOYEES





At
September 30, 2009, we had 412 full-time and part-time employees,
including 185 engaged in field operations and business
development, 152 in system and game development, 22 in sales
and marketing, 20 in accounting and 33 in other general
administrative and executive functions.  We do not have a collective
bargaining agreement with any of our employees and we believe our relationship
with our current employees is good.




8





GAMING
REGULATIONS/LICENSING STRATEGY





We
believe we hold all of the licenses and permits necessary to conduct business in
62 jurisdictions (commercial and tribal) following the recent addition of Class
III tribal casinos in California.  While the regulatory requirements vary
from jurisdiction to jurisdiction, most require:





§
            Documentation
      of qualification, including evidence of financial
    stability;


§
            Findings
      of Suitability for the Company, as well as its officers and directors;
      and


§
            Gaming
      equipment and game approvals following testing and certification by
      testing labs.




Laws of
various gaming regulatory agencies serve to protect the public and ensure that
gaming-related activity is conducted honestly and free from
corruption.   Regulatory oversight ensures local authorities receive
the appropriate amount of gaming tax revenues.  As such, our financial
systems and reporting functions are required to demonstrate  high
levels of detail and integrity. We are
working to expand our total addressable market by targeting new gaming
jurisdictions across the United States that build on our efforts in Oklahoma,
Rhode Island and Washington.  To accomplish this goal, we have
recently secured licenses in California, Minnesota and Ontario, and are
currently pursuing new licenses in a number of states, including: Connecticut,
Florida, Iowa, Louisiana, Michigan, Mississippi, Missouri, Nevada, New York
(tribal), Wisconsin, Indiana and Kansas (tribal).




Federal
Regulation





In
general, we are subject to a wide range of federal, state and Native American
laws and regulations that affect our general commercial relationships with our
Native American tribal customers and the products and services we
provide.  As we seek to enter the traditional commercial gaming
marketplace, we will also be subject to increased state regulatory requirements
that will require more in-depth state-by-state licensing and
oversight.  Furthermore, we are also subject to a range of state and
local regulations in the markets where we provide products and services for
charity bingo markets.





At the
federal level, we are subject to two key pieces of legislation.  Our
Native American customers are regulated by the National Indian Gaming Commission
(NIGC), which was established by the Indian Gaming Regulatory Act of 1988
(IGRA).  The NIGC has regulatory authority over certain aspects of
Native American gaming and defines the boundaries of our dealings with the
Native American marketplace and the level of regulatory authority these games
are subject to.





The
Federal Gambling Devices Act of 1962 (the Johnson Act) requires us to register
annually with the Criminal Division of the United States Department of Justice
and requires a wide variety of record-keeping and equipment-identification
efforts on our part.  Registration is required in order for us to
sell, distribute, manufacture, transport and/or receive gaming equipment,
machines or components across state lines.  If we fail to comply with
the requirements set forth under the Johnson Act, we could become subject to a
variety of penalties, including, but not limited to, the seizure and forfeiture
of equipment.





State
Licensing





In
various states where we conduct business, we are subject to state-by-state
licensing requirements .  Furthermore, we seek and obtain
determinations from each tribe’s gaming commission that our next-generation
Class II games comply with the definition set forth by IGRA prior to our
installation of these games at the tribe’s gaming facility.  Outside
the landscape of Native American gaming, we are licensed by the State of
Washington to sell Class III video lottery systems and to conduct
Class III gaming in that state, and we are licensed by the state of
Louisiana as a manufacturer of charitable gaming equipment.  In
Minnesota, we are licensed by the state as a linked bingo prize
provider.  We are also licensed by the State of New York for the
purpose of providing the central-determinant-driven video lottery system
operated at certain racetracks.





Tribal-State Compacts and
Tribal Regulation





Native
American gaming is subject to the review of the NIGC.  Native American
tribes must adopt and submit for NIGC approval the ordinances that regulate
their gaming activities.  Pursuant to the requirements of IGRA, our
tribal customers require the tribe to have the “sole proprietary interest” in
their gaming activities.




9





Class III
gaming on Native American tribal lands is subject to the negotiation of a
compact between the tribe and the state in which they plan to operate a gaming
facility.  These tribal-state compacts typically include provisions
entitling the state to receive a portion of the tribe’s gaming
revenues.  While tribal state compacts are intended to document the
agreement between the state and a tribe, these tribal state compacts can be
subject to disputes relative to permitted Class III gaming operations.
Currently, we operate in three states (Oklahoma, Washington and California)
where compacts significantly affect our business.





Oklahoma:
In 2004, the Oklahoma Legislature authorized certain forms of gaming at
racetracks and gaming at tribal facilities pursuant to tribal-state
compacts.  Class III gaming in Oklahoma was authorized in 2004 by the
state legislature to include facilities at racetracks and on Native American
lands, subject to tribal-state compacts.  While the racetrack
facilities can operate a limited number of instant and bonanza-style bingo games
and electronic amusement games, the compacts between the Native American tribes
and the state allow tribal facilities to include an unlimited number of
electronic instant and bonanza-style bingo games, electronic amusement games and
non-house-banked tournament card games.  Vendors placing games at any
of these facilities are required to gain state licensing approval as well as
licensing approval from each individual tribe.  Furthermore, all
electronic games must receive certification from independent testing
laboratories and are subject to technical specifications maintained by the
Oklahoma Horse Racing Commission and the individual tribal gaming
authorities.





Washington.
Our activities in Washington State are governed pursuant to compacts between the
state government and Native American tribes located in Washington.  We
offer a range of Class II and Class III player terminals to our customers in
Washington that are operated in conjunction with local central determinant
systems as described above.  Compacts between the state and tribes are
recognized by IGRA to permit Class III gaming.





Charity
Regulation





We supply
bingo games and systems to nonprofit organizations that operate these games for
charitable, educational and other lawful purposes.  Bingo for charity
is not subject to a nationwide regulatory system such as the system created by
IGRA to regulate Native American gaming and, as a result, regulation for this
market is generally on a state-by-state basis though, in some cases, it is
regulated by county commissions or other local government
authorities.  We currently offer charity bingo gaming systems in
Alabama pursuant to constitutional amendments and county regulations or other
local government authority regulations, and we offer games to certain
operatorsin
Minnesota.





International
Regulation




We
currently have operations in one international market, Mexico.  We
began placing bingo games in the Mexican market in 2006 under the jurisdiction
of the Ministry of the Interior (Secretaría de Gobernación), a branch of the
federal government of Mexico.  The entities and individuals who have
obtained bingo permits may only operate player terminals that comply with
Mexican law and regulations.  Accordingly, our contracts require us to
provide player terminals that comply with said laws and regulations, and
therefore, we submit our games for compliance certification to an independent
lab prior to placing them in a facility of a permit holder.




Available
Information.  Through the Investor Relations link on our
website (www.multimediagames.com),
we make available free of charge to the public, as soon as reasonably
practicable after such information has been filed with the Securities and
Exchange Commission, or SEC, our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports furnished pursuant to Section 13 or 15(d) of the Securities Exchange
Act.  The public may read and copy any materials we file with or
furnish to the SEC at the SEC’s Public Reference Room
at 100 F Street, N.E., Washington, D.C.
20549.  The public may also obtain information on the operation of the
Public Reference Room by calling the SEC at
1-800-SEC-0330.  Furthermore, the SEC maintains a free website
(www.sec.gov) which includes reports, proxy and information statements, and
other information regarding us and other issuers that file electronically with
the SEC.  Our website and the information contained therein or
connected thereto are not intended to be incorporated into this Annual Report on
Form 10-K.  Additionally, we make available free of charge on our
internet website: our Code of Business Conduct and Ethics; the charter of our
Nominating and Governance Committee; the charter of our Compensation Committee;
and the charter of our Audit Committee.


10




ITEM 1A.RISK FACTORS




Investing in our common
stock involves risks.  Prospective investors in our common stock
should carefully consider, among other things, the following risk factors in
connection with the other information and financial statements contained in this
Annual Report, including “PART II – Item 7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” prior to making an
investment decision. We have identified the following important factors that
could cause actual results to differ materially from those projected in any
forward looking statements we may make from time to time. We operate in a
continually changing business environment in which new risk factors emerge from
time to time. We can neither predict these new risk factors, nor can we assess
the impact, if any, of these new risk factors on our business or the extent to
which any factor, or combination of factors, may cause actual results to
differ materially from those projected in any forward looking statement. If any
of these risks, or combination of risks, actually occur, our business,
financial condition and results of operations could be seriously and materially
harmed, and the trading price of our common stock could decline.


Our
success in the gaming industry depends in large part on our ability to expand
into new and non-Native American markets.  Our expansion into
non-Native American gaming activities will present new challenges and risks that
could adversely affect our business and results of operations.




As we
expand into new markets, we expect to encounter business, legal, operational and
regulatory uncertainties similar to those we face in our Native American gaming
business. As a result, we may encounter legal and regulatory challenges that are
difficult or impossible to foresee and which could result in an unforeseen
adverse impact on planned revenues or costs associated with the new market
opportunity. If we are unable to effectively develop and operate within these
new markets, then our business, operating results and financial condition would
be impaired.




Successful
growth in new markets may require us to make changes to our gaming systems to
ensure that they comply with applicable regulatory requirements, and may require
us to obtain additional licenses. In certain jurisdictions and for certain
venues, our ability to enter these markets will depend on effecting changes to
existing laws and regulatory regimes. The ability to effect these changes is
subject to a great degree of uncertainty and may never be achieved. We may not
be successful in entering into other segments of the gaming
industry.




Generally,
our placement of systems, games and technology into new market segments involves
a number of business uncertainties, including:




§
            whether
      our resources and expertise will enable us to effectively operate and grow
      in such new markets;


§
            whether
      our internal processes and controls will continue to function effectively
      within these new segments;


§
            whether
      we have enough experience to accurately predict revenues and expenses in
      these new markets;


§
            whether
      the diversion of management attention and resources from our traditional
      business, caused by entering into new market segments, will have harmful
      effects on our traditional
business;


§
            whether
      we will be able to successfully compete against larger companies who
      dominate the markets that we are trying to enter;
  and


§
            whether
      we can timely perform under our agreements in these new markets because of
      other unforeseen obstacles.




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




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




11




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




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


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


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


§
            an
      increase in the popularity of competitors'
  games.




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




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




We
operate in an intensely competitive industry against larger companies with
significant financial, research design and development, and marketing resources.
These larger companies, most of whom have greater resources, are aggressively
competing against us in our core business operations, including but not limited
to, charity bingo, lottery, Class II, Class III, and international bingo
markets. Additionally, new smaller competitors may enter our traditional
markets. The increased competition will intensify pressure on our pricing model.
We expect to face increased competition as we attempt to enter new markets and
new geographical locations.




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




Competition
in the gaming industry is intense due to the number of providers, as well as the
limited number of facilities and jurisdictions in which they operate. As a
result of consolidation among the gaming facilities and the recent cutbacks in
spending by facility operators due to the downturn in the economy, the level of
competition among providers has increased significantly as the number of
potential customers has decreased.  Other members of our industry may
independently develop games similar to our games, and competitors may introduce
noncompliant games that unfairly compete in certain markets due to uneven
regulatory enforcement policies.




Additionally,
our customers compete with other providers of entertainment for their end user’s
entertainment budget. Consequently, our customers might not be able to spend new
capital on acquiring gaming equipment. Moreover, our customers might reduce
their utilization of revenue share agreements.




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




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




12




Our
business operations and product offerings are subject to strict regulatory
licenses, findings of suitability, registrations, permits and/or
approvals.




Our
ability to conduct our existing traditional business, expand operations, develop
and distribute new products, games and systems, and expand into new gaming
markets is subject to significant federal, state, local, Native American, and
foreign regulations. Specifically, our company; our officers, directors, key
employees, major shareholders; as well as our products, games and systems are
subject to licenses, findings of suitability, registrations, permits or
approvals necessary for the operation of our gaming activities.




We have
received licenses, findings of suitability, registrations, permits or approvals
from a number of state, local, Native American, and foreign gaming regulatory
authorities. Our tribal customers are empowered to develop their own licensing
procedures and requirements, and we currently have limited, if any, information
regarding the ultimate process or expenses involved with securing or maintaining
licensure by the tribes. Moreover, tribal policies and procedures, as well as
tribal selection of gaming vendors, are subject to the political and governance
environment within the tribe.




We
require new licenses, permits and approvals in order to meet our expectations
under our product rollout plan, and such licenses, permits or approvals may not
be timely granted to us, or granted to us at all, which could have a material
effect on our business in general and product rollout plan specifically.
Obtaining and maintaining all required licenses, findings of suitability,
registrations, permits or approvals is time consuming and expensive. The
suspension, revocation, nonrenewal or limitation of any of our licenses would
have a material adverse effect on our business operations, financial condition
and results of operations.




Our
ability to effectively compete in Native American gaming markets is vulnerable
to legal and regulatory uncertainties, including the ability to enforce
contractual rights on Native American land.




Historically,
we have derived most of our revenue from the placement of Class II player
terminals and systems for gaming activities conducted on Native American
lands.  Because federally recognized Native American tribes are
independent governments with sovereign powers, Native American tribes can enact
their own laws and regulate gaming operations and contracts.  Native
American tribes maintain their own governmental systems and often their own
judicial systems and have the right to tax persons and enterprises conducting
business on Native American lands, and also have the right to require licenses
and to impose other forms of regulation and regulatory fees on persons and
businesses operating on their lands.  In the absence of a specific
grant of authority by Congress, states may regulate activities taking place on
Native American lands only if the tribe has a specific agreement or compact with
the state. Our contracts with Native American customers normally provide that
only certain provisions will be subject to the governing law of the state in
which a tribe is located.  However, these choice-of-law clauses may
not be enforceable.




Further,
Native American tribes generally enjoy sovereign immunity from lawsuits similar
to that of the individual states and the United States.  In order for
the Company to sue or enforce contract rights with a Native American tribe (or
an agency or instrumentality of a Native American tribe), the tribe must
effectively waive its sovereign immunity with respect to the matter in dispute,
which we are not always able to obtain.  For example, our largest
customer, who accounts for over 42% of our revenue, has not given us a
limited waiver of sovereign immunity.  Without a limited waiver of
sovereign immunity or if such waiver is held to be ineffective, we could be
precluded from judicially enforcing any rights or remedies against a tribe,
including the right to enter Native American lands to retrieve our property in
the event of a breach of contract by the tribe party to that
contract.  Even if the waiver of sovereign immunity by a Native
American tribe is deemed effective, there will be an issue as to the forum in
which a lawsuit can be brought against the tribe.  Federal courts are
courts of limited jurisdiction and generally do not have jurisdiction to hear
civil cases relating to Native Americans and we may be unable to enforce any
arbitration decision effectively.




13




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




We could
be affected by alternative interpretations of the Gambling Devices Act, 15
U.S.C. § 1171, et seq,or theJohnson Act, as the
customers of our Class II games, the Native American tribes, could be subject to
significant fines and penalties if it is ultimately determined they are offering
an illegal game, and an adverse regulatory or judicial determination regarding
the legal status of our products could have material adverse consequences for
our business, operating results and prospects.




Government
enforcement, regulatory action, judicial decisions, and proposed legislative
action have in the past, and will likely continue to affect our business,
operating results and prospects in Native American lands.  We believe
that a number of our competitors have not complied with published regulation
restrictions.  We have lost, and could continue to lose, market share
to competitors who offer games that do not appear to comply with published
regulatory restrictions on Class II games and therefore offer features not
available in our products.  The legal and regulatory uncertainties
surrounding our Native American agreements could result in significant and
immediate adverse impacts on our business and operating results. Additionally,
such uncertainties could increase our cost of doing business and could take our
executives’ attention away from operations.  The trading price of our
common stock has in the past been, and may in the future be, subject to
significant fluctuations based upon market perceptions of the legal status of
our products and our ability to compete in the Native American
markets.  Regulatory action against our customers or equipment in
these or in other markets could result in machine seizures and significant
revenue disruptions, among other adverse consequences.  Moreover,
tribal policies and procedures, as well as tribal selection of gaming vendors,
are subject to the political and governance environment within the tribe.
Changes in tribal leadership or tribal political pressure can affect our
business relationships within Native American markets.




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




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







As a
result, we anticipate that the introduction of Class III games will create
further pressure on our market and revenue share percentages in Oklahoma or a
shift in the market from revenue share arrangements to a “for sale” model.
Additionally, we may be forced to compete with larger companies that specialize
in Class III gaming as they move into these new Class III markets.  We
believe the establishment of state compacts depends on a number of political,
social, and economic factors that are inherently difficult to ascertain.
Accordingly, although we attempt to closely monitor state legislative
developments that could affect our business, we may not be able to timely
predict if or when a compact could be entered into by one or more of our tribal
customers.




We
have limited control over our customers’ casino operations.




We seek
to provide assistance to our key customers in the form of project management,
with a focus on facility layout and planning, gaming floor configuration and
customized marketing and promotional initiatives. Our key customers, however,
are solely responsible for the operations of their facilities and are not
required to consult us or take our advice on their operations, marketing,
facility layout, gaming floor configuration, or promotional initiatives.Our customers
have in the past, and will in the future, remodel and expand their facilities.
To the extent that our machines are not a part of an optimized facility layout
or gaming floor configuration, or to the extent that our machines are not
supported by effective marketing or promotional initiatives or are scheduled to
be out of service during a facility remodeling, our operating results could
suffer.




14




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




For the
year ended September 30, 2009 and 2008, approximately 64%
and 58%, respectively, of our total revenues were from Native American
tribes located in Oklahoma, and approximately 42% and 39%,
respectively, of our gaming revenues were from one tribe in that state.
The significant concentration of our customers in Oklahoma means that local
economic, regulatory and licensing changes may adversely affect our customers,
and therefore our development agreements and our business, disproportionately to
changes in national economic conditions, including more sudden adverse economic
declines or slower economic recovery from prior declines. While we continue to
seek to diversify the markets in which we operate, the loss of any of our
Oklahoma tribes as customers would have a material and adverse effect upon our
financial condition and results of operations. In addition, the legislation
allowing tribal-state compacts in Oklahoma has resulted in increased competition
from other vendors, who we believe previously avoided entry into the Oklahoma
market due to its uncertain and ambiguous legal environment. Oklahoma permits
other types of gaming, both at tribal gaming facilities and at Oklahoma
racetracks, and many of our competitors may seek entry into this market. The
loss of significant market share to these new gaming opportunities or the
increased presence of our competitors’ products in Oklahoma could also have a
material adverse effect upon our financial condition and results of
operations.  We believe that the introduction of our competitor’s more
aggressive instant bingo machines, with characteristics of traditional slot
machines, into the Oklahoma market, has adversely affected our operating results
and market position in that state and may continue to do so in the
future.




We
may not realize satisfactory returns on money lent to new and existing customers
to develop or expand gaming facilities.




We enter
into development agreements to provide financing for construction, expansion, or
remodeling of gaming facilities, primarily in the state of Oklahoma, but have
since expanded operations to other jurisdictions.  Under our
development agreements, we secure a long-term revenue share percentage and a
fixed number of player terminal placements in the facility, in exchange for
funding the development and construction of the gaming facility.  We
may not, however, realize the anticipated benefits of any of these strategic
relationships or financings as our success in these ventures is dependent upon
the timely completion of the gaming facility and the placement of our player
terminals.




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




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




Interpretations
of regulations by governmental agencies may affect our business.




We may
face regulatory risks as a result of interpretations of other regulations, such
as banking regulations, as applied to our gaming systems. We may be required to
make changes to our games to comply with such regulations, with attendant costs
and delays that could adversely affect our business.




15




The
ultimate outcome of pending litigation is uncertain.




We are
involved in a number of commercial and intellectual property litigation matters.
Current estimates of loss regarding pending litigation may not be reflective of
any particular final outcome. The results of rulings, judgments or settlements
of pending litigation may result in financial liability that is materially
higher than what management has estimated at this time. We make no assurances
that we will not be subject to liability with respect to current or future
litigation. We maintain various forms of insurance coverage. However,
substantial rulings, judgments or settlements could exceed the amount of
insurance coverage (or any cost allocation agreement with an insurance carrier),
or could be excluded under the terms of an existing insurance policy.
Additionally, failure to secure favorable outcomes in pending litigation could
result in adverse consequences to our business, operating results and/or overall
financial condition (including without limitation, possible adverse effects on
compliance with the terms of our Credit Facility).




Our
charitable bingo operations in Alabama are subject to legal
uncertainty.




The
Alabama Supreme Court, in the recent decision related to the White Hall
Entertainment Center, established a definition of “bingo” that included a
limited set of standards for charity bingo games in Alabama.  Weare in the process
of making modifications to our games in the Alabama market, which we believe
will comply with these standards in advance of the anticipated, near
term mandatory implementation of these standards.  Notwithstanding our
initiatives to have our games comply with the specified standards, there can be
no assurance that we will not encounter further legal, regulatory, financial, or
competitive issues related to this matter.  We believe that our
modified games will comply with the standards established by the recent Alabama
Supreme Court decision and have submitted our games to independent gaming
laboratories to have each game certified as compliant with the
standards.  However, we cannot be certain operators in Alabama will
decide that our games, as reintroduced to the Alabama market, are in compliance
with the standard set forth by the Alabama Supreme Court or that a court will
not later determine that the modified equipment does not comply with the
standards set forth in the White Hall decision.  Furthermore,
unfavorable changes in laws, regulatory requirements or unanticipated
enforcement action against us, our games or customers, and/or adverse decisions
by courts, regulators and/or governmental bodies, in Alabama could have a
material adverse effect on our Alabama clients’ businesses, and, ultimately, a
material adverse impact on our results of operations and financial condition,
including our revenue and any  money lent pursuant to our development
agreements in the State may not be adequately repaid.  It remains a
possibility, for instance, that certain of our charity bingo equipment located
in Alabama could be seized and made subject to a forfeiture proceeding. In
addition, legal and regulatory uncertainty in Alabama has introduced new
competitive issues as other equipment manufacturers take different approaches to
compliance which may prove more popular with our customers than the approaches
we've taken.  If our reintroduced machines are not as popular with
customers as those of our competitors, our market share and operating results in
Alabama could suffer.




Our
Credit Facility contains covenants that limit our ability to finance future
operations or capital needs and to engage in other business
activities.




The
operating and financial restrictions and covenants in our debt agreements,
including the Credit Facility, may adversely affect our ability to finance
future operations or capital needs or to engage in other business activities.
Our Credit Facility requires us to maintain a minimum Adjusted EBITDA (earnings
(loss) before net interest expense, income taxes, depreciation, amortization and
accretion of contract rights, plus certain add-backs as agreed upon by the
lenders) of $60.0 million on a trailing twelve month basis, a total debt to
EBITDA leverage ratio of no more than 1.75:1.00 and a minimum fixed
charge coverage ratio of at least 1.5:1.0. The Credit Facility contains
certain covenants that, among other things, restrict our ability as well as our
restricted subsidiaries’ ability to:




§
            incur
      additional indebtedness, assume a guarantee or issue preferred
      stock;


§
            pay
      dividends or make other equity distributions or payments to or affecting
      our subsidiaries;


§
            purchase
      treasury stock;


§
            make
      certain investments;


§
            create
      liens;


§
            sell
      or dispose of assets or engage in mergers or
    consolidations;


§
            engage
      in certain transactions with subsidiaries and affiliates;
    and


§
            enter
      into sale leaseback transactions.




These
restrictions could limit our ability to obtain future financing, make strategic
acquisitions or needed capital expenditures, withstand economic downturns in our
business or the economy in general, conduct operations or otherwise take
advantage of business opportunities that may arise. A failure to comply with the
restrictions contained in the Credit Facility could lead to an event of default,
which could result in an acceleration of our indebtedness. Such acceleration
would constitute an event of default under the indentures governing the senior
unsecured notes. Our future operating results may not be sufficient to enable
compliance with the covenants in the Credit Facility or to remedy any such
default. In addition, in the event of acceleration, we may not have or be able
to obtain sufficient funds to refinance our indebtedness or make any accelerated
payments. Also, we may not be able to obtain new financing. Even if we were able
to obtain new financing, we cannot guarantee that the new financing will be on
commercially reasonable terms or terms that are acceptable to us. If we default
on our indebtedness, our business financial condition and results of operation
could be materially and adversely affected.




16




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




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




·
            adversely
      affect our ability to expand our business, market our products and make
      investments and capital
expenditures;


·
            adversely
      affect the cost and availability of funds from commercial lenders, debt
      financing transactions and other sources;
and


·
            create
      competitive disadvantages compared to other companies with lower debt
      levels.




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




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




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




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




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




·
            the
      financial strength of the gaming
industry;


·
            consumers'
      willingness to spend money on leisure
  activities;


·
            the
      timing and introduction of new products and
  services;


·
            the
      mix of products and services sold;


·
            the
      timing of significant orders from and shipments to
    customers;


·
            product
      and service pricing and discounts;
and


·
            the
      timing of acquisitions of other companies and businesses or
      dispositions.




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




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




17




§
            currency
      fluctuations;


§
            difficulty
      in enforcing agreements;


§
            higher
      operating costs due to local laws or
  regulations;


§
            unexpected
      changes in regulatory requirements;


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


§
            general
      government instability;


§
            costs
      and risks of localizing products for foreign
  countries;


§
            difficulties
      in staffing and managing geographically disparate
    operations;


§
            greater
      difficulty in safeguarding intellectual property, licensing and other
      trade restrictions;


§
            challenges
      negotiating and enforcing contractual
  provisions;


§
            repatriation
      of earnings; and


§
            anti-American
      sentiment due to the war in Iraq and other policies of the United States
      government that may be unpopular in certain regions, particularly in the
      Middle East.




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




We have
player stations not deployed as of September 30, 2009, which are considered part
of our rental pool. If the opening of new facilities or the expansion of
existing facilities is altered negatively, either by significant delay or by
cancellation, the realizable value of these assets could be adversely impacted.
In such instances we may be required to recognize impairment charges on these
assets.




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




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




We
may not be successful in protecting our intellectual property rights, or
avoiding claims that we are infringing upon the intellectual property rights of
others.




We rely
upon patent, copyright, trademark and trade secret laws, license agreements and
employee nondisclosure agreements to protect our proprietary rights and
technology, but these laws and contractual provisions provide only limited
protection. We rely to a greater extent upon proprietary know-how and continuing
technological innovation to maintain our competitive position. Insofar as we
rely on trade secrets, unpatented know-how and innovation, others may be able to
independently develop similar technology, or our secrecy could be breached. The
issuance of a patent to us does not necessarily mean that our technology does
not infringe upon the intellectual property rights of others. As we enter into
new markets by leveraging our existing technology, and by developing new
technology and new products, it becomes more and more likely that we will become
subject to infringement claims from other parties. We are currently involved in
a patent dispute with a competitor. See “Part II – Item I.
Financial Statements – Note 11 – Commitments and Contingencies.” Problems with
patents or other rights could increase the cost of our products, or delay or
preclude new product development and commercialization. If infringement claims
against us are valid, we may seek licenses that might not be available to us on
acceptable terms or at all. Litigation would be costly and time consuming, but
may become necessary to protect our proprietary rights or to defend against
infringement claims. We could incur substantial costs and diversion of
management resources in the defense of any claims relating to the proprietary
rights of others or in asserting claims against others. We cannot guarantee that
our intellectual property will provide us with a competitive advantage or that
it will not be circumvented by our competitors.




