**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-KSB**

 
| **ý**                                                                                                                                                                                                                                        | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                              |                                                                                      |
| **For the fiscal year  ended  December 31, 2003**                                                                                                                                                                                       |
|                                                                                                                                                                                                                                              |                                                                                      |
| **o**                                                                                                                                                                                                                                             | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**   |
|                                                                                                                                                                                                                                              |                                                                                      |
| **For the transition period  from                 to                 ** |
|                                                                                                                                                                                                                                              |                                                                                      |
| **Commission file  number  000-25855**                                                                                                                                                                                                  |

 
| **VendingData  Corporation**                                                      |
|-----------------------------------------------------------------------------------|
| (Name of small business  issuer in its charter)                                   |
|                                                                              |
| **Nevada**                                                                        |   | **91-1696010** |
| (State or other  jurisdiction of incorporation or organization)                   |   | (I.R.S. Employer  Identification No.) |
|                                                                              |   |   |
| **6830 Spencer Street, Las Vegas,  Nevada**                                       |   | **89119** |
| (Address of principal  executive offices)                                         |   | (Zip Code) |
|                                                                              |   |   |
| Issuer’s telephone  number:      **(702) 733-7195** |
|                                                                              |   |   |
| Securities registered under Section 12(b) of the  Exchange Act:                   |   |   |
|                                                                              |   |   |
| **Title of  each class**                                                          |   | **Name of  each exchange on which registered** |
|                                                                              |   |   |
|                                                                              |   |   |
| Securities  registered under Section 12(g) of the Exchange Act:                   |   |   |
|                                                                              |   |   |
| **Common Stock, $.001 par value**                                                 |
| (Title of each class)                                                             |
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| (Title of each class)                                                             |

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý  No o

 

Check if there is no disclosure of delinquent filersin response to Item 405 of Regulation S-B is not contained in this form, and nodisclosure will be contained, to the best of the registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form 10-KSB.  o

 

State issuer’s revenues for its most recent fiscalyear:           $6,710,919

 

State the aggregate market value of voting stock heldby non-affiliates computed by reference to the average bid and asked price ofsuch common equity, as of a specified date within the past 60 days.  $35,481,219 ($3.83 per share as ofMarch 26, 2004).

 

State the numberof shares outstanding of each of the issuer’s classes of common stock, as ofthe latest practicable date.

 
| Common Stock, $.001 par  value |   | 17,187,799 shares as of  February 29, 2004 |
|--------------------------------|--------|-------------------------------------------------|

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Part III ofthis report incorporates by reference portions of the proxy statement for the2004 Annual Meeting of Stockholders (to be filed with the Securities andExchange Commission within 120 days after December 31, 2003).

 

Transitional SmallBusiness Disclosure Format (check one): Yes o No ý

 

 

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**TABLE OF CONTENTS**

 
| **PART I**   |                                                                                                             |   |
|--------------|------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                             |   |
| Item 1.      | Description of Business                                                                                          |   |
| Item 2.      | Description of Property                                                                                          |   |
| Item 3.      | Legal Proceedings                                                                                                |   |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                                             |   |
|         |                                                                                                             |   |
| **PART II**  |                                                                                                             |   |
|         |                                                                                                             |   |
| Item 5.      | Market for Common Equity, Related Stockholder  Matters and Small Business Issuer Purchases of Equity Securities  |   |
| Item 6.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                      |   |
| Item 7.      | Financial Statements                                                                                             |   |
| Item  8.     | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                            |   |
| Item 8A.     | Controls and Procedures                                                                                          |   |
|         |                                                                                                             |   |
| **PART III** |                                                                                                             |   |
|         |                                                                                                             |   |
| Item 9.      | Directors, Executive Officers, Promoters and  Control Persons; Compliance with Section 16(a) of the Exchange Act |   |
| Item 10.     | Executive Compensation                                                                                           |   |
| Item 11.     | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                  |   |
| Item 12.     | Certain Relationships and Related Transactions                                                                   |   |
| Item 13.     | Exhibits and Reports on Form 8-K                                                                                 |   |
| Item 14.     | Principal Accountant Fees and Services                                                                           |   |

 

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**CAUTIONARYNOTICE**

 

This Annual Report of VendingData Corporation on Form 10-KSB containsforward-looking statements in which our management shares its knowledge andjudgment about factors that it believes may materially affect our performancein the future.  Terms expressing futureexpectations, outlook potential and anticipated growth in gaming industries andmarkets, acceptance of our products and services, estimates on revenues andearnings, and like expressions typically identify such statements.

 

All forward-looking statements, although made in good faith, aresubject to the uncertainties inherent in predicting the future.  Such forward-looking statements involveknown and unknown risks, uncertainties and other important factors that couldcause our actual results, performance or achievements or industry results todiffer materially from future results, performance or achievements expressed orimplied by such forward-looking statements. Such risks, uncertainties and other important factors include, amongothers:  our liquidity requirements, ourability to locate necessary sources of capital to sustain our operations, thecontinued growth of the gaming industry, the success of our product developmentactivities, the acceptance of our products in the marketplace, vigorous competitionin the gaming industry, our dependence on existing management, changes ingaming laws and regulations (including actions affecting licensing), ourleverage and debt service (including sensitivity to fluctuations in interestrates) and domestic or global economic conditions.

 

Forward-looking statements speak only as of the date they are made, andreaders are warned that we undertake no obligation to update or revise suchstatements to reflect new circumstances or unanticipated events as they occur.

 

Readers are urged to carefully review and consider the disclosures inthis and other reports that discuss factors relevant to our business.  See Part II.  “Item 6.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations—RiskFactors and Forward-Looking Information.”

 

# **PART I**

 

## **ITEM1.**                             DESCRIPTION OFBUSINESS

 

We develop, manufacture, sell and lease products for the gamingindustry that are intended to increase our customers’ security, productivityand profitability.  Since inception, wehave invested approximately $40 million to set up the company and develop ourproducts.  Our products are categorizedas casino revenue control system products or table game support products andare as follows:

 

**RecentDevelopments**

 

In February 2004,we expanded our management team with the hiring of Michael Jahnke as ChiefOperating Officer.

 

**Casino RevenueControl System Products—SecureDrop® System**

 

Our casino revenue control system products enable gaming operators tomore efficiently and securely track paper currency and coins from the time theyare deposited in slot machines or handed to dealers at table games on thecasino floor through the time the paper currency and coins are delivered to the“count room,” the location where all gaming proceeds from table games, slotmachines and various other games are collected and counted by the casinooperator.  The products that compriseour casino revenue control system, which we refer to as the SecureDrop® System,are:

 

•                  The SecureDrop® Soft CountModule, a bill (paper currency) canister identification system that enablesgaming operators to electronically track, secure and identify all slot machinebill canisters on the casino floor and in the count room.

 

•                  The SecureDrop® Hard CountModule, a coin (hard currency) bucket identification system that enables gamingoperators to electronically track, secure and identify all slot machine coinbuckets on the casino floor and in the count room.

 

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•                  The SecureDrop® TableCountTMModule, a bill (paper currency) drop box identification system that enablesgaming operators to electronically tack, secure and identify all drop boxes onthe casino floor and in the count room.

 

After the introduction of a prototype of the SecureDrop® TableCountTMModule in September 2003, this product was ready for sale at the end of 2003.

 

**Table Game SupportProducts**

 

Our table game support products are:

 

•                  The Deck CheckerTM, a cardsecurity device that scans decks of playing cards to ensure an accurate countand verifies that all of the cards are present.

 

•                  The Random EjectionShufflerTM, a shuffling device that is capable of shuffling between one andeight decks of cards.

 

•                  The Continuous RandomEjection Shuffler, a shuffling device that continuously shuffles and recyclesthe same group of between one and eight decks of cards.

 

We are developing a new version of the Random Ejection ShufflerTM and theContinuous Random Ejection Shuffler, referred to as the RandomPlusÔShuffler, which will include additional features, such as the switch in powerfrom alternating current, or AC, to direct current, or DC, conversion to anexternal power supply, redesign of the cabinet, and the addition of an externallever to adjust the shuffler for card thickness.  We anticipate conducting field trials of the RandomPlusÔShuffler in North America in the second half of 2004.

 

Furthermore, we are also developing the PokerOneTM Shuffler, which is ashuffling device that is designed for use with single deck******poker variation games.  The completed prototype of the PokerOneTMShuffler was introduced at the Global Gaming Expo in Las Vegas in September2002.  PokerOneTM is undergoing betatesting in the second quarter of 2004 in Asia, with production anticipated tobegin in the second half of 2004.

 

In connection with the development of the SecureDrop® System, ourautomated shufflers and Deck CheckerTM, we have secured five U.S. patents withrespect to SecureDrop®, we have secured five U.S. patents with respect to ourshufflers, and we have a patent application pending in the United States withrespect to the Deck CheckerTM.  Withrespect to our shufflers and our Deck CheckerTM, we have also filed a patentapplication under the Patent Cooperation Treaty, or PCT, which allows a filerto complete one application where the applicant designates certain countries inwhich patent protection is desired and which delays filing in these individualforeign countries for up to 30 months from the date of filing in the UnitedStates.

 

We maintain our principal offices at 6830 Spencer Street, Las Vegas,Nevada 89119.  Our telephone number andfacsimile number are (702) 733-7195 and (702) 733-7197, respectively.

 

**BUSINESS STRATEGY**

 

While we transitioned from a development stage to an operating companyin 2000, we have continued to develop or acquire new products.  The focus on the development and acquisitionof new

 

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products isreflected in our operating results.  Ourstrategy to increase revenue and margins is based on four key factors:

 

•                                          ***Developmentof two product lines with limited competition. ***Ourability to offer the SecureDrop® System and the Deck CheckerTM have given us twoproduct lines that our informal industry and patent research led us to concludehave limited or virtually no competition. In contrast, our shuffler products face intense competition due primarilyto the dominance in the installed shuffler market base in North America byShuffle Master, Inc.  In this regard,during 2001 and 2000, when a substantial portion of our revenue was generatedby our shuffler products, our margins declined.  By offering two products with limited competition, our managementbelieves that we will have a significant competitive advantage as our productsare installed and become accepted by the gaming industry.

 

•                                          ***Expansioninto additional domestic gaming markets and into international gaming marketsfor our products. ***The global economic downturn has forcednon-gaming jurisdictions to look at new ways to raise revenue.  Accordingly, from time to time differentstates and foreign countries may consider legalizing various forms of casinogaming as an additional revenue source. These include slot machines atracetracks, Native American Class-III casinos and Las Vegas-style casinos.  The worldwide expansion of gaming shouldprovide new markets for our products, and we have targeted sales opportunitiesin these new markets in addition to our traditional established gaming markets.

 

•                                          ***Increasein the market penetration of our products. ***Sincewe have only recently introduced certain elements of our SecureDrop® System in2002 and only introduced the Deck CheckerTM in early 2003, the marketpenetration of these products is low. As a result of the positive feedback received from senior executivesfrom Caesars Entertainment, Inc. (formerly Park Place EntertainmentCorporation), the parent company of over 29 casinos internationally,****onthe installations of the SecureDrop® Soft Count Module in the first half of2003, our management believes that our products will gain acceptance in theindustry, and we are seeking to increase the market penetration of ourproducts.

 

•                                          ***Implementationof cost reduction initiatives to increase gross margins. ***Through the implementation of cost reductioninitiatives, our management believes that the gross margins on our productswill improve over time.  The costreduction initiatives include the following:

 

•                  *Reducing the cost of our componentparts through the use of production facilities in China*. By opening an office, manufacturing, assembly, service and warehousefacility in Xiaolan Town in Zhongshan City, China, we propose to shift ourcomponent sources to China and lower our costs.  To date, we have shifted the production of over 80% of thecomponents of the SecureDrop® System and our shufflers to China.

 

•                  *Closing two of our five regionalservice locations and centralizing all technical service functions to ourfacilities in Las Vegas, Nevada.*  The use offive service locations with technicians and customer service representativesfor the repair and service of our shufflers has not been cost effective.  By closing the Atlantic City, New Jersey andMiami, Florida service locations and relying more on the use of spare machines,we centralized in Las Vegas all technical service functions.  The

 

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remaining servicelocations will continue to provide non-technical support through customerservice representatives.

 

•                  *Eliminating our Boise, Idahoresearch facility and consolidating the management of the research anddevelopment related to our table game and slot support products in Las Vegas.* Our management believes that consolidating all research and developmentto Las Vegas with support from our facility in China will speed development andbe more efficient in the set up of the manufacturing of our new products.  The Boise facility was closed on June 30,2003.

 

•                  *Implementing a new computer systemdesigned to improve productivity through the use of eleven modules, including afinancial and manufacturing application*.  Our newcomputer software will provide an integrated control process for purchasing,inventory control and manufacturing in our Las Vegas and China facilities.  The computer systemwas implemented in Las Vegas and China in the first quarter of 2004.

 

**CASINO REVENUE CONTROLSYSTEM PRODUCTS**

 

**SecureDrop® System**

 

We launched our initial versions of the elements of the SecureDrop®Hard Count Module in September 1999. The Hard Count Module was designed to provide casino operators with timeand labor savings, enhanced security and accountability in the slot machinecoin collection process.  We subsequentlyadapted the SecureDrop® System and created the Soft Count Module to apply tothe paper currency collection process as well. The coin collection process and the paper currency collection processare referred to as the hard drop and soft drop, respectively.  As of December 31, 2003, we have unitsinstalled to support 24,363 slot machines of the Hard Count Module at 29properties and units to support 12,021 slot machines of the Soft Count Moduleat 7 properties, and we are presently negotiating additional contracts to placeour SecureDrop® line of products.  Weintroduced a prototype of the TableCountTM Module at the Global GamingExpo in September 2003 and the system will be available for sale at the end ofthe second quarter of 2004.

 

The SecureDrop® System provides gaming operators with a reliable methodof tracking the currency and coin containers from the time currency and coinare removed from the gaming machine or table game to the time they arrive in the casino’scount room.  The SecureDrop® identificationand time stamp technology replaces the existing manual methods still usedthroughout the gaming industry.  TheSecureDrop® products are compatible with existing casino systems, includingoperators with or without online slot accounting systems.  The technology utilizes specially designedbill canisters, drop buckets and drop boxes that house a memory chip that worksin conjunction with a sensor base beneath the gaming machine that is mounted inthe bill accepter or beneath the gaming table.  The electronicchip system automatically links the canister to the relevant gaming machine orgaming table, or the drop box to the relevant table game, and transfers the data for electronicprocessing.  Using a specially designedSecureDrop® mobile command center with a built in data-recording device, all ofthe relevant information is captured from the memory chip.

 

The SecureDrop® System control software provides a complete trackingand control system for all slot and table game revenue containers on the gamingfloor.  The SecureDrop® System controlsoftware is responsible for running all of our SecureDrop® System modules.  The SecureDrop® System control software isdesigned to create a secure environment and maintains all databases and timeclocks throughout the system.  Everyfunction can be password protected, and each user can have a completelycustomized profile for system access.

 

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Based on customer feedback, our management believes that even some ofthe better operated casinos experience a shortfall in actual coins and billsarriving in the count rooms and that some operators have losses as high asseveral percentage points of slot and table game revenue.  Based upon feedback from our casinocustomers, the SecureDrop® System can reduce shortfalls in coins and billsarriving in the casino’s hard and soft count room, and personnel and collectiontimes can be reduced.

 

One potential limitation on our ability to successfully market theSecureDrop® Hard Count Module could be coinless gaming.  Since 1987, several companies have attemptedto develop coinless slot machines. California tribal casinos used “coinless” slots for eight years untilthe Native American tribes executed compacts governing the terms of gaming withthe Governor of California beginning in May 2000, at which time the Californiatribal casinos immediately began replacing coinless slot machines with thetraditional coin versions.

 

In 2000, International Gaming Technology introduced the EZ-PayTM system.  The EZ-PayTM system (or equivalent systems)attempts to reduce operating costs and machine downtime by providing gamingoperators with machines that drop coins for smaller payouts and print ticketsfor larger, predetermined payouts.  As aresult of the issuance of tickets, players are not required to wait forattendants in order to be paid larger payouts and may use their tickets atother machines equipped with the EZ-PayTM system and the number of slotoperations with an online system that use the EZ-PayTM system continues togrow.  Customer response to the EZ-PayTMsystem has been positive.  For example,the Borgata, a joint venture between Boyd Gaming and MGM Mirage, opened in AtlanticCity, New Jersey in July 2003 with a totally “coinless” slot floor, furtherevidencing that coinless technology has been accepted by major casinooperators.  Totally “coinless” slotfloors would not need SecureDrop® Hard Count Module.  However, to date, a majority of casinos that use EZ-PayTM orequivalent systems are continuing the use of coins.

 

We believe that the use of the EZ-PayTM system (or equivalent systems)could actually result in larger coin drops and enhance the need for theSecureDrop® Hard Count Module where coins are still inserted into the machinebecause larger payouts would be made by ticket, rather than in coin, whichwould result in more coin being left in the machine and the drop.  Nevertheless, assuming that the industry’smove toward coinless gaming does result in a reduction of demand for theSecureDrop® Hard Count Module, totally coinless gaming could potentiallyincrease the demand for our SecureDrop® Soft Count Module, which tracks paper,such as paper currency and tickets, rather than coins.  Operators that use the EZ-PayTM system (or anequivalent system) could elect to use our Soft Count Module because soft dropswould still be required.

 

We believe that in the domestic United States market, the greateremphasis of sales will be the SecureDrop® Soft Count Module due to the growthof coinless slot machines.  Ininternational markets, we intend to focus on our SecureDrop® Hard Count Module and the newTableCountTM Module in the initial time period until wegauge the demand for the Soft Count Module overseas.  We believe that a market exists for the TableCountTM Module inboth the domestic and international markets due to the improved revenue controlour system provides.

 

***SecureDrop® Soft CountModule***

 

The SecureDrop® Soft Count Module provides a bill (paper currency)canister identification system that enables gaming operators to electronicallytrack, secure and identify all bill canisters on the casino floor and in thecount room.  The SecureDrop® time stampsystem deters canister switching, theft and loss by recording all phases of thesoft drop process, accounting for the bill canister’s removal from the gamingmachine, the time the bill canister is in transport and the time of the billcanister’s arrival in the casino’s soft count room.  Through the comprehensive SecureDrop® database system, all billcanisters can be identified, tracked and accounted for with a high degree ofsecurity.

 

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The SecureDrop® Soft Count Module works as follows:

 

•                  First, a new or “cold” electronic billcanister is placed on a specially designed canister base in the gaming machine,and a green light is activated that indicates the beginning of the audit trail.

 

•                  Second, the full or “hot” electronic billcanister is removed from the gaming machine and then secured in the SecureDrop®transport vault, where a green light indicates the canister has been accepted.

 

•                  Third, the full canister is monitored bythe SecureDrop® transport vault until the electronic bill canister arrives atthe casino’s soft count room, where the failure of the canister to arrive willgenerate a missing canister report.

 

•                  Fourth, the full canister is placed onthe SecureDrop® canister docking station, which downloads the informationstored in the canister and clears the memory of the canister.

 

•                  Fifth, the data is saved to theSecureDrop® software and can then be used to generate reports or can betransferred to an existing slot accounting program.

 

•                  Sixth, a bar-coded ticket with a hardcopy of the audit trail is printed for each “hot” electronic bill canister foraccounting purposes.

 

•                  Lastly, the new or “cold” electronic billcanister is then returned to any gaming machine to begin a new audit trail.

 

With the SecureDrop® Soft Count Module, canister security is enhanced,canister movement is accounted for, soft count accuracy is improved, and adeterrence against theft is added to the soft count process by creating acomplete history of each canister’s movement from the gaming machine to thecasino’s soft count room.  Because ourSoft Count Module generates a missing canister report before the funds in thesoft count room are audited, casinos should know much earlier if there is amissing canister, which allows the casino personnel to immediately implementits procedures to locate the missing canister. By locating the missing canisters more quickly, the casino should reduceits variances, which are the amount of paper currency in the machines inrelation to the amount of funds that should be in the gaming machines accordingto the records of the casino’s accounting system.

 

***SecureDrop® Hard CountModule***

 

The SecureDrop® Hard Count Module provides a bucket identificationsystem that enables gaming operators to electronically track and identify allbuckets and slot machines, secure the coins immediately and we believe, inessence, brings the hard count room to the casino’s slot floor.  The heart of the SecureDrop® Hard CountModule is the electronic bucket featuring the patented SecureDrop®identification technology.  The smartbucket works with enhanced controls inside the slot machine to record the IDnumber and meter readings of the slot machine. Specially designed SecureDrop® multi-bin coin vaults are used to securethe coins on the casino’s slot floor.

 

The SecureDrop® time stamp system helps to deter theft and loss byrecording all phases of the drop process. After the buckets are weighed, that data gathered and the coins secured,the cleared buckets can be returned to any slot machine.  Any coin variance is immediately identified,and steps can be taken to correct the problem. When used with the SecureDrop® mobile command center, the SecureDrop®Hard Count Module allows operators to utilize a single-bucket drop system.  Using the comprehensive

 

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SecureDrop®database system, all drop buckets can be identified, tracked and accounted forwith a high degree of security.

 

The SecureDrop® Hard Count Module works as follows:

 

•                  First, an empty electronic bucket isplaced on a specially designed base in the gaming machine and a green light isactivated, indicating the beginning of the audit trail and the recording of thegaming machine’s identity through a memory chip affixed to the electronicbucket.

 

•                  Second, the electronic bucket is pulledfrom the gaming machine and placed on the SecureDrop® mobile command centerscale, where a green light acknowledges that all data, including the gamingmachine number, the amount of coins in the electronic bucket and any meterinformation, has been recorded and transferred to the tracking program.

 

•                  Third, after gathering data, theelectronic bucket’s contents are deposited into the SecureDrop® multi-bin coinvault, safely securing coins in seconds instead of hours.

 

•                  Fourth, upon removal from the scale, theelectronic bucket is considered clean and can be placed in any other slotmachine.

 

•                  Fifth, before leaving the slot floor, thedrop team can run a missing machine report to ensure the drop has beencompleted.

 

•                  Sixth, the data saved to the SecureDrop®software can then be used to generate reports or can be transferred to anexisting slot program for further analysis.

 

With the SecureDrop® Hard Count Module, once the coins are gathered,the only remaining task to complete in the casino’s hard count room is to wrap,bag and rack the coin.  The SecureDrop®conveyor belt system helps automate and streamline this process.  With the SecureDrop® Hard Count Module,security is enhanced, and hard count accuracy is improved.

 

***SecureDrop®TableCountTM Module***

 

The SecureDrop® TableCountTM Module provides a drop boxidentification system that enables gaming operators to electronically track,secure and identify all table game drop boxes on the casino floor and in thecount room.  The SecureDrop® time stampsystem deters drop box switching, theft and loss by recording all phases of thetable drop process.  The SecureDrop®time stamp accounts for the drop box’s removal from the gaming table, the timethe drop box is in transport and the time the drop box arrives in the casino’ssoft count room.  Through thecomprehensive SecureDrop® database system, all drop boxes can be identified,tracked and accounted for with a high degree of security.

 

The SecureDrop® TableCountTM Module works as follows:

 

•                  First, a new or“cold” specially designed electronic drop box is placed at the gaming table,and a green light is activated that indicates the beginning of the audit trail.

 

•                  Second, thefull or “hot” electronic drop box is removed from the gaming table and thensecured in the SecureDrop® transport vault (the same vault utilized in the SoftCount Module), where a green light indicates the drop box has been accepted.

 

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•                  Third, the fulldrop box is monitored by the SecureDrop® transport vault until the electronicdrop box arrives at the casino’s soft count room, where the failure of the dropbox to arrive will generate a missing drop box report.

 

•                  Fourth, thefull drop box is placed on the SecureDrop® docking station, which downloads theinformation stored in the drop box and clears the memory of the drop box.

 

•                Fifth, the data is saved tothe SecureDrop® software and can then be used to generate reports or can betransferred to an existing slot accounting program.

 

•                Sixth, a bar-coded ticketwith a hard copy of the audit trail is printed for each “hot” electronic dropbox for accounting purposes.

 

•                Lastly, the new or “cold”electronic drop box is then returned to any gaming table to begin a new audittrail.

 

As explained above, the SecureDrop®TableCountTM Moduleenhances drop box security, accounts for drop box movement and improves theaccuracy of the table count by creating a complete history of drop box movementfrom the gaming table to the casino’s soft count room.

 

***Market for theSecureDrop® System***

 

The world gaming machine market is complex and segmented based ondifferent machines in terms of technology, winnings, payout, range of bets andlosses and regulatory environments.  Ourmanagement believes that the current market for elements of the SecureDrop®System encompasses all casinos, gaming halls or other venues that feature 100or more coin and/or paper money based gaming machines.  We believe that there is a worldwide marketfor our SecureDrop® Hard and Soft Count Modules for the operators of anyproperties containing a significant number of slot machines and gamingdevices.  We believe that there are inexcess of 600,000 gaming machines currently in use in the United States andthat the total number of gaming machines in use throughout the rest of theworld is significantly greater.  Wefurther estimate that the potential market for the SecureDrop® TableCountTMModule consists of the approximately 41,000 gaming tables worldwide.  In addition, through the development ofadditional products and features for the SecureDrop® System, we believe that wewill be able to expand the market for the SecureDrop® System to additionalgames.  We further believe that withminor modifications the SecureDrop® System may be utilized in non-gamingapplications, such as vending machines and arcades.

 

We believe that in the domestic United States market, the greateremphasis of sales will be the SecureDrop® Soft Count Module.  For example, because its management valuesthe security provided by our technology, Caesars Entertainment, Inc. (formerlyPark Place Entertainment Corporation) installed our Soft Count Module even incertain of its gaming machines that accept bills but pay out coins.  In international markets, we intend to focuson our SecureDrop® Hard Count Module in the initial time period until we gaugethe demand for the Soft Count Module.

 

***Competition – SecureDrop®System***

 

We believe that the SecureDrop® System is the only method ofcomputerized bucket management and one-step processing of coins and bills onthe casino floor.  We believe that thealternative to the SecureDrop® System is the removal of the bucket, transportto the count room and verification of money manually.

 

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**TABLE GAME SUPPORT PRODUCTS**

 

**Shuffler ProductLine**

 

We currently offer the Random Ejection ShufflerTM, a batch shuffler, andthe Continuous Random Ejection Shuffler, a continuous shuffler.  We began shipping the Random EjectionShufflerTM in the spring of 1999****and****have spent considerable engineering timeand resources to improve its speed and reliability.  In the fourth quarter of 2000, we began to ship the ContinuousRandom Ejection Shuffler.  While webelieve that our products have begun to perform to or above designspecifications that will satisfy industry demands, we are continuing to improveour shufflers.  Accordingly, we havebegun to develop our RandomPlusÔ Shuffler, which includes a switch inpower from AC to DC, a conversion to an external power supply, a re-design ofthe cabinet, and the addition of an external lever to adjust the shuffler forcard thickness.  We expect to conduct field tests on the new RandomPlusÔ  Shuffler in the second half of 2004.  We are also currently developing a thirdshuffler, the PokerOneTM Shuffler, to provide shuffles of pre-dealt hands ofcards for specialty poker games.  We arecurrently conducting field tests of the PokerOneTM Shuffler in Asia and expectto begin sales in foreign markets in the second half of 2004.

 

We believe that the motivating factors for casino operators to adoptautomatic shufflers on gaming tables include the desire to increase dealerproductivity, reduce exposure to fraud and cheating by dealers, players or bothand reduce reliance on experienced dealers. The ability to turn more hands, or decisions, per hour and reduce the advantageknowledgeable players have with respect to poor manual shuffles will morelikely generate higher “holds,” the percentage of wagers that the casino earns,from automated shufflers than from manual shuffles.

