**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

| **(Mark One)** |
|----------------|
| **ý**     |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the quarterly period  ended:      June 30, 2003** |
|           |   |   |
| **OR**         |
|           |   |   |
| **o**          |   | **TRANSITION REPORT PURSUANT SECTION  13 OR 15(d) OF THE EXCHANGE ACT** |
|           |   |   |
|           |   | **For the transition period from:             to            ** |
|           |   |   |
|           |   | **Commission file number:    000-25855** |

 

**VendingData Corporation**

(Exact name of small business issuer as specified 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)                                            |
|                                                                                |   |                                 |
| **(702) 733-7195**                                                                  |
| (Issuer’s telephone number)                                                    |
|                                                                                |   |                                 |
|                                                                                |   |                                 |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

**APPLICABLE ONLY TOCORPORATE ISSUERS**

 

State the number of sharesoutstanding of each of the issuer’s classes of common equity, as of the latestpracticable date:   7,700,826 shares ofcommon stock, $.001 par value, as of July 31, 2003

 

Transitional Small BusinessDisclosure Format (check one):  YES oNO ý

 

 

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**VENDINGDATACORPORATION**

 

**FORM 10-QSB**

 

**TABLE OF CONTENTS**

 
| **PART I – FINANCIAL INFORMATION** |
|-----------------------------------------|
|                                    |   |   |
|                                    | ITEM 1. | FINANCIAL STATEMENTS. |
|                                    |   |   |
|                                    |   | Balance  Sheets |
|                                    |   |   |
|                                    |   | Statements of Operations |
|                                    |   |   |
|                                    |   | Statements of Cash Flows |
|                                    |   |   |
|                                    |   | Notes to Financial  Statements |
|                                    |   |   |
|                                    | ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
|                                    |   |   |
|                                    | ITEM 3. | CONTROLS AND PROCEDURES |
|                                    |   |   |
| **PART II – OTHER INFORMATION**    |
|                                    |   |   |
|                                    | ITEM 1. | LEGAL PROCEEDINGS. |
|                                    |   |   |
|                                    | ITEM 2. | CHANGES IN SECURITIES. |
|                                    |   |   |
|                                    | ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS. |
|                                    |   |   |
|                                    | ITEM 5. | OTHER INFORMATION. |
|                                    |   |   |
|                                    | ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K. |

 

i

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**PARTI – FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS.**

 

**VENDINGDATA CORPORATION**

**BalanceSheets**

 
|                                                                                                                |   | **June 30,  2003** |       | **December 31,  2002** |       |
|---------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                |   | **(Unaudited)**    |       |                   |       |
| **ASSETS**                                                                                                          |   |               | ** ** |                   | ** ** |
| Current assets:                                                                                                     |   |               |       |                   |       |
| Cash                                                                                                                |   | $                  | 406,574    |                   | $          | 1,778,297 |   |
| Accounts receivable, trade, net of allowance for uncollectibles of  $25,530 and $25,530, respectively               |   | 1,766,176          |       | 106,791                |       |
| Accounts receivable, trade, non-current portion                                                                     |   | 75,744             |       | 87,639                 |       |
| Due from affiliate                                                                                                  |   | 39,939             |       | 30,593                 |       |
| Inventories                                                                                                         |   | 3,906,663          |       | 1,850,051              |       |
| Prepaid expenses                                                                                                    |   | 217,733            |       | 236,579                |       |
|                                                                                                                |   | 6,412,829          |       | 4,089,950              |       |
|                                                                                                                |   |               |       |                   |       |
| Property and equipment, net of accumulated depreciation of $2,956,767  and $2,828,887                               |   | 1,775,826          |       | 1,947,178              |       |
| Intangible assets, net of accumulated amortization of $218,556 and  $191,520                                        |   | 334,483            |       | 352,603                |       |
| Due from affiliate                                                                                                  |   | —             |       | 118,800                |       |
| Other receivables                                                                                                   |   | 1,084,400          |       | —                 |       |
| Deferred expenses                                                                                                   |   | 454,987            |       | 100,000                |       |
| Deposits                                                                                                            |   | 1,002,038          |       | 868,520                |       |
|                                                                                                                |   | $                  | 11,064,563 |                   | $          | 7,477,051 |   |
|                                                                                                                |   |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY DEFICIENCY**                                                            |   |               |       |                   |       |
| Current liabilities:                                                                                                |   |               |       |                   |       |
| Current portion of leases payable                                                                                   |   | $                  | 1,934,846  |                   | $          | 1,977,380 |   |
| Accounts payable                                                                                                    |   | 1,512,607          |       | 1,073,134              |       |
| Accrued expenses                                                                                                    |   | 393,153            |       | 433,904                |       |
| Accrued wages                                                                                                       |   | 247,347            |       | 249,147                |       |
| Accrued interest                                                                                                    |   | 637,865            |       | 461,308                |       |
| Short-term debt                                                                                                     |   | 1,674,743          |       | 904,743                |       |
| Current portion of convertible debt                                                                                 |   | 803,076            |       | —                 |       |
| Customer deposits                                                                                                   |   | 441,545            |       | 386,819                |       |
|                                                                                                                |   | 7,645,182          |       | 5,486,435              |       |
|                                                                                                                |   |               |       |                   |       |
| Convertible debt, net of current portion                                                                            |   | 13,099,996         |       | 8,853,072              |       |
| Leases payable, net of current portion                                                                              |   | 2,783,906          |       | 3,180,196              |       |
|                                                                                                                |   | 23,529,084         |       | 17,519,703             |       |
|                                                                                                                |   |               |       |                   |       |
| Stockholders’ equity deficiency:                                                                               |   |               |       |                   |       |
| Preferred stock, $.001 par value, 10,000,000 shares authorized                                                      |   | —             |       | —                 |       |
| Common stock, $.001 par value, 25,000,000 shares authorized,  7,700,826 and 7,625,826 shares issued and outstanding |   | 7,701              |       | 7,626                  |       |
| Additional paid-in capital                                                                                          |   | 27,082,455         |       | 26,719,980             |       |
| Deficit                                                                                                             |   | (39,554,677        | )          | (36,770,258            | )          |
|                                                                                                                |   | (12,464,521        | )          | (10,042,652            | )          |
|                                                                                                                |   | $                  | 11,064,563 |                   | $          | 7,477,051 |   |

 

See accompanying notes to financial statements.

 

1

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**VENDINGDATA CORPORATION**

**Statementsof Operations**

 

(UNAUDITED)

 
|                                |   | **Three Months Ended June 30,** |       | **Six Months Ended  June 30,** |   |
|-------------------------------------|--------|---------------------------------|------------|--------------------------------|--------|
|                                |   | **2003**                        |       | **2002**                       |   | **2003** |   | **2002** |   |
|                                |   |                            |       |                           |   |   |   |   |   |
| Sales                               |   | $                               | 1,959,395  |                           | $      | 504,708 |   | $ | 3,564,320 |   | $ | 1,527,871 |   |
| Rental                              |   | 300,430                         |       | 360,807                        |   | 630,743 |   | 715,434 |   |
| Other                               |   | 12                              |       | 5,915                          |   | 132 |   | 11,637 |   |
|                                |   | 2,259,837                       |       | 871,430                        |   | 4,195,195 |   | 2,254,942 |   |
|                                |   |                            |       |                           |   |   |   |   |   |
| **Operating  expenses:**            |   |                            |       |                           |   |   |   |   |   |
| Cost of sales                       |   | 931,862                         |       | 659,391                        |   | 2,179,066 |   | 1,764,473 |   |
|                                |   |                            |       |                           |   |   |   |   |   |
| Selling, general and administrative |   | 1,732,033                       |       | 782,650                        |   | 3,064,524 |   | 1,452,379 |   |
| Research and development            |   | 228,476                         |       | 347,703                        |   | 372,860 |   | 720,924 |   |
| Loss from operations                |   | (632,534                        | )          | (917,667                       | )      | (1,421,255 | ) | (1,681,491 | ) |
|                                |   |                            |       |                           |   |   |   |   |   |
| Interest expense, unrelated parties |   | 556,095                         |       | 325,315                        |   | 1,053,771 |   | 616,565 |   |
| Interest expense, related parties   |   | 149,572                         |       | 98,612                         |   | 309,393 |   | 184,169 |   |
| Total interest expense              |   | 705,667                         |       | 423,927                        |   | 1,353,164 |   | 800,734 |   |
|                                |   |                            |       |                           |   |   |   |   |   |
| Net loss                            |   | $                               | (1,338,201 | )                              | $      | (1,342,241 | ) | $ | (2,784,419 | ) | $ | (2,483,568 | ) |
|                                |   |                            |       |                           |   |   |   |   |   |
| Basic loss per share                |   | $                               | (0.18      | )                              | $      | (0.18 | ) | $ | (0.37 | ) | $ | (0.33 | ) |
| Weighted average shares outstanding |   | 7,646,430                       |       | 7,625,814                      |   | 7,636,185 |   | 7,625,814 |   |

 

See accompanying notes to financial statements.

 

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**VENDINGDATA CORPORATION**

### **Statementsof Cash Flows**

(UNAUDITED)

 
|                                              |   | **Six Months Ended June 30****,** |       |
|---------------------------------------------------|--------|-----------------------------------|------------|
|                                              |   | **2003**                          |       | **2002** |   |
|                                              |   |                              |       |   |   |
| Net cash used in operating activities             |   | $                                 | (7,016,487 | ) | $ | (1,894,452 | ) |
|                                              |   |                              |       |   |   |
| Cash flows from investing activities:             |   |                              |       |   |   |
| Acquisition of intangible  assets                 |   | (8,915                            | )          | 13,350 |   |
| Acquisition of plant and  equipment               |   | (450,525                          | )          | (123,089 | ) |
| Acquisition of equipment  produced for rental     |   | (9,500                            | )          | (297,202 | ) |
| Disposition of equipment  produced for rental     |   | 502,791                           |       | — |   |
| Disposition of plant and  equipment               |   | 705                               |       | — |   |
| Deposits                                          |   | (133,518                          | )          | (58,640 | ) |
| Net cash used in investing activities             |   | (98,962                           | )          | (465,581 | ) |
|                                              |   |                              |       |   |   |
| Cash flows from financing activities:             |   |                              |       |   |   |
| Proceeds from sale of stock                       |   | 362,550                           |       | — |   |
| Proceeds from leases payable                      |   | 924,107                           |       | 1,022,846 |   |
| Repayment of leases payable                       |   | (1,362,931                        | )          | (1,180,352 | ) |
| Proceeds from short-term debt                     |   | 1,000,000                         |       | 1,990,000 |   |
| Proceeds from issuance of  convertible debentures |   | 5,000,000                         |       | 349,999 |   |
| Repayment of notes payable                        |   | (180,000                          | )          | — |   |
| Net cash provided by financing activities         |   | 5,743,726                         |       | 1,971,694 |   |
|                                              |   |                              |       |   |   |
| Decrease in cash                                  |   | (1,371,723                        | )          | (388,339 | ) |
| Cash balance at beginning of period               |   | 1,778,297                         |       | 866,998 |   |
| Cash balance at end of period                     |   | $                                 | 406,574    |   | $ | 478,659 |   |

 

See accompanying notes to financial statements.