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




18




We
rely on software and games licensed from third parties, and on technology
provided by third-party vendors, the loss of which could increase our costs and
delay deployment or suspend development of our gaming systems and player
terminals.




We
integrate various third-party software products as components of our software.
Our business would be disrupted if this software, or functional equivalents of
this software, were either no longer available to us or no longer offered to us
on commercially reasonable terms. In either case, we would be required to either
redesign our software to function with alternate third-party software, or to
develop these components ourselves, which would result in increased costs and
could result in delays in our deployment of our gaming systems and player
terminals. Furthermore, we might be forced to limit the features available in
our current or future software offerings.




We rely
on the content of certain software that we license from third-party vendors and
often distribute and sell such software to our customers. The software could
contain “open source” code, require a resale license or contain bugs that could
have an impact on our business.  We also rely on the technology of
third-party vendors, such as telecommunication providers, to operate our
nationwide broadband telecommunications network. A serious or sustained
disruption of the provision of these services could result in some of our player
terminals being non-operational for the duration of the disruption, which would
reduce over-all revenue from those player terminals.




WMS,




We
do not rely upon the term of our customer contracts to retain the business of
our customers.




Our contracts with our
customers are on a year-to-year or multi-year basis. Except for customers with
whom we have entered into development agreements, we do not rely upon the stated
term of our customer contracts to retain the business of our customers, as often
noncontractual considerations unique to doing business in the Native American
market override strict adherence to contractual provisions. We rely instead upon
providing competitively superior player terminals, games and systems to give our
customers the incentive to continue doing business with us. At any point in
time, a significant portion of our business is subject to nonrenewal, which may
materially and adversely affect our earnings, financial condition and cash
flows. In
addition, certain of our customer contracts have "buy out" provisions enabling
our customer to purchase machines formerly under revenue participation
arrangements.  To the extent our customers exercise their buy out rights
pursuant to these provisions, we recognize revenue from equipment sales in the
current period while losing future participation revenue from purchased
machines.  This could have the effect of reducing our overall future
revenues from these customers and thereby adversely affect our future operating
results.




If
our key personnel leave us, our business could be materially adversely
affected.




We depend
on the continued performance of the members of our senior management team and
our technology team to assist in the Company’s new strategic direction. If we
were to lose the services of any of our senior officers, directors, or any key
member of our technology team, and could not find suitable replacements for such
persons in a timely manner, it could have a material adverse effect on our
business.




If
we fail to maintain an effective system of internal controls, we may not be able
to accurately report financial results or prevent fraud.




Effective
internal controls are necessary to provide reliable financial reports and to
assist in the effective prevention of fraud. Any inability to provide reliable
financial reports or prevent fraud could harm our business. We must annually
evaluate our internal procedures to satisfy the requirements of Section 404
of the Sarbanes-Oxley Act of 2002, which requires management and auditors
to assess the effectiveness of internal controls. If we fail to remedy or
maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we could be subject to regulatory
scrutiny, civil or criminal penalties or shareholder litigation.




In
addition, failure to maintain adequate internal controls could result in
financial statements that do not accurately reflect our financial condition.
There can be no assurance that we will be able to complete the work necessary to
fully comply with the requirements of the Sarbanes-Oxley Act or that our
management and our independent registered public accounting firm will continue
to conclude that our internal controls are effective.




19




Our
business prospects and future success rely heavily upon the integrity of our
employees and executives and the security of our gaming systems.




The
integrity and security of our gaming systems are critical to our ability to
attract customers and players. We strive to set exacting standards of personal
integrity for our employees and for system security involving the gaming systems
that we provide to our customers. Our reputation in this regard is an important
factor in our business dealings with our current and potential customers as well
as state licensing boards. For this reason, an allegation or a finding of
improper conduct on our part or on the part of one or more of our employees that
is attributable to us, or of an actual or alleged system security defect or
failure attributable to us could have a material adverse effect upon our
business, financial condition, results and prospects, including our ability to
retain existing contracts or obtain new or renewed contracts.




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




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




We
may incur prize payouts in excess of game revenues.




Certain
of our contracts with our Native American customers relating to our Legacy and
Reel Time Bingo system games provide that our customers receive, on a daily
basis, an agreed percentage of gross gaming revenues based upon an assumed level
of prize payouts, rather than the actual level of prize payouts. This
arrangement can result in our paying our customers amounts greater than our
customers’ percentage share of the actual win per unit. In addition, because the
prizes awarded in our games are based upon assumptions as to the number of
players in each game and statistical assumptions as to the frequency of winners,
we may experience on any day, or over short periods of time, a “game deficit,”
where the aggregate amount of prizes paid exceeds aggregate game revenues. If we
have to make any excess payments to customers, or experience a game deficit over
any statistically relevant period of time, we are contractually entitled to
adjust the rates of prize payout to end users in order to recover any deficit.
In the future, we may miscalculate our statistical assumptions, or for other
reasons we may experience abnormally high rates of jackpot prize wins, which
could materially and adversely affect our cash flow on a temporary or long-term
basis, which could materially and adversely affect our earnings and financial
condition.




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




Our games
and systems, and games and systems we license or distribute from third parties,
could produce false payouts as the result of malfunctions, anomalies or
fraudulent activities, which we may be required to pay. We depend on our
security precautions to prevent fraud. We depend on regulatory safeguards, which
may not be available in all jurisdictions or markets, to protect us against
jackpots awarded as a result of malfunctions, anomalies or fraudulent
activities. There can be no guarantee that regulatory safeguards, in
jurisdictions or markets were they do exist, will be sufficient to protect us
from liabilities associated with malfunctions, anomalies or fraudulent
activities.




The
occurrence of malfunctions, anomalies or fraudulent activities could result in
litigation against us by our customers based on lost revenue or other claims
based in tort or breach of contract. Moreover, these occurrences could result in
investigations or disciplinary actions by applicable gaming regulators.
Additionally, in the event of such issues with our gaming devices or software,
substantial engineering and marketing resources may be diverted from other areas
to rectify the problem.




20




Any
disruption in our network or telecommunications services, adverse weather
conditions or other catastrophic events in the areas in which we operate could
affect our ability to operate our games, which would result in reduced revenues
and customer down time.




Our
network is susceptible to outages due to fire, floods, power loss, break-ins,
cyberattacks and similar events. We have multiple site back-up for our services
in the event of any such occurrence. Despite our implementation of network
security measures, our servers are vulnerable to computer viruses and
break-ins.  Similar disruptions from unauthorized tampering with our
computer systems in any such event could have a material adverse effect on our
business, operating results and financial condition.




Adverse
weather conditions, particularly flooding, tornadoes, heavy snowfall and other
extreme weather conditions often deter our customer’s end users from traveling,
or make it difficult for them to frequent the sites where our games are
installed. If any of those sites experienced prolonged adverse weather
conditions, or if the sites in Oklahoma, where a significant number of our games
are installed, simultaneously experienced adverse weather conditions, our
results of operations and financial condition would be materially and adversely
affected.




We are
parties to certain agreements that could require us to pay damages resulting
from loss of revenues if our systems are not properly functioning, or as a
result of a system malfunction or an inaccurate pay table.  In
addition, our agreement with the New York State Division of the Lottery permits
termination of the contract at any time for failure by us or our system to
perform properly. Failure to perform under this contract or similar contracts
could result in substantial monetary damages, as well as contract
termination.




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




In
mid-April of 2009, there was an outbreak of the influenza H1N1 virus, or “swine
flu,” in Mexico, which caused the temporary closing of several of our client’s
bingo parlors in that country. Additionally, there have been sporadic outbreaks
of swine flu, including in the southwestern United States and Mexico, where our
most significant clients are located. If the swine flu outbreak, or the outbreak
of another communicable disease (such as SARS or avian flu), discourages people
from traveling or causes people to avoid public places (including casinos and
bingo parlors), it could have a material adverse effect on our clients’ gaming
businesses and, ultimately, a material adverse impact on our results of
operations and financial condition.




Worsening
economic conditions may adversely affect our business.




The
demand for entertainment and leisure activities tends to be highly sensitive to
consumers’ disposable incomes, and thus a decline in general economic conditions
or an increase in gasoline prices may lead to our end users having less
discretionary income with which to wager. This situation could cause a reduction
in our revenues and have a material adverse effect on our operating results. The
gaming industry is currently experiencing a period of reduced demand. If, as a
result of deteriorating economic conditions, fewer people frequent our
customers’ facilities, or if amounts spent per person in our customers’
facilities are reduced from historical levels, our business could be materially
and adversely affected.  Additionally, a decline in general economic
conditions might negatively impact our customers’ abilities to pay us in a
timely fashion. Our customers’ failures to make timely payments could result in
an increase in our provision for bad debt.




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




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




21




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




We
believe future transactions with both existing and future customers may be more
complex than transactions entered into currently. As a result, we may enter into
more complicated business and contractual relationships with customers which, in
turn, can engender increased complexity in the related financial accounting.
Legal and regulatory uncertainty may also affect our ability to recognize
revenue associated with a particular project, and therefore the timing and
possibility of actual revenue recognition may differ from our
forecast.




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





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





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




22




ITEM 1B.  Unresolved Staff
Comments




None.




ITEM 2.  Properties




We do not
own any real property. As of September 30, 2009, we are under contract
for the following leases, and we believe the facilities are suitable to our
business and adequate for our current and near-term needs:


Square Feet
            
            
            Monthly Rent
            
            Expiration DateAustin,
      TexasCorporate
      Offices
            
            
            67,761
            
            
            $
            129,154
            
            July 2010Assembly
      and Warehouse Facilities
            
            
            55,140
            
            
            
            46,345
            
            December 2011;June 2010
      (for 14,400
      sf)Tulsa,
      OklahomaOperations
      and Sales Offices
            
            
            3,736
            
            
            
            3,105
            
            February 2010Warehouse
            
            
            77,000
            
            
            
            13,220
            
            November 2009Plano,
      Texas
            
            
            5,010
            
            
            
            8,976
            
            April 2010Kent,
      WashingtonWarehouse
            
            
            14,400
            
            
            
            8,606
            
            August 2011Albany,
      New YorkOffice
      Space
            
            
            2,708
            
            
            
            3,982
            
            December 2009Schenectady,
      New YorkOffice
      Space
            
            
            1,690
            
            
            
            3,013
            
            December
      2017St.
      Paul, MinnesotaOffice/Warehouse
            
            
            3,000
            
            
            
            2,100
            
            February 2010Mexico
      City, MexicoOffice/Warehouse/Training
      Center
            
            
            26,039
            
            
            
            9,168
            
            February 2010Office
            
            
            8,073
            
            
            
            8,138
            
            December
      2009




ITEM 3.  Legal
Proceedings




International
Gamco. International Gamco, Inc., or Gamco, claiming certain rights in
U.S. Patent No. 5,324,035, or the ‘035 Patent, brought suit against
the Company on May 25, 2004 in the U.S. District Court for the
Southern District of California alleging that the Company’s central determinant
system, as operated by the New York State Lottery, infringes the
‘035 Patent. Gamco claims to have acquired ownership of the
‘035 Patent from Oasis Technologies, Inc., or Oasis, a previous owner of
the ‘035 Patent. In February 2003, Gamco assigned the ‘035 Patent to
International Game Technology, or IGT. Gamco claims to have received a license
back from IGT for the New York State Lottery. The lawsuit claims that the
Company infringed the ‘035 Patent after the date on which Gamco assigned
the ‘035 Patent to IGT.




We have
made a number of challenges to Gamco’s standing to sue for infringement of the
‘035 Patent. On October 15, 2007, pursuant to an interlocutory
appeal, the federal circuit court reversed the district court’s order when it
held that Gamco did not have sufficient rights in the ‘035 Patent to sue us
without the involvement of the patent owner, IGT.




23




On
December 4, 2007, Gamco and IGT entered into an Amended and
Restated Exclusive License Agreement whereby IGT granted to Gamco exclusive
rights to the ‘035 Patent in the state of New York and the right to
sue for past infringement of the same. On January 9, 2008, Gamco filed
its third amended complaint for infringement of the ‘035 Patent against us.
On January 28, 2008, we filed an answer to the complaint denying
liability. We also filed a third amended counterclaim against Oasis, Gamco
and certain officers of Gamco, for fraud, promise without intent to perform,
negligent misrepresentation, breach of contract, specific performance and
reformation of contract with regard to the Company’s rights under the Sublicense
Agreement for the ‘035 Patent, as well as for non-infringement and
invalidity of the ‘035 Patent. These parties filed a motion to dismiss and
a motion for summary judgment as to these claims. On August 11, 2009, the Court
issued an order denying the motion to dismiss and granting in part and denying
in part the motion for summary judgment.  The Court entered judgment
against the Company on its claims for fraud, promise without intent to perform
and negligent misrepresentation.  However, the Court held that Gamco
was not entitled to judgment as a matter of law on our claims for breach of
contract, reformation and specific performance.  Our affirmative
motion for partial summary judgment was denied.




The court
issued a claim construction ruling in this case on April 20, 2009. We will
be filing motions for summary judgment of non-infringement of the ‘035 Patent
and to invalidate the ‘035 Patent in light of the Court’s claim construction
ruling.




On August
28, 2009, the court held a telephonic conference, issued pre-trial deadlines and
set the Final Pre-Trial Conference date for September 9, 2010.  A
trial date will be scheduled during the Final Pre-Trial Conference on September
9, 2010.




We
continue to vigorously defend this matter. Given the inherent uncertainties in
this litigation, we are unable to make any prediction as to the
ultimate outcome.




Cory Investments
Ltd.On September 2, 2009, we entered into a comprehensive settlement
agreement with Cory Investments, LTD., or Cory Investments, to resolve all
claims arising from a May 7, 2008 lawsuit filed by Cory against us and
several of our former officers, including Clifton Lind, Robert Lannert and
Gordon Graves, in the State Court in Oklahoma City, Oklahoma. The case asserted
that we offered allegedly illegal Class III games on the MegaNanza and Reel
Time Bingo gaming systems to Native American tribes in Oklahoma which had a
severe negative impact on Cory Investments’ market for its legal Class II
games.  Cory Investments also alleged that the defendants conspired to
drive it and other Class II competitors out of the Class II market in
Oklahoma and other states.  In addition to the conspiracy allegations,
Cory Investments alleged six causes of action: (i) deceptive trade
practices; (ii) common law unfair competition; (iii) wrongful
interference with business; (iv) malicious wrong / prima facie tort;
(v) intentional interference with contract; and
(vi) unreasonable restraint of trade. Cory Investments was seeking
unspecified actual and punitive damages and equitable relief.  The
settlement agreement was reached while the parties were engaged in mediation and
we did not admit any wrongdoing as a result of this settlement
agreement.




Other.In
addition to the threat of litigation relating to the Class II or
Class III status of our games and equipment, we are the
subject of various pending and threatened claims arising out of the ordinary
course of business. We  believe that any liability resulting from
these various other claims will not have a material adverse effect on its
results of operations or financial condition or cash flows. During our
ordinary course of business, we enter into obligations to defend,
indemnify and/or hold harmless various customers, officers, directors, employees
and other third parties. These contractual obligations could give rise
additional litigation cost and involvement in court proceedings.




Government
Regulation.We are not aware of any pending litigation or
sanctions related to violations of government regulations at this
time.  Existing federal and state regulations may impose civil and
criminal sanctions for various activities prohibited in connection with gaming
operations, including but not limited to: (i) false statements on
applications; (ii) failure or refusal
to obtain required licenses; and/or (iii) the placement of
gaming devices, terminals, player stations, and/or units.




24





The
Company may become subject to litigation related to its charity bingo business
in Alabama.  On November 13, 2009, the Supreme Court of Alabama, in a
6-3 decision, reversed and remanded a trial court’s preliminary injunction in
favor of a charity operating bingo in the Town of White Hall, Lowndes County,
Alabama, referred to herein as the White Hall decision.  The appeal
arose out of a raid conducted by the Governor’s Task Force on Illegal Gambling
on March 19, 2009.  The Governor’s Task Force on Illegal Gambling
seized server-based bingo gaming systems, computers, servers, and
cash.  Included with the equipment seized were approximately 34 of the
Company’s games and certain of the Company’s charity bingo equipment located in
Alabama.  In the White Hall decision, the Supreme Court of Alabama
established a definition of “bingo” that included a set of standards that apply
to the operation of charity bingo in Alabama.  The charity that
operates White Hall filed an application for rehearing with the Supreme Court of
Alabama.  The Supreme Court has not ruled on this
application.  The White Hall decision will become final if and when
the Supreme Court denies the application.  Additionally, the
Governor’s Task Force on Illegal Gambling filed a forfeiture action against all
of the equipment seized at White Hall.  The forfeiture action remains
pending in the trial court.  It is possible that further proceedings
will be initiated in the future.





Further,
three recent lower court decisions by both State and federal trial courts ruled
or implied that electronic bingo was illegal under the particular constitutional
amendments examined by those courts.  There may be other cases pending
or threatened involving electronic bingo that might have an impact upon our
operations in Alabama.




ITEM 4.  Submission of Matters to a Vote of
Securities Holders




No matter
was submitted to a vote of security holders during the fourth quarter of
fiscal 2009 covered by this report, through the solicitation of proxies or
otherwise.




25




PART
II




ITEM 5.Market for
Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity
Securities




Our
common stock is traded on the NASDAQ Global Select Market, or NASDAQ, under the
symbol “MGAM.” Prior to September 27, 2001, we were listed on the
Nasdaq Small Cap Market under the same symbol. The following table sets forth
the quarterly high and low closing sale prices per share of our common stock as
reported by NASDAQ for each quarter during the last two fiscal
years.




Fiscal Quarter
            
            High
            
            
            Low2009First
      Quarter
            
            $
            4.67
            
            
            $
            1.97Second
      Quarter
            
            
            2.71
            
            
            
            1.61Third
      Quarter
            
            
            5.16
            
            
            
            2.09Fourth
      Quarter
            
            
            5.97
            
            
            
            4.522008First
      Quarter
            
            $
            9.60
            
            
            $
            7.19Second
      Quarter
            
            
            8.34
            
            
            
            5.16Third
      Quarter
            
            
            5.94
            
            
            
            3.93Fourth
      Quarter
            
            
            5.65
            
            
            
            3.59




There
were approximately 54 holders of record of our common stock as of
December 8, 2009.




We
have never declared or paid any cash dividends on our common stock. We intend to
retain our earnings to finance growth and development, and therefore do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. The declaration and payment of any dividends on our common stock would
be at the sole discretion of our Board of Directors, subject to the terms of our
Credit Facility, our financial condition, capital requirements, future
prospects, and other factors deemed relevant.See
further discussion of the Credit Facility, inITEM 7.Management’s
Discussion and Analysis of Financial Condition and Results of Operations, Credit
Facility.








Equity
Compensation Plan Information


Plan Category(1)
            
            Number of securities to
              be issued upon exercise
              of outstanding options,
              warrants, and rights
              (#)
            
            
            Weighted-average
              exercise price of
              outstanding options,
              warrants, and right
              ($)
            
            
            Number of securities
              remaining available for
              future issuance under
              equity compensation
              plans (excluding
              securities reflected in
              the first column)
              (#)Equity
      compensation plansapproved
      by security holders
            
            
            4,371,234
            
            
            $
            6.32
            
            
            
            1,087,302Equity
      compensation plansnot
      approved by security holders
            
            
            2,465,014
            
            
            
            4.40
            
            
            
            94,986Total
            
            
            6,836,248
            
            
            $
            5.63
            
            
            
            1,182,288




(1)
            Stock
      Plans are discussed in further detailed under “PART IV – Item 15.
      Exhibits and Financial Statement Schedules – Note 10. Stockholders’
      Equity.”






26




Performance
Comparison Graph.The following graph depicts our total return to
shareholders from September 30, 2004 through
September 30, 2009, relative to the performance of (i) the NASDAQ
Composite Index; and (ii) stock in a selected peer group index, or the
“Peer Group”. The Peer Group consists of Progressive Gaming International Corp.
(formerly Mikohn Gaming Corp.), IGT, WMS, Bally and Shuffle Master, Inc. All
indices shown in the graph have been reset to a base of 100 as of
September 30, 2004, and assume an investment of $100 on that date
and the reinvestment of dividends paid since that date. Multimedia Games has
never paid a dividend on its common stock. The stock price performance shown in
the graph is not necessarily indicative of future price
performance.




9/04
                9/05
                9/06
                9/07
                9/08
                9/09Multimedia
      Games, Inc.
                100.00
                62.65
                58.58
                54.97
                27.94
                33.03NASDAQ
      Composite
                100.00
                113.78
                121.50
                143.37
                109.15
                112.55Peer
      Group
                100.00
                80.83
                117.83
                130.04
                64.38
                85.48


27




ITEM 6.Selected
Financial Data


The
following selected financial data are derived from our Consolidated Financial
Statements. The data below should be read in conjunction with our Consolidated
Financial Statements and Notes thereto, “Risk Factors” contained in Item 1(a) of
this Annual Report and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” contained in Item 7 of this Annual
Report.




Years
      Ended September 30,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Consolidated
      Income Statement Data
            
            (In
      thousands, except per-share amounts)Revenues
            
            $
            127,152
            
            
            $
            131,132
            
            
            $
            121,917
            
            
            $
            145,112
            
            
            $
            153,216Operating
      income (loss)
            
            
            (28,988
            )
            
            
            1,235
            
            
            
            (4,589
            )
            
            
            7,502
            
            
            
            29,822Net
      income (loss)
            
            
            (44,778
            )
            
            
            378
            
            
            
            (744
            )
            
            
            3,532
            
            
            
            17,643Earnings
      (loss) per share:Basic
            
            
            (1.67
            )
            
            
            0.01
            
            
            
            (0.03
            )
            
            
            0.13
            
            
            
            0.64Diluted
            
            
            (1.67
            )
            
            
            0.01
            
            
            
            (0.03
            )
            
            
            0.12
            
            
            
            0.60Consolidated
      Balance Sheet Data:Working
      capital (deficit)
            
            $
            28,125
            
            
            $
            34,149
            
            
            $
            22,621
            
            
            $
            (5,835
            )
            
            $
            (19,401
            )Total
      assets
            
            
            215,620
            
            
            
            276,940
            
            
            
            256,269
            
            
            
            268,541
            
            
            
            254,692Long-term
      obligations
            
            
            74,464
            
            
            
            86,575
            
            
            
            82,412
            
            
            
            47,243
            
            
            
            37,317Total
      stockholders’ equity
            
            
            107,455
            
            
            
            150,732
            
            
            
            147,809
            
            
            
            167,945
            
            
            
            158,917




Effective
October 1, 2005 (our fiscal year ended September 30, 2006),
we adopted the share-based payment provisions of ASC Topic 718, “Compensation –
Stock Compensation” (formerly Statement of Financial Accounting
Standards 123(revised), “Share-Based Payment”) using the modified
prospective transition method. Prior period amounts do not include a pro forma
adjustment for stock compensation expense.




ITEM 7.Management’s Discussion and
Analysis of Financial Condition and Results of Operations




The
following Management’s Discussion and Analysis is intended to enhance the
reader’s understanding of our operations and current business environment and
should be read in conjunction with our Item 1 – Business and our Consolidated
Financial Statements and Notes thereto included elsewhere in this
Report.  This discussion and analysis also contains forward-looking
statements and should also be read in conjunction with the disclosures and
information contained in “Cautionary Note” and Item 1A – Risk Factors in this
Report.




Overview




We are a
developer and distributor of comprehensive systems, content, electronic games
and gaming player terminals for the casino, charity, international bingo, and
video lottery markets. Initially, our customers were located primarily in the
Native American gaming sector; however, around 2003, we began diversifying
into broader domestic and international gaming markets.




Although
we continue to develop systems and products for Native American tribes
throughout the United States, we now also develop and market (i) products
and services for the commercial casino market; (ii) video lottery systems
and other products for domestic and international lotteries; and
(iii) products for charity and international bingo and other emerging
markets.




Our
products cover a broad spectrum of the gaming industry, including: interactive
systems for both server-based and stand-alone gaming operations; interactive
electronic bingo games for the Class II gaming market and for the
Class III, stand-alone and video lottery markets; proprietary gaming player
terminals in multiple configurations and formats; electronic instant lottery
scratch ticket systems; casino management systems, including player tracking,
cash and cage, slot accounting, and slot management modules; unified currency
systems; and other electronic and paper bingo systems. In addition, we provide
maintenance, operations support and other services for our customers and
products.




28




We design
and develop networks, software and content that provide our customers with,
among other things, comprehensive gaming systems, some of which are delivered
through a telecommunications network that links our player terminals with one
another, both within a single gaming facility or among several gaming
facilities.




We derive
the majority of our gaming revenue from participation (revenue share)
agreements, pursuant to which we place systems, player terminals, proprietary
and licensed content operated on player terminals, and back-office systems and
equipment (collectively referred to as “gaming systems”), into gaming
facilities. To a lesser degree, we earn revenue from the sale or placement of
gaming systems (e.g., the opening of a new casino, or a change in the law that
allows existing casinos to increase the number of player terminals permitted
under prior law) on a lease-purchase or participation basis and from the
back-office fees generated by video lottery systems, principally in the
Washington State, Class III market. We also generate gaming revenue as
consideration for providing the central determinant system for a network of
player terminals operated by the New York State Division of the Lottery. In
addition, we earn a small portion of our revenue from the sale of lottery
systems and the placement of nontraditional gaming products, such as electronic
scratch tickets, sweepstakes, or linked interactive paper bingo systems.
Recently, we entered the international electronic bingo market and currently
supply bingo systems to three customers in Mexico, whereby we receive fees based
on the net earnings of each system. During fiscal 2010, we intend to
continue to generate revenue from the sale of non-linked Class III player
terminals to Class III Native American markets.




Results
of Operations




The
following tables set forth our end-of-period and average installed base of
player terminals for the years ended September 30, 2009, 2008
and 2007.




