SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED JULY 31, 2004

OR

FOR THE TRANSITION PERIOD FROM                    TO                   

Commission File Number 000-23401

GAMETECH INTERNATIONAL, INC.

900 SANDHILL ROAD, RENO, NEVADA
89521
(Address of principal executive offices)
(Zip code)

Registrant’s telephone number, including area code: (775) 850-6000

     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 o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes o    No x

     On September 8, 2004, the registrant had 11,797,014 outstanding shares of its Common Stock, par value $0.001 per share.

GAMETECH INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10 –Q
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2004
INDEX

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GAMETECH INTERNATIONAL, INC.

See accompanying notes.

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GAMETECH INTERNATIONAL, INC.

See accompanying notes.

4

GAMETECH INTERNATIONAL, INC.

See accompanying notes.

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GAMETECH INTERNATIONAL, INC.

JULY 31, 2004
(UNAUDITED)

NOTES TO FINANCIAL STATEMENTS

NOTE A. BASIS OF PRESENTATION

     The accompanying unaudited condensed consolidated financial statements as of July 31, 2004 have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three- and nine-month periods ended July 31, 2004 are not necessarily indicative of the results that may be expected for the year ending October 31, 2004.

     The balance sheet at October 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended October 31, 2003.

     Certain amounts in the prior period’s condensed consolidated financial statements have been reclassified to conform to the current period’s presentation.

NOTE B. SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION

     Revenue is recognized for bingo terminals placed in bingo halls under contracts based on (1) a fixed fee per use per session; (2) a fixed weekly fee per terminal; or (3) a percentage of the revenue generated by each terminal. Our revenue recognition is a key component of our results of operations, and determines the timing of certain expenses, such as commissions and royalties. We recognize revenue when all of the following factors exist: (a) evidence of an arrangement with the customer; (b) play or availability of the bingo terminals; (c) a fixed or determinable fee; and (d) collectibility is reasonably assured. We exercise judgment in assessing the credit worthiness of our customers to determine whether collectibility is reasonably assured. Should changes in conditions cause us to determine the factors are not met for future transactions, revenue recognized for future reporting periods could be adversely affected.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

     We estimate the possible losses resulting from non-payment of outstanding accounts receivable. Our customer base consists primarily of entities operating in charitable, Native American, and commercial bingo halls located throughout the United States. In some jurisdictions, the billing and collection function is performed as part of a distributor relationship, and in those instances, we maintain allowances for possible losses resulting from non-payment by both the customer and distributor. We perform ongoing evaluations of customers and distributors for credit worthiness, economic trends, change in customer payment terms, and historical collection experience when evaluating the adequacy of our allowance for doubtful accounts. We also reserve a percentage of our accounts receivable based on aging category. In determining these percentages, we review historical write-offs of our receivables, payment trends, and other available information. While such estimates have been within our expectations and the provisions established, a change in financial condition of specific customers or in overall trends experienced may result in future adjustments of our estimates of recoverability of our receivables.

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BINGO EQUIPMENT, FURNITURE AND OTHER EQUIPMENT

     Bingo equipment includes file servers, caller’s units, point-of-sale units, other support equipment and the portable and fixed-base player terminals. Bingo equipment, furniture and other equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives are as follows:

     We provide reserves for excess or obsolete bingo terminals on hand that we do not expect to be used. Our reserves are based upon several factors, including our estimated forecast of bingo terminal demand for placement into halls. Our estimates of future bingo terminal demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete bingo terminals. Although we attempt to assure the accuracy of our estimated forecasts, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our bingo terminals and our reported operating results.

SOFTWARE DEVELOPMENT CAPITALIZATION

     We capitalize costs related to the development of certain software products that meet the criteria of Statement of Financial Accounting Standards (“SFAS”) No. 86 – Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed. SFAS No. 86 provides for the capitalization of computer software that is to be used as an integral part of a product or process to be sold or leased, after technological feasibility has been established for the software and all research and development activities for the other components of the product or process have been completed. We are capitalizing qualified costs of software developed for new products or for significant enhancements to existing products. We cease capitalizing costs when the product is available for general release to our customers. We amortize the costs on a straight-line method over the estimated economic life of the product beginning when the product is available for general release.

     The achievement of technological feasibility and the estimate of a products’ economic life require management’s judgment. Any changes in key assumptions, market conditions or other circumstances could result in an impairment of the capitalized asset and a charge to our operating results.

GOODWILL

     We are required to perform an annual goodwill impairment review, and depending upon the results of that measurement, the recorded goodwill may be written down and charged to income from operations when its carrying amount exceeds its estimated fair value. In addition, we assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable, such as a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, or a loss of key personnel.

LONG-LIVED ASSETS

     We have adopted the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires impairment losses to be recognized for long-lived assets and identifiable intangibles, other than goodwill, used in operations when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount.