 

3

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**VENDINGDATA CORPORATION AND SUBSIDIARIES**

** **

**NOTESTO FINANCIAL STATEMENTS**

** **

**(UNAUDITED)**

 

##### ***Note 1 – Basis ofPresentation***

 

The accompanying unaudited financial statements of VendingDataCorporation (the “Company”) have been prepared in accordance with generallyaccepted accounting principles for interim financial information and with theinstructions incorporated in Regulation S-B of the Securities and ExchangeCommission.  Accordingly, they do notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  In the opinion of management, alladjustments (consisting of normal recurring adjustments and accruals)considered necessary for a fair presentation have been included.

 

The results of operations for the periodspresented are not necessarily indicative of the results to be expected for thefull year.  The accompanying financialstatements should be read in conjunction with the Company’s audited financialstatements for the year ended December 31, 2002, as included in theCompany’s Annual Report on Form 10-KSB as filed with the Securities andExchange Commission fromwhich the accompanying balance sheet information as of that date wasderived.  Certain reclassifications havebeen made to amounts presented in prior periods for comparability to thecurrent period presentation.

 

##### ***Note 2 – Loss per Share(Basic and Diluted)***

 

Basic loss per share is computed by dividingnet income (loss) available to common stockholders by the weighted averagenumber of shares of common stock outstanding during the year.  Diluted loss per share is computed bydividing net income (loss) available to common stockholders by theweighted-average number of shares of common stock outstanding during the yearplus potential dilutive instruments such as stock options, warrants andconvertible debt.  The effect of stockoptions on diluted loss per share is determined through the application of thetreasury stock method, whereby proceeds received by the Company based onassumed exercises are hypothetically used to repurchase the Company’s commonstock at the average market price during 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.

 

##### ***Note 3 – Debt***

 

In the quarter endedJune 30, 2003, the Company received a short-term bridge loan for$1,000,000 and $2,400,000was raised as part of the private placement of 10% convertible notes.

 

##### ***Note 4 – Options***

 

The Company currently has two stock option plans.  Prior to 2003, the Company accounted forthose plans under the recognition and measurement provisions of APB OpinionNo. 25, “*Accounting for Stock Issued toEmployees*” (APBNo. 25) and related interpretations. No stock-based employee compensation expense for stock options was reflectedin net income for years prior to 2003, as all stock options granted under thoseplans had an exercise price equal to the fair market value of the underlying

 

4

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common stock on the date ofgrant.  During the second quarter of2003, the Company adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123 under the prospectivetransition method, effective as of January 1, 2003.

 

The impact of the adoption of the fair valuemethod of accounting for stock-based compensation was an increase tostock-based compensation expense of approximately $31,032 for the six-monthperiod ended June 30, 2003.  Thisstock compensation expense was recorded in selling, general and administrativeexpenses.  As a result of adopting SFASNo. 123 under the prospective transition method of SFAS No. 148,prior periods have not been restated to reflect the impact of the fair value method.  

 
|                                                                                                              |   | **Three Months Ended June 30,** |       | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|------------|-------------------------------------|--------|
|                                                                                                              |   | **2003**                        |       | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                                                              |   |                            |       |                                |   |   |   |   |   |
| Net loss, as reported                                                                                             |   | $                               | (1,338,201 | )                                   | $      | (1,342,241 | ) | $ | (2,784,419 | ) | $ | (2,483,568 | ) |
| Add – Stock-based employee compensation  expense included in reported net income, net of related tax effects |   | 31,032                          |       | —                              |   | 31,032 |   | — |   |
| Deduct – Stock-based employee compensation  expense determined under the fair value method                   |   | (31,032                         | )          | —                              |   | (31,032 | ) | (1,330 | ) |
| Net loss, pro forma                                                                                               |   | $                               | (1,338,201 | )                                   | $      | (1,342,241 | ) | $ | (2,784,419 | ) | $ | (2,483,568 | ) |
| Basic and diluted net loss per share                                                                              |   |                            |       |                                |   |   |   |   |   |
| As reported                                                                                                       |   | $                               | (0.18      | )                                   | $      | (0.18 | ) | $ | (0.37 | ) | $ | (0.33 | ) |
| Pro forma                                                                                                         |   | $                               | (0.18      | )                                   | $      | (0.18 | ) | $ | (0.37 | ) | $ | (0.33 | ) |

 

##### ***Note 5 – Going Concern***

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. The Company incurred a net loss of $2,784,419 for the six months endedJune 30, 2003.  Additionally, theCompany had a working capital deficiency of approximately $1,232,353 atJune 30, 2003.  Accordingly, theCompany’s ability to continue as a going concern may be dependent upon thesuccess of management’s plans to address and overcome these conditions.  Management’s plans with respect to thesematters include reducing operating costs through the manufacturing of componentparts in China and restructuring service functions to reduce labor and rentalexpense.  Management is evaluatingsources of additional capital, including debt or equity financings.  Moreover, management believes that theincreased sales in the first six months of 2003 indicates customer acceptanceof the Company’s product line and will result in improved revenue.  There is no assurance that the Company willbe successful in raising additional capital or in achieving profitable operations.  The accompanying financial statements do notinclude any adjustments that might be necessary should the Company be unable tocontinue as a going concern.

 

5

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##### ***Note 6 – TradeReceivables From Major Customers***

 

Approximately 51.5% of trade receivables are concentrated among 5 majorcustomers at June 30, 2003, none of which individually are in excess of 20% ofthe Company’s trade receivables.

 

##### ***Note 7 – Income Taxes***

 

The deferred tax asset resulting from a netoperating loss carryforward has been fully reserved resulting in an effectivetax benefit rate of zero for the periods presented.

 

##### ***Note 8 – Related PartyTransactions***

 

An officer and director of the Company has anoutstanding balance due to the Company in an amount equal to $36,116 that is attributableto disbursements that were personal expenses over the past five years.  Subsequent to June 30, 2003, the officer anddirector paid $5,040, which represented the net balance due arising afterJuly 30, 2002, the effective date of the Sarbanes-Oxley Act of 2002.

 

##### ***Note9 –***Contingencies

 

The Company is a party to certain claims, legal actions, andcomplaints, including patent infringement actions between the Company and oneof its main competitors.  The Companycannot predict the likely outcome of any such litigation or whether any suchsubstantial litigation would have a material adverse effect on its business aspresently conducted or as anticipated.

 

##### ***Note 10 – SubsequentEvent***

 

In July 2003, the Company borrowed $3,000,000 at a 10% interest rate,the principal and all accrued interest of which are due on November 22,2003.  At any time until the due date,the holder may convert up to 15% of its then outstanding principal amount intoshares of the Company’s common stock at $2.25 per share.  In connection with this transaction, theCompany also issued warrants to purchase 225,000 shares of its common stock at$2.25 per share.

 

6

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**ITEM 2.**               **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.**

 

The following discussion should be read in conjunction with ourfinancial statements and notes to our financial statements, included elsewherein this report.  This discussioncontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934.  These statements relate tofuture events or our future financial performance and include statements aboutour plans, objectives and business as well as our expectations and intentions.In some cases, you can identify these forward-looking statements by terminologysuch as “may,” “will,” “should,” “could,” “expects,” “plans,” “potential,”“anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue”or the negative of such terms or other comparable terminology.  These statements are only predictions andinvolve known and unknown risks, uncertainties and other factors that may causeour actual results, levels of activity, performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by any forward-looking statements. Theserisks and uncertainties include, but are not limited to, the following:

 

•                  General economicand business conditions, both nationally and internationally in those areas inwhich we operate;

 

•                  Competition inthe gaming industry;

 

•                  Regulatory andjudicial proceedings;

 

•                  Changes ingaming laws and regulations (including actions affecting licensing);

 

•                  Continued growthin the gaming industry;

 

•                  Changes in ourbusiness strategy or plans;

 

•                  Productdevelopment, product placement, and the acceptance of our products in themarketplace;

 

•                  Loss of any ofour management or key personnel;

 

•                  Financingsources and availability of capital to fund and sustain our operations; and

 

•                  Leverage anddebt service (including sensitivity to fluctuations in interest rates).

 

Although we believe that the expectations reflected in ourforward-looking statements are reasonable, we cannot guarantee future results,levels of activity, performance or achievements. We are under no duty to updateany of the forward-looking statements after the date of this report to conformthese statements to actual results.

 

**OVERVIEW**

 

For a complete description of our products, please review our mostrecent annual report on Form 10-KSB filed with the Securities and ExchangeCommission.

 

**Business Strategy. **While we transitioned froma development stage to an operating company in 2000, we have continued todevelop or acquire new products. The focus on the development and acquisitionof new products is reflected in our operating results. Our strategy to increaserevenue and margins is based on four key factors:

 

7

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•                  **We developed two product lines withlimited competition.**  Our abilityto offer the SecureDropTM System and the Deck Checker® have given us two productlines that our industry and informal patent research led us to conclude havelimited or virtually no competition.  Incontrast, our shuffler products face intense competition due primarily to thedominance of Shuffle Master, Inc. in the shuffler market.  In this regard, during 2001 and 2000, when asubstantial portion of our revenue was generated by our shuffler products, ourmargins declined.  By offering two productswith virtually no competition, our management believes that we will have asignificant competitive advantage as our products are installed and becomeaccepted by the gaming industry.