At September 30,2009
            
            
            2008
            
            
            2007End-of-period
      installed player terminal base:Oklahoma
      compact games
            
            
            6,363
            
            
            
            5,605
            
            
            
            4,088Class II
      player terminalsNew
      Generation system - Reel Time Bingo
            
            
            1,817
            
            
            
            2,223
            
            
            
            3,840Legacy
      system
            
            
            203
            
            
            
            303
            
            
            
            384Mexico
            
            
            5,401
            
            
            
            5,133
            
            
            
            2,515Other
      player terminals(1)
            
            
            2,368
            
            
            
            2,613
            
            
            
            2,735





Years Ended September 30,2009
            
            
            2008
            
            
            2007Average
      installed player terminal base:Oklahoma
      compact games
            
            
            6,364
            
            
            
            4,852
            
            
            
            3,548Class II
      player terminalsNew
      Generation system - Reel Time Bingo
            
            
            2,049
            
            
            
            2,742
            
            
            
            5,305Legacy
      system
            
            
            269
            
            
            
            324
            
            
            
            363Mexico
            
            
            5,400
            
            
            
            3,985
            
            
            
            1,536Other
      player terminals(1)
            
            
            2,605
            
            
            
            2,722
            
            
            
            2,613




(1)
            Other
      player terminals include charity, Rhode Island Lottery and
      Malta.




The
following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto, included in “PART IV –
Item 15. Exhibits and Financial Statement Schedules.”




29




Fiscal 2009
Compared to Fiscal 2008




Total
revenues for 2009 were $ 127.2 million, compared to $131.1
million in 2008, a $3.9 million,
or 3% decrease.




Gaming
Revenue – Oklahoma Compact




§
            Oklahoma
      compact games generated revenue of $58.1 million in 2009,
      compared to $55.2 million in 2008, an increase of
      $2.9 million, or 5.3%. The average installed base
      increased 31.2% as the conversion of Class II player terminals
      to compact games continued while hold per day decreased 12.9%.
      Accretion of contract rights related to development agreements, which is
      recorded as a reduction of revenue, increased to $5.2 million
      in 2009, compared to $2.8 million
    in 2008.




Gaming
Revenue – Class II




§
            Class II
      gaming revenue decreased by $10.1 million, or 35.3%, to
      $18.3 million in 2009, from $28.4 million in 2008. The
      decrease is attributable to increased competition from Class II providers,
      the influx of Oklahoma Compact and other Class III units and the economy
      as a whole.  We expect the number of Class II terminals to
      continue to decrease as they are replaced with higher-earning Oklahoma
      compact player terminals.


§
            Legacy
      revenue decreased $922,000, or 39.2%, to $1.4 million
      in 2009, from $2.4 million in 2008. The average installed
      base of player terminals and the average hold per day decreased 17.0%
      and 13.3%, respectively, due to competitive
  factors.


§
            Reel
      Time Bingo revenue was $16.9 million in 2009, compared to
      $26.0 million in 2008, a $9.1 million, or 35.0%
      decrease. The average installed base of player terminals and the average
      hold per day decreased 25.3% and 6.5% respectively. Accretion of
      contract rights related to development agreements, which is recorded as a
      reduction of revenue, decreased $128,000, or 11.5% to $984,000
      in 2009, compared to $1.1 million in 2008. The
      reduction in accretion of contract rights is the result of allocating the
      total accretion rights across all product lines with the majority being
      allocated to Oklahoma Compact. During 2009, we continued to convert
      Reel Time Bingo player terminals to games played under the compact, which
      are included in “Gaming revenue - Oklahoma compact,” and we expect this
      trend to continue in the future as Reel Time Bingo competes with the
      higher hold per day of compact games. In addition, as a result of the
      conversion from Reel Time Bingo to games played under the compact, our
      revenue share percentage will decrease to the market rate for compact
      games.




Gaming
Revenue – Charity




§
            Charity
      gaming revenues decreased $5.0 million, or 34.1%, to
      $9.6 million for 2009, compared to $14.6 million for the
      same period of 2008. The average installed base of player terminals
      and the average hold per day decreased 5.5% and 32.0%,
      respectively. The decrease in the hold per day is primarily attributable
      to competitive factors and to a lesser extent, economic factors.
      Competitive factors would include, but are not limited to, a significant
      increase of competitor units added to the gaming floor of our largest
      charity operation, players reward programs not offered on our player
      terminals and location of our player terminals on the gaming
      floor.




Gaming
Revenue – All Other




§
            Class III
      back-office fees decreased $327,000, or 9.0%, to $3.3 million in
      fiscal 2009, from $3.6 million during the same period
      of 2008.


§
            Revenues
      from the New York Lottery system increased $560,000, or 8.0%, to
      $7.6 million in 2009, from $7.0 million in 2008.
      At September 30, 2009, eight of the nine planned racetrack
      casinos are operating, with approximately 12,500 total terminals. At
      the current placement levels, we have obtained near break-even operations
      for the New York Lottery system and expect to achieve profitable
      operations after all of the facilities are operating.  The New
      York Lottery expects the additional facility to be operational during our
      2010 fiscal year.


§
            Revenues
      from the Mexico bingo market decreased $205,000 to $9.8 million
      in 2008, from $10.0 million in 2008. As of
      September 30, 2009, we had installed 5,401 player terminals
      at 27 parlors in Mexico compared to 5,133 terminals at 22
      parlors at September 30, 2008. Our revenue share arrangements in
      Mexico are comparable with our Oklahoma market revenue share
      arrangements.




30




Gaming
Equipment, System Sale and Lease Revenue and Cost of Sales




§
            Gaming equipment,
      system sale and lease revenue increased $7.2 million,
      or 72.9% to $17.2 million for 2009,
      from $10.0 million for the same period of 2008. Gaming
      equipment and system sale revenue of
      $14.9 million, for 2009, includes player terminal sales of
      $13.7 million and system sales of $1.2 million, of which $7.0 million
      was deferred in previous years.  These
      deferred amounts have now been included in revenue due to the delivery of
      previously undelivered elements of the contract or re-negotiation of the
      contract to remove undelivered elements.  Gaming equipment and
      system sale revenue of $8.8 million, for 2008, includes
      569 player terminal sales of $5.8 million and one system
      sale.  License revenues for 2009
      were $2.3 million, compared to $1.1
      million for 2008, an increase of $1.2 million due
      primarily to the player terminal sales discussed above. Total cost of
      sales, which includes cost of royalty fees,
      increased $6.3 million, to $11.3 million in 2009,
      from $5.0 million in 2008 due to the increased gaming
      equipment sales discussed above. As
      part of our strategy for growth and revenue diversification, we plan to
      continue to increase our revenue derived from gaming equipment and systems
      sales and lease revenue.  While we believe this strategy
      enhances our ability to generate increased cash flows from our business in
      current periods, it may also have the effect of reducing future revenues
      from participation agreements as customers choose to purchase our
      equipment rather than place it in their facilities under revenue sharing
      arrangements.




Other
Revenue




§
            Other
      revenues increased $1.0 million or 62.6%
      to $2.7 million for fiscal 2009,
      from $1.7 million during fiscal 2008. The increase is
      primarily due to a commission earned from allowing a vendor to sell player
      stations directly to one of our customers for which we had an exclusive
      arrangement to provide the vendor product to that
  customer.




Selling,
General and Administrative Expenses




§
            Selling,
      general and administrative expenses increased $11.7 million,
      or 16.2%, to $83.9 million in 2009, from $72.2 million
      in 2008. This increase was primarily a result of (i) a $7.2
      million increase in legal fees and settlement costs related to litigation
      as further described in Part II – Item I. Financial Statements – Note 11 –
      “Commitments and Contingencies”; ii) a $6.3 million increase in property
      and equipment and inventory write offs; (iii) an increase in bad debt
      expense of $2.2 million; and (iv) a net increase in personnel costs
      of $1.4 million, including an increase in stock compensation, an accrual
      under an annual incentive plan and other employee benefits; offsetting
      these increases was a decrease in (i) consulting and lobbying fees of
      $2.4 million: (ii) a $2.6 million decrease in inventory expense; and
      (iii) a $1.4 million decrease in travel and entertainment
      expenses.




Amortization
and Depreciation




§
            Amortization
      expense increased $80,000, or 1.7%, to $4.8 million
      in 2009, compared to $4.7 million in 2008. Depreciation
      expense increased $8.2 million, or 17.1%, to
      $56.2 million in 2008, from $48 million in 2008,
      primarily as a result of placing newer player terminal units in
      service.




Other
Income and Expense




§
            Interest
      income decreased 4.9%, to $4.8 million in 2009, from
      $5.0 million in 2008, due to a decrease in imputed interest
      resulting from the paydown of notes receivable under certain development
      agreements. Notes receivable balances related to development agreements
      with a customer for which we impute interest were $57.6 million as of
      September 30, 2009 compared to $72.7 million as of September 30, 2008.
      During fiscal 2009, we recorded imputed interest of $4.3 million
      relating to development agreements with an imputed interest rate range
      of 5.75% to 9.00% compared to $4.3 million in
      fiscal 2008.


§
            Interest
      expense decreased $2.1 million, or 23.8%,
      to $6.6 million in 2009, from $8.7 million
      in 2008, primarily due to a decrease in amounts outstanding under our
      Credit Facility. The balance of the Credit Facility, including accrued
      interest, decreased $11.2 million, or 12.9%, to $75.7 million from $87.0
      million as of September 30, 2008.  See further discussion of the
      Credit Facility, in ITEM 7.  Management’s Discussion and Analysis of
      Financial Condition and Results of Operations, Credit
      Facility.


§
            Other
      income was $74,000 for the year ended September 30, 2009,
      compared to $3.1 million for the year ended
      September 30, 2008. Other income consisted primarily of
      distributions from a partnership interest accounted for on the cost basis
      method in fiscal 2008. The last distribution from this partnership
      was received in early Fiscal 2008.  No additional distributions
      are expected from this partnership
interest.




31




Income
tax expense increased to $14.0 million for 2009, compared to $302,000
for 2008. These figures represent effective tax rates of (45.5%)
and 44.4% for fiscal 2009 and 2008, respectively. The 2009 income
tax expense was impacted by a valuation allowance placed on deferred tax
assets.  The Company recently hired a new management
team.  The management team conducted a thorough review of the
Company’s business during the fiscal year ended September 30, 2009 in an effort
to determine the proper go-forward strategy for the Company.  In
conjunction with this analysis, management also considered the likelihood of
realizing the future benefits associated with the Company’s existing deductible
temporary differences and carryforwards.  As a result of this
analysis, management has determined that it is not more likely than not that the
future benefit associated with all of the Company’s existing deductible
temporary differences and carryforwards will be realized.  As a
result, the Company recorded a valuation allowance against its deferred tax
assets to the extent that its gross deferred tax assets exceed the Company’s
carryback potential.




The
Financial Accounting Standards Board(FASB) has issued Accounting Standard
Codification(ASC) Topic 740, “Income Taxes” (formerly issued as FASB
Interpretation No. 48, or FIN 48, “Accounting for Uncertainty in
Income Taxes,” an interpretation of Statement of Financial Accounting Standards
(SFAS) No. 109, “Accounting for Income Taxes”) to clarify the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements. ASC Topic 740 also prescribes a recognition threshold and
measurement attribute for the financial statement recognition, and for the
measurement of a tax position taken or expected to be taken in a tax return. The
FASB standard also provides guidance on derecognition, classification, interest
and penalties, accounting in interim periods, disclosure, and transition. We
adopted ASC Topic 740 in the first quarter of fiscal 2008 and recorded a
liability of $295,000 (in the first quarter of fiscal 2008) related to
uncertain tax positions. This reserve was charged to Retained Earnings. During
the fiscal year ended September 30, 2009, management evaluated its tax positions
and concluded that no additional tax uncertainties existed; however, increased
the liability related to uncertain tax positions for an estimated interest
amount, for a total liability of $334,000.




Fiscal 2008
Compared to Fiscal 2007




Total
revenues for 2008 were $131.1 million, compared to $121.9 million
in 2007, a $9.2 million, or 8% increase.




Gaming
Revenue – Oklahoma Compact




§
            Oklahoma
      compact games generated revenue of $55.2 million in 2008,
      compared to $37.1 million in 2007, an increase of
      $18.1 million, or 49%. The average installed base increased 37%
      as the conversion of Class II player terminals to compact games
      continues. Hold per day increased 3%, primarily as a result of the
      higher installed base of the stand-alone units, which have a higher hold
      per day. Accretion of contract rights related to development agreements,
      which is recorded as a reduction of revenue, decreased to
      $2.8 million in 2008, compared to $2.9 million
      in 2007.




Gaming
Revenue – Class II




§
            Class II
      gaming revenue decreased by $19.6 million, or 41%, to
      $28.4 million in 2008, from $48.0 million in 2007. We
      expect the number of Class II terminals to continue to decrease as
      they are replaced with higher-earning Oklahoma compact player
      terminals.


§
            Legacy
      revenue decreased $494,000, or 17%, to
      $2.4 million in 2008, from $2.9 million in 2007. The
      average installed base of player terminals and the average hold per day
      decreased 11% and 5%, respectively. The decrease is
      primarily due to competitive factors, such asother types of games
      including other Class II and Compact
  games.


§
            Reel
      Time Bingo revenue was $26.0 million in 2008, compared to
      $45.1 million in 2007, a $19.1 million, or 42%
      decrease. The average installed base of player terminals
      decreased 48% which was partially offset by a 16% increase in
      hold per day. Accretion of contract rights related to development
      agreements, which is recorded as a reduction of revenue, decreased
      $1.5 million, or 57% to $1.1 million in 2008, compared
      to $2.6 million in 2007. The reduction in accretion of
      contract rights is the result of allocating the total accretion rights
      across all product lines with the majority being allocated to Oklahoma
      Compact. During 2008, we continued to convert Reel Time Bingo player
      terminals to games played under the compact, which are included in “Gaming
      revenue - Oklahoma compact.”




32




Gaming
Revenue – Charity




§
            Charity
      gaming revenues decreased $3.4 million, or 19%, to
      $14.6 million for 2008, compared to $18.0 million for the
      same period of 2007. The average installed base of player terminals
      and the average hold per day decreased 4% and 18%, respectively.
      The decrease in the hold per day is primarily attributable to competitive
      factors and to a lesser extent, economic factors. Competitive factors
      would include, but are not limited to, a significant increase of
      competitor units added to the gaming floor of our largest charity
      operation, players reward programs not offered on our player terminals and
      location of our player terminals on the gaming
  floor.




Gaming
Revenue – All Other




§
            Class III
      back-office fees decreased 2%, to $3.6 million in
      fiscal 2008, from $3.7 million during the same period
      of 2007.


§
            Revenues
      from the New York Lottery system increased 22%, to $7.0 million
      in 2008, from $5.8 million in 2007. At
      September 30, 2008, eight of the nine planned racetrack casinos
      are operating, with approximately 13,000 total
    terminals.


§
            Revenues
      from the Mexico bingo market increased $5.7 million to
      $10.0 million in 2008, from $4.3 million in 2007.
      As of September 30, 2008, we had installed 5,133 player
      terminals at 22 parlors in Mexico compared to 2,515 terminals at
      nine parlors at September 30, 2007. Our revenue share
      arrangements in Mexico are comparable with our Oklahoma market revenue
      share arrangements.




Gaming
Equipment, System Sale and Lease Revenue and Cost of Sales




§
            Gaming
      equipment, system sale and lease revenue increased $7.1 million,
      or 247% to $10.0 million for 2008,
      from $2.9 million for the same period of 2007. Gaming
      equipment and system sale revenue of
      $8.8 million, for 2008, includes 569 player terminal
      sales of $5.8 million and one system sale. Gaming equipment, system
      sale and lease revenue of $1.1 million, for 2007, included two
      system sales and no player terminals. In 2008 and 2007, gaming
      equipment sale revenue included revenues of $182,000 and
      $1.1 million, respectively, related to a certain equipment sale being
      recognized ratably over the term of the agreement. License revenues
      for 2008 were $1.1 million, compared
      to $689,000 for 2007, an increase of $427,000,
      or 62%, due primarily to the player terminal sales discussed above.
      Total cost of sales, which includes cost of royalty fees,
      increased $2.8 million, to $5.0 million in 2008,
      from $2.2 million in 2007 due to the large gaming equipment
      sale discussed above.




Other
Revenue




§
            Other
      revenues decreased $395,000 or 19% to $1.7 million for
      fiscal 2008, from $2.1 million during fiscal 2007. The
      decrease is primarily due to the discontinuation of the promotional
      sweepstakes system in
January 2007.




Selling,
General and Administrative Expenses




§
            Selling,
      general and administrative expenses increased $6.1 million,
      or 9%, to $72.2 million in 2008, from $66.1 million
      in 2007. This increase was primarily a result of (i) an increase
      in third-party game licenses, projects, and patents write offs and
      reserves of $3.2 million; ii) an increase in property and
      equipment reserves, repairs and maintenance, transportation and related
      costs of $2.6 million; (iii) an increase in salaries and wages
      and the related employee benefits of approximately $2.0 million,
      primarily related to costs of $675,000 associated with the
      resignation of our former Chief Executive Officer, along with headcount
      increases (at September 30, 2008, we employed 484 full-time
      and part-time employees, compared to 427 at
      September 30, 2007); and (iv) an increase in travel
      expenses of approximately $648,000; offsetting these increases was a
      decrease in legal and professional fees of approximately
      $2.9 million, due to the resolution of several legal matters during
      fiscal 2008.




33




Amortization
and Depreciation




§
            Amortization
      expense decreased $1.6 million, or 26%, to $4.7 million
      in 2008, compared to $6.3 million in 2007. Depreciation
      expense decreased $3.8 million, or 7%, to
      $48.0 million in 2007, from $51.8 million in 2007,
      primarily as a result of player terminals continuing in service beyond
      their estimated useful life.




Other
Income and Expense




§
            Interest
      income increased 10%, to $5.0 million in 2008, from
      $4.6 million in 2007, due to imputed interest resulting from
      advances under certain development agreements. We entered into development
      agreements with a customer under which approximately $72.7 million
      has been advanced and is outstanding at
      September 30, 2008, and for which we impute interest on
      these interest-free loans. During fiscal 2008, we recorded imputed
      interest of $4.3 million relating to development agreements with an
      imputed interest rate range of 6.00% to 9.00% compared to
      $2.6 million in
fiscal 2007.


§
            Interest
      expense increased $3.7 million, or 74%,
      to $8.7 million for 2008, from $5.0 million
      for 2007, due primarily to an increase in amounts outstanding under
      our Credit Facility. During April 2007, we entered into a
      $150 million Credit Facility which replaced our previous credit
      facility in its entirety. On October 26, 2007 we amended the
      Credit Facility, transferring $75 million of the revolving credit
      commitment to a fully funded $75 million term loan. We entered into a
      second amendment to the Credit Facility on December 20, 2007.
      The second amendment (i) extended the hedging arrangement date
      related to a portion of the term loan to June 1, 2008; and
      (ii) modified the interest rate margin applicable to the Credit
      Facility and the term loan.


§
            Other
      income was $3.1 million for the year ended
      September 30, 2008, compared to $3.1 million for the year
      ended September 30, 2007. Other income consisted primarily of
      distributions from a partnership interest accounted for on the cost basis
      method in fiscal 2008. Fiscal 2007 included this distribution,
      as well as the extinguishment of an intangible asset and related liability
      due to the termination of a non-compete agreement with our former Chief
      Executive Officer as of
  April 27, 2007.




Income
tax expense increased to $302,000 for 2008, compared to an income tax
benefit of $1.2 million in 2007. These figures represent effective tax
rates of 44.4% and 61.3% for fiscal 2008 and 2007,
respectively. The effective tax rate has been impacted by the tax treatment of
stock compensation expense. To the extent that we experience volatility in stock
compensation expense, there will remain volatility in the effective tax
rate.




Recent
Accounting Pronouncements Issued




In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and Hierarchy of Generally Accepted Accounting Principles (a replacement of SFAS
No. 162).” FASB Accounting Standards Codification (ASC) has become the source of
authoritative generally accepted accounting principles GAAP recognized by the
FASB to be applied by nongovernmental entities.  Rules and
interpretive releases of the SEC under authority of federal securities laws are
also sources of authoritative GAAP for SEC registrants.  On the
effective date of this statement, the codification will supersede all
then-existing non-SEC accounting and reporting standards; and all
non-grandfathered, non-SEC accounting literature not included in the
codification will be superseded and deemed non-authoritative.  The new
codification standards have been adopted by the Company in its annual report on
Form 10-K as of September 30, 2009.  Reference to the new ASC topic,
subtopic, or section will be provided along with the superceded historical
accounting literature. The adoption of codification standards did not impact our
consolidated financial position, results of operation or cash
flows.




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




34




In May
2009, the FASB issued ASC Topic 855, “Subsequent Events” (formerly SFAS No. 165,
“Subsequent Events”),  which establishes the accounting for and
disclosure of events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued.  It
requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for that date; that is, whether that date
represents the date the financial statements were issued or were available to be
issued. Consistent with ASC Topic 855 requirements for public entities, we
evaluate subsequent events through the date the financial statements are
issued.  ASC Topic 855 should not result in significant changes in the
subsequent events that an entity reports, either through recognition or
disclosure, in its financial statements.  ASC Topic 855 was adopted as
of June 30, 2009.  The adoption of ASC Topic 855 did not impact our
consolidated financial position, results of operations or cash
flows.




In
March 2008, the FASB issued ASC Topic 815, “Derivatives and Hedging”
(formerly SFAS No 161, “Disclosures about Derivative Instruments and
Hedging Activities—An Amendment of FASB Statement No. 133”). ASC Topic 815
enhances required disclosures regarding derivatives and hedging activities,
including enhanced disclosures regarding how: (a) an entity uses derivative
instruments; (b) derivative instruments and related hedged items are
accounted for, and (c) derivative instruments and related hedged items
affect an entity's financial position, financial performance, and cash flows.
ASC Topic 815 is effective for fiscal years, and interim periods within those
fiscal years, beginning after November 15, 2008, though earlier application
is encouraged. Accordingly, the Company expects to adopt ASC Topic 815 beginning
in fiscal 2010. The Company expects that ASC Topic 815 will have an impact
on accounting for derivative instruments and hedging activities once adopted,
but the significance of the effect is dependent upon entering into these related
transactions, if any, at that time.




Effective October 1, 2008,
the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures”
(formerly SFAS No. 157, “Fair Value Measurements”), for its financial
assets and financial liabilities, but it has not yet adopted ASC Topic 820 as it
relates to nonfinancial assets and liabilities as ASC Topic 820 permits a
one-year deferral of the its application for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually) to
fiscal years beginning after November 15, 2008. The adoption of ASC
Topic 820 as it pertains to financial assets and liabilities did not have a
material impact on the Company’s results of operations, financial position or
liquidity. The Company will adopt ASC Topic 820 for non-financial assets and
non-financial liabilities on October 1, 2009, and the Company is
currently evaluating the effect, if any, the adoption may have on its financial
position, results of operations, or cash flows.




In
December 2007, the FASB issued ASC Topic 805, “Business Combinations”
(formerly SFAS No. 141 (revised), “Business Combinations”). ASC Topic 805
changes the accounting for business combinations including the measurement of
acquirer shares issued in consideration for a business combination, the
recognition of contingent consideration, the accounting for preacquisition gain
and loss contingencies, the recognition of capitalized in-process research and
development, the accounting for acquisition-related restructuring cost accruals,
the treatment of acquisition related transaction costs and the recognition of
changes in the acquirer’s income tax valuation allowance. ASC Topic 805 is
effective for fiscal years beginning after December 15, 2008, with
early adoption prohibited. The Company is required to adopt ASC Topic 805
effective October 1, 2009, and the Company is currently evaluating the
effect, if any, the adoption may have on its financial position or the results
of its operations.




In
December 2007, the FASB issued ASC Topic 810, “Consolidation” (formerly
SFAS No. 160, “Non Controlling Interests in Consolidated Financial
Statements,” an amendment of Accounting Research Bulletin, or ARB No. 51,
“Consolidated Financial Statements”). ASC Topic 810 changes the accounting for
non controlling (minority) interests in consolidated financial statements,
including the requirement to classify non controlling interests as a component
of consolidated stockholders’ equity, and the elimination of “minority interest”
accounting in results of operations with earnings attributable to non
controlling interests reported as part of consolidated earnings. Additionally,
ASC Topic 810 revises the accounting for both increases and decreases in a
parent’s controlling ownership interest. ASC Topic 810 is effective for fiscal
years beginning after December 15, 2008, with early adoption
prohibited. The Company is required to adopt ASC Topic 810 effective
October 1, 2009, and the Company is currently evaluating the effect,
if any, the adoption may have on its results of operations or financial
position.




35




In
February 2007, the FASB issued ASC Topic 825,”Financial Instruments”
(formerly SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities, including an amendment of FASB Statement No. 115
“Accounting for Certain Investments in Debt and Equity Securities”), which
permits entities to choose to measure many financial instruments and certain
other items at fair value with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. This Statement
became effective for the Company beginning in October 2008. The
implementation of ASC Topic 825, effective October 1, 2008, did not
have a material effect on the consolidated financial statements in the year
ended September 30, 2009.




Liquidity
and Capital Resources




At
September 30, 2009, we had unrestricted cash and cash equivalents of
$12.5 million, compared to $6.3 million at
September 30, 2008. Our working capital as of
September 30, 2009 increased to $28.1 million, compared to
working capital of $26.6 million for 2008. The increase in working
capital was primarily the result of increases in cash and federal income tax
receivable, as well as a decrease in accounts payable and accrued expenses.
During 2009, we used $40.6 million for capital expenditures of
property and equipment, and collected $20.3 million on development
agreements, with $9.6 million advanced under development agreements. Under
the Credit Facility, our availability as of September 30, 2009, is
$50.0 million, subject to covenant restrictions.




As of
September 30, 2009, our total contractual cash obligations were as
follows (in thousands):




Contractual Obligations
            
            Less than
              1 year
            
            
            1-3
              years
            
            
            3-5
              years
            
            
            More than
              5 years
            
            
            TotalRevolving
      Credit Facility(1)
            
            $
            —
            
            
            $
            15,000
            
            
            $
            —
            
            
            $
            —
            
            
            $
            15,000Credit
      Facility Term Loan(2)
            
            
            2,073
            
            
            
            58,675
            
            
            
            —
            
            
            
            —
            
            
            
            60,748Operating
      leases(3)
            
            
            2,134
            
            
            
            235
            
            
            
            72
            
            
            
            117
            
            
            
            2,558Purchase
      commitments(4)
            
            
            16,884
            
            
            
            4,247
            
            
            
            —
            
            
            
            —
            
            
            
            21,131Development
      Agreement(5)
            
            
            1,500
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,500Total
            
            $
            22,591
            
            
            $
            78,157
            
            
            $
            72
            
            
            $
            117
            
            
            $
            100,937





(1)
            Relating
      to the Revolving Credit Facility, bearing interest at the Eurodollar rate
      plus the applicable spread (5.75 % as of
      September 30, 2009).