 

***Random Ejection ShufflerTMand Continuous Random Ejection Shuffler***

 

When manufacturing shufflers, we begin with a machine that we developinto one of two products.  The RandomEjection ShufflerTM is a batch shuffler that is capable of shuffling between oneand eight decks of cards.  With a slightand inexpensive modification, we may convert a batch shuffler into theContinuous Random Ejection Shuffler, which continuously recycles the same groupof cards.  Upon conversion, the shufflermay be used as either a batch shuffler or a continuous shuffler.  Both shufflers can accommodate differentgames of blackjack or baccarat.

 

The patented technology used in the Random Ejection ShufflerTM isdesigned to produce an independent card selection in that any card may beejected from the card tray at any time and restacked in an unpredictablemanner.  As a result, clumps, slugs ormemorized sequences are eliminated from shuffles.  We believe that this technology negates advantages achieved byexpert players.  While most shufflingmachines repeat the same mechanical action, each shuffle in the Random EjectionShufflerTM is random.  In the batch mode,the Random Ejection ShufflerTM can shuffle six decks of cards in approximatelythree minutes and, due to the speed of the shuffler, neutralize cardcounting.  Further, through the use of asecond batch of cards, the Random Ejection ShufflerTM maintains productivity andreduces downtime due to manual card shuffling. Through the use of the Random Ejection ShufflerTM, we believe that dealerproductivity can be increased.

 

With the Continuous Random Ejection Shuffler, all playing cards remainin a continuous shuffle, except for a small batch used during play.  After play, this batch is returned to theshuffler, and a new batch is used for play. The Continuous Random Ejection Shuffler provides operator security byneutralizing card counters and locaters, while increasing player satisfactionderived from a hand-held game.  Thecards may also be loaded and dealt from a traditional card-dealing shoe.

 

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We currently offer the Random Ejection ShufflerTM and the ContinuousRandom Ejection Shuffler for sale and rent to properties within the UnitedStates and only for sale to properties in foreign countries.  We offer the Random Ejection ShufflerTM andthe Continuous Random Ejection Shuffler for rent only to properties located inthe United States.  We have begun torefurbish existing shufflers for sale or lease at reduced rates to takeadvantage of existing inventory-on-hand.

 

***PokerOneTM Shuffler***

 

To complement our current shufflers, we are developing the PokerOneTMShuffler, a specialty game shuffler utilizing new and existing technology.  Specialty game shufflers are only used insingle deck poker variation games such as Caribbean StudTM, Let It RideTM, PaiGow Poker and Three Card Poker.  ThePokerOneTM Shuffler is designed to re-stack the deck and deliver the requirednumber of cards (3, 5 or 7 cards) into packets using a batch systemmethod.  We believe that the PokerOneTMShuffler will significantly raise the standard for specialty game shufflers andwill compete with the Ace® Shuffler, manufactured by Shuffle Master, Inc.  Currently, the Ace® Shuffler is the onlyspecialty game shuffler on the market that has the capability to shuffle asingle deck of cards and put the cards into individual packets.  The Ace® Shuffler is also able to verify thetotal quantity of cards shuffled and the quantity of cards in each packet.

 

In order to compete with the Ace® Shuffler in terms of the capabilitiesoffered, we have designed the PokerOneTM Shuffler to:

 

•                  shuffle and prepare the cards into theindividual packets required for the specialty poker game;

 

•                  provide sufficient speed to maintain thepace of the game even if just a single player is playing;

 

•                  verify the overall quantity of the cardsshuffled and the number of cards in each packet; and

 

•                  verify the actual cards dealt to eachplayer.

 

The PokerOneTM Shuffler is designed for the active specialty table gamemarket where non-traditional card dealing is accepted.  The PokerOneTM Shuffler will shuffle and dealpackets of cards to each player.  Anoptional vision module will be available in the future to record the individualcards that are dealt to each player and, as a result, allow operators to verifywinning hands that receive large payouts. Since many specialty poker games offer payouts in excess of $100,000,the value in verifying winning hands is substantial.  As a result of the characteristics of the PokerOneTM Shuffler, webelieve that we will be able to provide substantially improved speed andsecurity for our customers in the specialty table game market.

 

The prototype of the PokerOneTM Shuffler was completed and introduced atthe Global Gaming Expo in Las Vegas in September 2002.  Beta testing for the PokerOneTM Shuffler isexpected to begin in the second quarter of 2004 in Macau.  Introduction for sale in foreign marketswill begin in the second half of 2004.

 

***Shuffler Market***

 

We estimate that there are over 41,000 gaming tables worldwide.  We believe that the market penetration ofinstallations of automatic shufflers is low. We estimate that of the automatic shufflers installed, most of theseinstallations are on specialty gaming tables. Several companies have introduced automatic shufflers for the generalmarket, but for the most part, these efforts have been unsuccessful.  Since there is low penetration by ourcompetitors in the general gaming table market (blackjack and baccarat tables)to date, we believe that development of a shuffler that overcomes theshortcomings of the current shufflers in the market will lead to an increase inmarket penetration.

 

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There are several factors that have resulted in low acceptance ofautomatic shufflers for the general market, including security issues,reliability/productivity and player confidence.  We believe that our technology and ergonomic design will allowour products to overcome these industry concerns:

 

•            **Security.**** **Thedesign of existing shufflers has proven vulnerable to cheating and cardcounting schemes.  We believe that ourcombination of patented computer and mechanical technology safeguards againstcheating schemes.  The Random EjectionShufflerTM produces a computer-generated, random and untrackable shuffle, andthe Continuous Random Ejection Shuffler eliminates advantages achieved byknowledgeable players, as each card is available for the next round of play byproducing “full” decks of continuously shuffled random cards.  This has the added benefit of giving thecasino a higher hold from the gaming table since the shuffler preserves theoriginal odds of each game, which favor the casino.

 

•            **Reliability/Productivity.**  Given the paper handling demands placed on card shufflers,shufflers are prone to jamming and breakdown. We have designed our shufflers to be easily accessed by dealers so theycan hand-deal cards until the unit can be put back in****service and prevent a tablefrom shutting down.  In addition, thedealer, with little interruption, can easily put the unit back into play inmost cases.

 

•            **Player Confidence.**  To reduce cheating schemes, many existing shufflers completelycover or shield from players the deck(s) being shuffled, thereby reducingplayer confidence in a fair game.  Thedesign of our shufflers allows players to see the cards being ejected andre-stacked through a frosted cover without compromising security, which webelieve will gain better player acceptance.

 

***Shuffler Installations***

 

As of December 31, 2003,we had installed a net total of 708 units, representing the number of revenuegenerating shufflers installed at casinos through sale or rentalagreements.  Of the units installed asof December 31, 2003, 213 units were installed pursuant to rentalagreements, and 495 units were sales. In terms of location, as of December 31, 2003, we have installedour shuffler in 96 different gaming properties, including the Greektown Casinoin Detroit, Michigan; the Excalibur, the Luxor and the Venetian in Las Vegas,Nevada; the Viejas Casino in Alpine, California; the Silver Dollar in Tacoma,Washington; and the Crystal Palace in the Bahamas.

 

***Competition – Shufflers***

 

Competition in the shuffler market is intense.  The shuffler market is divided into twoseparate segments, traditional table game and specialty table games.  We estimate that Shuffle Master, Inc. is themarket leader in both the traditional table game and specialty table gamemarkets and that our other competitors have a small collective market share ofthe table game market.  With respect tothe traditional table game market segment, we compete with Shuffle Master,Inc., which markets the Shuffle Master KingÔ, TenStix, Inc., a U.S. company that markets the Pro Shuffler Shuffling System,Casinos Austria Research and Development, an Austrian company that markets theShuffle StarTM and the One2Six Shuffler, and John Huxley Casino Equipment, Ltd.,a United Kingdom company that markets the Quick Draw Shuffling System.  Shuffle Master, Inc. offers the ACE®, whichis currently the only product in the specialty table game market.

 

We believe our shufflers have a competitive advantage over othershufflers with respect to vulnerability to player cheating and card counting,reliability and player satisfaction. The advantage of our Random Ejection ShufflerTM is that it produces anindependent card selection in that any card may be ejected from the card trayat any time and restacked in an unpredictable manner, which eliminates clumps,

 

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slugs or memorizedsequences from shuffles.  We believethat the technology used in the Random Ejection ShufflerTM negates advantagesachieved by expert players.  Because theContinuous Random Ejection Shuffler is continuously recycling the cards, thisproduct provides casino operators heightened security by neutralizing cardcounters and locaters, while increasing player satisfaction derived from ahand-held game.

 

**The Deck CheckerTM**

 

The Deck CheckerTM is a card security device that specifically scansplaying cards to ensure an accurate count and verify that all of the cards in adeck of cards are present.  Thisinnovative product confirms the integrity of each card and will reject anynon-conforming cards.  The Deck CheckerTMhas multiple uses and can be used in the back of the house (casino supportdepartments) to reduce labor costs by expediting the verification process ofused cards, or it can be used in the front of the house (the casino floor) toensure that all table games open with complete and accurate decks, reducing theamount of time it takes to open a table game, thereby increasingproductivity.  The Deck CheckerTM allowsthe re-use of playing cards by providing a secure and reliable method ofputting used cards back into play, reducing card usage and the associatedcosts.  In addition, the Deck CheckerTMcan scan from one deck to up to eight decks at a time, can scan each deck inless than 15 seconds, is programmed for all standard playing cards,accommodates plastic, paper and plastic coated playing cards and is programmedwith many standard card games.

 

The Deck CheckerTM has an integrated management system and an on-boardstorage/vault system.  The integratedmanagement system gives a report for every transaction to provide an audittrail.  Further, the Deck CheckerTMrequires limited training time, as the machine prompts the user throughout theentire checking process.  Since the DeckCheckerTM does not require additional staff, the Deck CheckerTM is designed toincrease efficiency and shorten the start-of-the-day and the end-of-the-dayprocedures.

 

***Market and Distributionof the Deck CheckerTM***

 

Our management estimates that the potential market for the DeckCheckerTM to be one machine for every ten table games, or approximately 4,000machines installed at various casinos around the world.  We currently believe that a large portion ofthe Deck CheckerTM market segment is through rental arrangements, which wouldpotentially provide a source of recurring revenue to us.  In November 2002, we entered into afive-year agreement with TCS Aces, an Australian subsidiary of Technical CasinoServices, Ltd., a United Kingdom company that distributes gaming equipmentworldwide, under which the Deck CheckerTM will be distributedinternationally.  As of December 31, 2003, we had 59 units of the Deck CheckerTM installedat 17 casinos, 42 of which were purchased and 17 of which were rented.

 

***Development andProduction of the Deck CheckerTM***

 

Pursuant to a professional services agreement, Industrial ResearchLimited of New Zealand has agreed to assist us in the development, manufactureand assembly of the Deck CheckerÔ. The complete manufacturing of the Deck CheckerÔ willnow take place in our China facility.

 

***Competition – DeckCheckerTM***

 

We believe that the Deck CheckerTM is the only product of its kind inthe gaming industry at this time.  Wehave been issued one patent each in the United States and South Africa and havefive patent applications pending in the United States, Australia, Canada, Chinaand Europe.

 

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**RESEARCH AND DEVELOPMENT**

 

Our research and development facilities were moved to our Las Vegasheadquarters at the end of June 2003. We anticipate that the development and production of our products willbe more efficient as a result of this consolidation of our research anddevelopment functions and the opening of our facility in China.  Our current research and developmentemphasis is to improve our existing product lines, complete PokerOneÔShuffler and the SecureDrop® TableCountTM Module, and develop the nextgeneration of the Random Ejection ShufflerTM and the Continuous Random EjectionShuffler.  We expect our research anddevelopment expenses to increase as we develop a new shuffler, the RandomPlusÔShuffler, for release in 2004.

 

**REGULATION AND LICENSING**

 

The gaming industry is ahighly regulated industry and is subject to numerous statutes, rules andregulations administered by the gaming commissions or similar regulatoryauthorities of each jurisdiction. Generally, companies that seek to introduce gaming products or conceptsinto such jurisdictions may be required to submit applications relating totheir activities or products (including detailed background informationconcerning controlling persons within their organization) which are thenreviewed for approval.  Our productsgenerally fall within the classification of “associated equipment.”  “Associated equipment” is equipment which isnot classified as a “gaming device,” but which has an integral relationship tothe conduct of licensed gaming. Regulatory authorities in some jurisdictions have discretion to requiremanufacturers and distributors of associated equipment to meet licensing orsuitability requirements prior to or concurrent with the use of theirequipment.  In other jurisdictions,associated equipment must be approved by the regulatory authorities in advanceof its use at licensed locations.  Wehave obtained, or are seeking to obtain, approval of our associated equipment ineach jurisdiction in which we conduct business that requires suchapproval.  As of December 31, 2003, we have been issued key product approvalsand approval waivers from several governmental gaming regulators and NativeAmerican tribes, as described below.

 

With respect to theSecureDrop® System, we have received approvals or approval waivers for one ormore of the components, or no approvals are required, from ten U.S. stategaming jurisdictions, including Colorado, Illinois, Indiana, Iowa, Louisiana,Michigan, Mississippi, Missouri, Nevada, and North Dakota, and Saskatchewan,Canada.  In addition to the foregoingapprovals or approval waivers, we have installed various components of theSecureDrop® System in Argentina, Peru, Russia and Sweden, where the regulatoryrequirements are minimal.

 

With respect to ourshufflers, we have received approvals for the Random Ejection ShufflerTM and/orthe Continuous Random Ejection Shuffler from five state gamingjurisdictions.  The state gamingjurisdictions that have approved the Random Ejection ShufflerTM and theContinuous Random Ejection Shuffler are Indiana and Nevada, and the RandomEjection ShufflerTM is approved in Michigan, Mississippi and Washington.  In addition, Gaming LaboratoriesInternational, an independent product testing laboratory, has approved theRandom Ejection ShufflerTM for use in South Dakota, Missouri, North Dakota andOregon, and the Random Ejection ShufflerTM and the Continuous Random EjectionShuffler for use in Louisiana and Wisconsin. The PokerOneTM Shuffler, which is still in development, will be subjectto similar regulatory approvals to which the Random Ejection ShufflerTM and theContinuous Random Ejection Shuffler are subject.

 

With respect to the DeckCheckerTM, approval waivers were obtained from Connecticut, Michigan and Nevada,and approvals were obtained from Indiana and Washington.  In addition, Gaming LaboratoriesInternational approved the Deck CheckerTM for Arizona and California NativeAmerican tribes, Iowa, Illinois, Missouri, North Dakota, Oregon and Wisconsin.

 

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In addition, as of December 31, 2003, we hadobtained licenses, approvals or approval waivers from more than 25 NativeAmerican tribes with respect to the SecureDrop® System, the shufflers, or DeckCheckerTM.

 

**Nevada. **The manufacture and distribution of associatedequipment for use in Nevada are subject to the Nevada Gaming Control Act andthe regulations promulgated thereunder and various local ordinances andregulations.  These activities aresubject to the licensing and regulatory control of the Nevada GamingCommission, the Nevada Gaming Control Board and various local, city and countyregulatory agencies, which we collectively refer to as the Nevada GamingAuthorities.

 

The laws, regulations andsupervisory practices of the Nevada Gaming Authorities are based upon thefollowing declarations of public policy:

 

•                                          Preventing any involvement, direct orindirect, of any unsavory or unsuitable persons in gaming or in the manufactureor distribution of gaming devices at any time or in any capacity;

 

•                                          Strictly regulating all persons, locations,practices and activities related to the operation of licensed gamingestablishments and the manufacture or distribution of gaming devices andequipment;

 

•                                          Establishing and maintaining responsibleaccounting practices and procedures;

 

•                                          Maintaining effective controls over thefinancial practices of licensees (including requirements covering minimumprocedures for internal fiscal controls and safeguarding assets and revenues,reliable record keeping and periodic reports to be filed with Nevada GamingAuthorities);

 

•                                          Preventing cheating and fraudulent practices;and

 

•                                          Providing and monitoring sources of state andlocal revenue based on taxation and licensing fees.

 

Any changes in these laws,regulations and procedures, depending upon their nature, could have an adverseeffect on our operations.

 

We are not required toregister as a publicly traded corporation with the Nevada Gaming Control Boardbecause we do not fall within the definition of a manufacturer of a gamingdevice.  However, we are currentlyrequired to provide a copy of all periodic reports and other filings we makewith the Securities and Exchange Commission, or the SEC, to the Nevada GamingControl Board.  We do not believe thatwe will be required by the Nevada Gaming Authorities to register since we donot presently manufacture or sell “gaming devices” as defined by the NevadaGaming Control Act.  Further, eventhough applications for the approval of associated equipment are subject to aless comprehensive approval process, the Nevada Gaming Control Board mayinvestigate any individual who has a material relationship to, or materialinvolvement with, us in order to determine whether such individual is suitableor should be licensed as a business associate of ours.  Our officers, directors and certain keyemployees may be required to be licensed or found suitable by the Nevada GamingAuthorities.  The Nevada GamingAuthorities may deny an application for licensing for any cause that they deemreasonable.  A finding of suitability iscomparable to licensing.  Both requiresubmission of detailed personal and financial information, which is followed bya thorough investigation.  The applicantfor licensing or a finding of suitability must pay all costs of theinvestigation.

 

In the event that the NevadaGaming Authorities were to find an officer, director or key employee unsuitablefor licensing or unsuitable to continue having a relationship with us, we wouldhave to sever

 

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allrelationships with that individual.  Inaddition, the Nevada Gaming Commission may require us to terminate theemployment of any person who refuses to file appropriate applications.  Determinations of suitability or ofquestions pertaining to licensing are not subject to judicial review in Nevada.

 

In the event that we arefound to have violated the Nevada Gaming Control Act, the licenses and/orapprovals we hold could be limited, conditioned, suspended or revoked.  In addition, we and the persons involvedcould be required to pay substantial fines, at the discretion of the NevadaGaming Control Board, for each separate violation of the Nevada Gaming ControlAct.  The limitation, conditioning orsuspension of any license or approval held by us could (and revocation of anylicense or approval would) materially adversely affect our operations.

 

Any beneficial holder of ourvoting securities, regardless of the number of shares owned, may be required tofile an application, be investigated, and have the holder’s suitability as abeneficial holder of our voting securities determined if the Nevada GamingControl Board finds reason to believe that such ownership would otherwise beinconsistent with the declared policies of the State of Nevada.  The applicant must pay all costs ofinvestigation incurred by the Nevada Gaming Authorities in conducting any suchinvestigation.  Any person who fails orrefuses to apply for a finding of suitability or a license within thirty daysafter being ordered to do so by the Nevada Gaming Commission or the Chairman ofthe Nevada Gaming Control Board may be found unsuitable.  The same restrictions apply to a recordowner if the record owner, after request, fails to identify the beneficialowner.  In the event that an individualis found to be unsuitable, that individual would be required to transfer orotherwise dispose of all of our stock on such terms as may be required by theapplicable Nevada Gaming Authority.

 

Although we believe that weare not currently required to be licensed by the Nevada Gaming Authorities,other states in which we conduct operations have similar regulatoryrequirements and statutory schemes with respect to licensing of us and of ourkey individuals.  The manufacture anddistribution of gaming devices and of associated equipment is heavily regulatedwithin the United States, and each jurisdiction in which we conduct businessmay subject us and our key individuals to licensing requirements similar to thoseimposed in Nevada.  Our products requiredifferent levels of review in each jurisdiction in which we do business,depending on how our products are classified by the applicable gamingauthorities in that jurisdiction, and any change in classification of ourproducts by the applicable gaming authorities could cause us to apply foradditional, or initial, licenses of us and of our key individuals in thatjurisdiction.  Any change inclassification of our products by the applicable gaming authorities would havea material effect on our licensing requirements in that jurisdiction and couldhave a material effect on our ability to continue to do business in thatjurisdiction.  In addition, thelimitation, conditioning or suspension of any license, approval, or waiver ofapproval held by us in any of these jurisdictions could (and revocation ordenial of any license, approval or waiver of approval would) materiallyadversely effect our operations and may have a material effect in otherjurisdictions in which we previously have obtained licensing, approval, orwaivers of approval, as the case may be.

 

**Louisiana, Michigan, Washington, Indiana and OtherJurisdictions.**  We currently distribute products inLouisiana, Michigan, Washington, Indiana and other domestic gamingjurisdictions and intend to distribute products in other states andjurisdictions.  Although the regulatoryschemes in these jurisdictions are not identical, their material attributes aresubstantially similar, as described below.

 

The manufacture, sale,distribution and ownership of associated equipment in each jurisdiction aresubject to various provincial, state, county and/or municipal laws, regulationsand ordinances, which are administered by the relevant regulatory agency oragencies in that jurisdiction.  Theselaws, regulations and ordinances primarily concern the responsibility,financial stability and character of gaming equipment manufacturers,distributors and operators, as well as persons financially interested orinvolved in gaming or liquor operations.

 

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We have received a Notice ofAdministrative Charges and Opportunity for an Adjudicative Proceeding from theState of Washington Gambling Commission. The administrative charges arose out of our failure to timely delivercertain detailed financial and other information about certain of our largerdebtholders, (who were all subsequently repaid in December 2003).  As a result of our failure to timely andcompletely reply, the Notice of Administrative Charges asserted violations ofWashington regulatory provisions that could carry penalties including thesuspension or revocation of our Washington license.  We attempted to obtain the requested information from ourdebtholders but were unable to satisfy the agents of the State of WashingtonGambling Commission.  As a result of ourrepaying the debtholders, the State of Washington Gambling Commission issued anamended Notice of Administrative Charges, which reflected technicalmodifications to the lender-related charges and included a charge relating tothe provision of an automatic card shuffler device to an unlicensed dealerschool in Washington.  For moreinformation, see “Item 3.  LegalProceedings.”

 

**Mississippi.**  In many jurisdictions, our key personnelmay be subject to licensing requirements, qualification or suitabilityfindings.  In 1999, we begandistributing our shufflers in Mississippi through a subsidiary of ours that waslicensed at the time.  Subsequently, ourshufflers were distributed by a licensed company owned by one of our employeesin accordance with then-applicable regulatory guidance permitting theutilization of the separate company. After discussions with the Mississippi gaming authorities, we concludedthat the Mississippi gaming authorities preferred that we become licensed forthe distribution of our shuffler products and that the employee-owned companysurrender its license.  We initiallycommenced the licensing application process, but have temporarily asked thatour respective pending applications be withdrawn for two reasons.  First, one of our key employees mustre-submit corrected materials.  Second,our present revenue stream in Mississippi is not sufficient to justifyimmediately incurring the significant costs of application, investigation andlicensure.  We intend to re-submit ourapplications for licensure once the key employee has assembled the correctedmaterials and once potential shuffler revenues in Mississippi rise to a levelthat justifies incurring the application, investigatory and licensingcosts.  We believe that all theforegoing actions will be satisfactorily concluded in due course.  However, pending such licensure, we will notbe able to distribute new shuffler products in Mississippi.  We do not currently anticipate that we willbe restricted from selling the SecureDrop® or Deck CheckerTM product lines inMississippi, although the Mississippi gaming authorities could take a differentposition.  In addition, we are in theprocess of notifying other state gaming regulators of this information.  Other jurisdictions may not have similarinquiries into these facts and circumstances and such proceedings may have amaterial adverse impact on our ability to retain and renew existing licenses orto obtain new licenses in other jurisdictions.

 

**New Jersey. **We are seeking licensure under the New JerseyCasino Control Act, or the New Jersey Act, to be qualified to manufacture andsell gaming-related products to casinos in New Jersey.  As part of such licensure, parent companies,holding companies and certain officers and directors of the companies arerequired to be found qualified by the New Jersey Casino Control Commission, orthe New Jersey Commission.  The sale anddistribution of gaming equipment to casinos in New Jersey is also subject tothe New Jersey Act and the regulations promulgated thereunder by the New JerseyCommission.  The New Jersey Commissionhas broad discretion in promulgating and interpreting regulations under the NewJersey Act.  Amendments and supplementsto the New Jersey Act, if any, may be of a material nature, and accordingly mayadversely affect the ability of a company or its employees to obtain anyrequired licenses, permits and approvals from the New Jersey Commission, or anyrenewals thereof.  The currentregulations govern licensing requirements, standards for qualification, personsrequired to be qualified, disqualification criteria, competition, investigationof supplementary information, duration of licenses, record keeping, causes forsuspension, standards for renewals or revocation of licenses, standards forapproval of gaming related products, equal employment opportunity requirements,fees and exemptions.  An applicant for agaming related casino service industry license is required to establish, byclear and convincing evidence, financial stability, integrity andresponsibility; good character, honesty and integrity; and sufficient businessability and experience to conduct a successful

 

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operation.  This burden rests not only with theapplicant, but also its directors, officers, management and supervisorypersonnel, principal employees and stockholders as well as the adequacy of thefinancial resources of the applicant. New Jersey licenses are granted for a period of two or four yearsdepending on the length of time a company has been licensed, and arerenewable.  The New Jersey Commissionmay impose such conditions upon licensing, as it deems appropriate.  These include the ability of the New JerseyCommission to require the applicant or licensee to report the names of all ofits stockholders as well as the ability to require any stockholders whom theNew Jersey Commission finds not qualified to dispose of the stock, not receive dividends,not exercise any rights conferred by the shares, nor receive any remunerationfrom the licensee for services rendered or otherwise.  Failure of such stockholder to dispose of such stockholder’sstock could result in the loss of the license. Licenses are also subject to suspension, revocation or refusal forsufficient cause, including the violations of any law.  In addition, licensees are also subject tomonetary penalties for violations of the New Jersey Act or the regulations ofthe New Jersey Commission.

 

We have submitted anapplication for licensure in New Jersey. Upon a satisfactory initial background investigation, we may obtaintransactional waiver approval from the New Jersey Commission to engage inspecific transactions with New Jersey casinos pending the outcome of thecomplete investigation of our license application.  The transactional approval process permits us to continue ourbusiness with New Jersey casinos uninterrupted upon the completion of theinvestigation.

 

**Native American Gaming Regulation. **Gamingon Native American lands is extensively regulated under federal law,tribal-state compacts and tribal law. The Indian Gaming Regulatory Act of 1988, or IGRA, provides theframework for federal and state control over all gaming on Native Americanlands.  IGRA regulates the conduct ofgaming on Native American lands and the terms and conditions of contracts withthird parties for management of gaming operations.  IGRA is administered by the Bureau of Indian Affairs and theNational Indian Gaming Commission.

 

IGRA classifies games thatmay be conducted on Native American lands into three categories:

 

•                                          Class I Gaming;

 

•                                          Class II Gaming; and

 

•                                          Class III Gaming.

 

Class I Gaming includessocial games solely for prizes of minimal value, or traditional forms of NativeAmerican gaming engaged in by individuals as part of, or in connection with,tribal ceremonies or celebrations. Class I Gaming on Native American lands is within the exclusive jurisdictionof the Native American tribes and is not subject to the provisions of IGRA.

 

Class II Gaming includesbingo, pull-tabs, lotto, punchboards, tip jars, instant bingo, and other gamessimilar to bingo, if those games are played at the same location where bingo isplayed.  Class II Gaming is permittedon Native American lands if: (i) the state in which the Native Americanlands are located permits such gaming for any purpose by any person,organization or entity; (ii) the gaming is not otherwise specificallyprohibited on Native American lands by federal law; (iii) the gaming isconducted in accordance with a tribal ordinance or resolution which has beenapproved by the National Indian Gaming Commission; (iv) a Native Americantribe has sole proprietary interest in and responsibility for the conduct ofgaming; (v) the primary management officials and key employees aretribally licensed; and (vi) other miscellaneous requirements are met.

 

Class III Gamingincludes all other commercial forms of gaming, such as table games, slots,video casino games and other commercial gaming, such as sports betting andpari-mutuel wagering.