 

•                  **We expanded into additionaldomestic gaming markets and into international gaming markets for our products.**  The global economic downturn has forcednon-gaming jurisdictions to look at new ways to raise revenue.  As a result, at least four states as well asadditional countries in Europe, Asia and South America are considering thelegalizing of various forms of casino gaming. These include slot machines at racetracks, Native American Class-IIIcasinos and Las Vegas-style casinos. The worldwide expansion of gaming should provide new markets for ourproducts, and we have targeted sales opportunities in these new markets inaddition to our traditional established gaming markets.

 

•                  **We intend to increase the marketpenetration of our products.**  Since we have only recently introduced our SecureDropTM System andDeck Checker®, the market penetration of these products is low.  As a result of the positive feedbackreceived from senior executives from Park Place Entertainment Corporation, theparent company of 27 casinos internationally,****on theinstallations of the SecureDropTM Soft Count Module in the first quarter of2003, our management believes that our products are gaining acceptance in theindustry, and we are seeking to increase the market penetration of ourproducts.

 

•                  **We implemented cost reductioninitiatives to increase gross margins. **Through theimplementation of cost reduction initiatives, our management believes that thegross margins on our products will improve over time.  The cost reduction initiatives include the following:

 

•                  *Reducing the cost of our component parts through theuse of production facilities in China*.  By opening an office, manufacturing, 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 SecureDropTM System and our shufflers to China.  As a result, our management estimates thatthe cost of such components will decrease from approximately 40% of revenue toapproximately 20% of revenue.  Althoughwe propose to outsource many components of our products, we intend to maintaina five- to six-month inventory of components at our principal offices in LasVegas, Nevada.

 

•                  *Closing two of our five regional service locationsand centralizing all technical service functions to our facilities in LasVegas, 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 propose to centralize all technical service functions by the end of thethird quarter of 2003.  The remainingservice locations will continue to provide non-technical support throughcustomer service representatives.

 

•                  *Eliminating our Boise, Idaho research facility andconsolidating the management of the research and development related to ourtable game and slot support products in Las Vegas.*  Our management believes that consolidationof our research and

 

8

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developmentfacilities in Las Vegas will allow us to achieve reductions in our labor andoverhead costs for research and development of $100,000 in 2003.  The Boise facility was closed on June 30,2003.

 

•                  *Implementing a new computer system designed toimprove productivity through the use of eleven modules, including a financialand manufacturing application.* Our new computer software will provide an integrated control process forpurchasing, inventory control and manufacturing in our Las Vegas and Chinafacilities.

 

#### **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Following is a summary of what our management believes are the criticalaccounting policies related to our operations. The application of these policies, in some cases, requires ourmanagement to make subjective judgments regarding the effect of matters thatare inherently uncertain.

 

**Allowancefor Doubtful Accounts**. In connection with the preparation of our quarterly financialstatements, management reviews and evaluates the collectibility of our tradereceivables and adjusts our allowance for estimated uncollectible accounts asdeemed necessary in the circumstances. These estimates have the potential for critically affecting thedetermination of results of operations for any given period.  Factors considered by management in makingsuch estimates and adjustments include any concentrations among customers,changes in our relationships therewith, payment history and the apparentfinancial condition thereof.

 

**Revenue Recognition.** We recognize revenue from the sale of ourproducts upon installation and functional testing at customer locations sincethat is when the customer’s obligation becomes fixed and certain pursuant toour standard contracts for the sale of units of the SecureDropTM System,shufflers and Deck Checkers®.  Sales arerecognized immediately when shufflers that are rented are converted to purchases,which is permissible depending on the credit worthiness and payment history ofthe casino company since payment terms are from 24 to 48 months.  If the customer does not possess therequired credit worthiness or an established payment history with us, then webook the revenue as an installment sale and recognize it over time as therevenue is received.  Revenue fromrentals of shufflers is recorded as revenue at the first of each month inaccordance with lease contract terms. Although sales are not generally made with a right to return, uponoccasion, sales returns and allowances are recorded after returned goods arereceived and inspected.

 

**Stock-BasedCompensation**.  Wecurrently have two stock option plans. Prior to 2003, we accounted for those plans under the recognition andmeasurement provisions of APB Opinion No. 25, “*Accounting for Stock Issued toEmployees*” (APB No. 25) and related interpretations.  No stock-based employee compensation expensefor stock options was reflected in net income for years prior to 2003, as allstock options granted under those plans had an exercise price equal to the fairmarket value of the underlying common stock on the date of grant.  During the second quarter of 2003, weadopted the fair value recognition provisions of SFAS No. 123 under theprospective transition method effective as of January 1, 2003.  This change will probably result inincreased compensation expense in future periods.

 

The impact of the adoption of the fair value method of accounting forstock-based compensation was an increase to stock-based compensation expense ofapproximately $31,032 for the six-month period ended June 30, 2003.  This stock compensation expense was recordedin selling, general and administrative expenses.  As a result of adopting the prospective transition method of SFASNo. 123 and SFAS No. 148, prior periods have not been restated toreflect the impact of the adoption of the fair value method under SFASNo. 123.

 

9

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**FINANCIAL CONDITION**

 

During the three months ended June 30, 2003, total assets increased by$3,587,512 from $7,477,051, at December 31, 2002.  Accounts receivable (trade) increased from$106,791 to $1,766,176 between December 31, 2002 and June 30,2003.  The installation of the SecureDropTM System at two major Las Vegas casinoproperties in the first quarter of 2003 and the conversion of shufflerrentals to purchases were the primary reasons for the increase in tradereceivables.  Inventories have increasedduring the current period by $2,056,612 from $1,850,051 at December 31,2002.  The purchase****of200 Deck Checkers® and related components constituted approximately$1,000,000 of the increase in inventory. In addition, as we moved more manufacturing to China, the level ofinventories at our Las Vegas facility will increase in order to maintain afive- to six-month inventory on hand to guard against unexpected transportinterruptions.

 

Total liabilities have increased from $17,519,703 at December 31,2002 to $23,529,084 at June 30, 2003. Convertible debt increased primarily due to private placements of anadditional $2,400,000 during the quarter ended June 30, 2003.  Short-term debt increased from $904,743 atDecember 31, 2002 to $1,674,743 at June 30, 2003 due to a short-termloan for 90 days for $1,000,000.

 

#### **RESULTS OF OPERATIONS**

 

##### ***Comparison ofThree Months Ended June 30, 2003 and 2002***

##### *** ***

###### **Revenue**

###### ** **

For the three months ended June 30, 2003, we generated totalrevenues of $2,259,837, compared to $871,430 for the three months endedJune 30, 2002, an increase of $1,388,407, or 159.3%.  Our revenues for the three months endedJune 30, 2003 consisted of SecureDropTM sales of $185,224, shuffler salesof $1,555,222, shuffler rentals of $301,191, Deck Checker® sales of $216,584and miscellaneous other income of $1,617. The increase in revenue was primarily due to an increase in SecureDropTMsales and conversions from rental to customer purchases of shufflers.

 

**Revenues– SecureDropTM Sales. **Forthe three months ended June 30, 2003, we generated revenue from the saleof our SecureDropTM products of $185,224, compared to $504,708 for the threemonths ended June 30, 2002, a decrease of $319,484, or 63.3%.  The reduction in revenue was due to theinstallation delays at two major casino properties in Las Vegas to the thirdquarter of 2003.

 

**Revenues– Shuffler Sales. **Forthe three months ended June 30, 2003, we generated revenue from the saleof our shufflers of $1,555,222, compared to $0 for three months endedJune 30, 2002, an increase of $1,555,222. The increase in shuffler saleswas primarily due to casino operators purchasing shufflers instead ofrenting.  Many gaming companies preferthe purchase of equipment to rental.  Webelieve that the trend for shuffler revenues will be towards shuffler sales dueto lower interest rates for sales with terms.

 

**Revenue– Shuffler Rentals.** For the three months ended June 30, 2003, we generated revenue fromthe rental of our shufflers of $301,191, compared to $360,807 for the threemonths ended June 30, 2002, a decrease of $59,616, or 16.5%.  The decrease in shuffler rentals was primarily due to the shift of our customersto shuffler sales.  We believe thatshuffler rentals will increase somewhat when our next generation shuffler modelis introduced early next year.  Casinooperators will want to test new technology by renting the units beforecommitting to purchasing.

 

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**Revenue– Deck Checker**®.  Forthe three months ended June 30, 2003, we generated revenue from the sales and leases****of our Deck Checker® of$216,584.  As Deck Checker® is a newproduct this year, there was no revenue related to it for the three monthsended June 30, 2002.

 

**Revenue– Other Income. **Forthe three months ended June 30, 2003, we generated other income of $1,617,compared to $5,915 for the three months ended June 30, 2002, a decrease of$4,298, or 72.7%.

 

###### **Cost of Sales**

 

For the three months ended June 30, 2003, our cost of sales was$931,863, compared to $659,391 for the three months ended June 30, 2002,an increase of $272,472, or 41.3%.  Ourcost of sales for the three months ended June 30, 2003 included cost ofSecureDropTM sales of $212,147, cost of shuffler sales of $214,204, cost of DeckChecker® sales of $81,043, shuffler rental depreciation of $129,229, shufflerservice costs of $215,233, manufacturing costs of $0, and other expenses of$80,006.  We believe that theoutsourcing of components from China will continue the trend of reducing costof sales through the third and fourth quarters of 2003.  The gross margin on revenue for the threemonths ended June 30, 2003 was $1,327,975, or 58.8%, compared to the grossmargin on revenue for the three months ended June 30, 2002 of $212,039, or24.3%.  The increase in gross margin of$1,115,936 from the three months ended June 30, 2002 to the three monthsended June 30, 2003 reflects these efficiencies.