(2)
            Consists
      of amounts borrowed under our Credit Facility at the Eurodollar rate plus
      the applicable spread (6.5% as of
      September 30, 2009).


(3)
            Consists
      of operating leases for our facilities and office equipment that expire at
      varioustimes
      through 2017.


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


(5)
            Consists
      of commitments to fund in accordance with a development
      agreement.




During
fiscal 2009, we generated cash from operations of $48.7 million, compared
to $58.9 million during 2008. This $10.2 million decrease in cash
generated from operations over the prior period was primarily a result of the
net loss incurred during 2009 as a result of the lawsuit settlements compared to
the previous year and the timing of payments related to accounts payable and
collections from accounts receivable.




36




Cash used
in investing activities decreased to $32.9 million in 2009, down from
$64.9 million in 2008. The decrease was primarily the result of a
$10.7 million net reimbursement from development agreements in 2009 as compared
to a net $14.4 million increase in advances under development agreements in
2008; as well as a $5.4 million decrease in capital expenditures from 2008 to
2009. During the year ended September 30, 2009, capital expenditures
consisted of the following:




Capital
              Expenditures(In
      thousands)Gaming
      equipment
            
            $
            33,710Third-party
      gaming content licenses
            
            
            6,818Other
            
            
            52Total
            
            $
            40,580




Cash used
in financing activities for 2009 was $9.9 million, compared to cash
provided by financing activities of $6.4 million in 2008. The decrease
was primarily the result of a net decrease in borrowings under the Credit
Facility of $11.2 million during 2009, as compared to a net increase in
borrowings of $4.9 million in 2008.




Our
capital expenditures for the next twelve months will depend upon the number of
new player terminals that we are able to place into service at new or existing
facilities and the actual number of repairs and equipment upgrades to the player
terminals that are currently in the field. As a result of the earnings potential
of compact games in the Oklahoma market, it is our strategy to either place
compact games or to continue to convert our Oklahoma Class II games to
compact games. As part of our strategy, we will offer compact games developed by
us, as well as games from two other gaming suppliers. As a result, we have
entered into purchase commitments for future purchases of player stations and
licenses totaling $16.9 million.




In 2008,
we fulfilled a commitment to a significant, existing tribal customer to provide
approximately 43.8%, or $65.6 million, of the total funding for a
facility expansion. Because of our commitment to fund the expansion, we secured
the right to place an additional 1,400 gaming units in the expanded
facility in southern Oklahoma. We recorded all advances as a note receivable and
imputed interest on the interest free loan. The discount (imputed interest) was
recorded as contract rights and will be amortized over the life of the
agreement. The repayment period of the note will be based on the performance of
the facility. As of September 30, 2009, we had installed the
additional 1,400 units in the expanded facility. During 2009, the tribal
customer repaid $13.1 million of the balance; thus the balance as of September
30, 2009 was $52.5 million.




We
believe that our existing cash and cash equivalents, cash provided from our
operations, and amounts available under our Credit Facility can sustain our
current operations; however, our performance and financial results are, to a
certain extent, subject to general conditions in or affecting the Native
American gaming industry, and to general economic, political, financial,
competitive and regulatory factors beyond our control. If our business does not
continue to generate cash flow at current levels, or if the level of funding
required in connection with our joint development agreements is greater or
proceeds at a pace faster than anticipated, or if we receive a material judgment
against the Company in one of the various lawsuits (See “Risk Factors – “The
ultimate outcome of pending litigation is uncertain,” and  see
Part II Item 1. "Financial Statement - Note 11
- Commitmentsand
Contingencies"), we may need to raise additional financing, or
renegotiate terms of our existing Credit Facility. Sources of additional
financing might include additional bank debt or the public or private sale of
equity or debt securities. However, sufficient funds may not be available, on
terms acceptable to us or at all, from these sources or any others to
enable us to make necessary capital expenditures and to make discretionary
investments in the future.




Off
Balance Sheet Arrangements




At
September 30, 2009, we had no off balance sheet arrangements.




Credit
Facility




On
April 27, 2007, we entered into a $150 million Credit
Facility which replaced our previous credit facility in its entirety. On
October 26, 2007, we amended our Credit Facility,
transferring $75 million of the revolving credit commitment to a fully
funded $75 million term loan due April 27, 2012. The Term Loan is
amortized at an annual amount of 1% per year, payable in equal quarterly
installments beginning January 1, 2008, with the remaining amount due
on the maturity date. We
entered into a second amendment to the Credit Facility on
December 20, 2007 which (i) extended the hedging arrangement date
related to a portion of the term loan to June 1, 2008; and
(ii) modified the interest rate margin applicable to the Credit Facility
and the term loan.




37




The
Credit Facility provides us with the ability to finance development
agreements and acquisitions and working capital for general corporate purposes.
Amounts under the $65 million revolving credit commitment and
the $60 million term loan mature on April 27, 2012, and advances under
the term loan and revolving credit commitment bear interest at the Eurodollar
rate plus the applicable spread, tied to various levels of interest pricing
determined by total debt to EBITDA (EBITDA is defined as earnings before
interest, taxes, amortization, depreciation, and accretion of contract rights).
As of September 30, 2009, the $15.0 million drawn under the revolving
credit commitment bore interest at 5.75% and the $60 million under the
term loan bore interest at 6.5%. Also included in the September 30, 2009
and 2008 balances are approximately $750,000 and $680,000, respectively, of
accrued interest.




On July
22, 2009, we entered into a third amendment to the Credit
Facility.  Under the terms of the amended credit agreement, the
calculation of consolidated Adjusted EBITDA (EBITDA, plus certain add-backs as
agreed upon by the lenders) for the purposes of evaluating compliance with the
specified covenants will now reflect the add-back of several items including:
(i) legal costs and settlement fees incurred in the trailing four-quarter period
related to litigation with Diamond Game Enterprises, Inc., or Diamond Game,
which was settled on May 1, 2009; (ii) all non-cash stock-based compensation
expenses; and, (iii) up to $10 million, in aggregate, of additional non-cash
asset impairment charges that we may incur in future periods. In conjunction
with the third amendment, we reduced the total borrowing capacity of the
credit facility to $125 million from the previous total borrowing capacity of
$150 million and agreed to a LIBOR floor of 2%, which would have increased the
interest rate paid as of June 30, 2009 by approximately 1.7%. On July 23,
2009, we paid a one-time fee of 25 basis points of the total borrowing
capacity of $125 million as well as other customary fees associated with the
amendment.




The
Credit Facility is collateralized by substantially all of our assets, and also
contains financial covenants as defined in the agreement. These covenants
include (i) a minimum fixed-charge coverage-ratio of not less
than 1.50 : 1.00; (ii) a maximum total debt to Adjusted
EBITDA ratio of not more than 1.75 : 1.00 from
September 30, 2008 and thereafter; and (iii) a minimum trailing
twelve-month Adjusted EBITDA of not less than $60.0 million for the
quarter. As of September 30, 2009, the Company is in compliance with
its loan covenants. The Credit Facility requires certain mandatory prepayments
be made on the term loan from the net cash proceeds of certain asset sales and
condemnation proceedings (in each case to the extent not reinvested, within
certain specified time periods, in the replacement or acquisition of property to
be used in its businesses). In the second quarter of 2008, we made a
mandatory prepayment of the term loan in the amount of $4.5 million due to
an early prepayment of a development agreement note receivable. As of
September 30, 2009, the Credit Facility had availability of
$50.0 million, subject to covenant restrictions.




The
Credit Facility also required that we enter into hedging arrangements
covering at least $50 million of the term loan for a three-year period by
June 1, 2008; therefore, on May 29, 2008, we purchased,
for $390,000, an interest rate cap (5% cap rate) covering
$50 million of the term loan. We account for this hedge in
accordance with ASC Topic 815, “Derivatives and Hedging” (formerly FASB
Statement No. 133, “Accounting for Derivative Instruments and Hedging
Activities”) which requires entities to recognize all derivative instruments as
either assets or liabilities in the balance sheet, at their respective fair
values. We record, on a mark- to-market basis, changes to the fair value of
the interest rate cap on a quarterly basis. These changes in fair value are
recorded in interest expense in the consolidated statement of operations. See Item
1A Risk Factors - "Our Credit Facility Contains covenents that limit our ability
to finance future operations or capital needs and to engage in other business
activities."




Share
Repurchase




During
July 2007, we completed a modified “Dutch Auction” Tender Offer to purchase
up to $25.0 million of our common stock and the associated preferred share
purchase rights. We accepted, for purchase, an aggregate of 1,992,032
shares of our common stock at a purchase price of $12.74 per share,
for an aggregate share repurchase of approximately $25.0 million.
Additionally, we incurred costs of $387,457 related to the Tender Offer that was
recorded in treasury stock.




38




Stock
Repurchase Authorizations




During
fiscal 2008, we did not repurchase any shares of our common stock. During
fiscal 2007, we repurchased 1,992,032 shares, of our common stock, at
an average cost of $12.74.




Stock-Based
Compensation




At
September 30, 2009, we had approximately 6.8 million options
outstanding, with exercise prices ranging from $1.00 to $18.71 per
share. At September 30, 2009, approximately 3.5 million of the
outstanding options were exercisable.




During
fiscal 2009, options to purchase 1.7 million shares of common stock
were granted, and we issued 609,000 shares of common stock as a result of
stock option exercises with a weighted average exercise price
of $2.05.




Critical
Accounting Policies




We
prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States. As such, we are required to
make certain estimates, judgments and assumptions that we believe are reasonable
based on the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the periods
presented. There can be no assurance that actual results will not differ from
those estimates. We believe the following represent our most critical accounting
policies.




Management
considers an accounting estimate to be critical if:




§
            It
      requires assumptions to be made that were uncertain at the time the
      estimate was made (Critical
      Assumption #1), and


§
            Changes
      in the estimate or different estimates that could have been selected could
      have a material impact on our consolidated results of operation or
      financial condition (Critical
      Assumption #2).




Revenue
Recognition.As further discussed in the discussion of our Revenue
Recognition policy in Note 1 of our consolidated financial statements,
revenue from the sale of software is accounted for under ASC Topic 985,
“Software” (formerly Statement of Position 97-2, “Software Revenue
Recognition,”  and its various interpretations). If Vendor-Specific
Objective Evidence, or VSOE, of fair value does not exist, the revenue is
deferred until such time that all elements have been delivered or services have
been performed. If any element is determined to be essential to the function of
the other, revenues are generally recognized over the term of the services that
are rendered. In those limited situations where VSOE does not exist for any
undelivered elements of a multiple element arrangement, then the aggregate value
of the arrangement, including the value of products and services delivered or
performed, is initially deferred until all hardware and software is delivered,
and then is recognized ratably over the period of the last deliverable,
generally the service period of the contract. Depending upon the elements and
the terms of the arrangement, we recognize certain revenues under the residual
method. Under the residual method, revenue is recognized when VSOE of fair
value exists for all of the undelivered elements in the arrangement, but does
not exist for one or more of the delivered elements in the arrangement. Under
the residual method, we defer the fair value of undelivered elements, and the
remainder of the arrangement fee is then allocated to the delivered elements and
is recognized as revenue, assuming the other revenue recognition criteria are
met.




Assumptions/Approach
Used: The
determination whether all elements of sale have VSOE is a subjective measure,
where we have made determinations about our ability to price certain aspects of
transactions.




Effect
if Different Assumptions Used: When we have determined
that VSOE does not exist for any undelivered elements of an arrangement, then
the aggregate value of the arrangement, including the value of products and
services delivered or performed, is initially deferred until all hardware and
software is delivered, and then is recognized ratably over the period of the
last deliverable, generally the service period of the contract. The deferral of
revenue under arrangements where we have determined that VSOE does not exist has
resulted in $4.7 million being recorded as deferred revenue at
September 30, 2009. If we had made alternative assessments as to the
existence of VSOE in these arrangements, some or all of these amounts could have
been recognized as revenue prior to September 30, 2009.




39




Share-Based
Compensation Expense. We recognize compensation expense for all
share-based payments granted after October 1, 2005 and prior to but
not yet vested as of October 1, 2005, in accordance with ASC Topic
718, “Compensation-Stock Compensation” and ASC Subtopic 505-50, “Equity-Based
Payments to Non-Employees” (formerly SFAS 123(R), “Share-Based Payments”).
Under the fair value recognition provisions of ASC Topic 718 and Subtopic
505-50, we recognize share-based compensation net of an estimated forfeiture
rate, and only recognize compensation cost for those shares expected to vest on
a straight-line basis over the service period of the award.




Assumptions/Approach
Used: Determining the appropriate fair value model and calculating the
fair value of share-based payment awards requires the input of highly subjective
assumptions, including the expected life of the share-based payment awards, and
stock price volatility. Management determined that volatility is based on
historical volatility trends.  In addition, we are required to estimate the
expected forfeiture rate, and only recognize expense for those shares expected
to vest. If our actual forfeiture rate is materially different from our
estimate, the share-based compensation expense could be significantly different
from what we have recorded in the current period.




Effect
if Different Assumptions Used: The assumptions used in calculating the
fair value of share-based payment awards, along with the forfeiture rate
estimation, represent management’s best estimates, but these estimates involve
inherent uncertainties and the application of management’s judgment. As a
result, if factors change and we use different assumptions, our stock-based
compensation expense could be materially different in the
future.




Property and
Equipment and Leased Gaming Equipment. Property and equipment and
leased gaming equipment is stated at cost. The cost of property and equipment
and leased gaming equipment is depreciated over their estimated useful lives,
generally using the straight-line method for financial reporting, and regulatory
acceptable methods for tax reporting purposes. Player terminals placed with
customers under participation arrangements are included in leased gaming
equipment. Leased gaming equipment includes a “pool” of rental terminals, i.e.,
the “rental pool.” Rental pool units are those units that have previously been
placed in the field under participation arrangements, but are currently back
with us being refurbished and/or awaiting redeployment. Routine maintenance of
property and equipment and leased gaming equipment is expensed in the period
incurred, while major component upgrades are capitalized and depreciated over
the estimated useful life (Critical Assumption #1) of the component. Sales and
retirements of depreciable property are recorded by removing the related cost
and accumulated depreciation from the accounts. Gains or losses on sales and
retirements of property are reflected in our results of operations.




Management
reviews long-lived asset classes for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. (Critical Assumption #2)




Assumptions/Approach
used for Critical Assumption #1: The carrying value of the asset is
determined based upon management’s assumptions as to the useful life of the
asset, where the assets are depreciated over the estimated life on a straight
line basis, where the useful life of items in the rental pool has been
determined by management to be three years.




Effect
if different assumptions used for Critical Assumption #1: While we believe that the
useful lives that have been determined for our fixed assets are reasonable,
different assumptions could materially affect the carrying value of the assets,
as well as the depreciation expense recorded in each respective period related
to those assets. During the year ended September 30, 2009, a
significant portion of the $61.0 million of depreciation and amortization
expense related to assets in the rental pool. If the depreciable life of assets
in our rental pool were changed from three years to another period of time, we
could incur a materially different amount of depreciation expense during the
period.




Assumptions/Approach
used for Critical Assumption #2: Recoverability of assets to be held and
used is measured through considerations of the future undiscounted cash flows
expected to be generated by the assets as a group, as opposed to analysis by
individual asset.  We also reviewed the future undiscounted cash flows
of assets in place at a specific locations for further analysis. If such assets
are considered to be impaired, the impairment recognized is measured by the
amount by which the carrying amount of the assets exceeds their fair value.
Assets to be disposed of are reported at the lower of the carrying amount or the
fair value less costs of disposal. The carrying value of the asset is determined
based upon management’s assumptions as to the useful life of the asset, where
the assets are depreciated over the estimated life on a straight-line
basis.




40






Effect
if different assumptions used for Critical Assumption #2: Impairment
testing requires judgment, including estimations of useful lives of the assets,
estimated cash flows, and determinations of fair value. While we believe our
estimates of useful lives and cash flows are reasonable, different assumptions
could materially affect the measurement of useful lives, recoverability and fair
value. If actual cash flows fall below initial forecasts, we may need to record
additional amortization and/or impairment charges. Additionally, while we
believe that analysis of the recoverability of assets in our rental pool is
accurately assessed from a homogenous level due to the interchangeability of
player stations and parts, if these assets were to be reviewed for impairment
using another approach, there could be different outcomes to any impairment
analysis performed.




Development
Agreements.We enter into development agreements to provide financing for
new gaming facilities or for the expansion of existing facilities. In return,
the facility dedicates a percentage of its floor space to exclusive placement of
our player terminals, and we receive a fixed percentage of those player
terminals’ hold per day over the term of the agreement. Certain of the
agreements contain player terminal performance standards that could allow the
facility to reduce a portion of our guaranteed floor space. In addition, certain
development agreements allow the facilities to buy out floor space after
advances that are subject to repayment have been repaid. The agreements
typically provide for a portion of the amounts retained by the gaming facility
for their share of the hold to be used to repay some or all of the advances
recorded as notes receivable. Amounts advanced in excess of those to be
reimbursed by the customer for real property and land improvements are allocated
to intangible assets and are generally amortized over the life of the contract,
using the straight-line method of amortization (Critical Assumption #1),
which is recorded as a reduction of revenue generated from the gaming facility.
In the past and in the future, we may by mutual agreement and for consideration,
amend these contracts to reduce our floor space at the facilities. Any proceeds
received for the reduction of floor space is first applied against the
intangible asset for that particular development agreement, if any.




Management
reviews intangible assets related to development agreements for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable (Critical Assumption #2). For the year
ended September 30, 2009, there was no impairment to the assets’
carrying values.




Assumptions/Approach
used for Critical Assumption #1:Amounts advanced in excess
of those to be reimbursed by the customer for real property and land
improvements are allocated to intangible assets and are generally amortized over
the life of the contract, using the straight-line method of amortization, which
is recorded as a reduction of revenue generated from the gaming facility. We use
a straight-line amortization method, as a pattern of future benefits cannot be
readily determined.




Effect
if Different Assumptions used for Critical Assumption #1:While we believe that the
use of the straight-line method of amortization is the best way to account for
the costs associated with the costs of acquiring exclusive floor space rights at
our customers facilities, the use of an alternative method could have a material
effect on the amount recorded as a reduction to revenue in the current reporting
period.




Assumptions/Approach
used for Critical Assumption #2: We estimate cash flows directly
associated with the used of the intangible assets to test recoverability and
remaining useful lives based upon the forecasted utilization of the asset and
expected product revenues. In developing estimated cash flows, we incorporate
assumptions regarding future performance, including estimations of hold per day
and estimated units. When the carrying amount exceeds the undiscounted cash
flows expected to result from the use and eventual disposition of the asset, we
then compare the carrying amount to its current fair value. We recognize an
impairment loss if the carrying amount is not recoverable and exceeds its fair
value.




Effect
if Different Assumptions used for Critical Assumption #2:Impairment testing requires
judgment, including estimations of cash flows, and determinations of fair value.
While we believe our estimates of future revenues and cash flows are reasonable,
different assumptions could materially affect the measurement of useful lives,
recoverability and fair value. If actual cash flows fall below initial
forecasts, we may need to record additional amortization and/or impairment
charges.




Allowance for
Doubtful Accounts.We
maintain an allowance for doubtful accounts related to our accounts receivable
and notes receivable that have been deemed to have a high risk of
uncollectibility. Management reviews its accounts receivable and notes
receivable on a monthly basis to determine if any receivables will potentially
be uncollectible. Management analyzes historical collection trends and changes
in its customer payment patterns, customer concentration, and creditworthiness
when evaluating the adequacy of its allowance for doubtful accounts. In our
overall allowance for doubtful accounts, we include any receivable balances
where uncertainty exists as to whether the account balance has become
uncollectible. Based on the information available, management believes the
allowance for doubtful accounts is adequate; however, actual write-offs might
exceed the recorded allowance.




41




Income
Taxes.In
accordance with ASC Topic 740, “Income Taxes”, (formerly
SFAS, No. 109, “Accounting for Income Taxes”), we have recorded a
deferred tax assets and liabilities to account for the expected future tax
benefits and consequences of events that have been recognized in our financial
statements and our tax returns. There are several items that result in deferred
tax asset and liability impact to the balance sheet. If we conclude that it is
more likely than not that some portion or all of the deferred tax assets will
not be realized under accounting standards, it is reduced by a valuation
allowance to remove the benefit of recovering those deferred tax assets from our
financial statements. Additionally, in accordance with ASC Topic 740, (formerly
FIN 48, “Accounting for Uncertainty in Income Taxes”), we have recorded a
liability of $334,000 associated with uncertain tax positions. FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. We are required to determine whether it is more likely
than not (a likelihood of more than 50 percent) that a tax position will be
sustained upon examination, including resolution of any related appeals or
litigation processes, based on the technical merits of the position in order to
record any financial statement benefit. If that step is satisfied, then we must
measure the tax position to determine the amount of benefit to recognize in the
financial statements. The tax position is measured at the largest amount of
benefit that is greater than 50 percent likely of being realized upon
ultimate settlement.




Assumptions/Approach
Used: Numerous
judgments and assumptions are inherent in the determination of future taxable
income and tax return filing positions that we take, including factors such as
future operating conditions.




Effect
if Different Assumptions Used:Management, along with
consultation from an independent public accounting firm used in tax
consultation, continually evaluate complicated tax law requirements and their
effect on our current and future tax liability and our tax filing positions.
Despite our attempt to make an accurate estimate, the ultimate utilization of
our gross deferred tax assets of $29.1
million, primarily associated with the tax basis of our leased gaming
equipment and property and equipment is largely dependent upon our ability to
generate taxable income in the future or carryback losses to prior years with
taxable income. Our liability for uncertain tax positions is dependent upon our
judgment on the amount of financial statement benefit that an uncertain tax
position will realize upon ultimate settlement and on the probabilities of the
outcomes that could be realized upon ultimate settlement of an uncertain tax
position using the facts, circumstances and information available at the
reporting date to establish the appropriate amount of financial statement
benefit. To the extent that a valuation allowance or uncertain tax position is
established or increased or decreased during a period, we may be required to
include an expense or benefit within income tax expense in the income
statement.  As of September 30, 2009, we recorded a valuation
allowance on a substantial portion of our deferred tax assets in the amount of
$25.0 million.  This reserve was calculated based on our ability to
carryback losses to the prior periods and uncertainty as to our ability to
recover the full extent of these tax differences in future periods.




Inflation
and Other Cost Factors




Our
operations have not been nor are they expected to be materially affected by
inflation. However, our domestic and international operational expansion is
affected by the cost of hardware components, which are not considered to be
inflation sensitive, but rather, sensitive to changes in technology and
competition in the hardware markets. In addition, we expect to continue to incur
increased legal and other similar costs associated with regulatory compliance
requirements and the uncertainties present in the operating environment in which
we conduct our business. However, this expectation could change depending upon a
number of factors, including those described under “Item 1. Business – Risk
Factors.”




42




U.S.
GAAP Net Income (loss) to EBITDA and Adjusted EBITDA Reconciliation




EBITDA is
defined as earnings before interest, taxes, amortization, depreciation, and
accretion of contract rights. Adjusted EBITDA is defined as EBITDA, plus certain
add-backs as agreed upon by our lenders (as shown
below).  Although EBITDA and Adjusted EBITDA are not measures of
performance calculated in accordance with generally accepted accounting
principles, we believe the use of the non-GAAP financial measures, EBITDA and
Adjusted EBITDA, enhances an overall understanding of our past financial
performance, and provides useful information to the investor because of its
historical use by us as a performance measure, and the use of EBITDA and
Adjusted EBITDA by companies in the gaming sector as a measure of performance.
However, investors should not consider these measures in isolation or as a
substitute for net income, operating income, or any other measure for
determining our operating performance that is calculated in accordance with
GAAP. In addition, because EBITDA and Adjusted EBITDA are not calculated in
accordance with GAAP, the measures may not necessarily be comparable to
similarly titled measures employed by other companies. A reconciliation of
EBITDA and Adjusted EBITDA to the most comparable GAAP financial measure, net
income (loss), follows:




U.S.
      GAAP Net Income (Loss) toEBITDA
      ReconciliationYears
      Ended September 30,(In
      thousands)2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Net
      income (loss)
            
            $
            (44,778
            )
            
            $
            378
            
            
            $
            (744
            )
            
            $
            3,532
            
            
            $
            17,643Add
      back:Amortization
      and depreciation
            
            
            61,015
            
            
            
            52,717
            
            
            
            58,179
            
            
            
            57,227
            
            
            
            57,105Accretion
      of contract rights
            
            
            6,250
            
            
            
            4,092
            
            
            
            5,576
            
            
            
            4,256
            
            
            
            2,538Interest
      expense, net
            
            
            1,866
            
            
            
            3,687
            
            
            
            421
            
            
            
            1,454
            
            
            
            722Income
      tax expense (benefit)
            
            
            13,998
            
            
            
            302
            
            
            
            (1,179
            )
            
            
            2,516
            
            
            
            11,457EBITDA
            
            $
            38,351
            
            
            $
            61,176
            
            
            $
            62,253
            
            
            $
            68,985
            
            
            $
            89,465Adjusted
      EBITDA add backs:Income
      tax benefit
            
            
            5,357
            
            
            
            -
            
            
            
            1,179
            
            
            
            -
            
            
            
            -Interest
      income
            
            
            4,764
            
            
            
            5,011
            
            
            
            4,575
            
            
            
            3,024
            
            
            
            1,996Certain
      impairment charges1
            
            
            10,692
            
            
            
            5,884
            
            
            
            -
            
            
            
            -
            
            
            
            -Certain
      litigation costs2
            
            
            9,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock
      compensation
            
            
            1,888
            
            
            
            1,468
            
            
            
            1,164
            
            
            
            2,687
            
            
            
            -Severance
            
            
            135
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Adjusted
      EBITDA
            
            $
            70,187
            
            
            $
            73,539
            
            
            $
            69,171
            
            
            $
            74,696
            
            
            $
            91,461




1
            Includes up to $17.0
      million of non-cash asset impairment charges ($10.0 million for quarterly
      periods subsequent to March 31, 2009 and $7.0 million for the three
      quarterly periods prior to and including March 31, 2009).  These
      charges will be considered add backs for the Adjusted EBITDA calculation
      in the quarter incurred and the three quarters thereafter.2
            Includes legal costs
      and settlement fees incurred in the trailing four-quarter period ended
      June 30, 2009 related to litigation with Diamond Game Enterprises,
      Inc.  These charges will be considered add backs for the
      Adjusted EBITDA calculation in the quarter incurred and the three quarters
      thereafter.







ITEM 7A.  Quantitative and Qualitative
Disclosures about Market Risk




We are
subject to market risks in the ordinary course of business, primarily associated
with interest rate fluctuations.