LEGAL CONTINGENCIES

     We are currently involved in various legal claims and legal proceedings. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure can be reasonably estimated. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of

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the potential liabilities could have a material impact on our consolidated results of operations and financial position. See Note E of Notes to these Condensed Consolidated Financial Statements for a description of our material legal proceedings.

PRO FORMA STOCK – BASED COMPENSATION INFORMATION

     Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, and has been determined as if we had accounted for our employee stock options under the fair value method of that statement.

     Our pro forma information follows:

(In thousands, except per share amounts)

NEW ACCOUNTING PRONOUNCEMENTS

     In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 00-21, Multiple-Deliverable Revenue Arrangements (“Issue 00-21”). Issue 00-21 addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The consensus mandates how to identify whether goods or services or both that are to be delivered separately in a bundled sales arrangement should be accounted for separately because they are “separate units of accounting.” The guidance can affect the timing of revenue recognition for such arrangements, even though it does not change rules governing the timing or pattern of revenue recognition of individual items accounted for separately. The final consensus will be applicable to agreements entered into in fiscal years beginning after June 15, 2003 with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with APB Opinion No. 20, Accounting Changes. The adoption of Issue 00-21 did not have a material impact on our financial position, cash flows or results of operations.

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities — an Interpretation of ARB No. 51 (“FIN 46”). In December 2003, FIN 46 was revised to clarify certain provisions and effective dates for application. FIN 46 addresses consolidation by business enterprises of variable interest entities that have certain characteristics. Transferors to qualifying special-purpose entities and “grandfathered” qualifying special-purpose entities subject to the reporting requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, are excluded from the scope of FIN 46. FIN 46 is applicable no later than the end of the first interim or annual reporting

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period ending after March 15, 2004, unless we have an interest in a special purpose entity, which the effective date for application is no later than the end of the first interim or annual reporting period ending after December 15, 2003. We currently have no contractual relationship or other business relationship with a variable interest entity. However, if we entered into any such arrangement with a variable interest entity in the future, our financial position, cash flows or results of operations may be adversely impacted.

NOTE C. ACQUISITION OF ASSETS

     On November 7, 2002, we acquired certain assets of International Gaming Systems, Inc. for a cash purchase price of $3.5 million, which included approximately $69,000 of acquisition costs. The transaction was accounted for as a purchase of a business in accordance with SFAS No. 141, Business Combinations, and accordingly, the operating results have been included in our consolidated financial statements since the date of acquisition.

     The total purchase price of the transaction has been allocated to the identifiable intangible assets and tangible assets acquired, based on their estimated fair values at the date of acquisition, with any residual amount allocated to goodwill as follows:

     The maximum potential contingent payments relating to the acquisition were $2,043,000, which was placed in escrow pending the outcome of certain events. The escrow was comprised of the following four components: $900,000 (the “New York Escrow Amount”); $413,000 (the “Title Transfer Escrow Amount”); $230,000 (the Bingo Unit Escrow Amount”); and $500,000 (the “Holdback Escrow Amount”). The full amount of the Title Transfer Escrow Amount, the Bingo Unit Escrow Amount and the Holdback Escrow Amount has been released to IGS as a result of the successful transfer of title of certain assets to us, the verification of the number of bingo terminals acquired and the satisfaction of certain representations and warranties made by IGS. These amounts have been included in the purchase price allocated to the assets acquired. The release of the New York Escrow Amount is contingent upon the negotiation of new contracts with IGS’s former New York customers or the receipt by us of continuing revenues from the New York customers. As of July 31, 2004, $882,938 of the New York Escrow Amount has been released to IGS. The entire amount of the New York Escrow Amount has been included in the purchase price allocated to the assets acquired as we currently consider it probable that the remaining funds will be paid to IGS.

NOTE D. NET INCOME PER SHARE OF COMMON STOCK

     The calculation of the basic and diluted net income per share is the same except for the dilutive effect of outstanding stock options (determined using the treasury stock method). The dilution was 21,799 and 189,203 shares for the three months ended July 31, 2003 and 2004, respectively. The dilution was 179,428 and 164,809 shares for the nine months ended July 31, 2003 and 2004, respectively.