 

**Cost of Sales – SecureDropTM Sales.**  Our cost of SecureDropTM****sales was$212,147 for the three months ended June 30, 2003 compared to $278,611 forthe three months ended June 30, 2002, representing a decrease of $66,464,or 23.9%.  The revenue for the threemonths ended June 30, 2003 remained basically flat with 2002 due to a delay inthe installations in two major casino properties located in Las Vegas until thethird quarter of 2003.  The cost ofsales was impacted by a replacement of SecureDropTM canisters that could have become defective at an unknown time inthe future at two properties, which cost us approximately $50,000 in the secondquarter of 2003.  The gross margin onrevenue from SecureDropTM****sales revenue was $(26,923), or(12.7)%, for the three months ended June 30, 2003 compared to $226,097, or44.8%, for the three months ended June 30, 2002.  The decrease in gross margin/gross margin percentage on SecureDropTM sales revenue resultedprimarily from a decrease in SecureDropTMinstallations and continued fixed expense of installation staff.

 

**Cost of Sales – Shuffler Sales.**  Our cost of shuffler****salesrevenue was $214,204 for the three months ended June 30, 2003 compared to$0 for the three months ended June 30, 2002.  The gross margin on revenue from shuffler****sales was$1,341,018, or 86.2%, for the three months ended June 30, 2003.

 

**Cost ofSales – Deck Checker**®. For the three months ended June 30, 2003, our cost of sales fromthe sales and leases****ofour Deck Checker® was $81,043, resulting in a gross margin on revenue from DeckChecker® sales of $135,541, or 62.6%. There were no comparable numbers for the three months ended June 30,2002 as this product was not available for sale last year.

 

###### **Selling, General andAdministrative Expense**

###### ** **

For the three months ended June 30, 2003, our selling, general andadministrative expenses were $1,732,033, compared to $782,003 for the threemonths ended June 30, 2002, an increase of $950,030, or 121.5%.  The increase in selling, general andadministrative expenses related primarily to travel and lodging to set up theoffice, assembly area and warehouse facility in China, an under-accrual oftravel expenses in the first quarter of 2003, legal fees associated with theShuffle Master litigation, and regulatory expenses.  For more information, see “Part II, Item 1—Legal Proceedings.”

 

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Our selling, general and administrative expenses for the three monthsended June 30, 2003 consisted of the following: salaries and related costsof $546,782; consulting services of $114,296; advertising and marketing costsof $19,419; travel and entertainment costs of $302,581; gaming industry showscosts of $34,467; rent of $62,665; repairs and maintenance expenses of $13,756;legal and regulatory expenses of $315,480; supplies of $45,132; insuranceexpenses of $12,075; depreciation and amortization of $116,253; and otherexpenses of $149,127.

 

###### **Research and DevelopmentExpense**

###### ** **

For the three months endedJune 30, 2003, research anddevelopment expenses were $228,475, compared to $347,703 for the three months ended June 30, 2002, a decrease of $119,228, or34.3%.  The decrease in research and development expenses wasprimarily due to our transition from research to production on our productlines.

 

###### **Interest Expense**

###### ** **

For the three months ended June 30, 2003, we incurred interestexpense of $705,667, compared to $423,927 for the three months endedJune 30, 2002, an increase of $281,740, or 66.5%.  The increase in interest expense was primarilyattributable to increased borrowing.

 

###### **Net Loss**

###### ** **

For the three months ended June 30, 2003, we had a net loss of$1,338,201, compared to a net loss of $1,342,241 for the three months endedJune 30, 2002, a decreased net loss of $4,040, or 0.3%.  The net loss was basically flat with 2002even with an 86.0% increase in revenue. We have increased our infrastructure costs to sustain higher futurerevenues.  These increases include apermanent SecureDropTMinstallation team, and increased staffing in marketing, finance, sales andlegal.  Basic loss per share was $0.18for the three months ended June 30, 2003 and 2002.

 

##### ***Comparison of SixMonths Ended June 30, 2003 and 2002***

##### *** ***

###### **Revenue**

###### ** **

For the six months ended June 30, 2003, we generated totalrevenues of $4,195,195, compared to $2,254,942 for the six months endedJune 30, 2002, an increase of $1,940,253, or 86.0%.  Our revenues for the six months ended June 30,2003 consisted of SecureDropTM sales of $1,334,733, shuffler sales of$1,968,236, shuffler rentals of $632,993, Deck Checker® sales of $229,147 andmiscellaneous other income of $30,086. The increase in revenue was primarily due to an increase in shufflersales, which increase represented primarily conversions from rental to sales ofshufflers.

 

###### **Cost of Sales**

###### ** **

For the six months ended June 30, 2003, our cost of sales was$2,179,067, compared to $1,764,473 for the six months ended June 30, 2002,an increase of $414,594, or 23.5%.  Ourcost of sales for the six months ended June 30, 2003 included cost ofSecureDropTM sales of $680,704, cost of shuffler sales of $319,041, cost of DeckChecker® sales of $90,523, shuffler rental depreciation of $285,017, shufflerservice costs of $425,558, manufacturing costs of $232,801, and other expensesof $214,990.  The gross margin onrevenue for the six months ended June 30, 2003 was $2,016,129, or 48.1%,compared to the gross margin on revenue for the six months ended June 30,2002 of $490,469, or 22.0%.  Theincrease in gross margin of $1,525,660 from the six months ended June 30,2002 to the six months

 

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ended June 30, 2003 reflectsour transition from a development stage to an operating company and otherfactors previously described.

 

###### **Selling, General andAdministrative Expense**

###### ** **

For the six months ended June 30, 2003, our selling, general andadministrative expenses were $3,064,524, compared to $1,451,036 for the sixmonths ended June 30, 2002, an increase of $1,613,488, or 111.2%.  The increase in selling, general andadministrative expenses related primarily to travel and lodging to establishthe office, assembly area and warehouse facility in China, legal feesassociated with the Shuffle Master litigation, and regulatory expenses.

 

Our general and administrative expenses for the six months endedJune 30, 2003 consisted of the following: selling, salaries and related costs of $953,224; consulting services of$165,559; advertising and marketing costs of $25,070; travel and entertainmentcosts of $416,131; gaming industry trade show costs of $68,336; rent of$212,947; repairs and maintenance expenses of $42,550; legal and regulatoryexpenses of $571,593; supplies of $88,180; insurance expenses of $18,898;depreciation and amortization of $219,934; and other expenses of $282,103.

 

###### **Research and DevelopmentExpense**

###### ** **

For the six months ended June 30,2003, research and development expenseswere $372,860, compared to$720,924 for the six months ended June 30, 2002, a decrease of $348,064, or48.3%.  The decrease in research and development expenses wasprimarily due to our transition from research to production on our productlines.

 

###### **Interest Expense**

###### ** **

For the six months ended June 30, 2003, we incurred interestexpense of $1,363,164, compared to $800,734 for the six months endedJune 30, 2002, an increase of $562,430, or 70.2%.  The increase in interest expense wasprimarily attributable to increased borrowing.

 

###### **Net Loss**

###### ** **

For the six months ended June 30, 2003, we had a net loss of$2,784,419, compared to a net loss of $2,483,568 for the six months endedJune 30, 2002, an increase of $300,851, or 12.1%.  The increase in net loss was primarily dueto increasing our infrastructure costs to sustain higher future revenues and areplacement of SecureDropTMcanisters that could have become defective at some unknown time in the futureat two casino properties.  Theseinfrastructure increases include a permanent SecureDropTM installations team and increased staffing in marketing, finance,sales and legal.  Basic loss per sharewas $0.37 for the six months ended June 30, 2003, compared to $0.33 forthe six months ended June 30, 2002.

 

#### **LIQUIDITY AND CAPITAL RESOURCES**

 

###### **Overview**

###### ** **

Because of our efforts to transition from a development stage companyto an operating company, we have generated substantial cash flow deficits fromoperations, including cash used in operating activities of $5,206,489,$5,712,867, $7,016,487 and $1,894,452 in the years ended December 31, 2002and 2001 and the six months ended June 30, 2003 and 2002,respectively.  In addition, to fund ourdevelopment and operating activities, we have been provided cash by financingactivities of $6,683,001, $6,430,282, $5,743,726 and $1,971,694 in the yearsended December 31, 2002 and 2001 and the six

 

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months ended June 30, 2003and 2002, respectively.  Consequently,we have been substantially dependent on cash from financing activities to fundour development and operating activities. We will continue to require cash from financing activities for ourcurrent operating needs until our operations begin to generate sufficient cashflow to provide for such cash requirements.

 

To fund the execution of our business strategy described above, wecontinue to seek sources of outside financing. From December 2002 to May 2003, we conducted a private placement of 10%senior notes in the aggregate principal amount of $7,500,000 and warrants topurchase 900,000 shares of common stock. Of the $7,500,000, $2,400,000 was raised during the quarter ended June30, 2003.  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 per share.  There were 10% senior notes in principalamount of $7,500,000 outstanding at June 30, 2003.

 

During the six months ended June 30, 2003 and the year endedDecember 31, 2002, our sources of capital included equipment financingfrom a third party, short-term notes from stockholders, convertible debenturesand other private 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 $924,107 and repaid$1,362,931 due to the expiration of our lease financing arrangements pursuantto their terms in 2003, for the six months ended June 30, 2003.  As of June 30, 2003, there wasoutstanding equipment financing of $4,718,752, which includes $152,601 ofdeferred interest.  These equipmentleases have terms of 36 to 39 months and were not recorded as sales becauseeach of the leases included a mandatory buy back provision.  With respect to our short-term debt, we havereceived proceeds of $3,917,948 and repaid $650,000 for the year endedDecember 31, 2002 and have received proceeds of $1,000,000 and repaid$180,000 for the six months ended June 30, 2003.  As of June 30, 2003, there were outstanding short-term loansin the aggregate amount of $1,674,743. With respect to our convertible debentures, we received proceeds of$3,249,999 and $5,000,000 during the year ended December 31, 2002 and thesix months ended June 30, 2003, respectively, and have outstandingconvertible debentures in the aggregate amount of $13,903,072 as ofJune 30, 2003.

 

In June 2003, we secured a 90-day convertible loan from Triage CapitalManagement LP in the principal amount of $1,000,000 at a 10% interestrate.  If the loan is not paid within 90days, the holder has the option to convert the note into shares of our commonstock at $2.25 per share.  We alsoissued warrants to the lender to purchase 50,000 shares of our common stock ata price of $2.25 per share and agreed to issue additional warrants to purchase25,000 shares of our common stock for each 30-day period that the note remainsoutstanding past 90 days.