Our
Credit Facility provides us with additional liquidity to meet our short-term
financing needs, as further described under “PART II – Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations –
Liquidity and Capital Resources” and “PART IV – Item 15. Exhibits and
Financial Statement Schedules – Note 7. Credit Facility, Long-Term Debt.”
Pursuant to our Credit Facility, we may currently borrow up to a total of
$125 million, and our availability as of September 30, 2009, is
$50.0 million, subject to covenant restrictions.




In
connection with the development agreements we enter into with many of our Native
American tribal customers, we are required to advance funds to the tribes for
the construction and development of tribal gaming facilities, some of which are
required to be repaid. As a result of our adjustable interest rate notes payable
and fixed interest rate notes receivable described above, we are subject to
market risk with respect to interest rate fluctuations. Any material increase in
prevailing interest rates could cause us to incur significantly higher interest
expense.




To the
extent that Libor rates do not exceed the 5% Cap that we purchased in
fiscal 2008, we estimate that a hypothetical increase
of 100 basis points in interest rates would increase our interest
expense by approximately $754,000 annually, based on our variable debt
outstanding of $75.0 million as of September 30, 2009. The Credit
Facility also required that we enter into hedging arrangements covering at least
$50 million of the term loan for a three-year period. On
May 29, 2008, we purchased, for $390,000, an interest rate cap
(5% cap rate) covering $50 million of the term loan.




43




We
account for currency translation from our Mexico operations in accordance with
ASC Topic 830, “Foreign Currency Matters” (formerly SFAS No. 52,
“Foreign Currency Translation”).  Balance sheet accounts are
translated at the exchange rate in effect at each balance sheet date. Income
statement accounts are translated at the average rate of exchange prevailing
during the period. Translation adjustments resulting from this process are
charged or credited to other comprehensive income. We do not currently manage
this exposure with derivative financial instruments.




ITEM 8.  Financial Statements and
Supplementary Data




The
financial statements and supplemental data required by this item are included in
PART IV, Item 15.




ITEM 9.  Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure




None.




ITEM 9A.  Controls and
Procedures




Evaluation of
Disclosure Control and Procedures.As of the end of the period covered by
this report, an evaluation was carried out under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of
management’s disclosure controls and procedures (as defined in rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) to ensure
information required to be disclosed in our filings under the Securities
Exchange Act of 1934, is (i) recorded, processed, summarized and reported
within the time periods specified in the SEC rules and forms; and
(ii) accumulated and communicated to our management, including our Chief
Executive Officer and our Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. Management recognizes that any
controls and procedures, no matter how well designed and operated, can only
provide reasonable assurance of achieving desired control objectives, and
management is necessarily required to apply its judgment when evaluating the
cost-benefit relationship of potential controls and procedures. Based upon the
evaluation, the Chief Executive Officer and our Chief Financial Officer
concluded that the design and operation of these disclosure controls and
procedures were effective as of September 30, 2009.




There
were no significant changes in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.




Management’s
Report on Internal Control over Financial Reporting.Our management is
responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934. Our internal control over financial reporting
is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
reporting purposes in accordance with generally accepted accounting
principles.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




Our
management, including our Chief Executive Officer and our Chief Financial
Officer, assessed the effectiveness of our internal control over financial
reporting as of September 30, 2009. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control — Integrated
Framework. Based on our assessment and those criteria, we believe that we
maintained effective internal control over financial reporting as of
September 30, 2009.




44




Our
independent registered public accounting firm, BDO Seidman, LLP, have issued an
attestation report dated December 14, 2009 on our internal control
over financial reporting. That report is included on page 49.




Changes in
Internal Control over Financial Reporting.    There
were no changes in our internal control over financial reporting (as
defined in Rule 13a-15(f) of the Exchange Act) during the quarter
ended September 30, 2009, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




ITEM 9B.  Other
Information




None.


PART
III




Certain
information required by PART III is omitted from this Form 10-K, because we
will file a definitive Proxy Statement pursuant to Regulation 14A, or Proxy
Statement, no later than 120 days after the end of the fiscal year covered by
this Form 10-K, and certain information to be included therein is incorporated
herein by reference.




ITEM 10.  Directors, Executive Officers and
Corporate Governance




The
information required by this Item is incorporated by reference to the Proxy
Statement under the headings “Proposal One – Election of Directors,” and
“Information Regarding Executive Officer Compensation – Executive Officers” and
“Section 16(a) Beneficial Ownership Reporting Compliance.”




We have
adopted a code of ethics applicable to our Chief Executive Officer, Chief
Financial Officer, Controller and other finance leaders, which is a “code of
ethics” as defined by applicable rules of the SEC. This code is publicly
available on our website at http://ir.multimediagames.com/downloads.cfm. If we
make any amendments to this code other than technical, administrative or other
non-substantive amendments, or grants any waivers, including implicit waivers,
from a provision of this code to our Chief Executive Officer, Chief Financial
Officer or Controller, we will disclose the nature of the amendment or waiver,
its effective date and to whom it applies on our website or in a report on
Form 8-K filed with the SEC.




Information
required by this item relating to the Audit Committee of our Board of Directors
is incorporated by reference to the Proxy Statement under the heading “Corporate
Governance Board of Directors Meetings and Committees – Audit
Committee.”





ITEM 11.  Executive
Compensation




The
information required by this Item is incorporated by reference to the Proxy
Statement under the heading “Executive Compensation” and “Corporate Governance –
Compensation Committee.”





ITEM 12.  Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder
Matters




The
information required by this Item is incorporated by reference to the Proxy
Statement under the heading “Security Ownership of Certain Beneficial Owners and
Management” and “Executive Compensation – Equity Compensation Plan
Information.”




ITEM 13.  Certain Relationships and Related
Transactions and Director Independence




The
information required by this Item is incorporated by reference to the Proxy
Statement under the heading “Executive Compensation – Certain Relationships and
Related Transactions” and “Corporate Governance – Affirmative Determination
Regarding Director Independence and Other Matters.”




45




ITEM 14.  Principal Accountant Fees and
Services




The
information required by this Item is incorporated by reference to the Proxy
Statement under the heading “Independent Registered Public Accounting Firm Fees”
and “Policy on Audit Committee Pre Approved Audit and Permissible Non Audit
Services of the Independent Registered Public Accounting Firm.”




46




PART
IV




ITEM 15.  Exhibits and Financial Statement
Schedules




(a)
              The
      following documents are filed as part of this Annual Report on Form
      10-K:(1)
              Financial
      StatementsReports
      of Independent Registered Public Accounting Firm
              48Consolidated
      Balance Sheets, as of September 30, 2009
      and 2008
              50Consolidated
      Statements of Operations, Years Ended
      September 30, 2009, 2008
and 2007
              51Consolidated
      Statements of Stockholders’ Equity and Comprehensive Income
      (Loss),Years
      Ended September 30, 2009, 2008
      and 2007
              52Consolidated
      Statements of Cash Flows, Years Ended
      September 30, 2009, 2008
and 2007
              53Notes
      to Consolidated Financial Statements
              55(2)
              Financial
      Statement ScheduleSchedule
      II Valuation and Qualifying Accounts
              80(3)
              The
      Exhibits listed in the Exhibit Index, which appears immediately following
      the signature page and are incorporated herein by reference, and are filed
      as part of this Annual Report on Form 10-K
  47





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders


Multimedia
Games, Inc.


Austin,
Texas




We have
audited the accompanying consolidated balance sheets of Multimedia Games, Inc.,
or the Company, as of September 30, 2009 and 2008 and the related
consolidated statements of operations, stockholders’ equity and comprehensive
income (loss), and cash flows for each of the three years in the period ended
September 30, 2009. We have also audited the schedule listed in the
accompanying index. These financial statements and schedule are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audits.




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




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Multimedia Games, Inc. at
September 30, 2009 and 2008, and the results of its operations
and its cash flows for the each of the three years in the period ended
September 30, 2009, in conformity with accounting principles generally
accepted in the United States of America.




Also, in
our opinion, the schedule presents fairly, in all material respects, the
information set forth therein.




As
discussed in Note 9 of the consolidated financial statements, effective
October 1, 2008, the Company adopted the provisions of ASC Topic 740,
“Income Taxes” (formerly FASB Interpretation No. 48, or FIN 48,
“Accounting for Uncertainty in Income Taxes,” an interpretation of
SFAS No. 109, “Accounting for Income Taxes”).




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Multimedia Games, Inc. internal control over
financial reporting as of September 30, 2009, based on criteria established in
Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria) and our report dated
December 14, 2009 expressed an unqualified opinion
thereon.




/s/
BDO Seidman, LLP


Houston,
Texas


December 14, 2009




48




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders


Multimedia
Games, Inc.


Austin,
Texas




We have
audited Multimedia Games, Inc., or the Company’s, internal control over
financial reporting as of September 30, 2009, based on criteria
established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The Company’s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Item 9A,
Management’s Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on the company’s internal control over
financial reporting based on our audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.




A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




In our
opinion, Multimedia Games, Inc. maintained, in all material respects, effective
internal control over financial reporting as of September 30, 2009, based on the
COSO criteria.




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Multimedia
Games, Inc., or the Company, as of September 30, 2009 and 2008
and the related consolidated statements of operations, stockholders’ equity and
comprehensive income (loss), and cash flows for each of the three years in the
period ended September 30, 2009, and our report dated December 14,
2009 expressed an unqualified opinion thereon.




/s/
BDO Seidman, LLP


Houston,
Texas


December 14, 2009




49




MULTIMEDIA GAMES, INC.


CONSOLIDATED
BALANCE SHEETS


As
of September 30, 2009 and 2008


(In
thousands, except share and per-share amounts)




2009
            
            
            2008ASSETSCurrent
      Assets:Cash
      and cash equivalents
            
            $
            12,455
            
            
            $
            6,289Accounts
      receivable, net of allowance for doubtful accounts
              of
      $3,676 and $1,209, respectively
            
            
            13,424
            
            
            
            15,990Inventory
            
            
            5,742
            
            
            
            2,445Deferred
      contract costs
            
            
            1,826
            
            
            
            998Prepaid
      expenses and other
            
            
            2,806
            
            
            
            2,170Current
      portion of notes receivable, net
            
            
            15,780
            
            
            
            23,072Federal
      and state income tax receivable
            
            
            6,246
            
            
            
            2,198Deferred
      income taxes
            
            
            1,138
            
            
            
            6,876Total
      current assets
            
            
            59,417
            
            
            
            60,038Restricted
      cash and long-term investments
            
            
            804
            
            
            
            868Leased
      gaming equipment, net
            
            
            34,002
            
            
            
            36,024Property
      and equipment, net
            
            
            35,048
            
            
            
            67,329Long-term
      portion of notes receivable, net
            
            
            40,124
            
            
            
            46,690Intangible
      assets, net
            
            
            33,361
            
            
            
            37,356Deferred
      income taxes
            
            
            2,969
            
            
            
            16,902Other
      assets
            
            
            9,895
            
            
            
            11,733Total
      assets
            
            $
            215,620
            
            
            $
            276,940LIABILITIES AND
      STOCKHOLDERS’EQUITYCurrent
      Liabilities:Current
      portion of long-term debt
            
            $
            2,073
            
            
            $
            1,544Accounts
      payable and accrued expenses
            
            
            26,878
            
            
            
            29,281Deferred
      revenue
            
            
            2,341
            
            
            
            2,640Totalcurrentliabilities
            
            
            31,292
            
            
            
            33,465Revolving
      line of credit
            
            
            15,000
            
            
            
            19,000Long-term
      debt, less current portion
            
            
            58,675
            
            
            
            66,444Other
      long-term liabilities
            
            
            789
            
            
            
            1,131Deferred
      revenue, less current portion
            
            
            2,409
            
            
            
            6,168Totalliabilities
            
            
            108,165
            
            
            
            126,208Commitments
      and contingencies (Notes 6,7,8,9, 10 and 11)Stockholders’
      equity:Preferred
      stock:Series
      A, $0.01 par value, 1,800,000 shares authorized,
              no
      shares issued and outstanding;
            
            
            —
            
            
            
            —Series
      B, $0.01 par value, 200,000 shares authorized,
              no
      shares issued and outstanding
            
            
            —
            
            
            
            —Common
      stock, $0.01 par value, 75,000,000 shares authorized;
              33,121,337
      and 32,511,988 shares issued, and27,217,920
      and
              26,608,571shares
      outstanding, respectively
            
            
            331
            
            
            
            325Additional
      paid-in capital
            
            
            86,317
            
            
            
            83,076Treasury
      stock, 5,903,417 shares at cost
            
            
            (50,128
            )
            
            
            (50,128
            )Retained
      earnings
            
            
            72,803
            
            
            
            117,581Accumulated
      other comprehensive loss
            
            
            (1,868
            )
            
            
            (122
            )Total stockholders’equity
            
            
            107,455
            
            
            
            150,732Total liabilities andstockholders’equity
            
            $
            215,620
            
            
            $
            276,940




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




50





MULTIMEDIA
GAMES, INC.




CONSOLIDATED STATEMENTS OF OPERATIONS


For
the Years Ended September 30, 2009, 2008 and 2007


(In
thousands, except per-share amounts)




2009
            
            
            2008
            
            
            2007REVENUES:Gaming
      revenue:Oklahoma
      Compact
            
            $
            58,088
            
            
            $
            55,182
            
            
            $
            37,131Class
      II
            
            
            18,337
            
            
            
            28,360
            
            
            
            47,964Charity
            
            
            9,647
            
            
            
            14,632
            
            
            
            18,010All
      other
            
            
            21,162
            
            
            
            21,338
            
            
            
            13,887Equipment,
      system sale and lease revenue
            
            
            17,217
            
            
            
            9,959
            
            
            
            2,869Other
            
            
            2,701
            
            
            
            1,661
            
            
            
            2,056Total
      revenues
            
            
            127,152
            
            
            
            131,132
            
            
            
            121,917OPERATING
      COSTS AND EXPENSES:Cost
      of gaming equipment and systems sold
              and
      royalty fees paid
            
            
            11,273
            
            
            
            5,012
            
            
            
            2,223Selling,
      general and administrative expenses
            
            
            83,852
            
            
            
            72,168
            
            
            
            66,104Amortization
      and depreciation
            
            
            61,015
            
            
            
            52,717
            
            
            
            58,179Total
      operating costs and expenses
            
            
            156,140
            
            
            
            129,897
            
            
            
            126,506Operating
      income (loss)
            
            
            (28,988
            )
            
            
            1,235
            
            
            
            (4,589
            )OTHER
      INCOME (EXPENSE):Other
      income
            
            
            74
            
            
            
            3,132
            
            
            
            3,087Interest
      income
            
            
            4,764
            
            
            
            5,011
            
            
            
            4,575Interest
      expense
            
            
            (6,630
            )
            
            
            (8,698
            )
            
            
            (4,996
            )Income
      (loss) before income taxes
            
            
            (30,780
            )
            
            
            680
            
            
            
            (1,923
            )Income
      tax (expense) benefit
            
            
            (13,998
            )
            
            
            (302
            )
            
            
            1,179Net
      income (loss)
            
            $
            (44,778
            )
            
            $
            378
            
            
            $
            (744
            )Basic
      earnings (loss) per common share
            
            $
            (1.67
            )
            
            $
            0.01
            
            
            $
            (0.03
            )Diluted
      earnings (loss) per common share
            
            $
            (1.67
            )
            
            $
            0.01
            
            
            $
            (0.03
            )Shares
      used in earnings (loss) per common shareBasic
            
            
            26,759
            
            
            
            26,292
            
            
            
            27,389Diluted
            
            
            26,759
            
            
            
            27,201
            
            
            
            27,389




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





51





MULTIMEDIA GAMES,
INC.





CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


AND
COMPREHENSIVE INCOME (LOSS)


For
the Years Ended September 30, 2009, 2008 and 2007


(In
thousands, except share amounts)




Accum-
                ulatedOtherCommon
      Stock
              
              
              Additional
              
              
              Treasury
      Stock
              
              
              
              
              
              Compre-
                  hensive
              
              
              Total
                Stock-Numberof
              
              
              
              
              
              Paid-in
              
              
              Numberof
              
              
              
              
              
              Retained
              
              
              Income
              
              
              holders’Shares
              
              
              Amount
              
              
              Capital
              
              
              Shares
              
              
              Amount
              
              
              Earnings
              
              
              (Loss)
              
              
              EquityBalance,
      September 30, 2006
              
              
              31,422,818
              
              
              $
              314
              
              
              $
              74,121
              
              
              
              3,911,385
              
              
              $
              (24,741
              )
              
              $
              118,242
              
              
              $
              9
              
              
              $
              167,945Exercise
      of stock options
              
              
              711,796
              
              
              
              7
              
              
              
              3,397
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              3,404Purchase
      of treasury stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,992,032
              
              
              
              (25,387
              )
              
              
              —
              
              
              
              —
              
              
              
              (25,387
              )Tax
      benefit of stock options exercised
              
              
              —
              
              
              
              —
              
              
              
              1,430
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,430Share-based
      compensation expense
              
              
              —
              
              
              
              —
              
              
              
              1,164
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,164Comprehensive
      loss:Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (744
              )
              
              
              —
              
              
              
              (744
              )Foreign
      currency translation adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (3
              )
              
              
              (3
              )Comprehensive
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (747
              )Balance,
      September 30, 2007
              
              
              32,134,614
              
              
              
              321
              
              
              
              80,112
              
              
              
              5,903,417
              
              
              
              (50,128
              )
              
              
              117,498
              
              
              
              6
              
              
              
              147,809Exercise
      of stock options
              
              
              127,374
              
              
              
              1
              
              
              
              216
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              217Purchase
      of treasury stock
              
              
              —
              
              
              
              —
              
              
              
              112
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              112Tax
      benefit of stock optionsexercised
              
              
              —
              
              
              
              —
              
              
              
              1,469
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,469Establishment
      of reserve for income tax uncertainties upon adoption of ASC
      740
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (295
              )
              
              
              
              
              
              
              (295
              )Share-based
      compensation expense
              
              
              250,000
              
              
              
              3
              
              
              
              1,167
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,170Comprehensive
      income:Net
      income
              
              
              —
              
              
              
              —
              
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              378
              
              
              
              —
              
              
              
              378Foreign
      currency translation adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (128
              )
              
              
              (128
              )Comprehensive
      income
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              250Balance,
      September 30, 2008
              
              
              32,511,988
              
              
              
              325
              
              
              
              83,076
              
              
              
              5,903,417
              
              
              
              (50,128
              )
              
              
              117,581
              
              
              
              (122
              )
              
              
              150,732Exercise
      of stock options
              
              
              609,349
              
              
              
              6
              
              
              
              1,244
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,250Tax
      benefit of stock options exercised
              
              
              —
              
              
              
              —
              
              
              
              83
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              83Share-based
      compensation expense
              
              
              —
              
              
              
              —
              
              
              
              1,914
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,914Comprehensive
      loss:Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (44,778
              )
              
              
              —
              
              
              
              (44,778
              )Foreign
      currency translation adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,746
              )
              
              
              (1,746
              )Comprehensive
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (46,524
              )Balance,
      September 30, 2009
              
              
              33,121,337
              
              
              $
              331
              
              
              $
              86,317
              
              
              
              5,903,417
              
              
              $
              (50,128
              )
              
              $
              72,803
              
              
              $
              (1,868
              )
              
              $
              107,455




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




52




MULTIMEDIA GAMES, INC.




CONSOLIDATED
STATEMENTS OF CASH FLOWS


For
the Years Ended September 30, 2009, 2008 and 2007


(In thousands)




2009
            
            
            2008
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
            
            $
            (44,778
            )
            
            $
            378
            
            
            $
            (744
            )Adjustments
      to reconcile net income (loss) to cash provided
              by
      operating activities:Amortization
            
            
            4,782
            
            
            
            4,703
            
            
            
            6,338Depreciation
            
            
            56,233
            
            
            
            48,014
            
            
            
            51,841Accretion
      of contract rights
            
            
            6,250
            
            
            
            4,092
            
            
            
            5,576Provisions
      for impairment of long-lived assets
            
            
            11,249
            
            
            
            5,657
            
            
            
            320Deferred
      income taxes
            
            
            19,671
            
            
            
            (5,263
            )
            
            
            (10,833
            )Share-based
      compensation
            
            
            1,914
            
            
            
            1,469
            
            
            
            1,164Provision
      for doubtful accounts
            
            
            2,661
            
            
            
            421
            
            
            
            466Interest
      income from imputed interest
            
            
            (4,281
            )
            
            
            (4,308
            )
            
            
            (2,559
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (95
            )
            
            
            (1,987
            )
            
            
            (4,190
            )Inventory
            
            
            5,174
            
            
            
            4,178
            
            
            
            (2
            )Deferred
      contract costs
            
            
            (828
            )
            
            
            (998
            )
            
            
            —Prepaid
      expenses and other
            
            
            (872
            )
            
            
            76
            
            
            
            (2,743
            )Federal
      and state income tax payable/receivable
            
            
            (4,081
            )
            
            
            (4,904
            )
            
            
            319Notes
      receivable
            
            
            2,372
            
            
            
            (8,402
            )
            
            
            (335
            )Accounts
      payable and accrued expenses
            
            
            (2,370
            )
            
            
            7,227
            
            
            
            (9,650
            )Other
      long-term liabilities
            
            
            (278
            )
            
            
            263
            
            
            
            (96
            )Deferred
      revenue
            
            
            (4,058
            )
            
            
            8,307
            
            
            
            (762
            )NET
      CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            48,665
            
            
            
            58,923
            
            
            
            34,110CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisitions
      of property and equipment
              and
      leased gaming equipment
            
            
            (40,580
            )
            
            
            (45,997
            )
            
            
            (59,212
            )Proceeds
      from disposal of assets
            
            
            —
            
            
            
            340
            
            
            
            1,599Acquisition
      of intangible assets
            
            
            (3,011
            )
            
            
            (4,845
            )
            
            
            (3,850
            )Advances
      under development agreements
            
            
            (9,600
            )
            
            
            (41,660
            )
            
            
            (28,492
            )Repayments
      under development agreements
            
            
            20,271
            
            
            
            27,273
            
            
            
            43,629Proceeds
      from development agreement floor space buyback
            
            
            —
            
            
            
            —
            
            
            
            12,731NET
      CASH USED IN INVESTING ACTIVITIES
            
            
            (32,920
            )
            
            
            (64,889
            )
            
            
            (33,595
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from exercise of stock options,
              warrants
      and related tax benefit
            
            
            1,333
            
            
            
            329
            
            
            
            4,834Proceeds
      from shares issued
            
            
            —
            
            
            
            1,170
            
            
            
            —Proceeds
      from long-term debt
            
            
            8,730
            
            
            
            4,574
            
            
            
            75,047Principal
      payments of long-term debt and capital leases
            
            
            (15,970
            )
            
            
            (11,633
            )
            
            
            (5,124
            )Proceeds
      from revolving lines of credit
            
            
            17,000
            
            
            
            31,418
            
            
            
            23,777Payments
      on revolving lines of credit
            
            
            (21,000
            )
            
            
            (19,418
            )
            
            
            (72,791
            )Purchase
      of treasury stock
            
            
            —
            
            
            
            —
            
            
            
            (25,387
            )NET
      CASH PROVIDED BY (USED IN)  FINANCING ACTIVITIES
            
            
            (9,907
            )
            
            
            6,440
            
            
            
            356EFFECT
      OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
            
            
            328
            
            
            
            10
            
            
            
            (5
            )Net
      increase in cash and cash equivalents
            
            
            6,166
            
            
            
            484
            
            
            
            866Cash
      and cash equivalents, beginning of year
            
            
            6,289
            
            
            
            5,805
            
            
            
            4,939Cash
      and cash equivalents, end of year
            
            $
            12,455
            
            
            $
            6,289
            
            
            $
            5,805





53




MULTIMEDIA GAMES,
INC.




CONSOLIDATED
STATEMENTS OF CASH FLOWS – (Continued)


For
the Years Ended September 30, 2009, 2008 and 2007


(In
thousands)




2009
            
            
            2008
            
            
            2007SUPPLEMENTAL
      CASH FLOW DATA:Interest
      paid
            
            $
            5,695
            
            
            $
            7,564
            
            
            $
            4,805Income
      tax paid (refunded), net
            
            $
            (1,395
            )
            
            $
            10,852
            
            
            $
            7,629NONCASH
      TRANSACTIONS:Contract
      rights resulting from imputed interest on
              development
      agreement notes receivables
            
            $
            (399
            )
            
            $
            6,380
            
            
            $
            6,290Transfer
      of leased gaming equipment to inventory
            
            $
            3,506
            
            
            $
            3,021
            
            
            $
            —




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




54




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




1.  Summary of Significant Accounting
Policies




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




We derive
the majority of our gaming revenues from participation, or revenue share,
agreements.  Under our participation agreements, we place player
terminals and systems, along with our proprietary and other licensed game
content, at a customer’s facility in return for a share of the revenues that
these terminals and systems generate.  To a lesser extent, we generate
revenues from the sale of gaming units and systems though we are seeking to
expand our use of for-sale revenues as we expand into additional gaming
jurisdictions and into other segments of the gaming market.  We also
generate revenues from our provision of the central determinant system for video
lottery terminals installed at racetracks in the State of New York and operated
by the New York State Division of the Lottery.  The Company offers
content for its gaming systems that has been designed and developed by the
Company, as well as game themes the Company has licensed from others. The
Company currently operates in one business segment.




Consolidation
Principles –The Company’s consolidated financial statements include the
accounts of Multimedia Games, Inc. and its wholly-owned subsidiaries: Megabingo,
Inc., MGAM Systems, Inc., Innovative Sweepstakes Systems, Inc., MGAM Services,
LLC, MGAM Systems International, Inc., Megabingo International, LLC, Multimedia
Games de Mexico 1, S. de R.L. de C.V., and Servicios de Wild
Basin S. de R.L. de C.V. Intercompany balances and transactions
have been eliminated.




Accounting
Estimates –The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Examples include
share-based compensation, provisions for doubtful accounts and contract losses,
estimated useful lives of property and equipment and intangible assets,
impairment of property and equipment and intangible assets, deferred income
taxes, and the provision for and disclosure of litigation and loss
contingencies. Actual results may differ materially from these estimates in the
future.




Revenue
Recognition–In
accordance with the provision of Accounting Standards Codification (ASC) Topic
605, “Revenue Recognition” (formerly Staff Accounting Bulletin (SAB)
No. 104, “Revenue Recognition”), the Company recognizes revenue when all of
the following have been satisfied:




§
            Persuasive
      evidence of an arrangement exists;


§
            Delivery
      has occurred;


§
            Price
      to the buyer is fixed or determinable;
and


§
            Collectability
      is probable.