NOTE E. LITIGATION

     On March 22, 2001, we filed a claim in the United States District Court, District of Arizona, GAMETECH INTERNATIONAL, INC. V. TREND GAMING SYSTEMS, LLC, CV 01-540 PHX PGR, seeking a declaratory judgment that we are not in material breach of our November 1, 1999 distribution agreement with Trend Gaming Systems, LLC and seeking damages for past due payments and wrongful withholdings by Trend. Trend has counterclaimed, alleging that its payments are in compliance with its contractual obligations and that it is entitled to withhold certain monies. Trend also contends that we are in breach of certain of our contractual obligations to Trend or its customers. On December 16, 2002, the court entered at our request an order enjoining Trend from using approximately $540,000 in funds it had collected on our behalf, pending a trial on our ownership interest in those funds. The money has been placed in a bank account subject to the court’s control and now totals approximately $585,000. In addition, collections of accounts receivable by Trend, if any, will also be placed in that account, pending the trial of the case. Trend filed a motion for summary judgment alleging that the termination of the distribution agreement was improper. On May 16, 2003, the court dismissed Trend’s motion for summary judgment. On December 2, 2003, Trend filed a renewed motion for summary judgment alleging that we did not

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have the right to terminate the distribution agreement based upon Trend’s failure to insure that we received our minimum rate of return. The court, on March 19, 2004 denied Trend’s renewed motion for summary judgment. A May 10, 2004 trial date has been rescheduled for October 4, 2004. We have denied the allegations and intend to vigorously pursue and defend this matter. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     In June 2004, Steven W. Hieronymus, Rhonda Hieronymus and Trend Gaming Systems, LLC filed a claim in the 98th Judicial District Court, Travis County, Texas, STEVEN W. HIERONYMUS, RHONDA HIERONYMUS AND TREND GAMING SYSTEMS, LLC V. THE TEXAS LOTTERY COMMISSION AND GAMETECH INTERNATIONAL, INC, alleging that our judgment against Steven and Rhonda Hieronymus (involving a prior distribution agreement in Virginia) creates an unlawful “credit interest” in Trend Gaming Systems, LLC in violation of the Texas Bingo Enabling Act because Mr. Hieronymus owns a greater than 10% interest in Trend Gaming Systems, LLC. The plaintiffs request an injunction against our enforcement of the judgment against Steven and Rhonda Hieronymus. The plaintiffs have moved for summary judgment and we have filed a cross motion for summary judgment on the issue. Neither motion has been set for hearing. No discovery has been done and no trial date is scheduled. We intend to vigorously defend our position. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     On October 30, 2002, Capital Gaming Supplies filed a claim in the United States District Court, Southern District of Mississippi, CAPITAL GAMING SUPPLIES, INC. V. GAMETECH INTERNATIONAL, INC., 3:02 CV 1636 WS, seeking a judgment that we tortiously interfered with alleged existing and prospective customer accounts. We have denied the allegations and filed a counter-claim seeking a judgment that Capital tortiously interfered with our customer accounts. On April 18, 2003, Capital filed an amended complaint adding other claims against us and other defendants, including a claim for malicious breach of contract against IGS, and its principals. In November 2002, we acquired certain assets of IGS and we assumed certain claims filed by Capital against IGS and its principals. Capital seeks compensatory and punitive damages from all defendants. The January 28, 2004 trial date has been postponed indefinitely. We intend to defend and pursue vigorously this matter. We believe that Capital’s claims are without merit. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     We are involved in various other legal proceedings arising out of our operations in the ordinary course of our business. We do not believe that any of those proceedings will have a material adverse effect on our financial position, cash flows or results of operations. However, if settlement is not reached and the lawsuits proceed to trial, an unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

NOTE F. CREDIT AGREEMENTS

     Effective April 2, 2004, we renewed our revolving line-of-credit agreement with a bank. The maximum amount available under the terms of the agreement is $5.0 million, and borrowings bear interest based on the bank’s prime rate or LIBOR plus 2.0 percent, at our option. Interest is payable monthly and the agreement expires on April 2, 2005. The agreement is secured by substantially all our assets. The agreement contains certain restrictive covenants, which among other things require that specified financial balances and ratios be maintained, profitability be maintained on a rolling four quarter basis, and restrict the incurrence of additional indebtedness. At July 31, 2004, there was no outstanding balance under the line-of-credit.

NOTE G. INCOME TAXES

     Our income tax provision was recorded at an effective rate of 72.3% for the nine-months ended July 31, 2004 compared to 41.7% for the nine months ended July 31, 2003. The actual effective tax rate is different from the expected federal rate of 35% due to certain permanent differences between financial and tax accounting and state income taxes.

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

     The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this report, as well as our audited consolidated financial statements for the fiscal year ended October 31, 2003 contained in our annual report on Form 10-K. The following discussion contains

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certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of the factors set forth in this report and those risk factors included in our annual report on Form 10-K for the fiscal year ended October 31, 2003.

OVERVIEW

     We design, develop, and market interactive electronic bingo systems. We currently market portable systems that can be played anywhere within a bingo hall and a fixed-base system with touchscreen-activated monitors. For our three most recent fiscal years ended October 31, 2001, 2002 and 2003, our portable terminals generated approximately 77%, 77% and 73% of our revenues, respectively, while, during those same years, our fixed-base terminals generated the balance of our revenues. For the three- and nine-months ended July 31, 2004, portable terminals accounted for 74% of our revenues and fixed-based terminals accounted for 26% of our revenues. As of July 31, 2004, we had systems in service in 35 states and in five foreign countries.