 

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 may convert up to 15% ofits then outstanding principal amount into shares of our common stock at a rateof $2.25 per share.  In connection withthis transaction, we also issued warrants to purchase 225,000 shares of ourcommon stock at $2.25 per share.

 

Our cash and working capital requirements remain significant.  As a result, our management is currentlyevaluating other sources of financing. We are currently evaluating the need to seek public or private sourcesof debt or equity financing, institutional or bank financing, lease financing,or other

 

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sources of financing.  Should such financing sources not beavailable, we would be required to take other steps, including the sale ofcertain assets or the deferral or change of operating plans.

 

During the six months ended June 30, 2003 and the year endedDecember 31, 2002, we relied substantially upon loans from certainstockholders and directors, placements of senior notes and warrants and otherprivate sources of debt and equity capital to sustain our operations.  Until normalized sales levels are achievedsuch that our revenue is sufficient to sustain our operations, we will berelying upon private and institutional sources of debt and equity, and we mayseek public, private and institutional sources of capital for working capitalpurposes.  In the past, we have alsobeen substantially dependant on 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.

 

Based on presently known commitments and plans, we believe that we willbe able to fund our operations and required expenditures through the fourthquarter of 2003 from cash on hand, cash flow from operations, and cash from ourrecent private placement of senior notes and from our June 2003 $1,000,000short-term loan and our July 2003 $3,000,000 short-term loan.  However, to fund the repayment of the$1,000,000 short-term loan in September 2003 and the $3,000,000 short-term loanin November 2003, we will need to seek cash from private or public placementsof debt or equity, institutional or other lending sources, to sell certainassets or to change operating plans to accommodate our liquidity issues.  In the report on our most recent financialstatements, our independent auditor expressed substantial doubt as to ourability to continue as a going concern. No assurances can be given that we will successfully obtain otherliquidity sources as may be necessary to fund our operations in thefuture.  If adequate funds are notavailable or are not available on acceptable terms, we may, in fact, be unableto fund operations or otherwise continue as a going concern.  See “Risk Factors” discussed below.

 

**ContractualCash Obligations. **Ourcontractual cash obligations including principal and interest under our debtagreements, capital leases and operating leases as of June 30, 2003 andfor the next five years are as follows:

 
| **CONTRACTUAL**     |   |      |           | **PAYMENTS  DUE BY PERIOD** |   |
|---------------------|--------|-----------|----------------|-----------------------------|--------|
| **OBLIGATIONS**     |   | **TOTAL** |           | **1  Year**                 |   | **2-3  Years** |   | **4-5  Years** |   | **After  5 Years** |   |
| Debt  Agreements(1) |   | $         | 15,577,815     |                        | $      | 2,477,819 |   | $ | 9,150,000 |   | $ | 3,949,996 |   | $ | — |   |
| Capital Leases      |   | 5,859,683 |           | 2,806,402                   |   | 2,037,185 |   | 1,016,096 |   | — |   |
| Operating Leases    |   | 1,769,895 |           | 523,823                     |   | 515,616 |   | 515,616 |   | 214,840 |   |
| **Total**           |   | **$**     | **23,207,393** | ** **                  | **$**  | **5,808,044** | ** ** | **$** | **11,702,801** | ** ** | **$** | **5,481,708** | ** ** | **$** | **214,840** | ** ** |
|                     |        |           |                |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1) Does not include July 2003 $3,00,000 loan dueNovember 22, 2003.

 

#### **RISK FACTORS**

 

**RISKS RELATEDTO VENDINGDATA**

 

##### ***Given our recurring losses and accumulated deficits,we may be unable to continue as a going concern.***

 

Based on presently known commitments and plans, we believe that we willbe able to fund our operations and required expenditures through the fourthquarter of 2003 from cash on hand, cash flow from operations, and cash from ourrecent private placement of senior notes and cash from our June 2003 $1,000,000short-term loan and our July 2003 $3,000,000 short-term loan.  However, to fund the

 

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repayment of the $1,000,000short-term loan in September 2003 and the $3,000,000 short-term loan inNovember 2003, we will need to seek cash from private or public placements ofdebt or equity, institutional or other lending sources, to sell certain assetsor to change operating plans to accommodate our liquidity issues.  In the report on our most recent financialstatements, our independent auditors expressed substantial doubt as to ourability to continue as a going concern. No assurances can be given that we will successfully obtain other liquiditysources as may be necessary to fund our operations in the future.  If adequate funds are not available or arenot available on acceptable terms, we may not be able to fund operations orotherwise continue as a going concern.

 

##### ***We have a history of significant operating losses andanticipate continued operating losses, and we may be unable to achieveprofitability.***

 

We have a history of significant operating losses and anticipatecontinued operating losses for the foreseeable future.  For the years ended December 31, 2002and 2001 and the six months ended June 30, 2003, we have incurred netlosses of $6,192,786, $7,566,090 and $2,784,419, respectively, and ouroperations have used $5,206,489, $5,712,867 and $7,016,487 of cash, respectively.  As of December 31, 2002 and 2001 andJune 30, 2003, we had accumulated deficits of $36,770,258, $30,557,860 and$39,554,677, respectively.

 

If our revenues do not increase very substantially, or if our spendinglevels exceed our expectations, we will not become profitable.  We cannot assure that revenues will grow inthe future or that we will generate sufficient revenues for profitability, orthat profitability, if achieved, can be sustained on an ongoing basis.

 

##### ***We have limited operating results and no independentmarket research of potential demand for current operations.***

** **

Until January 2000, we were in the development stage and derivedminimal revenues from our products. Since January 2000, our activities have been limited to analyzing andconsulting with persons in the gaming industry, developing and manufacturingproducts, establishing distribution networks for our products, marketing ourproducts to the gaming industry, and commencing product sales.  During such time we have derived limitedrevenues insufficient to sustain our operations.  In addition, we have not yet commenced the sale or leasing of thePokerOneÔ Shuffler or theSecureHopperÔ.  Thereis no assurance that we will generate sufficient revenue to sustain ouroperations.  No independent organizationhas conducted market research providing management with independent assurancefrom which to estimate potential demand for our products.  There is no assurance that the overallmarket will be receptive to our products or that we will successfully competein the target market for our products. If we fail to generate sufficient demand for our products, there is noassurance that we will be able to sustain operations or generate a return toinvestors.

 

***The market has not yet demonstratedsignificant acceptance of our SecureDropTM System or the Deck Checker®, andthere is no assurance of market acceptance****.*

 

We began to sell our SecureDropTM System Hard Count Module in 1999 andhave only sold these products to a limited number of casinos.  The introduction of the SecureDropTM SystemSoft Count Module in 2002 has been slow to sell outside Nevada due to thelengthy regulatory approval process in various jurisdictions.  Even though SecureDropTM Systems sales began,much of our newer SecureDrop products were in beta tests through most of2002.  In addition, we believe thatcertain barriers and problems occurred that caused us to have problems breakinginto the market, including long sales lead time, glitches to the product that wecorrected, and gaming companies being resistant to change.  We began to distribute the Deck Checker® inlate 2002 and have only placed 21 units.  We have not yet

 

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demonstrated significant marketacceptance of those products and may be unable to do so.  The commercial success of our SecureDropTMSystem and Deck Checker®, or any other products that we may develop, 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 andreliability;

 

•                  Theprevalence and severity of any quality problems or defects in the early stageof introduction that were not anticipated in the design of those products;

 

•                  Effectivenessof our marketing and distribution capabilities;

 

•                  Abilityto promptly service and repair the products; and

 

•                  Receiptof approval by respective gaming jurisdictions.

 

If we fail to expand our sales and leases for our SecureDropTM Systemand our Deck Checker®, we will be dependent on our shuffler products or othernew products that we may develop.  If wefail to generate significant revenue from our existing products and are unableto introduce new products, our future operations will be limited and we may beunable to generate sufficient revenues to continue to operate our business.

 

##### ***The acceptance andexpansion of coinless gaming may adversely affect the demand for our products.***

 

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.  For example, International Game Technologyhas introduced the EZ-PayTM system, which attempts to reduce operating costs andmachine downtime by providing gaming operators with machines that drop coinsfor smaller payouts and print tickets for larger, predetermined payouts.  As a result of the issuance of tickets,players are not required to wait for attendants in order to be paid largerpayouts and may use their tickets at other machines equipped with the EZ-PayTMsystem.  Due to positive customerresponse, the number of slot operations with an online system that uses acoinless gaming system continues to grow. The acceptance and expansion of totally coinless gaming devices mayreduce the demand for the SecureDropTM Hard Count Module and SecureHopperTM,which are based on coin usage, and may adversely affect our operations in thefuture.

 

***We place our shufflers incasinos under short-term lease arrangements, which makes these productssusceptible to replacement due to pressure from competitors, changes ineconomic conditions, obsolescence and declining popularity.***

 

Many of our shufflers are placed with customers under short-term leasearrangements, which, unlike long-term leases or permanent sales of ourproducts, can easily be terminated by a dissatisfied customer.  This 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.  We cannot assurethat casino operators will not decide to terminate the use of our products orthat we can maintain and expand the number of installed shufflers throughenhancement of existing shufflers, introduction of new shufflers, customerservice or otherwise.

 

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***Our ability to compete may be damaged and our revenues may be reducedif we are unable to protect our intellectual property rights adequately.***

 

Our success depends upon maintaining the confidentiality andproprietary nature of our intellectual property rights.  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 technical measures.

 

Patent, trade secret, copyright and trademark laws provide limitedprotection.  Because patent applicationsfiled before November 29, 2000 in the United States are not publicly discloseduntil the relevant patent is issued, applications may have been filed, which,if issued as patents, could relate to our services and products as currentlydesigned or as we may modify them in the future to meet the market’srequirements.  Trade secret, copyrightand trademark laws, in combination with the steps we take to protect ourproprietary rights, may not adequately prevent misappropriation of thoserights.  We may be required to bringproceedings in the United States Patent and Trademark office or other legalaction to enforce our patents, trademarks or copyrights.  We may find it necessary to litigate toprotect our trade secrets and know-how. Any legal actions would be costly, time consuming, and would divert theattention of management and technical personnel.

 

The protections provided by laws protecting intellectual propertyrights do not prevent our competitors from developing, independently, productssimilar or superior to our products and technologies.  In addition, effective protection of copyrights, trade secrets, trademarks,and other proprietary rights may be unavailable or limited in certain foreigncountries.