Gaming
Revenue - The Company derives Gaming Revenue from the following
sources:




§
            Oklahoma
      Compact
            –
            Participation
      revenue generated from its games placed by the Company under the Oklahoma
      Compact§
            Class
      II
            –
            Participation
      revenue generated from the Company’s Native American Class II
      product§
            Charity
            –
            Participation
      revenue generated from its charity bingo product§
            All
      Other
            –
            Participation
      revenue from Class III back-office systems, New York Lottery system,
      Mexico bingo market, and certain other participation based
      markets




55


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The
majority of the Company’s gaming revenue is of a recurring nature, and is
generated under lease participation arrangements when the Company provides its
customers with player terminals, player terminal-content licenses and
back-office equipment, collectively referred to as gaming equipment. Under these
arrangements, the Company retains ownership of the gaming equipment installed at
customer facilities, and the Company receives revenue based on a percentage of
the net win per day generated by the gaming equipment. Revenue from lease
participation arrangements are considered both realizable and earned at the end
of each gaming day.




Gaming
Revenue generated by player terminals deployed at sites under development
agreements is reduced by the accretion of contract rights from those development
agreements. Contract rights are amounts allocated to intangible assets for
dedicated floor space resulting from development agreements, described under
“Development Agreements.” The related amortization expense, or accretion of
contract rights, is netted against its respective revenue category in the
consolidated statements of operations.




The
Company also generates gaming revenues from back-office fees with certain
customers. Back-office fees cover the service and maintenance costs for
back-office servers installed in each gaming facility to run its gaming
equipment, as well as the cost of related software updates. Back-office fees are
considered both realizable and earned at the end of each gaming
day.




Gaming equipment
and system sales - The Company periodically sells gaming equipment and
gaming systems under independent sales contracts through normal credit terms or
may grant extended credit terms under contracts secured by the related
equipment, with interest recognized at market rates.




For sales
arrangements with multiple deliverables, the Company applies the guidance from
ASC Topic 985, “Software” and ASC Topic 605, “Revenue Recognition” (formerly
Statement of Position, or SOP 97-2, “Software Revenue Recognition,” as amended,
and Emerging Issues Task Force, or EITF 00-21, “Revenue Arrangements with
Multiple Deliverables”). Deliverables are divided into separate units of
accounting if: (i) each item has value to the customer on a stand-alone
basis; (ii) there is objective and reliable evidence of the fair value of
the undelivered items; and (iii) delivery of the undelivered item is
considered probable and substantially in the Company’s control.




The
majority of the Company’s multiple element sales contracts are for some
combination of gaming equipment, player terminals, content, system software,
license fees and maintenance. For multiple element contracts considered a single
unit of accounting, the Company recognizes revenues based on the method
appropriate for the last delivered item.




The
Company allocates revenue to each accounting unit based upon its fair value as
determined by Vendor Specific Objective Evidence, or VSOE. VSOE of fair value
for all elements of an arrangement is based upon the normal pricing and
discounting practices for those products and services when sold individually.
The Company recognizes revenue when the product is physically delivered to a
customer controlled location or over the period in which the service is
performed and defers revenue for any undelivered elements.




§
            In
      those situations where each element is not essential to the function of
      the other, the “multiple deliverables” are bifurcated into accounting
      units based on their relative fair market value against the total contract
      value and revenue recognition on those deliverables are recorded when all
      requirements of revenue recognition have been
  met.


§
            If
      any element is determined to be essential to the function of the other,
      revenues are generally recognized over the term of the services that are
      rendered.




In those
situations where VSOE does not exist for any undelivered elements of a multiple
element arrangement, then the aggregate value of the arrangement, including the
value of products and services delivered or performed, is initially deferred
until all hardware and software is delivered, and then the entire amount of the
arrangement is recognized ratably over the period of the last deliverable,
generally the remaining service period of the contract. Depending upon the
elements and the terms of the arrangement, the Company recognizes certain
revenues under the residual method. Under the residual method, revenue is
recognized when VSOE of fair value exists for all of the undelivered
elements in the arrangement, but does not exist for one or more of the delivered
elements in the arrangement. Under the residual method, the Company defers the
fair value of undelivered elements, and the remainder of the arrangement fee is
then allocated to the delivered elements and is recognized as revenue, assuming
the other revenue recognition criteria are met.




56


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Costs and
Billings on Uncompleted Contract-During fiscal 2008 and
continuing during fiscal 2009, the Company entered into a fixed-price contract
with a customer, pursuant to which it will deliver an electronic bingo system.
Revenues from this fixed-price contract is being recognized on the
completed-contract method in accordance with ASC Subtopic 605-35,
“Construction-Type and Production-Type Contracts” (formerly American Institute
of Certified Public Accountants Statement of Position 81-1).




Contract
costs include all direct material and labor costs, and those indirect costs
related to contract performance, such as indirect labor, supplies and tools.
General and administrative costs are charged to expense as incurred. Provisions
for estimated losses on uncompleted contracts are made in the period in which
such losses are determined.




Costs
incurred in excess of amounts billed are classified as current assets under
“Deferred contract costs.”




At
September 30, 2009 and 2008, the following amounts were recorded in
the Company’s consolidated financial statements (in thousands):




September
      30,2009
            
            
            2008Costs
      incurred on uncompleted contracts
            
            $
            3,697
            
            
            $
            1,350Billings
      on uncompleted contracts
            
            
            (1,871
            )
            
            
            (352
            )Deferred
      contract costs, net
            
            $
            1,826
            
            
            $
            998




The
contract is expected to be completed during the first half of fiscal 2010, the
Company does not anticipate a loss on the contract at this time.




Cash and Cash
Equivalents –The Company considers all highly liquid investments (i.e.,
investments which, when purchased, have original maturities of three months or
less) to be cash equivalents.




Restricted Cash
and Long-Term Investments –Restricted cash and long-term investments at
September 30, 2009 and 2008 were $804,000 and $868,000,
respectively, representing the fair value of investments held by the Company’s
prize fulfillment firm related to outstanding MegaBingo®
jackpot prizes.




Allowance for
Doubtful Accounts –The Company maintains an allowance for doubtful
accounts related to its accounts receivable and notes receivable that have been
deemed to have a risk of collectibility. Management reviews its accounts
receivable and notes receivable on a monthly basis to determine if any
receivables will potentially be uncollectible. Management analyzes historical
collection trends and changes in its customer payment patterns, customer
concentration, and creditworthiness when evaluating the adequacy of its
allowance for doubtful accounts. In its overall allowance for doubtful accounts,
the Company includes any receivable balances where uncertainty exists as to
whether the account balance has become uncollectible. Based on the information
available, management believes the allowance for doubtful accounts is adequate;
however, actual write-offs might exceed the recorded allowance.




Inventory –The Company’s inventory consists primarily of completed player terminals,
related component parts and back-office computer equipment expected to be sold
over the next twelve months. Inventories are stated at the lower of cost (first
in, first out) or market.




Development
Agreements –The Company enters into development agreements to provide
financing for new gaming facilities or for the expansion of existing facilities.
In return, the facility dedicates a percentage of its floor space to placement
of the Company’s player terminals, and the Company receives a fixed percentage
of those player terminals’ hold per day over the term of the agreement which is
generally for 83 months. Certain of the agreements contain player terminal
performance standards that could allow the facility to reduce a portion of the
Company’s guaranteed floor space. In addition, certain development agreements
allow the facilities to buy out floor space after advances that are subject to
repayment have been repaid. The agreements typically provide for a portion of
the amounts retained by the gaming facility for their share of the operating
profits of the facility to be used to repay some or all of the advances recorded
as notes receivable. Amounts advanced in excess of those to be reimbursed by the
customer for real property and land improvements are allocated to intangible
assets and are generally amortized over the term of the contract, which is
recorded as a reduction of revenue generated from the gaming facility. In the
past and in the future, the Company may by mutual agreement and for
consideration, amend these contracts to reduce its floor space at the
facilities. Any proceeds received for the reduction of floor space is first
applied against the intangible asset recovered for that particular development
agreement, if any and the remaining net book value of the intangible asset is
prospectively amortized on a straight-line method over the remaining estimated
useful life.




57


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




At
September 30, 2009 and 2008, the following net amounts related to
advances made under development agreements were recorded in the following
balance sheet captions:




September
      30,2009
            
            
            2008(In
      thousands)Included
      in:Notes
      receivable, net of discount(1)
            
            $
            50,288
            
            
            $
            61,750Intangible
      assets – contract rights,net
      of accumulated amortization
            
            
            28,175
            
            
            
            29,368






(1) The
Company collected approximately $21.3 million on development agreement
notes receivable during 2009.





Notes
receivable from development agreements are generated from reimbursable amounts
advanced under development agreements. The Company has entered into development
agreements with customers under which approximately $57.6 million has been
advanced and is outstanding at September 30, 2009, and for which
we impute interest on these interest-free loans discounting the balances to
$50.3 million. During both fiscal 2009 and 2008, the Company recorded
imputed interest of $4.3 million relating to development agreements with an
imputed interest rate range of 5.75% to 9.00%.




Property and
Equipment and Leased Gaming Equipment –Property and equipment and leased
gaming equipment are stated at cost. The cost of property and equipment and
leased gaming equipment is depreciated over their estimated useful lives,
generally using the straight-line method for financial reporting, and regulatory
acceptable methods for income tax reporting purposes. Player terminals placed
with customers under participation arrangements are included in leased gaming
equipment. Leased gaming equipment includes a “pool” of rental terminals, i.e.,
the “rental pool.” Rental pool units are those units that have previously been
placed in the field under participation arrangements, but are currently back
with the Company, being refurbished and/or awaiting redeployment. Routine
maintenance of property and equipment and leased gaming equipment is expensed in
the period incurred, while major component upgrades are capitalized and
depreciated over the estimated remaining useful life of the component. Sales and
retirements of depreciable property are recorded by removing the related cost
and accumulated depreciation from the accounts. Gains or losses on sales and
retirements of property are reflected in the Company’s results of
operations.




Management
reviews long-lived asset classes for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to its fair value, which considers
the future undiscounted cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment recognized is measured
by the amount by which the carrying amount of the assets exceeds their fair
value. Assets to be disposed of are reported at the lower of the carrying amount
or the fair value less costs of disposal. During the years ended September 30,
2009 and 2008, the Company charged operations by recording reserves or writing
off $9.4 million and $5.9 million, respectively, of property and equipment and
leased gaming equipment (See Note 2, “Property and Equipment and Leased
Gaming Equipment.”)




58


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Deferred Revenue
–Deferred revenue represents amounts from the sale of gaming equipment
and systems that have been billed, or for which notes receivable have been
executed, but which transaction has not met the Company’s revenue recognition
criteria. The cost of the related gaming equipment and systems has been offset
against deferred revenue. Amounts are classified between current and long-term
liabilities, based upon the expected period in which the revenue will be
recognized.




Other Income-Other income was $74,000, $3.1 million and $3.1 million for the
years ended September 30, 2009, 2008 and 2007, respectively. Other
income consisted of distributions from a partnership interest, accounted for on
the cost basis, of $3.1 million in 2008 and $1.7 million
in 2007. Also in 2007, other income consisted of $1.4 million
resulting from the extinguishment of a liability resulting from the settlement
with the Company’s former Chief Executive Officer.




Research and
DevelopmentCosts -For
the years ended September 30, 2009, 2008 and 2007 research and
development costs were $10.3 million, $16.2 million and $18.1 million,
respectively.




Other Long-Term
Liabilities –Other long-term liabilities at September 30, 2009
and 2008 include the present value of investments held by the Company’s
prize-fulfillment firm related to outstanding MegaBingo jackpot-prize-winner
annuities of $800,000 and $868,000, respectively




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




Segment and
Related Information–Although the Company has a number of operating divisions, separate
segment data has not been presented as they meet the criteria for aggregation as
permitted by ASC Topic 280, “Segment Reporting” (formerly Statement of Financial
Accounting Standards (SFAS) No. 131, “Disclosures About Segments of an
Enterprise and Related Information”).




Costs of Computer
Software –Software
development costs have been accounted for in accordance with ASC Topic 985,
“Software” (formerly SFAS No. 86, “Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed”). Under ASC Topic
985, capitalization of software development costs begins upon the establishment
of technological feasibility and prior to the availability of the product for
general release to customers. We capitalized software development costs of
approximately $2.5 million during 2009, $3.7 million
during 2008, and $2.8 million during 2007. Software development
costs primarily consist of personnel costs. We begin to amortize capitalized
costs when a product is available for general release to customers. Amortization
expense is determined on a product-by-product basis at a rate not less than
straight-line basis over the product’s remaining estimated economic life, but
not to exceed five years. Amortization of software development costs was
approximately $3.8 million in 2009, $3.3 million in 2008,
and $4.3 million in 2007, and is included in amortization and
depreciation in the accompanying consolidated statements of
operations.




Income Taxes –The Company accounts for income taxes using the asset and liability
method and applies the provisions of ASC Topic 740, “Income Taxes” (formerly
SFAS, No. 109, “Accounting for Income Taxes”). Under ASC Topic 740,
deferred tax liabilities or assets arise from differences between the tax basis
of liabilities or assets and their bases for financial reporting, and are
subject to tests of recoverability in the case of deferred tax assets. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. A valuation allowance is provided for deferred tax
assets to the extent realization is not judged to be more likely than
not.  Additionally, in accordance with ASC Topic 740, (formerly
FIN 48, “Accounting for Uncertainty in Income Taxes”), we are required to
determine whether it is more likely than not (a likelihood of more than
50 percent) that a tax position will be sustained upon examination,
including resolution of any related appeals or litigation processes, based on
the technical merits of the position in order to record any financial statement
benefit. If that step is satisfied, then we must measure the tax position to
determine the amount of benefit to recognize in the financial statements. The
tax position is measured at the largest amount of benefit that is greater than
50 percent likely of being realized upon ultimate settlement.




59





MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




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




Earnings (Loss)
per Common Share – Earnings per common share is computed in accordance
with ASC Topic 260, “Earnings Per Share” (formerly SFAS No. 128, “Earnings
per Share”). Presented below is a reconciliation of net income (loss) available
to common stockholders and the differences between weighted average common
shares outstanding, which are used in computing basic earnings (loss) per share,
and weighted average common and potential shares outstanding, which are used in
computing diluted earnings (loss) per share.




For
      the Year Ended
              September 30,(In
      thousands, except share and per-share amounts)2009
            
            
            2008
            
            
            2007Income
      (loss) available to common stockholders
            
            $
            (44,778
            )
            
            $
            378
            
            
            $
            (744
            )Weighted
      average common shares outstanding
            
            
            26,758,873
            
            
            
            26,291,968
            
            
            
            27,388,921Effect
      of dilutive securities:Options
            
            
            —
            
            
            
            909,462
            
            
            
            —Weighted
      average common and potential shares outstanding
            
            
            26,758,873
            
            
            
            27,201,430
            
            
            
            27,388,921Basic
      earnings (loss) per share
            
            $
            (1.67
            )
            
            $
            0.01
            
            
            $
            (0.03
            )Diluted
      earnings (loss) per share
            
            $
            (1.67
            )
            
            $
            0.01
            
            
            $
            (0.03
            )




Stock Options -At September 30, 2009, options to purchase approximately
6.8 million shares of common stock, with exercise prices ranging
from $1.00 to $18.71 per share were outstanding, but were not included
in the computation of diluted earnings per share due to their antidilutive
effect, of which 6.0 million were not included due to their respective share
price and the balance due to the loss generated during the current
year.




At
September 30, 2008, options to purchase approximately 2.9 million
shares of common stock, with exercise prices ranging from $4.68
to $21.53 per share were outstanding, but were not included in the
computation of diluted earnings per share due to their antidilutive
effect.




At
September 30, 2007, options to purchase approximately 1.7 million
shares of common stock, with exercise prices ranging from $7.61
to $21.53 per share, were not included in the computation of diluted
earnings per share due to the antidilutive effect, and approximately
1.8 million equivalent shares were not included due to the loss generated
during fiscal 2007.




The
Company adopted the provisions of ASC Topic 718, “Compensation – Stock
Compensation” (formerly SFAS No. 123(R), “Share-Based Payment”). Among
other items, ASC Topic 718 requires the Company to recognize in the financial
statements, the cost of employee services received in exchange for awards of
equity instruments, based on the grant date fair value of those awards. To
measure the fair value of stock options granted to employees, the Company
currently utilizes the Black-Scholes-Merton option-pricing model. The Company
applied the “modified prospective” method, under which compensation cost is
recognized in the financial statements beginning with the adoption date for all
share-based payments granted after that date, and for all unvested awards
granted prior to the adoption date.  Expense is recognized over the
required service period, which is generally the vesting period of the
options.




The
Black-Scholes-Merton model incorporates various assumptions, including expected
volatility, expected life, and risk-free interest rates. The expected volatility
is based on the historical volatility of the Company’s common stock over the
most recent period commensurate with the estimated expected life of the
Company’s stock options, adjusted for the impact of unusual fluctuations not
reasonably expected to recur. The expected life of an award is based on
historical experience and on the terms and conditions of the stock awards
granted to employees.




60


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


There
were option grants to purchase 1.7 million, 2.7 million and 160,000 common
shares during the years ended September 30, 2009, 2008 and 2007,
respectively. The assumptions used for the years ended September 30,
2009, 2008 and 2007, and the resulting estimates of weighted-average
fair value per share of options granted during these periods are as
follows:




2009
            
            
            2008
            
            
            2007Weighted expected life
            
            4.97 years
            
            
            4.98 years
            
            
            4.63 yearsRisk-free
      interest rate
            
            1.5 -2.9%
            
            
            3.0% - 4.1%
            
            
            4.10%Expected
      volatility
            
            58.28%
            
            
            50.23%
            
            
            62.00%Expected
      dividend yields
            
            None
            
            
            None
            
            
            NoneWeighted-average
      fair value of options granted during the period
            
            $1.81
            
            
            $2.14
            
            
            $5.88Expected
      annual forfeiture rate
            
            5.31%
            
            
            5.31%
            
            
            5.31%




In
accordance with ASC Topic 718, “Compensation – Stock Compensation (Formerly SFAS
No. 123 (R), “Share-Based Payments”), the share-based compensation has
been recorded by the Company for the years
ended 2009, 2008 and 2007 in the amounts of
$1.8 million, $1.5 million and $1.2 million, respectively. The total
income tax benefit recognized in the statement of operations for share-based
compensation arrangements was $0 (due to a current year valuation
allowance), $234,000 and $162,000 for the years ended
September 30, 2009, 2008 and 2007,
respectively.




Foreign Currency
Translation. The Company accounts for currency translation in accordance
with ASC Topic 830. “Foreign Currency Matters” (formerly SFAS No. 52,
“Foreign Currency Translation”). Balance sheet accounts are translated at the
exchange rate in effect at each balance sheet date. Income statement accounts
are translated at the average rate of exchange prevailing during the period.
Translation adjustments resulting from this process are charged or credited to
other comprehensive income (loss) a component of stockholders’ equity, in
accordance with ASC Topic 220, “Comprehensive Income” (formerly SFAS 130,
“Reporting Comprehensive Income”). Transactional currency gains and losses
arising from transactions in currencies other than the Company’s local
functional currency are included in the consolidated statement of operations in
accordance with ASC Topic 830.




Recently Issued
Accounting Pronouncements –In June 2009, the FASB
issued SFAS No. 168, “The FASB Accounting Standards Codification and Hierarchy
of Generally Accepted Accounting Principles (a replacement of SFAS No. 162).”
FASB Accounting Standards Codification (ASC) has become the source of
authoritative generally accepted accounting principles GAAP recognized by the
FASB to be applied by nongovernmental entities.  Rules and
interpretive releases of the SEC under authority of federal securities laws are
also sources of authoritative GAAP for SEC registrants.  On the
effective date of this statement, the codification will supersede all
then-existing non-SEC accounting and reporting standards; and all
non-grandfathered, non-SEC accounting literature not included in the
codification will be superseded and deemed non-authoritative.  The new
codification standards have been adopted by the Company in its annual report on
Form 10-K as of September 30, 2009.  Reference to the new ASC topic,
subtopic, or section will be provided along with the superceded historical
accounting literature. The adoption of codification standards did not impact our
consolidated financial position, results of operation or cash
flows.




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




In May
2009, the FASB issued ASC Topic 855, “Subsequent Events” (formerly SFAS No. 165,
“Subsequent Events”),  which establishes the accounting for and
disclosure of events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued.  It
requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for that date; that is, whether that date
represents the date the financial statements were issued or were available to be
issued. Consistent with ASC Topic 855 requirements for public entities, we
evaluate subsequent events through the date the financial statements are
issued.  ASC Topic 855 should not result in significant changes in the
subsequent events that an entity reports, either through recognition or
disclosure, in its financial statements.  ASC Topic 855 was adopted as
of June 30, 2009.  The adoption of ASC Topic 855 did not impact our
consolidated financial position, results of operations or cash
flows.




61




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


In
March 2008, the FASB issued ASC Topic 815, “Derivatives and Hedging”
(formerly SFAS No 161, “Disclosures about Derivative Instruments and
Hedging Activities—An Amendment of FASB Statement No. 133”). ASC Topic 815
enhances required disclosures regarding derivatives and hedging activities,
including enhanced disclosures regarding how: (a) an entity uses derivative
instruments; (b) derivative instruments and related hedged items are
accounted, and (c) derivative instruments and related hedged items affect
an entity's financial position, financial performance, and cash flows. ASC Topic
815 is effective for fiscal years, and interim periods within those fiscal
years, beginning after November 15, 2008, though earlier application is
encouraged. Accordingly, the Company expects to adopt ASC Topic 815 beginning in
fiscal 2010. The Company expects that ASC Topic 815 will have an impact on
accounting for derivative instruments and hedging activities once adopted, but
the significance of the effect is dependent upon entering into these related
transactions, if any, at that time.




Effective October 1, 2008,
the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures”
(formerly SFAS No. 157, “Fair Value Measurements”), for its financial
assets and financial liabilities, but it has not yet adopted ASC Topic 820 as it
relates to nonfinancial assets and liabilities as ASC Topic 820 permits a
one-year deferral of the its application for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually) to
fiscal years beginning after November 15, 2008. The adoption of ASC
Topic 820 as it pertains to financial assets and liabilities did not have a
material impact on the Company’s results of operations, financial position or
liquidity. The Company will adopt ASC Topic 820 for non-financial assets and
non-financial liabilities on October 1, 2009, and the Company is
currently evaluating the effect, if any, the adoption may have on its financial
position, results of operations or cash flows.




In
December 2007, the FASB issued ASC Topic 805, “Business Combinations”
(formerly SFAS No. 141 (revised), “Business Combinations”). ASC Topic 805
changes the accounting for business combinations including the measurement of
acquirer shares issued in consideration for a business combination, the
recognition of contingent consideration, the accounting for preacquisition gain
and loss contingencies, the recognition of capitalized in-process research and
development, the accounting for acquisition-related restructuring cost accruals,
the treatment of acquisition related transaction costs and the recognition of
changes in the acquirer’s income tax valuation allowance. ASC Topic 805 is
effective for fiscal years beginning after December 15, 2008, with
early adoption prohibited. The Company is required to adopt ASC Topic 805
effective October 1, 2009, and the Company is currently evaluating the
effect, if any, the adoption may have on its financial position or the results
of its operations.




In
December 2007, the FASB issued ASC Topic 810, “Consolidation” (formerly
SFAS No. 160, “Non Controlling Interests in Consolidated Financial
Statements,” an amendment of Accounting Research Bulletin, or ARB No. 51,
“Consolidated Financial Statements”). ASC Topic 810 changes the accounting for
non controlling (minority) interests in consolidated financial statements,
including the requirement to classify non controlling interests as a component
of consolidated stockholders’ equity, and the elimination of “minority interest”
accounting in results of operations with earnings attributable to non
controlling interests reported as part of consolidated earnings. Additionally,
ASC Topic 810 revises the accounting for both increases and decreases in a
parent’s controlling ownership interest. ASC Topic 810 is effective for fiscal
years beginning after December 15, 2008, with early adoption
prohibited. The Company is required to adopt ASC Topic 810 effective
October 1, 2009, and the Company is currently evaluating the effect,
if any, the adoption may have on its results of operations or financial
position.




In
February 2007, the FASB issued ASC Topic 825,”Financial Instruments”
(formerly SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities, including an amendment of FASB Statement No. 115
“Accounting for Certain Investments in Debt and Equity Securities”), which
permits entities to choose to measure many financial instruments and certain
other items at fair value with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. This Statement
became effective for the Company beginning in October 2008. The
implementation of ASC Topic 825, effective October 1, 2008, did not
have a material effect on the consolidated financial statements in the year
ended September 30, 2009.




62





MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


2.  Property
and Equipment and Leased Gaming Equipment




At
September 30, 2009 and 2008, the Company’s property and equipment
and leased gaming equipment consisted of the following:




2009
            
            
            2008
            
            Estimated
              Useful
              Lives(In
      thousands)Gaming
      equipment and third-party gaming content licenses available for
      deployment(1)
            
            $
            6,449
            
            
            $
            30,252Deployed
      gaming equipment
            
            
            99,522
            
            
            
            96,584
            
            3-5
      yearsDeployed
      third-party gaming content licenses
            
            
            39,512
            
            
            
            34,444
            
            1.5-3
      yearsTribal
      gaming facilities and portable buildings
            
            
            3,563
            
            
            
            4,720
            
            5-7
      yearsThird-party
      software costs
            
            
            7,720
            
            
            
            7,732
            
            3-5
      yearsVehicles
            
            
            3,065
            
            
            
            3,502
            
            3-10
      yearsOther
            
            
            2,991
            
            
            
            3,191
            
            3-7
      yearsTotal
      property and equipment
            
            
            162,822
            
            
            
            180,425Less
      accumulated depreciation and amortization
            
            
            (127,774
            )
            
            
            (113,096
            )Total
      property and equipment, net
            
            $
            35,048
            
            
            $
            67,329Leased
      gaming equipment
            
            $
            156,474
            
            
            $
            165,903
            
            3
      yearsLess
      accumulated depreciation
            
            
            (122,472
            )
            
            
            (129,879
            )Total
      leased gaming equipment, net
            
            $
            34,002
            
            
            $
            36,024





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








During 2009,
the Company sold, disposed of, or wrote off $5.4 million of net book
value related to third-party gaming content licenses, installation costs, tribal
gaming facilities and portable buildings, and other equipment. Of this
$5.4 million, $3.3 million related to the sale of previously deployed
units.




Leased
gaming equipment includes player terminals placed under participation
arrangements that are either at customer facilities or in the rental
pool.




In
accordance with ASC Topic 360, “Property, Plant, and Equipment” (formerly
SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets”), the Company i) recognizes an impairment loss only if the carrying
amount of a long-lived asset is not recoverable from its undiscounted cash
flows; and (ii) measures an impairment loss as the difference between the
carrying amount and fair value of the asset.