 

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Class IIIGaming is permitted on Native American lands if the conditions applicable toClass II Gaming are met and, in addition, the gaming is conducted inconformance with the terms of a written agreement.

 

IGRA requires states tonegotiate in good faith with Native American tribes that seek to enter into atribal-state compact for the conduct of Class III gaming.  Such tribal-state compact may includeprovisions for the allocation of criminal and civil jurisdiction between thestate and the Native American tribe necessary for the enforcement of such lawsand regulations, taxation by the Native American tribe of such activity inamounts comparable to those amounts assessed by the state for comparableactivities, remedies for breach, standards for the operation of such activityand maintenance of the gaming facility, including licensing, and any othersubjects that are directly related to the operation of gaming activities.  The terms of tribal-state compacts vary fromstate to state.  Tribal-state compactswithin one state tend to be substantially similar to each other.  Tribal-state compacts usually specify thetypes of permitted games, entitle the state to inspect casinos, requirebackground investigations and licensing of casino employees, and may requirethe tribe to pay a portion of the state’s expenses for establishing andmaintaining regulatory agencies.

 

On March 7, 2000,California voters approved California’s tribal gaming initiative known asProposition 1A, and California’s constitution was amended to allow the Governorto compact with tribes for the operation of casinos including the operation oftraditional slot machines.  Since then,the Governor, with legislative approval, has entered into compacts withsignificant number of California tribes. We have approvals for certain California Native American casinos andapplications for additional licenses are pending.

 

Changes in federal, state or tribal laws or ordinancesmay limit or otherwise materially affect the types of gaming that may beconducted on Native American land.  Inaddition, numerous lawsuits nationwide seek to limit or expand Native Americangaming activities, the outcomes and impacts of which cannot be predicted.  In this regard, on March 1, 2004, the UnitedStates Supreme Court declined to consider on appeal recent decisions made bythe Eighth Circuit and the Tenth Circuit of the United States Court of Appeals.  Previously, the Eighth Circuit of the UnitedStates Court of Appeals held that the Federal Johnson Act of 1951, as amendedby the Federal Gambling Devices Act of 1962 (collectively, the “Federal Acts”)do apply to Class II technological aids, although the court also found that thepull tab player stations at issue in that case were not Federal Actsdevices.  In addition, the Tenth Circuitof the United States Court of Appeals held that the Federal Acts did notprohibit the use of technological aids to Class II gaming on Native Americanland.  As a result of the SupremeCourt’s refusal to reconsider the lower court decisions, the sale of Class IItechnological aids to, and the use of such aids by, Native American tribes havebeen upheld as legally permissible.

 

**United States-Federal.**  TheFederal Gambling Devices Act of 1962 makes it unlawful for a person tomanufacture, transport, deliver or receive gaming machines, gaming machine typedevices and components thereof across interstate lines unless that person hasfirst registered with the Attorney General of the Department of Justice of theUnited States.  We register annuallywith the Department of Justice in accordance with the Federal Gambling DevicesAct of 1962.

 

**Applicationof Future or Additional Regulatory Requirements. **In the future, we intend to seek the necessarylicenses, approvals and findings of suitability for us, our products and ourpersonnel in other jurisdictions throughout the United States and the worldwhere significant sales are anticipated. However, there can be no assurance that such licenses, approvals orfindings of suitability will be obtained, and if obtained that they will not berevoked, suspended or conditioned or that we will be able to obtain thenecessary approvals in a timely manner, or at all, for our future products asthey are developed.  If a license,approval or finding of suitability is required by a regulatory authority and wefail to seek or do not receive the necessary license, approval or finding ofsuitability, we may be prohibited from selling our products for use in therespective jurisdiction or may be required to sell our products through otherlicensed entities at a reduced profit.

 

**MARKETING**

 

As the gaming industrybecomes increasingly more competitive, our strategy is to developcost-effective niche products and services that increase the security,productivity and profitability for the global gaming industry.  As part of our strategy, we offer to leaseor sell our products to casinos and other lawful gaming establishments.  In addition, we permit casinos and otherpurchasers to purchase shufflers through installment sales, whereby purchaserspay a fixed monthly payment for a certain number of months.  We believe that our customers enjoy theflexibility of not having to pay the full cost of the product up front, as alarge percentage of our customers who have purchased shufflers have chosen topay for them in installments.

 

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We have a professional sales teamof five full-time employees with extensive gaming industry experience.  In addition, our chief executive officer andsenior vice president—slot development both actively participate in salesefforts.  We believe that the mosteffective sales tactic is to show the potential customer live demonstrations ofour products.  As such, when a member ofour sales team approaches a potential new customer, the sales representativetypically brings one of our mobile showrooms that contains our complete line ofproducts.  Our marketing departmentsupports the sales effort through direct mail advertising and presentations atinternational trade shows.

 

**CUSTOMER SERVICE**

 

In order to maintain and expand the market presence of our products, weare committed to providing a high level of customer service and support.  We have centralized all of our servicefunctions to Las Vegas, Nevada for the purposes of ensuring uniform repair ofour products.  As such, all majortechnical maintenance on our products is conducted by our technicians in LasVegas.  In this regard, we have providedour customers with additional back-up products for use until we can return theserviced products to them.

 

With respect to routine maintenance, we employ three customer servicerepresentatives, three service center managers and one technician (in additionto the nine technicians located in Las Vegas) in various locations in theUnited States.  Our servicerepresentatives regularly visit our customers to ensure our products areoperating satisfactorily.  In the eventthat a customer service representative discovers a problem with one of ourproducts, our representative will alert the customer that the equipment needsto be shipped to Las Vegas for repair. Our service representatives also assist our customers in trainingdealers and other casino employees how to use our products.

 

Our standard warranty period is 90 days for our products.  If a problem arises during the warrantyperiod, we will fix the product at no cost, however, it is the customer’sresponsibility to ship the product to us. Certain components that we use to manufacture our products are acquiredfrom third parties, and may contain a longer warranty period.  For example, the warranty period on allmemory chips is ten years.

 

In addition, as explained more fully below, we maintain a trainingcenter in Las Vegas to provide support and training to our distributors, whoare responsible for servicing their own products.

 

**CUSTOMERS**

 

Our customers are domesticand international casino and gaming operators. From time to time, however, we evaluate the application of our securityproducts in non-gaming contexts.  Infiscal year 2003, Caesars Entertainment, Inc. (formerly Park PlaceEntertainment Corporation), our largest customer, accounted for more than 10%of our revenues.  As of and during thetwelve months ended December 31, 2003, approximately 17.6% of tradereceivables and 13.3% of total sales were concentrated in the Nevada gamingindustry among five customers under the common ownership of CaesarsEntertainment, Inc.  Our futureoperations could be affected by adverse changes in the financial condition of,or our relationships with, the commonly owned Nevada gaming customers, oreconomic, competitive and political conditions in our customers’ respectivelocal areas or the gaming industry, in general.

 

**DISTRIBUTION**

 

We sell and lease ourproducts directly to gaming operators and indirectly through distributors.  In general, except as described below, wedepend on distributors to sell our products internationally and on our salesteam to sell our products domestically. Our distributors receive compensation because we sell them our productsat a set price that is lower than our direct sale price, and the distributorsin turn add

 

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areasonable mark up to our products.  Infiscal year 2003, our direct sales accounted for 85% of our revenue anddistributor-based sales accounted for 15%.

 

We use distributors to gainexposure of our products in certain geographic areas where we believedistributors with a local presence would be more effective than our own salesforce.  Management believes thatutilizing distributors to sell our products internationally has two mainadvantages:

 

•                                          Distributors have the authority to operate inthe respective market and are able to address and resolve regulatory complianceissues that may arise in a timely manner; and

 

•                                          Distributors have the internal infrastructureand superior contacts necessary to effectively sell our products in certainmarkets.

 

Accordingly,we have entered into various international exclusive and semi-exclusivedistributorship agreements with respect to our shufflers and the SecureDrop®System with companies in Uruguay, certain Canadian provinces, Australia and NewZealand.  In addition, we have enteredinto an exclusive five-year agreement with TCS Aces for the worldwidedistribution of the Deck CheckerTM, excluding North America and the CaribbeanIslands.  With respect to distributionof our SecureDrop® System in Asia, we have entered into an oralsub-distributorship agreement with the RGB Group.  With respect to distribution of our shufflers in Asia, we haveentered into three oral non-exclusive distributor agreements and in the futuremay explore having our sales team pursue selling shufflers directly in theAsian market.

 

We have also entered intoexclusive and non-exclusive relationships with certain domestic distributorswith respect to the distribution of the SecureDrop® System in Arizona,Colorado, New Mexico and Texas, the distribution of the Random EjectionShufflerTM in Wisconsin and Minnesota, the distribution of the SecureDrop®System in Wisconsin and to all Native American casinos in Michigan, and thedistribution of the Deck CheckerÔ and SecureDrop® in Missouri.

 

Because it is important to usthat our distributors provide excellent customer service, we require ourdistributors to participate in an extensive training program to ensure thatthey possess the skills necessary to repair and maintain all of ourproducts.  In this regard, distributorsperform the same tasks as our customer service representatives, and in mostcases are also responsible for major repairs of our products placed overseas.  As our business grows, we anticipateemploying an international support specialist to act as a customer servicerepresentative for our overseas customers.

 

**COMPETITION**

 

The gaming industry is extremely competitive.  Although we have assembled an experienced marketing team, whichuses its knowledge of the gaming industry to tailor our products and servicesto the needs of the gaming industry, we compete with many establishedcompanies, which possess resources substantially greater than ours.  Generally, we compete with other companiesthat are substantially larger, have more substantial histories, backgrounds,experience and records of successful operations; greater financial, technical,marketing and other resources; more employees and more extensive facilitiesthan we now have, or will have in the foreseeable future.  Even though our overall strategy is tocompete on the basis of quality and price, the competitive pressures of thegaming industry will require us to invest in additional research anddevelopment.  The constant need toupdate and innovate may result in increased costs for and reduced margins onour products and services.

 

**PRODUCT DEVELOPMENT,MANUFACTURING AND ASSEMBLY**

 

At our principal offices, wemaintain a state-of-the-art facility for our product development, service andfinal assembly divisions.  We have 10 full-time employees and onecontract person working in research and development of our shufflers, andenhancements to our SecureDrop® product line. We

 

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have35 full-time and four contractpersonnel in final assembly, installation and service.  We hire contract personnel on a varied basisdepending upon production and installation volume.  In addition, we occasionally engage consultants under certaincircumstances to purchase components for, manufacture or package ourproducts.  To facilitate development andassure quality control, we maintain three dedicated laboratory facilities.  Within these labs, we continue to developadditional features to the SecureDrop® System, conduct real-time testing forour shufflers, and test the Deck CheckerTM. We also prepare quality assurance analyses and internal product trialsat these labs, although the service and refurbishment center for our shufflersis also located on the premises of our principal offices in Las Vegas.

 

**SUPPLIERS**

 

A majority of the components for the SecureDrop® System and ourshuffler line are manufactured in facilities in Xiaolan Town in Zhongshan City,China, which are trucked through China, shipped by boat to Long Beach,California, and then trucked to our manufacturing center in Las Vegas,Nevada.  Despite these transportationcosts, we believe that having the components used to make our productsmanufactured in China is much more cost effective than having the suppliesmanufactured in the United States.  Tofacilitate the delivery of the components to our principal office in Las Vegas,we have set up an office, assembly and warehouse facility and hired a staff inXiaolan Town in China.

 

In addition, certain electronic components used in the production ofthe boards in our SecureDrop® products are manufactured in Costa Rica.  However, we intend to arrange to have thismanufacturing transferred to China in the future.

 

Memory chips, which are used in the bucket of the SecureDrop® System arethe raw materials that are the most difficult to obtain and are the mostsensitive to price fluctuations. Currently, Dallas Semiconductor, a company located in Dallas, Texas,supplies these raw materials to us. Because an interruption in the supply of memory chips could have amaterial adverse effect on our business, we maintain an adequate supply ofchips at our Las Vegas facility to permit us to transition to another supplier.

 

Components for the manufacture of the Deck CheckerÔunits are supplied by various vendors in Xiaolan Town in Zhongshan City, China.

 

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**INTELLECTUAL PROPERTY**

 

We have secured, and endeavorto secure, to the extent possible, exclusive rights in our products, primarilythrough federal and foreign intellectual property rights, such as patents,copyrights and trademarks.  We haveapplied for various other patents with respect to other concepts and products,including potential non-gaming application of our technology.  We believe that our intellectual property iscritical to our future profitability and growth.

 

With respect to the SecureDrop® System, the United States Patent andTrademark Office has issued five patents, Patent Nos. 5,875,879, 6,213,277,6,328,149, 6,336,544 and 6,675,067. These patents expire on dates between March 2017 andSeptember 2021.  In addition, thereis one patent application on file with the United States Patent and TrademarkOffice relating to the SecureDrop® System. On June 26, 2001, we purchased from Technology Development Center,LLC, the worldwide right, title and interest to the patents, pending patentapplications and all patent rights to the “Coin Operated Machine Having AnElectronically Identified Coin Collection Box” and the “Coin Operated MachineIncluding a Coin Box Having a Memory Device.” These intellectual propertyrights relate to the technology utilized in our SecureDrop® product line.

 

With respect to ourshufflers, the United States Patent and Trademark Office has issued fivepatents, Patent Nos. 5,584,483, 5,676,372, 6,019,368, 6,293,546, and6,299,167.  These patents expire ondates between April 2014 and September 2019.  In addition, there are seven patentapplications on file with the United States Patent and Trademark Office.  Our shufflers have also been issued twopatents in Australia and one patent in Canada. For additional information with respect to the ongoing litigationinvolving Shuffle Master, Inc., see “Item 3.  Legal Proceedings.”

 

With respect to the DeckCheckerTM, we acquired the rights to the Deck CheckerTM pursuant to a purchaseand sale agreement dated December 23, 2002 in which we purchased all ofthe tangible and intangible assets related to the Deck CheckerTM.  The purchase price was $1,009,800, where$504,900 was payable upon the successful production of five fully operationalunits of the Deck CheckerTM and $500,000 was payable within six months after thefirst payment is due.  The first payment in the amount of $504,900was made on August 1, 2003 and the final $500,000 payment was made inFebruary 2004.  In addition tothe purchase of these assets, we purchased tooling, inventory and spare partsfor $44,800.  In exchange for thepayments, the seller has agreed to transfer all of the tangible and intangibleassets related to the Deck CheckerTM and not to compete with us for60 months.

 

There can be no assurancethat any of the claims contained in our pending United States or foreign patentor trademark applications will be issued, that any of these rights will not beinfringed by others or that already issued patents or trademark registrationswill not be invalidated or canceled. Third parties could infringe on our rights or successfully duplicate ourproducts without infringing on our legal rights.  Many elements incorporated in our proprietary products are in thepublic domain or otherwise not amenable to legal protection, and the stepstaken by us will not, in and of themselves, preclude competition with ourproprietary products.

 

**EMPLOYEES**

 

As of December 31,2003, we had approximately 80 full-time employees in the United States and 22full-time employees in China, and 4 contract personnel in the UnitedStates.  None of our employees arerepresented by a labor union, and we consider our relationships with ouremployees to be satisfactory.  Allemployees have signed confidentiality agreements, which prohibit them fromdisclosing any of our confidential information at any time during or aftertheir employment with us.

 

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## **ITEM2.**                             DESCRIPTION OFPROPERTY

 

We lease approximately 58,725square feet for our headquarters at 6830 Spencer Street, Las Vegas, Nevada89119, which houses our corporate offices, including sales and engineering departments,and warehouse space.  The current leaserequires payments of approximately $53,000 per month and expires inOctober 2006.  We have an optionfor an additional term of five years.

 

The lease for the Tukwila,Washington service center is for approximately 1,500 square feet, requiresmonthly lease payments of $1,512 and expires in November 2006.  The lease for the Gulfport, Mississippiservice center is for approximately 1,500 square feet, requires monthly leasepayments of $725 and ended in August 2003.  We are continuing to lease the property in Mississippi on amonth-to-month basis under the same terms. The lease for the Berkley, Michigan service center is for approximately1,150 square feet, requires monthly lease payments of $961 and ends in March 2005.

 

We have leased office, manufacturing and warehouse space in XiaolanTown in Zhongshan City, Guangdong Province in China to meet our need forcost-saving manufacturing.  Thefacilities consist of over 7,000 square feet. The monthly lease payments are an aggregate of approximately $1,200 permonth, and the leases end between April and October 2008.  These facilities were opened betweenApril 2003 and January 2004.  Wehave also leased a corporate house and apartment for the use of management thattravel to the China facility.  The leasepayments began in November 2003 at approximately $820 per month and end inNovember 2008.

 

## **ITEM3.**                             LEGAL PROCEEDINGS

 

On March 27, 2002,Shuffle Master, Inc., or Shuffle Master, filed a complaint (CaseNo. CV-S-02-0438-JCM-PAL) against VendingData in the United StatesDistrict Court, District of Nevada.  Theamended complaint alleges, among other things, claims for patent infringementand requests treble damages, an injunction enjoining us from infringing on twoof Shuffle Master’s patents, an accounting of our gains and profits thatresulted from our alleged infringement, and for interest, costs and attorneys’fees.  The Shuffle Master patents thatare at issue in the litigation concern registering use of a playing cardshuffler apparatus and the displaying of the use on a display.  We have filed our answer, counterclaims, andamended counterclaims against Shuffle Master. In our answer, we deny Shuffle Master’s allegation of patentinfringement and request that Shuffle Master’s complaint be dismissed.  We also seek, in our amended counterclaim, adeclaration that we do not infringe Shuffle Master’s patents and that ShuffleMaster’s patents and certain of its related claims are invalid.  We further assert counterclaims againstShuffle Master for breach of contract and violation of the Uniform TradeSecrets Act.  On May 20, 2002, theUnited States District Court, District of Nevada denied Shuffle Master’s motionfor preliminary injunction against us. Discovery in this litigation is now closed.  On May 28, 2003, we filed a motion for summary judgmentrequesting that the court dismiss the case against us.  The hearing for our motion for summaryjudgment was taken off calendar pending a ruling by a magistrate judge with respectto a October 24, 2003 claim construction hearing to determine the scopeand definition of the patent claims at issue. As of the date of this annual report, the magistrate judge had thematter under advisement.

 

Inasmuch as Shuffle Masterhas asserted patent infringement claims and we have reasonable defenses, wecannot predict whether we will prevail in this litigation, nor whether damages,if awarded, would significantly impact our ability to continue to manufactureand sell particular products within the United States and its territories.  Similarly, we cannot predict whether ShuffleMaster will assert other patents it may currently or in the future own, nor canwe predict the likely outcome of any such litigation or whether any suchsubstantial litigation would have a material adverse effect on our business aspresently conducted or as anticipated. See “Item 6.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations—RiskFactors and Forward-Looking Information.”

 

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On July 22, 2003,Shuffle Master, Inc. filed a petition (Case No. 20003-11016) againstVendingData Corporation and Casinovations, Inc., an inactive wholly-ownedsubsidiary of VendingData Corporation, in the Civil District Court for theParish of Orleans, State of Louisiana. The petition alleges that VendingData and/or Casinovations violated theLouisiana Unfair Sales Law by offering to sell or lease the Random EjectionShufflerTM at a price that is below the cost of producing and selling or leasingthe Random Ejection ShufflerTM.  Thepetition further alleges that VendingData and/or Casinovations violated theLouisiana Unfair Trade Practices Act by intending to “dump” Random EjectionShufflersTM into the market with the intent to “steal” customers from ShuffleMaster.  The third claim asserted byShuffle Master is that the actions of VendingData and/or Casinovationsconstitute fraud, theft by conversion, misappropriation, intentionalmisrepresentation and/or general negligence. The petition requests the court to enter a preliminary and permanentinjunction against VendingData and/or Casinovations from selling or leasing theRandom Ejection ShufflerTM and other automatic playing card shufflers toHarrah’s Jazz Casino located in New Orleans, reasonable attorneys’ fees andcosts, and all other relief in law or in equity that the circumstancesmerit.  Based on advice of counsel, webelieve that we have meritorious defenses against all these claims and weintend to vigorously defend against these allegations.  In connection with this matter, we havereceived notice from the Louisiana Department of Justice that Shuffle Masterhas notified the Louisiana Department of Justice of its claims against us forthe purposes of preserving its right to treble damages, if successful.  The Louisiana Department of Justice has notinvestigated this matter and makes no determination as to the merits thereof.

 

On September 8, 2003, wereceived a Notice of Administrative Charges and Opportunity for an AdjudicativeProceeding from the State of Washington Gambling Commission.  The administrative charges arose out of ourfailure to timely deliver certain detailed financial and other informationabout certain of our larger debtholders, (who were all subsequently repaid inDecember 2003).  As a result of ourfailure to timely and completely reply, the Notice of Administrative Chargesasserted violations of Washington regulatory provisions that could carry penaltiesincluding up to the suspension or revocation of our Washington license.  We attempted to obtain the requestedinformation from our debtholders but were unable to satisfy the agents of theState of Washington Gambling Commission. While we have continued to cooperate and make efforts to comply with theinformation requests, we engaged Washington legal counsel to respond to thealleged violations and advise us on procedural and substantive steps we musttake.  The State of Washington GamblingCommission issued an amended Notice of Administrative Charges, which reflectedtechnical modifications to the lender-related charges and included a chargerelating to the provision of an automatic card shuffler device to an unlicenseddealer school in Washington. Nevertheless, we believe that a tentative settlement has been reached,although no formal documents have been executed.

 

On November 22, 1999, Moll Industries, Inc.,or Moll, filed a complaint (Case No. 817296) against VendingData in theSuperior Court of the State of California for the County of Orange,California.  The second amendedcomplaint alleged claims for breach of contract, quantum meruit, an accounting,and declaratory relief, and arises from a dispute between the parties regardingthe manufacture of parts for the Random Ejection ShufflerTM.  We answered Moll’s second amended complaintand filed a cross-complaint for breach of contract and breach of impliedcovenant of good faith and fair dealing. The parties entered into a stipulation as of December 2000, whichrequired us to pay Moll $60,000.  Todate, we have paid $35,000 and once we have completed all payments to Moll,this litigation will be dismissed.  Inlight of VendingData being informed that Moll has filed bankruptcy, paymentspursuant to the stipulation have been suspended.

 

## **ITEM4.**                             SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

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# **PART II**

 

## **ITEM 5.**      MARKET FOR COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

 

Our authorized capital stockconsists of 25,000,000 shares of common stock, $0.001 par value, and 10,000,000shares of preferred stock, $0.001 par value. Our common stock and preferred stock may be issued from time to timewithout action by the stockholders and may be issued for such consideration asmay be fixed from time to time by our board. As of February 29,2004, we had outstanding 17,187,799shares of common stock, held by approximately 349 stockholders of record.  We have not issued any shares of ourpreferred stock.

 

On December 23, 2002, wefiled a Certificate of Change in Number of Authorized Shares of VendingDataCorporation with the Nevada Secretary of State in which we consummated areverse stock split of common stock. The Certificate of Change in Number of Authorized Shares provided for aneffective date of January 3, 2003, for the reverse stock split.  The 1-for-5 reverse stock split affected theoutstanding and authorized shares of our common stock.  As a result of the reverse stock split, ourauthorized capital stock was decreased from 80,000,000 shares of common stock,$0.001 par value, and 10,000,000 shares of blank check-preferred stock, parvalue $0.001, to 16,000,000 shares of common stock, $0.001 par value, and10,000,000 shares of blank-check preferred stock, $0.001 par value,respectively.  Since the reverse stocksplit decreased the outstanding and authorized shares of our common stock on anequal basis, we were not required to obtain stockholder approval of the reversestock split.  Accordingly, effectiveJanuary 3, 2003, our stockholders own one share of common stock for everyfive shares of common stock owned prior to January 3, 2003.

 

Since there were no agreements withanti-dilution provisions that prevented the application of the 1-for-5 reversestock split, the reverse stock split was applied to all outstanding shares ofour common stock and to all shares of our common stock underlying convertibleinstruments, where, in the case of the latter, the exercise or conversion pricewas increased by a factor of five.  Inaddition, as part of the reverse stock split, we distributed to ourstockholders written instructions describing the procedure for the exchange ofthe pre-reverse stock split stock certificates for new stock certificatesreflecting the 1-for-5 reverse stock split.

 

**Market Information**

 

Until September 10, 2003, there was nopublic market for our common stock.  OnMarch 11, 2003, a Form 15c2-11 was filed with the NationalAssociation of Securities Dealers, Inc. by BrockingtonSecurities, Inc., a proposed market maker for our common stock.  After clearing the comments from theNational Association of Securities Dealers, Inc., our common stock becameeligible for quotation on the OTC Bulletin Board on September 10,2003.  The closing bid for our commonstock on the OTC Bulletin Board was $4.00 on March 26, 2004, which reflectinter-dealer prices, without retail mark-up, mark-down or commission and maynot represent an actual transaction.

 

The following table sets forth the high and low closing bid prices ofour common stock, as reported by the OTC Bulletin Board, during the periods indicated. 

 
| **Calendar  Quarter Ended** |   | **Low** |   | **High** |   |
|-----------------------------|--------|---------|--------|----------|--------|
| December 31,  2003          |   | $       | 3.70   |     | $      | 6.20 |   |
| September 30, 2003(1)       |   | $       | 2.25   |     | $      | 4.38 |   |

 

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(1)Represents the high and low closing bid prices for ourcommon stock from September 10, 2003, when our common stock became eligible forquotation on the OTC Bulletin Board, to September 30, 2003.

 

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We have entered into lockupagreements with certain stockholders and directors.  In connection with our public offering in 1998/99, certainstockholders have agreed not to sell or transfer 366,881 shares of common stockuntil such time as the Commissioner of the Department of Corporations of theState of California consents to the sale or transfer of such shares.

 

In connection with our December2003 public offering of up to 5,500,000 shares of common stock, thePennsylvania Securities Commission required our directors, executive officersand beneficial holders of 5% or more of our equity securities to enter into alock-in agreement.  Pursuant to suchagreement, our directors, executive officers and certain stockholders agreednot to sell or transfer 8,552,184 equity securities for a period of four yearsor until such time that we are listed on the New York Stock Exchange, theAmerican Stock Exchange or other national stock exchange as defined inRule 146(b) of the General Regulations under the Securities Act of 1933,or the Nasdaq National Market System. Beginning two years after the completion date of our offering of up to5,500,000 shares of common stock, two and one-half percent of the restrictedequity securities may be released each quarter pro rata among our directors,executive officers and beneficial holders of 5% or more of our equitysecurities.  All remaining restrictedequity securities will be released on the fourth anniversary of the completiondate of our offering of up to 5,500,000 shares of common stock.  Our current intention is to apply forlisting of our common stock on the American Stock Exchange as soon aspracticable.

 

We and certain of our directors and officersalso agreed for a period of 180 days from December 11, 2003, the effectivedate of the registration statement covering our offering of up to 5,500,000shares of common stock, without the prior written consent of PhiladelphiaBrokerage Corporation, not to sell or transfer any shares of our common stock,or any securities convertible into or exchangeable or exercisable for ourcommon stock, not to file any registration statement under the Securities Actof 1933 with respect to the disposition of our common stock or securitiesconvertible into or exchangeable for our common stock, and not to enter intoany swap or any other agreement that transfers the economic consequence ofownership of our common stock or any securities convertible into orexchangeable for common stock.

 

**Common Stock**

 

As of February 29, 2004, there were 17,187,799shares of our common stock outstanding and approximately 349 stockholders ofrecord.  The holders of our common stockare entitled to one vote per share on all matters submitted to a vote of thestockholders.  We do not allowcumulative voting of any kind, and are not required to do so under Nevadalaw.  Subject to preferences that may beapplicable to any then outstanding preferred stock, the holders of our commonstock will be entitled to receive dividends, if any, as may be declared fromtime to time by our board out of legally available funds.  Upon liquidation, dissolution, or winding upof our operations, the holders of our common stock will be entitled to a prorata share of our assets that are legally available for distribution afterpayment of all debts and other liabilities and subject to the prior rights ofany preferred stock then outstanding. The holders of our common stock have no preemptive, subscription,redemption, or conversion rights.