 

Our inability or failure to protect our proprietary technology coulddamage our ability to compete, reduce our revenues and damage our prospects forachieving growth and profitability.

 

***Our Random EjectionShufflerTM and our Continuous Random Ejection Shuffler are the subject of patentlitigation.***

 

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. Although we believe our position to be meritorious, litigation of thisnature is a drain on our cash resources and our management’s time.  Inasmuch as Shuffle Master has assertedpatent infringement claims and we have reasonable defenses, we cannot predictwhether we will prevail in this litigation, nor whether damages, if awarded,would significantly impact our ability to continue to manufacture and sellparticular products within the United States and its territories.  Similarly, we cannot predict whether ShuffleMaster will assert litigation claims based upon other patents it may currentlyor in the future own, nor can we predict the likely outcome of any suchlitigation or whether any such substantial litigation would have a materialadverse effect on our business as presently conducted or as anticipated.  For more information, see “Part II—OtherInformation—Legal Proceedings.”

 

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***If our future products incorporate technology that infringes theproprietary rights of third parties and we do not secure licenses from them, wecould be liable for substantial damages that would cause a material reductionin revenues and impair our prospects for achieving growth and profitability.***

 

Other than the allegations made by Shuffle Master, Inc. discussedabove, we are not aware of any claims or basis for our current productsinfringing on the proprietary rights of third parties.  To the extent that we introduce new productsthat incorporate same or similar technology, it is likely that Shuffle Master,Inc. will sue us.  Moreover, we believethat it is reasonably likely that if we introduce the PokerOneTM Shuffler inthe United States, Shuffle Master will bring some type of claim and will seekvarious remedies at equity or law.  Wecannot predict the outcome of any future litigation that may occur.

 

In furtherance of the development of our services or products, we mayneed to acquire licenses for intellectual property to avoid infringement ofthird party rights or claims of infringement. These licenses may not be available on commercially reasonable terms, ifat all.  Claims for infringement, ifmade, could damage our business prospects, our results of operations andfinancial condition, 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

 

•                  disrupting product sales andshipments.

 

If any third party prevails in an action against us for infringement ofits proprietary rights, we could be required to pay damages and either enterinto costly licensing arrangements or redesign our products so as to excludethe infringing technology.  As a result,we would incur substantial costs and delays in product development, sales andshipments, our revenues may decline substantially and we may not be able toachieve the growth required for us to achieve profitability.

 

***We may not compete successfully against innovative competitors or newentrants.***

 

Our market is characterized by changing technology, periodic product obsolescenceand continuous protection of proprietary technology.  Our success will depend upon our ability to sell our currentproducts and to develop successor systems. We will need to introduce new products and features in a timely mannerto meet evolving customer requirements. We may not succeed in these efforts. Even if we succeed, products or technologies developed by others mayrender our products or technologies noncompetitive or obsolete, which wouldimpair our ability to sell our products and reduce our revenue.

 

***We may not be able tocomplete the development of our specialty game shuffler.***

 

There is no assurance that our development of the PokerOneTM Shufflerwill be successfully completed.  We arecontinuing development on this product, and we plan to start the testing phasein Asia during either the fourth quarter of 2003 of the first quarter of2004.  We have expended significant timeand resources into the development of this product, and our failure to bringabout a viable product will cause us financial loss and have an adverse effecton our business.

 

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***The gaming industry hasdemonstrated a preference for relying on a single provider of shufflers.***

 

Our customers havedemonstrated a strong preference for conducting business with only one providerof automatic shuffler products.  Ourcompetitors, including our primary competitor, Shuffle Master, Inc., offerspecialty game shufflers in addition to shuffler products that performfunctions similar to our existing products, the Random Ejection ShufflerTM andthe Continuous Random Ejection Shuffler. Because our specialty game shuffler, the PokerOneTM Shuffler, is still indevelopment and may or may not be successfully added to our product line inNorth America, we will continue to be at a competitive disadvantage againstcompetitors that offer a broader product line than ours.  Our inability to increase our market shareof shufflers will continue to put pressure on our ability to generate revenueand profits.

 

***Our products will besubject to constant scrutiny and attempts by third parties to compromise theirsecurity.***

 

In the event that ourproducts become susceptible to attacks by third parties that result in adecrease or compromise of the security of our customer’s operations, we willmost likely be required to take back our products from existing customers andwill lose sales and rentals from prospective customers.  Although we have tested our products forsecurity and our products have been tested by certain gaming regulators as partof the approval process, there is no assurance that our products will not besusceptible to schemes by third parties to defraud the properties where areproducts are used.  Vulnerabilities inthe security of our products will almost certainly reduce demand for theseproducts.  There is no assurance thatour shufflers will not become vulnerable to card counters or expert players orthat the use of our shufflers will not result in financial losses for ourcustomers.  The occurrence of any ofthese events would likely have a material adverse effect on our operations.

 

***Any conditions thatadversely affect the gaming industry could also have a material adverse effecton our operation and our financial condition.***

 

The success of ourbusiness depends solely on the gaming industry where revenues are sensitive togeneral economic conditions and generally rise or fall rapidly in relation tothe condition of the overall economy. Although we cannot accurately estimate the economic impact of the recentterrorist attacks at this time, the gaming industry has been negatively affectedby the reduction in air travel and tourism, and we expect that any significantdecline in the economic health or growth of the gaming industry will reducedemand for our products.

 

***We are unable to predictthe future impact that extraordinary events, such as terrorism, the uncertaintyof war and worldwide health concerns, may have on our business and operations.***

 

Extraordinary events,such as terrorist attacks, acts of war or worldwide health concerns, may causedamage or disruption to our operations, which, in turn, could significantlyimpact our revenues, costs and expenses, and financial condition.  The terrorist attacks that took place in theUnited States on September 11, 2001 were unprecedented events that havecreated many economic and political uncertainties, especially to the gaming industry,some of which have materially adversely affected our business, results ofoperations, and financial condition and may do so again in the future.  In particular, the gaming industry has beenaffected by the downturn in the tourist industry as a result of theSeptember 11, 2001 attacks. Because our business is directly tied to the gaming industry, thelong-term effects from the September 11, 2001 attacks are unknown.  The potential for future terrorist attacks,the national and international responses to terrorist attacks, other acts ofwar or hostility and concerns about the spread of certain diseases, includingsevere acute respiratory syndrome, or SARS, have created many

 

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economic and political uncertainties,which could materially adversely affect our business, results of operations andfinancial condition in ways that we currently cannot predict.

 

***Reliance on ourmanufacturing facility in China could subject us to supply interruption.***

 

We have located mostphases of the manufacturing process of all of our products to our own facilityin Xiaolan Town in Zhongshan City, China. Although we intend to maintain a five- to six-month inventory of partsat our principal offices in Las Vegas, Nevada, we will be adversely impacted ifthere is an interruption in our ability to receive components from, or anincrease 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 businesscould be materially adversely affected.

 

***Our efforts to expandinto international markets pose special risks.***

 

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 issues relative toestablished 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 States affecting foreign trade and investment.

 

***We have limited salesexperience selling our products in foreign countries.***

 

We have limited sales experience and history in foreign markets.  We typically sell our products throughdistributors, who we believe to be experienced and reputable, however, if weare unable to manage these relationships, our ability to generate revenue andprofits may be adversely affected.

 

***Due to our management’scontrolling interest in our common stock, our management has the power to influenceall matters submitted to our stockholders.***

 

Our executive officers and members of our board beneficially own15,035,722 shares of common stock, or approximately 195.2%****of the outstanding shares ofour common stock, assuming exercise or conversion of all options, warrants andconvertible debentures that are exerciseable within 60 days.  Accordingly, these stockholders have thepower to control****all mattersrequiring approval by our stockholders, including the election of directors andapproval of mergers and other significant corporate transactions.  This concentration of ownership also has theeffect of delaying, preventing or expediting, as the case may be, a change incontrol of our company.

 

***We depend upon our keyemployees and certain members of our management.***

 

Our success is substantially dependent upon the efforts and skills ofSteven J. Blad, our chief executive officer and president, andJohn R. Spina, our chief financial officer.  We have entered into employment agreements with Messrs. Bladand Spina and nine other key employees. However, if we were to lose the services rendered by any of our keyemployees, our operations 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.

 

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***Even if our operations donot become profitable, our management will continue to be compensated throughthe payment of salaries and benefits.***

 

We currently compensate our management with substantial salaries andother benefits and, in the future, may pay increased salaries andbenefits.  In June and July 2003, weextended our employment agreements for an additional five years with Mr. Bladand three years with seven other key employees.  The payment of such compensation and benefits may be a burden onus and may be a factor in limiting or preventing our profitability.  Upon the expiration of those employmentagreements, we may elect to continue compensating management with similar orhigher salaries and other benefits.

 

***Our business may be adversely affected in the event thatholders of certain 9.5% convertible notes do not agree to extend the maturitiesof outstanding promissory notes or convert them to common stock.***

 

In February 2002, we commenced a private placement of $4,799,990 principalamount of convertible notes, which placement was completed in January 2003.  The convertible notes accrue interest at9.5% per annum and mature one year from the date of issuance (subject to theright of each holder to extend the maturity date for up to four one-yearperiods).  The notes are convertibleinto shares of our common stock at a rate of $1.75 per share.  In addition, for each convertible note of$49,999.95, we issued a warrant to purchase 2,500 shares of our common stockwith an exercise price of $1.75. Through June 30,2003, a total of $4,799,990 principal amount of convertible notes has beenissued for $675,000 in cash with the remaining $4,124,990 representing arollover of principal and interest of $3,124,990 and $1,000,000 for short-termand convertible notes, respectively. The maturity dates, as extended, for the 9.5% convertible notes arebetween April 2004 and January 2005.  InJune 2003, the holders of these convertible notes executed agreements in whichthey agreed to extend the respective maturity dates by one year and to deferreceipt of any accrued interest until December 31, 2003.  There can be no assurance that the holdersof these notes will agree to convert the notes to shares of our common stock orto extend the maturities of the convertible notes in the future, and in theevent that the holders do not agree to convert these notes to common stock orfurther extend the maturity dates in the future, we will be required to payprincipal and interest on these notes. If we do not at that time have sufficient cash available or sources ofcash to make such payments, we may not be able to continue as a going concern.