     We generate revenue by placing electronic bingo systems in bingo halls under contracts based on (1) a fixed fee per use per session; (2) a fixed weekly fee per terminal; or (3) a percentage of the revenues generated by each terminal. Revenue growth is affected by player acceptance of electronic bingo as an addition or an alternative to paper bingo, and our ability to expand operations into new markets. Fixed-base bingo terminals generate greater revenue per terminal than portable bingo terminals, but also require a greater initial capital investment.

     We typically install our electronic bingo systems at no charge to our customers, and we capitalize the costs. We record depreciation of bingo equipment over a three- and five-year estimated useful life using the straight-line method of depreciation.

     Our expenses consist primarily of (a) cost of revenue, consisting of expenses associated with technical and operational support of the bingo systems within bingo halls, depreciation of bingo systems, repair, refurbishment, and disposals of bingo terminals and related support equipment, and excess or obsolescence reserve; (b) general and administrative, consisting of activities associated with management of our company and related support, which includes finance and accounting, legal, compliance, information systems, and human resources; (c) sales and marketing, consisting primarily of commissions paid to distributors for promoting and supporting our products and an internal sales force with a focus upon generating new customers and upgrades for existing customers; and (d) research and development, consisting of company sponsored research and development activities to provide players with new or enhanced products.

     During the first nine months of fiscal 2004, the following events occurred that affected, or may in the future affect, our results of operations or liquidity and capital resources.

     We have incurred significant expenses in aggressively defending or pursuing certain legal issues, including defense of a patent infringement lawsuit in Nevada, our litigation with a former distributor in Texas, and litigation with a former distributor for IGS in Mississippi. The terms of the terminated distributor agreement with the former Texas distributor contain certain contingent commission liabilities, which if a final judgment were rendered unfavorable to us, could have an adverse effect on our financial position, results of operations and liquidity. The contingent commission liabilities, only if determined at trial to be payable, would be calculated based on terms included in the terminated distributor agreement. Assuming revenues for the three-year period following termination of the distributor agreement remained constant at the rate earned over the first 23 months following termination of the distributor agreement, the contingent liability would amount to approximately $2.1 million. Regarding the patent infringement matter, an unfavorable outcome at trial could result in substantial damages and payment of the plaintiff’s fees and costs. The Mississippi distributor lawsuit could result in a punitive damages award which could be materially adverse to our company. We have not accrued any amount related to these contingent liabilities. We have denied the allegations and intend to vigorously pursue and defend this matter.

     We are involved in various other legal proceedings arising out of the ordinary course of our business. While we do not believe that any of those proceedings will have a material adverse effect on our financial position, cash flows or results of operations, they do sometimes result in significant expenses in defending or pursuing our legal position. One such matter involving a terminated distributor in Virginia and Kentucky went to trial during February 2004. On March 2, 2004 the jury rendered a unanimous verdict in our favor awarding compensatory and punitive damages against Trend Gaming in the total amount of approximately $1.5 million. The court reduced compensatory damages against Trend Gaming to $1,055,330 but has upheld the $150,000 in punitive damages awarded against Trend Gaming. Compensatory damages against Mr. and Mrs. Hieronymus have been reduced to $761,851 but the punitive

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damage award against them in the amount of $150,000 remains unchanged. Of the total compensatory damages of $1,055,330 awarded against both sets of defendants, $761,851 represents compensation for lost profits. We can only collect such damages from one of the defendants to avoid a double recovery. We have petitioned the court for an award against Trend Gaming for our legal fees and costs. We can make no assurances whether we will be able to collect any award from the defendants.

     While this particular matter appears to be resolved, we anticipate that our legal expenses will continue at an elevated level as trial dates in two other proceedings have been set for fiscal 2004.

     We have significantly increased the staffing in our research and development and quality assurance departments. We expect to maintain a high level of expenditures in these areas as we focus on new product development and new features that can be added to our existing equipment.

     On January 16, 2004, we paid our first ever cash dividend. The one-time special dividend of $0.12 per share aggregated approximately $1.4 million. On March 31, 2004, a regular quarterly dividend of $0.03 per share was paid to stockholders of record as of March 22, 2004 and aggregated approximately $353,000. Additionally, on July 12, 2004, a regular quarterly dividend of $0.03 per share was paid to stockholders of record as of July 1, 2004 and aggregated approximately $354,000.

     During the first nine-month period of fiscal 2004, our capital expenditures were approximately $10.9 million, $10.2 million of which represented investments in bingo and related support equipment.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, bad debts, bingo terminal depreciation, goodwill impairment, and contingencies and litigation. We base our estimates and judgments on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     These estimates and assumptions are affected by the application of our significant accounting policies. Our significant accounting policies are described in Note B to the Condensed Consolidated Financial Statements contained elsewhere in this report.