During
the year ended September 30, 2009, the Company hired a new management
team.  The management team conducted a thorough review of the
Company’s business in an effort to determine the proper go-forward strategy for
the Company.  As part of this analysis, the Company’s revised
marketing efforts and a more standardized product mix, management considered
whether the future benefits expected from certain long-lived assets exceeded the
assets carrying value.  As a result of this analysis, it was
determined that certain assets should be written-off or reserved for as of
September 30, 2009.  The charges include the write-off of property and
equipment included in the Company’s rental pool and obsolete component parts of
$5.6 million, the write-off of certain licenses used for game development of
$2.0 million and a the reserve for slow-moving component parts of $1.8 million.
The Company considered the potential salvage value of the assets and determined
that such an amount would be negligible. Therefore, classification of these
assets as ‘held for sale’ is not necessary.




63


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


3.  Development
Agreements




The
Company enters into participation, or revenue share,
agreements.  Under our participation agreements, we place player
terminals and systems, along with our proprietary and other licensed game
content, at a customer’s facility in return for a share of the revenues that
these terminals and systems generate.  Often our participation
agreements are in the form of development agreements, which the Company enters
into in order to provide financing for new gaming facilities or for the
expansion of existing facilities. In return, the facility dedicates a percentage
of its floor space to placement of the Company’s player terminals, and the
Company receives a fixed percentage of those player terminals’ hold per day over
the term of the agreement. The agreements typically provide for some or all of
the advances to be repaid by the customer to the Company. Amounts advanced in
excess of those to be reimbursed by the customer are allocated to intangible
assets and are generally amortized over the life of the contract, which is
recorded as a reduction of revenue generated from the gaming facility. Certain
of the agreements contain player terminal performance standards that could allow
the facility to reduce a portion of the Company’s floor space. In the past and
in the future, the Company may by mutual agreement and for consideration, amend
these contracts to reduce its floor space at the facilities. Any proceeds
received for the reduction of floor space is first applied as a recovery against
the intangible asset or property and development for that particular development
agreement, if any. In the second quarter of fiscal 2008, the Company
modified a development agreement by agreeing to reduce the number of player
terminals at a development site. In return, the Company received a complete
payoff of a note receivable in the amount of $4.5 million.




In 2008,
the Company fulfilled a commitment to a significant, existing tribal customer to
provide approximately 43.8%, or $65.6 million, of the total funding
for a facility expansion. Because of our commitment to fund the expansion, the
Company secured the right to place an additional 1,400 gaming units in the
expanded facility in southern Oklahoma. The Company recorded all advances as a
note receivable and imputed interest on the interest free loan. The discount
(imputed interest) was recorded as contract rights and will be amortized over
the life of the agreement. The repayment period of the note will be based on the
performance of the facility. As of September 30, 2009, the Company had
installed the additional 1,400 units in the expanded facility. During 2009,
the tribal customer repaid $13.1 million of the balance; thus the balance as of
September 30, 2009 was $52.5 million.




In
addition, the Company funded two additional facilities in 2009 in the amount of
$5.1 million.  These funded amounts are expected to be repaid to the
Company from excess sales proceeds after giving effect to the revenue share
arrangements.




Management
reviews intangible assets related to development agreements for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. There were no events or changes in circumstance
during fiscal 2009 that would require an impairment charge to the assets’
carrying value.




The
following net amounts related to advances made under development agreements and
were recorded in the following balance sheet captions:




September
      30,2009
            
            
            2008(In
      thousands)Included
      in:Notes
      receivable, net
            
            $
            50,288
            
            
            $
            61,750Intangible
      assets – contract rights,net
      of accumulated amortization
            
            
            28,175
            
            
            
            29,368




64





MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


4.  Intangible
Assets




At
September 30, 2009 and 2008, the Company’s intangible assets
consisted of the following:




EstimatedSeptember
      30,
            
            Useful2009
            
            
            2008
            
            Lives(In
      thousands)Contract
      rights under development agreements
            
            $
            46,319
            
            
            $
            41,325
            
            5-7
      yearsInternally
      developed gaming software
            
            
            28,388
            
            
            
            26,473
            
            1-5
      yearsPatents
      and trademarks
            
            
            8,226
            
            
            
            8,464
            
            1-5
      yearsOther
            
            
            961
            
            
            
            1,054
            
            3-5
      yearsTotal
      intangible assets
            
            
            83,894
            
            
            
            77,316Less
      accumulated amortization – all other
            
            
            (50,533
            )
            
            
            (39,960
            )Total
      intangible assets, net
            
            $
            33,361
            
            
            $
            37,356




Contract
rights are amounts allocated to intangible assets for dedicated floor space
resulting from development agreements, described under “Development Agreements.”
The related amortization expense, or accretion of contract rights, is netted
against its respective revenue category in the consolidated statements of
operations.




Internally-developed
gaming software is accounted for under the provisions of ASC Topic 985,
“Software” (formerly SFAS No. 86, “Accounting for the Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed”) and is stated at cost, which
is amortized over the estimated useful life of the software, generally using the
straight-line method. The Company amortizes internally-developed games over a
twelve-month period, gaming engines over an eighteen-month period, gaming
systems over a three-year period and its central management systems over a
five-year period. Software development costs are capitalized once technological
feasibility has been established, and are amortized when the software is placed
into service. Any subsequent software maintenance costs, such as bug fixes and
subsequent testing, are expensed as incurred. Discontinued software development
costs are expensed when the determination to discontinue is made. For the years
ended September 30, 2009, 2008, and 2007, amortization expense
related to internally-developed gaming software was $3.8 million ,
$3.3 million and $4.3 million, respectively. During
fiscal 2009, 2008, and 2007, the Company wrote off $571,000,
$531,000 and $300,000, respectively, related to internally-developed
gaming software that the Company chose to abandon.




Management
reviews intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An analysis of intangible assets at September 30, 2008
indicated there was an impairment to goodwill which resulted in a $335,277
reserve being recorded.




65




MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Amortization
expense, inclusive of accretion of contract rights, totaled $11.0 million,
$8.8 million and $11.9 million for the years ended
September 30, 2009, 2008 and 2007, respectively. Annual estimated
amortization expense for each of the five succeeding fiscal years is as
follows:




Year
            
            Amount(In
      thousands)2010
            
            $
            9,2532011
            
            
            6,8542012
            
            
            5,6952013
            
            
            4,9282014
            
            
            2,923Total
            
            $
            29,653




5.  Notes
Receivable




At
September 30, 2009 and 2008, the Company’s notes receivable
consisted of the following:




September
      30,2009
            
            
            2008(In
      thousands)Notes
      receivable from development agreements
            
            $
            57,558
            
            
            $
            72,706Less
      imputed interest discount reclassed to contract rights
            
            
            (7,270
            )
            
            
            (10,956
            )Notes
      receivable from equipment sales and other
            
            
            5,616
            
            
            
            8,012Notes receivable,
      net
            
            
            55,904
            
            
            
            69,762Less
      current portion
            
            
            (15,780
            )
            
            
            (23,072
            )Notes receivable –
      noncurrent
            
            $
            40,124
            
            
            $
            46,690




Notes
receivable from development agreements are generated from reimbursable amounts
advanced under development agreements.




Notes
receivable from equipment sales outstanding as of September 30, 2009
consist of financial instruments issued by customers for the purchase of player
terminals and licenses, and bear interest at 5.75%. All of the Company’s
notes receivable from equipment sales are collateralized by the related
equipment sold, although the value of such equipment, if repossessed, may be
less than the note receivable outstanding.




6.  Accounts
Payable and Accrued Expenses




At
September 30, 2009 and 2008, the Company’s accounts payable and
accrued expenses consisted of the following:




September
      30,2009
            
            
            2008(In
      thousands)Trade
      accounts payable and accrued expenses
            
            $
            18,955
            
            
            $
            23,022Accrued
      bonus and salaries
            
            
            4,196
            
            
            
            2,474Other
            
            
            3,727
            
            
            
            3,785Accounts
      payable and accrued expenses
            
            $
            26,878
            
            
            $
            29,281




66





MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)





7.  Credit
Facility, Long-Term Debt




At
September 30, 2009 and 2008, the Company’s Credit Facility,
long-term debt and capital leases consisted of the following:




September
      30,2009
            
            
            2008(In
      thousands)Long-term
      revolving lines of credit
            
            $
            15,000
            
            
            $
            19,000Term
      loan facility
            
            $
            60,748
            
            
            $
            67,988Less
      current portion
            
            
            (2,073
            )
            
            
            (1,544
            )Long-term debt, less current
      portion
            
            $
            58,675
            
            
            $
            66,444




Credit
Facility. On April 27, 2007, the Company entered into a
$150 million Credit Facility which replaced its previous credit facility in
its entirety. On October 26, 2007, the Company amended the Credit
Facility, transferring $75 million of the revolving credit commitment
to a fully funded $75 million term loan due April 27, 2012. The
Term Loan is amortized at an annual amount of 1% per year, payable in equal
quarterly installments beginning January 1, 2008, with the remaining
amount due on the maturity date. The Company entered into a second amendment to
the Credit Facility on December 20, 2007 which (i) extended the
hedging arrangement date related to a portion of the term loan to
June 1, 2008; and (ii) modified the interest rate margin
applicable to the Revolving Credit Facility and the term loan.




The
Credit Facility provides the Company with the ability to finance development
agreements and acquisitions and working capital for general corporate purposes.
Amounts under the $65 million revolving credit commitment and
the $60 million term loan mature on April 27, 2012, and advances under
the term loan and revolving credit commitment bear interest at the Eurodollar
rate plus the applicable spread, tied to various levels of interest pricing
determined by total debt to EBITDA (EBITDA is defined as earnings before
interest, taxes, amortization, depreciation, and accretion of contract rights).
As of September 30, 2009, the $15.0 million drawn under the revolving
credit commitment bore interest at 5.75% and the $60.0 million under
the term loan bore interest at 6.5%. Also included in the September 30,
2009 and 2008 balances are approximately $748,000 and $680,000,
respectively, of accrued interest.




On July
22, 2009, the Company entered into a third amendment to the Credit
Facility.  Under the terms of the amended credit agreement, the
calculation of consolidated Adjusted EBITDA (EBITDA, plus certain add-backs as
agreed upon by our lenders) for the purposes of evaluating compliance with
the specified covenants will now reflect the add-back of several items
including: i) legal costs and settlement fees incurred in the trailing
four-quarter period related to litigation with Diamond Game Enterprises, Inc.,
or Diamond Game, which was settled on May 1, 2009; ii) all non-cash stock-based
compensation expenses; and, iii) up to $10 million, in aggregate, of additional
non-cash asset impairment charges that the Company may incur in future periods.
In conjunction with the third amendment, the Company reduced the total borrowing
capacity of the credit facility to $125 million from the previous total
borrowing capacity of $150 million and agreed to a LIBOR floor of 2%, which
would have increased the interest rate paid as of June 30, 2009 by approximately
1.7%. On July 23, 2009, the Company paid a one-time fee of 25 basis points of
the total borrowing capacity of $125 million as well as other customary fees
associated with the amendment.




The
Credit Facility is collateralized by substantially all of the Company’s assets,
and also contains financial covenants as defined in the agreement. These
covenants include (i) a minimum fixed-charge coverage-ratio of not less
than 1.50 : 1.00; (ii) a maximum total debt to Adjusted
EBITDA ratio of not more than 2.25 : 1.00 through June 30, 2008,
and 1.75 : 1.00 from September 30, 2008 thereafter; and
(iii) a minimum trailing twelve-month Adjusted EBITDA of not less
than $60.0 million for the quarter. As of
September 30, 2009, the Company is in compliance with its loan
covenants. The Credit Facility requires certain mandatory prepayments be made on
the term loan from the net cash proceeds of certain asset sales and condemnation
proceedings (in each case to the extent not reinvested, within certain specified
time periods, in the replacement or acquisition of property to be used in its
businesses). In the second quarter of 2008, the Company made a mandatory
prepayment of the term loan in the amount of $4.5 million due to an early
prepayment of a development agreement note receivable. As of
September 30, 2009, the Credit Facility had availability of
$50.0 million, subject to covenant restrictions.




67


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The
Credit Facility also required that the Company enter into hedging arrangements
covering at least $50 million of the term loan for a three-year period by
June 1, 2008; therefore, on May 29, 2008, the Company
purchased, for $390,000, an interest rate cap (5% cap rate) covering
$50 million of the term loan. The Company accounts for this hedge in
accordance with ASC Topic 815, “Derivatives and Hedging” (formerly FASB
Statement No. 133, “Accounting for Derivative Instruments and Hedging
Activities”) which requires entities to recognize all derivative instruments as
either assets or liabilities in the balance sheet, at their respective fair
values. The Company records, on a mark- to-market basis, changes to the fair
value of the interest rate cap on a quarterly basis. These changes in fair value
are recorded in interest expense in the consolidated statement of
operations.




Long-term
debt at September 30, 2009 and 2008, includes the Credit Facility’s
term loan.




A
schedule for each of the fiscal years ending after September 30, 2009,
representing the maturities of long-term debt is as follows:




Year
            
            Long-Term
              Debt
            
            
            Revolving
              Lines of Credit(In
      thousands)2010
            
            $
            2,073
            
            
            $
            —2011
            
            
            750
            
            
            
            —2012
            
            
            57,925
            
            
            
            15,000Total
            
            $
            60,748
            
            
            $
            15,000




8.  Leases




The
Company leases its corporate offices, warehouses and certain office equipment
under noncancelable operating leases. In addition, the Company leases certain
equipment used in its operations under capital lease arrangements.




A
schedule of future minimum rental payments required under noncancelable
operating leases is as follows:




Year
            
            Operating(In
      thousands)2010
            
            $
            2,1342011
            
            
            1992012
            
            
            362013
            
            
            362014
            
            
            36Total
      Minimum Lease Payments
            
            $
            2,441




Rental
expense during 2009, 2008, and 2007 amounted to
$2.8 million, $2.7 million and $2.5 million,
respectively.




68


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




9.  Income
Taxes




The
provision for income tax expense (benefit) consisted of the following for the
years ended September 30, 2009, 2008 and 2007:




2009
            
            
            2008
            
            
            2007(In
      thousands)Current:Federal
            
            $
            (6,271
            )
            
            $
            4,223
            
            
            $
            8,784State
            
            
            41
            
            
            
            828
            
            
            
            638Foreign
            
            
            692
            
            
            
            514
            
            
            
            274(5,538
            )
            
            
            5,565
            
            
            
            9,696Deferred:Federal
            
            
            18,185
            
            
            
            (4,673
            )
            
            
            (10,489
            )State
            
            
            1,351
            
            
            
            (590
            )
            
            
            (386
            )Foreign
            
            
            —
            
            
            
            —
            
            
            
            —19,536
            
            
            
            (5,263
            )
            
            
            (10,875
            )Income
      tax expense (benefit)
            
            $
            13,998
            
            
            $
            302
            
            
            $
            (1,179
            )




The
effective income tax rates differ from the statutory U.S. federal income tax
rates as follows for the years ended September 30, 2009, 2008,
and 2007:




2009
            
            
            2008
            
            
            2007Federal
      income tax expense (benefit) at statutory rate
            
            
            (35.0
            %)
            
            
            35.0
            %
            
            
            (35.0
            %)State
      income tax expense, net of federal benefit
            
            
            (2.6
            %)
            
            
            7.8
            %
            
            
            8.5
            %Foreign
      income tax expense, net of federal benefit
            
            
            1.1
            %
            
            
            47.7
            %
            
            
            9.3
            %Change
      in valuation allowance
            
            
            81.2
            %
            
            
            —
            
            
            
            —Other,
      net
            
            
            0.7
            %
            
            
            (46.1
            %)
            
            
            (44.7
            %)Provision
      (benefit) for income taxes
            
            
            45.4
            %
            
            
            44.4
            %
            
            
            (61.9
            %)




The
“other, net” category above captures the impact of several tax expense items,
the three largest of which, are all favorable to the Company in the fiscal
years 2008 and 2007, and included an unrecorded federal refund, an
over-accrual of state income tax expense, and the true-up of the Company’s
income tax accounts.




69


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Differences
between the book value and the tax basis of the Company’s assets and liabilities
at September 30, 2009 and 2008 result in deferred tax assets and
liabilities as follows:




2009
            
            
            2008(In
      thousands)Deferred
      tax asset – current:Allowance
      for doubtful accounts
            
            $
            1,383
            
            
            $
            455Inventory
      reserve
            
            
            1,038
            
            
            
            1,526Accruals
      not currently deductible for tax purposes
            
            
            3,345
            
            
            
            1,764Deferred
      revenue
            
            
            2,307
            
            
            
            3,131Current
      deferred tax asset
            
            
            8,073
            
            
            
            6,876Valuation
      allowance
            
            
            (6,935
            )
            
            
            -Current
      deferred tax asset, net
            
            
            1,138
            
            
            
            6,876Noncurrent
      deferred tax asset:Property
      and equipment, leased gaming equipment and
              intangible
      assets, due principally to depreciation and
              amortization
      differences
            
            
            19,560
            
            
            
            15,916Non-qualified
      stock compensation expense
            
            
            1,261
            
            
            
            986Net
      Operating Losses and credits
            
            
            250
            
            
            
            -Noncurrent
      deferred tax asset, net
            
            
            21,071
            
            
            
            16,902Valuation
      allowance
            
            
            (18,102
            )
            
            
            -Noncurrent
      deferred tax asset, net
            
            
            2,969
            
            
            
            16,902Deferred
      tax asset
            
            $
            4,107
            
            
            $
            23,778




As of
September 30, 2009, the Company had state net operating loss carryforwards
of approximately $4.0 million and a federal alternative minimum tax credit
carryforward of approximately $147,000. The state net operating losses will
begin to expire in varying amounts in 2024 if not utilized.




For 2009, 2008,
and 2007, the Company recorded reductions of $221,000, $112,000 and
$1.4 million respectively, of its federal and state income tax liability
due to the effects of stock compensation.




During
the year ended September 30, 2009, the Company hired a new management
team.  The management team conducted a thorough review of the
Company’s business in an effort to determine the proper go-forward strategy for
the Company.  In conjunction with this analysis, management also
considered the likelihood of realizing the future benefits associated with the
Company’s existing deductible temporary differences and
carryforwards.  As a result of this analysis and based on the current
year loss and a cumulative loss in the prior three fiscal years, management
determined that it is not more likely than not that the future benefit
associated with all of the Company’s existing deductible temporary differences
and carryforwards in the U.S. and Mexico will be realized.  As a
result, the Company recorded a valuation allowance against its deferred tax
assets to the extent that its gross deferred tax assets exceed the Company’s
carryback potential. Accordingly, for the year ended September 30, 2009, the
valuation allowance increased by approximately $25.0 million.  The
Company maintains a valuation allowance when management believes it is more
likely than not that all or a portion of a deferred tax asset will not be
realized. Changes in a valuation allowance from period to period are included in
the tax provision in the period of change.  Management evaluates the
recoverability of our deferred income tax assets by assessing the need for a
valuation allowance on a quarterly basis.  If we determine that it is
more likely than not that our deferred tax assets will be recovered, the
valuation allowance will be reduced.




The
Company paid income taxes, net of refunds received of ($1.4) million,
$10.9 million and $7.6 million in 2009, 2008 and 2007,
respectively.




In
fiscal 2009, the Company conducted operations in Mexico through a
subsidiary treated as a disregarded entity for U.S. income tax purposes.
Accordingly, income or losses are taxed or benefited, as appropriate, in the
Company’s U.S. tax provision. At present, Company management determined that it
is more likely than not that the Mexican operations can not
benefit from past losses, from a Mexican tax perspective. Accordingly, a
full valuation allowance has been recorded against the deferred tax asset
related to the Mexican net operating loss. The effect on the total income tax
expense is deemed immaterial.




70


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


On
November 6, 2009, the President signed H.R. 3548, which included a provision
that will allow most business taxpayers with losses to benefit from an increased
carryback period for net operating losses incurred in 2008 or
2009.  The effects of changes in tax law are taken into account during
the interim period in which the law is enacted.  The Company is still
evaluating whether the passage of H.R. 3548 will have a material
impact on its financial statements.




The
Company adopted the provisions of ASC 740-10-25 effective September 30,
2007.  ASC 740-10-25 prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax
return.  Benefits from tax positions should be recognized in the
financial statements only when it is more likely than not that the tax position
will be sustained upon examination by the appropriate taxing authority that
would have full knowledge of all the relevant information.  A tax
position that meets the more-likely-than-not recognition threshold is measured
at the largest amount of benefit that is greater than fifty percent likely of
being realized upon ultimate settlement.  Tax positions that
previously failed to meet the more-likely-than not recognition threshold should
be recognized in the first subsequent financial reporting period in which that
threshold is met.  Previously recognized tax positions that no longer
meet the more-likely-than-not recognition threshold should be derecognized in
the first subsequent financial reporting period in which that threshold is no
longer met.  ASC 740-10-25 also provides guidance on the accounting
for and disclosure of unrecognized tax benefits, interest, and
penalties.  Upon adoption and implementation of ASC 740-10-25, the
Company recognized a decrease of $295,000 to the October 1, 2007 balance of
retained earnings.





The
following is a tabular reconciliation of the total amounts of unrecognized tax
benefits for the years ended September 30,:





2009
            
            
            2008Unrecognized
      tax benefit – October 1,
            
            $
            311,000
            
            
            $
            295,000Gross
      increases – tax positions in prior period
            
            
            23,000
            
            
            
            16,000Gross
      decreases – tax positions in prior period
            
            
            -
            
            
            
            -Gross
      increases – tax positions in current period
            
            
            -
            
            
            
            -Settlements
            
            
            -
            
            
            
            -Lapse
      of statute of limitations
            
            
            -
            
            
            
            -Unrecognized
      tax benefit – September 30,
            
            $
            334,000
            
            
            $
            311,000





Included
in the balance of unrecognized tax benefits at September 30, 2009 and 2008, are
$334,000 and $311,000, respectively, of tax benefits that, if recognized,
would affect the effective tax rate.





The
Company recognizes interest accrued related to unrecognized tax benefits and
penalties as income tax expense.  Related to the unrecognized tax
benefits noted above, the Company accrued interest and penalties of $39,000 and
$16,000 as of September 30, 2009 and 2008, respectively.





The
Internal Revenue Service has concluded the examination and appeals phase for the
tax year ended September 30, 2003 and 2004.  The Company continues to
be under examination for the tax year ended September 30, 2005. We expect to
conclude the examination phase of this audit during 2010.




The
Company is subject to taxation in the US, including various states
jurisdictions, and Mexico.  With few exceptions, the Company is no
longer subject to U.S. federal and state examinations for tax years prior to
September 30, 2006, and September 30, 2005, respectively.




71


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


10.  Stockholders’
Equity




Preferred
Stock




During
fiscal 1995, the Company amended its articles of incorporation to provide for
the issuance of up to 2,000,000 shares of Preferred Stock in such series and
with such rights and preferences as may be approved by the Board of Directors.
In January 1995, the Board of Directors approved a Series A Preferred
Stock, which is cumulative, voting and convertible. In October 1998 the
Board of Directors approved a Series B Junior Participating Preferred Stock,
which is cumulative and voting. As of September 30, 2009 and 2008,
there were no shares of Series A Preferred Stock or Series B Junior
Participating Preferred Stock outstanding.




Treasury
Stock




During
July 2007, the Company completed a modified “Dutch Auction” Tender Offer
and purchased $25.0 million of its common stock and the associated
preferred share purchase rights. The Company accepted, for purchase, an
aggregate of 1,992,032 shares of its common stock at a net purchase price
of $12.74 per share, to record an aggregate share repurchase of
approximately $25.0 million and incurred transaction costs of $387,457
related to the Tender Offer that was recorded in treasury stock.




During
fiscal 2009 and 2008, the Company did not repurchase any shares of its
Common Stock.  During fiscal 2007, the Company repurchased with
cash 1,992,000 shares of its Common Stock at an average cost of
$12.74.




Director
Compensation Plan




The
Company maintains a plan to compensate the members of its Board of Directors for
their services as directors, including serving on committees of the board. Under
the Director Compensation Plan, each of the Company’s directors, will receive
$37,500 per year, except for the Chairman of the Board, who will receive
$75,000 per year. In addition, each director will receive $500 for
each board meeting attended in person, $250 for each board meeting attended
by telephone, $400 for each committee meeting attended in person and
$200 for each committee meeting attended by telephone. Each member of the
Audit Committee will also receive an additional $15,000 per year for
serving on the Audit Committee, except for the Chairman of the Audit Committee
who will receive $25,000 per year for serving on the Audit Committee as its
Chairman. The members of the Nominating and Governance Committee each receive an
additional $7,500 per year for serving on the Nominating and Governance
Committee, except for the Chairman of the Nominating and Governance Committee,
who receives $15,000 per year.  The members of the Compensation
Committee each receive an additional $15,000 per year for serving on the
Compensation Committee, except for the Chairman of the Compensation Committee,
who receives $25,000 per year.  In general, each sitting director
will receive an option grant on an annual basis for 10,000 shares of Common
Stock that will vest six months from the date of grant, subject to restrictions
which prevent the sale of such shares. These restrictions on the sale of the
underlying shares lapse with respect to 25% of the shares
annually.




Stock
Option Plans




Nonqualified
stock options have been granted to the Company’s directors under its nonemployee
director stock plans. Nonqualified and incentive stock options have been granted
to the Company’s officers and employees under its employee stock plans. Options
granted to its officers and employees generally vest over four years and expire
seven years from the date of grant. The Company expects to continue to issue
stock options to new employees as they are hired, as well as to current
employees as incentives from time to time.




The
Company issues new shares to satisfy stock option exercises under the
plans.