 

**RISKS RELATED TO OUR INDUSTRY**

 

***We face intensecompetition for customers for our products from companies with longer operatinghistories, greater resources and more established brand names.***

 

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 SecureDropTM System.  There is no assurance that we will be ableto compete successfully with other established gaming product manufacturers.  Our inability to compete successfully willlikely result in loss of market share and lower revenues, or increases inoperating costs, such as marketing costs, which would have an adverse effect onour business and financial condition.

 

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***We face extensiveregulation 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 no assurance can begiven that our products will be approved in any particular jurisdiction.  The failure to obtain such approval in anyjurisdiction in which we may seek to introduce our products or concepts couldhave a material adverse effect on our business.

 

***Any person who is the beneficial owner of our common stock orwith whom we have a material relationship that fails or refuses to apply for afinding of suitability, or that is found unsuitable for licensing, would berequired to dispose of all of our stock.***

 

Certain gaming regulatory agencies to which we are subject may investigateany beneficial holder of our voting securities (regardless of the numbers ofshares 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.  In the event that the gaming authoritieswere to find an officer, director, key employee, stockholder, or any otherindividual that has a material relationship with us, unsuitable for licensingor unsuitable to continue having a relationship with us, we would have to severall relationships with that individual, and that individual would be requiredto dispose of all of our stock.  Thiscould result in a material adverse effect on our business.

 

***Due to our focus onproducts designed for the gaming industry, our operations are not diversifiedand are dependent solely upon the gaming industry.***

 

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.

 

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

 

**RISKS RELATED TO OUR COMMON STOCK**

 

***There is no currentpublic market for our common stock, so our stockholders may be unable to disposeof their investment, or may lose the total value of their investment.***

 

There has been no trading market for our common stock.  There can be no assurance that an activetrading and/or a liquid market for our common stock will ever develop or, ifdeveloped, that it will be maintained. Accordingly, we cannot assure you of the liquidity of the market for ourcommon stock or the prices at which you may be able to sell our common stock,if at all.  In addition, if ouroperations are unsuccessful or we are unable to continue as a going concern andour company is dissolved or otherwise terminated, you could lose your entireinvestment in our common stock.

 

***Our common stockis deemed to be “penny stock” which may make it more difficult for investors toresell their shares due to suitability requirements.***

 

Our common stock is deemed to be “penny stock” asthat term is defined in Rule 3a51-1 promulgated under the Securities ExchangeAct of 1934.  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 under the Securities Exchange Act of 1934generally impose additional sale practice and disclosure requirements onbroker/dealers who sell or recommend our shares to certain investors.  Broker/dealers dealing in penny stocks are requiredto provide potential investors with a document disclosing the risks of pennystocks.  Moreover, broker/dealers arerequired to determine whether an investment in a penny stock is a suitableinvestment for a prospective investor and receive the investor’s writtenconsent to the transaction.  Inaddition, many institutional investors have restrictions regarding investmentsin penny stocks, which further limits the liquidity of the market for ourshares.  These requirements may reducethe potential market for our common stock by reducing the number of potentialinvestors, and any or all of these factors may make it more difficult forinvestors in our common stock to sell shares to third parties or to otherwisedispose of them and could cause our stock price to decline.

 

***We have no intention ofpaying any dividends since we intend to use our earnings, if any, to expand ouroperations.***

 

At the present time we are not permitted to pay a dividend underapplicable law because to do so could render us insolvent.  There can be no assurance that ouroperations will become profitable.  Ifwe become profitable, we intend to use any earnings that may be generated tofinance the growth of our business.  Anypayment of future dividends will be at the discretion of our board of directorsand will depend on, among other things, our earnings, financial condition,capital requirements, level of

 

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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.

 

***If we are unable togenerate sufficient revenue to provide the cash required to fund our operationsin the future, we may be required to issue additional equity or convertibledebt securities to provide our operations with additional working capitalwhich, in turn, will have the effect of diluting the relative ownership of ourexisting stockholders.***

 

We currently anticipate the need to supplement the cash deficit arisingfrom our operations with cash from private or public placements of debt orequity, institutional or other lending sources, to sell certain assets or tochange operating plans to accommodate our liquidity issues.  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 orprivileges to those of our common stock, such as registration rights andpreferences in liquidation.  In theevent we are required to raise additional funds to support our operations, wecannot assure our stockholders that the additional funds will be available onterms favorable to our company, or at all. If adequate funds are not available or are not available on acceptableterms, we may not be able to fund our operations or otherwise continue as agoing concern.

 

***Shares eligible for salein the near future may cause the market price for our common stock to decline.***

 

In the event that a public market for our common stock develops, wehave 1,622,594 shares of common stock that are freely tradable pursuant to Rule144(k) of the Securities Act of 1933. In addition, we have granted registration rights to holders of certainindebtedness and warrants with respect to an aggregate of an additional 6,046,180 shares ofcommon stock.  The future sale of asubstantial number of shares of our common stock in market transactions, or theperception that these sales could occur, may depress the market price for ourcommon stock.  These sales could alsoimpair our ability to raise additional capital through the sale of our equitysecurities in the future.

 

***Our board of directors may issue blank check preferred stockwhich may affect the voting rights of our holders and could deter or delay anattempt to obtain control of us.***

 

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.

 

**ITEM 3.**                    **CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures. **Our chief executive officer and our chief financial officer,after evaluating the effectiveness of our “disclosure controls and procedures”(as defined in the Securities Exchange Act of 1934, Rules 13a-15(e) and15d-15(e)) during the period in which this report is being prepared, haveconcluded that based upon the changes discussed below our

 

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disclosure controls andprocedures were adequate and designed to ensure that material information relatingto us and our consolidated subsidiaries would be made known to them by otherswithin those entities.

 

Disclosure controls and procedures are controls and other proceduresthat are designed to ensure that information required to be disclosed in ourreports filed or submitted under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported, within the timeperiods specified in the Commission’s rules and forms.  Based on our evaluation as of the end of theperiod covered by this report and based upon the changes discussed below, ourchief executive officer and our chief financial officer have concluded that ourdisclosure controls and procedures (as defined in Rule 13a-15(e) and Rule15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective.

 

**Changes in Internal Controls. **Our chief financialofficer undertook a review of our internal controls during the second quarterof this year.  This review was discussed with our outside auditors andresulted in a letter of reportable conditions. The letter of reportable conditions was discussed with our chiefexecutive officer and audit committee.  Areas subject to recommendedchanges in procedures included our purchasing and disbursement functions,inventory control and payroll.  As a result, we have increased ouraccounting staff, separated duties and modified our control procedures. These changes were implemented in our second quarter and in the beginning ofour third quarter.  We propose to form adisclosure committee in the third quarter of 2003 that will be designed toensure the reliability of our financial reporting, the effectiveness andefficiency of our operations and our compliance with applicable laws andregulations.  This committee will alsobe responsible for providing our chief executive officer and our auditcommittee with its assessments and recommendations with respect to ourdisclosure controls and procedures.  Thedisclosure committee will consist of our chief financial officer, our corporatecounsel, a representative from marketing and a representative fromoperations.  In addition, we will beimplementing a financial and manufacturing software application, which willprovide an integrated control process for purchasing, inventory control andmanufacturing and which will improve our financial reporting.

 

**PARTII – OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

On November 22, 1999, Moll Industries, Inc. filed a complaint(Case No. 817296) against VendingData in the Superior Court of the Stateof California for the County of Orange, California.  The parties entered into a stipulation as of December 2000, whichrequired us to pay Moll Industries $60,000. To date, we have paid $35,000 and once we have completed all payments toMoll Industries, this litigation will be dismissed.

 

On May 18, 2000, Heath Electronics Manufacturing Corporation filed acomplaint (Case No. CV OC 00-02422D) against VendingData in the District Courtof the Fourth Judicial District of the State of Idaho, Ada County.  In April 2003, the parties entered into asettlement agreement, the performance of which will lead to the filing andrecordation of a satisfaction of judgment. Upon payment of a final payment in August 2003, we will have fulfilledour obligations under the settlement agreement.

 

On July 29, 2002, Contract Manufacturing Service, Inc., filed acomplaint (Case No. A454098) in the District Court of Clark County,Nevada.  The complaint allegesnon-payment for product allegedly delivered, and requests compensatory damagesin the amount of $29,896.14, interest, attorneys’ fees and costs.  The parties have entered into a stipulationas of February 2003, which requires us to make monthly payment installments,the fulfillment of which will lead to the dismissal of this litigation.

 

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On March 27, 2002, Shuffle Master, Inc., or Shuffle Master, filed acomplaint (Case No. CV-S-02-0438-JCM-PAL) against VendingData in the UnitedStates District Court, District of Nevada. The amended complaint alleges, among other things, claims for patentinfringement and requests treble damages, an injunction enjoining us frominfringing on two of Shuffle Master’s patents, an accounting of our gains andprofits that resulted from our alleged infringement, and interest, costs andattorneys’ fees.  The Shuffle Masterpatents that are at issue in the litigation concern registering use of aplaying card shuffler apparatus and the displaying of the use on adisplay.  We have filed our answer, counterclaims,and amended 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 their 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.

 

Inasmuch as Shuffle Master has asserted patent infringement claims andwe have reasonable defenses, we cannot predict whether we will prevail in thislitigation, nor whether damages, if awarded, would significantly impact ourability to continue to manufacture and sell particular products within theUnited States and its territories. Similarly, we cannot predict whether Shuffle Master will assert otherpatents it may currently or in the future own, nor can we predict the likelyoutcome of any such litigation or whether any such substantial litigation wouldhave a material adverse effect on our business as presently conducted or asanticipated.  See “Part 1, Item 2,—RiskFactors.”