 

**Preferred Stock**

 

We are authorized to issue 10,000,000 sharesof undesignated preferred stock.  Wehave not issued any shares of our undesignated preferred stock and have nopresent plans to issue shares of our undesignated preferred stock.  Without further action by our stockholders,our board is empowered to issue one or more series of undesignated preferredstock with such rights, preferences, restrictions and privileges as may befixed by the board.  The issuance of theundesignated preferred stock could adversely affect the rights, includingvoting rights, of the holders of our common stock and could impede an attemptedtakeover of VendingData Corporation. We, however, have agreed not to offer preferred stock to executiveofficers, directors or beneficial holders of 5% or more of our equitysecurities, or to a person who is an affiliate or associate of an officer,director or beneficial holder of 5% or more of our

 

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equity securities, except on the same terms offered to all otherexisting or new stockholders.  We havefurther agreed that any issuance of preferred stock will be approved by amajority of our independent directors who do not have an interest in thetransactions and who have access, at our expense, to our outside and/orindependent counsel.

 

**Options**

 

We have two stock options plans, the Amended and Restated 1999 StockOption Plan and the Amended and Restated 1999 Directors’ Stock Option Plan,which were originally authorized to issue options to purchase an aggregate of100,000 shares and 20,000 shares, respectively.  Our board approved an increase in the number of shares authorizedfor issuance under the Amended and Restated 1999 Stock Option Plan to 2,000,000shares, which our stockholders approved on May 29, 2003.  In July 2003, our board, subject tostockholder approval, approved an increase in the number of shares authorizedfor issuance under our 1999 Directors’ Stock Option Plan to 300,000.  Pursuant to our stock options plans, as ofDecember 31, 2003, there were options outstanding to purchase 2,107,130shares of our common stock with a weighted average exercise price per share of$3.32 and options remaining to purchase 192,870 shares of our common stock.

 

As of December 31, 2003, we have issued 1,951,930 options topurchase our common stock pursuant to our Amended and Restated 1999 StockOption Plan and 155,200 options pursuant to our Amended and Restated 1999Directors’ Stock Option Plan.  We cannotmake any grants under our stock option plans of options to purchase commonstock at an exercise price of less than 100% of the fair market value of ourcommon stock on the date of grant.  Withthe optionee’s consent, certain options were made subject to the terms andconditions of the Amended and Restated 1999 Stock Option Plan.

 

**Warrants**

 

As of December 31, 2003 we had issued and outstanding warrants topurchase an aggregate of 2,430,000shares of our common stock at exercise prices ranging from $1.75 to $50.00 pershare with a weighted average exercise price per share of $3.13.  The warrants currently outstanding are asfollows:

 

•                                          warrants to purchase 10,000 shares that havean exercise price of $13.00 per share and were issued as part of our privateplacement of convertible debentures in 2000;

 

•                                          warrants to purchase 45,000 shares that wereissued in March 2001 in conjunction with our purchase of certain technology,have an exercise price of $50.00 per share and are exercisable untilMarch 2006;

 

•                                          warrants to purchase 240,000 shares that wereissued in April 2002 through January 2003 in conjunction with our 2002 privateplacement of convertible debentures, have an exercise price of $1.75 per shareand are exercisable until one year after the repayment or conversion of therelevant convertible debenture;

 

•                                          warrants to purchase 150,000 shares that wereissued pursuant to a consulting agreement in December 2002, have an exerciseprice of $2.50 per share and are exercisable until December 2005;

 

•                                          warrants to purchase 900,000 shares that wereissued in December 2002 through May 2003 in conjunction with our privateplacement of 10% senior notes, have an exercise

 

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price of $2.25 per share andare exercisable beginning in December 2004 and until December 2007;

 

•                                          warrants to purchase 375,000 shares that wereissued in June 2003 in conjunction with the placement of our 10% senior notes,have an exercise price of $2.25 per share and are exercisable beginning inDecember 2004 and until December 2007;

 

•                                          warrants to purchase 50,000 shares that wereissued in June 2003 in connection with a bridge financing loan, have anexercise price of $2.25 per share and are exercisable until June 2008;

 

•                                          warrants to purchase 25,000 shares that wereissued in June 2003 in conjunction with the placement of the bridge financing,have an exercise price of $2.25 per share and are exercisable untilJune 2008;

 

•                                          warrants to purchase 225,000 shares that wereissued in July 2003 in connection with a bridge financing loan, have anexercise price of $2.25 per share and are exercisable until July 2008;

 

•                                          warrants to purchase 50,000 shares that wereissued in September 2003 in connection with a bridge financing loan, have anexercise price of $2.25 per share and are exercisable untilJuly 2008;

 

•                                          warrants to purchase 75,000 shares that wereissued in September 2003 in connection with a bridge financing loan, have anexercise price of $2.25 per share and are exercisable untilSeptember 2008;

 

•                                          warrants to purchase 50,000 shares that wereissued in November 2003 in connection with a 30-day extension of a bridgefinancing loan, have an exercise price of $2.25 per share and will beexercisable until November 2008;

 

•                                          warrants to purchase 150,000 shares that wereissued in November 2003 in connection with a 30-day extension of a bridgefinancing loan, have an exercise price of $2.25 per share and will beexercisable until November 2008; and

 

•                                          warrants to purchase 25,000 shares that wereissued as of December 2003 in connection with a financial consulting contract,have an exercise price of $2.25 per share and will be exercisable untilDecember 2005.

 

We have issued demandregistration rights with respect to the following: the shares underlying the9.5% convertible notes due 2004, the shares underlying the 9.5% convertiblenotes due 2002 and the warrants issued in connection with the notes due 2002,and the shares underlying the 9.5% convertible notes due 2003 and the warrantsissued in connection with the notes due 2003. We have issued piggy-back registration rights with respect to thefollowing: warrants issued in connection with a loan in 2001, warrants issuedin conjunction with the extension of a loan in 2002, warrants issued inconjunction with the purchase of certain technology in 2001, warrants issuedpursuant to a consulting agreement in 2002, warrants issued in conjunction withour private placement of 10% senior notes due December 15, 2005, warrantsissued in conjunction with the placement of our 10% senior notes in 2003,warrants issued in June and July 2003 in connection with bridge loanfinancings, and warrants issued in conjunction with the placement of the bridgeloan financings.  We intend to file a registration statement toregister all shares underlying the conversion of notes and the exercise ofwarrants as soon as practicable in order to remedy any outstanding obligationsthat we may owe to these holders of registration rights.

 

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**Convertible Debentures**

 

From February 1999 through November 2000, we issued twoseries of unsecured convertible debentures, one series for an aggregateprincipal amount of $1,500,000 and another series for an aggregate principalamount of $1,800,000.  No convertibledebentures are outstanding.  As notedabove, these convertible debentures were issued with non-detachable warrants,of which warrants to purchase 10,000 shares of common stock at an exerciseprice of $13.00 per share remain.  Weused the proceeds from this private placement for general corporate purposesand working capital.  We relied upon theexemption from registration provided by Section 4(2) of theSecurities Act of 1933 and Rule 506 of Regulation D thereunder.

 

From February 2002 through January 2003, we conducted aprivate placement of 9.5% convertible notes in which we issued notes in theaggregate principal amount of $4,799,995 and warrants to purchase an aggregateof 240,000 shares of our common stock. The warrants were issued at a rate of 2,500 shares per $50,000invested.  The convertible notes plusaccrued interest were converted into shares of our common stock.  As consideration for the convertible notes,we received $675,000 in cash proceeds and rolled over $4,124,995 in outstandingindebtedness.  We used the cash proceedsfor general corporate purposes and working capital.  We relied upon the exemption from registration provided bySection 4(2) of the Securities Act of 1933 and did not use a broker-dealer.

 

On November 19, 2003, we received irrevocable elections fromholders of convertible notes and debentures, including holders controlled byJames E. Crabbe, our chairman of the board, Ronald O. Keil, a director, and BobL. Smith, a director, to convert convertible notes and debentures in theaggregate principal amount of approximately $5,200,000 and accrued and unpaidinterest of approximately $530,000 into shares of our common stock if theminimum number of shares was sold in our offering of up to 5,500,000 shares ofcommon stock.  These holders convertedthe principal and interest on December 12, 2003 into 3,215,871 shares ofcommon stock.  The 9.5% convertiblenotes mentioned above were part of the approximately $5,200,000 of convertibledebt that was converted in December 2003.

 

From December 2002 to May 2003, we conducted a privateplacement of 10% senior notes in the aggregate principal amount of $7,500,000and warrants to purchase 900,000 shares of common stock.  The warrants were issued at a rate of 6,000shares per $50,000 invested.  The 10%senior notes required the payment of accrued interest semi-annually in arrearswith the principal due on December 15, 2005 and, at any time afterDecember 15, 2004, and until June 15, 2005, may have up to 15% of itsthen outstanding principal converted into shares of our common stock at a rateof $2.25 per share for a total of 500,000 shares.  We used the proceeds from this private placement to acquireproperty rights related to the Deck CheckerTM and for general corporate purposesand working capital.  We relied upon theexemption from registration provided by Section 4(2) of the Securities Actof 1933, Rule 506 of Regulation D thereunder and Regulation Sand engaged Philadelphia Brokerage Corporation as the broker-dealer.  In December 2003, $7,110,000 wasretired by cash payments of $6,375,000 and $735,000 was converted into 348,885shares of common stock.  In January2004, the remainder of the $7,500,000 was converted, which amounted to $390,000into 173,333 shares.

 

In June 2003, we secured a 90-day convertible loan from TriageCapital Management LP in the principal amount of $1,000,000 at a 10% interestrate, the principal and all accrued interest of which were due onSeptember 16, 2003.  We also issuedwarrants to Triage Capital Management LP to purchase 50,000 shares of ourcommon stock at a price of $2.25 per share and agreed to issue additionalfive-year warrants to purchase 25,000 shares of our common stock at $2.25 pershare for each 30-day period that the note remained outstanding past September 16,2003.  The term of the note was extendeduntil November 20, 2003 in exchange for our issuance of additionalfive-year warrants to Triage Capital

 

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Management LP topurchase 50,000 shares of our common stock at a price of $2.25 per share.  Under the new terms, Triage CapitalManagement LP could convert up to 15% of its then outstanding principal amountinto shares of our common stock at a rate of $2.25 per share and would beissued additional five-year warrants to purchase 50,000 shares of our commonstock at a price of $2.25 per share for each 30-day period that the noteremained outstanding past November 20, 2003.  Since the loan remained outstanding at November 20, 2003, weissued a five-year warrant to purchase 50,000 shares of our common stock at$2.25 per share, and the note was extended to December 20, 2003.  On December 18, 2003, we repaid the$850,000 outstanding balance, with Triage Capital Management LP electing toconvert 15% of the $1,000,000 note.  Theconversion occurred in January 2004.

 

In July 2003, we borrowed $3,000,000 from Mellon HBV SPV, LLC, anaffiliate of Mellon Bank, at a 10% interest rate, the principal and all accruedinterest of which are due on November 22, 2003.  At any time until the due date, the holder could convert up to15% of its then outstanding principal amount into shares of our common stock ata rate of $2.25 per share.  Inconnection with this transaction, we also issued warrants to purchase 225,000shares of our common stock at $2.25 per share and agreed to issue additionalwarrants to purchase 50,000 shares of our common stock with an exercise priceof $2.25 per share for each $1,000,000 in principal that remained outstandingafter November 22, 2003.  Since theloan remained outstanding at November 22, 2003, we issued a five-yearwarrant to purchase 150,000 shares of our common stock at $2.25 per share, andthe note was extended to December 22, 2003.  On or around December 19, 2003, we repaid the $2,775,000outstanding balance, with Mellon HBV SPV, LLC electing to convert 7.5% of thenote and interest.  The conversionoccurred in January 2004.

 

In October 2003, we issued a promissory note to Triage OffshoreFund, Ltd. in the principal amount of $1,000,000.  The promissory note matured onJanuary 2, 2004 and required the payment of an interest fee in the amountof $50,000 on the maturity date.  TriageOffshore Fund, Ltd. could elect to waive payment of the interest fee inexchange for shares of our common stock at a rate of $2.25 per share.  For each 30-day period that the promissorynote remained outstanding after January 2, 2004, Triage Offshore Fund,Ltd. was entitled to a warrant to purchase 25,000 shares of common stock withan exercise price of $2.25 per share. This note was paid on December 18, 2003.

 

On November 5, 2003, we issued a promissory note toLC Capital Master Fund, Ltd. in the principal amount of$1,000,000.  The promissory note maturedon January 12, 2004 and required the payment of an interest fee in theamount of $50,000 on the maturity date. LC Capital Master Fund, Ltd. could elect to waive payment of theinterest fee in exchange for shares of our common stock at a rate of $2.25 pershare.  For each 30-day period that thepromissory note remained outstanding after January 12, 2004, LC CapitalMaster Fund, Ltd. was entitled to a warrant to purchase 25,000 shares of commonstock with an exercise price of $2.25 per share.  This note was paid on December 19, 2003.

 

We agreed to issue a promissory note convertible into 177,777 shares ofcommon stock, where the convertible note was issued upon the surrender of twopromissory notes in the aggregate amount of $400,000 note held by a charitablefoundation for which our Chairman of the Board is one of three trustees.  This conversion took place on December 12,2003.

 

**Stock Appreciation Rights**

 

In December 1999, we granted to each employee who was employed byus at that time a stock appreciation right to receive an amount of cash basedupon the appreciation in value of 100 shares of our common stock with anexercise price of $13.00, which became exercisable in December 2000.  The stock appreciation rights terminate uponthe earlier of 180 days after the employee’s death, three years after theemployee’s retirement, or the termination of the employee’s employment withus.  As of December 31, 2003, no stockappreciation rights had been exercised.

 

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**Dividend Policy**

 

We have never declared or paid cash dividends on our common stock.  We presently intend to retain earnings tofinance the operation and expansion of our business and do not anticipatedeclaring cash dividends in the foreseeable future.

 

**EquityCompensation Plan Information**

 

With respect toour equity compensation plans, we have adopted the Amended and Restated 1999Stock Option Plan and the Amended and Restated 1999 Directors’ Stock OptionPlan, which are authorized to issue 2,000,000 shares and 300,000 shares of ourcommon stock, respectively.

 

The followingtable summarizes our equity plan compensation that has been approved bystockholders and has not been approved by stockholders as of December 31, 2003.

 
| **Plan  category**                                      |   | **Number of  securities to be  issued upon exercise  of outstanding  options, warrants  and rights** |   | **Weighted  average exercise  price of  outstanding  options, warrants  and rights** |   | **Number of  securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** |    |
|---------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
|                                                    |   | **(a)**                                                                                              |   | **(b)**                                                                              |   | **(c)**                                                                                                                                               |    |
| Equity  compensation plans approved by stockholders(1)  |   | 2,107,130                                                                                            | (2)    | $                                                                                    | 3.32   |                                                                                                                                                  | 192,870 | (3) |
|                                                    |   |                                                                                                 |   |                                                                                 |   |                                                                                                                                                  |    |
| Equity  compensation plans not approved by stockholders |   | —                                                                                               |   | —                                                                               |   | —                                                                                                                                                |    |
| Total                                                   |   | 2,107,130                                                                                            |   | $                                                                                    | 3.32   |                                                                                                                                                  | 192,870 |   |

 

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(1)   Although stockholders have approved our Amendedand Restated 1999 Directors’ Stock Option Plan, an increase in the number ofshares authorized for issuance under the plan to 300,000 is subject tostockholder approval.

 

(2)   Reflects outstanding stock options topurchase 1,951,930 shares of common stock under our Amended and Restated 1999Stock Option Plan and stock options to purchase 155,200 shares of common stockunder our Amended and Restated 1999 Directors’ Stock Option Plan.

 

(3)   There were 48,070 shares available for futureissuance under our Amended and Restated 1999 Stock Option Plan and 144,800shares available for future issuance under our Amended and Restated 1999Directors’ Stock Option Plan.

 

## **ITEM6.**       MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

**Statement on Forward-Looking Information**

 

Certain information included herein contains statements that may beconsidered forward-looking statements within the meaning of Section 27A of theSecurities Act and Section 21E of the Exchange Act, such as statementsrelating to plans for product development, product placement, capital spendingand financing sources.  Suchforward-looking information involves important risks and uncertainties thatcould significantly affect anticipated results in the future and, accordingly,such results may differ from those expressed in any forward-looking statementsmade herein.  These risks anduncertainties include, but are not limited to, those relating to our liquidityrequirements, our ability to locate necessary sources of capital to sustain ouroperations, the continued growth of the gaming industry, the success of ourproduct development activities, the acceptance of our products in themarketplace, vigorous competition in the gaming industry, our dependence onexisting management, changes in gaming laws and regulations (including actionsaffecting licensing), our leverage and debt service (including sensitivity tofluctuations in interest rates) and domestic or global economic conditions.

 

**Overview**

 

Our strategy is to develop cost-effective niche products for the globalgaming industry.  We focus on productsthat increase the security, productivity and profitability of casinooperations.  Our strategy involvesmarketing certain of our products for sale or lease, depending on the product,the geographic location of the customer and other factors.  We rely on our internal sales staff anddistributor relationships for the sale and rental of our products.  Although we anticipate significant salesdevelopment and revenue growth, there is no assurance that we will generatesufficient revenue, cash flow or profit to sustain our operations.

 

**CRITICAL ACCOUNTING POLICIESAND ESTIMATES**

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires our management to make estimates andassumptions that affect reported amounts and disclosures, some of which mayrequire revision in future periods. Actual results could differ from these estimates.  The following is a summary of what our managementbelieves are the critical accounting

 

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policies relatedto our operations.  The application ofthese policies, in some cases, requires our management to make subjectivejudgments and estimates regarding the effect of matters that are inherentlyuncertain.  See Note 1,“Description of Business and Significant Accounting Policies,” to the notes tofinancial statements included in this annual report for a more detaileddiscussion of our accounting policies.

 

***Allowance for Doubtful Accounts.***

 

In connection with the preparation of our financial statements,management reviews and evaluates the collectibility of our trade receivablesand adjusts our allowance for estimated uncollectible accounts as deemednecessary in the circumstances.  Theseestimates have the potential for critically affecting the determination ofresults of operations for any given period. Factors considered by management in making such estimates andadjustments include any concentrations among customers, changes in ourrelationships therewith, payment history and the apparent financial conditionthereof.

 

***Revenue Recognition.***

 

We recognize revenue from the sale of our products upon installationand functional testing at customer locations because that is when thecustomer’s obligation becomes fixed and certain pursuant to our standardcontracts for the sale of units of the SecureDrop® System, shufflers and DeckCheckersTM.  Sales are recognized immediatelywhen shufflers that are rented are converted to purchases depending on thecreditworthiness and payment history of the casino company since payment termsare from 20 to 48 months.  The extendedwarranty and maintenance components that are part of long term sales contractsare unbundled and recognized as deferred revenue amortized over the remaininglife of the sales agreement after the initial 90-day warranty as required bythe *EmergingIssues Task Force Issue No. 00-21, Revenue Arrangements with MultipleDeliverables*.  The usefullife of our shufflers and Deck CheckersTM is five years with proper maintenance;the life can be extended with the replacement of component parts.  If the customer does not possess therequired creditworthiness or an established payment history with us, we wouldthen book the revenue as an installment sale and recognize it over time aspayments are received.  Revenue fromshuffler rentals is recorded at the first of each month in accordance withrental contract terms.  All rentalcontracts are cancelable upon 30-day written notice by the customer.  Maintenance expense for rental units isrecorded in the period it is incurred. Although sales are not generally made with a right to return, uponoccasion, usually associated with the performance warranty, sales returns andallowances are recorded after returned goods are received and inspected.  We provide currently for estimated warrantyrepair costs associated with sales contracts. Although there are no extended warranties offered for our products, wedo provide for maintenance contracts that are billed and recognized on amonthly basis.

 

***Intangible Assets.***

 

FAS 142 requires that intangible assets with definitelives be amortized over their estimated useful lives and reviewed forimpairment when events or changes in circumstances indicate that the carryingamount of such assets may not be recoverable. We have acquired patent rights for various products since 2001 andacquired the patent rights for the Deck CheckerTM for $1,004,900 in the thirdquarter of 2003.  We have estimated aneconomic useful life of 10 years for the Deck CheckerTM patents.  We currently amortize our intangible assetson a straight-line basis over the estimated useful lives of 10 years.

 

***Warranties.***

 

In November 2002, the Financial Accounting Standards Board issuedInterpretation No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of*

 

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*Indebtednessof Others*.  Among other things, Interpretation No. 45 supplementsthe requirements of Statement of Financial Accounting StandardsNo. 5, *Accounting for Contingencies*,relating disclosure with respect to product warranties. As part of the normal sale of our products, we have provided ourcustomers with product warranties.

 

***Stock-Based Compensation.***

 

We currently have two stock option plans.  No stock-based employeecompensation expense for stock options was reflected in net income for yearsprior to 2003, as all stock options granted under those plans had an exerciseprice equal to the fair market value of the underlying common stock on the dateof grant.  The impact of the adoption ofthe fair value method of accounting for stock-based compensation was anincrease to stock-based compensation expense of approximately $101,420 for thetwelve-month period ended December 31, 2003. This stock compensation expense was recorded in general andadministrative expenses.

 

**FINANCIAL CONDITION**

 

During the twelve months ended December 31, 2003, total assetsincreased by $16,093,432, from $8,066,746 at December 31, 2002 to$24,160,178 at December 31, 2003. Accounts receivable (trade) increased from $106,791 to $2,354,054between December 31, 2002 and December 31, 2003.  The primaryreasons for the increase in trade receivables were the installation of the SecureDrop® System at Paris Las Vegas andBally’s Las Vegas, the conversion of shuffler rentals to purchases andthe sale of Deck CheckersTM on terms. Inventories have increased during the current period by $2,300,363 from$1,850,051 at December 31, 2002 to $4,150,414 at December 31, 2003.  The increase is primarily due to thepurchase of 200 Deck CheckersTM and related components and SecureDrop®components.

 

Total liabilities have decreased from $18,109,398 at December 31,2002 to $9,914,953 at December 31, 2003. Accounts payable increased from $1,084,637 at December 31, 2002 to$1,727,460 at December 31, 2003 primarily due to costs associated with ourDecember 2003 offering of up to 5,500,000 shares of common stock, the purchaseof the intellectual property for the Deck CheckerTM and the components for 100Deck CheckerTM units.  Convertible debtdecreased from $8,853,072 at December 31, 2002 to $2,368,077 at December 31,2003 due to the retirement of long- and short-term convertible debt throughcash payments and conversion to common stock. Short-term debt decreased from $904,743 at December 31, 2002 to$270,743 at December 31, 2003 due to the conversion of a short-term note to commonstock and the payment of $24,000.

 

On November 19, 2003, James E. Crabbe, ourchairman of the board, Ronald O. Keil, a director, Bob L. Smith, adirector, and another stockholder notified us that they each irrevocablyelected to convert convertible notes and debentures in the aggregate principalamount and accrued and unpaid interest of approximately $5,730,000 beneficiallyowned by them into shares of our common stock if the minimum number of shareswas sold in our offering of up to 5,500,000 shares of common stock.  In December 2003, the principal and interestunder the convertible notes and debentures was converted into 3,215,871 sharesof common stock.

 

**Results of Operations - Years Ended December 31, 2003and 2002**

 

***Revenue***

 

For the year ended December 31, 2003, we generated total revenues of $6,710,919,compared to $3,480,299 for the year ended December 31, 2002, an increase of$3,230,620, or 92.8%.  Our revenues forthe year ended December 31, 2003 consisted of SecureDropTM sales of $2,221,962,shuffler rentals of

 

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$1,023,544, shuffler sales of $2,079,420, Deck Checker TM sales of$1,365,865 and miscellaneous other revenues of $20,128.  The increase in revenue was primarily due toan increase in SecureDropTM sales of $517,193, an increase in shuffler sales of$1,720,480 and an addition of Deck Checker TM sales of $1,365,865.

 

**Revenues– SecureDropTM Sales. **For the year ended December 31, 2003, wegenerated revenue related to the sale of our SecureDropTM products of$2,221,962, compared to $1,704,769 for the year ended December 31, 2002, anincrease of $517,193, or 30.3%.  Theintroduction and sale of the SecureDropTMSoft Count Module****in****2002 has attributed to the increase inrevenue.  The majority of the revenuewas generated by the installations at six casino properties owned by CaesarsEntertainment, Inc. (formerly Park Place Entertainment) in Nevada.  Management believes that sales growth willcontinue if the product is accepted by additional casino companies.

 

**Revenues– Shuffler Sales. **For the year ended December 31, 2003, wegenerated revenue related to the sale of our shufflers of $2,079,420, comparedto $358,940 for the year ended December 31, 2002, an increase of $1,720,480, or479.3%.  The majority of these saleswere from the conversion of shufflers on rent to purchases through long-termsales agreements that range from 24-48 months. We made a strategic decision to offer our customers the choice to eithercontinue renting or instead to purchase our shufflers for the same monthlypayments.  This decision was based oncompetitive forces in the marketplace and the anticipated introduction of ournext generation shufflers in 2004.  Byoffering some of our customers the ability to trade up to our new shuffler, theRandomPlusÔ Shuffler, when approved by the relevantregulatory bodies, we will be able to obtain binding purchase commitments forour shufflers and ensure that our products are not readily replaced with thoseof our competitors.  We believe that conversionswill not contribute to shuffler sales in the future to the same extentconversions did in 2003.  Theintroduction of the new RandomPlusÔ Shuffler in the second half of 2004 willprovide a needed addition to our product line.

 

**Revenue– Shuffler Rentals.**  For the year ended December 31, 2003, wegenerated revenue related to the rental of our shufflers of $1,023,544,compared to $1,399,968****for the year ended December 31, 2002, adecrease of $376,424, or 26.9%.  Theconversion of rental units to purchases reduced the number of shufflers thatwere rented throughout the year.  Thenew RandomPlusÔ Shuffler that we anticipate introducingin the second half of 2004 will reverse the trend and increase the number ofunits that are rented.

 

**Revenue– Deck Checker**Ô**.** For the year ended December 31, 2003, wegenerated revenue related to the sale of our Deck CheckerÔ of$1,365,865.  As the Deck CheckerÔ was introducedin the second quarter of 2003, we expect Deck CheckerÔ sales willcontinue to grow as the number of jurisdictions that we can sell the productincreases and with the anticipated acceptance of the product in the casinoindustry.

 

**Revenue– Other Income. **For the year ended December 31, 2003, wegenerated other revenues of $20,128, compared to income of $16,622 for the yearended December 31, 2002, an increase of $3,506.

 

***Cost of Sales***

*** ***

For the year ended December 31, 2003, our cost of sales was $4,171,687,compared to $2,541,130 for the year ended December 31, 2002, an increase of$1,630,557, or 64.2%.  Our cost of salesfor the year ended December 31, 2003 included cost of SecureDropTM sales of$1,089,732, cost of shuffler sales of $412,780, shuffler rental depreciation of$550,165, shuffler service costs of $932,978, manufacturing costs of $635,464,Deck CheckerÔ costs of $390,935, warranty costs of$6,003 and other expenses of $153,630. As we transition from a development to an operating company, we arereducing the cost of sales through more efficient purchasing and manufacturing.  The outsourcing of components

 

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from Chinacontinued the trend of reducing cost of sales through the second and thirdquarters of 2003.  The gross margin onrevenue for the year ended December 31, 2003 was $2,539,232, or 37.8%, comparedto the gross margin on revenue for the year ended December 31, 2002 of$939,169, or 27.0%.  The increase ingross margin of $1,600,063 from the year ended December 31, 2002 to the yearended December 31, 2003 reflected increased revenue, increased proficiencies inthe production and the installation of our products.