     Critical accounting policies are those that require management to make the most difficult, subjective, or complex judgments, often as a result of inherently uncertain matters that may change in subsequent periods. Our critical accounting policies include revenue recognition, allowance for doubtful accounts, reserves for bingo terminal obsolescence, capitalization of software development costs, impairment of assets, and assessment and evaluation of litigation and contingencies.

     Changes in internal or external conditions could cause actual results to differ from our estimates and could cause future reporting periods to be adversely affected. If changes in conditions lead us to believe that our criteria for revenue recognition are not met for future transactions, revenue recognized for future reporting periods could be significantly less. Changes in financial conditions of specific customers or in overall collection trends may result in adjustments to our reserves for doubtful accounts. Changes in technology, our competitor’s offerings, market conditions or other factors affecting our business prospects, could result in an increase in reserves for bingo terminal obsolescence or in an impairment to the carrying value of goodwill, other intangible assets or the capitalized cost of developed software. As additional information becomes available and we reassess our potential liability related to litigation or other contingencies, we may revise our estimates and such revisions could have an adverse effect on our financial position, cash flows and results of operations.

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RESULTS OF OPERATIONS

Three Months Ended July 31, 2004 Compared with Three Months Ended July 31, 2003

     REVENUE. We generated revenue of $12.9 million for the three-months ended July 31, 2004 compared to $12.8 million for the comparable prior-year period. The modest increase in revenue from the third quarter of fiscal 2003 was due to growth in the installed base of terminals and revenue per terminal in certain geographical markets and, to a lesser degree, the contribution from the growing deployment of our Pay-N-Play™ feature. These factors were sufficient to offset a decline in the installed base in other geographical markets and the effects of competitive pricing pressure in certain markets.

     COST OF REVENUE. Cost of revenue increased $435,000, or 7.4%, to $6.3 million for the three months ended July 31, 2004 from $5.9 million for the comparable prior-year period. Cost of revenue as a percent of revenue for the current three-month period increased to 49.1% compared to 46.2% for the three-months ended July 31, 2003. The increase in cost of revenue over the prior year third quarter was the result of an increase of nearly $308,000 in depreciation and amortization expense, primarily due to our investment in TED 2 C™ portable color terminals, Traveler™ portable color terminals and continuing purchases of our fixed base terminals. We expect the higher level of depreciation expense to continue as we invest in our new color portable terminal, the Traveler, and our fixed-base terminals. Disposals of bingo terminals and related support equipment, and the excess and obsolescence reserve increased approximately $172,000.

     GENERAL AND ADMINISTRATIVE. General and administrative costs decreased $336,000, or 12.7%, to $2.3 million for the three months ended July 31, 2004 from $2.7 million for the comparable prior-year period. General and administrative costs as a percent of revenue were 17.9% for the current period, down from 20.7% for the prior year three-month period. The third quarter of fiscal 2003 included elevated levels of legal expenses, including those related to defense of a patent infringement lawsuit in Nevada, litigation with a former distributor in Texas, litigation with a former distributor of IGS in Mississippi, and other legal proceedings including our successful litigation against a former distributor in Virginia and Kentucky and a Virginia sub-distributor in late 2003. Subject to collectibility, we were awarded at least $2.1 million in damages in these victories, however, no such amounts have been recorded.

     SALES AND MARKETING. Sales, marketing, and commission expenses increased $99,000, or 3.4%, to $3.0 million for the three months ended July 31, 2004 from $2.9 million for the comparable prior-year period. Sales, marketing, and commission expenses as a percent of revenue for the current three-month period were 23.4% compared to 22.9% for the three months ended July 31, 2003. Distributor commissions increased $107,000 to $2.1 million for the three months ended July 31, 2004. Commissions will fluctuate because the mix of revenue generated by distributors and those customers we serve directly varies.

     RESEARCH AND DEVELOPMENT. Research and development costs increased $92,000, or 9.4%, to $1.1 million for the three months ended July 31, 2004 from $974,000 for the comparable prior-year period. Research and development costs as a percent of revenue for the current three-month period were 8.3% compared to 7.6% for the three months ended July 31, 2003. The emphasis on new product development and feature enhancements for existing products continues as a major focus.

     During the third quarter of fiscal 2004, we capitalized $241,000 of costs, from our research and development and quality assurance functions, connected with the internal development of software that meets technological feasibility and recoverability tests in accordance with FASB Statement No. 86. We had no such capitalized costs in the third quarter of fiscal 2003.

     PROVISION FOR INCOME TAXES. Our income tax provision was adjusted during the current quarter to recognize an effective fiscal-year rate of 72.3%. Consequently, the rate for the quarter ended July 31, 2004 was 83.6% compared to 17.1%, which was adjusted last year for an effective fiscal-year rate of 41.7%, for the quarter ended July 31, 2003. The actual effective tax rate is different from the expected federal rate of 35% due to certain permanent differences between financial and tax accounting and state income taxes.