72


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




At
September 30, 2009, there were stock options available for grant under the
following plans:




Approved
              by
              Shareholders
            
            Options
      available
              for
      grant as of
              September 30, 20092000
      Stock Option Plan
            May 2001
            
            
            16,0152001
      Stock Option Plan
            May 2002
            
            
            185,8732002
      Stock Option Plan
            February 2003
            
            
            172,9142003
      Outside Director Stock Option Plan
            February 2004
            
            
            712,5002008
      Employment Inducement Plan
            
            
            
            94,986Total
            
            
            
            1,182,288




For the
year ended September 30, 2009, the activity relating to stock option
issuances under the stock option plans is as follows:




Number
              of
              Options
            
            
            Weighted-
              Average
              Exercise
              Price
      per
              Share
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
              (in years)
            
            
            Aggregate
              Intrinsic
              ValueStock
      Options Outstanding October 1, 2008
            
            
            6,689,508
            
            
            $
            6.14Granted
            
            
            1,719,433
            
            
            
            3.54Exercised
            
            
            (609,349
            )
            
            
            2.05Forfeited
            
            
            (963,344
            )
            
            
            7.75Stock
      Options Outstanding September 30, 2009
            
            
            6,836,248
            
            
            $
            5.63
            
            
            
            5.31
            
            
            $
            5,996,719Stock
      Options Exercisable September 30, 2009
            
            
            3,519,540
            
            
            $
            7.09
            
            
            
            3.71
            
            
            $
            2,461,461




For the
years ended September 30, 2009, 2008 and 2007, other
information pertaining to stock options was as follows:




2009
            
            
            2008
            
            
            2007Weighted-average
      grant-date fair value ofstock
      options granted
            
            $
            1.81
            
            
            $
            2.14
            
            
            $
            5.88Total
      intrinsic value of options exercised (in millions)
            
            
            0.8
            
            
            
            0.5
            
            
            
            4.8Total
      grant-date fair value of stock options vested during the year (in
      millions)
            
            
            2.1
            
            
            
            1.7
            
            
            
            2.4




A summary
of the status of the Company’s nonvested options as of
September 30, 2009 and changes during the year then ended is as
follows:




Nonvested
      Options
            
            Number
              of
              Options
            
            
            Weighted-
              Average
              Grant-Date
              Fair ValueNonvested
      at October 1, 2008
            
            
            2,842,375
            
            
            $
            2.25Granted
            
            
            1,719,433
            
            
            
            1.81Vested
            
            
            (281,756
            )
            
            
            7.33Forfeited
            
            
            (963,344
            )
            
            
            7.75Nonvested
      at September 30, 2009
            
            
            3,316,708
            
            
            
            2.09




Cash
received from option exercise under all share-based payment arrangements for the
years ended September 30, 2009, 2008 and 2007 was $1.3
million, $218,000, and $3.4 million. For September 2009, 2008,
and 2007, the Company recorded reductions of $221,000, $328,000,
and $1.4 million, respectively, of its federal and state income tax
liability, with an offsetting credit to additional paid-in capital resulting
from the tax benefits of stock options.




73


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


As of
September 30, 2009, there was $6.0 million of total unrecognized
compensation cost related to nonvested share-based compensation arrangements
granted under the plans. That cost is expected to be recognized over a
weighted-average period of 3.08 years. This estimate is subject to change
based upon a variety of future events which include, but are not limited to,
changes in estimated forfeiture rates, cancellations and the issuance of new
options.




Employee
Benefit Plans




The
Company has established a employee savings plan pursuant to Section 401(k) of
the Internal Revenue Code. The plan provides for the employees to make
tax-deferred deposits into the plan up to the maximum of
$22,000 for 2009. The Company has historically matched employees’
contributions. Such Company contributions amounted
to $688,000, $694,000, and $730,000 for the years ended
September 30, 2009, 2008, and 2007,
respectively.




11.  Commitments
and Contingencies




Litigation
and Regulatory Proceedings




The
Company is subject to the possibility of loss contingencies arising in its
business and such contingencies are accounted for in accordance with ASC Topic
450, “Contingencies” (formerly SFAS No. 5, “Accounting for Contingencies”).
In determining loss contingencies, the Company considers the possibility of a
loss as well as the ability to reasonably estimate the amount of such loss or
liability. An estimated loss is recorded when it is considered probable that a
liability has been incurred and when the amount of loss can be reasonably
estimated.




International
Gamco. International Gamco, Inc., or Gamco, claiming certain rights in
U.S. Patent No. 5,324,035, or the ‘035 Patent, brought suit against
the Company on May 25, 2004 in the U.S. District Court for the
Southern District of California alleging that the Company’s central determinant
system, as operated by the New York State Lottery, infringes the
‘035 Patent. Gamco claims to have acquired ownership of the
‘035 Patent from Oasis Technologies, Inc., or Oasis, a previous owner of
the ‘035 Patent. In February 2003, Gamco assigned the ‘035 Patent to
International Game Technology, or IGT. Gamco claims to have received a license
back from IGT for the New York State Lottery. The lawsuit claims that the
Company infringed the ‘035 Patent after the date on which Gamco assigned
the ‘035 Patent to IGT.




The
Company has made a number of challenges to Gamco’s standing to sue for
infringement of the ‘035 Patent. On October 15, 2007, pursuant to
an interlocutory appeal, the federal circuit court reversed the district court’s
order when it held that Gamco did not have sufficient rights in the
‘035 Patent to sue the Company without the involvement of the patent
owner, IGT.




On
December 4, 2007, Gamco and IGT entered into an Amended and
Restated Exclusive License Agreement whereby IGT granted to Gamco exclusive
rights to the ‘035 Patent in the state of New York and the right to
sue for past infringement of the same. On January 9, 2008, Gamco filed
its third amended complaint for infringement of the ‘035 Patent against the
Company. On January 28, 2008, the Company filed an answer to the
complaint denying liability. The Company also filed a third amended counterclaim
against Oasis, Gamco and certain officers of Gamco, for fraud, promise without
intent to perform, negligent misrepresentation, breach of contract, specific
performance and reformation of contract with regard to the Company’s rights
under the Sublicense Agreement for the ‘035 Patent, as well as for
non-infringement and invalidity of the ‘035 Patent. These parties have
filed a motion to dismiss and a motion for summary judgment as to these claims.
On August 11, 2009, the Court issued an order denying the motion to dismiss and
granting in part and denying in part the motion for summary
judgment.  The Court entered judgment against the Company on its
claims for fraud, promise without intent to perform and negligent
misrepresentation.  However, the Court held that Gamco was not
entitled to judgment as a matter of law on the Company’s claims for breach of
contract, reformation and specific performance.  The Company’s
affirmative motion for partial summary judgment was denied.  The court
issued a claim construction ruling in this case on April 20, 2009. The Company
will be filing motions for summary judgment of non-infringement of the ‘035
Patent and to invalidate the ‘035 Patent in light of the Court’s claim
construction ruling.




74


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


On August
28, 2009, the court held a telephonic conference, issued pre-trial deadlines and
set the Final Pre-Trial Conference date for September 9, 2010.  A
trial date will be scheduled during the Final Pre-Trial Conference on September
9, 2010.




The
Company continues to vigorously defend this matter. Given the inherent
uncertainties in this litigation, the Company is unable to make any prediction
as to the ultimate outcome.




Cory Investments
Ltd.On September 2, 2009, we entered into a comprehensive settlement
agreement with Cory Investments, LTD., or Cory Investments, to resolve all
claims arising from a May 7, 2008 lawsuit filed by Cory against us and
several of our former officers, including Clifton Lind, Robert Lannert and
Gordon Graves, in the State Court in Oklahoma City, Oklahoma. Litigation
expenses and settlement charges have been reflected in the Company’s
consolidated statement of operations as of September 30, 2009.  The
case asserted that we offered allegedly illegal Class III games on the
MegaNanza and Reel Time Bingo gaming systems to Native American tribes in
Oklahoma which had a severe negative impact on Cory Investments’ market for its
legal Class II games.  Cory Investments also alleged that the
defendants conspired to drive it and other Class II competitors out of the
Class II market in Oklahoma and other states.  In addition to the
conspiracy allegations, Cory Investments alleged six causes of action:
(i) deceptive trade practices; (ii) common law unfair competition;
(iii) wrongful interference with business; (iv) malicious wrong /
prima facie tort; (v) intentional interference with contract; and
(vi) unreasonable restraint of trade. Cory Investments was seeking
unspecified actual and punitive damages and equitable relief.  The
settlement agreement was reached while the parties were engaged in mediation and
we did not admit any wrongdoing as a result of this settlement
agreement.




Diamond Game
Enterprises, Inc.On May 1, 2009, the Company entered into a
comprehensive settlement agreement with Diamond Game Enterprises, Inc., or
Diamond Game, to resolve all claims arising from a  November, 2004
lawsuit filed by Diamond Game against the Company and several former officers,
including Clifton Lind, Robert Lannert and Gordon Graves. This settlement
agreement was reached while the parties were engaged in federal mediation and
the Company did not admit any wrongdoing in relation to the underlying
litigation. During fiscal 2009, the Company incurred $7.7 million in legal
fees and settlement costs, net of insurance proceeds.




Other.In
addition to the threat of litigation relating to the Class II or
Class III status of the Company’s games and equipment, the Company is the
subject of various pending and threatened claims arising out of the ordinary
course of business. The Company believes that any liability resulting from these
various other claims will not have a material adverse effect on its results of
operations or financial condition or cash flows. During its ordinary course of
business, the Company enters into obligations to defend, indemnify and/or hold
harmless various customers, officers, directors, employees and other third
parties. These contractual obligations could give rise additional litigation
cost and involvement in court proceedings.




Governmental
Regulation.  The Company is not aware of any pending litigation
or sanctions related to violations of government regulations at this
time.  Existing federal and state regulations may impose civil and
criminal sanctions for various activities prohibited in connection with gaming
operations, including but not limited to: (i) false statements on
applications; (ii) failure or refusal
to obtain required licenses; and / or (iii) the placement of
gaming devices, terminals, player stations, and / or units.




The
Company may become subject to litigation related to its charity bingo business
in Alabama.  On November 13, 2009, the Supreme Court of Alabama, in a
6-3 decision, reversed and remanded a trial court’s preliminary injunction in
favor of a charity operating bingo in the Town of White Hall, Lowndes County,
Alabama, referred to herein as the White Hall decision.  The appeal
arose out of a raid conducted by the Governor’s Task Force on Illegal Gambling
on March 19, 2009.  The Governor’s Task Force on Illegal Gambling
seized server-based bingo gaming systems, computers, servers, and
cash.  Included with the equipment seized were approximately 34 of the
Company’s games and certain of the Company’s charity bingo equipment located in
Alabama.  In the White Hall decision, the Supreme Court of Alabama
established a definition of “bingo” that included a set of standards that apply
to the operation of charity bingo in Alabama.  The charity that
operates White Hall filed an application for rehearing with the Supreme Court of
Alabama.  The Supreme Court has not ruled on this
application.  The White Hall decision will become final if and when
the Supreme Court denies the application.  Additionally, the
Governor’s Task Force on Illegal Gambling filed a forfeiture action against all
of the equipment seized at White Hall.  The forfeiture action remains
pending in the trial court.  It is possible that further proceedings
will be initiated in the future.




75


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Further,
three recent lower court decisions by both State and federal trial courts ruled
or implied that electronic bingo was illegal under the particular constitutional
amendments examined by those courts.  There may be other cases pending
or threatened involving electronic bingo that might have an impact upon our
operations in Alabama.




Off
Balance Sheet Arrangements




As of
September 30, 2009, the Company had no off balance sheet
arrangements.




Employment
Agreements




We have
employment agreements with each of our executive officers with positions of
Senior Vice President or above.  These employment agreements generally
provide for an initial rate of pay and other general employment
terms.  If there is a change in control of the Company, each of our
executives are entitled to certain severance benefits, which vary depending on
the length of the executive officer’s employ with the Company upon the change in
control or the termination without cause or termination of employment for good
reason (each as defined within the employment agreement). The employment
agreements include post-employment non-compete provisions and the terms of the
severance benefits generally range from twelve-to twenty-four month’s salary
continuation with similar non compete periods.




License
Agreements




In
June 2004, the Company entered into an agreement with WMS Gaming, Inc. to
purchase WMS cabinets and games for placement in various Class II and
Class III jurisdictions in North America. The agreement has been amended
several times, most recently in June 2009 to add additional purchase commitments
and to alter the method of Class II game theme license renewals. WMS and the
Company agreed to additional Class III cabinet purchases and agreed to
extend the term of the agreement until June 30, 2010 for certain
jurisdictions, with limited sell-off rights extending thereafter. The Company
has satisfied all required cabinet and game-theme purchases.




On
November 27, 2006 the Company entered into a letter agreement with
Aristocrat Technologies, Inc. in which the Company is granted the right to
purchase, as well as the exclusive right to place Aristocrat Class III
cabinets and attendant game themes to certain Native American tribes within the
State of Oklahoma. The initial term of the agreement is three years from
delivery of the first order of Aristocrat cabinets, with a two-year extension by
mutual agreement. In October 2008, Aristocrat and the Company agreed to
additional Class III cabinet purchases and agreed to extend the term of the
agreement until December 15, 2010.




In
April 2001, the Company entered into a license agreement with Bally
Technologies, Inc. to use and distribute Bally’s games themes and cabinets in
the Washington State Class III native American market. In
September 2001, Bally extended the license agreement to provide the Company
access to Bally’s catalog of game themes for use in Class II bingo games
for deployment in certain Class II jurisdictions.  The authorized market
was expanded in 2004 to include charitable bingo in Alabama and Native American
lottery in California.  The agreement expired in September of 2005. 
The Company retains the right to deploy in the authorized markets the licensed
games that is has purchased..




Certain
of the Company’s license agreements require it to pay royalty fees based on a
fixed percentage of the hold per day generated by a player
terminal.




12.  Concentrations
of Credit Risk




The
Company maintains its cash in bank deposit accounts which at times may exceed
the federal depository insurance limits. At September 30, 2009, the
Company had concentrations of cash in two banks totaling approximately
$8.2 million and $3.9 million. The Company has not experienced any losses
on such accounts in the past.




76


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Accounts
receivable represent short-term credit granted to customers for which collateral
is generally not required. As of September 30, 2009 and 2008,
approximately 59% and 44%, respectively, of the Company’s accounts
receivable were from Native American tribes or their gaming
enterprises.




In
addition, a large percentage of these tribes have their reservations and gaming
operations in the state of Oklahoma.  Despite the industry and
geographic concentrations related to the Company’s customers, due to the
historical experience of the Company on receivable collections, management
considers credit risk to be minimal with respect to accounts receivable. At
September 30, 2009 and 2008, the following concentrations existed
in the Company’s accounts receivable, as a percentage of total accounts
receivable:




2009
            
            
            2008Customer
      A
            
            
            33%
            
            
            
            17%Customer
      B
            
            
            10%
            
            
            
            13%




For the
years ended September 30, 2009, 2008 and 2007, the following
customers accounted for more than 10% of the Company’s total
revenues:




2009
            
            
            2008
            
            
            2007Customer
      A
            
            
            42%
            
            
            
            39%
            
            
            
            42%Customer
      B
            
            
            7%
            
            
            
            10%
            
            
            
            4%Customer
      C
            
            
            4%
            
            
            
            7%
            
            
            
            10%




Approximately 64%
and 58% of the Company’s total revenues for the years ended
September 30, 2009 and 2008, respectively, were from tribes
located in Oklahoma.




While the
Company believes that its relationships with all of its customers are good, the
loss of any of these customers would have a material and adverse effect upon its
financial condition and results of operations and cash flows.




Notes
receivable consist of financial instruments issued by customers for the purchase
of player terminals and licenses, and amounts generated from reimbursable
amounts advanced under development agreements, generally at prevailing interest
rates. Substantially all of the Company’s notes receivable are from Native
American tribes or their gaming enterprises. At September 30, 2009, two
customers represented approximately 85% and 10% of the notes
receivable.




13.  Related
Party Transactions




During
fiscal 2009, the Company paid approximately $293,000 and $136,000 to two
former Chief Executive Officers for consulting services.




During
fiscal 2008, the Company paid approximately $48,000 to a former Chairman of
the Board for consulting services and approximately $150,000 to the former
Chief Executive Officer for consulting services.




During
fiscal 2007, in connection with executing a content license agreement, the
Company paid $25,000 to a family member of the former Chairman of the
Board.




77


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




14.  Supplemental
Consolidated Quarterly Financial Data (Unaudited)




Year Ended
      September 30, 2009Quarters EndedDecember 31,
              2008
            
            
            March 31,
              2009
            
            
            June 30,
              2009
            
            
            September 30,
              2009(In
      thousands, except per-share amounts)Total
      revenues
            
            $
            28,576
            
            
            $
            33,870
            
            
            $
            32,129
            
            
            $
            32,577Operating
      income (loss)
            
            
            (8,400
            )
            
            
            (4,569
            )
            
            
            (1,239
            )
            
            
            (14,805
            )Income
      (loss) before taxes
            
            
            (9,171
            )
            
            
            (5,214
            )
            
            
            (1,473
            )
            
            
            (14,947
            )Net
      income (loss)
            
            
            (5,924
            )
            
            
            (3,394
            )
            
            
            (1,160
            )
            
            
            (34,300
            )Diluted
      earnings (loss) per share
            
            
            (0.22
            )
            
            
            (0.13
            )
            
            
            (0.04
            )
            
            
            (1.28
            )Weighted
      average common shares outstanding, diluted
            
            
            26,624
            
            
            
            26,643
            
            
            
            26,693
            
            
            
            27,073




Year Ended
      September 30, 2008Quarters EndedDecember 31,
              2007
            
            
            March 31,
              2008
            
            
            June 30,
              2008
            
            
            September 30,
              2008(In
      thousands, except per-share amounts)Total
      revenues
            
            $
            30,235
            
            
            $
            32,202
            
            
            $
            30,252
            
            
            $
            38,443Operating
      income (loss)
            
            
            821
            
            
            
            2,722
            
            
            
            209
            
            
            
            (2,517
            )Income
      (loss) before taxes
            
            
            153
            
            
            
            2,239
            
            
            
            348
            
            
            
            (2,060
            )Net
      income (loss)
            
            
            399
            
            
            
            1,258
            
            
            
            164
            
            
            
            (1,443
            )Diluted
      earnings (loss) per share
            
            
            0.01
            
            
            
            0.05
            
            
            
            0.01
            
            
            
            (0.06
            )Weighted
      average common shares outstanding, diluted
            
            
            27,380
            
            
            
            27,243
            
            
            
            27,153
            
            
            
            26,595




In
accordance with ASC Topic 360, the Company (i) recognizes an impairment
loss only if the carrying amount of a long-lived asset is not recoverable from
its undiscounted cash flows; and (ii) measures an impairment loss as the
difference between the carrying amount and fair value of the asset.




During
the year ended September 30, 2009, the Company hired a new management
team.  The management team conducted a thorough review of the
Company’s business in an effort to determine the proper go-forward strategy for
the Company.  As part of this analysis, management considered whether
the future benefits expected from certain long-lived assets exceeded the assets
carrying value; as well as the likelihood of realizing the future benefits
associated with the Company’s existing deductible temporary differences and
carryforwards.  As a result of this analysis, it was determined that
certain assets should be written-off or reserved for as of September 30,
2009.  The charges include a valuation allowance on deferred tax
assets of $25.0 million, the write-off of property and equipment included in the
Company’s rental pool and obsolete component parts of $5.6 million, the
write-off of certain licenses used for game development of $2.0 million and a
the reserve for slow-moving component parts of $1.8 million. The Company
considered the potential salvage value of the assets and determined that such an
amount would be negligible. Therefore, classification of these assets as ‘held
for sale’ is not necessary.




78


MULTIMEDIA
GAMES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


15.  Subsequent Events





The
Company has evaluated subsequent events through December 14, 2009, which is the
date the financial statements were issued, and determined that no events have
occurred subsequent to September 30, 2009 that warrant additional
disclosure.




79




MULTIMEDIA
GAMES, INC.




Schedule
II – Valuation and Qualifying Accounts




Allowance
for Doubtful Accounts




Balance
      at
              Beginning
      of
              Period
            
            
            (Recoveries)/
              Additions
            
            
            Deductions
            
            
            Balance
      at
              End
      of
              Period(In
      thousands)FY 2009
            
            $
            1,209
            
            
            $
            2,661
            
            
            $
            194
            
            
            $
            3,676FY 2008
            
            $
            854
            
            
            $
            421
            
            
            $
            66
            
            
            $
            1,209FY 2007
            
            $
            1,007
            
            
            $
            466
            
            
            $
            619
            
            
            $
            854




80




SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.




MULTIMEDIA GAMES,
      INC.Dated:
      December 14, 2009
              By:
              /s/ Adam
      D. ChibibAdam
      D. Chibib
                  Chief
      Financial Officer






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




/s/ ANTHONY M. SANFILIPPO
              
              Chief
      Executive Officer and Director
              
              December
      14, 2009Anthony
      M. Sanfilippo
              
              (Principal
      Executive Officer)/s/ ADAM D. CHIBIB
              
              Chief
      Financial Officer
              
              December
      14, 2009Adam
      D. Chibib
              
              (Principal
      Financial Officer and
                Principal
      Accounting Officer)/s/ MICHAEL J. MAPLES
              
              Chairman
      of the Board and Director
              
              December
      14, 2009Michael
      J. Maples/s/ ROBERT D. REPASS
              
              Director
              
              December
      14, 2009Robert
      D. Repass/s/ EMANUEL R. PEARLMAN
              
              Director
              
              December
      14, 2009Emanuel
      Pearlman/s/ NEIL E. JENKINS
              
              Director
              
              December
      14, 2009Neil
      E. Jenkins/s/ STEPHEN J. GREATHOUSE
              
              Director
              
              December
      14, 2009Stephen
      J. Greathouse/s/ JUSTIN A. ORLANDO
              
              Director
              
              December
      14, 2009Justin
      A. Orlando
  81





EXHIBIT
INDEX




EXHIBITNO.
                
                TITLE
                
                LOCATION3.1
                
                Amended
      and Restated Articles of Incorporation
                
                (1)3.2
                
                Amendment
      to Articles of Incorporation
                
                (2)3.3
                
                Second
      Amended and Restated Bylaws, as Amended
                
                (3)10.1
                
                1996
      Stock Incentive Plan, as Amended
                
                (4)10.2
                
                2000
      Stock Option Plan
                
                (4)10.3
                
                2001
      Stock Option Plan
                
                (5)10.4
                
                2002
      Stock Option Plan
                
                (6)10.5
                
                2003
      Outside Director Stock Option Plan
                
                (7)10.6
                
                Ad
      Hoc Option Plan
                
                (8)10.7
                
                2008
      Employment Inducement Award Plan
                
                (3)10.8
                
                Form
      of Indemnification Agreement
                
                (9)10.9
                
                Employment
      Agreement, dated as of June 15, 2008, between the Company and
      Anthony
      M. Sanfilippo
                
                (10)10.10
                
                Stock
      Purchase Agreement, dated as of June 15, 2008, between the
      Company and Anthony
      M. Sanfilippo
                
                (10)10.11
                
                First
      Amendment to Executive Employment Agreement, dated as of December 31,
      2008, between
      the Company and Anthony Sanfilippo
                
                (11)10.12
                
                Employment
      Agreement, dated as of July 28, 2008, between the Company and
      Virginia E. Shanks
                
                (*)10.13
                
                First
      Amendment to Executive Employment Agreement, dated as of December 31,
      2008, between
      the Company and Virginia E. Shanks
                
                (11)10.14
                
                Employment
      Agreement, dated as of August 16, 2008, between the Company and
      Uri L. Clinton
                
                (*)10.15
                
                First
      Amendment to Executive Employment Agreement, dated as of December 31,
      2008, between
      the Company and Uri L. Clinton
                
                (11)10.16
                
                Employment
      Agreement, dated as of September 14, 2008, between the Company
      and Patrick
      J. Ramsey
                
                (12)10.17
                
                First
      Amendment to Executive Employment Agreement, dated as of December 31,
      2008, between
      the Company and Patrick J. Ramsey
                
                (11)10.18
                
                Employment
      Agreement, dated as of February 10, 2009, between the Company
      and Adam
      D. Chibib
                
                (13)10.19
                
                Revolving
      Credit Agreement, dated as of April 27, 2007, by and among MegaBingo, Inc.
      and MGAM
      Systems, Inc. and those Banks listed therein with Comerica Bank, as
      Agent
                
                (14)10.20
                
                Amendment
      to Credit Agreement, dated as of October 26, 2007, by and among MGAM Systems,
      Inc., Megabingo, Inc., Comerica Bank, CIT Lending Services Corporation and
      the
      Banks party to Credit Agreement
                
                (15)10.21
                
                Second
      Amendment to Credit Agreement, dated as of December 20, 2007, by
      and among MGAM
      Systems, Inc., Megabingo, Inc. and Comerica Bank
                
                (16)10.22
                
                Third
      Amendment to Credit Agreement, dated as of July 22, 2009, by and
      among MGAM
      Systems, Inc., Megabingo, Inc. and Comerica Bank
                
                (17)10.23
                
                Settlement
      Agreement, effective as of May 1, 2009, by and among the Company, Diamond
      Game Enterprises, Inc., and those parties listed therein
                
                (18)21.1
                
                Subsidiaries
      of registrant
                
                (*)23.1
                
                Consent
      of BDO Seidman, LLP
                
                (*)31.1
                
                Certification
      of the Principle Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                
                (*)31.2
                
                Certification
      of the Principle Accounting Officer, pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                
                (*)32.1
                
                Certification
      of the Chief Executive Officer and Chief Financial Officer, Pursuant to
      U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002
                
                (*)
  82
 
 (1)
                Incorporated
      by reference to our Form 10-QSB for the quarter ended
      March 31, 1997, as filed with the Securities and Exchange
      Commission, or SEC, on May 15, 1997.(2)
                Incorporated
      by reference to our Form 10-Q for the quarter ended
      December 31, 2003, as filed with the SEC on February 17,
      2004.(3)
                Incorporated
      by reference to our Form 10-K for the fiscal year ended September 30,
      2008, as filed with the SEC on December 15, 2008.(4)
                Incorporated
      by reference to our Registration Statement on Form S-8, as filed with
      the SEC on December 1, 2000.(5)
                Incorporated
      by reference to our Registration Statement on Form S-8, as filed with the
      SEC on October 18, 2002.(6)
                Incorporated
      by reference to our Form 10-Q for the quarter ended March 31, 2003,
      as filed with the SEC on May 15, 2003.(7)
                Incorporated
      by reference to Appendix B of our Definitive Proxy Statement on Schedule
      14A, as filed with the SEC on
January 6, 2004.(8)
                Incorporated
      by reference to our Registration Statement on Form S-8, as filed with the
      SEC on October 18, 2002.(9)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on June 4,
      2008.(10)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on
      June 18, 2008.(11)
                Incorporated
      by reference to our Form 10-Q for the quarter ended December 31, 2009, as
      filed with the SEC on February 9, 2009.(12)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on September 17,
      2008.(13)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on February 2,
      2009.(14)
                Incorporated
      by reference to our Form 8-K, as field with the SEC on May 3,
      2007.(15)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on November 1,
      2007.(16)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on December 27,
      2007.(17)
                Incorporated
      by reference to our Form 8-K, as filed with the SEC on July 23, 2009, and
      as amended by our Form 8-K/A as filed with the SEC on September 29,
      2009.(18)
                Incorporated
      by reference to our Form 10-Q/A for the fiscal quarter ended June 30,
      2009, as filed with the SEC on September 29, 2009.(*)
                Filed
      herewith.






83