 

**Cost of Sales – SecureDropTM Sales.** Our cost of SecureDropTM****sales revenue was $1,089,732 forthe year ended December 31, 2003 compared to $1,127,160 for the year endedDecember 31, 2002, representing an decrease of $37,428, or 3.3%.  The gross margin percentage on revenue from SecureDropTMsales revenue was 51.0% in the year ended December 31, 2003compared to 33.9% for the year ended December 31, 2002.  The increase in gross margin percentage on SecureDropTM sales revenue resultedprimarily from improved efficiencies in the installation of the systems and theintroduction of component parts manufactured in China.  The introduction of components built at ourChina facility will improve the margins in the future.

 

**Cost of Sales – Shuffler Sales.** Our cost of shuffler****sales revenue was $412,780 for theyear ended December 31, 2003 compared to $51,292 for the year ended December31, 2002, representing an increase of $361,488, or 704.8%.  The increase in the cost of shuffler****salesrevenue was due to the increased placement of shuffler****units duringthe year ended December 31, 2003.  Thegross margin percentage on revenue from shuffler****sales revenue was 80.1% in the yearended December 31, 2003 compared to 85.7% for the year ended December 31,2002.  The conversion of existing rentalshufflers to purchases that had low book values due to depreciation reduced theproduct cost.

 

**Cost ofSales – Deck Checker**Ô**Sales. **Our cost of Deck CheckerÔsales revenue was $390,935 for the year ended December 31, 2003.  The gross margin percentage on revenue fromDeck CheckerÔ sales revenue was 71.4%.  This was the introductory year for the DeckCheckerÔ product.  We anticipate the move of the manufacture of component parts fromNew Zealand to China will improve the current margins.

 

***General and Administrative Expenses***

 

For the year ended December 31, 2003, our general and administrativeexpenses were $6,307,661, compared to $4,455,241 for the year ended December31, 2002, an increase of $1,852,420, or 41.6%. The increase in general and administrative expenses related primarily toa $584,202 increase in salaries and related costs, a $438,950 increase inconsulting expense, a $336,185 increase in legal and regulatory expenses and a$546,528 increase in finance fees.  Theaddition of new staff in the finance and legal departments is responsible forthe majority of the increase in payroll expense in G&A.  The increases in consulting, finance andlegal fees are related to the private placement of debt and the public offeringof common stock during 2003.  Weanticipate that these costs will not reoccur in 2004.  The increase in legal fees is primarily due to the Shuffle Masterlawsuit.

 

Our general and administrative expenses for the year ended December 31,2003 consisted of the following: salaries and related costs of $2,096,193;consulting services of $467,922; advertising and marketing costs of $64,563;travel and entertainment costs of $643,550; gaming industry show costs of$116,078; rent of $418,210; repairs and maintenance expense of $84,597;supplies of $147,377; legal and regulatory expenses of $822,411; insuranceexpenses of $83,923; depreciation and amortization of $448,717; finance fees of$546,528; and other expenses of $367,592.

 

***Research andDevelopment Expenses***

 

For the year ended December 31, 2003,research and development expenses were $1,010,558, compared to $810,327 for the year ended December 31, 2002, an increase of$200,231, or 24.7%.  The

 

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increase in research and development expenses was primarily due to thecontinued development of a new shuffler, the RandomPlusÔ Shuffler, andSecureDrop® products.  The trend willcontinue as we accelerate the introduction of new products in 2004.

 

***Interest Expense***

 

For the year ended December 31, 2003, we incurred interest expenses of$2,891,733, compared to $1,866,387 for the year ended December 31, 2002, anincrease of $1,025,346, or 54.9%.  This increase was primarily attributable tothe additional debt service as a result of an increase in our outstandingindebtedness during the year ended December 31, 2003.  The retirement and conversion of $20,331,995 in 2003 and early2004 will reduce this expense by approximately $2.0 million dollars if we donot incur additional debt.

 

***Net Loss***

 

For the year ended December 31, 2003, we had a net loss of $7,812,089compared to a net loss of $6,192,786 for the year ended December 31, 2002, anincrease of $1,619,303, or 26.1%.  Theincrease in net loss was primarily due to a $1,852,420 increase in general andadministrative expenses.  Basic loss pershare was $0.96 for the year ended December 31, 2003, compared to $0.81 for theyear ended December 31, 2002.  Theconsulting, finance and legal fees attributable to raising capital in 2003contributed to approximately $900,000 in expenses while the Shuffle Masterlawsuit cost approximately $400,000 in 2003.

 

**Liquidity and Capital Resources**

 

As a result of the public offering and theretirement of debt through cash payments and conversion to common stock in theamount of $17.9 million in 2003, net working capital has increased from anegative $1,716,851 at December 31, 2002 to a positive $10,366,458 atDecember 31, 2003, as shown in the table below:  

 
|                                                                                                        |   | **December  31,** |       |
|-------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|
|                                                                                                        |   | **2003**          |       | **2002** |   |
| **Current Assets**                                                                                          |   |              | ** ** |   | ** ** |
|                                                                                                        |   |              |       |   |   |
| Cash and cash equivalents                                                                                   |   | $                 | 11,526,664 |   | $ | 1,778,297 |   |
| Current portion of accounts receivable, trade, net  of allowance for uncollectibles of $125,530 and $25,530 |   | 2,354,054         |       | 106,791 |   |
| Due from affiliate                                                                                          |   | 31,802            |       | 30,593 |   |
| Other receivables                                                                                           |   | 29,836            |       | 39,305 |   |
| Inventories                                                                                                 |   | 4,150,414         |       | 1,850,051 |   |
| Prepaid expenses                                                                                            |   | 52,028            |       | 236,579 |   |
| Total current assets                                                                                        |   | 18,144,798        |       | 4,041,616 |   |
|                                                                                                        |   |              |       |   |   |
| Current portion of leases payable                                                                           |   | 2,237,073         |       | 2,286,243 |   |
| Accounts payable                                                                                            |   | 1,727,460         |       | 1,084,637 |   |
| Accrued expenses                                                                                            |   | 135,859           |       | 385,570 |   |
| Accrued wages                                                                                               |   | 343,697           |       | 249,147 |   |
| Accrued interest                                                                                            |   | 344,751           |       | 461,308 |   |
| Deferred revenues, current portion                                                                          |   | 171,875           |       | — |   |
| Short-term debt                                                                                             |   | 270,743           |       | 904,743 |   |
| Current portion of convertible debt                                                                         |   | 2,368,077         |       | — |   |
| Customer deposits                                                                                           |   | 178,805           |       | 386,819 |   |
| Total current liabilities                                                                                   |   | 7,778,340         |       | 5,758,467 |   |
|                                                                                                        |   |              |       |   |   |
| Net working capital                                                                                         |   | $                 | 10,366,458 |   | $ | (1,716,851 | ) |

 

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***Sources of Capital***

 

Should our cash on hand plus cash from operations be insufficientduring future periods, we anticipate relying upon private and institutionalsources of debt and equity, and we may seek public, private and institutionalsources of capital for working capital purposes.  During the years ended December 31, 2003 and 2002, our sources ofcapital included a public stock offering, equipment financing from a thirdparty, short-term notes from stockholders, convertible debentures and otherprivate sources of capital.

 

With respect to our equipment financing where we have sold and leasedback most of our furniture, equipment, tooling and shufflers held for rent, wehave received proceeds of $2,988,385 and repaid $2,823,331 for the year endedDecember 31, 2002 and have received proceeds of $989,820 and repaid$2,754,607 for the year ended December 31, 2003.  As of December 31, 2003, we had outstanding equipment financingof $4,153,796.  These equipment leaseshave terms of 36 to 39 months and were not recorded as sales because each ofthe leases included a mandatory buy-back provision.

 

With respect to our short-term debt, we have received proceeds of$2,264,871 and repaid $650,000 for the year ended December 31, 2002 andhave received proceeds of $700,000 and repaid $1,310,000 for the year ended December31, 2003.  As of December 31, 2003, wehad outstanding short-term loans in the aggregate amount of $270,743.  Prior to 2003, we were substantiallydependent on short-term loans from our principal stockholder and otherdirectors.  Despite such reliance,neither our principal stockholder nor our directors are obligated to provideadditional financing to us, and our principal stockholder and directors arefree to decline to fund additional financings to us at any time.  In such event and in the absence of thirdparty financing sources, we may have substantial difficulties in raisingadditional financings.

 

With respect to our convertible debentures, we received proceeds of$4,903,076 and $11,050,000 during the years ended December 31, 2002 and2003, respectively, and have outstanding convertible debentures in theaggregate amount of $2,368,077 as of December 31, 2003.  The recent issuance of convertibledebentures includes the following:

 

•                                          From December 2002 to May 2003, weconducted a private placement of 10% senior notes in the aggregate principalamount of $7,500,000 and warrants to purchase 900,000 shares of commonstock.  The warrants were issued at arate of warrants to purchase 6,000 shares per $50,000 of 10% senior notessold.  The 10% senior notes require thepayment of accrued interest semi-annually in arrears with the principal due onDecember 15, 2005 and, at any time after December 15, 2004, and untilJune 15, 2005, holders of these notes may convert up to 15% of their thenoutstanding principal into shares of our common stock at a rate of $2.25 pershare.  In December 2003 and January2004, we repaid $6,375,000 and issued 522,218 shares of common stock inaccordance with the holders’ conversion rights, thereby satisfying ourobligations in full.

 

•                                          In June 2003, we secured a 90-dayconvertible loan from Triage Capital Management LP in the principal amount of$1,000,000 at a 10% interest rate, the principal and all accrued interest ofwhich were due on September 16, 2003. We also issued warrants to Triage Capital Management LP to purchase50,000 shares of our common stock at a price of $2.25 per share and agreed toissue additional five-year warrants to purchase 25,000 shares of our commonstock at $2.25 per share for each 30-day period that the note remainedoutstanding past September 16, 2003. The term of the note was extended until November 20, 2003 inexchange for our issuance of additional five-year warrants to Triage CapitalManagement LP to purchase 50,000 shares of our common stock at a price of $2.25per share.  Under the new terms, TriageCapital Management LP could convert

 

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up to 15% of its thenoutstanding principal amount into shares of our common stock at a rate of $2.25per share and would be issued additional five-year warrants to purchase 50,000shares of our common stock at a price of $2.25 per share for each 30-day periodthat the note remained outstanding past November 20, 2003.  Since the loan remained outstanding atNovember 20, 2003, we issued a five-year warrant to purchase 50,000 sharesof our common stock at $2.25 per share, and the note was extended toDecember 20, 2003.  On December 18,2003, we repaid the $850,000 to Triage Capital Management LP and issued sharesof common stock pursuant to Triage Capital Management LP’s election to convert15% of the $1,000,000 note, thereby satisfying our obligations in full.

 

•                                          In July 2003, we borrowed $3,000,000 fromMellon HBV SPV, LLC, an affiliate of Mellon Bank, at a 10% interest rate, theprincipal and all accrued interest of which were due on November 22,2003.  At any time until the due date,the holder could convert up to 15% of its then outstanding principal amountinto shares of our common stock at a rate of $2.25 per share.  In connection with this transaction, we alsoissued warrants to purchase 225,000 shares of our common stock at $2.25 pershare and agreed to issue additional warrants to purchase 50,000 shares of ourcommon stock with an exercise price of $2.25 per share for each $1,000,000 inprincipal that remains outstanding after November 22, 2003.  Since the loan remained outstanding atNovember 22, 2003, we issued a five-year warrant to purchase 150,000shares of our common stock at $2.25 per share, and the note was extended toDecember 22, 2003.  On or aboutDecember 19, 2003, we paid the $2,775,000 outstanding balance and issued100,000 shares of common stock pursuant to Mellon HBV SPV, LLC’s election toconvert 7.5% of the note, thereby satisfying our obligations in full.

 

•                                          On October 9, 2003 and October 21, 2003,we received bridge financing from Triage Offshore Fund, Ltd. in the aggregateprincipal amount of $1,000,000.  InOctober 2003, we issued a promissory note in the principal amount of$1,000,000.  The promissory note maturedon January 2, 2004 and required the payment of an interest fee in the amount of$50,000 on the maturity date.  TriageOffshore Fund, Ltd. could elect to waive payment of the interest fee in exchangefor shares of our common stock at a rate of $2.25 per share.  For each 30-day period that the promissorynote remained outstanding after January 2, 2004, Triage Offshore Fund, Ltd. wasentitled to a warrant to purchase 25,000 shares of common stock with anexercise price of $2.25 per share.  Theproceeds from the bridge financing were used for working capital purposes.  We paid the note on December 18, 2003.

 

•                                          On November 5, 2003, we received bridgefinancing from LC Capital Master Fund, Ltd. in the aggregate principal amountof $1,000,000.  The promissory notematured on January 12, 2004 and required the payment of an interest fee inthe amount of $50,000 on the maturity date. LC Capital Master Fund, Ltd. could elect to waive payment of theinterest fee in exchange for shares of our common stock at a rate of $2.25 pershare.  For each 30-day period that thepromissory note remained outstanding after January 12, 2004, LC CapitalMaster Fund, Ltd. was entitled to a warrant to purchase 25,000 shares of commonstock with an exercise price of $2.25 per share.  The proceeds from the bridge financing were used for workingcapital purposes.  We paid the note onDecember 19, 2003.

 

With respect to the public offering of common stock inDecember 2003, we sold 5,500,000 shares at $5.00 per share to raiseapproximately $27,500,000.  The netproceeds after all offering and commission expenses were $24,800,000.

 

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**CashUsed in Operating Activities.**  For the yearended December 31, 2003, net cash used in operating activities was $11,731,150,compared to $5,206,489 for the year ended December 31, 2002.  The cash used in operating activities duringthe year ended December 31, 2003 resulted from a net loss of $7,812,089, anincrease in trade accounts receivable of $3,388,248, an increase in inventoryof $2,300,362, an increase in deposits with vendors of $313,936, a decrease inaccrued expenses of $249,711, a decrease in accrued expense of $116,557, adecrease in customer deposits of $208,014, offset by depreciation andamortization of $1,053,382, amortization of deferred interest of  $350,739, loss on retirement of assets of$141,460, a non-cash cost of sales expense of $115,890, a decrease in prepaidexpenses of $184,551, a decrease in deferred expenses of $5,597, an increase inaccounts payable of $311,573, an increase in accrued wages of $94,550, adecrease in other receivables of $8,260 and an increase in deferred revenues of$391,765.  The increase of $6,524,661 innet cash used in operating activities from the year ended December 31, 2002 tothe year ended December 31, 2003 resulted primarily from the $1,619,303increase in net loss, increase in trade accounts receivable, an increase ininventory, an increase in deferred expenses, an increase in accrued expenses,and a decrease in customer deposits offset, in part, by an increase indepreciation and amortization, a decrease in prepaid expenses, a decrease inother assets, and an increase in accounts payable and an increase in deferredrevenues.

 

**Net Cash Used In InvestingActivities. **For the year ended December 31, 2003, weused net cash in investing activities of $1,567,915 compared to $565,213 forthe year ended December 31, 2002.  Thenet cash used in investing activities during the year ended December 31, 2003consisted of $939,376 used in the acquisition of plant and equipment, $526,167used in the acquisition of intangible assets and $102,372 in deposits.

 

**ContractualCash Obligations. **Our contractual cash obligations underour debt agreements, capital leases and operating leases for the next fiveyears are as follows:

 
| **CONTRACTUAL** |   |      |          | **PAYMENTS  DUE BY PERIOD** |   |
|-----------------|--------|-----------|---------------|-----------------------------|--------|
| **OBLIGATIONS** |   | **TOTAL** |          | **1 YEAR**                  |   | **2-3 YEARS** | ** ** | **4-5 YEARS** | ** ** | **AFTER 5  YEARS** |   |
|            |   |      |          |                        |   |   |   |   |   |   |   |
| Debt Agreements |   | $         | 2,983,570     |                        | $      | 2,983,570 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
|            |   |      |          |                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital Leases  |   | 4,768,269 |          | 2,728,963                   |   | 2,031,309 |   | 7,997 |   | 0 |   |
|            |   |      |          |                        |   |   |   |   |   |   |   |
| Notes Payable   |   | 312,459   |          | 312,459                     |   | 0 |   | 0 |   | 0 |   |
|            |   |      |          |                        |   |   |   |   |   |   |   |
| Operating       |   | 13,953    |          | 13,953                      |   | 0 |   | 0 |   | 0 |   |
|            |   |      |          |                        |   |   |   |   |   |   |   |
| **TOTAL**       |   | **$**     | **8,078,251** | ** **                  | **$**  | **6,038,945** | ** ** | **$** | **2,031,309** | ** ** | **$** | **7,997** | ** ** | **$** | **0** | ** ** |

 

**Outlook**

 

Our ability to maintain adequate liquidity may be dependent upon thesuccess of management’s plans to address and overcome prior operatinglosses.  Management has developed andrefined its 2004 operating plan to increase its sales by expanding its productline and improving its sales efforts domestically and internationally.  Increased sales in the year ended December31, 2003 show increased acceptance of our product line.  Management has adopted efforts to reduceoperating costs through the transfer of manufacturing operations to China andrestructuring service functions to reduce labor and rental expense.   Management has focused on financialcondition and liquidity improvements through its capital raising efforts in2003 along with substantial debt reduction and debt conversion, resulting in animproved cash position and substantially reduced indebtedness at December 31,2003.  As a result of anticipated salesimprovements and operating cost initiatives, management believes that we willbegin to generate positive operating cash flow during the second half of2004.  In addition, our financialadvisors have expressed confidence that additional capital can be raised by us,if necessary, in 2004 and we have received a one-year commitment for a $3.0million lease line of credit.

 

Based on presently known commitments and plans, we believe that we willbe able to fund our operations and required expenditures through the fourthquarter of 2004 through cash on hand, cash flow from operations, and cash fromprivate placements of debt or equity or from lease financing sources.** **Inthe event that such sources are insufficient or unavailable, we will need toseek cash from public or private placements of debt or equity, institutional orother lending sources, sell certain assets or change operating plans toaccommodate such liquidity issues.  Noassurances can be given that we will successfully obtain liquidity sourcesnecessary to fund our operations in the upcoming year.

 

**Risk Factors andForward-Looking Information**

 

*ThisReport contains certain forward-looking statements within the meaning ofSection 27A of the Securities Act and Section 21E of the Exchange Act.  Such statements refer to events that couldoccur in the future and may be identified by the use of words such as “intend,”“plan,” “believe,” correlative*

 

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*words, and other expressions indicating that future eventsare contemplated.  Such statements aresubject to inherent risks and uncertainties, and actual results could differmaterially from those projected in the forward-looking statements as a resultof certain of the risk factors set forth below and elsewhere in this annualreport.  In addition to the otherinformation contained herein, investors should carefully consider the followingrisk factors.*

 

**Risks Related toVendingData**

 

***Givenour recurring losses and accumulated deficits, we must manage our liquidity.***

 

Our financial statements report recurring losses andaccumulated deficits.  Based onpresently known commitments and plans, we believe that we will be able to fundour operations and required expenditures through the fourth quarter of 2004from cash on hand, cash flow from operations and cash from debt or equity financingsor from lease financing sources.  The completion of the offering of 5,500,000 sharesof common stock in December 2003 allowed us to pay off all bridge financing, toconvert approximately $5,730,000 of our convertible debt and accrued interest,to repay our convertible debt, to retire $7,500,000 of our convertible 10%senior notes and still have adequate funds available with which to fundadditional product inventory, and use for general corporate purposes.  If we are unable to generate a sufficient amountof sales of our products to fund our operations, we will need to seek cash fromprivate or public placements of debt or equity, institutional or other lendingsources, to sell certain assets or to change operating plans to accommodate ourliquidity issues.  We may not be able toobtain other liquidity sources as may be necessary to fund our operations inthe future.

 

***Wehave a history of significant operating losses and anticipate continuedoperating losses, and we may be unable to achieve profitability.***

 

We have a history ofsignificant operating losses and anticipate continued operating losses for theforeseeable future.  For the years endedDecember 31, 2003 and 2002, we have incurred net losses of $7,812,089 and$6,192,786, respectively, and our operations have used $11,731,150 and$5,206,489 of cash, respectively.  As ofDecember 31, 2003 and 2002, we had accumulated deficits of $44,582,347 and$36,770,258, respectively.  If we areunable to generate a positive cash flow in 2004, we will be required to locateadditional sources of capital.  If ourrevenues do not increase very substantially, or if our spending levels exceedour expectations, we will not become profitable.  Revenues may not grow in the future, and we may not generatesufficient revenues for profitability. If we become profitable, we may not be able to sustain profitableoperations.

 

***Evenif our operations do not become profitable, we will continue to be obligated topay our management substantial salaries and benefits.***

 

We currently compensate our executive officers and significantemployees with substantial salaries and other benefits and, in the future, maypay increased salaries and benefits.  In2003, we paid an aggregate amount equal to approximately $1,300,000 to ourexecutive officers and significant employees. In June and July 2003, we extended our employment agreements for anadditional five years with Mr. Blad and an additional three years withseven other key employees.  In February2004, we expanded our management team with the hiring of Michael Jahnke asChief Operating Officer.  We intend tocontinue to pay substantial salaries and benefits to Mr. Blad and certainof our other executive officers and employees. The payment of such compensation and benefits may be a burden on us andmay be a factor in limiting or preventing our profitability.  Upon the expiration of those employment

 

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agreements, we mayelect to continue compensating management with similar or higher salaries andother benefits.

 

***Thedemand for our products may be insufficient to generate enough revenues tosustain our operations.***

 

If we fail to generate sufficient demand for our products, we may beunable to sustain operations or generate a return to investors.  Until January 2000, we were in thedevelopment stage and derived minimal revenues from our products.  Currently we are an operating company thatcontinues to develop new products. Since January 2000, our activities have been limited to analyzing andconsulting with persons in the gaming industry, developing and manufacturingnew products, establishing distribution networks for our products, marketingour products to the gaming industry, and commencing product sales.  During such time, we have derived onlylimited revenues, which have been insufficient to sustain our operations.  We may not generate sufficient revenue tosustain our operations.  No independentorganization has conducted market research providing management withindependent assurance from which to estimate potential demand for ourproducts.  The overall market may not bereceptive to our products, and we may not successfully compete in the targetmarket for our products.

 

***The market has not yet demonstrated significant acceptanceof our SecureDrop® System or the Deck Checker******Ô******, andthese products may never receive market acceptance****.*

 

We have not yet demonstrated significantmarket acceptance of our SecureDrop® System or the Deck CheckerTMand may be unable to do so.  Wehave only sold our SecureDrop® Hard Count Module to a small number ofcasinos.  The SecureDrop® System SoftCount Module has been slow to sell outside of Nevada.  Even though we have sold units of the SecureDrop® System tovarious customers in prior periods, newer versions of SecureDrop® products werein beta tests through most of 2002.  Webelieve that certain barriers and problems occurred that caused us to haveproblems breaking into the market, including a longer than expected salescycle, product flaws that we subsequently corrected, and the resistance ofgaming company customers to the implementation of unproven technologies.  We have only placed 59 Deck CheckerTM units (including 16 rentals) as of December 31, 2003.  The commercial success of our SecureDrop®System and Deck CheckerTM willdepend upon the degree of market acceptance of these products in the gamingcommunity and will depend on a number of factors, including:

 

•                  demonstration of effectiveness and reliability;

 

•                  the prevalence and severity of any quality problems ordefects in the early stage of introduction that were not anticipated in thedesign of those products;

 

•                  effectiveness of our marketing and distributioncapabilities;

 

•                  ability to promptly service and repair the products;and

 

•                  receipt of approval by respective gamingjurisdictions.

 

If we fail to expand our sales and leases for our SecureDrop® Systemand our Deck CheckerTM, we may be unable to generate sufficient revenues tocontinue to operate our business.

 

***Ourrevenues and receivables are concentrated among a few major customers, whichmeans that our financial condition could deteriorate if any meaningful reductionin the level of sales to any of these customers occurs.***

 

We are substantially dependent upon sales to a few majorcustomers.  In fiscal year 2003, CaesarsEntertainment, Inc. (formerly Park Place Entertainment Corporation), ourlargest customer, accounted for more than 10% of our revenues.  During the year ended December 31,2003, approximately 17.6% of

 

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trade receivablesand 13.3% of total sales were concentrated in the Nevada gaming industry amongfive customers under the common ownership of Caesars Entertainment, Inc.  Any adverse changes in the financialcondition of our major customers, any loss of our major customers, or anymeaningful reduction in the level of sales to any of these customers could havea materially adverse impact on us.

 

***Theacceptance and expansion of coinless gaming may adversely affect the demand forour SecureDrop® Hard Count Module.***

 

Certain gaming operators have tested and employed as part of theircurrent operations certain gaming devices that have totally eliminated the useof coins or tokens, or use a combination of coins and “cashless” vouchers.  The acceptance and expansion of totallycoinless gaming devices may reduce the demand for the SecureDrop® Hard CountModule, which is based on coin usage, and may adversely affect our operationsin the future.  For example,International Game Technology has introduced the EZ-PayTM system, which attemptsto reduce operating costs and machine downtime by providing gaming operatorswith machines that drop coins for smaller payouts and print tickets for larger,predetermined payouts.  As a result ofthe issuance of tickets, players are not required to wait for attendants inorder to be paid larger payouts and may use their tickets at other machinesequipped with the EZ-PayTM system or similar systems.  Due to positive customer response, the number of slot operationswith online systems that use coinless gaming systems continues to grow.  However, while SecureDrop® Hard Count Modulesales may be adversely impacted, we believe demand for our SecureDrop® SoftCount Module has been enhanced.

 

***Weplace our leased shufflers in casinos under short-term lease arrangements,which makes these products susceptible to replacement due to pressure fromcompetitors, changes in economic conditions, obsolescence and decliningpopularity.***

 

All of our leased shufflers are placed with customers under short-termlease arrangements, which, unlike long-term leases or permanent sales of ourproducts, can easily be terminated by a dissatisfied customer.  The manner in which such short-term leasesare structured puts our shufflers at greater risk of replacement due topressure from competitors, changes in economic conditions, obsolescence anddeclining popularity.  Casino operatorsmay terminate the use of our products, and we may not be able to maintain andexpand the number of installed shufflers through enhancement of existingshufflers, introduction of new shufflers, customer service or otherwise.

 

***Our ability to compete may bedamaged, and our revenues may be reduced if we are unable to protect our intellectualproperty rights adequately.***

 

Our success depends uponmaintaining the confidentiality and proprietary nature of our intellectualproperty rights.  Our ability tocompete may be damaged, and our revenues may be reduced if we are unable toprotect our intellectual property rights adequately.  To protect these rights, we rely principallyon a combination of:

 

•                  contractual arrangementsproviding for non-disclosure and prohibitions on use;

 

•                  patents and pending patentapplications;

 

•                  trade secret, copyright andtrademark laws; and

 

•                  certain built-in technicalproduct features.

 

Patent, trade secret,copyright and trademark laws provide limited protection.  The protections provided by laws governingintellectual property rights do not prevent our competitors from developing,independently, products similar or superior to our products andtechnologies.  In addition, effectiveprotection of copyrights, trade secrets, trademarks, and other proprietaryrights may be unavailable or

 

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limited in certain foreign countries. We may be unaware of certain non-publicly available patent applications,which, if issued as patents, could relate to our services and products ascurrently designed or as we may modify them in the future.  Legal or regulatory proceedings to enforceour patents, trademarks or copyrights could be costly, time consuming, andcould divert the attention of management and technical personnel.