 

On July 22, 2003, Shuffle Master, Inc. filed a petition (Case No.20003-11016) against VendingData Corporation and Casinovations, Inc. in theCivil District Court for the Parish of Orleans, State of Louisiana.  The petition alleges that VendingData and/orCasinovations violated the Louisiana Unfair Sales Law by offering to sell orlease the Random Ejection ShufflerTM at a price that is below the cost ofproducing and selling or leasing the Random Ejection ShufflerTM.  The petition further alleges that VendingDataand/or Casinovations violated the Louisiana Unfair Trade Practices Act byintending to “dump” Random Ejection ShufflersTM into the market with the intent to “steal”customers from Shuffle Master.  Thethird claim asserted by Shuffle Master is that the actions of VendingDataand/or Casinovations constitute fraud, theft by conversion, misappropriation,intentional misrepresentation and/or general negligence.  The petition requests the court to enter apreliminary and permanent injunction against VendingData and/or Casinovationsfrom selling or leasing the Random Ejection ShufflerTM and other automatic playing card shufflersto Harrah’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.

 

On August 5, 2003, Dan Purjes, one of our stockholders, filed acomplaint (Case No. 114071/03) against us in the Supreme Court of the State ofNew York, County of New York.  Thecomplaint alleges that we owe $28,500 plus attorneys’ fees and costs related toa promissory note that we executed in favor of Mr. Purjes.  We intend to vigorously defend against Mr.Purjes’ allegations.

 

**ITEM2.  CHANGES IN SECURITIES.**

 

(a)                                  RecentSales of Unregistered Securities.

 

From December 2002 to May 2003, we conducted a private placement of 10%senior notes in the aggregate principal amount of $7,500,000 and warrants topurchase 900,000 shares of common stock.

 

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The warrants were issued at arate of 6,000 shares per $50,000 of 10% senior notes sold.  The 10% senior notes require the payment ofaccrued interest semi-annually in arrears with the principal due on December15, 2005 and, at any time after December15, 2004 and until June 15, 2005, may have 15% of its then outstandingprincipal converted into shares of our common stock at a rate of $2.25per share.  All notes were placed withaccredited investors.  We received netproceeds from the private placement of approximately $7,200,000 after deductingthe underwriting discounts and commissions and the offering expenses.  The proceeds from this placement are beingused for the acquisition of the Deck Checker®,inventory and working capital. We relied upon the exemption from registration provided by Section 4(2)of the Securities Act, Rule 506 of Regulation D thereunder and Regulation S.

 

In June 2003, we secured a 90-day convertible loan from Triage CapitalManagement LP in the principal amount of $1,000,000 at a 10% interestrate.  If the loan is not paid within 90days, the holder has the option to convert the note into shares of our commonstock at $2.25 per share.  We alsoissued warrants to the lender to purchase 50,000 shares of our common stock ata price of $2.25 per share and agreed to issue additional warrants to purchase25,000 shares of our common stock for each 30-day period that the note remainsoutstanding past 90 days.  Because thisloan was negotiated with a single lender, we relied on the exemption fromregistration of securities provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D.

 

In July 2003, after the end of the second quarter, we borrowed$3,000,000 from Mellon HBV SPV, LLC, an affiliate of Mellon Bank, at a 10%interest rate, the principal and all accrued interest of which are due onNovember 22, 2003.  At any timeuntil the due date, the holder may convert up to 15% of its then outstandingprincipal amount into shares of our common stock at a rate of $2.25 pershare.  In connection with thistransaction, we also issued warrants to purchase 225,000 shares of our commonstock at $2.25 per share.  Because thisloan was negotiated with a single lender, we relied on the exemption fromregistration of securities provided by Section 4(2) of the Securities Act andRule 506 of Regulation D.

 

(b)                                 Dividends.

 

We have never paid cash dividends on our common stock and do notcurrently intend to pay cash dividends on our common stock in the foreseeablefuture.  We may be restricted frompaying dividends on our common stock under state law and we are currentlyrequired to comply with certain conditions pursuant to the terms of notes andwarrants issued by us related to our issuance of dividends.  We currently anticipate that we will retainany earnings for use in the continued development of our business.

 

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**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

Our Annual Meeting of Stockholders was held on May 29, 2003.  The following matters were voted on by thestockholders:

 

1.                                       Electionof Directors

 

|            |   | **For**   |   | **Against/Withheld** |   |
|-----------------|--------|-----------|--------|----------------------|--------|
|            |   |      |   |                 |   |
| Steven J. Blad  |   | 6,454,589 |   | 207,200              |   |
| James E. Crabbe |   | 6,461,089 |   | 203,100              |   |
| Ronald O. Keil  |   | 6,456,289 |   | 205,100              |   |
| Bob L. Smith    |   | 6,461,089 |   | 203,100              |   |

 

2.                                       Amendmentto Amended and Restated Articles of Incorporation to increase the authorizedshares of capital stock from 16,000,000 to 25,000,000 shares.

 

| For     |   | 6,576,187 |   |
|---------|--------|-----------|--------|
| Against |   | 86,002    |   |
| Abstain |   | 2,000     |   |

 

3.                                       Amendmentto the 1999 Stock Option Plan.

 

| For     |   | 5,990,963 |   |
|---------|--------|-----------|--------|
| Against |   | 92,202    |   |
| Abstain |   | 12,600    |   |

 

**ITEM 5. OTHER INFORMATION.**

 

In June and July 2003, we entered into indemnification agreements withmembers of our board of directors and certain of our executive officers andsignificant employees in which we agreed to hold harmless and indemnify suchdirectors, officers and significant employees to the fullest extent authorizedunder Nevada law, and to pay any and all related expenses reasonably incurredby the indemnitee.  The four members ofour board and the following executive officers and significant employees eachentered into an indemnification agreement: John R. Spina, Chief FinancialOfficer; Stacie L. Brown, Corporate Counsel and Secretary; D. DeanBarnett, Vice President, Sales; Kenneth R. Dickinson, Vice President, SlotSystems; Tyson K. Adams, Software Engineering Manager; Lynn C.Hessing, Director of Engineering; Robert G. Pietrosanto, Table Games Sales– Division President; William B. Roquemore, Vice President, Manufacturingand Service; Joseph D. Corradino, Director of Sales/Table Games; and Jessica N.Neville, Vice President of Marketing and Public Relations.

 

In June and July 2003, we entered into amended employment agreementswith seven employees under which the terms of their employment agreements wereextended three years.  In addition, weincreased the number of stock options granted to these employees andaccelerated the date of vesting of certain existing stock options.  Of the seven employees, Stacie L.Brown, Corporate Counsel and

 

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Secretary was included.  In addition, other significant employeesincluded: D. Dean Barnett, Vice President, Sales; Kenneth R.Dickinson, Vice President, Slot Systems; Tyson K. Adams, SoftwareEngineering Manager; Lynn C. Hessing, Director of Engineering;Robert G. Pietrosanto, Table Games Sales – Division President; andWilliam B. Roquemore, Vice President, Manufacturing and Service.  .  InJune 2003, we entered into a second amendment to the employment agreement ofSteven J. Blad, Chief Executive Officer and President, in which we extended theterm of Mr. Blad’s employment through December 31, 2009, granted to Mr. Bladstock options to purchase 500,000 shares of our common stock at $2.50 pershare, and agreed that Mr. Blad’s base salary shall be $282,000 per year.  In July 2003, we entered into an amendmentto the employment agreement of John R. Spina, Chief Financial Officer.  Pursuant to this amendment, we awarded Mr.Spina an option to purchase 25,000 shares of our common stock at an exerciseprice of $2.50 per share and accelerated the vesting date of certain existingoptions

 

**ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K.**

 

(a)                                  Exhibits.

 
| 10.1   | Form of Indemnification Agreement. (*)                                                                                                       |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                         |
| 10.2   | Amended and Restated 1999 Stock Option Plan. (*)                                                                                             |
|   |                                                                                                                                         |
| 10.3   | Form of First Amendment to Employment Agreement. (*)                                                                                         |
|   |                                                                                                                                         |
| 10.4   | Second Amendment to Employment Agreement of Steven  J. Blad. (*)                                                                             |
|   |                                                                                                                                         |
| 10.5   | Philadelphia Brokerage Corporation to Purchase  25,000 Shares of Common Stock. (*)                                                           |
|   |                                                                                                                                         |
| 10.6   | Triage Capital Management LP 10% Note due September  16, 2003. (*)                                                                           |
|   |                                                                                                                                         |
| 10.7   | Triage Capital Management LP Warrant to Purchase  50,000 Shares of Common Stock. (*)                                                         |
|   |                                                                                                                                         |
| 10.8   | Mellon HBV SBV, LLC 10% Note due November 22, 2003.  (*)                                                                                     |
|   |                                                                                                                                         |
| 10.9   | Mellon HBV SBV, LLC Warrant to Purchase Shares of  Common Stock. (*)                                                                         |
|   |                                                                                                                                         |
| 31.1   | Certifications Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                   |
|   |                                                                                                                                         |
| 32.1   | Certification of President and Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section  1350). |

 

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(*) To befiled by amendment

 

(b)                                 Reportson Form 8-K.

 

During thethree months ended June 30, 2003 and from the end of such period to the date ofthis report, we filed the following:

 

•                  CurrentReport on Form 8-K filed on April 22, 2003 (as amended by Form 8-K/A filedMay 6, 2003) reporting the retention of the firm of Piercy, Bowler, Taylor& Kern as our independent accountants;

 

•                  CurrentReport on Form 8-K filed on April 28, 2003 reporting the resignation of StevenJ. Blad as treasurer and the election of John R. Spina as our treasurer;

 

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•                  CurrentReport on Form 8-K/A-2 filed on May 29, 2003 supplementing the informationregarding the change in our auditors;

 

•                  CurrentReport on Form 8-K filed on June 3, 2003 reporting the results of mattersvoted on at the Annual Meeting of Stockholders; and

 

•                  CurrentReport on Form 8-K filed on June 18, 2003 reporting the filing of theSecond Amended and Restated Articles of Incorporation of the company.

 

**SIGNATURE**

 

In accordancewith the requirements of the Exchange Act, the registrant caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|                                                                                                     | **VENDINGDATA CORPORATION** |
|----------------------------------------------------------------------------------------------------------|-----------------------------|
|                                                                                                     | (Registrant)                |
|                                                                                                     |                        |   |
| Date:             August 18,  2003 | By:                         |   /s/ STEVEN  J. BLAD |   |
|                                                                                                     |                        |   Steven J. Blad |
|                                                                                                     | Its:                        |   Chief Executive Officer and President  (Principal Executive Officer and  Duly  Authorized Officer) |

 

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