Nine Months Ended July 31, 2004 Compared with Nine Months Ended July 31, 2003

     REVENUE. We generated revenue of $38.9 million for the nine months ended July 31, 2004 compared to $39.3 million for the comparable prior-year period. The $406,000, or 1.0%, net decrease in revenue from the first nine months of fiscal 2003 occurred during the first quarter of fiscal 2004 and was due to several factors, including fewer installed terminals in some geographical markets and price erosion due to competition in others. We believe

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the introduction of feature enhancements to existing products and the availability of new products will provide for future revenue growth. However, the time required to move newly developed features and products through beta testing and regulatory approvals, where required, is difficult to predict. Our newest portable color terminal, the Traveler, began with limited nationwide rollout in the third fiscal quarter of fiscal 2004.

     COST OF REVENUE. Cost of revenue increased $1.3 million, or 7.6%, to $18.0 million for the nine months ended July 31, 2004 from $16.8 million for the comparable prior-year period. Cost of revenue as a percent of revenue for the current nine-month period increased to 46.4% compared to 42.7% for the nine months ended July 31, 2003. The increase in cost of revenue over the prior year nine-month period was the result of an increase of $883,000 in depreciation and amortization expense, primarily due to our investment in TED 2 C portable color terminals, Traveler portable color terminals, and our fixed-base terminals, an increase of $274,000 in service cost due to increased staffing in field and product support centers and a $105,000 increase in operations expense that includes our quality assurance function that we have expanded to keep pace with the development of new features and new products. Additionally, costs associated with the repair, refurbishment and disposal of bingo terminals and related support equipment increased $121,000.

     GENERAL AND ADMINISTRATIVE. General and administrative costs decreased $600,000, or 6.9%, to $8.1 million for the nine months ended July 31, 2004 from $8.7 million for the comparable prior-year period. General and administrative costs as a percent of revenue for the current nine-month period were 20.7% compared to 22.0% for the prior year nine month period. The first nine-months of fiscal 2003 and fiscal 2004 included elevated levels of legal expenses, including those related to defense of a patent infringement lawsuit in Nevada, litigation with a former distributor in Texas, litigation with a former distributor of IGS in Mississippi, and other legal proceedings including our successful litigation against a former distributor in Virginia and Kentucky and a Virginia sub-distributor in late 2003. The improvement in general and administrative costs came as a net result of a decrease of $418,000 in consulting fees and in outside legal fees of $356,000; partially offset with increases of $52,000 in bad debt expense and outside accounting fees of $62,000.

     SALES AND MARKETING. Sales, marketing, and commission expenses increased $135,000, or 1.4%, to $9.5 million for the nine months ended July 31, 2004. Sales, marketing, and commission expenses as a percent of revenue for the current nine-month period were 24.3% compared to 23.7% for the nine months ended July 31, 2003. Distributor commissions increased $57,000 to $6.5 million for the nine months ended July 31, 2004. Commissions will fluctuate because the mix of revenue generated by distributors and those customers we serve directly varies. Costs associated with our internal sales force grew by $78,000 as a result of increases in non-payroll costs such as travel, marketing, facilities and property taxes.

     RESEARCH AND DEVELOPMENT. Research and development costs increased $228,000, or 8.0%, to $3.1 million for the nine months ended July 31, 2004 from $2.9 million for the comparable prior-year period. Research and development costs as a percent of revenue for the current nine-month period were 7.9% compared to 7.3% for the nine months ended July 31, 2003. The emphasis on new product development and feature enhancements for existing products continues as a major focus.

     During the first nine months of fiscal 2004, we capitalized approximately $594,000 of costs, from our research and development and quality assurance functions, connected with the internal development of software that meets technological feasibility and recoverability tests in accordance with FASB Statement No. 86. We had no such capitalized costs in the first nine months of fiscal 2003.

     PROVISION FOR INCOME TAXES. Our income tax provision was recorded at an effective rate of 72.3% for the nine months ended July 31, 2004 compared to 41.7% for the nine months ended July 31, 2003. The actual effective tax rate is different from the expected federal rate of 35% due to certain permanent differences between financial and tax accounting and state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

     Operating activities provided $9.9 million of cash for the nine months ended July 31, 2004 compared to $12.8 million for the nine months ended July 31, 2003. The $9.9 million consisted primarily of our income of $76,000 adjusted by $9.4 million of non-cash expense for depreciation, amortization, and obsolescence provisions, and $353,000 provided by changes in other operating assets and liabilities. During the nine months ended July 31, 2003, the $12.8 million provided by operating activities consisted primarily of net income of $999,000 adjusted by $8.0 million of non-cash expense for depreciation, amortization and obsolescence reserves, $3.9 million from refunded income taxes offset by $132,000 from changes in other operating assets and liabilities.