 

***Adverseresults in current litigation could result in substantial monetary damages andimpacts on the manufacture and sale of certain of our shuffler products.***

 

Shuffle Master, Inc., our principal competitor in the shuffler market,has sued us for patent infringement and alleges that our shufflers violate twoof its patents concerning registering use of a playing card shuffler apparatusand the displaying of the use on a display. Shuffle Master seeks treble damages, which, if awarded, could result inus owing them substantial sums of money, which if large enough would have amaterial adverse effect on our liquidity and our ability to conductoperations.  Although we believe ourposition to be meritorious, litigation of this nature is a drain on our cashresources and our management’s time. Inasmuch as Shuffle Master has asserted patent infringement claims andwe have reasonable defenses, we cannot determine whether we will prevail inthis litigation, nor whether damages, if awarded, would significantly impactour ability to continue to manufacture and sell particular products within theUnited States and its territories.  Ifwe do not prevail, we will be unable to sell our shuffler products unless wechange certain components used in the shufflers or obtain a license fromShuffle Master to use the playing card shuffler apparatus and the display.  Similarly, we cannot determine whetherShuffle Master will assert other litigation claims based upon other patents itmay currently or in the future own, nor can we determine the likely outcome ofany such litigation or whether any such substantial litigation would have amaterial adverse effect on our business as presently conducted or asanticipated.

 

***We believe that it is likely thatour PokerOne******TM******Shuffler******will be the subject of future patent litigation if the product is soldand installed in the United States and, if commenced, could subject us tocontinuing litigation costs and risks.***

 

Other than the allegationsmade by Shuffle Master, Inc. discussed above, we are not aware of any claims orbasis for our current products infringing on the proprietary rights of thirdparties.  To the extent that weintroduce new products that incorporate the same or similar technology, it islikely that Shuffle Master, Inc. will bring one or more claims against usseeking damages, injunctive or other equitable relief, or both.  Moreover, we believe that it is reasonablylikely that if we introduce the PokerOneTM Shuffler in the United States,Shuffle Master will bring one or more claims against us seeking various remediesat equity or law.  We cannot predict theoutcome of any future litigation that may occur.

 

***If our future products incorporatetechnology that infringes the proprietary rights of third parties and we do notsecure licenses from them, we could be liable for substantial damages thatwould cause a material reduction in revenues and impair our prospects forachieving growth and profitability.***

 

In furtherance of thedevelopment of our services or products, we may need to acquire licenses forintellectual property to avoid infringement of third party rights or claims ofinfringement.  These licenses may not beavailable on commercially reasonable terms, if at all.  Claims for infringement, if made, coulddamage our business prospects, our results of operations and financialcondition, whether or not the claims have merit, by:

 

•                  consuming substantial timeand financial resources required to defend against them;

 

•                  diverting the attention ofmanagement from growing our business and managing operations;

 

•                  resulting in costlylitigation; and

 

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•                  disrupting product sales andshipments.

 

If any third party prevailsin an action against us for infringement of its proprietary rights, we could berequired to pay damages and either enter into costly licensing arrangements orredesign our products so as to exclude the infringing technology.  As a result, we would incur substantialcosts and delays in product development, sales and shipments, our revenues maydecline substantially and we may not be able to achieve the growth required forus to achieve profitability.

 

***Our failure to compete successfully againstinnovative competitors or new entrants could adversely impact our ability tosell our products and generate revenues.***

 

Our market is characterizedby changing technology, periodic product obsolescence and continuous protectionof proprietary technology.  Our successwill depend upon our ability to sell our current products, and to developsuccessor systems.  We will need tointroduce new products and features in a timely manner to meet evolvingcustomer requirements.  We may notsucceed in these efforts.  Even if wesucceed, products or technologies developed by others may render our productsor technologies noncompetitive or obsolete, which would impair our ability tosell our products and reduce our revenue.

 

***Ourinability to complete the development of our specialty game shuffler couldadversely impact potential revenue growth.***

 

We may not be able to complete development of the PokerOneTMShuffler.  We are continuing to finetune this product, and we plan to start the testing phase in Asia by the end ofthe second quarter of 2004.  We haveexpended significant time and resources into the development of this product,and our failure to bring about a viable product may limit our long-term revenuegrowth in our shuffler product line.

 

***Scrutinyand attempts by third parties to compromise our products’ security, ifsuccessful, could injure product demand and force us to take back impactedproducts.***

 

In the event that our products become susceptible to attacks by thirdparties that result in a decrease or compromise of the security of ourcustomers’ operations, we will most likely be required to take back ourproducts from existing customers and will lose sales and rentals fromprospective customers.  Although we havetested our products for security and our products have been tested by certaingaming regulators as part of the approval process, our products may besusceptible to schemes by third parties to defraud the properties where ourproducts are used.  Vulnerabilities inthe security of our products will almost certainly reduce demand for these products.  Our shufflers may become vulnerable to cardcounters or expert players, and the use of our shufflers may result infinancial losses for our customers.  Theoccurrence of any of these events would likely have a material adverse effecton our sales revenues.

 

***Anyconditions that adversely affect the gaming industry could also have a materialadverse effect on demand for our products.***

 

The success of our business depends solely on the gaming industry whererevenues are sensitive to general economic conditions and generally rise orfall rapidly in relation to the condition of the overall economy.  Although we cannot accurately estimate theeconomic impact of the recent terrorist attacks or current internationalconflicts at this time, the gaming industry has been negatively affected by thereduction in air travel and tourism, and we expect that any significant declinein the economic health or growth of the gaming industry will reduce demand forour products.

 

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***Weare unable to predict the future impact that extraordinary events, such asterrorism, the uncertainty of war and worldwide health concerns, may have onour business and operations.***

 

Extraordinary events, such as terrorist attacks, acts of war orworldwide health concerns, may cause damage or disruption to our operations,which, in turn, could significantly impact our revenues, costs and expenses,and financial condition.  The terroristattacks that took place in the United States on September 11, 2001 wereunprecedented events that have created many economic and politicaluncertainties, especially to the gaming industry, some of which have materiallyadversely affected our business, results of operations, and financial conditionand may do so again in the future.  Inparticular, the gaming industry has been affected by the downturn in thetourist industry as a result of the September 11, 2001 attacks.  Because our business is directly tied to thegaming industry, the long-term effects from the September 11, 2001 attacksare unknown.  The potential for futureterrorist attacks, the national and international responses to terroristattacks, other acts of war or hostility and concerns about the spread ofcertain diseases, including severe acute respiratory syndrome, or SARS, havecreated many economic and political uncertainties, which could materiallyadversely affect our business, results of operations and financial condition inways that we currently cannot predict.

 

***Supplyinterruption from our manufacturing facility in China could cause us to fail tosupply customer orders on a timely basis.***

 

We have centralized most phases of the manufacturing process for ourproducts at our own facility in Xiaolan Town in Zhongshan City, China.  We will be adversely impacted if there is aninterruption in our ability to receive components or inventory from, or amaterial increase in labor costs in, China. Factors that may cause a supply interruption include political unrest,closure of ports, worldwide health concerns, including SARS, and other eventsbeyond our control.  In the event thatour manufacturing operations in Xiaolan Town are interrupted, our ability tofill orders, ship such orders and realize the revenues therefrom could beadversely affected.

 

***Ourefforts to expand into international markets pose special risks that couldadversely affect all of our business.***

 

As a result of the opening of our manufacturing facility in China, weare currently operating in international markets, and we propose to furtherexpand our international sales and operations. Engaging in business outside of the United States will subject us to thecustomary risks of doing business in foreign countries.  These risks include fluctuations in foreigncurrency exchange rates and controls, competitive disadvantages to establishedforeign businesses with significant current market share and business/customerrelationships, nationalization and other economic, tax and regulatory policiesof local governments and the possibility of trade embargoes, politicalinstability or war or other hostility, as well as the laws and policies of theUnited Sates affecting foreign trade and investment.  Any one or more of these factors could materially adverselyaffect our ability to conduct business outside the United States and thereforeour business as whole.

 

***Ourreliance on distributors in international markets and our limited salesexperience in foreign countries could cause us to lose sales and collections onsuch sales.***

 

In general, substantially all sales of our products outside the UnitedStates are achieved through distributor relationships.  We believe the distributors that we haveengaged are experienced and reputable, however, if we are unable to managethese relationships, our ability to generate revenue and profits in the non-U.S.market may be adversely affected.  Tothe extent that we engage in direct sales outside the United States, we havelimited sales experience and history in foreign markets.

 

47

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***Dueto our management’s controlling interest in our common stock, our managementhas the power to control all matters submitted to our stockholders, whichrenders non-management stockholders’ efforts to effect substantial changes inour company more difficult.***

 

Our executive officers and members of our board beneficially ownapproximately 9,598,944 shares of common stock, or approximately 53.0% of theoutstanding shares of our common stock, assuming exercise or conversion of alloptions, warrants and convertible debentures held by our executive officers andmembers of our board that are exercisable within 60 days of February 29,2004.  Accordingly, these stockholdershave the power to control****allmatters requiring approval by our stockholders, including the election ofdirectors and approval of mergers and other significant corporatetransactions.  This concentration ofownership also has the effect of delaying, preventing or expediting, as thecase may be, a change in control of our company.

 

***Theloss of our executive officers, significant employees or certain members of ourmanagement could adversely impact our operations.***

 

Our success is substantially dependent upon the efforts and skills ofSteven J. Blad, our chief executive officer and president, Michael Jahnke,our chief operating officer, and John R. Spina, our chief financialofficer and treasurer.  We have enteredinto employment agreements with Messrs. Blad, Jahnke and Spina and nineother executive officers and significant employees.  However, if we were to lose the services rendered by any of ourexecutive officers or significant employees, key management, productdevelopment and sales functions could be adversely affected.  In addition, we compete with other potentialemployers for employees, and we may not succeed in hiring and retaining theexecutives and other employees that we need. An inability to hire and retain quality employees could have a materialadverse effect on our business, financial condition and results of operations.

 

**RISKS RELATED TO OURINDUSTRY**

 

***Weface intense competition from companies with longer operating histories,greater resources and more established brand names that could use suchadvantages to lower our market share and reduce our revenues.***

 

There is significant competition in the shuffler market, where wecompete with established companies and other entities, most of which possesssubstantially greater resources than we do. Almost all of the companies with which we compete in the shuffler marketare substantially larger, have more substantial histories, backgrounds,experience and records of successful operations, greater financial, technical,marketing and other resources, more employees and more extensive facilitiesthan we now have, or will have in the foreseeable future.  It is also likely that other competitorswill emerge in the near future.  Othercompanies may develop products competitive to our SecureDrop® System.  We may not be able to compete successfully withother established gaming product manufacturers.  Our inability to compete successfully will likely result in lossof market share and lower revenues, or increases in operating costs, such asmarketing costs.

 

***Weface extensive regulation from gaming and other government authorities.***

 

The gaming industry is a highly regulated industry and is subject tonumerous statutes, rules and regulations administered by the gaming commissionsor similar regulatory authorities of each jurisdiction.  Generally, companies that seek to introducegaming products or concepts into such jurisdictions may be required to submitapplications relating to their activities or products (including detailedbackground information concerning controlling persons within theirorganization), which are then reviewed for approval.  In this regard, we may incur significant expenses in seeking toobtain licenses for our gaming products and concepts, and our products may notbe approved in all jurisdictions.  Thefailure to obtain

 

48

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such approval inany jurisdiction in which we may seek to introduce our products or conceptscould have a material adverse effect on our business.  In addition, any change to the applicable statutes, rules andregulations that restricts or prevents our ability to operate could have anadverse effect on us.

 

***Any person who isthe beneficial owner of our common stock or with whom we have a materialrelationship that fails or refuses to apply for a finding of suitability, orthat is found unsuitable for licensing, would be required to dispose of all ofour stock.***

 

Certain gaming regulatory agencies to which we are subject mayinvestigate any beneficial holder of our voting securities (regardless of thenumbers of shares owned), and any individual who has a material relationship orinvolvement with us, in order to determine whether such individual is suitableor should be licensed as a business associate of ours.  In addition, the gaming authorities ofvarious jurisdictions may require our officers, directors and certain keyemployees to be licensed or found suitable by these gaming authorities, whichwould require these officers, directors and key employees to submit detailedbackground information.  Any person whofails or refuses to apply for a finding of suitability or a license after beingordered to do so by gaming regulatory agencies may be found unsuitable and wecould be subject to adverse regulatory action. In the event that the gaming authorities were to find an officer,director, key employee, stockholder, or any other individual that has amaterial relationship with us, unsuitable for licensing or unsuitable tocontinue having a relationship with us, we would have to sever allrelationships with that individual, and that individual would be required todispose of all of our stock.  This couldresult in the loss of key persons critical to our success or in significantselling pressure on our stock if such persons are required to dispose of sharesof our common stock in an amount that exceeds typical trading volumes in ourshares.

 

***Ourfocus on products for the gaming industry subjects us to greater risk than wewould have if we marketed our products to multiple industries.***

 

We design and manufacture products and concepts solely for the gamingindustry and depend almost exclusively on our ability to generate revenues fromthe rental or sale of our products to customers in the gaming industry.  The economic health of the gaming industry,and, therefore, our revenues, are affected by a number of factors beyond ourcontrol, including:

 

•                  general economic conditions,such as recession, inflation, business cycle fluctuations and interest rates;

 

•                  levels of disposable incomeof gaming property patrons;

 

•                  acts of terrorism andanti-terrorism efforts;

 

•                  increased transportationcosts resulting in decreased travel by gaming patrons;

 

•                  changes or proposed changesin tax laws;

 

•                  legal and regulatory issuesaffecting the development, operation and licensing of our gaming customers; and

 

•                  competitive conditions inthe gaming industry.

 

These factors may adversely impact the demand for our products andmaterially affect the revenues that we realize on the sale or placement of ourproducts.

 

49

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**RISKS RELATED TO OUR COMMONSTOCK**

 

***Therehas only recently been a public market for our common stock, so ourstockholders may be unable to dispose of their investment, or may lose thetotal value of their investment.***

 

There had been no trading market for our common stock untilSeptember 10, 2003.  An activetrading and/or a liquid market may not be maintained.  In addition, in the event that we are unable to continue as agoing concern and our company is dissolved or otherwise terminated, you couldlose your investment in our common stock. Investment in our common stock is at risk of complete loss if ouroperations are unsuccessful.

 

***Our common stock is deemed to be“penny stock,” which may make it more difficult for investors to resell theirshares due to suitability requirements.***

 

Historically,our common stock has been deemed to be “penny stock” as that term is defined inRule 3a51-1 promulgated under the Securities Exchange Act of 1934.  Although the closing bid for our commonstock on the OTC Bulletin Board on March 26, 2004 was $4.00, our commonstock has traded above $5.00 per share during the period from December 2003through mid-February 2004.  Penny stockmay be more difficult for investors to resell. Penny stocks are stocks:

 

•                  with a price of less than$5.00 per share;

 

•                  that are not traded on a“recognized” national exchange;

 

•                  whose prices are not quotedon the Nasdaq automated quotation system (Nasdaq-listed stock must still have aprice of not less than $5.00 per share); or

 

•                  from issuers with nettangible assets less than $2.0 million (if the issuer has been in continuousoperation for at least three years) or $5.0 million (if in continuous operationfor less than three years), or with average revenues of less than $6.0 millionfor the last three years.

 

Federal rules and regulations generally impose additional sale practiceand disclosure requirements on broker/dealers who sell or recommend our sharesto certain investors.  These requirements may reduce the potentialmarket for our common stock by reducing the number of potential investors, andany or all of these factors may make it more difficult for investors in ourcommon stock to sell shares to third parties or to otherwise dispose of themand could cause our stock price to decline. Moreover, broker/dealers are required to determine whether an investmentin a penny stock is a suitable investment for a prospective investor andreceive the investor’s written consent to the transaction.  In addition, many institutional investorshave restrictions regarding investments in penny stocks, which further limitsthe liquidity of the market for our shares.

 

***Investorsseeking guaranteed dividend-paying investments should not invest in our commonstock.***

 

Our operations may not become profitable.  If we become profitable, we intend to use any earnings that maybe generated to finance the growth of our business.  Any payment of future dividends will be at the discretion of ourboard of directors and will depend on, among other things, our earnings,financial condition, capital requirements, level of indebtedness, statutory andcontractual restrictions applying to the payment of dividends, and otherconsiderations that our board of directors deems relevant.  Accordingly, stockholders may have to sellsome or all of their common stock in order to generate cash flow from theirinvestment.  Stockholders may notrealize a gain on their investment, and they may lose all or a significantamount of their investment when they sell their common stock.

 

50

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***Ifwe are unable to generate sufficient revenue to provide the cash required tofund our operations in the future, we may be required to issue additionalequity or convertible debt securities to provide our operations with additionalworking capital, which, in turn, will have the effect of diluting the relativeownership of our existing stockholders.***

 

We have supplemented the cash deficit arising from our operations withthe proceeds of our December 2003 offering of 5,500,000 shares of common stockand will, if necessary, continue to supplement with cash from private or publicplacements of debt or equity, institutional or other lending sources.  We have also utilized convertible debtsecurities and warrants to raise capital in the past.  The issuance of additional equity or convertible debt securitieswill have the effect of reducing the percentage ownership of our currentstockholders.  In addition, these equityor convertible debt securities may have additional rights, preferences or privilegesto those of our common stock, such as registration rights and preferences inliquidation.  In the event we arerequired to raise additional funds to support our operations, additional fundsmay not be available on terms favorable to our company, or at all.  If adequate funds are not available or arenot available on acceptable terms, we may not be able to fund our operations orotherwise continue as a going concern.

 

***Shareseligible for sale in the near future may cause the market price for our commonstock to decline.***

 

In addition to the number of shares registered through our December2003 public offering of 5,500,000 shares and the approximately 6,400,000 sharesof common stock that we have agreed to register on behalf of certain sellingstockholders, we have approximately 7,595,200shares of common stock that are either freely tradable pursuant to Rule 144(k)of the Securities Act of 1933 or have previously been registered by us througha registration statement filed with the SEC. As such, the future sale of a substantial number of shares of our commonstock in market transactions, or the perception that these sales could occur,may depress the market price for our common stock.  These sales could also impair our ability to raise additionalcapital through the sale of our equity securities in the future.

 

***Our board ofdirectors may issue blank check preferred stock, which may affect the votingrights of our holders and could deter or delay an attempt to obtain control ofus.***

 

Our board of directors is authorized, without stockholder approval, toissue preferred stock in series and to fix and state the voting rights andpowers, designation, preferences and relative, participating, optional or otherspecial rights of the shares of each such series and the qualifications,limitations and restrictions thereof. Preferred stock may rank prior to our common stock with respect todividends rights, liquidation preferences, or both, and may have full orlimited voting rights.  Accordingly,issuance of shares of preferred stock could adversely affect the voting powerof holders of our common stock and could have the effect of deterring ordelaying an attempt to obtain control of us.

 

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## **ITEM 7.**                             FINANCIAL STATEMENTS

 
|   | Independent  Auditors’ Reports                                                                      |
|--------|----------------------------------------------------------------------------------------------------------|
|   |                                                                                                     |
|   | Balance Sheets at December 31, 2003 and  2002                                                            |
|   |                                                                                                     |
|   | Statements of Operations for  the Years Ended December 31, 2003 and 2002                                 |
|   |                                                                                                     |
|   | Statements  of Changes in Stockholders’ Equity for the Years Ended December 31, 2003  and 2002 |
|   |                                                                                                     |
|   | Statements of Cash Flows for  the Years Ended December 31, 2003 and 2002                                 |
|   |                                                                                                     |
|   | Notes to Financial  Statements                                                                           |

 

52

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**INDEPENDENTAUDITORS' REPORT**

 

Board of Directors and Stockholders

VendingData Corporation

 

We have audited thebalance sheet of VendingData Corporation as of December 31, 2003, and therelated statements of operations, changes in stockholders’ equity, and cashflows for the year then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audit.

 

We conducted our audit inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe that our audit provides areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above, present fairly, in all materialrespects, the financial position of VendingData Corporation as of December 31,2003, and the results of its operations and cash flows for the year then ended,in conformity with accounting principles generally accepted in the UnitedStates of America.

 

 
|              |   /s/ PIERCY  BOWLER TAYLOR & KERN |
|-------------------|--------------------------------------------------|
|              | Piercy Bowler Taylor  & Kern                 |
|              | Certified Public  Accountants                    |
|              |                                             |
| Las Vegas, Nevada |                                             |
| March 25, 2004    |                                             |

 

53

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**REPORT OFINDEPENDENT PUBLIC ACCOUNTANT**

 

Board of Directors and Stockholders

VendingData Corporation

 

I have audited thebalance sheet of VendingData Corporation as of December 31, 2002, and therelated statements of income, changes in stockholders’ equity, and cash flowsfor the year then ended.  Thesefinancial statements are the responsibility of the Company’s management.  My responsibility is to express an opinionon these financial statements based on my audit.

 

I conducted my audit inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require that Iplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  I believe that my audit provides areasonable basis for my opinion.

 

In my opinion, thefinancial statements referred to above, present fairly, in all materialrespects, the financial position of VendingData Corporation as of December 31,2002, and the results of its operations and cash flows for the year then ended,in conformity with generally accepted accounting principles.

 

 
|             |   /s/ JAMES  E. SCHEIFLEY |
|------------------|-------------------------------------|
|             | James E. Scheifley                  |
|             | Certified Public  Accountant        |
|             |                                |
| Dillon, Colorado |                                |
| March 14, 2003   |                                |

 

54

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**VENDINGDATACORPORATION**

 

**Balance Sheets**

**December 31, 2003and 2002**

 
| **ASSETS**                                                                                                  |   | **2003**   |       | **2002**  |   |
|-------------------------------------------------------------------------------------------------------------|--------|------------|------------|-----------|--------|
| Current assets:                                                                                             |   |       |       |      |   |
| Cash and cash  equivalents                                                                                  |   | $          | 11,526,664 |      | $      | 1,778,297 |   |
| Current portion  of accounts receivable, trade net of allowance for uncollectibles of $125,530  and $25,530 |   | 2,354,054  |       | 106,791   |   |
| Due from  affiliate                                                                                         |   | 31,802     |       | 30,593    |   |
| Other  receivables                                                                                          |   | 29,836     |       | 39,305    |   |
| Inventories                                                                                                 |   | 4,150,414  |       | 1,850,051 |   |
| Prepaid expenses                                                                                            |   | 52,028     |       | 236,579   |   |
| Total current assets                                                                                        |   | 18,144,798 |       | 4,041,616 |   |
|                                                                                                        |   |       |       |      |   |
| Equipment rented  to customers, net of accumulated depreciation of $316,245 and $1,406,574                  |   | 608,555    |       | 1,353,925 |   |
| Property and  equipment, at cost, net of accumulated depreciation of $1,859,206 and  $1,422,313             |   | 1,063,951  |       | 593,253   |   |
| Intangible  assets, at cost, net of accumulated amortization of $288,203 and $191,520                       |   | 1,282,088  |       | 352,603   |   |
| Due from  affiliate                                                                                         |   | 118,800    |       | 118,800   |   |
| Accounts  receivable, trade, net of current portion, less unamortized discount                              |   | 1,140,984  |       |      |   |
| Deferred  expenses                                                                                          |   | 250,697    |       | 100,000   |   |
| Deposits                                                                                                    |   | 1,284,827  |       | 868,520   |   |
| Other assets                                                                                                |   | 265,478    |       | 638,029   |   |
|                                                                                                        |   | $          | 24,160,178 |      | $      | 8,066,746 |   |

 

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**VENDINGDATACORPORATION**

 

**Balance Sheets**

**December 31, 2003and 2002**

 
| **LIABILITIES AND STOCKHOLDERS’  EQUITY (DEFICIENCY)**                                                           |   | **2003**    |       | **2002**    |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|
|                                                                                                                  |   |        |       |        |   |
| Current  liabilities:                                                                                                 |   |        |       |        |   |
| Leases payable,  current portion                                                                                      |   | $           | 2,237,073  |        | $      | 2,286,243 |   |
| Accounts payable                                                                                                      |   | 1,727,460   |       | 1,084,637   |   |
| Accrued expenses                                                                                                      |   | 135,859     |       | 385,570     |   |
| Accrued wages                                                                                                         |   | 343,697     |       | 249,147     |   |
| Accrued interest                                                                                                      |   | 344,751     |       | 461,308     |   |
| Deferred  revenues, current portion                                                                                   |   | 171,875     |       |        |   |
| Short-term debt                                                                                                       |   | 270,743     |       | 904,743     |   |
| Convertible  debt, current portion                                                                                    |   | 2,368,077   |       |        |   |
| Customer  deposits                                                                                                    |   | 178,805     |       | 386,819     |   |
| Total current  liabilities                                                                                            |   | 7,778,340   |       | 5,758,467   |   |
|                                                                                                                  |   |        |       |        |   |
| Deferred  revenues, net of current portion                                                                            |   | 219,890     |       |        |   |
| Convertible  debt, net of current portion                                                                             |   |        |       | 8,853,072   |   |
| Leases payable,  net of current portion                                                                               |   | 1,916,723   |       | 3,497,859   |   |
|                                                                                                                  |   | 9,914,953   |       | 18,109,398  |   |
| Stockholders’  equity (deficiency):                                                                              |   |        |       |        |   |
| Preferred stock,  $.001 par value, 10,000,000 shares authorized                                                       |   |        |       |        |   |
| Common stock,  $.001 par value, 25,000,000 shares authorized, 16,765,580 and 7,625,814  shares issued and outstanding |   | 16,766      |       | 7,626       |   |
| Additional  paid-in capital                                                                                           |   | 58,810,806  |       | 26,719,980  |   |
| Deficit                                                                                                               |   | (44,582,347 | )          | (36,770,258 | )      |
|                                                                                                                  |   | 14,245,225  |       | (10,042,652 | )      |
|                                                                                                                  |   | $           | 24,160,178 |        | $      | 8,066,746 |   |

 

**See accompanying notes to financial statements.**

 

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**VENDINGDATACORPORATION**

 

**Statements ofOperations**

**Years EndedDecember 31, 2003 and 2002**

 
|                                 |   | **Year Ended December 31,** |       |
|--------------------------------------|--------|-----------------------------|------------|
|                                 |   | **2003**                    |       | **2002** |   |
|                                 |   |                        |       |   |   |
| Sales                                |   | $                           | 5,667,247  |   | $ | 2,063,709 |   |
| Rental                               |   | 1,023,544                   |       | 1,399,968 |   |
| Other                                |   | 20,128                      |       | 16,622 |   |
|                                 |   | 6,710,919                   |       | 3,480,299 |   |
|                                 |   |                        |       |   |   |
| Cost of sales                        |   | 4,171,687                   |       | 2,541,130 |   |
| General and  administrative          |   | 6,307,661                   |       | 4,455,241 |   |
| Research and  development            |   | 1,010,558                   |       | 810,327 |   |
|                                 |   | 11,489,906                  |       | 7,806,698 |   |
|                                 |   |                        |       |   |   |
| Loss from  operations                |   | (4,778,987                  | )          | (4,326,399 | ) |
|                                 |   |                        |       |   |   |
| Interest  expense, unrelated parties |   | 2,361,991                   |       | 1,477,765 |   |
| Interest  expense, related parties   |   | 529,742                     |       | 388,622 |   |
| Loss on  disposition of assets       |   | 141,369                     |       |   |   |
|                                 |   | 3,033,102                   |       | 1,866,387 |   |
|                                 |   |                        |       |   |   |
| Net loss                             |   | $                           | (7,812,089 | ) | $ | (6,192,786 | ) |
|                                 |   |                        |       |   |   |
| Basic loss per  share                |   | $                           | (0.96      | ) | $ | (0.81 | ) |
|                                 |   |                        |       |   |   |
| Weighted average  shares outstanding |   | 8,134,173                   |       | 7,625,814 |   |

 

**See accompanyingnotes to financial statements.**

 