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     We used approximately $12.4 million of cash in investing activities for the nine months ended July 31, 2004 compared to the $9.0 million of cash invested during the nine months ended July 31, 2003. In fiscal 2004, the $12.4 million consisted of $10.9 million of capital expenditures ($10.2 million of which was expended on bingo terminals and associated support equipment), the purchase and development of other intangible assets for a total of $741,000, and an increase in short-term investments of $763,000. During fiscal 2003, the $9.0 million consisted of $7.3 million of capital expenditures ($6.7 million of which was expended on bingo terminals and associated support equipment), the purchase of certain assets of IGS and other intangible assets for a total of $4.6 million and a decrease in short-term investments of $2.8 million.

     We used net cash of $2.2 million in financing activities for the nine months ended July 31, 2004 compared to $337,000 provided by financing activities for the nine months ended July 31, 2003. The $2.2 million used for the nine months ended July 31, 2004 was primarily for cash dividends of $2.1 million, payments of $275,000 on long-term debt, less proceeds from stock option exercises of $194,000. The $337,000 provided for the nine months ended July 31, 2003 was primarily proceeds from stock option exercises of $531,000, offset by payments of $194,000 on long-term debt.

     As of July 31, 2004, we had cash and cash equivalents and short-term investments of approximately $8.0 million. In addition to our cash and cash equivalents and short-term investments, we have a $5.0 million line of credit with Wells Fargo Bank, N.A., which has an interest rate based on the prime rate or London InterBank Offered Rate (“LIBOR”) plus 2.0%, at our option, on which there was no outstanding balance at July 31, 2004. The revolving credit facility expires on April 2, 2005. We believe that cash flows from operations and cash, cash equivalents, and short-term investments on hand will be sufficient to support our operations, provide for budgeted capital expenditures, make dividend payments, and meet liquidity requirements through the remainder of fiscal 2004. Our long-term liquidity requirements will depend on many factors, including the rate at which we expand our business, and whether we do so internally or through acquisitions. In addition, strategic opportunities we may pursue could require us to fund our portion of operating expenses of such ventures and may require us to advance additional amounts should any partners in such ventures be unable to meet unanticipated capital calls or similar funding events. To the extent that the funds generated from the sources described above are insufficient to fund our activities in the long term, we may be required to raise additional funds through public or private financing. No assurance can be given that additional financing will be available or that, if it is available, it will be on terms acceptable to us.

Contractual Obligations

     The following table summarizes information on contractual obligations as of July 31, 2004:

Purchase Commitments

     From time to time, we enter into commitments with our vendors to purchase terminals and support equipment at fixed prices or guaranteed quantities. During the second quarter of this fiscal year, we entered into such an agreement with one of our vendors to provide approximately $5.2 million in Traveler terminals, with the majority of the terminals to be delivered by the end of the current fiscal year. At July 31, 2004, $4.6 million of the commitment was outstanding.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We maintain an investment portfolio in available-for-sale debt securities of the U.S. Government and its agencies, and from time to time in investment grade corporate issues. The values of these investments are subject to changes in interest rates. However, because these investments are short-term and are generally allowed to mature, we do not believe that any risk inherent in our portfolio is likely to have a material effect on expected cash flows. We monitor these investments for impairment and make appropriate reductions in carrying value when necessary.

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     Our revolving credit facility with Wells Fargo is a $5.0 million line of credit with an interest rate based on the prime rate or LIBOR plus 2.0%, at our option. The agreement contains certain restrictive covenants, which among other things require that specified financial balances and ratios be maintained, annual profitability be maintained and restrictions on the incurrence of additional indebtedness. The line of credit expires on April 2, 2005.

     Because the interest rate on the revolving credit facility is variable, our cash flow may be affected by increases in interest rates, in that we would be required to pay more interest in the event that both the prime and LIBOR interest rates increase. We do not believe, however, that any risk inherent in the variable-rate nature of the loan is likely to have a material effect on our interest expense or available cash. We currently have no outstanding borrowings under the revolving credit facility.

     Sensitivity Analysis. Assuming we had a $2.0 million balance outstanding as of July 31, 2004, the rate of interest calculated using the prime rate option would be 4.25%. Our monthly interest payment, if the rate stayed constant, would be $7,083. If the prime rate rose to 8.0%, which assumes an unusually large increase, our monthly payment would be $13,333. A more likely increase of 1.0% or 2.0%, given the recent trend of decreasing or relatively low interest rates, would result in a monthly payment of $8,750 or $10,417, respectively. We do not believe the risk resulting from such fluctuations is material or that the payment required would have a material effect on cash flow.

ITEM 4. CONTROLS AND PROCEDURES

     We have evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of July 31, 2004. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have each concluded that our disclosure controls and procedures are effective to ensure that we record, process, summarize, and report information required to be disclosed by us in our quarterly reports filed under the Securities Exchange Act within the time periods specified by the Securities and Exchange Commission’s rules and forms. During the quarterly period covered by this report, there have not been any changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

     This document includes various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events. Statements containing expressions, such as “believes,” “anticipates,” or “expects,” used in our press releases and periodic reports on Forms 10-K and 10-Q filed with the Commission, are intended to identify forward-looking statements. All forward-looking statements involve risks and uncertainties. Although we believe our expectations are based upon reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurances that actual results will not materially differ from expected results. We caution that these and similar statements included in this report are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. Such factors include those discussed in our annual report on Form 10-K for the year ended October 31, 2003. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date thereof. We undertake no obligation to publicly release any revisions to such forward-looking statements to reflect events or circumstances after the date hereof.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     On March 22, 2001, we filed a claim in the United States District Court, District of Arizona, GAMETECH INTERNATIONAL, INC. V. TREND GAMING SYSTEMS, LLC, CV 01-540 PHX PGR, seeking a declaratory judgment that we are not in material breach of our November 1, 1999 distribution agreement with Trend Gaming Systems, LLC and seeking damages for past due payments and wrongful withholdings by Trend. Trend has counterclaimed, alleging that its payments are in compliance with its contractual obligations and that it is entitled to withhold certain monies. Trend also contends that we are in breach of certain of our contractual obligations to Trend or its customers. On December 16, 2002, the court entered at our request an order enjoining Trend from using

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approximately $540,000 in funds it had collected on our behalf, pending a trial on our ownership interest in those funds. The money has been placed in a bank account subject to the court’s control and now totals approximately $585,000. In addition, collections of accounts receivable by Trend, if any, will also be placed in that account, pending the trial of the case. Trend filed a motion for summary judgment alleging that the termination of the distribution agreement was improper. On May 16, 2003, the court dismissed Trend’s motion for summary judgment. On December 2, 2003, Trend filed a renewed motion for summary judgment alleging that we did not have the right to terminate the distribution agreement based upon Trend’s failure to insure that we received our minimum rate of return. The court, on March 19, 2004 denied Trend’s renewed motion for summary judgment. A May 10, 2004 trial date has been rescheduled for October 4, 2004. We have denied the allegations and intend to vigorously pursue and defend this matter. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     In June 2004, Steven W. Hieronymus, Rhonda Hieronymus and Trend Gaming Systems, LLC filed a claim in the 98th Judicial District Court, Travis County, Texas, STEVEN W. HIERONYMUS, RHONDA HIERONYMUS AND TREND GAMING SYSTEMS, LLC V. THE TEXAS LOTTERY COMMISSION AND GAMETECH INTERNATIONAL, INC, alleging that our judgment against Steven and Rhonda Hieronymus (involving a prior distribution agreement in Virginia) creates an unlawful “credit interest” in Trend Gaming Systems, LLC in violation of the Texas Bingo Enabling Act because Mr. Hieronymus owns a greater than 10% interest in Trend Gaming Systems, LLC. The plaintiffs request an injunction against our enforcement of the judgment against Steven and Rhonda Hieronymus. The plaintiffs have moved for summary judgment and we have filed a cross motion for summary judgment on the issue. Neither motion has been set for hearing. No discovery has been done and no trial date is scheduled. We intend to vigorously defend our position. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     On October 30, 2002, Capital Gaming Supplies filed a claim in the United States District Court, Southern District of Mississippi, CAPITAL GAMING SUPPLIES, INC. V. GAMETECH INTERNATIONAL, INC., 3:02 CV 1636 WS, seeking a judgment that we tortiously interfered with alleged existing and prospective customer accounts. We have denied the allegations and filed a counter-claim seeking a judgment that Capital tortiously interfered with our customer accounts. On April 18, 2003, Capital filed an amended complaint adding other claims against us and other defendants, including a claim for malicious breach of contract against IGS, and its principals. In November 2002, we acquired certain assets of IGS and we assumed certain claims filed by Capital against IGS and its principals. Capital seeks compensatory and punitive damages from all defendants. The January 28, 2004 trial date has been postponed indefinitely. We intend to defend and pursue vigorously this matter. We believe that Capital’s claims are without merit. However, we cannot provide assurance that we will obtain a favorable outcome. An unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

     We are involved in various other legal proceedings arising out of our operations in the ordinary course of our business. We do not believe that any of these proceedings will have a material adverse effect on our financial condition, cash flows or results of operations. However, if settlement is not reached and the lawsuits proceed to trial, an unfavorable outcome could have a material adverse effect on our financial position, cash flows and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

     Not Applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not Applicable

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

     Not Applicable

ITEM 5. OTHER INFORMATION

     Not Applicable

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ITEM 6. EXHIBITS AND REPORT ON FORM 8-K

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SIGNATURES

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

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