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**VENDINGDATACORPORATION**

** **

**Statements ofChanges in Stockholders’ Equity**

**Years EndedDecember 31, 2003 and 2002**

 
| **Activity**                        |   | **Common  Shares** |   | **Stock  Amount** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Total**   |        |
|-------------------------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|-------------|-------------|
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Balance, January 1, 2002       |   | 7,625,814          |   | $                 | 7,626  |                             | $      | 26,719,980               |   | $           | (30,577,472 | ) | $ | (3,849,866 | ) |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Net loss for the year 2002          |   |               |   |              |   |                             |   | (6,192,786               | )      | (6,192,786  | )           |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Balance, December 31, 2002          |   | 7,625,814          |   | 7,626             |   | 26,719,980                       |   | (36,770,258              | )      | (10,042,652 | )           |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Stock issued for services           |   | 75,000             |   | 75                |   | 168,675                          |   |                     |   | 168,750     |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Stock issued in public offering     |   | 5,500,000          |   | 5,500             |   | 24,839,460                       |   |                     |   | 24,844,960  |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Stock issued for conversion of debt |   | 3,564,766          |   | 3,565             |   | 6,512,147                        |   |                     |   | 6,515,712   |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Exercise of warrants                |   |               |   |              |   | 76,500                           |   |                     |   | 76,500      |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Warrants issued for service         |   |               |   |              |   | 298,250                          |   |                     |   | 298,250     |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Employee options issued             |   |               |   |              |   | 195,794                          |   |                     |   | 195,794     |        |
|                                |   |               |   |              |   |                             |   |                     |   |        |        |
| Net loss for the year 2003          |   |               |   |              |   |                             |   | (7,812,089               | )      | (7,812,089  | )           |
| Balance, December 31, 2003          |   | 16,765,580         |   | $                 | 16,766 |                             | $      | 58,810,806               |   | $           | (44,582,347 | ) | $ | 14,245,225 |   |

 

**Seeaccompanying notes to financial statements.**

 

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**VENDINGDATA CORPORATION**

 

**Statements of Cash Flows**

**Years EndedDecember 31, 2003 and 2002**

 
|                                               |   | **December  31,** |        |
|----------------------------------------------------|--------|-------------------|-------------|
|                                               |   | **2003**          |        | **2002** |   |
|                                               |   |              |        |   |   |
| Net cash used in  operating activities             |   | $                 | (11,731,150 | ) | $ | (5,206,489 | ) |
|                                               |   |              |        |   |   |
| Cash flows from  investing activities:             |   |              |        |   |   |
| Acquisition of  plant and equipment                |   | (939,376          | )           | (562,168 | ) |
| Acquisition of  intangible assets                  |   | (526,167          | )           | (3,045 | ) |
| Deposits                                           |   | (102,372          | )           |   |   |
| Net cash used in  investing activities             |   | (1,567,915        | )           | (565,213 | ) |
|                                               |   |              |        |   |   |
| Cash flows from  financing activities:             |   |              |        |   |   |
| Proceeds from  sale of stock, warrants and options |   | 25,415,504        |        |   |   |
| Proceeds from  leases payable                      |   | 989,820           |        | 2,988,385 |   |
| Repayment of  leases payable                       |   | (2,754,607        | )           | (2,823,331 | ) |
| Proceeds from  shareholder loans                   |   | 700,000           |        | 2,264,871 |   |
| Repayment of  shareholder loans                    |   | (1,310,000        | )           | (650,000 | ) |
| Repayment of  short-term debt                      |   | (24,000           | )           |   |   |
| Proceeds from  convertible debt                    |   | 11,050,000        |        | 4,903,076 |   |
| Repayment of  convertible debt                     |   | (11,019,285       | )           |   |   |
| Net cash  provided by financing activities         |   | 23,047,432        |        | 6,683,001 |   |
|                                               |   |              |        |   |   |
| Increase in cash                                   |   | 9,748,367         |        | 911,299 |   |
| Cash and cash  equivalents, beginning of period    |   | 1,778,297         |        | 866,998 |   |
| Cash and cash  equivalents, end of period          |   | $                 | 11,526,664  |   | $ | 1,778,297 |   |

 

**See accompanyingnotes to financial statements.**

 

59

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**VENDINGDATACORPORATION**

 

**NOTES TO FINANCIALSTATEMENTS**

 

**Note 1.**          Descriptionof Business and Significant Accounting Policies

 

VendingData Corporation (the “Company”) is in the business ofdeveloping and distributing products related to the gaming industry.  The Company’s principal products areelectronic card shuffling devices, an electronically identified coin collectionbucket and collection cart for use with coin operated gaming and vendingdevices and a “softcount” collection system for control over soft currency fromgaming and vending devices.  The Companyoperates principally in the United States of America, however, a portion of itsrevenues are derived from sales to customers in foreign countries.

 

On December 17, 2002, the Company’s Board of Directors approved aone share for five share reverse stock split. All shares and per share information included in the accompanyingfinancial statements and notes have been retroactively restated to reflect thereverse stock split.

 

***Cash Equivalents***

 

All highly liquid debt instruments with an original maturity of threemonths or less are considered cash equivalents.

 

***Estimates***

 

The preparation of the Company’s financial statements requiresmanagement to make estimates that affect the amounts reported in the financialstatements and accompanying notes which estimates may require revision infuture financial statements.

 

***Inventory***

 

Inventory is stated at the lower of cost or market using the first in,first out method.  Finished goodsinclude raw materials, direct labor and overhead.  Raw materials include purchase and delivery costs.  Inventory consisted of the following atDecember 31, 2003 and December 31, 2002:

 
|             |   | **December  31, 2003** |      | **December  31, 2002** |   |
|------------------|--------|------------------------|-----------|------------------------|--------|
|             |   |                   |      |                   |   |
| Raw material     |   | $                      | 2,048,707 |                   | $      | 1,021,032 |   |
| Work in progress |   | 2,089,387              |      | 731,419                |   |
| Finished goods   |   | 12,320                 |      | 97,600                 |   |
|             |   | $                      | 4,150,414 |                   | $      | 1,850,051 |   |

 

***Deposits***

 

The amounts of deposits (assets) were $1,284,827 and $868,520 as ofDecember 31, 2003 and 2002, respectively. The table below sets forth the details of the deposits as ofDecember 31, 2003 and 2002:

 
| **Item** |   | **December 31,  2003** |          | **December 31,  2002** |   |
|----------|--------|-----------------------------|---------------|-----------------------------|--------|
| Rent     |   | $                           | 42,968        |                        | $      | 42,968 |   |
| Leases   |   | 634,519                     |          | 793,269                     |   |
| Vendors  |   | 313,935                     |          | —                      |   |
| Other    |   | 293,405                     |          | 32,283                      |   |
|     |   | **$**                       | **1,284,827** |                        | **$**  | **868,520** | ** ** |

 

60

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***Property and equipment***

 

Property and equipment (Note 3) is carried at cost.  Depreciation is computed using thestraight-line method over the estimated useful lives of the assets of 3-5years.

 

***Patent and trademark costs***

 

Patent and trademark costs (Note 4) are amortized using thestraight-line method over an appropriate period pursuant to Statement ofFinancials Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*.

 

***Fair value of financialinstruments***

 

The Company’s financial instruments consist of cash and cashequivalents, accounts and loans receivable, and accounts payable andaccruals.  The carrying amounts of thesefinancial instruments approximate fair value because of their short-term maturitiesor yield interest that approximates market rates.

 

***Revenue recognition***

 

The Company recognizes revenue from the sale of its products uponinstallation and functional testing at customer locations because that is whenthe customer’s obligation becomes fixed and certain pursuant to our standardcontracts for the sale of units of the SecureDrop® System, shufflers and DeckCheckersTM.  Sales are recognizedimmediately when shufflers that are rented are converted to purchases or thereis a long-term contract for new equipment depending on the creditworthiness andpayment history of the casino company since payment terms are from 20 to 48months.  The extended warrant andmaintenance components that are part of long-term sales contracts are unbundledand recognized as deferred revenue amortized over the remaining life of thesales agreement after the initial 90-day warranty period as required by theEmerging Issues Task Force Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.  The useful life of the Company’s shufflers and Deck CheckersTM isfive years with proper maintenance; the life can be extended with thereplacement of component parts.  If thecustomer does not possess the required creditworthiness or an establishedpayment history with the Company, the Company would then book the revenue as aninstallment sale and recognize it over time as payments are received.  Revenue from shuffler rentals is recorded atthe first of each month in accordance with rental contract terms.  All rental contracts are cancelable upon30-day written notice by the customer. Maintenance expense for rental units is recorded in the period it isincurred.  Although sales are notgenerally made with a right to return, on occasion, usually associated with theperformance warranty, sales returns and allowances are recorded after returnedgoods are received and inspected.  TheCompany provides currently for estimated warranty repair costs associated withsales contracts.  The Company doesprovide for maintenance contracts that are billed and recognized on a monthlybasis.

 

***Advertising***

 

Advertising expenses are charged to selling, general and administrativeexpenses when incurred and were $64,563 and $76,686 for the years endedDecember 31, 2003 and 2002, respectively.

 

***Stock-based Compensation***

 

The Company currently has two stock option plans (Note 6).  Prior to 2003, those plans were accountedfor under the recognition and measurement provisions of APB OpinionNo. 25, “*Accounting for Stock Issued to Employees*” (APB No. 25) andrelated interpretations.  No stock-basedemployee compensation expense for stock options was reflected in operations foryears prior to 2003, as all stock

 

61

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options grantedunder those plans had an exercise price equal to the fair market value of theunderlying common stock on the date of grant. During the second quarter of 2003, management adopted the fair valuerecognition provisions of Statement of Financial Accounting Standards (“SFAS”)No. 123, *Accounting for Stock-Based Compensation*, under theprospective transition method of SFAS No. 148 *Accounting for Stock-BasedCompensation-Transition and Disclosure*, effective as ofJanuary 1, 2003.

 

A summary of the pro forma adjustments that reflect the impact of theadoption of SFAS No. 123 is as follows:

 
|                                                                                                           |   | **Twelve  Months Ended  December 31,** |       |
|----------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|------------|
|                                                                                                           |   | **2003**                               |       | **2002** |   |
|                                                                                                           |   |                                   |       |   |   |
| Net loss, as  reported                                                                                         |   | $                                      | (7,812,089 | ) | $ | (6,192,786 | ) |
| Add—Stock-based  employee compensation expense included in reported net loss, net of related  tax effects |   | 101,420                                |       | — |   |
| Deduct—Stock-based  employee compensation expense determined under the fair value method                  |   | (195,794                               | )          | (48,152 | ) |
| Net loss, pro  forma                                                                                           |   | $                                      | (7,906,463 | ) | $ | (6,240,938 | ) |
| Basic and  diluted net loss per share                                                                          |   |                                   |       |   |   |
| As reported                                                                                                    |   | $                                      | (0.96      | ) | $ | (0.81 | ) |
| Pro forma                                                                                                      |   | $                                      | (0.97      | ) | $ | (0.82 | ) |

 

***Loss per share (basic anddiluted)***

 

Basic loss per share is computed by dividing net income (loss)available to common stockholders by the weighted average number of shares ofcommon stock outstanding during the year. Diluted loss per share is computed by dividing net income (loss)available to common stockholders by the weighted-average number of shares ofcommon stock outstanding during the year plus potential dilutive instrumentssuch as stock options, warrants and convertible debt.  The effect of stock options on diluted loss per share isdetermined through the application of the treasury stock method, wherebyproceeds received by the Company based on assumed exercises are hypotheticallyused to repurchase the Company’s common stock at the average market priceduring the period.

 

The basic loss per share is computed by dividing the net loss for theperiod by the weighted average number of common shares outstanding for theperiod.  Loss per share is unchanged ona diluted basis since the assumed exercise of common stock equivalents wouldhave an anti-dilutive effect due to the existence of operating losses.

 

***Warranties***

 

In November 2002, the Financial Accounting Standards Board (“FASB”)issued Interpretation No. 45 (“FIN 45”), *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*.  Among otherthings, FIN 45 supplements the requirements of Statement ofFinancial Accounting Standards (“SFAS”) No. 5, *Accounting for Contingencies*, relating disclosure with respect to product warranties.  As part of the normal sale of its products,the Company has provided its customers with product warranties.  The warranties vary on the terms of thesales agreement and by product line. The Company’s product warranty accrual reflects management’s bestestimate of probable liability under our product warranties.  Management determines the warranty accrualon each sale based on known product failure rates of key components, historicalexperience, service staff costs and other variables that affect theliability.  The following summarizes theaccrual of product warranties that is recorded as accrued expenses in theaccompanying balance sheet at December 31, 2003 and 2002.

 

62

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|                      |   | **Twelve  Months Ended December 31,** |   |
|---------------------------|--------|--------------------------------------------|--------|
|                      |   | **2003**                                   |   | **2002** |   |
|                      |   |                                       |   |   |   |
| Opening Balance           |   | $                                          | 10,151 |   | $ | 14,357 |   |
| Accruals for  Warranties  |   | 29,804                                     |   | 15,738 |   |
| Payments in  Period       |   | (27,389                                    | )      | (19,944 | ) |
| Balance at end  of Period |   | $                                          | 12,566 |   | $ | 10,151 |   |

 

**Note 2.**                    Segments

 

The segments identifiedfor geographic region-based enterprise-wide data are as follows:

 
|          |   | **Year  Ended  December 31, 2003** |      | **Year  Ended  December 31, 2002** |   |
|---------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|
|          |   | **Revenue**                                  |      | **Long-lived  Assets**                       |   | **Revenue** |   | **Long-lived  Assets** |   |
|          |   |                                         |      |                                         |   |   |   |   |   |
| North America |   | $                                            | 6,001,089 |                                         | $      | 2,613,111 |   | $ | 3,479,400 |   | $ | 2,015,566 |   |
| Asia          |   | 261,360                                      |      | 310,046                                      |   | — |   | — |   |
| Europe        |   | 300,000                                      |      | —                                       |   | — |   | — |   |
| South America |   | 148,470                                      |      | —                                       |   | — |   | — |   |
| Australia     |   | —                                       |      | —                                       |   | 899 |   | — |   |
|               |        |                                              |           |                                              |        |  |  |  |  |  |  |  |  |

 

The Company’s revenues distributed byproduct are as follows:

 
| **Twelve Months Ended  December 31, 2003** |      | **Twelve Months Ended  December 31, 2002** |   |
|-------------------------------------------------|-----------|-------------------------------------------------|--------|
| **Shufflers**                                   |      | **Deck  CheckersTM**                        |   | **SecureDrop®** |   | **Shufflers** |   | **Deck  CheckersTM** |   | **SecureDrop®** |   |
|                                            |      |                                            |   |   |   |   |   |   |   |   |   |
| $                                               | 3,102,964 |                                            | $      | 1,365,865 |   | $ | 2,221,962 |   | $ | 1,519,801 |   | $ | — |   | $ | 1,704,769 |   |
|                                                 |           |                                                 |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 3.**                    Property and Equipment

 

Property and equipment consist of the following at December 31,2003 and 2002:

 
|                                            |   | **December  31, 2003** |      | **December 31,  2002** |   |
|-------------------------------------------------|--------|------------------------|-----------|-----------------------------|--------|
|                                            |   |                   |      |                        |   |
| Furniture and  fixtures                         |   | $                      | 325,769   |                        | $      | 240,655 |   |
| Equipment and  vehicles                         |   | 1,525,475              |      | 983,790                     |   |
| Tooling                                         |   | 697,304                |      | 541,897                     |   |
| Leasehold  improvements                         |   | 374,609                |      | 249,224                     |   |
|                                            |   | 2,923,157              |      | 2,015,566                   |   |
| Less accumulated  depreciation and amortization |   | 1,859,206              |      | 1,422,313                   |   |
|                                            |   | $                      | 1,063,951 |                        | $      | 593,253 |   |

 

A substantial portion of the Company’s furniture and equipment are heldunder capital leases described in Note 5 – Convertible Debt with Warrantsand Leases Payable.

 

**Note 4.**                      Intangible Assets

 

FAS 142 requires that intangible assets with definite lives beamortized over their estimated useful lives and reviewed for impairment whenevents or changes in circumstances indicate that the carrying amount of suchassets may not be recoverable.  TheCompany has acquired patent rights for various products since 2001 and acquiredthe patent rights for the Deck CheckerTM for $1,004,900 in the

 

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third quarter of2003.  The Company has estimated aneconomic useful life of ten years for the Deck CheckerTM patents.  The Company currently amortizes itsintangible assets on a straight-line basis over the estimated useful lives of10 years.  Amortization taken to date asof December 31, 2003 was $288,203. The following table sets forth the estimated aggregate amortizationexpenses for the next five years:

 
| **Year** |   | **Amortization  Expense** |    |
|----------|--------|---------------------------|---------|
| 2004     |   | $                         | 156,390 |   |
| 2005     |   | $                         | 156,390 |   |
| 2006     |   | $                         | 156,390 |   |
| 2007     |   | $                         | 140,853 |   |
| 2008     |   | $                         | 138,395 |   |

 

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**Note 5.**                    Convertible Debt with Warrants and Leases Payable

 

As of December 31, 2003 and 2002, our long-term obligationsconsist of convertible debt with warrants and capital lease obligations asfollows:

 
|                                                                                                                                                                                                                                                                                                                                                                                       |   | **December 31,  2003** |      | **December 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-----------|-----------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                        |      |                        |   |
| 9.5% unsecured  notes payable, convertible into shares of common stock one year after  issuance at $13.00 per share, with non-detachable warrants at $13.00 each,  all of which have expired except for 10,000 warrants                                                                                                                                                                    |   | $                           | 1,600,000 |                        | $      | 1,600,000 |   |
| 9.5% unsecured  notes payable, convertible into common stock at $13.00 per share                                                                                                                                                                                                                                                                                                           |   | 3,077                       |      | 3,077                       |   |
| 9.5% unsecured  notes payable, convertible into common stock one year after issuance at $1.75  per share, with non-detachable warrants to purchase 2,500 shares at $1.75 for  each $50,000 note                                                                                                                                                                                            |   | —                      |      | 4,749,995                   |   |
| 10% unsecured  notes payable, maturing in 2005, convertible into a maximum of 333,334 shares  of common stock beginning December 2004 until June 2005, at $2.25  per share, with detachable warrants to purchase 6,000 shares of common stock  at $2.25, for each $50,000 note                                                                                                   |   | 390,000                     |      | 2,500,000                   |   |
| 10% unsecured  notes payable due November 22, 2003 with 15% of its then outstanding  principal convertible into common stock at $2.25 per share, with detachable  warrants to purchase 225,000 shares at $2.25 and with additional five-year  warrants to purchase 50,000 shares of common stock at $2.25 per share for  each $1,000,000 in principal that remains after November 22, 2003 |   | 225,000                     |      | —                      |   |
| 10% unsecured  note payable due November 20, 2003 with 15% of its then outstanding principal  convertible into shares of common stock at $2.25 per share and with  additional five-year warrants to purchase 50,000 shares of common stock at  $2.25 per share for each 30-day period that the note remains outstanding past  November 20, 2003.                                           |   | 150,000                     |      | —                      |   |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 2,368,077                   |      | 8,853,072                   |   |
| Capitalized  lease obligations for leased furniture, tooling and equipment(1)  net of deferred interest of $418,873  and $626,526 for December 2003 and December 2002, respectively                                                                                                                                                                                                   |   | 4,153,796                   |      | 5,784,102                   |   |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 6,521,873                   |      | 14,637,174                  |   |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                       |   | (4,605,150                  | )         | (2,286,243                  | )      |
| Long-term  portion                                                                                                                                                                                                                                                                                                                                                                         |   | $                           | 1,916,723 |                        | $      | 12,350,931 |   |

 

----

Footnotes located on following page.

 

65

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Scheduled maturities ofthese obligations as of December 31, 2003 and 2002, are summarized asfollows:

 
| **December 31, 2003**                    |   | **Leases  Payable** |      | **Convertible  Notes Payable** |   | **Total**  |   |
|------------------------------------------|--------|---------------------|-----------|--------------------------------|--------|------------|--------|
|                                     |   |                |      |                           |   |       |   |
| Due during the  year ending December 31: |   |                |      |                           |   |       |   |
| 2004                                     |   | $                   | 2,751,848 |                           | $      | 2,368,077  |   | $ | 5,119,925 |   |
| 2005                                     |   | 1,826,957           |      | —                         |   | 1,826,957  |   |
| 2006                                     |   | 204,352             |      | —                         |   | 204,352    |   |
| 2007                                     |   | 7,977               |      | —                         |   | 7,977      |   |
| Minimum future  lease payments           |   | 4,791,134           |      | —                         |   | 7,159,211  |   |
| Less interest  component                 |   | (637,338            | )         | —                         |   | (637,338   | )      |
|                                     |   | 4,153,796           |      | 2,368,077                      |   | 6,521,873  |   |
| Less current  portion                    |   | (2,237,073          | )         | (2,368,077                     | )      | (4,605,150 | )      |
| Long-term  portion                       |   | $                   | 1,916,723 |                           | $      | —     |   | $ | 1,916,723 |   |

 
| **December 31, 2002**                    |   | **Leases  Payable** |      | **Convertible  Notes Payable** |   | **Total**  |   |
|-----------------------------------------------|--------|---------------------|-----------|--------------------------------|--------|------------|--------|
|                                          |   |                |      |                           |   |       |   |
| Due during the  year ending December 31: |   |                |      |                           |   |       |   |
| 2003                                          |   | $                   | 3,342,209 |                           | $      | —     |   | $ | 3,342,209 |   |
| 2004                                          |   | 2,495,733           |      | 1,614,635                      |   | 4,110,368  |   |
| 2005                                          |   | 1,531,340           |      | 4,726,107                      |   | 6,257,447  |   |
| 2006                                          |   | —              |      | 2,512,330                      |   | 2,512,330  |   |
| Minimum future  lease payments                |   | 7,369,282           |      | 8,853,072                      |   | 16,222,354 |   |
| Less interest  component                      |   | (1,585,180          | )         | —                         |   | (1,585,180 | )      |
|                                          |   | 5,784,102           |      | 8,853,072                      |   | 14,637,174 |   |
| Less current  portion                         |   | (2,286,243          | )         | —                         |   | (2,286,243 | )      |
| Long-term  portion                            |   | $                   | 3,497,859 |                           | $      | 8,853,072  |   | $ | 12,350,931 |   |

 

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(1)          The Company has enteredinto certain sale-leaseback transactions primarily for assets rented to, orintended to be rented to, customers, under operating leases.  Since the leases contained effectivemandatory buyback provisions resulting in the Company retaining rights to usethese assets in its business for their remaining useful lives, no gain or losswas recognized on the sale-leaseback transactions pursuant to paragraph 17of the Statements of Financial Accounting Standards (“SFAS”) No. 28 *Accountingfor Sales with Leasebacks*. The amortization of the assets recorded as capital leases is includedwith depreciation.  The effective annualinterest rates implicit in the capital leases range from 25% to 28%.  The terms of the leases range from 36 monthsto 39 months.  The Company’s futureobligations for capital lease transactions are $2,728,963, $1,826,957, $204,352and $7,977 in the years 2004, 2005, 2006 and 2007, respectively.

 

**Note 6.**                    Stockholders’ Equity

 

**PublicOffering**.  The company successfully completed a publicoffering of 5.5 million shares of common stock at $5 per share.  The gross proceeds was $27.5 million withnet proceeds after commissions and offering costs was $24.8 million.

 

**StockOptions.**  The Company has an aggregate of 651,450options to purchase common stock at $1.75 per share, 1,012,000 options at $2.50per share, 50,000 options at $3.00 per share, 95,100 options at $3.90 pershare, 5,000 options at $6.00 per share, 110,000 options at $7.50 per share,76,100 options at $12.50 per share, 107,380 options to purchase

 

66

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common stock at$13.00 per share and 100 options at $15.00 per share outstanding atDecember 31, 2003.

 

The following is a summary of transactions involving stock options:

 
|      |   |     |   | **Shares** |   | **Range of  Exercise Prices** |           | **Average  Price** |   |
|-----------|--------|----------|--------|------------|--------|-------------------------------|----------------|--------------------|--------|
| Balance   |   | 12/31/00 |   | 253,320    |   |                          | $5.00 - $15.00 |               | $      | 10.00 |   |
|      |   |     |   |       |   |                          |           |               |   |   |
| Granted   |   |     |   | 652,150    |   |                          | $1.75-$13.00   |               | $      | 4.20 |   |
| Cancelled |   |     |   | 70,800     |   |                          | $5.00-$15.00   |               | $      | 5.75 |   |
| Balance   |   | 12/31/01 |   | 834,670    |   |                          | $5.00-$15.00   |               | $      | 5.40 |   |
|      |   |     |   |       |   |                          |           |               |   |   |
| Granted   |   |     |   | 117,550    |   |                          | $1.75-$13.00   |               | $      | 3.80 |   |
| Cancelled |   |     |   | 25,450     |   |                          | $7.50-$13.00   |               | $      | 9.68 |   |
| Balance   |   | 12/31/02 |   | 926,770    |   |                          | $1.75-$15.00   |               | $      | 5.09 |   |
|      |   |     |   |       |   |                          |           |               |   |   |
| Granted   |   |     |   | 1,246,850  |   |                          | $1.75-$3.90    |               | $      | 2.60 |   |
| Cancelled |   |     |   | 66,490     |   |                          | $1.75-$13.00   |               | $      | 8.47 |   |
| Balance   |   | 12/31/03 |   | 2,107,130  |   |                          | $1.75-$15.00   |               | $      | 3.51 |   |

 

The weighted average fair value at the date of grant for optionsgranted during 2003 and 2002 as described above were $0.11, $0.24 and $0.75 in2003 and $0.41 per share in 2002.  Thefair value of the options at the date of grant was estimated using theBlack-Scholes model with assumptions as follows:

 
|                    |   | **2003**    |   | **2002** |   |
|-------------------------|--------|-------------|--------|----------|--------|
| Market value            |   | $2.25-$3.90 |   | $1.75    |   |
| Expected life in  years |   | 3 to 6      |   | 3 to 10  |   |
| Interest rate           |   | 2-3%        |   | 7%       |   |
| Volatility              |   | 1%          |   | 10%      |   |
| Dividend yield          |   | 0.00%       |   | 0.00%    |   |

 

Theimpact of the adoption of the fair value method of accounting for stock-basedcompensation was an increase to stock-based compensation expense included inselling, general and administrative expenses of approximately $101,420 for thetwelve-month period ended December 31, 2003. As a result of adopting SFAS No. 123 under the prospectivetransition method of SFAS No. 148, prior periods have not been restated toreflect the impact of the fair value method.

 

**Warrants.** The Company has outstanding an aggregate of 60,000 warrants to purchasecommon stock at $13.00 per share, 50,000 warrants to purchase common stock at$12.50 per share, 247,500 warrants to purchase common stock at $1.75 per share,150,000 warrants to purchase common stock at $0.05 per share and 45,000warrants to purchase common stock at $50.00 per share outstanding atDecember 31, 2003.  As of December 31, 2003, there were optionsand warrants outstanding to purchase a total of 4,537,130 shares of commonstock with a weighted average exercise price of $3.31 per share.

 

Inaddition, as of December 31,2003, there was indebtedness convertible into 485,536 shares of common stockwith a weighted average price of $4.98 per share.

 

**Note 7.**                    Income Taxes

 

At December 31, 2003, the Company had net operating loss carryforwardsfor federal income tax purposes of approximately $43,800,000 that may be offsetagainst future taxable income.  Theseoperating loss carryforwards expire in the years 2010 through 2023.  No tax benefit has been reported in thefinancial statements because the potential tax benefits of the net operatingloss carryforwards are

 

67

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effectively offsetby a valuation allowance of the same amount as a result of significantuncertainties as to their realizability in the future.

 

The reconciliation of theeffective tax rate to the statutory rates is as follows:

 
|                                         |   | **December  31,** |      |
|----------------------------------------------|--------|-------------------|-----------|
|                                         |   | **2003**          |      | **2002** |   |
|                                         |   | **Amount**        |      | **%** |   | **Amount** |   | **%** |   |
|                                         |   |              |      |   |   |   |   |   |   |
| Income tax  benefit at statutory rate of 34% |   | $                 | 2,656,110 |   | 34 | % | $ | 1,428,789 |   | 34 | % |
| Effect of  permanent   differences |   | (23,020           | )         |   |   |   |   |   |   |
| Change in  valuation allowance               |   | (2,633,090        | )         | 34 | % | (1,428,789 | ) | 34 | % |
|                                         |   |              |      |   |   |   |   |   |   |
| Net deferred tax  assets                     |   | —            |      | 0 | % | — |   | 0 | % |
|                                         |   |              |      |   |   |   |   |   |   |
|                                         |   | $                 | —    |   |   |   | $ | — |   |   |   |

 

Deferred tax assets(liabilities) are comprised of the following at December 31, 2003 and 2002:

 
|                           |   | **December  31,** |       |
|--------------------------------|--------|-------------------|------------|
|                           |   | **2003**          |       | **2002** |   |
| Operating loss  carry forwards |   | $                 | 14,885,000 |   | $ | 11,567,789 |   |
| Accrued vacation               |   | 54,000            |       |   |   |
| Deferred rent                  |   | 33,000            |       |   |   |
| Depreciation                   |   | (12,000           | )          |   |   |
| Less valuation  allowance      |   | (14,960,000       | )          | (11,567,789 | ) |
|                           |   | —            |       | — |   |
|                           |   | $                 | —     |   | $ | — |   |

 

**Note 8.**                    Related Party Transactions

 

The Company has anemployment agreement with its chief executive officer, effectiveJanuary 1, 2000, that provides for annual compensation of $284,000 throughDecember 31, 2004, at which time the compensation is to berenegotiated.  The agreement alsoprovided for the granting of 20,000 options ($12.50 per share) through 2002based upon the Company meeting its goals provided by the Board of Directors.  Options were granted in January 2001 for 20,000shares pursuant to the contract at an exercise price of $7.50 per share.  The Company extended the contract in June of2003 for an additional five years which included a grant of 500,000 options atan exercise price of $2.50.

 

68

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In connection with private placements and other transactions in 2002,2001 and 1999, the Company issued 9.5% unsecured notes payable to certaindirectors, officers and controlling stockholders, all of which, as described inNote 5, were convertible into and issued together with warrants topurchase shares of the Company’s common stock**,**in exchange for cash as follows:

 
|                                           |   | **Twelve  Months Ended  December 31,** |      |
|------------------------------------------------|--------|----------------------------------------|-----------|
|                                           |   | **2003**                               |      | **2002** |   |
|                                           |   |                                   |      |   |   |
| Balance  outstanding, beginning of period      |   | $                                      | 5,942,489 |   | $ | 2,187,789 |   |
| Notes issued for  cash                         |   | 100,000                                |      | 6,584,994 |   |
| Repayments                                     |   | (260,000                               | )         | (100,000 | ) |
| Conversion                                     |   | (4,599,996                             | )         | (2,730,294 | ) |
| Balances  outstanding, end of period           |   | $                                      | 1,182,493 |   | $ | 5,942,489 |   |
| Convertible  notes with attached warrants      |   | $                                      | 1,150,000 |   | $ | 5,299,996 |   |
| Other notes  payable                           |   | 32,493                                 |      | 642,493 |   |
|                                           |   | $                                      | 1,182,493 |   | $ | 5,942,489 |   |
|                                           |   |                                   |      |   |   |
| Related party  interest expense for the period |   | $                                      | 529,742   |   | $ | 388,662 |   |

 

On December 12, 2003, $4,599,996 in convertible 9.5% debt wasconverted to common stock by related parties. An additional $444,612 dollars in accrued interest due to the relatedparties was converted to common stock. The total number of shares issued for the principal and interestconversion was 2,823,612.

 

As of December 31, 2003, an officer anddirector of the Company had an outstanding balance due to the Company in anamount equal to $26,276 that was attributable to disbursements that were madeon his behalf for personal expenses over the past five years.  In August, 2003, the officer and directorpaid $5,040, which represented the net balance due from transactions arisingafter July 30, 2002, the effective date of the Sarbanes-Oxley Act of 2002.

 

**Note 9.**                    Commitments and Contingencies

 

**BuildingLease.**  The Company is obligated under a buildinglease agreement until December 31, 2006, with one (1) option to extend fora five-year period.  The lease agreementprovides for scheduled increases based, in part on the annual Consumer PriceIndex.  The Company also leases officespace in other locations including China and certain office equipment underoperating leases.  Rent expense was$418,210 and $639,392 for the years ended December 31, 2003 and 2002,respectively.

 

Future minimum rentals, including escalation provisions as ofDecember 31, 2003, under the leases are as follows:

 
| 2004 |   | $ | 594,033 |   |
|------|--------|---|---------|--------|
| 2005 |   | $ | 610,185 |   |
| 2006 |   | $ | 626,821 |   |

 

**Legal Matters. **On March 27, 2002, Shuffle Master,Inc. filed a complaint (Case No. CV-S-02-0438-JCM-PAL) against the Company inthe United States District Court, District of Nevada.  The

 

69

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complaint alleges,among other things, claims for patent infringement and requests treble damages,an injunction enjoining the Company from infringing Shuffle Master, Inc.’spatents, an accounting of gains and profits that resulted from the allegedinfringement, and for interest, costs and attorneys’ fees.  The Company has filed counterclaims seekingdeclaratory relief for invalidity of the patents and non-infringement.  The Company cannot predict the likely outcomeof this litigation or whether this litigation would have a material adverseeffect on our business as presently conducted or as anticipated.

 

**LiquidityIssues.**  The Company’sability to maintain adequate liquidity may be dependent upon the success ofmanagement’s plans to address and overcome prior operating losses.  Management has developed and refined its2004 operating plan to increase its sales by expanding its product line andimproving its sales efforts domestically and internationally.  Increased sales in the year ended December31, 2003 show increased acceptance of the Company’s product line.  Management has adopted efforts to reduceoperating costs through the transfer of manufacturing operations to China andrestructuring service functions to reduce labor and rental expense.   Management has focused on financialcondition and liquidity improvements through its capital raising efforts in2003 along with substantial debt reduction and debt conversion, resulting in animproved cash position and substantially reduced indebtedness at December 31,2003.  As a result of anticipated salesimprovements and operating cost initiatives, management believes that theCompany will begin to generate positive operating cash flow during the secondhalf of 2004.  In addition, theCompany’s financial advisors have expressed confidence that additional capitalcan be raised by the Company, if necessary, in 2004 and the Company has receiveda one-year commitment for a $3.0 million lease line of credit.

 

**Note 10.**             TradeReceivables From Major Customers

 

As of and during the yearended December 31, 2002, approximately 10.2% of trade receivables and 39% oftotal sales were the result of a one-time transaction with a single customer.  As of and during the twelve months endedDecember 31, 2003, approximately 17.6% of trade receivables and 13.3% of totalsales wereconcentrated in the Nevada gaming market among five customers under commonownership.  The Company’s futureoperations could be affected by adverse changes in the financial condition of,or the Company’s relationships with, the commonly owned Nevada gamingcustomers, or economic, competitive and political conditions in our customers’respective local areas or the gaming industry, in general.

 

Included in accountsreceivable, trade, at December 31, 2003, was $3,495,038 (with the non-current portion,$1,140,984), net of unamortized discounts of $44,188.  These receivables, which are payable over periods ranging from 20months to 35 months, and related revenues arose from the sale of shufflers andDeck CheckersTM to major customers during the twelve-month period ended December31, 2003, and were discounted in the Company’s financial statements based onthe fair value of the products sold resulting in imputed interest rates rangingfrom 1.08% to 9.55%.

 

The Company manages itsconcentrations of credit risk by evaluating the creditworthiness of customersbefore credit is extended and monitoring it thereafter.  The maximum losses that the Company wouldincur if a customer failed to pay amounts owed would be limited to the recordedreceivables after any allowances provided.

 

70

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**Note 11.**             SubsequentEvents

 

Harrah’s New Orleanscancelled a long term sales contract in February 2004 due to performanceissues. The contract was executed in the third quarter of 2003 with therecognition of $138,951 revenue for the sale of shufflers. Revenue was reducedfor the year ended 2003 for the full amount of revenue that was recognized inthe third quarter 2003.

 

In early February 2004, theState of Nevada initiated a sales/use tax audit of Central and MadisonLeasing.  The Company has sold andleased back shufflers and Deck Checkers over the last five years.  The auditor for the State of Nevada istrying to determine at what level a sale tax needs to be collected.  The Company now collects from our customersin Nevada and remits to the State of Nevada. There is a possibility that if the State of Nevada determines that thesales of the products to the leasing company is the level at which sales/usetax should have been collected there would be a liability that would be passedto the Company from the leasing companies. The amount of this potential liability could range from a refund of$144,000 to the payment of sales/use tax with interest and penalties up to$500,000.  The Company intends to defendits position in this matter.

 

**Note 12.**               Additional cash flow information

 
|                                                                             |   | **December  31,** |        |
|----------------------------------------------------------------------------------|--------|-------------------|-------------|
|                                                                             |   | **2003**          |        | **2002** |   |
|                                                                             |   |              |        |   |   |
| Net loss                                                                         |   | $                 | (7,812,089  | ) | $ | (6,192,786 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |   |              |        |   |   |
| Depreciation and  amortization                                                   |   | 1,053,382         |        | 972,525 |   |
| Amortization of  deferred interest                                               |   | 350,739           |        | 402,492 |   |
| Loss on retirement  of assets                                                    |   | 141,460           |        |   |   |
| Other non-cash  cost                                                             |   | 115,890           |        |   |   |
| Changes in  assets and liabilities:                                              |   |              |        |   |   |
| (Increase)  decrease in accounts receivable                                      |   | (3,388,248        | )           | 22,814 |   |
| Decrease in  other receivables                                                   |   | 9,469             |        |   |   |
| Increase in due  from affiliate                                                  |   | (1,209            | )           |   |   |
| Increase in  inventory                                                           |   | (2,300,362        | )           | (335,978 | ) |
| Decrease in  prepaid expenses                                                    |   | 184,551           |        | 35,354 |   |
| Increase in  other assets                                                        |   |              |        | (65,138 | ) |
| Increase in  deposits                                                            |   | (313,936          | )           | (162,540 | ) |
| Decrease in  deferred expenses                                                   |   | 5,597             |        |   |   |
| Increase in  accounts payable                                                    |   | 311,573           |        | 518,210 |   |
| Decrease in  accrued expenses                                                    |   | (249,711          | )           |   |   |
| Increase in  accrued wages                                                       |   | 94,550            |        |   |   |
| Increase  (decrease) in accrued interest                                         |   | (116,557          | )           | 94,312 |   |
| Increase in  deferred revenues                                                   |   | 391,765           |        |   |   |
| Decrease in  customer deposits                                                   |   | (208,014          | )           | (495,754 | ) |
| Net cash used in  operating activities                                           |   | $                 | (11,731,150 | ) | $ | (5,206,489 | ) |
|                                                                             |   |              |        |   |   |
| Supplemental  cash flow information:                                             |   |              |        |   |   |
| Cash paid for  interest                                                          |   | $                 | 1,636,512   |   | $ | 1,341,044 |   |
|                                                                             |   |              |        |   |   |
| Non-cash  investing and financing activities:                                    |   |              |        |   |   |
| Loans converted  into common stock                                               |   | $                 | 6,515,712   |   |   |   |
| Stock issued in  exchange for consulting services                                |   | $                 | 168,750     |   |   |   |
| Outstanding  balance on purchase of intangible included in accounts payable      |   | $                 | 500,000     |   |   |   |

 

71

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**ITEM8.       CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

## **ITEM 8A.**             CONTROLS ANDPROCEDURES

 

(a)                                  *Evaluation ofDisclosure Controls.*  We evaluated the effectiveness of ourdisclosure controls and procedures as of the end of the 2003 fiscal year.  This evaluation was done with theparticipation of our chief executive officer and our chief financialofficer.  Disclosure controls andprocedures are controls and other procedures that are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation,controls and procedures designed to ensure that information required to bedisclosed by us in the reports that we file under the Exchange Act isaccumulated and communicated to our management, as appropriate to allow timelydecisions regarding required disclosure.

 

### ***Limitations on the Effectiveness of Controls. ***Our management does not expect thatour disclosure controls and procedures or our internal controls over financialreporting will prevent all error and all fraud.  A control system, no matter how well conceived and operated, canprovide only reasonable, but not absolute, assurance that the objectives of acontrol system are met.  Further, anycontrol system reflects limitations on resources, and the benefits of a controlsystem must be considered relative to its costs.  Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, have been detected.  These inherent limitations include the realities that judgmentsin decision-making can be faulty and that breakdowns can occur because ofsimple error or mistake. Additionally, controls can be circumvented by theindividual acts of some persons, by collusion of two or more people, or bymanagement override of a control.  Thedesign of a control system is also based upon certain assumptions about thelikelihood of future events, there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions;over time, controls may become inadequate because of changes in conditions, orthe degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand may not be detected.

 

*Conclusions.* Based on this evaluation, we concluded that, subject to the limitationsnoted above, our disclosure controls and procedures are effective to ensurethat information we are required to disclose in reports that we file or submitunder the Exchange Act is recorded, processed, summarized, and reported withinthe time periods specified in the SEC’s rules and forms.

 

(b)                                 *Changes in DisclosureControls and Procedures.*  Although there have been nosignificant changes in internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation,we are continuously evaluating means of enhancing our internal controls.  During the twelve months ended December 31,2003, we added qualified staff to our accounting department, we improved ourapproval process for accounting entries, and we commenced implementation ofMAS-500 integrated financial and manufacturing software application.  MAS-500 will provide an integrated controlprocess for purchasing, inventory control and manufacturing and should improveour financial reporting accuracy and improved timeliness.

 

72

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# **PART III**

 

**ITEM 9.****       DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT**

 

This information is incorporated by reference from our proxy statementto be filed with the Commission in connection with our Annual Meeting ofStockholders.

 

**Code ofEthics**

 

We have adopted aCode of Ethics that applies to our board of directors, chief executive officer,chief financial officer, controller and any other individuals serving insimilar capacities.  The Code of Ethicsis designed to serve as the foundation of our standards of behavior and topromote honest and ethical conduct, proper disclosure of financial informationin our periodic reports, and compliance with applicable laws, rules, andregulations by our directors and senior officers who have operating andfinancial responsibilities.

 

## **ITEM 10.**               EXECUTIVECOMPENSATION

 

This information is incorporated by reference from our proxy statementto be filed with the Commission in connection with our Annual Meeting ofStockholders.

 

**ITEM 11.****     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

 

This information is incorporated by reference from our proxy statementto be filed with the Commission in connection with our Annual Meeting ofStockholders.

 

## **ITEM 12.**               CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS

 

This information is incorporated by reference from our proxy statementto be filed with the Commission in connection with our Annual Meeting ofStockholders.

 

## **ITEM 13.**               EXHIBITS AND REPORTSON FORM 8-K

 

(a)                                  Exhibits.

 

See exhibits listed on the Exhibit Index following the signature pageof this Annual Report on Form 10-KSB, which is incorporated herein byreference.

 

(b)                                 Reports on Form 8-K.

 

During the three months ended December 31, 2003, the following CurrentReports on Form 8-K were filed:

 

•             Current Report of Form 8-K filedDecember 18, 2003 announcing completion of public offering of 5,500,000shares of common stock;

 

•             Current Report on Form 8-K filed November 7,2003 announcing receipt of bridge financing; and

 

•             Current Report on Form 8-K filed October 27,2003 announcing bridge financing.

 

## **ITEM 14.**               PRINCIPAL ACCOUNTANTFEES AND SERVICES

 

This information isincorporated by reference from our proxy statement to be filed with theCommission in connection with our Annual Meeting of Stockholders.

 

73

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**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the Exchange Act, theregistrant has duly caused this report to be signed on our behalf by theundersigned, thereunto duly authorized.

 
|                            | **VENDINGDATA CORPORATION** |
|---------------------------------|-----------------------------|
|                            |                        |   |
|                            |                        |   |
| Date:  March 30, 2004 | By:                         | /s/ STEVEN J. BLAD |
|                            |                        | Steven  J. Blad, Chief Executive Officer,  President and Director |

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated. 

 
| **Signature**       |   | **Title**                                    |   | **Date**            |
|---------------------|--------|----------------------------------------------|--------|---------------------|
|                |   |                                         |   |                |
| /s/ STEVEN J. BLAD  |   | Chief Executive Officer, President and       |   | March 30, 2004 |
| Steven J. Blad      |   | Director (Principal Executive Officer)       |   |                |
|                |   |                                         |   |                |
|                |   |                                         |   |                |
| /s/ JOHN R. SPINA   |   | Chief Financial Officer and Treasurer        |   | March 30, 2004 |
| John R. Spina       |   | (Principal Financial and Accounting Officer) |   |                |
|                |   |                                         |   |                |
|                |   |                                         |   |                |
| /s/ JAMES E. CRABBE |   | Chairman of the Board                        |   | March 30, 2004 |
| James E. Crabbe     |   |                                         |   |                |
|                |   |                                         |   |                |
|                |   |                                         |   |                |
| /s/ RONALD O. KEIL  |   | Director                                     |   | March 30, 2004 |
| Ronald O. Keil      |   |                                         |   |                |
|                |   |                                         |   |                |
|                |   |                                         |   |                |
| /s/ BOB L. SMITH    |   | Director                                     |   | March 30, 2004 |
| Bob L. Smith        |   |                                         |   |                |

 

----

 

**EXHIBIT INDEX**

 
| **Exhibit  Number** |   | **Exhibit  Description**                                                                                                                                                                                                                                                          |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |   | Agreement and Plan of  Merger dated as of March 6, 1999, by and between the registrant and  Casinovations Nevada Incorporated, incorporated by reference from the  registrant’s Annual Report on Form 10-KSB filed on March 26, 1999.                                        |
|                |   |                                                                                                                                                                                                                                                                              |
| 3.1                 |   | Amended and Restated  Articles of Incorporation dated July 24, 2000, incorporated by reference from  the registrant’s Current Report on Form 8-K filed on July 28, 2000.                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                              |
| 3.2                 |   | Amended and Restated  Bylaws of the registrant dated November 13, 2002, incorporated by reference  from the registrant’s Current Report on Form 8-K filed on January 8, 2003.                                                                                                |
|                |   |                                                                                                                                                                                                                                                                              |
| 3.3                 |   | Certificate of Change  in Number of Authorized Shares filed on December 23, 2002 and effective  January 3, 2003, incorporated by reference from the registrant’s Current  Report on Form 8-K filed on January 8, 2003.                                                       |
|                |   |                                                                                                                                                                                                                                                                              |
| 4.1                 |   | Specimen certificate  for Common Stock, incorporated by reference from the registrant’s  Registration Statement on Form SB-2 filed on July 16, 1997.                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.1                |   | Shareholder Agreement  dated December 14, 1998, by and between VendingData Corporation and Richard  Huson, Bob Smith and Ron Keil, incorporated by reference from the  registrant’s Annual Report on Form 10-KSB filed on March 26, 1999.                                    |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.2                |   | Form of Warrant  Associated with 9.5% Convertible Note Due 2004, incorporated by reference  from the registrant’s Quarterly Report on Form 10-QSB filed on May 17, 1999.                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.3                |   | First Security Bank of  Nevada Master Equipment Lease Agreement, incorporated by reference from the  registrant’s Quarterly Report on Form 10-QSB filed on August 13, 1999.                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.4                |   | Lease Agreement dated  August 19, 1999, by and between the registrant and Spencer Airport Center,  LLC for 6830 Spencer incorporated by reference from the registrant’s  Quarterly Report on Form 10-QSB filed on November 15, 1999.                                         |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.5                |   | Durable Power of  Attorney Granting Voting Rights of the registrant’s Common Stock,  incorporated by reference from the registrant’s Quarterly Report on Form  10-QSB filed on November 15, 1999.                                                                       |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.6                |   | Employment Agreement of  Steven J. Blad dated August 10, 1999, incorporated by reference from the  registrant’s Quarterly Report on Form 10-QSB filed on August 13, 1999.                                                                                                    |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.7                |   | Form of Warrant,  attached as an exhibit to the Stand-By Credit Agreement by and between the  registrant and Josephthal & Co. Inc. dated as of February 6, 2001,  incorporated by reference from the registrant’s Annual Report on Form 10-KSB  filed on March 30, 2001. |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.8                |   | Agreement of Purchase  and Sale by and between the registrant and Malcolm C. Davenport V dated March  15, 2001, incorporated by reference from the registrant’s Quarterly Report on  Form 10-QSB filed on May 14, 2001.                                                      |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.9                |   | Standby Purchase  Agreement by and between the registrant and James E. Crabbe entered into June  15, 2001, incorporated by reference from the registrant’s Registration  Statement on Form S-3 filed on June 28, 2001.                                                       |
|                |   |                                                                                                                                                                                                                                                                              |
| 10.10               |   | Form of Employment  Agreement, incorporated by reference from the registrant’s Quarterly Report  on Form 10-QSB filed on August 14, 2001.                                                                                                                                    |

 

----

 
| **Exhibit  Number** |   | **Exhibit  Description**                                                                                                                                                                                                                                                                                           |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11               |   | First Amendment to Employment  Agreement by and between the registrant and Steven J. Blad entered into on  November 20, 2001, incorporated by reference from the registrant’s Annual  Report on Form 10-KSB filed on April 1, 2002.                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.12               |   | Agreement of Purchase  and Sale by and among the registrant, Georgina Louise Sangster, William  Purton, Dolphin Advanced Technologies Pty Ltd. and Dolphin Products Pty Ltd.  dated December 23, 2002, incorporated by reference from the registrant’s  Annual Report on Form 10-KSB filed on March 31, 2003. |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.13               |   | Form of Warrant to  Purchase 6,000 Shares of Common Stock, issued in conjunction with the  Registrant’s 10% Note Due December 2005, incorporated by reference from the  registrant’s Annual Report on Form 10-KSB filed on March 31, 2003.                                                               |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.14               |   | Form of Indemnification  Agreement, incorporated by reference from the registrant’s quarterly report  on 10-QSB/A filed on August 19, 2003.                                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.15               |   | Amended and Restated  1999 Stock Option Plan, incorporated by reference from the registrant’s  quarterly report on 10-QSB/A filed on August 19, 2003.                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.16               |   | Form of First Amendment  to Employment Agreement, incorporated by reference from the registrant’s  quarterly report on 10-QSB/A filed on August 19, 2003.                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.17               |   | Second Amendment to  Employment Agreement of Steven J. Blad, incorporated by reference from the  registrant’s quarterly report on 10-QSB/A filed on August 19, 2003.                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.18               |   | Philadelphia Brokerage  Corporation Warrant to Purchase 25,000 Shares of Common Stock, incorporated  by reference from the registrant’s quarterly report on 10-QSB/A filed on  August 19, 2003.                                                                                                               |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.19               |   | Financial Advisor  Agreement dated March 1, 2003, incorporated by reference from the  registrant’s registration statement on Form SB-2 filed on September 25, 2003.                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.20               |   | Triage Capital  Management LP Warrant to Purchase 50,000 Shares of Common Stock, incorporated  by reference from the registrant’s quarterly report on 10-QSB/A filed on  August 19, 2003.                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.21               |   | Mellon HBV SBV, LLC  Warrant to Purchase Shares of Common Stock, incorporated by reference from  the registrant’s quarterly report on 10-QSB/A filed on August 19, 2003.                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.22               |   | Letter Agreement with  Industrial Research Limited, incorporated by reference from the registrant’s  registration statement on Form SB-2/A filed on December 10, 2003.                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.23               |   | Amended and Restated  1999 Directors’ Stock Option Plan, incorporated by reference from the  registrant’s registration statement on Form S-8 filed on September 10, 2003.                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.24               |   | Form of Registration  Rights Agreement by and between the registrant and Philadelphia Brokerage  Corporation, incorporated by reference from the registrant’s registration  statement on Form SB-2 filed on September 25, 2003.                                                                               |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.25               |   | Form of Amended Escrow  Agreement by and between the registrant and Wells Fargo Bank, incorporated by  reference from the registrant’s registration statement on Form SB-2/A filed  on December 10, 2003.                                                                                                     |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.26               |   | Form of Lock-up,  incorporated by reference from the registrant’s registration statement on  Form SB-2 filed on September 25, 2003.                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                               |
| 10.27               |   | Acquisition Agreement  dated June 26, 2001, by and between the registrant and Technology Development  Center, LLC, incorporated by reference from the registrant’s current report  on Form 8-K filed on June 29, 2001.                                                                                        |

 

----

 
| **Exhibit  Number** |   | **Exhibit  Description**                                                                                                                                                                                                            |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.28               |   | Form of Subscription  Agreement, incorporated by reference from the registrant’s registration  statement on Form SB-2/A filed on December 10, 2003.                                                                            |
|                |   |                                                                                                                                                                                                                                |
| 10.29               |   | Consulting Agreement  dated December 31, 2002, by and between the registrant and John J. Gerard,  incorporated by reference from the registrant’s registration statement on  Form SB-2 filed on September 25, 2003.            |
|                |   |                                                                                                                                                                                                                                |
| 10.30               |   | First Amendment to  Consulting Agreement dated March 31, 2003 by and between registrant and John  J. Gerard, incorporated by reference from the registrant’s registration  statement on Form SB-2 filed on September 25, 2003. |
|                |   |                                                                                                                                                                                                                                |
| 10.31               |   | Employment Agreement of  Stacie L. Brown, incorporated by reference from the registrant’s registration  statement on Form SB-2 filed on September 25, 2003.                                                                    |
|                |   |                                                                                                                                                                                                                                |
| 10.32               |   | First Amendment to  Employment Agreement of Stacie L. Brown, incorporated by reference from the  registrant’s registration statement on Form SB-2 filed on September 25, 2003.                                                 |
|                |   |                                                                                                                                                                                                                                |
| 10.33               |   | Employment Agreement of  John R. Spina, incorporated by reference from the registrant’s registration  statement on Form SB-2 filed on September 25, 2003.                                                                      |
|                |   |                                                                                                                                                                                                                                |
| 10.34               |   | First Amendment to  Employment Agreement of John R. Spina, incorporated by reference from the  registrant’s registration statement on Form SB-2 filed on September 25, 2003.                                                   |
|                |   |                                                                                                                                                                                                                                |
| 10.35               |   | Philadelphia Brokerage  Corporation warrant to Purchase 75,000 Shares of Common Stock, incorporated  by reference from the registrant’s registration statement on Form SB-2 filed  on September 25, 2003.                      |
|                |   |                                                                                                                                                                                                                                |
| 10.36               |   | Distribution Agreement  by and between the registrant and TCS Aces Pty Limited, incorporated by  reference from the registrant’s registration statement on Form SB-2/A filed  on December 10, 2003.                       |
|                |   |                                                                                                                                                                                                                                |
| 14.1                |   | Code of Ethics                                                                                                                                                                                                                      |
|                |   |                                                                                                                                                                                                                                |
| 21.1                |   | Subsidiaries of  Registrant, incorporated by reference from the registrant’s Annual Report on  Form 10-KSB/A filed on April 28, 2003.                                                                                          |
|                |   |                                                                                                                                                                                                                                |
| 31.1                |   | Certification of Steven  J. Blad under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                               |
|                |   |                                                                                                                                                                                                                                |
| 31.2                |   | Certification of John  R. Spina under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                |
| 32.1                |   | Certifications Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.                                                                                                                                  |

 

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